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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, 2004



Commission File Number 000-49848



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MIDCAROLINA FINANCIAL CORPORATION

(Name of Small Business Issuer in Its
Charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|North Carolina                                                 |  | 56-2006811                          
|(State or Other Jurisdiction of Incorporation or Organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|3101 South Church Street Burlington, North Carolina            |  | 27215                               
|(Address of Principal Executive Offices)                       |  | (Zip Code)                          



(336) 538-1600

(Issuers Telephone Number, Including Area Code)



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



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

Title of Class



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Check whether the issuer (1) 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 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.  x



State issuers
revenues for its most recent fiscal year. $16.3 million.



State
the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was sold, or the average bid and asked prices of such common equity, as of a specified date
within the past 60 days. $30.8 million based on the closing price of the common stock on March 17, 2005 of $15.90.



State the number of shares outstanding of each of the issuers classes of common equity, as of the latest practicable date. 2,500,884 shares of
common stock, no par value, as of March 17, 2005.



DOCUMENTS
INCORPORATED BY REFERENCE



Portions of the Annual Report to Shareholders of
MidCarolina Bank for the year ended December 31, 2004 (the 2004 Annual Report), incorporated by reference into Parts I, II and III.



Portions of the Proxy Statement for the 2005 Annual Meeting of Shareholders of MidCarolina Financial Corporation, to be held on May 24, 2005 (the Proxy
Statement), are incorporated by reference into Part III.



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MidCarolina Financial Corporation

Table 1

Selected Consolidated Financial Information and Other Data

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



|                                      |  |                                       |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|------------------------------------- |  | ------------------------------------- | --------- | - | ---- | - | --------- | ---- |  | - | --------- | - |  | ---- | --------- | - |  | - | --------- | -
|                                      |  | At or for the Year Ended December 31, |          
|                                      |  | 2004                                  |           |   | 2003 |   |           | 2002 |  |   | 2001      |   |  | 2000 |          
|Operating Data:                       |  |                                       |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Total interest income                 |  | $                                     | 12,174    |   |      | $ | 9,652     |      |  | $ | 8,982     |   |  | $    | 9,199     |   |  | $ | 8,222     |  
|Total interest expense                |  |                                       | 4,383     |   |      |   | 3,298     |      |  |   | 3,338     |   |  |      | 4,879     |   |  |   | 4,580     |  
|                                      |  |                                       |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Net interest income                   |  |                                       | 7,791     |   |      |   | 6,354     |      |  |   | 5,644     |   |  |      | 4,320     |   |  |   | 3,642     |  
|Provision for loan losses             |  |                                       | 1,030     |   |      |   | 586       |      |  |   | 573       |   |  |      | 735       |   |  |   | 540       |  
|                                      |  |                                       |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Net interest income after provision   |  |                                       | 6,761     |   |      |   | 5,768     |      |  |   | 5,071     |   |  |      | 3,585     |   |  |   | 3,102     |  
|Noninterest income                    |  |                                       | 4,141     |   |      |   | 3,575     |      |  |   | 2,091     |   |  |      | 1,382     |   |  |   | 574       |  
|Noninterest expense                   |  |                                       | 8,010     |   |      |   | 6,845     |      |  |   | 5,398     |   |  |      | 4,049     |   |  |   | 3,208     |  
|                                      |  |                                       |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Income before income taxes            |  |                                       | 2,892     |   |      |   | 2,498     |      |  |   | 1,764     |   |  |      | 918       |   |  |   | 468       |  
|Provision for income taxes            |  |                                       | 950       |   |      |   | 835       |      |  |   | 489       |   |  |      | 151       |   |  |   |          |  
|                                      |  |                                       |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Net income                            |  | $                                     | 1,942     |   |      | $ | 1,663     |      |  | $ | 1,275     |   |  | $    | 767       |   |  | $ | 468       |  
|                                      |  |                                       |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Per Share Data (1):                   |  |                                       |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Earnings per share - basic            |  | $                                     | 0.78      |   |      | $ | 0.68      |      |  | $ | 0.53      |   |  | $    | 0.32      |   |  | $ | 0.19      |  
|Earnings per share - diluted          |  |                                       | 0.72      |   |      |   | 0.63      |      |  |   | 0.49      |   |  |      | 0.31      |   |  |   | 0.18      |  
|Market price                          |  |                                       |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|High                                  |  |                                       | 21.25     |   |      |   | 16.67     |      |  |   | 10.33     |   |  |      | 10.42     |   |  |   | 8.36      |  
|Low                                   |  |                                       | 13.00     |   |      |   | 9.31      |      |  |   | 9.55      |   |  |      | 5.52      |   |  |   | 5.52      |  
|Close                                 |  |                                       | 17.50     |   |      |   | 14.64     |      |  |   | 9.90      |   |  |      | 10.10     |   |  |   | 5.79      |  
|Book value                            |  |                                       | 6.56      |   |      |   | 5.82      |      |  |   | 5.16      |   |  |      | 4.61      |   |  |   | 4.23      |  
|                                      |  |                                       |           |   |     
|Weighted average shares outstanding   |  |                                       |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Basic                                 |  |                                       | 2,495,651 |   |      |   | 2,463,359 |      |  |   | 2,423,202 |   |  |      | 2,403,685 |   |  |   | 2,403,181 |  
|Diluted                               |  |                                       | 2,689,026 |   |      |   | 2,651,220 |      |  |   | 2,588,521 |   |  |      | 2,552,128 |   |  |   | 2,510,581 |  
|                                      |  |                                       |           |   |     
|Selected Year-End Balance Sheet Data: |  |                                       |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Total assets                          |  | $                                     | 284,888   |   |      | $ | 212,561   |      |  | $ | 169,429   |   |  | $    | 137,471   |   |  |   | 117,402   |  
|Loans, held to maturity               |  |                                       | 217,683   |   |      |   | 178,913   |      |  |   | 141,207   |   |  |      | 114,424   |   |  |   | 89,903    |  
|Allowance for loan losses             |  |                                       | 2,865     |   |      |   | 2,522     |      |  |   | 2,088     |   |  |      | 1,633     |   |  |   | 1,319     |  
|Deposits                              |  |                                       | 216,791   |   |      |   | 151,982   |      |  |   | 142,175   |   |  |      | 120,413   |   |  |   | 102,748   |  
|Short-term borrowings                 |  |                                       | 15,500    |   |      |   | 18,500    |      |  |   |          |   |  |      | 1,000     |   |  |   |          |  
|Long-term debt                        |  |                                       | 34,764    |   |      |   | 26,500    |      |  |   | 13,000    |   |  |      | 4,000     |   |  |   | 4,000     |  
|Shareholders equity                  |  |                                       | 16,424    |   |      |   | 14,411    |      |  |   | 12,681    |   |  |      | 11,096    |   |  |   | 10,163    |  
|                                      |  |                                       |           |   |     
|Selected Average Balances:            |  |                                       |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Total assets                          |  | $                                     | 253,352   |   |      | $ | 192,822   |      |  | $ | 157,437   |   |  |      | 128,632   |   |  |   | 103,499   |  
|Loans, net                            |  |                                       | 204,121   |   |      |   | 160,041   |      |  |   | 118,702   |   |  |      | 100,816   |   |  |   | 75,775    |  
|Total interest-earning assets         |  |                                       | 241,992   |   |      |   | 177,780   |      |  |   | 144,870   |   |  |      | 119,086   |   |  |   | 96,027    |  
|Deposits                              |  |                                       | 187,090   |   |      |   | 150,962   |      |  |   | 138,765   |   |  |      | 113,356   |   |  |   | 90,372    |  
|Total interest-bearing liabilities    |  |                                       | 215,080   |   |      |   | 158,961   |      |  |   | 131,171   |   |  |      | 106,028   |   |  |   | 85,364    |  
|Shareholders equity                  |  |                                       | 15,484    |   |      |   | 13,665    |      |  |   | 11,833    |   |  |      | 10,679    |   |  |   | 9,745     |  
|                                      |  |                                       |           |   |     
|Selected Performance Ratios:          |  |                                       |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |  
|Return on average assets              |  |                                       | 0.77      | % |      |   | 0.86      | %    |  |   | 0.81      | % |  |      | 0.60      | % |  |   | 0.45      | %
|Return on average equity              |  |                                       | 12.54     | % |      |   | 12.17     | %    |  |   | 10.77     | % |  |      | 7.18      | % |  |   | 4.80      | %
|Net interest spread                   |  |                                       | 2.99      | % |      |   | 3.35      | %    |  |   | 3.66      | % |  |      | 3.12      | % |  |   | 3.20      | %
|Net interest margin/yield             |  |                                       | 3.22      | % |      |   | 3.57      | %    |  |   | 3.90      | % |  |      | 3.63      | % |  |   | 3.79      | %
|Noninterest income to total revenue   |  |                                       | 34.70     | % |      |   | 36.01     | %    |  |   | 27.03     | % |  |      | 24.24     | % |  |   | 13.61     | %
|Noninterest income to average assets  |  |                                       | 1.63      | % |      |   | 1.85      | %    |  |   | 1.33      | % |  |      | 1.07      | % |  |   | 0.55      | %
|Noninterest expense to average assets |  |                                       | 3.16      | % |      |   | 3.55      | %    |  |   | 3.43      | % |  |      | 3.15      | % |  |   | 3.10      | %



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|                                                 |  |                                       |   |  |        |   |  |         |   |  |        |   |  |       |  
|------------------------------------------------ |  | ------------------------------------- | - |  | ------ | - |  | ------- | - |  | ------ | - |  | ----- | -
|                                                 |  | At or for the Year Ended December 31, |  
|                                                 |  | 2004                                  |   |  | 2003   |   |  | 2002    |   |  | 2001   |   |  | 2000  |  
|Asset Quality Ratios:                            |  |                                       |   |  |        |   |  |         |   |  |        |   |  |       |  
|Nonperforming loans to period-end loans          |  | 0.11                                  | % |  | 0.32   | % |  | 0.06    | % |  | 0.65   | % |  | 0.00  | %
|Allowance for loan losses to period-end loans    |  | 1.32                                  | % |  | 1.41   | % |  | 1.48    | % |  | 1.43   | % |  | 1.47  | %
|Allowance for loan losses to nonperforming loans |  | 1127.95                               | % |  | 428.18 | % |  | 2610.00 | % |  | 218.61 | % |  | NM    |  
|Nonperforming assets to total assets             |  | 0.80                                  | % |  | 0.29   | % |  | 0.05    | % |  | 0.54   | % |  | 0.00  | %
|Net loan charge-offs to average loans            |  | 0.34                                  | % |  | 0.09   | % |  | 0.10    | % |  | 0.42   | % |  | 0.21  | %
|                                                 |  |                                       |   |  |       
|Capital Ratios:                                  |  |                                       |   |  |        |   |  |         |   |  |        |   |  |       |  
|Total risk-based capital                         |  | 11.13                                 | % |  | 13.11  | % |  | 10.28   | % |  | 9.45   | % |  | 10.81 | %
|Tier 1 risk-based capital                        |  | 8.78                                  | % |  | 9.95   | % |  | 12.05   | % |  | 10.70  | % |  | 12.06 | %
|Leverage ratio                                   |  | 7.83                                  | % |  | 9.53   | % |  | 9.59    | % |  | 8.60   | % |  | 9.82  | %
|Equity to assets ratio                           |  | 5.77                                  | % |  | 6.78   | % |  | 7.48    | % |  | 8.07   | % |  | 8.66  | %
|                                                 |  |                                       |   |  |       
|Other Data:                                      |  |                                       |   |  |        |   |  |         |   |  |        |   |  |       |  
|Number of banking offices                        |  | 6                                     |   |  | 5      |   |  | 4       |   |  | 4      |   |  | 3     |  
|Number of full time equivalent employees         |  | 77                                    |   |  | 63     |   |  | 41      |   |  | 33     |   |  | 33    |  

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|(1) | All per share data has been restated to reflect the effects of a stock split effected in the form of a 20% stock dividend in 2001, a stock split effected in the form of a 10% stock
dividend in 2002 and a stock split effected in the form of a 20% stock dividend in 2003 and a declared stock dividend on January 14, 2005.
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PART I



ITEM 1. DESCRIPTION OF BUSINESS



General



MidCarolina Financial Corporation (the Company) was formed in 2002 to serve as a holding company for MidCarolina Bank (the Bank). The Company is registered with the Board of Governors of the
Federal Reserve System (the Federal Reserve) under the Bank Holding Company Act of 1956, as amended (the BHCA) and the bank holding company laws of North Carolina. The Companys office is located at 3101 South Church
Street, Burlington, North Carolina 27216. The Companys principal source of income is earnings on investments. In addition, the Company will receive any dividends that are declared and paid by the Bank on its capital stock.



The Bank is incorporated under the laws of North Carolina and began operations on August 14,
1997 as a North Carolina chartered commercial bank. The Bank is engaged in general commercial banking primarily in Alamance and Guilford Counties, North Carolina, and operates under the banking laws of North Carolina and the rules and regulations of
the Federal Deposit Insurance Corporation (the FDIC).



As a North
Carolina bank, the Bank is subject to examination and regulation by the FDIC and the Commissioner of Banks, North Carolina Department of Commerce (the Commissioner). The Bank is further subject to certain regulations of the Federal
Reserve governing reserve requirements to be maintained against deposits and other matters. The business and regulation of the Bank are also subject to legislative changes from time to time. See SUPERVISION AND REGULATION.



The Banks primary market area is Alamance County, North Carolina. The Banks main
office and Cum-Park office are located in Burlington, North Carolina, it has one full-service branch in Graham, North Carolina, one full-service branch located in Greensboro, North Carolina and one mortgage production office in Raleigh, North
Carolina. In February 2005, the Bank announced that it would discontinue mortgage production activities in Raleigh. The Bank has limited service offices in the Alamance Regional Medical Center and the Village of Brookwood Retirement Center, both of
which are located in Burlington, North Carolina. The Banks loans and deposits are primarily generated from the areas where its offices are located.



The Banks primary source of revenue is interest and fee income from its lending activities. These lending activities consist principally of originating commercial
operating and working capital loans, residential mortgage loans, home equity lines of credit, other consumer loans and loans secured by commercial real estate. The Banks current lending strategy is to establish market share throughout Alamance
and Guilford Counties, with an emphasis in Burlington, Graham and Greensboro, North Carolina. At December 31, 2004, the largest amount the Bank had outstanding to any one borrower and its affiliates was approximately $3.8 million.



Interest and dividend income from investment activities generally provide the second largest
source of income to the Bank after interest on loans. During 2004, the Bank chose to enhance its overall liquidity position by increasing its securities portfolio and deploying more of its funds into lower risk mortgage backed securities with short
durations and U.S. Agency securities. The interest and dividends on the investment portfolio therefore increased significantly during 2004.



Deposits are the primary source of the Banks funds for lending and other investment purposes. The Bank attracts both short-term and long-term deposits from the
general public by offering a variety of accounts and rates. The Bank offers statement savings accounts, negotiable order of withdrawal accounts, money market demand accounts, non-interest-bearing accounts and fixed interest rate certificates with
varying maturities. The Bank also utilizes alternative sources of funds such as Certificates of Deposit raised over the Internet, Brokered Certificates of Deposit and borrowings from the Federal Home Loan Bank (the FHLB) of Atlanta,
Georgia.



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



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The Bank is the sole banking subsidiary of the Company. Two Trusts (MidCarolina I and MidCarolina Trust II) have been
formed as subsidiaries to the Company to facilitate the infusion of Trust Preferred Securities as a form of non-dilutive equity into the Company. The trusts are not consolidated in the financial statements. The majority of the Companys
operations are located at the Bank level. Throughout this Annual Report, results of operations will be discussed by referring to the Banks operations, unless a specific reference is made to the Company and its operating results apart from the
Bank.



The Bank continues to experience steady growth since its formation in
1997. The Banks assets totaled $284.9 million, $212.6 million and $169.4 million as of December 31, 2004, 2003 and 2002, respectively. Net income for the year ended December 31, 2004 was $1.9 million, or $0.72 per diluted share, compared with
$1.7 million, or $0.63 per diluted share for the year ended December 31, 2003. The per share amounts have been adjusted to reflect the 6-for-5 stock split effective January 14, 2005.



At December 31, 2004, the Company had total assets of $284.9 million, net loans of $217.7 million, deposits of $216.8 million, investment
securities, available-for-sale of $35.9 million and shareholders equity of $16.4 million.



Subsidiaries



Other than the Bank, the
Company has two trust subsidiaries: MidCarolina I and MidCarolina Trust II. The Bank has one subsidiary, MidCarolina Investments, Inc. MidCarolina Investments engages in general securities brokerage and offers insurance and other financial services
through a contract arrangement with a third-party provider.



Employees



At December 31, 2004, the Bank had 77 full-time equivalent employees.



Competition and Market Area



The Bank faces strong competition both in attracting deposits and making real estate and
other loans. Its most direct competition for deposits comes from commercial banks, savings institutions and credit unions located in its primary market area, including large financial institutions that have greater financial and marketing resources
available to them. At December 31, 2004, there were 13 depository institutions with 47 offices in Alamance County. The Bank had a deposit market share of 8.8% in Alamance County. The Bank also faces additional significant competition for
investors funds from short-term money market securities and other corporate and government securities. The ability of the Bank to attract and retain savings deposits depends on its ability to generally provide a rate of return, liquidity and
risk comparable to that offered by competing investment opportunities.



The
Banks competition for real estate loans is from savings institutions, commercial banks, and mortgage banking companies. It competes for loans primarily through the interest rates and loan fees it charges and the efficiency and quality of
services it provides borrowers. Competition is increasing as a result of the reduction of restrictions on the interstate operations of financial institutions.



The Banks primary market area is Alamance County, North Carolina. The population of Alamance County is 135,453 and the per capita income is $26,459. Alamance
County has a diverse economy with no concentration in any specific industry. Major businesses and industries in the area are LabCorp, a laboratory that provides specialized testing services for the medical industry, Alamance Health Services, Elon
College and GKN Automotive, a manufacturer of automobile drive shafts.



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Supervision and Regulation



Bank holding companies and state commercial banks are extensively regulated under both federal and state law. The following is a brief
summary of certain statutes and rules and regulations that affect or will affect the Company and the Bank. This summary is qualified in its entirety by reference to the particular statute and regulatory provisions referred to below and is not
intended to be an exhaustive description of the statutes or regulations applicable to the business of the Company and the Bank. Supervision, regulation and examination of the Company and the Bank by the regulatory agencies are intended primarily for
the protection of depositors rather than shareholders of the Company.



General.There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by law and regulatory policy that are designed to minimize potential loss to the depositors
of such depository institutions and the FDIC insurance funds in the event the depository institution becomes in danger of default or in default. For example, to avoid receivership of an insured depository institution subsidiary, a bank holding
company is required to guarantee the compliance of any insured depository institution subsidiary that may become undercapitalized with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal
banking agency up to the lesser of (i) an amount equal to 5% of the banks total assets at the time the bank became undercapitalized or (ii) the amount which is necessary (or would have been necessary) to bring the bank into compliance with all
acceptable capital standards as of the time the bank fails to comply with such capital restoration plan. The Company, as a registered bank holding company, is subject to the regulation of the Federal Reserve. Under a policy of the Federal Reserve
with respect to bank holding company operations, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit resources to support such institutions in circumstances where it
might not do so absent such policy. The Federal Reserve under the BHCA also has the authority to require a bank holding company to terminate any activity or to relinquish control of a non-bank subsidiary (other than a non-bank subsidiary of a bank)
upon the Federal Reserves determination that such activity or control constitutes a serious risk to the financial soundness and stability of any bank subsidiary of the bank holding company.



In addition, insured depository institutions under common control are required to reimburse
the FDIC for any loss suffered by its deposit insurance funds as a result of the default of a commonly controlled insured depository institution or for any assistance provided by the FDIC to a commonly controlled insured depository institution in
danger of default. The FDIC may decline to enforce the cross-guarantee provisions if it determines that a waiver is in the best interest of the deposit insurance funds. The FDICs claim for damages is superior to claims of stockholders of the
insured depository institution or its holding company but is subordinate to claims of depositors, secured creditors and holders of subordinated debt (other than affiliates) of the commonly controlled insured depository institutions.



As a result of the Companys ownership of the Bank, the Company is also registered under
the bank holding company laws of North Carolina. Accordingly, the Company is also subject to regulation and supervision by the Commissioner.



Capital Adequacy Guidelines for Holding Companies.The Federal Reserve has adopted capital adequacy guidelines for bank holding companies and banks that are
members of the Federal Reserve System and have consolidated assets of $150 million or more. Bank holding companies subject to the Federal Reserves capital adequacy guidelines are required to comply with the Federal Reserves risk-based
capital guidelines. Under these regulations, the minimum ratio of total capital to risk-weighted assets is 8%. At least half of the total capital is required to be Tier I capital, principally consisting of common stockholders
equity, non-cumulative perpetual preferred stock, and a limited amount of cumulative perpetual preferred stock, less certain goodwill items. The remainder (Tier II capital) may consist of a limited amount of subordinated debt, certain
hybrid capital instruments and other debt securities, perpetual preferred stock and a limited amount of the allowance for loan losses. In addition to the risk-based capital guidelines, the Federal Reserve has adopted a minimum Tier I capital
(leverage) ratio, under which a bank holding company must maintain a minimum level of Tier I capital to average total consolidated assets of at least 3% in the case of a bank holding company which has the highest regulatory examination rating and is
not contemplating significant growth or expansion. All other bank holding companies are expected to maintain a Tier I capital (leverage) ratio of at least 1% to 2% above the stated minimum.



Capital Requirements for the Bank. The Bank, as a North Carolina commercial bank, is
required to maintain a



6



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surplus account equal to 50% or more of its paid-in capital stock. As a North Carolina chartered, FDIC-insured commercial bank that is not a member of the
Federal Reserve, the Bank is also subject to capital requirements imposed by the FDIC. Under the FDICs regulations, state nonmember banks that (a) receive the highest rating during the examination process and (b) are not anticipating or
experiencing any significant growth, are required to maintain a minimum leverage ratio of 3% of total consolidated assets; all other banks are required to maintain a minimum ratio of 1% or 2% above the stated minimum, with a minimum leverage ratio
of not less than 4%. The Bank exceeded all applicable capital requirements as of December 31, 2004.



Dividend and Repurchase Limitations.The Company must obtain Federal Reserve approval prior to repurchasing common stock in excess of 10% of its net worth during any twelve-month period unless the Company (i)
both before and after the redemption satisfies capital requirements for well capitalized state member banks; (ii) received a one or two rating in its last examination; and (iii) is not the subject of any unresolved supervisory issues.



Although the payment of dividends and repurchase of stock by the Company are
subject to certain requirements and limitations of North Carolina corporate law, except as set forth in this paragraph, neither the Commissioner nor the FDIC have promulgated any regulations specifically limiting the right of the Company to pay
dividends and repurchase shares. However, the ability of the Company to pay dividends or repurchase shares may be dependent upon the Companys receipt of dividends from the Bank.



North Carolina commercial banks, such as the Bank, are subject to legal limitations on the amounts of dividends they are permitted to pay.
The Bank may pay dividends from undivided profits, which are determined by deducting and charging certain items against actual profits, including any contributions to surplus required by North Carolina law. Also, an insured depository institution,
such as the Bank, is prohibited from making capital distributions, including the payment of dividends, if, after making such distribution, the institution would become undercapitalized (as such term is defined in the applicable law and
regulations).



Deposit Insurance Assessments.The Bank is subject to
insurance assessments imposed by the FDIC. Under current law, the insurance assessment to be paid by members of the Bank Insurance Fund, such as the Bank, shall be as specified in a schedule required to be issued by the FDIC. FDIC assessments for
deposit insurance range from 0 to 31 basis points per $100 of insured deposits, depending on the institutions capital position and other supervisory factors.



Federal Home Loan Bank System.The FHLB system provides a central credit facility for member institutions. In December 2004, the FHLB
of Atlanta implemented a new capital plan. As a member of the FHLB of Atlanta and under the new capital plan, the bank is required to own capital stock in the FHLB Atlanta in an amount at least equal to 0.20% (or 20 basis points) of the Banks
total assets at the end of each calendar year, plus 4.5% of its outstanding advances (borrowings) from the FHLB of Atlanta under the new activity-based stock ownership requirement. On December 31, 2004, the Bank was in compliance with this
requirement.



Community Reinvestment.Under the Community Reinvestment
Act (CRA), as implemented by regulations of the FDIC, an insured institution has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low
and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions, nor does it limit an institutions discretion to develop, consistent with the CRA, the types of products and
services that it believes are best suited to its particular community. The CRA requires the federal banking regulators, in connection with their examinations of insured institutions, to assess the institutions records of meeting the credit
needs of their communities, using the ratings of outstanding, satisfactory, needs to improve, or substantial noncompliance, and to take those records into account in its evaluation of certain
applications by those institutions. All institutions are required to make public disclosure of their CRA performance ratings. The Bank received a satisfactory rating in its last CRA examination that was conducted during May 2004.



Prompt Corrective Action.The FDIC has broad powers to take corrective
action to resolve the problems of insured depository institutions. The extent of these powers will depend upon whether the institution in question is well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized or critically undercapitalized. Under the regulations, an institution is considered well capitalized if it has (i) a total risk-based capital ratio of 10% or greater, (ii) a Tier I
risk-based capital ratio of 6% or greater, (iii) a leverage ratio of 5% or greater and (iv) is not subject to any order or written directive to meet and maintain a specific capital level for any capital measure. An adequately capitalized
institution is defined as one that has (i) a total risk-based capital ratio of 8% or greater, (ii) a Tier I risk-based capital ratio of 4% or greater and (iii) a leverage ratio of 4% or greater (or 3% or greater in the case of an institution with
the highest examination rating). An institution is considered (A) undercapitalized if it has (i) a total risk-based capital ratio of less than 8%, (ii) a Tier I risk-based capital ratio of



7



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less than 4% or (iii) a leverage ratio of less than 4% (or 3% in the case of an institution with the highest examination rating); (B) significantly
undercapitalized if the institution has (i) a total risk-based capital ratio of less than 6%, or (ii) a Tier I risk-based capital ratio of less than 3% or (iii) a leverage ratio of less than 3% and (C) critically undercapitalized
if the institution has a ratio of tangible equity to total assets equal to or less than 2%.



