##### Table of Contents

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U.S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-KSB



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Annual Report under Section 13 or 15(d) of the

Securities Exchange Act of 1934

For the Fiscal Year ended December 31,
2006

OR

Transition Report under Section 13 or 15(d) of the

Securities Exchange Act of 1934

For the Transition Period from  to

Commission File Number: 000-49898



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North State Bancorp

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|North Carolina                                                 |  | 65-1177289                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)

4270 The Circle at North Hills

Raleigh, North Carolina 27609

(Address of principal executive offices,
including zip code)

(919) 787-9696

(Issuers telephone number)

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



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Securities
Registered under Section 12(g) of the Act:



|                              |  |                                          
|----------------------------- |  | -----------------------------------------
|Title of Each Class           |  | Name of Each Exchange On Which Registered
|Common Stock, $1.00 Par Value |  | None                                     



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Check whether the issuer is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. ̈

Check whether the registrant (1) has filed all reports required to be filed by Section 13 or
15(d) of the Exchange Act during the past 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 ̈

Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of the registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. ̈

The registrants revenues for the year
ended December 31, 2006 were $27,586,000.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2
of the Exchange Act).    YES ̈NO  x.

The aggregate market value of the registrants common stock held by non-affiliates of the registrant on March 19, 2007 was
approximately $59,204,901, based on the average ($24.375) of the high and low traded prices of the registrants common stock on March 19, 2007. Common stock held by each officer and director and by each person known to the registrant who
owns 5% or more of the outstanding common stock has been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

The number of shares of the registrants common stock outstanding at March 5, 2007 was 4,568,810 shares.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrants definitive proxy statement to be filed for its 2007 Annual Meeting of Shareholders to be held on May 3, 2007 are incorporated by reference into Part III of this report.

Transitional Small Business Disclosure Format    YES ̈NO  x



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NORTH STATE BANCORP

ANNUAL REPORT ON FORM 10-KSB

Table of Contents



|         |  |                                                                                                                |  |     
|-------- |  | -------------------------------------------------------------------------------------------------------------- |  | ----
|         |  |                                                                                                                |  | Page
|PART I   |  |                                                                                                               
|         |  |                                                                                                               
|Item 1.  |  | Description of Business                                                                                        |  | 1   
|         |  |                                                                                                               
|Item 2.  |  | Description of Property                                                                                        |  | 6   
|         |  |                                                                                                               
|Item 3.  |  | Legal Proceedings                                                                                              |  | 6   
|         |  |                                                                                                               
|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                                            |  | 6   
|         | 
|PART II  |  |                                                                                                               
|         |  |                                                                                                               
|Item 5.  |  | Market for Common Equity, Related Stockholder Matters and Small Business Issuer Purchases of Equity Securities |  | 7   
|         |  |                                                                                                               
|Item 6.  |  | Managements Discussion and Analysis                                                                           |  | 9   
|         |  |                                                                                                               
|Item 7.  |  | Financial Statements                                                                                           |  | 27  
|         |  |                                                                                                               
|Item 8.  |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                           |  | 27  
|         |  |                                                                                                               
|Item 8A. |  | Controls and Procedures                                                                                        |  | 27  
|         |  |                                                                                                               
|Item 8B. |  | Other Information                                                                                              |  | 27  
|         | 
|PART III |  |                                                                                                               
|         |  |                                                                                                               
|Item 9.  |  | Directors and Executive Officers of the Registrant                                                             |  | 27  
|         |  |                                                                                                               
|Item 10. |  | Executive Compensation                                                                                         |  | 27  
|         |  |                                                                                                               
|Item 11. |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters                 |  | 27  
|         |  |                                                                                                               
|Item 12. |  | Certain Relationships and Related Transactions                                                                 |  | 27  
|         |  |                                                                                                               
|Item 13. |  | Exhibits                                                                                                       |  | 28  
|         |  |                                                                                                               
|Item 14. |  | Principal Accountant Fees and Services                                                                         |  | 29  



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NOTE REGARDING FORWARD-LOOKING STATEMENTS

Statements contained in this report, which are not historical facts, are forward-looking statements, as that term is defined in the Private Securities
Litigation Reform Act of 1995. Amounts herein could vary as a result of market and other factors. Such forward-looking statements are subject to risks and uncertainties which could cause actual results to differ materially from those currently
anticipated due to a number of factors, which include, but are not limited to, factors discussed in documents we file with the U.S. Securities and Exchange Commission from time to time. Such forward-looking statements may be identified by the use of
such words as believe, expect, anticipate, should, might, planned, estimated, and potential. Examples of forward-looking statements include, but are not
limited to, estimates with respect to our financial condition, expected or anticipated revenue, results of operations and business that are subject to various factors which could cause actual results to differ materially from these estimates. These
factors include, but are not limited to: our ability to manage growth; changes in interest rates, deposit flows, loan demand, and real estate values; general economic conditions; competition; changes in accounting principles, policies, or
guidelines; changes in legislation or regulation; and other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services.

PART I



|Item 1. | Description of Business.
|------- | ------------------------

Overview

We are a commercial bank holding company that was incorporated on June 5, 2002. We have one corporate subsidiary, North State
Bank, which we acquired on June 28, 2002 as part of the Banks holding company reorganization. Our primary business is the ownership and operation of North State Bank. We also have two trust subsidiaries that we established to issue trust
preferred securities.

North State Bank was incorporated under the laws of the State of North Carolina in May 2000 and opened for business
on June 1, 2000. The Bank is not a member of the Federal Reserve System. Our main office and that of the Bank is located at 4270 The Circle at North Hills, Raleigh, North Carolina. The Bank also operates offices at 6200 Falls of Neuse Road in
north Raleigh, 2413 Blue Ridge Road in west Raleigh, 14091 New Falls of Neuse Road in Raleigh, 835 Highway 70 West in Garner, North Carolina, and a loan production office at 1908 Eastwood Road in Wilmington, North Carolina which will be replaced by
a full service office late 2007. The Bank is in the process of opening a full service office in downtown Raleigh. The term we in this report refers interchangeably to North State Bancorp and North State Bank.

We focus on serving the total banking needs of professional firms, professionals, property management companies, churches and individuals who highly
value a mutually beneficial banking relationship in the cities of Raleigh, Garner and Wilmington and the greater Wake County and New Hanover County market areas, by providing banking services including checking, savings and investment accounts;
commercial, installment, mortgage, and personal loans; safe deposit boxes; savings bonds; wire transfer; and other associated services. Through the Banks subsidiary, North State Bank Financial Services, Inc., we offer brokerage services.

Supervision and Regulation

Regulation of North State Bank

North State Bank is a North Carolina banking corporation whose deposits are insured
by the Federal Deposit Insurance Corporation. As a commercial bank, we are subject to extensive regulation by the FDIC and the North Carolina Commissioner of Banks. The North Carolina Commissioner of Banks and the FDIC periodically examine our
operations and require us to submit periodic reports regarding our financial condition and operations.

We are subject to various state and
federal laws and regulations that restrict or otherwise apply to our lending, deposit-taking and other business activities. Additionally, federal law generally prohibits us from engaging as principal in activities that are not permitted for national
banks unless the FDIC determines that the activity would pose no significant risk to the deposit insurance fund, and we are, and continue to be, in compliance with all applicable capital standards. In addition, we generally are not able to acquire
or retain equity investments of a type, or in an amount, that is not permissible for a national bank.

A bank must obtain the prior
approval of the North Carolina Commissioner of Banks for any of the following events:



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| |  |  | the merger with or purchase of substantially all the assets or assumption of liabilities of another financial institution;
| | - |  | --------------------------------------------------------------------------------------------------------------------------



| |  |  | the establishment of a branch office; and
| | - |  | -----------------------------------------



| |  |  | the establishment or acquisition of a subsidiary corporation.
| | - |  | -------------------------------------------------------------

The North Carolina Commissioner of Banks or the FDIC may sanction any insured bank not operated in accordance with or not conforming to their regulations, policies, and directives. Proceedings may be instituted
against an insured bank or any director, officer or employee of a bank that engages in unsafe and unsound practices, including the violation of applicable laws and regulations. The FDIC can terminate insurance of accounts of any insured bank not
operated in accordance with or not conforming to its regulations, policies, and directives.

All FDIC-insured banks must maintain average
daily reserves against their transaction accounts. Because required reserves must be maintained in the form of vault cash or in a non-interest-bearing account at a Federal Reserve Bank, the effect of the reserve requirement is to reduce the amount
of the Banks interest-earning assets.

The Bank is subject to the provisions of Section 23A of the Federal Reserve Act.
Section 23A places limits on the amount of certain transactions with affiliate entities. The total amount of the transactions by the Bank with a single affiliate is limited to 10% of the Banks capital and surplus and, for all affiliates,
to 20% of the Banks capital and surplus. Each of the transactions among affiliates must also meet specified collateral requirements and must comply with other provisions of Section 23A designed to avoid transfers of low-quality assets
between affiliates.

The USA Patriot Act of 2001 is intended to strengthen the ability of U.S. law enforcement and the intelligence
community to work cohesively to combat terrorism on a variety of fronts. The Patriot Act contains sweeping anti-money laundering and financial transparency laws which require various regulations, including standards for verifying customer
identification at account opening, and rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering. The Patriot Act has required
financial institutions to adopt new policies and procedures to combat money laundering, and it grants the Secretary of the Treasury broad authority to establish regulations and impose requirements and restrictions on financial institutions
operations.

Community Reinvestment Act

We are subject to the provisions of the Community Reinvestment Act of 1977, which requires financial institutions to meet the credit needs of their local communities, including low and moderate income communities. In
accordance with the Community Reinvestment Act, the FDIC periodically assesses our record of meeting the credit needs of our local communities by assigning one of the following ratings to our performance in that regard:



| |  |  | outstanding;
| | - |  | ------------



| |  |  | satisfactory;
| | - |  | -------------



| |  |  | needs to improve; or
| | - |  | --------------------



| |  |  | substantial noncompliance.
| | - |  | --------------------------

In
addition, the FDIC will strongly consider our performance under the Community Reinvestment Act as a factor upon any application by us for any of the following:



| |  |  | the establishment of a branch;
| | - |  | ------------------------------



| |  |  | the relocation of a main office or branch; and
| | - |  | ----------------------------------------------



| |  |  | the merger or consolidation with or the acquisition of assets or assumption of liabilities of an insured depository institution.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------

Capital Requirements

We must comply
with the capital requirements imposed by the FDIC. Under the FDICs regulations, state-chartered, nonmember banks that receive the highest rating during the examination process have the following characteristics:



| |  |  | no anticipated or significant current growth;
| | - |  | ---------------------------------------------



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| |  |  | well-diversified risk (including no undue interest rate risk exposure), excellent asset quality, high liquidity and good earnings; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------



| |  |  | in general, are considered strong banking organizations.
| | - |  | --------------------------------------------------------

The FDIC requires banks to maintain a minimum leverage ratio of 3% of Tier 1 capital, which is common stockholders equity less intangible assets, identified losses and other adjustments, to average total
consolidated assets. The FDIC can require banks to maintain a ratio of 100 to 200 basis points above the stated minimum, and has generally set a minimum leverage ratio of not less than 4% for most banks.

To provide measurement of capital adequacy that is more sensitive to the individual risk profiles of financial institutions, the FDICs risk-based
capital regulations provide that, in addition to maintaining their required leverage ratio, banks are expected to maintain a level of capital commensurate with risk profiles assigned to their assets. The regulations generally require a minimum ratio
of Tier 1 capital to risk-weighted assets of 4%, and a minimum ratio of total capital to risk-weighted assets of 8%, of which at least one-half must be in the form of Tier 1 capital.

Dividends

The payment of any cash
dividend is subject to the Banks board of directors evaluation of its operating results, financial condition, future growth plans, general business conditions, and to tax and other relevant considerations and regulatory limitations,
including our minimum capital requirements. The Bank might not declare and pay any cash dividends, and if it were to do so, it might not continue to declare them or maintain them at the same level. As North State Bancorp owns all of the stock of
North State Bank, any dividend declared would be paid to it.

In addition, other statutory and regulatory restrictions apply to the payment
of cash dividends on our common stock. Under North Carolina law applicable to banks, our directors may declare a cash dividend in an amount equal to our undivided profits, as they deem appropriate, subject to the limitation that the banks
capital surplus is at least 50% of its paid-in capital. Cash dividends may only be paid out of retained earnings. We cannot pay a cash dividend at any time that we are undercapitalized or insolvent, or when payment of the dividend would
render us insolvent. Also, a FDIC-insured bank cannot pay a cash dividend while it is in default on any assessment due the FDIC.

Insurance Assessments

The FDIC insures our customers deposits. Under the Federal Deposit Insurance Reform Act of
2005, the FDIC uses a risk-based assessment system to determine the amount of a banks deposit insurance assessment based on an evaluation of the probability that the deposit insurance fund will incur a loss with respect to that bank. The
evaluation considers risks attributable to different categories and concentrations of the banks assets and liabilities and other factors the FDIC considers to be relevant, including information obtained from the banks federal and state
banking regulators. The FDIC is responsible for maintaining the adequacy of the deposit insurance fund, and the amount paid by a bank for deposit insurance is influenced not only by the assessment of the risk it poses to the deposit insurance fund,
but also by the adequacy of the insurance fund to cover the risk posed by all insured institutions. FDIC insurance assessments could be increased substantially in the future if the FDIC finds such an increase to be necessary in order to adequately
maintain the deposit insurance fund. The FDIC also may terminate a banks deposit insurance if it finds that the bank has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated
applicable laws, regulations, rules, or orders.

Interstate Banking and Branching

Subject to state law, federal law permits adequately capitalized and managed bank holding companies to acquire control of a bank in any state. In
addition, federal law permits banks to merge with banks located in other states and allows states to adopt legislation permitting out-of-state banks to open branch offices within that states borders. The North Carolina Reciprocal Interstate
Banking Act permits banking organizations in any state with similar reciprocal legislation to acquire North Carolina banking organizations. In addition, subject to another state having similar laws, the North Carolina Interstate Branch Banking Act:



| |  |  | permits North Carolina banks and out-of-state banks to merge;
| | - |  | -------------------------------------------------------------



| |  |  | authorizes North Carolina banks to establish or acquire branch offices in any other state; and
| | - |  | ----------------------------------------------------------------------------------------------



| |  |  | permits out-of-state banks to establish or acquire branch offices in North Carolina.
| | - |  | ------------------------------------------------------------------------------------



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Prompt Corrective Action

The Federal Deposit Insurance Corporation Improvement Act of 1991 establishes a system of prompt corrective action to resolve the problems of
undercapitalized institutions. Under this system, the federal banking regulators must rate supervised institutions on a basis of five capital categories. The federal banking regulators also must take certain mandatory supervisory actions and are
authorized to take all other discretionary actions with respect to institutions in the three undercapitalized categories, the severity of which will depend upon the capital category in which the institution is placed. Generally, subject to narrow
exception, the Federal Deposit Insurance Corporation Improvement Act requires the primary or appropriate banking regulator to appoint a receiver or conservator for an institution that is critically undercapitalized. The federal banking agencies have
specified by regulation the relevant capital level for each category.

Under the Federal Deposit Insurance Corporation Improvement Act, the
FDIC adopted regulations setting forth a five-tier scheme for measuring the capital adequacy of FDIC-insured commercial banks. Under the regulations, a bank is placed in one of the following capital categories:



| |  |  | Well Capitalized  a bank which has a total capital ratio of at least 10%, a Tier 1 capital ratio of at least 6%, and a Tier 1 leverage ratio of at
least 5%;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Adequately Capitalized  a bank which has a total capital ratio of at least 8%, a Tier 1 capital ratio of at least 4%, and a Tier 1 leverage ratio of at
least 4%;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Undercapitalized  a bank that has a total capital ratio of under 8%, a Tier 1 capital ratio of under 4%, or a Tier 1 leverage ratio of under 4%;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Significantly Undercapitalized  a bank that has a total capital ratio of under 6%, a Tier 1 capital ratio of under 3%, or a Tier 1 leverage ratio of
under 3%; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Critically Undercapitalized  a bank whose tangible equity is not greater than 2% of total tangible assets.
| | - |  | -----------------------------------------------------------------------------------------------------------

The regulations permit the FDIC to downgrade a bank to the next lower category if the FDIC determines after notice and opportunity for hearing or
response that the bank is in an unsafe or unsound condition or that the bank has received and not corrected a less-than-satisfactory rating for any of the categories of asset quality, management, earnings, or liquidity in its most recent
examination. Supervisory actions by the appropriate federal banking regulator depend upon an institutions classification within the five categories.

The Federal Deposit Insurance Corporation Improvement Act generally prohibits a depository institution from making any capital distribution including payment of a cash dividend if the depository institution would
thereafter be undercapitalized. Undercapitalized depository institutions are subject to restrictions on borrowing from the Federal Reserve System. In addition, undercapitalized depository institutions are subject to growth limitations and are
required to submit capital restoration plans. If a depository institution fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized.

Significantly undercapitalized depository institutions might be subject to a number of requirements and restrictions including orders to sell sufficient voting stock to become adequately capitalized, requirements to
reduce total assets, and cessation of receipt of deposits from correspondent banks. Critically undercapitalized depository institutions are subject to appointment of a receiver or conservator.

Safety and Soundness Standards

The
Federal Deposit Insurance Act requires the federal bank regulatory agencies to prescribe standards relating to internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate risk exposure,
asset growth, asset quality, earnings, stock valuation, and compensation, fees and benefits, and such other operational and managerial standards as the agencies deem appropriate. The federal bank regulatory agencies have adopted a set of guidelines
prescribing safety and soundness standards under the Federal Deposit Insurance Corporation Improvement Act. In general, the guidelines require appropriate systems and practices to identify and manage the risks and exposures specified in the
guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by the executive officer,
employee, director or principal shareholder. In addition, the agencies adopted regulations that authorize, but do not require, an agency to order an institution that has been given notice by an agency that is not satisfying any of such safety and
soundness standards to submit a compliance plan. If, after being so



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notified, an institution fails to submit an acceptable compliance plan, the agency must issue an order directing action to correct the deficiency and may
issue an order directing other actions of the types to which an undercapitalized institution is subject under the prompt correction action provisions of the Federal Deposit Insurance Corporation Improvement Act. If an institution fails to comply
with such an order, the agency may seek to enforce such order in judicial proceedings and to impose civil money penalties.

Financial
Modernization Legislation

The Gramm-Leach-Bliley Act of 1999 permits bank holding companies meeting management, capital and Community
Reinvestment Act standards to engage in a broad range of non-banking activities, including insurance underwriting and investment banking. The Act allows insurance companies and other financial services companies to acquire banks and allows bank
holding companies to acquire securities firms and mutual fund advisory companies. The Act requires appropriate safeguards if a bank holding company wishes to engage in any of these activities. The Act also contains extensive customer privacy
protection provisions which require banks to adopt and implement policies and procedures for the protection of the financial privacy of their customers, including procedures that allow customers to elect that certain financial information not be
disclosed to certain persons.

Regulation of North State Bancorp

As a registered bank holding company, we are subject to the supervision of, and to regular inspection by, the Board of Governors of the Federal Reserve
System.

The Federal Reserve is authorized to adopt regulations affecting various aspects of bank holding companies. As a bank holding
company, our activities, and those of companies which we control or in which we hold more than 5% of the voting stock, is limited to banking or managing or controlling banks or furnishing services to or performing services for our subsidiaries, or
any other activity which the Federal Reserve determines to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. In making such determinations, the Federal Reserve is required to consider whether the
performance of such activities by a bank holding company or its subsidiaries can reasonably be expected to produce benefits to the public such as greater convenience, increased competition or gains in efficiency that outweigh possible adverse
effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices.

Generally, bank holding companies are required to obtain prior approval of the Federal Reserve to engage in any new activity not previously approved by the Federal Reserve or acquire more than 5% of any class of voting stock of any company.
Bank holding companies also must obtain the prior approval of the Federal Reserve before acquiring more than 5% of any class of voting stock of any bank that is not already majority-owned by the bank holding company. Similarly, an entity seeking to
acquire more than 5% of the voting securities of a bank holding company such as our company must first receive Federal Reserve approval.

Bank holding companies are required to give the Federal Reserve Board prior written notice of any purchase or redemption of outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net
consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of the holding companys consolidated net worth. The Federal Reserve Board may disapprove such a purchase or redemption if it
determines that the proposal would constitute an unsafe and unsound practice, or would violate any law, regulation, Federal Reserve Board order or directive, or any condition imposed by, or written agreement with, the Federal Reserve Board. Such
notice and approval is not required for a bank holding company that would be treated as well capitalized under applicable regulations of the Federal Reserve Board, that has received a composite 1 or 2 rating at
its most recent bank holding company inspection by the Federal Reserve Board, and that is not the subject of any unresolved supervisory issues.

Bank holding companies are required to serve as a source of financial strength for their depository institution subsidiaries, and, if their depository institution subsidiaries become undercapitalized, bank holding companies may be required
to guarantee the subsidiaries compliance with capital restoration plans filed with their bank regulators, subject to certain limits.

Bank holding companies must meet minimum capital requirements imposed by the Federal Reserve. These capital requirements generally are the same as those for banks imposed by the FDIC.

Dividends

As a bank holding company
that does not, as an entity, currently engage in separate business activities of a material nature, our ability to pay cash dividends depends upon the cash dividends we receive from our subsidiary, North State Bank. At present, our only sources of
income are cash dividends paid by the Bank and interest earned on any investment securities we hold. We must pay all



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of our operating expenses from funds we receive from the Bank. Therefore, shareholders may receive cash dividends from us only to the extent that funds are
available after payment of our operating expenses and only in the event that the board decides to declare a dividend. In addition, the Federal Reserve Board generally prohibits bank holding companies from paying cash dividends except out of
operating earnings where the prospective rate of earnings retention appears consistent with the bank holding companys capital needs, asset quality and overall financial condition. To date, we have retained our earnings for use in the
development of our business. As a relatively young bank holding company that expects to continue to expand its operations in Wake County, and other markets in North Carolina, we are not likely to pay any cash dividends on our common stock in the
foreseeable future, and we might not ever be in a position to pay cash dividends. We might not declare and pay any cash dividends, and if we were to do so, we might not continue to declare them or maintain them at the same level. We expect that, for
the foreseeable future, any cash dividends paid by the Bank to us will likely be limited to amounts needed to pay any separate expenses or to make required payments on our debt obligations, including the interest payments on our junior subordinated
debt.

Competition

The banking laws of
North Carolina allow banks located in North Carolina to develop branches throughout the state. In addition, out-of-state institutions may open branches in North Carolina as well as acquire or merge with institutions located in North Carolina. As a
result of such laws, banking in North Carolina is highly competitive.

Our five existing full-service offices are all located in Wake
County, which has numerous branches and corporate headquarters of money-center, super-regional, regional and statewide institutions, some of which have a major presence in Raleigh. A similar array of financial institutions are located in the
Wilmington, North Carolina market where we have a loan production office. In our market areas, we face competition from other banks, savings and loan associations, savings banks, credit unions, finance companies and major retail stores that offer
competing financial services. Many of these competitors have greater resources, broader geographic coverage and higher lending limits than we do. As a result, we focus on our customer relationships to help us provide a competitive advantage in
attracting and keeping customers.

Employees

As of December 31, 2006, we had 75 full time employees. We believe that our future success will depend in part on our continued ability to attract, hire, and retain qualified personnel. None of our employees are represented by a labor
union. We have not experienced any work stoppages and consider our relations with our employees to be good.



|Item 2. | Description of Property.
|------- | ------------------------

Our
headquarters are located in Raleigh, North Carolina, where we occupy approximately 12,000 square feet of office space in a stand-alone building under a lease extending through March 2015. We have an office and operations center in north Raleigh that
consists of approximately 8,352 square feet of office space under a lease extending through September 2007. We own an office in west Raleigh that consists of approximately 10,000 square feet, approximately 5,200 square feet of which we occupy and
the remainder of which is vacant. We have an office in Garner, North Carolina, where we own a building that has approximately 5,000 square feet of office space. We own an office in the Wakefield area of Raleigh which has approximately 10,000 square
feet of office space. We occupy under lease approximately 850 square feet of office space for our loan production office in Wilmington, North Carolina. This lease runs through May 2007. We are in the process of constructing a full service office in
Wilmington, North Carolina, that will occupy approximately 8,400 square feet. We expect to open this office in the fourth quarter of 2007. Upon opening of this office, we will close our loan production office in Wilmington. We are also leasing
approximately 3,700 square feet of office space in downtown Raleigh through October 2011 with plans to open a full service office in the near future.



|Item 3. | Legal Proceedings.
|------- | ------------------

From time to
time, we are party to various legal proceedings or claims, either asserted or unasserted, which arise in the ordinary course of business. Although the ultimate outcome of these matters is not yet determined, we do not believe that the resolution of
these matters will have a material effect upon our financial condition or results of operations in any interim or annual period.



|Item 4. | Submission of Matters to a Vote of Security Holders.
|------- | ----------------------------------------------------

No matter was submitted to a vote of our shareholders during the fourth quarter of the year ended December 31, 2006.



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PART II



|Item 5. | Market for Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
|------- | -----------------------------------------------------------------------------------------------

Stock Information

Our common stock is not traded on
any exchange. Our stock is listed on the Over-the-Counter Bulletin Board. Set forth below for each quarter in 2005 and 2006 is information on the high and low bid and asked prices of our common stock as reported on the Over-the-Counter Bulletin
Board. Prices have been adjusted for the 6-for-5 stock split effected in the fourth quarter of 2005 in the form of a 20% stock dividend and for the 3-for-2 stock split effected in the third quarter of 2006 in the form of a 50% stock dividend.



|                                    |  |      |       |     |   |      
|----------------------------------- |  | ---- | ----- | --- | - | -----
|                                    |  | High |       | Low
|Fiscal Year Ended December 31, 2006 |  |      |       |     |   |      
|January 1 through March 31, 2006    |  | $    | 18.33 |     | $ | 14.33
|April 1 through June 30, 2006       |  |      | 17.00 |     |   | 14.67
|July 1 through September 30, 2006   |  |      | 22.00 |     |   | 16.00
|October 1 through December 31, 2006 |  |      | 24.99 |     |   | 21.25
|                                    |  |     
|Fiscal Year Ended December 31, 2005 |  |      |       |     |   |      
|January 1 through March 31, 2005    |  | $    | 11.67 |     | $ | 9.64 
|April 1 through June 30, 2005       |  |      | 10.83 |     |   | 9.55 
|July 1 through September 30, 2005   |  |      | 11.11 |     |   | 10.42
|October 1 through December 31, 2005 |  |      | 15.00 |     |   | 8.15 

As of March 17, 2007, there were approximately 800 shareholders of record. We estimate that
there were approximately 1,100 beneficial owners on March 17, 2007.

