U. S. Securities and Exchange Commission

Washington, D.C. 20549





Form 10-K





ANNUAL REPORT UNDER SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF
1934

For the fiscal year ended December 31, 2007

Commission File Number 000-49848





MIDCAROLINA FINANCIAL
CORPORATION

(Name of Issuer in Its Charter)







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



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

(336) 538-1600

(Issuers Telephone Number, Including Area Code)





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



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





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

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No   ̈

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

Indicate by check mark whether the
registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company, (as defined in Rule 12b-2 of the Exchange Act).



|                           |  |                            |  | 
|-------------------------- |  | -------------------------- |  | 
|Large Accelerated filer   ̈ |  | Accelerated filer   ̈       |  | 
|                           |  |                           
|Non-accelerated filer   ̈   |  | Smaller reporting filer  x |  | 

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

The aggregate market value of the Registrants voting and non-voting equity, held by non affiliates, computed by reference to the average bid and asked price of such common equity, as of the last business day of
the Registrants most recently completed second fiscal quarter was $55.5 million.

State the number of shares outstanding of each of
the issuers classes of common equity, as of the latest practicable date. 4,919,251 shares of common stock, no par value, as of March 15, 2008.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the 2008 Annual Meeting of Shareholders of
MidCarolina Financial Corporation, to be held on May 27, 2008 (the Proxy Statement), are incorporated by reference into Part III.









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Statement Regarding Forward Looking Statements

This Annual Report on Form 10-K contains certain forward-looking statements with respect to the financial condition, results of operations and business of MidCarolina
Financial Corporation (Company) and its banking subsidiary, MidCarolina Bank (Bank). These forward-looking statements involve risks and uncertainties and are based on the beliefs and assumptions of management of the Company
and the Bank and on the information available to management at the time that these disclosures were prepared. These statements can be identified by the use of words like expect, anticipate, estimate and
believe, variations of these words and other similar expressions. Readers should not place undue reliance on forward-looking statements as a number of important factors could cause results to differ materially from those in the
forward-looking statements. Factors that could cause actual results to differ materially include, but are not limited to, (1) competition in the Banks markets, (2) changes in the interest rate environment, (3) general national,
regional or local economic conditions may be less favorable than expected, resulting in, among other things, a deterioration in credit quality and the possible impairment of collectibility of loans, (4) legislative or regulatory changes
including changes in accounting standards, (5) significant changes in the federal and state legal and regulatory environment and tax laws, (6) the impact of changes in monetary and fiscal policies, laws, rules, and regulations and
(7) other risks and factors identified in the Companys other filings with the Securities and Exchange Commission. The Company undertakes no obligation to update any forward-looking statements.



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PART I



|ITEM 1. | DESCRIPTION OF BUSINESS
|------- | -----------------------

General

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

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

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

The Banks primary market area is
Alamance County and Guilford County, North Carolina. The Banks main office is located in Burlington, North Carolina. The Bank also has one full-service branch in Burlington, NC, one full-service branch in Graham, North Carolina, two
full-service branches in Greensboro, North Carolina and one full-service branch in Mebane, North Carolina. The Bank has limited service offices in the Alamance Regional Medical Center and the Village of Brookwood Retirement Center, both of which are
located in Burlington. The Banks loans and deposits are primarily generated from the areas where its offices are located.

The Banks primary
sources of revenue are interest and fee income from its lending activities. These lending activities consist principally of originating commercial operating and working capital loans, residential mortgage loans, home equity lines of credit, other
consumer loans and loans secured by commercial real estate. The Banks current lending strategy is to establish market share throughout Alamance and Guilford Counties, with an emphasis in Burlington, Graham, Greensboro amd Mebane. At
December 31, 2007, the largest amount the Bank had outstanding to any one borrower and its affiliates was approximately $5.3 million.

Interest and
dividend income from investment activities generally provide the second largest source of income to the Bank after interest on loans. During 2007, the Bank chose to manage its overall liquidity position by marginally increasing the average balance
of its securities portfolio and deploying more of its funds into lower risk mortgage-backed securities with short durations, U.S. Agency securities and State and Local Government issued federally tax-exempt securities. The interest and dividends
earned from the investment portfolio therefore increased during 2007.

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

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



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The Bank is the sole banking subsidiary of the Company. Two trusts (MidCarolina I and MidCarolina Trust II) were formed
as subsidiaries of the Company to facilitate the infusion of Trust Preferred Securities as a form of non-dilutive equity into the Company. The trusts are not consolidated in these financial statements. The majority of the Companys operations
are located at the Bank level. Throughout this Annual Report on Form 10-K, results of operations will be discussed by referring to the Banks operations, unless a specific reference is made to the Company and its operating results apart from
the Bank.

The Bank has continued to experience steady growth since its formation in 1997. The Banks assets totaled $466.5 million, $420.9 million
and $370.4 million as of December 31, 2007, 2006 and 2005, respectively. The Company had net income available to shareholders for the year ended December 31, 2007 of $4.5 million, or $0.92 per diluted share. When adjusted for an after-tax
one time adjustment of $579,000 related to the reversal of accrued benefits originally designated for the benefit of a former executive officer, diluted earnings per common share for 2007 were $0.80, compared with $3.5 million, or $0.73 per diluted
share for the year ended December 31, 2006. The per share amounts have been adjusted to reflect the 5-for-4 stock split effective January 19, 2007.

At December 31, 2007, the Company had total assets of $467.2 million, net loans of $367.2 million, deposits of $373.9 million, investment securities available-for-sale of $70.8 million and shareholders equity of $33.2 million.

Subsidiaries

Other than the Bank, the Company has two
trust subsidiaries: MidCarolina I and MidCarolina Trust II. The Banks only subsidiary, MidCarolina Investments, Inc, was dormant during 2007. MidCarolina Investments engaged in general securities brokerage and offered insurance and other
financial services through a contract arrangement with a third-party provider. The Bank continues to offer these services through a third-party provider.

Employees

At December 31, 2007, the Bank had 77 full-time equivalent employees.

Competition and Market Area

The Bank faces strong competition both
in attracting deposits and making real estate and other loans. Its most direct competition for deposits comes from commercial banks, savings institutions and credit unions located in its primary market area, including large financial institutions
that have greater financial and marketing resources available to them. At December 31, 2007, there were 16 depository institutions with 50 offices in Alamance County. The Bank had a deposit market share of 13.9% in Alamance County. The Bank
also faces additional significant competition for investors funds from short-term money market securities and other corporate and government securities. The ability of the Bank to attract and retain savings deposits depends on its ability to
generally provide a rate of return, liquidity and risk comparable to that offered by competing investment opportunities.

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

The
Banks primary market area is Alamance County. The population of Alamance County is 139,786 and the median household income is $40,365. Alamance County has a diverse economy with no concentration in any one specific industry. Major businesses
and industries in the area include LabCorp, a laboratory that provides specialized testing services for the medical industry, Alamance Health Services, Elon University, Honda Power Equipment Manufacturing and GKN Automotive, a manufacturer of
automobile drive shafts.

Supervision and Regulation

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



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

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

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

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

Capital Requirements for the Bank.The Bank, as a North Carolina commercial
bank, is required to maintain a surplus account equal to 50% or more of its paid-in capital stock. As a North Carolina chartered, FDIC-insured commercial bank that is not a member of the Federal Reserve, the Bank is also subject to capital
requirements imposed by the FDIC. Under the FDICs regulations, state nonmember banks that (a) receive the highest rating during the examination process and (b) are not anticipating or experiencing any significant growth, are required
to maintain a minimum leverage ratio of 3% of total consolidated assets; all other banks are required to maintain a minimum ratio of 1% or 2% above the stated minimum, with a minimum leverage ratio of not less than 4%. The Bank exceeded all
applicable capital requirements as of December 31, 2007.

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



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

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

Deposit Insurance. The deposits of the Bank are currently insured to a maximum of $100,000 per depositor, subject to aggregation rules. The FDIC establishes rates for the payment of premiums by federally insured banks and thrifts for
deposit insurance. Since 1993, insured depository institutions like the Bank have paid for deposit insurance under a risk-based premium system. Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in
unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order, or condition imposed by the FDIC. Due to its severe consequences, the FDIC historically uses
insurance termination as an enforcement action of last resort and the termination process itself involves substantial notice, a formal adjudicative hearing and federal appellate review. In instances where insurance deposit is terminated, the
financial institution is required to notify its depositors and insured funds on the date of termination that they will continue to be insured for at least six months and up to two years, at the discretion of the FDIC. After the date of termination,
no new deposits accepted by the financial institution will be federally insured.

Federal Deposit Insurance Reform. On February 8, 2006,
President Bush signed the Federal Deposit Insurance Reform Act of 2005 (FDIRA). The FDIC was required to adopt rules implementing the various provisions of FDIRA by November 5, 2006. Among other things, FDIRA changes the federal deposit
insurance system by:



| |  |  | raising the coverage level for retirement accounts to $250,000;
| | - |  | ---------------------------------------------------------------



| |  |  | indexing deposit insurance coverage levels for inflation beginning in 2012;
| | - |  | ---------------------------------------------------------------------------



| |  |  | prohibiting undercapitalized financial institutions from accepting employee benefit plan deposits;
| | - |  | --------------------------------------------------------------------------------------------------



| |  |  | merging the Bank Insurance Fund and Savings Association Insurance Fund into a new Deposit Insurance Fund (the DIF); and
| | - |  | -----------------------------------------------------------------------------------------------------------------------



| |  |  | providing credits to financial institutions that capitalized the FDIC prior to 1996 to offset future assessment premiums.
| | - |  | -------------------------------------------------------------------------------------------------------------------------

FDIRA also authorizes the FDIC to revise the current risk-based assessment system, subject to notice and comment and caps the amount of the DIF at 1.50% of domestic
deposits. The FDIC must issue cash dividends, awarded on a historical basis, for the amount of the DIF over the 1.50% ratio. Additionally, if the DIF exceeds 1.35% of domestic deposits at year-end, the FDIC must issue cash dividends, awarded on a
historical basis, for half of the amount of the excess.

Deposit Insurance Assessments. The Bank is subject to insurance assessments imposed by the
FDIC. Under current law, the insurance assessment to be paid by members of the Deposit Insurance Fund, such as the Bank, is specified in a schedule required to be issued by the FDIC. Prior to January 1, 2007, FDIC assessments for deposit
insurance ranged from 0 to 27 basis points per $100 of insured deposits, depending on the institutions capital position and other supervisory factors. Effective January 1, 2007, the assessments range from 5 to 43 basis points per $100 of
insured deposits. The assessment rate schedule can change from time to time, at the discretion of the FDIC, subject to certain limits. Under the current system, premiums are charged quarterly.

Federal Home Loan Bank System.The Federal Home Loan Bank System provides a central credit facility for member institutions. In December 2004, the FHLB of Atlanta
implemented a new capital plan. As a member of the FHLB of Atlanta and under the new capital plan, the Bank is required to own capital stock in the FHLB of Atlanta in an amount equal to at least 0.20% (or 20 basis points) of the Banks total
assets at the end of each calendar year, plus 4.5% of its outstanding advances (borrowings) from the FHLB under the new activity-based stock ownership requirement. On December 31, 2007, the Bank was in compliance with this requirement.



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Community Reinvestment.Under the Community Reinvestment Act (CRA), as implemented by regulations of
the FDIC, an insured institution has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not
establish specific lending requirements or programs for financial institutions, nor does it limit an institutions discretion to develop, consistent with the CRA, the types of products and services that it believes are best suited to its
particular community. The CRA requires the federal banking regulators, in connection with their examinations of insured institutions, to assess the institutions records of meeting the credit needs of their communities, using the ratings of
outstanding, satisfactory, needs to improve, or substantial noncompliance, and to take those records into account in its evaluation of certain applications by those institutions. All institutions are
required to make public disclosure of their CRA performance ratings. The Bank received a satisfactory rating in its last CRA examination that was conducted during August 2007.

Prompt Corrective Action.The FDIC has broad powers to take corrective action to resolve the problems of insured depository institutions. The extent of these
powers will depend upon whether the institution in question is well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized or critically undercapitalized.
Under the regulations, an institution is considered well capitalized if it has (i) a total risk-based capital ratio of 10% or greater, (ii) a Tier I risk-based capital ratio of 6% or greater, (iii) a leverage ratio of 5%
or greater and (iv) is not subject to any order or written directive to meet and maintain a specific capital level for any capital measure. An adequately capitalized institution is defined as one that has (i) a total risk-based
capital ratio of 8% or greater, (ii) a Tier I risk-based capital ratio of 4% or greater and (iii) a leverage ratio of 4% or greater (or 3% or greater in the case of an institution with the highest examination rating). An institution is
considered (A) undercapitalized if it has (i) a total risk-based capital ratio of less than 8%, (ii) a Tier I risk-based capital ratio of less than 4% or (iii) a leverage ratio of less than 4% (or 3% in the case of an
institution with the highest examination rating); (B) significantly undercapitalized if the institution has (i) a total risk-based capital ratio of less than 6%, or (ii) a Tier I risk-based capital ratio of less than 3% or
(iii) a leverage ratio of less than 3%; and (C) critically undercapitalized if the institution has a ratio of tangible equity to total assets equal to or less than 2%. At December 31, 2007, the Bank had the requisite
capital levels to qualify as well capitalized.

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

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

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



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

Gramm-Leach-Bliley Act. The federal Gramm-Leach-Bliley Act enacted in 1999 (the GLB Act) dramatically changed various federal laws governing the
banking, securities and insurance industries. The GLB Act has expanded opportunities for banks and bank holding companies to provide services and engage in other revenue-generating activities that previously were prohibited to them. In doing so it
increased competition in the financial services industry, presenting greater opportunities to our larger competitors who were more able to expand their services and products than smaller oriented financial institutions, such as the Bank.

USA Patriot Act of 2001. The USA Patriot Act of 2001 was enacted in response to the terrorist attacks that occurred in New York, Pennsylvania and Washington,
D.C. on September 11, 2001. The Act is intended to strengthen the ability of U.S. law enforcement and the intelligence community to work cohesively to combat terrorism on a variety of fronts. The impact of the Act on financial institutions of
all kinds is significant and wide ranging. The Act contains sweeping anti-money laundering and financial transparency laws and imposes various regulations, including standards for verifying customer identification at account opening and rules to
promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering.

Sarbanes-Oxley Act of 2002.The Sarbanes-Oxley Act of 2002 was signed into law and included significant changes addressing accounting, corporate governance and disclosure issues. The impact of the
Sarbanes-Oxley Act is wide-ranging as it applies to all public companies and imposes significant new requirements for public company governance and disclosure requirements.

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

The economic and operational effects of this Act on public companies, including the Bank, has been and is expected to continue to be significant in terms of the time, resources and costs associated with complying with
the law.

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

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

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



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



|ITEM 1A. | Risk Factors
|-------- | ------------

The Company is subject to certain risks. In addition
to the factors discussed below, please see the discussion under Item 7A. Quantitative and Qualitative Disclosure about Market Risk beginning on page 46. These factors, along with the other information in this Annual Report on Form 10-K,
should be considered in evaluating forward-looking statements, and undue reliance should not be placed on such statements.

We may have higher credit
losses than the reserve we have set aside

Our credit losses could exceed the allowance for credit losses we have set aside. Our average loan size
continues to increase. Reliance on historic credit loss experience may not be indicative of future credit losses. Approximately 71.7% of our loan portfolio is composed of construction, commercial mortgage and commercial loans. Repayment of such
loans is generally considered more vulnerable to market risk than residential mortgage loans. Industry experience shows that a portion of loans will become delinquent and a portion of the loans will require partial or entire charge-off. Regardless
of the underwriting criteria we utilize, losses may be experienced as a result of various factors beyond our control, including, among other things, changes in market conditions affecting the value of our loan collateral and problems affecting the
credit repayment capacity of our borrowers.

A significant amount of the Banks business is concentrated in lending which is secured by property
located in Alamance and Guilford Counties and surrounding areas

In addition to the financial strength and cash flow characteristics of the borrower in
each case, the Bank often secures its loans with real estate collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the
credit is extended. If the Bank is required to liquidate the collateral securing a loan during a period of reduced real estate values to satisfy the debt, the Banks earnings and capital could be adversely affected.

Additionally, with most of the Banks loans concentrated in Alamance and Guilford Counties and surrounding areas, a decline in local economic conditions could
adversely affect the values of the Banks real estate collateral. Consequently, a decline in local economic conditions may have a greater effect on the Banks earnings and capital than on the earnings and capital of larger financial
institutions whose real estate loan portfolios are geographically diverse.

Changes in technology may impact the Banks business

The Bank uses various technologies in its business and the banking industry is undergoing rapid technological changes. The effective use of technology increases
efficiency and enables financial institutions to reduce costs. The Banks future success will depend in part on its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer
demands for convenience as well as create additional efficiencies in the Banks operations. The Banks competitors may have substantially greater resources to invest in technological improvements.

The small amount of trading volume in our common stock can cause price volatility

The trading history of our common stock has been characterized by relatively low trading volume. The value of a shareholders investment may be subject to sudden decreases due to the volatility of the price of
our common stock, which is traded over-the-counter, with quotations available on the National Daily Quotation Services Bulletin Board. The market price of our common stock may be volatile and subject to fluctuations in response to
numerous factors, including, but not limited to, the factors discussed in other risk factors and the following:



| |  |  | actual or anticipated fluctuation in our operating results;
| | - |  | -----------------------------------------------------------



9



---

| |  |  | changes in interest rates;
| | - |  | --------------------------



| |  |  | changes in the legal or regulatory environment in which we operate;
| | - |  | -------------------------------------------------------------------



| |  |  | press releases, announcements or publicity relating to us or our competitors or relating to trends in our industry;
| | - |  | -------------------------------------------------------------------------------------------------------------------



| |  |  | changes in expectations as to our future financial performance, including financial estimates or recommendations by securities analysts and investors;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | future sales of our common stock;
| | - |  | ---------------------------------



| |  |  | changes in economic conditions in our market, general conditions in the U.S. economy, financial markets or the banking industry; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------



| |  |  | other developments affecting us or our competitors.
| | - |  | ---------------------------------------------------

These factors may adversely affect the trading price of our common stock, regardless of our actual operating performance, and could prevent a shareholder from selling common stock at or above the current market price.

Our growth strategy may not be successful.

As a strategy, we have
sought to increase the size of our franchise by aggressively pursuing business development opportunities, and we have grown rapidly during the last decade. We can provide no assurance that we will continue to be successful in increasing the volume
of our loans and deposits at acceptable risk levels and upon acceptable terms, expanding our asset base while managing the costs and implementation risks associated with this growth strategy. There can be no assurance that any further expansion will
be profitable or that we will continue to be able to sustain our historical rate of growth, either through internal growth or through other successful expansions of our banking markets, or that we will be able to maintain capital sufficient to
support our continued growth.

Interest rate volatility could significantly harm our business.

The Companys results of operations are affected by the monetary and fiscal policies of the federal government and the regulatory policies of governmental
authorities. The principal component of the Companys earnings is the net interest income of the Bank. Net interest income is the difference between income from interest-earning assets, such as loans, and the expense of interest-bearing
liabilities, such as deposits. We may not be able to effectively manage changes in what we charge as interest on our earning assets and the expense we must pay on interest-bearing liabilities, which may significantly reduce our earnings. The Federal
Reserve has made significant changes in interest rates. Since rates charged on loans often tend to react to market conditions faster than do rates paid on deposit accounts, these rate changes may have a negative impact on our earnings until we can
make appropriate adjustments in our deposit rates. In addition, there are costs associated with our risk management techniques, and these costs could be material. Fluctuations in interest rates are not predictable or controllable and, therefore,
there can be no assurances of our ability to continue to maintain a consistent positive spread between the interest earned on our earning assets and the interest paid on our interest-bearing liabilities.

If we lose key employees with significant business contacts in our market area, our business may suffer.

Our success is largely dependent on the personal contacts of our officers and employees in our market areas. If we lose key employees temporarily or permanently, our
business could be hurt. We could be particularly hurt if our key employees go to work for competitors. Our future success depends on the continued contributions of our existing senior management personnel, many of whom have significant local
experience and contacts in our market areas.

Government regulations may prevent or impair our ability to pay dividends, engage in additional
acquisitions, or operate in other ways.

Current and future legislation and the policies established by federal and state regulatory authorities will
affect our operations. We are subject to supervision and periodic examination by the Reserve Bank and the Commission. Our subsidiary bank, as a state chartered commercial bank, also receives regulatory scrutiny from the FDIC and the Commission.
Banking regulations, designed primarily for the protection of depositors, may limit our growth and the return to you as an investor in our Company, by restricting our activities, such as:



| |  |  | the payment of dividends to shareholders;
| | - |  | -----------------------------------------



10



---

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



| |  |  | desired investments;
| | - |  | --------------------



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



| |  |  | the level of our allowance for loan losses;
| | - |  | -------------------------------------------



| |  |  | imposing higher capital requirements;
| | - |  | -------------------------------------



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



| |  |  | the possible expansion of branch offices; and
| | - |  | ---------------------------------------------



| |  |  | the ability to provide other services.
| | - |  | --------------------------------------

We cannot
predict what changes, if any, will be made to existing federal and state legislation and regulations or the effect that such changes may have on our business. The cost of compliance with regulatory requirements may adversely affect our ability to
operate profitably.

We may be subject to examinations by taxing authorities which could adversely affect our results of operations.

In the normal course of business, we may be subject to examinations from federal and state taxing authorities regarding the amount of taxes due in connection with
investments we have made and the businesses in which we are engaged. Recently, federal and state taxing authorities have become increasingly aggressive in challenging tax positions taken by financial institutions. The challenges made by taxing
authorities may result in adjustments to the timing or amount of taxable income or deductions or the allocation of income among tax jurisdictions. If any such challenges are made and are not resolved in our favor, they could have an adverse effect
on our financial condition and results of operations.

We face strong competition in our market areas, which may limit our asset growth and
profitability.

The banking business in our market areas is very competitive, and the level of competition facing us may increase further, which may
limit our asset growth and/or profitability. We experience competition in both lending and attracting deposits from other banks and nonbank financial institutions located within our market area, some of which are significantly larger institutions.
Nonbank competitors for deposits and deposit-type accounts include savings associations, credit unions, securities firms, money market funds, life insurance companies and the mutual funds industry. For loans, we encounter competition from other
banks, savings associations, finance companies, mortgage bankers and brokers, insurance companies, small loan and credit card companies, credit unions, pension trusts and securities firms.

The Companys common stock is not FDIC insured.

The common
stock of the Company is not a savings or deposit account or other obligation of any bank and is not insured by the Federal Deposit Insurance Corporation or any other governmental agency and is subject to investment risk, including loss of principal.



|ITEM 2. | DESCRIPTION OF PROPERTY
|------- | -----------------------

The Bank owns its main office, which is
located at 3101 South Church Street in Burlington, as well as its full-service branch offices located at 5509-A West Friendly Avenue, Suite 102, Greensboro, North Carolina and 842 South Main Street, Graham, North Carolina. The Bank leases its
full-service offices located at Cum-Park Plaza, 2214 North Church Street, Burlington; 701 Green Valley Road, Greensboro; and 1107 South Fifth Street, Mebane, North Carolina. The Bank occupies space in the Alamance Regional Medical Center in
Burlington from which it operates a limited-service office as well as a limited-service office located in the Village of Brookwood Retirement Center located in Burlington.

The total net book value of the Banks furniture, fixtures, leasehold improvements, land, buildings and equipment at December 31, 2007 was approximately $6.8 million. All properties are considered by the
Banks management to be in good condition and adequately covered by insurance. Additional information about this property is set forth in Note (F) to the Consolidated Financial Statements contained in Item 8 of this Annual Report on
Form 10-K, which note is incorporated herein by reference.



11



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|ITEM 3. | LEGAL PROCEEDINGS
|------- | -----------------

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



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

No matter was
submitted to a vote of the stockholders of the Company during the fourth quarter of the fiscal year ended December 31, 2007.

PART II



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

There currently is a limited trading market for the Companys common stock, and there can be no assurance that a more active market will develop. The Companys
common stock is traded over-the-counter with quotations available on the National Daily Quotation Services Bulletin Board under the symbol MCFI. There were 1,599 stockholders of record as of February 5, 2008, not
including the persons or entities whose stock is held in nominee or street name and by various banks and brokerage firms.

The table below
presents the over-the-counter market quotations for the Companys common stock for the year- ended December 31, 2007 and 2006. The quotations, which have been adjusted to reflect declared stock splits in the form of stock dividends in 2007
and 2006, reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not represent actual transactions.



|               |  |      |       |     |   |      
|-------------- |  | ---- | ----- | --- | - | -----
|               |  | High |       | Low
|2007           |  |      |       |     |   |      
|First quarter  |  | $    | 19.60 |     | $ | 12.75
|Second quarter |  | $    | 15.00 |     | $ | 13.70
|Third quarter  |  | $    | 14.95 |     | $ | 12.50
|Fourth quarter |  | $    | 13.75 |     | $ | 9.00 
|               |  |     
|2006           |  |      |       |     |   |      
|First quarter  |  | $    | 18.18 |     | $ | 10.51
|Second quarter |  | $    | 16.00 |     | $ | 13.09
|Third quarter  |  | $    | 15.12 |     | $ | 13.20
|Fourth quarter |  | $    | 16.00 |     | $ | 13.60



12



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The following graph and index compare (i) the yearly change in the cumulative total stockholders return on the
Companys common stock with (ii) the cumulative return of the Nasdaq Composite, and (iii) the Nasdaq Bank index. The graph and index assume that the value of an investment in the Companys common stock was $100.00 on
December 31, 2002, and that all dividends were reinvested. The performance shown in the graph and index represents past performance and should not be considered an indication of future performance.

MidCarolina Financial Corporation

LOGO



|                                  |  |               |  |          |  |          |  |          |  |          |  |         
|--------------------------------- |  | ------------- |  | -------- |  | -------- |  | -------- |  | -------- |  | --------
|                                  |  | Period Ending
|Index                             |  | 12/31/02      |  | 12/31/03 |  | 12/31/04 |  | 12/31/05 |  | 12/31/06 |  | 12/31/07
|MidCarolina Financial Corporation |  | 100.00        |  | 147.96   |  | 176.84   |  | 180.00   |  | 274.42   |  | 165.00  
|NASDAQ Composite                  |  | 100.00        |  | 150.01   |  | 162.89   |  | 165.13   |  | 180.85   |  | 198.60  
|NASDAQ Bank                       |  | 100.00        |  | 129.93   |  | 144.21   |  | 137.97   |  | 153.15   |  | 119.35  

Recent Sale of Unregistered Securities

The following table provides information with respect to all securities sold by the Company during the three years ended December 31, 2007 that were not registered under the Securities Act of 1933, as amended.
All of the sales concern exercises of options to purchase shares of the Companys common stock by participants in the Companys employee or director stock option plans and did not involve underwriters. The sales are exempt from
registration under Section 4(2) of the Securities Act of 1933, as amended, by virtue of being transactions not involving any public offering.



|             |  |                      |  |                                |      |                |   |          
|------------ |  | -------------------- |  | ------------------------------ | ---- | -------------- | - | ---------
|Year of Sale |  | Number ofshares sold |  | Averageexercise priceper share |      | Aggregateprice
|2005         |  | 7,734                |  | $                              | 2.75 |                | $ | 21,269   
|2006         |  | 219,607              |  | $                              | 4.99 |                | $ | 1,095,839
|2007         |  | 65,301               |  | $                              | 2.94 |                | $ | 191,985  



13



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Recent Repurchase of Companys Securities

The Company did not repurchase any of its securities in the last quarter of the fiscal year ending December 31, 2007.

Securities Authorized for Issuance Under Equity Compensation Plans

In 1998, the Banks board of directors and shareholders approved a
non-qualified stock option plan for certain Bank directors, and an incentive stock option plan for certain officers and key employees (together the 1998 Plans). In 2004, the Companys Board of Directors and shareholders approved the
MidCarolina Financial Corporation Omnibus Equity Compensation Plan (the 2004 Omnibus Plan). For more information on these plans, see Note L in the Notes to Consolidated Financial Statements of this Annual Report on Form 10-K.

The following table presents, as of December 31, 2007, the numbers of shares of common stock to be issued upon the exercise of outstanding options, warrants and
rights, the weighted-average price of the outstanding options, warrants and rights, and the number of securities remaining that may be issued under the 1998 Plans and 2004 Omnibus Plan.

