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

**General      Description of Business**

** **

***    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*                                                                                                                                                     |
|                                                                                                                                                                                                                   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                                                                                                                                                   |   |                              2005 |   |                              2004 |   |                              2003 |   |                              2002 |   |                              2001 |   |
| **Summary                    of Operations**                                                                                                                                                                           |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest                    income                                                                                                                                                                                     |   | $ | 43,371 |   |   | 36,292 |   |   | 34,935 |   |   | 36,649 |   |   | 41,932 |   |
| Interest                    expense                                                                                                                                                                                    |   |   | 15,429 |   |   | 12,335 |   |   | 12,749 |   |   | 15,777 |   |   | 23,027 |   |
|                                                                                                                                                                                                                   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net                    interest income                                                                                                                                                                                 |   |   | 27,942 |   |   | 23,957 |   |   | 22,186 |   |   | 20,872 |   |   | 18,905 |   |
| Provision                    for loan losses                                                                                                                                                                           |   |   | 3,110 |   |   | 3,256 |   |   | 6,744 |   |   | 5,432 |   |   | 3,545 |   |
|                                                                                                                                                                                                                   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net                    interest income after provision for loan losses                                                                                                                                                 |   |   | 24,832 |   |   | 20,701 |   |   | 15,442 |   |   | 15,440 |   |   | 15,360 |   |
| Non-interest                    income                                                                                                                                                                                 |   |   | 6,696 |   |   | 6,020 |   |   | 5,845 |   |   | 6,466 |   |   | 8,229 |   |
| Non-interest                    expense                                                                                                                                                                                |   |   | 21,816 |   |   | 20,057 |   |   | 18,228 |   |   | 16,758 |   |   | 16,752 |   |
|                                                                                                                                                                                                                   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Income                    before taxes                                                                                                                                                                                 |   |   | 9,712 |   |   | 6,664 |   |   | 3,059 |   |   | 5,148 |   |   | 6,837 |   |
| Income                    taxes                                                                                                                                                                                        |   |   | 3,381 |   |   | 2,233 |   |   | 1,055 |   |   | 1,712 |   |   | 2,262 |   |
| Net                    income                                                                                                                                                                                          |   | $ | 6,331 |   |   | 4,431 |   |   | 2,004 |   |   | 3,436 |   |   | 4,575 |   |
|                                                                                                                                                                                                                   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Selected                    Year-End Balances**                                                                                                                                                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Assets                                                                                                                                                                                                                 |   | $ | 730,280 |   |   | 686,348 |   |   | 674,032 |   |   | 645,638 |   |   | 619,505 |   |
| Available                    for sale securities                                                                                                                                                                       |   |   | 115,158 |   |   | 105,598 |   |   | 79,460 |   |   | 71,736 |   |   | 84,286 |   |
| Loans,                    net                                                                                                                                                                                          |   |   | 559,239 |   |   | 527,419 |   |   | 542,404 |   |   | 519,122 |   |   | 484,517 |   |
| Mortgage                    loans held for sale                                                                                                                                                                        |   |   | 2,248 |   |   | 3,783 |   |   | 587 |   |   | 5,065 |   |   | 5,339 |   |
| Interest-earning                    assets                                                                                                                                                                             |   |   | 692,402 |   |   | 652,678 |   |   | 639,501 |   |   | 608,619 |   |   | 586,496 |   |
| Deposits                                                                                                                                                                                                               |   |   | 582,854 |   |   | 556,522 |   |   | 549,802 |   |   | 515,739 |   |   | 490,223 |   |
| Interest-bearing                    liabilities                                                                                                                                                                        |   |   | 576,681 |   |   | 553,135 |   |   | 550,357 |   |   | 527,525 |   |   | 516,422 |   |
| Shareholders'                    equity                                                                                                                                                                                |   | $ | 54,353 |   |   | 50,938 |   |   | 48,554 |   |   | 48,605 |   |   | 45,401 |   |