Changes in Control.The BHCA prohibits the Company from acquiring direct or indirect control of more than 5% of the outstanding voting stock or substantially all of the assets of any bank or savings bank or
merging or consolidating with another bank holding company or savings bank holding company without prior approval of the Federal Reserve. Similarly, Federal Reserve approval (or, in certain cases, non-disapproval) must be obtained prior to any
person acquiring control of the Company. Control is conclusively presumed to exist if, among other things, a person acquires more than 25% of any class of voting stock of the Company or controls in any manner the election of a majority of the
directors of the Company. Control is presumed to exist if a person acquires more than 10% of any class of voting stock and the stock is registered under Section 12 of the Securities Exchange Act of 1934, as amended (the Exchange Act) or
the acquirer will be the largest shareholder after the acquisition.



Federal
Securities Law.The Company has registered its common stock with the Securities and Exchange Commission (the SEC) pursuant to Section 12(g) of the Exchange Act. As a result of such registration, the proxy and tender offer rules,
insider trading reporting requirements, annual and periodic reporting and other requirements of the Exchange Act are applicable to the Company.



Transactions with Affiliates.Under current federal law, depository institutions are subject to the restrictions contained in Section 22(h) of the Federal Reserve
Act with respect to loans to directors, executive officers and principal shareholders. Under Section 22(h), loans to directors, executive officers and shareholders who own more than 10% of a depository institution (18% in the case of institutions
located in an area with less than 30,000 in population) and certain affiliated entities of any of the foregoing, may not exceed, together with all other outstanding loans to such person and affiliated entities, the institutions
loans-to-one-borrower limit (as discussed below). Section 22(h) also prohibits loans above amounts prescribed by the appropriate federal banking agency to directors, executive officers and shareholders who own more than 10% of an institution and
their respective affiliates, unless such loans are approved in advance by a majority of the board of directors of the institution. Any interested director may not participate in the voting. The FDIC has prescribed the loan amount (which
includes all other outstanding loans to such person), as to which such prior board of director approval is required, as being the greater of $25,000 or 5% of capital and surplus (up to $500,000). Further, pursuant to Section 22(h), the Federal
Reserve requires that loans to directors, executive officers, and principal shareholders be made on terms substantially the same as offered in comparable transactions with non-executive employees of the Bank. The FDIC has imposed additional limits
on the amount a bank can loan to an executive officer.



Loans to One
Borrower.The Bank is subject to the Commissioners loans to one borrower limits, which are substantially the same as those applicable to national banks. Under these limits, no loans and extensions of credit to any borrower outstanding at
one time and not fully secured by readily marketable collateral shall exceed 15% of the unimpaired capital and unimpaired surplus of the bank. Loans and extensions of credit fully secured by readily marketable collateral may comprise an additional
10% of unimpaired capital and unimpaired surplus.



Gramm-Leach-Bliley
Act. The federal Gramm-Leach-Bliley Act enacted in 1999 (the GLB Act) dramatically changed various federal laws governing the banking, securities and insurance industries. The GLB Act has expanded opportunities for banks and bank
holding companies to provide services and engage in other revenue-generating activities that previously were prohibited to them. However, this expanded authority also may present us with new challenges as our larger competitors are able to expand
their services and products into areas that are not feasible for smaller, community oriented financial institutions. The GLB Act likely will have a significant economic impact on the banking industry and on competitive conditions in the financial
services industry generally.



USA Patriot Act of 2001. The USA Patriot
Act of 2001was enacted in response to the terrorist attacks that occurred in New York, Pennsylvania and Washington, D.C. on September 11, 2001. The Act 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 potential impact of the Act on financial institutions of all kinds is significant and wide ranging. The Act contains sweeping anti-money laundering and financial transparency laws and
imposes 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.



8



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Sarbanes-Oxley Act of 2002.On July 30, 2002, the Sarbanes-Oxley Act of 2002 was signed into law and made some of
the most sweeping federal legislation addressing accounting, corporate governance and disclosure issues. The impact of the Sarbanes-Oxley Act is wide-ranging as it applies to all public companies and imposes significant new requirements for public
company governance and disclosure requirements.



In general, the Sarbanes-Oxley
Act mandates corporate governance and financial reporting requirements intended to enhance the accuracy and transparency of public companies reported financial results. It establishes new responsibilities for corporate chief executive
officers, chief financial officers and audit committees in the financial reporting process and creates a new regulatory body to oversee auditors of public companies. It backs these requirements with new SEC enforcement tools, increases criminal
penalties for federal mail, wire and securities fraud and creates new criminal penalties for document and record destruction in connection with federal investigations. It also increases the opportunity for more private litigation by lengthening the
statute of limitations for securities fraud claims and providing new federal corporate whistleblower protection.



The economic and operational effects of this new legislation on public companies, including the Bank, will be significant in terms of the time, resources and costs
associated with complying with the new law. Because the Sarbanes-Oxley Act, for the most part, applies equally to larger and smaller public companies, we will be presented with additional challenges as a smaller, community-oriented financial
institution seeking to compete with larger financial institutions in our market.



Other.The federal banking agencies, including the FDIC, have developed joint regulations requiring annual examinations of all insured depository institutions by the appropriate federal banking agency, with some exceptions for small,
well-capitalized institutions and state chartered institutions examined by state regulators and establish operational and managerial, asset quality, earnings and stock valuation standards for insured depository institutions as well as compensation
standards when such compensation would endanger the insured depository institution or would constitute an unsafe practice.



In addition, the Bank is subject to various other state and federal laws and regulations, including state usury laws, laws relating to fiduciaries, consumer credit and
equal credit, fair credit reporting laws and laws relating to branch banking. The Bank, as an insured North Carolina commercial bank, is prohibited from engaging as a principal in activities that are not permitted for national banks, unless (i) the
FDIC determines that the activity would pose no significant risk to the appropriate deposit insurance fund and (ii) the Bank is, and continues to be, in compliance with all applicable capital standards.



Under Chapter 53 of the North Carolina General Statutes, if the capital stock of a North
Carolina commercial bank is impaired by losses or otherwise, the Commissioner is authorized to require payment of the deficiency by assessment upon the banks shareholders, pro rata, and to the extent necessary, if any such assessment is not
paid by any shareholder, upon 30 days notice, to sell as much as is necessary of the stock of such shareholder to make good the deficiency.



ITEM 2. DESCRIPTION OF PROPERTY



The Banks main office is located at 3101 South Church Street, Burlington, North Carolina. The Bank also has full-service branch offices located at Cum-Park Plaza,
2214 North Church Street, Burlington, 701 Green Valley Road, Greensboro, North Carolina and 842 South Main Street, Graham, North Carolina. The Bank occupies space in the Alamance Regional Medical Center in Burlington from which it operates a
limited-service office as well as a limited-service office located in the Village of Brookwood Retirement Center located in Burlington, North Carolina. The Bank operates an in-house mortgage operations facility in Burlington, North Carolina The Bank
will no longer operate its mortgage production facility in Raleigh, North Carolina. The Cum-Park Plaza office property, the Greensboro branch and the Banks in-house mortgage operations facility located in Burlington, are leased.



The total net book value of the Banks furniture, fixtures, leasehold improvements and
equipment at December 31, 2004 was approximately $4.1 million. All properties are considered by the Banks management to be in good condition and adequately covered by insurance. Additional information about this property is set forth in Note
(F) to the Consolidated Financial Statements contained in this Form 10-KSB, which note is incorporated herein by reference. Any property acquired as a result of foreclosure or by deed in lieu of foreclosure is classified as Other Real Estate Owned
until such time as it is sold or otherwise disposed of by the Bank to recover its investment. As of December 31, 2004, the Bank had $2.0 million classified as Other Real Estate Owned.



9



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ITEM 3. LEGAL PROCEEDINGS



In the opinion of management, neither the Company nor the Bank is involved in any pending legal proceedings other than routine litigation
that is incidental to its business.



ITEM 4. SUBMISSION OF MATTERS TO A VOTE
OF SECURITY HOLDERS



No matter was submitted to a vote of the stockholders
of the Company during the fourth quarter of the fiscal year ended December 31, 2004.



PART II



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



There currently is a limited local trading market for the Companys common stock, and there can be no assurance that a more active market will develop. The Companys common stock is traded over-the-counter with quotations
available on the National Daily Quotation Services Bulletin Board under the symbol MFC1. Scott & Stringfellow is the market maker for the Companys common stock. There were 1,398 stockholders of record as of December
31, 2004, not including the persons or entities whose stock is held in nominee or street name and by various banks and brokerage firms.



The table below presents the over-the-counter market quotations for the Companys or the Banks common stock, as appropriate, for the year- ended December 31,
2004 and 2003. The quotations, which have been adjusted to reflect declared stock splits in the form of stock dividends in 2004 and 2003, reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not represent actual
transactions.



|               |  |      |       |     |   |      
|-------------- |  | ---- | ----- | --- | - | -----
|               |  | High |       | Low
|2004           |  |      |       |     |   |      
|First quarter  |  | $    | 14.64 |     | $ | 13.01
|Second quarter |  | $    | 15.00 |     | $ | 13.00
|Third quarter  |  | $    | 16.67 |     | $ | 13.54
|Fourth quarter |  | $    | 21.25 |     | $ | 14.38
|               |  |     
|2003           |  |      |       |     |   |      
|First quarter  |  | $    | 10.21 |     | $ | 9.31 
|Second quarter |  | $    | 12.89 |     | $ | 9.83 
|Third quarter  |  | $    | 16.67 |     | $ | 12.95
|Fourth quarter |  | $    | 15.42 |     | $ | 13.54



See ITEM 1. DESCRIPTION OF
BUSINESS  Supervision and Regulation above for regulatory restrictions which limit the ability of the Bank to pay dividends. Neither the Company nor the Bank has paid any cash dividends to stockholders from the time either began
operations through December 31, 2004. Management believes that the most effective use of its capital is to retain it for the purpose of supporting continued growth in earning assets.



Information required by Item 201 (d) by Regulation KSB can be found in the Proxy Statement under section captioned Proposal I 
Election of Directors.



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ITEM 6. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND PLAN OF OPERATIONS



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



FORWARD LOOKING STATEMENTS



This report contains certain forward-looking statements with respect to the financial condition, results of operations and business of
the Company and the Bank. These forward-looking statements involve risks and uncertainties and are based on the beliefs and assumptions of management of the Company and on the information available to management at the time that these disclosures
were prepared. These statements can be identified by the use of words like expect, anticipate, estimate and believe, variations of these words and other similar expressions. Readers should not place
undue reliance on forward-looking statements as a number of important factors could cause actual results to differ materially from those in the forward-looking statements. Factors that could cause actual results to differ materially include, but are
not limited to, (1) competition in the Banks markets, (2) changes in the interest rate environment, (3) general national, regional or local economic conditions may be less favorable than expected, resulting in, among other things, a
deterioration in credit quality and the possible impairment of collectibility of loans, (4) legislative or regulatory changes, including changes in accounting standards, (5) significant changes in the federal and state legal and regulatory
environment and tax laws, (6) the impact of changes in monetary and fiscal policies, laws, rules and regulations and (7) other risks and factors identified in the Companys other filings with the SEC. The Company undertakes no obligation to
update any forward-looking statements.



EXECUTIVE OVERVIEW



Significant accomplishments



In the opinion of MidCarolinas management, the Companys most significant
accomplishments during 2004, which are discussed in more detail in this Item 6, were as follows:



| |  |  | Total loans held to maturity increased 21.2%
| | - |  | --------------------------------------------



| |  |  | Total real estate loans increased 26.5%
| | - |  | ---------------------------------------



| |  |  | Commercial and industrial loans increased 23.0%
| | - |  | -----------------------------------------------



| |  |  | Average non-interest bearing deposits increased 25.4%
| | - |  | -----------------------------------------------------



| |  |  | Mortgage banking income increased 31.7%
| | - |  | ---------------------------------------



| |  |  | Total mortgage originations reached a record $120.8 million
| | - |  | -----------------------------------------------------------



| |  |  | The Green Valley full service branch was opened in Greensboro, NC during July 2004
| | - |  | ----------------------------------------------------------------------------------



Challenges



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



| |  |  | Sustaining profitable growth
| | - |  | ----------------------------



| |  |  | Improving efficiency
| | - |  | --------------------



| |  |  | Volatility in mortgage banking business
| | - |  | ---------------------------------------



| |  |  | Competition from bank and non-bank entities
| | - |  | -------------------------------------------



| |  |  | Fierce price competition
| | - |  | ------------------------



SELECTED CONSOLIDATED FINANCIAL INFORMATION AND OTHER DATA



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



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FINANCIAL CONDITION

DECEMBER 31, 2004 AND 2003



The Company reported strong asset growth
during 2004, with total assets increasing by $72.3 million, or 34.0%, to $284.9 million at year-end. This growth was principally reflected in increased loans and securities. Loans, excluding those held for sale, increased by $38.8 million, or 21.7%,
from $178.9 million at the beginning of the year to $217.7 million at year end. Investment securities increased by $28.2 million, or 364.3%, from $7.7 million to $35.9 million. The increase in loans was composed principally of increases of $13.4
million and $17.1 million, respectively, in construction loans and commercial mortgage loans, two areas of lending the Company targets and intends to continue targeting in the future. Liquid assets, consisting of cash and demand balances due from
banks, interest-earning deposits in other banks and investment securities, were 16.2% of total assets, at December 31, 2004, an increase from the 7.8% of total assets at December 31, 2003. The Bank, as a member of the FHLB of Atlanta, has an
investment of $2.3 million in FHLB stock. The Banks investment in life insurance used to offset the cost of employee benefit plans, increased by $234,000 during 2004 to $6.8 million. The increase was due to an increase in the cash surrender
value of the policies.



Deposits increased $64.8 million during 2004.
Non-interest-bearing demand accounts increased $4.8 million, or 25.4%, money market and NOW accounts increased $19.7 million, or 60.3%, and time deposits increased $39.6 million or 42.0%. The Bank also used the wholesale certificate of deposit
(CD) market, brokered CDs and the FHLB of Atlanta, Georgia as funding sources during 2004 because of the increased loan demand as discussed above. Borrowings from the FHLB increased from $36.5 million at the end of 2003 to $41.5
million at December 31, 2004. Wholesale CDs comprised approximately 18.4% of total CD balances. Brokered CDs comprised approximately 22.0% of total CD balances. Typically wholesale and brokered CDs have similar terms to CDs
issued in the Banks local markets, with rates marginally lower than local market CD rates.



Total shareholders equity increased by $2.0 million, or 14.0%, during 2004. All capital ratios continue to place the Company in excess of the minimum required to be a well-capitalized bank by regulatory
measures. The Company has issued $8.5 million in Trust Preferred Securities during prior years, so as to remain well capitalized under regulatory capital guidelines without diluting existing shareholders ownership. The Trust
Preferred Securities should provide sufficient capital to retain a well-capitalized designation as defined by regulatory capital guidelines for future years. See RECENT ACCOUNTING PRONOUNCEMENTS for additional discussions of
the qualification of the Trust Preferred Securities as regulatory capital. The 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 junior subordinated debentures do not qualify as Tier 1 regulatory capital. On July 2, 2003, 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 I capital for regulatory capital purposes. In the event of
a disallowance, there would be a reduction in the Companys consolidated capital ratios. However, the Company believes that the Bank would remain well capitalized under Federal Reserve guidelines.



At December 31, 2004, the Bank was well capitalized.



NET INTEREST INCOME



Similar to most financial institutions, the primary component of earnings for the Bank is net interest income. Net interest income is the
difference between interest income, principally from the loan and investment securities portfolios, and interest expense, principally on deposits and borrowings. Changes in net interest income result from changes in volume, spread and margin. For
this purpose, volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities, spread refers to the difference between the average yield on interest-earning assets and the average cost of
interest-bearing liabilities and margin refers to net interest income divided by average interest-earning assets and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities, as well as
levels of non-interest-bearing liabilities. During the years ended December 31, 2004, 2003 and 2002; average interest-earning assets were $242.0 million, $177.8 million and $144.9 million, respectively. During these same years, the Banks net
yields on average interest-earning assets were 3.22%, 3.57% and 3.90%, respectively. The decrease in net yields from 2002 to 2004 is a reflection of competitive pressures and the interest rate environment. The Banks balance sheet is positioned
for an increase in interest rates. When interest rates increase, the Banks earnings and net yields should show improvement.



12



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Table 2, following this discussion, Average Balances and Net Interest Income, presents an analysis of the
Banks net interest income for 2004 and 2003.



Table 3, following this
discussion, Volume and Rate Variance Analysis, illustrates that the change in the average volume of loans and deposits was the predominant factor in the higher amount of net interest income realized by the Bank in 2004, which increased
because of higher loan demand as compared to 2003.



RESULTS OF OPERATIONS

YEARS ENDED DECEMBER 31, 2004 AND 2003



Overview.The Company reported net income of $1.9 million or $0.72 per diluted share for the year ended December 31, 2004, compared with net income of $1.7 million
or $0.63 per diluted share for 2003, an improvement of $279,000 or $0.09 per diluted share. Net interest income increased $1.4 million, or 22.6%, in 2004, while non-interest income increased by $566,000 or 15.8%. This combined growth in income out
paced the 17.0% increase in non-interest expense, which totaled $8.0 million in 2004 compared to $6.8 million in 2003.



Net Interest Income.Net interest income increased to $7.8 million for the year ended December 31, 2004, a $1.4 million or 22.6% increase from $6.4 million earned
in 2003. Total interest income benefited from strong growth in the level of average earning assets, which offset lower asset yields caused by the continued trend of low interest rates during the first six months of the period. The rates earned on a
significant portion of the Banks loans adjust immediately when indexes like the prime rate change. Conversely a large portion of interest-bearing liabilities, including certificates of deposit and Bank borrowings have rates fixed until
maturity. As a result, interest rate reductions will generally result in an immediate drop in the Banks interest income on loans, with a more delayed impact on interest expense because reductions in interest costs will only occur upon renewals
of certificates of deposit or borrowings. Average total interest-earning assets increased $64.2 million, or 36.1%, during 2004 compared to 2003, while the average yield dropped by 40 basis points from 5.43% to 5.03%. Even though interest rates
increased during the second half of 2004, competitive pressures caused the average rate on loans to decrease year over year. The average rate on investment securities increased in 2004 compared to 2003, reflecting managements decision to
purchase higher yielding securities during the second half of 2004 as interest rates began to rise. Average total interest-bearing liabilities increased by $56.1 million, or 35.3%, consistent with the increase in interest-earning assets. The average
cost of interest-bearing liabilities decreased by 3 basis points from 2.07% to 2.04%. With the yield on earning assets dropping more significantly than the cost of interest bearing liabilities, the Banks net interest margin decreased by 35
basis points. For the year ended December 31, 2004, the net interest margin was 3.22%, while for the year ended December 31, 2003, the net interest margin was 3.57%. Table 3 reflects the volume and rate variances from 2004 vs. 2003.



Provision for Loan Losses.The Bank recorded $1.0 million as the provision for loan
losses in 2004, an increase of $444,000 from the $586,000 provision made in 2003. Provisions for loan losses are charged to income to bring the allowance for loan losses to a level deemed appropriate by management. In evaluating the allowance for
loan losses, management considers factors that include growth, composition and industry diversification of the portfolio, historical loan loss experience, current delinquency levels, adverse situations that may affect a borrowers ability to
repay, estimated value of any underlying collateral, prevailing economic conditions and other relevant factors. For 2004 and 2003 the provision for loan losses was made principally in response to growth in loans as total loans outstanding, net of
loans held for sale, increased by $38.4 million in 2004 and by $44.2 million in 2003. At December 31, 2004, the allowance for loan losses was $2.9 million, an increase of $343,000, or 13.6%, from the $2.5 million at the end of 2003. The allowance
represents 1.32% and 1.41%, respectively, of loans outstanding at the end of 2004 and 2003, net of loans held for sale. At December 31, 2004 the Bank had $254,000 in non-accrual loans. In 2003, the Bank had $589,000 in non-accrual loans. It is
managements opinion that reserve levels are adequate.



Non-Interest
Income.Non-interest income increased to $4.1 million for the year ended December 31, 2004 compared to $3.6 million for the year ended December 31, 2003, an increase of $566,000 or 15.8%. Since inception, the Bank has actively pursued sources of
non-interest income, including income from investment service activities and mortgage operations. Mortgage operations income increased to $2.3 million in 2004, from $1.8 million in 2003. Service charges on deposit accounts in 2004 were $1.087
million, an increase of $70,000, or 6.9%, compared to $1.017 million in 2003. With the February 2005 announcement of the discontinuance of the Raleigh mortgage origination office, management is faced with the challenge of off setting lost mortgage
origination revenues with increases in in-house mortgage originations and decreases in Raleigh related expenses. Table 4, following this discussion, is a comparative analysis of the components of non-interest income for 2004 and 2003.



13



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Non-Interest Expenses.Non-interest expenses totaled $8.0 million for the year ended December 31, 2004, an
increase of $1.2 million over the $6.8 million reported for 2003. Substantially all of this increase resulted from the Banks growth and development during 2004 and 2003. Personnel costs increased by $743,000 in 2004, primarily due to the
hiring of additional personnel to operate the full service branch converted from a loan production office in Greensboro, NC, additions to commissioned Mortgage Loan Origination personnel located in Raleigh, NC and the affects of hiring of a full
time Chief Financial Officer in the third quarter of 2003. Commissions paid on mortgage operations increased $587,000 during 2004. Professional and other services increased $93,000 due to increased corporate governance regulatory requirements and
outsourced internal audit activities. Equipment expense increased by $83,000 primarily due to increases in maintenance costs and increased depreciation on purchases of furniture, fixtures and computer hardware and software. Table 5, following this
discussion, presents a comparative analysis of the components of non-interest expenses for 2004 and 2003.



Income Taxes.The provision for income tax was $950,000 in 2004 and $835,000 in 2003. The effective tax rates were 32.8% and 33.4%, respectively, on income before income taxes.



LIQUIDITY



The Banks sources of funds are customer deposits, cash and demand balances due from other banks, interest-earning deposits in other
banks and investment securities available for sale. These funds, together with loan repayments, are used to make loans and to fund continuing operations. At December 31, 2004, the Bank had credit availability with the FHLB of $49.5 million, with
$41.5 million outstanding.



Total deposits were $216.8 million and $152.0
million at December 31, 2004 and 2003, respectively. The Banks deposits increased 42.6%. Because the Banks deposit growth was not sufficient in amount to meet the total funding needs of the Banks asset growth, the Bank looked to
alternative funding sources during 2004. In light of compacting spreads and margins during 2004 the Bank found it less costly to access FHLB lines of credit and utilize Internet CDs and brokered CDs rather than compete for finite, higher
cost of funds sources within its local markets. The Bank will continue to evaluate all funding sources for cost, accessibility, dependability and efficiency.



At December 31, 2004 and 2003, time deposits represented 61.9% and 62.4%, respectively, of the Banks total deposits. Certificates of deposit of $100,000 or more
represented 29.4% and 19.9%, respectively, of the Banks total deposits at December 31, 2004 and 2003. At December 31, 2004, the Bank had $2.9 million in public deposits, $24.7 million in Internet CDs and $29.6 million in brokered time
deposits. Management believes that most other time deposits are relationship-oriented. While the Bank appreciates the need to pay competitive rates to retain these deposits, other subjective factors also influence deposit retention. Based upon prior
experience, the Bank anticipates that a substantial portion of outstanding certificates of deposit will renew upon maturity.



Management anticipates that the Bank will utilize non-local market funding sources such as Internet CDs, wholesale NOW accounts, CDARS (Certificate of Deposit
Account Registry Service) a deposit placement network (a new innovation that allows banks to offer up to $1.5 million of FDIC insurance per depositor by networking with other banks within the CDARS system), FHLB advances and brokered deposits as a
less costly diversified funding source to complement the Banks local market deposits. Deposits, loan repayments, mortgage backed securities prepayments, bond maturities, FLHB advances and current earnings will be employed to provide liquidity,
generate loans, purchase securities, procure fixed assets and meet other operating needs incurred in normal banking activities.



In the normal course of business there are various outstanding contractual obligations of the Bank that will require future cash outflows. In addition, there are
commitments and contingent liabilities, such as commitments to extend credit that may or may not require future cash outflows. Table 6, following this discussion, Contractual Obligations and Commitments, summarizes the Banks
contractual obligations and commitments as of December 31, 2004. The Bank participates in an off-Balance sheet interest rate swap with a notional amount of $5 million. The bank sells variable rate 90 day LIBOR indexed interest and purchases fixed
rate interest. This transaction locks the interest expense at 6.90% for five years.



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CAPITAL RESOURCES



At December 31, 2004 and 2003, the Companys shareholders equity totaled $16.4 million and $14.4 million, respectively. The Companys equity to asset
ratio on those dates was 5.8% and 6.8%, respectively, reflecting the Companys aggressive growth. The Company and the Bank are subject to minimum capital requirements. See PART 1, ITEM 1 - DESCRIPTION OF BUSINESS  SUPERVISION AND
REGULATION. 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.



All capital ratios place the Bank in excess of minimum requirements to be classified as
well capitalized by regulatory measures. The Banks Leverage ratio as of December 31, 2004 and 2003 was 8.9% and 9.5%, respectively.



Note P to the accompanying consolidated financial statements presents an analysis of the Banks regulatory capital position as of December 31, 2004 and 2003.
Management anticipates that the Bank will remain well-capitalized for regulatory purposes throughout 2005.



ASSET/LIABILITY MANAGEMENT



The Banks results of operations depend substantially on its net interest income. Like most financial institutions, the Banks interest income and cost of funds are affected by general economic conditions
and by competition in the market place. The purpose of asset/liability management is to provide stable net interest income growth by protecting the Banks earnings from undue interest rate risk, which arises from volatile interest rates and
changes in the balance sheet mix, and by managing the risk/return relationships between liquidity, interest rate risk, market risk and capital adequacy. The Bank maintains, and has complied with, an asset/liability management policy approved by the
Board of Directors of the Company and the Bank that provides guidelines for controlling exposure to interest rate risk by utilizing the following ratios and trend analysis: liquidity, equity, volatile liability dependence, portfolio maturities,
maturing assets and maturing liabilities. The Banks policy is to control the exposure of its earnings to changing interest rates by generally endeavoring to maintain a position within a range around an earnings neutral position,
which is defined as the mix of assets and liabilities that generate a net interest margin that is least affected by interest rate changes.