EQUITY COMPENSATION PLAN INFORMATION



|                                                           |  |                                                                                            |        |  |                                                                                 |      |                                                                                                                                             |        
|---------------------------------------------------------- |  | ------------------------------------------------------------------------------------------ | ------ |  | ------------------------------------------------------------------------------- | ---- | ------------------------------------------------------------------------------------------------------------------------------------------- | -------
|Plan category                                              |  | (a) Number of sharesto be issued uponexercise
ofoutstanding options,warrants and rights(2) |        |  | (b) Weighted-averageexercise price ofoutstanding options,warrants and rights(2) |      | (c) Number of securities remainingavailable for future issuance underequity compensation plans (excludingshares reflected in column (a))(2)
|Equity compensation plans approved by our stockholders     |  | 536,519                                                                                    | (1)(2) |  | $                                                                               | 5.53 |                                                                                                                                             | 202,309
|Equity compensation plans not approved by our stockholders |  |                                                                                           |        |  | $                                                                               |     |                                                                                                                                             |       
|Total                                                      |  | 536,519                                                                                    |        |  | $                                                                               | 5.53 |                                                                                                                                             | 202,309



|(1) | Of the 536,519 stock options issued under the 1998 Plans and the 2004 Omnibus Plan, a total of 522,519 of those stock
options have vested or are exercisable within 60 days.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | All per share data has been restated to reflect the effects of a stock split effected in the form of a 10% stock
dividend in 2002, a stock split effected in the form of a 20% stock dividend in 2003 and 2004, a stock split effected in the form of a 25% stock dividend in 2005, a stock split effected in the form of a 10% stock dividend in 2006 and a 25% stock
split in the form of a stock dividend in January 2007.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



14



---

See ITEM 1. DESCRIPTION OF BUSINESS  Supervision and Regulation above, and NOTE P 
Shareholders Equity  Notes to Consolidated Financial Statements below for regulatory restrictions which limit the ability of the Bank to pay dividends. Except for cash dividends paid by the Bank to MidCarolina Financial Corporation, the
Company has not paid any cash dividends to common stockholders from the time either began operations through December 31, 2007. Management believes that the most effective use of its capital is to retain it for the purpose of supporting
continued growth in earning assets. The Company paid cash dividends in the amount of $417 thousand to non-cumulative perpetual preferred stockholders during 2007. Cash dividends in the amount of $417 thousand were paid to non-cumulative perpetual
preferred stockholders during 2006.



15



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|ITEM 6. | SELECTED FINANCIAL DATA
|------- | -----------------------

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

MidCarolina
Financial Corporation

Table 1

Selected
Consolidated Financial Information and Other Data

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



|                                                   |  |                                       |           |      |   |           |  |      |           |      |   |           |  |   |          
|-------------------------------------------------- |  | ------------------------------------- | --------- | ---- | - | --------- |  | ---- | --------- | ---- | - | --------- |  | - | ---------
|                                                   |  | At or for the Year Ended December 31,
|                                                   |  | 2007                                  |           | 2006 |   | 2005      |  | 2004 |           | 2003
|Operating Data:                                    |  |                                       |           |      |   |           |  |      |           |      |   |           |  |   |          
|Total interest income                              |  | $                                     | 31,053    |      | $ | 27,061    |  | $    | 19,208    |      | $ | 12,174    |  | $ | 9,652    
|Total interest expense                             |  |                                       | 17,721    |      |   | 14,241    |  |      | 8,327     |      |   | 4,383     |  |   | 3,298    
|                                                   |  |                                       |           |      |   |           |  |      |           |      |   |           |  |   |          
|Net interest income                                |  |                                       | 13,332    |      |   | 12,820    |  |      | 10,881    |      |   | 7,791     |  |   | 6,354    
|Provision for loan losses                          |  |                                       | 425       |      |   | 394       |  |      | 1,373     |      |   | 1,030     |  |   | 586      
|                                                   |  |                                       |           |      |   |           |  |      |           |      |   |           |  |   |          
|Net interest income after provision                |  |                                       | 12,907    |      |   | 12,426    |  |      | 9,508     |      |   | 6,761     |  |   | 5,768    
|Noninterest income                                 |  |                                       | 3,108     |      |   | 2,304     |  |      | 2,683     |      |   | 4,141     |  |   | 3,575    
|Noninterest expense                                |  |                                       | 8,786     |      |   | 9,077     |  |      | 8,546     |      |   | 8,010     |  |   | 6,845    
|                                                   |  |                                       |           |      |   |           |  |      |           |      |   |           |  |   |          
|Income before income taxes                         |  |                                       | 7,229     |      |   | 5,653     |  |      | 3,645     |      |   | 2,892     |  |   | 2,498    
|Provision for income taxes                         |  |                                       | 2,342     |      |   | 1,757     |  |      | 1,277     |      |   | 950       |  |   | 835      
|                                                   |  |                                       |           |      |   |           |  |      |           |      |   |           |  |   |          
|Net income                                         |  |                                       | 4,887     |      |   | 3,896     |  |      | 2,368     |      |   | 1,942     |  |   | 1,663    
|Dividends on preferred stock                       |  |                                       | 417       |      |   | 417       |  |      | 104       |      |   |          |  |   |         
|                                                   |  |                                       |           |      |   |           |  |      |           |      |   |           |  |   |          
|Net income available to common shareholders        |  | $                                     | 4,470     |      | $ | 3,479     |  | $    | 2,264     |      | $ | 1,942     |  | $ | 1,663    
|                                                   |  |                                       |           |      |   |           |  |      |           |      |   |           |  |   |          
|Per Share Data (1):                                |  |                                       |           |      |   |           |  |      |           |      |   |           |  |   |          
|Earnings per common sharebasic                    |  | $                                     | 0.98      |      | $ | 0.80      |  | $    | 0.53      |      | $ | 0.45      |  | $ | 0.39     
|Earnings per common sharediluted                  |  |                                       | 0.92      |      |   | 0.73      |  |      | 0.48      |      |   | 0.42      |  |   | 0.36     
|Market price                                       |  |                                       |           |      |   |           |  |      |           |      |   |           |  |   |          
|High                                               |  |                                       | 19.60     |      |   | 18.18     |  |      | 12.37     |      |   | 10.67     |  |   | 9.68     
|Low                                                |  |                                       | 9.00      |      |   | 10.51     |  |      | 8.44      |      |   | 7.52      |  |   | 5.43     
|Close                                              |  |                                       | 9.50      |      |   | 15.80     |  |      | 10.36     |      |   | 8.49      |  |   | 8.51     
|Book valuecommon shares                           |  |                                       | 6.13      |      |   | 5.20      |  |      | 4.25      |      |   | 3.83      |  |   | 3.40     
|                                                   |  |                                       |           |      |  
|Weighted average common shares outstanding         |  |                                       |           |      |   |           |  |      |           |      |   |           |  |   |          
|Basic                                              |  |                                       | 4,548,565 |      |   | 4,348,128 |  |      | 4,299,522 |      |   | 4,289,401 |  |   | 4,233,899
|Diluted                                            |  |                                       | 4,864,893 |      |   | 4,775,853 |  |      | 4,669,601 |      |   | 4,621,764 |  |   | 4,556,784
|                                                   |  |                                       |           |      |  
|Selected Year-End Balance Sheet Data:              |  |                                       |           |      |   |           |  |      |           |      |   |           |  |   |          
|Total assets                                       |  | $                                     | 467,186   |      | $ | 420,850   |  | $    | 370,440   |      | $ | 284,888   |  | $ | 212,561  
|Loans, held to maturity                            |  |                                       | 371,714   |      |   | 313,572   |  |      | 279,962   |      |   | 217,683   |  |   | 178,913  
|Allowance for loan losses                          |  |                                       | 4,462     |      |   | 4,222     |  |      | 4,090     |      |   | 2,865     |  |   | 2,522    
|Deposits                                           |  |                                       | 373,897   |      |   | 339,275   |  |      | 300,262   |      |   | 216,791   |  |   | 151,982  
|Short-term borrowings                              |  |                                       | 19,000    |      |   | 25,000    |  |      | 10,000    |      |   | 15,500    |  |   | 18,500   
|Long-term debt                                     |  |                                       | 38,764    |      |   | 26,764    |  |      | 34,764    |      |   | 34,764    |  |   | 26,500   
|Shareholders equity                               |  |                                       | 33,150    |      |   | 28,259    |  |      | 23,093    |      |   | 16,424    |  |   | 14,411   
|                                                   |  |                                       |           |      |  
|Selected Average Balances:                         |  |                                       |           |      |   |           |  |      |           |      |   |           |  |   |          
|Total assets                                       |  | $                                     | 447,442   |      | $ | 397,514   |  | $    | 329,395   |      | $ | 253,352   |  | $ | 192,822  
|Loans, net                                         |  |                                       | 344,620   |      |   | 301,405   |  |      | 252,914   |      |   | 204,121   |  |   | 160,041  
|Total interest-earning assets                      |  |                                       | 427,142   |      |   | 379,168   |  |      | 309,935   |      |   | 241,992   |  |   | 177,780  
|Deposits                                           |  |                                       | 370,128   |      |   | 329,724   |  |      | 264,730   |      |   | 187,090   |  |   | 150,962  
|Total interest-bearing liabilities                 |  |                                       | 380,288   |      |   | 338,283   |  |      | 280,412   |      |   | 215,080   |  |   | 158,961  
|Shareholders equity                               |  |                                       | 29,901    |      |   | 24,550    |  |      | 19,743    |      |   | 15,484    |  |   | 13,665   
|Shareholders equity less average preferred equity |  |                                       | 25,082    |      |   | 19,731    |  |      | 17,910    |      |   | 15,484    |  |   | 13,665   



16



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MidCarolina Financial Corporation

Table 1

Selected Consolidated Financial Information and Other Data

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



|                                                    |  |                                       |   |  |        |   |  |         |   |  |         |   |  |        |  
|--------------------------------------------------- |  | ------------------------------------- | - |  | ------ | - |  | ------- | - |  | ------- | - |  | ------ | -
|                                                    |  | At or for the Year Ended December 31, |  
|                                                    |  | 2007                                  |   |  | 2006   |   |  | 2005    |   |  | 2004    |   |  | 2003   |  
|Selected Performance Ratios:                        |  |                                       |   |  |        |   |  |         |   |  |         |   |  |        |  
|Return on average assets                            |  | 1.09                                  | % |  | 0.98   | % |  | 0.72    | % |  | 0.77    | % |  | 0.86   | %
|Return on average equity excluding preferred equity |  | 17.82                                 | % |  | 17.63  | % |  | 12.64   | % |  | 12.54   | % |  | 12.17  | %
|Net interest spread                                 |  | 2.61                                  | % |  | 2.93   | % |  | 3.23    | % |  | 2.99    | % |  | 3.35   | %
|Net interest margin                                 |  | 3.12                                  | % |  | 3.38   | % |  | 3.51    | % |  | 3.22    | % |  | 3.57   | %
|Noninterest income to total net revenue             |  | 18.91                                 | % |  | 15.23  | % |  | 19.78   | % |  | 34.70   | % |  | 36.01  | %
|Noninterest income to average assets                |  | 0.69                                  | % |  | 0.58   | % |  | 0.81    | % |  | 1.63    | % |  | 1.85   | %
|Noninterest expense to average assets               |  | 1.96                                  | % |  | 2.28   | % |  | 2.59    | % |  | 3.16    | % |  | 3.55   | %
|                                                    |  |                                       |   |  |       
|Asset Quality Ratios:                               |  |                                       |   |  |        |   |  |         |   |  |         |   |  |        |  
|Nonperforming loans to period-end loans             |  | 0.19                                  | % |  | 0.25   | % |  | 0.08    | % |  | 0.11    | % |  | 0.32   | %
|Allowance for loan losses to period-end loans       |  | 1.20                                  | % |  | 1.35   | % |  | 1.46    | % |  | 1.32    | % |  | 1.41   | %
|Allowance for loan losses to nonperforming loans    |  | 637.43                                | % |  | 531.74 | % |  | 1725.74 | % |  | 1127.95 | % |  | 428.18 | %
|Nonperforming assets to total assets                |  | 0.21                                  | % |  | 0.74   | % |  | 0.83    | % |  | 0.80    | % |  | 0.29   | %
|Net loan charge-offs to average loans               |  | 0.05                                  | % |  | 0.09   | % |  | 0.06    | % |  | 0.34    | % |  | 0.09   | %
|                                                    |  |                                       |   |  |       
|Capital Ratios:                                     |  |                                       |   |  |        |   |  |         |   |  |         |   |  |        |  
|Total risk-based capital                            |  | 11.48                                 | % |  | 11.28  | % |  | 11.34   | % |  | 11.13   | % |  | 13.11  | %
|Tier 1 risk-based capital                           |  | 10.37                                 | % |  | 10.12  | % |  | 9.90    | % |  | 8.78    | % |  | 9.95   | %
|Leverage ratio                                      |  | 8.95                                  | % |  | 8.73   | % |  | 8.64    | % |  | 7.83    | % |  | 9.53   | %
|Equity to assets ratio                              |  | 7.10                                  | % |  | 6.71   | % |  | 6.23    | % |  | 5.77    | % |  | 6.78   | %
|                                                    |  |                                       |   |  |       
|Other Data:                                         |  |                                       |   |  |        |   |  |         |   |  |         |   |  |        |  
|Number of banking offices                           |  | 8                                     |   |  | 8      |   |  | 6       |   |  | 6       |   |  | 5      |  
|Number of full time equivalent employees            |  | 77                                    |   |  | 71     |   |  | 69      |   |  | 77      |   |  | 63     |  



|(1) | All per share data has been restated to reflect the effects of a stock split effected in the form of a 10% stock dividend in 2002, a stock split effected in the form of a 20% stock
dividend in 2003 and 2004, a stock split effected in the form of a 25% stock dividend in 2005, a stock split effected in the form of a 10% stock dividend in 2006 and a 25% stock split in the form of a stock dividend effected in January 2007.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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|ITEM 7. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------

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

EXECUTIVE OVERVIEW

Significant accomplishments

In the opinion of its management, the
Companys most significant accomplishments during 2007, which are discussed in more detail in this Item 7, were as follows:



| |  |  | Total loans classified as held for investment increased 18.5%
| | - |  | -------------------------------------------------------------



| |  |  | Commercial and industrial loans outstanding at year end increased 20.3%
| | - |  | -----------------------------------------------------------------------



| |  |  | Average non-interest bearing deposits increased 7.2%
| | - |  | ----------------------------------------------------



| |  |  | Total deposits at year end increased 10.2%
| | - |  | ------------------------------------------



| |  |  | Non interest income increased 34.9%
| | - |  | -----------------------------------



| |  |  | Net income available to common shareholders increased 28.5%
| | - |  | -----------------------------------------------------------



| |  |  | Improved operating efficiencies
| | - |  | -------------------------------

Challenges.

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



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



| |  |  | Managing margins in an uncertain economic environment
| | - |  | -----------------------------------------------------



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



| |  |  | Uncertainty of commercial real estate regulatory environment
| | - |  | ------------------------------------------------------------



| |  |  | Obtaining adequate funding of asset growth
| | - |  | ------------------------------------------



| |  |  | Meeting capital adequacy requirements
| | - |  | -------------------------------------

SELECTED
CONSOLIDATED FINANCIAL INFORMATION AND OTHER DATA

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

FINANCIAL CONDITION

DECEMBER 31, 2007 AND 2006

The Company reported total assets increasing by
$46.3 million, or 11.0%, to $467.2 million at year-end 2007. This growth was principally reflected in increased loans. Loans, excluding those held for sale, increased by $58.1 million, or 18.5%, from $313.6 million at the beginning of the year to
$371.7 million at year end. Investment securities decreased by $3.0 million, or 4.1%, from $73.8 million to $70.8 million. The increase in loans was composed principally of increases of $15.8 million in commercial mortgage loans, $20.2 million in
residential mortgage loans (including income producing properties) and $7.9 million in commercial and industrial loans, all of which are segments of lending the Company targets and intends to continue targeting in the future. Liquid assets,
consisting of cash and demand balances due from banks, interest-earning deposits in other banks and investment securities, were 16.1% of total assets, at December 31, 2007, a decrease from the 20.4% of total assets at December 31, 2006.
The Bank, as a member of the FHLB of Atlanta, has an investment of $3.0 million in FHLB stock. The Banks investment in life insurance used to offset the cost of employee benefit plans, increased by $290 thousand during 2006 to $7.6 million.
The increase was due to an increase in the cash surrender value of the policies.



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Deposits increased $34.6 million during 2007. Non-interest-bearing demand accounts decreased $4.1 million, or 11.8%,
money market and NOW accounts increased $3.5 million, or 4.9%, and time deposits increased $35.7 million or 15.7%, over the amount of such deposits at December 31, 2006. The Bank also used wholesale brokered certificates of deposit and advances
from the FHLB of Atlanta, Georgia as funding sources during 2007 to serve as a secondary source of funding asset growth. Borrowings from the FHLB increased from $43.0 million at the end of 2006 to $49.0 million at December 31, 2007. Wholesale
brokered certificates of deposit comprised approximately 33.7% of total certificate of deposit balances. Typically brokered certificates of deposit have similar terms to retail certificates of deposit issued in the Banks local markets, with
rates marginally lower than local market certificates of deposit rates.

Total shareholders equity increased by $4.9 million, or 17.3%, during 2007.
All capital ratios continue to place the Company and the Bank in excess of the minimum required to be a well-capitalized institution by regulatory measures. The proceeds from the exercising of stock options of $279 thousand during 2007 increased
shareholders equity by that amount. The Company issued $4.8 million in Non-Cumulative Perpetual Preferred Stock on August 15, 2005 and $8.5 million in Trust Preferred Securities during prior years, so as to remain well
capitalized under regulatory capital guidelines without diluting existing shareholders ownership. The Trust Preferred Securities and Preferred Stock should provide sufficient capital to retain a well-capitalized designation
as defined by regulatory capital guidelines for the foreseeable future. The Trust Preferred Securities qualify as Tier 1 regulatory capital and are reported in Federal Reserve regulatory reports as a qualifying security in a consolidated subsidiary.
The junior subordinated debentures issued to guarantee the Trust Preferred Securities do not qualify as Tier 1 regulatory capital. On July 2, 2003, the Federal Reserve issued a letter, SR 03-13, stating that notwithstanding any potential
implications FIN 46 may have on reporting trust preferred securities on financial statements, trust preferred securities will continue to be included in Tier 1 capital until notice is given to the contrary. There can be no assurance that the Federal
Reserve will continue to allow institutions to include trust-preferred securities in Tier I capital for regulatory capital purposes. In the event of a disallowance, there would be a reduction in the Companys consolidated capital ratios.
However, the Company believes that the Bank would remain well capitalized under FDIC guidelines.

At December 31, 2007, the Bank was
considered to be well capitalized under the FDIC guidelines.

NET INTEREST INCOME

Similar to most financial institutions, the primary component of earnings for the Bank is net interest income. Net interest income is the difference between interest income, principally from the loan and investment
securities portfolios, and interest expense, principally on deposits and borrowings. Changes in net interest income result from changes in volume, spread and margin. For this purpose, volume refers to the average dollar level of
interest-earning assets and interest-bearing liabilities, spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities and margin refers to net
interest income divided by average interest-earning assets and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities, as well as levels of non-interest-bearing liabilities. During the years ended
December 31, 2007, 2006 and 2005, average interest-earning assets were $427.1 million, $379.2 million and $310.0 million, respectively. During these same years, the Banks net yields on average interest-earning assets were 3.12%, 3.38% and
3.51%, respectively. The decrease in net yields from 2006 to 2007 is a reflection of the flatness of the yield curve during much of the year and an overall increase in cost of funding earning assets due to extreme competitive pressures in our
markets. The Banks balance sheet is moderately positioned for stable interest rates. When interest rates change, the Banks earnings and net yields may compact.

Table 2, following this discussion, Average Balances and Net Interest Income, presents an analysis of the Banks net interest income for 2007, 2006 and 2005.

Table 3, following this discussion, Volume and Rate Variance Analysis, shows the amounts of changes in net interest income due to changes in volume and rates
and illustrates that the change in the average volume of loans and the increase in average deposit rates were the predominant factors in the higher amount of net interest income realized by the Bank in 2007, when compared to 2006.



19



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RESULTS OF OPERATIONS

YEARS
ENDED DECEMBER 31, 2007 AND 2006

Overview.The Company reported net income available to common shareholders of $4.5 million, or $0.92 per diluted
common share, for the year ended December 31, 2007, compared with net income available to shareholders of $3.5 million, or $0.73 per diluted common share, for 2006, an improvement of $1.0 million or $0.19 per diluted share. When adjusted for an
after-tax one time adjustment of $579 thousand related to the reversal of accrued benefits originally designated for the benefit of a former executive officer, net income available to common shareholders is $3.9 million, or $0.80 per diluted share,
an increase of $412 thousand or 11.8%. Net interest income increased $512 thousand, or 4.0%, in 2007, and the provision for loan losses increased $31 thousand, or 7.9%, while non-interest income increased by $804 thousand or 34.9%. Non-interest
expense decreased by $291 thousand or 3.2% in 2007, when adjusted for a $905 thousand pre-tax reversal of accrued benefits originally designated for a former executive officer, non-interest expense totaled $9.7 million in 2007 compared to $9.1
million in 2006, or an increase of 6.8%.

Net Interest Income.Net interest income increased to $13.3 million for the year ended December 31,
2007, a $512 thousand or 4.0% increase from the $12.8 million earned in 2006. Total interest income benefited from strong growth in the level of average earning assets and higher asset yields caused by the increase in interest rates during the year.
The rates earned on a significant portion of the Banks loans adjust immediately when indexes like the prime rate change. Conversely, a large portion of interest-bearing liabilities, including certificates of deposit and Bank borrowings, have
rates fixed until maturity. As a result, interest rate reductions will generally result in an immediate drop in the Banks interest income on loans, with a more delayed impact on interest expense because reductions in interest costs will only
occur upon renewals of certificates of deposit or borrowings. Interest rate increases will generally result in an immediate increase in the Banks interest income on loans, with a more delayed impact on interest expense because increases in
interest costs will only occur upon renewals of certificates of deposit or borrowings. Average total interest-earning assets increased $48.0 million, or 12.7%, during 2007 compared to 2006, while the average yield increased by 13 basis points from
7.14% to 7.27%. As interest rates increased during 2007, the average rate on loans increased year over year. The average rate on investment securities increased in 2007 compared to 2006, reflecting managements decision to purchase higher
yielding securities during 2007 as interest rates began to rise. Average total interest-bearing liabilities increased by $42.0 million, or 12.4%, consistent with the increase in interest-earning assets. The average cost of interest-bearing
liabilities increased by 45 basis points from 4.21% to 4.66%. With the yield on earning assets increasing less significantly than the cost of interest bearing liabilities, the Banks net interest margin decreased by 26 basis points. For the
year ended December 31, 2007, the net interest margin was 3.12%, while for the year ended December 31, 2006, the net interest margin was 3.38%. Table 3 reflects the volume and rate variances from 2007 vs. 2006.

Provision for Loan Losses.The Bank recorded $425 thousand as the provision for loan losses in 2007, an
increase of $31 thousand from the $394 thousand provision made in 2006. Provisions for loan losses are charged to income to bring the allowance for loan losses to a level deemed appropriate by management. In evaluating the allowance for loan losses,
management considers factors that include growth, composition and industry diversification of the portfolio, historical loan loss experience, current delinquency levels, adverse situations that may affect a borrowers ability to repay,
estimated value of any underlying collateral, prevailing economic conditions and other relevant factors. For 2007 the provision for loan losses was made in response to a weakening economy and real estate market in the 4thquarter as well as growth in loans, as total loans outstanding, net of loans held for sale, increased by $58.1 million in 2007 and by $33.6 million in 2006.
At December 31, 2007, the allowance for loan losses was $4.5 million, an increase of $240 thousand, or 5.7%, from the $4.2 million at the end of 2006. The allowance represented 1.20% and 1.35%, respectively, of loans outstanding at the end of
2007 and 2006, net of loans held for sale. At December 31, 2007, the Bank had $700 thousand in non-accrual loans. In 2006, the Bank had $794 thousand in non-accrual loans. It is managements opinion that reserve levels are adequate.

Non-Interest Income.Non-interest income increased to $3.1 million for the year ended December 31, 2007 compared to $2.3 million for the year
ended December 31, 2006, an increase of $804 thousand or 34.9%. A one time gain on the sale of other real estate in the amount of $481 thousand accounted for 15.5% of total non-interest income. Excluding the gain on the sale of other real
estate, non-interest income increased $323 thousand or 14.0% for 2007. Mortgage operations income decreased to $600 thousand in 2007, from $632 thousand in 2006, reflecting a softening in the overall mortgage origination market. Service charges on
deposit accounts in 2007 were $1.1 million, an increase of $114 thousand, or 12.1%, compared to $944 thousand in 2006 reflecting the positive results of a focused marketing effort to increase demand deposit accounts. Table 4, following this
discussion, is a comparative analysis of the components of non-interest income for 2007, 2006 and 2005.



20



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Non-Interest Expenses.Non-interest expenses totaled $8.8 million for the year ended December 31, 2007, a
decrease of $291 thousand over the $9.1 million reported for 2006. Adjusting non-interest expense for a one-time adjustment of $905 thousand related to the reversal of accrued benefits originally designated for a former executive officer,
non-interest expense for 2007 would have totaled $9.7 million, an increase of $614 thousand or 6.8%. Substantially all of this increase resulted from the Banks growth and development during 2007 and 2006. Personnel costs after a one-time
adjustment of $905 thousand related to the reversal of accrued benefits originally designated for a former executive officer increased by $248 thousand in 2007, or 4.8%. Professional and other services increased $69 thousand primarily due to
expenses incurred related to the preparation of anticipated regulatory changes. Deposit and other insurance expense increased $144 thousand or 69.2% because of increased FDIC premiums. Occupancy and equipment expense increased by $7 thousand due to
increases in maintenance costs. Data processing and other outside services increased $99 thousand, or 14.7%, due to the enhancement of computer systems. Advertising expense decreased $90 thousand reflecting new marketing strategies during 2007.
Table 5, following this discussion, presents a comparative analysis of the components of non-interest expenses for 2007, 2006 and 2005.

Income Taxes.The provision for income tax was $2.3 million in 2007 and $1.8 million in 2006. The effective tax rates were 32.4% and 31.1%, respectively, on income before income taxes. The increase in the effective tax rate for 2007 reflects an decrease in
the proportion of tax-exempt income to total income for 2007 over 2006.

RESULTS OF OPERATIONS

YEARS ENDED DECEMBER 31, 2006 AND 2005

Overview.The Company reported
net income available to shareholders of $3.5 million, or $0.73 per diluted common share, for the year ended December 31, 2006, compared with net income available to shareholders of $2.3 million, or $0.48 per diluted common share, for 2005, an
improvement of $1.2 million or $0.25 per diluted share. Net interest income increased $1.9 million, or 17.8%, in 2006, and the provision for loan losses decreased $979 thousand, or 71.3%, while non-interest income decreased by $379 thousand or
14.1%. This aggregate growth in income outpaced the 6.2% increase in non-interest expense, which totaled $9.1 million in 2006 compared to $8.5 million in 2005.

Net Interest Income.Net interest income increased to $12.8 million for the year ended December 31, 2006, a $1.9 million or 17.8% increase from the $10.9 million earned in 2005. Total interest income benefited from strong growth
in the level of average earning assets and higher asset yields caused by the increase in market interest rates during the year. The rates earned on a significant portion of the Banks loans adjust immediately when indexes like the prime rate
change. Conversely, a large portion of interest-bearing liabilities, including certificates of deposit and Bank borrowings, have rates fixed until maturity. As a result, interest rate reductions will generally result in an immediate drop in the
Banks interest income on loans, with a more delayed impact on interest expense because reductions in interest costs will only occur upon renewals of certificates of deposit or borrowings. Interest rate increases will generally result in an
immediate increase in the Banks interest income on loans, with a more delayed impact on interest expense because increases in interest costs will only occur upon renewals of certificates of deposit or borrowings. Average total interest-earning
assets increased $69.2 million, or 22.3%, during 2006 compared to 2005, while the average yield increased by 94 basis points from 6.20% to 7.14%. As interest rates increased during 2006, the average rate on loans increased year over year. The
average rate on investment securities increased in 2006 compared to 2005, reflecting managements decision to purchase higher yielding securities during 2006 as interest rates began to rise. Average total interest-bearing liabilities increased
by $57.9 million, or 20.6%, consistent with the increase in interest-earning assets. The average cost of interest-bearing liabilities increased by 124 basis points from 2.97% to 4.21%. With the yield on earning assets increasing less significantly
than the cost of interest bearing liabilities, the Banks net interest margin decreased by 13 basis points. For the year ended December 31, 2006, the net interest margin was 3.38%, while for the year ended December 31, 2005, the net
interest margin was 3.51%. Table 3 reflects the volume and rate variances from 2006 vs. 2005.

Provision for Loan Losses.The Bank recorded $394
thousand as the provision for loan losses in 2006, a decrease of $979 thousand from the $1.4 million provision made in 2005. Provisions for loan losses are charged to income to bring the allowance for loan losses to a level deemed appropriate by
management. In evaluating the allowance for loan losses, management considers factors that include growth, composition and industry diversification of the portfolio, historical loan loss experience, current delinquency levels, adverse situations
that may affect a borrowers ability to repay, estimated value of any underlying collateral, prevailing economic conditions and other relevant factors. For 2006 and 2005 the provision for loan losses was made principally in response to growth
in loans as total loans outstanding, net of loans held for sale, increased by $33.6 million in 2006 and by $62.3 million in 2005. At



21



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December 31, 2006, the allowance for loan losses was $4.2 million, an increase of $132 thousand, or 3.2%, from the $4.1 million at the end of 2005. The
allowance represented 1.35% and 1.46%, respectively, of loans outstanding at the end of 2006 and 2005, net of loans held for sale. At December 31, 2006, the Bank had $794 thousand in non-accrual loans. In 2005, the Bank had $237 thousand in
non-accrual loans. It is managements opinion that reserve levels are adequate.