Dividends

To date, we have not paid any cash dividends. Our ability to pay cash dividends is dependent on the earnings of our subsidiary, North State Bank. Pursuant
to the order of the North Carolina Commissioner of Banks approving the organization of North State Bank in 2000, North State Bank could not pay cash dividends for its first three years of operation. In the future, we expect that any earnings will be
used for the development of our business as we seek to expand our operations in Wake County, North Carolina. Subject to these restrictions, the Board of Directors will consider the payment of cash dividends when it is deemed prudent to do so.
Further, our ability to declare and pay cash dividends depends upon, among other things, restrictions imposed by the reserve and capital requirements of North Carolina and federal law, our income and fiscal condition, tax considerations, and general
business conditions. Therefore, it is not likely that we will pay any cash dividends on our common stock in the foreseeable future, and we might never pay cash dividends.

On March 17, 2004, our trust subsidiary issued preferred securities in a private placement. On December 15, 2005, our second trust subsidiary issued preferred securities in a private placement. In each
instance, we, in turn, issued unsecured subordinated debentures to each trust to serve as the income source for the trusts payment of interest on its preferred securities. Pursuant to the terms of the indentures that govern our debentures, we
are prohibited from paying cash dividends on our stock in the event we are in default on the terms of the debentures or the indentures.

Equity
Compensation Plans

Set forth below is information on our equity compensation plans as of December 31, 2006.



|                                                       |  |                                                                                           |  |                                                                           |      |                                                                                              |      
|------------------------------------------------------ |  | ----------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------- | ---- | -------------------------------------------------------------------------------------------- | -----
|Plan Category                                          |  | Number of securities to be issued upon exercise
ofoutstanding options,warrants and rights |  | Weighted-average exercise price ofoutstanding options,warrants and rights |      | Number of securities remaining available for future issuance under equity compensation plans
|Equity compensation plans approved by our shareholders |  | 482,876                                                                                   |  | $                                                                         | 5.02 |                                                                                              | 1,937



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|                                                           |  |         |  |   |      |  |      
|---------------------------------------------------------- |  | ------- |  | - | ---- |  | -----
|Equity compensation plans not approved by our shareholders |  |        |  |   |     |  |     
|                                                           |  |         |  |   |      |  |      
|Total                                                      |  | 482,876 |  | $ | 5.02 |  | 1,937
|                                                           |  |         |  |   |      |  |      

Our equity compensation plans consist of the 2000 Stock Option Plan for Employees, the 2000 Stock
Option Plan for Non-Employee Directors and the 2003 Stock Plan, all of which were approved by our shareholders. We do not have any equity compensation plans or arrangements that have not been approved by our shareholders.



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##### Table of Contents

|Item 6. | Managements Discussion and Analysis.
|------- | -------------------------------------

The following table sets forth selected consolidated financial information for our company as of and for the years ended December 31, 2006, 2005, 2004, 2003 and 2002. The data has been derived from our audited
consolidated financial statements. The consolidated financial statements as of December 31, 2006 and 2005 and for the years then ended, and the independent registered public accounting firms report thereon, are included elsewhere in this
report. The following should also be read in conjunction with Managements Discussion and Analysis of Financial Condition and Results of Operations included in this report.



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|                                                          |  |                                               |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|--------------------------------------------------------- |  | --------------------------------------------- | --------- | - | ---- | - | --------- | ---- |  | - | --------- | - |  | ---- | --------- | - |  | - | --------- | -
|                                                          |  | 2006                                          |           |   | 2005 |   |           | 2004 |  |   | 2003      |   |  | 2002 |          
|                                                          |  | (Dollars in thousands, except per share data) |          
|Operating Data:                                           |  |                                               |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Total interest income                                     |  | $                                             | 26,412    |   |      | $ | 18,781    |      |  | $ | 12,599    |   |  | $    | 9,213     |   |  | $ | 7,920     |  
|Total interest expense                                    |  |                                               | 11,587    |   |      |   | 6,497     |      |  |   | 4,135     |   |  |      | 3,251     |   |  |   | 3,115     |  
|                                                          |  |                                               |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Net interest income                                       |  |                                               | 14,825    |   |      |   | 12,284    |      |  |   | 8,464     |   |  |      | 5,962     |   |  |   | 4,805     |  
|Provision for loan losses                                 |  |                                               | 69        |   |      |   | 792       |      |  |   | 920       |   |  |      | 690       |   |  |   | 546       |  
|                                                          |  |                                               |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Net interest income after provision                       |  |                                               | 14,756    |   |      |   | 11,492    |      |  |   | 7,544     |   |  |      | 5,272     |   |  |   | 4,259     |  
|Noninterest income                                        |  |                                               | 1,174     |   |      |   | 1,310     |      |  |   | 1,034     |   |  |      | 996       |   |  |   | 845       |  
|Noninterest expense                                       |  |                                               | 10,743    |   |      |   | 8,901     |      |  |   | 6,364     |   |  |      | 4,853     |   |  |   | 4,154     |  
|                                                          |  |                                               |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Income before income taxes                                |  |                                               | 5,187     |   |      |   | 3,901     |      |  |   | 2,214     |   |  |      | 1,415     |   |  |   | 950       |  
|Provision for income taxes                                |  |                                               | 1,915     |   |      |   | 1,463     |      |  |   | 838       |   |  |      | 436       |   |  |   |          |  
|                                                          |  |                                               |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Net income                                                |  | $                                             | 3,272     |   |      | $ | 2,438     |      |  | $ | 1,376     |   |  | $    | 979       |   |  | $ | 950       |  
|                                                          |  |                                               |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Per Share Data: (1)                                       |  |                                               |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Earnings per share - basic                                |  | $                                             | 0.74      |   |      | $ | 0.57      |      |  | $ | 0.48      |   |  | $    | 0.23      |   |  | $ | 0.23      |  
|Earnings per share - diluted                              |  |                                               | 0.69      |   |      |   | 0.53      |      |  |   | 0.30      |   |  |      | 0.22      |   |  | $ | 0.22      |  
|Market price                                              |  |                                               |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|High                                                      |  |                                               | 24.99     |   |      |   | 15.00     |      |  |   | 13.92     |   |  |      | 8.45      |   |  |   | 5.31      |  
|Low                                                       |  |                                               | 14.33     |   |      |   | 8.15      |      |  |   | 7.04      |   |  |      | 4.39      |   |  |   | 4.59      |  
|Close                                                     |  |                                               | 24.00     |   |      |   | 14.47     |      |  |   | 13.92     |   |  |      | 7.25      |   |  |   | 5.31      |  
|Book value                                                |  |                                               | 5.86      |   |      |   | 4.96      |      |  |   | 4.44      |   |  |      | 4.12      |   |  |   | 3.96      |  
|                                                          |  |                                               |           |   |     
|Weighted average shares outstanding                       |  |                                               |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Basic                                                     |  |                                               | 4,411,485 |   |      |   | 4,261,418 |      |  |   | 4,253,036 |   |  |      | 4,220,291 |   |  |   | 4,198,631 |  
|Diluted                                                   |  |                                               | 4,774,747 |   |      |   | 4,629,446 |      |  |   | 4,529,320 |   |  |      | 4,389,808 |   |  |   | 4,302,325 |  
|                                                          |  |                                               |           |   |     
|Selected Year-End Balance Sheet Data:                     |  |                                               |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Total assets                                              |  | $                                             | 455,477   |   |      | $ | 382,438   |      |  | $ | 309,542   |   |  | $    | 249,020   |   |  | $ | 195,478   |  
|Loans                                                     |  |                                               | 345,943   |   |      |   | 294,175   |      |  |   | 244,620   |   |  |      | 181,532   |   |  |   | 118,653   |  
|Allowance for loan losses                                 |  |                                               | 3,983     |   |      |   | 3,679     |      |  |   | 3,053     |   |  |      | 2,360     |   |  |   | 1,845     |  
|Deposits                                                  |  |                                               | 402,078   |   |      |   | 337,371   |      |  |   | 269,133   |   |  |      | 208,548   |   |  |   | 166,431   |  
|Short-term borrowings                                     |  |                                               | 10,670    |   |      |   | 10,006    |      |  |   | 14,273    |   |  |      | 15,911    |   |  |   | 4,892     |  
|Long-term debt                                            |  |                                               | 11,196    |   |      |   | 11,215    |      |  |   | 5,155     |   |  |      | 6,000     |   |  |   | 6,000     |  
|Shareholders equity                                      |  |                                               | 26,597    |   |      |   | 21,140    |      |  |   | 18,914    |   |  |      | 17,514    |   |  |   | 16,647    |  
|                                                          |  |                                               |           |   |     
|Selected Average Balances:                                |  |                                               |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Total assets                                              |  | $                                             | 398,097   |   |      | $ | 330,922   |      |  | $ | 271,694   |   |  | $    | 211,387   |   |  | $ | 156,031   |  
|Loans                                                     |  |                                               | 316,620   |   |      |   | 262,962   |      |  |   | 212,127   |   |  |      | 141,224   |   |  |   | 102,312   |  
|Total interest-earning assets                             |  |                                               | 382,899   |   |      |   | 318,720   |      |  |   | 261,559   |   |  |      | 200,832   |   |  |   | 148,863   |  
|Deposits                                                  |  |                                               | 349,070   |   |      |   | 293,565   |      |  |   | 230,265   |   |  |      | 179,973   |   |  |   | 128,602   |  
|Short-term borrowings                                     |  |                                               | 10,784    |   |      |   | 10,003    |      |  |   | 15,699    |   |  |      | 6,992     |   |  |   | 4,815     |  
|Long-term debt                                            |  |                                               | 11,205    |   |      |   | 5,166     |      |  |   | 6,043     |   |  |      | 6,000     |   |  |   | 5,556     |  
|Total interest-bearing liabilities                        |  |                                               | 284,504   |   |      |   | 233,631   |      |  |   | 194,680   |   |  |      | 140,779   |   |  |   | 100,686   |  
|Shareholders Equity                                      |  |                                               | 23,944    |   |      |   | 20,017    |      |  |   | 18,338    |   |  |      | 17,389    |   |  |   | 16,268    |  
|                                                          |  |                                               |           |   |     
|Selected Performance Ratios:                              |  |                                               |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Return on average assets                                  |  |                                               | 0.82      | % |      |   | 0.74      | %    |  |   | 0.51      | % |  |      | 0.46      | % |  |   | 0.61      | %
|Return on average equity                                  |  |                                               | 13.67     | % |      |   | 12.18     | %    |  |   | 7.50      | % |  |      | 5.63      | % |  |   | 5.84      | %
|Net interest spread                                       |  |                                               | 2.90      | % |      |   | 3.17      | %    |  |   | 2.74      | % |  |      | 2.33      | % |  |   | 2.29      | %
|Net interest margin                                       |  |                                               | 3.91      | % |      |   | 3.89      | %    |  |   | 3.27      | % |  |      | 3.00      | % |  |   | 3.26      | %
|Noninterest income to total revenue                       |  |                                               | 7.34      | % |      |   | 9.64      | %    |  |   | 10.89     | % |  |      | 14.31     | % |  |   | 14.96     | %
|Noninterest income to average assets                      |  |                                               | 0.29      | % |      |   | 0.40      | %    |  |   | 0.38      | % |  |      | 0.47      | % |  |   | 0.54      | %
|Noninterest expense to average assets                     |  |                                               | 2.70      | % |      |   | 2.69      | %    |  |   | 2.34      | % |  |      | 2.30      | % |  |   | 2.66      | %
|Efficiency ratio                                          |  |                                               | 67.15     | % |      |   | 65.48     | %    |  |   | 67.00     | % |  |      | 69.75     | % |  |   | 73.52     | %
|                                                          |  |                                               |           |   |     
|Asset Quality Ratios:                                     |  |                                               |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Nonperforming loans to period-end loans                   |  |                                               | 0.11      | % |      |   | 0.00      | %    |  |   | 0.11      | % |  |      | 0.55      | % |  |   | 0.09      | %
|Allowance for loan losses to period-end loans             |  |                                               | 1.15      | % |      |   | 1.25      | %    |  |   | 1.25      | % |  |      | 1.30      | % |  |   | 1.55      | %
|Ratio of allowance for loan losses to nonperforming loans |  |                                               | 10.03     | x |      |   | 0.00      | x    |  |   | 11.74     | x |  |      | 2.36      | x |  |   | 16.62     | x
|Nonperforming assets to total assets                      |  |                                               | 0.09      | % |      |   | 0.00      | %    |  |   | 0.25      | % |  |      | 0.40      | % |  |   | 0.06      | %
|Net loan recoveries/(charge-offs) to average loans        |  |                                               | 0.07      | % |      |   | -0.06     | %    |  |   | -0.11     | % |  |      | -0.12     | % |  |   | -0.02     | %



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|                                         |  |                                               |   |  |       |   |  |       |   |  |       |   |  |       |  
|---------------------------------------- |  | --------------------------------------------- | - |  | ----- | - |  | ----- | - |  | ----- | - |  | ----- | -
|                                         |  | At or for the Year Ended December 31,         |  
|                                         |  | 2006                                          |   |  | 2005  |   |  | 2004  |   |  | 2003  |   |  | 2002  |  
|                                         |  | (Dollars in thousands, except per share data) |  
|Capital Ratios (2):                      |  |                                               |   |  |       |   |  |       |   |  |       |   |  |       |  
|Total risk-based capital                 |  | 10.21                                         | % |  | 10.30 | % |  | 11.01 | % |  | 10.85 | % |  | 14.31 | %
|Tier 1 risk-based capital                |  | 9.09                                          | % |  | 9.09  | % |  | 9.76  | % |  | 9.60  | % |  | 13.06 | %
|Leverage ratio                           |  | 7.58                                          | % |  | 7.53  | % |  | 7.94  | % |  | 7.87  | % |  | 8.84  | %
|Equity to assets ratio                   |  | 5.84                                          | % |  | 5.53  | % |  | 6.11  | % |  | 7.03  | % |  | 8.52  | %
|Average equity to average assets         |  | 6.01                                          | % |  | 6.05  | % |  | 6.75  | % |  | 8.23  | % |  | 10.43 | %
|                                         |  |                                               |   |  |      
|Other Data (3,4):                        |  |                                               |   |  |       |   |  |       |   |  |       |   |  |       |  
|Number of banking offices                |  | 6                                             |   |  | 5     |   |  | 4     |   |  | 3     |   |  | 2     |  
|Number of full time equivalent employees |  | 75                                            |   |  | 68    |   |  | 48    |   |  | 43    |   |  | 37    |  

---

|(1) | Adjusted for the 3-for-2 stock split effected in the form of a 50% stock dividend in 2006, the 6-for-5 stock split effected in the form of a 20% stock dividend in 2005, a 23-for-20
stock split effected in the form of a 15% stock dividend in 2004 and the 11-for-10 stock splits effected in the form of 10% stock dividends in 2003 and 2002.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Capital ratios are for bank only.
|--- | ---------------------------------

|(3) | Includes one loan production office for years 2006, 2005, 2004 and 2003.
|--- | ------------------------------------------------------------------------

|(4) | Year 2004 does not include our full-service main banking office that opened in March 2005.
|--- | ------------------------------------------------------------------------------------------

Managements Discussion and Analysis

The following discussion and
analysis is presented to assist in understanding our consolidated financial condition and results of operations for the years ended December 31, 2006 and 2005. You should read this discussion and the related financial data in conjunction with
our audited consolidated financial statements and the related footnotes, which are included elsewhere in this report. During 2006, we issued a 3-for-2 stock split effected in the form of a 50% stock dividend, in 2005 we issued a 6-for-5 stock split
effected in the form of a 20% dividend, in 2004, we issued a 23-for-20 stock split effected in the form of a 15% stock dividend and in 2003, 2002 and 2001 we issued an 11-for-10 stock split effected in the form of a 10% stock dividend. All
references in this report to per share results and weighted average common and common equivalent shares outstanding have been adjusted for the effects of these stock splits. Because we have no operations and our only significant business is the
ownership of North State Bank, the following discussion concerns primarily the business of the Bank. However, for ease of reading and because the financial statements are presented on a consolidated basis, this discussion makes no distinction
between our company and our bank unless otherwise noted.

Description of Business

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 our bank holding company reorganization. In March 2004, we established a subsidiary trust, North State Statutory Trust I, to issue trust preferred securities. In December 2005, we established a second subsidiary trust,
North State Statutory Trust II. Our only business is the ownership and operation of North State Bank, North State Statutory Trust I and North State Statutory Trust II.

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 five full-service banking offices located in Raleigh and Garner, North Carolina and one loan production office located in Wilmington, North Carolina. Our principal customers consist of professional firms, professionals, churches,
property management companies and individuals who value a mutually beneficial banking relationship.

Financial Condition at December 31, 2006 and
2005

We continued to experience good growth in our balance sheet during 2006, our sixth full calendar year of operations. Total assets
as of December 31, 2006 were $455.5 million, an increase of $73.0 million or 19.1% from December 31, 2005. Loans were $345.9 million at December 31, 2006 compared to $294.2 million on December 31, 2005, an increase of $51.8
million or 17.6%. Other earning assets, principally investments and federal funds sold, increased $10.8 million or 14.1% over the previous year.

The growth in assets was principally funded by deposits, which grew $64.7 million or 19.2% during the year ended December 31, 2006. Interest-bearing transaction accounts continue to be the largest type of deposit account with balances
of $154.4 million as of December 31, 2006, an increase of $15.4 million or 11.1% over the same period in 2005. Demand deposits grew $18.4 million to $105.2 million or 21.2% and time deposits grew $31.0 million or 27.8% over December 31,
2005 levels. Time deposit growth accelerated during the second half of 2006 as additional deposits were generated as our Wake Forest office transitioned from a loan production office only to a full service facility in August 2006.

Our premises and equipment grew $2.0 million during 2006 primarily for the addition of a new full service office in the Wake Forest area and a loan
production office in Wilmington. Other assets increased $1.6 million to $3.6 million at December 31,



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2006. A tax benefit of $844,000 was realized during 2006 from the exercise of nonqualified stock options, increase in deferred tax assets and
managements decision to add a derivative financial instrument in the form of an interest floor during the fourth quarter of 2006.

Results of
Operations For the Years Ended December 31, 2006 and 2005

Overview. For the year ended December 31, 2006, our
net income was $3.3 million compared to $2.4 million for the year ended December 31, 2005, an increase of 34.2%. Diluted net income per share of common stock was $0.69 in 2006 and $0.53 in 2005, an increase of $0.16 or 31.0%. Return on average
assets was 0.82% in 2006 versus 0.74% in 2005 while return on average equity was 13.67% and 12.18% for the years ended December 31, 2006 and December 31, 2005, respectively.

Net Interest Income. Net interest income was $14.8 million for the year ended December 31, 2006, an increase of $2.5 million or 20.7%
over the year ended December 31, 2005. The increase in net interest income was attributable to an overall higher level of earning assets and a better spread between the income we received from our earning assets and the expense we paid to fund
those assets. We increased average earning assets by $63.4 million in 2006 as compared to 2005. The average yield on our earning assets in 2006 was 6.97% compared to 5.95% during 2005, up 102 basis points. During the same period, the cost of our
interest-bearing liabilities increased by 129 basis points to 4.07%. The yield and rate increases were driven by strategic pricing of both our loans and deposits to reflect the increase in market rates, principally changes in the Fed Funds rate and
subsequent changes to the prime lending rate. The national prime lending rate increased 100 basis points to 8.25% at December 31, 2006 from 7.25% at December 31, 2005. The 129 basis point increase in cost of funds reflects changes in our
deposit mix due to growth in higher costing time deposits and competitive pricing. Our net interest margin increased slightly to 3.91% during 2006 compared to 3.89% during 2005.

Provision for Loan Losses. We recorded a $69,000 provision for loan losses in 2006, representing a decrease of $723,000 from the $792,000
provision recorded in 2005. Provisions for loan losses are charged to income to bring the allowance for loan losses to a level deemed appropriate by our management. The reduction in the provision during 2006 resulted principally from significant
recoveries during the current year of loans that were charged off prior to 2006, a decrease in the level of loan charge-offs during the year, and from modifications to the methodology used to estimate the allowance for loan losses. During 2005, the
provision for loan losses was made principally in response to growth in loans. Net recoveries of $235,000 were recorded during 2006 and net-charge-offs were $167,000 in 2005. The allowance for loan losses was $4.0 million at December 31, 2006
and $3.7 million at December 31, 2005, representing 1.15% and 1.25%, respectively, of loans outstanding at December 31, 2006 and 2005. See Asset Quality and the Allowance For Loan Losses.

Non-interest Income. Non-interest income is derived primarily from service fees on deposit accounts and income from mortgage lending
operations. Non-interest income was $1.2 million for the year 2006, a decrease of $136,000 from the prior year period. Income from mortgage lending decreased $166,000 in 2006 to $326,000 as a restructuring of our mortgage loan performance standards
resulted in fewer mortgage loan originators, which slowed overall mortgage loan production. Fees earned on deposit accounts decreased slightly by $17,000 to $754,000. During 2005, we added a full-time in-house Director of Wealth Management to expand
on the financial products and services (such as annuities, stocks, bonds and mutual fund offerings) offered through our offices. Fees generated from financial and wealth management services provided $50,000 in non-interest income during 2006
compared to $10,000 during 2005. We expect wealth management income to be a key driver in our non-interest income growth in the future.

Non-interest Expense. Non-interest expense includes salaries and benefits paid to employees, occupancy and equipment expenses and all other operating costs. Non-interest expense increased $1.8 million to $10.7 million for the
year ended December 31, 2006 compared to $8.9 million for the year ended December 31, 2005. Salaries and employee benefits comprised over half of the non-interest expense for 2006 and increased $937,000 compared to 2005. This reflects an
increase in additional loan officers and support staff added throughout the year. The Bank hired additional staff for the opening of our full service office in the Wake Forest area during the third quarter, additional staff for the opening of our
new loan production office in Wilmington during the second quarter and two officers for our corporate accounting and risk management staff. Premises and equipment costs increased $302,000 for the year ended December 31, 2006 compared to the
previous year. Most of this increase related to the opening of the full service office in the Wake Forest area, new lease expense for the future downtown office and a full year of expenses related to our corporate headquarters at North Hills. Other
non-interest expense increased $603,000 during 2006 led by director fees, increasing $239,000 and data processing and other outsourced services, increasing $155,000. Directors fees are directly tied to the change in the value of our stock, which
increased 66% during 2006. In addition, the Bank began paying its advisory boards members a nominal fee in 2006. 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. Professional fees decreased $46,000 as most of our expenses for compliance with Section 404
of Sarbanes Oxley were incurred during 2005. In the aggregate, non-interest expense as a percentage of average total assets remained basically unchanged at 2.70% for 2006 and 2.69% for 2005.



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Income Taxes. We recorded $1.9 million in income tax expense for the year ended
December 31, 2006 and $1.5 million for the year ended December 31, 2005. Income tax expense as a percentage of pretax income was 36.9% for 2006 and 37.5% for 2005. The increase in income taxes was attributable to higher pretax earnings, up
$1.3 million or 33.0% over the previous year-end.

Net Interest Income

Like most financial institutions, the primary component of our earnings is net interest income. Net interest income is the difference between interest income, principally from loan and investment securities
portfolios, and interest expense, principally on customer deposits and borrowings. Changes in net interest income result from changes in volume, spread and margin. For this purpose, volume refers to the average dollar level of interest-earning
assets and interest-bearing liabilities, spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities, and margin refers to net interest income divided by average
interest-earning assets and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities, as well as levels of non-interest-bearing liabilities. The following table sets forth, for the periods indicated,
information with regard to average balances of assets and liabilities, as well as the total dollar amounts of interest income from interest-earning assets and interest expense on interest-bearing liabilities, resultant yields or costs, net interest
income, net interest spread, net interest margin and ratio of average interest-earning assets to average interest-bearing liabilities. Non-accrual loans are included in determining average loans outstanding. Loan fees are included in interest income
in the table below.