| Shares                    outstanding*                                                                                                                                                                                 |   |   | 3,440,805 |   |   | 3,448,341 |   |   | 3,448,722 |   |   | 3,446,902 |   |   | 3,540,585 |   |
|                                                                                                                                                                                                                   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Selected                    Average Balances**                                                                                                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Assets                                                                                                                                                                                                                 |   | $ | 706,843 |   |   | 684,385 |   |   | 661,077 |   |   | 625,227 |   |   | 575,142 |   |
| Available                    for sale securities                                                                                                                                                                       |   |   | 108,690 |   |   | 93,770 |   |   | 72,072 |   |   | 77,414 |   |   | 84,549 |   |
| Loans                                                                                                                                                                                                                  |   |   | 550,545 |   |   | 547,753 |   |   | 539,559 |   |   | 507,879 |   |   | 454,371 |   |
| Interest-earning                    assets                                                                                                                                                                             |   |   | 668,181 |   |   | 650,095 |   |   | 625,764 |   |   | 592,947 |   |   | 545,945 |   |
| Deposits                                                                                                                                                                                                               |   |   | 570,997 |   |   | 558,142 |   |   | 533,703 |   |   | 499,224 |   |   | 481,289 |   |
| Interest-bearing                    liabilities                                                                                                                                                                        |   |   | 563,210 |   |   | 553,880 |   |   | 540,676 |   |   | 516,747 |   |   | 472,435 |   |
| Shareholders'                    equity                                                                                                                                                                                |   | $ | 55,989 |   |   | 51,978 |   |   | 49,971 |   |   | 48,257 |   |   | 47,432 |   |
| Shares                    outstanding*                                                                                                                                                                                 |   |   | 3,449,873 |   |   | 3,459,379 |   |   | 3,447,056 |   |   | 3,467,173 |   |   | 3,540,585 |   |
|                                                                                                                                                                                                                   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Profitability                    Ratios**                                                                                                                                                                            |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Return                    on average total assets                                                                                                                                                                      |   |   | 0.90 | % |   | 0.65 | % |   | 0.30 | % |   | 0.55 | % |   | 0.80 | % |
| Return                    on average shareholders' equity                                                                                                                                                              |   |   | 11.31 | % |   | 8.52 | % |   | 4.01 | % |   | 7.12 | % |   | 9.65 | % |
| Dividend                    payout ratio                                                                                                                                                                               |   |   | 22.34 | % |   | 28.37 | % |   | 62.56 | % |   | 36.58 | % |   | 28.14 | % |
|                                                                                                                                                                                                                   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Liquidity                    and Capital Ratios (averages)**                                                                                                                                                         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loan                    to deposit                                                                                                                                                                                     |   |   | 96.42 | % |   | 98.14 | % |   | 101.10 | % |   | 101.73 | % |   | 94.41 | % |
| Shareholders'                    equity to total assets                                                                                                                                                                |   |   | 7.92 | % |   | 7.59 | % |   | 7.56 | % |   | 7.72 | % |   | 8.25 | % |
|                                                                                                                                                                                                                   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Per                    share of common stock***                                                                                                                                                                      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                    net income                                                                                                                                                                                    |   | $ | 1.84 |   |   | 1.28 |   |   | 0.58 |   |   | 0.99 |   |   | 1.29 |   |
| Diluted                    net income                                                                                                                                                                                  |   | $ | 1.80 |   |   | 1.26 |   |   | 0.58 |   |   | 0.99 |   |   | 1.29 |   |
| Cash                    dividends                                                                                                                                                                                      |   | $ | 0.41 |   |   | 0.36 |   |   | 0.36 |   |   | 0.36 |   |   | 0.36 |   |
| Book                    value                                                                                                                                                                                          |   | $ | 15.80 |   |   | 14.77 |   |   | 14.08 |   |   | 14.10 |   |   | 12.83 |   |
|                                                                                                                                                                                                                   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| *Shares                    outstanding and per share computations have been retroactively                    restated to                    reflect a 10% stock dividend during first quarter                    2005. |