Non-Interest Income.Non-interest income decreased to $2.3
million for the year ended December 31, 2006 compared to $2.7 million for the year ended December 31, 2005, a decrease of $379 thousand or 14.1%. Mortgage operations income decreased to $632 thousand in 2006, from $1.1 million in 2005
reflecting the discontinuance of the mortgage origination office in Raleigh, North Carolina during the first half of 2005 as well as a softening in the overall mortgage origination market. Service charges on deposit accounts in 2006 were $944
thousand, a decrease of $65 thousand, or 6.4%, compared to $1.0 million in 2005 reflecting the competitive demand for free checking accounts. Table 4, following this discussion, is a comparative analysis of the components of non-interest income for
2006, 2005 and 2004.

Non-Interest Expenses.Non-interest expenses totaled $9.1 million for the year ended December 31, 2006, an increase of
$531 thousand over the $8.5 million reported for 2005. Substantially all of this increase resulted from the Banks growth and development during 2006 and 2005. Personnel costs increased by $313 thousand in 2006, or 6.5% primarily due to the
increase in staffing of two new branches brought on-line during the year. Professional and other services decreased $165 thousand primarily due to expenses incurred in 2005 related to the preparation of anticipated regulatory changes that were not
repeated in 2006. Occupancy and equipment expense increased by $21 thousand primarily due to increases in maintenance costs and increased depreciation on purchases of furniture, fixtures and computer hardware and software. Data processing and other
outside services increased $108 thousand, or 19%, due to the enhancement of computer security systems and costs associated with adding two new branches. Advertising expense increased $52 thousand reflecting new marketing campaigns during 2006. Table
5, following this discussion, presents a comparative analysis of the components of non-interest expenses for 2006, 2005 and 2004.

Income Taxes.The
provision for income tax was $1.8 million in 2006 and $1.3 million in 2005. The effective tax rates were 31.08% and 35.04%, respectively, on income before income taxes. The decrease in the effective tax rate for 2006 reflects an increase in the
proportion of tax-exempt income to total income for 2006 over 2005.

LIQUIDITY

The Banks sources of liquidity are customer deposits, cash and demand balances due from other banks, interest-earning deposits in other banks and investment securities available for sale. These funds, together
with loan and securities repayments, are used to fund loans and continuing operations. At December 31, 2007, the Bank had credit availability with the FHLB of $61.4 million, with $49.0 million outstanding.

Total deposits were $373.9 million and $339.3 million at December 31, 2007 and 2006, respectively. The Banks deposits increased 10.2% in 2007. Because the
Banks organic deposit growth was not sufficient in amount to meet the total funding needs of the Banks asset growth, the Bank looked to alternative funding sources during 2007. In light of local market deposit competition during the
year, the Bank found it less costly to access brokered certificates of deposits rather than compete for higher cost of funds sources within its local markets. The Bank will continue to evaluate all funding sources for cost, accessibility,
dependability and efficiency. Brokered certificates of deposits decreased by $4.8 million during 2007, from $93.5 million in 2006 to $88.7 million in 2007, a decrease of 5.1%.

At December 31, 2007 and 2006, time deposits represented 70.3% and 67.0%, respectively, of the Banks total deposits. Certificates of deposit of $100,000 or more represented 51.5% and 47.5%, respectively, of
the Banks total deposits at December 31, 2007 and 2006. At December 31, 2007, the Bank had $5.2 million in public deposits and $88.7 million in brokered time deposits. These sources of funds are generally considered to be less stable
than deposits from the Banks local markets. However, management believes that the other non-alternative funding time deposits are relationship oriented. While the Bank appreciates the need to pay competitive rates to retain these deposits,
other subjective factors also influence deposit retention. Based upon prior experience, the Bank anticipates that a substantial portion of outstanding certificates of deposit will renew upon maturity. The Banks aggregate wholesale funding as a
percentage of total assets decreased to 34.7% in 2007 from 34.9% in 2006. The wholesale funding aggregate decrease is due primarily to the discontinued renewal and issuance of certificates of deposit raised over the internet, whose outstanding
balance decreased from $2.6 million in 2006 to $491 thousand in 2007.



22



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Management anticipates that the Bank will utilize non-local market funding sources such as wholesale NOW accounts, CDARS
(Certificate of Deposit Account Registry Service) a deposit placement network (an innovation that allows banks to offer up to $30 million of FDIC insurance per depositor by networking with other banks within the CDARS system), FHLB advances and
brokered certificates of deposits as a less costly diversified funding source to complement the Banks local market deposits. Deposits, loan repayments, mortgage-backed securities prepayments, bond maturities, FHLB advances and current earnings
will be employed to provide liquidity, generate loans, purchase securities, procure fixed assets and meet other operating needs incurred in normal banking activities.

In the normal course of business there are various outstanding contractual obligations of the Bank that will require future cash outflows. In addition, there are commitments and contingent liabilities, such as
commitments to extend credit that may or may not require future cash outflows. Table 6, following this discussion, Contractual Obligations and Commitments, summarizes the Banks contractual obligations and commitments as of
December 31, 2007.

CAPITAL RESOURCES

At
December 31, 2007 and 2006, shareholders equity of the Company totaled $33.2 million and $28.3 million, respectively. The Companys equity to asset ratio on those dates was 7.1% and 6.7%, respectively, reflecting the Companys
aggressive growth. The Company and the Bank are subject to minimum capital requirements. See PART 1, ITEM 1DESCRIPTION OF BUSINESS  SUPERVISION AND REGULATION. Because the Companys only significant asset is its
investment in the Bank, information concerning capital ratios is essentially the same for the Company and the Bank.

All capital ratios place the Bank in
excess of minimum requirements to be classified as well capitalized by regulatory measures. The Banks leverage ratio was 8.95% at December 31, 2007.

Note P to the accompanying consolidated financial statements presents an analysis of the Banks regulatory capital position as of December 31, 2007 and 2006. Management anticipates that the Bank will remain
well-capitalized for regulatory purposes throughout 2008.

ASSET/LIABILITY MANAGEMENT

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

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

In reviewing the needs of the Bank with regard to proper management of its asset/liability program, the Banks management estimates its future needs,
taking into consideration historical periods of high loan demand and low deposit balances, estimated loan and deposit increases (due to increased demand through marketing) and forecasted interest rate changes. A number of measures are used to
monitor and manage interest rate risk, including income simulations and interest sensitivity (gap) analyses. An income simulation model is the primary tool used to assess the direction and magnitude of changes in net interest income resulting from
changes in interest rates. Key assumptions



23



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in the model include prepayments on loan and loan-backed assets, cash flows and maturities of other investment securities, loan and deposit volumes and
pricing. These assumptions are inherently uncertain and, as a result, the model cannot precisely estimate net interest income or precisely predict the impact of higher or lower interest rates on net interest income. Actual results will differ from
simulated results due to timing, magnitude and frequency of interest rate changes and changes in market conditions and management strategies, among other factors.

Based on the results of the income simulation model, as of December 31, 2007, the Bank would expect a decrease in net interest income of $193 thousand if interest rates increase from current rates by an instantaneous 100 basis points
and a decrease in net interest income of $127 thousand if interest rates decrease from current rates by an instantaneous 100 basis points.

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

Table 7, following this discussion, Interest Rate Sensitivity Analysis, sets forth the amounts of interest-earning assets and interest-bearing liabilities
outstanding at December 31, 2007, which are projected to reprice or mature in each of the future time periods shown. Except as stated below, the amounts of assets and liabilities shown which reprice or mature within a particular period were
determined in accordance with the contractual terms of the assets or liabilities. Loans with adjustable rates are shown as being due at the end of the next upcoming adjustment period. Money market deposit accounts are considered rate sensitive and
are placed in the shortest period, while negotiable order of withdrawal or other transaction accounts are assumed to be more stable sources that are less price elastic and are placed in the longest period. In making the gap computations, none of the
assumptions sometimes made regarding prepayment rates and deposit decay rates are used for any interest-earning assets or interest-bearing liabilities. In addition, the table does not reflect scheduled principal payments that will be received
throughout the lives of the loans. The interest rate sensitivity of the Banks assets and liabilities illustrated in the table would vary substantially if different assumptions were used or if actual experience differs from that indicated by
such assumptions.

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

LENDING ACTIVITIES

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

The Banks loan policies and procedures establish the basic guidelines governing its lending operations. Generally, the guidelines address the types of loans that
the Bank seeks, target markets, underwriting and collateral



24



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

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

Table 9, Loan Maturities, following this discussion, presents, at December 31, 2007, (i) the
aggregate maturities or re-pricings of commercial, industrial and commercial mortgage loans and of real estate constructions loans and (ii) the aggregate amounts of such loans by variable and fixed rates.

Commercial and Industrial Loans.At December 31, 2007, the Banks commercial and industrial loan portfolio equaled $46.9 million, or 12.6% of total
loans, as compared with $39.0 million, or 12.2% of total loans, at December 31, 2006. Commercial and industrial loans include both secured and unsecured loans for working capital, expansion and other business purposes. Short-term working
capital loans generally are secured by accounts receivable, inventory and/or equipment. The Bank also makes term commercial loans secured by equipment and real estate. Lending decisions are based on an evaluation of the financial strength,
management and credit history of the borrower, and the quality of the collateral securing the loan. With few exceptions, the Bank requires personal guarantees and secondary sources of repayment.

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

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

Residential 1- 4 family loans are classified into two categories: conforming
loans, that are originated under the underwriting guidelines established by FNMA or FHLMC and held for sale and nonconforming loans that are originated and retained in the Banks loan portfolio. The terms conforming and
nonconforming do not refer to credit quality, but rather to whether the loan is underwritten so that it can be sold in the secondary market. At December 31, 2007, loans held for sale amounted to $823 thousand while nonconforming
loans held in the Banks permanent portfolio amounted to $57.3 million. The Banks permanent residential mortgage loans are generally secured by properties located within the Banks market area. Most of the one to four family
residential mortgage loans that the Bank makes are conforming loans and are sold within 30 days of closing to a correspondent bank. The Bank originated 207 loans in the amount of $27.3 million for sale in the secondary market during 2007. The Bank
receives a fee for each loan originated, with fees aggregating $600 thousand for the year ended December 31, 2007 and $632 thousand for the year ended December 31, 2006. The Bank anticipates that it will continue to be an active originator
of residential loans. Nonconforming residential mortgage loans that are retained in the Banks loan portfolio generally have rate terms of five years or less, with amortizations up to 20 years.

The Bank has made, and anticipates continuing to make, commercial real estate loans. Commercial real estate loans amounted to $140.2 million at December 31, 2007.
These loans are secured principally by commercial buildings for office, storage and warehouse space, and by agricultural properties. Generally in underwriting commercial real estate loans, the Bank requires the personal guarantee of borrowers and a
demonstrated cash flow capability sufficient to service the debt. Loans secured by commercial real estate usually involve a greater degree of risk than 1-4 family residential mortgage loans. Payments on such loans are often dependent on successful
operation or management of the properties.

The Bank originates 1- 4 family residential construction loans for the construction of custom homes (where the
home buyer is the borrower) and provides financing to builders and consumers for the construction of pre-sold homes. The Bank generally receives a pre-arranged permanent financing commitment from an outside entity prior to financing



25



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the construction of pre-sold homes. The Bank lends to builders who have demonstrated a favorable record of performance and profitable operations and who are
building in markets that management believes it understands and in which it is comfortable with the economic conditions. The Bank also makes commercial real estate construction loans, generally for owner-occupied properties. The Bank further
endeavors to limit its construction lending risk through adherence to established underwriting procedures. The Bank generally requires documentation for all draw requests and utilizes loan officers to inspect the project prior to honoring draw
requests from the builder. With few exceptions, the Bank requires personal guarantees and secondary sources of repayment on construction loans.

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

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

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

The President and the Chief Credit Officer each have the authority to approve loans up to $400 thousand. The President in conjunction with the Chief Credit Officer have
the combined authority to approve loans up to $2 million which is the maximum staff, in-house lending limit set by the Board of Directors. The Boards Loan Committee approves all loans in excess of the staffs in-house lending limit. The
Committee consists of the President, the Chairman and Vice Chairman of the Banks Board and four outside directors as appointed by the Board of the Bank

Additionally, all loans of $50 thousand or greater and all loans with relationship exposure of $200,000 or above are reviewed by the Management Loan Committee comprised of the President, Chief Credit Officer, and the Senior Commercial Loan
Officers for Burlington, Graham and Greensboro. The Banks Loan Committee reviews all loans with total exposure of $1.0 million or greater and approves all loans with total exposure of $2.0 million or greater. The Banks legal lending
limit was $6.9 million at December 31, 2007. The Bank seldom makes loans approaching its legal lending limit.

COMMITMENTS TO EXTEND CREDIT

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

ASSET QUALITY

The Bank considers asset quality to be of primary importance,
and employs a formal internal loan review process to ensure adherence to the lending policy as approved by the Banks Board of Directors. It is the responsibility of each



26



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loan officer to assign an appropriate risk grade to loans when originated. Credit Administration, through the loan review process, validates the accuracy of
the initial risk grade assessment. In addition, as a given loans credit quality changes, it is the responsibility of Credit Administration to change the borrowers risk grade accordingly. The process of determining the allowance for loan
losses is fundamentally driven by the risk grade system. In determining the allowance for loan losses and any resulting provision to be charged against earnings, particular emphasis is placed on the results of the loan review process. Consideration
is also given to historical loan loss experience, the value and adequacy of collateral, economic conditions in the Banks market area and other factors. For loans determined to be impaired, the allowance is based on discounted cash flows using
the loans initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. This evaluation is inherently subjective, as it requires material estimates, including the amounts and timing of future cash
flows expected to be received on impaired loans that may be susceptible to significant change. The allowance for loan losses represents managements estimate of the appropriate level of reserve to provide for probable losses inherent in the
loan portfolio.

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

NONPERFORMING ASSETS

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

The
Companys consolidated financial statements are prepared on the accrual basis of accounting, including the recognition of interest income on loans, unless a loan is placed on non-accrual basis. Loans are accounted for on a non-accrual basis
when management has serious concerns about the collectibility of principal or interest. Generally, the Banks policy is to place a loan on non-accrual status when the loan becomes 90 days past due. Loans are also placed on non-accrual status in
cases where management is uncertain whether the borrower can satisfy the contractual terms of the loan agreement. Payments received on non-accrual loans generally are applied to principal first, and then to interest after all principal payments have
been satisfied. Restructured loans are those for which concessions, including the reduction of interest rates below a rate otherwise available to that borrower or the deferral of interest or principal, have been granted due to the borrowers
weakened financial condition. The Bank accrues interest on restructured loans at the restructured rate when management anticipates that no loss of original principal will occur. Potential problem loans are defined as loans currently performing that
are not included in non-accrual or restructured loans, but are loans that management has concerns as to the borrowers ability to comply with present repayment terms. These loans could deteriorate to non-accrual, past due or restructured loans
status. Therefore, management quantifies the risk associated with problem loans in assessing the adequacy of the allowance for loan losses. At December 31, 2007, the Bank identified $700 thousand in non-accrual loans. Management anticipates
that the vast majority of the non-accruing loans at December 31, 2007 will be paid out or returned to accrual status. At December 31, 2006, the Bank identified $794 thousand in non-accrual loans.

Real estate owned consists of foreclosed, repossessed and idled properties. At December 31, 2007, there were $264 thousand assets classified as real estate owned.
At December 31, 2006, there were $2.3 million assets classified as real estate owned.

ANALYSIS OF ALLOWANCE FOR LOAN LOSSES

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

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

The provision for loan losses charged to operating expense is based on factors
which, in managements judgment, deserve current recognition in estimating probable loan losses. Such factors considered by management include



27



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growth and composition of the loan portfolio, the relationship of the allowance for loan losses to outstanding loans and economic conditions. While
management uses the best information available to make evaluations, this evaluation is inherently subjective as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans, that may
be susceptible to significant change.

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

Growth in loans outstanding has, throughout the Banks history, been the primary reason for increases in the Banks allowance for loan losses and the resultant
provisions for loan losses necessary to provide for those increases. This growth has been spread among the Banks major loan categories, with the concentrations of major loan categories being relatively consistent. Between December 31,
2006 and December 31, 2007, the range of each major category of loans as a percentage of total loans outstanding is as follows: residential mortgage loans  11.8% to 15.4%; commercial mortgage loans  39.7% to 37.7%; construction
loans  22.8% to 21.5%; commercial and industrial loans  12.4% to 12.6%; loans to individuals  2.7% to 1.6%; and home equity lines of credit  10.5% to 11.1%. For the past five fiscal years through 2007, the Banks loan
loss experience has been similar to that of other peer banks in North Carolina, with net loan charge-offs in each year of ranging from 0.05% to 0.34% of average loans outstanding. Charge offs are typically recognized when it is the opinion of
management that all or a portion of an outstanding loan becomes uncollectible. Loan repayment may be realized through a contractual agreement, or through liquidation of assets pledged as collateral. Net charge-offs totaled $262,000 or 0.09% of
outstanding loans for 2006 and $185,000 or 0.05% of outstanding loans for 2007. The Banks allowance for loan losses at December 31, 2007 of $4.5 million represents 1.20% of total loans outstanding, net of loans held for sale. The
Banks allowance for loan losses at December 31, 2006 was $4.2 or 1.35% of outstanding loans, net of loans held for sale. The allowance for loan losses as a percentage of loans outstanding decreased in 2007 compared to 2006 due to an
improvement in asset quality in the portfolio including a decrease in non performing loans and an increase in loans outstanding.

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

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

INVESTMENT ACTIVITIES

The Banks portfolio of investment securities, all of which are available for sale, consists
primarily of U.S. government agency securities, mortgage-backed securities and securities issued by local governments . Securities to be held for indefinite periods of time and not intended to be held to maturity are classified as available for sale
and carried at fair value, with any unrealized gains or losses reflected as an adjustment to stockholders equity. Securities held for indefinite periods of time include securities that management intends to use as part of its asset/liability
management strategy and that may be sold in response to changes in interest rates and/or significant prepayment risks. It is the Banks policy to classify its investment securities as available for sale. Table 13, Securities Portfolio
Composition, following this discussion, summarizes investment securities by type at December 31, 2007, 2006 and 2005.

Table 14,
Securities Portfolio Composition, following this discussion, summarizes the amortized costs, fair values and weighted average yields of the Banks investment securities at December 31, 2007, by contractual maturity groups.

The Bank does not engage in, nor does it presently intend to engage in, securities trading activities and therefore does not maintain a trading account.
At December 31, 2007, there were no securities of any issuer (other than governmental agencies) held in the Banks portfolio that exceeded 10% of the Companys shareholders equity.



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SOURCES OF FUNDS

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

Table 15, Average Deposits, following this discussion, sets forth for the for the years ended December 31, 2007, 2006 and 2005 the average balances
outstanding and average interest rates for each major category of deposits.

Table 16, Maturities of Time Deposits of $100,000 or More, which
follows this discussion, presents maturities of certificates of deposit with balances of $100,000 or more at December 31, 2007.

Borrowings.As
additional sources of funding, the Bank uses advances from the FHLB under a line of credit equal to 30% of the Banks total assets, subject to qualifying collateral. The available aggregate line of credit was $61.4 million at December 31,
2007. Outstanding advances at December 31, 2007 totaled $49.0 million, and included: $19.0 million of daily rate credit advances at a weighted average rate at December 31, 2007 of 4.56%; $4.0 million maturing in 2010, bearing interest at a
weighted average rate of 5.79%; $10 million maturing in 2013 bearing interest at 2.91%, $6 million maturing in 2017 at 3.98% and $10 million maturing in 2018 at 2.98%. Pursuant to collateral agreements with the FHLB, at December 31, 2007,
advances are secured by loans with a carrying amount of $107.9 million, which approximates market value. Advances outstanding at December 31, 2006 totaled $43.0 million.

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

CRITICAL ACCOUNTING POLICY

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

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

RISKS ASSOCIATED WITH THE BANK AND
THE COMPANY

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

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



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



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



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



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

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

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

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

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



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



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



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



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



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



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



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

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



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MidCarolina Financial Corporation

Table 2

Average Balances and Net Interest Income (1)

($ in thousands)



|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |        |                |      |   |          |   |             |   |  |   |        |  |      |  
|-------------------------------------------------------------------------------- |  | ---------------------------- | ------- | - | ---------------------------- | - | ----------- | ---------------------------- | ---- | -------------- |  | - | -------- | - | ----------- | - | ------ | -------------- | ---- | - | -------- | - | ----------- | - |  | - | ------ |  | ---- | -
|                                                                                 |  | Year Ended December 31, 2007 |         |   | Year Ended December 31, 2006 |   |             | Year Ended December 31, 2005 |     
|                                                                                 |  | AverageBalance               |         |   | Interest                     |   | AverageRate |                              |      | AverageBalance |  |   | Interest |   | AverageRate |   |        | AverageBalance |      |   | Interest |   | AverageRate |  
|Interest-earning assets:                                                         |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |        |                |      |   |          |   |             |   |  |   |        |  |      |  
|Loans, net                                                                       |  | $                            | 344,620 |   |                              | $ | 27,037      |                              | 7.85 | %              |  | $ | 301,405  |   |             | $ | 23,429 |                | 7.77 | % |          | $ | 252,914     |   |  | $ | 16,915 |  | 6.69 | %
|Investment securities                                                            |  |                              | 72,013  |   |                              |   | 3,581       |                              | 4.97 | %              |  |   | 67,590   |   |             |   | 3,215  |                | 4.76 | % |          |   | 46,681      |   |  |   | 1,991  |  | 4.27 | %
|Interest-earning cash deposits                                                   |  |                              | 8,080   |   |                              |   | 264         |                              | 3.27 | %              |  |   | 8,017    |   |             |   | 304    |                | 3.79 | % |          |   | 8,248       |   |  |   | 206    |  | 2.50 | %
|Other                                                                            |  |                              | 2,429   |   |                              |   | 171         |                              | 7.04 | %              |  |   | 2,156    |   |             |   | 113    |                | 5.24 | % |          |   | 2,092       |   |  |   | 96     |  | 4.59 | %
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |        |                |      |   |          |   |             |   |  |   |        |  |      |  
|Total interest-earning assets                                                    |  |                              | 427,142 |   |                              |   | 31,053      |                              | 7.27 | %              |  |   | 379,168  |   |             |   | 27,061 |                | 7.14 | % |          |   | 309,935     |   |  |   | 19,208 |  | 6.20 | %
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |        |                |      |   |          |   |             |   |  |   |        |  |      |  
|Other assets                                                                     |  |                              | 20,300  |   |                              |   |             |                              |      |                |  |   | 18,346   |   |             |   |        |                |      |   |          |   | 19,460      |   |  |   |        |  |      |  
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |        |                |      |   |          |   |             |   |  |   |        |  |      |  
|Total assets                                                                     |  | $                            | 447,442 |   |                              |   |             |                              |      |                |  | $ | 397,514  |   |             |   |        |                |      |   |          | $ | 329,395     |   |  |   |        |  |      |  
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |        |                |      |   |          |   |             |   |  |   |        |  |      |  
|Interest-bearing liabilities:                                                    |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |        |                |      |   |          |   |             |   |  |   |        |  |      |  
|Deposits:                                                                        |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |        |                |      |   |          |   |             |   |  |   |        |  |      |  
|Demand deposits                                                                  |  |                              | 80,529  |   |                              |   | 2,796       |                              | 3.47 | %              |  |   | 64,189   |   |             |   | 1,983  |                | 3.09 | % |          |   | 55,152      |   |  |   | 1,070  |  | 1.94 | %
|Savings deposits                                                                 |  |                              | 6,024   |   |                              |   | 60          |                              | 1.00 | %              |  |   | 6,449    |   |             |   | 65     |                | 1.01 | % |          |   | 7,028       |   |  |   | 49     |  | 0.70 | %
|Fixed maturity deposits                                                          |  |                              | 249,096 |   |                              |   | 12,501      |                              | 5.02 | %              |  |   | 226,927  |   |             |   | 10,125 |                | 4.46 | % |          |   | 175,110     |   |  |   | 5,516  |  | 3.15 | %
|Short term borrowed funds                                                        |  |                              | 16,636  |   |                              |   | 1,094       |                              | 6.58 | %              |  |   | 14,044   |   |             |   | 711    |                | 5.06 | % |          |   | 8,622       |   |  |   | 316    |  | 3.67 | %
|Long term borrowed funds                                                         |  |                              | 28,003  |   |                              |   | 1,270       |                              | 4.54 | %              |  |   | 26,674   |   |             |   | 1,357  |                | 5.09 | % |          |   | 34,500      |   |  |   | 1,376  |  | 3.99 | %
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |        |                |      |   |          |   |             |   |  |   |        |  |      |  
|Total interest-bearing liabilities                                               |  |                              | 380,288 |   |                              |   | 17,721      |                              | 4.66 | %              |  |   | 338,283  |   |             |   | 14,241 |                | 4.21 | % |          |   | 280,412     |   |  |   | 8,327  |  | 2.97 | %
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |        |                |      |   |          |   |             |   |  |   |        |  |      |  
|Noninterest-bearing deposits                                                     |  |                              | 34,479  |   |                              |   |             |                              |      |                |  |   | 32,159   |   |             |   |        |                |      |   |          |   | 27,440      |   |  |   |        |  |      |  
|Other liabilities                                                                |  |                              | 2,774   |   |                              |   |             |                              |      |                |  |   | 2,522    |   |             |   |        |                |      |   |          |   | 1,800       |   |  |   |        |  |      |  
|Stockholders equity                                                             |  |                              | 29,901  |   |                              |   |             |                              |      |                |  |   | 24,550   |   |             |   |        |                |      |   |          |   | 19,743      |   |  |   |        |  |      |  
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |        |                |      |   |          |   |             |   |  |   |        |  |      |  
|Total liabilities and stockholders equity                                       |  | $                            | 447,442 |   |                              |   |             |                              |      |                |  | $ | 397,514  |   |             |   |        |                |      |   |          | $ | 329,395     |   |  |   |        |  |      |  
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |        |                |      |   |          |   |             |   |  |   |        |  |      |  
|Net interest income and interest rate spread                                     |  |                              |         |   |                              | $ | 13,332      |                              | 2.61 | %              |  |   |          |   |             | $ | 12,820 |                | 2.93 | % |          |   |             |   |  | $ | 10,881 |  | 3.23 | %
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |        |                |      |   |          |   |             |   |  |   |        |  |      |  
|Net yield on average interest-earning assets                                     |  |                              |         |   |                              |   |             |                              | 3.12 | %              |  |   |          |   |             |   |        |                | 3.38 | % |          |   |             |   |  |   |        |  | 3.51 | %
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |        |                |      |   |          |   |             |   |  |   |        |  |      |  
|Ratio of average interest-earning assets to average interest-bearing liabilities |  |                              | 112.32  | % |                              |   |             |                              |      |                |  |   | 112.09   | % |             |   |        |                |      |   |          |   | 110.53      | % |  |   |        |  |      |  
|                                                                                 |  |                              |         |   |                              |   |             |                              |      |                |  |   |          |   |             |   |        |                |      |   |          |   |             |   |  |   |        |  |      |  



|(1) | includes nonaccrual and nonperforming loans, the impact of which is not significant. Tax exempt income is not computed on a tax equivalent basis.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------



31



---

MidCarolina Financial Corporation

Table 3

Volume and Rate Variance Analysis

(In Thousands)



|                                        |  |                                       |       |   |                                       |   |        |       |  |   |        |   |  |      |       |   |       |   |       |   |  |   |       |  
|--------------------------------------- |  | ------------------------------------- | ----- | - | ------------------------------------- | - | ------ | ----- |  | - | ------ | - |  | ---- | ----- | - | ----- | - | ----- | - |  | - | ----- | -
|                                        |  | Year Ended December 31, 2007 vs. 2006 |       |   | Year Ended December 31, 2006 vs. 2005 |  
|                                        |  | Increase (Decrease) Due to            |       |   | Increase (Decrease) Due to            |  
|                                        |  | Volume                                |       |   | Rate                                  |   |        | Total |  |   | Volume |   |  | Rate |       |   | Total |  
|Interest income:                        |  |                                       |       |   |                                       |   |        |       |  |   |        |   |  |      |       |   |       |   |       |   |  |   |       |  
|Loans, net                              |  | $                                     | 3,375 |   |                                       | $ | 233    |       |  | $ | 3,608  |   |  | $    | 3,506 |   |       | $ | 3,008 |   |  | $ | 6,514 |  
|Investment securities                   |  |                                       | 215   |   |                                       |   | 151    |       |  |   | 366    |   |  |      | 943   |   |       |   | 281   |   |  |   | 1,224 |  
|Interest-earning cash deposits          |  |                                       | 2     |   |                                       |   | (42    | )     |  |   | (40    | ) |  |      | (7    | ) |       |   | 105   |   |  |   | 98    |  
|Other                                   |  |                                       | 17    |   |                                       |   | 41     |       |  |   | 58     |   |  |      | 3     |   |       |   | 14    |   |  |   | 17    |  
|                                        |  |                                       |       |   |                                       |   |        |       |  |   |        |   |  |      |       |   |       |   |       |   |  |   |       |  
|Total interest income                   |  |                                       | 3,609 |   |                                       |   | 383    |       |  |   | 3,992  |   |  |      | 4,445 |   |       |   | 3,408 |   |  |   | 7,853 |  
|                                        |  |                                       |       |   |                                       |   |        |       |  |   |        |   |  |      |       |   |       |   |       |   |  |   |       |  
|Interest expense:                       |  |                                       |       |   |                                       |   |        |       |  |   |        |   |  |      |       |   |       |   |       |   |  |   |       |  
|Deposits                                |  |                                       |       |   |                                       |   |        |       |  |   |        |   |  |      |       |   |       |   |       |   |  |   |       |  
|Demand deposits                         |  |                                       | 536   |   |                                       |   | 277    |       |  |   | 813    |   |  |      | 227   |   |       |   | 686   |   |  |   | 913   |  
|Savings deposits                        |  |                                       | (4    | ) |                                       |   | (1     | )     |  |   | (5     | ) |  |      | (5    | ) |       |   | 21    |   |  |   | 16    |  
|Fixed maturity deposits                 |  |                                       | 1,051 |   |                                       |   | 1,325  |       |  |   | 2,376  |   |  |      | 1,972 |   |       |   | 2,637 |   |  |   | 4,609 |  
|Short term borrowed funds               |  |                                       | 151   |   |                                       |   | 232    |       |  |   | 383    |   |  |      | 237   |   |       |   | 158   |   |  |   | 395   |  
|Long term borrowed funds                |  |                                       | 64    |   |                                       |   | (151   | )     |  |   | (87    | ) |  |      | (355  | ) |       |   | 336   |   |  |   | (19   | )
|                                        |  |                                       |       |   |                                       |   |        |       |  |   |        |   |  |      |       |   |       |   |       |   |  |   |       |  
|Total interest expense                  |  |                                       | 1,798 |   |                                       |   | 1,682  |       |  |   | 3,480  |   |  |      | 2,076 |   |       |   | 3,838 |   |  |   | 5,914 |  
|                                        |  |                                       |       |   |                                       |   |        |       |  |   |        |   |  |      |       |   |       |   |       |   |  |   |       |  
|Net interest income increase (decrease) |  | $                                     | 1,811 |   |                                       | $ | (1,299 | )     |  | $ | 512    |   |  | $    | 2,369 |   |       | $ | (430  | ) |  | $ | 1,939 |  
|                                        |  |                                       |       |   |                                       |   |        |       |  |   |        |   |  |      |       |   |       |   |       |   |  |   |       |  