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|                                                                                 |  |                              |         |   |                              |   |              |                              |      |                 |  |   |          |   |              |   |        |                 |      |   |          |   |              |   |  |   |        |  |      |  
|-------------------------------------------------------------------------------- |  | ---------------------------- | ------- | - | ---------------------------- | - | ------------ | ---------------------------- | ---- | --------------- |  | - | -------- | - | ------------ | - | ------ | --------------- | ---- | - | -------- | - | ------------ | - |  | - | ------ |  | ---- | -
|                                                                                 |  | Year Ended December 31, 2006 |         |   | Year Ended December 31, 2005 |   |              | Year Ended December 31, 2004 |     
|                                                                                 |  | (Dollars in thousands)       |        
|                                                                                 |  | Average Balance              |         |   | Interest                     |   | Average Rate |                              |      | Average Balance |  |   | Interest |   | Average Rate |   |        | Average Balance |      |   | Interest |   | Average Rate |  
|                                                                                 |  |                              |         |   |                              |   |              |                              |     
|Interest-earning assets:                                                         |  |                              |         |   |                              |   |              |                              |      |                 |  |   |          |   |              |   |        |                 |      |   |          |   |              |   |  |   |        |  |      |  
|Loans, net                                                                       |  | $                            | 312,557 |   |                              | $ | 23,426       |                              | 7.49 | %               |  | $ | 259,633  |   |              | $ | 16,911 |                 | 6.51 | % |          | $ | 209,502      |   |  | $ | 11,383 |  | 5.43 | %
|Investment securities available for sale                                         |  |                              | 42,658  |   |                              |   | 1,739        |                              | 4.08 | %               |  |   | 37,503   |   |              |   | 1,188  |                 | 3.17 | % |          |   | 37,765       |   |  |   | 1,044  |  | 2.76 | %
|Other interest-earning assets                                                    |  |                              | 23,621  |   |                              |   | 1,247        |                              | 5.28 | %               |  |   | 18,255   |   |              |   | 682    |                 | 3.74 | % |          |   | 11,667       |   |  |   | 172    |  | 1.47 | %
|                                                                                 |  |                              |         |   |                              |   |              |                              |      |                 |  |   |          |   |              |   |        |                 |      |   |          |   |              |   |  |   |        |  |      |  
|Total interest-earning assets                                                    |  |                              | 378,836 |   |                              |   | 26,412       |                              | 6.97 | %               |  |   | 315,391  |   |              |   | 18,781 |                 | 5.95 | % |          |   | 258,934      |   |  |   | 12,599 |  | 4.87 | %
|                                                                                 |  |                              |         |   |                              |   |              |                              |      |                 |  |   |          |   |              |   |        |                 |      |   |          |   |              |   |  |   |        |  |      |  
|Other assets                                                                     |  |                              | 19,261  |   |                              |   |              |                              |      |                 |  |   | 15,531   |   |              |   |        |                 |      |   |          |   | 12,760       |   |  |   |        |  |      |  
|                                                                                 |  |                              |         |   |                              |   |              |                              |      |                 |  |   |          |   |              |   |        |                 |      |   |          |   |              |   |  |   |        |  |      |  
|Total assets                                                                     |  | $                            | 398,097 |   |                              |   |              |                              |      |                 |  | $ | 330,922  |   |              |   |        |                 |      |   |          | $ | 271,694      |   |  |   |        |  |      |  
|                                                                                 |  |                              |         |   |                              |   |              |                              |      |                 |  |   |          |   |              |   |        |                 |      |   |          |   |              |   |  |   |        |  |      |  
|Interest-bearing liabilities:                                                    |  |                              |         |   |                              |   |              |                              |      |                 |  |   |          |   |              |   |        |                 |      |   |          |   |              |   |  |   |        |  |      |  
|Deposits:                                                                        |  |                              |         |   |                              |   |              |                              |      |                 |  |   |          |   |              |   |        |                 |      |   |          |   |              |   |  |   |        |  |      |  
|Savings, NOW and money market                                                    |  | $                            | 143,123 |   |                              |   | 5,210        |                              | 3.64 | %               |  | $ | 123,705  |   |              |   | 2,786  |                 | 2.25 | % |          | $ | 98,714       |   |  |   | 1,529  |  | 1.55 | %
|Time deposits over $100,000                                                      |  |                              | 56,916  |   |                              |   | 2,677        |                              | 4.70 | %               |  |   | 37,252   |   |              |   | 1,406  |                 | 3.77 | % |          |   | 28,651       |   |  |   | 847    |  | 2.96 | %
|Other time deposits                                                              |  |                              | 62,476  |   |                              |   | 2,645        |                              | 4.23 | %               |  |   | 57,505   |   |              |   | 1,735  |                 | 3.02 | % |          |   | 45,573       |   |  |   | 1,182  |  | 2.59 | %
|Borrowings:                                                                      |  |                              |         |   |                              |   |              |                              |      |                 |  |   |          |   |              |   |        |                 |      |   |          |   |              |   |  |   |        |  |      |  
|Short-term borrowings                                                            |  |                              | 10,784  |   |                              |   | 274          |                              | 2.54 | %               |  |   | 10,003   |   |              |   | 229    |                 | 2.28 | % |          |   | 15,699       |   |  |   | 308    |  | 1.96 | %
|Long-term debt                                                                   |  |                              | 11,205  |   |                              |   | 781          |                              | 6.97 | %               |  |   | 5,166    |   |              |   | 341    |                 | 6.60 | % |          |   | 6,043        |   |  |   | 269    |  | 4.45 | %
|                                                                                 |  |                              |         |   |                              |   |              |                              |      |                 |  |   |          |   |              |   |        |                 |      |   |          |   |              |   |  |   |        |  |      |  
|Total interest-bearing liabilities                                               |  |                              | 284,504 |   |                              |   | 11,587       |                              | 4.07 | %               |  |   | 233,631  |   |              |   | 6,497  |                 | 2.78 | % |          |   | 194,680      |   |  |   | 4,135  |  | 2.12 | %
|                                                                                 |  |                              |         |   |                              |   |              |                              |      |                 |  |   |          |   |              |   |        |                 |      |   |          |   |              |   |  |   |        |  |      |  
|Non-interest-bearing deposits                                                    |  |                              | 86,555  |   |                              |   |              |                              |      |                 |  |   | 75,103   |   |              |   |        |                 |      |   |          |   | 57,327       |   |  |   |        |  |      |  
|Other liabilities                                                                |  |                              | 3,094   |   |                              |   |              |                              |      |                 |  |   | 2,171    |   |              |   |        |                 |      |   |          |   | 1,349        |   |  |   |        |  |      |  
|Shareholders equity                                                             |  |                              | 23,944  |   |                              |   |              |                              |      |                 |  |   | 20,017   |   |              |   |        |                 |      |   |          |   | 18,338       |   |  |   |        |  |      |  
|                                                                                 |  |                              |         |   |                              |   |              |                              |      |                 |  |   |          |   |              |   |        |                 |      |   |          |   |              |   |  |   |        |  |      |  
|Total liabilities and shareholders equity                                       |  | $                            | 398,097 |   |                              |   |              |                              |      |                 |  | $ | 330,922  |   |              |   |        |                 |      |   |          | $ | 271,694      |   |  |   |        |  |      |  
|                                                                                 |  |                              |         |   |                              |   |              |                              |      |                 |  |   |          |   |              |   |        |                 |      |   |          |   |              |   |  |   |        |  |      |  
|Net interest income and interest rate spread                                     |  |                              |         |   |                              | $ | 14,825       |                              | 2.90 | %               |  |   |          |   |              | $ | 12,284 |                 | 3.17 | % |          |   |              |   |  | $ | 8,464  |  | 2.74 | %
|                                                                                 |  |                              |         |   |                              |   |              |                              |      |                 |  |   |          |   |              |   |        |                 |      |   |          |   |              |   |  |   |        |  |      |  
|Net interest margin                                                              |  |                              |         |   |                              |   |              |                              | 3.91 | %               |  |   |          |   |              |   |        |                 | 3.89 | % |          |   |              |   |  |   |        |  | 3.27 | %
|                                                                                 |  |                              |         |   |                              |   |              |                              |      |                 |  |   |          |   |              |   |        |                 |      |   |          |   |              |   |  |   |        |  |      |  
|Ratio of average interest-earning assets to average interest-bearing liabilities |  |                              | 133.16  | % |                              |   |              |                              |      |                 |  |   | 135.00   | % |              |   |        |                 |      |   |          |   | 133.00       | % |  |   |        |  |      |  
|                                                                                 |  |                              |         |   |                              |   |              |                              |      |                 |  |   |          |   |              |   |        |                 |      |   |          |   |              |   |  |   |        |  |      |  



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Rate/Volume Analysis

The following table analyzes the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. The table distinguishes between
(i) changes attributable to volume (changes in volume multiplied by the prior periods rate), (ii) changes attributable to rate (changes in rate multiplied by the prior periods volume), and (iii) net change (the sum of the
previous columns). The change attributable to both rate and volume (changes in rate multiplied by changes in volume) has been allocated equally to both the changes attributable to volume and the changes attributable to rate.



|                                         |  |                                       |       |                                       |   |       |  |        |       |  |      |       |       |  |   |       |  |   |       |  
|---------------------------------------- |  | ------------------------------------- | ----- | ------------------------------------- | - | ----- |  | ------ | ----- |  | ---- | ----- | ----- |  | - | ----- |  | - | ----- | -
|                                         |  | Year Ended December 31, 2006 vs. 2005 |       | Year Ended December 31, 2005 vs. 2004 |  
|                                         |  | Increase Due to                       |       | Increase (Decrease) Due to            |  
|                                         |  | Volume                                |       | Rate                                  |   | Total |  | Volume |       |  | Rate |       | Total | 
|                                         |  | (Dollars in thousands)                |      
|Interest income:                         |  |                                       |       |                                       |   |       |  |        |       |  |      |       |       |  |   |       |  |   |       |  
|Loans, net                               |  | $                                     | 3,707 |                                       | $ | 2,808 |  | $      | 6,515 |  | $    | 2,995 |       |  | $ | 2,533 |  | $ | 5,528 |  
|Investment securities available for sale |  |                                       | 187   |                                       |   | 364   |  |        | 551   |  |      | (8    | )     |  |   | 152   |  |   | 144   |  
|Other interest-earning assets            |  |                                       | 242   |                                       |   | 323   |  |        | 565   |  |      | 172   |       |  |   | 338   |  |   | 510   |  
|                                         |  |                                       |       |                                       |   |       |  |        |       |  |      |       |       |  |   |       |  |   |       |  
|Total interest income                    |  |                                       | 4,136 |                                       |   | 3,495 |  |        | 7,631 |  |      | 3,159 |       |  |   | 3,023 |  |   | 6,182 |  
|                                         |  |                                       |       |                                       |   |       |  |        |       |  |      |       |       |  |   |       |  |   |       |  
|Interest expense:                        |  |                                       |       |                                       |   |       |  |        |       |  |      |       |       |  |   |       |  |   |       |  
|Deposits:                                |  |                                       |       |                                       |   |       |  |        |       |  |      |       |       |  |   |       |  |   |       |  
|Savings, NOW and money market            |  |                                       | 572   |                                       |   | 1,852 |  |        | 2,424 |  |      | 475   |       |  |   | 782   |  |   | 1,257 |  
|Time deposits over $100,000              |  |                                       | 834   |                                       |   | 437   |  |        | 1,271 |  |      | 289   |       |  |   | 270   |  |   | 559   |  
|Other time deposits                      |  |                                       | 180   |                                       |   | 730   |  |        | 910   |  |      | 335   |       |  |   | 218   |  |   | 553   |  
|Borrowings:                              |  |                                       |       |                                       |   |       |  |        |       |  |      |       |       |  |   |       |  |   |       |  
|Short-term borrowings                    |  |                                       | 19    |                                       |   | 26    |  |        | 45    |  |      | (120  | )     |  |   | 41    |  |   | (79   | )
|Long-term debt                           |  |                                       | 410   |                                       |   | 30    |  |        | 440   |  |      | (48   | )     |  |   | 120   |  |   | 72    |  
|                                         |  |                                       |       |                                       |   |       |  |        |       |  |      |       |       |  |   |       |  |   |       |  
|Total interest expense                   |  |                                       | 2,015 |                                       |   | 3,075 |  |        | 5,090 |  |      | 931   |       |  |   | 1,431 |  |   | 2,362 |  
|                                         |  |                                       |       |                                       |   |       |  |        |       |  |      |       |       |  |   |       |  |   |       |  
|Net interest income increase             |  | $                                     | 2,121 |                                       | $ | 420   |  | $      | 2,541 |  | $    | 2,228 |       |  | $ | 1,592 |  | $ | 3,820 |  
|                                         |  |                                       |       |                                       |   |       |  |        |       |  |      |       |       |  |   |       |  |   |       |  

Liquidity

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, federal funds sold and investment securities classified as available for sale) comprised 21.8% and 21.6% of our total assets at December 31, 2006 and 2005, respectively.

We have been a net seller of federal funds, as our liquidity has exceeded our need to fund new loan demand. Should the need arise; we
would have the capability to sell securities classified as available for sale or to borrow funds as necessary. We have established credit lines with other financial institutions to purchase up to $9.5 million in federal funds. As a member of the
Federal Home Loan Bank of Atlanta, we may obtain advances up to 10% of our banks assets. As another source of short-term borrowings, we also utilize securities sold under agreements to repurchase. At December 31, 2006, borrowings
consisted of securities sold under agreements to repurchase of $10.7 million. In addition, on that date we had borrowed $886,000 from the Federal Home Loan Bank of Atlanta.

Total deposits were $402.1 million and $337.4 million at December 31, 2006 and 2005, respectively. Time deposits, which are the only deposit
accounts that have stated maturity dates, are generally considered to be rate sensitive. Time deposits represented 35.4% and 33.0%, respectively, of total deposits at December 31, 2006 and 2005. Time deposits of $100,000 or more represented
18.2% and 15.1%, respectively, of our total deposits at December 31, 2006 and 2005. We believe that most of these time deposits are relationship-oriented. While we will need to pay competitive rates to retain these deposits at their maturities,
there are other subjective factors that will determine their continued retention. Based upon prior experience, we anticipate that a substantial portion of outstanding certificates of deposit will renew upon maturity.

We believe that current sources of funds provide adequate liquidity for our current cash flow needs.



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##### Table of Contents

Asset/Liability Management

Our results of operations depend substantially on our net interest income. Like most financial institutions, our interest income and cost of funds are affected by general economic conditions and by competition in the
marketplace.

The purpose of asset/liability management is to provide stable net interest income growth by protecting our earnings from
undue interest rate risk, which arises from volatile interest rates and changes in the balance sheet mix, and by managing the risk/return relationships between liquidity, interest rate risk, market risk, and capital adequacy. We maintain, and have
complied with, our Board approved asset/liability management policy that provides guidelines for controlling exposure to interest rate risk by utilizing the following ratios and trend analysis: liquidity, equity, volatile liability dependence,
portfolio maturities, maturing assets and maturing liabilities. Our policy is to control the exposure of our earnings to changing interest rates by generally endeavoring to maintain a position within a narrow range around an earnings neutral
position, which is defined as the mix of assets and liabilities that generate a net interest margin that is least affected by interest rate changes.

When suitable lending opportunities are not sufficient to utilize available funds, we have generally invested such funds in securities, primarily securities issued by governmental agencies and mortgage-backed
securities. The securities portfolio contributes to our earnings and plays an important part in our overall interest rate management. However, management of the securities portfolio alone cannot balance overall interest rate risk. The securities
portfolio must be used in combination with other asset/liability techniques to actively manage the balance sheet. The primary objectives in our overall management of our securities portfolio are safety, liquidity, yield, asset/liability management,
which is also known as interest rate risk, and investing in securities that can be pledged for public deposits.

In reviewing our needs
with regard to proper management of our asset/liability program, we estimate our future needs, taking into consideration historical periods of high loan demand and low deposit balances, estimated loan and deposit increases (due to increased demand
through marketing), and forecasted interest rate changes.

The analysis of an institutions interest rate gap, which is the difference
between the repricing of interest-earning assets and interest-bearing liabilities during a given period of time, is a standard tool for the measurement of exposure to interest rate risk. The following table sets forth the amounts of our
interest-earning assets and interest-bearing liabilities outstanding at December 31, 2006, which are projected to reprice or mature in each of the future time periods shown. Except as stated below, the amounts of assets and liabilities shown
which reprice or mature within a particular period were determined in accordance with the contractual terms of the assets or liabilities. Loans with adjustable rates are shown as being due at the end of the next upcoming adjustment period. Money
market deposit accounts and negotiable order of withdrawal or other transaction accounts are assumed to be subject to immediate repricing and depositor availability and have been placed in the shortest period. In making the gap computations, none of
the assumptions made regarding prepayment rates and deposit decay rates have been used for any interest-earning assets or interest-bearing liabilities. In addition, the table does not reflect scheduled principal payments that will be received
throughout the lives of the loans. The interest rate sensitivity of our assets and liabilities illustrated in the following table would vary substantially if different assumptions were used or if actual experience differs from that indicated by such
assumptions.



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##### Table of Contents

|                                                                                  |  |                                         |         |   |                           |   |         |                       |  |   |               |   |  |       |         |   |  |   |         |  
|--------------------------------------------------------------------------------- |  | --------------------------------------- | ------- | - | ------------------------- | - | ------- | --------------------- |  | - | ------------- | - |  | ----- | ------- | - |  | - | ------- | -
|                                                                                  |  | Terms to Repricing at December 31, 2006 |        
|                                                                                  |  | 3 Monthsor Less                         |         |   | Over 3 Monthsto 12 Months |   |         | Total Within12 Months |  |   | Over 12Months |   |  | Total |        
|                                                                                  |  | (Dollars in thousands)                  |        
|Interest-earning assets:                                                          |  |                                         |         |   |                           |   |         |                       |  |   |               |   |  |       |         |   |  |   |         |  
|Loans                                                                             |  | $                                       | 141,578 |   |                           | $ | 24,882  |                       |  | $ | 166,460       |   |  | $     | 179,483 |   |  | $ | 345,943 |  
|Investment securities available for sale                                          |  |                                         | 5,068   |   |                           |   | 8,123   |                       |  |   | 13,191        |   |  |       | 28,741  |   |  |   | 41,932  |  
|Other earning assets                                                              |  |                                         | 45,795  |   |                           |   | 452     |                       |  |   | 46,247        |   |  |       |        |   |  |   | 46,247  |  
|                                                                                  |  |                                         |         |   |                           |   |         |                       |  |   |               |   |  |       |         |   |  |   |         |  
|Total interest-earning assets                                                     |  | $                                       | 192,441 |   |                           | $ | 33,457  |                       |  | $ | 225,898       |   |  | $     | 208,224 |   |  | $ | 434,122 |  
|                                                                                  |  |                                         |         |   |                           |   |         |                       |  |   |               |   |  |       |         |   |  |   |         |  
|Percent of total interest-earning assets                                          |  |                                         | 44.33   | % |                           |   | 7.71    | %                     |  |   | 52.04         | % |  |       | 47.96   | % |  |   | 100.00  | %
|Cumulative percent of total interest-earning assets                               |  |                                         | 44.33   | % |                           |   | 52.04   | %                     |  |   | 52.04         | % |  |       | 100.00  | % |  |   | 100.00  | %
|                                                                                  |  |                                         |         |   |                          
|Interest-bearing liabilities                                                      |  |                                         |         |   |                           |   |         |                       |  |   |               |   |  |       |         |   |  |   |         |  
|Deposits:                                                                         |  |                                         |         |   |                           |   |         |                       |  |   |               |   |  |       |         |   |  |   |         |  
|Savings, money market, and NOW                                                    |  | $                                       | 154,400 |   |                           | $ |        |                       |  | $ | 154,400       |   |  | $     |        |   |  | $ | 154,400 |  
|Time deposits                                                                     |  |                                         | 32,470  |   |                           |   | 71,272  |                       |  |   | 103,742       |   |  |       | 38,708  |   |  |   | 142,450 |  
|Borrowings:                                                                       |  |                                         |         |   |                           |   |         |                       |  |   |               |   |  |       |         |   |  |   |         |  
|Short-term borrowings                                                             |  |                                         | 10,670  |   |                           |   |        |                       |  |   | 10,670        |   |  |       |        |   |  |   | 10,670  |  
|Long-term debt                                                                    |  |                                         | 10,310  |   |                           |   |        |                       |  |   | 10,310        |   |  |       | 886     |   |  |   | 11,196  |  
|                                                                                  |  |                                         |         |   |                           |   |         |                       |  |   |               |   |  |       |         |   |  |   |         |  
|                                                                                  |  | $                                       | 207,850 |   |                           | $ | 71,272  |                       |  | $ | 279,122       |   |  | $     | 39,594  |   |  | $ | 318,716 |  
|                                                                                  |  |                                         |         |   |                           |   |         |                       |  |   |               |   |  |       |         |   |  |   |         |  
|Percent of total interest-bearing liabilities                                     |  |                                         | 65.21   | % |                           |   | 22.36   | %                     |  |   | 87.58         | % |  |       | 12.42   | % |  |   | 100.00  | %
|Cumulative percent of total interest-bearing liabilities                          |  |                                         | 65.21   | % |                           |   | 87.58   | %                     |  |   | 87.58         | % |  |       | 100.00  | % |  |   | 100.00  | %
|                                                                                  |  |                                         |         |   |                          
|Interest sensitivity gap                                                          |  | $                                       | (15,409 | ) |                           | $ | (37,815 | )                     |  | $ | (53,224       | ) |  | $     | 168,630 |   |  | $ | 115,406 |  
|Cumulative interest sensitivity gap                                               |  |                                         | (15,409 | ) |                           |   | (53,224 | )                     |  |   | (53,224       | ) |  |       | 115,406 |   |  |   | 115,406 |  
|Cumulative interest sensitivity gap as a percent of total interest-earning assets |  |                                         | -3.55   | % |                           |   | -12.26  | %                     |  |   | -12.26        | % |  |       | 26.58   | % |  |   | 26.58   | %
|Cumulative ratio of interest-sensitive assets to interest-sensitive liabilities   |  |                                         | 92.59   | % |                           |   | 80.93   | %                     |  |   | 80.93         | % |  |       | 136.21  | % |  |   | 136.21  | %

Capital

A significant measure of the strength of a financial institution is its capital base. Federal bank regulators have classified capital into the following components: (1) Tier I capital, which includes common
shareholders equity (excluding accumulated other comprehensive income) and qualifying preferred equity, and (2) Tier II capital, which includes a portion of the allowance for loan losses, certain qualifying long-term debt and preferred
stock that does not qualify as Tier I capital. Minimum capital levels are regulated by risk-based capital adequacy guidelines, which require a financial institution to maintain capital as a percentage of its risk-adjusted assets, which are the
institutions assets and certain off-balance sheet items adjusted for predefined credit risk factors. A financial institution is required to maintain, at a minimum, Tier I capital as a percentage of risk-adjusted assets of 4.0% and combined
Tier I and Tier II capital as a percentage of risk-adjusted assets of 8.0%. In addition to the risk-based guidelines, federal regulations require a financial institution to maintain a minimum leverage ratio (Tier I capital as a percentage of
tangible assets) of 4.0%. Our equity to assets ratio was 5.84% and 5.53%, respectively, at December 31, 2006 and December 31, 2005. As the following table indicates, at December 31, 2006 we exceeded our regulatory capital
requirements.



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|                                |  |                      |   |  |                    |   |  |                             |  
|------------------------------- |  | -------------------- | - |  | ------------------ | - |  | --------------------------- | -
|                                |  | At December 31, 2006 |  
|                                |  | ActualRatio          |   |  | MinimumRequirement |   |  | Well-CapitalizedRequirement |  
|Total risk-based capital ratio  |  | 10.21                | % |  | 8.00               | % |  | 10.00                       | %
|                                |  |                      |  
|Tier 1 risk-based capital ratio |  | 9.09                 | % |  | 4.00               | % |  | 6.00                        | %
|                                |  |                      |  
|Leverage ratio                  |  | 7.58                 | % |  | 4.00               | % |  | 5.00                        | %

In March 2004, we established a trust, North State Statutory Trust I, which sold $5.2 million of
its preferred and common securities in a pooled private placement and in turn used these funds in the purchase of $5.2 million of junior subordinated debentures issued by us. In December 2005, we established a second trust, North State Statutory
Trust II, which sold $5.2 million of its preferred and common securities in a pooled private placement and in turn used these funds in the purchase of $5.2 million of junior subordinated debentures issued by us.

We intend that our company and our bank remain well-capitalized for regulatory purposes. To do so, we might need additional capital in the
future due to our continuing growth, greater than expected future growth or other reasons. If necessary, we will consider all viable alternatives for raising capital including additional issuances of trust preferred securities.

Our trust preferred securities presently qualify as Tier 1 regulatory capital and are reported in Federal Reserve regulatory reports as a minority
interest in a consolidated subsidiary. The Federal Accounting Standards Board adopted in 2003 a rule, FASB Interpretation No. 46, that requires trust preferred securities be deconsolidated from our financial statements. On July 2, 2003,
the Board of Governors of the Federal Reserve issued a letter, SR 03-13, stating that notwithstanding FIN 46, trust preferred securities will continue to be included in Tier 1 capital until notice is given to the contrary. There can be no assurance
that the Federal Reserve will continue to allow institutions to include trust preferred securities in Tier 1 capital for regulatory capital purposes. In the event of a disallowance, there would be a reduction in our consolidated capital ratios.

Loan Portfolio

We make loans
primarily to professional firms, professionals, property management companies, churches and individuals. These loans consist of commercial and consumer real estate loans, business loans and loans to individuals. Our total loan portfolio grew by
$51.8 million or 17.6% between December 31, 2005 and December 31, 2006. We attribute this growth to our focus on relationship banking, our experienced loan officers and the vibrant market in the Wake County area and our new market in New
Hanover County.

Real estate construction and land development loans comprised 19.5% and real estate loans secured by one-to-four family
residential properties comprised 10.5% of our total loan portfolio at December 31, 2006. These loans increased 19.1% and 7.1%, respectively, between December 31, 2005 and December 31, 2006. Other commercial loans secured by real
estate comprised 69.0% of our total loan portfolio and are principally secured by owner-occupied buildings including professional practices, office, flex, retail and church properties. Properties securing these loans are located primarily within our
markets of Wake and New Hanover County, North Carolina. These loans typically have interest rates that are initially fixed for one to seven years with the remainder of the loan term subject to repricing based on various market indices.

Home equity loans, the predominant type of consumer loan in our portfolio, remained substantially unchanged between December 31, 2005 and
December 31, 2006 and comprised 4.3% and 5.0% of our total loan portfolio on those dates. These loans are typically secured by the primary residence of the borrower and the combined loan-to-value ratio is usually 90% or less.

While we originate mortgage loans, we do not retain them in our portfolio. We do not service loans for other financial institutions.

The table below presents information on our loan portfolio by major category at the dates indicated.