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

**AND        RESULTS OF OPERATIONS**

**Introduction**

**Overview**

**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, 2005** |    | **December                    31, 2004** |   | **December                    31, 2003** |
| **(Dollars                    in Thousands)**                                                                                                                                                                                                                                                                                                                                                                                       | **Average                    Balance** |                                     |    | **Interest**                             |   |                                     | **Yield                    / Rate** |   |   | **Average                    Balance** |   |    | **Interest** |   |   | **Yield                    / Rate** |   |   | **Average                    Balance** |   |   | **Interest** |   |   | **Yield                    / Rate** |   |
| **Interest-earning                    assets:**                                                                                                                                                                                                                                                                                                                                                                                     |                                   |                                     |    |                                     |   |                                     |                                |   |   |                                   |   |    |         |   |   |                                |   |   |                                   |   |   |   |   |   |   |   |   |   |
| Loans                                                                                                                                                                                                                                                                                                                                                                                                                               |                                   | $                                        | 550,545 |                                     |   | 37,234                                   |                                |   | 6.76   | %                                      |   | 547,753 |         |   | 29,826 |                                |   | 5.45   | %                                      |   | 539,559 |   |   | 28,700 |   |   | 5.32 | % |
| Interest                    rate swap agreements                                                                                                                                                                                                                                                                                                                                                                                    |                                   |                                     | -       |                                     |   | (575                                     | )                                   |   | -0.14  | %                                      |   | -       |         |   | 1,056  |                                |   | 2.21   | %                                      |   | - |   |   | 1,522 |   |   | 3.22 | % |
| Loan                    fees                                                                                                                                                                                                                                                                                                                                                                                                        |                                   |                                     | -       |                                     |   | 1,951                                    |                                |   | 0.29   | %                                      |   | -       |         |   | 1,409  |                                |   | 0.26   | %                                      |   | - |   |   | 1,390 |   |   | 0.26 | % |
| **Total                    loans**                                                                                                                                                                                                                                                                                                                                                                                                  |                                   |                                     | 550,545 |                                     |   | 38,610                                   |                                |   | 7.01   | %                                      |   | 547,753 |         |   | 32,291 |                                |   | 5.90   | %                                      |   | 539,559 |   |   | 31,612 |   |   | 5.86 | % |
|                                                                                                                                                                                                                                                                                                                                                                                                                                |                                   |                                     |    |                                     |   |                                     |                                |   |   |                                   |   |    |         |   |   |                                |   |   |                                   |   |   |   |   |   |   |   |   |   |
| Investments                    - taxable                                                                                                                                                                                                                                                                                                                                                                                            |                                   |                                     | 37,487  |                                     |   | 1,597                                    |                                |   | 4.26   | %                                      |   | 35,920  |         |   | 1,545  |                                |   | 4.30   | %                                      |   | 49,082 |   |   | 2,186 |   |   | 4.45 | % |
| Investments                    - nontaxable*                                                                                                                                                                                                                                                                                                                                                                                        |                                   |                                     | 71,203  |                                     |   | 3,389                                    |                                |   | 4.76   | %                                      |   | 57,850  |         |   | 2,741  |                                |   | 4.74   | %                                      |   | 22,990 |   |   | 1,228 |   |   | 5.34 | % |
| Federal                    funds sold                                                                                                                                                                                                                                                                                                                                                                                               |                                   |                                     | 2,272   |                                     |   | 73                                       |                                |   | 3.21   | %                                      |   | 3,363   |         |   | 35     |                                |   | 1.05   | %                                      |   | 5,981 |   |   | 58 |   |   | 0.98 | % |
| Other                                                                                                                                                                                                                                                                                                                                                                                                                               |                                   |                                     | 6,674   |                                     |   | 238                                      |                                |   | 3.57   | %                                      |   | 5,209   |         |   | 141    |                                |   | 2.70   | %                                      |   | 8,152 |   |   | 174 |   |   | 2.14 | % |