32



---

MidCarolina Financial Corporation

Table 4

Noninterest Income

(In thousands)



|                                                   |  |                         |       |      |   |       |      |  |   |       |  
|-------------------------------------------------- |  | ----------------------- | ----- | ---- | - | ----- | ---- |  | - | ----- | -
|                                                   |  | Year Ended December 31, |      
|                                                   |  | 2007                    |       | 2006 |   |       | 2005 | 
|Service charges on deposit accounts                |  | $                       | 1,058 |      | $ | 944   |      |  | $ | 1,009 |  
|Mortgage operations                                |  |                         | 600   |      |   | 632   |      |  |   | 1,086 |  
|Investment brokerage fees                          |  |                         | 288   |      |   | 229   |      |  |   | 200   |  
|Increase in cash surrender value of life insurance |  |                         | 290   |      |   | 267   |      |  |   | 254   |  
|                                                   |  |                         |       |      |   |       |      |  |   |       |  
|Core noninterest income                            |  |                         | 2,236 |      |   | 2,072 |      |  |   | 2,549 |  
|Securities gains (losses), net                     |  |                         | 8     |      |   | (217  | )    |  |   | (74   | )
|Gain on sale of other real estate                  |  |                         | 481   |      |   |      |      |  |   |      |  
|Other noninterest income                           |  |                         | 383   |      |   | 449   |      |  |   | 208   |  
|                                                   |  |                         |       |      |   |       |      |  |   |       |  
|Total noninterest income                           |  | $                       | 3,108 |      | $ | 2,304 |      |  | $ | 2,683 |  
|                                                   |  |                         |       |      |   |       |      |  |   |       |  



33



---

MidCarolina Financial Corporation

Table 5

Noninterest Expenses

(In thousands)



|                                      |  |                         |       |   |      |   |       |  |   |      
|------------------------------------- |  | ----------------------- | ----- | - | ---- | - | ----- |  | - | -----
|                                      |  | Year Ended December 31,
|                                      |  | 2007                    |       |   | 2006 |   | 2005 
|Salaries                              |  | $                       | 4,085 |   |      | $ | 3,800 |  | $ | 3,739
|Employee benefits                     |  |                         | 1,299 |   |      |   | 1,336 |  |   | 1,084
|Reversal of accrued employee benefits |  |                         | (905  | ) |      |   |      |  |   |     
|                                      |  |                         |       |   |      |   |       |  |   |      
|Total salaries and benefits           |  |                         | 4,479 |   |      |   | 5,136 |  |   | 4,823
|Occupancy expense                     |  |                         | 428   |   |      |   | 397   |  |   | 368  
|Equipment expense                     |  |                         | 425   |   |      |   | 449   |  |   | 457  
|Data processing                       |  |                         | 774   |   |      |   | 675   |  |   | 567  
|Office supplies and postage           |  |                         | 317   |   |      |   | 352   |  |   | 268  
|Deposit and other insurance           |  |                         | 352   |   |      |   | 208   |  |   | 205  
|Professional and other services       |  |                         | 476   |   |      |   | 407   |  |   | 572  
|Advertising                           |  |                         | 256   |   |      |   | 346   |  |   | 294  
|Other                                 |  |                         | 1,279 |   |      |   | 1,107 |  |   | 992  
|                                      |  |                         |       |   |      |   |       |  |   |      
|Total noninterest expenses            |  | $                       | 8,786 |   |      | $ | 9,077 |  | $ | 8,546
|                                      |  |                         |       |   |      |   |       |  |   |      



34



---

MidCarolina Financial Corporation

Table 6

Contractual Obligations and Commitments

($ in thousands)



|                                                      |  |                                            |         |                          |   |            |  |            |       |              |   |        |  |   |       
|----------------------------------------------------- |  | ------------------------------------------ | ------- | ------------------------ | - | ---------- |  | ---------- | ----- | ------------ | - | ------ |  | - | ------
|                                                      |  | Payments Due by Period                    
|Contractual Obligations                               |  | Total                                      |         | On Demandor Within1 Year |   | 2 -3 Years |  | 4 -5 Years |       | After5 Years
|Short-term borrowings                                 |  | $                                          | 19,000  |                          | $ | 19,000     |  | $          |      |              | $ |       |  | $ |      
|Long-term debt                                        |  |                                            | 38,764  |                          |   |           |  |            | 4,000 |              |   | 10,000 |  |   | 24,764
|Operating leases                                      |  |                                            | 205     |                          |   | 121        |  |            | 84    |              |   |       |  |   |      
|                                                      |  |                                            |         |                          |   |            |  |            |       |              |   |        |  |   |       
|Total contractual cash obligations excluding deposits |  |                                            | 57,969  |                          |   | 19,121     |  |            | 4,084 |              |   | 10,000 |  |   | 24,764
|Time deposits                                         |  |                                            | 262,954 |                          |   | 261,117    |  |            | 1,837 |              |   |       |  |   |      
|                                                      |  |                                            |         |                          |   |            |  |            |       |              |   |        |  |   |       
|Total contractual cash obligations                    |  | $                                          | 320,923 |                          | $ | 280,238    |  | $          | 5,921 |              | $ | 10,000 |  | $ | 24,764
|                                                      |  |                                            |         |                          |   |            |  |            |       |              |   |        |  |   |       
|                                                      | 
|                                                      |  | Amount of Commitment Expiration Per Period
|Commercial Commitments                                |  | TotalAmountsCommitted                      |         | Within1 Year             |   | 2 -3 Years |  | 4 -5 Years |       | After5 Years
|Lines of credit and loan commitments (1)              |  | $                                          | 73,967  |                          | $ | 38,554     |  | $          | 3,345 |              | $ |       |  |   | 32,068
|                                                      |  |                                            |         |                          |   |            |  |            |       |              |   |        |  |   |       
|Commitments to sell loans held for sale               |  | $                                          | 823     |                          | $ | 823        |  | $          |      |              | $ |       |  | $ |      
|                                                      |  |                                            |         |                          |   |            |  |            |       |              |   |        |  |   |       



|(1) | includes financial standby letters of credit, net
|--- | -------------------------------------------------



35



---

MidCarolina Financial Corporation

Table 7

Interest Rate Sensitivity Analysis

($ in thousands)



|                                                                                  |  |                      |         |   |                           |   |          |                       |  |   |               |   |  |       |         |   |  |   |         |  
|--------------------------------------------------------------------------------- |  | -------------------- | ------- | - | ------------------------- | - | -------- | --------------------- |  | - | ------------- | - |  | ----- | ------- | - |  | - | ------- | -
|                                                                                  |  | At December 31, 2007 |        
|                                                                                  |  | 3 Monthsor Less      |         |   | Over 3 Monthsto 12 Months |   |          | Total Within12 Months |  |   | Over 12Months |   |  | Total |        
|Interest-earning assets:                                                          |  |                      |         |   |                           |   |          |                       |  |   |               |   |  |       |         |   |  |   |         |  
|Loans and loans held for sale                                                     |  | $                    | 179,332 |   |                           | $ | 47,689   |                       |  | $ | 227,021       |   |  | $     | 145,516 |   |  | $ | 372,537 |  
|Securities available for sale                                                     |  |                      | 1,083   |   |                           |   | 6,977    |                       |  |   | 8,060         |   |  |       | 62,741  |   |  |   | 70,801  |  
|Other earning assets                                                              |  |                      | 5,945   |   |                           |   |         |                       |  |   | 5,945         |   |  |       |        |   |  |   | 5,945   |  
|                                                                                  |  |                      |         |   |                           |   |          |                       |  |   |               |   |  |       |         |   |  |   |         |  
|Total interest-earning assets                                                     |  | $                    | 186,360 |   |                           | $ | 54,666   |                       |  | $ | 241,026       |   |  | $     | 208,257 |   |  | $ | 449,283 |  
|                                                                                  |  |                      |         |   |                           |   |          |                       |  |   |               |   |  |       |         |   |  |   |         |  
|Interest-bearing liabilities                                                      |  |                      |         |   |                           |   |          |                       |  |   |               |   |  |       |         |   |  |   |         |  
|Fixed maturity deposits                                                           |  | $                    | 77,030  |   |                           |   | 184,139  |                       |  |   | 261,169       |   |  | $     | 1,785   |   |  | $ | 262,954 |  
|All other deposits                                                                |  |                      | 80,375  |   |                           |   |         |                       |  |   | 80,375        |   |  |       |        |   |  |   | 80,375  |  
|Borrowings                                                                        |  |                      | 19,000  |   |                           |   |         |                       |  |   | 19,000        |   |  |       | 38,764  |   |  |   | 57,764  |  
|                                                                                  |  |                      |         |   |                           |   |          |                       |  |   |               |   |  |       |         |   |  |   |         |  
|                                                                                  |  | $                    | 176,405 |   |                           | $ | 184,139  |                       |  | $ | 360,544       |   |  | $     | 40,549  |   |  | $ | 401,093 |  
|                                                                                  |  |                      |         |   |                           |   |          |                       |  |   |               |   |  |       |         |   |  |   |         |  
|Interest sensitivity gap                                                          |  | $                    | 9,955   |   |                           | $ | (129,473 | )                     |  | $ | (119,518      | ) |  | $     | 167,708 |   |  | $ | 48,190  |  
|Cumulative interest sensitivity gap                                               |  |                      | 9,955   |   |                           |   | (119,518 | )                     |  |   | (119,518      | ) |  |       | 48,190  |   |  |   | 48,190  |  
|Cumulative interest sensitivity gap as a percent of total interest-earning assets |  |                      | 2.22    | % |                           |   | -26.60   | %                     |  |   | -26.60        | % |  |       | 10.73   | % |  |   | 10.73   | %
|Cumulative ratio of interest-sensitive assets to interest-sensitive liabilities   |  |                      | 105.64  | % |                           |   | 66.85    | %                     |  |   | 66.85         | % |  |       | 112.01  | % |  |   | 112.01  | %



36



---

MidCarolina Financial Corporation

Table 8

Loan Portfolio Composition

($ in thousands)



|                                                                           |  |                 |         |   |                |        |   |        |   |         |                |  |        |        |  |                |         |  |        |   |                |   |         |        |        |   |                |   |         |   |  |        |  
|-------------------------------------------------------------------------- |  | --------------- | ------- | - | -------------- | ------ | - | ------ | - | ------- | -------------- |  | ------ | ------ |  | -------------- | ------- |  | ------ | - | -------------- | - | ------- | ------ | ------ | - | -------------- | - | ------- | - |  | ------ | -
|                                                                           |  | At December 31, |        
|                                                                           |  | 2007            |         |   | 2006           |        |   | 2005   |   |         | 2004           |  |        | 2003   | 
|                                                                           |  | Amount          |         |   | % ofTotalLoans |        |   | Amount |   |         | % ofTotalLoans |  |        | Amount |  | % ofTotalLoans |         |  | Amount |   | % ofTotalLoans |   |         | Amount |        |   | % ofTotalLoans |  
|Real Estate:                                                               |  |                 |         |   |                |        |   |        |   |         |                |  |        |        |  |                |         |  |        |   |                |   |         |        |        |   |                |   |         |   |  |        |  
|Construction loans                                                         |  | $               | 80,051  |   |                | 21.49  | % |        | $ | 71,348  |                |  | 22.61  | %      |  | $              | 67,170  |  | 23.92  | % |                | $ | 27,715  |        | 12.41  | % |                | $ | 14,276  |   |  | 7.76   | %
|Commercial mortgage loans                                                  |  |                 | 140,198 |   |                | 37.63  | % |        |   | 124,385 |                |  | 39.41  | %      |  |                | 100,292 |  | 35.71  | % |                |   | 88,220  |        | 39.51  | % |                |   | 71,113  |   |  | 38.66  | %
|Home equity lines of credit                                                |  |                 | 41,479  |   |                | 11.13  | % |        |   | 33,090  |                |  | 10.49  | %      |  |                | 30,072  |  | 10.71  | % |                |   | 34,715  |        | 15.55  | % |                |   | 29,221  |   |  | 15.89  | %
|Residential mortgage loans                                                 |  |                 | 57,342  |   |                | 15.39  | % |        |   | 37,163  |                |  | 11.78  | %      |  |                | 38,656  |  | 13.76  | % |                |   | 28,630  |        | 12.82  | % |                |   | 27,010  |   |  | 14.69  | %
|Residential mortgage loans held for sale                                   |  |                 | 823     |   |                | 0.22   | % |        |   | 2,016   |                |  | 0.63   | %      |  |                | 893     |  | 0.32   | % |                |   | 5,657   |        | 2.53   | % |                |   | 4,981   |   |  | 2.71   | %
|                                                                           |  |                 |         |   |                |        |   |        |   |         |                |  |        |        |  |                |         |  |        |   |                |   |         |        |        |   |                |   |         |   |  |        |  
|Total real estate loans                                                    |  |                 | 319,893 |   |                | 85.86  | % |        |   | 268,002 |                |  | 84.92  | %      |  |                | 237,083 |  | 84.42  | % |                |   | 184,937 |        | 82.82  | % |                |   | 146,601 |   |  | 79.71  | %
|Commercial and industrial loans                                            |  |                 | 46,893  |   |                | 12.59  | % |        |   | 38,965  |                |  | 12.35  | %      |  |                | 38,929  |  | 13.86  | % |                |   | 30,464  |        | 13.64  | % |                |   | 30,893  |   |  | 16.80  | %
|Loans to individuals for household, family and other personal expenditures |  |                 | 5,796   |   |                | 1.55   | % |        |   | 8,625   |                |  | 2.73   | %      |  |                | 4,836   |  | 1.72   | % |                |   | 7,911   |        | 3.54   | % |                |   | 6,431   |   |  | 3.50   | %
|                                                                           |  |                 |         |   |                |        |   |        |   |         |                |  |        |        |  |                |         |  |        |   |                |   |         |        |        |   |                |   |         |   |  |        |  
|Loans, gross                                                               |  |                 | 372,582 |   |                | 100.00 | % |        |   | 315,592 |                |  | 100.00 | %      |  |                | 280,848 |  | 100.00 | % |                |   | 223,312 |        | 100.00 | % |                |   | 183,925 |   |  | 100.00 | %
|                                                                           |  |                 |         |   |                |        |   |        |   |         |                |  |        |        |  |                |         |  |        |   |                |   |         |        |        |   |                |   |         |   |  |        |  
|Less net deferred loan origination (fees) costs                            |  |                 | (45     | ) |                |        |   |        |   | (4      | )              |  |        |        |  |                | 7       |  |        |   |                |   | 28      |        |        |   |                |   | (31     | ) |  |        |  
|                                                                           |  |                 |         |   |                |        |   |        |   |         |                |  |        |        |  |                |         |  |        |   |                |   |         |        |        |   |                |   |         |   |  |        |  
|Total loans                                                                |  | $               | 372,537 |   |                |        |   |        | $ | 315,588 |                |  |        |        |  | $              | 280,855 |  |        |   |                | $ | 223,340 |        |        |   |                | $ | 183,894 |   |  |        |  
|                                                                           |  |                 |         |   |                |        |   |        |   |         |                |  |        |        |  |                |         |  |        |   |                |   |         |        |        |   |                |   |         |   |  |        |  



37



---

MidCarolina Financial Corporation

Table 9

Loan Maturities

(In thousands)



|                                                  |  |                      |         |       |                                   |   |        |                     |        |  |       |        |  |       |        |  |        |   |       |   |         |  |      |  
|------------------------------------------------- |  | -------------------- | ------- | ----- | --------------------------------- | - | ------ | ------------------- | ------ |  | ----- | ------ |  | ----- | ------ |  | ------ | - | ----- | - | ------- |  | ---- | -
|                                                  |  | At December 31, 2007 |        
|                                                  |  | Due within oneyear   |         |       | Due after oneyear but within five |   |        | Due after fiveyears |        |  | Total |       
|                                                  |  | Amount               |         | Yield |                                   |   | Amount |                     | Yield  |  |       | Amount |  | Yield |        |  | Amount |   | Yield |  
|By loan type:                                     |  |                      |         |       |                                   |   |        |                     |        |  |       |        |  |       |        |  |        |   |       |   |         |  |      |  
|Commercial and industrial and commercial mortgage |  | $                    | 87,329  |       | 7.37                              | % |        | $                   | 89,634 |  | 7.30  | %      |  | $     | 10,128 |  | 7.27   | % |       | $ | 187,091 |  | 7.33 | %
|Real estateconstruction                          |  |                      | 66,493  |       | 7.70                              | % |        |                     | 9,726  |  | 7.70  | %      |  |       | 3,832  |  | 7.19   | % |       |   | 80,051  |  | 7.67 | %
|                                                  |  |                      |         |       |                                   |   |        |                     |        |  |       |        |  |       |        |  |        |   |       |   |         |  |      |  
|Total                                             |  | $                    | 153,822 |       | 7.51                              | % |        | $                   | 99,360 |  | 7.34  | %      |  | $     | 13,960 |  | 7.25   | % |       | $ | 267,142 |  | 7.43 | %
|                                                  |  |                      |         |       |                                   |   |        |                     |        |  |       |        |  |       |        |  |        |   |       |   |         |  |      |  
|By interest rate type:                            |  |                      |         |       |                                   |   |        |                     |        |  |       |        |  |       |        |  |        |   |       |   |         |  |      |  
|Fixed rate loans                                  |  | $                    | 23,227  |       |                                   |   |        | $                   | 99,360 |  |       |        |  | $     | 13,960 |  |        |   |       | $ | 136,547 |  |      |  
|Variable rate loans                               |  |                      | 130,595 |       |                                   |   |        |                     |       |  |       |        |  |       |       |  |        |   |       |   | 130,595 |  |      |  
|                                                  |  |                      |         |       |                                   |   |        |                     |        |  |       |        |  |       |        |  |        |   |       |   |         |  |      |  
|                                                  |  | $                    | 153,822 |       |                                   |   |        | $                   | 99,360 |  |       |        |  | $     | 13,960 |  |        |   |       | $ | 267,142 |  |      |  
|                                                  |  |                      |         |       |                                   |   |        |                     |        |  |       |        |  |       |        |  |        |   |       |   |         |  |      |  

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



38



---

MidCarolina Financial Corporation

Table 10

Nonperforming Assets

($ in thousands)



|                                                    |  |                 |        |   |      |   |        |      |  |   |         |   |  |      |         |   |  |   |        |  
|--------------------------------------------------- |  | --------------- | ------ | - | ---- | - | ------ | ---- |  | - | ------- | - |  | ---- | ------- | - |  | - | ------ | -
|                                                    |  | At December 31, |       
|                                                    |  | 2007            |        |   | 2006 |   |        | 2005 |  |   | 2004    |   |  | 2003 |        
|Nonaccrual loans                                    |  | $               | 700    |   |      | $ | 794    |      |  | $ | 237     |   |  | $    | 254     |   |  | $ | 589    |  
|Restructured loans                                  |  |                 |       |   |      |   |       |      |  |   |        |   |  |      |        |   |  |   |       |  
|                                                    |  |                 |        |   |      |   |        |      |  |   |         |   |  |      |         |   |  |   |        |  
|Total nonperforming loans                           |  |                 | 700    |   |      |   | 794    |      |  |   | 237     |   |  |      | 254     |   |  |   | 589    |  
|Repossessed Assets                                  |  |                 |       |   |      |   |       |      |  |   | 19      |   |  |      |        |   |  |   | 22     |  
|Other real estate owned                             |  |                 | 264    |   |      |   | 2,337  |      |  |   | 2,803   |   |  |      | 2,031   |   |  |   |       |  
|                                                    |  |                 |        |   |      |   |        |      |  |   |         |   |  |      |         |   |  |   |        |  
|Total nonperforming assets                          |  | $               | 964    |   |      | $ | 3,131  |      |  | $ | 3,059   |   |  | $    | 2,285   |   |  | $ | 611    |  
|                                                    |  |                 |        |   |      |   |        |      |  |   |         |   |  |      |         |   |  |   |        |  
|Accruing loans past due 90 days or more             |  | $               |       |   |      | $ |       |      |  | $ |        |   |  | $    |        |   |  | $ |       |  
|Allowance for loan losses                           |  |                 | 4,462  |   |      |   | 4,222  |      |  |   | 4,090   |   |  |      | 2,865   |   |  |   | 2,522  |  
|Nonperforming loans to year end loans               |  |                 | 0.19   | % |      |   | 0.25   | %    |  |   | 0.08    | % |  |      | 0.11    | % |  |   | 0.32   | %
|Allowance for loan losses to year end loans         |  |                 | 1.20   | % |      |   | 1.35   | %    |  |   | 1.46    | % |  |      | 1.32    | % |  |   | 1.41   | %
|Nonperforming assets to loans and other real estate |  |                 | 0.27   | % |      |   | 0.99   | %    |  |   | 1.08    | % |  |      | 1.01    | % |  |   | 0.33   | %
|Nonperforming assets to total assets                |  |                 | 0.21   | % |      |   | 0.74   | %    |  |   | 0.83    | % |  |      | 0.80    | % |  |   | 0.29   | %
|Allowance for loan losses to nonperforming loans    |  |                 | 637.43 | % |      |   | 531.74 | %    |  |   | 1725.74 | % |  |      | 1127.95 | % |  |   | 428.18 | %



39



---

MidCarolina Financial Corporation

Table 11

Allocation of the Allowance for Loan Losses

(In thousands)



|                                         |  |        |       |                     |        |   |        |      |                     |  |        |        |  |                     |       |  |        |   |                     |   |       |        |        |                     |  |   |       |  |        |  
|---------------------------------------- |  | ------ | ----- | ------------------- | ------ | - | ------ | ---- | ------------------- |  | ------ | ------ |  | ------------------- | ----- |  | ------ | - | ------------------- | - | ----- | ------ | ------ | ------------------- |  | - | ----- |  | ------ | -
|                                         |  | 2007   |       |                     | 2006   |   |        | 2005 |                     |  | 2004   |        |  | 2003                |      
|                                         |  | Amount |       | % of TotalLoans (1) |        |   | Amount |      | % of TotalLoans (1) |  |        | Amount |  | % of TotalLoans (1) |       |  | Amount |   | % of TotalLoans (1) |   |       | Amount |        | % of TotalLoans (1) | 
|Real estate loans:                       |  |        |       |                     |        |   |        |      |                     |  |        |        |  |                     |       |  |        |   |                     |   |       |        |        |                     |  |   |       |  |        |  
|Construction loans                       |  | $      | 959   |                     | 21.49  | % |        | $    | 954                 |  | 22.61  | %      |  | $                   | 978   |  | 23.92  | % |                     | $ | 356   |        | 12.41  | %                   |  | $ | 196   |  | 7.76   | %
|Commercial mortgage loans                |  |        | 1,679 |                     | 37.63  | % |        |      | 1,664               |  | 39.41  | %      |  |                     | 1,461 |  | 35.71  | % |                     |   | 1,132 |        | 39.51  | %                   |  |   | 996   |  | 39.51  | %
|Home equity lines of credit              |  |        | 497   |                     | 11.13  | % |        |      | 443                 |  | 10.49  | %      |  |                     | 438   |  | 10.71  | % |                     |   | 445   |        | 15.55  | %                   |  |   | 392   |  | 15.55  | %
|Residential mortgage loans               |  |        | 687   |                     | 15.39  | % |        |      | 497                 |  | 11.78  | %      |  |                     | 548   |  | 13.39  | % |                     |   | 357   |        | 12.82  | %                   |  |   | 323   |  | 12.82  | %
|Residential mortgage loans held for sale |  |        | 10    |                     | 0.22   | % |        |      | 27                  |  | 0.63   | %      |  |                     |      |  | 0.69   | % |                     |   |      |        | 2.53   | %                   |  |   |      |  | 2.53   | %
|                                         |  |        |       |                     |        |   |        |      |                     |  |        |        |  |                     |       |  |        |   |                     |   |       |        |        |                     |  |   |       |  |        |  
|Total real estate loans                  |  |        | 3,832 |                     | 85.86  | % |        |      | 3,585               |  | 84.92  | %      |  |                     | 3,425 |  | 84.42  | % |                     |   | 2,290 |        | 82.82  | %                   |  |   | 1,907 |  | 82.82  | %
|Commercial and industrial loans          |  |        | 562   |                     | 12.59  | % |        |      | 521                 |  | 12.35  | %      |  |                     | 580   |  | 13.86  | % |                     |   | 489   |        | 13.64  | %                   |  |   | 442   |  | 13.64  | %
|Loans to individuals                     |  |        | 69    |                     | 1.55   | % |        |      | 115                 |  | 2.73   | %      |  |                     | 70    |  | 1.72   | % |                     |   | 101   |        | 3.54   | %                   |  |   | 89    |  | 3.54   | %
|                                         |  |        |       |                     |        |   |        |      |                     |  |        |        |  |                     |       |  |        |   |                     |   |       |        |        |                     |  |   |       |  |        |  
|                                         |  | $      | 4,462 |                     | 100.00 | % |        | $    | 4,222               |  | 100.00 | %      |  | $                   | 4,090 |  | 100.00 | % |                     | $ | 2,865 |        | 100.00 | %                   |  | $ | 2,522 |  | 100.00 | %
|                                         |  |        |       |                     |        |   |        |      |                     |  |        |        |  |                     |       |  |        |   |                     |   |       |        |        |                     |  |   |       |  |        |  



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



40



---

MidCarolina Financial Corporation

Table 12

Loan Loss and Recovery Experience

($ in thousands)



|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|-------------------------------------------------------------- |  | ------------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | - |  | ---- | ------- | - |  | - | ------- | -
|                                                               |  | At or for the Year Ended December 31, |        
|                                                               |  | 2007                                  |         |   | 2006 |   |         | 2005 |  |   | 2004    |   |  | 2003 |        
|Loans outstanding at the end of the year                       |  | $                                     | 371,714 |   |      | $ | 313,572 |      |  | $ | 279,962 |   |  | $    | 217,683 |   |  | $ | 178,913 |  
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Average loans outstanding during the year                      |  | $                                     | 344,620 |   |      | $ | 301,405 |      |  | $ | 252,914 |   |  | $    | 204,121 |   |  | $ | 160,041 |  
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Allowance for loan losses at beginning of year                 |  | $                                     | 4,222   |   |      | $ | 4,090   |      |  | $ | 2,865   |   |  | $    | 2,522   |   |  | $ | 2,088   |  
|Provision for loan losses                                      |  |                                       | 425     |   |      |   | 394     |      |  |   | 1,373   |   |  |      | 1,030   |   |  |   | 586     |  
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|                                                               |  |                                       | 4,647   |   |      |   | 4,484   |      |  |   | 4,238   |   |  |      | 3,552   |   |  |   | 2,674   |  
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Loans charged off:                                             |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Real estate loans                                              |  |                                       | (268    | ) |      |   | (214    | )    |  |   |        |   |  |      | (5      | ) |  |   | (3      | )
|Commercial and industrial loans                                |  |                                       |        |   |      |   | (87     | )    |  |   | (137    | ) |  |      | (693    | ) |  |   | (73     | )
|Installment loans                                              |  |                                       | (28     | ) |      |   | (17     | )    |  |   | (44     | ) |  |      | (56     | ) |  |   | (126    | )
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Total charge-offs                                              |  |                                       | (296    | ) |      |   | (318    | )    |  |   | (181    | ) |  |      | (754    | ) |  |   | (202    | )
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Recoveries of loans previously charged off:                    |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Real estate loans                                              |  |                                       | 66      |   |      |   | 2       |      |  |   |        |   |  |      |        |   |  |   |        |  
|Commercial and industrial loans                                |  |                                       | 38      |   |      |   | 46      |      |  |   | 26      |   |  |      | 14      |   |  |   | 41      |  
|Installment loans                                              |  |                                       | 7       |   |      |   | 8       |      |  |   | 7       |   |  |      | 53      |   |  |   | 9       |  
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Total recoveries                                               |  |                                       | 111     |   |      |   | 56      |      |  |   | 33      |   |  |      | 67      |   |  |   | 50      |  
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net charge-offs                                                |  |                                       | (185    | ) |      |   | (262    | )    |  |   | (148    | ) |  |      | (687    | ) |  |   | (152    | )
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Allowance for loan losses at end of year                       |  | $                                     | 4,462   |   |      | $ | 4,222   |      |  | $ | 4,090   |   |  | $    | 2,865   |   |  | $ | 2,522   |  
|                                                               |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Ratios:                                                        |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net charge-offs as a percent of average loans                  |  |                                       | 0.05    | % |      |   | 0.09    | %    |  |   | 0.06    | % |  |      | 0.34    | % |  |   | 0.09    | %
|Allowance for loan losses as a percent of loans at end of year |  |                                       | 1.20    | % |      |   | 1.35    | %    |  |   | 1.46    | % |  |      | 1.32    | % |  |   | 1.41    | %