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



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



Based on the results of the income simulation model, as of December 31, 2004, the Bank would
expect an increase in net interest income of $788,000 if interest rates increase from current rates by an instantaneous 100 basis points and a decrease in net interest income of $451,000 if interest rates decrease from current rates by an
instantaneous 100 basis points.



The analysis of an institutions interest
rate gap (the difference between the repricing of interest-earning assets and interest-bearing liabilities during a given period of time) is another standard tool for the measurement of the



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exposure to interest rate risk. Management believes that because interest rate gap analysis does not address all factors that can affect earnings
performance, it should be used in conjunction with other methods of evaluating interest rate risk.



Table 7, following this discussion, Interest Rate Sensitivity Analysis, sets forth the amounts of interest-earning assets and interest-bearing liabilities outstanding at December 31, 2004, which are
projected to reprice or mature in each of the future time periods shown. Except as stated below, the amounts of assets and liabilities shown which reprice or mature within a particular period were determined in accordance with the contractual terms
of the assets or liabilities. Loans with adjustable rates are shown as being due at the end of the next upcoming adjustment period. Money market deposit accounts are considered rate sensitive and are placed in the shortest period, while negotiable
order of withdrawal or other transaction accounts are assumed to be more stable sources that are less price elastic and are placed in the longest period. In making the gap computations, none of the assumptions sometimes made regarding prepayment
rates and deposit decay rates are used for any interest-earning assets or interest-bearing liabilities. In addition, the table does not reflect scheduled principal payments that will be received throughout the lives of the loans. The interest rate
sensitivity of the Banks assets and liabilities illustrated in the table would vary substantially if different assumptions were used or if actual experience differs from that indicated by such assumptions.



Table 7 illustrates that if assets and liabilities reprice in the time intervals indicated in
the table, the Bank is asset sensitive within three months, liability sensitive over three months to twelve months, liability sensitive within twelve months and asset sensitive thereafter. As stated above, certain shortcomings are inherent in the
method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the
interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market interest rates. For instance, while the table is based on
the assumption that money market accounts are immediately sensitive to movements in rates, the Bank expects that in a changing rate environment the amount of the adjustment in interest rates for such accounts would be less than the adjustment in
categories of assets that are considered to be immediately sensitive. The same is true for all other interest bearing transaction accounts. Additionally, certain assets have features that restrict changes in the interest rates of such assets both on
a short-term basis and over the lives of such assets. Further, in the event of a change in market interest rates, prepayment and early withdrawal levels could deviate significantly from those assumed in calculating the tables. Finally, the ability
of many borrowers to service their adjustable-rate debt may decrease in the event of an increase in market interest rates. Due to these shortcomings, the Bank places primary emphasis on its income simulation model when managing its exposure to
changes in interest rates. The Bank does not normally make interest rate predictions, or take undue risk on potential changes in interest rate direction. The Bank is currently asset sensitive. Should interest rates increase, the Banks earnings,
margins and spreads would be positively impacted.



LENDING ACTIVITIES



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



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



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



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Table 9, Loan Maturities, following this discussion, presents, at December 31, 2004, (i) the aggregate
maturities or re-pricings of commercial, industrial and commercial mortgage loans and of real estate constructions loans and (ii) the aggregate amounts of such loans by variable and fixed rates.



Commercial and Industrial Loans.Commercial business lending is a primary focus of the
Banks lending activities. At December 31, 2004, the Banks commercial and industrial loan portfolio equaled $30.5 million or 13.6% of total loans, as compared with $30.9 million or 16.8% of total loans at December 31, 2003. Commercial and
industrial loans include both secured and unsecured loans for working capital, expansion and other business purposes. Short-term working capital loans generally are secured by accounts receivable, inventory and/or equipment. The Bank also makes term
commercial loans secured by equipment and real estate. Lending decisions are based on an evaluation of the financial strength, management and credit history of the borrower, and the quality of the collateral securing the loan. With few exceptions,
the Bank requires personal guarantees and secondary sources of repayment.



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



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



Residential one to four family loans are classified into two categories: conforming loans, that are originated under the underwriting guidelines established by FNMA or FHLMC and held for sale and nonconforming loans that are originated and
retained in the Banks loan portfolio. The terms conforming and nonconforming do not refer to credit quality, but rather to whether the loan is underwritten so that it can be sold in the secondary market. At December 31,
2004, loans held for sale amounted to $5.7 million while nonconforming loans held in the Banks permanent portfolio amounted to $27.8 million. The Banks permanent residential mortgage loans are generally secured by properties located
within the Banks market area. Most of the one to four family residential mortgage loans that the Bank makes are conforming loans and are sold within 30 days of closing to a correspondent bank. The Bank originated 846 loans in the amount of
$120.8 million for sale in the secondary market during 2004. The Bank receives a fee for each loan originated, with fees aggregating $2.3 million for the year ended December 31, 2004 and $1.8 million for the year ended December 31, 2003. The Bank
anticipates that it will continue to be an active originator of residential loans. Nonconforming residential mortgage loans that are retained in the Banks loan portfolio generally have rate terms of five years or less, with amortizations up to
20 years.



The Bank has made, and anticipates continuing to make, commercial
real estate loans. Commercial real estate loans amounted to $88.2 million at December 31, 2004. These loans are secured principally by commercial buildings for office, storage and warehouse space, and by agricultural properties. Generally in
underwriting commercial real estate loans, the Bank requires the personal guarantee of borrowers and a demonstrated cash flow capability sufficient to service the debt. Loans secured by commercial real estate usually involve a greater degree of risk
than one to four family residential mortgage loans. Payments on such loans are often dependent on successful operation or management of the properties.



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



Consumer Loans and Home Equity Lines of Credits.Loans to individuals include
automobile loans, boat and recreational vehicle financing, home equity and home improvement loans and miscellaneous secured and unsecured personal loans. Consumer loans generally can carry significantly greater risks than other loans, even if
secured, if



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the collateral consists of rapidly depreciating assets such as automobiles and equipment. Repossessed collateral securing a defaulted consumer loan may not
provide an adequate source of repayment of the loan. Consumer loan collections are sensitive to job loss, illness and other personal factors. The Bank attempts to manage the risks inherent in consumer lending by following established credit
guidelines and underwriting practices designed to minimize risk of loss.



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



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



The President, Senior Credit Officer, and the Senior Commercial Lending Officer each have the authority to approve loans up to $400,000. The
President in conjunction with the Senior Credit Officer or the Senior Commercial Lending Officer and the Senior Credit Officer have the combined authority to approve loans up to $1 million, which is the maximum staff, in-house lending limit set by
the Board of Directors. The Boards Loan Committee approves all loans in excess of the staffs in-house lending limit. The committee consists of the President, the Chairman and Vice Chairman of the Board and four outside directors as
appointed by the Board of Directors of the Bank



Additionally, all loans of
$50,000 or greater and all loans with relationship exposure of $200,000 or above are reviewed by the Management Loan Committee comprised of the President, Senior Credit Officer, and the Senior Commercial Loan Officers for Burlington, Graham and
Greensboro. The Bank Boards Loan Committee approves all loans with total exposure of $800,000 or greater. The Banks legal lending limit was $4.2 million at December 31, 2004. The Bank seldom makes loans approaching its legal lending
limit.



COMMITMENTS TO EXTEND CREDIT



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



ASSET QUALITY



The Bank considers asset quality to be of primary importance, and employs a formal internal
loan review process to ensure adherence to the lending policy as approved by the Banks Board of Directors. It is the responsibility of each loan officer to assign an appropriate risk grade to loans when originated. Credit Administration,
through the loan review process, validates the accuracy of the initial risk grade assessment. In addition, as a given loans credit quality changes, it is the responsibility of Credit Administration to change the borrowers risk grade
accordingly. The process of determining the allowance for loan losses is fundamentally driven by the risk grade system. In determining the allowance for loan losses and any resulting provision to be charged against earnings, particular emphasis is
placed on the results of the loan review process. Consideration is also given to historical loan loss experience, the value and adequacy of collateral, economic conditions in the Banks market area and other factors. For loans determined to be
impaired, the allowance is based on discounted cash flows using the loans initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. This evaluation is inherently subjective, as it requires
material estimates, including the amounts and timing of future cash flows expected to



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be received on impaired loans that may be susceptible to significant change. The allowance for loan losses represents managements estimate of the
appropriate level of reserve to provide for probable losses inherent in the loan portfolio.



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



NONPERFORMING ASSETS



Table 10, Nonperforming Assets, following this discussion, sets forth, for the last five years, information with respect to the
Banks nonperforming assets.



The Companys consolidated financial
statements are prepared on the accrual basis of accounting, including the recognition of interest income on loans, unless a loan is placed on non-accrual basis. Loans are accounted for on a non-accrual basis when management has serious concerns
about the collectibility of principal or interest. Generally, the Banks policy is to place a loan on non-accrual status when the loan becomes 90 days past due. Loans are also placed on non-accrual status in cases where management is uncertain
whether the borrower can satisfy the contractual terms of the loan agreement. Payments received on non-accrual loans generally are applied to principal first, and then to interest after all principal payments have been satisfied. Restructured loans
are those for which concessions, including the reduction of interest rates below a rate otherwise available to that borrower or the deferral of interest or principal, have been granted due to the borrowers weakened financial condition. The
Bank accrues interest on restructured loans at the restructured rate when management anticipates that no loss of original principal will occur. Potential problem loans are defined as loans currently performing that are not included in non-accrual or
restructured loans, but are loans that management has concerns as to the borrowers ability to comply with present repayment terms. These loans could deteriorate to non-accrual, past due or restructured loans status. Therefore, management
quantifies the risk associated with problem loans in assessing the adequacy of the allowance for loan losses. At December 31, 2004, the Bank identified $254,000 in non-accrual loans. Management anticipates that the vast majority of the non-accruing
loans at December 31, 2004 will be paid out or returned to accrual status. At December 31, 2003, the Bank identified $589,000 in nonaccrual loans.



Real estate owned consists of foreclosed, repossessed and idled properties. At December 31, 2004, there were $2.0 million assets are classified as real estate owned. $1.2
million of the real estate owned is related to a single borrower with a 70% guarantee issued by the USDA (United States Department of Agriculture). At December 31, 2003, there were no assets classified as real estate owned.



ANALYSIS OF ALLOWANCE FOR LOAN LOSSES



The allowance for loan losses is established through charges to earnings in the form of a
provision for loan losses. Management increases the allowance for loan losses by provisions charged to operations and by recoveries of amounts previously charged off. The allowance is reduced by loans charged off. Management evaluates the adequacy
of the allowance at least quarterly. In addition, on a monthly basis the Banks Board of Directors reviews all loan transactions and reviews the computation of the loan loss provision, recommending changes as may be required. In evaluating the
adequacy of the allowance, management considers the growth, composition and industry diversification of the portfolio, historical loan loss experience, current delinquency levels, adverse situations that may affect a borrowers ability to
repay, estimated value of any underlying collateral, prevailing economic conditions and other relevant factors deriving from the Banks limited history of operations. In addition, regulatory agencies, as an integral part of their examination
process, periodically review the Banks allowance for loan losses and may require it to make adjustments to the allowance for loan losses based upon judgments different from those of our management.



Management uses a risk-grading system, as described under ASSET QUALITY, to
facilitate evaluation of probable inherent loan losses and the adequacy of the allowance for loan losses. In this program, risk grades are initially assigned by loan officers and reviewed by Credit Administration, and tested by the Banks
internal auditor. The testing program includes an evaluation of a sample of new loans, large loans, loans that are identified as having potential credit weaknesses, accruing loans past due 90 days or more, and non-accrual loans. The Bank strives to
maintain its loan portfolio in accordance with conservative loan underwriting policies that result in loans specifically tailored to the needs of the Banks market area. Every effort is made to identify and minimize the credit risks associated
with such lending strategies. The Bank has no foreign loans and does not engage in significant lease financing or highly leveraged transactions.



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The Bank follows a loan review program designed to evaluate the credit risk in its loan portfolio. Through this loan
review process, an internally classified watch list is maintained that helps management assess the overall quality of the loan portfolio and the adequacy of the allowance for loan losses. In establishing the appropriate classification for specific
assets, management considers, among other factors, the estimated value of the underlying collateral, the borrowers ability to repay, the borrowers payment history and the current delinquent status. As a result of this process, certain
loans are categorized as substandard, doubtful or loss, and reserves are allocated based on managements judgment and historical experience.



Loans classified as substandard are those loans with clear and defined weaknesses such as unfavorable financial ratios, uncertain repayment sources or poor
financial condition that may jeopardize the collection of the debt. They are characterized by the distinct possibility that the Bank will sustain some losses if the deficiencies are not corrected. A reserve of 20% is generally allocated to these
loans. Loans classified as doubtful are those loans that have characteristics similar to substandard loans but with an increased risk that collection or liquidation in full is highly questionable and improbable. A reserve of 50% is
generally allocated to loans classified as doubtful. Loans classified as loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the
loan has absolutely no recovery or salvage value but rather it is not practical or desirable to defer writing off this asset even though partial recovery may be achieved in the future. As a practical matter, when loans are identified as loss they
are charged off against the allowance for loan losses. In addition to the above classification categories, the Bank also categorizes loans based upon risk grade and loan type, assigning an allowance allocation based upon each category.



Growth in loans outstanding has, throughout the Banks history, been the primary
reason for increases in the Banks allowance for loan losses and the resultant provisions for loan losses necessary to provide for those increases. This growth has been spread among the Banks major loan categories, with the concentrations
of major loan categories being relatively consistent. Between December 31, 2003 and December 31, 2004, the range of each major category of loans as a percentage of total loans outstanding is as follows: residential mortgage loans  14.7% to
12.5%; commercial mortgage loans  38.7% to 39.5%; construction loans  7.8% to 12.4%; commercial and industrial loans  16.8% to 13.6%; loans to individuals  3.5% to 3.5%; and home equity lines of credit  15.9% to 15.6%.
For the past five fiscal years through 2004, the Banks loan loss experience has been similar to that of other peer banks in North Carolina, with net loan charge-offs in each year of ranging from 0.09% to 0.42% of average loans outstanding.
Charge offs are typically recognized when it is the opinion of management that all or a portion of an outstanding loan becomes uncollectible. Examples of when a loan may be deemed uncollectible are when principal and interest payments are past due,
and/or when the fair market value of underlying pledged collateral is less than the outstanding loan balance and the borrower is not meeting contractual obligations. Loan repayment may be realized through a contractual agreement, or through
liquidation of assets pledged as collateral. Net charge-offs totaled $152,000 or 0.09% of outstanding loans for 2003 and $687,000 or 0.35% of outstanding loans for 2004. The Banks allowance for loan losses at December 31, 2004 of $2.9 million
represents 1.32% of total loans outstanding, net of loans held for sale. The Banks allowance for loan losses at December 31, 2003 was $2.5 or 1.45% of outstanding loans, net of loans held for sale. The allowance for loan losses as a percentage
of loans outstanding decreased in 2004 compared to 2003 due to an increase in charged off loans during 2004.



The allowance for loan losses represents managements estimate of an amount adequate to provide for known and inherent losses in the loan portfolio in the normal course of business. Management makes specific
allowances that are allocated to certain individual loans and pools of loans based on risk characteristics, as discussed below. While management believes that it uses the best information available to establish the allowance for loan losses, future
adjustments to the allowance may be necessary and results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making the determinations. Furthermore, while management believes that it has
established the allowance for loan losses in conformity with generally accepted accounting principles, there can be no assurance that regulators, in reviewing our portfolio, will not require adjustment to the allowance for loan losses. In addition,
because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that increases will not be necessary should the quality of any loans
deteriorate as a result of the factors discussed herein. Any material increase in the allowance for loan losses may adversely affect the Banks and the Companys financial condition and results of operations.



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



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



INVESTMENT ACTIVITIES



The Banks portfolio of investment
securities, substantially all of which are available for sale, consists primarily of U.S. government agency securities, mortgage-backed securities and securities issued by local governmental municipalities. Securities to be held for indefinite
periods of time and not intended to be held to maturity are classified as available for sale and carried at fair value, with any unrealized gains or losses reflected as an adjustment to stockholders equity. Securities held for indefinite
periods of time include securities that management intends to use as part of its asset/liability management strategy and that may be sold in response to changes in interest rates and/or significant prepayment risks. It is the Banks policy to
classify most investment securities as available for sale. Table 13, Securities Portfolio Composition, following this discussion, summarizes investment securities by type at December 31, 2004, 2003 and 2002.



Table 14, Securities Portfolio Composition, following this discussion, summarizes
the amortized costs, fair values and weighted average yields of securities available-for-sale at December 31, 2004, by contractual maturity groups.



The Bank does not engage in, nor does it presently intend to engage in, securities trading activities and therefore does not maintain a trading account. At December 31,
2004, there were no securities of any issuer (other than governmental agencies) that exceeded 10% of the Companys shareholders equity.



SOURCES OF FUNDS



Deposit Activities.The Bank provides a range of deposit services, including non-interest-bearing checking accounts, interest-bearing checking and savings accounts, money market accounts and certificates of
deposit. These accounts generally earn interest at rates established by management based on competitive market factors and managements desire to increase or decrease certain types or maturities of deposits. The Bank has used wholesale deposits
as a funding source. However, it strives to establish customer relations to attract core deposits in non-interest-bearing transactional accounts and thus to reduce its costs of funds.



Table 15, Average Deposits, following this discussion, sets forth for the for the years ended December 31, 2004 and 2003 the
average balances outstanding and average interest rates for each major category of deposits.



Table 16, Maturities of Time Deposits of $100,000 or More, which follows this discussion, presents maturities of certificates of deposit with balances of $100,000 or more at December 31, 2004.



Borrowings.As additional sources of funding, the Bank uses advances from the FHLB
of Atlanta under a line of credit equal to 30% of the Banks total assets, subject to qualifying collateral. The available aggregate line of credit was $49.5 million at December 31, 2004. Outstanding advances at December 31, 2004 totaled $41.5
million, and included: $15.5 million of daily rate credit advances at a weighted average rate at December 31, 2004 of 2.44%; $8.0 million maturing in 2009, bearing a weighted average rate of 1.73%; $4.0 million maturing in 2010, bearing interest at
a weighted average rate of 5.79%; $4.0 million maturing in 2012, bearing interest at 3.56%; and $10 million maturing in 2013 bearing interest at 2.91%. Pursuant to collateral agreements with the FHLB, at December 31, 2004, advances are secured by
loans with a carrying amount of $119.6 million, which approximates market value. Advances outstanding at December 31, 2003 totaled $36.5 million.



In addition to FHLB advances, the Company issued $8.8 million of junior subordinated debentures to its wholly owned capital trusts, MidCarolina I and MidCarolina Trust
II, to fully and unconditionally guarantee the preferred securities issued by the trusts. These long term obligations, which currently quality as Tier I capital for the Company, constitute a full and unconditional guarantee by the Company of the
trusts obligations under the Capital Trust Securities. See also Note B for a detailed discussion of the January 2003 FASB Interpretation No. 46R, Consolidation of Variable Interest Entities.



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RECENT ACCOUNTING PRONOUNCEMENTS



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



In December 2003, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) 03-3,Accounting for Loans or Certain Debt Securities Acquired in a Transfer. The SOP
addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investors initial investment in loans or debt securities acquired in a transfer, if those differences relate to a deterioration
of credit quality. The SOP also prohibits companies from carrying over or creating a valuation allowance in the initial accounting for loans acquired that meet the scope criteria of the SOP. The SOP is effective for loans acquired in
fiscal years beginning after December 15, 2004. The adoption of this SOP is not expected to have a material impact on the Companys financial position or results of operations.



In December 2004, the FASB issued SFAS No. 123(R),Accounting for Stock-Based Compensation (SFAS No. 123(R)). SFAS No. 123(R)
establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. This Statement focuses primarily on accounting for transactions in which an entity obtains employee services in
share-based payment transactions. SFAS No. 123(R) requires that the fair value of such equity instruments be recognized as an expense in the historical financial statements as services are performed. Prior to SFAS No. 123(R), only certain pro forma
disclosures of fair value were required. The provisions of this Statement are effective for the first interim reporting period that begins after December 15, 2005. Accordingly, we will adopt SFAS No. 123(R) commencing with the quarter ending March
31, 2006. If we had included the cost of employee stock option compensation in our consolidated financial statements, our net income for the fiscal years ended December 31, 2004 and 2003 would have decreased by approximately $51,000 for both years.
Accordingly, the adoption of SFAS No. 123(R) is not expected to have a material effect on our consolidated financial statements.



CRITICAL ACCOUNTING POLICY



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



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



RISKS ASSOCIATED WITH THE BANK AND THE COMPANY



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



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



22



---

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



| |  | changes in regulations;
|- |  | -----------------------



| |  | changes in technology and product delivery systems; and
|- |  | -------------------------------------------------------



| |  | the accelerating pace of consolidation among financial services providers.
|- |  | --------------------------------------------------------------------------



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



Trading Volume.The trading volume
in the Companys common stock on the OTC Bulletin Board has been comparable to other similarly sized banks and companies trading on the OTC Bulletin Board. Nevertheless, this trading is relatively low when compared with more seasoned companies
listed on the Nasdaq Small Cap Market, the Nasdaq National Market System, the New York Stock Exchange or other consolidated reporting systems or stock exchanges. The market in the Companys common stock may be limited in scope relative to other
companies. The Company cannot guarantee that a more active and liquid trading market for the Companys common stock will develop in the future.



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



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



| |  | the payment of dividends to the Companys shareholders;
|- |  | -------------------------------------------------------



| |  | possible mergers with or acquisitions of or by other institutions;
|- |  | ------------------------------------------------------------------



| |  | investment policies;
|- |  | --------------------



| |  | loans and interest rates on loans;
|- |  | ----------------------------------



| |  | interest rates paid on deposits;
|- |  | --------------------------------



| |  | expansion of branch offices; and/or
|- |  | -----------------------------------



| |  | the possibility to provide or expand securities or trust services.
|- |  | ------------------------------------------------------------------



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



23



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MidCarolina Financial Corporation

Table 2

Average Balances and Net Interest Income

($ in thousands)



|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |       |                |      |   |          |   |             |   |  |   |       |  |      |  
|-------------------------------------------------------------------------------- |  | ---------------------------- | ------- | - | ---------------------------- | - | ----------- | ---------------------------- | ---- | -------------- |  | - | -------- | - | ----------- | - | ----- | -------------- | ---- | - | -------- | - | ----------- | - |  | - | ----- |  | ---- | -
|                                                                                 |  | Year Ended December 31, 2004 |         |   | Year Ended December 31, 2003 |   |             | Year Ended December 31, 2002 |     
|                                                                                 |  | AverageBalance               |         |   | Interest                     |   | AverageRate |                              |      | AverageBalance |  |   | Interest |   | AverageRate |   |       | AverageBalance |      |   | Interest |   | AverageRate |  
|Interest-earning assets:                                                         |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |       |                |      |   |          |   |             |   |  |   |       |  |      |  
|Loans, net                                                                       |  | $                            | 204,121 |   |                              | $ | 10,840      |                              | 5.31 | %              |  | $ | 160,041  |   |             | $ | 9,189 |                | 5.74 | % |          | $ | 118,702     |   |  | $ | 8,209 |  | 6.92 | %
|Investment securities                                                            |  |                              | 28,018  |   |                              |   | 1,180       |                              | 4.21 | %              |  |   | 8,079    |   |             |   | 322   |                | 3.99 | % |          |   | 10,902      |   |  |   | 496   |  | 4.55 | %
|Interest-earning cash deposits                                                   |  |                              | 7,664   |   |                              |   | 74          |                              | 0.97 | %              |  |   | 8,449    |   |             |   | 94    |                | 1.11 | % |          |   | 14,824      |   |  |   | 248   |  | 1.67 | %
|Other                                                                            |  |                              | 2,189   |   |                              |   | 80          |                              | 3.65 | %              |  |   | 1,211    |   |             |   | 47    |                | 3.88 | % |          |   | 442         |   |  |   | 29    |  | 6.56 | %
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |       |                |      |   |          |   |             |   |  |   |       |  |      |  
|Total interest-earning assets                                                    |  |                              | 241,992 |   |                              |   | 12,174      |                              | 5.03 | %              |  |   | 177,780  |   |             |   | 9,652 |                | 5.43 | % |          |   | 144,870     |   |  |   | 8,982 |  | 6.20 | %
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |       |                |      |   |          |   |             |   |  |   |       |  |      |  
|Other assets                                                                     |  |                              | 11,360  |   |                              |   |             |                              |      |                |  |   | 15,042   |   |             |   |       |                |      |   |          |   | 12,567      |   |  |   |       |  |      |  
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |       |                |      |   |          |   |             |   |  |   |       |  |      |  
|Total assets                                                                     |  | $                            | 253,352 |   |                              |   |             |                              |      |                |  | $ | 192,822  |   |             |   |       |                |      |   |          | $ | 157,437     |   |  |   |       |  |      |  
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |       |                |      |   |          |   |             |   |  |   |       |  |      |  
|Interest-bearing liabilities:                                                    |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |       |                |      |   |          |   |             |   |  |   |       |  |      |  
|Deposits:                                                                        |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |       |                |      |   |          |   |             |   |  |   |       |  |      |  
|Demand deposits                                                                  |  |                              | 50,781  |   |                              |   | 614         |                              | 1.21 | %              |  |   | 36,346   |   |             |   | 313   |                | 0.86 | % |          |   | 36,831      |   |  |   | 504   |  | 1.37 | %
|Savings deposits                                                                 |  |                              | 6,549   |   |                              |   | 32          |                              | 0.49 | %              |  |   | 5,569    |   |             |   | 27    |                | 0.48 | % |          |   | 4,342       |   |  |   | 38    |  | 0.88 | %
|Fixed maturity deposits                                                          |  |                              | 108,160 |   |                              |   | 2,152       |                              | 1.99 | %              |  |   | 90,110   |   |             |   | 1,953 |                | 2.17 | % |          |   | 83,775      |   |  |   | 2,469 |  | 2.95 | %
|Short-term borrowed funds                                                        |  |                              | 23,090  |   |                              |   | 311         |                              | 1.35 | %              |  |   | 3,677    |   |             |   | 40    |                | 1.09 | % |          |   | 5,360       |   |  |   | 273   |  | 5.09 | %
|Long-term borrowed funds                                                         |  |                              | 26,500  |   |                              |   | 1,274       |                              | 4.81 | %              |  |   | 23,259   |   |             |   | 965   |                | 4.15 | % |          |   | 863         |   |  |   | 54    |  | 6.26 | %
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |       |                |      |   |          |   |             |   |  |   |       |  |      |  
|Total interest-bearing liabilities                                               |  |                              | 215,080 |   |                              |   | 4,383       |                              | 2.04 | %              |  |   | 158,961  |   |             |   | 3,298 |                | 2.07 | % |          |   | 131,171     |   |  |   | 3,338 |  | 2.54 | %
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |       |                |      |   |          |   |             |   |  |   |       |  |      |  
|Non-interest-bearing deposits                                                    |  |                              | 21,600  |   |                              |   |             |                              |      |                |  |   | 18,937   |   |             |   |       |                |      |   |          |   | 13,817      |   |  |   |       |  |      |  
|Other liabilities                                                                |  |                              | 1,188   |   |                              |   |             |                              |      |                |  |   | 1,259    |   |             |   |       |                |      |   |          |   | 616         |   |  |   |       |  |      |  
|Stockholders equity                                                             |  |                              | 15,484  |   |                              |   |             |                              |      |                |  |   | 13,665   |   |             |   |       |                |      |   |          |   | 11,833      |   |  |   |       |  |      |  
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |       |                |      |   |          |   |             |   |  |   |       |  |      |  
|Total liabilities and stockholders equity                                       |  | $                            | 253,352 |   |                              |   |             |                              |      |                |  | $ | 192,822  |   |             |   |       |                |      |   |          | $ | 157,437     |   |  |   |       |  |      |  
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |       |                |      |   |          |   |             |   |  |   |       |  |      |  
|Net interest income and interest rate spread                                     |  |                              |         |   |                              | $ | 7,791       |                              | 2.99 | %              |  |   |          |   |             | $ | 6,354 |                | 3.35 | % |          |   |             |   |  | $ | 5,644 |  | 3.66 | %
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |       |                |      |   |          |   |             |   |  |   |       |  |      |  
|Net yield on average interest-earning assets                                     |  |                              |         |   |                              |   |             |                              | 3.22 | %              |  |   |          |   |             |   |       |                | 3.57 | % |          |   |             |   |  |   |       |  | 3.90 | %
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |       |                |      |   |          |   |             |   |  |   |       |  |      |  
|Ratio of average interest-earning assets to average interest-bearing liabilities |  |                              | 112.51  | % |                              |   |             |                              |      |                |  |   | 111.84   | % |             |   |       |                |      |   |          |   | 110.44      | % |  |   |       |  |      |  
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |       |                |      |   |          |   |             |   |  |   |       |  |      |  