|                                                                                                                                                                                                                                                                                                                                                                                                                                |                                   |                                     |    |                                     |   |                                     |                                |   |   |                                   |   |    |         |   |   |                                |   |   |                                   |   |   |   |   |   |   |   |   |   |
| **Total                    interest-earning assets**                                                                                                                                                                                                                                                                                                                                                                                |                                   |                                     | 668,181 |                                     |   | 43,907                                   |                                |   | 6.57   | %                                      |   | 650,095 |         |   | 36,753 |                                |   | 5.65   | %                                      |   | 625,764 |   |   | 35,258 |   |   | 5.63 | % |
|                                                                                                                                                                                                                                                                                                                                                                                                                                |                                   |                                     |    |                                     |   |                                     |                                |   |   |                                   |   |    |         |   |   |                                |   |   |                                   |   |   |   |   |   |   |   |   |   |
| Cash                    and due from banks                                                                                                                                                                                                                                                                                                                                                                                          |                                   |                                     | 15,149  |                                     |   |                                     |                                |   |   |                                   |   | 13,058  |         |   |   |                                |   |   |                                   |   | 12,587 |   |   |   |   |   |   |   |
| Other                    assets                                                                                                                                                                                                                                                                                                                                                                                                     |                                   |                                     | 31,324  |                                     |   |                                     |                                |   |   |                                   |   | 30,601  |         |   |   |                                |   |   |                                   |   | 31,008 |   |   |   |   |   |   |   |
| Allowance                    for loan losses                                                                                                                                                                                                                                                                                                                                                                                        |                                   |                                     | (7,811  | )                                        |   |                                     |                                |   |   |                                   |   | (9,369  | )            |   |   |                                |   |   |                                   |   | (8,282 | ) |   |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                |                                   |                                     |    |                                     |   |                                     |                                |   |   |                                   |   |    |         |   |   |                                |   |   |                                   |   |   |   |   |   |   |   |   |   |
| **Total                    assets**                                                                                                                                                                                                                                                                                                                                                                                                 |                                   | $                                        | 706,843 |                                     |   |                                     |                                |   |   |                                   |   | 684,385 |         |   |   |                                |   |   |                                   |   | 661,077 |   |   |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                |                                   |                                     |    |                                     |   |                                     |                                |   |   |                                   |   |    |         |   |   |                                |   |   |                                   |   |   |   |   |   |   |   |   |   |
| **Interest-bearing                    liabilities:**                                                                                                                                                                                                                                                                                                                                                                                |                                   |                                     |    |                                     |   |                                     |                                |   |   |                                   |   |    |         |   |   |                                |   |   |                                   |   |   |   |   |   |   |   |   |   |
| NOW                    accounts                                                                                                                                                                                                                                                                                                                                                                                                     |                                   | $                                        | 110,852 |                                     |   | 1,468                                    |                                |   | 1.32   | %                                      |   | 106,832 |         |   | 1,292  |                                |   | 1.21   | %                                      |   | 75,757 |   |   | 688 |   |   | 0.91 | % |
| Regular                    savings accounts                                                                                                                                                                                                                                                                                                                                                                                         |                                   |                                     | 21,205  |                                     |   | 65                                       |                                |   | 0.31   | %                                      |   | 21,845  |         |   | 72     |                                |   | 0.33   | %                                      |   | 21,131 |   |   | 75 |   |   | 0.35 | % |