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|                                    |  |                        |         |   |                |        |   |        |   |         |                |  |        |        |  |   |                |   |  |        |   |  |                |         |   |        |        |   |                |   |         |   |  |        |  
|----------------------------------- |  | ---------------------- | ------- | - | -------------- | ------ | - | ------ | - | ------- | -------------- |  | ------ | ------ |  | - | -------------- | - |  | ------ | - |  | -------------- | ------- | - | ------ | ------ | - | -------------- | - | ------- | - |  | ------ | -
|                                    |  | At December 31,        |        
|                                    |  | 2006                   |         |   | 2005           |        |   | 2004   |   |         | 2003           |  |        | 2002   | 
|                                    |  | Amount                 |         |   | % ofTotalLoans |        |   | Amount |   |         | % ofTotalLoans |  |        | Amount |  |   | % ofTotalLoans |   |  | Amount |   |  | % ofTotalLoans |         |   | Amount |        |   | % ofTotalLoans |  
|                                    |  | (Dollars in thousands) |        
|Commercial                          |  | $                      | 239,014 |   |                | 69.04  | % |        | $ | 200,950 |                |  | 68.25  | %      |  | $ | 174,107        |   |  | 71.12  | % |  | $              | 137,385 |   |        | 75.64  | % |                | $ | 89,501  |   |  | 75.38  | %
|Real estate - construction          |  |                        | 67,404  |   |                | 19.47  | % |        |   | 56,586  |                |  | 19.22  | %      |  |   | 35,987         |   |  | 14.70  | % |  |                | 19,162  |   |        | 10.55  | % |                |   | 12,753  |   |  | 10.74  | %
|Real estate -1 to 4 family mortgage |  |                        | 21,438  |   |                | 6.19   | % |        |   | 19,222  |                |  | 6.53   | %      |  |   | 19,170         |   |  | 7.83   | % |  |                | 12,392  |   |        | 6.82   | % |                |   | 6,433   |   |  | 5.42   | %
|Loans to individuals                |  |                        | 3,414   |   |                | 0.99   | % |        |   | 2,933   |                |  | 1.00   | %      |  |   | 2,359          |   |  | 0.96   | % |  |                | 1,897   |   |        | 1.04   | % |                |   | 1,891   |   |  | 1.59   | %
|Home equity lines of credit         |  |                        | 14,933  |   |                | 4.31   | % |        |   | 14,732  |                |  | 5.00   | %      |  |   | 13,189         |   |  | 5.39   | % |  |                | 10,807  |   |        | 5.95   | % |                |   | 8,160   |   |  | 6.87   | %
|                                    |  |                        |         |   |                |        |   |        |   |         |                |  |        |        |  |   |                |   |  |        |   |  |                |         |   |        |        |   |                |   |         |   |  |        |  
|Loans, gross                        |  |                        | 346,203 |   |                | 100.00 | % |        |   | 294,423 |                |  | 100.00 | %      |  |   | 244,812        |   |  | 100.00 | % |  |                | 181,643 |   |        | 100.00 | % |                |   | 118,738 |   |  | 100.00 | %
|                                    |  |                        |         |   |                |        |   |        |   |        
|Unamortized net deferred loan fees  |  |                        | (260    | ) |                |        |   |        |   | (248    | )              |  |        |        |  |   | (192           | ) |  |        |   |  |                | (111    | ) |        |        |   |                |   | (85     | ) |  |        |  
|                                    |  |                        |         |   |                |        |   |        |   |         |                |  |        |        |  |   |                |   |  |        |   |  |                |         |   |        |        |   |                |   |         |   |  |        |  
|Total loans, net                    |  | $                      | 345,943 |   |                |        |   |        | $ | 294,175 |                |  |        |        |  | $ | 244,620        |   |  |        |   |  | $              | 181,532 |   |        |        |   |                | $ | 118,653 |   |  |        |  
|                                    |  |                        |         |   |                |        |   |        |   |         |                |  |        |        |  |   |                |   |  |        |   |  |                |         |   |        |        |   |                |   |         |   |  |        |  



19



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##### Table of Contents

The table below presents as of December 31, 2006 (i) the aggregate maturities of loans in the
named categories of our loan portfolio and (ii) the aggregate amounts of such loans, by variable and fixed rates.



|                                     |  |                        |         |       |                                 |   |        |                      |         |  |       |        |  |       |        |  |        |   |       |   |         |  |      |  
|------------------------------------ |  | ---------------------- | ------- | ----- | ------------------------------- | - | ------ | -------------------- | ------- |  | ----- | ------ |  | ----- | ------ |  | ------ | - | ----- | - | ------- |  | ---- | -
|                                     |  | At December 31, 2006   |        
|                                     |  | Due within one year    |         |       | Due after one year but within 5 |   |        | Due after five years |         |  | Total |       
|                                     |  | Amount                 |         | Yield |                                 |   | Amount |                      | Yield   |  |       | Amount |  | Yield |        |  | Amount |   | Yield |  
|                                     |  | (Dollars in thousands) |        
|Variable rate loans:                 |  |                        |         |       |                                 |   |        |                      |         |  |       |        |  |       |        |  |        |   |       |   |         |  |      |  
|Real estate - construction           |  | $                      | 34,534  |       | 8.85                            | % |        | $                    | 7,250   |  | 7.72  | %      |  | $     | 5,104  |  | 5.58   | % |       | $ | 46,888  |  | 8.32 | %
|Commercial and industrial loans      |  |                        | 41,552  |       | 9.36                            | % |        |                      | 19,038  |  | 11.24 | %      |  |       | 6,132  |  | 7.23   | % |       |   | 66,722  |  | 9.70 | %
|Installment loans                    |  |                        | 97      |       | 9.15                            | % |        |                      |        |  | 0.00  | %      |  |       |       |  | 0.00   | % |       |   | 97      |  | 9.15 | %
|Equity lines                         |  |                        | 8,857   |       | 8.47                            | % |        |                      | 5,899   |  | 8.41  | %      |  |       | 207    |  | 8.71   | % |       |   | 14,963  |  | 8.45 | %
|                                     |  |                        |         |       |                                 |   |        |                      |         |  |       |        |  |       |        |  |        |   |       |   |         |  |      |  
|Total at variable rates              |  |                        | 85,040  |       | 9.06                            | % |        |                      | 32,187  |  | 9.93  | %      |  |       | 11,443 |  | 6.52   | % |       |   | 128,670 |  | 9.05 | %
|                                     |  |                        |         |       |                                 |   |        |                      |         |  |       |        |  |       |        |  |        |   |       |   |         |  |      |  
|Fixed rate loans:                    |  |                        |         |       |                                 |   |        |                      |         |  |       |        |  |       |        |  |        |   |       |   |         |  |      |  
|Real estate - construction           |  |                        | 1,852   |       | 7.30                            | % |        |                      | 7,630   |  | 6.47  | %      |  |       | 11,725 |  | 6.29   | % |       |   | 21,207  |  | 6.44 | %
|Real estate - 1 to 4 family mortgage |  |                        | 5,596   |       | 6.73                            | % |        |                      | 10,400  |  | 6.19  | %      |  |       | 4,665  |  | 5.72   | % |       |   | 20,661  |  | 6.23 | %
|Commercial and industrial loans      |  |                        | 28,039  |       | 6.88                            | % |        |                      | 91,041  |  | 6.54  | %      |  |       | 52,606 |  | 5.12   | % |       |   | 171,686 |  | 6.16 | %
|Installment loans                    |  |                        | 1,891   |       | 7.30                            | % |        |                      | 1,097   |  | 7.01  | %      |  |       | 334    |  | 16.46  | % |       |   | 3,322   |  | 8.13 | %
|                                     |  |                        |         |       |                                 |   |        |                      |         |  |       |        |  |       |        |  |        |   |       |   |         |  |      |  
|Total at fixed rates                 |  |                        | 37,378  |       | 6.90                            | % |        |                      | 110,168 |  | 6.51  | %      |  |       | 69,330 |  | 5.41   | % |       |   | 216,876 |  | 6.22 | %
|                                     |  |                        |         |       |                                 |   |        |                      |         |  |       |        |  |       |        |  |        |   |       |   |         |  |      |  
|Subtotal                             |  |                        | 122,418 |       | 8.40                            | % |        |                      | 142,355 |  | 7.28  | %      |  |       | 80,773 |  | 5.57   | % |       |   | 345,546 |  | 7.28 | %
|                                     |  |                        |         |       |                                 |   |        |                     
|Nonaccrual loans                     |  |                        |        |       |                                 |   |        |                      | 397     |  |       |        |  |       |       |  |        |   |       |   | 397     |  |      |  
|                                     |  |                        |         |       |                                 |   |        |                      |         |  |       |        |  |       |        |  |        |   |       |   |         |  |      |  
|Loans, gross                         |  | $                      | 122,418 |       |                                 |   |        | $                    | 142,752 |  |       |        |  | $     | 80,773 |  |        |   |       | $ | 345,943 |  |      |  
|                                     |  |                        |         |       |                                 |   |        |                      |         |  |       |        |  |       |        |  |        |   |       |   |         |  |      |  

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

Asset Quality and the Allowance for Loan Losses

We prepare our consolidated financial statements on the accrual basis of accounting, including the recognition of interest income on our loan portfolio,
unless a loan is placed on a non-accrual basis. We place loans on a non-accrual basis when we have serious doubts about the collectibility of principal or interest. Amounts received on non-accrual loans generally are applied first to principal and
then to interest only after all principal has been collected. Restructured loans are those for which concessions, including the reduction of interest rates below a rate otherwise available to that borrower or the deferral of interest or principal,
have been granted due to the borrowers weakened financial condition. Interest on restructured loans is accrued at the restructured rates when it is anticipated that no loss of original principal will occur. At December 31, 2006, we had
$397,000 in non-accrual loans, no accruing loans that were past due 90 days or more, and no restructured loans.

The table below sets forth for the dates
indicated information about our non-performing assets.



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|                                                          |  |                        |         |   |      |   |        |      |  |   |         |   |  |      |        |   |  |   |         |  
|--------------------------------------------------------- |  | ---------------------- | ------- | - | ---- | - | ------ | ---- |  | - | ------- | - |  | ---- | ------ | - |  | - | ------- | -
|                                                          |  | At December 31,        |        
|                                                          |  | 2006                   |         |   | 2005 |   |        | 2004 |  |   | 2003    |   |  | 2002 |       
|                                                          |  | (Dollars in thousands) |        
|Nonaccrual loans                                          |  | $                      | 397     |   |      | $ |       |      |  | $ | 260     |   |  | $    | 1,002  |   |  | $ | 111     |  
|Restructured loans                                        |  |                        |        |   |      |   |       |      |  |   |        |   |  |      |       |   |  |   |        |  
|                                                          |  |                        |         |   |      |   |        |      |  |   |         |   |  |      |        |   |  |   |         |  
|Total nonperforming loans                                 |  |                        | 397     |   |      |   |       |      |  |   | 260     |   |  |      | 1,002  |   |  |   | 111     |  
|                                                          |  |                        |         |   |     
|Other real estate owned                                   |  |                        |        |   |      |   |       |      |  |   | 520     |   |  |      |       |   |  |   |        |  
|                                                          |  |                        |         |   |      |   |        |      |  |   |         |   |  |      |        |   |  |   |         |  
|Total nonperforming assets                                |  | $                      | 397     |   |      | $ |       |      |  | $ | 780     |   |  | $    | 1,002  |   |  | $ | 111     |  
|                                                          |  |                        |         |   |      |   |        |      |  |   |         |   |  |      |        |   |  |   |         |  
|Accruing loans past due 90 days or more                   |  | $                      |        |   |      | $ |       |      |  | $ | 46      |   |  | $    |       |   |  | $ | 191     |  
|Allowance for loan losses                                 |  |                        | 3,983   |   |      |   | 3,679  |      |  |   | 3,053   |   |  |      | 2,360  |   |  |   | 1,845   |  
|Nonperforming loans to period end loans                   |  |                        | 0.11    | % |      |   | 0.00   | %    |  |   | 0.11    | % |  |      | 0.55   | % |  |   | 0.09    | %
|Allowance for loan losses to period end loans             |  |                        | 1.15    | % |      |   | 1.25   | %    |  |   | 1.25    | % |  |      | 1.30   | % |  |   | 1.55    | %
|Nonperforming assets to loans and other real estate       |  |                        | 0.11    | % |      |   | 0.00   | %    |  |   | 0.32    | % |  |      | 0.55   | % |  |   | 0.09    | %
|Nonperforming assets to total assets                      |  |                        | 0.09    | % |      |   | 0.00   | %    |  |   | 0.25    | % |  |      | 0.40   | % |  |   | 0.06    | %
|Ratio of allowance for loan losses to nonperforming loans |  |                        | 10.03 x |   |      |   | 0.00 x |      |  |   | 11.74 x |   |  |      | 2.36 x |   |  |   | 16.62 x |  

Our allowance for loan losses is maintained at a level that our management considers adequate to
provide for probable loan losses based on our assessment of various factors affecting our loan portfolio, including a review of problem loans, business conditions and loss experience and an overall evaluation of the quality of the underlying
collateral. The allowance is increased by provisions charged to operations and reduced by loans charged off, net of recoveries. During the second half of 2006, management re-evaluated and implemented improvements to its methodology used to estimate
the allowance for loan losses. At December 31, 2006, our loan loss provision as a percentage of loans was 1.15%, down from 1.25% at December 31, 2005. In evaluating the allowance for loan losses, we prepare a statistically-based analysis
of our current loan portfolio through the use of historical loss rates through the use of peer statistics utilizing key loan portfolio quality measures such as net losses to average loans, allowance for loan losses to nonaccrual loans and the
percentage of loans over 30 days past due. Homogeneous loan groups are assigned risk factors based on their perceived loss potential and on their respective risk ratings. The Bank utilizes a system of nine possible risk ratings. The risk ratings are
established based on perceived probability of loss. All loans risk rated doubtful and loss are removed from their homogeneous group and individually analyzed for impairment as detailed in FAS 114. Other groups of loans based
on loan size may be selected for impairment review. The Bank has identified seven qualitative factors that are considered indicators of changes in the level of risk of loss inherent in the Banks loan portfolio. These factors include and
consider the risk of payment performance, overall portfolio quality (utilizing weighted average risk rating), general economic factors such as unemployment, inflation, delinquency and charge-off rates, regulatory examination results, interest rate
environment, levels of highly leveraged transactions (as defined in Section 365.2 of the FDIC regulations) and levels of construction, development and non-owner occupied commercial real estate lending.

While we believe that our management uses the best information available to determine the allowance for loan losses, unforeseen market conditions could
result in adjustments to the allowance for loan losses, and net income could be significantly affected, if circumstances differ substantially from the assumptions used in making the final determination. Because these factors and managements
assumptions are subject to change, the allocation is not necessarily indicative of future loan portfolio performance. Additional information regarding our allowance for loan losses and loan loss experience is presented in Note E to our consolidated
financial statements included in this report.



21



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##### Table of Contents

The table below provides information on our allocation of our allowance for loan losses among various
loan categories at the dates presented.



|                            |  |                        |       |                     |        |   |        |      |                     |  |        |        |  |                     |       |  |        |   |                     |   |       |        |        |                     |  |   |       |  |        |  
|--------------------------- |  | ---------------------- | ----- | ------------------- | ------ | - | ------ | ---- | ------------------- |  | ------ | ------ |  | ------------------- | ----- |  | ------ | - | ------------------- | - | ----- | ------ | ------ | ------------------- |  | - | ----- |  | ------ | -
|                            |  | At December 31,        |      
|                            |  | 2006                   |       |                     | 2005   |   |        | 2004 |                     |  | 2003   |        |  | 2002                |      
|                            |  | Amount                 |       | % of TotalLoans (1) |        |   | Amount |      | % of TotalLoans (1) |  |        | Amount |  | % of TotalLoans (1) |       |  | Amount |   | % of TotalLoans (1) |   |       | Amount |        | % of TotalLoans (1) | 
|                            |  | (Dollars in thousands) |      
|Real estate loans:          |  |                        |       |                     |        |   |        |      |                     |  |        |        |  |                     |       |  |        |   |                     |   |       |        |        |                     |  |   |       |  |        |  
|Commercial                  |  | $                      | 2,750 |                     | 69.04  | % |        | $    | 1,565               |  | 68.25  | %      |  | $                   | 2,041 |  | 71.12  | % |                     | $ | 1,794 |        | 75.64  | %                   |  | $ | 1,436 |  | 75.38  | %
|Real estate - construction  |  |                        | 775   |                     | 19.47  | % |        |      | 748                 |  | 19.22  | %      |  |                     | 422   |  | 14.70  | % |                     |   | 259   |        | 10.55  | %                   |  |   | 120   |  | 10.74  | %
|Real estate - 1 to 4 family |  |                        | 247   |                     | 6.19   | % |        |      | 502                 |  | 6.53   | %      |  |                     | 225   |  | 7.83   | % |                     |   | 71    |        | 6.82   | %                   |  |   | 86    |  | 5.42   | %
|Loans to individuals        |  |                        | 39    |                     | 0.99   | % |        |      | 12                  |  | 1.00   | %      |  |                     | 27    |  | 0.96   | % |                     |   | 22    |        | 1.04   | %                   |  |   | 17    |  | 1.59   | %
|Home equity lines of credit |  |                        | 172   |                     | 4.31   | % |        |      | 197                 |  | 5.00   | %      |  |                     | 155   |  | 5.39   | % |                     |   | 71    |        | 5.95   | %                   |  |   | 57    |  | 6.87   | %
|                            |  |                        |       |                     |        |   |        |      |                     |  |        |        |  |                     |       |  |        |   |                     |   |       |        |        |                     |  |   |       |  |        |  
|Total allocated             |  |                        | 3,983 |                     | 100.00 | % |        |      | 3,024               |  | 100.00 | %      |  |                     | 2,870 |  | 100.00 | % |                     |   | 2,217 |        | 100.00 | %                   |  |   | 1,716 |  | 100.00 | %
|Unallocated                 |  |                        |      |                     |        |   |        |      | 655                 |  |        |        |  |                     | 183   |  |        |   |                     |   | 143   |        |        |                     |  |   | 129   |  |        |  
|                            |  |                        |       |                     |        |   |        |      |                     |  |        |        |  |                     |       |  |        |   |                     |   |       |        |        |                     |  |   |       |  |        |  
|Total                       |  | $                      | 3,983 |                     |        |   |        | $    | 3,679               |  |        |        |  | $                   | 3,053 |  |        |   |                     | $ | 2,360 |        |        |                     |  | $ | 1,845 |  |        |  
|                            |  |                        |       |                     |        |   |        |      |                     |  |        |        |  |                     |       |  |        |   |                     |   |       |        |        |                     |  |   |       |  |        |  

---

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

The table below presents information regarding the changes in our allowance for loan/losses at or for the years indicated.



|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |    |  |      |         |    |  |   |         |   
|-------------------------------------------------------------- |  | ------------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -- |  | ---- | ------- | -- |  | - | ------- | --
|                                                               |  | At or for the Year Ended December 31, |        
|                                                               |  | 2006                                  |         |   | 2005 |   |         | 2004 |  |   | 2003    |    |  | 2002 |        
|                                                               |  | (Dollars in thousands)                |        
|Loan outstanding at the end of the year                        |  | $                                     | 345,943 |   |      | $ | 294,175 |      |  | $ | 244,620 |    |  | $    | 181,532 |    |  | $ | 118,653 |   
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |    |  |      |         |    |  |   |         |   
|Average loans outstanding during the year                      |  | $                                     | 316,620 |   |      | $ | 262,962 |      |  | $ | 212,127 |    |  | $    | 141,224 |    |  | $ | 102,312 |   
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |    |  |      |         |    |  |   |         |   
|Allowance for loan losses at beginning of year                 |  | $                                     | 3,679   |   |      | $ | 3,053   |      |  | $ | 2,360   |    |  | $    | 1,845   |    |  | $ | 1,323   |   
|Provision for loan losses                                      |  |                                       | 69      |   |      |   | 792     |      |  |   | 920     |    |  |      | 690     |    |  |   | 546     |   
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |    |  |      |         |    |  |   |         |   
|                                                               |  |                                       | 3,748   |   |      |   | 3,845   |      |  |   | 3,280   |    |  |      | 2,535   |    |  |   | 1,869   |   
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |    |  |      |         |    |  |   |         |   
|Loans charged off:                                             |  |                                       |         |   |      |   |         |      |  |   |         |    |  |      |         |    |  |   |         |   
|Real estate loans                                              |  |                                       |        |   |      |   | (32     | )    |  |   | (82     | )  |  |      | (171    | )  |  |   | (24     | ) 
|Commercial and industrial loans                                |  |                                       |        |   |      |   | (169    | )    |  |   | (183    | )  |  |      | (4      | )  |  |   |        |   
|Installment loans                                              |  |                                       | (5      | ) |      |   | (5      | )    |  |   | (13     | )  |  |      |        |    |  |   |        |   
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |    |  |      |         |    |  |   |         |   
|Total charge-offs                                              |  |                                       | (5      | ) |      |   | (206    | )    |  |   | (278    | )  |  |      | (175    | )  |  |   | (24     | ) 
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |    |  |      |         |    |  |   |         |   
|Recoveries of loans previously charged off:                    |  |                                       |         |   |      |   |         |      |  |   |         |    |  |      |         |    |  |   |         |   
|Real estate loans                                              |  |                                       | 230     |   |      |   | 9       |      |  |   |        |    |  |      |        |    |  |   |        |   
|Commercial and industrial loans                                |  |                                       | 2       |   |      |   | 22      |      |  |   | 50      |    |  |      |        |    |  |   |        |   
|Installment loans                                              |  |                                       | 8       |   |      |   | 9       |      |  |   | 1       |    |  |      |        |    |  |   |        |   
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |    |  |      |         |    |  |   |         |   
|Total recoveries                                               |  |                                       | 240     |   |      |   | 40      |      |  |   | 51      |    |  |      |        |    |  |   |        |   
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |    |  |      |         |    |  |   |         |   
|Net recoveries/(charge-offs)                                   |  |                                       | 235     |   |      |   | (166    | )    |  |   | (227    | )  |  |      | (175    | )  |  |   | (24     | ) 
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |    |  |      |         |    |  |   |         |   
|Allowance for loan losses at end of year                       |  | $                                     | 3,983   |   |      | $ | 3,679   |      |  | $ | 3,053   |    |  | $    | 2,360   |    |  | $ | 1,845   |   
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |    |  |      |         |    |  |   |         |   
|Ratios:                                                        |  |                                       |         |   |      |   |         |      |  |   |         |    |  |      |         |    |  |   |         |   
|Nonperforming loans to period-end loans                        |  |                                       | 0.11    | % |      |   | 0.00    | %    |  |   | 0.11    | %  |  |      | 0.55    | %  |  |   | 0.09    | % 
|Allowance for loan losses as a percent of loans at end of year |  |                                       | 1.15    | % |      |   | 1.25    | %    |  |   | 1.25    | %  |  |      | 1.30    | %  |  |   | 1.55    | % 
|Net recoveries/(charge-offs) as a percent of average loans     |  |                                       | 0.07    | % |      |   | (0.06   | %)   |  |   | (0.11   | %) |  |      | (0.12   | %) |  |   | (0.02   | %)



22



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##### Table of Contents

Deposits

Our deposits are the primary source of our funds for loans. Our deposit strategy is to raise our deposits in our market area through relationship banking. We believe that the great majority of our deposits are from individuals and entities
located in our market area.

The table below presents information on our deposits for the years presented.



|                                |  |                                 |         |             |      |   |               |      |             |  |      |               |  |             |         |  |      |  
|------------------------------- |  | ------------------------------- | ------- | ----------- | ---- | - | ------------- | ---- | ----------- |  | ---- | ------------- |  | ----------- | ------- |  | ---- | -
|                                |  | For the Year Ended December 31, |        
|                                |  | 2006                            |         |             | 2005 |   |               | 2004 |            
|                                |  | AverageAmount                   |         | AverageRate |      |   | AverageAmount |      | AverageRate |  |      | AverageAmount |  | AverageRate |        
|                                |  | (Dollars in thousands)          |        
|Savings, NOW and money market   |  | $                               | 143,123 |             | 3.64 | % |               | $    | 123,705     |  | 2.25 | %             |  | $           | 98,714  |  | 1.55 | %
|Time deposits over $ 100,000    |  |                                 | 56,916  |             | 4.70 | % |               |      | 37,252      |  | 3.77 | %             |  |             | 28,651  |  | 2.96 | %
|Other time deposits             |  |                                 | 62,476  |             | 4.23 | % |               |      | 57,505      |  | 3.02 | %             |  |             | 45,573  |  | 2.59 | %
|                                |  |                                 |         |             |      |   |               |      |             |  |      |               |  |             |         |  |      |  
|Total interest-bearing deposits |  |                                 | 262,515 |             | 4.01 | % |               |      | 218,462     |  | 2.71 | %             |  |             | 172,938 |  | 2.06 | %
|                                |  |                                 |         |             |      |  
|Non-interest-bearing deposits   |  |                                 | 86,555  |             |     |   |               |      | 75,103      |  |     |               |  |             | 57,327  |  |     |  
|                                |  |                                 |         |             |      |   |               |      |             |  |      |               |  |             |         |  |      |  
|Total deposits                  |  | $                               | 349,070 |             | 3.02 | % |               | $    | 293,565     |  | 2.02 | %             |  | $           | 230,265 |  | 1.55 | %
|                                |  |                                 |         |             |      |   |               |      |             |  |      |               |  |             |         |  |      |  

The following table presents the amounts and maturities of deposits with balances of $100,000 or
more:



|                       |  |                      |       
|---------------------- |  | -------------------- | ------
|                       |  | At December 31, 2006
|                       |  | (In thousands)      
|Remaining maturity:    |  |                      |       
|Less than three months |  | $                    | 16,115
|Three to six months    |  |                      | 17,891
|Six to twelve months   |  |                      | 14,425
|Over twelve months     |  |                      | 24,797
|                       |  |                      |       
|Total                  |  | $                    | 73,228
|                       |  |                      |       

Borrowings

The following table sets forth certain information regarding our short-term borrowings for the periods indicated.



|                                                              |  |                                 |        |   |      |   |        |      |  |   |        |  
|------------------------------------------------------------- |  | ------------------------------- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                              |  | For the Year Ended December 31, |       
|                                                              |  | 2006                            |        |   | 2005 |   |        | 2004 | 
|                                                              |  | (Dollars in thousands)          |       
|Short-term borrowings:                                        |  |                                 |        |   |      |   |        |      |  |   |        |  
|Repurchase agreements and federal funds purchased             |  |                                 |        |   |      |   |        |      |  |   |        |  
|Balance outstanding at end of period                          |  | $                               | 10,670 |   |      | $ | 10,006 |      |  | $ | 14,273 |  
|Maximum amount outstanding at any month end during the period |  |                                 | 11,031 |   |      |   | 12,299 |      |  |   | 16,184 |  
|Average balance outstanding                                   |  |                                 | 10,784 |   |      |   | 10,003 |      |  |   | 15,699 |  
|Weighted-average interest rate during the period              |  |                                 | 2.54   | % |      |   | 2.28   | %    |  |   | 1.96   | %
|Weighted-average interest rate at end of period               |  |                                 | 2.05   | % |      |   | 2.34   | %    |  |   | 1.66   | %



23



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##### Table of Contents

Investments

Our investment portfolio primarily consists of U.S. Treasury and U.S. Government agency securities, including mortgage-backed securities, or MBSs. The MBSs consist of fixed rate mortgage securities underwritten and guaranteed by Ginnie Mae
(GNMA), Freddie Mac (FHLMC) and Fannie Mae (FNMA). All of the securities held in our investment portfolio are available for sale. In addition to economic and market conditions, our overall management strategy for our investment portfolio is
determined by, among other factors, loan demand, deposit mix, liquidity and collateral needs, our interest rate risk position and the overall structure of our balance sheet.