24



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MidCarolina Financial Corporation

Table 3

Volume and Rate Variance Analysis

(In Thousands)



|                                        |  |                                       |       |   |      |   |      |       |  |   |       |  
|--------------------------------------- |  | ------------------------------------- | ----- | - | ---- | - | ---- | ----- |  | - | ----- | -
|                                        |  | Year Ended December 31, 2004 vs. 2003 |      
|                                        |  | Increase (Decrease) Due to            |      
|                                        |  | Volume                                |       |   | Rate |   |      | Total | 
|Interest income:                        |  |                                       |       |   |      |   |      |       |  |   |       |  
|Loans, net                              |  | $                                     | 2,436 |   |      | $ | (785 | )     |  | $ | 1,651 |  
|Investment securities                   |  |                                       | 817   |   |      |   | 41   |       |  |   | 858   |  
|Interest-earning cash deposits          |  |                                       | (8    | ) |      |   | (12  | )     |  |   | (20   | )
|Other                                   |  |                                       | 37    |   |      |   | (4   | )     |  |   | 33    |  
|                                        |  |                                       |       |   |      |   |      |       |  |   |       |  
|Total interest income                   |  |                                       | 3,282 |   |      |   | (760 | )     |  |   | 2,522 |  
|                                        |  |                                       |       |   |      |   |      |       |  |   |       |  
|Interest expense:                       |  |                                       |       |   |      |   |      |       |  |   |       |  
|Deposits                                |  |                                       |       |   |      |   |      |       |  |   |       |  
|Demand deposits                         |  |                                       | 149   |   |      |   | 152  |       |  |   | 301   |  
|Savings deposits                        |  |                                       | 5     |   |      |   |     |       |  |   | 5     |  
|Fixed maturity deposits                 |  |                                       | 375   |   |      |   | (176 | )     |  |   | 199   |  
|Borrowed funds                          |  |                                       | 785   |   |      |   | (205 | )     |  |   | 580   |  
|                                        |  |                                       |       |   |      |   |      |       |  |   |       |  
|Total interest expense                  |  |                                       | 1,314 |   |      |   | (229 | )     |  |   | 1,085 |  
|                                        |  |                                       |       |   |      |   |      |       |  |   |       |  
|Net interest income increase (decrease) |  | $                                     | 1,968 |   |      | $ | (531 | )     |  | $ | 1,437 |  
|                                        |  |                                       |       |   |      |   |      |       |  |   |       |  



25



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MidCarolina Financial Corporation

Table 4

Non-Interest Income

(In thousands)



|                                                   |  |                         |       |      |   |       |      |  |   |       |  
|-------------------------------------------------- |  | ----------------------- | ----- | ---- | - | ----- | ---- |  | - | ----- | -
|                                                   |  | Year Ended December 31, |      
|                                                   |  | 2004                    |       | 2003 |   |       | 2002 | 
|Service charges on deposit accounts                |  | $                       | 1,087 |      | $ | 1,017 |      |  | $ | 782   |  
|Mortgage operations                                |  |                         | 2,325 |      |   | 1,766 |      |  |   | 800   |  
|Investment brokerage fees                          |  |                         | 235   |      |   | 298   |      |  |   | 140   |  
|Increase in cash surrender value of life insurance |  |                         | 234   |      |   | 298   |      |  |   | 187   |  
|                                                   |  |                         |       |      |   |       |      |  |   |       |  
|Core noninterest income                            |  |                         | 3,881 |      |   | 3,379 |      |  |   | 1,909 |  
|                                                   |  |                         |      
|Securities gains, net                              |  |                         | 70    |      |   | 28    |      |  |   | 51    |  
|Gain (loss) on disposal of foreclosed assets       |  |                         | 5     |      |   | (3    | )    |  |   | (24   | )
|Other noninterest income                           |  |                         | 185   |      |   | 171   |      |  |   | 155   |  
|                                                   |  |                         |       |      |   |       |      |  |   |       |  
|Total non-interest income                          |  | $                       | 4,141 |      | $ | 3,575 |      |  | $ | 2,091 |  
|                                                   |  |                         |       |      |   |       |      |  |   |       |  



26



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MidCarolina Financial Corporation

Table 5

Non-Interest Expenses

(In thousands)



|                                |  |                         |       |      |   |       |  |   |      
|------------------------------- |  | ----------------------- | ----- | ---- | - | ----- |  | - | -----
|                                |  | Year Ended December 31,
|                                |  | 2004                    |       | 2003 |   | 2002 
|Salaries                        |  | $                       | 3,926 |      | $ | 3,322 |  | $ | 2,091
|Employee benefits               |  |                         | 1,001 |      |   | 862   |  |   | 871  
|                                |  |                         |       |      |   |       |  |   |      
|Total salaries and benefits     |  |                         | 4,927 |      |   | 4,184 |  |   | 2,962
|                                |  |                         |      
|Occupancy expense               |  |                         | 282   |      |   | 265   |  |   | 180  
|Equipment expense               |  |                         | 448   |      |   | 365   |  |   | 339  
|Data processing                 |  |                         | 468   |      |   | 414   |  |   | 344  
|Office supplies and postage     |  |                         | 285   |      |   | 268   |  |   | 188  
|Deposit and other insurance     |  |                         | 149   |      |   | 158   |  |   | 161  
|Professional and other services |  |                         | 444   |      |   | 351   |  |   | 353  
|Advertising                     |  |                         | 180   |      |   | 140   |  |   | 291  
|Other                           |  |                         | 827   |      |   | 700   |  |   | 580  
|                                |  |                         |       |      |   |       |  |   |      
|Total non-interest expenses     |  | $                       | 8,010 |      | $ | 6,845 |  | $ | 5,398
|                                |  |                         |       |      |   |       |  |   |      



27



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MidCarolina Financial Corporation

Table 6

Contractual Obligations and Commitments

($ in thousands)



|                                                      |  |                                            |         |                           |   |            |  |             |        |               |   |       |  |   |       
|----------------------------------------------------- |  | ------------------------------------------ | ------- | ------------------------- | - | ---------- |  | ----------- | ------ | ------------- | - | ----- |  | - | ------
|                                                      |  | Payments Due by Period                    
|Contractual Obligations                               |  | Total                                      |         | On Demandor Within 1 Year |   | 2 - 3Years |  | 4 - 5 Years |        | After 5 Years
|Short-term borrowings                                 |  | $                                          | 15,500  |                           | $ | 15,500     |  | $           |       |               | $ |      |  | $ |      
|Long-term debt                                        |  |                                            | 34,764  |                           |   |           |  |             |       |               |   | 8,000 |  |   | 26,764
|Operating leases                                      |  |                                            | 286     |                           |   | 84         |  |             | 118    |               |   | 84    |  |   |      
|                                                      |  |                                            |         |                           |   |            |  |             |        |               |   |       |  |   |       
|Total contractual cash obligations excluding deposits |  |                                            | 50,550  |                           |   | 15,584     |  |             | 118    |               |   | 8,084 |  |   | 26,764
|                                                      |  |                                            |         |                           |  
|Time deposits                                         |  |                                            | 134,114 |                           |   | 106,364    |  |             | 26,847 |               |   | 903   |  |   |      
|                                                      |  |                                            |         |                           |   |            |  |             |        |               |   |       |  |   |       
|Total contractual cash obligations                    |  | $                                          | 184,664 |                           | $ | 121,948    |  | $           | 26,965 |               | $ | 8,987 |  | $ | 26,764
|                                                      |  |                                            |         |                           |   |            |  |             |        |               |   |       |  |   |       
|                                                      | 
|                                                      |  | Amount of Commitment Expiration Per Period
|Commercial Commitments                                |  | TotalAmountsCommitted                      |         | Within 1 Year             |   | 2 - 3Years |  | 4 - 5 Years |        | After 5 Years
|Lines of credit and loan commitments                  |  | $                                          | 53,691  |                           | $ | 48,601     |  | $           | 5,090  |               | $ |      |  | $ |      
|                                                      |  |                                            |         |                           |   |            |  |             |        |               |   |       |  |   |       
|Commitments to sell loans held for sale               |  | $                                          | 5,657   |                           | $ | 5,657      |  | $           |       |               | $ |      |  | $ |      
|                                                      |  |                                            |         |                           |   |            |  |             |        |               |   |       |  |   |       



28



---

MidCarolina Financial Corporation

Table 7

Interest Rate Sensitivity Analysis

($ in thousands)



|                                                                                  |  |                      |         |   |                           |   |         |                        |  |   |               |   |  |       |        |   |  |   |         |  
|--------------------------------------------------------------------------------- |  | -------------------- | ------- | - | ------------------------- | - | ------- | ---------------------- |  | - | ------------- | - |  | ----- | ------ | - |  | - | ------- | -
|                                                                                  |  | At December 31, 2004 |        
|                                                                                  |  | 3 Monthsor Less      |         |   | Over 3 Monthsto 12 Months |   |         | Total Within 12 Months |  |   | Over 12Months |   |  | Total |       
|Interest-earning assets:                                                          |  |                      |         |   |                           |   |         |                        |  |   |               |   |  |       |        |   |  |   |         |  
|Loans and loans held for sale                                                     |  | $                    | 131,887 |   |                           | $ | 41,589  |                        |  | $ | 173,476       |   |  | $     | 49,864 |   |  | $ | 223,340 |  
|Securities available for sale                                                     |  |                      | 3,152   |   |                           |   | 6,223   |                        |  |   | 9,375         |   |  |       | 26,537 |   |  |   | 35,912  |  
|Securities held to maturity                                                       |  |                      | 250     |   |                           |   |        |                        |  |   | 250           |   |  |       |       |   |  |   | 250     |  
|Other earning assets                                                              |  |                      | 11,199  |   |                           |   |        |                        |  |   | 9,187         |   |  |       | 2,292  |   |  |   | 11,479  |  
|                                                                                  |  |                      |         |   |                           |   |         |                        |  |   |               |   |  |       |        |   |  |   |         |  
|Total interest-earning assets                                                     |  | $                    | 146,488 |   |                           | $ | 47,812  |                        |  | $ | 192,288       |   |  | $     | 78,693 |   |  | $ | 270,981 |  
|                                                                                  |  |                      |         |   |                           |   |         |                        |  |   |               |   |  |       |        |   |  |   |         |  
|Percent of total interest-earning assets                                          |  |                      | 54.06   | % |                           |   | 17.64   | %                      |  |   | 70.96         | % |  |       | 29.04  | % |  |   | 100.00  | %
|Cumulative percent of total interest-earning assets                               |  |                      | 54.06   | % |                           |   | 71.70   | %                      |  |   | 71.70         | % |  |       | 100.74 | % |  |   | 100.74  | %
|                                                                                  |  |                      |         |   |                          
|Interest-bearing liabilities                                                      |  |                      |         |   |                           |   |         |                        |  |   |               |   |  |       |        |   |  |   |         |  
|Fixed maturity deposits                                                           |  | $                    | 27,459  |   |                           | $ | 86,302  |                        |  | $ | 106,364       |   |  | $     | 27,750 |   |  | $ | 134,114 |  
|All other deposits                                                                |  |                      | 59,000  |   |                           |   |        |                        |  |   | 59,000        |   |  |       |       |   |  |   | 59,000  |  
|Borrowings                                                                        |  |                      | 24,000  |   |                           |   |        |                        |  |   | 24,000        |   |  |       | 26,264 |   |  |   | 50,264  |  
|                                                                                  |  |                      |         |   |                           |   |         |                        |  |   |               |   |  |       |        |   |  |   |         |  
|                                                                                  |  | $                    | 110,459 |   |                           | $ | 86,302  |                        |  | $ | 189,364       |   |  | $     | 54,014 |   |  | $ | 243,378 |  
|                                                                                  |  |                      |         |   |                           |   |         |                        |  |   |               |   |  |       |        |   |  |   |         |  
|Percent of total interest-bearing liabilities                                     |  |                      | 45.39   | % |                           |   | 35.46   | %                      |  |   | 77.81         | % |  |       | 22.19  | % |  |   | 100.00  | %
|Cumulative percent of total interest-bearing liabilities                          |  |                      | 45.39   | % |                           |   | 80.85   | %                      |  |   | 80.85         | % |  |       | 103.04 | % |  |   | 103.04  | %
|                                                                                  |  |                      |         |   |                          
|Interest sensitivity gap                                                          |  | $                    | 36,029  |   |                           | $ | (38,490 | )                      |  | $ | 2,924         |   |  | $     | 24,679 |   |  | $ | 27,603  |  
|Cumulative interest sensitivity gap                                               |  |                      | 36,029  |   |                           |   | (2,461  | )                      |  |   | (2,461        | ) |  |       | 22,218 |   |  |   | 22,218  |  
|Cumulative interest sensitivity gap as a percent of total interest-earning assets |  |                      | 13.30   | % |                           |   | -0.91   | %                      |  |   | -0.91         | % |  |       | 8.20   | % |  |   | 8.20    | %
|Cumulative ratio of interest-sensitive assets to interest-sensitive liabilities   |  |                      | 132.62  | % |                           |   | 101.54  | %                      |  |   | 101.54        | % |  |       | 111.34 | % |  |   | 111.34  | %



29



---

MidCarolina Financial Corporation

Table 8

Loan Portfolio Composition

($ in thousands)



|                                                                           |  |                 |         |                |        |   |        |      |         |                |      |        |        |      |   |                |   |  |        |   |  |                |         |   |        |        |   |                |   |        |   |  |        |  
|-------------------------------------------------------------------------- |  | --------------- | ------- | -------------- | ------ | - | ------ | ---- | ------- | -------------- | ---- | ------ | ------ | ---- | - | -------------- | - |  | ------ | - |  | -------------- | ------- | - | ------ | ------ | - | -------------- | - | ------ | - |  | ------ | -
|                                                                           |  | At December 31, |        
|                                                                           |  | 2004            |         |                | 2003   |   |        | 2002 |         |                | 2001 |        |        | 2000 |  
|                                                                           |  | Amount          |         | % ofTotalLoans |        |   | Amount |      |         | % ofTotalLoans |      |        | Amount |      |   | % ofTotalLoans |   |  | Amount |   |  | % ofTotalLoans |         |   | Amount |        |   | % ofTotalLoans |  
|Real Estate:                                                               |  |                 |         |                |        |   |        |      |         |                |      |        |        |      |   |                |   |  |        |   |  |                |         |   |        |        |   |                |   |        |   |  |        |  
|Construction loans                                                         |  | $               | 27,715  |                | 12.41  | % |        | $    | 14,276  |                |      | 7.76   | %      |      | $ | 13,940         |   |  | 9.86   | % |  | $              | 10,396  |   |        | 9.08   | % |                | $ | 7,029  |   |  | 7.82   | %
|Commercial mortgage loans                                                  |  |                 | 88,220  |                | 39.51  | % |        |      | 71,113  |                |      | 38.66  | %      |      |   | 43,879         |   |  | 31.05  | % |  |                | 31,263  |   |        | 27.30  | % |                |   | 23,190 |   |  | 25.79  | %
|Home equity lines of credit                                                |  |                 | 34,715  |                | 15.55  | % |        |      | 29,221  |                |      | 15.89  | %      |      |   | 23,484         |   |  | 16.62  | % |  |                | 20,034  |   |        | 17.49  | % |                |   | 20,159 |   |  | 22.42  | %
|Residential mortgage loans                                                 |  |                 | 28,630  |                | 12.82  | % |        |      | 27,010  |                |      | 14.69  | %      |      |   | 16,528         |   |  | 11.70  | % |  |                | 13,946  |   |        | 12.18  | % |                |   | 9,904  |   |  | 11.01  | %
|Residential mortgage loans held for sale                                   |  |                 | 5,657   |                | 2.53   | % |        |      | 4,981   |                |      | 2.71   | %      |      |   | 6,541          |   |  | 4.63   | % |  |                | 7,145   |   |        | 6.24   | % |                |   | 1,479  |   |  | 1.64   | %
|                                                                           |  |                 |         |                |        |   |        |      |         |                |      |        |        |      |   |                |   |  |        |   |  |                |         |   |        |        |   |                |   |        |   |  |        |  
|Total real estate loans                                                    |  |                 | 184,937 |                | 82.82  | % |        |      | 146,601 |                |      | 79.71  | %      |      |   | 104,372        |   |  | 73.86  | % |  |                | 82,784  |   |        | 72.29  | % |                |   | 61,761 |   |  | 68.67  | %
|Commercial and industrial loans                                            |  |                 | 30,464  |                | 13.64  | % |        |      | 30,893  |                |      | 16.80  | %      |      |   | 27,501         |   |  | 19.46  | % |  |                | 24,237  |   |        | 21.16  | % |                |   | 22,462 |   |  | 24.98  | %
|Loans to individuals for household, family and other personal expenditures |  |                 | 7,911   |                | 3.54   | % |        |      | 6,431   |                |      | 3.50   | %      |      |   | 9,439          |   |  | 6.68   | % |  |                | 7,499   |   |        | 6.55   | % |                |   | 5,711  |   |  | 6.35   | %
|                                                                           |  |                 |         |                |        |   |        |      |         |                |      |        |        |      |   |                |   |  |        |   |  |                |         |   |        |        |   |                |   |        |   |  |        |  
|Loans, gross                                                               |  |                 | 223,312 |                | 100.00 | % |        |      | 183,925 |                |      | 100.00 | %      |      |   | 141,312        |   |  | 100.00 | % |  |                | 114,520 |   |        | 100.00 | % |                |   | 89,934 |   |  | 100.00 | %
|                                                                           |  |                 |         |                |        |   |        |      |         |                |      |        |        |      |   |                |   |  |        |   |  |                |         |   |        |        |   |                |   |        |   |  |        |  
|Less net deferred loan origination (fees) costs                            |  |                 | 28      |                |        |   |        |      | (31     | )              |      |        |        |      |   | (105           | ) |  |        |   |  |                | (96     | ) |        |        |   |                |   | (31    | ) |  |        |  
|                                                                           |  |                 |         |                |        |   |        |      |         |                |      |        |        |      |   |                |   |  |        |   |  |                |         |   |        |        |   |                |   |        |   |  |        |  
|Total loans, net                                                           |  | $               | 223,340 |                |        |   |        | $    | 183,894 |                |      |        |        |      | $ | 141,207        |   |  |        |   |  | $              | 114,424 |   |        |        |   |                | $ | 89,903 |   |  |        |  
|                                                                           |  |                 |         |                |        |   |        |      |         |                |      |        |        |      |   |                |   |  |        |   |  |                |         |   |        |        |   |                |   |        |   |  |        |  



30



---

MidCarolina Financial Corporation

Table 9

Loan Maturities

(In thousands)



|                                                  |  |                      |         |       |                                   |   |        |                      |        |  |       |        |  |       |     |  |        |   |       |   |         |  |      |  
|------------------------------------------------- |  | -------------------- | ------- | ----- | --------------------------------- | - | ------ | -------------------- | ------ |  | ----- | ------ |  | ----- | --- |  | ------ | - | ----- | - | ------- |  | ---- | -
|                                                  |  | At December 31, 2004 |        
|                                                  |  | Due within one year  |         |       | Due after oneyear but within five |   |        | Due after five years |        |  | Total |       
|                                                  |  | Amount               |         | Yield |                                   |   | Amount |                      | Yield  |  |       | Amount |  | Yield |     |  | Amount |   | Yield |  
|By loan type:                                     |  |                      |         |       |                                   |   |        |                      |        |  |       |        |  |       |     |  |        |   |       |   |         |  |      |  
|Commercial and industrial and commerical mortgage |  | $                    | 90,026  |       | 5.50                              | % |        | $                    | 28,168 |  | 6.31  | %      |  | $     | 490 |  | 7.17   | % |       | $ | 118,684 |  | 5.70 | %
|Real estate - construction                        |  |                      | 22,153  |       | 5.67                              | % |        |                      | 5,437  |  | 6.13  | %      |  |       | 125 |  | 6.08   | % |       |   | 27,715  |  | 5.76 | %
|                                                  |  |                      |         |       |                                   |   |        |                      |        |  |       |        |  |       |     |  |        |   |       |   |         |  |      |  
|Total                                             |  | $                    | 112,179 |       | 5.53                              | % |        | $                    | 33,605 |  | 6.28  | %      |  | $     | 615 |  | 6.95   | % |       | $ | 146,399 |  | 5.71 | %
|                                                  |  |                      |         |       |                                   |   |        |                      |        |  |       |        |  |       |     |  |        |   |       |   |         |  |      |  
|By interest rate type:                            |  |                      |         |       |                                   |   |        |                      |        |  |       |        |  |       |     |  |        |   |       |   |         |  |      |  
|Fixed rate loans                                  |  | $                    | 7,723   |       |                                   |   |        | $                    | 33,605 |  |       |        |  | $     | 615 |  |        |   |       | $ | 41,943  |  |      |  
|Variable rate loans                               |  |                      | 104,456 |       |                                   |   |        |                      |       |  |       |        |  |       |    |  |        |   |       |   | 104,456 |  |      |  
|                                                  |  |                      |         |       |                                   |   |        |                      |        |  |       |        |  |       |     |  |        |   |       |   |         |  |      |  
|                                                  |  | $                    | 112,179 |       |                                   |   |        | $                    | 33,605 |  |       |        |  | $     | 615 |  |        |   |       | $ | 146,399 |  |      |  
|                                                  |  |                      |         |       |                                   |   |        |                      |        |  |       |        |  |       |     |  |        |   |       |   |         |  |      |  



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



31



---

MidCarolina Financial Corporation

Table 10

Nonperforming Assets

($ in thousands)



|                                                    |  |                 |         |   |      |   |        |      |  |   |         |   |  |      |        |   |  |   |       |  
|--------------------------------------------------- |  | --------------- | ------- | - | ---- | - | ------ | ---- |  | - | ------- | - |  | ---- | ------ | - |  | - | ----- | -
|                                                    |  | At December 31, |        
|                                                    |  | 2004            |         |   | 2003 |   |        | 2002 |  |   | 2001    |   |  | 2000 |       
|Nonaccrual loans                                    |  | $               | 254     |   |      | $ | 589    |      |  | $ | 80      |   |  | $    | 747    |   |  | $ |      |  
|Restructured loans                                  |  |                 |        |   |      |   |       |      |  |   |        |   |  |      |       |   |  |   |      |  
|                                                    |  |                 |         |   |      |   |        |      |  |   |         |   |  |      |        |   |  |   |       |  
|Total nonperforming loans                           |  |                 | 254     |   |      |   | 589    |      |  |   | 80      |   |  |      | 747    |   |  |   |      |  
|                                                    |  |                 |         |   |     
|Repossed Assets                                     |  |                 |        |   |      |   | 22     |      |  |   | 11      |   |  |      |       |   |  |   |      |  
|Other real estate owned                             |  |                 | 2,031   |   |      |   |       |      |  |   |        |   |  |      |       |   |  |   |      |  
|                                                    |  |                 |         |   |      |   |        |      |  |   |         |   |  |      |        |   |  |   |       |  
|Total nonperforming assets                          |  | $               | 2,285   |   |      | $ | 611    |      |  | $ | 91      |   |  | $    | 747    |   |  | $ |      |  
|                                                    |  |                 |         |   |      |   |        |      |  |   |         |   |  |      |        |   |  |   |       |  
|Accruing loans past due 90 days or more             |  | $               |        |   |      | $ |       |      |  | $ |        |   |  | $    |       |   |  | $ |      |  
|Allowance for loan losses                           |  |                 | 2,865   |   |      |   | 2,522  |      |  |   | 2,088   |   |  |      | 1,633  |   |  |   | 1,319 |  
|Nonperforming loans to year end loans               |  |                 | 0.11    | % |      |   | 0.32   | %    |  |   | 0.06    | % |  |      | 0.65   | % |  |   | 0.00  | %
|Allowance for loan losses to year end loans         |  |                 | 1.32    | % |      |   | 1.41   | %    |  |   | 1.48    | % |  |      | 1.43   | % |  |   | 1.47  | %
|Nonperforming assets to loans and other real estate |  |                 | 1.01    | % |      |   | 0.33   | %    |  |   | 0.06    | % |  |      | 0.65   | % |  |   | 0.00  | %
|Nonperforming assets to total assets                |  |                 | 0.80    | % |      |   | 0.29   | %    |  |   | 0.05    | % |  |      | 0.54   | % |  |   | 0.00  | %
|Allowance for loan losses to nonperforming loans    |  |                 | 1127.95 | % |      |   | 428.18 | %    |  |   | 2610.00 | % |  |      | 218.61 | % |  |   | NM    |  