41



---

MidCarolina Financial Corporation

Table 13

Securities Portfolio Composition

(In thousands)



|                                    |  |                |        |      |   |        |  |   |       
|----------------------------------- |  | -------------- | ------ | ---- | - | ------ |  | - | ------
|                                    |  | At December 31
|                                    |  | 2007           |        | 2006 |   | 2005  
|Securities available for sale:      |  |                |        |      |   |        |  |   |       
|U. S. Government agencies           |  | $              | 21,610 |      | $ | 20,113 |  | $ | 15,690
|Mortgage-backed securities          |  |                | 29,761 |      |   | 25,308 |  |   | 22,847
|State and municipal governments     |  |                | 19,275 |      |   | 28,219 |  |   | 19,712
|Other                               |  |                | 155    |      |   | 155    |  |   | 124   
|                                    |  |                |        |      |   |        |  |   |       
|Total securities available for sale |  |                | 70,801 |      |   | 73,795 |  |   | 58,373
|                                    |  |                |        |      |   |        |  |   |       
|Securities held to maturity:        |  |                |        |      |   |        |  |   |       
|Other                               |  |                |       |      |   |       |  |   | 250   
|                                    |  |                |        |      |   |        |  |   |       
|Total securities                    |  | $              | 70,801 |      | $ | 73,795 |  | $ | 58,623
|                                    |  |                |        |      |   |        |  |   |       



42



---

MidCarolina Financial Corporation

Table 14

Securities Portfolio Composition

($ in thousands)



|                                    |  |               |        |           |   |           |  |      |  
|----------------------------------- |  | ------------- | ------ | --------- | - | --------- |  | ---- | -
|                                    |  | AmortizedCost |        | FairValue |   | BookYield | 
|Securities available for sale:      |  |               |        |           |   |           |  |      |  
|U. S. Government agencies           |  |               |        |           |   |           |  |      |  
|Due after one but within five years |  | $             | 13,934 |           | $ | 15,016    |  | 5.82 | %
|Due after five but within ten years |  |               | 1,219  |           |   | 1,226     |  | 5.66 | %
|Due after ten years                 |  |               | 6,281  |           |   | 5,368     |  | 5.83 | %
|                                    |  |               |        |           |   |           |  |      |  
|                                    |  |               | 21,434 |           |   | 21,610    |  | 5.81 | %
|                                    |  |               |        |           |   |           |  |      |  
|Mortgage-backed securities          |  |               |        |           |   |           |  |      |  
|Due within one year                 |  |               | 2,438  |           |   | 2,414     |  | 4.90 | %
|Due after one but within five years |  |               | 9,801  |           |   | 9,713     |  | 4.73 | %
|Due after five but within ten years |  |               | 10,937 |           |   | 10,704    |  | 4.97 | %
|Due after ten years                 |  |               | 6,881  |           |   | 6,930     |  | 5.28 | %
|                                    |  |               |        |           |   |           |  |      |  
|                                    |  |               | 30,057 |           |   | 29,761    |  | 4.96 | %
|                                    |  |               |        |           |   |           |  |      |  
|State and municipal securities      |  |               |        |           |   |           |  |      |  
|Due after five but within ten years |  |               | 9,039  |           |   | 8,953     |  | 4.33 | %
|Due after ten years                 |  |               | 10,665 |           |   | 10,322    |  | 4.27 | %
|                                    |  |               |        |           |   |           |  |      |  
|                                    |  |               | 19,704 |           |   | 19,275    |  | 4.30 | %
|                                    |  |               |        |           |   |           |  |      |  
|Total securities available for sale |  |               |        |           |   |           |  |      |  
|Due within one year                 |  |               | 2,438  |           |   | 2,414     |  | 4.90 | %
|Due after one but within five years |  |               | 23,735 |           |   | 24,729    |  | 5.39 | %
|Due after five but within ten years |  |               | 21,195 |           |   | 20,883    |  | 4.74 | %
|Due after ten years                 |  |               | 23,982 |           |   | 22,775    |  | 4.92 | %
|                                    |  |               |        |           |   |           |  |      |  
|                                    |  | $             | 71,350 |           | $ | 70,801    |  | 5.03 | %
|                                    |  |               |        |           |   |           |  |      |  



|(1) | Yields on tax-exempt investments have been adjusted to a taxable equivalent basis
|--- | ---------------------------------------------------------------------------------



43



---

MidCarolina Financial Corporation

Table 15

Average Deposits

($ in thousands)



|                                |  |                                 |         |             |      |   |               |      |             |  |      |               |  |             |         |  |      |  
|------------------------------- |  | ------------------------------- | ------- | ----------- | ---- | - | ------------- | ---- | ----------- |  | ---- | ------------- |  | ----------- | ------- |  | ---- | -
|                                |  | For the Year Ended December 31, |        
|                                |  | 2007                            |         |             | 2006 |   |               | 2005 |            
|                                |  | AverageAmount                   |         | AverageRate |      |   | AverageAmount |      | AverageRate |  |      | AverageAmount |  | AverageRate |        
|Demand deposits                 |  |                                 | 80,529  |             | 3.47 | % |               | $    | 64,189      |  | 3.09 | %             |  | $           | 55,152  |  | 1.94 | %
|Savings deposits                |  |                                 | 6,024   |             | 1.00 | % |               |      | 6,449       |  | 1.01 | %             |  |             | 7,028   |  | 0.70 | %
|Fixed maturity deposits         |  |                                 | 249,096 |             | 5.02 | % |               |      | 226,927     |  | 4.46 | %             |  |             | 175,110 |  | 3.15 | %
|                                |  |                                 |         |             |      |   |               |      |             |  |      |               |  |             |         |  |      |  
|Total interest-bearing deposits |  |                                 | 335,649 |             | 4.58 | % |               |      | 297,565     |  | 4.09 | %             |  |             | 237,290 |  | 2.80 | %
|Noninterest-bearing deposits    |  |                                 | 34,479  |             |     |   |               |      | 32,159      |  |     |               |  |             | 27,440  |  |     |  
|                                |  |                                 |         |             |      |   |               |      |             |  |      |               |  |             |         |  |      |  
|Total deposits                  |  | $                               | 370,128 |             | 4.15 | % |               | $    | 329,724     |  | 3.69 | %             |  | $           | 264,730 |  | 2.51 | %
|                                |  |                                 |         |             |      |   |               |      |             |  |      |               |  |             |         |  |      |  



44



---

MidCarolina Financial Corporation

Table 16

Maturities of Time Deposits of $100,000 or More

(In thousands)



|                                  |  |                      |        |                          |   |                           |  |               |        |       |   |     |  |   |        
|--------------------------------- |  | -------------------- | ------ | ------------------------ | - | ------------------------- |  | ------------- | ------ | ----- | - | --- |  | - | -------
|                                  |  | At December 31, 2007
|                                  |  | 3 Monthsor Less      |        | Over 3 Monthsto 6 Months |   | Over 6 Monthsto 12 Months |  | Over 12Months |        | Total
|Time Deposits of $100,000 or more |  | $                    | 57,027 |                          | $ | 89,383                    |  | $             | 45,049 |       | $ | 514 |  | $ | 191,973
|                                  |  |                      |        |                          |   |                           |  |               |        |       |   |     |  |   |        



45



---

|Item 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
|-------- | ---------------------------------------------------------

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

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



46



---

|ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
|------- | --------------------------------------------

QUARTERLY FINANCIAL INFORMATION

The table below sets forth for the periods indicated, certain of our consolidated quarterly
financial information. This information is derived from our unaudited financial statements, which include, in the opinion of management, all normal recurring adjustments which management considers necessary for a fair presentation of the results for
such periods. This information should be read in conjunction with our consolidated financial statements included elsewhere in this report. The results for any quarter are not necessarily indicative of results for any future period.

MidCarolina Financial Corporation

Quarterly Financial Data

($ In thousands, except per share data)



|                                            |  |                              |       |                              |   |               |  |              |       |               |   |              |  |               |       |              |   |       |  |   |       |  |   |      
|------------------------------------------- |  | ---------------------------- | ----- | ---------------------------- | - | ------------- |  | ------------ | ----- | ------------- | - | ------------ |  | ------------- | ----- | ------------ | - | ----- |  | - | ----- |  | - | -----
|                                            |  | Year Ended December 31, 2007 |       | Year Ended December 31, 2006
|                                            |  | FourthQuarter                |       | ThirdQuarter                 |   | SecondQuarter |  | FirstQuarter |       | FourthQuarter |   | ThirdQuarter |  | SecondQuarter |       | FirstQuarter
|Operating Data:                             |  |                              |       |                              |   |               |  |              |       |               |   |              |  |               |       |              |   |       |  |   |       |  |   |      
|Total interest income                       |  | $                            | 8,025 |                              | $ | 8,054         |  | $            | 7,669 |               | $ | 7,305        |  | $             | 7,162 |              | $ | 7,069 |  | $ | 6,732 |  | $ | 6,098
|Total interest expense                      |  |                              | 4,604 |                              |   | 4,641         |  |              | 4,374 |               |   | 4,102        |  |               | 3,976 |              |   | 3,812 |  |   | 3,496 |  |   | 2,957
|                                            |  |                              |       |                              |   |               |  |              |       |               |   |              |  |               |       |              |   |       |  |   |       |  |   |      
|Net interest income                         |  |                              | 3,421 |                              |   | 3,413         |  |              | 3,295 |               |   | 3,203        |  |               | 3,186 |              |   | 3,257 |  |   | 3,236 |  |   | 3,141
|Provision for loan losses                   |  |                              | 425   |                              |   |              |  |              |      |               |   |             |  |               |      |              |   | 35    |  |   | 127   |  |   | 232  
|                                            |  |                              |       |                              |   |               |  |              |       |               |   |              |  |               |       |              |   |       |  |   |       |  |   |      
|Net interest income after provision         |  |                              | 2,996 |                              |   | 3,413         |  |              | 3,295 |               |   | 3,203        |  |               | 3,186 |              |   | 3,222 |  |   | 3,109 |  |   | 2,909
|Noninterest income                          |  |                              | 1,115 |                              |   | 657           |  |              | 759   |               |   | 577          |  |               | 613   |              |   | 610   |  |   | 587   |  |   | 494  
|Noninterest expense                         |  |                              | 1,615 |                              |   | 2,325         |  |              | 2,458 |               |   | 2,388        |  |               | 2,337 |              |   | 2,263 |  |   | 2,342 |  |   | 2,135
|                                            |  |                              |       |                              |   |               |  |              |       |               |   |              |  |               |       |              |   |       |  |   |       |  |   |      
|Income before income taxes                  |  |                              | 2,496 |                              |   | 1,745         |  |              | 1,596 |               |   | 1,392        |  |               | 1,462 |              |   | 1,569 |  |   | 1,354 |  |   | 1,268
|Provision for income taxes                  |  |                              | 898   |                              |   | 540           |  |              | 479   |               |   | 425          |  |               | 417   |              |   | 460   |  |   | 426   |  |   | 454  
|                                            |  |                              |       |                              |   |               |  |              |       |               |   |              |  |               |       |              |   |       |  |   |       |  |   |      
|Net income                                  |  |                              | 1,598 |                              |   | 1,205         |  |              | 1,117 |               |   | 967          |  |               | 1,045 |              |   | 1,109 |  |   | 928   |  |   | 814  
|Dividends on preferred stock                |  |                              | 105   |                              |   | 104           |  |              | 104   |               |   | 104          |  |               | 105   |              |   | 103   |  |   | 105   |  |   | 104  
|                                            |  |                              |       |                              |   |               |  |              |       |               |   |              |  |               |       |              |   |       |  |   |       |  |   |      
|Net income available to common shareholders |  |                              | 1,493 |                              |   | 1,101         |  |              | 1,013 |               |   | 863          |  |               | 940   |              |   | 1,006 |  |   | 823   |  |   | 710  
|                                            |  |                              |       |                              |   |               |  |              |       |               |   |              |  |               |       |              |   |       |  |   |       |  |   |      
|NET INCOME PER COMMON SHARE                 |  |                              |       |                              |   |               |  |              |       |               |   |              |  |               |       |              |   |       |  |   |       |  |   |      
|Basic                                       |  |                              | 0.32  |                              |   | 0.24          |  |              | 0.23  |               |   | 0.19         |  |               | 0.20  |              |   | 0.24  |  |   | 0.20  |  |   | 0.16 
|Diluted                                     |  |                              | 0.31  |                              |   | 0.22          |  |              | 0.21  |               |   | 0.18         |  |               | 0.19  |              |   | 0.21  |  |   | 0.18  |  |   | 0.15 



47



---

MIDCAROLINA FINANCIAL CORPORATION

CONSOLIDATED FINANCIAL STATEMENTS

Years Ended December 31,
2007, 2006 and 2005



48



---

MIDCAROLINA FINANCIAL CORPORATION AND SUBSIDIARY

INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS



|                                                                                                                |  |         
|--------------------------------------------------------------------------------------------------------------- |  | --------
|                                                                                                                |  | Page No.
|Report of Independent Registered Public Accounting Firm                                                         |  | 50      
|                                                                                                                | 
|Consolidated Statements of Financial Condition as of December 31, 2007 and 2006                                 |  | 51      
|                                                                                                                | 
|Consolidated Statements of Operations for the years ended December 31, 2007, 2006 and 2005                      |  | 52      
|                                                                                                                | 
|Consolidated Statements of Comprehensive Income for the years ended December 31, 2007, 2006 and 2005            |  | 53      
|                                                                                                                | 
|Consolidated Statements of Changes in Shareholders Equity for the years ended December 31, 2007, 2006 and 2005 |  | 54      
|                                                                                                                | 
|Consolidated Statements of Cash Flows for the years ended December 31, 2007, 2006 and 2005                      |  | 55      
|                                                                                                                | 
|Notes to Consolidated Financial Statements                                                                      |  | 56      



49



---

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders

MidCarolina Financial Corporation and Subsidiary

Burlington, North Carolina

We have audited the accompanying consolidated
statements of financial condition of MidCarolina Financial Corporation and Subsidiary (hereinafter referred to as the Company) as of December 31, 2007 and 2006, and the related consolidated statements of operations, comprehensive
income, changes in shareholders equity and cash flows for each of the years in the three-year period ended December 31, 2007. These consolidated financial statements are the responsibility of the Companys management. Our
responsibility is to express an opinion on these consolidated financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of MidCarolina Financial Corporation and Subsidiary as of December 31, 2007 and 2006, and the results of their operations and their cash flows for each of the years in the three-year period ended
December 31, 2007, in conformity with accounting principles generally accepted in the United States of America.



|                       
|-----------------------
|LOGO                   
|                       
|Raleigh, North Carolina
|March 25, 2008         



50



---

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

December 31, 2007 and 2006



|                                                                                                                                                            |  |                                          |         |   |      |   |         |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------------------- | ------- | - | ---- | - | ------- | -
|                                                                                                                                                            |  | 2007                                     |         |   | 2006 |  
|                                                                                                                                                            |  | (Amounts in thousands,except share data) |        
|Assets                                                                                                                                                      |  |                                          |         |   |      |   |         |  
|Cash and due from banks                                                                                                                                     |  | $                                        | 1,632   |   |      | $ | 1,496   |  
|Federal funds sold and interest-earning deposits                                                                                                            |  |                                          | 2,979   |   |      |   | 10,942  |  
|Investment securities:                                                                                                                                      |  |                                          |         |   |      |   |         |  
|Available for sale                                                                                                                                          |  |                                          | 70,801  |   |      |   | 73,795  |  
|Loans held for sale                                                                                                                                         |  |                                          | 823     |   |      |   | 2,016   |  
|Loans                                                                                                                                                       |  |                                          | 371,714 |   |      |   | 313,572 |  
|Allowance for loan losses                                                                                                                                   |  |                                          | (4,462  | ) |      |   | (4,222  | )
|                                                                                                                                                            |  |                                          |         |   |      |   |         |  
|Net loans                                                                                                                                                   |  |                                          | 367,252 |   |      |   | 309,350 |  
|Investment in stock of Federal Home Loan Bank of Atlanta                                                                                                    |  |                                          | 2,966   |   |      |   | 2,676   |  
|Investment in life insurance                                                                                                                                |  |                                          | 7,594   |   |      |   | 7,304   |  
|Premises and equipment, net                                                                                                                                 |  |                                          | 6,834   |   |      |   | 6,624   |  
|Other assets                                                                                                                                                |  |                                          | 6,305   |   |      |   | 6,647   |  
|                                                                                                                                                            |  |                                          |         |   |      |   |         |  
|Total assets                                                                                                                                                |  | $                                        | 467,186 |   |      | $ | 420,850 |  
|                                                                                                                                                            |  |                                          |         |   |      |   |         |  
|                                                                                                                                                            |  |                                         
|Liabilities and Shareholders Equity                                                                                                                        |  |                                          |         |   |      |   |         |  
|Deposits:                                                                                                                                                   |  |                                          |         |   |      |   |         |  
|Noninterest-bearing demand deposits                                                                                                                         |  | $                                        | 30,568  |   |      | $ | 34,662  |  
|Interest-bearing demand deposits                                                                                                                            |  |                                          | 74,913  |   |      |   | 71,447  |  
|Savings                                                                                                                                                     |  |                                          | 5,462   |   |      |   | 5,892   |  
|Time                                                                                                                                                        |  |                                          | 262,954 |   |      |   | 227,274 |  
|                                                                                                                                                            |  |                                          |         |   |      |   |         |  
|Total deposits                                                                                                                                              |  |                                          | 373,897 |   |      |   | 339,275 |  
|                                                                                                                                                            |  |                                         
|Short-term borrowings                                                                                                                                       |  |                                          | 19,000  |   |      |   | 25,000  |  
|Long-term debt                                                                                                                                              |  |                                          | 38,764  |   |      |   | 26,764  |  
|Accrued expenses and other liabilities                                                                                                                      |  |                                          | 2,375   |   |      |   | 1,552   |  
|                                                                                                                                                            |  |                                          |         |   |      |   |         |  
|Total liabilities                                                                                                                                           |  |                                          | 434,036 |   |      |   | 392,591 |  
|                                                                                                                                                            |  |                                          |         |   |      |   |         |  
|Shareholders equity:                                                                                                                                       |  |                                          |         |   |      |   |         |  
|Noncumulative, perpetual preferred stock, no par value, 20,000,000 shares authorized; 5,000 shares issued and outstanding at December 31,
2007 and 2006     |  |                                          | 4,819   |   |      |   | 4,819   |  
|Common stock, no par value; 80,000,000 shares authorized; 4,618,528 and 3,619,786 shares issued and outstanding at December 31, 2007 and
2006, respectively |  |                                          | 13,290  |   |      |   | 13,007  |  
|Retained earnings                                                                                                                                           |  |                                          | 15,378  |   |      |   | 10,908  |  
|Accumulated other comprehensive loss                                                                                                                        |  |                                          | (337    | ) |      |   | (475    | )
|                                                                                                                                                            |  |                                          |         |   |      |   |         |  
|Total shareholders equity                                                                                                                                  |  |                                          | 33,150  |   |      |   | 28,259  |  
|                                                                                                                                                            |  |                                          |         |   |      |   |         |  
|Total liabilities and shareholders equity                                                                                                                  |  | $                                        | 467,186 |   |      | $ | 420,850 |  
|                                                                                                                                                            |  |                                          |         |   |      |   |         |  

See accompanying notes to consolidated financial statements.



51



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CONSOLIDATED STATEMENTS OF OPERATIONS

Years Ended December 31,
2007, 2006 and 2005



|                                                    |  |                                               |        |   |      |   |        |      |  |   |        |  
|--------------------------------------------------- |  | --------------------------------------------- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                    |  | 2007                                          |        |   | 2006 |   |        | 2005 | 
|                                                    |  | (Amounts in thousands, except per share data) |       
|Interest Income                                     |  |                                               |        |   |      |   |        |      |  |   |        |  
|Loans                                               |  | $                                             | 27,037 |   |      | $ | 23,429 |      |  | $ | 16,915 |  
|Investment securities:                              |  |                                               |        |   |      |   |        |      |  |   |        |  
|Taxable                                             |  |                                               | 2,556  |   |      |   | 2,249  |      |  |   | 1,525  |  
|Tax-exempt                                          |  |                                               | 1,025  |   |      |   | 966    |      |  |   | 466    |  
|Federal funds sold and interest-earning deposits    |  |                                               | 264    |   |      |   | 304    |      |  |   | 206    |  
|Other                                               |  |                                               | 171    |   |      |   | 113    |      |  |   | 96     |  
|                                                    |  |                                               |        |   |      |   |        |      |  |   |        |  
|Total interest income                               |  |                                               | 31,053 |   |      |   | 27,061 |      |  |   | 19,208 |  
|                                                    |  |                                               |        |   |      |   |        |      |  |   |        |  
|Interest Expense                                    |  |                                               |        |   |      |   |        |      |  |   |        |  
|Demand deposits                                     |  |                                               | 2,796  |   |      |   | 1,983  |      |  |   | 1,070  |  
|Savings deposits                                    |  |                                               | 60     |   |      |   | 65     |      |  |   | 49     |  
|Time deposits                                       |  |                                               | 12,501 |   |      |   | 10,125 |      |  |   | 5,516  |  
|Short-term borrowings                               |  |                                               | 1,094  |   |      |   | 711    |      |  |   | 316    |  
|Long-term debt                                      |  |                                               | 1,270  |   |      |   | 1,357  |      |  |   | 1,376  |  
|                                                    |  |                                               |        |   |      |   |        |      |  |   |        |  
|Total interest expense                              |  |                                               | 17,721 |   |      |   | 14,241 |      |  |   | 8,327  |  
|                                                    |  |                                               |        |   |      |   |        |      |  |   |        |  
|Net Interest Income                                 |  |                                               | 13,332 |   |      |   | 12,820 |      |  |   | 10,881 |  
|Provision for loan losses                           |  |                                               | 425    |   |      |   | 394    |      |  |   | 1,373  |  
|                                                    |  |                                               |        |   |      |   |        |      |  |   |        |  
|Net interest income after provision for loan losses |  |                                               | 12,907 |   |      |   | 12,426 |      |  |   | 9,508  |  
|                                                    |  |                                               |        |   |      |   |        |      |  |   |        |  
|Noninterest Income                                  |  |                                               |        |   |      |   |        |      |  |   |        |  
|Service charges on deposit accounts                 |  |                                               | 1,058  |   |      |   | 944    |      |  |   | 1,009  |  
|Mortgage operations                                 |  |                                               | 600    |   |      |   | 632    |      |  |   | 1,086  |  
|Investment services                                 |  |                                               | 288    |   |      |   | 229    |      |  |   | 200    |  
|Increase in cash surrender value of life insurance  |  |                                               | 290    |   |      |   | 267    |      |  |   | 254    |  
|Gain (loss) on sale of investment securities        |  |                                               | 8      |   |      |   | (217   | )    |  |   | (74    | )
|Gain (loss) on sale of other real estate            |  |                                               | 481    |   |      |   | 21     |      |  |   | 8      |  
|Other                                               |  |                                               | 383    |   |      |   | 428    |      |  |   | 200    |  
|                                                    |  |                                               |        |   |      |   |        |      |  |   |        |  
|Total noninterest income                            |  |                                               | 3,108  |   |      |   | 2,304  |      |  |   | 2,683  |  
|                                                    |  |                                               |        |   |      |   |        |      |  |   |        |  
|Noninterest Expense                                 |  |                                               |        |   |      |   |        |      |  |   |        |  
|Salaries and employee benefits                      |  |                                               | 5,384  |   |      |   | 5,136  |      |  |   | 4,823  |  
|Reversal of accrued employee benefits               |  |                                               | (905   | ) |      |   |       |      |  |   |       |  
|Occupancy and equipment                             |  |                                               | 853    |   |      |   | 846    |      |  |   | 825    |  
|Data processing                                     |  |                                               | 774    |   |      |   | 675    |      |  |   | 567    |  
|Office supplies and postage                         |  |                                               | 317    |   |      |   | 352    |      |  |   | 268    |  
|Deposit and other insurance                         |  |                                               | 352    |   |      |   | 208    |      |  |   | 205    |  
|Professional and other services                     |  |                                               | 476    |   |      |   | 407    |      |  |   | 572    |  
|Advertising                                         |  |                                               | 256    |   |      |   | 346    |      |  |   | 294    |  
|Other                                               |  |                                               | 1,279  |   |      |   | 1,107  |      |  |   | 992    |  
|                                                    |  |                                               |        |   |      |   |        |      |  |   |        |  
|Total noninterest expense                           |  |                                               | 8,786  |   |      |   | 9,077  |      |  |   | 8,546  |  
|                                                    |  |                                               |        |   |      |   |        |      |  |   |        |  
|Income before income taxes                          |  |                                               | 7,229  |   |      |   | 5,653  |      |  |   | 3,645  |  
|Provision for income taxes                          |  |                                               | 2,342  |   |      |   | 1,757  |      |  |   | 1,277  |  
|                                                    |  |                                               |        |   |      |   |        |      |  |   |        |  
|Net income                                          |  |                                               | 4,887  |   |      |   | 3,896  |      |  |   | 2,368  |  
|Dividends on preferred stock                        |  |                                               | (417   | ) |      |   | (417   | )    |  |   | (104   | )
|                                                    |  |                                               |        |   |      |   |        |      |  |   |        |  
|Net income available to common shareholders         |  | $                                             | 4,470  |   |      | $ | 3,479  |      |  | $ | 2,264  |  
|                                                    |  |                                               |        |   |      |   |        |      |  |   |        |  
|Net Income Per Common Share:                        |  |                                               |        |   |      |   |        |      |  |   |        |  
|Basic                                               |  | $                                             | .98    |   |      | $ | .80    |      |  | $ | .53    |  
|                                                    |  |                                               |        |   |      |   |        |      |  |   |        |  
|Diluted                                             |  | $                                             | .92    |   |      | $ | .73    |      |  | $ | .48    |  
|                                                    |  |                                               |        |   |      |   |        |      |  |   |        |  

See accompanying notes to consolidated financial statements.



52



---

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

Years Ended December 31, 2007, 2006 and 2005



|                                                                   |  |                        |       |   |      |   |       |      |  |   |       |  
|------------------------------------------------------------------ |  | ---------------------- | ----- | - | ---- | - | ----- | ---- |  | - | ----- | -
|                                                                   |  | 2007                   |       |   | 2006 |   |       | 2005 | 
|                                                                   |  | (Amounts in thousands) |      
|Net income                                                         |  | $                      | 4,887 |   |      | $ | 3,896 |      |  | $ | 2,368 |  
|                                                                   |  |                        |       |   |      |   |       |      |  |   |       |  
|Other comprehensive income:                                        |  |                        |       |   |      |   |       |      |  |   |       |  
|Securities available for sale:                                     |  |                        |       |   |      |   |       |      |  |   |       |  
|Unrealized holding gains (losses) on available for sale securities |  |                        | 232   |   |      |   | 21    |      |  |   | (905  | )
|Tax effect                                                         |  |                        | (89   | ) |      |   | (8    | )    |  |   | 353   |  
|Reclassification of (gains) losses recognized in net income        |  |                        | (8    | ) |      |   | 217   |      |  |   | 74    |  
|Tax effect                                                         |  |                        | 3     |   |      |   | (84   | )    |  |   | (28   | )
|                                                                   |  |                        |       |   |      |   |       |      |  |   |       |  
|Net of tax amount                                                  |  |                        | 138   |   |      |   | 146   |      |  |   | (506  | )
|                                                                   |  |                        |       |   |      |   |       |      |  |   |       |  
|Cash flow hedging activities:                                      |  |                        |       |   |      |   |       |      |  |   |       |  
|Unrealized holding gains (losses) on cash flow hedging activities  |  |                        |      |   |      |   | (12   | )    |  |   | 95    |  
|Tax effect                                                         |  |                        |      |   |      |   | 4     |      |  |   | (37   | )
|Reclassification of gains recognized in net income                 |  |                        |      |   |      |   | (108  | )    |  |   |      |  
|Tax effect                                                         |  |                        |       |   |      |   | 42    |      |  |   |      |  
|                                                                   |  |                        |       |   |      |   |       |      |  |   |       |  
|Net of tax amount                                                  |  |                        |      |   |      |   | (74   | )    |  |   | 58    |  
|                                                                   |  |                        |       |   |      |   |       |      |  |   |       |  
|Total other comprehensive income (loss)                            |  |                        | 138   |   |      |   | 72    |      |  |   | (448  | )
|                                                                   |  |                        |       |   |      |   |       |      |  |   |       |  
|Comprehensive income                                               |  | $                      | 5,025 |   |      | $ | 3,968 |      |  | $ | 1,920 |  
|                                                                   |  |                        |       |   |      |   |       |      |  |   |       |  

See accompanying notes to consolidated financial statements.



