**PEOPLES      BANCORP OF NORTH CAROLINA, INC.**

**General      Description of Business**

** **

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***This      report contains certain forward-looking statements with respect to the financial      condition, results of***
***operations      and business of Peoples Bancorp of North Carolina, Inc. (the “Company”). These      forward-looking statements involve risks and uncertainties and are based on      the      beliefs and assumptions of management of the Company and on the information      available to management at the time that these disclosures were prepared. These      statements can be identified by the use of words like “expect,” “anticipate,”“estimate” and “believe,” variations of these words and other similar      expressions. Readers should not place undue reliance on forward-looking      statements as a number of important factors could cause actual results to differ      materially from those in the forward-looking statements. Factors that could      cause actual results to differ materially include, but are not limited to,      (1)      competition in the markets served by Peoples Bank (the “Bank”), (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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| **SELECTED                    FINANCIAL DATA**                                                                                                                                                                                                                   |                                                                            |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                             |                                                                            |   |   |   |   |   |   |   |   |   |   |
| *Dollars                    in Thousands Except Per Share Amounts*                                                                                                                                                                                               |                                                                            |
|                                                                                                                                                                                                                                                             |                                                                            |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                                                                                                                                             |                                                                            |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                                                                                                                                             |                               2006 |                               2005 |                               2004 |                              2003 |                 2002 |   |
| **Summary                    of Operations**                                                                                                                                                                                                                     |                                                                            |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest                    income                                                                                                                                                                                                                               |                                                                            | $ | 55,393 |   |   | 41,913 |   |   | 35,095 |   |   | 33,799 |   |   | 35,550 |   |
| Interest                    expense                                                                                                                                                                                                                              |                                                                            | 23,110 |   |   | 15,429 |   |   | 12,335 |   |   | 12,749 |   |   | 15,777 |   |
|                                                                                                                                                                                                                                                             |                                                                            |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net                    interest income                                                                                                                                                                                                                           |                                                                            |   | 32,283 |   |   | 26,484 |   |   | 22,760 |   |   | 21,050 |   |   | 19,773 |   |
| Provision                    for loan losses                                                                                                                                                                                                                     |                                                                            | 2,513 |   |   | 3,110 |   |   | 3,256 |   |   | 6,744 |   |   | 5,432 |   |
|                                                                                                                                                                                                                                                             |                                                                            |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net                    interest income after provision for loan losses                                                                                                                                                                                           |                                                                            |   | 29,770 |   |   | 23,374 |   |   | 19,504 |   |   | 14,306 |   |   | 14,341 |   |
| Non-interest                    income                                                                                                                                                                                                                           |                                                                            |   | 7,554 |   |   | 6,668 |   |   | 6,000 |   |   | 5,825 |   |   | 6,443 |   |
| Non-interest                    expense                                                                                                                                                                                                                          |                                                                            | 22,983 |   |   | 20,330 |   |   | 18,840 |   |   | 17,072 |   |   | 15,636 |   |
|                                                                                                                                                                                                                                                             |                                                                            |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Income                    before taxes                                                                                                                                                                                                                           |                                                                            |   | 14,341 |   |   | 9,712 |   |   | 6,664 |   |   | 3,059 |   |   | 5,148 |   |
| Income                    taxes                                                                                                                                                                                                                                  |                                                                            | 5,170 |   |   | 3,381 |   |   | 2,233 |   |   | 1,055 |   |   | 1,712 |   |
| Net                    income                                                                                                                                                                                                                                    | $                                                                               | 9,171 |   |   | 6,331 |   |   | 4,431 |   |   | 2,004 |   |   | 3,436 |   |
|                                                                                                                                                                                                                                                             |                                                                            |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Selected                    Year-End Balances**                                                                                                                                                                                                                |                                                                            |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Assets                                                                                                                                                                                                                                                           |                                                                            | $ | 818,948 |   |   | 730,280 |   |   | 686,348 |   |   | 674,032 |   |   | 645,638 |   |
| Available                    for sale securities                                                                                                                                                                                                                 |                                                                            |   | 117,581 |   |   | 115,158 |   |   | 105,598 |   |   | 79,460 |   |   | 71,736 |   |
| Loans,                    net                                                                                                                                                                                                                                    |                                                                            |   | 643,078 |   |   | 559,239 |   |   | 527,419 |   |   | 542,404 |   |   | 519,122 |   |
| Mortgage                    loans held for sale                                                                                                                                                                                                                  |                                                                            |   | - |   |   | 2,248 |   |   | 3,783 |   |   | 587 |   |   | 5,065 |   |
| Interest-earning                    assets                                                                                                                                                                                                                       |                                                                            |   | 780,082 |   |   | 692,835 |   |   | 653,111 |   |   | 639,934 |   |   | 609,052 |   |
| Deposits                                                                                                                                                                                                                                                         |                                                                            |   | 633,820 |   |   | 582,854 |   |   | 556,522 |   |   | 549,802 |   |   | 515,739 |   |
| Interest-bearing                    liabilities                                                                                                                                                                                                                  |                                                                            |   | 650,364 |   |   | 576,681 |   |   | 553,135 |   |   | 550,357 |   |   | 527,525 |   |
| Shareholders'                    equity                                                                                                                                                                                                                          |                                                                            | $ | 62,835 |   |   | 54,353 |   |   | 50,938 |   |   | 48,554 |   |   | 48,605 |   |
| Shares                    outstanding*                                                                                                                                                                                                                           |                                                                            | 3,830,634 |   |   | 3,784,886 |   |   | 3,793,175 |   |   | 3,793,594 |   |   | 3,791,592 |   |
|                                                                                                                                                                                                                                                             |                                                                            |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Selected                    Average Balances**                                                                                                                                                                                                                 |                                                                            |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Assets                                                                                                                                                                                                                                                           |                                                                            | $ | 772,585 |   |   | 706,843 |   |   | 684,385 |   |   | 661,077 |   |   | 625,227 |   |
| Available                    for sale securities                                                                                                                                                                                                                 |                                                                            |   | 118,137 |   |   | 108,690 |   |   | 93,770 |   |   | 72,072 |   |   | 77,414 |   |
| Loans                                                                                                                                                                                                                                                            |                                                                            |   | 604,427 |   |   | 550,545 |   |   | 547,753 |   |   | 539,559 |   |   | 507,879 |   |
| Interest-earning                    assets                                                                                                                                                                                                                       |                                                                            |   | 732,244 |   |   | 668,614 |   |   | 650,528 |   |   | 626,197 |   |   | 593,380 |   |
| Deposits                                                                                                                                                                                                                                                         |                                                                            |   | 605,407 |   |   | 570,997 |   |   | 558,142 |   |   | 533,703 |   |   | 499,224 |   |
| Interest-bearing                    liabilities                                                                                                                                                                                                                  |                                                                            |   | 613,686 |   |   | 563,210 |   |   | 553,880 |   |   | 540,676 |   |   | 516,747 |   |
| Shareholders'                    equity                                                                                                                                                                                                                          |                                                                            | $ | 62,465 |   |   | 55,989 |   |   | 51,978 |   |   | 49,971 |   |   | 48,257 |   |
| Shares                    outstanding*                                                                                                                                                                                                                           |                                                                            | 3,801,219 |   |   | 3,794,860 |   |   | 3,805,317 |   |   | 3,791,761 |   |   | 3,813,890 |   |
|                                                                                                                                                                                                                                                             |                                                                            |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Profitability                    Ratios**                                                                                                                                                                                                                      |                                                                            |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Return                    on average total assets                                                                                                                                                                                                                |                                                                            |   | 1.19 | % |   | 0.90 | % |   | 0.65 | % |   | 0.30 | % |   | 0.55 | % |
| Return                    on average shareholders' equity                                                                                                                                                                                                        |                                                                            |   | 14.68 | % |   | 11.31 | % |   | 8.52 | % |   | 4.01 | % |   | 7.12 | % |
| Dividend                    payout ratio                                                                                                                                                                                                                         |                                                                            | 20.78 | % |   | 22.34 | % |   | 28.37 | % |   | 62.56 | % |   | 36.58 | % |
|                                                                                                                                                                                                                                                             |                                                                            |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Liquidity                    and Capital Ratios (averages)**                                                                                                                                                                                                   |                                                                            |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loan                    to deposit                                                                                                                                                                                                                               |                                                                            |   | 99.84 | % |   | 96.42 | % |   | 98.14 | % |   | 101.10 | % |   | 101.73 | % |
| Shareholders'                    equity to total assets                                                                                                                                                                                                          |                                                                            | 8.09 | % |   | 7.92 | % |   | 7.59 | % |   | 7.56 | % |   | 7.72 | % |
|                                                                                                                                                                                                                                                             |                                                                            |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Per                    share of common stock***                                                                                                                                                                                                                |                                                                            |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                    net income                                                                                                                                                                                                                              |                                                                            | $ | 2.41 |   |   | 1.67 |   |   | 1.16 |   |   | 0.53 |   |   | 0.90 |   |
| Diluted                    net income                                                                                                                                                                                                                            |                                                                            | $ | 2.36 |   |   | 1.64 |   |   | 1.15 |   |   | 0.53 |   |   | 0.90 |   |
| Cash                    dividends                                                                                                                                                                                                                                |                                                                            | $ | 0.50 |   |   | 0.37 |   |   | 0.33 |   |   | 0.33 |   |   | 0.33 |   |
| Book                    value                                                                                                                                                                                                                                    | $                                                                               | 16.40 |   |   | 14.36 |   |   | 13.43 |   |   | 12.80 |   |   | 12.82 |   |
|                                                                                                                                                                                                                                                             |                                                                            |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| *Shares                    outstanding and per share computations have been retroactively                    restated to                    reflect 10% stock dividends during first quarter 2005 and second                    quarter                    2006. |

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**MANAGEMENT'S      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION **

**AND      RESULTS OF OPERATIONS**

***The        following is a discussion of our financial        position and results of operations and should be read in conjunction with        the        information set forth under Item 1A Risk Factors and the Company’s consolidated        financial statements and notes thereto on pages******A-26        through A-56.***

**Introduction**

**Overview**

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**Summary      of Significant Accounting Policies**

*.*

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**Results      of Operations**

*Summary.      *

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*Net      Interest Income. *

| **Table                  1- Average Balance Table**                                                                                                                                                                                                                                                                                                                                                                  |                                 |                                   |                                   |                                   |         |                                 |                                 |         |                                       |    |   |    |   |   |   |   |    |   |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------------------------------------|----------------------------------------|----------------------------------------|----------------------------------------|--------------|--------------------------------------|--------------------------------------|--------------|--------------------------------------------|---------|--------|---------|--------|--------|--------|--------|---------|--------|--------|
|                                                                                                                                                                                                                                                                                                                                                                                                                 |                                 |                                   |                                   |                                   |         |                                 |                                 |         |                                       |    |   |    |   |   |   |   |    |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                 |                                 | **December                  31, 2006** | **December                  31, 2005** | **December                  31, 2004** |         |
| **(Dollars                  in Thousands)**                                                                                                                                                                                                                                                                                                                                                                          | **Average                  Balance** | **Interest**                           | **Yield                  /****Rate**   | **Average                  Balance**   | **Interest** | **Yield                  /****Rate** | **Average                  Balance** | **Interest** | **Yield                  /**** Rate** |    |
| **Interest-earning                  assets:**                                                                                                                                                                                                                                                                                                                                                                        |                                 |                                   |                                   |                                   |         |                                 |                                 |         |                                       |    |   |    |   |   |   |   |    |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                 |                                 |                                   |                                   |                                   |         |                                 |                                 |         |                                       |    |   |    |   |   |   |   |    |   |   |   |   |   |   |   |   |   |   |   |
| Loans                                                                                                                                                                                                                                                                                                                                                                                                                |                                 | $                                      | 604,427                                |                                   |         | 49,665                               |                                 |         | 8.22                                       | %       |   | 550,545 |   |   | 37,234 |   |    | 6.76   | %      |   | 547,753 |   |   | 29,826 |   |   | 5.45 | % |
| Interest                  rate swap agreements                                                                                                                                                                                                                                                                                                                                                                       |                                 |                                   | -                                      |                                   |         | (698                                 | )                                    |         | -0.12                                      | %       |   | -       |   |   | (575   | )      |    | -0.14  | %      |   | - |   |   | 1,056 |   |   | 2.21 | % |
| Loan                  fees                                                                                                                                                                                                                                                                                                                                                                                           |                                 |                                   | -                                      |                                   |         | 701                                  |                                 |         | 0.12                                       | %       |   | -       |   |   | 464    |   |    | 0.80   | %      |   | - |   |   | 191 |   |   | 0.03 | % |
| **Total                  loans**                                                                                                                                                                                                                                                                                                                                                                                     |                                 |                                   | 604,427                                |                                   |         | 49,668                               |                                 |         | 8.22                                       | %       |   | 550,545 |   |   | 37,123 |   |    | 6.74   | %      |   | 547,753 |   |   | 31,073 |   |   | 5.67 | % |
|                                                                                                                                                                                                                                                                                                                                                                                                                 |                                 |                                   |                                   |                                   |         |                                 |                                 |         |                                       |    |   |    |   |   |   |   |    |   |   |   |   |   |   |   |   |   |   |   |
| Investments                  - taxable                                                                                                                                                                                                                                                                                                                                                                               |                                 |                                   | 29,784                                 |                                   |         | 1,306                                |                                 |         | 4.38                                       | %       |   | 37,487  |   |   | 1,595  |   |    | 4.25   | %      |   | 35,920 |   |   | 1,545 |   |   | 4.30 | % |
| Investments                  - nontaxable*                                                                                                                                                                                                                                                                                                                                                                           |                                 |                                   | 88,353                                 |                                   |         | 4,642                                |                                 |         | 5.25                                       | %       |   | 71,202  |   |   | 3,472  |   |    | 4.88   | %      |   | 57,850 |   |   | 2,741 |   |   | 4.74 | % |
| Federal                  funds sold                                                                                                                                                                                                                                                                                                                                                                                  |                                 |                                   | 1,766                                  |                                   |         | 85                                   |                                 |         | 4.81                                       | %       |   | 2,272   |   |   | 73     |   |    | 3.21   | %      |   | 3,363 |   |   | 35 |   |   | 1.05 | % |
| Other                                                                                                                                                                                                                                                                                                                                                                                                                |                                 |                                   | 7,914                                  |                                   |         | 424                                  |                                 |         | 5.36                                       | %       |   | 7,108   |   |   | 269    |   |    | 3.61   | %      |   | 5,642 |   |   | 161 |   |   | 2.70 | % |
|                                                                                                                                                                                                                                                                                                                                                                                                                 |                                 |                                   |                                   |                                   |         |                                 |                                 |         |                                       |    |   |    |   |   |   |   |    |   |   |   |   |   |   |   |   |   |   |   |
| **Total                  interest-earning assets**                                                                                                                                                                                                                                                                                                                                                                   |                                 |                                   | 732,244                                |                                   |         | 56,125                               |                                 |         | 7.66                                       | %       |   | 668,614 |   |   | 42,532 |   |    | 6.36   | %      |   | 650,528 |   |   | 35,555 |   |   | 5.47 | % |
|                                                                                                                                                                                                                                                                                                                                                                                                                 |                                 |                                   |                                   |                                   |         |                                 |                                 |         |                                       |    |   |    |   |   |   |   |    |   |   |   |   |   |   |   |   |   |   |   |
| Cash                  and due from banks                                                                                                                                                                                                                                                                                                                                                                             |                                 |                                   | 17,022                                 |                                   |         |                                 |                                 |         |                                       |    |   | 15,149  |   |   |   |   |    |   |   |   | 13,058 |   |   |   |   |   |   |   |
| Other                  assets                                                                                                                                                                                                                                                                                                                                                                                        |                                 |                                   | 31,218                                 |                                   |         |                                 |                                 |         |                                       |    |   | 30,891  |   |   |   |   |    |   |   |   | 30,185 |   |   |   |   |   |   |   |
| Allowance                  for loan losses                                                                                                                                                                                                                                                                                                                                                                           |                                 |                                   | (7,899                                 | )                                      |         |                                 |                                 |         |                                       |    |   | (7,811  | )      |   |   |   |    |   |   |   | (9,386 | ) |   |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                 |                                 |                                   |                                   |                                   |         |                                 |                                 |         |                                       |    |   |    |   |   |   |   |    |   |   |   |   |   |   |   |   |   |   |   |
| **Total                  assets**                                                                                                                                                                                                                                                                                                                                                                                    |                                 | $                                      | 772,585                                |                                   |         |                                 |                                 |         |                                       |    |   | 706,843 |   |   |   |   |    |   |   |   | 684,385 |   |   |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                 |                                 |                                   |                                   |                                   |         |                                 |                                 |         |                                       |    |   |    |   |   |   |   |    |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                 |                                 |                                   |                                   |                                   |         |                                 |                                 |         |                                       |    |   |    |   |   |   |   |    |   |   |   |   |   |   |   |   |   |   |   |
| **Interest-bearing                  liabilities:**                                                                                                                                                                                                                                                                                                                                                                   |                                 |                                   |                                   |                                   |         |                                 |                                 |         |                                       |    |   |    |   |   |   |   |    |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                 |                                 |                                   |                                   |                                   |         |                                 |                                 |         |                                       |    |   |    |   |   |   |   |    |   |   |   |   |   |   |   |   |   |   |   |
| NOW                  accounts                                                                                                                                                                                                                                                                                                                                                                                        |                                 | $                                      | 87,329                                 |                                   |         | 1,214                                |                                 |         | 1.39                                       | %       |   | 110,852 |   |   | 1,468  |   |    | 1.32   | %      |   | 106,832 |   |   | 1,292 |   |   | 1.21 | % |
| Regular                  savings accounts                                                                                                                                                                                                                                                                                                                                                                            |                                 |                                   | 19,768                                 |                                   |         | 57                                   |                                 |         | 0.29                                       | %       |   | 21,205  |   |   | 65     |   |    | 0.31   | %      |   | 21,845 |   |   | 72 |   |   | 0.33 | % |
| Money                  market accounts                                                                                                                                                                                                                                                                                                                                                                               |                                 |                                   | 66,035                                 |                                   |         | 1,789                                |                                 |         | 2.71                                       | %       |   | 56,858  |   |   | 1,112  |   |    | 1.96   | %      |   | 51,069 |   |   | 535 |   |   | 1.05 | % |
| Time                  deposits                                                                                                                                                                                                                                                                                                                                                                                       |                                 |                                   | 335,092                                |                                   |         | 14,189                               |                                 |         | 4.23                                       | %       |   | 292,807 |   |   | 8,923  |   |    | 3.05   | %      |   | 300,175 |   |   | 7,145 |   |   | 2.38 | % |
| FHLB                  borrowings                                                                                                                                                                                                                                                                                                                                                                                     |                                 |                                   | 74,082                                 |                                   |         | 3,588                                |                                 |         | 4.84                                       | %       |   | 65,934  |   |   | 2,889  |   |    | 4.38   | %      |   | 58,656 |   |   | 2,603 |   |   | 4.44 | % |
| Demand                  notes payable to U.S. Treasury                                                                                                                                                                                                                                                                                                                                                               |                                 |                                   | 722                                    |                                   |         | 34                                   |                                 |         | 4.71                                       | %       |   | 702     |   |   | 21     |   |    | 3.02   | %      |   | 678 |   |   | 8 |   |   | 1.14 | % |
| Trust                  preferred securities                                                                                                                                                                                                                                                                                                                                                                          |                                 |                                   | 24,878                                 |                                   |         | 1,963                                |                                 |         | 7.89                                       | %       |   | 14,433  |   |   | 938    |   |    | 6.50   | %      |   | 14,433 |   |   | 677 |   |   | 4.69 | % |
| Other                                                                                                                                                                                                                                                                                                                                                                                                                |                                 |                                   | 5,780                                  |                                   |         | 276                                  |                                 |         | 4.78                                       | %       |   | 419     |   |   | 13     |   |    | 3.00   | %      |   | 192 |   |   | 3 |   |   | 1.46 | % |
|                                                                                                                                                                                                                                                                                                                                                                                                                 |                                 |                                   |                                   |                                   |         |                                 |                                 |         |                                       |    |   |    |   |   |   |   |    |   |   |   |   |   |   |   |   |   |   |   |
| **Total                  interest-bearing liabilities**                                                                                                                                                                                                                                                                                                                                                              |                                 |                                   | 613,686                                |                                   |         | 23,110                               |                                 |         | 3.77                                       | %       |   | 563,210 |   |   | 15,429 |   |    | 2.74   | %      |   | 553,880 |   |   | 12,335 |   |   | 2.23 | % |
|                                                                                                                                                                                                                                                                                                                                                                                                                 |                                 |                                   |                                   |                                   |         |                                 |                                 |         |                                       |    |   |    |   |   |   |   |    |   |   |   |   |   |   |   |   |   |   |   |
| Demand                  deposits                                                                                                                                                                                                                                                                                                                                                                                     |                                 |                                   | 97,183                                 |                                   |         |                                 |                                 |         |                                       |    |   | 89,275  |   |   |   |   |    |   |   |   | 78,221 |   |   |   |   |   |   |   |
| Other                  liabilities                                                                                                                                                                                                                                                                                                                                                                                   |                                 |                                   | 3,044                                  |                                   |         |                                 |                                 |         |                                       |    |   | 1,275   |   |   |   |   |    |   |   |   | 2,137 |   |   |   |   |   |   |   |
| Shareholders'                  equity                                                                                                                                                                                                                                                                                                                                                                                |                                 |                                   | 62,465                                 |                                   |         |                                 |                                 |         |                                       |    |   | 55,989  |   |   |   |   |    |   | 51,978 |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                 |                                 |                                   |                                   |                                   |         |                                 |                                 |         |                                       |    |   |    |   |   |   |   |    |   |   |   |   |   |   |   |   |   |   |   |
| **Total                  liabilities and shareholder's equity**                                                                                                                                                                                                                                                                                                                                                      |                                 | $                                      | 776,378                                |                                   |         |                                 |                                 |         |                                       | 709,749 |   |    |   |   |   |   | 686,216 |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                 |                                 |                                   |                                   |                                   |         |                                 |                                 |         |                                       |    |   |    |   |   |   |   |    |   |   |   |   |   |   |   |   |   |   |   |
| **Net                  interest spread**                                                                                                                                                                                                                                                                                                                                                                             |                                 |                                   |                                   | $                                      | 33,015       |                                 |                                 | 3.89         | %                                          |    |   |    | 27,103 |   |   | 3.62   | %       |   |   |   | 23,220 |   |   | 3.24 | % |
|                                                                                                                                                                                                                                                                                                                                                                                                                 |                                 |                                   |                                   |                                   |         |                                 |                                 |         |                                       |    |   |    |   |   |   |   |    |   |   |   |   |   |   |   |   |   |   |   |
| **Net                  yield on interest-earning assets**                                                                                                                                                                                                                                                                                                                                                            |                                 |                                   |                                   |                                   |         |                                 |                                 | 4.51         | %                                          |    |   |    |   |   |   | 4.05   | %       |   |   |   |   |   | 3.57 | % |
|                                                                                                                                                                                                                                                                                                                                                                                                                 |                                 |                                   |                                   |                                   |         |                                 |                                 |         |                                       |    |   |    |   |   |   |   |    |   |   |   |   |   |   |   |   |   |   |   |
| **Taxable                  equivalent adjustment**                                                                                                                                                                                                                                                                                                                                                                   |                                 |                                   |                                   |                                   |         |                                 |                                 |         |                                       |    |   |    |   |   |   |   |    |   |   |   |   |   |   |   |   |   |   |   |
| **Investment                  securities**                                                                                                                                                                                                                                                                                                                                                                           |                                 |                                   |                                   | $                                      | 731          |                                 |                                 |         |                                       |    |   | 619     |   |   |   |   |    |   | 460    |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                 |                                 |                                   |                                   |                                   |         |                                 |                                 |         |                                       |    |   |    |   |   |   |   |    |   |   |   |   |   |   |   |   |   |   |   |
| **Net                  interest income**                                                                                                                                                                                                                                                                                                                                                                             |                                 |                                   |                                   | $                                      | 32,284       |                                 |                                 |         |                                       |    |   | 26,484  |   |   |   |   |    |   | 22,760 |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                 |                                 |                                   |                                   |                                   |         |                                 |                                 |         |                                       |    |   |    |   |   |   |   |    |   |   |   |   |   |   |   |   |   |   |   |
| *Includes                  U.S. government agency securities that are non-taxable for state                  income                  tax purposes of $65.9 million in 2006, $50.7 million in 2005 and                  $40.4                  million in 2004. An effective tax rate of 6.90% was used to calculate                  the                  tax equivalent yield on these                  securities. |