32



---

MidCarolina Financial Corporation

Table 11

Allocation of the Allowance for Loan Losses

(In thousands)



|                                         |  |        |       |                     |        |   |        |      |                     |  |        |        |  |                     |       |  |        |   |                     |   |       |        |        |                     |  |   |       |  |        |  
|---------------------------------------- |  | ------ | ----- | ------------------- | ------ | - | ------ | ---- | ------------------- |  | ------ | ------ |  | ------------------- | ----- |  | ------ | - | ------------------- | - | ----- | ------ | ------ | ------------------- |  | - | ----- |  | ------ | -
|                                         |  | 2004   |       |                     | 2003   |   |        | 2002 |                     |  | 2001   |        |  | 2000                |      
|                                         |  | Amount |       | % of TotalLoans (1) |        |   | Amount |      | % of TotalLoans (1) |  |        | Amount |  | % of TotalLoans (1) |       |  | Amount |   | % of TotalLoans (1) |   |       | Amount |        | % of TotalLoans (1) | 
|Real estate loans:                       |  |        |       |                     |        |   |        |      |                     |  |        |        |  |                     |       |  |        |   |                     |   |       |        |        |                     |  |   |       |  |        |  
|Construction loans                       |  | $      | 356   |                     | 12.41  | % |        | $    | 196                 |  | 7.76   | %      |  | $                   | 206   |  | 9.86   | % |                     | $ | 148   |        | 9.08   | %                   |  | $ | 103   |  | 7.82   | %
|Commercial mortgage loans                |  |        | 1,132 |                     | 39.51  | % |        |      | 975                 |  | 38.66  | %      |  |                     | 648   |  | 31.05  | % |                     |   | 446   |        | 27.30  | %                   |  |   | 340   |  | 25.79  | %
|Home equity lines of credit              |  |        | 445   |                     | 15.55  | % |        |      | 401                 |  | 15.89  | %      |  |                     | 347   |  | 16.62  | % |                     |   | 286   |        | 17.49  | %                   |  |   | 296   |  | 22.42  | %
|Residential mortgage loans               |  |        | 357   |                     | 12.45  | % |        |      | 370                 |  | 14.69  | %      |  |                     | 244   |  | 11.70  | % |                     |   | 199   |        | 12.18  | %                   |  |   | 145   |  | 11.01  | %
|Residential mortgage loans held for sale |  |        |      |                     | 2.90   | % |        |      |                    |  | 2.71   | %      |  |                     |      |  | 4.63   | % |                     |   |      |        | 6.24   | %                   |  |   |      |  | 1.64   | %
|                                         |  |        |       |                     |        |   |        |      |                     |  |        |        |  |                     |       |  |        |   |                     |   |       |        |        |                     |  |   |       |  |        |  
|Total real estate loans                  |  |        | 2,290 |                     | 82.82  | % |        |      | 1,942               |  | 79.71  | %      |  |                     | 1,445 |  | 73.86  | % |                     |   | 1,079 |        | 72.29  | %                   |  |   | 884   |  | 68.67  | %
|Commercial and industrial loans          |  |        | 489   |                     | 13.64  | % |        |      | 522                 |  | 16.80  | %      |  |                     | 504   |  | 19.46  | % |                     |   | 447   |        | 21.16  | %                   |  |   | 351   |  | 24.98  | %
|Loans to individuals                     |  |        | 101   |                     | 3.54   | % |        |      | 88                  |  | 3.50   | %      |  |                     | 139   |  | 6.68   | % |                     |   | 107   |        | 6.55   | %                   |  |   | 84    |  | 6.35   | %
|                                         |  |        |       |                     |        |   |        |      |                     |  |        |        |  |                     |       |  |        |   |                     |   |       |        |        |                     |  |   |       |  |        |  
|                                         |  | $      | 2,865 |                     | 100.00 | % |        | $    | 2,522               |  | 100.00 | %      |  | $                   | 2,088 |  | 100.00 | % |                     | $ | 1,633 |        | 100.00 | %                   |  | $ | 1,319 |  | 100.00 | %
|                                         |  |        |       |                     |        |   |        |      |                     |  |        |        |  |                     |       |  |        |   |                     |   |       |        |        |                     |  |   |       |  |        |  

---

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



33



---

MidCarolina Financial Corporation

Table 12

Loan Loss and Recovery Experience

($ in thousands)



|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |        |  
|-------------------------------------------------------------- |  | ------------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | - |  | ---- | ------- | - |  | - | ------ | -
|                                                               |  | At or for the Year Ended December 31, |        
|                                                               |  | 2004                                  |         |   | 2003 |   |         | 2002 |  |   | 2001    |   |  | 2000 |        
|Loans outstanding at the end of the year                       |  | $                                     | 217,683 |   |      | $ | 178,913 |      |  | $ | 141,207 |   |  | $    | 114,424 |   |  | $ | 89,903 |  
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |        |  
|Average loans outstanding during the year                      |  | $                                     | 204,121 |   |      | $ | 160,041 |      |  | $ | 118,702 |   |  | $    | 100,816 |   |  | $ | 75,775 |  
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |        |  
|Allowance for loan losses at beginning of year                 |  | $                                     | 2,522   |   |      | $ | 2,088   |      |  | $ | 1,633   |   |  | $    | 1,319   |   |  | $ | 936    |  
|Provision for loan losses                                      |  |                                       | 1,030   |   |      |   | 586     |      |  |   | 573     |   |  |      | 735     |   |  |   | 540    |  
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |        |  
|                                                               |  |                                       | 3,552   |   |      |   | 2,674   |      |  |   | 2,206   |   |  |      | 2,054   |   |  |   | 1,476  |  
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |        |  
|Loans charged off:                                             |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |        |  
|Real estate loans                                              |  |                                       | (5      | ) |      |   | (3      | )    |  |   |        |   |  |      |        |   |  |   |       |  
|Commercial and industrial loans                                |  |                                       | (693    | ) |      |   | (73     | )    |  |   | (60     | ) |  |      | (321    | ) |  |   | (157   | )
|Installment loans                                              |  |                                       | (56     | ) |      |   | (126    | )    |  |   | (67     | ) |  |      | (103    | ) |  |   |       |  
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |        |  
|Total charge-offs                                              |  |                                       | (754    | ) |      |   | (202    | )    |  |   | (127    | ) |  |      | (424    | ) |  |   | (157   | )
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |        |  
|Recoveries of loans previously charged off:                    |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |        |  
|Commercial and industrial loans                                |  |                                       | 14      |   |      |   | 41      |      |  |   | 3       |   |  |      | 3       |   |  |   |       |  
|Installment loans                                              |  |                                       | 53      |   |      |   | 9       |      |  |   | 6       |   |  |      |        |   |  |   |       |  
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |        |  
|Total recoveries                                               |  |                                       | 67      |   |      |   | 50      |      |  |   | 9       |   |  |      | 3       |   |  |   |       |  
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |        |  
|Net charge-offs                                                |  |                                       | (687    | ) |      |   | (152    | )    |  |   | (118    | ) |  |      | (421    | ) |  |   | (157   | )
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |        |  
|Allowance for loan losses at end of year                       |  | $                                     | 2,865   |   |      | $ | 2,522   |      |  | $ | 2,088   |   |  | $    | 1,633   |   |  | $ | 1,319  |  
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |        |  
|Ratios:                                                        |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |        |  
|Net charge-offs as a percent of average loans                  |  |                                       | 0.34    | % |      |   | 0.09    | %    |  |   | 0.10    | % |  |      | 0.42    | % |  |   | 0.21   | %
|Allowance for loan losses as a percent of loans at end of year |  |                                       | 1.32    | % |      |   | 1.41    | %    |  |   | 1.48    | % |  |      | 1.43    | % |  |   | 1.47   | %



34



---

MidCarolina Financial Corporation

Table 13

Securities Portfolio Composition

(In thousands)



|                                    |  |                |        |      |   |       |  |   |       
|----------------------------------- |  | -------------- | ------ | ---- | - | ----- |  | - | ------
|                                    |  | At December 31
|                                    |  | 2004           |        | 2003 |   | 2002 
|Securities available for sale:      |  |                |        |      |   |       |  |   |       
|U. S. Government agencies           |  | $              | 2,484  |      | $ | 2,034 |  | $ | 5,185 
|Mortgage-backed securities          |  |                | 25,900 |      |   | 2,645 |  |   | 4,188 
|State and local governments         |  |                | 7,404  |      |   | 2,931 |  |   | 405   
|Other                               |  |                | 124    |      |   | 124   |  |   | 78    
|                                    |  |                |        |      |   |       |  |   |       
|Total securities available for sale |  |                | 35,912 |      |   | 7,734 |  |   | 9,856 
|                                    |  |                |        |      |   |       |  |   |       
|Securities held to maturity:        |  |                |        |      |   |       |  |   |       
|Other                               |  |                | 250    |      |   | 250   |  |   | 250   
|                                    |  |                |        |      |   |       |  |   |       
|Total securities                    |  | $              | 36,162 |      | $ | 7,984 |  | $ | 10,106
|                                    |  |                |        |      |   |       |  |   |       



35



---

MidCarolina Financial Corporation

Table 14

Securities Portfolio Composition

($ in thousands)



|                                    |  |               |        |           |   |               |  |      |  
|----------------------------------- |  | ------------- | ------ | --------- | - | ------------- |  | ---- | -
|                                    |  | AmortizedCost |        | FairValue |   | BookYield (1) | 
|Securities available for sale:      |  |               |        |           |   |               |  |      |  
|U. S. Government agencies           |  |               |        |           |   |               |  |      |  
|Due after one but within five years |  | $             | 1,999  |           | $ | 1,988         |  | 4.02 | %
|Due after five but within ten years |  |               | 500    |           |   | 496           |  | 5.96 | %
|                                    |  |               |        |           |   |               |  |      |  
|                                    |  |               | 2,499  |           |   | 2,484         |  | 4.41 | %
|                                    |  |               |        |           |   |               |  |      |  
|Mortgage-backed securities          |  |               |        |           |   |               |  |      |  
|Due within one year                 |  |               | 4,483  |           |   | 4,450         |  | 4.18 | %
|Due after one but within five years |  |               | 14,906 |           |   | 14,824        |  | 4.20 | %
|Due after five but within ten years |  |               | 4,526  |           |   | 4,493         |  | 4.20 | %
|Due after ten years                 |  |               | 2,148  |           |   | 2,133         |  | 4.36 | %
|                                    |  |               |        |           |   |               |  |      |  
|                                    |  |               | 26,063 |           |   | 25,900        |  | 4.21 | %
|                                    |  |               |        |           |   |               |  |      |  
|State and local governments (1)     |  |               |        |           |   |               |  |      |  
|Due after one but within five years |  |               | 1,927  |           |   | 1,924         |  | 6.18 | %
|Due after five but within ten years |  |               | 1,958  |           |   | 1,936         |  | 6.20 | %
|Due after ten years                 |  |               | 3,520  |           |   | 3,544         |  | 6.32 | %
|                                    |  |               |        |           |   |               |  |      |  
|                                    |  |               | 7,405  |           |   | 7,404         |  | 6.25 | %
|                                    |  |               |        |           |   |               |  |      |  
|Other                               |  |               |        |           |   |               |  |      |  
|Due after ten years                 |  |               | 124    |           |   | 124           |  | 0.00 | %
|                                    |  |               |        |           |   |               |  |      |  
|                                    |  |               | 124    |           |   | 124           |  | 0.00 | %
|                                    |  |               |        |           |   |               |  |      |  
|Total securities available for sale |  |               |        |           |   |               |  |      |  
|Due within one year                 |  |               | 4,483  |           |   | 4,450         |  | 4.18 | %
|Due after one but within five years |  |               | 18,832 |           |   | 18,736        |  | 4.38 | %
|Due after five but within ten years |  |               | 6,984  |           |   | 6,925         |  | 4.89 | %
|Due after ten years                 |  |               | 5,792  |           |   | 5,801         |  | 5.46 | %
|                                    |  |               |        |           |   |               |  |      |  
|                                    |  | $             | 36,091 |           | $ | 35,912        |  | 4.63 | %
|                                    |  |               |        |           |   |               |  |      |  
|Securities held to maturity         |  |               |        |           |   |               |  |      |  
|Other                               |  |               |        |           |   |               |  |      |  
|Due after ten years                 |  | $             | 250    |           | $ | 250           |  | 4.75 | %
|                                    |  |               |        |           |   |               |  |      |  
|                                    |  |               | 250    |           |   | 250           |  | 4.75 | %
|                                    |  |               |        |           |   |               |  |      |  
|Total securities held to maturity   |  |               |        |           |   |               |  |      |  
|Due after ten years                 |  |               | 250    |           |   | 250           |  | 4.75 | %
|                                    |  |               |        |           |   |               |  |      |  
|                                    |  | $             | 250    |           | $ | 250           |  | 4.75 | %
|                                    |  |               |        |           |   |               |  |      |  

---

|(1) | Yields on tax-exempt investments have been adjusted to a taxable equivalent basis using a 34% tax rate.
|--- | -------------------------------------------------------------------------------------------------------



36



---

MidCarolina Financial Corporation

Table 15

Average Deposits

($ in thousands)



|                                |  |                                 |         |             |      |   |               |      |             |  |      |               |  |             |         |  |      |  
|------------------------------- |  | ------------------------------- | ------- | ----------- | ---- | - | ------------- | ---- | ----------- |  | ---- | ------------- |  | ----------- | ------- |  | ---- | -
|                                |  | For the Year Ended December 31, |        
|                                |  | 2004                            |         |             | 2003 |   |               | 2002 |            
|                                |  | AverageAmount                   |         | AverageRate |      |   | AverageAmount |      | AverageRate |  |      | AverageAmount |  | AverageRate |        
|Demand deposits                 |  | $                               | 50,781  |             | 1.21 | % |               | $    | 36,346      |  | 0.86 | %             |  | $           | 36,831  |  | 1.37 | %
|Savings deposits                |  |                                 | 6,549   |             | 0.49 | % |               |      | 5,569       |  | 0.48 | %             |  |             | 4,342   |  | 0.88 | %
|Fixed maturity deposits         |  |                                 | 108,160 |             | 1.99 | % |               |      | 90,110      |  | 2.17 | %             |  |             | 83,775  |  | 2.95 | %
|                                |  |                                 |         |             |      |   |               |      |             |  |      |               |  |             |         |  |      |  
|Total interest-bearing deposits |  |                                 | 165,490 |             | 1.69 | % |               |      | 132,025     |  | 1.74 | %             |  |             | 124,948 |  | 2.41 | %
|Non-interest-bearing deposits   |  |                                 | 21,600  |             |     |   |               |      | 18,937      |  |     |               |  |             | 13,817  |  |     |  
|                                |  |                                 |         |             |      |   |               |      |             |  |      |               |  |             |         |  |      |  
|Total deposits                  |  | $                               | 187,090 |             | 1.50 | % |               | $    | 150,962     |  | 1.52 | %             |  | $           | 138,765 |  | 2.17 | %
|                                |  |                                 |         |             |      |   |               |      |             |  |      |               |  |             |         |  |      |  



37



---

MidCarolina Financial Corporation

Table 16

Maturities of Time Deposits of $100,000 or More

(In thousands)



|                                  |  |                      |        |                          |   |                           |  |               |        |       |   |       |  |   |       
|--------------------------------- |  | -------------------- | ------ | ------------------------ | - | ------------------------- |  | ------------- | ------ | ----- | - | ----- |  | - | ------
|                                  |  | At December 31, 2004
|                                  |  | 3 Monthsor Less      |        | Over 3 Monthsto 6 Months |   | Over 6 Monthsto 12 Months |  | Over 12Months |        | Total
|Time Deposits of $100,000 or more |  | $                    | 13,801 |                          | $ | 39,184                    |  | $             | 11,357 |       | $ | 2,687 |  | $ | 67,029
|                                  |  |                      |        |                          |   |                           |  |               |        |       |   |       |  |   |       



38



---

ITEM 7. FINANCIAL STATEMENTS



MIDCAROLINA FINANCIAL CORPORATION



CONSOLIDATED FINANCIAL STATEMENTS



Years Ended December 31, 2004 and 2003



39



---

MIDCAROLINA FINANCIAL CORPORATION AND SUBSIDIARIES



INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS



|                                                                                                          |  |         
|--------------------------------------------------------------------------------------------------------- |  | --------
|                                                                                                          |  | Page No.
|Report of Independent Registered Public Accounting Firm                                                   |  | 41      
|                                                                                                          | 
|Consolidated Statements of Financial Condition as of December 31, 2004 and 2003                           |  | 42      
|                                                                                                          | 
|Consolidated Statements of Operations for the years ended December 31, 2004 and 2003                      |  | 43      
|                                                                                                          | 
|Consolidated Statements of Comprehensive Income for the years ended December 31, 2004 and 2003            |  | 44      
|                                                                                                          | 
|Consolidated Statements of Changes in Shareholders Equity for the years ended December 31, 2004 and 2003 |  | 45      
|                                                                                                          | 
|Consolidated Statements of Cash Flows for the years ended December 31, 2004 and 2003                      |  | 46      
|                                                                                                          | 
|Notes to Consolidated Financial Statements                                                                |  | 47      



40



---

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



The Board of Directors and Shareholders

MidCarolina Financial Corporation



We have audited the accompanying
consolidated statements of financial condition of MidCarolina Financial Corporation and subsidiary as of December 31, 2004 and 2003 and the related consolidated statements of operations, comprehensive income, 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. The Company is not required to have, nor were we
engaged to perform, an audit of its 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 includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.



In our opinion, the consolidated
financial statements referred to above present fairly, in all material respects, the financial position of MidCarolina Financial Corporation and subsidiary as of December 31, 2004 and 2003, 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.



Sanford, North Carolina

March 9, 2005



41



---

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION



December 31, 2004 and 2003



|                                                                                                                                                            |  |                                          |         |   |      |   |         |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------------------- | ------- | - | ---- | - | ------- | -
|                                                                                                                                                            |  | 2004                                     |         |   | 2003 |  
|                                                                                                                                                            |  | (Amounts in thousands,except share data) |        
|Assets                                                                                                                                                      |  |                                          |         |   |      |   |         |  
|Cash and due from banks                                                                                                                                     |  | $                                        | 906     |   |      | $ | 2,551   |  
|Federal funds sold and interest-earning deposits                                                                                                            |  |                                          | 9,187   |   |      |   | 5,994   |  
|Investment securities:                                                                                                                                      |  |                                          |         |   |      |   |         |  
|Available for sale                                                                                                                                          |  |                                          | 35,912  |   |      |   | 7,734   |  
|Held to maturity (fair value approximates $250)                                                                                                             |  |                                          | 250     |   |      |   | 250     |  
|Loans held for sale                                                                                                                                         |  |                                          | 5,657   |   |      |   | 4,981   |  
|Loans                                                                                                                                                       |  |                                          | 217,683 |   |      |   | 178,913 |  
|Allowance for loan losses                                                                                                                                   |  |                                          | (2,865  | ) |      |   | (2,522  | )
|                                                                                                                                                            |  |                                          |         |   |      |   |         |  
|Net loans                                                                                                                                                   |  |                                          | 214,818 |   |      |   | 176,391 |  
|Investment in stock of Federal Home Loan Bank of Atlanta                                                                                                    |  |                                          | 2,292   |   |      |   | 1,825   |  
|Investment in life insurance                                                                                                                                |  |                                          | 6,783   |   |      |   | 6,549   |  
|Premises and equipment, net                                                                                                                                 |  |                                          | 4,139   |   |      |   | 4,246   |  
|Other assets                                                                                                                                                |  |                                          | 4,944   |   |      |   | 2,040   |  
|                                                                                                                                                            |  |                                          |         |   |      |   |         |  
|Total assets                                                                                                                                                |  | $                                        | 284,888 |   |      | $ | 212,561 |  
|                                                                                                                                                            |  |                                          |         |   |      |   |         |  
|Liabilities and Shareholders Equity                                                                                                                        |  |                                          |         |   |      |   |         |  
|Deposits:                                                                                                                                                   |  |                                          |         |   |      |   |         |  
|Noninterest-bearing demand deposits                                                                                                                         |  | $                                        | 23,667  |   |      | $ | 18,877  |  
|Interest-bearing demand deposits                                                                                                                            |  |                                          | 52,345  |   |      |   | 32,657  |  
|Savings                                                                                                                                                     |  |                                          | 6,665   |   |      |   | 5,966   |  
|Time                                                                                                                                                        |  |                                          | 134,114 |   |      |   | 94,482  |  
|                                                                                                                                                            |  |                                          |         |   |      |   |         |  
|Total deposits                                                                                                                                              |  |                                          | 216,791 |   |      |   | 151,982 |  
|                                                                                                                                                            |  |                                         
|Short-term borrowings                                                                                                                                       |  |                                          | 15,500  |   |      |   | 18,500  |  
|Long-term debt                                                                                                                                              |  |                                          | 34,764  |   |      |   | 26,500  |  
|Accrued expenses and other liabilities                                                                                                                      |  |                                          | 1,409   |   |      |   | 1,168   |  
|                                                                                                                                                            |  |                                          |         |   |      |   |         |  
|Total liabilities                                                                                                                                           |  |                                          | 268,464 |   |      |   | 198,150 |  
|                                                                                                                                                            |  |                                          |         |   |      |   |         |  
|Shareholders equity:                                                                                                                                       |  |                                          |         |   |      |   |         |  
|Preferred stock, no par value, 20,000,000 shares authorized; none issued                                                                                    |  |                                          |        |   |      |   |        |  
|Common stock, no par value; 80,000,000 shares authorized; 2,084,392 and 2,065,006 shares issued and outstanding at December 31, 2004 and 2003,
respectively |  |                                          | 11,352  |   |      |   | 11,161  |  
|Retained earnings                                                                                                                                           |  |                                          | 5,171   |   |      |   | 3,229   |  
|Accumulated other comprehensive income (loss)                                                                                                               |  |                                          | (99     | ) |      |   | 21      |  
|                                                                                                                                                            |  |                                          |         |   |      |   |         |  
|Total shareholders equity                                                                                                                                  |  |                                          | 16,424  |   |      |   | 14,411  |  
|                                                                                                                                                            |  |                                          |         |   |      |   |         |  
|Total liabilities and shareholders equity                                                                                                                  |  | $                                        | 284,888 |   |      | $ | 212,561 |  
|                                                                                                                                                            |  |                                          |         |   |      |   |         |  



See accompanying notes to
consolidated financial statements.



42



---

CONSOLIDATED STATEMENTS OF OPERATIONS



Years Ended December 31, 2004 and 2003



|                                                    |  |                                              |        |      |   |      
|--------------------------------------------------- |  | -------------------------------------------- | ------ | ---- | - | -----
|                                                    |  | 2004                                         |        | 2003
|                                                    |  | (Amounts in thousands,except per share data)
|Interest Income                                     |  |                                              |        |      |   |      
|Loans                                               |  | $                                            | 10,840 |      | $ | 9,189
|Investment securities:                              |  |                                              |        |      |   |      
|Taxable                                             |  |                                              | 895    |      |   | 268  
|Tax-exempt                                          |  |                                              | 285    |      |   | 54   
|Federal funds sold and interest-earning deposits    |  |                                              | 74     |      |   | 94   
|Other                                               |  |                                              | 80     |      |   | 47   
|                                                    |  |                                              |        |      |   |      
|Total interest income                               |  |                                              | 12,174 |      |   | 9,652
|                                                    |  |                                              |        |      |   |      
|Interest Expense                                    |  |                                              |        |      |   |      
|Demand deposits                                     |  |                                              | 614    |      |   | 313  
|Savings deposits                                    |  |                                              | 32     |      |   | 27   
|Time deposits                                       |  |                                              | 2,152  |      |   | 1,953
|Short-term borrowings                               |  |                                              | 311    |      |   | 40   
|Long-term debt                                      |  |                                              | 1,274  |      |   | 965  
|                                                    |  |                                              |        |      |   |      
|Total interest expense                              |  |                                              | 4,383  |      |   | 3,298
|                                                    |  |                                              |        |      |   |      
|Net Interest Income                                 |  |                                              | 7,791  |      |   | 6,354
|Provision for loan losses                           |  |                                              | 1,030  |      |   | 586  
|                                                    |  |                                              |        |      |   |      
|Net interest income after provision for loan losses |  |                                              | 6,761  |      |   | 5,768
|                                                    |  |                                              |        |      |   |      
|Non-Interest Income                                 |  |                                              |        |      |   |      
|Service charges on deposit accounts                 |  |                                              | 1,087  |      |   | 1,017
|Mortgage operations                                 |  |                                              | 2,325  |      |   | 1,766
|Investment brokerage fees                           |  |                                              | 235    |      |   | 298  
|Increase in cash surrender value of life insurance  |  |                                              | 234    |      |   | 298  
|Gain on sale of investment securities               |  |                                              | 70     |      |   | 28   
|Other income                                        |  |                                              | 190    |      |   | 168  
|                                                    |  |                                              |        |      |   |      
|Total non-interest income                           |  |                                              | 4,141  |      |   | 3,575
|                                                    |  |                                              |        |      |   |      
|Non-Interest Expense                                |  |                                              |        |      |   |      
|Salaries and employee benefits                      |  |                                              | 4,927  |      |   | 4,184
|Occupancy and equipment                             |  |                                              | 730    |      |   | 630  
|Data processing                                     |  |                                              | 468    |      |   | 414  
|Office supplies and postage                         |  |                                              | 285    |      |   | 268  
|Deposit and other insurance                         |  |                                              | 149    |      |   | 158  
|Professional and other services                     |  |                                              | 444    |      |   | 351  
|Advertising                                         |  |                                              | 180    |      |   | 140  
|Other                                               |  |                                              | 827    |      |   | 700  
|                                                    |  |                                              |        |      |   |      
|Total non-interest expense                          |  |                                              | 8,010  |      |   | 6,845
|                                                    |  |                                              |        |      |   |      
|Income before income taxes                          |  |                                              | 2,892  |      |   | 2,498
|Provision for income taxes                          |  |                                              | 950    |      |   | 835  
|                                                    |  |                                              |        |      |   |      
|Net income                                          |  | $                                            | 1,942  |      | $ | 1,663
|                                                    |  |                                              |        |      |   |      
|Net Income Per Share:                               |  |                                              |        |      |   |      
|Basic                                               |  | $                                            | .78    |      | $ | .68  
|                                                    |  |                                              |        |      |   |      
|Diluted                                             |  | $                                            | .72    |      | $ | .63  
|                                                    |  |                                              |        |      |   |      



See accompanying notes to
consolidated financial statements.