| Money                    market accounts                                                                                                                                                                                                                                                                                                                                                                                            |                                   |                                     | 56,858  |                                     |   | 1,112                                    |                                |   | 1.96   | %                                      |   | 51,069  |         |   | 535    |                                |   | 1.05   | %                                      |   | 58,134 |   |   | 556 |   |   | 0.96 | % |
| Time                    deposits                                                                                                                                                                                                                                                                                                                                                                                                    |                                   |                                     | 292,807 |                                     |   | 8,923                                    |                                |   | 3.05   | %                                      |   | 300,175 |         |   | 7,145  |                                |   | 2.38   | %                                      |   | 310,991 |   |   | 8,157 |   |   | 2.62 | % |
| FHLB                    borrowings                                                                                                                                                                                                                                                                                                                                                                                                  |                                   |                                     | 65,934  |                                     |   | 2,889                                    |                                |   | 4.38   | %                                      |   | 58,656  |         |   | 2,603  |                                |   | 4.44   | %                                      |   | 59,305 |   |   | 2,597 |   |   | 4.38 | % |
| Demand                    notes payable to U.S. Treasury                                                                                                                                                                                                                                                                                                                                                                            |                                   |                                     | 702     |                                     |   | 21                                       |                                |   | 3.02   | %                                      |   | 678     |         |   | 8      |                                |   | 1.14   | %                                      |   | 710 |   |   | 7 |   |   | 0.99 | % |
| Trust                    preferred securities                                                                                                                                                                                                                                                                                                                                                                                       |                                   |                                     | 14,433  |                                     |   | 938                                      |                                |   | 6.50   | %                                      |   | 14,433  |         |   | 677    |                                |   | 4.69   | %                                      |   | 14,433 |   |   | 668 |   |   | 4.62 | % |
| Other                                                                                                                                                                                                                                                                                                                                                                                                                               |                                   |                                     | 419     |                                     |   | 13                                       |                                |   | 3.00   | %                                      |   | 192     |         |   | 3      |                                |   | 1.46   | %                                      |   | 215 |   |   | 1 |   |   | 0.47 | % |
|                                                                                                                                                                                                                                                                                                                                                                                                                                |                                   |                                     |    |                                     |   |                                     |                                |   |   |                                   |   |    |         |   |   |                                |   |   |                                   |   |   |   |   |   |   |   |   |   |
| **Total                    interest-bearing liabilities**                                                                                                                                                                                                                                                                                                                                                                           |                                   |                                     | 563,210 |                                     |   | 15,429                                   |                                |   | 2.74   | %                                      |   | 553,880 |         |   | 12,335 |                                |   | 2.23   | %                                      |   | 540,676 |   |   | 12,749 |   |   | 2.36 | % |
|                                                                                                                                                                                                                                                                                                                                                                                                                                |                                   |                                     |    |                                     |   |                                     |                                |   |   |                                   |   |    |         |   |   |                                |   |   |                                   |   |   |   |   |   |   |   |   |   |
| Demand                    deposits                                                                                                                                                                                                                                                                                                                                                                                                  |                                   |                                     | 89,275  |                                     |   |                                     |                                |   |   |                                   |   | 78,221  |         |   |   |                                |   |   |                                   |   | 67,690 |   |   |   |   |   |   |   |
| Other                    liabilities                                                                                                                                                                                                                                                                                                                                                                                                |                                   |                                     | 1,275   |                                     |   |                                     |                                |   |   |                                   |   | 2,137   |         |   |   |                                |   |   |                                   |   | 2,800 |   |   |   |   |   |   |   |
| Shareholders'                    equity                                                                                                                                                                                                                                                                                                                                                                                             |                                   |                                     | 55,989  |                                     |   |                                     |                                |   |   |                                   |   | 51,978  |         |   |   |                                |   |   |                                   |   | 49,971 |   |   |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                |                                   |                                     |    |                                     |   |                                     |                                |   |   |                                   |   |    |         |   |   |                                |   |   |                                   |   |   |   |   |   |   |   |   |   |