----

| **Table                  2 - Rate/Volume Analysis-Tax Equivalent Basis** |                                                 |                                                |                                              |                                                 |                                                |                                              |   |   |   |   |   |   |   |
|--------------------------------------------------------------------------|------------------------------------------------------|-----------------------------------------------------|---------------------------------------------------|------------------------------------------------------|-----------------------------------------------------|---------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|
|                                                                     |                                                 |                                                |                                              |                                                 |                                                |                                              |   |   |   |   |   |   |   |
|                                                                     |                                                 | **December                  31, 2006**              |                                              | **December                  31, 2005**               |                                                |
| **(Dollars                  in Thousands)**                              | **Changes                  in****average****volume** | **Changes                  in****average****rates** | **Total****Increase                  (Decrease)** | **Changes                  in****average****volume** | **Changes                  in****average****rates** | **Total****Increase                  (Decrease)** |   |
| **Interest                  Income:**                                    |                                                 |                                                |                                              |                                                 |                                                |                                              |   |   |   |   |   |   |   |
|                                                                     |                                                 |                                                |                                              |                                                 |                                                |                                              |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans:                  Net of unearned income                           |                                                 | $                                                   | 4,030                                             |                                                 |                                                | 8,515                                             |   |   | 12,545 |   |   | 173    |   |   | 5,877 |   |   | 6,050 |   |
|                                                                     |                                                 |                                                |                                              |                                                 |                                                |                                              |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Investments                  - taxable                                   |                                                 |                                                | (333                                              | )                                                    |                                                | 44                                                |   |   | (289   | )      |   | 67     |   |   | (17 | ) |   | 50 |   |
| Investments                  - nontaxable                                |                                                 |                                                | 869                                               |                                                 |                                                | 301                                               |   |   | 1,170  |   |   | 642    |   |   | 89 |   |   | 731 |   |
| Federal                  funds sold                                      |                                                 |                                                | (20                                               | )                                                    |                                                | 32                                                |   |   | 12     |   |   | (23    | )      |   | 61 |   |   | 38 |   |
| Other                                                                    |                                                 |                                                | 37                                                |                                                 |                                                | 118                                               |   |   | 155    |   |   | 49     |   |   | 59 |   |   | 108 |   |
|                                                                     |                                                 |                                                |                                              |                                                 |                                                |                                              |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Total                  interest income**                               |                                                 |                                                | 4,583                                             |                                                 |                                                | 9,010                                             |   |   | 13,593 |   |   | 908    |   |   | 6,069 |   |   | 6,977 |   |
|                                                                     |                                                 |                                                |                                              |                                                 |                                                |                                              |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Interest                  expense:**                                   |                                                 |                                                |                                              |                                                 |                                                |                                              |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                     |                                                 |                                                |                                              |                                                 |                                                |                                              |   |   |   |   |   |   |   |   |   |   |   |   |   |
| NOW                  accounts                                            |                                                 |                                                | (320                                              | )                                                    |                                                | 66                                                |   |   | (254   | )      |   | 51     |   |   | 125 |   |   | 176 |   |
| Regular                  savings accounts                                |                                                 |                                                | (4                                                | )                                                    |                                                | (4                                                | )      |   | (8     | )      |   | (2     | )      |   | (5 | ) |   | (7 | ) |
| Money                  market accounts                                   |                                                 |                                                | 214                                               |                                                 |                                                | 463                                               |   |   | 677    |   |   | 87     |   |   | 490 |   |   | 577 |   |
| Time                  deposits                                           |                                                 |                                                | 1,540                                             |                                                 |                                                | 3,726                                             |   |   | 5,266  |   |   | (200   | )      |   | 1,978 |   |   | 1,778 |   |
| FHLB                  Borrowings                                         |                                                 |                                                | 375                                               |                                                 |                                                | 324                                               |   |   | 699    |   |   | 321    |   |   | (35 | ) |   | 286 |   |
| Demand                  notes payable to                                 |                                                 |                                                |                                              |                                                 |                                                |                                              |   |   |   |   |   |   |   |   |   |   |   |   |   |
| U.S.                  Treasury                                           |                                                 |                                                | 1                                                 |                                                 |                                                | 12                                                |   |   | 13     |   |   | -      |   |   | 13 |   |   | 13 |   |
| Trust                  Preferred Securities                              |                                                 |                                                | 752                                               |                                                 |                                                | 273                                               |   |   | 1,025  |   |   | 24     |   |   | 237 |   |   | 261 |   |
| Other                                                                    |                                                 |                                                | 208                                               |                                                 |                                                | 55                                                |   |   | 263    |   |   | 5      |   |   | 5 |   |   | 10 |   |
|                                                                     |                                                 |                                                |                                              |                                                 |                                                |                                              |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Total                  interest expense**                              |                                                 |                                                | 2,766                                             |                                                 |                                                | 4,915                                             |   |   | 7,681  |   |   | 286    |   |   | 2,808 |   |   | 3,094 |   |
|                                                                     |                                                 |                                                |                                              |                                                 |                                                |                                              |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Net                  interest income**                                 |                                                 | $                                                   | 1,817                                             |                                                 |                                                | 4,095                                             |   |   | 5,912  |   |   | 622    |   |   | 3,261 |   |   | 3,883 |   |

----

*Provision      for Loan Losses. *

*Non-Interest      Income.*

----

| **Table                  3 - Non-Interest Income**         |   |                                                                       |   |   |                                                                        |   |   |
|------------------------------------------------------------|--------|----------------------------------------------------------------------------|--------|--------|-----------------------------------------------------------------------------|--------|--------|
|                                                       |   |                                                                       |   |   |                                                                        |   |   |
| **(Dollars                  in Thousands)**                |   | **                          2006** |   |   | **                           2005** |   |   | **                            2004** |   |
| Service                  charges                           |   | $                                                                          | 3,930  |   |                                                                        | 3,780  |   |   | 3,435 |   |
| Other                  service charges and fees            |   |                                                                       | 1,540  |   |                                                                        | 1,142  |   |   | 677 |   |
| Gain                  (loss) on sale of securities         |   |                                                                       | (592   | )      |                                                                        | (730   | )      |   | (64 | ) |
| Mortgage                  banking income                   |   |                                                                       | 289    |   |                                                                        | 469    |   |   | 356 |   |
| Insurance                  and brokerage commissions       |   |                                                                       | 389    |   |                                                                        | 387    |   |   | 430 |   |
| Loss                  on foreclosed and repossessed assets |   |                                                                       | (108   | )      |                                                                        | (38    | )      |   | (179 | ) |
| Miscellaneous                                              |   |                                                                       | 2,106  |   |                                                                        | 1,658  |   |   | 1,345 |   |
| **Total                  non-interest income**             |   | $                                                                          | 7,554  |   |                                                                        | 6,668  |   |   | 6,000 |   |

*Non-Interest      Expense.*

| **Table                  4 - Non-Interest Expense** |   |                                         |         |                                         |   |                             |   |
|-----------------------------------------------------|--------|----------------------------------------------|--------------|----------------------------------------------|--------|----------------------------------|--------|
|                                                |   |                                         |         |                                         |   |                             |   |
| **(Dollars                  in Thousands)**         |   | **                     2006** |         | **                     2005** |   | **                   2004** |
| Salaries                  and wages                 |   | $                                            |  9,368  |                                         |   | 7,162                            |   |   | 7,023 |   |
| Employee                  benefits                  |   |                                         | 2,417        |                                         |   | 3,702                            |   |   | 3,237 |   |
| **Total                  personnel expense**        |   |                                         | 11,785       |                                         |   | 10,864                           |   |   | 10,260 |   |
| Occupancy                  expense                  |   |                                         | 4,180        |                                         |   | 3,949                            |   |   | 3,672 |   |
| Office                  supplies                    |   |                                         | 436          |                                         |   | 314                              |   |   | 314 |   |
| FDIC                  deposit insurance             |   |                                         | 75           |                                         |   | 76                               |   |   | 81 |   |
| Professional                  services              |   |                                         | 239          |                                         |   | 389                              |   |   | 290 |   |
| Postage                                             |   |                                         | 307          |                                         |   | 264                              |   |   | 211 |   |
| Telephone                                           |   |                                         | 338          |                                         |   | 403                              |   |   | 337 |   |
| Director                  fees and expense          |   |                                         | 423          |                                         |   | 334                              |   |   | 351 |   |
| Marketing                  and public relations     |   |                                         | 772          |                                         |   | 656                              |   |   | 620 |   |
| Consulting                  fees                    |   |                                         | 575          |                                         |   | 233                              |   |   | 306 |   |
| Taxes                  and licenses                 |   |                                         | 293          |                                         |   | 218                              |   |   | 200 |   |
| Other                  operating expense            |   |                                         | 3,560        |                                         | 2,630  |                             |   | 2,198 |   |
| **Total                  non-interest expense**     |   | $                                            |  22,983 |                                         |   | 20,330                           |   |   | 18,840 |   |

----

*Income      Taxes. *

*Liquidity.      *

*Asset      Liability and Interest Rate Risk Management. *

----

| **Table                  5 - Interest Sensitivity Analysis**                                                  |   |          |               |              |   |               |    |                                                                 |       |                                                                                 |   |        |    |
|---------------------------------------------------------------------------------------------------------------|--------|---------------|--------------------|-------------------|--------|--------------------|---------|----------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------|--------|-------------|---------|
|                                                                                                          |   |          |               |              |   |               |    |                                                                 |       |                                                                                 |   |        |    |
| **(Dollars                  in Thousands)**                                                                   |   | **Immediate** |               | **1-3****months** |   | **4-12****months** |    | **Total                  Within**** One                  Year** |       | **Over                  One**** ****Year                  & Non-sensitive** |   | **Total**   |
| **Interest-earning                  assets:**                                                                 |   |          |               |              |   |               |    |                                                                 |       |                                                                                 |   |        |    |   |   |   |   |   |   |
| Loans                                                                                                         |   | $             | 465,884            |              |   | 19,944             |    |                                                                 | 10,724     |                                                                                 |   | 496,552     |    |   | 154,829 |   | $ | 651,381 |   |
| Mortgage                  loans available for sale                                                            |   |          | -                  |              |   | -                  |    |                                                                 | -          |                                                                                 |   | -           |    |   | - |   |   | - |   |
| Investment                  securities                                                                        |   |          | -                  |              |   | 1,415              |    |                                                                 | -          |                                                                                 |   | 1,415       |    |   | 116,166 |   |   | 117,581 |   |
| Federal                  funds sold                                                                           |   |          | 2,640              |              |   | -                  |    |                                                                 | -          |                                                                                 |   | 2,640       |    |   | - |   |   | 2,640 |   |
| Interest-bearing                  deposit accounts                                                            |   |          | 1,471              |              |   | -                  |    |                                                                 | -          |                                                                                 |   | 1,471       |    |   | - |   |   | 1,471 |   |
| Other                  interest-earning assets                                                                |   |          | -                  |              |   | -                  |    |                                                                 | -          |                                                                                 |   | -           |    |   | 7,009 |   |   | 7,009 |   |
|                                                                                                          |   |          |               |              |   |               |    |                                                                 |       |                                                                                 |   |        |    |   |   |   |   |   |   |
| **Total                  interest-earning assets**                                                            |   |          | 469,995            |              |   | 21,359             |    |                                                                 | 10,724     |                                                                                 |   | 502,078     |    |   | 278,004 |   | $ | 780,082 |   |
|                                                                                                          |   |          |               |              |   |               |    |                                                                 |       |                                                                                 |   |        |    |   |   |   |   |   |   |
| **Interest-bearing                  liabilities:**                                                            |   |          |               |              |   |               |    |                                                                 |       |                                                                                 |   |        |    |   |   |   |   |   |   |
| NOW,                  savings, and money market deposits                                                      |   |          | 174,578            |              |   | -                  |    |                                                                 | -          |                                                                                 |   | 174,578     |    |   | - |   | $ | 174,578 |   |
| Time                  deposits                                                                                |   |          | 86,059             |              |   | 119,909            |    |                                                                 | 127,463    |                                                                                 |   | 333,431     |    |   | 24,418 |   |   | 357,849 |   |
| Other                  short term borrowings                                                                  |   |          | 1,600              |              |   | -                  |    |                                                                 | -          |                                                                                 |   | 1,600       |    |   | - |   |   | 1,600 |   |
| FHLB                  borrowings                                                                              |   |          | 19,800             |              |   | 42,500             |    |                                                                 | -          |                                                                                 |   | 62,300      |    |   | 27,000 |   |   | 89,300 |   |
| Securities                  sold under agreement to repurchase                                                |   |          | 6,418              |              |   | -                  |    |                                                                 | -          |                                                                                 |   | 6,418       |    |   | - |   |   | 6,418 |   |
| Trust                  preferred securities                                                                   |   |          | -                  |              |   | 20,619             |    |                                                                 | -          |                                                                                 |   | 20,619      |    |   | - |   |   | 20,619 |   |
|                                                                                                          |   |          |               |              |   |               |    |                                                                 |       |                                                                                 |   |        |    |   |   |   |   |   |   |
| **Total                  interest-bearing liabilities**                                                       |   |          | 288,455            |              |   | 183,028            |    |                                                                 | 127,463    |                                                                                 |   | 598,946     |    |   | 51,418 |   | $ | 650,364 |   |
|                                                                                                          |   |          |               |              |   |               |    |                                                                 |       |                                                                                 |   |        |    |   |   |   |   |   |   |
| **Interest-sensitive                  gap**                                                                   |   | $             | 181,540            |              |   | (161,669           | )       |                                                                 | (116,739   | )                                                                                    |   | (96,868     | )       |   | 226,586 |   | $ | 129,718 |   |
|                                                                                                          |   |          |               |              |   |               |    |                                                                 |       |                                                                                 |   |        |    |   |   |   |   |   |   |
| **Cumulative                  interest-sensitive gap**                                                        |   | $             | 181,540            |              |   | 19,871             |    |                                                                 | (96,868    | )                                                                                    |   | (96,868     | )       |   | 129,718 |   |   |   |   |
|                                                                                                          |   |          |               |              |   |               |    |                                                                 |       |                                                                                 |   |        |    |   |   |   |   |   |   |
| **Interest-earning                  assets as a percentage of interest-bearing                  liabilities** |   |          |  162.94  | %            |   | 11.67         |  % |                                                                 | 8.41  |  %                                                                              |   | 83.83  |  % |   | 540.67  |  % |   |   |   |