53



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CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY

Years Ended December 31, 2007, 2006 and 2005



|                                                                     |  |                 |  |              |       |                                           |                  |        |   |                                            |   |  |                          |        |   |  |   |      |   |  |   |        |  
|-------------------------------------------------------------------- |  | --------------- |  | ------------ | ----- | ----------------------------------------- | ---------------- | ------ | - | ------------------------------------------ | - |  | ------------------------ | ------ | - |  | - | ---- | - |  | - | ------ | -
|                                                                     |  | Preferred stock |  | Common stock |       |                                           | Retainedearnings |        |   | Accumulatedothercomprehensiveincome (loss) |   |  | Totalshareholdersequity |       
|                                                                     |  | Shares          |  | Amount       |       | Shares                                    |                  | Amount |   |                                            |   | 
|                                                                     |  |                 |  |              |       | (Amounts in thousands, except share data) |                  |        |   |                                            |   |  |                         
|Balance at December 31, 2004                                         |  |                |  | $            |      |                                           | 2,084,392        |        | $ | 11,352                                     |   |  | $                        | 5,171  |   |  | $ | (99  | ) |  | $ | 16,424 |  
|Preferred stock issue, net                                           |  | 5,000           |  |              | 4,819 |                                           |                 |        |   |                                           |   |  |                          |       |   |  |   |     |   |  |   | 4,819  |  
|Net income                                                           |  |                |  |              |      |                                           |                 |        |   |                                           |   |  |                          | 2,368  |   |  |   |     |   |  |   | 2,368  |  
|Other comprehensive loss                                             |  |                |  |              |      |                                           |                 |        |   |                                           |   |  |                          |       |   |  |   | (448 | ) |  |   | (448   | )
|Effect of 6-for-5 stock split                                        |  |                |  |              |      |                                           | 416,492          |        |   |                                           |   |  |                          | (6     | ) |  |   |     |   |  |   | (6     | )
|Effect of 5-for-4 stock split                                        |  |                |  |              |      |                                           | 624,871          |        |   | (7                                         | ) |  |                          |       |   |  |   |     |   |  |   | (7     | )
|Preferred dividends paid                                             |  |                |  |              |      |                                           |                 |        |   |                                           |   |  |                          | (104   | ) |  |   |     |   |  |   | (104   | )
|Stock options exercised                                              |  |                |  |              |      |                                           | 5,625            |        |   | 21                                         |   |  |                          |       |   |  |   |     |   |  |   | 21     |  
|Current income tax benefit                                           |  |                |  |              |      |                                           |                 |        |   | 26                                         |   |  |                          |       |   |  |   |     |   |  |   | 26     |  
|                                                                     |  |                 |  |              |       |                                           |                  |        |   |                                            |   |  |                          |        |   |  |   |      |   |  |   |        |  
|Balance at December 31, 2005                                         |  | 5,000           |  |              | 4,819 |                                           | 3,131,380        |        |   | 11,392                                     |   |  |                          | 7,429  |   |  |   | (547 | ) |  |   | 23,093 |  
|Net income                                                           |  |                |  |              |      |                                           |                 |        |   |                                           |   |  |                          | 3,896  |   |  |   |     |   |  |   | 3,896  |  
|Other comprehensive loss                                             |  |                |  |              |      |                                           |                 |        |   |                                           |   |  |                          |       |   |  |   | 72   |   |  |   | 72     |  
|Effect of 11-for-10 stock split                                      |  |                |  |              |      |                                           | 312,719          |        |   | (7                                         | ) |  |                          |       |   |  |   |     |   |  |   | (7     | )
|Preferred dividends paid                                             |  |                |  |              |      |                                           |                 |        |   |                                           |   |  |                          | (417   | ) |  |   |     |   |  |   | (417   | )
|Stock options exercised                                              |  |                |  |              |      |                                           | 175,687          |        |   | 1,072                                      |   |  |                          |       |   |  |   |     |   |  |   | 1,072  |  
|Current income tax benefit                                           |  |                |  |              |      |                                           |                 |        |   | 550                                        |   |  |                          |       |   |  |   |     |   |  |   | 550    |  
|                                                                     |  |                 |  |              |       |                                           |                  |        |   |                                            |   |  |                          |        |   |  |   |      |   |  |   |        |  
|Balance at December 31, 2006                                         |  | 5,000           |  |              | 4,819 |                                           | 3,619,786        |        |   | 13,007                                     |   |  |                          | 10,908 |   |  |   | (475 | ) |  |   | 28,259 |  
|Net income                                                           |  |                |  |              |      |                                           |                 |        |   |                                           |   |  |                          | 4,887  |   |  |   |     |   |  |   | 4,887  |  
|Other comprehensive loss                                             |  |                |  |              |      |                                           |                 |        |   |                                           |   |  |                          |       |   |  |   | 138  |   |  |   | 138    |  
|Effect of 5-for-4 stock split                                        |  |                |  |              |      |                                           | 904,481          |        |   | (10                                        | ) |  |                          |       |   |  |   |     |   |  |   | (10    | )
|Preferred dividends paid                                             |  |                |  |              |      |                                           |                 |        |   |                                           |   |  |                          | (417   | ) |  |   |     |   |  |   | (417   | )
|Stock options exercised                                              |  |                |  |              |      |                                           | 94,137           |        |   | 279                                        |   |  |                          |       |   |  |   |     |   |  |   | 279    |  
|Expense recognized in connection with stock awards and stock options |  |                |  |              |      |                                           | 124              |        |   | 14                                         |   |  |                          |       |   |  |   |     |   |  |   | 14     |  
|                                                                     |  |                 |  |              |       |                                           |                  |        |   |                                            |   |  |                          |        |   |  |   |      |   |  |   |        |  
|Balance at December 31, 2007                                         |  | 5,000           |  | $            | 4,819 |                                           | 4,618,528        |        | $ | 13,290                                     |   |  | $                        | 15,378 |   |  | $ | (337 | ) |  | $ | 33,150 |  
|                                                                     |  |                 |  |              |       |                                           |                  |        |   |                                            |   |  |                          |        |   |  |   |      |   |  |   |        |  



54



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CONSOLIDATED STATEMENTS OF CASH FLOWS

Years Ended
December 31, 2007, 2006 and 2005



|                                                                                      |  |                        |         |   |      |   |         |      |  |   |         |  
|------------------------------------------------------------------------------------- |  | ---------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                      |  | 2007                   |         |   | 2006 |   |         | 2005 | 
|                                                                                      |  | (Amounts in thousands) |        
|Operating Activities                                                                  |  |                        |         |   |      |   |         |      |  |   |         |  
|Net income                                                                            |  | $                      | 4,887   |   |      | $ | 3,896   |      |  | $ | 2,368   |  
|Depreciation and amortization                                                         |  |                        | 458     |   |      |   | 496     |      |  |   | 470     |  
|Provision for loan loss                                                               |  |                        | 425     |   |      |   | 394     |      |  |   | 1,373   |  
|Stock option expense                                                                  |  |                        | 14      |   |      |   |        |      |  |   |        |  
|Deferred income tax liability (benefit)                                               |  |                        | 138     |   |      |   | (233    | )    |  |   | (478    | )
|(Gain) loss on sale of investment securities available for sale                       |  |                        | (8      | ) |      |   | 217     |      |  |   | 74      |  
|(Gain) loss on disposal of foreclosed assets                                          |  |                        | (481    | ) |      |   | (21     | )    |  |   | (8      | )
|Gain on sale of derivative contract                                                   |  |                        |        |   |      |   | (108    | )    |  |   |        |  
|Gain on sale of loans                                                                 |  |                        | (598    | ) |      |   | (632    | )    |  |   | (1,086  | )
|Origination of loans held for sale                                                    |  |                        | (27,280 | ) |      |   | (31,582 | )    |  |   | (57,615 | )
|Proceeds from sales of loans held for sale                                            |  |                        | 29,071  |   |      |   | 31,091  |      |  |   | 63,465  |  
|Increase in cash surrender value life insurance                                       |  |                        | (290    | ) |      |   | (267    | )    |  |   | (254    | )
|Changes in assets and liabilities:                                                    |  |                        |         |   |      |   |         |      |  |   |         |  
|(Increase) decrease in other assets                                                   |  |                        | (1,877  | ) |      |   | (379    | )    |  |   | 60      |  
|(Increase) decrease in other real estate                                              |  |                        |        |   |      |   |        |      |  |   |        |  
|Increase (decrease) in accrued expenses and other liabilities                         |  |                        | 729     |   |      |   | (701    | )    |  |   | 817     |  
|                                                                                      |  |                        |         |   |      |   |         |      |  |   |         |  
|Net cash provided by operating activities                                             |  |                        | 5,188   |   |      |   | 2,171   |      |  |   | 9,186   |  
|                                                                                      |  |                        |         |   |      |   |         |      |  |   |         |  
|Investing Activities                                                                  |  |                        |         |   |      |   |         |      |  |   |         |  
|Purchases of investment securities available for sale                                 |  |                        | (33,316 | ) |      |   | (47,857 | )    |  |   | (48,187 | )
|Maturities and calls of investment securities available for sale                      |  |                        | 4,845   |   |      |   | 6,445   |      |  |   | 5,912   |  
|Maturities and calls of investment security held to maturity                          |  |                        |        |   |      |   | 250     |      |  |   |        |  
|Sales of investment securities available for sale                                     |  |                        | 31,677  |   |      |   | 25,947  |      |  |   | 18,800  |  
|Net increase in loans from originations and principal repayments                      |  |                        | (58,591 | ) |      |   | (35,341 | )    |  |   | (62,427 | )
|(Purchase) redemption of FHLB stock                                                   |  |                        | (290    | ) |      |   | (487    | )    |  |   | 103     |  
|Purchases of premises and equipment                                                   |  |                        | (632    | ) |      |   | (934    | )    |  |   | (2,331  | )
|Acquisition of real estate                                                            |  |                        |        |   |      |   |        |      |  |   | (1,124  | )
|Proceeds from sale of foreclosed assets                                               |  |                        | 2,818   |   |      |   | 1,935   |      |  |   | 353     |  
|                                                                                      |  |                        |         |   |      |   |         |      |  |   |         |  
|Net cash used by investing activities                                                 |  |                        | (53,489 | ) |      |   | (50,042 | )    |  |   | (88,901 | )
|                                                                                      |  |                        |         |   |      |   |         |      |  |   |         |  
|Financing Activities                                                                  |  |                        |         |   |      |   |         |      |  |   |         |  
|Net increase in deposits                                                              |  |                        | 34,622  |   |      |   | 39,013  |      |  |   | 83,471  |  
|Net increase (decrease) in short-term borrowings                                      |  |                        | (6,000  | ) |      |   | 15,000  |      |  |   | (5,500  | )
|Proceeds from (repayment of) long-term debt                                           |  |                        | 12,000  |   |      |   | (8,000  | )    |  |   |        |  
|Issuance of non-cumulative perpetual preferred stock                                  |  |                        |        |   |      |   |        |      |  |   | 4,819   |  
|Non-cumulative perpetual preferred stock dividends paid                               |  |                        | (417    | ) |      |   | (417    | )    |  |   | (104    | )
|Purchase of fractional shares                                                         |  |                        | (10     | ) |      |   | (7      | )    |  |   | (13     | )
|Proceeds from stock options exercised                                                 |  |                        | 279     |   |      |   | 1,072   |      |  |   | 21      |  
|Tax benefit from exercise of stock options                                            |  |                        |        |   |      |   | 550     |      |  |   | 26      |  
|                                                                                      |  |                        |         |   |      |   |         |      |  |   |         |  
|Net cash provided by financing activities                                             |  |                        | 40,474  |   |      |   | 47,211  |      |  |   | 82,720  |  
|                                                                                      |  |                        |         |   |      |   |         |      |  |   |         |  
|Net increase (decrease) in cash and cash equivalents                                  |  |                        | (7,827  | ) |      |   | (660    | )    |  |   | 3,005   |  
|Cash and cash equivalents, beginning of year                                          |  |                        | 12,438  |   |      |   | 13,098  |      |  |   | 10,093  |  
|                                                                                      |  |                        |         |   |      |   |         |      |  |   |         |  
|Cash and cash equivalents, end of year                                                |  | $                      | 4,611   |   |      | $ | 12,438  |      |  | $ | 13,098  |  
|                                                                                      |  |                        |         |   |      |   |         |      |  |   |         |  
|Supplemental Cash Flow Disclosure                                                     |  |                        |         |   |      |   |         |      |  |   |         |  
|Interest paid on deposits and borrowed funds                                          |  | $                      | 17,614  |   |      | $ | 14,445  |      |  | $ | 7,742   |  
|Income taxes paid                                                                     |  |                        | 1,573   |   |      |   | 1,757   |      |  |   | 1,467   |  
|Summary of Noncash Investing and Financing Activities                                 |  |                        |         |   |      |   |         |      |  |   |         |  
|Unrealized gain (loss) on investment securities available for sale, net of tax effect |  |                        | 138     |   |      |   | 146     |      |  |   | (506    | )
|Unrealized gain on cash flow hedging activities, net of tax                           |  |                        |        |   |      |   |        |      |  |   | 58      |  

See accompanying notes to consolidated financial statements.



55



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2007, 2006 and 2005

Note AOrganization and Operations

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

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

Note BSummary of Significant Accounting Policies

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

Use of Estimates

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

Cash and Cash Equivalents

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

Investment Securities

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

Loans and
Interest Income

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



56



---

NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2007, 2006 and
2005



Loans Held for Sale

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

Allowance for Loan Losses

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

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

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

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

Premises and Equipment

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



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

Foreclosed Assets

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



57



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NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

December 31, 2007, 2006 and 2005



Stock in Federal Home Loan Bank of Atlanta

As a requirement for membership, the Company invests in stock of the Federal Home Loan Bank of Atlanta (FHLB). This investment is carried at cost. Due to the redemption provisions of the FHLB, the Company
estimated that fair value equals cost and that this investment was not impaired at December 31, 2007.

Income Taxes

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

Comprehensive Income

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

Accumulated other comprehensive income (loss) at
December 31, 2007, 2006 and 2005 consists of the following:



|                                                            |  |                        |      |   |      |   |      |      |  |   |        |  
|----------------------------------------------------------- |  | ---------------------- | ---- | - | ---- | - | ---- | ---- |  | - | ------ | -
|                                                            |  | 2007                   |      |   | 2006 |   |      | 2005 | 
|                                                            |  | (Amounts in thousands) |     
|Unrealized holding lossessecurities available for sale     |  | $                      | (548 | ) |      | $ | (773 | )    |  | $ | (1,011 | )
|Deferred income taxes                                       |  |                        | 211  |   |      |   | 298  |      |  |   | 390    |  
|                                                            |  |                        |      |   |      |   |      |      |  |   |        |  
|Net unrealized holding lossessecurities available for sale |  |                        | (337 | ) |      |   | (475 | )    |  |   | (621   | )
|                                                            |  |                        |      |   |      |   |      |      |  |   |        |  
|Unrealized holding gainscash flow hedging activities       |  |                        |     |   |      |   |     |      |  |   | 120    |  
|Deferred income taxes                                       |  |                        |     |   |      |   |     |      |  |   | (46    | )
|                                                            |  |                        |      |   |      |   |      |      |  |   |        |  
|Net unrealized holding gainscash flow hedging activities   |  |                        |     |   |      |   |     |      |  |   | 74     |  
|                                                            |  |                        |      |   |      |   |      |      |  |   |        |  
|Total other accumulated other comprehensive loss            |  | $                      | (337 | ) |      | $ | (475 | )    |  | $ | (547   | )
|                                                            |  |                        |      |   |      |   |      |      |  |   |        |  

Stock Compensation Plans

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



58



---

NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2007, 2006 and
2005



The Company adopted SFAS No. 123R using the modified prospective application as permitted under SFAS
No. 123R. Accordingly, prior period amounts have not been restated. Under this application, the Company is required to record compensation expense for all awards granted after the date of adoption and for the unvested portion of previously
granted awards that remain outstanding at the date of adoption. Prior to the adoption of SFAS No. 123R, the Company used the intrinsic value method as prescribed by APB No. 25 and thus recognized no compensation expense for options granted
with exercise prices equal to the fair market value of the Companys common stock on the date of grant.

Since the Companys stock options had
vested prior to January 1, 2006, there was no impact on income from the adoption of SFAS 123R. Cash flows provided by financing activities from the exercise of stock options amounted to$279 thousand and $1.6 million for the years ended
December 31, 2007 and 2006 respectively.

The following table illustrates the effect on net income and earnings per share if the Company had applied
the fair value recognition provisions of SFAS 123R to options granted under the Companys stock option plans for the year ended December 31, 2005. For purposes of this pro forma disclosure, the value of the options is estimated using the
Black-Scholes option-pricing model and amortized to expense over the options vesting periods.



|                                                                                                                                        |  |                                              |        |  
|--------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------------------------- | ------ | -
|                                                                                                                                        |  | 2005                                         |       
|                                                                                                                                        |  | (Amounts in thousands,except per share data) |       
|Net income:                                                                                                                             |  |                                              |        |  
|As reported                                                                                                                             |  | $                                            | 2,368  |  
|Less preferred dividends                                                                                                                |  |                                              | (104   | )
|                                                                                                                                        |  |                                              |        |  
|Net income available to common shareholders                                                                                             |  |                                              | 2,264  |  
|Stock-based compensation                                                                                                                |  |                                              |        |  
|Deduct: Total stock-based employee compensation expenses determined under fair value method for all amounts, net of related tax
effects |  |                                              | (1,030 | )
|                                                                                                                                        |  |                                              |        |  
|Pro forma                                                                                                                               |  | $                                            | 1,234  |  
|                                                                                                                                        |  |                                              |        |  
|Basic net income per common share:                                                                                                      |  |                                              |        |  
|As reported                                                                                                                             |  | $                                            | .53    |  
|Pro forma                                                                                                                               |  |                                              | .32    |  
|                                                                                                                                        | 
|Diluted net income per common share:                                                                                                    |  |                                              |        |  
|As reported                                                                                                                             |  | $                                            | .48    |  
|Pro forma                                                                                                                               |  |                                              | .27    |  

Net Income Per Common Share

Basic and diluted net income per share has been computed based on the weighted average number of shares outstanding during each period after retroactively adjusting for all applicable declared stock splits effected in
the form of stock dividends. Diluted net income per share reflect additional shares of common stock that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the
assumed issuance. At December 31, 2007, 2006 and 2005, there were no antidilutive options.

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



59



---

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

December 31, 2007, 2006 and 2005



|                                                                                                                             |  |           |  |           |  |          
|---------------------------------------------------------------------------------------------------------------------------- |  | --------- |  | --------- |  | ---------
|                                                                                                                             |  | 2007      |  | 2006      |  | 2005     
|Weighted average number of common shares used in computing basic net income per share                                        |  | 4,548,565 |  | 4,348,128 |  | 4,299,522
|Effect of dilutive stock options                                                                                             |  | 303,172   |  | 427,725   |  | 370,079  
|                                                                                                                             |  |           |  |           |  |          
|Weighted average number of common shares and dilutive potential common shares used in computing diluted net income per share |  | 4,851,738 |  | 4,775,853 |  | 4,669,601
|                                                                                                                             |  |           |  |           |  |          

Segment Reporting

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

Derivative Instruments

Interest rate swaps are contractual
agreements between two parties to exchange a series of cash flows representing interest payments. A swap allows both parties to alter the repricing characteristics of assets or liabilities without affecting the underlying principal positions.
Through the use of a swap, assets and liabilities may be transformed from fixed to floating rates, from floating rates to fixed rates or from one type of floating rate to another.

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

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

Recent Accounting Pronouncements

In July 2006, the FASB issued FIN 48 Accounting for Uncertainty in Income Taxes (FIN 48). FIN 48 is an interpretation of SFAS No. 109, Accounting for Income Taxes (SFAS
109). FIN 48 provides interpretive guidance for the financial statement recognition and measurement of a tax position taken, or expected to be taken, in a tax return. FIN 48 requires the affirmative evaluation that is more likely than not,
based on the technical merits of a tax position, that an enterprise is entitled to economic benefits resulting from positions taken in income tax returns. If a tax position does not meet the more-likely-than-not recognition threshold,
the benefit of that position is not recognized in the financial statements. FIN 48 also requires companies to disclose additional quantitative and qualitative information in their financial statements about uncertain tax positions. FIN 48 was
effective for fiscal year beginning January 1, 2007. No adjustment was reported to the opening balance of retained earnings for this fiscal year.



60



---

NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2007, 2006 and
2005



In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157)
which defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. SFAS 157 does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in
various prior accounting pronouncements. SFAS 157 is effective for fiscal years beginning after November 15, 2007, however, on December 14, 2007 the FASB issued proposed FASB Staff Position (FSP) FAS 157-2 (FSP
157-2), which would delay the effective date of SFAS 157 for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least
annually). FSP 157-2 partially defers the effective date of SFAS 157 to fiscal years beginning after November 2008, and interim periods within those fiscal years for items within the scope of FSP 157-2. The Company will adopt SFAS 157 during 2008,
except as it applies to those non-financial assets and non-financial liabilities as noted in FSP 157-2. The partial adoption of SFAS 157 is not expected to have a material impact on the Companys financial position, results of operations or
cash flows.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, including an
amendment of FASB Statement No. 115 (SFAS 159). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value and
establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS 159 is effective for financial statements issued
for fiscal years beginning after November 15, 2007. The Company does not expect SFAS 159 to have a material impact on its financial position, results of operations or cash flows upon adoption.

In November 2007, the SEC issued SAB No. 109, Written Loan Commitments Recorded at Fair Value Through Earnings (SAB 109). SAB 109 supersedes
guidance provided by SAB No. 105, Loan Commitments Accounted for Derivative Instruments (SAB 105) and provides guidance on written loan commitments accounted for at fair value through earnings. Specifically, SAB 109
addresses the inclusion of expected net future cash flows related to the associated servicing of a loan in the measurement of all written loan commitments accounted for at fair value through earnings. In addition, SAB 109 retains the SECs
position on the exclusion of internally-developed intangible assets as part of the fair value of a derivative loan commitment originally established in SAB 105. SAB 109 is effective for fiscal years beginning after December 15, 2007. The
expected impact that SAB 109 may have on the Companys financial position, results of operations or cash flows is anticipated to be immaterial.

In
December 2007, the FASB issued SFAS 141(R), Business Combinations. SFAS 141 (R) will significantly change how entities apply the acquisition method to business combinations. The most significant changes affecting how the corporation
will account for business combinations under this Statement include: the acquisition date will be the date the acquirer obtains control; all (and only) identifiable assets acquired, liabilities assumed, and noncontrolling interests in the acquiree
will be stated at fair value on the acquisition date; assets or liabilities arising from noncontractual contingencies will be measured at their acquisition date fair value only if it is more likely than not that they meet the definition of an asset
or liability on the acquisition date; adjustments subsequently made to the provisional amounts recorded on the acquisition date will be made retroactively during a measurement period not to exceed one year; acquisition-related restructuring costs
that do not meet the criteria in SFAS 146, Accounting for Costs Associated with Exit or Disposal Activities, will be expensed as incurred; transaction costs will be expensed as incurred; reversals of deferred income tax valuation
allowances and income tax contingencies will be recognized in earnings subsequent to the measurement period; and the allowance for loan losses of an acquiree will not be permitted to be recognized by the acquirer. Additionally, SFAS 141
(R) will require new and modified disclosures surrounding subsequent changes to acquisition-related contingencies, contingent consideration, noncontrolling interests, acquisition-related transaction costs, fair values and cash flows not
expected to be collected for acquired loans, and enhanced goodwill rollforward.



61



---

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

December 31, 2007, 2006 and 2005



The Company will be required to prospectively apply SFAS 141 (R) to all business combinations completed on or
after January 1, 2009. Early adoption is not permitted. Management is currently evaluating the effects of SFAS 141 (R) will have on the financial condition, results of operations, liquidity, and the disclosures that will be presented in
the consolidated financial statements.

In December 2007, FASB issued SFAS 160, Noncontrolling interests in Consolidated Financial Statements, an
Amendment of ARB 51. SFAS 160 establishes new accounting and reporting standards for noncontrolling interests in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 will require entities to classify noncontrolling interests as a
component of stockholders equity and will require subsequent changes in ownership interests in a subsidiary to be accounted for as an equity transaction. Additionally, SFAS 160 will require entities to recognize a gain or loss upon the loss of
control of a subsidiary and to remeasure any ownership interest retained at fair value on that date. This statement also requires expanded disclosures that clearly identify and distinguish between the interests of the parent and the interests of the
noncontrolling owners. SFAS 160 is effective on a prospective basis for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008, except for the presentation and disclosure requirements, which are
required to be applied retrospecdtively. Early adoption is not permitted. At December 31, 2007, the Company had no noncontrolling interests in subsidiaries. Management is currently evaluating the effects, if any, that SFAS 160 will have upon
adoption.

EITF 06-4  The Emerging Issues Task Force (EITF) reached a consensus at its September 2006 meeting regarding EITF 06-4,
Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements. The scope of EITF 06-4 is limited to the recognition of a liability and related compensation costs for
endorsement split-dollar life insurance policies that provide a benefit to an employee that extends to postretirement periods. Therefore, this EITF would not apply to a split-dollar life insurance arrangement that provides a specified benefit to an
employee that is limited to the employees active service period with an employer. This EITF 06-4 is effective for fiscal years beginning after December 15, 2007, with earlier application permitted. The effects of this EITF had no impact
on the Company.

EITF 06-5  The EITF reached a consensus at its September 2006 meeting regarding EITF 06-5, Accounting for Purchases of Life
Insurance Determining the Amount That Could be Realized in Accordance with FASB Technical Bulletin No. 85-5. The scope of EITF 06-5 is limited to the determination of net cash surrender value of a life insurance contract in accordance with
Technical Bulletin 85-4. This EITF outlines when contractual limitations of the policy should be considered when determining the net realizable value of the contract. EITF 06-5 is effective for fiscal years beginning after December 15, 2006,
with earlier application permitted. The effects of this EITF had no impact on the Company.

