##### Table of Contents

---

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



---



FORM 10-KSB



---



| ̈ | Annual Report under Section 13 or 15(d) of the Securities Exchange Act of 1934
|- | ------------------------------------------------------------------------------



For the Fiscal Year ended December 31, 2004



OR



| ̈ | Transition Report under Section 13 or 15(d) of the Securities Exchange Act of 1934
|- | ----------------------------------------------------------------------------------



For the Transition Period from  to



Commission File Number: 000-49898



---



North State Bancorp

(Exact name of registrant as specified in its charter)



---



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



4270 The Circle at
North Hills

Raleigh, North Carolina 27609

(Address of principal executive offices, including zip code)



(919) 787-9696

(Issuers telephone number)



---



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



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



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



---



Check whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act
during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  x    NO ̈



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



The registrants revenues for the year ended December 31, 2004 were $13,634,000.



The aggregate market value of the registrants common stock held by non-affiliates of the registrant on March 18, 2005 was approximately
$22,210,000, based on the average of the bid and asked prices of the registrants common stock on March 18, 2005. Common stock held by each officer and director and by each person known to the registrant who owns 5% or more of the
outstanding common stock has been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.



The number of shares of the registrants common stock outstanding at
March 18, 2005 was 2,366,041 shares.



DOCUMENTS
INCORPORATED BY REFERENCE



Portions of the
registrants definitive proxy statement to be filed for its 2005 Annual Meeting of Shareholders to be held on May 10, 2005 are incorporated by reference into Part III of this report.



Transitional Small Business Disclosure Format    YES ̈NO  x



---



---

##### Table of Contents

NORTH STATE BANCORP



ANNUAL REPORT ON
FORM 10-KSB



Table of Contents



|         |  |                                                                                                       |  |     
|-------- |  | ----------------------------------------------------------------------------------------------------- |  | ----
|         |  |                                                                                                       |  | Page
|PART I  
|Item 1.  |  | Description of Business                                                                               |  | 1   
|         |  |                                                                                                      
|Item 2.  |  | Description of Property                                                                               |  | 6   
|         |  |                                                                                                      
|Item 3.  |  | Legal Proceedings                                                                                     |  | 6   
|         |  |                                                                                                      
|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                                   |  | 6   
|        
|PART II 
|         |  |                                                                                                      
|Item 5.  |  | Market for Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities       |  | 6   
|         |  |                                                                                                      
|Item 6.  |  | Managements Discussion and Analysis                                                                  |  | 8   
|         |  |                                                                                                      
|Item 7.  |  | Financial Statements                                                                                  |  | 23  
|         |  |                                                                                                      
|Item 8.  |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.                 |  | 23  
|         |  |                                                                                                      
|Item 8A. |  | Controls and Procedures                                                                               |  | 23  
|         |  |                                                                                                      
|Item 8B. |  | Other Information                                                                                     |  | 23  
|        
|PART III
|         |  |                                                                                                      
|Item 9.  |  | Directors and Executive Officers of the Registrant; Compliance with Section 16(a) of the Exchange Act |  | 24  
|         |  |                                                                                                      
|Item 10. |  | Executive Compensation                                                                                |  | 24  
|         |  |                                                                                                      
|Item 11. |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters        |  | 24  
|         |  |                                                                                                      
|Item 12. |  | Certain Relationships and Related Transactions                                                        |  | 24  
|         |  |                                                                                                      
|Item 13. |  | Exhibits                                                                                              |  | 25  
|         |  |                                                                                                      
|Item 14. |  | Principal Accountant Fees and Services                                                                |  | 25  



---

##### Table of Contents

NOTE REGARDING FORWARD-LOOKING STATEMENTS



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



PART I



Item 1.Description of Business.



Overview



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



North State Bank was incorporated under the laws of the
State of North Carolina in May 2000 and opened for business on June 1, 2000. The Bank is not a member of the Federal Reserve System. Our main office and that of the Bank is located at 4270 The Circle at North Hills, Raleigh, North Carolina. The Bank
also operates branch offices at 6200 Falls of Neuse Road in north Raleigh, 2413 Blue Ridge Road in west Raleigh and 835 Highway 70 West in Garner, North Carolina and a loan production office at 11410 Common Oaks Drive in the Wakefield Corporate
Center in Raleigh. The term we in this report refers interchangeably to North State Bancorp and North State Bank.



We offer a wide range of banking services to individuals, professional firms and businesses in the cities of Raleigh and Garner, including checking,
savings and investment accounts; commercial, installment, mortgage, and personal loans; safe deposit boxes; savings bonds; wire transfer; and other associated services. Through the Banks subsidiary, North State Bank Financial Services, Inc.,
we offer brokerage services.



Supervision and Regulation



Regulation of North State Bank



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



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



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



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



1



---

##### Table of Contents

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



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



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



Any change in applicable law or regulation could have a material adverse effect on our business.



Community Reinvestment Act



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



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



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



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



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



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



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



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



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



Capital Requirements



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



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



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



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



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



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



Dividends



The North Carolina Commissioner of Banks generally
prohibits the payment of cash dividends during the first three years of a banks operations. To date, we have retained our earnings for use in the development of our business. As a relatively new bank that



2



---

##### Table of Contents

expects to continue to expand its operations in Wake County, North Carolina, we are not likely to pay any cash dividends on our common stock in the
foreseeable future, and we might not ever be in a position to pay cash dividends. The payment of any cash dividend is subject to our Board of Directors evaluation of our operating results, financial condition, future growth plans, general
business conditions, and to tax and other relevant considerations and regulatory limitations, including our minimum capital requirements. We might not declare and pay any cash dividends, and if we were to do so, we might not continue to declare them
or maintain them at the same level.



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



Insurance Assessments



The FDICs Bank
Insurance Fund insures our deposits. To maintain deposit insurance coverage, each insured bank pays assessments to the Bank Insurance Fund that are calculated as a percentage of its average assessment base. The assessment rate applicable to each
individual bank is based on that institutions classification as well capitalized, adequately capitalized or undercapitalized, as such terms are defined in federal banking regulations, and whether an
institutions supervisory agency considers it to be financially sound or to have supervisory concerns. Annual Bank Insurance Fund assessment rates currently range from 0% for the strongest banks to .27% for the lowest rated banks. Banks whose
assessment rates are 0% are subject to an annual statutory minimum assessment. Insurance assessment rates could change in the future, and increases in rates would have a negative effect on our operating results.



Monetary Policy



The policies of the Federal Reserve Board affect our earnings. The Federal
Reserve Board is a federal agency that regulates the money supply in order to mitigate recessionary and inflationary pressures. Among the techniques used to implement its objectives are open market transactions in U.S. government securities, changes
in the rate paid by banks on bank borrowings, and changes in reserve requirements against bank deposits. The Federal Reserve Board uses these techniques in varying combinations to influence overall growth and distribution of bank loans, investments
and deposits, and its use of these techniques might also affect interest rates charged on loans or paid for deposits. The monetary policies of the Federal Reserve Board have had a significant effect on the operating results of commercial banks in
the past and are expected to continue to do so in the future.



Interstate Banking and Branching



Federal law
permits adequately capitalized and managed bank holding companies to acquire control of a bank in any state. In addition, federal law permits banks to merge with banks located in other states and allows states to adopt legislation permitting
out-of-state banks to open branch offices within that states borders. In accordance with the federal law, a few states chose to prohibit interstate mergers of banks by adopting legislation prohibiting interstate bank mergers. However, most
states, including North Carolina, allow interstate mergers.



The North Carolina Reciprocal Interstate Banking Act permits banking organizations in any state with similar reciprocal legislation to acquire North Carolina banking organizations. In addition, the North Carolina Interstate Branch Banking
Act:



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



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



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



However, an out-of-state bank may only take advantage of the Branch Banking Act if prior to June 1, 1997 its home
states laws permit North Carolina banks to establish branches or acquire banks in that state on substantially the same terms and conditions as are contained in the North Carolina Act.



Interstate banking and branching has increased competition in the banking
industry in North Carolina and nationwide.



3



---

##### Table of Contents

Change of Control



State and federal law restricts the amount of voting stock of a bank that a person may acquire without the prior approval of
banking regulators. The overall effect of such laws is to make it more difficult to acquire control of a bank than it might be to acquire control of another type of corporation. Consequently, our shareholders might be less likely to benefit from the
rapid increases in stock prices that often result from tender offers or similar efforts to acquire control of other companies.



Pursuant to North Carolina law, no person may directly or indirectly purchase or acquire voting stock of any bank that would result in the change in
control of that bank without the prior approval of the North Carolina Commissioner of Banks. A person will be deemed to have acquired control of a bank if he, she or it directly or indirectly owns, controls or has power to vote 10% or
more of the voting stock of the bank, or otherwise possesses the power to direct or cause the direction of the management and policy of the bank.



Federal law imposes additional restrictions on acquisitions of stock in FDIC-insured banks. Under the federal Change in Bank Control Act and its
regulations, a person or group acting in concert must give advance notice to the FDIC before directly or indirectly acquiring the power to direct the management or policies of, or to vote 25% or more of any class of voting securities of, any
federally-insured bank. Upon receipt of such notice, the FDIC either may approve or disapprove the acquisition. The Act generally creates a rebuttable presumption of a change in control if:



| |  |  | a person or group acquires ownership or control of or the power to vote 10% or more of any class of a banks voting securities;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------



| |  |  | the bank has a class of outstanding securities that are subject to registration under the Securities Exchange Act of 1934; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------



| |  |  | no other person owns a greater percentage of that class of the banks voting securities.
| | - |  | ----------------------------------------------------------------------------------------



Prompt Corrective Action



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



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



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



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



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



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



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



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



4



---

##### Table of Contents

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



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



Safety and Soundness Standards



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



Financial Modernization Legislation



The Gramm-Leach-Bliley Act of 1999 represented the most sweeping reform of
financial services regulation in over 60 years. The Act permits bank holding companies meeting management, capital and Community Reinvestment Act standards to engage in a broad range of non-banking activities, including insurance underwriting and
investment banking. The Act allows insurance companies and other financial services companies to acquire banks and allows bank holding companies to acquire securities firms and mutual fund advisory companies. The Act requires appropriate safeguards
if a bank holding company wishes to engage in any of these activities.



Regulation of North State Bancorp



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



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



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



5



---

##### Table of Contents

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



As a bank holding company, we also are subject to the North Carolina Bank Holding Company Act of 1984, and are registered as a bank holding company with the Commissioner of Banks of the State of North Carolina.



Competition



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



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



Employees



As of December 31, 2004, we had 48 employees. We believe that our future success will depend in part on our continued
ability to attract, hire, and retain qualified personnel. None of our employees is represented by a labor union. We have not experienced any work stoppages and consider our relations with our employees to be good.



Item 2.Description of Property.



Our headquarters are located in Raleigh, North Carolina, where we occupy approximately 12,000 square feet of office space in a stand-alone building under a lease extending through March 2015. We have a branch in north
Raleigh that consists of approximately 8,352 square feet of office space under a lease extending through September 2006. We have a branch in west Raleigh that consists of approximately 10,000 square feet, approximately 5,200 square feet of which we
occupy and the remainder of which we lease. We have a branch office in Garner, North Carolina, where we own a building that has approximately 5,000 square feet of office space.



Item 3.Legal Proceedings.



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



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



No matter was submitted to a vote of our shareholders during the fourth quarter of the year ended December 31, 2004.



PART II



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



Stock Information



Our common stock is not traded on any exchange. In August 2003, our stock was listed on the Over-the-Counter Bulletin Board. Set forth below for each
quarter in 2003 and 2004 is information on the high and low sale prices of our common stock prior to August 2003, and the high and low bid and asked prices of our common stock after that date as reported on the Over-the-Counter Bulletin Board.
Prices have been adjusted for the 11-for-10 stock split effected in December 2003 and the 23-for-20 stock split effected in December 2004.



|                                    |  |      |       |     |   |      
|----------------------------------- |  | ---- | ----- | --- | - | -----
|                                    |  | High |       | Low
|Fiscal Year Ended December 31, 2004 |  |      |       |     |   |      
|January 1 through March 31, 2004    |  |      | 15.44 |     |   | 13.04
|April 1 through June 30, 2004       |  |      | 14.34 |     |   | 13.48
|July 1 through September 30, 2004   |  |      | 14.78 |     |   | 13.04
|October 1 through December 31, 2004 |  |      | 25.05 |     |   | 12.67
|                                    |  |     
|Fiscal Year Ended December 31, 2003 |  |      |       |     |   |      
|January 1 through March 31, 2003    |  | $    | 8.70  |     | $ | 8.70 
|April 1 through June 30, 2003       |  |      | 8.70  |     |   | 7.91 
|July 1 through September 30, 2003   |  |      | 10.05 |     |   | 7.97 
|October 1 through December 31, 2003 |  |      | 13.04 |     |   | 11.97



6



---

##### Table of Contents

As of March 18, 2005, there were approximately 750 shareholders of record. We estimate that there were
approximately 800 beneficial owners on December 31, 2004.



Dividends



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



On March 17, 2004, our trust subsidiary issued
preferred securities in a private placement. We, in turn, issued unsecured subordinated debentures to the trust to serve as the income source for the trusts payment of interest on its preferred securities. Pursuant to the terms of the
indenture that governs our debentures, we are prohibited from paying cash dividends on our stock in the event of a default by our company on the terms of the debentures or the indenture.



Equity Compensation Plans



Set forth below is information on our equity compensation plans as of December 31, 2004.



|                                                           |  |                                                                                           |  |                                                                           |      |                                                                                              |       
|---------------------------------------------------------- |  | ----------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------- | ---- | -------------------------------------------------------------------------------------------- | ------
|Plan Category                                              |  | Number of securities to be issued upon exercise ofoutstanding options,warrants and
rights |  | Weighted-average exercise price ofoutstanding options,warrants and rights |      | Number of securities remaining available for future issuance under equity compensation plans
|Equity compensation plans approved by our shareholders     |  | 407,711                                                                                   |  | $                                                                         | 7.64 |                                                                                              | 18,936
|Equity compensation plans not approved by our shareholders |  |                                                                                          |  |                                                                           |     |                                                                                              |      
|                                                           |  |                                                                                           |  |                                                                           |      |                                                                                              |       
|Total                                                      |  | 407,711                                                                                   |  | $                                                                         | 7.64 |                                                                                              | 18,936
|                                                           |  |                                                                                           |  |                                                                           |      |                                                                                              |       



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



7



---

##### Table of Contents

Item 6.Managements Discussion and Analysis.



The following table sets forth selected consolidated financial information for our company as of and for the years ended December 31, 2004, 2003, 2002,
2001 and 2000. The data has been derived from our audited consolidated financial statements. The consolidated financial statements as of December 31, 2004 and 2003 and for the years then ended, and the independent registered public accounting
firms report thereon, are included elsewhere in this report. The following should also be read in conjunction with Managements Discussion and Analysis of Financial Condition and Results of Operations included in this report.



Selected Consolidated Financial Information and Other Data



|                                                                    |  |                                               |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |   
|------------------------------------------------------------------- |  | --------------------------------------------- | --------- | - | ---- | - | --------- | ---- |  | - | --------- | - |  | ---- | --------- | - |  | - | --------- | --
|                                                                    |  | At or for the Year Ended December 31,         |          
|                                                                    |  | 2004                                          |           |   | 2003 |   |           | 2002 |  |   | 2001      |   |  | 2000 |          
|                                                                    |  | (Dollars in thousands, except per share data) |          
|Operating Data:                                                     |  |                                               |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |   
|Total interest income                                               |  | $                                             | 12,599    |   |      | $ | 9,213     |      |  | $ | 7,920     |   |  | $    | 6,249     |   |  | $ | 1,710     |   
|Total interest expense                                              |  |                                               | 4,135     |   |      |   | 3,251     |      |  |   | 3,115     |   |  |      | 2,542     |   |  |   | 534       |   
|                                                                    |  |                                               |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |   
|Net interest income                                                 |  |                                               | 8,464     |   |      |   | 5,962     |      |  |   | 4,805     |   |  |      | 3,707     |   |  |   | 1,176     |   
|Provision for loan losses                                           |  |                                               | 920       |   |      |   | 690       |      |  |   | 546       |   |  |      | 836       |   |  |   | 587       |   
|                                                                    |  |                                               |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |   
|Net interest income after provision for loan losses                 |  |                                               | 7,544     |   |      |   | 5,272     |      |  |   | 4,259     |   |  |      | 2,871     |   |  |   | 589       |   
|Total non-interest income                                           |  |                                               | 1,035     |   |      |   | 996       |      |  |   | 845       |   |  |      | 352       |   |  |   | 42        |   
|Total non-interest expense                                          |  |                                               | 6,365     |   |      |   | 4,853     |      |  |   | 4,154     |   |  |      | 2,963     |   |  |   | 1,561     |   
|                                                                    |  |                                               |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |   
|Income before income taxes                                          |  |                                               | 2,214     |   |      |   | 1,415     |      |  |   | 950       |   |  |      | 260       |   |  |   |          |   
|Provision for income taxes                                          |  |                                               | 838       |   |      |   | 436       |      |  |   |          |   |  |      |          |   |  |   |          |   
|                                                                    |  |                                               |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |   
|Net income (loss)                                                   |  | $                                             | 1,376     |   |      | $ | 979       |      |  | $ | 950       |   |  | $    | 260       |   |  | $ | (930      | ) 
|                                                                    |  |                                               |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |   
|Per Common Share Data:                                              |  |                                               |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |   
|Earnings per share  basic(1)                                       |  | $                                             | 0.58      |   |      | $ | 0.42      |      |  | $ | 0.41      |   |  | $    | 0.11      |   |  | $ | (0.40     | ) 
|Earnings per share  diluted(1)                                     |  |                                               | 0.55      |   |      |   | 0.40      |      |  |   | 0.46      |   |  |      | 0.11      |   |  |   | (0.40     | ) 
|Book value(1)                                                       |  |                                               | 7.99      |   |      |   | 7.42      |      |  |   | 7.14      |   |  |      | 6.72      |   |  |   | 6.57      |   
|Weighted Average Shares Outstanding                                 |  |                                               |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |   
|Basic                                                               |  |                                               | 2,362,798 |   |      |   | 2,344,606 |      |  |   | 2,332,573 |   |  |      | 2,332,573 |   |  |   | 2,325,000 |   
|Diluted                                                             |  |                                               | 2,516,289 |   |      |   | 2,438,782 |      |  |   | 2,390,181 |   |  |      | 2,334,584 |   |  |   | 2,325,000 |   
|Selected Year-End Balance Sheet Data:                               |  |                                               |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |   
|Total assets                                                        |  | $                                             | 309,542   |   |      | $ | 249,020   |      |  | $ | 195,478   |   |  | $    | 124,830   |   |  | $ | 59,654    |   
|Loans                                                               |  |                                               | 244,620   |   |      |   | 181,532   |      |  |   | 118,653   |   |  |      | 84,256    |   |  |   | 33,526    |   
|Allowance for loan losses                                           |  |                                               | 3,053     |   |      |   | 2,360     |      |  |   | 1,845     |   |  |      | 1,323     |   |  |   | 587       |   
|Deposits                                                            |  |                                               | 269,133   |   |      |   | 208,548   |      |  |   | 166,431   |   |  |      | 104,268   |   |  |   | 42,332    |   
|Short-term borrowings                                               |  |                                               | 14,273    |   |      |   | 15,911    |      |  |   | 4,892     |   |  |      | 4,050     |   |  |   | 1,629     |   
|Long-term debt                                                      |  |                                               | 5,155     |   |      |   | 6,000     |      |  |   | 6,000     |   |  |      |          |   |  |   |          |   
|Shareholders equity                                                |  |                                               | 18,914    |   |      |   | 17,514    |      |  |   | 16,647    |   |  |      | 15,683    |   |  |   | 15,343    |   
|Selected Average Balances:                                          |  |                                               |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |   
|Total assets                                                        |  | $                                             | 271,694   |   |      | $ | 211,387   |      |  | $ | 156,031   |   |  | $    | 98,142    |   |  | $ | 40,144    |   
|Loans                                                               |  |                                               | 209,502   |   |      |   | 139,095   |      |  |   | 100,701   |   |  |      | 57,581    |   |  |   | 15,545    |   
|Total interest-earning assets                                       |  |                                               | 258,934   |   |      |   | 198,703   |      |  |   | 147,252   |   |  |      | 92,410    |   |  |   | 36,518    |   
|Deposits                                                            |  |                                               | 230,265   |   |      |   | 179,973   |      |  |   | 128,602   |   |  |      | 78,040    |   |  |   | 23,042    |   
|Short-term borrowings                                               |  |                                               | 15,699    |   |      |   | 6,992     |      |  |   | 4,815     |   |  |      | 3,961     |   |  |   | 1,149     |   
|Long-term debt                                                      |  |                                               | 6,043     |   |      |   | 6,000     |      |  |   | 5,556     |   |  |      |          |   |  |   |          |   
|Total interest-bearing liabilities                                  |  |                                               | 194,680   |   |      |   | 140,779   |      |  |   | 100,686   |   |  |      | 56,712    |   |  |   | 15,896    |   
|Shareholders equity                                                |  |                                               | 18,338    |   |      |   | 17,389    |      |  |   | 16,268    |   |  |      | 15,529    |   |  |   | 15,772    |   
|Selected Performance Ratios                                         |  |                                               |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |   
|Return on average assets                                            |  |                                               | 0.51      | % |      |   | 0.46      | %    |  |   | 0.61      | % |  |      | 0.26      | % |  |   | (3.96     | )%
|Return on average equity                                            |  |                                               | 7.50      | % |      |   | 5.63      | %    |  |   | 5.84      | % |  |      | 1.67      | % |  |   | (10.08    | )%
|Net interest spread                                                 |  |                                               | 2.75      | % |      |   | 2.33      | %    |  |   | 2.29      | % |  |      | 2.28      | % |  |   | 2.26      | % 
|Net interest margin                                                 |  |                                               | 3.27      | % |      |   | 3.00      | %    |  |   | 3.26      | % |  |      | 4.01      | % |  |   | 5.51      | % 
|Non-interest income to net interest income plus non-interest income |  |                                               | 10.89     | % |      |   | 14.31     | %    |  |   | 14.96     | % |  |      | 8.67      | % |  |   | 3.45      | % 
|Non-interest income to average assets                               |  |                                               | 0.38      | % |      |   | 0.47      | %    |  |   | 0.54      | % |  |      | 0.36      | % |  |   | 0.18      | % 
|Non-interest expense to average assets                              |  |                                               | 2.34      | % |      |   | 2.30      | %    |  |   | 2.66      | % |  |      | 3.02      | % |  |   | 6.65      | % 
|Efficiency ratio                                                    |  |                                               | 67.00     | % |      |   | 69.75     | %    |  |   | 73.52     | % |  |      | 73.00     | % |  |   | 128.16    | % 
|Asset Quality Ratios:                                               |  |                                               |           |   |      |   |           |      |  |   |           |   |  |      |           |   |  |   |           |   
|Nonperforming loans to period-end loans                             |  |                                               | 0.11      | % |      |   | 0.55      | %    |  |   | 0.09      | % |  |      | 0.03      | % |  |   | 0.00      | % 
|Allowance for loan losses to period-end loans                       |  |                                               | 1.25      | % |      |   | 1.30      | %    |  |   | 1.55      | % |  |      | 1.57      | % |  |   | 1.75      | % 
|Allowance for loan losses to nonperforming loans                    |  |                                               | 1174.23   | % |      |   | 235.53    | %    |  |   | 1662.16   | % |  |      | 5292.00   | % |  |   | 0.00      | % 
|Nonperforming assets to total assets                                |  |                                               | 0.25      | % |      |   | 0.40      | %    |  |   | 0.06      | % |  |      | 0.02      | % |  |   | 0.00      | % 
|Net loan charge-offs to average loans                               |  |                                               | 0.11      | % |      |   | 0.13      | %    |  |   | 0.02      | % |  |      | 0.17      | % |  |   | 0.00      | % 