The tables below present information on our investment portfolio at the dates indicated.



|                                                                          |  |                        |        |                        |   |                         |  |           |     |  |   |       
|------------------------------------------------------------------------- |  | ---------------------- | ------ | ---------------------- | - | ----------------------- |  | --------- | --- |  | - | ------
|                                                                          |  | At December 31, 2006  
|                                                                          |  | Amortized cost         |        | Gross unrealized gains |   | Gross Unrealized losses |  | Fairvalue
|                                                                          |  | (Dollars in thousands)
|Securities available for sale:                                            |  |                        |        |                        |   |                         |  |           |     |  |   |       
|U. S. government securities and obligations of U.S. governmental agencies |  | $                      | 11,991 |                        | $ | 9                       |  | $         | 57  |  | $ | 11,943
|State and municipal securities                                            |  |                        | 6,110  |                        |   |                        |  |           | 34  |  |   | 6,076 
|Mortgage-backed securities                                                |  |                        | 24,240 |                        |   | 11                      |  |           | 338 |  |   | 23,913
|                                                                          |  |                        |        |                        |   |                         |  |           |     |  |   |       
|Total securities available for sale                                       |  | $                      | 42,341 |                        | $ | 20                      |  | $         | 429 |  | $ | 41,932
|                                                                          |  |                        |        |                        |   |                         |  |           |     |  |   |       
|                                                                          | 
|                                                                          |  | At December 31, 2005  
|                                                                          |  | Amortizedcost          |        | Grossunrealizedgains   |   | Grossunrealizedlosses   |  | Fairvalue
|                                                                          |  | (Dollars in thousands)
|Securities available for sale:                                            |  |                        |        |                        |   |                         |  |           |     |  |   |       
|U. S. government securities and obligations of U.S. governmental agencies |  | $                      | 13,990 |                        | $ |                        |  | $         | 145 |  | $ | 13,845
|State and municipal securities                                            |  |                        | 6,231  |                        |   |                        |  |           | 72  |  |   | 6,159 
|Mortgage-backed securities                                                |  |                        | 22,169 |                        |   | 9                       |  |           | 480 |  |   | 21,698
|                                                                          |  |                        |        |                        |   |                         |  |           |     |  |   |       
|Total securities available for sale                                       |  | $                      | 42,390 |                        | $ | 9                       |  | $         | 697 |  | $ | 41,702
|                                                                          |  |                        |        |                        |   |                         |  |           |     |  |   |       
|                                                                          | 
|                                                                          |  | At December 31, 2004  
|                                                                          |  | Amortizedcost          |        | Grossunrealizedgains   |   | Grossunrealizedlosses   |  | Fairvalue
|                                                                          |  | (Dollars in thousands)
|Securities available for sale:                                            |  |                        |        |                        |   |                         |  |           |     |  |   |       
|U. S. government securities and obligations of U.S. governmental agencies |  | $                      | 11,955 |                        | $ | 2                       |  | $         | 95  |  | $ | 11,862
|State and municipal securities                                            |  |                        | 2,472  |                        |   | 2                       |  |           |    |  |   | 2,474 
|Mortgage-backed securities                                                |  |                        | 21,259 |                        |   | 32                      |  |           | 256 |  |   | 21,035
|                                                                          |  |                        |        |                        |   |                         |  |           |     |  |   |       
|Total securities available for sale                                       |  | $                      | 35,686 |                        | $ | 36                      |  | $         | 351 |  | $ | 35,371
|                                                                          |  |                        |        |                        |   |                         |  |           |     |  |   |       



24



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##### Table of Contents

The amortized cost and fair values of securities available for sale at December 31, 2006 by
contractual maturity and the weighted average yield by maturity of our securities available for sale at December 31, 2006 amortized cost 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.



|                                     |  |                        |        |            |   |                        |  |      |  
|------------------------------------ |  | ---------------------- | ------ | ---------- | - | ---------------------- |  | ---- | -
|                                     |  | Amortized Cost         |        | Fair Value |   | Weighted Average Yield | 
|                                     |  | (Dollars in thousands) |       
|Securities available for sale:       |  |                        |        |            |   |                        |  |      |  
|                                     |  |                        |       
|U. S. Government agencies            |  |                        |        |            |   |                        |  |      |  
|Due within one year                  |  | $                      | 7,976  |            | $ | 7,939                  |  | 4.18 | %
|Due after one but within five years  |  |                        | 4,015  |            |   | 4,004                  |  | 4.91 | %
|Due after five but within ten years  |  |                        |       |            |   |                       |  |     |  
|                                     |  |                        |        |            |   |                        |  |      |  
|                                     |  |                        | 11,991 |            |   | 11,943                 |  | 4.43 | %
|                                     |  |                        |        |            |   |                        |  |      |  
|State and local governments          |  |                        |        |            |   |                        |  |      |  
|Due within one year                  |  |                        | 100    |            |   | 100                    |  | 4.25 | %
|Due after one but within five years  |  |                        | 1,017  |            |   | 999                    |  | 4.32 | %
|Due after five but within ten years  |  |                        |       |            |   |                       |  |     |  
|Due after ten years                  |  |                        | 4,993  |            |   | 4,977                  |  | 5.39 | %
|                                     |  |                        |        |            |   |                        |  |      |  
|                                     |  |                        | 6,110  |            |   | 6,076                  |  | 5.19 | %
|                                     |  |                        |        |            |   |                        |  |      |  
|Mortgage-backed securities           |  |                        |        |            |   |                        |  |      |  
|Due within one year                  |  |                        | 209    |            |   | 208                    |  | 4.50 | %
|Due after one but within five years  |  |                        | 1,171  |            |   | 1,163                  |  | 4.93 | %
|Due after five but within ten years  |  |                        | 2,297  |            |   | 2,245                  |  | 3.90 | %
|Due after ten years                  |  |                        | 20,563 |            |   | 20,297                 |  | 4.40 | %
|                                     |  |                        |        |            |   |                        |  |      |  
|                                     |  |                        | 24,240 |            |   | 23,913                 |  | 4.38 | %
|                                     |  |                        |        |            |   |                        |  |      |  
|Total securities available for sale: |  |                        |        |            |   |                        |  |      |  
|Due within one year                  |  |                        | 8,285  |            |   | 8,247                  |  | 4.19 | %
|Due after one but within five years  |  |                        | 6,203  |            |   | 6,166                  |  | 4.82 | %
|Due after five but within ten years  |  |                        | 2,297  |            |   | 2,245                  |  | 3.90 | %
|Due after ten years                  |  |                        | 25,556 |            |   | 25,274                 |  | 4.60 | %
|                                     |  |                        |        |            |   |                        |  |      |  
|                                     |  | $                      | 42,341 |            | $ | 41,932                 |  | 4.51 | %
|                                     |  |                        |        |            |   |                        |  |      |  



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##### Table of Contents

Contractual Obligations and Commitments

In the normal course of business, we have various outstanding contractual obligations that will require future cash outflows, as well as commitments and
contingent liabilities, such as commitments to extend credit, that may or may not require future cash outflows. To meet the financing needs of our customers, we issue various financial instruments, such as lines of credit, loan commitments and
standby letters of credit. These instruments either are not recorded on our balance sheet or are recorded on our balance sheet in amounts that differ from the full contract or notional amounts. These instruments involve varying elements of market,
credit and liquidity risk. The following table reflects our expected contractual obligations and future operating lease commitments as of December 31, 2006.



|                                   |  |                        |         |                            |   |             |  |             |        |              |   |       |  |   |      
|---------------------------------- |  | ---------------------- | ------- | -------------------------- | - | ----------- |  | ----------- | ------ | ------------ | - | ----- |  | - | -----
|                                   |  | Payments Due by Period
|Contractual Obligations            |  | Total                  |         | On Demand or Within 1 Year |   | 2 - 3 Years |  | 4 - 5 Years |        | After5 Years
|                                   |  | (Dollars in thousands)
|Short-term borrowings              |  | $                      | 10,670  |                            | $ | 10,670      |  | $           |       |              | $ |      |  | $ |     
|Long-term debt                     |  |                        | 11,196  |                            |   |            |  |             | 5,155  |              |   | 5,155 |  |   | 886  
|Operating lease obligations        |  |                        | 3,718   |                            |   | 642         |  |             | 928    |              |   | 914   |  |   | 1,234
|Deposits                           |  |                        | 142,450 |                            |   | 103,649     |  |             | 36,337 |              |   | 2,464 |  |   |     
|                                   |  |                        |         |                            |   |             |  |             |        |              |   |       |  |   |      
|Total contractual cash obligations |  | $                      | 168,034 |                            | $ | 114,961     |  | $           | 42,420 |              | $ | 8,533 |  | $ | 2,120
|                                   |  |                        |         |                            |   |             |  |             |        |              |   |       |  |   |      

The following table reflects our other commitments outstanding as of December 31, 2006.



|                                                      |  |                                            |        |              |   |             |  |             |       |              |   |       |  |   |      
|----------------------------------------------------- |  | ------------------------------------------ | ------ | ------------ | - | ----------- |  | ----------- | ----- | ------------ | - | ----- |  | - | -----
|                                                      |  | Amount of Commitment Expiration Per Period
|Contractual Obligations                               |  | TotalAmountsCommitted                      |        | Within1 Year |   | 2 - 3 Years |  | 4 - 5 Years |       | After5 Years
|                                                      |  | (Dollars in thousands)                    
|Lines of credit and loan commitments and credit lines |  | $                                          | 61,742 |              | $ | 43,117      |  | $           | 5,010 |              | $ | 6,307 |  | $ | 7,308
|Standby letters of credit                             |  |                                            | 1,785  |              |   | 1,741       |  |             | 44    |              |   |      |  |   |     
|                                                      |  |                                            |        |              |   |             |  |             |       |              |   |       |  |   |      
|Total commercial commitments                          |  | $                                          | 63,527 |              | $ | 44,858      |  | $           | 5,054 |              | $ | 6,307 |  | $ | 7,308
|                                                      |  |                                            |        |              |   |             |  |             |       |              |   |       |  |   |      

Off-Balance Sheet Arrangements

As part of our ongoing business, we do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships,
such as entities often referred to as special purpose entities, or SPEs, which generally are established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of December 31, 2006,
our sole SPE activity is with North State Statutory Trust I (Trust I) and North State Statutory Trust II (Trust II). We issued $5.2 million of junior subordinated debentures, included in long-term debt on the balance sheet,
to Trust I and Trust II on March 17, 2004 and December 15, 2005, respectively, in exchange for the proceeds of trust preferred securities issued by Trust I and Trust II.

Recent Accounting Pronouncements

See Note B to our consolidated financial statements for a
discussion of recent accounting pronouncements and managements assessment of the potential impact on our consolidated financial statements.

Critical Accounting Policy

Our most significant critical accounting policy is the determination of our allowance for loan
losses. A critical accounting policy is one that is both very important to the portrayal of our financial condition and results, and requires our most difficult, subjective or complex judgments. What makes these judgments difficult, subjective
and/or complex is the need to make estimates about the effects of matters that are inherently uncertain. If the mix and amount of future write-offs differ significantly from those assumptions we use in making our determination, the allowance for
loan losses and provision for loan losses on our income statement could be materially affected. For further discussion of the allowance for loan losses and a detailed description of the methodology we use in determining the adequacy of the
allowance, see the section of this discussion titled Asset Quality and the Allowance for Loan



26



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##### Table of Contents

Losses and Note E to our consolidated financial statements contained in this report.



|Item 7. | Financial Statements and Supplementary Data.
|------- | --------------------------------------------

The information required by this Item is found beginning at page F-1 of this report.



|Item 8. | Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
|------- | -------------------------------------------------------------------------------------

Not applicable.



|Item 8A. | 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 Exchange Act Rule 13a-15. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective.

(b) There has been no change during the last fiscal quarter in our internal controls over financial reporting that has materially affected, or is
reasonably likely to materially affect, our internal controls over financial reporting.



|Item 8B. | Other Information.
|-------- | ------------------

Not applicable.

PART III



|Item 9. | Directors and Executive Officers of the Registrant; Compliance with Section 16(a) of the Exchange Act.
|------- | ------------------------------------------------------------------------------------------------------

The information required by this Item concerning our directors and executive officers is incorporated by reference from the sections captioned
Proposal No. 1 - Election of Directors, Other Information  Other Directors and Executive Officers contained in our proxy statement related to the 2007 Annual Meeting of Shareholders scheduled to be held
on May 3, 2007. The information required by this Item concerning compliance with Section 16(a) of the United States Securities Exchange Act of 1934, as amended, is incorporated by reference from the section of our proxy statement captioned
Section 16(a) Beneficial Ownership Reporting Compliance.

Our Board of Directors has determined that the members of the Audit
Committee are independent as defined in Rule 4200(a)(15) of the Nasdaq listing standards. Our Board of Directors also has determined that Mr. Jack M. Stancil is an audit committee financial expert as defined in Item 401(h)
of Regulation S-B.

Our Board of Directors has adopted a code of ethics for our Chief Executive Officer, Chief Financial Officer and any
other senior accounting officer or other persons performing similar functions. We will provide copies of our code of ethics without charge upon request. To obtain a copy of our code of ethics, please send your written request to North State Bancorp,
4270 The Circle at North Hills, Raleigh, North Carolina 27609, Attention: Stacey Koble.

Since the date of our proxy statement for our 2006
Annual Meeting of Shareholders, we have not made any material change to the procedures by which our shareholders may recommend nominees to our Board of Directors. Those procedures are discussed under the section captioned Director
Nominations in our proxy statement for the 2007 Annual Meeting of Shareholders.



|Item 10. | Executive Compensation.
|-------- | -----------------------

The
information required by this Item is incorporated by reference to the information under the sections captioned Executive Compensation, Employment Agreements and Director Compensation contained in our proxy
statement.



|Item 11. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
|-------- | -----------------------------------------------------------------------------------------------

The information required by this Item is incorporated by reference to the information under the section captioned Security Ownership of Management
and Certain Beneficial Owners contained in our proxy statement and in Part II, Item 5 of this report.



|Item 12. | Certain Relationships and Related Transactions.
|-------- | -----------------------------------------------

The information required by this Item is incorporated by reference to the information under the section captioned Certain Transactions
contained in our proxy statement.



27



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##### Table of Contents

|Item 13. | Exhibits.
|-------- | ---------



|(A) | Exhibits
|--- | --------



|            |  |                                                                                                                                                                                                                                                                                   
|----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Exhibit Title                                                                                                                                                                                                                                                                     
|3.1 (a)     |  | Articles of Incorporation filed on June 5, 2002                                                                                                                                                                                                                                   
|            | 
|3.2 (a)     |  | Bylaws adopted June 7, 2002                                                                                                                                                                                                                                                       
|            | 
|4.1 (a)     |  | Form of North State Bancorp stock certificate                                                                                                                                                                                                                                     
|            | 
|4.2 (f)     |  | Amended and Restated Declaration of Trust by and among U.S. Bank National Association, as Institutional Trustee, North State Bancorp, as Sponsor, and Larry D. Barbour and Kirk A. Whorf as
administrators, dated as of March 17, 2004                                            
|            | 
|4.3 (f)     |  | Indenture dated as of March 17, 2004, between North State Bancorp, as Issuer and U.S. Bank National Association, as Trustee                                                                                                                                                       
|            | 
|4.4 (b)     |  | Amended and Restated Declaration of Trust by and among Wilmington Trust Company, as Delaware Trustee, Wilmington Trust Company, as Institutional Trustee, North State Bancorp, as Sponsor, and
Larry D. Barbour and Kirk A. Whorf as administrators, dated as of December 15, 2005
|            | 
|4.5 (b)     |  | Indenture dated as of December 15, 2005, between North State Bancorp, as Issuer and Wilmington Trust Company, as Trustee                                                                                                                                                          
|            | 
|10.1 (c)    |  | Stock Option Plan for Non-Employee Directors, assumed as of June 28, 2002                                                                                                                                                                                                         
|            | 
|10.2 (c)    |  | Stock Option Plan for Employees, assumed as of June 28, 2002                                                                                                                                                                                                                      
|            | 
|10.3 (d)    |  | Employment Agreement between North State Bank and Larry D. Barbour, dated as of June 1, 2000                                                                                                                                                                                      
|            | 
|10.4 (d)    |  | Change in Control Agreement between North State Bank and Kirk A. Whorf, dated as of June 1, 2000, as amended on October 29, 2002                                                                                                                                                  
|            | 
|10.5 (d)    |  | Change in Control Agreement between North State Bank and Judy M. Stephenson, dated as of June 1, 2000                                                                                                                                                                             
|            | 
|10.6 (d)    |  | Change in Control Agreement between North State Bank and Sandra A. Temple, dated as of June 1, 2000, as amended on October 24, 2002                                                                                                                                               
|            | 
|10.7 (e)    |  | 2003 Stock Plan                                                                                                                                                                                                                                                                   
|            | 
|10.8 (f)    |  | Guarantee Agreement dated as of March 17, 2004, by and between North State Bancorp and U.S. Bank National Association                                                                                                                                                             
|            | 
|10.9 (b)    |  | Guarantee Agreement dated as of December 15, 2005, by and between North State Bancorp and Wilmington Trust Company                                                                                                                                                                
|            | 
|10.11(g)    |  | Lease dated May 1, 2003 between North State Bancorp and NHM00, LLC.                                                                                                                                                                                                               
|            | 
|10.12(g)    |  | Assignment and Assumption of Lease effective January 14, 2000 among North State Bank, Oberlin Investors Two, LLC and Branch Banking & Trust Company.                                                                                                                              
|            | 
|10.13(g)    |  | Office Lease dated April 10, 2000 between North State Bank and Oberlin Investors Two, LLC (including Amendment No. One dated March 29, 2001).                                                                                                                                     
|            | 
|10.14       |  | Lease agreement dated as of December 29, 2006 by and between North State Bank and Atrium Investments, LLC                                                                                                                                                                         



28



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##### Table of Contents

|         |  |                                                                                                                       
|-------- |  | ----------------------------------------------------------------------------------------------------------------------
|10.15    |  | Lease agreement dated as of November 1, 2006 between North State Bancorp and Capital Club Properties, LLC             
|         | 
|21.1 (f) |  | List of Subsidiaries                                                                                                  
|         | 
|23       |  | Consent of Dixon Hughes PLLC                                                                                          
|         | 
|31.1     |  | Certification pursuant to Rule 13a-14(a)                                                                              
|         | 
|31.2     |  | Certification pursuant to Rule 13a-14(a)                                                                              
|         | 
|32.1     |  | Certifications pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

---

|(a) | Incorporated by reference to exhibits filed with our Current Report of Form 8-K filed pursuant to Rule 12g-3 on July 1, 2002.
|--- | -----------------------------------------------------------------------------------------------------------------------------

|(b) | Incorporated by reference to exhibits filed with our Current Report on Form 8-K filed on December 20, 2005.
|--- | -----------------------------------------------------------------------------------------------------------

|(c) | Incorporated by reference to exhibits filed with our Registration Statement on Form S-8 filed on July 31, 2002 (Registration Statement No. 333-97419).
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------

|(d) | Incorporated by reference to exhibits filed with our Annual Report on Form 10-KSB for the year ended December 31, 2002.
|--- | -----------------------------------------------------------------------------------------------------------------------

|(e) | Incorporated by reference to exhibits filed with our Registration Statement on Form S-8 filed on July 25, 2003 (Registration Statement No. 333-107337).
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------

|(f) | Incorporated by reference to exhibits filed with our Annual Report on Form 10-KSB for the year ended December 31, 2005.
|--- | -----------------------------------------------------------------------------------------------------------------------

|(g) | Incorporated by reference to exhibits filed with our Quarterly Report on Form 10-QSB for the quarter ended March 31, 2005.
|--- | --------------------------------------------------------------------------------------------------------------------------



|Item 14. | Principal Accountant Fees and Services.
|-------- | ---------------------------------------

The information required by this Item is incorporated by reference to the information under the section captioned Report of the Audit Committee contained in our proxy statement.



29



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##### Table of Contents

ITEM 7  FINANCIAL STATEMENTS

NORTH STATE BANCORP & SUBSIDIARY

INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS



|                                                                                                          |  |         
|--------------------------------------------------------------------------------------------------------- |  | --------
|                                                                                                          |  | Page No.
|Report of Independent Registered Public Accounting Firm                                                   |  | F-2     
|                                                                                                          | 
|Consolidated Balance Sheets as of December 31, 2006 and 2005                                              |  | F-3     
|                                                                                                          | 
|Consolidated Statements of Operations for the years ended December 31, 2006 and 2005                      |  | F-4     
|                                                                                                          | 
|Consolidated Statements of Changes in Shareholders Equity for the years ended December 31, 2006 and 2005 |  | F-5     
|                                                                                                          | 
|Consolidated Statements of Cash Flows for the years ended December 31, 2006 and 2005                      |  | F-6     
|                                                                                                          | 
|Notes to Consolidated Financial Statements                                                                |  | F-7     



F-1



---

##### Table of Contents

LOGO

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders and the Board of Directors

North State Bancorp

Raleigh, North Carolina

We have audited the accompanying consolidated balance sheets of North State Bancorp and subsidiary as of December 31, 2006 and 2005, and the related consolidated
statements of operations, changes in shareholders equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of North State
Bancorp and subsidiary at December 31, 2006 and 2005 and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.

LOGO

Raleigh, North Carolina

March 28, 2007



F-2



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##### Table of Contents

NORTH STATE BANCORP

CONSOLIDATED BALANCE SHEETS

December 31, 2006 and 2005



|                                                                                                                                                     |  |                                                        |         |   |      |   |         |  
|---------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------------------------ | ------- | - | ---- | - | ------- | -
|                                                                                                                                                     |  | 2006                                                   |         |   | 2005 |  
|                                                                                                                                                     |  | (Amounts in thousands,except share and per share data) |        
|ASSETS                                                                                                                                               |  |                                                        |         |  
|Cash and due from banks                                                                                                                              |  | $                                                      | 12,189  |   |      | $ | 5,991   |  
|Interest-earning deposits with banks                                                                                                                 |  |                                                        | 1,249   |   |      |   | 4,523   |  
|Federal funds sold                                                                                                                                   |  |                                                        | 44,059  |   |      |   | 30,206  |  
|Investment securities available for sale, at fair value (Note C)                                                                                     |  |                                                        | 41,932  |   |      |   | 41,702  |  
|                                                                                                                                                     |  |                                                       
|Loans (Note D)                                                                                                                                       |  |                                                        | 345,943 |   |      |   | 294,175 |  
|Less allowances for loan losses (Note E)                                                                                                             |  |                                                        | 3,983   |   |      |   | 3,679   |  
|                                                                                                                                                     |  |                                                        |         |   |      |   |         |  
|NET LOANS                                                                                                                                            |  |                                                        | 341,960 |   |      |   | 290,496 |  
|                                                                                                                                                     |  |                                                       
|Accrued interest receivable                                                                                                                          |  |                                                        | 1,754   |   |      |   | 1,286   |  
|Stock in the Federal Home Loan Bank of Atlanta, at cost                                                                                              |  |                                                        | 939     |   |      |   | 644     |  
|Premises and equipment (Note F)                                                                                                                      |  |                                                        | 7,810   |   |      |   | 5,858   |  
|Other assets (Note I)                                                                                                                                |  |                                                        | 3,585   |   |      |   | 2,027   |  
|                                                                                                                                                     |  |                                                        |         |   |      |   |         |  
|TOTAL ASSETS                                                                                                                                         |  | $                                                      | 455,477 |   |      | $ | 382,733 |  
|                                                                                                                                                     |  |                                                        |         |   |      |   |         |  
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                 |  |                                                        |         |   |      |   |         |  
|                                                                                                                                                     |  |                                                       
|Deposits:                                                                                                                                            |  |                                                        |         |   |      |   |         |  
|Demand                                                                                                                                               |  | $                                                      | 105,228 |   |      | $ | 86,856  |  
|Savings, money market and NOW                                                                                                                        |  |                                                        | 154,400 |   |      |   | 139,022 |  
|Time (Note G)                                                                                                                                        |  |                                                        | 142,450 |   |      |   | 111,493 |  
|                                                                                                                                                     |  |                                                        |         |   |      |   |         |  
|TOTAL DEPOSITS                                                                                                                                       |  |                                                        | 402,078 |   |      |   | 337,371 |  
|                                                                                                                                                     |  |                                                       
|Accrued interest payable                                                                                                                             |  |                                                        | 2,297   |   |      |   | 1,394   |  
|Short-term borrowings (Note H)                                                                                                                       |  |                                                        | 10,670  |   |      |   | 10,006  |  
|Long-term debt (Note H)                                                                                                                              |  |                                                        | 11,196  |   |      |   | 11,215  |  
|Accrued expenses and other liabilities (Note N)                                                                                                      |  |                                                        | 2,639   |   |      |   | 1,607   |  
|                                                                                                                                                     |  |                                                        |         |   |      |   |         |  
|TOTAL LIABILITIES                                                                                                                                    |  |                                                        | 428,880 |   |      |   | 361,593 |  
|                                                                                                                                                     |  |                                                        |         |   |      |   |         |  
|Commitments (Notes H and L)                                                                                                                          |  |                                                        |         |   |      |   |         |  
|                                                                                                                                                     |  |                                                       
|Shareholders equity (Notes K and N):                                                                                                                |  |                                                        |         |   |      |   |         |  
|Preferred stock, no par value, 1,000,000 shares authorized, none issued                                                                              |  |                                                        |        |   |      |   |        |  
|Common stock, $1 par value, 10,000,000 shares authorized; 4,542,061 and 2,842,159 issued and outstanding at December 31, 2006 and 2005,
respectively |  |                                                        | 4,542   |   |      |   | 2,842   |  
|Additional paid-in capital                                                                                                                           |  |                                                        | 14,002  |   |      |   | 13,652  |  
|Accumulated earnings                                                                                                                                 |  |                                                        | 8,344   |   |      |   | 5,072   |  
|Accumulated other comprehensive loss                                                                                                                 |  |                                                        | (291    | ) |      |   | (426    | )
|                                                                                                                                                     |  |                                                        |         |   |      |   |         |  
|TOTAL SHAREHOLDERS EQUITY                                                                                                                           |  |                                                        | 26,597  |   |      |   | 21,140  |  
|                                                                                                                                                     |  |                                                        |         |   |      |   |         |  
|TOTAL LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                           |  | $                                                      | 455,477 |   |      | $ | 382,733 |  
|                                                                                                                                                     |  |                                                        |         |   |      |   |         |  

See accompanying notes.



F-3



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##### Table of Contents

NORTH STATE BANCORP

CONSOLIDATED STATEMENTS OF OPERATIONS

Years Ended December 31, 2006 and 2005



|                                                    |  |                                                        |           |      |   |          
|--------------------------------------------------- |  | ------------------------------------------------------ | --------- | ---- | - | ---------
|                                                    |  | 2006                                                   |           | 2005
|                                                    |  | (Amounts in thousands, exceptshare and per share data)
|INTEREST INCOME                                     |  |                                                        |           |      |   |          
|Loans                                               |  | $                                                      | 23,426    |      | $ | 16,911   
|Investment securities:                              |  |                                                        |           |      |   |          
|Taxable                                             |  |                                                        | 1,474     |      |   | 1,078    
|Tax-exempt                                          |  |                                                        | 265       |      |   | 110      
|Federal funds sold                                  |  |                                                        | 1,031     |      |   | 643      
|Dividends and interest earning deposits             |  |                                                        | 216       |      |   | 39       
|                                                    |  |                                                        |           |      |   |          
|TOTAL INTEREST INCOME                               |  |                                                        | 26,412    |      |   | 18,781   
|                                                    |  |                                                        |           |      |   |          
|INTEREST EXPENSE                                    |  |                                                        |           |      |   |          
|Money market, NOW and savings deposits              |  |                                                        | 5,210     |      |   | 2,786    
|Time deposits                                       |  |                                                        | 5,322     |      |   | 3,141    
|Short-term borrowings                               |  |                                                        | 274       |      |   | 229      
|Long-term debt                                      |  |                                                        | 781       |      |   | 341      
|                                                    |  |                                                        |           |      |   |          
|TOTAL INTEREST EXPENSE                              |  |                                                        | 11,587    |      |   | 6,497    
|                                                    |  |                                                        |           |      |   |          
|NET INTEREST INCOME                                 |  |                                                        | 14,825    |      |   | 12,284   
|                                                    |  |                                                       
|PROVISION FOR LOAN LOSSES (Note E)                  |  |                                                        | 69        |      |   | 792      
|                                                    |  |                                                        |           |      |   |          
|NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES |  |                                                        | 14,756    |      |   | 11,492   
|                                                    |  |                                                        |           |      |   |          
|NON-INTEREST INCOME (Note J)                        |  |                                                        | 1,174     |      |   | 1,310    
|                                                    |  |                                                        |           |      |   |          
|                                                    |  |                                                       
|NON-INTEREST EXPENSE                                |  |                                                        |           |      |   |          
|Salaries and employee benefits (Note N)             |  |                                                        | 5,539     |      |   | 4,602    
|Occupancy and equipment (Note F)                    |  |                                                        | 1,672     |      |   | 1,370    
|Other (Note J)                                      |  |                                                        | 3,532     |      |   | 2,929    
|                                                    |  |                                                        |           |      |   |          
|TOTAL NON-INTEREST EXPENSE                          |  |                                                        | 10,743    |      |   | 8,901    
|                                                    |  |                                                        |           |      |   |          
|INCOME BEFORE INCOME TAXES                          |  |                                                        | 5,187     |      |   | 3,901    
|                                                    |  |                                                       
|INCOME TAXES (Note I)                               |  |                                                        | 1,915     |      |   | 1,463    
|                                                    |  |                                                        |           |      |   |          
|NET INCOME                                          |  | $                                                      | 3,272     |      | $ | 2,438    
|                                                    |  |                                                        |           |      |   |          
|NET INCOME PER COMMON SHARE                         |  |                                                        |           |      |   |          
|Basic                                               |  | $                                                      | .74       |      | $ | .57      
|                                                    |  |                                                        |           |      |   |          
|Diluted                                             |  | $                                                      | .69       |      | $ | .53      
|                                                    |  |                                                        |           |      |   |          
|WEIGHTED AVERAGE SHARES OUTSTANDING                 |  |                                                        |           |      |   |          
|Basic                                               |  |                                                        | 4,411,485 |      |   | 4,261,418
|                                                    |  |                                                        |           |      |   |          
|Diluted                                             |  |                                                        | 4,774,747 |      |   | 4,629,446
|                                                    |  |                                                        |           |      |   |          

See accompanying notes.