43



---

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME



Years Ended December 31, 2004 and 2003



|                                                                  |  |                        |       |   |      |   |       |  
|----------------------------------------------------------------- |  | ---------------------- | ----- | - | ---- | - | ----- | -
|                                                                  |  | 2004                   |       |   | 2003 |  
|                                                                  |  | (Amounts in thousands) |      
|Net income                                                        |  | $                      | 1,942 |   |      | $ | 1,663 |  
|                                                                  |  |                        |       |   |      |   |       |  
|Other comprehensive income:                                       |  |                        |       |   |      |   |       |  
|Securities available for sale:                                    |  |                        |       |   |      |   |       |  
|Unrealized holding losses on available for sale securities        |  |                        | (208  | ) |      |   | (110  | )
|Tax effect                                                        |  |                        | 76    |   |      |   | 40    |  
|Reclassification of gains recognized in net income                |  |                        | (70   | ) |      |   | (28   | )
|Tax effect                                                        |  |                        | 25    |   |      |   | 10    |  
|                                                                  |  |                        |       |   |      |   |       |  
|Net of tax amount                                                 |  |                        | (177  | ) |      |   | (88   | )
|                                                                  |  |                        |       |   |      |   |       |  
|Cash flow hedging activities:                                     |  |                        |       |   |      |   |       |  
|Unrealized holding gains (losses) on cash flow hedging activities |  |                        | 90    |   |      |   | (55   | )
|Tax effect                                                        |  |                        | (33   | ) |      |   | 21    |  
|                                                                  |  |                        |       |   |      |   |       |  
|Net of tax amount                                                 |  |                        | 57    |   |      |   | (34   | )
|                                                                  |  |                        |       |   |      |   |       |  
|Total other comprehensive loss                                    |  |                        | (120  | ) |      |   | (122  | )
|                                                                  |  |                        |       |   |      |   |       |  
|Comprehensive income                                              |  | $                      | 1,822 |   |      | $ | 1,541 |  
|                                                                  |  |                        |       |   |      |   |       |  



See accompanying notes to
consolidated financial statements.





44



---

CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY



Years Ended December 31, 2004 and 2003



|                              |  |                                           |  |                   |        |                                              |   |       |                            |   |      |   |  |   |        |  
|----------------------------- |  | ----------------------------------------- |  | ----------------- | ------ | -------------------------------------------- | - | ----- | -------------------------- | - | ---- | - |  | - | ------ | -
|                              |  | Common stock                              |  | Retained earnings |        | Accumulatedother comprehensive income (loss) |   |       | Total shareholders equity |  
|                              |  | Shares                                    |  | Amount            |        |                                              |  
|                              |  | (Amounts in thousands, except share data) | 
|Balance at December 31, 2002  |  | 1,696,732                                 |  | $                 | 10,972 |                                              | $ | 1,566 |                            | $ | 143  |   |  | $ | 12,681 |  
|Net income                    |  |                                          |  |                   |       |                                              |   | 1,663 |                            |   |     |   |  |   | 1,663  |  
|Other comprehensive loss      |  |                                          |  |                   |       |                                              |   |      |                            |   | (122 | ) |  |   | (122   | )
|Effect of 6-for-5 stock split |  | 339,301                                   |  |                   |       |                                              |   |      |                            |   |     |   |  |   |       |  
|Stock options exercised       |  | 28,863                                    |  |                   | 134    |                                              |   |      |                            |   |     |   |  |   | 134    |  
|Current income tax benefit    |  |                                          |  |                   | 54     |                                              |   |      |                            |   |     |   |  |   | 54     |  
|Stock awards                  |  | 110                                       |  |                   | 1      |                                              |   |      |                            |   |     |   |  |   | 1      |  
|                              |  |                                           |  |                   |        |                                              |   |       |                            |   |      |   |  |   |        |  
|Balance at December 31, 2003  |  | 2,065,006                                 |  |                   | 11,161 |                                              |   | 3,229 |                            |   | 21   |   |  |   | 14,411 |  
|Net income                    |  |                                          |  |                   |       |                                              |   | 1,942 |                            |   |     |   |  |   | 1,942  |  
|Other comprehensive loss      |  |                                          |  |                   |       |                                              |   |      |                            |   | (120 | ) |  |   | (120   | )
|Stock options exercised       |  | 19,336                                    |  |                   | 110    |                                              |   |      |                            |   |     |   |  |   | 110    |  
|Current income tax benefit    |  |                                          |  |                   | 80     |                                              |   |      |                            |   |     |   |  |   | 80     |  
|Stock awards                  |  | 50                                        |  |                   | 1      |                                              |   |      |                            |   |     |   |  |   | 1      |  
|                              |  |                                           |  |                   |        |                                              |   |       |                            |   |      |   |  |   |        |  
|Balance at December 31, 2004  |  | 2,084,392                                 |  | $                 | 11,352 |                                              | $ | 5,171 |                            | $ | (99  | ) |  | $ | 16,424 |  
|                              |  |                                           |  |                   |        |                                              |   |       |                            |   |      |   |  |   |        |  



See accompanying notes to
consolidated financial statements.



45



---

CONSOLIDATED STATEMENTS OF CASH FLOWS



Years Ended December 31, 2004 and 2003



|                                                                               |  |                        |         |   |      |   |         |  
|------------------------------------------------------------------------------ |  | ---------------------- | ------- | - | ---- | - | ------- | -
|                                                                               |  | 2004                   |         |   | 2003 |  
|                                                                               |  | (Amounts in thousands) |        
|Operating Activities                                                           |  |                        |         |   |      |   |         |  
|Net income                                                                     |  | $                      | 1,942   |   |      | $ | 1,663   |  
|Depreciation and amortization                                                  |  |                        | 565     |   |      |   | 418     |  
|Provision for loan losses                                                      |  |                        | 1,030   |   |      |   | 586     |  
|Deferred income tax benefit                                                    |  |                        | (109    | ) |      |   | (341    | )
|Gain on sale of investment securities available for sale                       |  |                        | (70     | ) |      |   | (28     | )
|(Gain) loss on disposal of foreclosed assets                                   |  |                        | (5      | ) |      |   | 3       |  
|(Increase) decrease in loans held for sale                                     |  |                        | (676    | ) |      |   | 1,560   |  
|Increase in cash surrender value life insurance                                |  |                        | (234    | ) |      |   | (298    | )
|Changes in assets and liabilities:                                             |  |                        |         |   |      |   |         |  
|Increase in other assets                                                       |  |                        | (619    | ) |      |   | (185    | )
|Increase (decrease) in accrued expenses and other liabilities                  |  |                        | 588     |   |      |   | (333    | )
|                                                                               |  |                        |         |   |      |   |         |  
|Net cash provided by operating activities                                      |  |                        | 2,412   |   |      |   | 3,045   |  
|                                                                               |  |                        |         |   |      |   |         |  
|Investing Activities                                                           |  |                        |         |   |      |   |         |  
|Purchases of investment securities available for sale                          |  |                        | (53,181 | ) |      |   | (3,537  | )
|Maturities and calls of investment securities available for sale               |  |                        | 5,321   |   |      |   | 5,096   |  
|Sales of investment securities available for sale                              |  |                        | 19,280  |   |      |   | 381     |  
|Investment in life insurance                                                   |  |                        |        |   |      |   | (983    | )
|Net increase in loans from originations and principal repayments               |  |                        | (41,488 | ) |      |   | (44,676 | )
|Purchase of FHLB stock                                                         |  |                        | (467    | ) |      |   | (1,363  | )
|Purchases of premises and equipment                                            |  |                        | (253    | ) |      |   | (465    | )
|Proceeds from sale of foreclosed assets                                        |  |                        | 5       |   |      |   | 274     |  
|                                                                               |  |                        |         |   |      |   |         |  
|Net cash used by investing activities                                          |  |                        | (70,783 | ) |      |   | (45,273 | )
|                                                                               |  |                        |         |   |      |   |         |  
|Financing Activities                                                           |  |                        |         |   |      |   |         |  
|Net increase in deposits                                                       |  |                        | 64,809  |   |      |   | 9,807   |  
|Net increase (decrease) in short-term borrowings                               |  |                        | (3,000  | ) |      |   | 18,500  |  
|Net increase in long-term debt                                                 |  |                        | 8,000   |   |      |   | 13,500  |  
|Proceeds from stock options exercised                                          |  |                        | 110     |   |      |   | 134     |  
|                                                                               |  |                        |         |   |      |   |         |  
|Net cash provided by financing activities                                      |  |                        | 69,919  |   |      |   | 41,941  |  
|                                                                               |  |                        |         |   |      |   |         |  
|Net increase (decrease) in cash and cash equivalents                           |  |                        | 1,548   |   |      |   | (287    | )
|Cash and cash equivalents, beginning of year                                   |  |                        | 8,545   |   |      |   | 8,832   |  
|                                                                               |  |                        |         |   |      |   |         |  
|Cash and cash equivalents, end of year                                         |  | $                      | 10,093  |   |      | $ | 8,545   |  
|                                                                               |  |                        |         |   |      |   |         |  
|Supplemental Cash Flow Disclosure                                              |  |                        |         |   |      |   |         |  
|Interest paid on deposits and borrowed funds                                   |  | $                      | 4,468   |   |      | $ | 3,248   |  
|Income taxes paid                                                              |  |                        | 1,114   |   |      |   | 1,435   |  
|                                                                               |  |                       
|Summary of Noncash Investing and Financing Activities                          |  |                        |         |   |      |   |         |  
|Transfer from loans to foreclosed assets                                       |  |                        | 2,031   |   |      |   | 277     |  
|Unrealized loss on investment securities available for sale, net of tax effect |  |                        | (177    | ) |      |   | (88     | )
|Unrealized gain (loss) on cash flow hedging activities, net of tax             |  |                        | 57      |   |      |   | (34     | )
|Deconsolidation of grantor trusts                                              |  |                        | 264     |   |      |   |        |  



See accompanying notes to
consolidated financial statements.





46



---

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



December 31, 2004 and 2003



Note A - Organization and Operations



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



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



Note B - Summary of Significant Accounting Policies



The consolidated financial statements include the accounts and transactions of MidCarolina
Financial Corporation, and its wholly owned subsidiary MidCarolina Bank and its wholly owned subsidiary, MidCarolina Investment Corporation which, through an unaffiliated broker-dealer, provides customers of the Bank with securities products and
services and earns revenues through sharing of commissions. All intercompany transactions and balances have been eliminated in consolidation. MidCarolina Financial Corporation and its subsidiary are collectively referred to herein as the
Company.



Use of Estimates



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



Cash and Cash Equivalents



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



Investment Securities



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



Loans and Interest Income



Loans are carried at their
principal amount outstanding. Interest income is recorded as earned on an accrual basis. The Company discontinues the recognition of interest income when, in the opinion of management, collection of such interest is doubtful. It is the general
policy of the Company to discontinue the accrual of interest on loans, including loans impaired under Statement of Financial Accounting Standards (SFAS) No. 114, Accounting by Creditors for Impairment of a Loan, when principal or interest
payments are delinquent 90 to 120 days or more. Any unpaid amounts previously accrued on these loans are reversed from income, and thereafter interest is recognized only to the extent payments are received.





47



---

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



December 31, 2004 and 2003



Loans Held for Sale



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



Allowance for Loan Losses



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



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



The provision for loan losses charged to operating expense is based on factors which, in managements judgment, deserve current
recognition in estimating probable loan losses. Such factors considered by management include growth and composition of the loan portfolio, the relationship of the allowance for loan losses to outstanding loans and economic conditions. While
management uses the best information available to make evaluations, this evaluation is inherently subjective as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans, that may
be susceptible to significant change.



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



Premises and Equipment



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



|                        |  |              
|----------------------- |  | -------------
|Buildings               |  | 15 - 40 years
|Leasehold improvements  |  | 15 years     
|Furniture and equipment |  | 3 - 10 years 



Foreclosed Assets



Assets acquired through, or in lieu of, loan foreclosure are held for sale and are
initially recorded at fair value at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less
cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in other non-interest expense.





48



---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS



December 31, 2004 and 2003



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, 2004.



Income Taxes



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



Comprehensive Income



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



Accumulated other comprehensive
income (loss) at December 31, 2004 and 2003 consists of the following:



|                                                             |  |                        |      |   |      |   |     |  
|------------------------------------------------------------ |  | ---------------------- | ---- | - | ---- | - | --- | -
|                                                             |  | 2004                   |      |   | 2003 |  
|                                                             |  | (Amounts in thousands) |     
|Unrealized holding gains - securities available for sale     |  | $                      | (179 | ) |      | $ | 100 |  
|Deferred income taxes                                        |  |                        | 64   |   |      |   | (37 | )
|                                                             |  |                        |      |   |      |   |     |  
|Net unrealized holding gains - securities available for sale |  |                        | (115 | ) |      |   | 63  |  
|                                                             |  |                        |      |   |      |   |     |  
|Unrealized holding gains - cash flow hedging activities      |  | $                      | 25   |   |      | $ | (65 | )
|Deferred income taxes                                        |  |                        | (9   | ) |      |   | 23  |  
|                                                             |  |                        |      |   |      |   |     |  
|Net unrealized holding gains - cash flow hedging activities  |  |                        | 16   |   |      |   | (42 | )
|                                                             |  |                        |      |   |      |   |     |  
|Total other accumulated other comprehensive income (loss)    |  | $                      | (99  | ) |      | $ | 21  |  
|                                                             |  |                        |      |   |      |   |     |  



Stock Options



Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based
Compensation, encourages but does not require that companies record compensation cost for stock-based employee compensation plans at fair value. The Company has chosen to account for stock-based compensation plans using the intrinsic value
method prescribed in Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. Under the intrinsic value based method, compensation cost is the excess, if any, of the quoted market price of the
stock at grant date or other measurement date over the amount an employee must pay to acquire the stock. All of the Companys stock options have no intrinsic value at grant date and, consequently, no compensation cost is recognized for them.



An employer that continues to apply the intrinsic value accounting method
rather than the fair value based method must disclose certain pro forma information. Under the fair value based method, compensation cost is measured at the grant date of the option based on the value of the award and is recognized over the service
period, which is usually the vesting period. As required by SFAS No. 123, disclosures are presented below for the effect on the net



49



---

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



December 31, 2004 and 2003



income and net income per share for the years ended December 31, 2004 and 2003 that would
result from the use of the fair value based method to measure compensation cost related to stock option grants. The effects of applying the provisions of SFAS No. 123 are not necessarily indicative of future effects.



|                                                                                                                                        |  |                                              |       |   |      |   |       |  
|--------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------------------------- | ----- | - | ---- | - | ----- | -
|                                                                                                                                        |  | 2004                                         |       |   | 2003 |  
|                                                                                                                                        |  | (Amounts in thousands,except per share data) |      
|Net income:                                                                                                                             |  |                                              |       |   |      |   |       |  
|As reported                                                                                                                             |  | $                                            | 1,942 |   |      | $ | 1,663 |  
|Deduct: Total stock-based employee compensation expenses determined under fair value method for all amounts, net of related tax
effects |  |                                              | (51   | ) |      |   | (51   | )
|                                                                                                                                        |  |                                              |       |   |      |   |       |  
|Pro forma                                                                                                                               |  | $                                            | 1,890 |   |      | $ | 1,612 |  
|                                                                                                                                        |  |                                              |       |   |      |   |       |  
|Basic net income per share:                                                                                                             |  |                                              |       |   |      |   |       |  
|As reported                                                                                                                             |  | $                                            | .78   |   |      | $ | .68   |  
|Pro forma                                                                                                                               |  |                                              | .76   |   |      |   | .66   |  
|                                                                                                                                        |  |                                             
|Diluted net income per share:                                                                                                           |  |                                              |       |   |      |   |       |  
|As reported                                                                                                                             |  | $                                            | .72   |   |      | $ | .63   |  
|Pro forma                                                                                                                               |  |                                              | .70   |   |      |   | .61   |  



Net Income Per Share



Basic and diluted net income per share has been computed based on the
weighted average number of shares outstanding during each period after retroactively adjusting for a 6-for-5 stock split effected in the form of a 20% stock dividend declared on November 23, 2004 and distributed on January 14, 2005, and a 6-for-5
stock split effected in the form of a 20% stock dividend distributed on August 15, 2003. Diluted net income 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. At December 31, 2004 and 2003, there were no antidilutive options.



Basic and diluted net income per 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:



|                                                                                                                             |  |           |  |          
|---------------------------------------------------------------------------------------------------------------------------- |  | --------- |  | ---------
|                                                                                                                             |  | 2004      |  | 2003     
|Weighted average number of common shares used in computing basic net income per share                                        |  | 2,495,651 |  | 2,463,359
|Effect of dilutive stock options                                                                                             |  | 193,375   |  | 187,861  
|                                                                                                                             |  |           |  |          
|Weighted average number of common shares and dilutive potential common shares used in computing diluted net income per share |  | 2,689,026 |  | 2,651,220
|                                                                                                                             |  |           |  |          





50



---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS



December 31, 2004 and 2003



Segment Reporting



SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information,
requires management to report selected financial and descriptive information about reportable operating segments. It also establishes standards for related disclosures about products and services, geographic areas and major customers. Generally,
disclosures are required for segments internally identified to evaluate performance and resource allocation. In all material respects, the Companys operations are entirely within the commercial banking segment, and the consolidated financial
statements presented herein reflect the results of that segment. Also, the Company has no foreign operations or customers.



Derivative Instruments



The Company utilizes interest rate swaps in the management of interest rate risk. Interest rate swaps are contractual agreements between two parties to exchange a series of cash flows representing interest payments. A
swap allows both parties to alter the repricing characteristics of assets or liabilities without affecting the underlying principal positions. Through the use of a swap, assets and liabilities may be transformed from fixed to floating rates, from
floating rates to fixed rates or from one type of floating rate to another. Swap terms generally range from one year to ten years depending on the need



The net interest payable or receivable on interest rate swaps that are designated as hedges is accrued and recognized as an adjustment to the interest income or expense
of the related asset or liability. Gains and losses from early terminations of derivatives are deferred and amortized as yield adjustments over the shorter of the remaining term of the hedged asset or liability or the remaining term of the
derivative instrument. Upon disposition or settlement of the asset or liability being hedged, deferral accounting is discontinued and any gains or losses are recognized in income. Unrealized holding gains and losses on derivatives designated as
hedges are reported, net of applicable income tax effect, in accumulated other comprehensive income.



Derivative financial instruments that fail to qualify as a hedge are carried at fair value with gains and losses recognized in current earnings.



Recent Accounting Pronouncements



In January 2003, the FASB issued FASB Interpretation No. (FIN) 46, Consolidation of Variable Interest Entities. This interpretation addresses the consolidation by
business enterprises of variable interest entities as defined in the interpretation. In December 2003, the FASB issued a revision to FIN 46 (FIN 46R) to clarify some of the provisions of FIN 46 and to exempt certain entities from its requirements.
FIN 46R is effective for public entities that have interests in structures that are commonly referred to as special-purpose entities for periods ending after December 15, 2003. Application by public entities, other than small business issuers, for
all other types of variable interest entities is required in financial statements for periods ending after March 15, 2004. Application by small business issuers to variable interest entities other than special-purpose entities is required for
periods ending after December 15, 2004. During 2004, the Company adopted FIN 46,which resulted in the deconsolidation of the Companys trust preferred subsidiaries, MidCarolina I and MidCarolina Trust II. Upon deconsolidation,
the junior subordinated debentures issued by the Company to the trusts are included in long-term debt and the Companys equity interest in the trust was included in other assets. The deconsolidation of the trust did not materially impact net
income.



On March 9, 2004, the SEC Staff issued Staff Accounting Bulletin No.
105,Application of Accounting Principles to Loan Commitments (SAB 105). SAB 105 clarifies existing accounting practices relating to the valuation of issued loan commitments, including interest rate lock commitments
(IRLC), subject to SFAS No. 149 and Derivative Implementation Group Issue C13,Scope Exceptions: When a Loan Commitment is included in the Scope of Statement 133. Furthermore, SAB 105 disallows the inclusion of the values of a
servicing component and other internally developed intangible assets in the initial and subsequent IRLC valuation. The provisions of SAB 105 were effective for loan commitments entered into after March 31, 2004. The adoption of SAB 105 did not have
a material impact on the consolidated financial statements.



51



---

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



December 31, 2004 and 2003



In March 2004, the Emerging Issues Task Force (EITF) released EITF Issue
03-01,The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments. The Issue provides guidance for determining whether an investment is other-than-temporarily impaired and requires certain disclosures with
respect to these investments. The recognition and measurement guidance for other-than-temporary impairment has been delayed by the issuance of FASB Staff Position EITF 03-1-1 on September 30, 2004. The adoption of Issue 03-1 did not result in any
other-than-temporary impairment.



In December 2003, the American
Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) 03-3,Accounting for Loans or Certain Debt Securities Acquired in a Transfer. The SOP addresses accounting for differences between contractual cash flows and
cash flows expected to be collected from an investors initial investment in loans or debt securities acquired in a transfer if those differences relate to a deterioration of credit quality. The SOP also prohibits companies from carrying
over or creating a valuation allowance in the initial accounting for loans acquired that meet the scope criteria of the SOP. The SOP is effective for loans acquired in fiscal years beginning after December 15, 2004. The adoption of this SOP is
not expected to have a material impact on the Companys financial position or results of operations.



In December 2004, the FASB issued SFAS No. 123(R),Accounting for Stock-Based Compensation (SFAS No. 123(R)). SFAS No. 123(R) establishes standards for the accounting for transactions in which an entity
exchanges its equity instruments for goods or services. This Statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. SFAS No. 123(R) requires that the fair value of
such equity instruments be recognized as an expense in the historical financial statements as services are performed. Prior to SFAS No. 123(R), only certain pro forma disclosures of fair value were required. The provisions of this Statement are
effective for the first interim reporting period that begins after December 15, 2005. Accordingly, we will adopt SFAS No. 123(R) commencing with the quarter ending March 31, 2006. If we had included the cost of employee stock option compensation in
our consolidated financial statements, our net income for the fiscal years ended December 31, 2004 and 2003 would have decreased by approximately $51,000 for both years. Accordingly, the adoption of SFAS No. 123(R) is not expected to have a material
effect on our consolidated financial statements.



Reclassification



Certain amounts in the 2003 consolidated financial statements have been
reclassified to conform with the 2004 presentation. The reclassifications had no effect on net income or shareholders equity as previously reported.