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



62



---

NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2007, 2006 and
2005



Note CInvestment Securities

The following is a summary of investment securities by major classification at December 31, 2007 and 2006:



|                                  |  |                        |        |                      |   |                       |  |           |     |  |   |       
|--------------------------------- |  | ---------------------- | ------ | -------------------- | - | --------------------- |  | --------- | --- |  | - | ------
|                                  |  | December 31, 2007     
|                                  |  | Amortizedcost          |        | Grossunrealizedgains |   | Grossunrealizedlosses |  | Fairvalue
|                                  |  | (Amounts in thousands)
|Securities available for sale:    |  |                        |        |                      |   |                       |  |           |     |  |   |       
|U.S. government agency securities |  | $                      | 21,434 |                      | $ | 220                   |  | $         | 44  |  | $ | 21,610
|Mortgage-backed securities        |  |                        | 30,057 |                      |   | 54                    |  |           | 350 |  |   | 29,761
|State and municipal               |  |                        | 19,704 |                      |   | 10                    |  |           | 439 |  |   | 19,275
|Other                             |  |                        | 155    |                      |   |                      |  |           |    |  |   | 155   
|                                  |  |                        |        |                      |   |                       |  |           |     |  |   |       
|Total                             |  | $                      | 71,350 |                      | $ | 284                   |  | $         | 833 |  | $ | 70,801
|                                  |  |                        |        |                      |   |                       |  |           |     |  |   |       
|                                  | 
|                                  |  | December 31, 2006     
|                                  |  | Amortizedcost          |        | Grossunrealizedgains |   | Grossunrealizedlosses |  | Fairvalue
|                                  |  | (Amounts in thousands)
|Securities available for sale:    |  |                        |        |                      |   |                       |  |           |     |  |   |       
|U.S. government agency securities |  | $                      | 20,245 |                      | $ | 45                    |  | $         | 177 |  | $ | 20,113
|Mortgage-backed securities        |  |                        | 25,891 |                      |   | 15                    |  |           | 598 |  |   | 25,308
|State and municipal               |  |                        | 28,277 |                      |   | 93                    |  |           | 151 |  |   | 28,219
|Other                             |  |                        | 155    |                      |   |                      |  |           |    |  |   | 155   
|                                  |  |                        |        |                      |   |                       |  |           |     |  |   |       
|Total                             |  | $                      | 74,568 |                      | $ | 153                   |  | $         | 926 |  | $ | 73,795
|                                  |  |                        |        |                      |   |                       |  |           |     |  |   |       

The following tables show investments gross unrealized losses and fair value, aggregated by investment
category and length of time that the individual securities have been in a continuous unrealized loss position, at December 31, 2007 and 2006. All unrealized losses on investment securities are considered by management to be temporarily impaired
given the credit ratings on these investment securities and the short duration of the unrealized loss.



|                                      |  |                        |        |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    
|------------------------------------- |  | ---------------------- | ------ | ----------------- | - | --------- |  | ---------------- | ------ | --------- | - | ---------------- |  | - | ------ |  | - | ---
|                                      |  | 2007                  
|                                      |  | 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 agency securities     |  | $                      |       |                   | $ |          |  | $                | 2,226  |           | $ | 44               |  | $ | 2,226  |  | $ | 44 
|Mortgage-backed securities            |  |                        | 6,515  |                   |   | 74        |  |                  | 16,782 |           |   | 276              |  |   | 23,297 |  |   | 350
|State and municipal                   |  |                        | 15,381 |                   |   | 415       |  |                  | 376    |           |   | 24               |  |   | 15,757 |  |   | 439
|                                      |  |                        |        |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    
|Total temporarily impaired securities |  | $                      | 21,896 |                   | $ | 489       |  | $                | 19,384 |           | $ | 344              |  | $ | 41,280 |  | $ | 833
|                                      |  |                        |        |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    



63



---

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

December 31, 2007, 2006 and 2005



|                                      |  |                        |        |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    
|------------------------------------- |  | ---------------------- | ------ | ----------------- | - | --------- |  | ---------------- | ------ | --------- | - | ---------------- |  | - | ------ |  | - | ---
|                                      |  | 2006                  
|                                      |  | 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 agency securities     |  | $                      | 8,918  |                   | $ | 95        |  | $                | 4,559  |           | $ | 82               |  | $ | 13,477 |  | $ | 177
|Mortgage-backed securities            |  |                        | 5,293  |                   |   | 50        |  |                  | 18,529 |           |   | 548              |  |   | 23,822 |  |   | 598
|State and municipal                   |  |                        | 16,243 |                   |   | 151       |  |                  |       |           |   |                 |  |   | 16,243 |  |   | 151
|                                      |  |                        |        |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    
|Total temporarily impaired securities |  | $                      | 30,454 |                   | $ | 296       |  | $                | 23,088 |           | $ | 630              |  | $ | 53,542 |  | $ | 926
|                                      |  |                        |        |                   |   |           |  |                  |        |           |   |                  |  |   |        |  |   |    

The aggregate amortized cost and fair value of debt securities at December 31, 2007, by remaining contractual
maturity, are shown below. Actual expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations.



|                                   |  |                        |        |           |   |       
|---------------------------------- |  | ---------------------- | ------ | --------- | - | ------
|                                   |  | Available for Sale    
|                                   |  | Amortizedcost          |        | Fairvalue
|                                   |  | (Amounts in thousands)
|U.S. agency securities:            |  |                        |        |           |   |       
|Due in 1 year through 5 years      |  | $                      | 13,934 |           | $ | 15,016
|Due after 5 years through 10 years |  |                        | 1,219  |           |   | 1,226 
|Due after 10 years                 |  |                        | 6,281  |           |   | 5,368 
|State and municipal securities:    |  |                        |        |           |   |       
|Due after 5 years through 10 years |  |                        | 9,039  |           |   | 8,953 
|Due after 10 years                 |  |                        | 10,665 |           |   | 10,322
|Other:                             |  |                        |        |           |   |       
|Due after 10 years                 |  |                        | 155    |           |   | 155   
|Mortgage-backed securities         |  |                        | 30,057 |           |   | 29,761
|                                   |  |                        |        |           |   |       
|Total                              |  | $                      | 71,350 |           | $ | 70,801
|                                   |  |                        |        |           |   |       

Proceeds from sales of investment securities available for sale amounted to $31.7 million, $25.9 million and $18.8
million for the years ended December 31, 2007, 2006 and 2005, respectively. Aggregate realized gains (losses) from the sales of investment securities available for sale amounted to $8 thousand, $(217 thousand) and ($74 thousand) for the years
ended December 31, 2007, 2006 and 2005, respectively.

Investment securities with amortized cost of $9.2 million and fair value of $9.0 million at
December 31, 2007 were pledged to secure both financing from the FHLB and for public monies on deposit as required by law.



64



---

NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2007, 2006 and
2005



Note DLoans

Following is a summary of loans at December 31, 2007 and 2006:



|                                                                           |  |                        |         |   |      |   |         |  
|-------------------------------------------------------------------------- |  | ---------------------- | ------- | - | ---- | - | ------- | -
|                                                                           |  | 2007                   |         |   | 2006 |  
|                                                                           |  | (Amounts in thousands) |        
|Real estate:                                                               |  |                        |         |   |      |   |         |  
|Construction loans                                                         |  | $                      | 80,051  |   |      | $ | 71,348  |  
|Commercial mortgage loans                                                  |  |                        | 140,198 |   |      |   | 124,385 |  
|Home equity lines of credit                                                |  |                        | 41,479  |   |      |   | 33,090  |  
|Residential mortgage loans                                                 |  |                        | 57,342  |   |      |   | 37,163  |  
|                                                                           |  |                        |         |   |      |   |         |  
|Total real estate loans                                                    |  |                        | 319,070 |   |      |   | 265,986 |  
|Commercial and industrial loans                                            |  |                        | 46,893  |   |      |   | 38,965  |  
|Loans to individuals for household, family and other personal expenditures |  |                        | 5,796   |   |      |   | 8,625   |  
|Net deferred loan origination (fees) costs                                 |  |                        | (45     | ) |      |   | (4      | )
|                                                                           |  |                        |         |   |      |   |         |  
|Total loans                                                                |  | $                      | 371,714 |   |      | $ | 313,572 |  
|                                                                           |  |                        |         |   |      |   |         |  

At December 31, 2007 and 2006, the recorded investment in loans considered impaired in accordance with SFAS
No. 114 totaled $1.5 million and $794,000, respectively. Impaired loans of $1.1 million and $695,000 at December 31, 2007 and 2006 had corresponding valuation allowances of $104,000 and $153,000, respectively. Impaired loans of $400,000
and $159,000 at December 31, 2007 and 2006 had no valuation allowances. For the years ended December 31, 2007 and 2006, the average recorded investment in impaired loans was approximately $1.6 million and $1 million, respectively. The
amount of interest recognized on impaired loans during the portion of the year that they were impaired was not material.

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



|                             |  |   |        |  
|---------------------------- |  | - | ------ | -
|Balance at December 31, 2006 |  | $ | 3,316  |  
|New loans                    |  |   | 4,298  |  
|Principal repayments         |  |   | (3,849 | )
|                             |  |   |        |  
|Balance at December 31, 2007 |  | $ | 3,765  |  
|                             |  |   |        |  

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

Note EAllowance for Loan Losses

An analysis of activity in the
allowance for loan losses for the years ended December 31, 2007, 2006 and 2005 follows:



|                             |  |                        |       |   |      |   |       |      |  |   |       |  
|---------------------------- |  | ---------------------- | ----- | - | ---- | - | ----- | ---- |  | - | ----- | -
|                             |  | 2007                   |       |   | 2006 |   |       | 2005 | 
|                             |  | (Amounts in thousands) |      
|Balance at beginning of year |  | $                      | 4,222 |   |      | $ | 4,090 |      |  | $ | 2,865 |  
|Provision for loan losses    |  |                        | 425   |   |      |   | 394   |      |  |   | 1,373 |  
|                             |  |                        |      
|Charge-offs                  |  |                        | (296  | ) |      |   | (318  | )    |  |   | (181  | )
|Recoveries                   |  |                        | 111   |   |      |   | 56    |      |  |   | 33    |  
|                             |  |                        |       |   |      |   |       |      |  |   |       |  
|Net charge-offs              |  |                        | (185  | ) |      |   | (262  | )    |  |   | (148  | )
|                             |  |                        |       |   |      |   |       |      |  |   |       |  
|Balance at end of year       |  | $                      | 4,462 |   |      | $ | 4,222 |      |  | $ | 4,090 |  
|                             |  |                        |       |   |      |   |       |      |  |   |       |  



65



---

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

December 31, 2007, 2006 and 2005



Note FPremises and Equipment

The following is a summary of premises and equipment:



|                                     |  |                        |        |   |      |   |        |  
|------------------------------------ |  | ---------------------- | ------ | - | ---- | - | ------ | -
|                                     |  | 2007                   |        |   | 2006 |  
|                                     |  | (Amounts in thousands) |       
|Land                                 |  | $                      | 1,829  |   |      | $ | 1,280  |  
|Buildings and leasehold improvements |  |                        | 5,203  |   |      |   | 5,168  |  
|Furniture and equipment              |  |                        | 2,609  |   |      |   | 2,563  |  
|                                     |  |                        |        |   |      |   |        |  
|                                     |  |                        |        |   |      |   | 9,011  |  
|Less accumulated depreciation        |  |                        | (2,807 | ) |      |   | (2,387 | )
|                                     |  |                        |        |   |      |   |        |  
|Total                                |  | $                      | 6,834  |   |      | $ | 6,624  |  
|                                     |  |                        |        |   |      |   |        |  

Depreciation expense for the years ended December 31, 2007, 2006 and 2005 amounted to approximately $422,
$425,000 and $355,000, respectively.

Note GTime Deposits

Time deposits in denominations of $100,000 or more were $192 million and $161.1 million at December 31, 2007 and 2006, respectively. Interest expense on such deposits aggregated approximately $9.6 million and $7.4 million in 2007 and
2006, respectively. Time deposits in denominations of $100,000 or more, maturing subsequent to December 31, 2007 are as follows (amounts in thousands):



|     |  |   |        
|---- |  | - | -------
|2008 |  | $ | 191,459
|2009 |  |   | 514    
|     |  |   |        
|     |  | $ | 191,973
|     |  |   |        

Note HLeases

As of December 31, 2007, the Company leases office space under non-cancelable operating leases. Future minimum lease payments required under the leases are as follows (amounts in thousands):



|                         |  |   |    
|------------------------ |  | - | ---
|Year Ending December 31, |  |  
|2008                     |  | $ | 121
|2009                     |  |   | 66 
|2010                     |  |   | 18 
|                         |  |   |    
|                         |  | $ | 205
|                         |  |   |    

The leases contain options for renewals after the expiration of the current lease terms. The cost of such rentals
is not included above. Total rent expense for the years ended December 31, 2007, 2006 and 2005 amounted to $135,000, $127,000 and $115,000, respectively.

Note IBorrowings

Short-term borrowings

The Company has remaining credit availability totaling approximately $20 million from the FHLB, with $19 million outstanding with a daily rate of interest of 4.56% at December 31, 2007. This has been classified as short-term borrowings
in the balance sheet. Borrowings must be adequately collateralized. At December 31, 2006, the outstanding short-term borrowings amounted to $25 million.



66



---

NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2007, 2006 and
2005



Long-term debt

The Company is a member of the FHLB. As a member, the Company is required to invest in the stock of the FHLB. The stock is carried at cost since it has no quoted fair value. All stock in the FHLB, together with various investment securities
and a blanket lien of $102.5 million on qualifying loans, are pledged as collateral to secure any borrowings. At December 31, there were the following borrowings:



|                   |  |                    |   |  |                        |        |      |   |       
|------------------ |  | ------------------ | - |  | ---------------------- | ------ | ---- | - | ------
|Maturity           |  | FixedInterest Rate |   |  | 2007                   |        | 2006
|                   |  |                    |   |  | (Amounts in thousands)
|March 17, 2010     |  | 5.92               | % |  | $                      | 1,500  |      | $ | 1,500 
|March 17, 2010     |  | 5.71               | % |  |                        | 2,500  |      |   | 2,500 
|September 4, 2012  |  | 3.56               | % |  |                        |       |      |   | 2,000 
|September 4, 2012  |  | 3.56               | % |  |                        |       |      |   | 2,000 
|March 10, 2013     |  | 2.91               | % |  |                        | 10,000 |      |   | 10,000
|September 21, 2017 |  | 3.98               | % |  |                        | 6,000  |      |   |      
|November 30, 2018  |  | 2.98               | % |  |                        | 10,000 |      |   |      
|                   |  |                    |   |  |                        |        |      |   |       
|                   |  |                    |   |  | $                      | 30,000 |      | $ | 18,000
|                   |  |                    |   |  |                        |        |      |   |       

At December 31, 2007 and 2006, the weighted average interest rates on the above advances were 3.53% and
3.69%, respectively. The above borrowings have been classified as long-term debt in the balance sheet.

The Company has issued $8.8 million of Junior
Subordinated debentures to its wholly owned capital trusts, MidCarolina I and MidCarolina Trust II, to fully and unconditionally guarantee the preferred securities issued by the Trusts. These long term obligations, which currently qualify as Tier I
capital for the Company, constitute a full and unconditional guarantee by the Company of the Trusts obligations under the Capital Trust Securities.

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



|                     |  |                 |  |                 |   |      |              |  |                                        |       |  |   |      
|-------------------- |  | --------------- |  | --------------- | - | ---- | ------------ |  | -------------------------------------- | ----- |  | - | -----
|Issuing Entity       |  | Date ofIssuance |  | Interest Rate   |   |      | MaturityDate |  | (Amounts in thousands)Principal Amount
|                     |  |                 |  | 2007            |   | 2006
|MidCarolina I        |  | 10/29/2002      |  | Libor plus 3.45 | % |      | 11/07/2032   |  | $                                      | 5,155 |  | $ | 5,155
|MidCarolina Trust II |  | 12/03/2003      |  | Libor plus 2.90 | % |      | 10/07/2033   |  |                                        | 3,609 |  |   | 3,609
|                     |  |                 |  |                 |   |      |              |  |                                        |       |  |   |      
|                     |  |                 |  |                 |   |      |              |  | $                                      | 8,764 |  | $ | 8,764
|                     |  |                 |  |                 |   |      |              |  |                                        |       |  |   |      

The Company is able to repay the debt five years after the issuance date.

Note JIncome Taxes

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



|                                  |  |                        |       |      |   |       |      |  |   |       |  
|--------------------------------- |  | ---------------------- | ----- | ---- | - | ----- | ---- |  | - | ----- | -
|                                  |  | 2007                   |       | 2006 |   |       | 2005 | 
|                                  |  | (Amounts in thousands) |      
|Current tax provision:            |  |                        |       |      |   |       |      |  |   |       |  
|Federal                           |  | $                      | 1,787 |      | $ | 1,697 |      |  | $ | 1,421 |  
|State                             |  |                        | 417   |      |   | 293   |      |  |   | 334   |  
|                                  |  |                        |       |      |   |       |      |  |   |       |  
|                                  |  |                        | 2,204 |      |   | 1,990 |      |  |   | 1,755 |  
|                                  |  |                        |       |      |   |       |      |  |   |       |  
|Deferred tax provision (benefit): |  |                        |       |      |   |       |      |  |   |       |  
|Federal                           |  |                        | 112   |      |   | (193  | )    |  |   | (272  | )
|State                             |  |                        | 26    |      |   | (40   | )    |  |   | (206  | )
|                                  |  |                        |       |      |   |       |      |  |   |       |  
|                                  |  |                        | 138   |      |   | (233  | )    |  |   | (478  | )
|                                  |  |                        |       |      |   |       |      |  |   |       |  
|Net provision for income taxes    |  | $                      | 2,342 |      | $ | 1,757 |      |  | $ | 1,277 |  
|                                  |  |                        |       |      |   |       |      |  |   |       |  



67



---

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

December 31, 2007, 2006 and 2005



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



|                                                  |  |                        |       |   |      |   |       |      |  |   |       |  
|------------------------------------------------- |  | ---------------------- | ----- | - | ---- | - | ----- | ---- |  | - | ----- | -
|                                                  |  | 2007                   |       |   | 2006 |   |       | 2005 | 
|                                                  |  | (Amounts in thousands) |      
|Income tax at statutory rate                      |  | $                      | 2,458 |   |      | $ | 1,922 |      |  | $ | 1,240 |  
|                                                  |  |                        |      
|Increase (decrease) in income tax resulting from: |  |                        |       |   |      |   |       |      |  |   |       |  
|State income taxes, net of federal tax effect     |  |                        | 293   |   |      |   | 167   |      |  |   | 84    |  
|Income from bank-owned life insurance             |  |                        | (99   | ) |      |   | (91   | )    |  |   | (98   | )
|Nontaxable interest                               |  |                        | (286  | ) |      |   | (272  | )    |  |   | (141  | )
|Other                                             |  |                        | (24   | ) |      |   | 31    |      |  |   | 192   |  
|                                                  |  |                        |       |   |      |   |       |      |  |   |       |  
|Provision for income taxes                        |  | $                      | 2,342 |   |      | $ | 1,757 |      |  | $ | 1,277 |  
|                                                  |  |                        |       |   |      |   |       |      |  |   |       |  



68



---

NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2007, 2006 and
2005



The tax effects of temporary differences that give rise to significant portions of deferred tax assets (liabilities)
at December 31 were are follows:



|                                      |  |                        |       |   |      |   |       |  
|------------------------------------- |  | ---------------------- | ----- | - | ---- | - | ----- | -
|                                      |  | 2007                   |       |   | 2006 |  
|                                      |  | (Amounts in thousands) |      
|Deferred tax assets relating to:      |  |                        |       |   |      |   |       |  
|Allowance for loan losses             |  | $                      | 1,567 |   |      | $ | 1,452 |  
|Deferred compensation                 |  |                        | 353   |   |      |   | 623   |  
|Other comprehensive income            |  |                        | 212   |   |      |   | 298   |  
|                                      |  |                        |       |   |      |   |       |  
|Total deferred tax assets             |  |                        | 2,132 |   |      |   | 2,373 |  
|                                      |  |                        |       |   |      |   |       |  
|Deferred tax liabilities relating to: |  |                        |       |   |      |   |       |  
|Property and equipment                |  |                        | (27   | ) |      |   | (64   | )
|Deferred loan fees                    |  |                        | (161  | ) |      |   | (141  | )
|                                      |  |                        |       |   |      |   |       |  
|Total deferred tax liabilities        |  |                        | (188  | ) |      |   | (205  | )
|                                      |  |                        |       |   |      |   |       |  
|Net recorded deferred tax asset       |  | $                      | 1,944 |   |      | $ | 2,168 |  
|                                      |  |                        |       |   |      |   |       |  

The Bank has adopted the provisions of FASB Interpretation No. 48 (FIN 48). There was no material
impact from the adoption of FIN 48. It is the Banks policy to recognize interest and penalties associated with uncertain tax positions as components of income taxes. There were no interest or penalties accrued during the year. The Banks
federal and state income tax returns are subject to examination for the years 2004, 2005 and 2006.

Note KSavings Plan

The Company maintains a contributory savings plan under Section 401(k) of the Internal Revenue Code covering all employees who have completed three months of service
and are at least eighteen years of age. Under the plan, employee contributions are matched by the Company in an amount equal to 100% of the first 6% of compensation contributed by the employee. Total savings plan expense for the years ended
December 31, 2007, 2006 and 2005 was $208,000, $203,000 and $175,000, respectively.

Note LStock Options

In 2004, the Board of Directors and shareholders of the Company approved the MidCarolina Financial Corporation Omnibus Stock Ownership and Long Term Incentive Plan
(2004 Omnibus Plan) for officers and key employees. Under the provisions of the 2004 Omnibus Plan, Rights (as defined in the 2004 Omnibus Plan) are awarded at the discretion of an administrative committee appointed by the Board of
Directors at the fair value of the stock on the date of grant. The Board reserved 412,500 shares of authorized and unissued stock for grant.

During 1998,
the Board of Directors and shareholders of the Bank approved a Non-Qualified Stock Option Plan for certain original directors of the Bank, and 326,700 shares of authorized and unissued stock were reserved for award. At adoption, all options were
granted at a split-adjusted exercise price of $2.75 per share, the split-adjusted fair value of the stock on the date of grant. Director options vested 100% on the date of grant. The options are granted for a ten-year term.

During 1998, the Board of Directors and shareholders of the Bank approved an Incentive Stock Option Plan for officers and key employees. Under the provisions of the
Plan, grants are made at the discretion of an administrative committee appointed by the Board of Directors at the fair value of the stock on the date of grant. The Board reserved 326,700 shares of authorized and unissued stock for grant. Options
have a vesting schedule that provides that 20% of the options granted will be vested and exercisable on the date of grant and 20% will vest and become exercisable on each of the next four annual anniversary dates thereafter. The options are granted
for a ten-year term. The two 1998 plans were adopted by the Company and its shareholders in the 2002 organization of the Company.



69



---

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

December 31, 2007, 2006 and 2005



A summary of the Companys stock option activity and related information for the years ended December 31,
2007 reflecting the effects of stock dividends declared, including the 25% stock dividend declared in December 2006 and distributed in January 2007, the 10% stock dividend declared in May 2006 and distributed in June 2006, the 25% stock dividend
distributed in November 2005, and the 20% stock dividend declared in 2004 and distributed in 2005:



|                                 |  |              |  |                      |       |                                         |         |                         |   |            
|-------------------------------- |  | ------------ |  | -------------------- | ----- | --------------------------------------- | ------- | ----------------------- | - | -----------
|                                 |  | Numbershares |  | AverageExercisePrice |       | WeightedAverageRemainingContractualTerm |         | AggregateIntrinsicValue
|At December 31, 2006             |  | 616,656      |  | $                    | 4.94  |                                         |         |                         |   |            
|Options granted                  |  | 14,000       |  |                      | 14.57 |                                         |         |                         |   |            
|Options vested                   |  |             |  |                      |      |                                         |         |                         |   |            
|Options exercised                |  | 94,137       |  |                      | 3.00  |                                         |         |                         |   |            
|Options forfeited                |  |             |  |                      |      |                                         |         |                         |   |            
|                                 |  |              |  |                      |       |                                         |         |                         |   |            
|Outstanding at December 31, 2007 |  | 536,519      |  | $                    | 5.53  |                                         | 3 years |                         | $ | 2.1 million
|                                 |  |              |  |                      |       |                                         |         |                         |   |            
|Exercisable at December 31, 2007 |  | 522,519      |  | $                    | 5.29  |                                         | 3 years |                         | $ | 2.2 million
|                                 |  |              |  |                      |       |                                         |         |                         |   |            

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



|                                        |  |      |      |      |   |      |  |   |     
|--------------------------------------- |  | ---- | ---- | ---- | - | ---- |  | - | ----
|                                        |  | 2007 |      | 2006 |   | 2005
|Estimated fair value of options granted |  | $    | 3.60 |      | $ |     |  | $ | 4.94
|                                        |  |      |      |      |   |      |  |   |     

The risk-free interest rate is based upon a U.S. Treasury instrument with a life that is similar to the expected
life of the option grant. Expected volatility is based upon the historical volatility of the Company based upon the previous 3 years trading history. The expected term of the options is based upon the average life of previously issued stock options.
The expected dividend yield is based upon current yield on date of grant. No post-vesting restrictions exist for these options. The following table illustrates the assumptions for the Black-Scholes model used in determining the fair value of options
granted to employees in the year ended December 31, 2007, 2006 and 2005.



|                                                                                                                  |  |          |   |  |      |     |      |   |          |  
|----------------------------------------------------------------------------------------------------------------- |  | -------- | - |  | ---- | --- | ---- | - | -------- | -
|                                                                                                                  |  | 2007     |   |  | 2006 |     | 2005 |  
|Assumptions in estimating option values:                                                                          |  |          |   |  |      |     |      |   |          |  
|Risk-free rate                                                                                                    |  | 4.71     | % |  |      | n/a |      |   | 4.37     | %
|Dividend yield                                                                                                    |  | 0        | % |  |      | n/a |      |   | 0        | %
|Volatility                                                                                                        |  | 26.87    | % |  |      | n/a |      |   | 27.19    | %
|Expected life                                                                                                     |  | 3 years  |   |  |      | n/a |      |   | 10 years |  
|                                                                                                                 
|For the years ended December 31, 2007, 2006 and 2005, the intrinsic value of options exercised was approximately: | 
|                                                                                                                  |  |          |  
|                                                                                                                  |  | 2007     |   |  | 2006 |     | 2005 |  
|                                                                                                                  |  | $971,000 |   |  | $    |    |      | $ | 65,000   |  



70



---

NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2007, 2006 and
2005



Cash received from options exercised under all share-based payment arrangements for year ended December 31, 2007
was approximately $279 thousand. The actual tax benefit in shareholders equity realized for the tax deduction from option exercise in the share-based payment arrangements totaled $0 for the year ended December 31, 2007.

The unrecognized compensation expense for outstanding options at December 31, 2007 was $38 thousand.

Note MOfficers Deferred Compensation

In 2002, the Company implemented a non-qualifying deferred
compensation plan for certain key executive officers. The Company has purchased life insurance policies on the participating officers in order to offset the cost of benefit payments. Benefits for each officer participating in the plan will accrue
and vest during the period of employment, and will be paid in monthly benefit payments over the participants life after retirement. The plan also provides for payment of disability or death benefits in the event a participating officer becomes
permanently disabled or dies while employed at the Bank. Provisions of $278,000 in 2007, $370,000 in 2006 and $361,000 in 2005 were expensed for future benefits to be provided under this plan. The total liability under this plan was $915 thousand
after the reversal of accrued benefits for a former executive officer at December 31, 2007 and $1.6 million at December 31, 2006, and is included in accrued expenses and other liabilities in the accompanying consolidated statements of
financial condition.

Note NEmployment Agreement

The Company has entered into severance agreements with certain key officers to ensure a stable and competent management base. In the event of a change in control of the Company, as defined in the agreements, the acquirer will be bound to
the terms of the agreements.

Note OContingent Liabilities and Commitments

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

A
summary of the Companys commitments and contingent liabilities at December 31, 2007 is as follows (amounts in thousands):



|                                                                                                |  |      |       
|----------------------------------------------------------------------------------------------- |  | ---- | ------
|                                                                                                |  | 2007
|Unfunded commitments to extend credit under existing equity line and commercial lines of credit |  | $    | 73,967
|Commitments to sell loans held for sale                                                         |  |      | 823   
|Financial standby letters of credit, net                                                        |  |      |      

Commitments to originate new loans or extend credit and letters of credit all include exposure to some credit loss
in the event of nonperformance by the customer. The Companys credit policies and procedures for credit commitments are the same as those for extensions of credit that are recorded in the balance sheets. Because these instruments have fixed
maturity dates, and because many of them expire without being drawn upon, they do not generally present any significant liquidity risk to the Company. The Company has not incurred any losses on its commitments in 2007, 2006 or 2005.

Commitments to sell loans held for sale are agreements to sell loans to a third party at an agreed upon price. The aggregate fair value of the commitments is immaterial.

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



71



---

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

December 31, 2007, 2006 and 2005



Note PShareholders Equity

Regulatory Matters

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

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

As of December 31, 2007 and 2006, the Banks capital ratios exceeded levels deemed well-capitalized
under the regulatory framework for prompt corrective action. There are no events or conditions since the notification that management believes have changed the Banks category.



|                                                        |  |                        |        |              |                      |   |                     |      |   |                       |       |  
|------------------------------------------------------- |  | ---------------------- | ------ | ------------ | -------------------- | - | ------------------- | ---- | - | --------------------- | ----- | -
|                                                        |  | For the Bank           |        |              | Minimum Requirements |  
|                                                        |  | CapitalAmount          |        | CapitalRatio |                      |   | For CapitalAdequacy |      |   | To Be WellCapitalized |      
|                                                        |  | (Dollars in thousands) |       
|As of December 31, 2007                                 |  |                        |        |              |                      |   |                     |      |   |                       |       |  
|Tier I capital (to risk-weighted assets)                |  | $                      | 41,696 |              | 10.37                | % |                     | 4.00 | % |                       | 6.00  | %
|Total capitalTier II capital (to risk-weighted assets) |  |                        | 46,158 |              | 11.48                | % |                     | 8.00 | % |                       | 10.00 | %
|LeverageTier I capital (to average assets)             |  |                        | 41,696 |              | 8.95                 | % |                     | 4.00 | % |                       | 5.00  | %
|                                                        |  |                        |        |             
|As of December 31, 2006                                 |  |                        |        |              |                      |   |                     |      |   |                       |       |  
|Tier I capital (to risk-weighted assets)                |  | $                      | 37,059 |              | 10.30                | % |                     | 4.00 | % |                       | 6.00  | %
|Total capitalTier II capital (to risk-weighted assets) |  |                        | 41,281 |              | 11.48                | % |                     | 8.00 | % |                       | 10.00 | %
|LeverageTier I capital (to average assets)             |  |                        | 37,059 |              | 9.04                 | % |                     | 4.00 | % |                       | 5.00  | %

The Company is also subject to these capital requirements except for the prompt corrective action requirements of
the FDIC. At December 31, 2007, the Companys total capital to risk-weighted assets, Tier I capital to risk-weighted assets and Tier I capital to average assets were 11.52%, 10.41% and 8.99%, respectively. At December 31, 2006, the
Companys total capital to risk-weighted assets, Tier I capital to risk-weighted assets and Tier I capital to average assets were 11.28%, 10.12% and 8.73%, respectively.



72



---

NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2007, 2006 and
2005



Note QDerivatives

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



|                |  |                        |       |  
|--------------- |  | ---------------------- | ----- | -
|Type            |  | 2005                   |      
|                |  | (Amounts in thousands) |      
|Notional amount |  | $                      | 5,000 |  
|Receive rate    |  |                        | 4.34  | %
|Pay rate        |  |                        | 3.45  | %
|Fair value      |  | $                      | 120   |  

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

Although off-balance sheet derivative financial
instruments do not expose the Company to credit risk equal to the notional amount, such agreements generate credit risk to the extent of the fair value gain in an off-balance sheet derivative financial instrument if the counterparty fails to
perform. Such risk is minimized through the creditworthiness of the counterparties and the consistent monitoring of these agreements. The counterparties to these arrangements were primarily large commercial banks and investment banks. Where
appropriate, master netting agreements are arranged or collateral is obtained in the form of rights to securities. On August 14, 2006, the Company determined that the derivatives did not meet the hedge accounting qualifications and hedge
accounting was immediately discontinued and the derivative was sold. The impact of the transaction was immaterial to the financial statements.