8



---

##### Table of Contents

|                                         |  |                                               |        |  |       |     |  |       |   |  |       |   |  |       |  
|---------------------------------------- |  | --------------------------------------------- | ------ |  | ----- | --- |  | ----- | - |  | ----- | - |  | ----- | -
|                                         |  | At or for the Year Ended December 31,         |       
|                                         |  | 2004                                          |        |  | 2003  |     |  | 2002  |   |  | 2001  |   |  | 2000  |  
|                                         |  | (Dollars in thousands, except per share data) |       
|Capital Ratios:(4)                       |  |                                               |        |  |       |     |  |       |   |  |       |   |  |       |  
|Total risk-based capital                 |  | 11.01                                         | %      |  | 10.85 | %   |  | 14.31 | % |  | 19.13 | % |  | 40.62 | %
|Tier 1 risk-based capital                |  | 9.76                                          | %      |  | 9.60  | %   |  | 13.06 | % |  | 17.88 | % |  | 39.36 | %
|Leverage ratio                           |  | 7.94                                          | %      |  | 7.87  | %   |  | 8.84  | % |  | 13.10 | % |  | 25.68 | %
|Equity to assets ratio                   |  | 6.11                                          | %      |  | 7.03  | %   |  | 8.52  | % |  | 12.56 | % |  | 25.72 | %
|Average equity to average assets         |  | 6.75                                          | %      |  | 8.23  | %   |  | 10.43 | % |  | 15.82 | % |  | 39.29 | %
|Other Data:                              |  |                                               |        |  |       |     |  |       |   |  |       |   |  |       |  
|Number of banking offices                |  | 4                                             | (2)(3) |  | 3     | (2) |  | 2     |   |  | 2     |   |  | 2     |  
|Number of full time equivalent employees |  | 48                                            |        |  | 43    |     |  | 37    |   |  | 32    |   |  | 32    |  

---

|(1) | Adjusted for the 23-for-20 stock split effected in the form of a 15% stock dividend in 2004 and the 11-for-10 stock splits effected in the form of 10% stock dividends in 2003, 2002
and 2001.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Includes one loan production office.
|--- | ------------------------------------

|(3) | Does not include our full-service main banking office that opened in March 2005.
|--- | --------------------------------------------------------------------------------

|(4) | Capital ratios are for bank only.
|--- | ---------------------------------



Managements Discussion and Analysis



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



Description of Business



We are a commercial bank holding company that was incorporated on June 5, 2002. We have one subsidiary, North State Bank,
which we acquired on June 28, 2002 as part of our bank holding company reorganization. In March 2004, we established a subsidiary trust, North State Statutory Trust I, to issue trust preferred securities. Our only business is the ownership and
operation of North State Bank and North State Statutory Trust I.



North State Bank is a North Carolina chartered banking corporation. The bank, which offers a full array of commercial and retail banking services, opened for business on June 1, 2000. Through the bank, we currently operate four full-service
banking offices located in Raleigh and Garner, North Carolina and one loan production office located in Wake Forest, North Carolina. Our principal customers consist of individuals and small to medium-sized businesses, including professional firms,
small businesses, churches, property management companies, individuals and others who value a mutually beneficial banking relationship.



Financial Condition at December 31, 2004 and 2003



We continued to experience very good growth in our balance sheet during 2004, our fourth full calendar year of operations. Total assets as of December 31,
2004 were $309.5 million, an increase of $60.5 million or 24.3% from December 31, 2003. Loans were $244.6 million at December 31, 2004 compared to $181.5 million on December 31, 2003, an increase of $63.1 million or 34.7%. Other earning assets,
principally investments and fed funds sold, increased $4.8 million or 9.3% over the previous year.



The growth in assets was principally funded by deposits, which grew $60.6 million during the year ended December 31, 2004. Interest bearing transaction
accounts continue to be the largest type of deposit account with balances of $113.7 million as of December 31, 2004, an increase of $26.9 million or 30.9% over the same period in 2003. Demand deposits grew $16.6 million to $73.7 million or 29.1% and
time deposits grew $17.1 million or 26.4% over December 31, 2003 levels. Additional funding was provided by the issuance of $5.2 million in junior subordinated debentures in March 2004. For a discussion of these junior subordinated debentures, see
Note H to our consolidated financial statements contained in this report.



Results of Operations For the Years Ended December 31, 2004 and 2003



Overview. For the year ended December 31, 2004, our net income was $1,376,000 compared to $979,000 for the year ended December 31, 2003, an increase of 40.6%. Diluted net income per share of common stock
was $0.58 in 2004 and $0.42 in 2003, an increase of $0.16 or 38.1%. Return on average assets was .51% in 2004 versus .46% in 2003 while return on average equity was 7.50% and 5.63% for the years ended December 31, 2004 and December 31, 2003,
respectively.



9



---

##### Table of Contents

Net Interest Income. Net interest income was $8.5 million for the year ended December 31,
2004, an increase of $2.5 million or 41.9% over the year ended December 31, 2003. The increase in net interest income was attributable to an overall higher level of earning assets, a change in earning asset mix and a better spread between the income
we received from our earning assets and the expense we paid to fund those assets. We increased average earning assets by $60.3 million in 2004 as compared to 2003. We also changed the mix of our earning assets. Average loans for 2004 increased $70.4
million or 50.6% from 2003, while the average balance of investments and other earning assets decreased $10.2 million or 17.1%. This shifting of earning assets from lower yielding investments to higher yielding loans contributed to an overall
increase in net interest income. The shift in earning assets combined with a better pricing discipline and overall higher market rates contributed to higher spreads between earning assets and costing liabilities. Net interest spread increased from
2.33% in 2003 to 2.75% or 42 basis points during 2004. Our net interest margin, which is computed by dividing net interest income by total interest-earning assets, was 3.27% for 2004 and 3.00% in 2003, with the increase resulting primarily from
faster growth in our non-interest-bearing deposits and a decrease in the rates we paid on our deposits.



Provision for Loan Losses. We recorded a $920,000 provision for loan losses in 2004, representing an increase of $230,000 from the $690,000
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 our management. In evaluating the allowance for loan losses, we consider factors that include growth,
composition and industry diversification of our portfolio, historical loan loss experience, current delinquency levels, adverse situations that might affect a borrowers ability to repay, estimated value of any underlying collateral, prevailing
economic conditions and other relevant factors. In both 2004 and 2003, the provision for loan losses was made principally in response to growth in loans, as total loans outstanding increased by $63.1 million in 2004 and by $62.9 million in 2003. In
addition, net loan charge-offs were $227,000 in 2004, an increase of $52,000 from net loan charge-offs of $175,000 in 2003. The allowance for loan losses was $3.1 million at December 31, 2004 and $2.4 million at December 31, 2003, representing 1.25%
and 1.30%, respectively, of loans outstanding. See Asset Quality and the Allowance For Loan Losses.



Noninterest Income. Noninterest income is derived primarily from service fees on deposit accounts and income from mortgage lending
operations. Noninterest income increased $39,000 or 3.9% in 2004. Fees earned on deposit accounts increased by $89,000 as a result of deposit growth. Income from mortgage lending in 2004 decreased to $311,000, a decrease of $117,000 from 2003 as
rising interest rates significantly slowed mortgage refinancing activity. Other noninterest income, led by increasing fees on merchant credit card services, increased $64,000 over 2003.



Noninterest Expense. Noninterest expense includes salaries and benefits paid to employees, occupancy and
equipment expenses and all other operating costs. Noninterest expense increased $1.5 million for the year ended December 31, 2004 compared to the year ended December 31, 2003. Salaries and employee benefits comprised the largest portion of
noninterest expense for 2004 and increased $872,000 compared to 2003. This reflects an increase in additional loan officers and support staff added throughout the year plus increasing costs of our director compensation plan. In addition, the opening
of our west Raleigh location in March 2004 added to the salary expense increases. Premises and equipment costs increased $159,000 for the year ended December 31, 2004 compared to the previous year. Most of this increase related to the opening of the
west Raleigh office and the loan production office in Wake Forest being open the entire year in 2004 versus a portion of the year in 2003. Other noninterest expense increased $481,000 during 2004 led by increases in merchant card expenses and
advertising. In the aggregate, noninterest expense as a percentage of average total assets was 2.34% for 2004, an increase from 2.30% for 2003.



Income Taxes. We recorded $838,000 in income tax expense for the year ended December 31, 2004 and $436,000 for the year ended December 31,
2003. Income tax expense as a percentage of pretax income was 37.9% for 2004 and 30.8% for 2003. The increase in income taxes was attributable to higher pretax earnings, up $799,000 or 56.5% over the previous year-end. In addition, income tax
expense in 2003 reflected the recognition of $91,000 of deferred tax assets that arose in prior years.



Net Interest Income



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



10



---

##### Table of Contents

|                                                                                 |  |                              |         |   |                              |   |              |                              |      |                 |  |   |          |   |              |   |       |                 |      |   |          |   |              |   |  |   |       |  |      |  
|-------------------------------------------------------------------------------- |  | ---------------------------- | ------- | - | ---------------------------- | - | ------------ | ---------------------------- | ---- | --------------- |  | - | -------- | - | ------------ | - | ----- | --------------- | ---- | - | -------- | - | ------------ | - |  | - | ----- |  | ---- | -
|                                                                                 |  | Year Ended December 31, 2004 |         |   | Year Ended December 31, 2003 |   |              | Year Ended December 31, 2002 |     
|                                                                                 |  | (Dollars in thousands)       |        
|                                                                                 |  | Average Balance              |         |   | Interest                     |   | Average Rate |                              |      | Average Balance |  |   | Interest |   | Average Rate |   |       | Average Balance |      |   | Interest |   | Average Rate |  
|Interest-earning assets:                                                         |  |                              |         |   |                              |   |              |                              |      |                 |  |   |          |   |              |   |       |                 |      |   |          |   |              |   |  |   |       |  |      |  
|Loans, net                                                                       |  | $                            | 209,502 |   |                              |   | 11,383       |                              | 5.43 | %               |  | $ | 139,095  |   |              | $ | 8,020 |                 | 5.77 | % |          | $ | 100,701      |   |  | $ | 6,638 |  | 6.59 | %
|Investment securities                                                            |  |                              | 37,765  |   |                              |   | 1,018        |                              | 2.70 | %               |  |   | 41,366   |   |              |   | 985   |                 | 2.38 | % |          |   | 23,690       |   |  |   | 923   |  | 3.89 | %
|Other interest-earning assets                                                    |  |                              | 11,667  |   |                              |   | 198          |                              | 1.70 | %               |  |   | 18,242   |   |              |   | 208   |                 | 1.14 | % |          |   | 22,861       |   |  |   | 360   |  | 1.57 | %
|                                                                                 |  |                              |         |   |                              |   |              |                              |      |                 |  |   |          |   |              |   |       |                 |      |   |          |   |              |   |  |   |       |  |      |  
|Total interest-earning assets                                                    |  |                              | 258,934 |   |                              |   | 12,599       |                              | 4.87 | %               |  |   | 198,703  |   |              |   | 9,213 |                 | 4.64 | % |          |   | 147,252      |   |  |   | 7,920 |  | 5.38 | %
|                                                                                 |  |                              |         |   |                              |   |              |                              |      |                 |  |   |          |   |              |   |       |                 |      |   |          |   |              |   |  |   |       |  |      |  
|Other assets                                                                     |  |                              | 12,760  |   |                              |   |              |                              |      |                 |  |   | 12,684   |   |              |   |       |                 |      |   |          |   | 8,779        |   |  |   |       |  |      |  
|                                                                                 |  |                              |         |   |                              |   |              |                              |      |                 |  |   |          |   |              |   |       |                 |      |   |          |   |              |   |  |   |       |  |      |  
|Total assets                                                                     |  | $                            | 271,694 |   |                              |   |              |                              |      |                 |  | $ | 211,387  |   |              |   |       |                 |      |   |          | $ | 156,031      |   |  |   |       |  |      |  
|                                                                                 |  |                              |         |   |                              |   |              |                              |      |                 |  |   |          |   |              |   |       |                 |      |   |          |   |              |   |  |   |       |  |      |  
|Interest-bearing liabilities:                                                    |  |                              |         |   |                              |   |              |                              |      |                 |  |   |          |   |              |   |       |                 |      |   |          |   |              |   |  |   |       |  |      |  
|Deposits:                                                                        |  |                              |         |   |                              |   |              |                              |      |                 |  |   |          |   |              |   |       |                 |      |   |          |   |              |   |  |   |       |  |      |  
|Savings, NOW and money market                                                    |  | $                            | 98,714  |   |                              |   | 1,529        |                              | 1.55 | %               |  |   | 63,363   |   |              |   | 970   |                 | 1.53 | % |          |   | 42,867       |   |  |   | 903   |  | 2.11 | %
|Time deposits over $100,000                                                      |  |                              | 28,651  |   |                              |   | 847          |                              | 2.96 | %               |  |   | 25,605   |   |              |   | 816   |                 | 3.19 | % |          |   | 19,638       |   |  |   | 802   |  | 4.08 | %
|Other time deposits                                                              |  |                              | 45,573  |   |                              |   | 1,183        |                              | 2.59 | %               |  |   | 38,819   |   |              |   | 1,139 |                 | 2.93 | % |          |   | 27,810       |   |  |   | 1,104 |  | 3.97 | %
|Borrowings:                                                                      |  |                              |         |   |                              |   |              |                              |      |                 |  |   |          |   |              |   |       |                 |      |   |          |   |              |   |  |   |       |  |      |  
|Short-term borrowings                                                            |  |                              | 15,699  |   |                              |   | 307          |                              | 1.96 | %               |  |   | 6,992    |   |              |   | 63    |                 | 0.90 | % |          |   | 4,815        |   |  |   | 63    |  | 1.31 | %
|Long-term debt                                                                   |  |                              | 6,043   |   |                              |   | 269          |                              | 4.45 | %               |  |   | 6,000    |   |              |   | 263   |                 | 4.38 | % |          |   | 5,556        |   |  |   | 243   |  | 4.37 | %
|                                                                                 |  |                              |         |   |                              |   |              |                              |      |                 |  |   |          |   |              |   |       |                 |      |   |          |   |              |   |  |   |       |  |      |  
|Total interest-bearing liabilities                                               |  |                              | 194,680 |   |                              |   | 4,135        |                              | 2.12 | %               |  |   | 140,779  |   |              |   | 3,251 |                 | 2.31 | % |          |   | 100,686      |   |  |   | 3,115 |  | 3.09 | %
|                                                                                 |  |                              |         |   |                              |   |              |                              |      |                 |  |   |          |   |              |   |       |                 |      |   |          |   |              |   |  |   |       |  |      |  
|Noninterest-bearing deposits                                                     |  |                              | 57,327  |   |                              |   |              |                              |      |                 |  |   | 52,186   |   |              |   |       |                 |      |   |          |   | 38,287       |   |  |   |       |  |      |  
|Other liabilities                                                                |  |                              | 1,349   |   |                              |   |              |                              |      |                 |  |   | 1,033    |   |              |   |       |                 |      |   |          |   | 790          |   |  |   |       |  |      |  
|Shareholders equity                                                             |  |                              | 18,338  |   |                              |   |              |                              |      |                 |  |   | 17,389   |   |              |   |       |                 |      |   |          |   | 16,268       |   |  |   |       |  |      |  
|                                                                                 |  |                              |         |   |                              |   |              |                              |      |                 |  |   |          |   |              |   |       |                 |      |   |          |   |              |   |  |   |       |  |      |  
|Total liabilities and shareholders equity                                       |  | $                            | 271,694 |   |                              |   |              |                              |      |                 |  | $ | 211,387  |   |              |   |       |                 |      |   |          | $ | 156,031      |   |  |   |       |  |      |  
|                                                                                 |  |                              |         |   |                              |   |              |                              |      |                 |  |   |          |   |              |   |       |                 |      |   |          |   |              |   |  |   |       |  |      |  
|Net interest income and interest rate spread                                     |  |                              |         |   |                              | $ | 8,464        |                              | 2.75 | %               |  |   |          |   |              | $ | 5,962 |                 | 2.33 | % |          |   |              |   |  | $ | 4,805 |  | 2.29 | %
|                                                                                 |  |                              |         |   |                              |   |              |                              |      |                 |  |   |          |   |              |   |       |                 |      |   |          |   |              |   |  |   |       |  |      |  
|Net interest margin                                                              |  |                              |         |   |                              |   |              |                              | 3.27 | %               |  |   |          |   |              |   |       |                 | 3.00 | % |          |   |              |   |  |   |       |  | 3.26 | %
|                                                                                 |  |                              |         |   |                              |   |              |                              |      |                 |  |   |          |   |              |   |       |                 |      |   |          |   |              |   |  |   |       |  |      |  
|Ratio of average interest-earning assets to average interest-bearing liabilities |  |                              | 133.00  | % |                              |   |              |                              |      |                 |  |   | 141.15   | % |              |   |       |                 |      |   |          |   | 146.25       | % |  |   |       |  |      |  
|                                                                                 |  |                              |         |   |                              |   |              |                              |      |                 |  |   |          |   |              |   |       |                 |      |   |          |   |              |   |  |   |       |  |      |  