----

**Analysis      of Financial Condition**

*Investment      Securities. *
*.      *

| **Table                  6 - Summary of Investment Portfolio**    |                                         |                                          |                                                                        |   |   |    |   |
|-------------------------------------------------------------------|----------------------------------------------|-----------------------------------------------|-----------------------------------------------------------------------------|--------|--------|---------|--------|
|                                                              |                                         |                                          |                                                                        |   |   |    |   |
| **(Dollars                  in Thousands)**                       | **                     2006** | **                      2005** | **                           2004** |   |
| Obligations                  of United States government          |                                         |                                          |                                                                        |   |   |    |   |   |   |   |
| agencies                  and corporations                        |                                         | $                                             | 72,744                                                                      |   |   | 60,243  |   |   | 46,570 |   |
|                                                              |                                         |                                          |                                                                        |   |   |    |   |   |   |   |
| Obligations                  of states and political subdivisions |                                         |                                          | 24,366                                                                      |   |   | 21,609  |   |   | 20,649 |   |
|                                                              |                                         |                                          |                                                                        |   |   |    |   |   |   |   |
| Mortgage                  backed securities                       |                                         |                                          | 19,220                                                                      |   |   | 31,004  |   |   | 36,543 |   |
|                                                              |                                         |                                          |                                                                        |   |   |    |   |   |   |   |
| Trust                  preferred securities                       |                                         |                                          | 750                                                                         |   |   | 1,750   |   |   | 1,750 |   |
|                                                              |                                         |                                          |                                                                        |   |   |    |   |   |   |   |
| Equity                  securities                                |                                         |                                          | 501                                                                         |   |   | 552     |   |   | 86 |   |
|                                                              |                                         |                                          |                                                                        |   |   |    |   |   |   |   |
| **Total                  securities**                             |                                         | $                                             | 117,581                                                                     |   |   | 115,158 |   |   | 105,598 |   |

----

***.***

| **Table                  7 - Maturity Distribution and Weighted Average Yield on                  Investments** |       |                                  |                                    |                                 |       |                                  |                                    |                                |       |       |                                    |   |       |   |                                    |
|-----------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|-----------------------------------------|--------------------------------------|------------|---------------------------------------|-----------------------------------------|-------------------------------------|------------|------------|-----------------------------------------|--------|------------|--------|-----------------------------------------|
|                                                                                                            |       |                                  |                                    |                                 |       |                                  |                                    |                                |       |       |                                    |   |       |   |                                    |   |   |   |   |   |   |
|                                                                                                            |       |                                  |                                    |                                 |       |                                  |                                    |                                |       |       |                                    |   |       |   |                                    |   |   |   |   |   |   |
|                                                                                                            |       |                                  |                                    |                                 |       | **After                  One Year**   |                                    | **After                  5 Years**  |       |       |                                    |   |       |   |                                    |   |   |
|                                                                                                            |       | **One                  Year or Less** |                                    | **Through                  5 Years** |       | **Through                  10 Years** |                                    | **After                  10 Years** |       | **Totals** |                                    |
| **(Dollars                  in Thousands)**                                                                     | **Amount** |                                  | **Yield                    ** |                                 | **Amount** |                                  | **Yield                    ** |                                | **Amount** |       | **Yield                    ** |   | **Amount** |   | **Yield                    ** |   | **Amount** |   | **Yield                    ** |   |
| **Book                  value:**                                                                                |       |                                  |                                    |                                 |       |                                  |                                    |                                |       |       |                                    |   |       |   |                                    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                            |       |                                  |                                    |                                 |       |                                  |                                    |                                |       |       |                                    |   |       |   |                                    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| United                  States Government agencies                                                              |       | $                                     | -                                       |                                 |       | -                                     |                                    |                                | 49,535     |       |                                    | 4.74%  |       |   | 23,303                                  |   |   | 5.31% |   |   | - |   |   | - |   | $ | 72,838 |   |   | 4.92% |   |
|                                                                                                            |       |                                  |                                    |                                 |       |                                  |                                    |                                |       |       |                                    |   |       |   |                                    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| States                  and political subdivisions                                                              |       |                                  | 910                                     |                                 |       | 7.19%                                 |                                    |                                | 9,598      |       |                                    | 4.98%  |       |   | 10,261                                  |   |   | 5.74% |   |   | 3,725 |   |   | 7.03% |   |   | 24,494 |   |   | 5.69% |   |
|                                                                                                            |       |                                  |                                    |                                 |       |                                  |                                    |                                |       |       |                                    |   |       |   |                                    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Mortgage                  backed securities                                                                     |       |                                  | 17                                      |                                 |       | 4.95%                                 |                                    |                                | 580        |       |                                    | 4.63%  |       |   | 4,008                                   |   |   | 4.38% |   |   | 15,061 |   |   | 4.50% |   |   | 19,666 |   |   | 4.31% |   |
|                                                                                                            |       |                                  |                                    |                                 |       |                                  |                                    |                                |       |       |                                    |   |       |   |                                    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Trust                  preferred securities                                                                     |       |                                  | -                                       |                                 |       | -                                     |                                    |                                | -          |       |                                    | -      |       |   | -                                       |   |   | - |   |   | 750 |   |   | 8.70% |   |   | 750 |   |   | 8.70% |   |
|                                                                                                            |       |                                  |                                    |                                 |       |                                  |                                    |                                |       |       |                                    |   |       |   |                                    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Equity                  securities                                                                              |       |                                  | -                                       |                                 |       | -                                     |                                    |                                | -          |       |                                    | -      |       |   | -                                       |   |   | - |   |   | 815 |   |   | 0.22% |   |   | 815 |   |   | 0.22% |   |
|                                                                                                            |       |                                  |                                    |                                 |       |                                  |                                    |                                |       |       |                                    |   |       |   |                                    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Total                  securities**                                                                           |       | $                                     | 927                                     |                                 |       | 7.15%                                 |                                    |                                | 59,713     |       |                                    | 4.78%  |       |   | 37,572                                  |   |   | 5.33% |   |   | 20,351 |   |   | 4.94% |   | $ | 118,563 |   |   | 4.97% |   |

*Loans.      *

| **Table                  8 - Loan Portfolio**       |       |     |                            |     |       |     |                            |     |       |     |                            |    |       |   |                            |   |       |    |                            |   |    |
|-----------------------------------------------------|------------|----------|---------------------------------|----------|------------|----------|---------------------------------|----------|------------|----------|---------------------------------|---------|------------|--------|---------------------------------|--------|------------|---------|---------------------------------|--------|---------|
|                                                |       |     |                            |     |       |     |                            |     |       |     |                            |    |       |   |                            |   |       |    |                            |   |    |
|                                                |       | **2006** |                            | **2005** |       | **2004** |                            | **2003** |       | **2002** |                            |
| **(Dollars                  in Thousands)**         | **Amount** |     | **%                  of Loans** |     | **Amount** |     | **%                  of Loans** |     | **Amount** |     | **%                  of Loans** |    | **Amount** |   | **%                  of Loans** |   | **Amount** |    | **%                  of Loans** |   |
| **Breakdown                  of loan receivables:** |       |     |                            |     |       |     |                            |     |       |     |                            |    |       |   |                            |   |       |    |                            |   |    |
| Commercial                                          |       | $        | 85,064                          |     |       | 13.06%   |                            |     | 79,902     |     |                            | 14.10%  |       |   | 79,189                          |   |       | 14.79%  |                            |   | 90,558  |   |   | 16.41% |   |   | 92,141 |   |   | 17.51% |   |
| Real                  estate - mortgage             |       |     | 364,595                         |     |       | 55.97%   |                            |     | 330,227    |     |                            | 58.28%  |       |   | 312,988                         |   |       | 58.45%  |                            |   | 332,730 |   |   | 60.26% |   |   | 322,987 |   |   | 61.36% |   |
| Real                  estate - construction         |       |     | 187,960                         |     |       | 28.86%   |                            |     | 141,420    |     |                            | 24.96%  |       |   | 127,042                         |   |       | 23.73%  |                            |   | 110,392 |   |   | 19.99% |   |   | 80,552 |   |   | 15.30% |   |
| Consumer                                            |       |     | 13,762                          |     |       | 2.11%    |                            |     | 15,115     |     |                            | 2.66%   |       |   | 16,249                          |   |       | 3.03%   |                            |   | 18,446  |   |   | 3.34% |   |   | 30,690 |   |   | 5.83% |   |
|                                                |       |     |                            |     |       |          |                            |     |       |     |                            |         |       |   |                            |   |       |         |                            |   |    |   |   |  |   |   |   |   |   |  |   |
| **Total                  loans**                    |       | $        | 651,381                         |     |       | 100.00%  |                            |     | 566,664    |     |                            | 100.00% |       |   | 535,468                         |   |       | 100.00% |                            |   | 552,126 |   |   | 100.00% |   |   | 526,370 |   |   | 100.00% |   |
|                                                |       |     |                            |     |       |     |                            |     |       |     |                            |    |       |   |                            |   |       |    |                            |   |    |   |   |   |   |   |   |   |   |   |   |
| Less:                  Allowance for loan losses    |       |     | 8,303                           |     |       |     |                            |     | 7,425      |     |                            |    |       |   | 8,049                           |   |       |    |                            |   | 9,722   |   |   |   |   |   | 7,248 |   |   |   |   |
|                                                |       |     |                            |     |       |     |                            |     |       |     |                            |    |       |   |                            |   |       |    |                            |   |    |   |   |   |   |   |   |   |   |   |   |
| **Net                  loans**                      |       | $        | 643,078                         |     |       |     |                            |     | 559,239    |     |                            |    |       |   | 527,419                         |   |       |    |                            |   | 542,404 |   |   |   |   |   | 519,122 |   |   |   |   |

----

| **Table                  9 - Maturity and Repricing Data for Loans** |   |                                                             |    |                                                      |   |                                     |   |                             |   |
|----------------------------------------------------------------------|--------|------------------------------------------------------------------|---------|-----------------------------------------------------------|--------|------------------------------------------|--------|----------------------------------|--------|
|                                                                 |   |                                                             |    |                                                      |   |                                     |   |                             |   |
| **(Dollars                  in Thousands)**                          |   | **Within                  one****year                  or less** |    | **After                  one year through five****years** |   | **After                  five****years** |   | **Total                  Loans** |   |
| Commercial                                                           |   | $                                                                | 71,767  |                                                      |   | 12,258                                   |   |                             | 1,039  |   | $ | 85,064 |   |
| Real                  estate - mortgage                              |   |                                                             | 243,720 |                                                      |   | 82,895                                   |   |                             | 37,980 |   |   | 364,595 |   |
| Real                  estate - construction                          |   |                                                             | 175,369 |                                                      |   | 10,177                                   |   |                             | 2,414  |   |   | 187,960 |   |
| Consumer                                                             |   |                                                             | 5,696   |                                                      |   | 7,002                                    |   |                             | 1,064  |   |   | 13,762 |   |
|                                                                 |   |                                                             |    |                                                      |   |                                     |   |                             |   |   |   |   |   |
| **Total                  loans**                                     |   | $                                                                | 496,552 |                                                      |   | 112,332                                  |   |                             | 42,497 |   | $ | 651,381 |   |
|                                                                 |   |                                                             |    |                                                      |   |                                     |   |                             |   |   |   |   |   |
| Total                  fixed rate loans                              |   | $                                                                | 15,852  |                                                      |   | 74,376                                   |   |                             | 42,497 |   | $ | 132,725 |   |
| Total                  floating rate loans                           |   |                                                             | 480,700 |                                                      |   | 37,956                                   |   |                             | -      |   |   | 518,656 |   |
|                                                                 |   |                                                             |    |                                                      |   |                                     |   |                             |   |   |   |   |   |
| **Total                  loans**                                     |   | $                                                                | 496,552 |                                                      |   | 112,332                                  |   |                             | 42,497 |   | $ | 651,381 |   |

*Allowance      for Loan Losses. *

| ·   | the                Bank’s loan loss experience; |
|--------------------|-------------------------------------------------------|

| ·   | the                amount of past due and non-performing loans; |
|--------------------|-----------------------------------------------------------------|

| ·   | specific                known risks; |
|--------------------|--------------------------------------|

| ·   | the                status and amount of other past due and non-performing                assets; |
|--------------------|--------------------------------------------------------------------------------------------------|

| ·   | underlying                estimated values of collateral securing loans; |
|--------------------|--------------------------------------------------------------------------|

| ·   | current                and anticipated economic conditions; and |
|--------------------|-----------------------------------------------------------------|

| ·   | other                factors which management believes affect the allowance for potential                credit losses. |
|--------------------|-------------------------------------------------------------------------------------------------------------------------|

----

*“Accounting      By Creditors for Impairment of a Loan.” *

** **
**.**

----

| **Table                  10 - Analysis of Allowance for Loan Losses** |                       |   |                       |   |                       |   |                                   |   |                                                                 |   |   |
|-----------------------------------------------------------------------|----------------------------|--------|----------------------------|--------|----------------------------|--------|----------------------------------------|--------|----------------------------------------------------------------------|--------|--------|
|                                                                  |                       |   |                       |   |                       |   |                                   |   |                                                                 |   |   |
|                                                                  |                       |   |                       |   |                       |   |                                   |   |                                                                 |   |   |
| **(Dollars                  in Thousands)**                           | **2006   ** |   | **2005   ** |   | **2004   ** |   | ** 2003    ** |   | **2002                         ** |
| Reserve                  for loan losses at beginning                 |                       | $      | 7,425                      |   |                       | 8,049  |                                   |   | 9,722                                                                |   |   | 7,248 |   |   | 6,091 |   |
|                                                                  |                       |   |                       |   |                       |   |                                   |   |                                                                 |   |   |   |   |   |   |   |
| Loans                  charged off:                                   |                       |   |                       |   |                       |   |                                   |   |                                                                 |   |   |   |   |   |   |   |
| Commercial                                                            |                       |   | 505                        |   |                       | 293    |                                   |   | 1,004                                                                |   |   | 1,179 |   |   | 3,737 |   |
| Real                  estate - mortgage                               |                       |   | 568                        |   |                       | 2,141  |                                   |   | 3,842                                                                |   |   | 2,422 |   |   | 158 |   |
| Real                  estate - construction                           |                       |   | 250                        |   |                       | 1,250  |                                   |   | 4                                                                    |   |   | 251 |   |   | - |   |
| Consumer                                                              |                       |   | 636                        |   |                       | 516    |                                   |   | 535                                                                  |   |   | 630 |   |   | 546 |   |
|                                                                  |                       |   |                       |   |                       |   |                                   |   |                                                                 |   |   |   |   |   |   |   |
| **Total                  loans charged off**                          |                       |   | 1,959                      |   |                       | 4,200  |                                   |   | 5,385                                                                |   |   | 4,482 |   |   | 4,441 |   |
|                                                                  |                       |   |                       |   |                       |   |                                   |   |                                                                 |   |   |   |   |   |   |   |
| Recoveries                  of losses previously charged off:         |                       |   |                       |   |                       |   |                                   |   |                                                                 |   |   |   |   |   |   |   |
|                                                                  |                       |   |                       |   |                       |   |                                   |   |                                                                 |   |   |   |   |   |   |   |
| Commercial                                                            |                       |   | 64                         |   |                       | 144    |                                   |   | 162                                                                  |   |   | 36 |   |   | 40 |   |
| Real                  estate - mortgage                               |                       |   | 108                        |   |                       | 162    |                                   |   | 144                                                                  |   |   | 18 |   |   | - |   |
| Real                  estate - construction                           |                       |   | 2                          |   |                       | -      |                                   |   | -                                                                    |   |   | 1 |   |   | 4 |   |
| Consumer                                                              |                       |   | 150                        |   |                       | 160    |                                   |   | 150                                                                  |   |   | 157 |   |   | 122 |   |
|                                                                  |                       |   |                       |   |                       |   |                                   |   |                                                                 |   |   |   |   |   |   |   |
| **Total                  recoveries**                                 |                       |   | 324                        |   |                       | 466    |                                   |   | 456                                                                  |   |   | 212 |   |   | 166 |   |
|                                                                  |                       |   |                       |   |                       |   |                                   |   |                                                                 |   |   |   |   |   |   |   |
| **Net                  loans charged off**                            |                       |   | 1,635                      |   |                       | 3,734  |                                   |   | 4,929                                                                |   |   | 4,270 |   |   | 4,275 |   |
|                                                                  |                       |   |                       |   |                       |   |                                   |   |                                                                 |   |   |   |   |   |   |   |
| Provision                  for loan losses                            |                       |   | 2,513                      |   |                       | 3,110  |                                   |   | 3,256                                                                |   |   | 6,744 |   |   | 5,432 |   |
|                                                                  |                       |   |                       |   |                       |   |                                   |   |                                                                 |   |   |   |   |   |   |   |
| **Reserve                  for loan losses at end of year**           |                       | $      | 8,303                      |   |                       | 7,425  |                                   |   | 8,049                                                                |   |   | 9,722 |   |   | 7,248 |   |
|                                                                  |                       |   |                       |   |                       |   |                                   |   |                                                                 |   |   |   |   |   |   |   |
| Loans                  charged off net of recoveries, as              |                       |   |                       |   |                       |   |                                   |   |                                                                 |   |   |   |   |   |   |   |
| a                  percent of average loans outstanding               |                       |   | 0.27                       | %      |                       | 0.68   | %                                      |   | 0.90                                                                 | %      |   | 0.79 | % |   | 0.84 | % |

*Non-performing      Assets. *

----

| **Table                    11 - Non-performing Assets**              |   |                       |   |   |                       |   |   |                       |   |   |                       |
|----------------------------------------------------------------------|--------|----------------------------|--------|--------|----------------------------|--------|--------|----------------------------|--------|--------|----------------------------|
|                                                                 |   |                       |   |   |                       |   |   |                       |   |   |                       |
| **(Dollars                    in Thousands)**                        |   | **2006   ** |   |   | **2005   ** |   |   | **2004   ** |   |   | **2003   ** |   |   | **2002   ** |   |
| Non-accrual                    loans                                 |   | $                          | 7,560  |   |                       | 3,492  |   |                       | 5,097  |   |                       | 4,343 |   |   | 4,602 |   |
| Loans                    90 days or more past due and still accruing |   |                       | 78     |   |                       | 946    |   |                       | 245    |   |                       | 271 |   |   | 239 |   |
| **Total                    non-performing loans**                    |   |                       | 7,638  |   |                       | 4,438  |   |                       | 5,342  |   |                       | 4,614 |   |   | 4,841 |   |
| All                    other real estate owned                       |   |                       | 344    |   |                       | 531    |   |                       | 682    |   |                       | 1,447 |   |   | 240 |   |
| All                    other repossessed assets                      |   |                       | -      |   |                       | -      |   |                       | -      |   |                       | 206 |   |   | 1,538 |   |
| **Total                    non-performing assets**                   |   | $                          | 7,982  |   |                       | 4,969  |   |                       | 6,024  |   |                       | 6,267 |   |   | 6,619 |   |
|                                                                 |   |                       |   |   |                       |   |   |                       |   |   |                       |   |   |   |   |   |
| **As                    a percent of total loans at year end**       |   |                       |   |   |                       |   |   |                       |   |   |                       |   |   |   |   |   |
| Non-accrual                    loans                                 |   |                       | 1.16   | %      |                       | 0.62   | %      |                       | 0.95   | %      |                       | 0.79 | % |   | 0.87 | % |
| Loans                    90 days or more past due and still accruing |   |                       | 0.01   | %      |                       | 0.17   | %      |                       | 0.05   | %      |                       | 0.05 | % |   | 0.05 | % |
| Total                    non-performing assets                       |   |                       | 1.23   | %      |                       | 0.88   | %      |                       | 1.12   | %      |                       | 1.14 | % |   | 1.26 | % |

*                      Deposits. *
** **

| **Table                    12 - Maturities of Time Deposits over $100,000** |   |                                                                               |    |
|-----------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------|---------|
|                                                                        |   |                                                                               |    |   |
| **(Dollars                    in Thousands)**                               |   | **                             2006** |    |
| Three                    months or less                                     |   | $                                                                                  | 70,290  |   |
| Over                    three months through six months                     |   |                                                                               | 63,214  |   |
| Over                    six months through twelve months                    |   |                                                                               | 41,234  |   |
| Over                    twelve months                                       |   |                                                                               | 19,438  |   |
| **Total**                                                                   |   | $                                                                                  | 194,176 |   |

*Borrowed          Funds. *
** **

----

*Junior          Subordinated Debentures (related to Trust Preferred Securities).*