F-4



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##### Table of Contents

NORTH STATE BANCORP

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY

Years Ended December 31, 2006 and 2005



|                                                                 |        |                                           |                      |   |       |  |                                               |                            |   |  |   |       |  |   |      |   |  |   |        |  
|---------------------------------------------------------------- | ------ | ----------------------------------------- | -------------------- | - | ----- |  | --------------------------------------------- | -------------------------- | - |  | - | ----- |  | - | ---- | - |  | - | ------ | -
|                                                                 |        | Common stock                              |                      |   |       |  |                                               |                            |   |  |   |       | 
|                                                                 |        |                                           |                      |   |       |  | Accumulated other comprehensive income (loss) |                            |   |  |  
|                                                                 |        | Additional paid-in capital                |                      |   |       |  |                                               | Total shareholders equity |  
|                                                                 |        |                                           | Accumulated earnings |   |      
|                                                                 | Shares |                                           | Amount               |   |       |  |                                              
|                                                                 |        | (Amounts in thousands, except share data) |                     
|Balance at December 31, 2004                                     |        | 2,366,041                                 |                      | $ | 2,366 |  | $                                             | 14,110                     |   |  | $ | 2,634 |  | $ | (196 | ) |  | $ | 18,914 |  
|Comprehensive income:                                            |        |                                           |                      |   |       |  |                                               |                            |   |  |   |       |  |   |      |   |  |   |        |  
|Net income                                                       |        |                                          |                      |   |      |  |                                               |                           |   |  |   | 2,438 |  |   |     |   |  |   | 2,438  |  
|Other comprehensive loss, net of tax                             |        |                                          |                      |   |      |  |                                               |                           |   |  |   |      |  |   | (230 | ) |  |   | (230   | )
|                                                                 |        |                                           |                      |   |       |  |                                               |                            |   |  |   |       |  |   |      |   |  |   |        |  
|Total comprehensive income                                       |        |                                           |                      |   |       |  |                                               |                            |   |  |   |       |  |   |      |   |  |   | 2,208  |  
|6-for-5 stock split effected in the form of a 20% stock dividend |        | 473,980                                   |                      |   | 474   |  |                                               | (474                       | ) |  |   |      |  |   |     |   |  |   |       |  
|Stock options exercised                                          |        | 2,138                                     |                      |   | 2     |  |                                               | 16                         |   |  |   |      |  |   |     |   |  |   | 18     |  
|                                                                 |        |                                           |                      |   |       |  |                                               |                            |   |  |   |       |  |   |      |   |  |   |        |  
|Balance at December 31, 2005                                     |        | 2,842,159                                 |                      |   | 2,842 |  |                                               | 13,652                     |   |  |   | 5,072 |  |   | (426 | ) |  |   | 21,140 |  
|Comprehensive income:                                            |        |                                           |                      |   |       |  |                                               |                            |   |  |   |       |  |   |      |   |  |   |        |  
|Net income                                                       |        |                                          |                      |   |      |  |                                               |                           |   |  |   | 3,272 |  |   |     |   |  |   | 3,272  |  
|Other comprehensive income, net of tax                           |        |                                          |                      |   |      |  |                                               |                           |   |  |   |      |  |   | 135  |   |  |   | 135    |  
|                                                                 |        |                                           |                      |   |       |  |                                               |                            |   |  |   |       |  |   |      |   |  |   |        |  
|Total comprehensive income                                       |        |                                           |                      |   |       |  |                                               |                            |   |  |   |       |  |   |      |   |  |   | 3,407  |  
|3-for-2 stock split effected in the form of a 50% stock dividend |        | 1,471,881                                 |                      |   | 1,472 |  |                                               | (1,472                     | ) |  |   |      |  |   |     |   |  |   |       |  
|Stock based compensation                                         |        |                                          |                      |   |      |  |                                               | 65                         |   |  |   |      |  |   |     |   |  |   | 65     |  
|Stock options exercised including income tax benefit of $844     |        | 228,021                                   |                      |   | 228   |  |                                               | 1,757                      |   |  |   |      |  |   |     |   |  |   | 1,985  |  
|                                                                 |        |                                           |                      |   |       |  |                                               |                            |   |  |   |       |  |   |      |   |  |   |        |  
|Balance at December 31, 2006                                     |        | 4,542,061                                 |                      | $ | 4,542 |  | $                                             | 14,002                     |   |  | $ | 8,344 |  | $ | (291 | ) |  | $ | 26,597 |  
|                                                                 |        |                                           |                      |   |       |  |                                               |                            |   |  |   |       |  |   |      |   |  |   |        |  

See accompanying notes.



F-5



---

##### Table of Contents

NORTH STATE BANCORP

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years Ended December 31, 2006 and 2005



|                                                                                    |  |                        |         |   |      |   |         |  
|----------------------------------------------------------------------------------- |  | ---------------------- | ------- | - | ---- | - | ------- | -
|                                                                                    |  | 2006                   |         |   | 2005 |  
|                                                                                    |  | (Amounts in thousands) |        
|CASH FLOWS FROM OPERATING ACTIVITIES                                                |  |                        |         |   |      |   |         |  
|Net income                                                                          |  | $                      | 3,272   |   |      | $ | 2,438   |  
|Adjustments to reconcile net income to net cash provided by operating activities:   |  |                        |         |   |      |   |         |  
|Depreciation and amortization                                                       |  |                        | 542     |   |      |   | 489     |  
|Net amortization of premiums on investment securities                               |  |                        | 21      |   |      |   | 108     |  
|Provision for loan losses                                                           |  |                        | 69      |   |      |   | 792     |  
|Stock based compensation                                                            |  |                        | 65      |   |      |   |        |  
|Deferred income taxes                                                               |  |                        | (278    | ) |      |   | (313    | )
|Realized gain on sales of investment securities available for sale                  |  |                        |        |   |      |   | (3      | )
|Loss from sale of foreclosed assets                                                 |  |                        |        |   |      |   | 9       |  
|Change in assets and liabilities:                                                   |  |                        |         |   |      |   |         |  
|Increase in accrued interest receivable                                             |  |                        | (468    | ) |      |   | (396    | )
|Increase in other assets                                                            |  |                        | (1,423  | ) |      |   | (492    | )
|Increase in accrued interest payable                                                |  |                        | 903     |   |      |   | 516     |  
|Increase in accrued expenses and other liabilities                                  |  |                        | 1,031   |   |      |   | 759     |  
|                                                                                    |  |                        |         |   |      |   |         |  
|NET CASH PROVIDED BY OPERATING ACTIVITIES                                           |  |                        | 3,734   |   |      |   | 3,907   |  
|                                                                                    |  |                        |         |   |      |   |         |  
|CASH FLOWS FROM INVESTING ACTIVITIES                                                |  |                        |         |   |      |   |         |  
|Purchase of investment securities available for sale                                |  |                        | (12,177 | ) |      |   | (20,619 | )
|Proceeds from maturities and repayments of investment securities available for sale |  |                        | 12,205  |   |      |   | 12,923  |  
|Proceeds from sales of investment securities available for sale                     |  |                        |        |   |      |   | 887     |  
|Net increase in loans                                                               |  |                        | (51,533 | ) |      |   | (49,721 | )
|Redemption (purchase) of Federal Home Loan Bank stock                               |  |                        | (295    | ) |      |   | 125     |  
|Purchases of premises and equipment                                                 |  |                        | (2,494  | ) |      |   | (2,105  | )
|Proceeds from disposal of premises and equipment                                    |  |                        |        |   |      |   | 14      |  
|Proceeds from sale of foreclosed assets                                             |  |                        |        |   |      |   | 512     |  
|                                                                                    |  |                        |         |   |      |   |         |  
|NET CASH USED BY INVESTING ACTIVITIES                                               |  |                        | (54,294 | ) |      |   | (57,984 | )
|                                                                                    |  |                        |         |   |      |   |         |  
|CASH FLOWS FROM FINANCING ACTIVITIES                                                |  |                        |         |   |      |   |         |  
|Net increase in deposits                                                            |  |                        | 64,707  |   |      |   | 68,238  |  
|Net change in short term borrowings                                                 |  |                        | 664     |   |      |   | (4,267  | )
|Net change in long-term debt                                                        |  |                        | (19     | ) |      |   | 6,060   |  
|Excess tax benefits from exercise of stock options                                  |  |                        | 844     |   |      |   |        |  
|Proceeds from exercise of stock options                                             |  |                        | 1,141   |   |      |   | 18      |  
|                                                                                    |  |                        |         |   |      |   |         |  
|NET CASH PROVIDED BY FINANCING ACTIVITIES                                           |  |                        | 67,337  |   |      |   | 70,049  |  
|                                                                                    |  |                        |         |   |      |   |         |  
|NET INCREASE IN CASH AND CASH EQUIVALENTS                                           |  |                        | 16,777  |   |      |   | 15,972  |  
|                                                                                    |  |                       
|CASH AND CASH EQUIVALENTS, BEGINNING                                                |  |                        | 40,720  |   |      |   | 24,748  |  
|                                                                                    |  |                        |         |   |      |   |         |  
|CASH AND CASH EQUIVALENTS, ENDING                                                   |  | $                      | 57,497  |   |      | $ | 40,720  |  
|                                                                                    |  |                        |         |   |      |   |         |  
|SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION                                   |  |                        |         |   |      |   |         |  
|Interest paid                                                                       |  | $                      | 12,490  |   |      | $ | 5,981   |  
|Income taxes paid                                                                   |  |                        | 1,814   |   |      |   | 1,885   |  
|                                                                                    |  |                       
|SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING ACTIVITIES                            |  |                        |         |   |      |   |         |  
|Unrealized gain (loss) on investment securities available for sale, net of tax      |  | $                      | 172     |   |      | $ | (230    | )
|Unrealized loss on hedging activities, net of tax                                   |  |                        | (37     | ) |      |   |        |  

See accompanying notes.



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##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2006 and 2005



NOTE A - ORGANIZATION AND OPERATIONS

On June 28, 2002, North State Bancorp (the Company) was formed as a holding company for North State Bank (the Bank). Upon formation, one share of the Companys $1 par value common
stock was exchanged for each of the outstanding shares of the Banks $5 par value common stock. The Company currently has no operations and conducts no business on its own other than owning the Bank, North State Statutory Trust I and North
State Statutory Trust II, wholly-owned subsidiaries of the Company. The Company is subject to the rules and regulations of the Federal Reserve Bank and the North Carolina Commissioner of Banks.

The Bank was incorporated May 25, 2000 and began banking operations on June 1, 2000. The Bank is engaged in general commercial and retail banking in central
North Carolina, principally Wake County and in southeast North Carolina in New Hanover County, operating under the banking laws of North Carolina and the rules and regulations of the Federal Deposit Insurance Corporation and the North Carolina
Commissioner of Banks. The Bank undergoes periodic examinations by those regulatory authorities.

NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying
consolidated financial statements include the accounts and transactions of North State Bancorp and its wholly owned subsidiary North State Bank. All significant intercompany transactions and balances are eliminated in consolidation. North State
Bancorp and its subsidiary are collectively referred to herein as the Company.

Use of Estimates

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

Cash and Cash Equivalents

For the purpose of presentation in
the statement of cash flows, cash and cash equivalents include cash and due from banks, interest-earning deposits with banks and federal funds sold.

Securities Available for Sale

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. Declines in the fair value of available for sale securities below their cost that are other than temporary would result in write-downs of the individual
securities to their fair value. Such write-downs would be included in earnings as realized losses. Premiums and discounts are recognized in interest income using the interest method over the period to maturity.

Loans

Loans that management has the intent and ability to
hold for the foreseeable future or until maturity are reported at their outstanding principal adjusted for any charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans and unamortized premiums or discounts on
purchased loans. Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield of the related loan. The accrual of interest on loans is discontinued when, in managements opinion, the
borrower may be unable to meet payments



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##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2006 and 2005

NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Loans (Continued)



as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed against interest income. Interest income is subsequently
recognized only to the extent cash payments are received. Loans are written down or charged off when management has determined the loan to be uncollectible in part or in total.

Allowance for Loan Losses

The provision for loan losses is based upon managements
estimate of the amount needed to maintain the allowance for loan losses at an adequate level. In evaluating the allowance for loan losses the Company prepares a statistically-based analysis of its current loan portfolio through the use of historical
loss rates through the use of peer statistics utililizing key loan portfolio quality measures such as net losses to average loans, allowance for loan losses to nonaccrual loans and the percentage of loans over 30 days past due. Homogeneous loan
groups are assigned risk factors based on their perceived loss potential and on their respective risk ratings. The Company utilizes a system of nine possible risk ratings. The risk ratings are established based on perceived probability of loss. All
loans risk rated doubtful and loss are removed from their homogeneous group and individually evaluated for impairment as detailed in Statement of Financial Accounting Standards (SFAS) No. 114,
Accounting by Creditors for Impairment of a Loan as amended by SFAS No. 118, Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosure. Other groups of loans based on loan size may be selected for
impairment review. The Company has identified seven factors that are considered as indicators of changes in the level of risk of loss inherent with the Companys loan portfolio. These factors include payment performance, overall portfolio
quality utilizing weighted average risk rating, general economic factors such as unemployment, inflation, delinquency and charge-off rates, regulatory examination results, the interest rate environment, levels of highly leveraged transactions and
levels of commercial real estate concentrations, which address the risks associated with construction, development and non-owner occupied commercial real estate lending.

In accordance with SFAS No. 114, a loan is considered impaired, when based on current information and events, it is considered probable that the Company will be unable to collect the scheduled payments of
principal and interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans is generally based on the present value of expected future cash flows discounted at the historical effective interest rate,
or upon the fair value of the collateral if the loan is collateral dependent. If the recorded investment in the loan exceeds the measure of fair value, a valuation allowance is established as a component of the allowance for loan losses.

While management uses the best information available to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from
the assumptions used in making the evaluations. In addition, regulatory examiners may require the Company to recognize adjustments to the allowance for loan losses based on their judgments about information available to them at the time of their
examination.

Mortgage Origination Fees

The Company originates single family, residential first mortgage loans on a presold basis. The Company recognizes certain origination and service release fees upon the sale, which are included in non-interest income as Mortgage
origination fees.



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##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2006 and 2005

NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)



Premises and Equipment

Premises and equipment are stated at cost less accumulated depreciation. Depreciation is calculated on the straight-line method over the estimated useful lives of the assets which are 3 - 10 years for furniture and
equipment and 30 years for buildings. Leasehold improvements are amortized over the terms of the respective leases or the estimated useful lives of the improvements, whichever is shorter. Repairs and maintenance costs are charged to operations as
incurred and additions and improvements to premises and equipment are capitalized. Upon sale or retirement, the cost and related accumulated depreciation are removed from the accounts and any gains or losses are reflected in current operations.
Long-lived depreciable assets are evaluated periodically for impairment when events or changes in circumstances indicate the carrying amount may not be recoverable.

Foreclosed Assets

Assets acquired through, or in lieu of, foreclosure are held for sale and are
initially recorded at fair value at the date of foreclosure, establishing a new cost basis. Principal and interest losses existing at the time of acquisition of such assets are charged against the allowance for loan losses and interest income,
respectively. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less estimated cost to sell. Revenue and expenses from operations and changes in
the valuation allowance are included in other expenses.

Stock in Federal Home Loan Bank of Atlanta

As a requirement for membership, the Company invests in stock of the Federal Home Loan Bank of Atlanta (FHLB). This investment is carried at cost. Due to the
redemption provisions of the FHLB, the Company estimated that fair value equals cost and that this investment was not impaired at December 31, 2006.

Income Taxes

Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable
to differences between the tax of assets and liabilities and their carrying amounts for financial reporting purposes. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which the temporary differences
are expected to be recovered or settled. Deferred tax assets are reduced by a valuation allowance if it is more likely than not that the tax benefits will not be realized.

Stock Compensation Plans

Effective January 1, 2006, the Company adopted Statement of
Financial Accounting Standards (SFAS) No. 123 (revised 2004), Share-Based Payment (SFAS No. 123R), which was issued by the FASB in December 2004. SFAS No. 123R revises SFAS No. 123,
Accounting for Stock Based Compensation, and supersedes Accounting Principles Board (APB) No. 25, Accounting for Stock Issued to Employees (APB No. 25), and its related interpretations. SFAS
No.123R requires recognition of the cost of employee services received in exchange for an award of equity instruments in the financial statements over the period the employee is required to perform the services in exchange for the award
(presumptively the vesting period). SFAS No. 123R also requires measurement of the cost of employee services received in exchange for an award based on the grant-date fair value of the award. SFAS No. 123R also amends SFAS No. 95,
Statement of Cash Flows, to require that excess tax benefits be reported as financing cash inflows, rather than as a reduction of taxes paid, which is included within operating cash flows.

The Company adopted SFAS No. 123R on January 1, 2006 using the modified prospective application as permitted under SFAS No.123R. Accordingly, prior period
amounts have not been restated. Under this application, the Company is required to record compensation expense for all awards granted after the date of adoption and for the unvested portion of previously granted awards that remain outstanding at the
date of adoption. Prior to the adoption of SFAS No. 123R, the Company used the intrinsic value method as prescribed by APB No. 25 and thus recognized



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##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2006 and 2005

NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Stock Compensation Plan (Continued)



no compensation expense for options granted with exercise prices equal to the fair market value of the Companys common stock on the date of grant.

At December 31, 2006, the Company had three stock-based compensation plans, which are more fully described in Note N.

Earnings Per Common Share

The Company issued a 3-for-2 stock
split in the form of a 50% stock dividend in 2006 and a 6-for-5 stock split in the form of a 20% stock dividend in 2005. All references in these financial statements to per share results and weighted average common and common equivalent shares
outstanding have been adjusted for the effects of these stock splits.

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:



|                                                                                                                             |  |           |  |          
|---------------------------------------------------------------------------------------------------------------------------- |  | --------- |  | ---------
|                                                                                                                             |  | 2006      |  | 2005     
|Weighted average number of common shares used in computing basic net income per share                                        |  | 4,411,485 |  | 4,261,418
|                                                                                                                             |  |          
|Effect of dilutive stock options                                                                                             |  | 363,262   |  | 368,028  
|                                                                                                                             |  |           |  |          
|Weighted average number of common shares and dilutive potential common shares used in computing diluted net income per share |  | 4,774,747 |  | 4,629,446
|                                                                                                                             |  |           |  |          
|For the year ended December 31, 2006 and 2005 there were no antidulitive shares.                                             |  |           |  |          

Comprehensive Income (Loss)

The Company reports as comprehensive income all changes in shareholders equity during the year from sources other than shareholders. Other comprehensive income refers to all components (revenues, expenses, gains
and losses) of comprehensive income that is excluded from net income. The Companys other comprehensive income includes unrealized gains and losses on investment securities available for sale, net of income taxes and unrealized holding gains
(losses) on hedge instruments, net of income taxes.



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##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2006 and 2005

NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)



The components of other comprehensive income (loss), net of tax, are as follows:



|                                                                   |  |                        |      |   |      |   |      |  
|------------------------------------------------------------------ |  | ---------------------- | ---- | - | ---- | - | ---- | -
|                                                                   |  | 2006                   |      |   | 2005 |  
|                                                                   |  | (Amounts in thousands) |     
|Other comprehensive income (loss):                                 |  |                        |      |  
|Securities available for sale:                                     |  |                        |      |   |      |   |      |  
|Unrealized holding gains (losses) on available for sale securities |  | $                      | 278  |   |      | $ | (373 | )
|Tax effect                                                         |  |                        | (106 | ) |      |   | 145  |  
|Reclassification of gains recognized in net income                 |  |                        |     |   |      |   | (3   | )
|Tax effect                                                         |  |                        |     |   |      |   | 1    |  
|                                                                   |  |                        |      |   |      |   |      |  
|Net of tax amount                                                  |  |                        | 172  |   |      |   | (230 | )
|                                                                   |  |                        |      |   |      |   |      |  
|Cash flow hedging activities:                                      |  |                        |      |   |      |   |      |  
|Unrealized holding losses on hedging activities                    |  |                        | (60  | ) |      |   |     |  
|Tax effect                                                         |  |                        | 23   |   |      |   |     |  
|                                                                   |  |                        |      |   |      |   |      |  
|Net of tax amount                                                  |  |                        | (37  | ) |      |   |     |  
|                                                                   |  |                        |      |   |      |   |      |  
|Total other comprehensive income (loss)                            |  | $                      | 135  |   |      | $ | (230 | )
|                                                                   |  |                        |      |   |      |   |      |  

Accumulated other comprehensive income consists of the following:



|                                                               |  |                        |      |   |      |   |      |  
|-------------------------------------------------------------- |  | ---------------------- | ---- | - | ---- | - | ---- | -
|                                                               |  | 2006                   |      |   | 2005 |  
|                                                               |  | (Amounts in thousands) |     
|Unrealized holding losses on available for sale securities     |  | $                      | (410 | ) |      | $ | (688 | )
|Tax effect                                                     |  |                        | 156  |   |      |   | 262  |  
|                                                               |  |                        |      |   |      |   |      |  
|Net unrealized holding losses on available for sale securities |  |                        | (254 | ) |      |   | (426 | )
|                                                               |  |                        |      |   |      |   |      |  
|Unrealized holding losses on hedging activities                |  |                        | (60  | ) |      |   |     |  
|Tax effect                                                     |  |                        | 23   |   |      |   |     |  
|                                                               |  |                        |      |   |      |   |      |  
|Net unrealized holding losses on hedging activities            |  |                        | (37  | ) |      |   |     |  
|                                                               |  |                        |      |   |      |   |      |  
|Total accumulated other comprehensive loss                     |  | $                      | (291 | ) |      | $ | (426 | )
|                                                               |  |                        |      |   |      |   |      |  

Derivative Instruments

The Company manages interest rate risk based on the varying circumstances of the Companys fixed and floating assets and liabilities. Examples of interest rate management strategies, based on the Companys
then current asset-liability position, include locking in or fixing interest income on loans or other floating-rate assets, fixing interest expense on floating-rate liabilities, capping interest rates using targeted interest cost benchmarks, hedging
portions of the total amount of assets or debt, and/or hedging a period of time but not necessarily to maturity. The Company may fix rates, taking into account factors that influence the hedging decision, including the degree of certainty, timing
and amount, the material benefit of the hedge, the actual level of rates, and the state of the financial markets. The Company will generally seek to pursue interest rate risk mitigation strategies that result in the least amount of reported earnings
volatility under generally accepted accounting principles while still meeting strategic economic objectives and maintaining adequate liquidity and flexibility.

The Companys deposit and loan activities are vulnerable to interest rate risk. The associated variability in cash flows may impact the results of operations of the Company. The Companys hedging strategy is generally intended to
take advantage of opportunities to reduce, to the extent possible, unpredictable cash flows. The Company 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.

Segment Reporting

SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, requires management to



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##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2006 and 2005

NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Segment Reporting (Continued)



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

Recent Accounting Pronouncements

SFAS No. 155,
Accounting for Certain Hybrid Financial Instruments  an amendment of SFAS No. 133 and 140 provides entities relief from the requirement to separately determine the fair value of an embedded derivative that would
otherwise be bifurcated from the host contract under SFAS 133. This statement allows an irrevocable election on an instrument-by-instrument basis to measure such a hybrid financial instrument at fair value. This statement is effective for all
financial instruments acquired or issued after the beginning of fiscal years beginning after September 15, 2006. The Company has evaluated this statement and does not believe it will have a material effect on the Companys financial
position, results of operations or cash flows.

SFAS No. 156, Accounting for Servicing of Financial Assets  an amendment of
SFAS No. 140 requires that all separately recognized servicing assets and liabilities be initially measured at fair value and permits (but does not require) subsequent measurement of servicing assets and liabilities at fair value.
This statement is effective for fiscal years beginning after September 15, 2006. The Company has evaluated this statement and does not believe it will have a material effect on the Companys financial position, results of operations or
cash flows.

SFAS No. 158,Employers Accounting for Defined Benefit Pension and Other Postretirement Plans (SFAS 158),
requires recognition on the balance sheet of a plans overfunded or underfunded status with an offset to comprehensive income. This statement also requires, with limited exceptions, that the funded status of the plan be determined as of the
employers fiscal year end. The balance sheet recognition provisions of SFAS 158 are effective for entities with publicly traded equity securities for years ending after December 15, 2006 and for all other entities for years ending after
June 15, 2007. The Company does not anticipate that this statement will have an impact on the Companys financial position, results of operations or cash flows.

In July 2006, the FASB issued Financial Interpretation No. 48, Accounting for Uncertainty in Income Taxes -an interpretation of FASB Statement No. 109 (FIN 48), which is a change in
accounting for income taxes. FIN 48 specifies how tax benefits for uncertain tax positions are to be recognized, measured, and derecognized in financial statements; requires certain disclosures of uncertain tax matters; specifies how reserves for
uncertain tax positions should be classified on the balance sheet; and provides transition and interim period guidance, among other provisions. FIN 48 is effective for fiscal years beginning after December 15, 2006 and as a result, is effective
for the Company in the first quarter of fiscal 2008. The Company is currently evaluating the impact of FIN 48 on its consolidated financial statements.

In
September 2006, the SEC staff issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB 108). SAB 108 was
issued in order to eliminate the diversity of practice surrounding how public companies quantify financial statement misstatements.

Traditionally, there
have been two widely-recognized methods for quantifying the effects of financial statement misstatements, the roll-over method and the iron curtain method. The roll-over method focuses primarily on the impact of a
misstatement on the income statement  including the reversing effect of prior year misstatements  but its use can lead to the accumulation of misstatements in the balance sheet. The iron-curtain method, on the other hand, focuses
primarily on the effect of correcting the period-end balance sheet with less emphasis on the reversing



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##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2006 and 2005

NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Recent Accounting Pronouncements (Continued)



effects of prior year errors on the income statement. We currently use the roll-over method for quantifying identified financial statement misstatements.

In SAB 108, the SEC staff established an approach that requires quantification of financial statement misstatements based on the effects of the
misstatements on each of the Companys financial statements and the related financial statement disclosures. This model is commonly referred to as a dual approach because it requires quantification of errors under both the iron
curtain and the roll-over-methods.

SAB 108 permits existing public companies to initially apply its provisions either by (i) restating prior
financial statements as if the dual approach had always been used or (ii) recording the cumulative effect of initially applying the dual approach as adjustments to the carrying values of assets and liabilities as of
October 1, 2006 with an offsetting adjustment recorded to the opening balance of retained earnings. The cumulative effect transition method requires detailed disclosure of the nature and amount of each individual error being
corrected through the cumulative adjustment and how and when it arose. The Company adopted SAB 108 effective for the year ended December 31, 2006 with no impact on the reported results of operations or financial conditions.

The EITF reached a consensus at its September 2006 meeting regarding EITF 06-5, Accounting for Purchases of Life Insurance Determining the Amount That Could be
Realized in Accordance with FASB Technical Bulletin No. 85-5. The scope of EITF 06-5 is limited to the determination of net cash surrender value of a life insurance contract in accordance with Technical Bulletin 85-4. This EITF outlines
when contractual limitations of the policy should be considered when determining the net realizable value of the contract. EITF 06-5 is effective for fiscal years beginning after December 15, 2006, with earlier application permitted. The
Company has not yet evaluated the effects of this EITF.