52



---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS



December 31, 2004 and 2003



Note C - Investment Securities



The following is a summary of investment securities by major classification at December 31,
2004 and 2003:



|                               |  |                        |        |                       |   |                        |  |           |     |  |   |       
|------------------------------ |  | ---------------------- | ------ | --------------------- | - | ---------------------- |  | --------- | --- |  | - | ------
|                               |  | December 31, 2004     
|                               |  | Amortizedcost          |        | Gross unrealizedgains |   | Gross unrealizedlosses |  | Fairvalue
|                               |  | (Amounts in thousands)
|Securities available for sale: |  |                        |        |                       |   |                        |  |           |     |  |   |       
|U.S. agency securities         |  | $                      | 2,499  |                       | $ |                       |  | $         | 15  |  | $ | 2,484 
|Mortgage-backed securities     |  |                        | 26,063 |                       |   | 5                      |  |           | 168 |  |   | 25,900
|State and municipal            |  |                        | 7,405  |                       |   | 29                     |  |           | 30  |  |   | 7,404 
|Other                          |  |                        | 124    |                       |   |                       |  |           |    |  |   | 124   
|                               |  |                        |        |                       |   |                        |  |           |     |  |   |       
|Total                          |  | $                      | 36,091 |                       | $ | 34                     |  | $         | 213 |  | $ | 35,912
|                               |  |                        |        |                       |   |                        |  |           |     |  |   |       
|Securities held to maturity:   |  |                        |        |                       |   |                        |  |           |     |  |   |       
|Other                          |  | $                      | 250    |                       | $ |                       |  | $         |    |  | $ | 250   
|                               |  |                        |        |                       |   |                        |  |           |     |  |   |       
|                               | 
|                               |  | December 31, 2003     
|                               |  | Amortizedcost          |        | Gross unrealizedgains |   | Gross unrealizedlosses |  | Fairvalue
|                               |  | (Amounts in thousands)
|Securities available for sale: |  |                        |        |                       |   |                        |  |           |     |  |   |       
|U.S. agency securities         |  | $                      | 2,007  |                       | $ | 32                     |  | $         | 5   |  | $ | 2,034 
|Mortgage-backed securities     |  |                        | 2,603  |                       |   | 42                     |  |           |    |  |   | 2,645 
|State and municipal            |  |                        | 2,900  |                       |   | 35                     |  |           | 4   |  |   | 2,931 
|Other                          |  |                        | 124    |                       |   |                       |  |           |    |  |   | 124   
|                               |  |                        |        |                       |   |                        |  |           |     |  |   |       
|Total                          |  | $                      | 7,634  |                       | $ | 109                    |  | $         | 9   |  | $ | 7,734 
|                               |  |                        |        |                       |   |                        |  |           |     |  |   |       
|Securities held to maturity:   |  |                        |        |                       |   |                        |  |           |     |  |   |       
|Other                          |  | $                      | 250    |                       | $ |                       |  | $         |    |  | $ | 250   
|                               |  |                        |        |                       |   |                        |  |           |     |  |   |       



The following table shows
investments gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, at December 31, 2004 and 2003. All unrealized losses on
investment securities are considered by management to be temporarily impaired given the credit ratings on these investment securities and the short duration of the unrealized loss.



|                                      |  |                     |        |                   |   |           |  |                  |     |           |   |                  |  |   |        |  |   |    
|------------------------------------- |  | ------------------- | ------ | ----------------- | - | --------- |  | ---------------- | --- | --------- | - | ---------------- |  | - | ------ |  | - | ---
|                                      |  | 2004               
|                                      |  | Less Than 12 Months |        | 12 Months or More |   | Total    
|                                      |  | FairValue           |        | Unrealizedlosses  |   | Fairvalue |  | Unrealizedlosses |     | Fairvalue |   | Unrealizedlosses
|Securities available for sale:        |  |                     |        |                   |   |           |  |                  |     |           |   |                  |  |   |        |  |   |    
|U.S. agency securities                |  | $                   | 2,484  |                   | $ | 15        |  | $                |    |           | $ |                 |  | $ | 2,484  |  | $ | 15 
|Mortgage-backed securities            |  |                     | 18,923 |                   |   | 168       |  |                  |    |           |   |                 |  |   | 18,923 |  |   | 168
|State and municipal                   |  |                     | 2,085  |                   |   | 18        |  |                  | 618 |           |   | 12               |  |   | 2,703  |  |   | 30 
|                                      |  |                     |        |                   |   |           |  |                  |     |           |   |                  |  |   |        |  |   |    
|Total temporarily impaired securities |  | $                   | 23,492 |                   | $ | 201       |  | $                | 618 |           | $ | 12               |  | $ | 24,110 |  | $ | 213
|                                      |  |                     |        |                   |   |           |  |                  |     |           |   |                  |  |   |        |  |   |    





53



---

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



December 31, 2004 and 2003



|                                      |  |                     |       |                   |   |           |  |                  |   |           |   |                  |  |   |       |  |   |  
|------------------------------------- |  | ------------------- | ----- | ----------------- | - | --------- |  | ---------------- | - | --------- | - | ---------------- |  | - | ----- |  | - | -
|                                      |  | 2003               
|                                      |  | Less Than 12 Months |       | 12 Months or More |   | Total    
|                                      |  | Fairvalue           |       | Unrealizedlosses  |   | Fairvalue |  | Unrealizedlosses |   | Fairvalue |   | Unrealizedlosses
|Securities available for sale:        |  |                     |       |                   |   |           |  |                  |   |           |   |                  |  |   |       |  |   |  
|U.S. agency securities                |  | $                   | 1,016 |                   | $ | 5         |  | $                |  |           | $ |                 |  | $ | 1,016 |  | $ | 5
|State and municipal                   |  |                     | 655   |                   |   | 4         |  |                  |  |           |   |                 |  |   | 655   |  |   | 4
|                                      |  |                     |       |                   |   |           |  |                  |   |           |   |                  |  |   |       |  |   |  
|Total temporarily impaired securities |  | $                   | 1,671 |                   | $ | 9         |  | $                |  |           | $ |                 |  | $ | 1,671 |  | $ | 9
|                                      |  |                     |       |                   |   |           |  |                  |   |           |   |                  |  |   |       |  |   |  



The aggregate amortized cost and fair
value of investment securities available for sale at December 31, 2004, by remaining contractual maturity, are shown below. Actual expected maturities may differ from contractual maturities because issuers may have the right to call or prepay
obligations.



|                                   |  |                        |        |                  |   |               |  |           |     |  |   |    
|---------------------------------- |  | ---------------------- | ------ | ---------------- | - | ------------- |  | --------- | --- |  | - | ---
|                                   |  | Available for Sale     |        | Held to Maturity
|                                   |  | Amortizedcost          |        | Fairvalue        |   | Amortizedcost |  | Fairvalue
|                                   |  | (Amounts in thousands)
|U.S. agency securities:            |  |                        |        |                  |   |               |  |           |     |  |   |    
|Due in 1 year through 5 years      |  | $                      | 1,999  |                  | $ | 1,988         |  | $         |    |  | $ |   
|Due after 5 years through 10 years |  |                        | 500    |                  |   | 496           |  |           |    |  |   |   
|State and municipal securities:    |  |                        |        |                  |   |               |  |           |     |  |   |    
|Due in 1 year through 5 years      |  |                        | 1,927  |                  |   | 1,924         |  |           |    |  |   |   
|Due after 5 years through 10 years |  |                        | 1,958  |                  |   | 1,936         |  |           |    |  |   |   
|Due after 10 years                 |  |                        | 3,520  |                  |   | 3,544         |  |           |    |  |   |   
|Other:                             |  |                        |        |                  |   |               |  |           |     |  |   |    
|Due after 10 years                 |  |                        | 124    |                  |   | 124           |  |           | 250 |  |   | 250
|Mortgage-backed securities         |  |                        | 26,063 |                  |   | 25,900        |  |           |    |  |   |   
|                                   |  |                        |        |                  |   |               |  |           |     |  |   |    
|Total                              |  | $                      | 36,091 |                  | $ | 35,912        |  | $         | 250 |  | $ | 250
|                                   |  |                        |        |                  |   |               |  |           |     |  |   |    



Proceeds from sales of investment
securities available for sale amounted to $19.3 million and $381,000 for the years ended December 31, 2004 and 2003 respectively. Gross and net realized gains from the sales of investment securities available for sale amounted to $70,000 and $28,000
for the years ended December 31, 2004 and 2003, respectively.



Investment
securities with amortized cost of $8.41 million and fair value of $8.38 million at December 31, 2004 were pledged to secure both financing from the Federal Home Loan Bank and for public monies on deposit as required by law.





54



---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS



December 31, 2004 and 2003



Note D - Loans



Following is a summary of loans at December 31, 2004 and 2003:



|                                                                           |  |                        |         |      |   |         |  
|-------------------------------------------------------------------------- |  | ---------------------- | ------- | ---- | - | ------- | -
|                                                                           |  | 2004                   |         | 2003 |  
|                                                                           |  | (Amounts in thousands) |        
|Real estate:                                                               |  |                        |         |      |   |         |  
|Construction loans                                                         |  | $                      | 27,715  |      | $ | 14,276  |  
|Commercial mortgage loans                                                  |  |                        | 88,220  |      |   | 71,113  |  
|Home equity lines of credit                                                |  |                        | 34,715  |      |   | 29,221  |  
|Residential mortgage loans                                                 |  |                        | 28,630  |      |   | 27,010  |  
|                                                                           |  |                        |         |      |   |         |  
|Total real estate loans                                                    |  |                        | 179,280 |      |   | 141,620 |  
|                                                                           |  |                       
|Commercial and industrial loans                                            |  |                        | 30,464  |      |   | 30,893  |  
|Loans to individuals for household, family and other personal expenditures |  |                        | 7,911   |      |   | 6,431   |  
|Net deferred loan origination costs (fees)                                 |  |                        | 28      |      |   | (31     | )
|                                                                           |  |                        |         |      |   |         |  
|Total loans                                                                |  | $                      | 217,683 |      | $ | 178,913 |  
|                                                                           |  |                        |         |      |   |         |  



At December 31, 2004 and 2003, the
recorded investment in loans considered impaired in accordance with SFAS No. 114 totaled $254,000 and $589,000, respectively, consisting of nonaccrual loans. The corresponding valuation allowances were $28,000 and $134,000, respectively. For the
years ended December 31, 2004 and 2003, the average recorded investment in impaired loans was approximately $834,000 and $480,000, respectively. The amount of interest recognized on impaired loans during the portion of the year that they were
impaired was not material.



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



|                             |  |   |       |  
|---------------------------- |  | - | ----- | -
|Balance at December 31, 2003 |  | $ | 1,569 |  
|New loans                    |  |   | 1,335 |  
|Principal repayments         |  |   | (724  | )
|                             |  |   |       |  
|Balance at December 31, 2004 |  | $ | 2,180 |  
|                             |  |   |       |  



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





55



---

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



December 31, 2004 and 2003



Note E - Allowance for Loan Losses



An analysis of activity in the allowance for loan losses for the years ended December 31,
2004 and 2003 follows:



|                             |  |                        |       |   |      |   |       |  
|---------------------------- |  | ---------------------- | ----- | - | ---- | - | ----- | -
|                             |  | 2004                   |       |   | 2003 |  
|                             |  | (Amounts in thousands) |      
|Balance at beginning of year |  | $                      | 2,522 |   |      | $ | 2,088 |  
|Provision for loan losses    |  |                        | 1,030 |   |      |   | 586   |  
|                             |  |                       
|Charge-offs                  |  |                        | (754  | ) |      |   | (202  | )
|Recoveries                   |  |                        | 67    |   |      |   | 50    |  
|                             |  |                        |       |   |      |   |       |  
|Net charge-offs              |  |                        | (687  | ) |      |   | (152  | )
|                             |  |                        |       |   |      |   |       |  
|Balance at end of year       |  | $                      | 2,865 |   |      | $ | 2,522 |  
|                             |  |                        |       |   |      |   |       |  



Note F - Premises and Equipment



The following is a summary of premises and equipment:



|                                     |  |                        |        |   |      |   |        |  
|------------------------------------ |  | ---------------------- | ------ | - | ---- | - | ------ | -
|                                     |  | 2004                   |        |   | 2003 |  
|                                     |  | (Amounts in thousands) |       
|Land                                 |  | $                      | 1,081  |   |      | $ | 1,081  |  
|Buildings and leasehold improvements |  |                        | 3,005  |   |      |   | 2,975  |  
|Furniture and equipment              |  |                        | 2,197  |   |      |   | 1,974  |  
|                                     |  |                        |        |   |      |   |        |  
|                                     |  |                        | 6,283  |   |      |   | 6,030  |  
|Less accumulated depreciation        |  |                        | (2,144 | ) |      |   | (1,784 | )
|                                     |  |                        |        |   |      |   |        |  
|Total                                |  | $                      | 4,139  |   |      | $ | 4,246  |  
|                                     |  |                        |        |   |      |   |        |  



Depreciation expense for the years
ended December 31, 2004 and 2003 amounted to $360,000 and $308,000, respectively.



Note G - Time Deposits



Time deposits in denominations of
$100,000 or more were $67.0 million and $30.2 million at December 31, 2004 and 2003, respectively. Interest expense on such deposits aggregated approximately $919,000 and $1.0 million in 2004 and 2003, respectively. Time deposits maturing subsequent
to December 31, 2004 are as follows (amounts in thousands):



|     |  |   |        
|---- |  | - | -------
|2005 |  | $ | 106,364
|2006 |  |   | 25,063 
|2007 |  |   | 1,784  
|2008 |  |   | 553    
|2009 |  |   | 350    
|     |  |   |        
|     |  | $ | 134,114
|     |  |   |        



56



---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS



December 31, 2004 and 2003



Note H - Leases



As of December 31, 2004, the Company leases office space under non-cancelable operating
leases. Future minimum lease payments required under the leases are as follows (amounts in thousands):



|                         |  |   |    
|------------------------ |  | - | ---
|Year Ending December 31, |  |  
|2005                     |  | $ | 84 
|2006                     |  |   | 59 
|2007                     |  |   | 59 
|2008                     |  |   | 59 
|2009                     |  |   | 25 
|                         |  |   |    
|                         |  | $ | 286
|                         |  |   |    



The leases contain options for
renewals after the expiration of the current lease terms. The cost of such rentals is not included above. Total rent expense for the years ended December 31, 2004 and 2003 amounted to $91,000 and $56,000, respectively.



Note I  Borrowings



Short-term borrowings



The Company has credit availability totaling approximately $23.5 million from the FHLB, with $15.5 million outstanding with a daily rate of
interest of 2.44% at December 31, 2004. This has been classified as short-term borrowings in the balance sheet. Borrowings must be adequately collateralized. At December 31, 2003, the outstanding short-term borrowings amounted to $18.5 million.



Long-term debt



The Company is a member of the Federal Home Loan Bank of Atlanta (FHLB). As a member, the
Company is required to invest in the stock of the FHLB. The stock is carried at cost since it has no quoted fair value. All stock in the FHLB, together with various investment securities and a floating lien of $105.6 million on qualifying loans, are
pledged as collateral to secure any borrowings. At December 31, there were the following borrowings:



|                  |  |                    |   |  |                        |        |      |   |       
|----------------- |  | ------------------ | - |  | ---------------------- | ------ | ---- | - | ------
|Maturity          |  | FixedInterest Rate |   |  | 2004                   |        | 2003
|                  |  |                    |   |  | (Amounts in thousands)
|March 17, 2009    |  | 1.73               | % |  | $                      | 8,000  |      |   |      
|March 17, 2010    |  | 5.92               | % |  |                        | 1,500  |      | $ | 1,500 
|March 17, 2010    |  | 5.71               | % |  |                        | 2,500  |      |   | 2,500 
|September 4, 2012 |  | 3.56               | % |  |                        | 2,000  |      |   | 2,000 
|September 4, 2012 |  | 3.56               | % |  |                        | 2,000  |      |   | 2,000 
|March 10, 2013    |  | 2.91               | % |  |                        | 10,000 |      |   | 10,000
|                  |  |                    |   |  |                        |        |      |   |       
|                  |  |                    |   |  | $                      | 26,000 |      | $ | 18,000
|                  |  |                    |   |  |                        |        |      |   |       



At December 31, 2004 and 2003, the
weighted average interest rates on the above advances were 3.09% and 3.69%, respectively. The above borrowings have been classified as long-term debt in the balance sheet.



The Company issued $8.8 million of junior subordinated debentures to its wholly owned capital trusts, MidCarolina I and MidCarolina Trust
II, to fully and unconditionally guarantee the preferred securities issued by the trusts. These long term obligations, which currently quality as Tier I capital for the Company, constitute a full and unconditional guarantee by the Company of the
trusts obligations under the Capital Trust Securities. See also Note B for a detailed discussion of the January 2003 FASB Interpretation No. 46R, Consolidation of Variable Interest Entities.





57



---

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



December 31, 2004 and 2003



A description of the Junior Subordinated debentures outstanding is as follows:



|                     |  |                 |  |                  |  |              |  |                  |       |  |   |      
|-------------------- |  | --------------- |  | ---------------- |  | ------------ |  | ---------------- | ----- |  | - | -----
|Issuing Entity       |  | Date ofIssuance |  | Interest Rate    |  | MaturityDate |  | Principal Amount
|                     |  |                 |  | 2004             |  | 2003        
|MidCarolina I        |  | 10/29/2002      |  | Libor plus 3.45% |  | 11/07/2032   |  | $                | 5,155 |  | $ | 5,000
|                     |  |                 |  |                  | 
|MidCarolina Trust II |  | 12/03/2003      |  | Libor plus 2.90% |  | 10/07/2033   |  |                  | 3,609 |  |   | 3,500
|                     |  |                 |  |                  |  |              |  |                  |       |  |   |      
|                     |  |                 |  |                  |  |              |  | $                | 8,764 |  | $ | 8,500
|                     |  |                 |  |                  |  |              |  |                  |       |  |   |      



Note J - Income Taxes



The significant components of the provision for income taxes are as
follows:



|                               |  |                        |       |   |      |   |       |  
|------------------------------ |  | ---------------------- | ----- | - | ---- | - | ----- | -
|                               |  | 2004                   |       |   | 2003 |  
|                               |  | (Amounts in thousands) |      
|Current tax provision:         |  |                        |       |   |      |   |       |  
|Federal                        |  | $                      | 828   |   |      | $ | 973   |  
|State                          |  |                        | 231   |   |      |   | 203   |  
|                               |  |                        |       |   |      |   |       |  
|                               |  |                        | 1,059 |   |      |   | 1,176 |  
|                               |  |                        |       |   |      |   |       |  
|Deferred tax provision:        |  |                        |       |   |      |   |       |  
|Federal                        |  |                        | (89   | ) |      |   | (277  | )
|State                          |  |                        | (20   | ) |      |   | (64   | )
|                               |  |                        |       |   |      |   |       |  
|                               |  |                        | (109  | ) |      |   | (341  | )
|                               |  |                        |       |   |      |   |       |  
|Net provision for income taxes |  | $                      | 950   |   |      | $ | 835   |  
|                               |  |                        |       |   |      |   |       |  



A reconciliation of expected income
taxes at the statutory federal income tax rate of 34% with the recorded provision for income taxes follows:



|                                                  |  |                        |      |   |      |   |      |  
|------------------------------------------------- |  | ---------------------- | ---- | - | ---- | - | ---- | -
|                                                  |  | 2004                   |      |   | 2003 |  
|                                                  |  | (Amounts in thousands) |     
|Income tax at statutory rate                      |  | $                      | 983  |   |      | $ | 849  |  
|                                                  |  |                       
|Increase (decrease) in income tax resulting from: |  |                        |      |   |      |   |      |  
|State income taxes, net of federal tax effect     |  |                        | 139  |   |      |   | 92   |  
|Income from bank-owned life insurance             |  |                        | (91  | ) |      |   | (115 | )
|Nontaxable interest                               |  |                        | (118 | ) |      |   |     |  
|Other                                             |  |                        | 37   |   |      |   | 9    |  
|                                                  |  |                        |      |   |      |   |      |  
|Provision for income taxes                        |  | $                      | 950  |   |      | $ | 835  |  
|                                                  |  |                        |      |   |      |   |      |  





58



---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS



December 31, 2004 and 2003



The tax effects of temporary differences that give rise to significant
portions of deferred tax assets (liabilities) at December 31, 2004 and 2003 are presented below:



|                                      |  |                        |       |   |      |   |       |  
|------------------------------------- |  | ---------------------- | ----- | - | ---- | - | ----- | -
|                                      |  | 2004                   |       |   | 2003 |  
|                                      |  | (Amounts in thousands) |      
|Deferred tax assets relating to:      |  |                        |       |   |      |   |       |  
|Allowance for loan losses             |  | $                      | 930   |   |      | $ | 902   |  
|Deferred compensation                 |  |                        | 328   |   |      |   | 224   |  
|Other comprehensive income            |  |                        | 55    |   |      |   |      |  
|                                      |  |                        |       |   |      |   |       |  
|Total deferred tax assets             |  |                        | 1,313 |   |      |   | 1,126 |  
|                                      |  |                        |       |   |      |   |       |  
|Deferred tax liabilities relating to: |  |                        |       |   |      |   |       |  
|Property and equipment                |  |                        |      |   |      |   | (71   | )
|Deferred loan fees                    |  |                        | (78   | ) |      |   | (5    | )
|Other comprehensive income            |  |                        |      |   |      |   | (12   | )
|Other                                 |  |                        | (21   | ) |      |   |      |  
|                                      |  |                        |       |   |      |   |       |  
|Total deferred tax liabilities        |  |                        | (99   | ) |      |   | (88   | )
|                                      |  |                        |       |   |      |   |       |  
|Net recorded deferred tax asset       |  | $                      | 1,214 |   |      | $ | 1,038 |  
|                                      |  |                        |       |   |      |   |       |  



Note K - Savings Plan



The Company maintains a contributory savings plan under Section 401(k) of
the Internal Revenue Code covering all employees who have completed three months of service and are at least eighteen years of age. Under the plan, employee contributions are matched by the Company in an amount equal to 75% of the first 6% of
compensation contributed by the employee. Such matching becomes fully vested when the employee reaches five years of service according to the following schedule: 1 year, 20%; 2 years, 40%; 3 years, 60%, 4 years, 80%, 5 or more years, 100%. Total
savings plan expense was $119,000 for 2004 and $173,000 for 2003.



Note L -
Stock Options



During 1998, the Board of Directors and shareholders
approved a non-qualified stock option plan for certain original Directors of the Company, and 237,600 shares of authorized and unissued stock were reserved for award. At adoption, all options were granted at an exercise price of $4.73 per share, the
fair value of the stock on the date of grant. Director options vested 100% on the date of grant. The options are granted for a ten-year term.



During 1998, the Board of Directors and shareholders approved an Incentive Stock Option Plan for officers and key employees. Under the provisions of the Plan, grants are
made at the discretion of an administrative committee appointed by the Board of Directors at the fair value of the stock on the date of grant. The Board reserved 237,600 shares of authorized and unissued stock for grant. Options have a vesting
schedule that provides that 20% of the options granted will be vested and exercisable on the date of grant and 20% will vest and become exercisable on each of the next four annual anniversary dates thereafter. The options are granted for a ten-year
term.





59



---

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



December 31, 2004 and 2003



A summary of the Companys stock option activity and related information for the years
ended December 31, 2004 and 2003 reflecting the effects of stock dividends declared, including the 20% stock dividend declared in 2004 and distributed in 2005 and the 20% stock dividend declared and distributed in 2004, is as follows:



|                     |  |                                  |   |  |                               |   |                     |   |       |                              |         |   |  |   |      
|-------------------- |  | -------------------------------- | - |  | ----------------------------- | - | ------------------- | - | ----- | ---------------------------- | ------- | - |  | - | -----
|                     |  | SharesAvailable for FutureGrants |   |  | Outstanding Options           |   | Exercisable Options
|                     |  | NumberOutstanding                |   |  | WeightedAverage ExercisePrice |   | NumberOutstanding   |   |       | WeightedAverageExercisePrice
|At December 31, 2002 |  | 18,717                           |   |  | 416,354                       |   |                     | $ | 5.15  |                              | 381,507 |   |  | $ | 4.89 
|                     |  |                                  |   |  |                              
|Options granted      |  | (14,400                          | ) |  | 14,400                        |   |                     |   | 11.73 |                              | 2,880   |   |  |   | 11.73
|Options vested       |  |                                 |   |  |                              |   |                     |   |      |                              | 8,787   |   |  |   | 5.05 
|Options exercised    |  |                                 |   |  | (34,635                       | ) |                     |   | 4.85  |                              | (34,635 | ) |  |   | 4.85 
|Options forfeited    |  | 4,486                            |   |  | (4,486                        | ) |                     |   | 5.30  |                              |        |   |  |   |     
|                     |  |                                  |   |  |                               |   |                     |   |       |                              |         |   |  |   |      
|At December 31, 2003 |  | 8,803                            |   |  | 391,633                       |   |                     | $ | 5.41  |                              | 358,539 |   |  | $ | 5.03 
|                     |  |                                  |   |  |                              
|Options granted      |  |                                 |   |  |                              |   |                     |   |      |                              |        |   |  |   |     
|Options vested       |  |                                 |   |  |                              |   |                     |   |      |                              | 14,634  |   |  |   | 8.35 
|Options exercised    |  |                                 |   |  | (23,204                       | ) |                     |   | 4.73  |                              | (23,204 | ) |  |   | 4.73 
|Options forfeited    |  |                                 |   |  |                              |   |                     |   |      |                              |        |   |  |   |     
|                     |  |                                  |   |  |                               |   |                     |   |       |                              |         |   |  |   |      
|At December 31, 2004 |  | 8,803                            |   |  | 368,429                       |   |                     | $ | 5.45  |                              | 349,969 |   |  | $ | 5.19 
|                     |  |                                  |   |  |                               |   |                     |   |       |                              |         |   |  |   |      



Additional information concerning the
Companys stock options is as follows:



|                           |  |                                       |  |                                      
|-------------------------- |  | ------------------------------------- |  | -------------------------------------
|Range of Exercise Prices   |  | NumberOutstanding atDecember 31, 2004 |  | NumberExercisable atDecember 31, 2004
|$4.73 - 6.31               |  | 329,477                               |  | 329,477                              
|$9.15 - 13.37              |  | 38,952                                |  | 20,492                               
|                           |  |                                       |  |                                      
|Outstanding at end of year |  | 368,429                               |  | 349,969                              
|                           |  |                                       |  |                                      



The weighted average remaining
contractual life of those options was 45 months.



The estimated per share fair
value of options granted together with the assumptions used in estimating these fair values, are displayed below:



|                                         |  |      |   |      |   |          |  
|---------------------------------------- |  | ---- | - | ---- | - | -------- | -
|                                         |  | 2004 |   | 2003 |  
|Estimated fair value of options granted  |  | $    |  |      | $ | 1.86     |  
|                                         |  |      |   |      |   |          |  
|Assumptions in estimating option values: |  |      |   |      |   |          |  
|Risk-free rate                           |  |      |  |      |   | 3.00     | %
|Dividend yield                           |  |      |  |      |   | 0.00     | %
|Volatility                               |  |      |  |      |   | 27.00    | %
|Expected life                            |  |      |  |      |   | 10 years |  





60



---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS



December 31, 2004 and 2003



Note M - Officers Deferred Compensation



In 2002 the Company implemented a non-qualifying deferred compensation plan for certain key
executive officers. The Company has purchased life insurance policies on the participating officers in order to offset the cost of benefit payments. Benefits for each officer participating in the plan will accrue and vest during the period of
employment, and will be paid in monthly benefit payments over the participants life after retirement. The plan also provides for payment of disability or death benefits in the event a participating officer becomes permanently disabled or dies
prior to attainment of retirement age. Provisions of $331,000 in 2004 and $359,000 in 2003 were expensed for future benefits to be provided under this plan. The total liability under this plan was $884,000 at December 31, 2004 and is included in
accrued expenses and other liabilities in the accompanying consolidated statements of financial condition.



Note N - Employment Agreement



The
Company has entered into an employment agreement with its chief executive officer to ensure a stable and competent management base. The 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 rights 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 the contract.



Note O - Contingent Liabilities and Commitments



The Companys consolidated financial statements do not reflect
various commitments and contingent liabilities which arise in the normal course of business and which involve elements of credit risk, interest rate risk and liquidity risk. These commitments and contingent liabilities are commitments to extend
credit, letters of credit and commitments to sell loans.