11



---

##### Table of Contents

Rate/Volume Analysis



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



|                                        |  |                                      |       |   |                                      |   |      |       |  |   |        |   |  |      |       |   |       |   |        |   |  |   |       |  
|--------------------------------------- |  | ------------------------------------ | ----- | - | ------------------------------------ | - | ---- | ----- |  | - | ------ | - |  | ---- | ----- | - | ----- | - | ------ | - |  | - | ----- | -
|                                        |  | Year Ended December 31,2004 vs. 2003 |       |   | Year Ended December 31,2003 vs. 2002 |  
|                                        |  | Increase (Decrease) Due to           |       |   | Increase (Decrease) Due to           |  
|                                        |  | Volume                               |       |   | Rate                                 |   |      | Total |  |   | Volume |   |  | Rate |       |   | Total |  
|                                        |  | (Dollars in thousands)               |      
|Interest income                         |  |                                      |       |   |                                      |   |      |       |  |   |        |   |  |      |       |   |       |   |        |   |  |   |       |  
|Loans                                   |  | $                                    | 3,943 |   |                                      | $ | (580 | )     |  | $ | 3,363  |   |  | $    | 2,372 |   |       | $ | (990   | ) |  | $ | 1,382 |  
|Investment securities                   |  |                                      | (93   | ) |                                      |   | 152  |       |  |   | 59     |   |  |      | 554   |   |       |   | (491   | ) |  |   | 63    |  
|Other interest-earning assets           |  |                                      | (86   | ) |                                      |   | 50   |       |  |   | (36    | ) |  |      | (63   | ) |       |   | (89    | ) |  |   | (152  | )
|                                        |  |                                      |       |   |                                      |   |      |       |  |   |        |   |  |      |       |   |       |   |        |   |  |   |       |  
|Total interest income                   |  |                                      | 3,764 |   |                                      |   | (378 | )     |  |   | 3,386  |   |  |      | 2,864 |   |       |   | (1,571 | ) |  |   | 1,293 |  
|                                        |  |                                      |       |   |                                      |   |      |       |  |   |        |   |  |      |       |   |       |   |        |   |  |   |       |  
|Interest expense:                       |  |                                      |       |   |                                      |   |      |       |  |   |        |   |  |      |       |   |       |   |        |   |  |   |       |  
|Deposits:                               |  |                                      |       |   |                                      |   |      |       |  |   |        |   |  |      |       |   |       |   |        |   |  |   |       |  
|Savings, NOW and money market           |  |                                      | 544   |   |                                      |   | 15   |       |  |   | 559    |   |  |      | 373   |   |       |   | (306   | ) |  |   | 67    |  
|Time deposits over $100,000             |  |                                      | 94    |   |                                      |   | (63  | )     |  |   | 31     |   |  |      | 217   |   |       |   | (203   | ) |  |   | 14    |  
|Other time deposits                     |  |                                      | 187   |   |                                      |   | (144 | )     |  |   | 43     |   |  |      | 380   |   |       |   | (345   | ) |  |   | 35    |  
|Borrowings:                             |  |                                      |       |   |                                      |   |      |       |  |   |        |   |  |      |       |   |       |   |        |   |  |   |       |  
|Short-term borrowings                   |  |                                      | 125   |   |                                      |   | 120  |       |  |   | 245    |   |  |      | 24    |   |       |   | (24    | ) |  |   |      |  
|Long-term debt                          |  |                                      | 2     |   |                                      |   | 4    |       |  |   | 6      |   |  |      | 19    |   |       |   | 1      |   |  |   | 20    |  
|                                        |  |                                      |       |   |                                      |   |      |       |  |   |        |   |  |      |       |   |       |   |        |   |  |   |       |  
|Total interest expense                  |  |                                      | 952   |   |                                      |   | (68  | )     |  |   | 884    |   |  |      | 1,013 |   |       |   | (877   | ) |  |   | 136   |  
|                                        |  |                                      |       |   |                                      |   |      |       |  |   |        |   |  |      |       |   |       |   |        |   |  |   |       |  
|Net interest income increase (decrease) |  | $                                    | 2,813 |   |                                      | $ | (311 | )     |  | $ | 2,502  |   |  | $    | 1,851 |   |       | $ | (694   | ) |  | $ | 1,157 |  
|                                        |  |                                      |       |   |                                      |   |      |       |  |   |        |   |  |      |       |   |       |   |        |   |  |   |       |  



Liquidity



Our liquidity is a measure of our ability to fund loans, withdrawals and
maturities of deposits, and other cash outflows in a cost effective manner. Our principal sources of liquidity are deposits, scheduled payments and prepayments of loan principal, maturities of investment securities, access to liquid assets, and
funds provided by operations. While scheduled loan payments and maturing investments are relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and
competition.



Liquid assets (consisting of cash and due from
banks, interest-earning deposits with other banks, federal funds sold and investment securities classified as available for sale) comprised 19.4% and 25.8% of our total assets at December 31, 2004 and 2003, respectively.



We have been a net seller of federal funds, as our liquidity has exceeded our
need to fund new loan demand. Should the need arise, we would have the capability to sell securities classified as available for sale or to borrow funds as necessary. We have established credit lines with other financial institutions to purchase up
to $9.5 million in federal funds. As a member of the Federal Home Loan Bank of Atlanta, we may obtain advances up to 10% of our banks assets. As another source of short-term borrowings, we also utilize securities sold under agreements to
repurchase. At December 31, 2004, borrowings consisted of securities sold under agreements to repurchase of $8.3 million. In addition, on that date we had borrowed $6.0 million from the Federal Home Loan Bank of Atlanta.



Total deposits were $269.1 million and $208.5 million at December 31, 2004
and 2003, respectively. Time deposits, which are the only deposit accounts that have stated maturity dates, are generally considered to be rate sensitive. Time deposits represented 30.4% and 31.0%, respectively, of total deposits at December 31,
2004 and 2003. Time deposits of $100,000 or more represented 10.8% and 13.0%, respectively, of our total deposits at December 31, 2004 and 2003. We believe that most of these time deposits are relationship-oriented. While we will need to pay
competitive rates to retain these deposits at their maturities, there are other subjective factors that will determine their continued retention. Based upon prior experience, we anticipate that a substantial portion of outstanding certificates of
deposit will renew upon maturity.



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



Asset/Liability Management



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



The purpose of asset/liability management is to provide stable net interest
income growth by protecting our earnings from



12



---

##### Table of Contents

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



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



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



The analysis of an institutions interest rate gap, which is the difference between the repricing of interest-earning assets and interest-bearing liabilities during a given period of time, is a standard tool for
the measurement of exposure to interest rate risk. The following table sets forth the amounts of our interest-earning assets and interest-bearing liabilities outstanding at December 31, 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 and negotiable order of withdrawal or other transaction accounts are assumed to be subject to immediate repricing and depositor
availability and have been placed in the shortest period. In making the gap computations, none of the assumptions sometimes made regarding prepayment rates and deposit decay rates have been used for any interest-earning assets or interest-bearing
liabilities. In addition, the table does not reflect scheduled principal payments that will be received throughout the lives of the loans. The interest rate sensitivity of our assets and liabilities illustrated in the following table would vary
substantially if different assumptions were used or if actual experience differs from that indicated by such assumptions.



13



---

##### Table of Contents

|                                                                                   |  |                                         |         |    |                            |   |         |                        |  |   |                |    |  |       |         |   |  |   |         |  
|---------------------------------------------------------------------------------- |  | --------------------------------------- | ------- | -- | -------------------------- | - | ------- | ---------------------- |  | - | -------------- | -- |  | ----- | ------- | - |  | - | ------- | -
|                                                                                   |  | Terms to Repricing at December 31, 2004 |        
|                                                                                   |  | 3 Months or Less                        |         |    | Over 3 Months to 12 Months |   |         | Total Within 12 Months |  |   | Over 12 Months |    |  | Total |        
|                                                                                   |  | (Dollars in thousands)                  |        
|Interest-earning assets:                                                           |  |                                         |         |    |                            |   |         |                        |  |   |                |    |  |       |         |   |  |   |         |  
|Loans                                                                              |  | $                                       | 124,094 |    |                            | $ | 18,403  |                        |  | $ | 142,497        |    |  | $     | 102,123 |   |  | $ | 244,620 |  
|Securities available for sale                                                      |  |                                         | 5,495   |    |                            |   | 5,981   |                        |  |   | 11,476         |    |  |       | 23,895  |   |  |   | 35,371  |  
|Other earning assets                                                               |  |                                         | 20,733  |    |                            |   |        |                        |  |   | 20,733         |    |  |       |        |   |  |   | 20,733  |  
|                                                                                   |  |                                         |         |    |                            |   |         |                        |  |   |                |    |  |       |         |   |  |   |         |  
|Total interest-earning assets                                                      |  | $                                       | 150,322 |    |                            | $ | 24,384  |                        |  | $ | 174,706        |    |  | $     | 126,018 |   |  | $ | 300,724 |  
|                                                                                   |  |                                         |         |    |                            |   |         |                        |  |   |                |    |  |       |         |   |  |   |         |  
|Percent of total interest-earning assets                                           |  |                                         | 49.99   | %  |                            |   | 8.11    | %                      |  |   | 58.10          | %  |  |       | 41.90   | % |  |   | 100.00  | %
|Cumulative percent of total interest-earning assets                                |  |                                         | 49.99   | %  |                            |   | 58.10   | %                      |  |   | 58.10          | %  |  |       | 100.00  | % |  |   | 100.00  | %
|                                                                                   |  |                                         |         |    |                           
|Interest-bearing liabilities:                                                      |  |                                         |         |    |                            |   |         |                        |  |   |                |    |  |       |         |   |  |   |         |  
|Deposits:                                                                          |  |                                         |         |    |                            |   |         |                        |  |   |                |    |  |       |         |   |  |   |         |  
|Savings, money market, and NOW deposits                                            |  | $                                       | 113,687 |    |                            | $ |        |                        |  | $ | 113,687        |    |  | $     |        |   |  | $ | 113,687 |  
|Time deposits                                                                      |  |                                         | 23,604  |    |                            |   | 35,945  |                        |  |   | 59,549         |    |  |       | 22,149  |   |  |   | 81,698  |  
|Borrowings:                                                                        |  |                                         |         |    |                            |   |         |                        |  |   |                |    |  |       |         |   |  |   |         |  
|Short-term borrowings                                                              |  |                                         | 14,273  |    |                            |   |        |                        |  |   | 14,273         |    |  |       |        |   |  |   | 14,273  |  
|Long-term borrowings                                                               |  |                                         |        |    |                            |   |        |                        |  |   |               |    |  |       | 5,155   |   |  |   | 5,155   |  
|                                                                                   |  |                                         |         |    |                            |   |         |                        |  |   |                |    |  |       |         |   |  |   |         |  
|Total interest-bearing liabilities                                                 |  | $                                       | 151,564 |    |                            | $ | 35,945  |                        |  | $ | 187,509        |    |  | $     | 27,304  |   |  | $ | 214,658 |  
|                                                                                   |  |                                         |         |    |                            |   |         |                        |  |   |                |    |  |       |         |   |  |   |         |  
|Percent of total interest-bearing liabilities                                      |  |                                         | 70.56   | %  |                            |   | 16.73   | %                      |  |   | 87.29          | %  |  |       | 12.71   | % |  |   | 100.00  | %
|Cumulative percent of total interest-bearing liabilities                           |  |                                         | 70.56   | %  |                            |   | 87.29   | %                      |  |   | 87.29          | %  |  |       | 100.00  | % |  |   | 100.00  | %
|Interest sensitivity gap per period                                                |  | $                                       | (1,242  | )  |                            | $ | (11,561 | )                      |  | $ | (12,803        | )  |  | $     | 98,714  |   |  | $ | 85,911  |  
|Cumulative interest sensitivity gap                                                |  |                                         | (1,242  | )  |                            |   | (12,803 | )                      |  |   | (12,803        | )  |  |       | 85,911  |   |  |   | 85,911  |  
|Cumulative gap as a percentage of total interest-earning assets                    |  |                                         | (-0.41  | )% |                            |   | (-4.26  | )%                     |  |   | (-4.26         | )% |  |       | 28.57   | % |  |   | 28.57   | %
|Cumulative interest-earning assets as a percentage of interest-bearing liabilities |  |                                         | 99.18   | %  |                            |   | 93.17   | %                      |  |   | 93.17          | %  |  |       | 139.99  | % |  |   | 139.99  | %



Capital



A significant measure of the strength of a financial institution is its
capital base. Federal bank regulators have classified capital into the following components: (1) Tier I capital, which includes common shareholders equity (excluding accumulated other comprehensive income) and qualifying preferred equity, and
(2) Tier II capital, which includes a portion of the allowance for loan losses, certain qualifying long-term debt and preferred stock that does not qualify as Tier I capital. Minimum capital levels are regulated by risk-based capital adequacy
guidelines, which require a financial institution to maintain capital as a percentage of its risk-adjusted assets, which are the institutions assets and certain off-balance sheet items adjusted for predefined credit risk factors. A financial
institution is required to maintain, at a minimum, Tier I capital as a percentage of risk-adjusted assets of 4.0% and combined Tier I and Tier II capital as a percentage of risk-adjusted assets of 8.0%. In addition to the risk-based guidelines,
federal regulations require a financial institution to maintain a minimum leverage ratio (Tier I capital as a percentage of tangible assets) of 4.0%. Our banks equity to assets ratio was 7.66% at December 31, 2004. As the following table
indicates, at December 31, 2004 we exceeded our regulatory capital requirements.



14



---

##### Table of Contents

|                                |  |                      |   |  |                     |   |  |                              |  
|------------------------------- |  | -------------------- | - |  | ------------------- | - |  | ---------------------------- | -
|                                |  | At December 31, 2004 |  
|                                |  | Actual Ratio         |   |  | Minimum Requirement |   |  | Well-Capitalized Requirement |  
|Total risk-based capital ratio  |  | 11.01                | % |  | 8.00                | % |  | 10.00                        | %
|Tier 1 risk-based capital ratio |  | 9.76                 | % |  | 4.00                | % |  | 6.00                         | %
|Leverage ratio                  |  | 7.94                 | % |  | 4.00                | % |  | 5.00                         | %



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



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



Our trust preferred securities presently qualify as Tier 1 regulatory capital and are reported in Federal Reserve regulatory reports as a minority interest in a consolidated subsidiary. The Federal Accounting
Standards Board adopted in 2003 a rule, FASB Interpretation No. 46, that requires trust preferred securities be deconsolidated from our financial statements for the year ended December 31, 2004. On July 2, 2003, the Board of Governors of the Federal
Reserve issued a letter, SR 03-13, stating that notwithstanding FIN 46, trust preferred securities will continue to be included in Tier 1 capital until notice is given to the contrary. There can be no assurance that the Federal Reserve will continue
to allow institutions to include trust preferred securities in Tier 1 capital for regulatory capital purposes. In the event of a disallowance, there would be a reduction in our consolidated capital ratios.



Loan Portfolio



We make loans primarily to professional firms, small and medium size businesses, churches and individuals. These loans
consist of commercial and consumer real estate loans, business loans and loans to individuals. Our total loan portfolio grew by 34.8% between December 31, 2003 and December 31, 2004. We attribute this growth to our focus on relationship banking, our
experienced loan officers and the vibrant Raleigh/Durham metropolitan statistical area market.



Real estate construction and land development loans comprised 14.7% and real estate loans secured by one-to-four family residential properties comprised 13.2% of our total loan portfolio at December 31, 2004. These
loans increased 36.7% and 39.5%, respectively, between December 31, 2003 and December 31, 2004. Other commercial loans secured by real estate comprised 71.1% of our total loan portfolio and are principally secured by owner-occupied buildings
including professional practice, office, flex, retail and church properties. Properties securing these loans are located primarily within our market of Wake County, North Carolina. These loans typically have interest rates that are initially fixed
for one to seven years with the remainder of the loan term subject to repricing based on various market indices. We typically require an early payout penalty on fixed-rate commercial real estate term loans in order to reduce the negative effect of
refinancing activity within the portfolio during a declining interest rate environment.



Home equity loans, the predominate type of consumer loan in our portfolio, increased by 22.0% between December 31, 2003 and December 31, 2004 and comprised 5.4% of our total loan portfolio at that date. These loans
are typically secured by the primary residence of the borrower and the combined loan-to-value ratio is 90% or less.



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



15



---

##### Table of Contents

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



|                                     |  |                 |         |   |                  |        |   |        |   |         |                  |  |        |                        |  |   |                  |   |  |        |   |  |                  |        |   |        |        |   |                  |   |        |   |  |        |  
|------------------------------------ |  | --------------- | ------- | - | ---------------- | ------ | - | ------ | - | ------- | ---------------- |  | ------ | ---------------------- |  | - | ---------------- | - |  | ------ | - |  | ---------------- | ------ | - | ------ | ------ | - | ---------------- | - | ------ | - |  | ------ | -
|                                     |  | At December 31, |        
|                                     |  | 2004            |         |   | 2003             |        |   | 2002   |   |         | 2001             |  |        | 2000                   | 
|                                     |  | Amount          |         |   | % of Total Loans |        |   | Amount |   |         | % of Total Loans |  |        | Amount                 |  |   | % of Total Loans |   |  | Amount |   |  | % of Total Loans |        |   | Amount |        |   | % of Total Loans |  
|                                     |  |                 |         |   |                  |        |   |        |   |         |                  |  |        | (Dollars in thousands) |  |   |                  |   |  |        |   |  |                  |        |   |        |       
|Commercial                           |  | $               | 174,107 |   |                  | 71.13  | % |        | $ | 137,385 |                  |  | 75.64  | %                      |  | $ | 89,501           |   |  | 75.38  | % |  | $                | 60,314 |   |        | 71.56  | % |                  | $ | 24,775 |   |  | 73.88  | %
|Real Estate  construction           |  |                 | 35,987  |   |                  | 14.70  | % |        |   | 19,162  |                  |  | 10.55  | %                      |  |   | 12,753           |   |  | 10.74  | % |  |                  | 11,290 |   |        | 13.39  | % |                  |   | 2,638  |   |  | 7.87   | %
|Real estate  1 to 4 family mortgage |  |                 | 19,170  |   |                  | 7.83   | % |        |   | 12,392  |                  |  | 6.82   | %                      |  |   | 6,433            |   |  | 5.42   | % |  |                  | 4,868  |   |        | 5.77   | % |                  |   | 3,105  |   |  | 9.26   | %
|Loans to individuals                 |  |                 | 2,359   |   |                  | 0.95   | % |        |   | 1,897   |                  |  | 1.04   | %                      |  |   | 1,891            |   |  | 1.59   | % |  |                  | 1,822  |   |        | 2.16   | % |                  |   | 1,136  |   |  | 3.39   | %
|Home equity lines of credit          |  |                 | 13,189  |   |                  | 5.39   | % |        |   | 10,807  |                  |  | 5.95   | %                      |  |   | 8,160            |   |  | 6.87   | % |  |                  | 6,003  |   |        | 7.12   | % |                  |   | 1,878  |   |  | 5.60   | %
|                                     |  |                 |         |   |                  |        |   |        |   |         |                  |  |        |                        |  |   |                  |   |  |        |   |  |                  |        |   |        |        |   |                  |   |        |   |  |        |  
|Loans, gross                         |  |                 | 244,812 |   |                  | 100.00 |   |        |   | 181,643 |                  |  | 100.00 |                        |  |   | 118,738          |   |  | 100.00 |   |  |                  | 84,297 |   |        | 100.00 |   |                  |   | 33,532 |   |  | 100.00 |  
|Unamortized net deferred loan fees   |  |                 | (192    | ) |                  |        |   |        |   | (111    | )                |  |        |                        |  |   | (85              | ) |  |        |   |  |                  | (41    | ) |        |        |   |                  |   | (6     | ) |  |        |  
|                                     |  |                 |         |   |                  |        |   |        |   |         |                  |  |        |                        |  |   |                  |   |  |        |   |  |                  |        |   |        |        |   |                  |   |        |   |  |        |  
|Total loans, net                     |  | $               | 244,620 |   |                  |        |   |        | $ | 181,532 |                  |  |        |                        |  | $ | 118,653          |   |  |        |   |  | $                | 84,256 |   |        |        |   |                  | $ | 33,526 |   |  |        |  
|                                     |  |                 |         |   |                  |        |   |        |   |         |                  |  |        |                        |  |   |                  |   |  |        |   |  |                  |        |   |        |        |   |                  |   |        |   |  |        |  



16



---

##### Table of Contents

The table below presents as of December 31, 2004 (i) the aggregate maturities of loans in the named
categories of our loan portfolio and (ii) the aggregate amounts of such loans, by variable and fixed rates.