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

Reclassification

Certain amounts in the 2005 financial statements have been reclassified to conform with the 2006
presentation. The reclassifications had no effect on net income or shareholders equity as previously reported.



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##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2006 and 2005



NOTE C - INVESTMENT SECURITIES

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



|                                                                          |  |                        |        |                      |   |                       |  |           |     |  |   |       
|------------------------------------------------------------------------- |  | ---------------------- | ------ | -------------------- | - | --------------------- |  | --------- | --- |  | - | ------
|                                                                          |  | At December 31, 2006  
|                                                                          |  | AmortizedCost          |        | Grossunrealizedgains |   | Grossunrealizedlosses |  | Fairvalue
|                                                                          |  | (Amounts in thousands)
|Securities available for sale:                                            |  |                        |        |                      |   |                       |  |           |     |  |   |       
|U. S. government securities and obligations of U.S. governmental agencies |  | $                      | 11,991 |                      | $ | 9                     |  | $         | 57  |  | $ | 11,943
|State and municipal securities                                            |  |                        | 6,110  |                      |   |                      |  |           | 34  |  |   | 6,076 
|Mortgage-backed securities                                                |  |                        | 24,240 |                      |   | 11                    |  |           | 338 |  |   | 23,913
|                                                                          |  |                        |        |                      |   |                       |  |           |     |  |   |       
|Total securities available for sale                                       |  | $                      | 42,341 |                      | $ | 20                    |  | $         | 429 |  | $ | 41,932
|                                                                          |  |                        |        |                      |   |                       |  |           |     |  |   |       
|                                                                          | 
|                                                                          |  | At December 31, 2005  
|                                                                          |  | Amortizedcost          |        | Grossunrealizedgains |   | Grossunrealizedlosses |  | Fairvalue
|                                                                          |  | (Amounts in thousands)
|Securities available for sale:                                            |  |                        |        |                      |   |                       |  |           |     |  |   |       
|U. S. government securities and obligations of U.S. governmental agencies |  | $                      | 13,990 |                      | $ |                      |  | $         | 145 |  | $ | 13,845
|State and municipal securities                                            |  |                        | 6,231  |                      |   |                      |  |           | 72  |  |   | 6,159 
|Mortgage-backed securities                                                |  |                        | 22,169 |                      |   | 9                     |  |           | 480 |  |   | 21,698
|                                                                          |  |                        |        |                      |   |                       |  |           |     |  |   |       
|Total securities available for sale                                       |  | $                      | 42,390 |                      | $ | 9                     |  | $         | 697 |  | $ | 41,702
|                                                                          |  |                        |        |                      |   |                       |  |           |     |  |   |       

The following table shows at December 31, 2006 and 2005 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 investment securities and the Companys intent and ability to hold its securities to maturity. The unrealized losses relate to eight U.S. Government Agency bonds, 23 mortgage-backed securities and six
municipal bonds. 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 none of the unrealized losses relate to the marketability of the
securities or the issuers ability to honor redemption obligations, none of the securities are deemed to be other than temporarily impaired.



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##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2006 and 2005

NOTE C - INVESTMENT SECURITIES (Continued)



|                                                                        |  |                        |        |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    
|----------------------------------------------------------------------- |  | ---------------------- | ------ | ----------------- | - | --------- |  | ---------------- | ------ | --------- | - | ---------------- |  | - | ------ |  | - | ---
|                                                                        |  | 2006                  
|                                                                        |  | Less than 12 months    |        | 12 months of more |   | Total    
|                                                                        |  | FairValue              |        | UnrealizedLosses  |   | FairValue |  | UnrealizedLosses |        | FairValue |   | UnrealizedLosses
|                                                                        |  | (Amounts in thousands)
|Securities available for sale:                                          |  |                        |        |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    
|U. S. government securities and obligations of U.S. government agencies |  | $                      | 1,979  |                   | $ | 9         |  | $                | 7,926  |           | $ | 48               |  | $ | 9,905  |  | $ | 57 
|State and municipal governments                                         |  |                        | 1,529  |                   |   | 12        |  |                  | 1,547  |           |   | 22               |  |   | 3,076  |  |   | 34 
|Mortgage-backed securities                                              |  |                        | 4,634  |                   |   | 19        |  |                  | 14,615 |           |   | 319              |  |   | 19,249 |  |   | 338
|                                                                        |  |                        |        |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    
|Total temporarily impaired securities                                   |  | $                      | 8,142  |                   | $ | 40        |  | $                | 24,088 |           | $ | 389              |  | $ | 32,230 |  | $ | 429
|                                                                        |  |                        |        |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    
|                                                                        | 
|                                                                        |  | 2005                  
|                                                                        |  | Less than 12 months    |        | 12 months of more |   | Total    
|                                                                        |  | FairValue              |        | UnrealizedLosses  |   | FairValue |  | UnrealizedLosses |        | FairValue |   | UnrealizedLosses
|                                                                        |  | (Amounts in thousands)
|Securities available for sale:                                          |  |                        |        |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    
|U. S. government securities and obligations of U.S. government agencies |  | $                      | 8,850  |                   | $ | 85        |  | $                | 4,995  |           | $ | 60               |  | $ | 13,845 |  | $ | 145
|State and municipal governments                                         |  |                        | 3,160  |                   |   | 72        |  |                  |       |           |   |                 |  |   | 3,160  |  |   | 72 
|Mortgage-backed securities                                              |  |                        | 6,256  |                   |   | 95        |  |                  | 13,562 |           |   | 385              |  |   | 19,818 |  |   | 480
|                                                                        |  |                        |        |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    
|Total temporarily impaired securities                                   |  | $                      | 18,266 |                   | $ | 252       |  | $                | 18,557 |           | $ | 445              |  | $ | 36,823 |  | $ | 697
|                                                                        |  |                        |        |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    

The amortized cost and fair values of securities available for sale at December 31, 2006 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.



|                                    |  |                        |        |           |   |       
|----------------------------------- |  | ---------------------- | ------ | --------- | - | ------
|                                    |  | AmortizedCost          |        | FairValue
|                                    |  | (Amounts in thousands)
|Securities available for sale:      |  |                        |        |           |   |       
|Due within one year                 |  | $                      | 8,285  |           | $ | 8,247 
|Due after one but within five years |  |                        | 6,203  |           |   | 6,166 
|Due after five but within ten years |  |                        | 2,297  |           |   | 2,245 
|Due after ten years                 |  |                        | 25,556 |           |   | 25,574
|                                    |  |                        |        |           |   |       
|                                    |  | $                      | 42,341 |           | $ | 41,932
|                                    |  |                        |        |           |   |       

Securities with a carrying value of $17.3 and $17.5 million at December 31, 2006 and 2005, respectively, were
pledged to secure securities sold under agreements to repurchase and public deposits.

No investment securities were sold during 2006. During 2005,
proceeds from the sale of investment securities of $887,000 resulted in a net gain of $3,000.



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##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2006 and 2005



NOTE D - LOANS

Following is a summary of loans:



|                                     |  |                        |         |   |                |        |   |        |   |         |                |  |        |  
|------------------------------------ |  | ---------------------- | ------- | - | -------------- | ------ | - | ------ | - | ------- | -------------- |  | ------ | -
|                                     |  | At December 31,        |        
|                                     |  | 2006                   |         |   | 2005           |       
|                                     |  | Amount                 |         |   | % ofTotalLoans |        |   | Amount |   |         | % ofTotalLoans | 
|                                     |  | (Dollars in thousands) |        
|Commercial                           |  | $                      | 239,014 |   |                | 69.04  | % |        | $ | 200,950 |                |  | 68.26  | %
|Real estate - construction           |  |                        | 67,404  |   |                | 19.47  | % |        |   | 56,586  |                |  | 19.22  | %
|Real estate - 1 to 4 family mortgage |  |                        | 21,438  |   |                | 6.19   | % |        |   | 19,222  |                |  | 6.52   | %
|Loans to individuals                 |  |                        | 3,414   |   |                | 0.99   | % |        |   | 2,933   |                |  | 1.00   | %
|Home equity lines of credit          |  |                        | 14,933  |   |                | 4.31   | % |        |   | 14,732  |                |  | 5.00   | %
|                                     |  |                        |         |   |                |        |   |        |   |         |                |  |        |  
|Subtotal                             |  |                        | 346,203 |   |                | 100.00 | % |        |   | 294,423 |                |  | 100.00 | %
|Unamortized net deferred loan fees   |  |                        | (260    | ) |                |        |   |        |   | (248    | )              |  |        |  
|                                     |  |                        |         |   |                |        |   |        |   |         |                |  |        |  
|Total loans                          |  | $                      | 345,943 |   |                |        |   |        | $ | 294,175 |                |  |        |  
|                                     |  |                        |         |   |                |        |   |        |   |         |                |  |        |  

Loans are primarily made 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 the local economic conditions.

Nonperforming assets at December 31, 2006 and 2005 consisted of the following:



|                           |  |                        |     |      |   |  
|-------------------------- |  | ---------------------- | --- | ---- | - | -
|                           |  | At December 31,       
|                           |  | 2006                   |     | 2005
|                           |  | (Amounts in thousands)
|Nonaccrual loans           |  | $                      | 397 |      | $ | 
|Restructured loans         |  |                        |    |      |   | 
|                           |  |                        |     |      |   |  
|Total nonperforming loans  |  |                        | 397 |      |   | 
|                           |  |                       
|Other real estate owned    |  |                        |    |      |   | 
|                           |  |                        |     |      |   |  
|Total nonperforming assets |  | $                      | 397 |      | $ | 
|                           |  |                        |     |      |   |  

All loans rated Doubtful and Loss are individually analyzed for impairment as detailed in
SFAS No. 114. Other groups of loans based on loan size may be selected for impairment review. Impaired loans at December 31, 2006 aggregated $639,000, consisting of three loans, two of which were on nonaccrual status. There were no
impaired loans at December 31, 2005. Related allowances for loan losses amounted to $534,000 and $0 at December 31, 2006 and 2005, respectively. The average recorded investment in impaired loans during the years ended December 31,
2006 and 2005 was $266,000 and $65,000, respectively. For the years ended December 31, 2006 and 2005, the interest income the Company recognized from impaired loans during the portion of the year that they were impaired was not material.

F-16



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##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2006 and 2005

NOTE D  LOANS (Continued)



The Company has had loan transactions with its directors and executive officers. Such loans were made in the ordinary
course of business and on substantially the same terms and collateral as those for comparable transactions prevailing at the time and did not involve more than the normal risk of collectibility or present other unfavorable features. A summary of
related party loan transactions is as follows (amounts in thousands):



|                             |  |   |        |  
|---------------------------- |  | - | ------ | -
|Balance at December 31, 2005 |  | $ | 11,419 |  
|Additional borrowings        |  |   | 7,068  |  
|Loan repayments              |  |   | (5,907 | )
|                             |  |   |        |  
|Balance at December 31, 2006 |  | $ | 12,580 |  
|                             |  |   |        |  

At December 31, 2006, the Company had pre-approved but unused lines of credit totaling $3.5 million to
executive officers, directors and their affiliates.

NOTE E - ALLOWANCE FOR LOAN LOSSES

An analysis of the allowance for loan losses for the years ended December 31, 2006 and 2005 follows:



|                             |  |                        |       |   |      |   |       |  
|---------------------------- |  | ---------------------- | ----- | - | ---- | - | ----- | -
|                             |  | 2006                   |       |   | 2005 |  
|                             |  | (Amounts in thousands) |      
|Beginning balance            |  | $                      | 3,679 |   |      | $ | 3,053 |  
|                             |  |                        |       |   |      |   |       |  
|Provision for loan losses    |  |                        | 69    |   |      |   | 792   |  
|                             |  |                        |       |   |      |   |       |  
|Charge-offs                  |  |                        | (5    | ) |      |   | (206  | )
|Recoveries                   |  |                        | 240   |   |      |   | 40    |  
|                             |  |                        |       |   |      |   |       |  
|Net recoveries/(charge-offs) |  |                        | 235   |   |      |   | (166  | )
|                             |  |                        |       |   |      |   |       |  
|Ending balance               |  | $                      | 3,983 |   |      | $ | 3,679 |  
|                             |  |                        |       |   |      |   |       |  

NOTE F - PREMISES AND EQUIPMENT

Following is a summary of premises and equipment at December 31, 2006 and 2005:



|                                  |  |                        |        |   |      |   |        |  
|--------------------------------- |  | ---------------------- | ------ | - | ---- | - | ------ | -
|                                  |  | 2006                   |        |   | 2005 |  
|                                  |  | (Amounts in thousands) |       
|Land                              |  | $                      | 2,492  |   |      | $ | 2,487  |  
|Buildings                         |  |                        | 3,683  |   |      |   | 1,974  |  
|Leasehold improvements            |  |                        | 805    |   |      |   | 795    |  
|Furniture, fixtures and equipment |  |                        | 2,999  |   |      |   | 2,186  |  
|Construction in process           |  |                        | 9      |   |      |   | 55     |  
|                                  |  |                        |        |   |      |   |        |  
|                                  |  |                        | 9,988  |   |      |   | 7,497  |  
|Accumulated depreciation          |  |                        | (2,178 | ) |      |   | (1,639 | )
|                                  |  |                        |        |   |      |   |        |  
|Total                             |  | $                      | 7,810  |   |      | $ | 5,858  |  
|                                  |  |                        |        |   |      |   |        |  

Depreciation and amortization amounting to $547,000 in 2006 and $477,000 in 2005 is included in occupancy and
equipment expense.



F-17



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##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2006 and 2005

NOTE F - PREMISES AND EQUIPMENT (Continued)



The Company leases office facilities under non-cancelable operating leases. Future minimum lease payments required
under the leases are as follows (amounts in thousands):

Year ending December 31:



|           |  |   |      
|---------- |  | - | -----
|2007       |  | $ | 642  
|2008       |  |   | 464  
|2009       |  |   | 464  
|2010       |  |   | 464  
|2011       |  |   | 450  
|Thereafter |  |   | 1,234
|           |  |   |      
|           |  | $ | 3,718
|           |  |   |      

Total rental expense for the years ended December 31, 2006 and 2005 amounted to $809,000 and $647,000,
respectively. Rent expense is included in occupancy and equipment expenses.

NOTE G - DEPOSITS

The aggregate amount of time deposits in denominations of $100,000 or more at December 31, 2006 and 2005 was approximately $73.2 million and $51.1 million,
respectively.

At December 31, 2006, the scheduled maturities of time deposits were as follows:



|     |  |                        |        |                  |   |        |  |   |        
|---- |  | ---------------------- | ------ | ---------------- | - | ------ |  | - | -------
|     |  | At December 31, 2006  
|     |  | Less than$ 100,000     |        | $ 100,000or more |   | Total 
|     |  | (Amounts in thousands)
|2007 |  | $                      | 55,218 |                  | $ | 48,431 |  | $ | 103,649
|2008 |  |                        | 11,685 |                  |   | 19,753 |  |   | 31,438 
|2009 |  |                        | 1,995  |                  |   | 2,904  |  |   | 4,899  
|2010 |  |                        | 205    |                  |   | 1,400  |  |   | 1,605  
|2011 |  |                        | 119    |                  |   | 740    |  |   | 859    
|     |  |                        |        |                  |   |        |  |   |        
|     |  | $                      | 69,222 |                  | $ | 73,228 |  | $ | 142,450
|     |  |                        |        |                  |   |        |  |   |        

NOTE H  BORROWINGS

Short-term Borrowings

The Company had repurchase agreements outstanding in the amount of $10.7 million and
$10.0 million at December 31, 2006 and 2005, respectively. Securities sold under agreements to repurchase generally mature within one to four days from the transaction date and are collateralized by U.S. Government Agency obligations. These
repurchase agreements are due within one year and are classified as short-term borrowings in the accompanying consolidated balance sheets.

As of
December 31, 2006 the Company had available lines of credit totaling approximately $55.0 million with various financial institutions for borrowing on a short-term basis, with no amounts outstanding at that date. These lines are subject to
annual renewals with varying interest rates.

Long-term Debt

On March 17, 2004, the Company issued $5.2 million of junior subordinated debentures to North State Statutory Trust I (Trust I) in exchange for the proceeds of trust preferred securities issued by
Trust I. On December 15,



F-18



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##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2006 and 2005

NOTE H - BORROWINGS (Continued)



2005, the Company issued $5.2 million of junior subordinated debentures to North State Statutory Trust II (Trust II) in exchange for the proceeds
of trust preferred securities issued by Trust II. Trust I and Trust II are wholly owned by the Company. The junior subordinated deferrable interest debentures are included in long-term debt and the Companys equity interests in Trust I and
Trust II are included in other assets.

The junior subordinated debentures for Trust I pay interest quarterly at an annual rate, reset quarterly, equal to
3-month LIBOR plus 2.79%. The debentures are redeemable on July 17, 2009 or afterwards in whole or in part, on any January 17, April 17, July 17 or October 17. Redemption is mandatory at April 17, 2034. The
Company has fully and unconditionally guaranteed the repayment of the trust preferred securities. The Companys obligation under the guarantee is unsecured and subordinate to senior and subordinated indebtedness of the Company.

The junior subordinated debentures for Trust II pay interest quarterly at an annual rate, reset quarterly, equal to 3-month LIBOR plus 1.65%. The debentures are
redeemable on July 15, 2010 or afterwards in whole or in part, on any January 15, April 15, July 15 or October 15. Redemption is mandatory at April 15, 2035. The Company has fully and unconditionally
guaranteed the repayment of the trust preferred securities. The Companys obligation under the guarantee is unsecured and subordinate to senior and subordinated indebtedness of the Company.

The trust preferred securities issued by Trust I and Trust II presently qualify as Tier 1 regulatory capital for regulatory capital purposes subject to certain
limitations, none of which were applicable at December 31, 2006.

At December 31, 2006 and 2005, the Company had $886,300 and $905,000,
respectively, in a long-term Federal Home Loan Bank advance. This advance, maturing October 7, 2025, funds a qualified Community Investment Program loan. The Company pays 2.00% interest for the advance with the loan earning 4.00%.

NOTE I - INCOME TAXES

The significant components of the provision
for income taxes for the years ended December 31, 2006 and 2005 are as follows:



|                                                                                             |  |                        |       |   |      |   |       |  
|-------------------------------------------------------------------------------------------- |  | ---------------------- | ----- | - | ---- | - | ----- | -
|                                                                                             |  | 2006                   |       |   | 2005 |  
|                                                                                             |  | (Amounts in thousands) |      
|Current tax expense:                                                                         |  |                        |       |   |      |   |       |  
|Federal                                                                                      |  | $                      | 1,781 |   |      | $ | 1,487 |  
|State                                                                                        |  |                        | 412   |   |      |   | 289   |  
|                                                                                             |  |                        |       |   |      |   |       |  
|                                                                                             |  |                        | 2,193 |   |      |   | 1,776 |  
|                                                                                             |  |                        |       |   |      |   |       |  
|Deferred tax provision:                                                                      |  |                        |       |   |      |   |       |  
|Federal                                                                                      |  |                        | (241  | ) |      |   | (259  | )
|State                                                                                        |  |                        | (60   | ) |      |   | (82   | )
|                                                                                             |  |                        |       |   |      |   |       |  
|Provision for income tax expense before adjustment to deferred tax asset valuation allowance |  |                        | (301  | ) |      |   | (341  | )
|                                                                                             |  |                        |       |   |      |   |       |  
|                                                                                             |  |                        | 1,892 |   |      |   | 1,435 |  
|                                                                                             |  |                       
|Increase in valuation allowance                                                              |  |                        | 23    |   |      |   | 28    |  
|                                                                                             |  |                        |       |   |      |   |       |  
|Net provision for income taxes                                                               |  | $                      | 1,915 |   |      | $ | 1,463 |  
|                                                                                             |  |                        |       |   |      |   |       |  



F-19



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##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2006 and 2005

NOTE I - INCOME TAXES (Continued)



The difference between the provision for income taxes and the amounts computed by applying the statutory federal
income tax rate of 34% to income before income taxes is summarized below:



|                                                     |  |                        |       |   |      |   |       |  
|---------------------------------------------------- |  | ---------------------- | ----- | - | ---- | - | ----- | -
|                                                     |  | 2006                   |       |   | 2005 |  
|                                                     |  | (Amounts in thousands) |      
|Expected income tax expense                          |  | $                      | 1,764 |   |      | $ | 1,326 |  
|                                                     |  |                       
|Increase (decrease) resulting from:                  |  |                        |       |   |      |   |       |  
|State income taxes, net of federal tax effect        |  |                        | 232   |   |      |   | 137   |  
|Adjustment to deferred tax asset valuation allowance |  |                        | 23    |   |      |   | 28    |  
|Other permanent differences                          |  |                        | (104  | ) |      |   | (28   | )
|                                                     |  |                        |       |   |      |   |       |  
|Provision for income taxes                           |  | $                      | 1,915 |   |      | $ | 1,463 |  
|                                                     |  |                        |       |   |      |   |       |  

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets
and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of deferred taxes at December 31, 2006 and 2005 are as follows:



|                                                          |  |                        |       |   |      |   |       |  
|--------------------------------------------------------- |  | ---------------------- | ----- | - | ---- | - | ----- | -
|                                                          |  | 2006                   |       |   | 2005 |  
|                                                          |  | (Amounts in thousands) |      
|Deferred tax assets relating to:                          |  |                        |       |   |      |   |       |  
|Allowance for loan losses                                 |  | $                      | 1,282 |   |      | $ | 1,255 |  
|Deferred compensation                                     |  |                        | 502   |   |      |   | 277   |  
|Unrealized loss on available for sale securities          |  |                        | 155   |   |      |   | 262   |  
|Unrealized loss on hedging activities                     |  |                        | 24    |   |      |   |      |  
|Lease obligations                                         |  |                        | 19    |   |      |   |      |  
|State net operating loss carryforwards                    |  |                        | 55    |   |      |   | 28    |  
|                                                          |  |                        |       |   |      |   |       |  
|Total deferred tax assets                                 |  |                        | 2,037 |   |      |   | 1,822 |  
|Less: Valuation Allowance                                 |  |                        | (51   | ) |      |   | (28   | )
|                                                          |  |                        |       |   |      |   |       |  
|Net deferred tax asset                                    |  |                        | 1,986 |   |      |   | 1,794 |  
|                                                          |  |                        |       |   |      |   |       |  
|Deferred tax liabilities relating to:                     |  |                        |       |   |      |   |       |  
|Deferred loan origination fees                            |  |                        | (140  | ) |      |   | (147  | )
|Property and equipment                                    |  |                        | (65   | ) |      |   | (73   | )
|Prepaid expenses                                          |  |                        | (41   | ) |      |   | (29   | )
|                                                          |  |                        |       |   |      |   |       |  
|Total deferred tax liabilities                            |  |                        | (246  | ) |      |   | (249  | )
|                                                          |  |                        |       |   |      |   |       |  
|Net recorded deferred tax assets included in other assets |  | $                      | 1,740 |   |      | $ | 1,545 |  
|                                                          |  |                        |       |   |      |   |       |  



F-20



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##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2006 and 2005



NOTE J - NON-INTEREST INCOME AND OTHER NON-INTEREST EXPENSE

The major components of non-interest income for the years ended December 31, 2006 and 2005 are as follows:



|                                      |  |                        |       |      |   |      
|------------------------------------- |  | ---------------------- | ----- | ---- | - | -----
|                                      |  | 2006                   |       | 2005
|                                      |  | (Amounts in thousands)
|Mortgage origination fees             |  | $                      | 326   |      | $ | 492  
|Service charges and fees on deposits  |  |                        | 754   |      |   | 682  
|Gain on sale of investment securities |  |                        |      |      |   | 3    
|Other                                 |  |                        | 94    |      |   | 133  
|                                      |  |                        |       |      |   |      
|Total non-interest income             |  | $                      | 1,174 |      | $ | 1,310
|                                      |  |                        |       |      |   |      

The major components of other non-interest expense for the years ended December 31, 2006 and 2005 are as
follows:



|                                            |  |                        |       |      |   |      
|------------------------------------------- |  | ---------------------- | ----- | ---- | - | -----
|                                            |  | 2006                   |       | 2005
|                                            |  | (Amounts in thousands)
|Professional fees                           |  | $                      | 295   |      | $ | 341  
|Postage, printing & office supplies         |  |                        | 144   |      |   | 126  
|Advertising and promotion                   |  |                        | 295   |      |   | 276  
|Data processing & other outsourced services |  |                        | 553   |      |   | 398  
|Directors fees                              |  |                        | 638   |      |   | 399  
|Other                                       |  |                        | 1,607 |      |   | 1,389
|                                            |  |                        |       |      |   |      
|Total non-interest expense                  |  | $                      | 3,532 |      | $ | 2,929
|                                            |  |                        |       |      |   |      

NOTE K - REGULATORY MATTERS

The Bank, as a North Carolina banking corporation, may pay cash dividends to the Company only out of undivided profits as determined pursuant to North Carolina General Statutes Section 53-87. However, regulatory
authorities may limit payment of dividends by any bank when it is determined that such limitation is in the public interest and is necessary to ensure financial soundness of the bank.

The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Companys consolidated financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices.
The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.

As of December 31, 2006, the most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective
action. To be categorized as well capitalized, the Bank must maintain minimum amounts and ratios. There are no conditions or events since that notification that management believes have changed the Banks category.