Note
RFair Value of Financial Instruments

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

Fair
value estimates are made at a specific point in time based on relevant market information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Companys
entire holding of a particular financial instrument. In cases where quoted market prices are not available, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of
various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly
affect the estimates. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates. Finally, the fair value
estimates presented herein are based on pertinent information available to management as of December 31, 2007 and 2006, respectively.

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

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

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



73



---

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

December 31, 2007, 2006 and 2005



Investment Securities

Fair value for investment securities, excluding FHLB stock, is based on quoted market price if such information is available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar
securities. The carrying value of FHLB stock approximates fair value based on the redemption provisions of the FHLB.

Loans Held for Sale

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

Loans

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

Investment in Life Insurance

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

Deposits, Short-term Borrowings and Long-term Debt

Deposits and short-term borrowings without a stated maturity, or insignificant term to maturity, including demand, interest bearing demand, savings accounts and FHLB
borrowings are reported at their carrying value in accordance with SFAS 107. No value has been assigned to the franchise value of deposits. For other types of deposits and long-term debt, with fixed rates and longer maturities is estimated based
upon the discounted value of projected future cash outflows using the rates currently offered for instruments of similar remaining maturities.

Accrued
Interest Receivable and Accrued Interest Payable

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

Derivative Financial Instruments

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

Financial Instruments with
Off-Balance Sheet Risk

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



74



---

NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2007, 2006 and
2005



The following table presents the carrying values and estimated fair values of the Companys financial
instruments at December 31, 2007 and 2006:



|                                         |  |                        |         |                     |   |        
|---------------------------------------- |  | ---------------------- | ------- | ------------------- | - | -------
|                                         |  | Carryingvalue          |         | Estimatedfair value
|                                         |  | (Amounts in thousands)
|As of December 31, 2007                  |  |                        |         |                     |   |        
|Financial assets:                        |  |                        |         |                     |   |        
|Cash and cash equivalents                |  | $                      | 4,611   |                     | $ | 4,611  
|Investment securities available for sale |  |                        | 70,801  |                     |   | 70,801 
|Loans held for sale                      |  |                        | 823     |                     |   | 823    
|Loans                                    |  |                        | 371,714 |                     |   | 372,023
|Federal Home Loan Bank stock             |  |                        | 2,966   |                     |   | 2,966  
|Investment in life insurance             |  |                        | 7,594   |                     |   | 7,594  
|Accrued interest receivable              |  |                        | 2,443   |                     |   | 2,443  
|Financial liabilities:                   |  |                        |         |                     |   |        
|Deposits                                 |  | $                      | 373,897 |                     | $ | 374,297
|Short-term borrowings                    |  |                        | 19,000  |                     |   | 19,000 
|Long-term debt                           |  |                        | 38,764  |                     |   | 39,082 
|Accrued interest payable                 |  |                        | 684     |                     |   | 684    
|                                         |  |                       
|As of December 31, 2006                  |  |                        |         |                     |   |        
|Financial assets:                        |  |                        |         |                     |   |        
|Cash and cash equivalents                |  | $                      | 12,438  |                     | $ | 12,438 
|Investment securities available for sale |  |                        | 73,795  |                     |   | 73,795 
|Loans held for sale                      |  |                        | 2,016   |                     |   | 2,016  
|Loans                                    |  |                        | 313,572 |                     |   | 309,531
|Federal Home Loan Bank stock             |  |                        | 2,676   |                     |   | 2,676  
|Investment in life insurance             |  |                        | 7,304   |                     |   | 7,304  
|Accrued interest receivable              |  |                        | 2,116   |                     |   | 2,116  
|Financial liabilities:                   |  |                        |         |                     |   |        
|Deposits                                 |  | $                      | 339,275 |                     | $ | 338,528
|Short-term borrowings                    |  |                        | 25,000  |                     |   | 25,000 
|Long-term debt                           |  |                        | 26,764  |                     |   | 26,519 
|Accrued interest payable                 |  |                        | 581     |                     |   | 581    



75



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NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

December 31, 2007, 2006 and 2005



Note SParent Company Financial Data

The Companys condensed statement of financial condition as of December 31, 2007 and 2006, and its related condensed statements of operations and cash flows for the three year period ended December 31,
2007, are as follows:

Condensed Statement of Financial Condition

December 31, 2007 and 2006

(Amounts in thousands)



|                                           |  |      |        |   |      |   |        |  
|------------------------------------------ |  | ---- | ------ | - | ---- | - | ------ | -
|                                           |  | 2007 |        |   | 2006 |  
|Assets:                                    |  |      |        |   |      |   |        |  
|Investment in subsidiaries                 |  | $    | 41,359 |   |      | $ | 36,583 |  
|Other assets                               |  |      | 680    |   |      |   | 572    |  
|                                           |  |      |        |   |      |   |        |  
|Total assets                               |  | $    | 42,039 |   |      | $ | 37,155 |  
|                                           |  |      |        |   |      |   |        |  
|Liabilities and Shareholders Equity:      |  |      |        |   |      |   |        |  
|Liabilities:                               |  |      |        |   |      |   |        |  
|Junior subordinated debentures             |  | $    | 8,764  |   |      | $ | 8,764  |  
|Other liabilities                          |  |      | 125    |   |      |   | 132    |  
|                                           |  |      |        |   |      |   |        |  
|Total liabilities                          |  |      | 8,889  |   |      |   | 8,896  |  
|                                           |  |      |        |   |      |   |        |  
|Shareholders Equity:                      |  |      |        |   |      |   |        |  
|Preferred stock                            |  |      | 4,819  |   |      |   | 4,819  |  
|Common stock                               |  |      | 13,290 |   |      |   | 13,007 |  
|Retained earnings                          |  |      | 15,378 |   |      |   | 10,908 |  
|Accumulated other comprehensive loss       |  |      | (337   | ) |      |   | (475   | )
|                                           |  |      |        |   |      |   |        |  
|Total shareholders equity                 |  |      | 33,150 |   |      |   | 28,259 |  
|                                           |  |      |        |   |      |   |        |  
|Total liabilities and shareholders equity |  | $    | 42,039 |   |      | $ | 37,155 |  
|                                           |  |      |        |   |      |   |        |  

Condensed Statements of Operations

Years ended December 31, 2007, 2006 and 2005

(Amounts in thousands)



|                                            |  |      |       |   |      |   |       |      |  |   |       |  
|------------------------------------------- |  | ---- | ----- | - | ---- | - | ----- | ---- |  | - | ----- | -
|                                            |  | 2007 |       |   | 2006 |   |       | 2005 | 
|Undistributed earnings of subsidiaries      |  | $    | 4,354 |   |      | $ | 3,299 |      |  | $ | 2,367 |  
|Subsidiary dividend income                  |  |      | 1,155 |   |      |   | 1,121 |      |  |   | 570   |  
|Interest expense                            |  |      | (742  | ) |      |   | (698  | )    |  |   | (569  | )
|Income tax benefit                          |  |      | 120   |   |      |   | 174   |      |  |   |      |  
|                                            |  |      |       |   |      |   |       |      |  |   |       |  
|Net income                                  |  |      | 4,887 |   |      |   | 3,896 |      |  |   | 2,368 |  
|Dividends on preferred stock                |  |      | (417  | ) |      |   | (417  | )    |  |   | (104  | )
|                                            |  |      |       |   |      |   |       |      |  |   |       |  
|Net income available to common shareholders |  | $    | 4,470 |   |      | $ | 3,479 |      |  | $ | 2,264 |  
|                                            |  |      |       |   |      |   |       |      |  |   |       |  



76



---

NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2007, 2006 and
2005



Condensed Statements of Cash Flow

Years ended December 31, 2007, 2006 and 2005

(Amounts in thousands)



|                                                                              |  |      |        |   |      |   |        |      |  |   |        |  
|----------------------------------------------------------------------------- |  | ---- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                                              |  | 2007 |        |   | 2006 |   |        | 2005 | 
|Cash flows from operating activities:                                         |  |      |        |   |      |   |        |      |  |   |        |  
|Net income                                                                    |  | $    | 4,887  |   |      | $ | 3,896  |      |  | $ | 2,368  |  
|Adjustments to reconcile net income to net cash used by operating activities: |  |      |        |   |      |   |        |      |  |   |        |  
|Equity in undistributed earnings of subsidiaries                              |  |      | (4,354 | ) |      |   | (3,299 | )    |  |   | (2,367 | )
|Stock compensation expense                                                    |  |      | 14     |   |      |   |       |      |  |   |       |  
|Amortization                                                                  |  |      | 8      |   |      |   | 8      |      |  |   | 8      |  
|Decrease (increase) in other assets                                           |  |      | (117   | ) |      |   | (222   | )    |  |   | 243    |  
|Increase (decrease) in other liabilities                                      |  |      | (7     | ) |      |   | 34     |      |  |   | (182   | )
|                                                                              |  |      |        |   |      |   |        |      |  |   |        |  
|Net cash provided by operating activities                                     |  |      | 431    |   |      |   | 417    |      |  |   | 70     |  
|                                                                              |  |      |        |   |      |   |        |      |  |   |        |  
|Cash flows from investing activities:                                         |  |      |        |   |      |   |        |      |  |   |        |  
|Investment in subsidiary                                                      |  |      | (283   | ) |      |   | (1,615 | )    |  |   | (4,819 | )
|                                                                              |  |      |        |   |      |   |        |      |  |   |        |  
|Net cash used by investing activities                                         |  |      | (283   | ) |      |   | (1,615 | )    |  |   | (4,819 | )
|                                                                              |  |      |        |   |      |   |        |      |  |   |        |  
|Cash flow from financing activities:                                          |  |      |        |   |      |   |        |      |  |   |        |  
|Proceeds from issuance of preferred stock                                     |  |      |       |   |      |   |       |      |  |   | 4,819  |  
|Proceeds from exercise of stock options                                       |  |      | 279    |   |      |   | 1,072  |      |  |   | 21     |  
|Tax benefit from exercise of stock options                                    |  |      |       |   |      |   | 550    |      |  |   | 26     |  
|Purchase of fractional common shares                                          |  |      | (10    | ) |      |   | (7     | )    |  |   | (13    | )
|Non-cumulative perpetual preferred stock dividends paid                       |  |      | (417   | ) |      |   | (417   | )    |  |   | (104   | )
|                                                                              |  |      |        |   |      |   |        |      |  |   |        |  
|Net cash (used) provided by financing activities                              |  |      | (148   | ) |      |   | 1,198  |      |  |   | 4,749  |  
|                                                                              |  |      |        |   |      |   |        |      |  |   |        |  
|Net increase in cash and cash equivalents                                     |  |      |       |   |      |   |       |      |  |   |       |  
|Cash and cash equivalents, beginning                                          |  |      |       |   |      |   |       |      |  |   |       |  
|                                                                              |  |      |        |   |      |   |        |      |  |   |        |  
|Cash and cash equivalents, ending                                             |  | $    |       |   |      | $ |       |      |  | $ |       |  
|                                                                              |  |      |        |   |      |   |        |      |  |   |        |  



77



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|Item 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
|------- | ------------------------------------------------------------------------------------

N/A



|Item 9A(T). | DISCLOSURE CONTROLS AND PROCEDURES.
|----------- | -----------------------------------

The Companys management
is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Exchange Act. As of December 31, 2007, an evaluation was performed under the supervision and
with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Companys disclosure controls and procedures. Based on that evaluation, management
concluded that disclosure controls and procedures as of December 31, 2007 were effective in ensuring material information required to be disclosed in the Annual Report on Form 10-K was recorded, processed, summarized, and reported on a timely
basis.

MANAGEMENTS REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING.

Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. The Companys internal control over financial reporting is a process designed under
supervision of the Companys Chief Executive Officer and Chief Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Companys financial statements for external
reporting purposes in accordance with U.S. generally accepted accounting principles. Management has made a comprehensive review, evaluation and assessment of the Companys internal control over financial reporting as of December 31, 2007.
In making this assessment of internal control over financial reporting, management used the criteria issued by the Committee Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control  Integrated Framework.Based on this assessment, management believes that, as of December 31, 2007, the Companys internal control over financial reporting is effective. In accordance with Section 404 of the Sarbanes-Oxley Act of 2002, management makes
the following assertions:



| |  |  | Management has implemented a process to monitor and assess both design and operating effectiveness of internal control over financial reporting.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

This Annual Report on Form 10-K does not include an attestation report of the Companys registered public accounting firm regarding internal control over financial
reporting. Managements report was not subject to attestation by the Companys registered public accounting firm pursuant to temporary rules of the SEC that permit the Company to provide only Managements report on this Annual Report
on Form 10-K.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

There were no changes in internal control over financial reporting during the quarter ended December 31, 2007 that have materially affected, or are reasonably likely to materially affect, the Companys
internal control over financial reporting.



|Item 9B. | OTHER INFORMATION
|-------- | -----------------

N/A

PART III



|Item 10. | DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
|-------- | ------------------------------------------------------

(a)
Directors and Executive OfficersThe information required by this Item regarding directors (including those nominated for election at the Annual Meeting of Shareholders to be held on May 27, 2008) and executive officers of the Company is
set forth under the sections captioned PROPOSAL 1  ELECTION OF DIRECTORS  General,



78



---

EXECUTIVE OFFICERS, and Report of Audit Committee  in the Companys Proxy Statement, to be filed with the SEC with respect to
the aforementioned Annual Meeting of Shareholders (the Proxy Statement), which sections are incorporated herein by reference.

(b) Section 16(a) Compliance  The information required by this Item regarding compliance with Section 16(a) of the Exchange Act is set forth under the Proxy Statement section captioned SECTION 16(A) BENEFICIAL
OWNERSHIP REPORTING COMPLIANCE, which section is incorporated herein by reference.

(c) Audit Committee Financial Expert  The
information required by the Item regarding the Companys Audit Committee, including the Audit Committee Finance Expert, is set forth under the Proxy Statement section captioned Report of Audit Committee, which section is
incorporated by reference.

(d) Code of Ethics  The Company has adopted a Code of Business Conduct and Ethics that is applicable to
all of its directors, officers and employees, including its principal executive and senior financial officers, as required by Section 406 of the Sarbanes-Oxley Act of 2002 and applicable SEC rules. A copy of the Companys Code of Business
Conduct and Ethics may be obtained, without charge, by sending a written request to the Company at 3101 South Church Street, Burlington, North Carolina 27215, attn: Corporate Secretary.

In the event that the Company makes any amendment to, or grants any waivers of, a provision of its Code of Business Conduct and Ethics that applies to
the principal executive officer or senior financial officers that requires disclosure under applicable SEC rules, the Company intends to disclose such amendment or waiver by filing a Form 8-K with the SEC.



|Item 11. | EXECUTIVE COMPENSATION
|-------- | ----------------------

The information required by this Item is
set forth under the section captioned EXECUTIVE AND DIRECTOR COMPENSATION, contained in the Proxy Statement, which section is incorporated by reference.



|Item 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
|-------- | ----------------------------------------------------------------------------------------------

The information required by this Item is set forth under the section captioned SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS contained in the Proxy Statement and under the section captioned
Securities Authorized for Issuance Under Equity Compensation Plans in Item 5 of this Annual Report on Form 10-K, which sections are incorporated herein by reference.



|Item 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
|-------- | ------------------------------------------------------------------------

The information required by this Item is set forth under the sections captioned Proposal 1ELECTION OF DIRECTORS  GENERAL and CERTAIN INDEBTEDNESS and TRANSACTIONS of MANAGEMENT contained in the Proxy
Statement, which sections are incorporated herein by reference.



|Item 14. | PRINCIPAL ACCOUNTANT FEES AND SERVICES
|-------- | --------------------------------------

The information required by
this Item is set forth under the section captioned PROPOSAL 4RATIFICATION OF APPOINTMENT OF INDEPENDENT AUDITORS, contained in the Proxy Statement, which section is incorporated herein by reference.



79



---

Part IV



|Item 15. | EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
|-------- | ------------------------------------------

(a)(1) Financial
Statements. The following financial statements and supplementary data are included in Item 8 of this report.



|                                                                                                                    |  |               
|------------------------------------------------------------------------------------------------------------------- |  | --------------
|Financial Statements                                                                                                |  | Form 10-K Page
|Report of Independent Registered Public Accounting Firm                                                             |  | 50            
|                                                                                                                    | 
|Consolidated Statements of Financial Condition as of December 31, 2007 and 2006                                     |  | 51            
|                                                                                                                    | 
|Consolidated Statements of Operations and Comprehensive Income for the years ended December 31, 2007, 2006 and 2005 |  | 52 - 53       
|                                                                                                                    | 
|Consolidated Statements of Changes in Shareholders Equity for the years ended December 31, 2007, 2006 and 2005     |  | 54            
|                                                                                                                    | 
|Consolidated Statements of Cash Flows for the years ended December 31, 2007, 2006 and 2005                          |  | 55            
|                                                                                                                    | 
|Notes to Consolidated Financial Statements                                                                          |  | 56            

(a)(2) Financial Statement Schedules. All applicable financial statement schedules required under
Regulation S-X have been included in the Notes to the Consolidated Financial Statements.

(a)(3) Exhibits. The exhibits required by Item 601 of
Regulation S-K are listed below.



|             |  |                                                                                                                                                                                                                                                                                                                                                                                             
|------------ |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No.  |  | Description                                                                                                                                                                                                                                                                                                                                                                                 
|Exhibit 3.1  |  | Amended and Restated Articles of Incorporation, incorporated herein by reference to Exhibit 3(i) to the Form 8-A12G filed with the SEC on June 5, 2002, as amended on August 15, 2005 by Articles
of Amendment, incorporated herein by reference to Exhibit 3(i) to the Form 8-K filed with the SEC on August 29, 2005.                                                                     
|             | 
|Exhibit 3.2  |  | Bylaws, incorporated herein by reference to Exhibit 3(ii) to the Form 8-A12G filed with the SEC on June 5, 2002.                                                                                                                                                                                                                                                                            
|             | 
|Exhibit 4.1  |  | Form of Stock Certificate, incorporated herein by reference to the Form 10-QSB filed with the SEC on November 12, 2002.                                                                                                                                                                                                                                                                     
|             | 
|Exhibit 4.2  |  | Certain instruments defining the rights of the holders of long-term debt of the Company and of a subsidiary, involving a total amount of indebtedness not in excess of 10% of the total assets of
the Company and its subsidiaries on a consolidated basis, have not been filed as exhibits. The Company hereby agrees to furnish a copy of any of these agreements to the SEC upon request.
|             | 
|Exhibit 10.1 |  | Bank Employee Stock Option Plan, incorporated herein by reference to Exhibit 6(ii) to the Form 10-SB filed with the FDIC on April 30, 1998                                                                                                                                                                                                                                                  
|             | 
|Exhibit 10.2 |  | Bank Director Stock Option Plan, incorporated herein by reference to Exhibit 6(iii) to the Form 10-SB filed with the FDIC on April 30, 1998                                                                                                                                                                                                                                                 



80



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|              |  |                                                                                                                                                                                                                                                                                    
|------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit 10.3  |  | Land Lease dated October 15, 1997 between the Bank and Crescent Center Associates, incorporated herein by reference to Exhibit 10(iv) to the Form 10-KSB for the fiscal year ended
December 31, 1998.                                                                              
|              | 
|Exhibit 10.4  |  | Lease dated June 27, 2000 between the Bank and Cum-Park Plaza, LLC incorporated herein by reference to Exhibit 10(v) to the Form 10-KSB, filed with the SEC for the fiscal year ended December 31,
2000.                                                                           
|              | 
|Exhibit 10.5  |  | Company Omnibus Stock Ownership and Long-Term Incentive Plan, incorporated herein by reference to Exhibit 10(vi) to the Form 10-KSB, filed with the SEC for the fiscal year ended December 31,
2003.                                                                               
|              | 
|Exhibit 10.6  |  | Form of stock option award agreements for incentive stock options and nonqualified stock options granted under the Omnibus Stock Ownership and Long-Term Incentive Plan, incorporated herein by
reference to Exhibit 10.7 to the Form 10-KSB, filed with the SEC on March 29, 2006.
|              | 
|Exhibit 10.7  |  | Amendment of Stock Option Agreements granted under the Bank Employee Stock Option Plan, incorporated herein by reference to Exhibit 99.2 to the Form 8-K, filed with the SEC on December 27, 2005.                                                                                 
|              | 
|Exhibit 10.8  |  | Amendment of Stock Option Agreement, with resale restrictions, granted under the Bank Employee Stock Option Plan, incorporated herein by reference to Exhibit 99.3 to the Form 8-K, filed with the
SEC on December 27, 2005.                                                       
|              | 
|Exhibit 10.9  |  | Salary Continuation Agreement dated October 1, 2004 between the Bank and Charles T. Canaday Jr., incorporated herein by reference to Exhibit 10.11 to the Form 10-KSB filed with the SEC on March
29, 2006.                                                                        
|              | 
|Exhibit 10.10 |  | Salary Continuation Agreement dated October 1, 2004 between the Bank and Christopher B. Redcay, incorporated herein by reference to Exhibit 10.12 to the Form 10-KSB filed with the SEC on March
29, 2006.                                                                         
|              | 
|Exhibit 10.11 |  | Endorsement Split Dollar Agreement dated October 1, 2004 between the Bank and Charles T. Canaday Jr., incorporated herein by reference to Exhibit 10.15 to the Form 10-KSB filed with the SEC on
March 29, 2006.                                                                   
|              | 
|Exhibit 10.12 |  | Endorsement Split Dollar Agreement dated October 1, 2004 between the Bank and Christopher B. Redcay, incorporated herein by reference to Exhibit 10.16 to the Form 10-KSB filed with the SEC on
March 29, 2006.                                                                    
|              | 
|Exhibit 10.13 |  | Endorsement Split Dollar Agreement dated October 1, 2004 between the Bank and R. Craig Patterson, incorporated herein by reference to Exhibit 10.17 to the Form 10-KSB filed with the SEC on March
29, 2006.                                                                       
|              | 
|Exhibit 10.14 |  | Severance Agreement dated March 11, 2005 between the Company and Charles T. Canaday Jr., incorporated herein by reference to Exhibit 10.18 to the Form 10-KSB filed with the SEC on March 29,
2006.                                                                                
|              | 
|Exhibit 10.15 |  | Severance Agreement dated March 11, 2005 between the Company and Christopher B. Redcay, incorporated herein by reference to Exhibit 10.19 to the Form 10-KSB filed with the SEC on March 29, 2006.                                                                                 



81



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|              |  |                                                                                                                                                                                                                                                                              
|------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit 10.16 |  | Severance Agreement dated March 7, 2006 between the Company and R. Craig Patterson, incorporated herein by reference to Exhibit 99.1 to the Form 8-K, filed with the SEC on March 7,
2006.                                                                                   
|              | 
|Exhibit 10.17 |  | Indemnification Agreement with directors, incorporated herein by reference to Exhibit 99.1 to the Form 8-K, filed with the SEC on December 27, 2005.                                                                                                                         
|              | 
|Exhibit 10.18 |  | Amended Salary Continuation Agreement dated December 6, 2006, between MidCarolina Bank and Robert C. Patterson, incorporated herein by reference to Exhibit 99.1 to the Form 8- K, filed with the
SEC on December 11, 2006.                                                  
|              | 
|Exhibit 10.19 |  | Amendment to Bank Director Stock Option Plan, dated April 24, 2007, incorporated herein by Reference to Exhibit 10.23 to the form 10Q, filed with the SEC on August 13, 2007.                                                                                                
|              | 
|Exhibit 10.20 |  | Amendment to the Bank Employee Stock Option Plan dated April 24, 2007, incorporated herein by reference to Exhibit 10.24 to the form 10Q, filed with the SEC on August 13, 2007.                                                                                             
|              | 
|Exhibit 10.21 |  | Form of Amendment to Endorsement Split Dollar Agreement, between MidCarolina Bank and (i) Charles T. Canaday; and (ii) Christopher B. Redcay, dated December 7, 2007 incorporated herein by
reference to Exhibit 10.01 to the Form 8-K, filed with the SEC on March 21, 2008.
|              | 
|Exhibit 10.22 |  | Form of Amendment to Endorsement Split Dollar Agreement, between MidCarolina Bank and Robert C. Patterson; dated December 7, 2007 incorporated herein by reference to Exhibit 10.01 to the Form
8-K, filed with the SEC on March 21, 2008.                                   
|              | 
|Exhibit 11    |  | Statement Regarding Computation of Per Share Earnings                                                                                                                                                                                                                        
|              | 
|Exhibit 14    |  | Code of Ethics incorporated herein by reference to Exhibit 14 to the Form 10-KSB for the fiscal year ended December 31, 2003.                                                                                                                                                
|              | 
|Exhibit 21    |  | Schedule of Subsidiaries.                                                                                                                                                                                                                                                    
|              | 
|Exhibit 23    |  | Consent of Dixon Hughes PLLC                                                                                                                                                                                                                                                 
|              | 
|Exhibit 31.1  |  | Rule 13a-14(a)/15d-14(a) Certification by Chief Executive Officer                                                                                                                                                                                                            
|              | 
|Exhibit 31.2  |  | Rule 13a-14(a)/15d-14(a) Certification by Chief Financial Officer                                                                                                                                                                                                            
|              | 
|Exhibit 32    |  | Section 1350 Certifications                                                                                                                                                                                                                                                  



82



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SIGNATURES

Pursuant to the requirements of 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.



|                     |  |  |  |                                   |  |                                      
|-------------------- |  |  |  | --------------------------------- |  | -------------------------------------
|                     |  |  |  | MIDCAROLINA FINANCIAL CORPORATION
|                     |  |  | 
|Date: March 25, 2008 |  |  |  | By:                               |  | /s/ CHARLES T. CANADAY, JR.          
|                     |  |  |  |                                   |  | Charles T. Canaday, Jr.              
|                     |  |  |  |                                   |  | President and Chief Executive Officer

Pursuant to the requirements of 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 dates indicated.



|                          |  |                                                   |  |               
|------------------------- |  | ------------------------------------------------- |  | --------------
|Signature                 |  | Title                                             |  | Date          
|                          |  |                                                  
|/s/ CHARLES T. CANADAY    |  | President, Chief Executive Officer and Director   |  | March 25, 2008
|Charles T. Canaday        |  |                                                   | 
|                          |  |                                                  
|/s/ CHRISTOPHER B. REDCAY |  | Senior Vice President and Chief Financial
Officer |  | March 25, 2008
|Christopher B. Redcay     |  |                                                   | 
|                          |  |                                                  
|/s/ JAMES R. COPLAND III  |  | Chairman and Director                             |  | March 25, 2008
|James R. Copland, III     |  |                                                   | 
|                          |  |                                                  
|/s/ DEXTER R. BARBEE, SR. |  | Director                                          |  | March 25, 2008
|Dexter R. Barbee, Sr.     |  |                                                   |  |               
|                          |  |                                                  
|/s/ H. THOMAS BOBO        |  | Director                                          |  | March 25, 2008
|H. Thomas Bobo            |  |                                                   |  |               
|                          |  |                                                  
|/s/ THOMAS E. CHANDLER    |  | Director                                          |  | March 25, 2008
|Thomas E. Chandler        |  |                                                   |  |               
|                          |  |                                                  
|/s/ J. ANTHONY HOLT       |  | Director                                          |  | March 25, 2008
|J. Anthony Holt           |  |                                                   |  |               
|                          |  |                                                  
|/s/ F. D. HORNADAY        |  | Vice Chairman and Director                        |  | March 25, 2008
|F.D. Hornaday, III        |  |                                                   |  |               
|                          |  |                                                  
|/s/ TEENA M. KOURY        |  | Director                                          |  | March 25, 2008
|Teena M. Koury            |  |                                                   |  |               
|                          |  |                                                  
|/s/ JOHN LOVE             |  | Director                                          |  | March 25, 2008
|John Love                 |  |                                                   |  |               
|                          |  |                                                  
|/s/ JAMES B. POWELL       |  | Director                                          |  | March 25, 2008
|James B. Powell           |  |                                                   |  |               
|                          |  |                                                  
|/s/ JOHN K. ROBERTS       |  | Director                                          |  | March 25, 2008
|John K. Roberts           |  |                                                   |  |               
|                          |  |                                                  
|/s/ JAMES H. SMITH, JR.   |  | Director                                          |  | March 25, 2008
|James H. Smith, Jr.       |  |                                                   |  |               
|                          |  |                                                  
|/s/ ROBERT A. WARD        |  | Director                                          |  | March 25, 2008
|Robert A. Ward            |  |                                                   |  |               



83



---

INDEX TO EXHIBITS



|             |  |                                                                  
|------------ |  | -----------------------------------------------------------------
|Exhibit No.  |  | Description                                                      
|Exhibit 11   |  | Statement Regarding Computation of Per Share Earnings            
|             | 
|Exhibit 21   |  | Schedule of Subsidiaries.                                        
|             | 
|Exhibit 23   |  | Consent of Dixon Hughes                                          
|             | 
|Exhibit 31.1 |  | Rule 13a-14(a)/15d-14(a) Certification by Chief Executive Officer
|             | 
|Exhibit 31.2 |  | Rule 13a-14(a)/15d-14(a) Certification by Chief Financial Officer
|             | 
|Exhibit 32   |  | Section 1350 Certifications