*Contractual          Obligations and Off-Balance Sheet Arrangements. *

| **Table                      13 - Contractual Obligations and Other                      Commitments**                                                         |                                        |   |                                        |   |                                         |   |                                        |   |      |   |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------|---------------------------------------------|--------|---------------------------------------------|--------|----------------------------------------------|--------|---------------------------------------------|--------|-----------|--------|--------|
|                                                                                                                                                           |                                        |   |                                        |   |                                         |   |                                        |   |      |   |   |
| **(Dollars                      in Thousands)**                                                                                                                | **Within                      one****year** |   | **One                      to Three Years** |   | **Three                      to Five Years** |   | **Five                      Years or More** |   | **Total** |   |
| **Contractual                      Cash Obligations**                                                                                                          |                                        |   |                                        |   |                                         |   |                                        |   |      |   |   |   |   |   |   |   |
| Long-term                      borrowings*                                                                                                                     |                                        | $      | 2,500                                       |   |                                         | -      |                                        |   | 42,000    |   |   | 25,000 |   | $ | 69,500 |   |
| Junior                      subordinated debentures                                                                                                            |                                        |   | -                                           |   |                                         | -      |                                        |   | -         |   |   | 20,619 |   |   | 20,619 |   |
| Operating                      lease obligations                                                                                                               |                                        |   | 1,067                                       |   |                                         | 1,907  |                                        |   | 1,385     |   |   | 3,650 |   |   | 8,009 |   |
|                                                                                                                                                           |                                        |   |                                        |   |                                         |   |                                        |   |      |   |   |   |   |   |   |   |
| **Total**                                                                                                                                                      |                                        | $      | 3,567                                       |   |                                         | 1,907  |                                        |   | 43,385    |   |   | 49,269 |   | $ | 98,128 |   |
|                                                                                                                                                           |                                        |   |                                        |   |                                         |   |                                        |   |      |   |   |   |   |   |   |   |
| **Other                      Commitments**                                                                                                                     |                                        |   |                                        |   |                                         |   |                                        |   |      |   |   |   |   |   |   |   |
| Commitments                      to extend credit                                                                                                              |                                        | $      | 3,547                                       |   |                                         | 72,373 |                                        |   | 8,027     |   |   | 67,750 |   | $ | 151,697 |   |
| Standby                      letters of credit                                                                                                                 |                                        |   |                                        |   |                                         |   |                                        |   |      |   |   |   |   |   |   |   |
| and                      financial guarantees written                                                                                                          |                                        |   | 4,570                                       |   |                                         | 4      |                                        |   | -         |   |   | - |   |   | 4,574 |   |
|                                                                                                                                                           |                                        |   |                                        |   |                                         |   |                                        |   |      |   |   |   |   |   |   |   |
| **Total**                                                                                                                                                      |                                        | $      | 8,117                                       |   |                                         | 72,377 |                                        |   | 8,027     |   |   | 67,750 |   | $ | 156,271 |   |
|                                                                                                                                                           |                                        |   |                                        |   |                                         |   |                                        |   |      |   |   |   |   |   |   |   |
| *Excludes                      $19.8 million adjustable rate credit due to the FHLB, which                      matured in                      February 2007. |                                        |   |                                        |   |                                         |   |                                        |   |      |   |   |

----

*Capital          Resources. *

| **Table                      14 - Equity Ratios**     |     |     |                                 |   |   |   |   |
|-------------------------------------------------------|----------|----------|--------------------------------------|--------|--------|--------|--------|
|                                                  |     |     |                                 |   |   |   |   |
|                                                  | **2006** | **2005** | **                       2004** |
| Return                      on average assets         |     |     | 1.19%                                |   |   | 0.90%  |   |   | 0.65% |   |
| Return                      on average equity         |     |     | 14.68%                               |   |   | 11.31% |   |   | 8.52% |   |
| Dividend                      payout ratio            |     |     | 20.78%                               |   |   | 22.34% |   |   | 28.37% |   |
| Average                      equity to average assets |     |     | 8.09%                                |   |   | 7.92%  |   |   | 7.59% |   |

----

*Quarterly          Financial Data. *

| **Table                      15 - Quarterly Financial Data**              |      |       |   |      |   |       |   |                                                                |   |       |   |      |   |       |   |   |   |
|---------------------------------------------------------------------------|-----------|------------|--------|-----------|--------|------------|--------|---------------------------------------------------------------------|--------|------------|--------|-----------|--------|------------|--------|--------|--------|
|                                                                      |      |       |   |      |   |       |   |                                                                |   |       |   |      |   |       |   |   |   |
|                                                                      |      | **2006**   |   | **2005**  |   |
| **(Dollars                      in thousands, except per share amounts)** | **First** | **Second** |   | **Third** |   | **Fourth** |   | **                            First** |   | **Second** |   | **Third** |   | **Fourth** |   |
|                                                                      |      |       |   |      |   |       |   |                                                                |   |       |   |      |   |       |   |   |   |   |   |   |   |   |   |   |   |
| Total                      interest income                                |      | $          | 12,484 |      |   | 13,559     |   |                                                                | 14,390 |       |   | 14,961    |   |       | 9,216  |   |   | 9,984 |   |   | 10,987 |   |   | 11,726 |   |
| Total                      interest expense                               |      |       | 4,863  |      |   | 5,429      |   |                                                                | 6,243  |       |   | 6,575     |   |       | 3,346  |   |   | 3,686 |   |   | 3,978 |   |   | 4,418 |   |
|                                                                      |      |       |   |      |   |       |   |                                                                |   |       |   |      |   |       |   |   |   |   |   |   |   |   |   |   |   |
| **Net                      interest income**                              |      |       | 7,621  |      |   | 8,130      |   |                                                                | 8,147  |       |   | 8,386     |   |       | 5,870  |   |   | 6,298 |   |   | 7,009 |   |   | 7,308 |   |
|                                                                      |      |       |   |      |   |       |   |                                                                |   |       |   |      |   |       |   |   |   |   |   |   |   |   |   |   |   |
| Provision                      for loan losses                            |      |       | 759    |      |   | 413        |   |                                                                | 686    |       |   | 655       |   |       | 690    |   |   | 723 |   |   | 930 |   |   | 767 |   |
| Other                      income                                         |      |       | 1,929  |      |   | 2,017      |   |                                                                | 2,043  |       |   | 1,564     |   |       | 1,632  |   |   | 1,835 |   |   | 1,788 |   |   | 1,413 |   |
| Other                      expense                                        |      |       | 5,307  |      |   | 5,548      |   |                                                                | 5,787  |       |   | 6,341     |   |       | 4,888  |   |   | 4,929 |   |   | 5,016 |   |   | 5,498 |   |
|                                                                      |      |       |   |      |   |       |   |                                                                |   |       |   |      |   |       |   |   |   |   |   |   |   |   |   |   |   |
| **Income                      before income taxes**                       |      |       | 3,484  |      |   | 4,186      |   |                                                                | 3,717  |       |   | 2,954     |   |       | 1,924  |   |   | 2,481 |   |   | 2,851 |   |   | 2,456 |   |
| Income                      taxes                                         |      |       | 1,249  |      |   | 1,525      |   |                                                                | 1,344  |       |   | 1,052     |   |       | 647    |   |   | 873 |   |   | 1,010 |   |   | 851 |   |
|                                                                      |      |       |   |      |   |       |   |                                                                |   |       |   |      |   |       |   |   |   |   |   |   |   |   |   |   |   |
| **Net                      earnings**                                     |      | $          | 2,235  |      |   | 2,661      |   |                                                                | 2,373  |       |   | 1,902     |   |       | 1,277  |   |   | 1,608 |   |   | 1,841 |   |   | 1,605 |   |
|                                                                      |      |       |   |      |   |       |   |                                                                |   |       |   |      |   |       |   |   |   |   |   |   |   |   |   |   |   |
| **Basic                      earnings per share**                         |      | $          | 0.59   |      |   | 0.70       |   |                                                                | 0.62   |       |   | 0.50      |   |       | 0.35   |   |   | 0.42 |   |   | 0.48 |   |   | 0.42 |   |
| **Diluted                      earnings per share**                       |      | $          | 0.58   |      |   | 0.68       |   |                                                                | 0.61   |       |   | 0.49      |   |       | 0.32   |   |   | 0.42 |   |   | 0.48 |   |   | 0.42 |   |

----

**QUANTATIVE          AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

** **

| **Table                      16 - Market Risk Table**              |                                       |                                                                                   |                                                   |   |                                             |   |                                     |   |           |   |                                                                                  |   |                                |   |    |
|--------------------------------------------------------------------|--------------------------------------------|----------------------------------------------------------------------------------------|--------------------------------------------------------|--------|--------------------------------------------------|--------|------------------------------------------|--------|----------------|--------|---------------------------------------------------------------------------------------|--------|-------------------------------------|--------|---------|
|                                                               |                                       |                                                                                   |                                                   |   |                                             |   |                                     |   |           |   |                                                                                  |   |                                |   |    |
| **(Dollars                      In Thousands)**                    |                                       | **Principal/Notional                      Amount Maturing in Year Ended December 31,** |                                                   |
| **Loans                      Receivable**                          | **                        2007** |                                                                                   | **                          2008** |   | **                         2009** |   | **2010                      & 2011** |   | **Thereafter** |   | **                               Total** |   | **Fair                      Value** |   |
| Fixed                      rate                                    |                                       | $                                                                                      | 25,067                                                 |   |                                             | 18,783 |                                     |   | 17,991         |   |                                                                                  | 34,946 |                                |   | 35,937  |   | $ | 132,725 |   | $ | 131,681 |   |
| Average                      interest rate                         |                                       |                                                                                   | 7.59%                                                  |   |                                             | 7.25%  |                                     |   | 7.35%          |   |                                                                                  | 7.38%  |                                |   | 7.23%   |   |   |   |   |   |   |   |
| Variable                      rate                                 |                                       | $                                                                                      | 198,692                                                |   |                                             | 69,214 |                                     |   | 50,713         |   |                                                                                  | 73,559 |                                |   | 126,478 |   | $ | 518,656 |   | $ | 518,036 |   |
| Average                      interest rate                         |                                       |                                                                                   | 8.76%                                                  |   |                                             | 8.63%  |                                     |   | 8.49%          |   |                                                                                  | 8.49%  |                                |   | 8.46%   |   |   |   |   |   |   |   |
|                                                               |                                       |                                                                                   |                                                   |   |                                             |   |                                     |   |           |   |                                                                                  |   |                                |   |    |   | $ | 651,381 |   | $ | 649,717 |   |
| **Investment                      Securities**                     |                                       |                                                                                   |                                                   |   |                                             |   |                                     |   |           |   |                                                                                  |   |                                |   |
| Interest                      bearing cash                         |                                       | $                                                                                      | -                                                      |   |                                             | -      |                                     |   | -              |   |                                                                                  | -      |                                |   | 1,471   |   | $ | 1,471 |   | $ | 1,471 |   |
| Average                      interest rate                         |                                       |                                                                                   | -                                                      |   |                                             | -      |                                     |   | -              |   |                                                                                  | -      |                                |   | 5.26%   |   |   |   |   |   |   |   |
| Federal                      funds sold                            |                                       | $                                                                                      | 2,640                                                  |   |                                             | -      |                                     |   | -              |   |                                                                                  | -      |                                |   | -       |   | $ | 2,640 |   | $ | 2,640 |   |
| Average                      interest rate                         |                                       |                                                                                   | 5.13%                                                  |   |                                             | -      |                                     |   | -              |   |                                                                                  | -      |                                |   | -       |   |   |   |   |   |   |   |
| Securities                      available for sale                 |                                       | $                                                                                      | 14,719                                                 |   |                                             | 23,292 |                                     |   | 25,077         |   |                                                                                  | 43,336 |                                |   | 11,156  |   | $ | 117,581 |   | $ | 117,581 |   |
| Average                      interest rate                         |                                       |                                                                                   | 4.77%                                                  |   |                                             | 4.74%  |                                     |   | 4.77%          |   |                                                                                  | 4.32%  |                                |   | 3.57%   |   |   |   |   |   |   |   |
| Nonmarketable                      equity securities               |                                       | $                                                                                      | -                                                      |   |                                             | -      |                                     |   | -              |   |                                                                                  | -      |                                |   | 7,295   |   | $ | 7,295 |   | $ | 7,295 |   |
| Average                      interest rate                         |                                       |                                                                                   | -                                                      |   |                                             | -      |                                     |   | -              |   |                                                                                  | -      |                                |   | 5.48%   |   |   |   |   |   |   |   |
|                                                               |                                       |                                                                                   |                                                   |   |                                             |   |                                     |   |           |   |                                                                                  |   |                                |   |    |   |   |   |   |   |   |   |
| **Debt                      Obligations**                          |                                       |                                                                                   |                                                   |   |                                             |   |                                     |   |           |   |                                                                                  |   |                                |   |
| Deposits                                                           |                                       | $                                                                                      | 339,620                                                |   |                                             | 30,295 |                                     |   | 13,080         |   |                                                                                  | 2,682  |                                |   | 248,143 |   | $ | 633,820 |   | $ | 633,771 |   |
| Average                      interest rate                         |                                       |                                                                                   | 4.28%                                                  |   |                                             | 4.47%  |                                     |   | 4.60%          |   |                                                                                  | 3.95%  |                                |   | 1.65%   |   |   |   |   |   |   |   |
| Advances                      from FHLB                            |                                       | $                                                                                      | 62,300                                                 |   |                                             | -      |                                     |   | 15,000         |   |                                                                                  | 12,000 |                                |   | -       |   | $ | 89,300 |   | $ | 88,819 |   |
| Average                      interest rate                         |                                       |                                                                                   | 4.78%                                                  |   |                                             | -      |                                     |   | 4.65%          |   |                                                                                  | 5.08%  |                                |   | -       |   |   |   |   |   |   |   |
| Demand                      notes payable to U.S. Treasury         |                                       | $                                                                                      | 1,600                                                  |   |                                             | -      |                                     |   | -              |   |                                                                                  | -      |                                |   | -       |   | $ | 1,600 |   | $ | 1,600 |   |
| Average                      interest rate                         |                                       |                                                                                   | 4.95%                                                  |   |                                             | -      |                                     |   | -              |   |                                                                                  | -      |                                |   | -       |   |   |   |   |   |   |   |
| Securities                      sold under agreement to repurchase |                                       | $                                                                                      | 6,418                                                  |   |                                             | -      |                                     |   | -              |   |                                                                                  | -      |                                |   | -       |   | $ | 6,418 |   | $ | 6,418 |   |
| Average                      interest rate                         |                                       |                                                                                   | 5.25%                                                  |   |                                             | -      |                                     |   | -              |   |                                                                                  | -      |                                |   | -       |   |   |   |   |   |   |   |
| Junior                      subordinated debentures                |                                       | $                                                                                      | -                                                      |   |                                             | -      |                                     |   | -              |   |                                                                                  | -      |                                |   | 20,619  |   | $ | 20,619 |   | $ | 20,619 |   |
| Average                      interest rate                         |                                       |                                                                                   | -                                                      |   |                                             | -      |                                     |   | -              |   |                                                                                  | -      |                                |   | 6.99%   |   |   |   |   |   |   |   |
|                                                               |                                       |                                                                                   |                                                   |   |                                             |   |                                     |   |           |   |                                                                                  |   |                                |   |    |   |   |   |   |   |   |   |
| **Derivative                      Instruments (notional amount)**  |                                       |                                                                                   |                                                   |   |                                             |   |                                     |   |           |   |                                                                                  |   |
| Interest                      rate floor contracts                 |                                       | $                                                                                      | -                                                      |   |                                             | 70,000 |                                     |   | 80,000         |   |                                                                                  | -      |                                |   | -       |   | $ | 150,000 |   | $ | 481 |   |
| Average                      interest rate                         |                                       |                                                                                   | -                                                      |   |                                             | 6.63%  |                                     |   | 7.72%          |   |                                                                                  | -      |                                |   | -       |   |   |   |   |   |   |   |

----

| **Table                        17 - Interest Rate Risk**                                                  |   |                                                                                                     |                                                                                                                                           |                                |   |
|-----------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------|-------------------------------------|--------|
| **(Dollars                        in thousands)**                                                         |   |                                                                                                     |                                                                                                                                           |                                |   |
|                                                                                                      |   | **Estimated                        Resulting Theoretical Net****Interest                        Income** |                                                                                                                                           |
| **Hypothetical                        rate change**** (ramp                        over 12 months)** |   | **Amount**                                                                                               |                                                                                                                                           | **%                        Change** |   |
| +2%                                                                                                       |   | $                                                                                                        | 38,283                                                                                                                                         |                                |   | 7.46 | % |
| +1%                                                                                                       |   | $                                                                                                        | 36,968                                                                                                                                         |                                |   | 3.77 | % |
| 0%                                                                                                        |   | $                                                                                                        | 35,627                                                                                                                                         |                                |   | 0.00 | % |
| -1%                                                                                                       |   | $                                                                                                        | 34,382                                                                                                                                         |                                |   | -3.49 | % |
| -2%                                                                                                       |   | $                                                                                                        | 33,375                                                                                                                                         |                                |   | -6.32 | % |
|                                                                                                      |   |                                                                                                     |                                                                                                                                           |                                |   |   |   |
|                                                                                                      |   |                                                                                                     |                                                                                                                                           |                                |   |   |   |
|                                                                                                      |   |                                                                                                     |                                                                                                                                           |                                |   |   |   |
|                                                                                                      |   |                                                                                                     | **Estimated                        Resulting Theoretical****Market                        Value of                        Equity**   |                                |
| **Hypothetical                        rate change****(immediate                        shock)**           |   |                                                                                                     | **Amount**                                                                                                                                     |                                |   | **%                        Change** |   |
| +2%                                                                                                       |   | $                                                                                                        | 57,371                                                                                                                                         |                                |   | -7.03 | % |
| +1%                                                                                                       |   | $                                                                                                        | 59,416                                                                                                                                         |                                |   | -3.71 | % |
| 0%                                                                                                        |   | $                                                                                                        | 61,708                                                                                                                                         |                                |   | 0.00 | % |
| -1%                                                                                                       |   | $                                                                                                        | 64,568                                                                                                                                         |                                |   | 4.63 | % |
| -2%                                                                                                       |   | $                                                                                                        | 67,893                                                                                                                                         |                                |   | 10.02 | % |

----

**MARKET          FOR THE COMPANY’S COMMON EQUITY**

**AND          RELATED SHAREHOLDER MATTERS**

** **

| **Table                      18 - Market and Dividend Data** |   |   |                             |   |   |                              |
|--------------------------------------------------------------|--------|--------|----------------------------------|--------|--------|-----------------------------------|
|                                                         |   |   |                             |   |   |                              |   |   |   |   |
|                                                         |   |   |                             |   |   |                              |   |   | **Cash                      Dividend** |   |
| **2006**                                                     |   |   | **Low                      Bid** |   |   | **High                      Bid** |   |   | **Per                      Share** |   |
| First                      Quarter                           |   | $      | 20.06                            |   |   | 24.55                             |   |   | 0.10 |   |
|                                                         |   |   |                             |   |   |                              |   |   |   |   |
| Second                      Quarter                          |   | $      | 23.66                            |   |   | 29.21                             |   |   | 0.11 |   |
|                                                         |   |   |                             |   |   |                              |   |   |   |   |
| Third                      Quarter                           |   | $      | 24.27                            |   |   | 29.20                             |   |   | 0.11 |   |
|                                                         |   |   |                             |   |   |                              |   |   |   |   |
| Fourth                      Quarter                          |   | $      | 26.95                            |   |   | 30.13                             |   |   | 0.18 |   |
|                                                         |   |   |                             |   |   |                              |   |   |   |   |
|                                                         |   |   |                             |   |   |                              |   |   |   |   |
|                                                         |   |   |                             |   |   |                              |   |   | **Cash                      Dividend** |   |
| **2005**                                                     |   |   | **Low                      Bid** |   |   | **High                      Bid** |   |   | **Per                      Share** |   |
| First                      Quarter                           |   | $      | 16.14                            |   |   | 20.25                             |   |   | 0.09 |   |
|                                                         |   |   |                             |   |   |                              |   |   |   |   |
| Second                      Quarter                          |   | $      | 15.68                            |   |   | 20.00                             |   |   | 0.09 |   |
|                                                         |   |   |                             |   |   |                              |   |   |   |   |
| Third                      Quarter                           |   | $      | 16.51                            |   |   | 20.25                             |   |   | 0.09 |   |
|                                                         |   |   |                             |   |   |                              |   |   |   |   |
| Fourth                      Quarter                          |   | $      | 17.70                            |   |   | 21.82                             |   |   | 0.10 |   |