|                                     |  |                        |        |       |                                         |   |        |                      |         |  |       |        |  |       |        |  |        |   |       |   |         |  |      |  
|------------------------------------ |  | ---------------------- | ------ | ----- | --------------------------------------- | - | ------ | -------------------- | ------- |  | ----- | ------ |  | ----- | ------ |  | ------ | - | ----- | - | ------- |  | ---- | -
|                                     |  | At December 31, 2004   |       
|                                     |  | Due with oneyear       |        |       | Due after one year but within fiveyears |   |        | Due after five years |         |  | Total |       
|                                     |  | Amount                 |        | Yield |                                         |   | Amount |                      | Yield   |  |       | Amount |  | Yield |        |  | Amount |   | Yield |  
|                                     |  | (Dollars in thousands) |       
|Variable rate loans                  |  |                        |        |       |                                         |   |        |                      |         |  |       |        |  |       |        |  |        |   |       |   |         |  |      |  
|Real Estate - construction           |  | $                      | 20,186 |       | 5.57                                    | % |        | $                    | 3,836   |  | 5.45  | %      |  | $     | 318    |  | 4.62   | % |       | $ | 24,340  |  | 5.54 | %
|Commercial and industrial loans      |  |                        | 32,558 |       | 5.48                                    | % |        |                      | 34,598  |  | 5.33  | %      |  |       | 13,881 |  | 5.05   | % |       |   | 81,037  |  | 5.34 | %
|Real estate  1 to 4 family mortgage |  |                        | 2,057  |       | 5.49                                    | % |        |                      |        |  | 0.00  | %      |  |       |       |  | 0.00   | % |       |   | 2,057   |  | 5.49 | %
|Installment loans                    |  |                        | 70     |       | 5.14                                    | % |        |                      |        |  | 5.24  | %      |  |       |       |  | 5.62   | % |       |   | 70      |  | 5.14 | %
|Equity Lines                         |  |                        | 358    |       | 6.28                                    | % |        |                      | 12,040  |  | 5.10  | %      |  |       | 791    |  | 4.80   | % |       |   | 13,189  |  | 5.11 | %
|                                     |  |                        |        |       |                                         |   |        |                      |         |  |       |        |  |       |        |  |        |   |       |   |         |  |      |  
|Total at variable rates              |  |                        | 55,229 |       | 5.52                                    | % |        |                      | 50,474  |  | 5.28  | %      |  |       | 14,990 |  | 5.03   | % |       |   | 120,693 |  | 5.36 | %
|                                     |  |                        |        |       |                                         |   |        |                      |         |  |       |        |  |       |        |  |        |   |       |   |         |  |      |  
|Fixed rate loans:                    |  |                        |        |       |                                         |   |        |                      |         |  |       |        |  |       |        |  |        |   |       |   |         |  |      |  
|Real estate  construction           |  |                        | 1,005  |       | 6.03                                    | % |        |                      | 3,520   |  | 6.00  | %      |  |       | 4,507  |  | 5.32   | % |       |   | 9,032   |  | 5.66 | %
|Real estate  1 to 4 family mortgage |  |                        | 2,350  |       | 5.55                                    | % |        |                      | 6,078   |  | 5.64  | %      |  |       | 8,008  |  | 5.58   | % |       |   | 16,436  |  | 5.60 | %
|Commercial and industrial loans      |  |                        | 11,272 |       | 5.81                                    | % |        |                      | 52,688  |  | 5.80  | %      |  |       | 32,141 |  | 5.77   | % |       |   | 96,101  |  | 5.79 | %
|Installment loans                    |  |                        | 645    |       | 7.04                                    | % |        |                      | 1,630   |  | 6.50  | %      |  |       | 15     |  | 9.99   | % |       |   | 2,289   |  | 6.67 | %
|Equity lines                         |  |                        |       |       | 0.00                                    | % |        |                      |        |  | 0.00  | %      |  |       |       |  | 0.00   | % |       |   |        |  | 0.00 | %
|                                     |  |                        |        |       |                                         |   |        |                      |         |  |       |        |  |       |        |  |        |   |       |   |         |  |      |  
|Total at fixed rates                 |  |                        | 15,272 |       | 5.83                                    | % |        |                      | 63,916  |  | 5.81  | %      |  |       | 44,671 |  | 5.69   | % |       |   | 123,858 |  | 5.77 | %
|                                     |  |                        |        |       |                                         |   |        |                      |         |  |       |        |  |       |        |  |        |   |       |   |         |  |      |  
|Subtotal                             |  |                        | 70,501 |       | 5.59                                    | % |        |                      | 114,390 |  | 5.58  | %      |  |       | 59,661 |  | 5.53   | % |       |   | 244,552 |  | 5.57 | %
|Nonaccrual loans                     |  |                        | 260    |       |                                         |   |        |                      |        |  |       |        |  |       |       |  |        |   |       |   | 260     |  |      |  
|                                     |  |                        |        |       |                                         |   |        |                      |         |  |       |        |  |       |        |  |        |   |       |   |         |  |      |  
|Loans, gross                         |  | $                      | 70,761 |       |                                         |   |        | $                    | 114,390 |  |       |        |  | $     | 59,661 |  |        |   |       | $ | 244,812 |  |      |  
|                                     |  |                        |        |       |                                         |   |        |                      |         |  |       |        |  |       |        |  |        |   |       |   |         |  |      |  



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



Asset Quality and the Allowance For Loan Losses



We prepare our consolidated financial statements on the accrual basis of accounting, including the recognition of interest income on our loan portfolio,
unless a loan is placed on a nonaccrual basis. We place loans on a nonaccrual basis when we have serious doubts about the collectibility of principal or interest. Amounts received on non-accrual loans generally are applied first to principal and
then to interest only after all principal has been collected. Restructured loans are those for which concessions, including the reduction of interest rates below a rate otherwise available to that borrower or the deferral of interest or principal,
have been granted due to the borrowers weakened financial condition. Interest on restructured loans is accrued at the restructured rates when it is anticipated that no loss of original principal will occur. At December 31, 2004, we had
$260,000 of nonaccrual loans, no accruing loans that were past due 90 days or more, and no restructured loans. Our nonaccrual loans consisted of one credit that is secured by a residential property. We believe we are adequately secured and have
listed the property for sale. We recorded $5,991 in gross interest income on this loan in fiscal 2004. Had this non-accrual loan been current and outstanding during the full year ended December 31, 2004, we would have recorded an additional $10,529
in gross interest income on such loan.



17



---

##### Table of Contents

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



|                                                    |  |                        |         |   |      |   |        |      |  |   |         |   |  |      |         |   |  |   |      |  
|--------------------------------------------------- |  | ---------------------- | ------- | - | ---- | - | ------ | ---- |  | - | ------- | - |  | ---- | ------- | - |  | - | ---- | -
|                                                    |  | At December 31,        |        
|                                                    |  | 2004                   |         |   | 2003 |   |        | 2002 |  |   | 2001    |   |  | 2000 |        
|                                                    |  | (Dollars in thousands) |        
|Nonaccrual loans                                    |  | $                      | 260     |   |      | $ | 1,002  |      |  | $ | 111     |   |  | $    | 25      |   |  | $ |     |  
|Restructured loans                                  |  |                        |        |   |      |   |       |      |  |   |        |   |  |      |        |   |  |   |     |  
|                                                    |  |                        |         |   |      |   |        |      |  |   |         |   |  |      |         |   |  |   |      |  
|Total nonperforming loans                           |  |                        | 260     |   |      |   | 1,002  |      |  |   | 111     |   |  |      | 25      |   |  |   |     |  
|                                                    |  |                        |         |   |     
|Other real estate owned                             |  |                        | 520     |   |      |   |       |      |  |   |        |   |  |      |        |   |  |   |     |  
|                                                    |  |                        |         |   |      |   |        |      |  |   |         |   |  |      |         |   |  |   |      |  
|Total nonperforming assets                          |  | $                      | 780     |   |      | $ | 1,002  |      |  | $ | 111     |   |  | $    | 25      |   |  | $ |     |  
|                                                    |  |                        |         |   |      |   |        |      |  |   |         |   |  |      |         |   |  |   |      |  
|Accruing loans past due 90 days or more             |  | $                      | 46      |   |      | $ |       |      |  | $ | 191     |   |  | $    |        |   |  | $ |     |  
|Allowance for loan losses                           |  |                        | 3,053   |   |      |   | 2,360  |      |  |   | 1,845   |   |  |      | 587     |   |  |   | 587  |  
|Nonperforming loans to period end loans             |  |                        | 0.11    | % |      |   | 0.55   | %    |  |   | 0.09    | % |  |      | 0.03    | % |  |   | 0.00 | %
|Allowance for loan losses to period end loans       |  |                        | 1.25    | % |      |   | 1.30   | %    |  |   | 1.55    | % |  |      | 1.57    | % |  |   | 1.75 | %
|Nonperforming assets to loans and other real estate |  |                        | 0.32    | % |      |   | 0.55   | %    |  |   | 0.09    | % |  |      | 0.03    | % |  |   | 0.00 | %
|Nonperforming assets to total assets                |  |                        | 0.25    | % |      |   | 0.40   | %    |  |   | 0.06    | % |  |      | 0.02    | % |  |   | 0.00 | %
|Allowance for loan losses to nonperforming loans    |  |                        | 1174.23 | % |      |   | 235.53 | %    |  |   | 1662.16 | % |  |      | 5292.00 | % |  |   | 0.00 | %



Our allowance for loan
losses is maintained at a level that our management considers adequate to provide for probable loan losses based on our assessment of various factors affecting our loan portfolio, including a review of problem loans, business conditions and loss
experience and an overall evaluation of the quality of the underlying collateral. The allowance is increased by provisions charged to operations and reduced by loans charged off, net of recoveries. Because of the seasoning of our loan portfolio and
our historically low loan loss experience and reduction in nonperforming loans, in 2004 we reduced our allowance for loan losses as a percentage of total loans from 1.30% to 1.25%. While we believe that our management uses the best information
available to determine the allowance for loan losses, unforeseen market conditions could result in adjustments to the allowance for loan losses, and net income could be significantly affected, if circumstances differ substantially from the
assumptions used in making the final determination. Because these factors and managements assumptions are subject to change, the allocation is not necessarily indicative of future loan portfolio performance. Additional information regarding
our allowance for loan losses and loan loss experience is presented in Note E to our consolidated financial statements included in this report.



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



|                            |  |                        |       |                      |        |   |        |      |                      |  |        |        |  |                      |       |  |        |   |                      |   |       |        |        |                      |  |   |     |  |        |  
|--------------------------- |  | ---------------------- | ----- | -------------------- | ------ | - | ------ | ---- | -------------------- |  | ------ | ------ |  | -------------------- | ----- |  | ------ | - | -------------------- | - | ----- | ------ | ------ | -------------------- |  | - | --- |  | ------ | -
|                            |  | 2004                   |       |                      | 2003   |   |        | 2002 |                      |  | 2001   |        |  | 2000                 |      
|                            |  | Amount                 |       | % of Total Loans (1) |        |   | Amount |      | % of Total Loans (1) |  |        | Amount |  | % of Total Loans (1) |       |  | Amount |   | % of Total Loans (1) |   |       | Amount |        | % of Total Loans (1) | 
|                            |  | (Dollars in thousands) |      
|Real estate loans:          |  |                        |       |                      |        |   |        |      |                      |  |        |        |  |                      |       |  |        |   |                      |   |       |        |        |                      |  |   |     |  |        |  
|Commercial                  |  | $                      | 2,041 |                      | 71.13  | % |        | $    | 1,794                |  | 75.64  | %      |  | $                    | 1,436 |  | 75.38  | % |                      | $ | 905   |        | 71.56  | %                    |  | $ | 372 |  | 73.88  | %
|Real estate - construction  |  |                        | 422   |                      | 14.70  | % |        |      | 259                  |  | 10.55  | %      |  |                      | 120   |  | 10.74  | % |                      |   | 152   |        | 13.39  | %                    |  |   | 36  |  | 7.87   | %
|Real estate - 1 to 4 family |  |                        | 225   |                      | 7.83   | % |        |      | 71                   |  | 6.82   | %      |  |                      | 86    |  | 5.42   | % |                      |   | 37    |        | 5.77   | %                    |  |   | 23  |  | 9.26   | %
|Loans to individuals        |  |                        | 27    |                      | 0.96   | % |        |      | 22                   |  | 1.04   | %      |  |                      | 17    |  | 1.59   | % |                      |   | 27    |        | 2.16   | %                    |  |   | 17  |  | 3.39   | %
|Home equity lines of credit |  |                        | 155   |                      | 5.38   | % |        |      | 71                   |  | 5.94   | %      |  |                      | 57    |  | 6.87   | % |                      |   | 39    |        | 7.12   | %                    |  |   | 12  |  | 5.60   | %
|                            |  |                        |       |                      |        |   |        |      |                      |  |        |        |  |                      |       |  |        |   |                      |   |       |        |        |                      |  |   |     |  |        |  
|Total allocated             |  |                        | 2,870 |                      | 100.00 | % |        |      | 2,217                |  | 100.00 | %      |  |                      | 1,716 |  | 100.00 | % |                      |   | 1,160 |        | 100.00 | %                    |  |   | 460 |  | 100.00 | %
|Unallocated                 |  |                        | 183   |                      |        |   |        |      | 143                  |  |        |        |  |                      | 129   |  |        |   |                      |   | 163   |        |        |                      |  |   | 127 |  |        |  
|                            |  |                        |       |                      |        |   |        |      |                      |  |        |        |  |                      |       |  |        |   |                      |   |       |        |        |                      |  |   |     |  |        |  
|Total                       |  | $                      | 3,053 |                      |        |   |        | $    | 2,360                |  |        |        |  | $                    | 1,845 |  |        |   |                      | $ | 1,323 |        |        |                      |  | $ | 587 |  |        |  
|                            |  |                        |       |                      |        |   |        |      |                      |  |        |        |  |                      |       |  |        |   |                      |   |       |        |        |                      |  |   |     |  |        |  

---

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



18



---

##### Table of Contents

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



|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |        |   |  |   |        |  
|-------------------------------------------------------------- |  | ------------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | - |  | ---- | ------ | - |  | - | ------ | -
|                                                               |  | At or for the Year Ended December 31, |        
|                                                               |  | 2004                                  |         |   | 2003 |   |         | 2002 |  |   | 2001    |   |  | 2000 |       
|                                                               |  | (Dollars in thousands)                |        
|Loans outstanding at the end of the year                       |  | $                                     | 244,620 |   |      | $ | 181,532 |      |  | $ | 118,653 |   |  | $    | 84,256 |   |  | $ | 33,526 |  
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |        |   |  |   |        |  
|Average loans outstanding during the year                      |  | $                                     | 212,205 |   |      | $ | 139,095 |      |  | $ | 100,701 |   |  | $    | 57,581 |   |  | $ | 15,545 |  
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |        |   |  |   |        |  
|Allowance for loan losses at beginning of year                 |  | $                                     | 2,360   |   |      | $ | 1,845   |      |  | $ | 1,323   |   |  | $    | 587    |   |  | $ |       |  
|Provision for loan losses                                      |  |                                       | 920     |   |      |   | 690     |      |  |   | 546     |   |  |      | 836    |   |  |   | 587    |  
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |        |   |  |   |        |  
|                                                               |  |                                       | 3,280   |   |      |   | 2,535   |      |  |   | 1,869   |   |  |      | 1,423  |   |  |   | 587    |  
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |        |   |  |   |        |  
|Loans charged off:                                             |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |        |   |  |   |        |  
|Real estate loans                                              |  |                                       | (82     | ) |      |   | (171    | )    |  |   | (24     | ) |  |      | (100   | ) |  |   |       |  
|Commercial and industrial loans                                |  |                                       | (183    | ) |      |   | (4      | )    |  |   |        |   |  |      |       |   |  |   |       |  
|Installment loans                                              |  |                                       | (13     | ) |      |   |        |      |  |   |        |   |  |      |       |   |  |   |       |  
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |        |   |  |   |        |  
|Total charge-offs                                              |  |                                       | (278    | ) |      |   | (175    | )    |  |   | (24     | ) |  |      | (100   | ) |  |   |       |  
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |        |   |  |   |        |  
|Recoveries of loans previously charged off:                    |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |        |   |  |   |        |  
|Real estate loans                                              |  |                                       |        |   |      |   |        |      |  |   |        |   |  |      |       |   |  |   |       |  
|Commercial and industrial loans                                |  |                                       | 50      |   |      |   |        |      |  |   |        |   |  |      |       |   |  |   |       |  
|Installment loans                                              |  |                                       | 1       |   |      |   |        |      |  |   |        |   |  |      |       |   |  |   |       |  
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |        |   |  |   |        |  
|Total recoveries                                               |  |                                       | 51      |   |      |   |        |      |  |   |        |   |  |      |       |   |  |   |       |  
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |        |   |  |   |        |  
|Net charge-offs                                                |  |                                       | (227    | ) |      |   | (175    | )    |  |   | (24     | ) |  |      | (100   | ) |  |   |       |  
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |        |   |  |   |        |  
|Allowance for loan losses at end of year                       |  | $                                     | 3,053   |   |      | $ | 2,360   |      |  | $ | 1,845   |   |  | $    | 1,323  |   |  | $ | 587    |  
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |        |   |  |   |        |  
|Ratios:                                                        |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |        |   |  |   |        |  
|Nonperforming loans to period-end loans                        |  |                                       | 0.11    | % |      |   | 0.55    | %    |  |   | 0.09    | % |  |      | 0.03   | % |  |   | 0.00   | %
|Allowance for loan losses as a percent of loans at end of year |  |                                       | 1.25    | % |      |   | 1.30    | %    |  |   | 1.55    | % |  |      | 1.57   | % |  |   | 1.75   | %
|Net charge-offs as a percentage of average loans               |  |                                       | 0.11    | % |      |   | 0.13    | %    |  |   | 0.02    | % |  |      | 0.17   | % |  |   | 0.00   | %



19



---

##### Table of Contents

Deposits



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



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



|                                |  |                                 |         |              |      |   |                |      |              |  |      |                |  |              |         |  |      |  
|------------------------------- |  | ------------------------------- | ------- | ------------ | ---- | - | -------------- | ---- | ------------ |  | ---- | -------------- |  | ------------ | ------- |  | ---- | -
|                                |  | For the Year Ended December 31, |        
|                                |  | 2004                            |         |              | 2003 |   |                | 2002 |             
|                                |  | Average Amount                  |         | Average Rate |      |   | Average Amount |      | Average Rate |  |      | Average Amount |  | Average Rate |        
|                                |  | (Dollars in thousands)          |        
|Savings, NOW and money market   |  | $                               | 98,714  |              | 1.55 | % |                | $    | 63,363       |  | 1.53 | %              |  | $            | 42,867  |  | 2.11 | %
|Time deposits over $100,000     |  |                                 | 28,651  |              | 2.96 | % |                |      | 25,605       |  | 3.19 | %              |  |              | 19,638  |  | 4.08 | %
|Other time deposits             |  |                                 | 45,573  |              | 2.59 | % |                |      | 38,819       |  | 2.93 | %              |  |              | 27,810  |  | 3.97 | %
|                                |  |                                 |         |              |      |   |                |      |              |  |      |                |  |              |         |  |      |  
|Total interest-bearing deposits |  |                                 | 172,938 |              | 2.06 | % |                |      | 127,787      |  | 2.29 | %              |  |              | 90,315  |  | 3.11 | %
|Non-interest-bearing deposits   |  |                                 | 57,327  |              |     |   |                |      | 52,186       |  |     |                |  |              | 38,287  |  |     |  
|                                |  |                                 |         |              |      |   |                |      |              |  |      |                |  |              |         |  |      |  
|Total deposits                  |  | $                               | 230,265 |              | 1.55 | % |                | $    | 179,973      |  | 1.63 | %              |  | $            | 128,602 |  | 2.18 | %
|                                |  |                                 |         |              |      |   |                |      |              |  |      |                |  |              |         |  |      |  



The following table
presents the amounts and maturities of deposits with balances of $100,000 or more at December 31, 2004:



|                       |  |                      |       
|---------------------- |  | -------------------- | ------
|                       |  | At December 31, 2004
|                       |  | (In thousands)      
|Remaining maturity:    |  |                      |       
|Less than three months |  | $                    | 7,706 
|Three to six months    |  |                      | 5,840 
|Six to twelve months   |  |                      | 4,114 
|Over twelve months     |  |                      | 11,540
|                       |  |                      |       
|Total                  |  | $                    | 29,200
|                       |  |                      |       