| **Total                    liabilities and shareholder's equity**                                                                                                                                                                                                                                                                                                                                                                   |                                   | $                                        | 709,749 |                                     |   |                                     |                                |   |   |                                   |   | 686,216 |         |   |   |                                |   |   |                                   |   | 661,137 |   |   |   |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                |                                   |                                     |    |                                     |   |                                     |                                |   |   |                                   |   |    |         |   |   |                                |   |   |                                   |   |   |   |   |   |   |   |   |   |
| **Net                    interest spread**                                                                                                                                                                                                                                                                                                                                                                                          |                                   |                                     |    |                                     | $      | 28,478                                   |                                |   | 3.83   | %                                      |   |    |         |   | 24,418 |                                |   | 3.43   | %                                      |   |   |   |   | 22,509 |   |   | 3.27 | % |
|                                                                                                                                                                                                                                                                                                                                                                                                                                |                                   |                                     |    |                                     |   |                                     |                                |   |   |                                   |   |    |         |   |   |                                |   |   |                                   |   |   |   |   |   |   |   |   |   |
| **Net                    yield on interest-earning assets**                                                                                                                                                                                                                                                                                                                                                                         |                                   |                                     |    |                                     |   |                                     |                                |   | 4.26   | %                                      |   |    |         |   |   |                                |   | 3.76   | %                                      |   |   |   |   |   |   |   | 3.60 | % |
|                                                                                                                                                                                                                                                                                                                                                                                                                                |                                   |                                     |    |                                     |   |                                     |                                |   |   |                                   |   |    |         |   |   |                                |   |   |                                   |   |   |   |   |   |   |   |   |   |
| **Taxable                    equivalent adjustment**                                                                                                                                                                                                                                                                                                                                                                                |                                   |                                     |    |                                     |   |                                     |                                |   |   |                                   |   |    |         |   |   |                                |   |   |                                   |   |   |   |   |   |   |   |   |   |
| **Investment                    securities**                                                                                                                                                                                                                                                                                                                                                                                        |                                   |                                     |    |                                     | $      | 536                                      |                                |   |   |                                   |   |    |         |   | 460    |                                |   |   |                                   |   |   |   |   | 323 |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                |                                   |                                     |    |                                     |   |                                     |                                |   |   |                                   |   |    |         |   |   |                                |   |   |                                   |   |   |   |   |   |   |   |   |   |
| **Net                    interest income**                                                                                                                                                                                                                                                                                                                                                                                          |                                   |                                     |    |                                     | $      | 27,942                                   |                                |   |   |                                   |   |    |         |   | 23,958 |                                |   |   |                                   |   |   |   |   | 22,186 |   |   |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                |                                   |                                     |    |                                     |   |                                     |                                |   |   |                                   |   |    |         |   |   |                                |   |   |                                   |   |   |   |   |   |   |   |   |   |
| *Includes                    U.S. government agency securities that are non-taxable for state                    income                    tax purposes of $50.7 million in 2005, $40.4 million in 2004                    and $9.4                    million in 2003. 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, 2005** |                                          | **December                  31, 2004** |                                           |
| **(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                           |                                           | $                                      | 180                                           |                                   |                                           | 6,139  |                                           |   | 6,319                                         |   |   | 481 |   |   | 198 |   |   | 679 |   |
|                                                                     |                                           |                                   |                                          |                                   |                                           |   |                                           |   |                                          |   |   |   |   |   |   |   |   |   |   |