----

**STOCK            PERFORMANCE GRAPH**

|                                                                  | Period                    Ending |
|-----------------------------------------------------------------------|----------------------------------|
| ***Index***                                                           | **12/31/01**                     | **12/31/02** | **12/31/03** | **12/31/04** | **12/31/05** | **12/31/06** |
| Peoples                    Bancorp of North Carolina, Inc.            | 100.00                           | 101.19 | 138.16 | 144.23 | 188.93 | 263.12 |
| NASDAQ                    Composite                                   | 100.00                           | 68.76 | 103.67 | 113.16 | 115.57 | 127.58 |
| SNL                    Southeast Bank Index                           | 100.00                           | 110.46 | 138.72 | 164.50 | 168.39 | 197.45 |
|                                                                  |                             |   |   |   |   |   |
|                                                                  |                             |   |   |   |   |   |
| **Source                    : SNL Financial LC, Charlottesville, VA** |                             |   |   |   |  **(434)                  977-1600** |
| **©                    2007**                                    |                             |   |   |   |  www.snl.com |

----

| **PEOPLES                    BANCORP OF NORTH CAROLINA, INC. AND                    SUBSIDIARIES**                                                   |
|------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Consolidated                    Financial Statements**                                                                                             |
| **December                    31, 2006, 2005 and 2004**                                                                                              |
|                                                                                                                                                 |   |
|                                                                                                                                                 |   |
| **INDEX**                                                                                                                                            |
|                                                                                                                                                 |   |
|                                                                                                                                                 | **PAGE(S)** |
|                                                                                                                                                 |   |
| Management's                    Report on Internal Control Over Financial Reporting                                                                  | A-27 |
|                                                                                                                                                 |   |
| Report                    of Independent Registered Public Accounting Firm on Internal                    Control Over                    Financial  |   |
| Reporting                                                                                                                                            | A-28                    - A-29 |
|                                                                                                                                                 |   |
| Report                    of Independent Registered Public Accounting Firm on the Consolidated                    Financial Statements               | A-30 |
|                                                                                                                                                 |   |
|                                                                                                                                                 |   |
| Financial                    Statements                                                                                                              |   |
| Consolidated                    Balance Sheets at December 31, 2006 and December 31, 2005                                                            | A-31 |
|                                                                                                                                                 |   |
| Consolidated                    Statements of Earnings for the years ended December 31, 2006,                    2005 and                    2004    | A-32 |
|                                                                                                                                                 |   |
| Consolidated                    Statements of Changes in Shareholders' Equity for the years ended                    December                    31, |   |
| 2006,                    2005 and 2004                                                                                                               | A-33 |
|                                                                                                                                                 |   |
| Consolidated                    Statements of Comprehensive Income for the years ended December                    31, 2006,                    2005 |   |
| and                    2004                                                                                                                          | A-34 |
|                                                                                                                                                 |   |
| Consolidated                    Statements of Cash Flows for the years ended December 31, 2006,                    2005 and                    2004  | A-35                    - A-36 |
|                                                                                                                                                 |   |
| Notes                    to Consolidated Financial Statements                                                                                        | A-37                    - A-56 |

----

**MANAGEMENT’S          REPORT ON INTERNAL CONTROLS OVER FINANCIAL REPORTING**

| /s/                Tony W. Wolfe             |   | /s/                A. Joseph Lampron   |
|----------------------------------------------|--------|----------------------------------------|
| Tony                W. Wolfe                 |   | A.                Joseph Lampron       |
| Chief                Executive Officer  |   | Chief                Financial Officer |
| March                15, 2007                |   | March                15, 2007          |

----

**REPORT        OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

| Certified                Public Accountants |
|---------------------------------------------|

| www.pkm.com |
|-------------|

----

|                                 |   |   |                                                                     /s/                  Porter Keadle Moore, LLP |
|--------------------------------------|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                 |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| Atlanta,                    Georgia  |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |
| February                    27, 2007 |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |   |   |

----

**REPORT        OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

|                                 |   |   | /s/                  Porter Keadle Moore, LLP |
|--------------------------------------|--------|--------|-----------------------------------------------|
|                                 |   |   |                                          |
| Atlanta,                    Georgia  |   |   |                                          |
| February                    27, 2007 |   |   |                                          |

| Certified                    Public Accountants |
|-------------------------------------------------|

| www.pkm.com |
|-------------|

----

| **PEOPLES                  BANCORP OF NORTH CAROLINA, INC. AND                  SUBSIDIARIES** |
|------------------------------------------------------------------------------------------------|
|                                                                                           |   |   |   |   |   |
| **Consolidated                  Balance Sheets**                                               |
|                                                                                           |   |   |   |   |   |
| **December                  31, 2006 and 2005**                                                |
|                                                                                           |   |   |   |   |   |
|  Assets                                                                                   |   |                       2006 |   |                       2005 |   |
|                                                                                           |   |   |   |   |   |
|                                                                                           |   |   |   |   |   |   |   |
| Cash                  and due from banks, including reserve requirements                       |   | $ | 18,860,318 |   |   | 18,468,999 |   |
| of                  $6,243,000 and $5,229,000                                                  |   |   |   |   |   |   |   |
| Federal                  funds sold                                                            |   |   | 2,640,000 |   |   | 1,347,000 |   |
| Cash                  and cash equivalents                                                     |   |   | 21,500,318 |   |   | 19,815,999 |   |
|                                                                                           |   |   |   |   |   |   |   |
| Investment                  securities available for sale                                      |   |   | 117,581,000 |   |   | 115,158,184 |   |
| Other                  investments                                                             |   |   | 7,295,449 |   |   | 5,810,749 |   |
| Total                  securities                                                              |   |   | 124,876,449 |   |   | 120,968,933 |   |
|                                                                                           |   |   |   |   |   |   |   |
| Mortgage                  loans held for sale                                                  |   |   | -                       |   |   | 2,247,900 |   |
|                                                                                           |   |   |   |   |   |   |   |
| Loans                                                                                          |   |   | 651,381,129 |   |   | 566,663,416 |   |
| Less                  allowance for loan losses                                                |   |   | (8,303,432 | ) |   | (7,424,782 | ) |
| Net                  loans                                                                     |   |   | 643,077,697 |   |   | 559,238,634 |   |
|                                                                                           |   |   |   |   |   |   |   |
| Premises                  and equipment, net                                                   |   |   | 12,816,385 |   |   | 12,662,153 |   |
| Cash                  surrender value of life insurance                                        |   |   | 6,532,406 |   |   | 6,311,757 |   |
| Accrued                  interest receivable and other assets                                  |   |   | 10,144,283 |   |   | 9,034,239 |   |
| Total                  assets                                                                  |   | $ | 818,947,538 |   |   | 730,279,615 |   |
|                                                                                           |   |   |   |   |   |   |   |
|                    Liabilities and Shareholders' Equity                                   |   |   |   |   |   |   |   |
|                                                                                           |   |   |   |   |   |   |   |
| Deposits:                                                                                      |   |   |   |   |   |   |   |
| Non-interest                  bearing demand                                                   |   | $ | 101,393,142 |   |   | 94,660,721 |   |
| NOW,                  MMDA & savings                                                       |   |   | 174,577,641 |   |   | 183,248,699 |   |
| Time,                  $100,000 or more                                                        |   |   | 194,176,291 |   |   | 152,410,976 |   |
| Other                  time                                                                    |   |   | 163,673,215 |   |   | 152,533,265 |   |
| Total                  deposits                                                                |   |   | 633,820,289 |   |   | 582,853,661 |   |
|                                                                                           |   |   |   |   |   |   |   |
| Demand                  notes payable to U.S. Treasury                                         |   |   | 1,600,000 |   |   | 1,473,693 |   |
| Securities                  sold under agreement to repurchase                                 |   |   | 6,417,803 |   |   | 981,050 |   |
| FHLB                  borrowings                                                               |   |   | 89,300,000 |   |   | 71,600,000 |   |
| Junior                  subordinated debentures                                                |   |   | 20,619,000 |   |   | 14,433,000 |   |
| Accrued                  interest payable and other liabilities                                |   |   | 4,355,073 |   |   | 4,585,217 |   |
| Total                  liabilities                                                             |   |   | 756,112,165 |   |   | 675,926,621 |   |
|                                                                                           |   |   |   |   |   |   |   |
| Shareholders'                  equity:                                                         |   |   |   |   |   |   |   |
|                                                                                           |   |   |   |   |   |   |   |
| Preferred                  stock, no par value; authorized                                     |   |   |   |   |   |   |   |
| 5,000,000                  shares; no shares issued                                            |   |   |   |   |   |   |   |
| and                  outstanding                                                               |   |   | -                       |   |   | -                       |   |
| Common                  stock, no par value; authorized                                        |   |   |   |   |   |   |   |
| 20,000,000                  shares; issued and                                                 |   |   |   |   |   |   |   |
| outstanding                  3,830,634 shares in 2006                                          |   |   |   |   |   |   |   |
| and                  3,440,805 shares in 2005                                                  |   |   | 51,122,147 |   |   | 41,096,500 |   |
| Retained                  earnings                                                             |   |   | 12,484,463 |   |   | 14,656,160 |   |
| Accumulated                  other comprehensive income (loss)                                 |   |   | (771,237 | ) |   | (1,399,666 | ) |
| Total                  shareholders' equity                                                    |   |   | 62,835,373 |   |   | 54,352,994 |   |
|                                                                                           |   |   |   |   |   |   |   |
| Total                  liabilities and shareholders' equity                                    |   | $ | 818,947,538 |   |   | 730,279,615 |   |
|                                                                                           |   |   |   |   |   |   |   |
| See                  accompanying notes to consolidated financial statements.                  |   |   |   |   |   |   |   |

----

| **PEOPLES                  BANCORP OF NORTH CAROLINA, INC. AND                  SUBSIDIARIES** |
|------------------------------------------------------------------------------------------------|
|                                                                                           |   |   |   |   |   |   |   |
| **Consolidated                  Statements of Earnings**                                       |
|                                                                                           |   |   |   |   |   |   |   |
| **For                  the Years Ended December 31, 2006, 2005 and                  2004**     |
|                                                                                           |   |   |   |   |   |   |   |
|                                                                                           |   |                    2006 |   |                    2005 |   |                    2004 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Interest                  income:                                                              |   |   |   |   |   |   |   |   |   |   |
| Interest                  and fees on loans                                                    |   | $ | 49,667,700 |   |   | 37,123,327 |   |   | 31,073,135 |   |
| Interest                  on federal funds sold                                                |   |   | 85,307 |   |   | 72,578 |   |   | 35,236 |   |
| Interest                  on investment securities:                                            |   |   |   |   |   |   |   |   |   |   |
| U.S.                  Government agencies                                                      |   |   | 4,321,346 |   |   | 3,584,755 |   |   | 2,903,865 |   |
| States                  and political subdivisions                                             |   |   | 798,185 |   |   | 735,892 |   |   | 660,227 |   |
| Other                                                                                          |   |   | 521,077 |   |   | 396,020 |   |   | 422,377 |   |
| Total                  interest income                                                         |   |   | 55,393,615 |   |   | 41,912,572 |   |   | 35,094,840 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Interest                  expense:                                                             |   |   |   |   |   |   |   |   |   |   |
| NOW,                  MMDA & savings deposits                                              |   |   | 3,060,201 |   |   | 2,644,413 |   |   | 1,899,249 |   |
| Time                  deposits                                                                 |   |   | 14,188,623 |   |   | 8,923,488 |   |   | 7,145,486 |   |
| FHLB                  borrowings                                                               |   |   | 3,588,169 |   |   | 2,888,785 |   |   | 2,602,866 |   |
| Junior                  subordinated debentures                                                |   |   | 1,962,692 |   |   | 938,145 |   |   | 676,547 |   |
| Other                                                                                          |   |   | 310,188 |   |   | 33,790 |   |   | 10,518 |   |
| Total                  interest expense                                                        |   |   | 23,109,873 |   |   | 15,428,621 |   |   | 12,334,666 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Net                  interest income                                                           |   |   | 32,283,742 |   |   | 26,483,951 |   |   | 22,760,174 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Provision                  for loan losses                                                     |   |   | 2,513,282 |   |   | 3,110,000 |   |   | 3,256,000 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Net                  interest income after provision for loan losses                           |   |   | 29,770,460 |   |   | 23,373,951 |   |   | 19,504,174 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Other                  income:                                                                 |   |   |   |   |   |   |   |   |   |   |
| Service                  charges                                                               |   |   | 3,929,956 |   |   | 3,779,933 |   |   | 3,434,544 |   |
| Other                  service charges and fees                                                |   |   | 1,539,367 |   |   | 1,141,879 |   |   | 677,191 |   |
| Loss                  on sale of securities                                                    |   |   | (591,856 | ) |   | (729,727 | ) |   | (63,688 | ) |
| Mortgage                  banking income                                                       |   |   | 289,293 |   |   | 469,109 |   |   | 356,782 |   |
| Insurance                  and brokerage commissions                                           |   |   | 388,559 |   |   | 386,662 |   |   | 429,788 |   |
| Loss                  on sale of repossessed assets                                            |   |   | (107,712 | ) |   | (37,811 | ) |   | (179,886 | ) |
| Miscellaneous                                                                                  |   |   | 2,106,188 |   |   | 1,658,189 |   |   | 1,345,100 |   |
| Total                  other income                                                            |   |   | 7,553,795 |   |   | 6,668,234 |   |   | 5,999,831 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Other                  expense:                                                                |   |   |   |   |   |   |   |   |   |   |
| Salaries                  and employee benefits                                                |   |   | 11,785,094 |   |   | 10,863,779 |   |   | 10,259,795 |   |
| Occupancy                                                                                      |   |   | 4,180,058 |   |   | 3,948,694 |   |   | 3,672,051 |   |
| Other                                                                                          |   |   | 7,017,986 |   |   | 5,517,832 |   |   | 4,907,923 |   |
| Total                  other expenses                                                          |   |   | 22,983,138 |   |   | 20,330,305 |   |   | 18,839,769 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Earnings                  before income taxes                                                  |   |   | 14,341,117 |   |   | 9,711,880 |   |   | 6,664,236 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Income                  taxes                                                                  |   |   | 5,170,300 |   |   | 3,380,900 |   |   | 2,233,300 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Net                  earnings                                                                  |   | $ | 9,170,817 |   |   | 6,330,980 |   |   | 4,430,936 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Basic                  earnings per share                                                      |   | $ | 2.41 |   |   | 1.67 |   |   | 1.16 |   |
| Diluted                  earnings per share                                                    |   | $ | 2.36 |   |   | 1.64 |   |   | 1.15 |   |
| Cash                  dividends declared per share                                             |   | $ | 0.50 |   |   | 0.37 |   |   | 0.33 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| See                  accompanying notes to consolidated financial statements.                  |   |   |   |   |   |   |   |   |   |   |

----

| **PEOPLES                  BANCORP OF NORTH CAROLINA, INC.**                               |
|--------------------------------------------------------------------------------------------|
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |
| **Consolidated                  Statements of Changes in Shareholders' Equity**            |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |
| **For                  the Years Ended December 31, 2006, 2005 and                  2004** |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   | Accumulated  |   |   |   |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   | Other  |   |   |   |   |
|                                                                                       |   |   | Common                  Stock  |   |   |                      Retained |   |   | Comprehensive |   |   |   |   |
|                                                                                       |   |   |                      Shares  |   |   |                      Amount |   |   |                      Earnings |   |   | Income                  (Loss) |   |   |                      Total |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Balance,                  December 31, 2003                                                |   |   | 3,135,202 |   | $ | 35,121,510 |   |   | 12,844,524 |   |   | 587,862 |   |   | 48,553,896 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash                  dividends declared                                                   |   |   | -                       |   |   | -                       |   |   | (1,257,254 | ) |   | -                       |   |   | (1,257,254 | ) |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Repurchase                  and retirement of common                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| stock                                                                                      |   |   | (15,100 | ) |   | (290,826 | ) |   | -                       |   |   | -                       |   |   | (290,826 | ) |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Exercise                  of stock options                                                 |   |   | 14,972 |   |   | 209,706 |   |   | -                       |   |   | -                       |   |   | 209,706 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net                  earnings                                                              |   |   | -                       |   |   | -                       |   |   | 4,430,936 |   |   | -                       |   |   | 4,430,936 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Change                  in accumulated other                                               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| comprehensive                  income (loss), net of tax                                   |   |   | -                       |   |   | -                       |   |   | -                       |   |   | (708,606 | ) |   | (708,606 | ) |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Balance,                  December 31, 2004                                                |   |   | 3,135,074 |   |   | 35,040,390 |   |   | 16,018,206 |   |   | (120,744 | ) |   | 50,937,852 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 10%                  stock dividend                                                        |   |   | 313,546 |   |   | 6,274,087 |   |   | (6,274,087 | ) |   | -                       |   |   | -                       |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash                  paid in lieu of fractional shares                                    |   |   | -                       |   |   | -                       |   |   | (4,700 | ) |   | -                       |   |   | (4,700 | ) |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash                  dividends declared                                                   |   |   | -                       |   |   | -                       |   |   | (1,414,239 | ) |   | -                       |   |   | (1,414,239 | ) |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Repurchase                  and retirement of common                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| stock                                                                                      |   |   | (15,000 | ) |   | (314,750 | ) |   | -                       |   |   | -                       |   |   | (314,750 | ) |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Exercise                  of stock options                                                 |   |   | 7,185 |   |   | 96,773 |   |   | -                       |   |   | -                       |   |   | 96,773 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net                  earnings                                                              |   |   | -                       |   |   | -                       |   |   | 6,330,980 |   |   | -                       |   |   | 6,330,980 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Change                  in accumulated other                                               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| comprehensive                  income (loss), net of tax                                   |   |   | -                       |   |   | -                       |   |   | -                       |   |   | (1,278,922 | ) |   | (1,278,922 | ) |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Balance,                  December 31, 2005                                                |   |   | 3,440,805 |   |   | 41,096,500 |   |   | 14,656,160 |   |   | (1,399,666 | ) |   | 54,352,994 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 10%                  stock dividend                                                        |   |   | 343,850 |   |   | 9,430,532 |   |   | (9,430,532 | ) |   | -                       |   |   | -                       |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash                  paid in lieu of fractional shares                                    |   |   | -                       |   |   | -                       |   |   | (6,426 | ) |   | -     |   |   | (6,426 | ) |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash                  dividends declared                                                   |   |   | -                       |   |   | -                       |   |   | (1,905,556 | ) |   | -                       |   |   | (1,905,556 | ) |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Repurchase                  and retirement of common                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| stock                                                                                      |   |   | (19,250 | ) |   | (425,000 | ) |   | -                       |   |   | -                       |   |   | (425,000 | ) |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Exercise                  of stock options                                                 |   |   | 65,229 |   |   | 771,325 |   |   | -                       |   |   | -                       |   |   | 771,325 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Stock                  option tax benefit                                                  |   |   | -                       |   |   | 243,100 |   |   | -                       |   |   | -                       |   |   | 243,100 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Stock                  option compensation expense                                         |   |   | -                       |   |   | 5,690 |   |   | -                       |   |   | -                       |   |   | 5,690 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net                  earnings                                                              |   |   | -                       |   |   | -                       |   |   | 9,170,817 |   |   | -                       |   |   | 9,170,817 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Change                  in accumulated other                                               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| comprehensive                  income (loss), net of tax                                   |   |   | -                       |   |   | -                       |   |   | -                       |   |   | 628,429 |   |   | 628,429 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Balance,                  December 31, 2006                                                |   |   | 3,830,634 |   | $ | 51,122,147 |   |   | 12,484,463 |   |   | (771,237 | ) |   | 62,835,373 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| See                  accompanying notes to consolidated financial statements.              |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |

----

| **PEOPLES                  BANCORP OF NORTH CAROLINA, INC. AND                  SUBSIDIARIES** |
|------------------------------------------------------------------------------------------------|
|                                                                                           |   |   |   |   |   |   |   |
| **Consolidated                  Statements of Comprehensive Income**                           |
|                                                                                           |   |   |   |   |   |   |   |
| **For                  the Years Ended December 31, 2006, 2005 and                  2004**     |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
|                                                                                           |   |   | 2006 |   |   | 2005 |   |   | 2004 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Net                  earnings                                                                  |   | $ | 9,170,817 |   |   | 6,330,980 |   |   | 4,430,936 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Other                  comprehensive income (loss):                                            |   |   |   |   |   |   |   |   |   |   |
| Unrealized                  holding gains (losses) on securities                               |   |   |   |   |   |   |   |   |   |   |
| available                  for sale                                                            |   |   | 197,569 |   |   | (3,045,565 | ) |   | 30,988 |   |
| Reclassification                  adjustment for losses on                                     |   |   |   |   |   |   |   |   |   |   |
| sales                  of securities available for sale included                               |   |   |   |   |   |   |   |   |   |   |
| in                  net earnings                                                               |   |   | 591,856 |   |   | 729,727 |   |   | 63,688 |   |
| Unrealized                  holding losses on derivative                                       |   |   |   |   |   |   |   |   |   |   |
| financial                  instruments qualifying as cash flow                                 |   |   |   |   |   |   |   |   |   |   |
| hedges                                                                                         |   |   | (345,049 | ) |   | (283,493 | ) |   | (702,000 | ) |
| Reclassification                  adjustment for losses (gains) on                             |   |   |   |   |   |   |   |   |   |   |
| derivative                  financial instruments qualifying as                                |   |   |   |   |   |   |   |   |   |   |
| cash                  flow hedges included in net earnings                                     |   |   | 386,285 |   |   | 483,715 |   |   | (553,375 | ) |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Total                  other comprehensive income (loss),                                      |   |   |   |   |   |   |   |   |   |   |
| before                  income taxes                                                           |   |   | 830,661 |   |   | (2,115,616 | ) |   | (1,160,699 | ) |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Income                  tax expense (benefit) related to other                                 |   |   |   |   |   |   |   |   |   |   |
| comprehensive                  income:                                                         |   |   |   |   |   |   |   |   |   |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Unrealized                  holding gains (losses) on securities                               |   |   |   |   |   |   |   |   |   |   |
| available                  for sale                                                            |   |   | 76,953 |   |   | (1,186,248 | ) |   | 12,070 |   |
| Reclassification                  adjustment for losses on                                     |   |   |   |   |   |   |   |   |   |   |
| sales                  of securities available for sale included                               |   |   |   |   |   |   |   |   |   |   |
| in                  net earnings                                                               |   |   | 230,528 |   |   | 284,229 |   |   | 24,806 |   |
| Unrealized                  holding losses on derivative                                       |   |   |   |   |   |   |   |   |   |   |
| financial                  instruments qualifying as cash flow                                 |   |   |   |   |   |   |   |   |   |   |
| hedges                                                                                         |   |   | (255,707 | ) |   | (123,082 | ) |   | (273,429 | ) |
| Reclassification                  adjustment for losses (gains) on                             |   |   |   |   |   |   |   |   |   |   |
| derivative                  financial instruments qualifying as                                |   |   |   |   |   |   |   |   |   |   |
| cash                  flow hedges included in net earnings                                     |   |   | 150,458 |   |   | 188,407 |   |   | (215,540 | ) |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Total                  income tax expense (benefit) related to                                 |   |   |   |   |   |   |   |   |   |   |
| other                  comprehensive income                                                    |   |   | 202,232 |   |   | (836,694 | ) |   | (452,093 | ) |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Total                  other comprehensive income (loss),                                      |   |   |   |   |   |   |   |   |   |   |
| net                  of tax                                                                    |   |   | 628,429 |   |   | (1,278,922 | ) |   | (708,606 | ) |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Total                  comprehensive income                                                    |   | $ | 9,799,246 |   |   | 5,052,058 |   |   | 3,722,330 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| See                  accompanying notes to consolidated financial statements.                  |   |   |   |   |   |   |   |   |   |   |

----

| **PEOPLES                  BANCORP OF NORTH CAROLINA, INC.**                               |
|--------------------------------------------------------------------------------------------|
|                                                                                       |   |   |   |   |   |   |   |
| **Consolidated                  Statements of Cash Flows**                                 |
|                                                                                       |   |   |   |   |   |   |   |
| **For                  the Years Ended December 31, 2006, 2005 and                  2004** |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |
|                                                                                       |   |   | 2006 |   |   | 2005 |   |   | 2004 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |
| Cash                  flows from operating activities:                                     |   |   |   |   |   |   |   |   |   |   |
| Net                  earnings                                                              |   | $ | 9,170,817 |   |   | 6,330,980 |   |   | 4,430,936 |   |
| Adjustments                  to reconcile net earnings to                                  |   |   |   |   |   |   |   |   |   |   |
| net                  cash provided by operating activities:                                |   |   |   |   |   |   |   |   |   |   |
| Depreciation,                  amortization and accretion                                  |   |   | 1,616,558 |   |   | 1,643,459 |   |   | 1,563,245 |   |
| Provision                  for loan losses                                                 |   |   | 2,513,282 |   |   | 3,110,000 |   |   | 3,256,000 |   |
| Deferred                  income taxes                                                     |   |   | (615,626 | ) |   | 332,806 |   |   | 341,441 |   |
| Loss                  on sale of investment securities                                     |   |   | 591,856 |   |   | 729,727 |   |   | 63,688 |   |
| Recognition                  of gain (loss) on sale of                                     |   |   |   |   |   |   |   |   |   |   |
| derivative                  instruments                                                    |   |   | 386,285 |   |   | 483,715 |   |   | (553,375 | ) |
| Amortization                  of deferred gain on sale of premises                         |   |   | (20,896 | ) |   | (21,984 | ) |   | (22,412 | ) |
| Loss                  (gain) on sale of repossessed assets                                 |   |   | (2,288 | ) |   | (2,189 | ) |   | 15,412 |   |
| Writedown                  of other real estate and repossessions                          |   |   | 110,000 |   |   | 40,000 |   |   | 164,474 |   |
| Amortization                  of deferred issuance costs on                                |   |   |   |   |   |   |   |   |   |   |
| trust                  preferred securities                                                |   |   | 461,298 |   |   | 17,742 |   |   | 17,742 |   |
| Stock                  option compensation expense                                         |   |   | 5,690 |   |   | -                       |   |   | -                       |   |
| Change                  in:                                                                |   |   |   |   |   |   |   |   |   |   |
| Mortgage                  loans held for sale                                              |   |   | 2,247,900 |   |   | 1,535,275 |   |   | (3,195,680 | ) |
| Cash                  surrender value of life insurance                                    |   |   | (220,649 | ) |   | (277,569 | ) |   | (988,739 | ) |
| Other                  assets                                                              |   |   | (1,206,937 | ) |   | 444,944 |   |   | (3,460,214 | ) |
| Other                  liabilities                                                         |   |   | (230,144 | )  |   | 651,204 |   |   | 1,470,823 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |
| Net                  cash provided by operating activities                                 |   |   | 14,807,146 |   |   | 15,018,110 |   |   | 3,103,341 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |
| Cash                  flows from investing activities:                                     |   |   |   |   |   |   |   |   |   |   |
| Purchases                  of investment securities available for sale                     |   |   | (30,579,262 | ) |   | (49,431,813 | ) |   | (48,667,610 | ) |
| Proceeds                  from calls and maturities of investment securities               |   |   |   |   |   |   |   |   |   |   |
| available                  for sale                                                        |   |   | 8,562,058 |   |   | 9,655,995 |   |   | 19,413,975 |   |
| Proceeds                  from sales of investment securities available                    |   |   |   |   |   |   |   |   |   |   |
| for                  sale                                                                  |   |   | 19,871,979 |   |   | 27,768,392 |   |   | 2,986,313 |   |
| Purchases                  of other investments                                            |   |   | (12,748,200 | ) |   | (5,367,790 | ) |   | (4,822,500 | ) |
| Proceeds                  from sale of other investments                                   |   |   | 11,263,500 |   |   | 4,239,000 |   |   | 3,642,514 |   |
| Net                  change in loans                                                       |   |   | (86,825,349 | ) |   | (35,062,738 | ) |   | 12,578,820 |   |
| Purchases                  of premises and equipment                                       |   |   | (1,624,299 | ) |   | (1,373,019 | ) |   | (1,502,346 | ) |
| Proceeds                  from sale of premises and equipment                              |   |   | -                       |   |   | 1,750 |   |   | -                       |   |
| Proceeds                  from sale of repossessed assets                                  |   |   | 825,115 |   |   | 246,218 |   |   | 2,153,103 |   |
| Purchases                  of derivative financial instruments                             |   |   | (961,500 | ) |   | (364,000 | ) |   | -                       |   |
| Proceeds                  from (payment on) settlement of                                  |   |   |   |   |   |   |   |   |   |   |
| derivative                  financial instruments                                          |   |   | -                       |   |   | (870,000 | ) |   | -                       |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |
| Net                  cash used by investing activities                                     |   |   | (92,215,958 | ) |   | (50,558,005 | ) |   | (14,217,731 | ) |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |
| Cash                  flows from financing activities:                                     |   |   |   |   |   |   |   |   |   |   |
| Net                  change in deposits                                                    |   |   | 50,966,628 |   |   | 26,331,588 |   |   | 6,719,841 |   |
| Net                  change in demand notes payable to U.S. Treasury                       |   |   | 126,307 |   |   | 289,301 |   |   | 741,008 |   |
| Net                  change in securities sold under agreement to repurchase               |   |   | 5,436,753 |   |   | 981,050 |   |   | -                       |   |
| Proceeds                  from FHLB borrowings                                             |   |   | 700,800,000 |   |   | 162,300,000 |   |   | 95,850,000 |   |
| Repayments                  of FHLB borrowings                                             |   |   | (683,100,000 | ) |   | (149,700,000 | ) |   | (94,850,000 | ) |
| Proceeds                  from issuance of trust preferred securities                      |   |   | 20,619,000 |   |   | -                       |   |   | -                       |   |
| Repayments                  of trust preferred securities                                  |   |   | (14,433,000 | ) |   | -                       |   |   | -                       |   |
| Proceeds                  from exercise of stock options                                   |   |   | 1,014,425 |   |   | 96,773 |   |   | 209,706 |   |
| Common                  stock repurchased                                                  |   |   | (425,000 | ) |   | (314,750 | ) |   | (290,826 | ) |
| Cash                  paid in lieu of fractional shares                                    |   |   | (6,426 | ) |   | (4,700 | ) |   | -                       |   |
| Cash                  dividends paid                                                       |   |   | (1,905,556 | ) |   | (1,414,239 | ) |   | (1,257,254 | ) |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |
| Net                  cash provided by financing activities                                 |   |   | 79,093,131 |   |   | 38,565,023 |   |   | 7,122,475 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |
| Net                  change in cash and cash equivalent                                    |   |   | 1,684,319 |   |   | 3,025,128 |   |   | (3,991,915 | ) |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |
| Cash                  and cash equivalents at beginning of period                          |   |   | 19,815,999 |   |   | 16,790,871 |   |   | 20,782,786 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |
| Cash                  and cash equivalents at end of period                                |   | $ | 21,500,318 |   |   | 19,815,999 |   |   | 16,790,871 |   |

----

| **PEOPLES                  BANCORP OF NORTH CAROLINA, INC.**                               |
|--------------------------------------------------------------------------------------------|
|                                                                                       |   |   |   |   |   |   |   |
| **Consolidated                  Statements of Cash Flows, continued**                      |
|                                                                                       |   |   |   |   |   |   |   |
| **For                  the Years ended December 31, 2006, 2005 and                  2004** |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |
|                                                                                       |   |   |                    2006 |   |   |                    2005 |   |   |                    2004 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |
| Supplemental                  disclosures of cash flow information:                        |   |   |   |   |   |   |   |   |   |   |
| Cash                  paid during the year for:                                            |   |   |   |   |   |   |   |   |   |   |
| Interest                                                                                   |   | $ | 23,171,572 |   |   | 15,189,559 |   |   | 11,833,234 |   |
| Income                  taxes                                                              |   | $ | 6,398,100 |   |   | 2,245,000 |   |   | 2,483,394 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |
| Noncash                  investing and financing activities:                               |   |   |   |   |   |   |   |   |   |   |
| Change                  in unrealized gain (loss) on investment securities                 |   |   |   |   |   |   |   |   |   |   |
| available                  for sale, net                                                   |   | $ | 481,944 |   |   | (1,413,819 | ) |   | 57,800 |   |
| Change                  in unrealized gain (loss) on derivative financial                  |   |   |   |   |   |   |   |   |   |   |
| instruments,                  net                                                          |   | $ | 146,485 |   |   | 134,897 |   |   | (766,406 | ) |
| Transfer                  of loans to other real estate and repossessions                  |   | $ | 746,004 |   |   | 133,210 |   |   | 1,362,138 |   |
| Financed                  portion of sale of other real estate                             |   | $ | 273,000 |   |   | -                       |   |   | 2,212,142 |   |
| Transfer                  of retained earnings to common stock for                         |   |   |   |   |   |   |   |   |   |   |
| issuance                  of stock dividend                                                |   | $ | 9,430,532 |   |   | 6,274,087 |   |   | -                       |   |
| Reclassification                  of a security from other investments                     |   |   |   |   |   |   |   |   |   |   |
| to                  securities available for sale                                          |   | $ | -     |   |   | 715,000 |   |   | -                       |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |
| See                  accompanying notes to consolidated financial statements.              |   |   |   |   |   |   |   |   |   |   |

----

**PEOPLES      BANCORP OF NORTH CAROLINA, INC.**

**Notes      to Consolidated Financial Statements**

**(1)**
**Summary      of Significant Accounting Policies**

----

----

| Buildings                and improvements |   |  10                - 50 years |
|-------------------------------------------|--------|------------------------------------|
| Furniture                and equipment    |   |  3                - 10 years  |

----

| **Stock                  Option Activity**                                                 |
|--------------------------------------------------------------------------------------------|
| **For                  the years ended December 31, 2006, 2005 and                  2004** |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                       |   |   |                      Shares  |   |   | Weighted                  Average                  Option Price                  Per Share |   |   | Weighted                  Average Remaining Contractual                  Term (in years) |   |   | Aggregate                  Intrinsic Value |   |
| Outstanding,                  December 31, 2003                                            |   |   | 238,409 |   | $ | 12.91 |   |   |   |   |   |   |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Granted                  during the period                                                 |   |   | 4,840 |   |   | 15.66 |   |   |   |   |   |   |   |
| Forfeited                  during the period                                               |   |   | (2,486 | ) |   | 11.99 |   |   |   |   |   |   |   |
| Exercised                  during the period                                               |   |   | (18,112 | ) |   | 11.57 |   |   |   |   |   |   |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Outstanding,                  December 31, 2004                                            |   |   | 222,652 |   |   | 12.17 |   |   |   |   |   |   |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Granted                  during the period                                                 |   |   | -                       |   |   | -                       |   |   |   |   |   |   |   |
| Forfeited                  during the period                                               |   |   | (1,313 | ) |   | 11.65 |   |   |   |   |   |   |   |
| Exercised                  during the period                                               |   |   | (8,210 | ) |   | 11.79 |   |   |   |   |   |   |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Outstanding,                  December 31, 2005                                            |   |   | 213,128 |   |   | 12.19 |   |   |   |   |   |   |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Granted                  during the period                                                 |   |   | -                       |   |   | -                       |   |   |   |   |   |   |   |
| Forfeited                  during the period                                               |   |   | (110 | ) |   | 11.07 |   |   |   |   |   |   |   |
| Exercised                  during the period                                               |   |   | (65,229 | ) |   | 11.81 |   |   |   |   |   |   |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Outstanding,                  December 31, 2006                                            |   |   | 147,789 |   | $ | 12.36 |   |   | 4.94 |   | $ | 2,314,401 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Exercisable,                  December 31, 2006                                            |   |   | 146,175 |   | $ | 12.32 |   |   | 4.91 |   | $ | 2,294,448 |   |

----

|                                          |   |   |                                     |   |   | 2005      |   |   | 2004      |   |
|-----------------------------------------------|--------|--------|------------------------------------------|--------|--------|-----------|--------|--------|-----------|--------|
|                                          |   |   |                                     |   |   |      |   |   |      |   |
| Net                    earnings               |   |   | As                    reported           |   | $      | 6,330,980 |   |   | 4,430,936 |   |
|                                          |   |   | Effect                    of grants      |   |   | (143,747  | )      |   | (312,444  | )      |
|                                          |   |   | Effect                    of forfeitures |   |   | 5,253     |   |   | 14,092    |   |
|                                          |   |   |                                     |   |   |      |   |   |      |   |
|                                          |   |   | Proforma                                 |   | $      | 6,192,486 |   |   | 4,132,584 |   |
|                                          |   |   |                                     |   |   |      |   |   |      |   |
| Basic                    earnings per share   |   |   | As                    reported           |   | $      | 1.67      |   |   | 1.16      |   |
|                                          |   |   | Proforma                                 |   | $      | 1.63      |   |   | 1.09      |   |
|                                          |   |   |                                     |   |   |      |   |   |      |   |
| Diluted                    earnings per share |   |   | As                    reported           |   | $      | 1.64      |   |   | 1.15      |   |
|                                          |   |   | Proforma                                 |   | $      | 1.61      |   |   | 1.07      |   |

| For                    the year ended December 31, 2006: |   |   |                      Net Earnings  |   |   |                       Common                       Shares |   |   |                       Per Share                          Amount   |   |
|----------------------------------------------------------|--------|--------|-----------------------------------------|--------|--------|-------------------------------------------------------------------------------|--------|--------|----------------------------------------------------------------------------------------------------------------|--------|
| Basic                    earnings per share              |   | $      | 9,170,817                               |   |   | 3,801,219                                                                     |   | $      | 2.41                                                                                                           |   |
| Effect                    of dilutive securities:        |   |   |                                    |   |   |                                                                          |   |   |                                                                                                           |   |
| Stock                    options                         |   |   | -                        |   |   | 89,943                                                                        |   |   |                                                                                                           |   |
| Diluted                    earnings per share            |   | $      | 9,170,817                               |   |   | 3,891,162                                                                     |   | $      | 2.36                                                                                                           |   |
|                                                     |   |   |                                    |   |   |                                                                          |   |   |                                                                                                           |   |
| For                    the year ended December 31, 2005: |   |   | Net                    Earnings         |   |   |                      Common                       Shares       |   |   | Per                    Share Amount                                                                            |   |
| Basic                    earnings per share              |   | $      | 6,330,980                               |   |   | 3,794,860                                                                     |   | $      | 1.67                                                                                                           |   |
| Effect                    of dilutive securities:        |   |   |                                    |   |   |                                                                          |   |   |                                                                                                           |   |
| Stock                    options                         |   |   | -                        |   |   | 59,825                                                                        |   |   |                                                                                                           |   |
| Diluted                    earnings per share            |   | $      | 6,330,980                               |   |   | 3,854,685                                                                     |   | $      | 1.64                                                                                                           |   |