Borrowings



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



|                                                              |  |                                 |        |   |      |   |        |      |  |   |       |  
|------------------------------------------------------------- |  | ------------------------------- | ------ | - | ---- | - | ------ | ---- |  | - | ----- | -
|                                                              |  | For the Year Ended December 31, |       
|                                                              |  | 2004                            |        |   | 2003 |   |        | 2002 | 
|                                                              |  | (In thousands)                  |       
|Short-term borrowings:                                        |  |                                 |        |   |      |   |        |      |  |   |       |  
|Repurchase agreements and federal funds purchased             |  |                                 |        |   |      |   |        |      |  |   |       |  
|Balance outstanding at end of period                          |  | $                               | 8,273  |   |      | $ | 15,911 |      |  | $ | 4,892 |  
|Maximum amount outstanding at any month end during the period |  |                                 | 16,184 |   |      |   | 15,911 |      |  |   | 5,898 |  
|Average balance outstanding                                   |  |                                 | 12,005 |   |      |   | 6,992  |      |  |   | 4,815 |  
|Weighted-average interest rate during the period              |  |                                 | 1.96   | % |      |   | 0.90   | %    |  |   | 1.31  | %
|Weighted-average interest rate at end of period               |  |                                 | 1.66   | % |      |   | 1.25   | %    |  |   | 1.20  | %



Investments



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



20



---

##### Table of Contents

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



|                                                                          |  |                        |        |                        |   |                         |  |            |     |  |   |       
|------------------------------------------------------------------------- |  | ---------------------- | ------ | ---------------------- | - | ----------------------- |  | ---------- | --- |  | - | ------
|                                                                          |  | At December 31, 2004  
|                                                                          |  | Amortized cost         |        | Gross Unrealized gains |   | Gross unrealized losses |  | Fair value
|                                                                          |  | (Dollars in thousands)
|Securities available for sale:                                            |  |                        |        |                        |   |                         |  |            |     |  |   |       
|U. S. government securities and obligations of U.S. governmental agencies |  | $                      | 11,955 |                        | $ | 2                       |  | $          | 95  |  | $ | 11,862
|State and municipal securities                                            |  |                        | 2,472  |                        |   | 2                       |  |            |    |  |   | 2,474 
|Mortgage-backed securities                                                |  |                        | 21,259 |                        |   | 32                      |  |            | 256 |  |   | 21,035
|                                                                          |  |                        |        |                        |   |                         |  |            |     |  |   |       
|Total securities available for sale                                       |  | $                      | 35,686 |                        | $ | 36                      |  | $          | 351 |  | $ | 35,371
|                                                                          |  |                        |        |                        |   |                         |  |            |     |  |   |       
|                                                                          | 
|                                                                          |  | At December 31, 2003  
|                                                                          |  | Amortized cost         |        | Gross unrealized gains |   | Gross unrealized losses |  | Fair value
|                                                                          |  | (Dollars in thousands)
|Securities available for sale:                                            |  |                        |        |                        |   |                         |  |            |     |  |   |       
|U. S. government treasury                                                 |  | $                      | 989    |                        | $ | 2                       |  | $          |    |  | $ | 991   
|U. S. government securities and obligations of U.S. governmental agencies |  |                        | 13,288 |                        |   | 44                      |  |            | 45  |  |   | 13,287
|State and municipal securities                                            |  |                        | 2,000  |                        |   |                        |  |            |    |  |   | 2,000 
|Mortgage-backed securities                                                |  |                        | 25,887 |                        |   | 132                     |  |            | 415 |  |   | 25,604
|                                                                          |  |                        |        |                        |   |                         |  |            |     |  |   |       
|Total securities available for sale                                       |  | $                      | 42,164 |                        | $ | 178                     |  | $          | 460 |  | $ | 41,882
|                                                                          |  |                        |        |                        |   |                         |  |            |     |  |   |       



21



---

##### Table of Contents

The amortized cost and fair values of securities available for sale at December 31, 2004 by contractual
maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.



|                                                |  |                        |        |            |   |                         |  |      |  
|----------------------------------------------- |  | ---------------------- | ------ | ---------- | - | ----------------------- |  | ---- | -
|                                                |  | Amortized Cost         |        | Fair Value |   | Weighted Average/ Yield | 
|                                                |  | (Dollars in thousands) |       
|Securities available for sale:                  |  |                        |        |            |   |                         |  |      |  
|                                                |  |                        |       
|U.S. government agencies                        |  |                        |        |            |   |                         |  |      |  
|Due within one year                             |  | $                      | 6,522  |            | $ | 6,484                   |  | 1.90 | %
|Due after one but within five years             |  |                        | 5,433  |            |   | 5,378                   |  | 2.36 | %
|                                                |  |                        | 11,955 |            |   | 11,862                  |  | 2.11 | %
|                                                |  |                        |        |            |   |                         |  |      |  
|State and local governments Due after ten years |  |                        | 2,472  |            |   | 2,474                   |  | 1.50 | %
|                                                |  |                        |        |            |   |                         |  |      |  
|Mortgage-backed securities                      |  |                        |        |            |   |                         |  |      |  
|Due within one year                             |  |                        |       |            |   |                        |  | 0.00 | %
|Due after one but within five years             |  |                        | 1,783  |            |   | 1,811                   |  | 3.72 | %
|Due after five but within ten years             |  |                        | 998    |            |   | 972                     |  | 2.53 | %
|Due after ten years                             |  |                        | 18,478 |            |   | 18,252                  |  | 3.28 | %
|                                                |  |                        |        |            |   |                         |  |      |  
|                                                |  |                        | 21,259 |            |   | 21,035                  |  | 3.28 | %
|                                                |  |                        |        |            |   |                         |  |      |  
|Total securities available for sale             |  |                        |        |            |   |                         |  |      |  
|Due within one year                             |  |                        | 6,522  |            |   | 6,484                   |  | 1.90 | %
|Due after one but within five years             |  |                        | 7,216  |            |   | 7,189                   |  | 2.70 | %
|Due after five but within ten years             |  |                        | 998    |            |   | 972                     |  | 2.53 | %
|Due after ten years                             |  |                        | 20,950 |            |   | 20,726                  |  | 3.07 | %
|                                                |  |                        |        |            |   |                         |  |      |  
|                                                |  | $                      | 35,686 |            | $ | 35,371                  |  | 2.77 | %
|                                                |  |                        |        |            |   |                         |  |      |  



22



---

##### Table of Contents

Contractual Obligations and Commitments



In the normal course of business, we have various outstanding contractual obligations that will require future cash
outflows, as well as commitments and contingent liabilities, such as commitments to extend credit, that may or may not require future cash outflows. To meet the financing needs of our customers, we issue various financial instruments, such as lines
of credit, loan commitments and standby letters of credit. These instruments either are not recorded on our balance sheet or are recorded on our balance sheet in amounts that differ from the full contract or notional amounts. These instruments
involve varying elements of market, credit and liquidity risk. See Note L to our consolidated financial statements for more information regarding these commitments and contingent liabilities.



Off-Balance Sheet Arrangements



As part of our ongoing business, we do not participate in transactions that
generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as special purpose entities, or SPEs, which generally are established for the purpose of facilitating off-balance sheet arrangements or
other contractually narrow or limited purposes. As of December 31, 2004, we were not involved in any unconsolidated SPE transactions.



Recent Accounting Pronouncements



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



Critical Accounting Policy



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



Item 7.Financial Statements and Supplementary Data.



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



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



Not applicable.



Item 8A.Controls and Procedures.



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



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



Item 8B.Other Information.



Not applicable.



23



---

##### Table of Contents

PART III



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



The information required by this Item concerning our directors and executive officers is incorporated by reference from the
sections captioned Proposal No. 1 - Election of Directors, Other Information  Other Directors and Executive Officers contained in our proxy statement related to the 2005 Annual Meeting of Shareholders
scheduled to be held on May 10, 2005. The information required by this Item concerning compliance with Section 16(a) of the United States Securities Exchange Act of 1934, as amended, is incorporated by reference from the section of our proxy
statement captioned Section 16(a) Beneficial Ownership Reporting Compliance.



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



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



Since
the date of our proxy statement for our 2004 Annual Meeting of Shareholders, we have not made any material change to the procedures by which our shareholders may recommend nominees to our Board of Directors. Those procedures are discussed under the
section captioned Director Nominations in our proxy statement for the 2005 Annual Meeting of Shareholders.



Item 10.Executive Compensation.



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



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



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



Item 12.Certain Relationships and Related Transactions.



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



24



---

##### Table of Contents

Item 13.Exhibits.



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



|            |  |                                                                                                                                    
|----------- |  | -----------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Exhibit Title                                                                                                                      
|            | 
|3.1 (a)     |  | Articles of Incorporation filed on June 5, 2002                                                                                    
|            | 
|3.2 (a)     |  | Bylaws adopted June 7, 2002                                                                                                        
|            | 
|4.1 (a)     |  | Form of North State Bancorp stock certificate                                                                                      
|            | 
|10.1 (b)    |  | Stock Option Plan for Non-Employee Directors, assumed as of June 28, 2002                                                          
|            | 
|10.2 (b)    |  | Stock Option Plan for Employees, assumed as of June 28, 2002                                                                       
|            | 
|10.3 (c)    |  | Employment Agreement between North State Bank and Larry D. Barbour, dated as of June 1, 2000                                       
|            | 
|10.4 (c)    |  | Change in Control Agreement between North State Bank and Kirk A. Whorf, dated as of June 1, 2000, as amended on October 29, 2002   
|            | 
|10.5 (c)    |  | Change in Control Agreement between North State Bank and Judy M. Stephenson, dated as of June 1, 2000                              
|            | 
|10.6 (c)    |  | Change in Control Agreement between North State Bank and Sandra A. Temple, dated as of June 1, 2000, as amended on October 24, 2002
|            | 
|10.7 (d)    |  | 2003 Stock Plan                                                                                                                    
|            | 
|21.1        |  | List of Subsidiaries                                                                                                               
|            | 
|23          |  | Consent of Dixon Hughes PLLC                                                                                                       
|            | 
|31.1        |  | Certification pursuant to Rule 13a-14(a)                                                                                           
|            | 
|31.2        |  | Certification pursuant to Rule 13a-14(a)                                                                                           
|            | 
|32.1        |  | Certifications pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002             

---

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

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

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

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



Item 14.Principal Accountant Fees and Services.



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



25



---

##### Table of Contents

NORTH STATE BANCORP & SUBSIDIARY

INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS



|                                                                                                          |  |         
|--------------------------------------------------------------------------------------------------------- |  | --------
|                                                                                                          |  | Page No.
|Report of Independent Registered Public Accounting Firm                                                   |  | F-2     
|                                                                                                          | 
|Consolidated Balance Sheets as of December 31, 2004 and 2003                                              |  | F-3     
|                                                                                                          | 
|Consolidated Statements of Operations for the years ended December 31, 2004 and 2003                      |  | F-4     
|                                                                                                          | 
|Consolidated Statements of Changes in Shareholders Equity for the years ended December 31, 2004 and 2003 |  | F-5     
|                                                                                                          | 
|Consolidated Statements of Cash Flows for the years ended December 31, 2004 and 2003                      |  | F-6     
|                                                                                                          | 
|Notes to Consolidated Financial Statements                                                                |  | F-7     



F-1



---

##### Table of Contents

LOGO



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



To the Shareholders and the Board of Directors

North State Bancorp

Raleigh, North Carolina



We have audited the accompanying consolidated balance sheets of North State Bancorp and subsidiary as of December 31, 2004 and 2003, and the related consolidated statements of operations, changes in shareholders
equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our
audits.



We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. 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 North State Bancorp and subsidiary at 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.



LOGO



Sanford, North Carolina

February 22, 2005



F-2



---

##### Table of Contents

NORTH STATE BANCORP

CONSOLIDATED BALANCE SHEETS

December 31, 2004 and 2003



|                                                                                                                                                     |  |                                                        |         |   |      |   |         |  
|---------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------------------------ | ------- | - | ---- | - | ------- | -
|                                                                                                                                                     |  | 2004                                                   |         |   | 2003 |  
|                                                                                                                                                     |  | (Amounts in thousands, exceptshare and per share data) |        
|ASSETS                                                                                                                                               |  |                                                        |         |   |      |   |         |  
|Cash and due from banks                                                                                                                              |  | $                                                      | 4,015   |   |      | $ | 13,028  |  
|Interest-earning deposits with banks (Note H)                                                                                                        |  |                                                        | 1,345   |   |      |   | 768     |  
|Federal funds sold                                                                                                                                   |  |                                                        | 19,388  |   |      |   | 8,683   |  
|Investment securities available for sale, at fair value (Note C)                                                                                     |  |                                                        | 35,371  |   |      |   | 41,882  |  
|                                                                                                                                                     |  |                                                       
|Loans (Notes D and H)                                                                                                                                |  |                                                        | 244,620 |   |      |   | 181,532 |  
|Less allowance for loan losses (Note E)                                                                                                              |  |                                                        | 3,053   |   |      |   | 2,360   |  
|                                                                                                                                                     |  |                                                        |         |   |      |   |         |  
|NET LOANS                                                                                                                                            |  |                                                        | 241,567 |   |      |   | 179,172 |  
|                                                                                                                                                     |  |                                                       
|Accrued interest receivable                                                                                                                          |  |                                                        | 890     |   |      |   | 697     |  
|Stock in the Federal Home Loan Bank of Atlanta, at cost                                                                                              |  |                                                        | 769     |   |      |   | 393     |  
|Premises and equipment (Note F)                                                                                                                      |  |                                                        | 4,244   |   |      |   | 3,419   |  
|Other assets (Note I)                                                                                                                                |  |                                                        | 1,953   |   |      |   | 978     |  
|                                                                                                                                                     |  |                                                        |         |   |      |   |         |  
|TOTAL ASSETS                                                                                                                                         |  | $                                                      | 309,542 |   |      | $ | 249,020 |  
|                                                                                                                                                     |  |                                                        |         |   |      |   |         |  
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                 |  |                                                        |         |   |      |   |         |  
|                                                                                                                                                     |  |                                                       
|Deposits:                                                                                                                                            |  |                                                        |         |   |      |   |         |  
|Demand                                                                                                                                               |  | $                                                      | 73,748  |   |      | $ | 57,107  |  
|Savings, money market and NOW                                                                                                                        |  |                                                        | 113,687 |   |      |   | 86,822  |  
|Time (Note G)                                                                                                                                        |  |                                                        | 81,698  |   |      |   | 64,619  |  
|                                                                                                                                                     |  |                                                        |         |   |      |   |         |  
|TOTAL DEPOSITS                                                                                                                                       |  |                                                        | 269,133 |   |      |   | 208,548 |  
|                                                                                                                                                     |  |                                                       
|Accrued interest payable                                                                                                                             |  |                                                        | 878     |   |      |   | 684     |  
|Short-term borrowings (Note H)                                                                                                                       |  |                                                        | 14,273  |   |      |   | 15,911  |  
|Long-term debt (Note H)                                                                                                                              |  |                                                        | 5,155   |   |      |   | 6,000   |  
|Accrued expenses and other liabilities (Note N)                                                                                                      |  |                                                        | 1,189   |   |      |   | 363     |  
|                                                                                                                                                     |  |                                                        |         |   |      |   |         |  
|TOTAL LIABILITIES                                                                                                                                    |  |                                                        | 290,628 |   |      |   | 231,506 |  
|                                                                                                                                                     |  |                                                        |         |   |      |   |         |  
|Commitments (Notes F and L)                                                                                                                          |  |                                                        |         |   |      |   |         |  
|                                                                                                                                                     |  |                                                       
|Shareholders equity (Notes K and N):                                                                                                                |  |                                                        |         |   |      |   |         |  
|Preferred stock, no par value, 1,000,000 shares authorized, none issued                                                                              |  |                                                        |        |   |      |   |        |  
|Common stock, $1 par value, 10,000,000 shares authorized; 2,366,041 and 2,051,684 issued and outstanding at December 31, 2004 and 2003,
respectively |  |                                                        | 2,366   |   |      |   | 2,052   |  
|Additional paid-in capital                                                                                                                           |  |                                                        | 14,110  |   |      |   | 14,379  |  
|Accumulated earnings                                                                                                                                 |  |                                                        | 2,634   |   |      |   | 1,258   |  
|Accumulated other comprehensive loss                                                                                                                 |  |                                                        | (196    | ) |      |   | (175    | )
|                                                                                                                                                     |  |                                                        |         |   |      |   |         |  
|TOTAL SHAREHOLDERS EQUITY                                                                                                                           |  |                                                        | 18,914  |   |      |   | 17,514  |  
|                                                                                                                                                     |  |                                                        |         |   |      |   |         |  
|TOTAL LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                           |  | $                                                      | 309,542 |   |      | $ | 249,020 |  
|                                                                                                                                                     |  |                                                        |         |   |      |   |         |  



See accompanying notes.



F-3



---

##### Table of Contents

NORTH STATE BANCORP

CONSOLIDATED STATEMENTS OF OPERATIONS

Years Ended December 31, 2004 and 2003



|                                                    |  |                                                        |           |      |   |          
|--------------------------------------------------- |  | ------------------------------------------------------ | --------- | ---- | - | ---------
|                                                    |  | 2004                                                   |           | 2003
|                                                    |  | (Amounts in thousands, exceptshare and per share data)
|INTEREST INCOME                                     |  |                                                        |           |      |   |          
|Loans                                               |  | $                                                      | 11,383    |      | $ | 8,020    
|Investments:                                        |  |                                                        |           |      |   |          
|Taxable                                             |  |                                                        | 1,000     |      |   | 952      
|Tax-exempt                                          |  |                                                        | 18        |      |   | 33       
|Federal funds sold and deposits in other banks      |  |                                                        | 175       |      |   | 181      
|Other                                               |  |                                                        | 23        |      |   | 27       
|                                                    |  |                                                        |           |      |   |          
|TOTAL INTEREST INCOME                               |  |                                                        | 12,599    |      |   | 9,213    
|                                                    |  |                                                        |           |      |   |          
|INTEREST EXPENSE                                    |  |                                                        |           |      |   |          
|Money market, NOW and savings deposits              |  |                                                        | 1,529     |      |   | 970      
|Time deposits                                       |  |                                                        | 2,030     |      |   | 1,955    
|Short-term borrowings                               |  |                                                        | 307       |      |   | 63       
|Long-term debt                                      |  |                                                        | 269       |      |   | 263      
|                                                    |  |                                                        |           |      |   |          
|TOTAL INTEREST EXPENSE                              |  |                                                        | 4,135     |      |   | 3,251    
|                                                    |  |                                                        |           |      |   |          
|NET INTEREST INCOME                                 |  |                                                        | 8,464     |      |   | 5,962    
|                                                    |  |                                                       
|PROVISION FOR LOAN LOSSES (Note E)                  |  |                                                        | 920       |      |   | 690      
|                                                    |  |                                                        |           |      |   |          
|NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES |  |                                                        | 7,544     |      |   | 5,272    
|                                                    |  |                                                        |           |      |   |          
|NON-INTEREST INCOME (Note J)                        |  |                                                        | 1,035     |      |   | 996      
|                                                    |  |                                                        |           |      |   |          
|NON-INTEREST EXPENSE                                |  |                                                        |           |      |   |          
|Salaries and employee benefits                      |  |                                                        | 3,633     |      |   | 2,761    
|Occupancy and equipment (Note F)                    |  |                                                        | 801       |      |   | 642      
|Other (Note J)                                      |  |                                                        | 1,931     |      |   | 1,450    
|                                                    |  |                                                        |           |      |   |          
|TOTAL NON-INTEREST EXPENSE                          |  |                                                        | 6,365     |      |   | 4,853    
|                                                    |  |                                                        |           |      |   |          
|INCOME BEFORE INCOME TAXES                          |  |                                                        | 2,214     |      |   | 1,415    
|                                                    |  |                                                       
|INCOME TAXES (Note I)                               |  |                                                        | 838       |      |   | 436      
|                                                    |  |                                                        |           |      |   |          
|NET INCOME                                          |  | $                                                      | 1,376     |      | $ | 979      
|                                                    |  |                                                        |           |      |   |          
|NET INCOME PER COMMON SHARE                         |  |                                                        |           |      |   |          
|Basic                                               |  | $                                                      | .58       |      | $ | .42      
|                                                    |  |                                                        |           |      |   |          
|Diluted                                             |  | $                                                      | .55       |      | $ | .40      
|                                                    |  |                                                        |           |      |   |          
|WEIGHTED AVERAGE SHARES OUTSTANDING                 |  |                                                        |           |      |   |          
|Basic                                               |  |                                                        | 2,362,798 |      |   | 2,344,606
|                                                    |  |                                                        |           |      |   |          
|Diluted                                             |  |                                                        | 2,516,289 |      |   | 2,438,782
|                                                    |  |                                                        |           |      |   |          



See accompanying notes.