| Investments                  - taxable                                   |                                           |                                   | 67                                            |                                   |                                           | (15    | )                                              |   | 52                                            |   |   | (603 | ) |   | (38 | ) |   | (641 | ) |
| Investments                  - nontaxable                                |                                           |                                   | 634                                           |                                   |                                           | 14     |                                           |   | 648                                           |   |   | 1,756 |   |   | (243 | ) |   | 1,513 |   |
| Federal                  funds sold                                      |                                           |                                   | (23                                           | )                                      |                                           | 61     |                                           |   | 38                                            |   |   | (26 | ) |   | 3 |   |   | (23 | ) |
| Other                                                                    |                                           |                                   | 45                                            |                                   |                                           | 52     |                                           |   | 97                                            |   |   | (73 | ) |   | 40 |   |   | (33 | ) |
|                                                                     |                                           |                                   |                                          |                                   |                                           |   |                                           |   |                                          |   |   |   |   |   |   |   |   |   |   |
| **Total                  interest income**                               |                                           |                                   | 903                                           |                                   |                                           | 6,251  |                                           |   | 7,154                                         |   |   | 1,535 |   |   | (40 | ) |   | 1,495 |   |
|                                                                     |                                           |                                   |                                          |                                   |                                           |   |                                           |   |                                          |   |   |   |   |   |   |   |   |   |   |
| **Interest                  expense:**                                   |                                           |                                   |                                          |                                   |                                           |   |                                           |   |                                          |   |   |   |   |   |   |   |   |   |   |
|                                                                     |                                           |                                   |                                          |                                   |                                           |   |                                           |   |                                          |   |   |   |   |   |   |   |   |   |   |
| NOW                  accounts                                            |                                           |                                   | 51                                            |                                   |                                           | 125    |                                           |   | 176                                           |   |   | 329 |   |   | 275 |   |   | 604 |   |
| Regular                  savings accounts                                |                                           |                                   | (2                                            | )                                      |                                           | (5     | )                                              |   | (7                                            | ) |   | 2 |   |   | (5 | ) |   | (3 | ) |
| Money                  market accounts                                   |                                           |                                   | 87                                            |                                   |                                           | 490    |                                           |   | 577                                           |   |   | (71 | ) |   | 50 |   |   | (21 | ) |
| Time                  deposits                                           |                                           |                                   | (200                                          | )                                      |                                           | 1,978  |                                           |   | 1,778                                         |   |   | (271 | ) |   | (741 | ) |   | (1,012 | ) |
| FHLB                  Borrowings                                         |                                           |                                   | 321                                           |                                   |                                           | (35    | )                                              |   | 286                                           |   |   | (28 | ) |   | 34 |   |   | 6 |   |
| Demand                  notes payable to                                 |                                           |                                   |                                          |                                   |                                           |   |                                           |   |                                          |   |   |   |   |   |   |   |   |   |   |
| U.S.                  Treasury                                           |                                           |                                   | -                                             |                                   |                                           | 13     |                                           |   | 13                                            |   |   | - |   |   | 1 |   |   | 1 |   |
| Trust                  Preferred Securities                              |                                           |                                   | 24                                            |                                   |                                           | 237    |                                           |   | 261                                           |   |   | - |   |   | 9 |   |   | 9 |   |
| Other                                                                    |                                           |                                   | 5                                             |                                   |                                           | 5      |                                           |   | 10                                            |   |   | - |   |   | 2 |   |   | 2 |   |
|                                                                     |                                           |                                   |                                          |                                   |                                           |   |                                           |   |                                          |   |   |   |   |   |   |   |   |   |   |
| **Total                  interest expense**                              |                                           |                                   | 286                                           |                                   |                                           | 2,808  |                                           |   | 3,094                                         |   |   | (39 | ) |   | (375 | ) |   | (414 | ) |
|                                                                     |                                           |                                   |                                          |                                   |                                           |   |                                           |   |                                          |   |   |   |   |   |   |   |   |   |   |
| **Net                  interest income**                                 |                                           | $                                      | 617                                           |                                   |                                           | 3,443  |                                           |   | 4,060                                         |   |   | 1,574 |   |   | 335 |   |   | 1,909 |   |