----

| For                    the year ended December 31, 2004: |   |   | Net                    Earnings               |   |   |                      Common                      Shares |   |   |                      Per Share                      Amount |   |
|----------------------------------------------------------|--------|--------|-----------------------------------------------|--------|--------|-------------------------------------------------------------------|--------|--------|---------------------------------------------------------------------------|--------|
| Basic                    earnings per share              |   | $      | 4,430,936                      |   |   | 3,805,317                                          |   | $      | 1.16                                                            |   |
| Effect                    of dilutive securities:        |   |   |                                          |   |   |                                                              |   |   |                                                                      |   |
| Stock                    options                         |   |   | -                         |   |   | 47,396                                             |   |   |                                                                      |   |
| Diluted                    earnings per share            |   | $      | 4,430,936                      |   |   | 3,852,713                                          |   | $      | 1.15                                                            |   |

*.*

----

| **(2)** | **Investment                    Securities** |
|---------|----------------------------------------------|

|                                                      |    |  December                          31, 2006 |
|-----------------------------------------------------------|---------|--------------------------------------------------|
|                                                      |    |  Amortized                          Cost    |   | Gross                          Unrealized                          Gains |   | Gross                          Unrealized                          Losses |   | Estimated                          Fair Value |   |
|                                                      |    |                                        |   |   |   |   |   |   |   |
| Mortgage-backed                          securities       |  $ |  19,666,345                                 |   | -                               |   | 446,751 |   | 19,219,594 |   |
| U.S.                          government agencies         |    |  72,838,407                                 |   | 171,828 |   | 265,821 |   | 72,744,414 |   |
| State                          and political subdivisions |    |                                             | 24,493,444 |   |   | 242,204 |   |   | 369,178 |   |   | 24,366,470 |   |
| Trust                          preferred securities       |    |                                             | 750,000 |   |   | -                               |   |   | -                               |   |   | 750,000 |   |
| Equity                          securities                |    |                                             | 814,995 |   |   | -                               |   |   | 314,473 |   |   | 500,522 |   |
|                                                      |    |                                             |   |   |   |   |   |   |   |   |   |   |   |
| Total                                                     | $       |                                             | 118,563,191 |   |   | 414,032 |   |   | 1,396,223 |   |   | 117,581,000 |   |
|                                                      |    |                                             |   |   |   |   |   |   |   |   |   |   |   |
|                                                      |    |                                             | December                          31, 2005  |
|                                                      |    |                                             | Amortized                          Cost |   |   | Gross                          Unrealized                          Gains |   |   | Gross                          Unrealized                          Losses |   |   | Estimated                          Fair Value |   |
|                                                      |    |                                             |   |   |   |   |   |   |   |   |   |   |   |
| Mortgage-backed                          securities       |  $ |                                             | 31,865,547 |   |   | -                               |   |   | 861,583 |   |   | 31,003,964 |   |
| U.S.                          government agencies         |    |                                             | 60,751,179 |   |   | 83,410 |   |   | 591,506 |   |   | 60,243,083 |   |
| State                          and political subdivisions |    |                                             | 21,748,079 |   |   | 268,720 |   |   | 407,307 |   |   | 21,609,492 |   |
| Trust                          preferred securities       |    |                                             | 1,750,000 |   |   | -                               |   |   | -                               |   |   | 1,750,000 |   |
| Equity                          securities                |    |                                             | 814,995 |   |   | -                               |   |   | 263,350 |   |   | 551,645 |   |
|                                                      |    |                                             |   |   |   |   |   |   |   |   |   |   |   |
| Total                                                     |  $ |                                             | 116,929,800 |   |   | 352,130 |   |   | 2,123,746 |   |   | 115,158,184 |   |

|                                                    |   |   | December                        31, 2006     |   |
|---------------------------------------------------------|--------|--------|---------------------------------------------------|--------|
|                                                    |   |   | Less                        than 12 Months   |   |   | 12                        Months or More |   |   | Total |   |
|                                                    |   |   | Fair                        Value                 |   |   | Unrealized                        Losses |   |   | Fair                        Value |   |   | Unrealized                        Losses |   |   | Fair                        Value |   |   | Unrealized                        Losses |   |
|                                                    |   |   |                                              |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Mortgage-backed                        securities       |   | $      | -                                  |   |   | -                             |   |   | 19,202,188 |   |   | 446,751 |   |   | 19,202,188 |   |   | 446,751 |   |
| U.S.                        government agencies         |   |   | 23,069,770                                        |   |   | 13,361 |   |   | 21,510,425 |   |   | 252,460 |   |   | 44,580,195 |   |   | 265,821 |   |
| State                        and political subdivisions |   |   | 1,445,462                                         |   |   | 35,988 |   |   | 11,589,682 |   |   | 333,190 |   |   | 13,035,144 |   |   | 369,178 |   |
| Equity                        securities                |   |   | -                             |   |   | -                             |   |   | 500,522 |   |   | 314,473 |   |   | 500,522 |   |   | 314,473 |   |
|                                                    |   |   |                                              |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                                                   |   | $      | 24,515,232                                        |   |   | 49,349 |   |   | 52,802,817 |   |   | 1,346,874 |   |   | 77,318,049 |   |   | 1,396,223 |   |

----

|                                                    |   |   | December                        31, 2005    |   |
|---------------------------------------------------------|--------|--------|--------------------------------------------------|--------|
|                                                    |   |   | Less                        than 12 Months  |   |   | 12                        Months or More |   |   | Total |   |
|                                                    |   |   | Fair                        Value           |   |   | Unrealized                        Losses |   |   | Fair                        Value |   |   | Unrealized                        Losses |   |   | Fair                        Value |   |   | Unrealized                        Losses |   |
|                                                    |   |   |                                             |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Mortgage-backed                        securities       |   | $      | 19,267,931                                       |   |   | 436,110 |   |   | 11,725,154 |   |   | 425,473 |   |   | 30,993,085 |   |   | 861,583 |   |
| U.S.                        government agencies         |   |   | 27,541,468                                       |   |   | 313,598 |   |   | 11,221,262 |   |   | 277,908 |   |   | 38,762,730 |   |   | 591,506 |   |
| State                        and political subdivisions |   |   | 5,986,444                                        |   |   | 106,833 |   |   | 6,546,483 |   |   | 300,474 |   |   | 12,532,927 |   |   | 407,307 |   |
| Equity                        securities                |   |   | 479,050                                          |   |   | 235,950 |   |   | 72,595 |   |   | 27,400 |   |   | 551,645 |   |   | 263,350 |   |
|                                                    |   |   |                                             |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                                                   |   | $      | 53,274,893                                       |   |   | 1,092,491 |   |   | 29,565,494 |   |   | 1,031,255 |   |   | 82,840,387 |   |   | 2,123,746 |   |

|                                              |   |   | Amortized                        Cost  |   |   | Estimated                        Fair Value |   |
|---------------------------------------------------|--------|--------|---------------------------------------------|--------|--------|---------------------------------------------|--------|
|                                              |   |   |                                        |   |   |                                        |   |
| Due                        within one year        |   | $      | 910,301                                     |   |   | 914,199                                     |   |
| Due                        from one to five years |   |   | 59,133,199                                  |   |   | 58,715,846                                  |   |
| Due                        from five to ten years |   |   | 33,563,846                                  |   |   | 33,669,408                                  |   |
| Due                        after ten years        |   |   | 4,474,505                                   |   |   | 4,561,431                                   |   |
| Mortgage-backed                        securities |   |   | 19,666,345                                  |   |   | 19,219,594                                  |   |
| Equity                        securities          |   |   | 814,995                                     |   |   | 500,522                                     |   |
|                                              |   |   |                                        |   |   |                                        |   |
| Total                                             |   | $      | 118,563,191                                 |   |   | 117,581,000                                 |   |

**(3)**
**Loans**

|                                                  |   |   | 2006        |   |   | 2005        |   |
|-------------------------------------------------------|--------|--------|-------------|--------|--------|-------------|--------|
|                                                  |   |   |        |   |   |        |   |
| Commercial                                            |   | $      | 85,064,322  |   |   | 79,902,157  |   |
| Real                        estate - mortgage         |   |   | 364,595,188 |   |   | 330,226,315 |   |
| Real                        estate - construction     |   |   | 187,959,880 |   |   | 141,420,338 |   |
| Consumer                                              |   |   | 13,761,739  |   |   | 15,114,606  |   |
|                                                  |   |   |        |   |   |        |   |
| Total                        loans                    |   |   | 651,381,129 |   |   | 566,663,416 |   |
|                                                  |   |   |        |   |   |        |   |
| Less                        allowance for loan losses |   |   | 8,303,432   |   |   | 7,424,782   |   |
|                                                  |   |   |        |   |   |        |   |
| Total                        net loans                |   | $      | 643,077,697 |   |   | 559,238,634 |   |

----

|                                                                |   |   | 2006       |   |   | 2005       |   |   | 2004       |   |
|---------------------------------------------------------------------|--------|--------|------------|--------|--------|------------|--------|--------|------------|--------|
|                                                                |   |   |       |   |   |       |   |   |       |   |
| Balance                        at beginning of year                 |   | $      | 7,424,782  |   |   | 8,048,627  |   |   | 9,722,267  |   |
| Amounts                        charged off                          |   |   | (1,958,551 | )      |   | (4,199,650 | )      |   | (5,385,199 | )      |
| Recoveries                        on amounts previously charged off |   |   | 323,919    |   |   | 465,805    |   |   | 455,559    |   |
| Provision                        for loan losses                    |   |   | 2,513,282  |   |   | 3,110,000  |   |   | 3,256,000  |   |
|                                                                |   |   |       |   |   |       |   |   |       |   |
| Balance                        at end of year                       |   | $      | 8,303,432  |   |   | 7,424,782  |   |   | 8,048,627  |   |

**(4)**
**Premises            and Equipment**

|                                                    |   |   | 2006       |   |   | 2005       |   |
|---------------------------------------------------------|--------|--------|------------|--------|--------|------------|--------|
|                                                    |   |   |       |   |   |       |   |
| Land                                                    |   | $      | 2,349,041  |   |   | 2,187,254  |   |
| Buildings                        and improvements       |   |   | 10,618,896 |   |   | 10,405,684 |   |
| Furniture                        and equipment          |   |   | 13,992,524 |   |   | 12,743,224 |   |
|                                                    |   |   |       |   |   |       |   |
| Total                        premises and equipment     |   |   | 26,960,461 |   |   | 25,336,162 |   |
|                                                    |   |   |       |   |   |       |   |
| Less                        accumulated depreciation    |   |   | 14,144,076 |   |   | 12,674,009 |   |
|                                                    |   |   |       |   |   |       |   |
| Total                        net premises and equipment |   | $      | 12,816,385 |   |   | 12,662,153 |   |

**(5)**
**Time            Deposits**

| 2007                                       |   | $      | 333,430,893 |   |
|--------------------------------------------|--------|--------|-------------|--------|
| 2008                                       |   |   | 17,734,675  |   |
| 2009                                       |   |   | 4,001,857   |   |
| 2010                                       |   |   | 2,478,971   |   |
| 2011                        and thereafter |   |   | 203,110     |   |
|                                       |   |   |        |   |
| Total                                      |   | $      | 357,849,506 |   |

----

**(6)**
**Federal            Home Loan Bank Advances**

| Maturity                        Date     |   | Call                        Date |                                                 | Rate   |   | Rate                        Type |   | Amount   |                              |
|------------------------------------------|--------|----------------------------------|------------------------------------------------------|--------|--------|----------------------------------|--------|--------------------|-----------------------------------|
|                                     |   |                             |                                                 |   |   |                             |   |               |                              |   |   |   |   |
| February                        2, 2007  |   |                             | N/A                                                  |   |   | 5.490                            | %      |               | Daily                        Rate |   | $ | 19,800,000 |   |
|                                     |   |                             |                                                 |   |   |                             |   |               |                              |   |   |   |   |
| March                        30, 2010    |   |                             | September                        30, 2000 and every  |   |   |                             |   |               |                              |   |   |   |   |
|                                     |   |                             | three                        months thereafter       |   |   | 5.880                            | %      |               | Convertible                       |   |   | 5,000,000 |   |
|                                     |   |                             |                                                 |   |   |                             |   |               |                              |   |   |   |   |
| May                        24, 2010      |   |                             | May                        24, 2001 and every three  |   |   |                             |   |               |                              |   |   |   |   |
|                                     |   |                             | months                        thereafter        |   |   | 6.490                            | %      |               | Convertible                       |   |   | 2,000,000 |   |
|                                     |   |                             |                                                 |   |   |                             |   |               |                              |   |   |   |   |
| January                        25, 2007  |   |                             | N/A                                                  |   |   | 5.397                            | %      |               | Adjustable                        |   |   | 2,500,000 |   |
|                                     |   |                             |                                                 |   |   |                             |   |               |                              |   |   |   |   |
| June                        24, 2015     |   |                             | June                        24, 2010                 |   |   | 3.710                            | %      |               | Convertible                       |   |   | 5,000,000 |   |
|                                     |   |                             |                                                 |   |   |                             |   |               |                              |   |   |   |   |
| July                        23, 2012     |   |                             | July                        23, 2007                 |   |   | 4.850                            | %      |               | Convertible                       |   |   | 5,000,000 |   |
|                                     |   |                             |                                                 |   |   |                             |   |               |                              |   |   |   |   |
| March                        25, 2019    |   |                             | March                        25, 2009                |   |   | 4.865                            | %      |               | Convertible                       |   |   | 5,000,000 |   |
|                                     |   |                             |                                                 |   |   |                             |   |               |                              |   |   |   |   |
| March                        31, 2016    |   |                             | March                        31, 2009 and every      |   |   |                             |   |               |                              |   |   |   |   |
|                                     |   |                             | three                        months thereafter  |   |   | 4.620                            | %      |               | Convertible                       |   |   | 5,000,000 |   |
|                                     |   |                             |                                                 |   |   |                             |   |               |                              |   |   |   |   |
| October                        5, 2016   |   |                             | October                        5, 2009               |   |   | 4.450                            | %      |               | Convertible                       |   |   | 5,000,000 |   |
|                                     |   |                             |                                                 |   |   |                             |   |               |                              |   |   |   |   |
| October                        5, 2011   |   |                             | April                        5, 2007 and every       |   |   |                             |   |               |                              |   |   |   |   |
|                                     |   |                             | month                        thereafter         |   |   | 4.350                            | %      |               | Convertible                       |   |   | 30,000,000 |   |
|                                     |   |                             |                                                 |   |   |                             |   |               |                              |   |   |   |   |
| December                        12, 2011 |   |                             | December                        12, 2007 and every   |   |   | 4.210                            | %      |               | Convertible                       |   |   | 5,000,000 |   |
|                                     |   |                             | three                        months thereafter       |   |   |                             |   |               |                              |   |   |   |   |
|                                     |   |                             |                                                 |   |   |                             |   |               |                              |   |   |   |   |
|                                     |   |                             |                                                 |   |   |                             |   |               |                              |   | $ | 89,300,000 |   |

**(7)**
**Junior            Subordinated Debentures**

----

**(8)**
**Income            Taxes**

|     |   |   |                                        2006  |   |   |                             2005  |   |   |                               2004  |   |
|----------|--------|--------|------------------------------------------------------------------------------------------------------------------------------|--------|--------|------------------------------------------------------------|--------|--------|------------------------------------------------------------------------|--------|
| Current  |   | $      | 5,785,926                                                                                                                    |   |   | 3,048,094                                                  |   |   | 1,891,859                                                              |   |
| Deferred |   |   | (615,626                                                                                                                     | )      |   | 332,806                                                    |   |   | 341,441                                                                |   |
| Total    |   | $      | 5,170,300                                                                                                                    |   |   | 3,380,900                                                  |   |   | 2,233,300                                                              |   |

|                                                            |   |   |                                 2006   |   |   |                                      2005       |   |   |                                     2004       |   |
|-----------------------------------------------------------------|--------|--------|------------------------------------------------------------------------------------------|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------|--------|
| Pre-tax                        income at statutory rates (34%)  |   | $      | 4,875,980                                                                                |   |   | 3,302,039                                                                                                                                      |   |   | 2,265,840                                                                                                                           |   |
| Differences:                                                    |   |   |                                                                                     |   |   |                                                                                                                                           |   |   |                                                                                                                                |   |
| Tax                        exempt interest income               |   |   | (280,826                                                                                 | )      |   | (263,555                                                                                                                                       | )      |   | (243,346                                                                                                                            | )      |
| Nondeductible                        interest and other expense |   |   | 45,872                                                                                   |   |   | 30,511                                                                                                                                         |   |   | 21,588                                                                                                                              |   |
| Cash                        surrender value of life insurance   |   |   | (75,021                                                                                  | )      |   | (73,973                                                                                                                                        | )      |   | (65,871                                                                                                                             | )      |
| State                        taxes, net of federal benefits     |   |   | 576,444                                                                                  |   |   | 363,264                                                                                                                                        |   |   | 236,544                                                                                                                             |   |
| Other,                        net                               |   |   | 27,851                                                                                   |   |   | 22,614                                                                                                                                         |   |   | 18,545                                                                                                                              |   |
| Total                                                           |   | $      | 5,170,300                                                                                |   |   | 3,380,900                                                                                                                                      |   |   | 2,233,300                                                                                                                           |   |

|                                                                    |   |   |                                2006   |   |   |                                 2005   |   |
|-------------------------------------------------------------------------|--------|--------|------------------------------------------------------------------------------------|--------|--------|------------------------------------------------------------------------------------------|--------|
| Deferred                        tax assets:                             |   |   |                                                                               |   |   |                                                                                     |   |
| Allowance                        for loan losses                        |   | $      | 3,201,305                                                                          |   |   | 2,862,550                                                                                |   |
| Amortizable                        intangible assets                    |   |   | 108,472                                                                            |   |   | 141,010                                                                                  |   |
| Accrued                        retirement expense                       |   |   | 664,581                                                                            |   |   | 533,155                                                                                  |   |
| Income                        from non-accrual loans                    |   |   | 72,475                                                                             |   |   | 9,639                                                                                    |   |
| Deferred                        gain on sale of premises                |   |   | 212,820                                                                            |   |   | 220,876                                                                                  |   |
| Unrealized                        loss on cash flow hedges              |   |   | 328,933                                                                            |   |   | 223,684                                                                                  |   |
| Unrealized                        loss on available for sale securities |   |   | 382,564                                                                            |   |   | 690,044                                                                                  |   |
| Other                                                                   |   |   | -                                                              |   |   | 33,578                                                                                   |   |
| Total                        gross deferred tax assets                  |   |   | 4,971,150                                                                          |   |   | 4,714,536                                                                                |   |
|                                                                    |   |   |                                                                               |   |   |                                                                                     |   |
| Deferred                        tax liabilities:                        |   |   |                                                                               |   |   |                                                                                     |   |
| Deferred                        loan fees                               |   |   | 1,310,178                                                                          |   |   | 1,135,448                                                                                |   |
| Premises                        and equipment                           |   |   | 291,107                                                                            |   |   | 545,570                                                                                  |   |
| Deferred                        income from servicing rights            |   |   | -                                                              |   |   | 87,330                                                                                   |   |
| Other                                                                   |   |   | 10,283                                                                             |   |   | -                                                                    |   |
| Total                        gross deferred tax liabilities             |   |   | 1,611,568                                                                          |   |   | 1,768,348                                                                                |   |
| Net                        deferred tax asset                           |   | $      | 3,359,582                                                                          |   |   | 2,946,188                                                                                |   |

----

**(9)**
**Related            Party Transactions**

| Beginning                      balance |   |   $                                        7,220,72 |      |
|----------------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------|-----------|
| New                      loans         |   |                                                                                                                                                    | 1,882,173 |   |
| Repayments                             |   |                                                                                                                                                    | 1,828,124 |   |
|                                   |   |                                                                                                                                                    |      |   |
| Ending                      balance    |   | $                                                                                                                                                       | 7,274,778 |   |