A summary of the
Companys commitments and contingent liabilities at December 31, 2004 and 2003 is as follows (amounts in thousands):



|                                                                                                |  |      |        |      |   |       
|----------------------------------------------------------------------------------------------- |  | ---- | ------ | ---- | - | ------
|                                                                                                |  | 2004 |        | 2003
|Unfunded commitments to extend credit under existing equity line and commercial lines of credit |  | $    | 53,691 |      | $ | 47,041
|Commitments to sell loans held for sale                                                         |  |      | 5,657  |      |   | 4,981 
|Financial standby letters of credit, net                                                        |  |      | 1,878  |      |   |      



Commitments to originate new loans or
extend credit and letters of credit all include exposure to some credit loss in the event of nonperformance by the customer. The Companys credit policies and procedures for credit commitments are the same as those for extensions of credit that
are recorded in the balance sheets. Because these instruments have fixed maturity dates, and because many of them expire without being drawn upon, they do not generally present any significant liquidity risk to the Company. The Company has not
incurred any losses on its commitments in both 2004 and 2003.



Commitments to
sell loans held for sale are agreements to sell loans to a third party at an agreed upon price. At December 31, 2004 and 2003, the aggregate fair value of the commitments approximated the carrying value of the loans to be sold.



Financial standby letters of credit are conditional lending commitments issued by the Company
to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. Essentially all letters of credit issued have expiration dates within one year. The
credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.



61



---

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



December 31, 2004 and 2003



Note P - Shareholders Equity



Regulatory Matters



As a North Carolina banking corporation, the Bank may pay cash dividends to the Company only out of undivided profits as determined pursuant
to North Carolina banking laws. However, regulatory authorities may limit payment of dividends when it is determined that such a limitation is in the public interest and is necessary to ensure a banks financial soundness.



The Bank is subject to the capital requirements of the Federal Deposit Insurance Corporation
(FDIC). The FDIC requires the Bank to maintain minimum ratios of Tier I capital to total risk-weighted assets and total capital to risk-weighted assets of 4% and 8%, respectively. To be well-capitalized, the FDIC requires
ratios of Tier I capital to risk-weighted assets and total capital to risk-weighted assets of 6% and 10%, respectively. Tier I capital consists of total shareholders equity calculated in accordance with accounting principles generally accepted
in the United States of America less intangible assets, and total capital is comprised of Tier I capital plus certain adjustments, the only one of which applicable to the Bank is the allowance for loan losses. Risk-weighted assets refer to the on-
and off-balance sheet exposures of the Bank adjusted for their relative risk levels using formulas set forth in FDIC regulations. The Bank is also subject to a FDIC leverage capital requirement, which calls for a minimum ratio of Tier I capital (as
defined above) to quarterly average total assets of 4% and a ratio of 5% to be well-capitalized.



As of December 31, 2004 and 2003, the Banks capital ratios exceeded levels deemed well-capitalized under the regulatory framework for prompt corrective action. There are no events or conditions since
the notification that management believes have changed the Banks category.



|                                                          |  |                        |        |              |                      |   |                     |      |   |                       |       |  
|--------------------------------------------------------- |  | ---------------------- | ------ | ------------ | -------------------- | - | ------------------- | ---- | - | --------------------- | ----- | -
|                                                          |  | For the Bank           |        |              | Minimum Requirements |  
|                                                          |  | CapitalAmount          |        | CapitalRatio |                      |   | For CapitalAdequacy |      |   | To Be WellCapitalized |      
|                                                          |  | (Dollars in thousands) |       
|As of December 31, 2004                                   |  |                        |        |              |                      |   |                     |      |   |                       |       |  
|Tier I capital (to risk-weighted assets)                  |  | $                      | 24,946 |              | 9.96                 | % |                     | 4.00 | % |                       | 6.00  | %
|Total capital - Tier II capital (to risk-weighted assets) |  |                        | 27,811 |              | 11.10                | % |                     | 8.00 | % |                       | 10.00 | %
|Leverage - Tier I capital (to average assets)             |  |                        | 24,946 |              | 8.85                 | % |                     | 4.00 | % |                       | 5.00  | %
|                                                          |  |                        |        |             
|As of December 31, 2003                                   |  |                        |        |              |                      |   |                     |      |   |                       |       |  
|Tier I capital (to risk-weighted assets)                  |  | $                      | 19,187 |              | 9.89                 | % |                     | 4.00 | % |                       | 6.00  | %
|Total capital - Tier II capital (to risk-weighted assets) |  |                        | 25,346 |              | 13.06                | % |                     | 8.00 | % |                       | 10.00 | %
|Leverage - Tier I capital (to average assets)             |  |                        | 19,187 |              | 9.51                 | % |                     | 4.00 | % |                       | 5.00  | %



The Company is also subject to these
capital requirements. At December 31, 2004, the Companys total capital to risk-weighted assets, Tier I capital to risk-weighted assets and Tier I capital to average assets were 11.13%, 8.78% and 7.83%, respectively.





62



---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS



December 31, 2004 and 2003



Note Q - Derivatives



The following table sets forth certain information concerning the Companys interest
rate swap at December 31, 2004:



|                           |  |                        |       |  
|-------------------------- |  | ---------------------- | ----- | -
|                           |  | (Amounts in thousands) |      
|Type                       |  |                        |       |  
|Receive fixed swap         |  | $                      | 5,000 |  
|Receive rate               |  |                        | 2.53  | %
|Pay rate                   |  |                        | 3.45  | %
|Fair value                 |  | $                      | 25    |  
|                           | 
|Year-to-date Activity      |  |                        |       |  
|Balance, December 31, 2003 |  | $                      | 5,000 |  
|Additions                  |  |                        |      |  
|Maturities/amortizations   |  |                        |      |  
|                           |  |                        |       |  
|Balance, December 31, 2004 |  | $                      | 5,000 |  
|                           |  |                        |       |  
|                           | 
|Maturity Schedule          |  |                        |       |  
|Three years                |  | $                      | 5,000 |  
|                           |  |                        |       |  



The $5.0 million notional amount of
derivatives used in interest rate risk management is used to hedge LIBOR based subordinated debt securities. The Company does not utilize derivatives for trading purposes.



Although off-balance sheet derivative financial instruments do not expose the Company to credit risk equal to the notional amount, such
agreements generate credit risk to the extent of the fair value gain in an off-balance sheet derivative financial instrument if the counterparty fails to perform. Such risk is minimized through the creditworthiness of the counterparties and the
consistent monitoring of these agreements. The counterparties to these arrangements were primarily large commercial banks and investment banks. Where appropriate, master netting agreements are arranged or collateral is obtained in the form of rights
to securities. At December 31, 2004, the Companys interest rate swap reflected an unrealized gain of $25,000



Other risks associated with interest-sensitive derivatives include the effect on fixed rate positions during periods of changing interest rates. Indexed amortizing
swaps notional amounts and maturities change based on certain interest rates indices. Generally, as rates fall the notional amounts decline more rapidly, and as rates increase notional amounts decline more slowly. At December 31, 2004, the
Company had no indexed amortizing swaps outstanding. Under unusual circumstances, financial derivatives also increase liquidity risk, which could result from an environment of rising interest rates in which derivatives produce negative cash flows
while being offset by increased cash flows from variable rate loans. Such risk is considered insignificant due to the relatively small derivative positions held by the Company.



Note R - Fair Value of Financial Instruments



SFAS No. 107, Disclosures About Fair Value of Financial Instruments, requires a company to disclose the fair value of its financial
instruments, whether or not recognized in the balance sheet, where it is practical to estimate that value.



Fair value estimates are made at a specific point in time based on relevant market 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 holding of a particular financial instrument. In cases where quoted market prices are not



63



---

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



December 31, 2004 and 2003



available, 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. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and
have not been considered in the estimates. Finally, the fair value estimates presented herein are based on pertinent information available to management as of December 31, 2004 and 2003, respectively.



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, Federal Funds Sold and Interest-Earning Deposits



The carrying amounts for cash and due from banks, federal funds sold and interest-earning deposits approximate fair value because of the short maturities of those instruments. These instruments are considered cash and
cash equivalents.



Investment Securities



Fair value for investment securities, excluding Federal Home Loan Bank stock, is based on
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. The carrying value of Federal Home Loan Bank stock approximates fair value
based on the redemption provisions of the Federal Home Loan Bank.



Loans
Held for Sale



Fair values of mortgage loans held for sale are based on
commitments on hand from investors or prevailing market prices.



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 rate at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.



Investment in Life Insurance



The carrying value of life insurance approximates fair value because this investment is carried at cash surrender value, as determined by the insurer.



Deposits, Short-term Borrowings and Long-term Debt



The fair value of demand deposits and savings accounts is the amount payable on demand at
the reporting date. The fair value of time deposits, short-term borrowings and long-term debt is estimated based upon the discounted value of projected future cash outflows using the rates currently offered for instruments of similar remaining
maturities.



Accrued Interest Receivable and Accrued Interest Payable



The carrying amounts of accrued interest receivable and accrued interest
payable are assumed to approximate fair values.



Derivative Financial
Instruments



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





64



---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS



December 31, 2004 and 2003



Financial Instruments with Off-Balance Sheet Risk



With regard to financial instruments with off-balance sheet risk discussed in Note O, 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, 2004 and 2003:



|                                         |  |                        |         |                     |   |        
|---------------------------------------- |  | ---------------------- | ------- | ------------------- | - | -------
|                                         |  | Carryingvalue          |         | Estimatedfair value
|                                         |  | (Amounts in thousands)
|As of December 31, 2004                  |  |                        |         |                     |   |        
|Financial assets:                        |  |                        |         |                     |   |        
|Cash and cash equivalents                |  | $                      | 10,093  |                     | $ | 10,093 
|Investment securities available for sale |  |                        | 35,912  |                     |   | 35,912 
|Investment securities held to maturity   |  |                        | 250     |                     |   | 250    
|Loans held for sale                      |  |                        | 5,657   |                     |   | 5,657  
|Loans                                    |  |                        | 217,683 |                     |   | 219,635
|Federal Home Loan Bank stock             |  |                        | 2,292   |                     |   | 2,292  
|Investment in life insurance             |  |                        | 6,783   |                     |   | 6,783  
|Accrued interest receivable              |  |                        | 1,000   |                     |   | 1,000  
|Financial liabilities:                   |  |                        |         |                     |   |        
|Deposits                                 |  | $                      | 216,791 |                     | $ | 210,807
|Short-term borrowings                    |  |                        | 15,500  |                     |   | 15,500 
|Long-term debt                           |  |                        | 34,764  |                     |   | 29,606 
|Accrued interest payable                 |  |                        | 138     |                     |   | 138    
|Derivative financial instruments:        |  |                        |         |                     |   |        
|Interest rate swap - asset               |  | $                      | 25      |                     | $ | 25     
|                                         |  |                       
|As of December 31, 2003                  |  |                        |         |                     |   |        
|Financial assets:                        |  |                        |         |                     |   |        
|Cash and cash equivalents                |  | $                      | 8,545   |                     | $ | 8,545  
|Investment securities available for sale |  |                        | 7,734   |                     |   | 7,734  
|Investment securities held to maturity   |  |                        | 250     |                     |   | 250    
|Loans held for sale                      |  |                        | 4,981   |                     |   | 4,981  
|Loans                                    |  |                        | 178,913 |                     |   | 180,093
|Federal Home Loan Bank stock             |  |                        | 1,825   |                     |   | 1,825  
|Investment in life insurance             |  |                        | 6,549   |                     |   | 6,549  
|Accrued interest receivable              |  |                        | 655     |                     |   | 655    
|Financial liabilities:                   |  |                        |         |                     |   |        
|Deposits                                 |  | $                      | 151,982 |                     | $ | 154,696
|Short-term borrowings                    |  |                        | 18,500  |                     |   | 18,500 
|Long-term debt                           |  |                        | 26,500  |                     |   | 26,394 
|Accrued interest payable                 |  |                        | 223     |                     |   | 223    
|Derivative financial instruments:        |  |                        |         |                     |   |        
|Interest rate swap - liability           |  | $                      | 65      |                     | $ | 65     



65



---

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



December 31, 2004 and 2003



Note S - Parent Company Financial Data



MidCarolina Financial Corporations condensed balance sheets as of December 31, 2004
and 2003, and its related condensed statements of operations and cash flows for the years then ended are as follows:



Condensed Balance Sheets

December 31, 2004 and 2003

(Amounts in thousands)



|                                           |  |      |        |   |      |   |       
|------------------------------------------ |  | ---- | ------ | - | ---- | - | ------
|                                           |  | 2004 |        |   | 2003
|Assets:                                    |  |      |        |   |      |   |       
|Investment in subsidiaries                 |  | $    | 24,826 |   |      | $ | 22,923
|Other assets                               |  |      | 615    |   |      |   | 252   
|                                           |  |      |        |   |      |   |       
|Total assets                               |  | $    | 25,441 |   |      | $ | 23,175
|                                           |  |      |        |   |      |   |       
|Liabilities and Shareholders Equity:      |  |      |        |   |      |   |       
|Liabilities:                               |  |      |        |   |      |   |       
|Junior subordinated debentures             |  | $    | 8,764  |   |      | $ | 8,500 
|Other liabilities                          |  |      | 253    |   |      |   | 264   
|                                           |  |      |        |   |      |   |       
|Total liabilities                          |  |      | 9,017  |   |      |   | 8,764 
|                                           |  |      |        |   |      |   |       
|Shareholders Equity:                      |  |      |        |   |      |   |       
|Common stock                               |  |      | 11,352 |   |      |   | 11,161
|Retained earnings                          |  |      | 5,171  |   |      |   | 3,229 
|Accumulated other comprehensive income     |  |      | (99    | ) |      |   | 21    
|                                           |  |      |        |   |      |   |       
|Total shareholders equity                 |  |      | 16,424 |   |      |   | 14,411
|                                           |  |      |        |   |      |   |       
|Total liabilities and shareholders equity |  | $    | 25,441 |   |      | $ | 23,175
|                                           |  |      |        |   |      |   |       



Condensed
Statements of Operations

Years ended December 31, 2004 and 2003

(Amounts in thousands)



|                                   |  |   |       |   |  |   |       |  
|---------------------------------- |  | - | ----- | - |  | - | ----- | -
|Equity in earnings of subsidiaries |  | $ | 2,268 |   |  | $ | 2,019 |  
|Interest expense                   |  |   | (433  | ) |  |   | (356  | )
|Income tax benefit                 |  |   | 107   |   |  |   |      |  
|                                   |  |   |       |   |  |   |       |  
|Net income                         |  | $ | 1,942 |   |  | $ | 1,663 |  
|                                   |  |   |       |   |  |   |       |  





66



---

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS



December 31, 2004 and 2003



Condensed Statements of Cash Flow

Years ended December 31, 2004 and 2003

(Amounts in thousands)



|                                                                              |  |      |        |   |      |   |        |  
|----------------------------------------------------------------------------- |  | ---- | ------ | - | ---- | - | ------ | -
|                                                                              |  | 2004 |        |   | 2003 |  
|Cash flows from operating activities:                                         |  |      |        |   |      |   |        |  
|Net income                                                                    |  | $    | 1,942  |   |      | $ | 1,663  |  
|Adjustments to reconcile net income to net cash used by operating activities: |  |      |        |   |      |   |        |  
|Equity in earnings of subsidiaries                                            |  |      | (2,268 | ) |      |   | (2,019 | )
|Amortization                                                                  |  |      | 8      |   |      |   | 6      |  
|Increase in other liabilities                                                 |  |      | 20     |   |      |   | 87     |  
|                                                                              |  |      |        |   |      |   |        |  
|Net increase provided by operating activities                                 |  |      | (298   | ) |      |   | (263   | )
|                                                                              |  |      |        |   |      |   |        |  
|Cash flows from investing activities:                                         |  |      |        |   |      |   |        |  
|Investment in subsidiaries                                                    |  |      | (237   | ) |      |   | (3,640 | )
|                                                                              |  |      |        |   |      |   |        |  
|Net decrease used by investing activities                                     |  |      | (237   | ) |      |   | (3,640 | )
|                                                                              |  |      |        |   |      |   |        |  
|Cash flow from financing activities:                                          |  |      |        |   |      |   |        |  
|Debt issuance costs                                                           |  |      |       |   |      |   | (87    | )
|Proceeds from subordinated debentures                                         |  |      |       |   |      |   | 3,500  |  
|Proceeds from exercise of stock options                                       |  |      | 110    |   |      |   | 134    |  
|Dividends from subsidiaries                                                   |  |      | 425    |   |      |   | 356    |  
|                                                                              |  |      |        |   |      |   |        |  
|Net increase provided by financing activities                                 |  |      | 535    |   |      |   | 3,903  |  
|                                                                              |  |      |        |   |      |   |        |  
|Net increase in cash and cash equivalents                                     |  |      |       |   |      |   |       |  
|                                                                              |  |     
|Cash and cash equivalents, beginning                                          |  |      |       |   |      |   |       |  
|                                                                              |  |      |        |   |      |   |        |  
|Cash and cash equivalents, ending                                             |  | $    |       |   |      | $ |       |  
|                                                                              |  |      |        |   |      |   |        |  



Note T - Subsequent Events
(Unaudited)



On February 23, 2005, MidCarolina Financial Corporation
announced that it has reached an agreement with Diversified Mortgage Products, Inc. (DMI) to terminate its contract with DMI over the next ninety days, with the final day of the contract term expected to be May 11, 2005. Under this contract, DMI has
been processing mortgages for Lending Tree and placing residential mortgage loans within the Companys wholly owned banking subsidiary, MidCarolina Bank. The Company anticipates that over the remainder of 2005, it will substantially offset the
discontinuation of loan production under its contract with DMI through MidCarolina Banks continued development of other lines of business and its internal loan production and through the reduction in loan production expenses resulting from the
termination of the DMI contract. The Company will incur no termination penalties. The Company and DMI mutually agreed to terminate the contract given the Companys desire to focus upon its internal loan production activities and DMIs need
for greater capacity and flexibly.





67



---

Item 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE



N/A



Item 8A. CONTROLS AND PROCEDURES.The companys management, under the supervision and with participation of the Chief
Executive Officer and the Chief Financial Officer of the Company (its principal executive officer and principal financial officer, respectively) have concluded based on their evaluation as of the end of the period covered by this Report, that the
Companys disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in the reports filed or submitted by it under the Securities and Exchange Act of 1934, as amended, is recorded,
processed, summarized and reported within the time periods specified in the applicable rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by the Company in such reports is accumulated
and communicated to the Companys management, including the Chief Executive Officer and the Chief Financial Officer of the Company, as appropriate to allow timely decisions regarding required disclosure.



There have been no significant changes in internal control over financial reporting during
the period covered by this Report that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting.



PART III



Item 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH 16(a) OF THE EXCHANGE ACT



The information required by this Item regarding (i) Company directors is set forth under the
section captioned Proposal I  Election of Directors  Nominees contained in the Proxy Statement, (ii) Company executive officers is set forth under the section captioned Proposal I  Election of directors 
Executive Officers contained in the Proxy Statement, and (iii) Section 16(a) compliance is set forth under the section captioned Section 16 (a) Beneficial Ownership Reporting Compliance contained in the Proxy Statement, all of
which is incorporated herein by reference.



Item 10. EXECUTIVE COMPENSATION



The information required by this Item is set forth under the section
captioned  Proposal I  Election of Directors  Director Compensation and   Executive Compensation contained in the Proxy Statement, all of which is incorporated by reference.



Item 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS



The information required by this Item is set forth
under the section captioned Security Ownership of Certain Beneficial Owners contained in the Proxy Statement which is incorporated herein by reference.



Item 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS



The information required by this Item set forth under the section captioned Certain Indebtedness and Transactions of Management
contained in the Proxy Statement, which is incorporated herein by reference.





68



---

Item 13. EXHIBITS AND REPORTS ON FORM 8-K



13(a) Exhibits



|                  |  |                                                                                                                                                                                                     
|----------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                  | 
|Exhibit (3)(i)    |  | Articles of Incorporation, incorporated herein by reference to Exhibit 2(i) to the Form 10-SB filed with the FDIC on April 30, 1998                                                                 
|                  | 
|Exhibit (3)(ii)   |  | Bylaws, incorporated herein by reference to Exhibit 2(ii) to the Form 10-SB filed with the FDIC on April 30, 1998                                                                                   
|                  | 
|Exhibit (4)       |  | Form of Stock Certificate, incorporated herein by reference to the Form 10-QSB filed with the SEC on November 12, 2002.                                                                             
|                  | 
|Exhibit (10)(i)   |  | Employment Agreement with Randolph J. Cary, Jr., incorporated herein by reference to Exhibit 6(i) to the Form 10-SB filed with the FDIC on April 30, 1998                                           
|                  | 
|Exhibit (10)(ii)  |  | MidCarolina Bank Employee Stock Option Plan, incorporated herein by reference to Exhibit 6(ii) to the Form 10-SB filed with the FDIC on April 30, 1998                                              
|                  | 
|Exhibit (10)(iii) |  | MidCarolina Bank Director Stock Option Plan, incorporated herein by reference to Exhibit 6(iii) to the Form 10-SB filed with the FDIC on April 30, 1998                                             
|                  | 
|Exhibit (10)(iv)  |  | Land Lease dated October 15, 1997 between the Bank and Crescent Center Associates, incorporated herein by reference to Exhibit 10(iv) to the Form 10-KSB for the fiscal year ended December 31,
1998
|                  | 
|Exhibit (10)(v)   |  | Lease dated June 27, 2000 between the Bank and Cum-Park Plaza, LLC incorporated herein by reference to Exhibit 10(v) to the Form 10-KSB for the fiscal year ended December 31,
2000.                
|                  | 
|Exhibit (10)(vi)  |  | Omnibus Stock Ownership and Long-Term Incentive Plan incorporated herein by reference to Exhibit 10(vi) to the Form 10-KSB for the fiscal year ended December 31, 2003                              
|                  | 
|Exhibit (14)      |  | Code of Ethics incorporated herein by reference to Exhibit 14 to the Form 10-KSB for the fiscal year ended December 31, 2003                                                                        
|                  | 
|Exhibit 31.1:     |  | Rule 13a-14(a)/15d-14(a) Certification by Chief Executive Officer                                                                                                                                   
|                  | 
|Exhibit 31.2:     |  | Rule 13a-14(a)/15d-14(a) Certification by Chief Financial Officer                                                                                                                                   
|                  | 
|Exhibit 32:       |  | Section 1350 Certifications                                                                                                                                                                         



13 (b) Reports on Form 8-K. Earnings
release dated October 24, 2003.



Item 14. PRINCIPAL ACCOUNTANT FEES AND
SERVICES



The information required by this Item is set forth under the
section captioned Principal Accountant Fees and Services contained in the Proxy statement, which is incorporated herein by reference.





69



---

SIGNATURES



In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.



|                     |  |                  |  |                                      
|-------------------- |  | ---------------- |  | -------------------------------------
|                     |  | MIDCAROLINA BANK
|                     |  |                 
|Date: March 22, 2005 |  | By:              |  | /s/ Randolph J. Cary, Jr.            
|                     |  |                  |  | Randolph J. Cary, Jr.                
|                     |  |                  |  | President and Chief Executive Officer



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



|                          |  |                                                  |  |               
|------------------------- |  | ------------------------------------------------ |  | --------------
|Signature                 |  | Title                                            |  | Date          
|/s/ Randolph J. Cary, Jr. |  | President, Chief Executive Officerand Director   |  | March 22, 2005
|Randolph J. Cary, Jr.     |  |                                                  | 
|                          |  |                                                 
|/s/ Charles T. Canaday    |  | Senior Vice President andChief Operating Officer |  | March 22, 2005
|Charles T. Canaday        |  |                                                  | 
|                          |  |                                                 
|/s/ Christopher B. Redcay |  | Senior Vice President andChief Financial Officer |  | March 22, 2005
|Christopher B. Redcay     |  |                                                  | 
|                          |  |                                                 
|/s/ R. Craig Patterson    |  | Senior Vice President                            |  | March 22, 2005
|R. Craig Patterson        |  |                                                  |  |               
|                          |  |                                                 
|/s/ H. Thomas Bobo        |  | Director                                         |  | March 22, 2005
|H. Thomas Bobo            |  |                                                  |  |               
|                          |  |                                                 
|/s/ James R. Copland, III |  | Chairman and Director                            |  | March 22, 2005
|James R. Copland, III     |  |                                                  |  |               
|                          |  |                                                 
|/s/ Thomas E. Chandler    |  | Director                                         |  | March 22, 2005
|Thomas E. Chandler        |  |                                                  |  |               
|                          |  |                                                 
|/s/ Ralph M. Holt, Jr.    |  | Vice Chairman and Director                       |  | March 22, 2005
|Ralph M. Holt, Jr.        |  |                                                  |  |               
|                          |  |                                                 
|/s/ F.D. Hornaday, III    |  | Director                                         |  | March 22, 2005
|F.D. Hornaday, III        |  |                                                  |  |               
|                          |  |                                                 
|/s/ Teena M. Koury        |  | Director                                         |  | March 22, 2005
|Teena M. Koury            |  |                                                  |  |               
|                          |  |                                                 
|/s/ John Love             |  | Director                                         |  | March 22, 2005
|John Love                 |  |                                                  |  |               
|                          |  |                                                 
|/s/ James B. Powell       |  | Director                                         |  | March 22, 2005
|James B. Powell           |  |                                                  |  |               
|                          |  |                                                 
|/s/ John K. Roberts       |  | Director                                         |  | March 22, 2005
|John K. Roberts           |  |                                                  |  |               
|                          |  |                                                 
|/s/ James H. Smith, Jr.   |  | Director                                         |  | March 22, 2005
|James H. Smith, Jr.       |  |                                                  |  |               
|                          |  |                                                 
|/s/ Robert A. Ward        |  | Director                                         |  | March 22, 2005
|Robert A. Ward            |  |                                                  |  |               
|                          |  |                                                 
|/s/ Dexter R. Barbee, Sr. |  | Director                                         |  | March 22, 2005
|Dexter R. Barbee, Sr.     |  |                                                  |  |               



70