F-21



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##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2006 and 2005

NOTE K - REGULATORY MATTERS (Continued)



Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to
maintain minimum amounts and ratios, as prescribed by regulations, of total and Tier I capital to risk-weighted assets and of Tier I capital to average assets. Because the Companys only significant asset is its investment in the Bank,
information concerning capital ratios is essentially the same for the Company and the Bank. As of December 31, 2006 and 2005, the Bank met its capital adequacy requirements as set forth below:



|                                         |  |                        |        |       |                                      |   |        |                                                                        |        |  |      |        |  |       |        |  |       |  
|---------------------------------------- |  | ---------------------- | ------ | ----- | ------------------------------------ | - | ------ | ---------------------------------------------------------------------- | ------ |  | ---- | ------ |  | ----- | ------ |  | ----- | -
|                                         |  | Actual                 |        |       | Minimum for capitaladequacy purposes |   |        | Minimum to be wellcapitalized under promptcorrective action provisions |       
|                                         |  | Amount                 |        | Ratio |                                      |   | Amount |                                                                        | Ratio  |  |      | Amount |  | Ratio |       
|                                         |  | (Dollars in thousands) |       
|As of December 31, 2006:                 |  |                        |        |       |                                      |   |        |                                                                        |        |  |      |        |  |       |        |  |       |  
|Total Capital (to Risk-Weighted Assets)  |  | $                      | 36,308 |       | 10.21                                | % |        | $                                                                      | 28,436 |  | 8.00 | %      |  | $     | 35,546 |  | 10.00 | %
|                                         |  |                        |        |       |                                      |  
|Tier I Capital (to Risk-Weighted Assets) |  |                        | 32,325 |       | 9.09                                 | % |        |                                                                        | 14,218 |  | 4.00 | %      |  |       | 21,327 |  | 6.00  | %
|                                         |  |                        |        |       |                                      |  
|Tier I Capital (to Average Assets)       |  |                        | 32,325 |       | 7.58                                 | % |        |                                                                        | 17,049 |  | 4.00 | %      |  |       | 21,311 |  | 5.00  | %
|                                         |  |                        |        |       |                                      |  
|As of December 31, 2005:                 |  |                        |        |       |                                      |   |        |                                                                        |        |  |      |        |  |       |        |  |       |  
|Total Capital (to Risk-Weighted Assets)  |  | $                      | 31,138 |       | 10.30                                | % |        | $                                                                      | 24,180 |  | 8.00 | %      |  | $     | 30,224 |  | 10.00 | %
|                                         |  |                        |        |       |                                      |  
|Tier I Capital (to Risk-Weighted Assets) |  |                        | 27,459 |       | 9.09                                 | % |        |                                                                        | 12,090 |  | 4.00 | %      |  |       | 18,135 |  | 6.00  | %
|                                         |  |                        |        |       |                                      |  
|Tier I Capital (to Average Assets)       |  |                        | 27,459 |       | 7.53                                 | % |        |                                                                        | 14,581 |  | 4.00 | %      |  |       | 18,226 |  | 5.00  | %

NOTE L - DERIVATIVES AND OFF-BALANCE SHEET RISK

Derivative Financial Instruments

The Company utilizes a
stand-alone derivative financial instrument, in the form of an interest rate floor (a purchased option), in its asset/liability management program. The transaction involves both credit and market risk. Direct credit exposure is limited to the net
difference between the calculated amounts to be received and paid, if any. The instrument is designated as a cash flow hedge of the risk of overall changes in cash flows below the strike rate on the floor (when the prime interest rate, interpreted
as the prime rate published in The Wall Street Journal, falls below 7.50%). The effective portion of change in the fair value of the derivative instrument is reflected on the Companys consolidated balance sheets as a derivative asset
and other comprehensive income. On a quarterly basis, the Company will perform its prospective and retrospective effectiveness assessments and measure ineffectiveness by comparing the actual option with a hypothetically perfect option. Under this
approach, the cumulative change in fair value of the actual floor is compared to the cumulative change in fair value of a hypothetically perfect floor with key features that exactly match the key features of the hedged transactions. Hedge
ineffectiveness for 2006 was not material. The cash flow hedge is consistent with the Companys risk management objective and strategy to reduce its exposure to decreases in cash flows relating to interest receipts on its prime-based
variable-rate loans.

The Company is exposed to credit-related losses in the event of nonperformance by the counterparties to these agreements. The Company
controls the credit risk of its financial contracts through credit approvals, limits and monitoring procedures, and does not expect any counterparties to fail their obligations. The Company deals only with primary dealers.

Risk Management Policies  Hedging Instruments

The
primary focus of the Companys asset/liability management program is to monitor the sensitivity of the Companys net income under varying interest rate scenarios to take steps to control its risks. The Company manages interest rate risk
based on the varying circumstances of the Companys fixed and floating assets and liabilities including interest rate management strategies, based on the Companys then current asset-liability position, locking



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##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2006 and 2005

NOTE L  DERIVATIVES AND OFF-BALANCE SHEET RISK (Continued)

Risk Management Policies  Hedging Instruments (Continued)



in or fixing interest income on loans or other floating-rate assets (or unlocking fixed-rate assets), fixing interest expense on floating-rate liabilities
(or unlocking fixed-rate liabilities), capping interest rates using targeted interest cost benchmarks, hedging portions of the total amount of assets or debt, and /or hedging a period of time but not necessarily to maturity. The Company may fix
rates, taking into account factors that influence the hedging decision, including the degree of certainty, timing and amount, the material benefit of the hedge, the actual level of rates, and the state of the financial markets. The Company will
generally seek to pursue interest rate risk mitigation strategies that result in the least amount of reported earnings volatility under generally accepted accounting principles while still meeting strategic economic objectives and maintaining
adequate liquidity and flexibility.

Interest Rate Risk Management  Cash Flow Hedging Instruments

The Companys deposit and loan activities are vulnerable to interest rate risk. The associated variability in cash flows may impact the results of operations of the
Company. The hedging strategy is generally intended to take advantage of opportunities to reduce, to the extent possible, unpredictable cash flows. To mitigate exposure to variability in expected future cash flows resulting from changes in interest
rates, the Company may use a variety of commonly used derivative products that are 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.
During 2006, the Company purchased an interest rate option agreement that provided for payments to the Company in the event interest rates decrease below levels provided in the agreement. The Company instrument is designated as a hedge under SFAS
No. 133 (as amended), Accounting for Derivative Instruments and Hedging Activities and the Company has formally documented the hedging relationship and the risk management objective and strategy for undertaking all qualifying
hedges. This documentation includes identification of the hedging instrument, the hedged transaction, the nature of the risk being hedged and how the hedging instruments effectiveness in hedging the exposure to the hedged transactions
variability in cash flows attributable to the hedged risk will be assessed and how hedge ineffectiveness, if any, will be measured.

At December 31,
2006 the information pertaining to the outstanding interest rate floor (purchased option) agreement is as follows:



|                                                            |  |                        |        |  
|----------------------------------------------------------- |  | ---------------------- | ------ | -
|                                                            |  | December 31, 2006      |       
|                                                            |  | (Amounts in thousands) |       
|Notional amount                                             |  | $                      | 50,000 |  
|Fair value                                                  |  |                        | 305    |  
|Unrealized loss relating to interest rate floor, net of tax |  |                        | (37    | )

At December 31, 2006, the fair value of the interest rate floor was recorded in other assets in accordance
with SFAS No. 133 and the unrealized loss, net of tax, relating to the interest rate floor was reported in accumulated other comprehensive income.

The floor has an effective date of November 1, 2006 and a maturity date of November 1, 2009. Should the prime rate fall below 7.50% on a rate reset date during the period from November 1, 2006 and November 1, 2009, the
counterparty will pay the Company the amount equal to $50 million multiplied by 7.50% minus the prime rate multiplied by the number of days in the period divided by 360.

Off-Balance Sheet Risk, Commitments and Contingencies

The Company is a party to financial instruments with
off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees,
elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The contract or notional amounts of those instruments reflect the extent



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##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2006 and 2005

NOTE L - DERIVATIVES AND OFF-BALANCE SHEET RISK (Continued)



of involvement the Company has in particular classes of financial instruments. The Company uses the same credit policies in making commitments and
conditional obligations as it does for on-balance-sheet instruments.

Commitments to extend credit are agreements to lend to a customer as long as there is
no violation of conditions established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawn upon,
the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customers creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company, upon
extension of credit is based on managements credit evaluation of the borrower. Collateral obtained varies but may include real estate, stocks, bonds, and certificates of deposit.

A summary of the contract amount of the Companys exposure to off-balance sheet credit risk as of December 31, 2006 is as follows (amounts in thousands):



|                                                                    |  |   |       
|------------------------------------------------------------------- |  | - | ------
|Financial instruments whose contract amounts represent credit risk: |  |   |       
|Commitments to extend credit                                        |  | $ | 46,804
|Undisbursed lines of credit                                         |  |   | 14,938
|Standby letters of credit                                           |  |   | 1,785 

NOTE M - DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS

Financial instruments include cash and due from banks, interest-bearing deposits with banks, federal funds sold, investments, accrued interest, loans, deposit accounts
and borrowings. 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 for cash and due from banks, and interest-earning deposits
with banks and federal funds sold approximate fair value because of the short maturities of those instruments.

Investment Securities Available for
Sale

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.

Loans

For certain homogenous categories of loans, such as residential mortgages, fair value is estimated using the quoted market prices for securities backed by similar loans,
adjusted for differences in loan characteristics. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for
the same remaining maturities.



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##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2006 and 2005

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



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.

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.

Derivative Financial Instruments

Fair values for the interest rate floor are based upon amounts required to
settle the contracts.

Financial Instruments with Off-Balance Sheet Risk

With regard to financial instruments with off-balance sheet risk discussed in Note L, 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 at December 31, 2006 and 2005.



|                                                   |  |                        |         |                     |   |                |  |                     |         |  |   |        
|-------------------------------------------------- |  | ---------------------- | ------- | ------------------- | - | -------------- |  | ------------------- | ------- |  | - | -------
|                                                   |  | 2006                   |         | 2005               
|                                                   |  | CarryingAmount         |         | EstimatedFair Value |   | CarryingAmount |  | EstimatedFair Value
|                                                   |  | (Amounts in thousands)
|Financial assets:                                  |  |                        |         |                     |   |                |  |                     |         |  |   |        
|Cash and due from banks                            |  | $                      | 12,189  |                     | $ | 12,189         |  | $                   | 5,991   |  | $ | 5,991  
|Interest-earning deposits with banks               |  |                        | 1,249   |                     |   | 1,249          |  |                     | 4,523   |  |   | 4,523  
|Federal funds sold                                 |  |                        | 44,059  |                     |   | 44,059         |  |                     | 30,206  |  |   | 30,206 
|Investment securities available for sale           |  |                        | 41,932  |                     |   | 41,932         |  |                     | 41,702  |  |   | 41,702 
|Loans, net                                         |  |                        | 341,960 |                     |   | 336,544        |  |                     | 290,496 |  |   | 287,376
|Accrued interest receivable                        |  |                        | 1,754   |                     |   | 1,754          |  |                     | 1,286   |  |   | 1,286  
|Stock in the Federal Home Loan Bank                |  |                        | 939     |                     |   | 939            |  |                     | 644     |  |   | 644    
|                                                   |  |                        |         |                    
|Financial liabilities:                             |  |                        |         |                     |   |                |  |                     |         |  |   |        
|Deposits                                           |  | $                      | 402,078 |                     | $ | 402,070        |  | $                   | 337,371 |  | $ | 337,181
|Short-term borrowings                              |  |                        | 10,670  |                     |   | 10,670         |  |                     | 10,006  |  |   | 10,006 
|Long-term debt                                     |  |                        | 11,196  |                     |   | 11,185         |  |                     | 11,215  |  |   | 10,905 
|Accrued interest payable                           |  |                        | 2,297   |                     |   | 2,297          |  |                     | 1,394   |  |   | 1,394  
|                                                   |  |                        |         |                    
|On-balance sheet derivative financial instruments: |  |                        |         |                     |   |                |  |                     |         |  |   |        
|Interest rate floor agreement                      |  |                        |         |                     |   |                |  |                     |         |  |   |        
|                                                   |  | $                      | 305     |                     | $ | 305            |  | $                   |        |  | $ |       



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##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2006 and 2005



NOTE N - EMPLOYEE AND DIRECTOR BENEFIT PLANS

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 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 826,551 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 estimated based on the
Companys historical low level of activity. The expected term of the options is based upon the average life of previously 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 years ended December 31, 2006 and 2005.



|                                         |  |      |         |   |      |   |         |  
|---------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|                                         |  | 2005 |         |   | 2006 |  
|Estimated fair value of options granted  |  | $    | 8.45    |   |      | $ | 4.88    |  
|                                         |  |     
|Assumptions in estimating option values: |  |      |         |   |      |   |         |  
|Risk-free interest rate                  |  |      | 5.37    | % |      |   | 4.17    | %
|Dividend yield                           |  |      | 0.00    | % |      |   | 0.00    | %
|Volatility                               |  |      | 25.00   | % |      |   | 25.00   | %
|Expected life                            |  |      | 10years |   |      |   | 10years |  

A summary of option activity under the stock option plans for the year ended December 31, 2006 adjusted for
the effect of the 3-for-2 stock split effected in the form of a 50% stock dividend in 2006 is as follows:



|                                 |  |               |   |                           |                  |       |                          |            |                |   |      
|-------------------------------- |  | ------------- | - | ------------------------- | ---------------- | ----- | ------------------------ | ---------- | -------------- | - | -----
|                                 |  | Shares        |   |                           | Weighted Average |       | Aggregate IntrinsicValue
|                                 |  | ExercisePrice |   | RemainingContractual Term |                 
|                                 |  |               |   |                           |                  |       |                          |            | (In thousands)
|Outstanding December 31, 2005    |  | 748,818       |   |                           | $                | 4.33  |                          | 4.84 years |                |   |      
|                                 |  |               |   |                          
|Granted                          |  | 24,075        |   |                           |                  | 16.93 |                          |            |                |   |      
|Exercised                        |  | (278,752      | ) |                           |                  | 4.07  |                          |            |                |   |      
|Forfeited                        |  | (11,265       | ) |                           |                  | 10.56 |                          |            |                |   |      
|                                 |  |               |   |                           |                  |       |                          |            |                |   |      
|Outstanding December 31, 2006    |  | 482,876       |   |                           | $                | 5.02  |                          | 4.24 years |                | $ | 9,165
|                                 |  |               |   |                           |                  |       |                          |            |                |   |      
|Exercisable at December 31, 2006 |  | 423,415       |   |                           | $                | 4.18  |                          |            |                | $ | 8,392
|                                 |  |               |   |                           |                  |       |                          |            |                |   |      

For the year ended December 31, 2006, the intrinsic value of options exercised was approximately $3.7
million. On August 7, 2006, 24,075 options were granted with a fair value of $8.45 per option. The fair value of options vested was approximately $65,000 for the year ended December 31, 2006. As of December 31, 2006, approximately
$266,000 of share-based compensation expense remained to be recognized over a weighted average period of 2.98 years.

Cash received from option exercises
under share-based payment arrangements for the year ended December 31, 2006 was approximately $1.1 million. A tax benefit of $844,000 was realized for tax deductions from option exercise of the share-based payment arrangements during the year
ended December 31, 2006.



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##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2006 and 2005

NOTE N - EMPLOYEE AND DIRECTOR BENEFIT PLANS (Continued)



The adoption of SFAS 123R and its fair value compensation cost recognition provisions are different from the
nonrecognition provisions under SFAS 123 and the intrinsic value method for compensation cost allowed by APB25.

The impact of the adoption of SFAS 123R is
as follows:



|                                           |  |                                     |          |  
|------------------------------------------ |  | ----------------------------------- | -------- | -
|                                           |  | For the year endedDecember 31, 2006 |         
|Income before income tax expense           |  | $                                   | (65,000  | )
|Net income                                 |  | $                                   | (65,000  | )
|                                           | 
|Cash flow from operating activities        |  | $                                   | (844,000 | )
|Cash flow provided by financing activities |  | $                                   | 844,000  |  
|                                           | 
|Basic earnings per share                   |  | $                                   | (.01     | )
|Diluted earnings per share                 |  | $                                   | (.01     | )

The following illustrates the effect on net income available to common stockholders if the Company had applied the
fair value recognition provisions of SFAS No. 123 to the prior year ended December 31, 2005 (in thousands, except per share data):



|                                                                                                                                     |  |   |       |  
|------------------------------------------------------------------------------------------------------------------------------------ |  | - | ----- | -
|Net income, as reported                                                                                                              |  | $ | 2,438 |  
|Deduct: Stock-based employee compensation expense determined underfair value based method of all awards, net of related income
taxes |  |   | (178  | )
|                                                                                                                                     |  |   |       |  
|Pro forma net income                                                                                                                 |  | $ | 2,260 |  
|                                                                                                                                     |  |   |       |  
|Basic net income per share:                                                                                                          |  |   |       |  
|As reported                                                                                                                          |  | $ | .57   |  
|Pro forma                                                                                                                            |  | $ | .53   |  
|                                                                                                                                     | 
|Diluted net income per share:                                                                                                        |  |   |       |  
|As reported                                                                                                                          |  | $ | .53   |  
|Pro forma                                                                                                                            |  | $ | .49   |  

Employment Agreements

The Company has entered into an employment agreement with its chief executive officer to ensure a stable and competent management base. This agreement provides for benefits as spelled out in the contract and cannot be terminated by the
Board of Directors, except for cause, without prejudicing the officers right to receive certain vested rights, including compensation. In the event of a change in control of the Company, as outlined in the agreement, the acquirer will be bound
to the terms of this contract.

The Company has entered into agreements with four executive officers that provide for severance pay benefits in the event
of a change in control of the Company which results in the termination of such executive officers or diminished compensation, duties or benefits.

Deferred Compensation Plan for Directors

In December 2001, the Company implemented a non-qualifying deferred compensation plan for
directors. Under the plan, a participating director may elect to defer receipt of all or a portion of his or her director fees that would otherwise be payable in cash. At the end of each calendar year, the fees electively deferred during the year
are converted, using a formula based upon 125% of the dollar amount of fees deferred and the fair value of the Companys common stock at the close of business on the preceding January 1, into a hypothetical number of shares (the
phantom shares) credited to the participating directors account. The then current value of all phantom shares accumulated under the plan is payable to the participating director, or to his or her designated beneficiary, upon



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##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2006 and 2005

NOTE N - EMPLOYEE AND DIRECTOR BENEFIT PLANS (Continued)



retirement, disability or death. Provisions of $613,000 in 2006 and $399,000 in 2005 were expensed to provide for future obligations payable under this plan.
At December 31, 2006 and December 31, 2005, the outstanding deferred obligations were $1.3 million and $719,000, respectively. Effective December 31, 2006, the amount of phantom shares credited to a director under the plan was
converted to a cash amount based on a value of $24.00 per phantom share. Beginning January 1, 2007, this amount will be credited to a bookkeeping account for each director, and each month a rate of earnings will be credited to the account for
the month equal to the 3-month LIBOR rate in effect on the last business day of the month plus 2%.

Beginning in 2007, the Company will implement a new
deferred compensation plan for directors. Under this plan, a director may elect to defer the payment of all or a portion of his or her directors fees that would otherwise have been paid currently. The fees deferred will be increased by 25% and
credited to a bookkeeping account kept by the Company for the director.

NOTE O - PARENT COMPANY FINANCIAL DATA

Following are the condensed financial statements of North State Bancorp as of and for the years ended December 31, 2006 and 2005:

Condensed Statements of Financial Condition

December 31, 2006 and 2005

(Amounts in thousands)



|                                             |  |      |        |   |      |   |        |  
|-------------------------------------------- |  | ---- | ------ | - | ---- | - | ------ | -
|                                             |  | 2006 |        |   | 2005 |  
|Assets                                       |  |      |        |   |      |   |        |  
|Cash                                         |  | $    | 3,720  |   |      | $ | 4,101  |  
|Investment in North State Bank               |  |      | 32,034 |   |      |   | 27,033 |  
|Investment in North State Statutory Trust I  |  |      | 155    |   |      |   | 155    |  
|Investment in North State Statutory Trust II |  |      | 155    |   |      |   | 155    |  
|Other assets                                 |  |      | 876    |   |      |   | 35     |  
|                                             |  |      |        |   |      |   |        |  
|Total Assets                                 |  | $    | 36,940 |   |      | $ | 31,479 |  
|                                             |  |      |        |   |      |   |        |  
|Liabilities and Shareholders equity         |  |      |        |   |      |   |        |  
|Other liabilities                            |  | $    | 33     |   |      | $ | 29     |  
|Long-term debt                               |  |      | 10,310 |   |      |   | 10,310 |  
|                                             |  |     
|Shareholders equity                         |  |      |        |   |      |   |        |  
|Common stock                                 |  |      | 4,542  |   |      |   | 2,842  |  
|Additional paid-in capital                   |  |      | 14,002 |   |      |   | 13,652 |  
|Retained earnings                            |  |      | 8,344  |   |      |   | 5,072  |  
|Accumulated other comprehensive loss         |  |      | (291   | ) |      |   | (426   | )
|                                             |  |      |        |   |      |   |        |  
|Total shareholders equity                   |  |      | 26,597 |   |      |   | 21,140 |  
|                                             |  |      |        |   |      |   |        |  
|Total liabilities and shareholders equity   |  | $    | 36,940 |   |      | $ | 31,479 |  
|                                             |  |      |        |   |      |   |        |  



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##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2006 and 2005

NOTE O - PARENT COMPANY FINANCIAL DATA (Continued)



Condensed Statements of Operations

Years Ended December 31, 2006 and 2005

(Amounts in thousands)



|                                 |  |      |       |   |      |   |       |  
|-------------------------------- |  | ---- | ----- | - | ---- | - | ----- | -
|                                 |  | 2006 |       |   | 2005 |  
|Equity in earnings of subsidiary |  | $    | 3,867 |   |      | $ | 2,760 |  
|Interest income                  |  |      | 213   |   |      |   | 3     |  
|Interest expense                 |  |      | (763  | ) |      |   | (334  | )
|Other income                     |  |      | 23    |   |      |   | 9     |  
|Other expense                    |  |      | (68   | ) |      |   |      |  
|                                 |  |      |       |   |      |   |       |  
|Net income                       |  | $    | 3,272 |   |      | $ | 2,438 |  
|                                 |  |      |       |   |      |   |       |  

Condensed Statements of Cash Flows

Years Ended December 31, 2006 and 2005

(Amounts in thousands)



|                                                                              |  |      |        |   |      |   |        |  
|----------------------------------------------------------------------------- |  | ---- | ------ | - | ---- | - | ------ | -
|                                                                              |  | 2006 |        |   | 2005 |  
|Cash flows from operating activities:                                         |  |      |        |   |      |   |        |  
|Net income                                                                    |  | $    | 3,272  |   |      | $ | 2,438  |  
|Adjustments to reconcile net income to net cash used by operating activities: |  |      |        |   |      |   |        |  
|Amortization                                                                  |  |      | 1      |   |      |   | 12     |  
|Stock based compensation                                                      |  |      | 65     |   |      |   |       |  
|Equity in earnings of subsidiaries                                            |  |      | (3,867 | ) |      |   | (2,760 | )
|Changes in assets and liabilities:                                            |  |      |        |   |      |   |        |  
|Increase in other assets                                                      |  |      | (707   | ) |      |   |       |  
|Increase in other liabilities                                                 |  |      | 4      |   |      |   | 17     |  
|                                                                              |  |      |        |   |      |   |        |  
|Net cash used by operating activities                                         |  |      | (1,232 | ) |      |   | (293   | )
|                                                                              |  |      |        |   |      |   |        |  
|Cash flows from investing activities:                                         |  |      |        |   |      |   |        |  
|Investment in subsidiaries                                                    |  |      | (1,134 | ) |      |   | (1,165 | )
|                                                                              |  |      |        |   |      |   |        |  
|Net cash used by investing activities                                         |  |      | (1,134 | ) |      |   | (1,165 | )
|                                                                              |  |      |        |   |      |   |        |  
|Cash flows from financing activities:                                         |  |      |        |   |      |   |        |  
|Issuance of junior subordinated debentures                                    |  |      |       |   |      |   | 5,155  |  
|Proceeds from stock options exercised                                         |  |      | 1,141  |   |      |   | 18     |  
|Excess tax benefits from stock options                                        |  |      | 844    |   |      |   |       |  
|Dividends from subsidiaries                                                   |  |      |       |   |      |   | 177    |  
|                                                                              |  |      |        |   |      |   |        |  
|Net cash provided by financing activities                                     |  |      | 1,985  |   |      |   | 5,350  |  
|                                                                              |  |     
|Net increase in cash and cash equivalents                                     |  |      | (381   | ) |      |   | 3,892  |  
|                                                                              |  |     
|Cash and cash equivalents, beginning                                          |  |      | 4,101  |   |      |   | 209    |  
|                                                                              |  |      |        |   |      |   |        |  
|Cash and cash equivalents, ending                                             |  | $    | 3,720  |   |      | $ | 4,101  |  
|                                                                              |  |      |        |   |      |   |        |  



F-29



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##### Table of Contents

SIGNATURES

In accordance with Section 13 or 15(d) 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.



|                     |  |                     |  |                            
|-------------------- |  | ------------------- |  | ---------------------------
|Date: March 28, 2007 |  | NORTH STATE BANCORP
|                     |  |                    
|                     |  | By:                 |  | /s/ Larry D. Barbour       
|                     |  |                     |  | Larry D. Barbour, President
|                     |  |                     |  | and Chief Executive Officer

In accordance with the Securities Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the date indicated.



|                          |  |                                                                               |  |               
|------------------------- |  | ----------------------------------------------------------------------------- |  | --------------
|Signature                 |  | Title                                                                         |  | Date          
|                          |  |                                                                              
|/s/ Larry D. Barbour      |  | President, Chief Executive Officer and Director (principal executive officer) |  | March 28, 2007
|Larry D. Barbour          |  |                                                                               | 
|                          |  |                                                                              
|/s/ Kirk A. Whorf         |  | Chief Financial Officer (principal financial officer)                         |  | March 28, 2007
|Kirk A. Whorf             |  |                                                                               | 
|                          |  |                                                                              
|/s/ JoAnn B. Bratton      |  | Controller (principal accounting officer)                                     |  | March 28, 2007
|JoAnn B. Bratton          |  |                                                                               |  |               
|                          |  |                                                                              
|/s/ Forrest H. Ball       |  | Director                                                                      |  | March 28, 2007
|Forrest H. Ball           |  |                                                                               |  |               
|                          |  |                                                                              
|/s/ James C. Branch       |  | Director                                                                      |  | March 28, 2007
|James C. Branch           |  |                                                                               |  |               
|                          |  |                                                                              
|/s/ Charles T. Francis    |  | Director                                                                      |  | March 28, 2007
|Charles T. Francis        |  |                                                                               |  |               
|                          |  |                                                                              
|/s/ Glenn Futrell         |  | Director                                                                      |  | March 28, 2007
|Glenn Futrell             |  |                                                                               |  |               
|                          |  |                                                                              
|/s/ C. Thomas Hendrickson |  | Director                                                                      |  | March 28, 2007
|C. Thomas Hendrickson     |  |                                                                               |  |               
|                          |  |                                                                              
|/s/ Jeanette W. Hyde      |  | Director                                                                      |  | March 28, 2007
|Jeanette W. Hyde          |  |                                                                               |  |               



S-1



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##### Table of Contents

|                            |  |          |  |               
|--------------------------- |  | -------- |  | --------------
|/s/ J. Keith Keener         |  | Director |  | March 28, 2007
|J. Keith Keener             |  |          |  |               
|                            |  |         
|/s/ Burley B. Mitchell, Jr. |  | Director |  | March 28, 2007
|Burley B. Mitchell, Jr.     |  |          |  |               
|                            |  |         
|/s/ Barry W. Partlo         |  | Director |  | March 28, 2007
|Barry W. Partlo             |  |          |  |               
|                            |  |         
|/s/ Gary H. Pendleton       |  | Director |  | March 28, 2007
|Gary H. Pendleton           |  |          |  |               
|                            |  |         
|/s/ W. Harold Perry         |  | Director |  | March 28, 2007
|W. Harold Perry             |  |          |  |               
|                            |  |         
|/s/ Nutan T. Shah           |  | Director |  | March 28, 2007
|Nutan T. Shah               |  |          |  |               
|                            |  |         
|                            |  | Director |  | , 2007        
|Fred J. Smith, Jr.          |  |          |  |               
|                            |  |         
|/s/ Jack M. Stancil         |  | Director |  | March 28, 2007
|Jack M. Stancil             |  |          |  |               
|                            |  |         
|/s/ George C. Venters       |  | Director |  | March 28, 2007
|George C. Venters           |  |          |  |               



S-2