**(10)**
**Commitments          and Contingencies**

| Year                                          |   |                                                                                                                                                                                           |      |
|-----------------------------------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------|
| 2007                                          |   | $                              1,067,414 |      |
| 2008                                          |   |                                                                                                                                                                                           | 1,035,118 |   |
| 2009                                          |   |                                                                                                                                                                                           | 871,441   |   |
| 2010                                          |   |                                                                                                                                                                                           | 725,288   |   |
| 2011                                          |   |                                                                                                                                                                                           | 659,848   |   |
| Thereafter                                    |   |                                                                                                                                                                                           | 3,649,845 |   |
|                                          |   |                                                                                                                                                                                           |      |   |
| Total                      minimum obligation |   | $                                                                                                                                                                                              | 8,008,954 |   |

|                                                                                    |   |   | Contractual                      Amount |   |
|-----------------------------------------------------------------------------------------|--------|--------|-----------------------------------------|--------|
|                                                                                    |   |   | 2006                                    |   |   | 2005 |   |
| Financial                      instruments whose contract amount represent credit risk: |   |   |                                    |   |   |   |   |
|                                                                                    |   |   |                                    |   |   |   |   |
| Commitments                      to extend credit                                       |   | $      | 151,696,931                             |   |   | 133,409,227 |   |
|                                                                                    |   |   |                                    |   |   |   |   |
| Standby                      letters of credit and financial guarantees written         |   | $      | 4,573,544                               |   |   | 2,692,192 |   |

----

**(11)**
**Derivative          Financial Instruments and Hedging Transactions**

----

**(12)**
**Employer            and Director Benefit Programs**

|                                                                 |   |   | 2006    |   |   | 2005    |   |
|----------------------------------------------------------------------|--------|--------|---------|--------|--------|---------|--------|
|                                                                 |   |   |    |   |   |    |   |
| Accumulated                        postretirement benefit obligation |   | $      | 196,002 |   |   | 244,304 |   |
| Unrecognized                        gain (loss)                      |   |   | (38,327 | )      |   | (80,495 | )      |
|                                                                 |   |   |    |   |   |    |   |
| Net                        liability recognized                      |   | $      | 157,675 |   |   | 163,809 |   |

----

|                                                    |   | 2006   |                                        | 2005   |   | 2004                                                                                                             |   |
|---------------------------------------------------------|--------|--------|---------------------------------------------|--------|--------|------------------------------------------------------------------------------------------------------------------|--------|
|                                                    |   |   |                                        |   |   |                                                                                                             |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                    |   |   | Shares                                      |   |   | Weighted                        Average Price                        of Book                        Value Shares |   |   | Shares |   |   | Weighted                        Average Price                        of Book                        Value Shares |   |   | Shares |   |   | Weighted                        Average Price                        of Book                        Value Shares |   |
|                                                    |   |   |                                        |   |   |                                                                                                             |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Outstanding,                        beginning of period |   |   | 64,918                                      |   | $      | 11.07                                                                                                            |   |   | 77,900 |   | $ | 10.80 |   |   | 58,425 |   |  $ | 9.70 |   |
| Granted                        during the period        |   |   | -                            |   | $      | -                                                                                                 |   |   | -                            |   | $ | -    |   |   | 25,966 |   |  $ | 12.95 |   |
| Forfeited                        during the period      |   |   | -                            |   | $      | -                                                                                                 |   |   | -                            |   | $ | -    |   |   | (1,298 | ) |  $ | 9.46 |   |
| Exercised                        during the period      |   |   | -                            |   | $      | -                                                                                                 |   |   | (12,982 | ) | $ | 9.46 |   |   | (5,193 | ) |  $ | 9.46 |   |
|                                                    |   |   |                                        |   |   |                                                                                                             |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Outstanding,                        end of period       |   |   | 64,918                                      |   | $      | -                                                                                                      |   |   | 64,918 |   | $ | 11.07 |   |   | 77,900 |   |  $ | 10.80 |   |
|                                                    |   |   |                                        |   |   |                                                                                                             |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Number                        of shares exercisable     |   |   | 49,332                                      |   | $      | 10.47                                                                                                            |   |   | 44,139 |   | $ | 10.18 |   |   | 50,305 |   |  $ | 9.66 |   |

**(13)                    Regulatory Matters**

----

|                                                            |   | Actual                                          |    | For                        Capital Adequacy                        Purposes |   | To                        Be Well Capitalized                        Under Prompt                        Corrective Action                        Provisions |   |
|-----------------------------------------------------------------|--------|-------------------------------------------------|---------|-----------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                            |   |                                            |    |                                                                        |   |                                                                                                                                                         |   |   |   |   |   |   |   |
|                                                            |   | Amount                                          |    | Ratio                                                                       |   | Amount                                                                                                                                                       |   | Ratio |   | Amount |   | Ratio |   |
|                                                            |   | *(dollars                        in thousands)* |    |
|                                                            |   |                                            |    |                                                                        |   |                                                                                                                                                         |   |   |   |   |   |   |   |   |   |   |   |   |   |
| As                        of December 31, 2006:                 |   |                                            |    |                                                                        |   |                                                                                                                                                         |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                            |   |                                            |    |                                                                        |   |                                                                                                                                                         |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                        Capital (to Risk-Weighted Assets)  |   |                                            |    |                                                                        |   |                                                                                                                                                         |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consolidated                                                    |   |                                            | $91,718 |                                                                        |   | 12.86%                                                                                                                                                       |   |   | 57,056 |   |   | 8.00% |   |   | N/A |   |   | N/A |   |
| Bank                                                            |   |                                            | $80,857 |                                                                        |   | 11.37%                                                                                                                                                       |   |   | 56,875 |   |   | 8.00% |   |   | 71,094 |   |   | 10.00% |   |
| Tier                        1 Capital (to Risk-Weighted Assets) |   |                                            |    |                                                                        |   |                                                                                                                                                         |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consolidated                                                    |   |                                            | $83,415 |                                                                        |   | 11.70%                                                                                                                                                       |   |   | 28,528 |   |   | 4.00% |   |   | N/A |   |   | N/A |   |
| Bank                                                            |   |                                            | $72,554 |                                                                        |   | 10.21%                                                                                                                                                       |   |   | 28,438 |   |   | 4.00% |   |   | 42,656 |   |   | 6.00% |   |
| Tier                        1 Capital (to Average Assets)       |   |                                            |    |                                                                        |   |                                                                                                                                                         |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consolidated                                                    |   |                                            | $83,415 |                                                                        |   | 10.80%                                                                                                                                                       |   |   | 30,903 |   |   | 4.00% |   |   | N/A |   |   | N/A |   |
| Bank                                                            |   |                                            | $72,554 |                                                                        |   | 9.41%                                                                                                                                                        |   |   | 30,857 |   |   | 4.00% |   |   | 38,571 |   |   | 5.00% |   |
|                                                            |   |                                            |    |                                                                        |   |                                                                                                                                                         |   |   |   |   |   |   |   |   |   |   |   |   |   |
| As                        of December 31, 2005:                 |   |                                            |    |                                                                        |   |                                                                                                                                                         |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                            |   |                                            |    |                                                                        |   |                                                                                                                                                         |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                        Capital (to Risk-Weighted Assets)  |   |                                            |    |                                                                        |   |                                                                                                                                                         |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consolidated                                                    |   |                                            | $76,993 |                                                                        |   | 12.19%                                                                                                                                                       |   |   | 50,514 |   |   | 8.00% |   |   | N/A |   |   | N/A |   |
| Bank                                                            |   |                                            | $73,265 |                                                                        |   | 11.64%                                                                                                                                                       |   |   | 50,360 |   |   | 8.00% |   |   | 62,951 |   |   | 10.00% |   |
| Tier                        1 Capital (to Risk-Weighted Assets) |   |                                            |    |                                                                        |   |                                                                                                                                                         |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consolidated                                                    |   |                                            | $69,568 |                                                                        |   | 11.02%                                                                                                                                                       |   |   | 25,257 |   |   | 4.00% |   |   | N/A |   |   | N/A |   |
| Bank                                                            |   |                                            | $65,840 |                                                                        |   | 10.46%                                                                                                                                                       |   |   | 25,180 |   |   | 4.00% |   |   | 37,770 |   |   | 6.00% |   |
| Tier                        1 Capital (to Average Assets)       |   |                                            |    |                                                                        |   |                                                                                                                                                         |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consolidated                                                    |   |                                            | $69,568 |                                                                        |   | 9.84%                                                                                                                                                        |   |   | 28,273 |   |   | 4.00% |   |   | N/A |   |   | N/A |   |
| Bank                                                            |   |                                            | $65,840 |                                                                        |   | 9.33%                                                                                                                                                        |   |   | 28,217 |   |   | 4.00% |   |   | 35,272 |   |   | 5.00% |   |

**(14)                   Shareholders’ Equity**

**(15)**
**Other            Operating Expense**

|             |   |    |                                  2006 |   |                                 2005 |   |                                 2004 |
|-------------|--------|---------|----------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------|
| Advertising |   |  $ |  772,917                                                                                |   |  656,184                                                                          |   |  619,731                                                                          |

----

**(16)**
**Fair            Value of Financial Instruments**

----

|                                                            |   |   | 2006                      |   |   | 2005                                                 |   |
|-----------------------------------------------------------------|--------|--------|-----------------------------------------------|--------|--------|--------------------------------------------------------------------------|--------|
|                                                            |   |   | Carrying                        Amount   |   |   | Estimated                        Fair                        Value  |   |   | Carrying                        Amount  |   |   | Estimated                        Fair                        Value  |   |
|                                                            |   |   | (dollars                        in thousands) |   |
|                                                            |   |   |                                          |   |   |                                                                     |   |   |   |   |   |   |   |
| Assets:                                                         |   |   |                                          |   |   |                                                                     |   |   |   |   |   |   |   |
| Cash                        and cash equivalents                |   | $      | 21,500                                        |   |   | 21,500                                                                   |   |   | 19,816 |   |   | 19,816 |   |
| Investment                        securities available for sale |   | $      | 117,581                                       |   |   | 117,581                                                                  |   |   | 115,158 |   |   | 115,158 |   |
| Other                        investments                        |   | $      | 7,295                                         |   |   | 7,295                                                                    |   |   | 5,811 |   |   | 5,811 |   |
| Mortgage                        loans held for sale             |   | $      | -                                             |   |   | -                                                                        |   |   | 2,248 |   |   | 2,248 |   |
| Loans,                        net                               |   | $      | 643,078                                       |   |   | 641,414                                                                  |   |   | 559,239 |   |   | 559,122 |   |
| Cash                        surrender value of life insurance   |   | $      | 6,532                                         |   |   | 6,532                                                                    |   |   | 6,312 |   |   | 6,312 |   |
| Mortgage                        servicing rights                |   | $      | -                                             |   |   | -                                                                        |   |   | 227 |   |   | 227 |   |
| Derivative                        instruments                   |   | $      | 481                                           |   |   | 481                                                                      |   |   | 176 |   |   | 176 |   |
|                                                            |   |   |                                          |   |   |                                                                     |   |   |   |   |   |   |   |
| Liabilities:                                                    |   |   |                                          |   |   |                                                                     |   |   |   |   |   |   |   |
| Deposits                        and demand notes payable        |   | $      | 635,420                                       |   |   | 635,371                                                                  |   |   | 584,327 |   |   | 584,786 |   |
| FHLB                        advances                            |   | $      | 89,300                                        |   |   | 88,819                                                                   |   |   | 71,600 |   |   | 71,804 |   |
| Junior                        subordinated debentures           |   | $      | 20,619                                        |   |   | 20,619                                                                   |   |   | 14,433 |   |   | 14,433 |   |

----

**               **

**                **
| **Balance                          Sheets**                                       |   |
|-----------------------------------------------------------------------------------|--------|
|                                                                              |   |   |   |   |   |   |   |
| **December                          31, 2006 and 2005**                           |   |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
| Assets                                                                            |   |   |   |   |   | 2006 |   |   | 2005 |   |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
| Cash                                                                              |   |   |   |   | $ | 1,646,880 |   |   | 519,089 |   |
| Interest-bearing                          time deposit                            |   |   |   |   |   | 8,000,000 |   |   | 2,000,000 |   |
| Investment                          in subsidiaries                               |   |   |   |   |   | 72,593,671 |   |   | 65,057,096 |   |
| Investment                          securities available for sale                 |   |   |   |   |   | 750,521 |   |   | 801,645 |   |
| Other                          investments                                        |   |   |   |   |   | 600,000 |   |   | -                              |   |
| Other                          assets                                             |   |   |   |   |   | 293,049 |   |   | 683,493 |   |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
| Total                          assets                                             |   |   |   |   | $ | 83,884,121 |   |   | 69,061,323 |   |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
|                             Liabilities and Shareholders' Equity        |   |   |   |   |   |   |   |   |   |   |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
| Accrued                          expenses                                         |   |   |   |   | $ | 429,748 |   |   | 275,329 |   |
| Junior                          subordinated debentures                           |   |   |   |   |   | 20,619,000 |   |   | 14,433,000 |   |
| Shareholders'                          equity                                     |   |   |   |   |   | 62,835,373 |   |   | 54,352,994 |   |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
| Total                          liabilities and shareholders' equity               |   |   |   |   | $ | 83,884,121 |   |   | 69,061,323 |   |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
| **Statements                          of Earnings**                               |   |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
| **For                          the Years Ended December 31, 2006, 2005 and 2004** |   |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
| Revenues:                                                                         |   |   | 2006 |   |   | 2005 |   |   | 2004 |   |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
| Dividends                          from subsidiaries                              |   | $ | 3,855,556 |   |   | 2,346,897 |   |   | 1,942,254 |   |
| Interest                          and dividend income                             |   |   | 672,922 |   |   | 111,777 |   |   | 84,172 |   |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
| Total                          revenues                                           |   |   | 4,528,478 |   |   | 2,458,674 |   |   | 2,026,426 |   |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
| Expenses:                                                                         |   |   |   |   |   |   |   |   |   |   |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
| Interest                                                                          |   |   | 1,962,692 |   |   | 938,145 |   |   | 676,547 |   |
| Other                          operating expenses                                 |   |   | 786,014 |   |   | 289,691 |   |   | 280,002 |   |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
| Total                          expenses                                           |   |   | 2,748,706 |   |   | 1,227,836 |   |   | 956,549 |   |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
| Earnings                          before income tax benefit and equity in         |   |   |   |   |   |   |   |   |   |   |
| undistributed                          earnings of subsidiaries                   |   |   | 1,779,772 |   |   | 1,230,838 |   |   | 1,069,877 |   |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
| Income                          tax benefit                                       |   |   | 705,800 |   |   | 379,500 |   |   | 296,700 |   |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
| Earnings                          before undistributed earnings in subsidiaries   |   |   | 2,485,572 |   |   | 1,610,338 |   |   | 1,366,577 |   |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
| Equity                          in undistributed earnings in subsidiaries         |   |   | 6,685,245 |   |   | 4,720,642 |   |   | 3,064,359 |   |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
| Net                          earnings                                             |   | $ | 9,170,817 |   |   | 6,330,980 |   |   | 4,430,936 |   |

----

**                **
| **Statements                          of Cash Flows**                             |   |
|-----------------------------------------------------------------------------------|--------|
|                                                                              |   |   |   |   |   |   |   |   |   |   |
| **For                          the Years Ended December 31, 2006, 2005 and 2004** |   |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
|                                                                              |   |   | 2006 |   |   | 2005 |   |   | 2004 |   |
| Cash                          flows from operating activities:                    |   |   |   |   |   |   |   |   |   |   |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
| Net                          earnings                                             |   | $ | 9,170,817 |   |   | 6,330,980 |   |   | 4,430,936 |   |
| Adjustments                          to reconcile net earnings to net             |   |   |   |   |   |   |   |   |   |   |
| cash                          provided by operating activities:                   |   |   |   |   |   |   |   |   |   |   |
| Amortization                                                                      |   |   | 461,298 |   |   | 17,742 |   |   | 17,742 |   |
| Book                          value shares accrual                                |   |   | 128,444 |   |   | 21,818 |   |   | 66,933 |   |
| Equity                          in undistributed earnings of subsidiaries         |   |   | (6,685,245 | ) |   | (4,720,642 | ) |   | (3,064,359 | ) |
| Deferred                          income tax benefit                              |   |   | (49,520 | ) |   | (8,412 | ) |   | (25,806 | ) |
| Change                          in:                                               |   |   |   |   |   |   |   |   |   |   |
| Accrued                          income                                           |   |   | (1,421 | ) |   | 17,930 |   |   | (9,033 | ) |
| Accrued                          expense                                          |   |   | 25,975 |   |   | (21,063 | ) |   | -                               |   |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
| Net                          cash provided by operating activities                |   |   | 3,050,348 |   |   | 1,638,353 |   |   | 1,416,413 |   |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
| Cash                          flows from investing activities:                    |   |   |   |   |   |   |   |   |   |   |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
| Net                          change in interest-bearing time deposit              |   |   | (6,000,000 | ) |   | -                               |   |   | -                               |   |
| Purchases                          of other investments                           |   |   | (600,000 | ) |   | -                               |   |   | (250,000 | ) |
| Purchase                          of equity in PEBK Capital Trust II              |   |   | (619,000 | ) |   | -                               |   |   | -                               |   |
| Proceeds                          from liquidation of PEBK Capital Trust I        |   |   | 433,000 |   |   | -                               |   |   | -                               |   |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
| Net                          cash used by investing activities                    |   |   | (6,786,000 | ) |   | -                               |   |   | (250,000 | ) |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
| Cash                          flows from financing activities:                    |   |   |   |   |   |   |   |   |   |   |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
| Proceeds                          from issuance of trust preferred securities     |   |   | 20,619,000 |   |   | -                               |   |   | -                               |   |
| Repayments                          of trust preferred securities                 |   |   | (14,433,000 | ) |   | -                               |   |   | -                               |   |
| Cash                          dividends paid                                      |   |   | (1,905,556 | ) |   | (1,414,239 | ) |   | (1,257,254 | ) |
| Cash                          paid in lieu of fractional shares                   |   |   | (6,426 | ) |   | (4,700 | ) |   | -                               |   |
| Common                          stock repurchased                                 |   |   | (425,000 | ) |   | (314,750 | ) |   | (290,826 | ) |
| Proceeds                          from exercise of stock options                  |   |  | 1,014,425 |   |   | 96,773 |   |   | 209,706 |   |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
| Net                          cash provided (used) by financing activities         |   |   | 4,863,443 |   |   | (1,636,916 | ) |   | (1,338,374 | ) |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
| Net                          change in cash                                       |   |   | 1,127,791 |   |   | 1,437 |   |   | (171,961 | ) |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
| Cash                          at beginning of year                                |   |   | 519,089 |   |   | 517,652 |   |   | 689,613 |   |
|                                                                              |   |   |   |   |   |   |   |   |   |   |
| Cash                          at end of year                                      |   | $ | 1,646,880 |   |   | 519,089 |   |   | 517,652 |   |

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**DIRECTORS              AND OFFICERS OF THE COMPANY**

**DIRECTORS**

**Robert                C. Abernethy - Chairman**

**James                S. Abernethy**

**Douglas                S. Howard**

**John                W. Lineberger, Jr.**

**Gary                E. Matthews**

**Billy                L. Price, Jr. MD**

**Larry                E. Robinson**

**William                Gregory (Greg) Terry**

**Dan                Ray Timmerman, Sr.**

**Benjamin                I. Zachary**

**OFFICERS**

**Tony                W. Wolfe**

**Joseph                F. Beaman, Jr.**

**Lance                A. Sellers**

**William                D. Cable**

**A.                Joseph Lampron**

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