F-4



---

##### Table of Contents

NORTH STATE BANCORP

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY

Years Ended December 31, 2004 and 2003



|                                                               |  |                                           |  |                            |       |  |                      |        |                                               |  |   |              |  |   |      |   |  |   |        |  
|-------------------------------------------------------------- |  | ----------------------------------------- |  | -------------------------- | ----- |  | -------------------- | ------ | --------------------------------------------- |  | - | ------------ |  | - | ---- | - |  | - | ------ | -
|                                                               |  | Common stock                              |  | Additional paid-in capital |       |  | Accumulated earnings |        | Accumulated other comprehensive income (loss) |  |   | Total equity | 
|                                                               |  | Shares                                    |  | Amount                     |       |  |                      |       
|                                                               |  | (Amounts in thousands, except share data) | 
|Balance at December 31, 2002                                   |  | 1,843,931                                 |  | $                          | 1,844 |  | $                    | 14,396 |                                               |  | $ | 279          |  | $ | 128  |   |  | $ | 16,647 |  
|                                                               |  |                                           |  |                            |       | 
|Comprehensive income:                                          |  |                                           |  |                            |       |  |                      |        |                                               |  |   |              |  |   |      |   |  |   |        |  
|Net income                                                     |  |                                          |  |                            |      |  |                      |       |                                               |  |   | 979          |  |   |     |   |  |   | 979    |  
|Unrealized holding losses on available for sale securities     |  |                                          |  |                            |      |  |                      |       |                                               |  |   |             |  |   | (303 | ) |  |   | (303   | )
|                                                               |  |                                           |  |                            |       |  |                      |        |                                               |  |   |              |  |   |      |   |  |   |        |  
|Total comprehensive income                                     |  |                                           |  |                            |       |  |                      |        |                                               |  |   |              |  |   |      |   |  |   | 676    |  
|                                                               |  |                                           |  |                            |       | 
|11-for-10 stock split effected in the form of a stock dividend |  | 186,699                                   |  |                            | 187   |  |                      | (187   | )                                             |  |   |             |  |   |     |   |  |   |       |  
|Stock options exercised                                        |  | 21,054                                    |  |                            | 21    |  |                      | 170    |                                               |  |   |             |  |   |     |   |  |   | 191    |  
|                                                               |  |                                           |  |                            |       |  |                      |        |                                               |  |   |              |  |   |      |   |  |   |        |  
|Balance at December 31, 2003                                   |  | 2,051,684                                 |  |                            | 2,052 |  |                      | 14,379 |                                               |  |   | 1,258        |  |   | (175 | ) |  |   | 17,514 |  
|                                                               |  |                                           |  |                            |       | 
|Comprehensive income:                                          |  |                                           |  |                            |       |  |                      |        |                                               |  |   |              |  |   |      |   |  |   |        |  
|Net income                                                     |  |                                          |  |                            |      |  |                      |       |                                               |  |   | 1,376        |  |   |     |   |  |   | 1,376  |  
|Unrealized holding losses on available for sale securities     |  |                                          |  |                            |      |  |                      |       |                                               |  |   |             |  |   | (21  | ) |  |   | (21    | )
|                                                               |  |                                           |  |                            |       |  |                      |        |                                               |  |   |              |  |   |      |   |  |   |        |  
|Total comprehensive income                                     |  |                                           |  |                            |       |  |                      |        |                                               |  |   |              |  |   |      |   |  |   | 1,355  |  
|                                                               |  |                                           |  |                            |       | 
|23-for-20 stock split effected in the form of a stock dividend |  | 308,928                                   |  |                            | 309   |  |                      | (309   | )                                             |  |   |             |  |   |     |   |  |   |       |  
|                                                               |  |                                           |  |                            |       | 
|Stock options exercised                                        |  | 5,429                                     |  |                            | 5     |  |                      | 40     |                                               |  |   |             |  |   |     |   |  |   | 45     |  
|                                                               |  |                                           |  |                            |       |  |                      |        |                                               |  |   |              |  |   |      |   |  |   |        |  
|Balance at December 31, 2004                                   |  | 2,366,041                                 |  | $                          | 2,366 |  | $                    | 14,110 |                                               |  | $ | 2,634        |  | $ | (196 | ) |  | $ | 18,914 |  
|                                                               |  |                                           |  |                            |       |  |                      |        |                                               |  |   |              |  |   |      |   |  |   |        |  



See accompanying notes.



F-5



---

##### Table of Contents

NORTH STATE BANCORP

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years Ended December 31, 2004 and 2003



|                                                                                    |  |                        |         |   |      |   |         |  
|----------------------------------------------------------------------------------- |  | ---------------------- | ------- | - | ---- | - | ------- | -
|                                                                                    |  | 2004                   |         |   | 2003 |  
|                                                                                    |  | (Amounts in thousands) |        
|CASH FLOWS FROM OPERATING ACTIVITIES                                                |  |                        |         |   |      |   |         |  
|Net income                                                                          |  | $                      | 1,376   |   |      | $ | 979     |  
|Adjustments to reconcile net income to net cash provided by operating activities:   |  |                        |         |   |      |   |         |  
|Depreciation and amortization                                                       |  |                        | 356     |   |      |   | 282     |  
|Net amortization of premiums on investment securities                               |  |                        | 125     |   |      |   | 503     |  
|Provision for loan losses                                                           |  |                        | 920     |   |      |   | 690     |  
|Deferred income taxes                                                               |  |                        | (242    | ) |      |   | (135    | )
|Realized loss on sales of investment securities available for sale                  |  |                        |        |   |      |   | 3       |  
|Realized loss on disposals of premises and equipment                                |  |                        |        |   |      |   | 4       |  
|Change in assets and liabilities:                                                   |  |                        |         |   |      |   |         |  
|Increase in accrued interest receivable                                             |  |                        | (193    | ) |      |   | (139    | )
|Increase in other assets                                                            |  |                        | (202    | ) |      |   | (187    | )
|Increase in accrued interest payable                                                |  |                        | 194     |   |      |   | 40      |  
|Increase (decrease) in accrued expenses and other liabilities                       |  |                        | 826     |   |      |   | (501    | )
|                                                                                    |  |                        |         |   |      |   |         |  
|NET CASH PROVIDED BY OPERATING ACTIVITIES                                           |  |                        | 3,160   |   |      |   | 1,539   |  
|                                                                                    |  |                        |         |   |      |   |         |  
|CASH FLOWS FROM INVESTING ACTIVITIES                                                |  |                        |         |   |      |   |         |  
|Purchase of investment securities available for sale                                |  |                        | (13,667 | ) |      |   | (42,499 | )
|Proceeds from maturities and repayments of investment securities available for sale |  |                        | 17,399  |   |      |   | 30,022  |  
|Proceeds from sales of investment securities available for sale                     |  |                        | 2,620   |   |      |   | 1,349   |  
|Net increase in loans                                                               |  |                        | (63,836 | ) |      |   | (63,172 | )
|Purchase of Federal Home Loan Bank stock                                            |  |                        | (376    | ) |      |   | (93     | )
|Purchases of premises and equipment                                                 |  |                        | (1,178  | ) |      |   | (2,571  | )
|Proceeds from disposal of premises and equipment                                    |  |                        |        |   |      |   | 543     |  
|Proceeds from sale of foreclosed assets                                             |  |                        |        |   |      |   | 118     |  
|                                                                                    |  |                        |         |   |      |   |         |  
|NET CASH USED BY INVESTING ACTIVITIES                                               |  |                        | (59,038 | ) |      |   | (76,303 | )
|                                                                                    |  |                        |         |   |      |   |         |  
|CASH FLOWS FROM FINANCING ACTIVITIES                                                |  |                        |         |   |      |   |         |  
|Net increase in deposits                                                            |  |                        | 60,585  |   |      |   | 42,117  |  
|Net change in short-term borrowings                                                 |  |                        | (7,638  | ) |      |   | 11,019  |  
|Net change in long-term debt                                                        |  |                        | 5,155   |   |      |   |        |  
|Net proceeds from issuance of common stock                                          |  |                        | 45      |   |      |   | 191     |  
|                                                                                    |  |                        |         |   |      |   |         |  
|NET CASH PROVIDED BY FINANCING ACTIVITIES                                           |  |                        | 58,147  |   |      |   | 53,327  |  
|                                                                                    |  |                        |         |   |      |   |         |  
|NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                                |  |                        | 2,269   |   |      |   | (21,437 | )
|                                                                                    |  |                       
|CASH AND CASH EQUIVALENTS, BEGINNING                                                |  |                        | 22,479  |   |      |   | 43,916  |  
|                                                                                    |  |                        |         |   |      |   |         |  
|CASH AND CASH EQUIVALENTS, ENDING                                                   |  | $                      | 24,748  |   |      | $ | 22,479  |  
|                                                                                    |  |                        |         |   |      |   |         |  
|SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION                                   |  |                        |         |   |      |   |         |  
|Interest paid                                                                       |  | $                      | 3,905   |   |      | $ | 3,211   |  
|Income taxes paid                                                                   |  |                        | 741     |   |      |   | 1,199   |  
|                                                                                    |  |                       
|SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING ACTIVITIES                            |  |                        |         |   |      |   |         |  
|Unrealized loss on investment securities available for sale, net                    |  | $                      | (21     | ) |      | $ | (303    | )
|Transfer of loans to foreclosed assets                                              |  |                        | 521     |   |      |   | 118     |  



See accompanying notes.



F-6



---

##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2004 and 2003



NOTE A - ORGANIZATION AND OPERATIONS



On June 28, 2002, North State Bancorp (the Company) was formed as a holding
company for North State Bank (the Bank). Upon formation, one share of the Companys $1 par value common stock was exchanged for each of the outstanding shares of the Banks $5 par value common stock. The Company is subject to
the rules and regulations of the Federal Reserve Bank and the North Carolina Commissioner of Banks.



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



NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES



Basis of Presentation



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



During 2004, the Company formed North State Statutory
Trust I (the Trust), a wholly owned subsidiary, which was formed in order to facilitate the issuance of trust preferred securities. The Trust has invested the total proceeds from the sale of the trust preferred securities in junior
subordinated deferrable interest debentures issued by the Company. In addition, the Company adopted FASB Interpretation No. (FIN) 46, Consolidation of Variable Interest Entities that resulted in the deconsolidation of the trust preferred
subsidiary. Upon deconsolidation, the junior subordinated debentures issued by the Company to the trust were included in long-term debt and the Companys equity interest in the trust were included in other assets. The deconsolidation of the
trust did not materially impact net income.



Use of Estimates



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



Cash and Cash
Equivalents



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



F-7



---

##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2004 and 2003



NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)



Securities Available for Sale



Available for sale securities are reported at fair value and consist of debt instruments not
classified as trading securities or as held to maturity securities. Unrealized holding gains and losses on available for sale securities are reported, net of related tax effect, in other comprehensive income. Gains and losses on the sale of
available for sale securities are determined using the specific-identification method. Declines in the fair value of available for sale securities below their cost that are other than temporary would result in write-downs of the individual
securities to their fair value. Such write-downs would be included in earnings as realized losses. Premiums and discounts are recognized in interest income using the interest method over the period to maturity.



Loans



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



Allowance for Loan Losses



The provision for loan losses is based upon managements estimate of the amount needed to maintain the allowance for loan losses at an adequate level. In making the
evaluation of the adequacy of the allowance for loan losses, management gives consideration to current economic conditions, statutory examinations of the loan portfolio by regulatory agencies, delinquency information and managements internal
review of the loan portfolio. Loans are considered impaired when it is probable that all amounts due under the contractual terms of the loan will not be collected. The measurement of impaired loans is generally based on the present value of expected
future cash flows discounted at the historical effective interest rate, or upon the fair value of the collateral if the loan is collateral dependent. If the recorded investment in the loan exceeds the measure of fair value, a valuation allowance is
established as a component of the allowance for loan losses. While management uses the best information available to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the assumptions used
in making the evaluations. In addition, regulatory examiners may require the Company to recognize changes to the allowance for loan losses based on their judgments about information available to them at the time of their examination.



Mortgage Origination Fees



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



F-8



---

##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2004 and 2003



NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)



Premises and Equipment



Premises and equipment are stated at cost less accumulated depreciation. Depreciation is
calculated on the straight-line method over the estimated useful lives of the assets which are 3 - 10 years for furniture and equipment and 30 years for buildings. Leasehold improvements are amortized over the terms of the respective leases or the
estimated useful lives of the improvements, whichever is shorter. Repairs and maintenance costs are charged to operations as incurred and additions and improvements to premises and equipment are capitalized. Upon sale or retirement, the cost and
related accumulated depreciation are removed from the accounts and any gains or losses are reflected in current operations.



Stock in Federal Home Loan Bank of Atlanta



As a requirement for membership, the Bank 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.



Income Taxes



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



Stock Compensation Plans



Statement of Financial
Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, encourages all entities to adopt a fair value-based method of accounting for employee stock compensation plans, whereby compensation cost is measured at
the grant date based on the value of the award and is recognized over the service period, which is usually the vesting period. However, it also allows an entity to continue to measure compensation cost for those plans using the intrinsic value-based
method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees,whereby compensation cost is the excess, if any, of the quoted market price of the stock at the grant
date (or other measurement date) over the amount an employee must pay to acquire the stock. Stock options issued under the Companys stock option plans have no intrinsic value at the grant date and, under APB Opinion No. 25, no compensation
cost is recognized for them. The Company has elected to continue with the accounting methodology in APB Opinion No. 25 and, as a result, has provided pro forma disclosures of net income and earnings per share and other disclosures as if the fair
value-based method of accounting had been applied.



F-9



---

##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2004 and 2003



NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)



Stock Compensation Plans (Continued)



At December 31, 2004, the Company had two stock-based compensation plans, which are more
fully described in Note N. Had compensation costs for the Companys stock option plans been determined based on the fair value at the grant date for awards in 2004 and 2003, the Companys net income and net income per share would have
changed to the pro forma amounts indicated as follows:



|                                                                                                                                          |  |                        |       |   |      |   |      |   |  | 
|----------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------- | ----- | - | ---- | - | ---- | - |  | 
|                                                                                                                                          |  | 2004                   |       |   | 2003 |  
|                                                                                                                                          |  | (Amounts in thousands) |      
|Net income:                                                                                                                               |  |                        |       |   |      |   |      |  
|As reported                                                                                                                               |  | $                      | 1,376 |   |      | $ | 979  |  
|Deduct:     Total stock-based employee compensation expense determined under fair
value method for all awards, net of related tax effects |  |                        | (153  | ) |      |   | (141 | )
|                                                                                                                                          |  |                        |       |   |      |   |      |   |  | 
|Pro forma                                                                                                                                 |  | $                      | 1,223 |   |      | $ | 838  |  
|                                                                                                                                          |  |                        |       |   |      |   |      |   |  | 
|Basic net income per share:                                                                                                               |  |                        |       |   |      |   |      |  
|As reported                                                                                                                               |  | $                      | 0.58  |   |      | $ | 0.41 |  
|Pro forma                                                                                                                                 |  |                        | 0.52  |   |      |   | 0.35 |  
|                                                                                                                                          |  |                       
|Diluted net income per share:                                                                                                             |  |                        |       |   |      |   |      |  
|As reported                                                                                                                               |  | $                      | 0.55  |   |      | $ | 0.40 |  
|Pro forma                                                                                                                                 |  |                        | 0.49  |   |      |   | 0.34 |  



Earnings Per Common Share



During 2004 the Company issued a twenty-three for twenty stock split
effected in the form of a 15% stock dividend and in 2003 the Company issued an eleven for ten stock split effected in the form of a 10% stock dividend. All references in these financial statements to per share results and weighted average common and
common equivalent shares outstanding have been adjusted for the effects of these stock splits.



Basic earnings per share represents income available to common shareholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflect additional common
shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate to
outstanding stock options.



|                                                                                                                             |  |           |  |          
|---------------------------------------------------------------------------------------------------------------------------- |  | --------- |  | ---------
|                                                                                                                             |  | 2004      |  | 2003     
|Weighted average number of common shares used in computing basic net income per share                                        |  | 2,362,798 |  | 2,344,606
|                                                                                                                             |  |          
|Effective of dilutive stock options                                                                                          |  | 153,491   |  | 94,176   
|                                                                                                                             |  |           |  |          
|                                                                                                                             |  |          
|Weighted average number of common shares and dilutive potential common shares used in computing diluted net income per share |  | 2,516,289 |  | 2,438,782
|                                                                                                                             |  |           |  |          



For the year ended December 31, 2004,
there were 464 of antidilutive shares because the exercise price of the options exceeded the average market price of the Companys common stock for the year. These options were granted in 2004 and adjusted for the period outstanding. There were
no antidilutive shares for the year ended December 31, 2003.



F-10



---

##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2004 and 2003



NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)



Comprehensive Income (Loss)



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



The components of other comprehensive loss and related tax effects are as follows:



|                                                           |  |                        |     |   |      |   |      |  
|---------------------------------------------------------- |  | ---------------------- | --- | - | ---- | - | ---- | -
|                                                           |  | 2004                   |     |   | 2003 |  
|                                                           |  | (Amounts in thousands) |    
|Unrealized holding losses on available for sale securities |  | $                      | (33 | ) |      | $ | (493 | )
|Tax effect                                                 |  |                        | 12  |   |      |   | 188  |  
|Reclassification of losses recognized in net income        |  |                        |    |   |      |   | 3    |  
|Tax effect                                                 |  |                        |    |   |      |   | (1   | )
|                                                           |  |                        |     |   |      |   |      |  
|Other comprehensive loss                                   |  | $                      | (21 | ) |      | $ | (303 | )
|                                                           |  |                        |     |   |      |   |      |  



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 and retail banking segment,
and the consolidated financial statements presented herein reflect the results of that segment. Also, the Company has no foreign operations or customers.



Recent Accounting Pronouncements



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.



F-11



---

##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2004 and 2003



NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)



Recent Accounting Pronouncements



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 $153,000, and $141,000, respectively. Accordingly, the
adoption of SFAS No. 123(R) is expected to have a material effect on our consolidated financial statements.



Reclassification



Certain
amounts in the 2003 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.



F-12



---

##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2004 and 2003



NOTE C - INVESTMENT SECURITIES



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



|                                                                       |  |                        |        |                       |   |                       |  |           |     |  |   |       
|---------------------------------------------------------------------- |  | ---------------------- | ------ | --------------------- | - | --------------------- |  | --------- | --- |  | - | ------
|                                                                       |  | December 31, 2004     
|                                                                       |  | Amortizedcost          |        | Gross unrealizedgains |   | Grossunrealizedlosses |  | Fairvalue
|                                                                       |  | (Amounts in thousands)
|Securities available for sale:                                         |  |                        |        |                       |   |                       |  |           |     |  |   |       
|U.S. government securities and obligations of U.S. government agencies |  | $                      | 11,955 |                       | $ | 2                     |  | $         | 95  |  | $ | 11,862
|State and municipal securities                                         |  |                        | 2,472  |                       |   | 2                     |  |           |    |  |   | 2,474 
|Mortgage-backed securities                                             |  |                        | 21,259 |                       |   | 32                    |  |           | 256 |  |   | 21,035
|                                                                       |  |                        |        |                       |   |                       |  |           |     |  |   |       
|                                                                       |  | $                      | 35,686 |                       | $ | 36                    |  | $         | 351 |  | $ | 35,371
|                                                                       |  |                        |        |                       |   |                       |  |           |     |  |   |       
|                                                                       | 
|                                                                       |  | December 31, 2003     
|                                                                       |  | Amortizedcost          |        | Grossunrealizedgains  |   | Grossunrealizedlosses |  | Fairvalue
|                                                                       |  | (Amounts in thousands)
|Securities available for sale:                                         |  |                        |        |                       |   |                       |  |           |     |  |   |       
|U.S. government treasury                                               |  | $                      | 989    |                       | $ | 2                     |  | $         |    |  | $ | 991   
|U.S. government securities and obligations of U.S. government agencies |  |                        | 13,288 |                       |   | 44                    |  |           | 45  |  |   | 13,287
|State and municipal securities                                         |  |                        | 2,000  |                       |   |                      |  |           |    |  |   | 2,000 
|Mortgage-backed securities                                             |  |                        | 25,887 |                       |   | 132                   |  |           | 415 |  |   | 25,604
|                                                                       |  |                        |        |                       |   |                       |  |           |     |  |   |       
|                                                                       |  | $                      | 42,164 |                       | $ | 178                   |  | $         | 460 |  | $ | 41,882
|                                                                       |  |                        |        |                       |   |                       |  |           |     |  |   |       



The following tables show the
Companys investments gross unrealized losses and fair values, 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 temporary given the credit ratings on these investment securities and the Companys intent and ability to hold its securities to maturity.



|                                                                       |  |                        |        |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    
|---------------------------------------------------------------------- |  | ---------------------- | ------ | ----------------- | - | --------- |  | ---------------- | ------ | --------- | - | ---------------- |  | - | ------ |  | - | ---
|                                                                       |  | 2004                  
|                                                                       |  | Less Than 12 Months    |        | 12 Months or More |   | Total    
|                                                                       |  | Fairvalue              |        | Unrealizedlosses  |   | Fairvalue |  | Unrealizedlosses |        | Fairvalue |   | Unrealizedlosses
|                                                                       |  | (Amounts in thousands)
|Securities available for sale:                                         |  |                        |        |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    
|U.S. government securities and obligations of U.S. government agencies |  | $                      | 9,468  |                   | $ | 52        |  | $                | 2,083  |           | $ | 43               |  | $ | 11,551 |  | $ | 95 
|Mortgage-backed securities                                             |  |                        | 8,614  |                   |   | 88        |  |                  | 8,189  |           |   | 168              |  |   | 16,803 |  |   | 256
|                                                                       |  |                        |        |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    
|Total temporarily impaired securities                                  |  | $                      | 18,082 |                   | $ | 140       |  | $                | 10,272 |           | $ | 211              |  | $ | 28,354 |  | $ | 351
|                                                                       |  |                        |        |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    



F-13



---

##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2004 and 2003



NOTE C - INVESTMENT SECURITIES (Continued)



|                                                                       |  |                        |        |                   |   |           |  |                  |   |           |   |                  |  |   |        |  |   |    
|---------------------------------------------------------------------- |  | ---------------------- | ------ | ----------------- | - | --------- |  | ---------------- | - | --------- | - | ---------------- |  | - | ------ |  | - | ---
|                                                                       |  | 2003                  
|                                                                       |  | Less Than 12 Months    |        | 12 Months or More |   | Total    
|                                                                       |  | Fairvalue              |        | Unrealizedlosses  |   | Fairvalue |  | Unrealizedlosses |   | Fairvalue |   | Unrealizedlosses
|                                                                       |  | (Amounts in thousands)
|Securities available for sale:                                         |  |                        |        |                   |   |           |  |                  |   |           |   |                  |  |   |        |  |   |    
|U.S. government securities and obligations of U.S. government agencies |  | $                      | 4,225  |                   | $ | 45        |  | $                |  |           | $ |                 |  | $ | 4,225  |  | $ | 45 
|Mortgage-backed securities                                             |  |                        | 17,641 |                   |   | 415       |  |                  |  |           |   |                 |  |   | 17,641 |  |   | 415
|                                                                       |  |                        |        |                   |   |           |  |                  |   |           |   |                  |  |   |        |  |   |    
|Total temporarily impaired securities                                  |  | $                      | 21,866 |                   | $ | 460       |  | $                |  |           | $ |                 |  | $ | 21,866 |  | $ | 460
|                                                                       |  |                        |        |                   |   |           |  |                  |   |           |   |                  |  |   |        |  |   |    



The amortized cost and fair values of
securities available for sale at December 31, 2004 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or
prepayment penalties.



|                                    |  |                        |        |           |   |       
|----------------------------------- |  | ---------------------- | ------ | --------- | - | ------
|                                    |  | AmortizedCost          |        | FairValue
|                                    |  | (Dollars in thousands)
|Securities available for sale:      |  |                        |        |           |   |       
|Due within one year                 |  | $                      | 6,522  |           | $ | 6,484 
|Due after one but within five years |  |                        | 7,217  |           |   | 7,189 
|Due after five but within ten years |  |                        | 998    |           |   | 972   
|Due after ten years                 |  |                        | 20,949 |           |   | 20,726
|                                    |  |                        |        |           |   |       
|                                    |  | $                      | 35,686 |           | $ | 35,371
|                                    |  |                        |        |           |   |       



Securities with a carrying value of
$19.4 million and $12.2 million at December 31, 2004 and 2003, respectively, were pledged to secure securities sold under agreements to repurchase and public deposits.



Proceeds from the sale of an investment security of $2.6 million in 2004 resulted in a gain of $495. Proceeds from sales of investment
securities of $1.3 million in 2003 resulted in gross losses of $3,000.



F-14



---

##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2004 and 2003



NOTE D - LOANS



Following is a summary of loans:



|                                   |  |                        |         |   |                 |        |   |        |   |         |                 |  |        |  
|---------------------------------- |  | ---------------------- | ------- | - | --------------- | ------ | - | ------ | - | ------- | --------------- |  | ------ | -
|                                   |  | At December 31,        |        
|                                   |  | 2004                   |         |   | 2003            |       
|                                   |  | Amount                 |         |   | Percentof total |        |   | Amount |   |         | Percentof total | 
|                                   |  | (Dollars in thousands) |        
|Commercial                         |  | $                      | 174,107 |   |                 | 71.12  | % |        | $ | 137,385 |                 |  | 75.64  | %
|Real estate - construction         |  |                        | 35,987  |   |                 | 14.70  | % |        |   | 19,162  |                 |  | 10.55  | %
|Real estate - 1-4 family mortgage  |  |                        | 19,170  |   |                 | 7.83   | % |        |   | 12,392  |                 |  | 6.82   | %
|Loans to individuals               |  |                        | 2,359   |   |                 | 0.96   | % |        |   | 1,897   |                 |  | 1.04   | %
|Home equity lines of credit        |  |                        | 13,189  |   |                 | 5.39   | % |        |   | 10,807  |                 |  | 5.95   | %
|                                   |  |                        |         |   |                 |        |   |        |   |         |                 |  |        |  
|Subtotal                           |  |                        | 244,812 |   |                 | 100.00 | % |        |   | 181,643 |                 |  | 100.00 | %
|                                   |  |                        |         |   |                 |        |   |        |   |         |                 |  |        |  
|Unamortized net deferred loan fees |  |                        | (192    | ) |                 |        |   |        |   | (111    | )               |  |        |  
|                                   |  |                        |         |   |                 |        |   |        |   |         |                 |  |        |  
|Total loans                        |  | $                      | 244,620 |   |                 |        |   |        | $ | 181,532 |                 |  |        |  
|                                   |  |                        |         |   |                 |        |   |        |   |         |                 |  |        |  



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



Impaired loans consist entirely of nonaccrual loans, which aggregated $260,000 and $1.0 million at December 31, 2004 and 2003, respectively,
with related allowances for loan losses of $39,000 and $150,000 at December 31, 2004 and 2003, respectively. The average recorded investment in impaired loans during the years ended December 31, 2004 and 2003 was $648,000 and $496,000, respectively.
For the years ended December 31, 2004 and 2003, the interest income the Company recognized from impaired loans during the portion of the year that they were impaired was not material.



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



|                             |  |   |        |  
|---------------------------- |  | - | ------ | -
|Balance at December 31, 2003 |  | $ | 13,479 |  
|Additional borrowings        |  |   | 6,589  |  
|Loan repayments              |  |   | (6,523 | )
|                             |  |   |        |  
|Balance at December 31, 2004 |  | $ | 13,545 |  
|                             |  |   |        |  



At December 31, 2004, the Company had
pre-approved but unused lines of credit totaling $412,000 to executive officers, directors and their affiliates.



F-15



---

##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2004 and 2003



NOTE E - ALLOWANCE FOR LOAN LOSSES



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



|                          |  |                        |       |   |      |   |       |  
|------------------------- |  | ---------------------- | ----- | - | ---- | - | ----- | -
|                          |  | 2004                   |       |   | 2003 |  
|                          |  | (Amounts in thousands) |      
|Beginning balance         |  | $                      | 2,360 |   |      | $ | 1,845 |  
|                          |  |                        |       |   |      |   |       |  
|Provision for loan losses |  |                        | 920   |   |      |   | 690   |  
|                          |  |                        |       |   |      |   |       |  
|Charge-offs               |  |                        | (278  | ) |      |   | (175  | )
|Recoveries                |  |                        | 51    |   |      |   |      |  
|                          |  |                        |       |   |      |   |       |  
|Net charge-offs           |  |                        | (227  | ) |      |   | (175  | )
|                          |  |                        |       |   |      |   |       |  
|Ending balance            |  | $                      | 3,053 |   |      | $ | 2,360 |  
|                          |  |                        |       |   |      |   |       |  



NOTE F - PREMISES AND EQUIPMENT



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



|                                  |  |                        |       |   |      |   |       |  
|--------------------------------- |  | ---------------------- | ----- | - | ---- | - | ----- | -
|                                  |  | 2004                   |       |   | 2003 |  
|                                  |  | (Amounts in thousands) |      
|Land                              |  | $                      | 1,266 |   |      | $ | 1,200 |  
|Buildings                         |  |                        | 1,971 |   |      |   | 768   |  
|Leasehold improvements            |  |                        | 242   |   |      |   | 242   |  
|Furniture, fixtures and equipment |  |                        | 1,652 |   |      |   | 1,290 |  
|Construction in process           |  |                        | 112   |   |      |   | 730   |  
|                                  |  |                        |       |   |      |   |       |  
|                                  |  |                        | 5,243 |   |      |   | 4,230 |  
|Accumulated depreciation          |  |                        | (999  | ) |      |   | (811  | )
|                                  |  |                        |       |   |      |   |       |  
|Total                             |  | $                      | 4,244 |   |      | $ | 3,419 |  
|                                  |  |                        |       |   |      |   |       |  



Depreciation and amortization
amounting to $353,000 in 2004 and $282,000 in 2003 is included in occupancy and equipment expense.



During 2004, the Company entered into a 10 year lease for a 12,000 square foot building to be used as the Companys corporate headquarters and a new branch office. The new location is part of the North Hills
redevelopment project in Raleigh NC. As part of the construction, the Company will incur approximately $355,000 in leasehold improvement costs. None of these costs had been incurred as of December 31, 2004. The expected completion date of the office
opening is during the first quarter of 2005.



F-16



---

##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2004 and 2003



NOTE F - PREMISES AND EQUIPMENT (Continued)



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



Year ending December 31:



|     |  |   |      
|---- |  | - | -----
|2005 |  | $ | 603  
|2006 |  |   | 555  
|2007 |  |   | 411  
|2008 |  |   | 385  
|     |  |   |      
|     |  | $ | 1,954
|     |  |   |      



Total rental expense under operating
leases for the years ended December 31, 2004 and 2003 amounted to $216,000 and $201,000, respectively. Rent expense is included in occupancy and equipment expenses.



NOTE G - DEPOSITS



The aggregate amount of time deposits in denominations of $100,000 or more at December 31, 2004 and 2003 was approximately $29.2 million and $27.2 million, respectively.



At December 31, 2004, the scheduled maturities of time deposits were as
follows:



|     |  |                        |        |                  |   |        |  |   |       
|---- |  | ---------------------- | ------ | ---------------- | - | ------ |  | - | ------
|     |  | Less than $100,000     |        | $100,000 or more |   | Total 
|     |  |                       
|     |  | (Amounts in thousands)
|2005 |  | $                      | 41,891 |                  | $ | 17,660 |  | $ | 59,551
|2006 |  |                        | 7,064  |                  |   | 6,839  |  |   | 13,903
|2007 |  |                        | 2,002  |                  |   | 3,036  |  |   | 5,038 
|2008 |  |                        | 1,217  |                  |   | 1,523  |  |   | 2,740 
|2009 |  |                        | 324    |                  |   | 142    |  |   | 466   
|     |  |                        |        |                  |   |        |  |   |       
|     |  | $                      | 52,498 |                  | $ | 29,200 |  | $ | 81,698
|     |  |                        |        |                  |   |        |  |   |       



NOTE H - BORROWINGS



Short-term Borrowings



At December 31, 2004 and 2003, the Company had a $6.0 million advance from the Federal Home
Loan Bank of Atlanta. This advance matures on January 28, 2005 and bears a fixed interest rate of 4.38%. This advance is classified as a short-term debt in 2004 and long-term debt in 2003 in the accompanying consolidated balance sheets. Under
collateral agreements with the Federal Home Loan Bank at December 31, 2004, this advance is secured by loans with a carrying value of $26.4 million.



F-17



---

##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2004 and 2003



NOTE H - BORROWINGS (Continued)



In addition to the above advance, the Company also had repurchase agreements outstanding in the amount of $8.3 million and $15.9 million at
December 31, 2004 and 2003, respectively. Securities sold under agreements to repurchase generally mature with one to four days from the transaction date and are collateralized by U.S. Government Agency obligations. These repurchase agreements are
due within one year and are classified as short-term borrowings in the accompanying consolidated balance sheets.



As of December 31, 2004 the Company had available lines of credit totaling approximately $28.0 million with various financial institutions for borrowing on a short-term
basis, with no amounts outstanding at that date. These lines are subject to annual renewals with varying interest rates.



Long-term Debt



The Company issued $5.2 million of junior subordinated debentures to the Trust in exchange for the proceeds of trust preferred securities issued by Trust. The Trust is wholly owned by the Company. The junior
subordinated deferrable interest debentures are included in long-term debt and the Companys equity interest in the trust is included in other assets.



The junior subordinated debentures pay interest quarterly at an annual rate, reset quarterly, equal to 3 month LIBOR plus 2.79%. The debentures are redeemable on July 17,
2009 or afterwards, in whole or in part, on any January 17, April 17, July 17, or October 17. Redemption is mandatory at April 17, 2034. The Company has fully and unconditionally guaranteed the repayment of the trust preferred securities. The
Companys obligation under the guarantee is unsecured and subordinate to senior and subordinated indebtedness of the Company. The trust preferred securities presently qualify as Tier 1 regulatory capital for regulatory capital purposes subject
to certain limitations, none of which were applicable at December 31, 2004.



NOTE I - INCOME TAXES



The significant components of
the provision for income taxes for the years ended December 31, 2004 and 2003 are as follows:



|                                                                                             |  |                        |       |   |      |   |      |  
|-------------------------------------------------------------------------------------------- |  | ---------------------- | ----- | - | ---- | - | ---- | -
|                                                                                             |  | 2004                   |       |   | 2003 |  
|                                                                                             |  | (Amounts in thousands) |      
|Current tax expense:                                                                         |  |                        |       |   |      |   |      |  
|Federal                                                                                      |  | $                      | 895   |   |      | $ | 578  |  
|State                                                                                        |  |                        | 185   |   |      |   | 84   |  
|                                                                                             |  |                        |       |   |      |   |      |  
|                                                                                             |  |                        | 1,080 |   |      |   | 662  |  
|                                                                                             |  |                        |       |   |      |   |      |  
|Deferred tax provision:                                                                      |  |                        |       |   |      |   |      |  
|Federal                                                                                      |  |                        | (181  | ) |      |   | (112 | )
|State                                                                                        |  |                        | (61   | ) |      |   | (23  | )
|                                                                                             |  |                        |       |   |      |   |      |  
|                                                                                             |  |                        | (242  | ) |      |   | (135 | )
|                                                                                             |  |                        |       |   |      |   |      |  
|Provision for income tax expense before adjustment to deferred tax asset valuation allowance |  |                        | 838   |   |      |   | 527  |  
|Decrease in valuation allowance                                                              |  |                        |      |   |      |   | (91  | )
|                                                                                             |  |                        |       |   |      |   |      |  
|Net provision for income taxes                                                               |  | $                      | 838   |   |      | $ | 436  |  
|                                                                                             |  |                        |       |   |      |   |      |  



F-18



---

##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2004 and 2003



NOTE I - INCOME TAXES (Continued)



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



|                                                     |  |                        |     |      |   |     |  
|---------------------------------------------------- |  | ---------------------- | --- | ---- | - | --- | -
|                                                     |  | 2004                   |     | 2003 |  
|                                                     |  | (Amounts in thousands) |    
|Expected income tax expense                          |  | $                      | 753 |      | $ | 481 |  
|                                                     |  |                       
|Increase (decrease) resulting from:                  |  |                        |     |      |   |     |  
|State income taxes, net of federal tax effect        |  |                        | 82  |      |   | 40  |  
|Adjustment to deferred tax asset valuation allowance |  |                        |    |      |   | (91 | )
|Other permanent differences                          |  |                        | 3   |      |   | 6   |  
|                                                     |  |                        |     |      |   |     |  
|Provision for income taxes                           |  | $                      | 838 |      | $ | 436 |  
|                                                     |  |                        |     |      |   |     |  



Deferred income taxes reflect the net
tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of deferred taxes at December 31, 2004 and 2003 are as
follows:



|                                                         |  |                        |       |   |      |   |      |  
|-------------------------------------------------------- |  | ---------------------- | ----- | - | ---- | - | ---- | -
|                                                         |  | 2004                   |       |   | 2003 |  
|                                                         |  | (Amounts in thousands) |      
|Deferred tax assets relating to:                         |  |                        |       |   |      |   |      |  
|Allowance for loan losses                                |  | $                      | 975   |   |      | $ | 724  |  
|Pre-opening costs and expenses                           |  |                        | 18    |   |      |   | 60   |  
|Deferred compensation                                    |  |                        | 175   |   |      |   | 78   |  
|Unrealized loss on available for sale securities         |  |                        | 119   |   |      |   | 107  |  
|Other                                                    |  |                        | 12    |   |      |   | 11   |  
|                                                         |  |                        |       |   |      |   |      |  
|Total deferred tax assets                                |  |                        | 1,299 |   |      |   | 980  |  
|                                                         |  |                        |       |   |      |   |      |  
|Deferred tax liabilities relating to:                    |  |                        |       |   |      |   |      |  
|Deferred loan origination fees                           |  |                        | (93   | ) |      |   | (72  | )
|Property and equipment                                   |  |                        | (117  | ) |      |   | (74  | )
|                                                         |  |                        |       |   |      |   |      |  
|Total deferred tax liabilities                           |  |                        | (210  | ) |      |   | (146 | )
|                                                         |  |                        |       |   |      |   |      |  
|Net recorded deferred tax asset included in other assets |  | $                      | 1,089 |   |      | $ | 834  |  
|                                                         |  |                        |       |   |      |   |      |  



F-19



---

##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2004 and 2003



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



The major components of non-interest income for the years ended December 31, 2004 and 2003
are as follows:



|                                             |  |                        |       |      |   |     |  
|-------------------------------------------- |  | ---------------------- | ----- | ---- | - | --- | -
|                                             |  | 2004                   |       | 2003 |  
|                                             |  | (Amounts in thousands) |      
|Mortgage origination fees                    |  | $                      | 311   |      | $ | 428 |  
|Service charges and fees on deposit accounts |  |                        | 588   |      |   | 499 |  
|Loss on sale of investment securities        |  |                        |      |      |   | (3  | )
|Other                                        |  |                        | 136   |      |   | 72  |  
|                                             |  |                        |       |      |   |     |  
|Total non-interest income                    |  | $                      | 1,035 |      | $ | 996 |  
|                                             |  |                        |       |      |   |     |  



The major components of other
non-interest expense for the years ended December 31, 2004 and 2003 are as follows:



|                                              |  |                        |       |      |   |      
|--------------------------------------------- |  | ---------------------- | ----- | ---- | - | -----
|                                              |  | 2004                   |       | 2003
|                                              |  | (Amounts in thousands)
|Professional fees                             |  | $                      | 230   |      | $ | 173  
|Postage, printing and office supplies         |  |                        | 145   |      |   | 122  
|Advertising and promotion                     |  |                        | 184   |      |   | 104  
|Data processing and other outsourced services |  |                        | 319   |      |   | 293  
|Bankcard expenses                             |  |                        | 252   |      |   | 185  
|Other                                         |  |                        | 801   |      |   | 573  
|                                              |  |                        |       |      |   |      
|Total non-interest expense                    |  | $                      | 1,931 |      | $ | 1,450
|                                              |  |                        |       |      |   |      



NOTE K - REGULATORY MATTERS



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



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



F-20



---

##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2004 and 2003



NOTE K - REGULATORY MATTERS (Continued)



As of December 31, 2004 and 2003, the most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory
framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum amounts and ratios.



Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios, as prescribed by
regulations, of total and Tier I capital to risk-weighted assets and of Tier I capital to average assets. As of December 31, 2004 and 2003, the Bank met its capital adequacy requirements as set forth below:



|                                           |  |        |        |       |                                       |   |                        |                                                                          |        |  |      |        |  |       |        |  |       |  
|------------------------------------------ |  | ------ | ------ | ----- | ------------------------------------- | - | ---------------------- | ------------------------------------------------------------------------ | ------ |  | ---- | ------ |  | ----- | ------ |  | ----- | -
|                                           |  | Actual |        |       | Minimum for capital adequacy purposes |   |                        | Minimum to be well Capitalized under prompt corrective action provisions |       
|                                           |  | Amount |        | Ratio |                                       |   | Amount                 |                                                                          | Ratio  |  |      | Amount |  | Ratio |       
|                                           |  |        |        |       |                                       |   | (Dollars in thousands) |                                                                          |        |  |      |        | 
|As of December 31, 2004:                   |  |        |        |       |                                       |   |                        |                                                                          |        |  |      |        |  |       |        |  |       |  
|                                           |  |        |        |       |                                       |  
|Total Capital (to Risk - Weighted Assets)  |  | $      | 26,918 |       | 11.01                                 | % |                        | $                                                                        | 19,572 |  | 8.00 | %      |  | $     | 24,464 |  | 10.00 | %
|Tier I Capital (to Risk - Weighted Assets) |  |        | 23,865 |       | 9.76                                  | % |                        |                                                                          | 9,786  |  | 4.00 | %      |  |       | 14,679 |  | 6.00  | %
|Tier I Capital (to Average Assets)         |  |        | 23,865 |       | 7.94                                  | % |                        |                                                                          | 12,016 |  | 4.00 | %      |  |       | 15,020 |  | 5.00  | %
|                                           |  |        |        |       |                                       |  
|As of December 31, 2003:                   |  |        |        |       |                                       |   |                        |                                                                          |        |  |      |        |  |       |        |  |       |  
|                                           |  |        |        |       |                                       |  
|Total Capital (to Risk - Weighted Assets)  |  | $      | 19,994 |       | 10.85                                 | % |                        | $                                                                        | 14,742 |  | 8.00 | %      |  | $     | 18,427 |  | 10.00 | %
|Tier I Capital (to Risk - Weighted Assets) |  |        | 17,689 |       | 9.60                                  | % |                        |                                                                          | 7,371  |  | 4.00 | %      |  |       | 11,056 |  | 6.00  | %
|Tier I Capital (to Average Assets)         |  |        | 17,689 |       | 7.87                                  | % |                        |                                                                          | 8,995  |  | 4.00 | %      |  |       | 11,244 |  | 5.00  | %



The Company is also subject to these
requirements. At December 31, 2004, the Companys total capital risk-weighted assets, Tier I capital to risk-weighted assets and Tier I capital to average assets were 11.10%, 9.86% and 8.03%, respectively.



NOTE L - OFF-BALANCE SHEET RISK



The Company is a party to financial instruments with off-balance sheet risk in the normal
course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk
in excess of the amount recognized in the balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. The Company uses the same credit
policies in making commitments and conditional obligations as it does for on-balance sheet instruments.



F-21



---

##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2004 and 2003



NOTE L - OFF-BALANCE SHEET RISK (Continued)



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



A summary of the contract amount of the Companys exposure to off-balance sheet credit risk as of December 31, 2004 is as follows
(amounts in thousands):



Financial
instruments whose contract amounts represent credit risk:



|                             |  |   |       
|---------------------------- |  | - | ------
|Commitments to extend credit |  | $ | 38,438
|Undisbursed lines of credit  |  |   | 11,069
|Standby letters of credit    |  |   | 1,251 



NOTE M - DISCLOSURES ABOUT FAIR
VALUES OF FINANCIAL INSTRUMENTS



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



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



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



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



Investment Securities Available for Sale



Fair value for investment securities available for sale equals quoted market price if such
information is available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.



F-22



---

##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2004 and 2003



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



Loans



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



Stock
in Federal Home Loan Bank of Atlanta



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



Deposits



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



Borrowings



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



Accrued Interest



The carrying amounts of accrued
interest approximate fair value.



Financial Instruments with Off-Balance
Sheet Risk



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



F-23



---

##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2004 and 2003



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



The following table presents the carrying values and estimated fair values of the
Companys financial instruments at December 31, 2004 and 2003.



|                                         |  |                        |         |                     |   |                |  |                     |         |  |   |        
|---------------------------------------- |  | ---------------------- | ------- | ------------------- | - | -------------- |  | ------------------- | ------- |  | - | -------
|                                         |  | 2004                   |         | 2003               
|                                         |  | CarryingAmount         |         | EstimatedFair Value |   | CarryingAmount |  | EstimatedFair Value
|                                         |  | (Amounts in thousands)
|Financial assets:                        |  |                        |         |                     |   |                |  |                     |         |  |   |        
|Cash and due from banks                  |  | $                      | 4,015   |                     | $ | 4,015          |  | $                   | 13,028  |  | $ | 13,028 
|Interest-earning deposits with banks     |  |                        | 1,345   |                     |   | 1,345          |  |                     | 768     |  |   | 768    
|Federal funds sold                       |  |                        | 19,388  |                     |   | 19,388         |  |                     | 8,683   |  |   | 8,683  
|Investment securities available for sale |  |                        | 35,371  |                     |   | 35,371         |  |                     | 41,882  |  |   | 41,882 
|Loans, net                               |  |                        | 241,567 |                     |   | 240,189        |  |                     | 179,172 |  |   | 178,874
|Accrued interest receivable              |  |                        | 890     |                     |   | 890            |  |                     | 697     |  |   | 697    
|Stock in the Federal Home Loan Bank      |  |                        | 769     |                     |   | 769            |  |                     | 393     |  |   | 393    
|                                         |  |                        |         |                    
|Financial liabilities:                   |  |                        |         |                     |   |                |  |                     |         |  |   |        
|Deposits                                 |  | $                      | 269,133 |                     | $ | 268,694        |  | $                   | 208,548 |  | $ | 209,335
|Short-term borrowings                    |  |                        | 14,273  |                     |   | 14,284         |  |                     | 15,911  |  |   | 15,911 
|Long-term debt                           |  |                        | 5,155   |                     |   | 5,155          |  |                     | 6,000   |  |   | 6,171  
|Accrued interest payable                 |  |                        | 878     |                     |   | 878            |  |                     | 684     |  |   | 684    



NOTE N - EMPLOYEE AND DIRECTOR
BENEFIT PLANS



Stock Option Plans



During 2000 the Bank adopted, with shareholder approval, an Employee Stock Option Plan and a
Non-Employee Director Stock Option Plan. The Company assumed these plans in July 2002 as part of the Banks holding company reorganization. In 2003, the Company adopted, with shareholder approval, the 2003 Stock Plan. The 2003 Stock Plan
replaced the two prior plans. All shares available for issuance under the prior plans, plus any shares covered by outstanding options that are forfeited under the prior plans, were transferred to the 2003 Plan. An aggregate of 459,195 shares of the
Companys common stock is reserved for options. Certain of the options granted to directors in 2000 vested immediately at the time of grant. All other options granted vest 20% annually. All unexercised options expire ten years after the date of
grant. A summary of the Companys option plans as of and for the years ended December 31, 2004 and 2003, adjusted for the effects of the twenty-three-for-twenty stock split effected in the form of a 15% stock dividend in 2004 and adjusted for
the effects of the eleven-for-ten stock split effected in the form of a 10% stock dividend in 2003, is as follows:



F-24



---

##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2004 and 2003



NOTE N - EMPLOYEE AND DIRECTOR BENEFIT PLANS



Stock Option Plans (Continued)



|                     |  |                                 |   |  |                     |   |                     |                              |       |                   |         |   |                              |   |     
|-------------------- |  | ------------------------------- | - |  | ------------------- | - | ------------------- | ---------------------------- | ----- | ----------------- | ------- | - | ---------------------------- | - | ----
|                     |  |                                 |   |  | Outstanding Options |   | Exercisable Options
|                     |  | SharesAvailablefor FutureGrants |   |  | NumberOutstanding   |   |                     | WeightedAverageExercisePrice |       | NumberOutstanding |         |   | WeightedAverageExercisePrice
|At December 31, 2002 |  | 29,150                          |   |  | 431,574             |   |                     | $                            | 7.20  |                   | 235,445 |   |                              | $ | 7.19
|Options granted      |  | (14,548                         | ) |  | 14,548              |   |                     |                              | 8.70  |                   |        |   |                              |   |    
|Options vesting      |  |                                |   |  |                    |   |                     |                              |      |                   | 63,877  |   |                              |   | 7.22
|Option exercised     |  |                                |   |  | (26,633             | ) |                     |                              | 7.19  |                   | (26,633 | ) |                              |   | 7.19
|Options forfeited    |  | 24,270                          |   |  | (24,270             | ) |                     |                              | 7.19  |                   | (2,606  | ) |                              |   | 7.19
|                     |  |                                 |   |  |                     |   |                     |                              |       |                   |         |   |                              |   |     
|At December 31, 2003 |  | 38,872                          |   |  | 395,219             |   |                     |                              | 7.26  |                   | 270,083 |   |                              |   | 7.20
|Options granted      |  | (23,148                         | ) |  | 23,148              |   |                     |                              | 14.01 |                   |        |   |                              |   |    
|Options vesting      |  |                                |   |  |                    |   |                     |                              |      |                   | 58,503  |   |                              |   | 7.28
|Option exercised     |  |                                |   |  | (6,243              | ) |                     |                              | 7.19  |                   | (6,243  | ) |                              |   | 7.19
|Options forfeited    |  | 4,413                           |   |  | (4,413              | ) |                     |                              | 7.63  |                   | (1,219  | ) |                              |   | 7.19
|                     |  |                                 |   |  |                     |   |                     |                              |       |                   |         |   |                              |   |     
|At December 31, 2004 |  | 20,137                          |   |  | 407,711             |   |                     | $                            | 7.64  |                   | 321,124 |   |                              | $ | 7.21
|                     |  |                                 |   |  |                     |   |                     |                              |       |                   |         |   |                              |   |     



The weighted average remaining life of
options outstanding at December 31, 2004 is 7.8 years. The range of exercise prices for options outstanding at December 31, 2004 is $7.19 to $14.50. Information pertaining to options outstanding at December 31, 2004 is as follows:



|                           |  |                              |  |                             
|-------------------------- |  | ---------------------------- |  | ----------------------------
|Range of Exercise Prices   |  | Number ofOptions Outstanding |  | Number ofOptions Exercisable
|$7.19 - $8.70              |  | 384,851                      |  | 321,124                     
|$13.91 - $14.50            |  | 22,860                       |  |                            
|                           |  |                              |  |                             
|Outstanding at end of year |  | 407,711                      |  | 321,124                     
|                           |  |                              |  |                             



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



|                                         |  |      |          |   |      |   |          |  
|---------------------------------------- |  | ---- | -------- | - | ---- | - | -------- | -
|                                         |  | 2004 |          |   | 2003 |  
|Estimated fair value of options granted  |  | $    | 4.22     |   |      | $ | 3.73     |  
|                                         |  |      |          |   |      |   |          |  
|Assumptions in estimating option values: |  |      |          |   |      |   |          |  
|Risk-free interest rate                  |  |      | 3.81     | % |      |   | 3.50     | %
|Dividend yield                           |  |      | 0.00     | % |      |   | 0.00     | %
|Volatility                               |  |      | 25.00    | % |      |   | 25.00    | %
|Expected life                            |  |      | 10 years |   |      |   | 10 years |  



F-25



---

##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2004 and 2003



NOTE N - EMPLOYEE AND DIRECTOR BENEFIT PLANS (Continued)



Employment Agreements



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



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



Deferred Compensation Plan for Directors



In December 2001, the Company implemented a non-qualifying deferred compensation plan for outside directors. Under the plan, a participating director may elect to defer
receipt of all or a portion of his or her director fees that would otherwise be payable in cash. At the end of each calendar year, the fees electively deferred during the year are converted, using a formula based upon 125% of the dollar amount of
fees deferred and the average closing price of the Companys common stock for the 20 trading days preceding January 1, into a hypothetical number of shares (the phantom shares) credited to the participating directors account.
The then current value of all phantom shares accumulated under the plan is payable to the participating director, or to his or her designated beneficiary, upon retirement, disability or death. Provisions of $257,000 in 2004 and $123,000 in 2003 were
expensed to provide for future obligations payable under this plan.



F-26



---

##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2004 and 2003



NOTE O - PARENT COMPANY FINANCIAL DATA



Following are the condensed financial statements of North State Bancorp as of and for the years ended December 31, 2004 and 2003:



Condensed Statements of Financial Condition

December 31, 2004 and 2003

(Amounts in
thousands)



|                                                  |  |      |        |   |      |   |        |  
|------------------------------------------------- |  | ---- | ------ | - | ---- | - | ------ | -
|                                                  |  | 2004 |        |   | 2003 |  
|Assets                                            |  |      |        |   |      |   |        |  
|Cash                                              |  | $    | 209    |   |      | $ |       |  
|Investment in North State Bank                    |  |      | 23,670 |   |      |   | 17,514 |  
|Investment in North State Statutory Trust I       |  |      | 155    |   |      |   |       |  
|Other Assets                                      |  |      | 47     |   |      |   |       |  
|                                                  |  |      |        |   |      |   |        |  
|Total assets                                      |  | $    | 24,081 |   |      | $ | 17,514 |  
|                                                  |  |      |        |   |      |   |        |  
|Liabilities and Shareholders Equity Liabilities: |  |      |        |   |      |   |        |  
|Other liabilities                                 |  | $    | 12     |   |      | $ |       |  
|Junior subordinated debentures                    |  |      | 5,155  |   |      |   |       |  
|                                                  |  |      |        |   |      |   |        |  
|Total liabilities                                 |  |      | 5,167  |   |      |   |       |  
|                                                  |  |      |        |   |      |   |        |  
|Shareholders equity:                             |  |      |        |   |      |   |        |  
|Common stock                                      |  |      | 2,366  |   |      |   | 2,052  |  
|Additional paid-in capital                        |  |      | 14,110 |   |      |   | 14,379 |  
|Retained earnings                                 |  |      | 2,634  |   |      |   | 1,258  |  
|Accumulated other comprehensive loss              |  |      | (196   | ) |      |   | (175   | )
|                                                  |  |      |        |   |      |   |        |  
|Total shareholders equity                        |  |      | 18,914 |   |      |   | 17,514 |  
|                                                  |  |      |        |   |      |   |        |  
|Total liabilities and shareholders equity        |  | $    | 24,081 |   |      | $ | 17,514 |  
|                                                  |  |      |        |   |      |   |        |  



F-27



---

##### Table of Contents

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2004 and 2003



NOTE O - PARENT COMPANY FINANCIAL DATA (Continued)



Condensed Statements of Operations

Years Ended December 31, 2004 and 2003

(Amounts in thousands)



|                                 |  |      |       |   |      |   |    
|-------------------------------- |  | ---- | ----- | - | ---- | - | ---
|                                 |  | 2004 |       |   | 2003
|Equity in earnings of subsidiary |  | $    | 1,551 |   |      | $ | 979
|Interest income                  |  |      | 2     |   |      |   |   
|Interest expense                 |  |      | (182  | ) |      |   |   
|Other income                     |  |      | 5     |   |      |   |   
|                                 |  |      |       |   |      |   |    
|Net income                       |  | $    | 1,376 |   |      | $ | 979
|                                 |  |      |       |   |      |   |    



Condensed Statements of
Cash Flows

Years Ended December 31, 2004 and 2003

(Amounts in thousands)



|                                                                              |  |      |        |   |      |   |      |  
|----------------------------------------------------------------------------- |  | ---- | ------ | - | ---- | - | ---- | -
|                                                                              |  | 2004 |        |   | 2003 |  
|Cash flows from operating activities:                                         |  |      |        |   |      |   |      |  
|Net income                                                                    |  | $    | 1,376  |   |      | $ | 979  |  
|Adjustments to reconcile net income to net cash used in operating activities: |  |      |        |   |      |   |      |  
|Amortization                                                                  |  |      | 3      |   |      |   |     |  
|Equity in earnings of North State Bank                                        |  |      | (1,551 | ) |      |   | (979 | )
|Changes in assets and liabilities:                                            |  |      |        |   |      |   |      |  
|Increase in other assets                                                      |  |      | (50    | ) |      |   |     |  
|Increase in other liabilities                                                 |  |      | 12     |   |      |   |     |  
|                                                                              |  |      |        |   |      |   |      |  
|Net cash used in operating activities                                         |  |      | (210   | ) |      |   |     |  
|                                                                              |  |      |        |   |      |   |      |  
|Cash flows from investing activities:                                         |  |      |        |   |      |   |      |  
|Investment in North State Bank                                                |  |      | (4,626 | ) |      |   | (191 | )
|Investment in North State Statutory Trust I                                   |  |      | (155   | ) |      |   |     |  
|                                                                              |  |      |        |   |      |   |      |  
|Net cash used in investing activities                                         |  |      | (4,781 | ) |      |   | (191 | )
|                                                                              |  |      |        |   |      |   |      |  
|Cash flows from financing activities:                                         |  |      |        |   |      |   |      |  
|Issuance of junior subordinated debentures                                    |  |      | 5,155  |   |      |   |     |  
|Proceeds from stock options exercised                                         |  |      | 45     |   |      |   | 191  |  
|                                                                              |  |      |        |   |      |   |      |  
|Net cash provided from financing activities                                   |  |      | 5,200  |   |      |   | 191  |  
|                                                                              |  |      |        |   |      |   |      |  
|Net increase in cash and cash equivalents                                     |  |      | 209    |   |      |   |     |  
|Cash and cash equivalents, beginning                                          |  |      |       |   |      |   |     |  
|                                                                              |  |      |        |   |      |   |      |  
|Cash and cash equivalents, ending                                             |  | $    | 209    |   |      | $ |     |  
|                                                                              |  |      |        |   |      |   |      |  



F-28



---

##### Table of Contents

SIGNATURES



In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.



|                     |  |                     |  |                                                        
|-------------------- |  | ------------------- |  | -------------------------------------------------------
|                     |  | NORTH STATE BANCORP
|                     |  |                    
|Date: March 28, 2005 |  | By:                 |  | /s/ Larry D. Barbour                                   
|                     |  |                     |  | Larry D. Barbour, President and Chief Executive
Officer



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



|                                               |  |                                                                               |  |               
|---------------------------------------------- |  | ----------------------------------------------------------------------------- |  | --------------
|Signature                                      |  | Title                                                                         |  | Date          
|/s/ Larry D. BarbourLarry D. Barbour           |  | President, Chief Executive Officer and Director (principal executive officer) |  | March 28, 2005
|                                               |  |                                                                              
|/s/ Kirk A. WhorfKirk A. Whorf                 |  | Chief Financial Officer (principal financial and accounting officer)          |  | March 28, 2005
|                                               |  |                                                                              
|/s/ Forrest H. BallForrest H. Ball             |  | Director                                                                      |  | March 28, 2005
|                                               |  |                                                                              
|James C. Branch                                |  | Director                                                                      |  | March , 2005  
|                                               |  |                                                                              
|/s/ Charles T. FrancisCharles T. Francis       |  | Director                                                                      |  | March 28, 2005
|                                               |  |                                                                              
|/s/ Glenn FutrellGlenn Futrell                 |  | Director                                                                      |  | March 28, 2005
|                                               |  |                                                                              
|/s/ C. Thomas HendricksonC. Thomas Hendrickson |  | Director                                                                      |  | March 28, 2005
|                                               |  |                                                                              
|/s/ Jeanette W. HydeJeanette W. Hyde           |  | Director                                                                      |  | March 28, 2005



S-1



---

##### Table of Contents

|                                                   |  |          |  |               
|-------------------------------------------------- |  | -------- |  | --------------
|/s/ J. Keith KeenerJ. Keith Keener                 |  | Director |  | March 28, 2005
|                                                   |  |         
|/s/ Burley B. Mitchell, Jr.Burley B. Mitchell, Jr. |  | Director |  | March 28, 2005
|                                                   |  |         
|/s/ Barry W. PartloBarry W. Partlo                 |  | Director |  | March 28, 2005
|                                                   |  |         
|/s/ Gary H. PendletonGary H. Pendleton             |  | Director |  | March 28, 2005
|                                                   |  |         
|/s/ W. Harold PerryW. Harold Perry                 |  | Director |  | March 28, 2005
|                                                   |  |         
|/s/ Nutan T. ShahNutan T. Shah                     |  | Director |  | March 28, 2005
|                                                   |  |         
|/s/ Fred J. Smith, Jr.Fred J. Smith, Jr.           |  | Director |  | March 28, 2005
|                                                   |  |         
|/s/ Jack M. StancilJack M. Stancil                 |  | Director |  | March 28, 2005
|                                                   |  |         
|/s/ George C. VentersGeorge C. Venters             |  | Director |  | March 28, 2005



S-2