----

*Provision        for Loan Losses. *

*Non-Interest        Income.*

----

| **Table                  3 - Non-Interest Income**         |                                                                                         |   |                                                                                         |   |                                                                                         |   |   |
|------------------------------------------------------------|----------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------|--------|--------|
|                                                       |                                                                                         |   |                                                                                         |   |                                                                                         |   |   |
| **(Dollars                  in Thousands)**                | **                             2005** |   | **                             2004** |   | **                             2003** |   |
| Service                  charges                           |                                                                                         | $      | 3,780                                                                                        |   |                                                                                         | 3,435  |   |   | 3,267 |   |
| Other                  service charges and fees            |                                                                                         |   | 1,142                                                                                        |   |                                                                                         | 677    |   |   | 611 |   |
| Gain                  (loss) on sale of securities         |                                                                                         |   | (730                                                                                         | )      |                                                                                         | (64    | )      |   | (53 | ) |
| Mortgage                  banking income                   |                                                                                         |   | 469                                                                                          |   |                                                                                         | 356    |   |   | 604 |   |
| Insurance                  and brokerage commissions       |                                                                                         |   | 387                                                                                          |   |                                                                                         | 430    |   |   | 421 |   |
| Loss                  on foreclosed and repossessed assets |                                                                                         |   | (38                                                                                          | )      |                                                                                         | (179   | )      |   | (747 | ) |
| Gain                  on sale of loans                     |                                                                                         |   | -                                                                                            |   |                                                                                         | -      |   |   | 479 |   |
| Miscellaneous                                              |                                                                                         |   | 1,686                                                                                        |   |                                                                                         | 1,365  |   |   | 1,263 |   |
| **Total                  non-interest income**             |                                                                                         | $      | 6,696                                                                                        |   |                                                                                         | 6,020  |   |   | 5,845 |   |

*Non-Interest        Expense.*

| **Table                    4 - Non-Interest Expense** |                                                 |   |                                                 |   |                                                 |   |   |
|-------------------------------------------------------|------------------------------------------------------|--------|------------------------------------------------------|--------|------------------------------------------------------|--------|--------|
|                                                  |                                                 |   |                                                 |   |                                                 |   |   |
| **(Dollars                    in Thousands)**         | **                        2005** |   | **                        2004** |   | **                        2003** |   |
| Salaries                    and wages                 |                                                 | $      | 8,648                                                |   |                                                 | 8,240  |   |   | 7,733 |   |
| Employee                    benefits                  |                                                 |   | 3,702                                                |   |                                                 | 3,237  |   |   | 2,367 |   |
| **Total                    personnel expense**        |                                                 |   | 12,350                                               |   |                                                 | 11,477 |   |   | 10,100 |   |
| Occupancy                    expense                  |                                                 |   | 3,949                                                |   |                                                 | 3,672  |   |   | 3,390 |   |
| Office                    supplies                    |                                                 |   | 314                                                  |   |                                                 | 314    |   |   | 270 |   |
| FDIC                    deposit insurance             |                                                 |   | 76                                                   |   |                                                 | 81     |   |   | 82 |   |
| Professional                    services              |                                                 |   | 389                                                  |   |                                                 | 290    |   |   | 333 |   |
| Postage                                               |                                                 |   | 264                                                  |   |                                                 | 211    |   |   | 217 |   |
| Telephone                                             |                                                 |   | 403                                                  |   |                                                 | 337    |   |   | 333 |   |
| Director                    fees and expense          |                                                 |   | 334                                                  |   |                                                 | 351    |   |   | 234 |   |
| Marketing                    and public relations     |                                                 |   | 656                                                  |   |                                                 | 620    |   |   | 541 |   |
| Consulting                    fees                    |                                                 |   | 233                                                  |   |                                                 | 306    |   |   | 280 |   |
| Taxes                    and licenses                 |                                                 |   | 218                                                  |   |                                                 | 200    |   |   | 443 |   |
| Other                    operating expense            |                                                 |   | 2,631                                                |   |                                                 | 2,198  |   |   | 2,005 |   |
| **Total                    non-interest expense**     |                                                 | $      | 21,817                                               |   |                                                 | 20,057 |   |   | 18,228 |   |

----

*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                                                                                                             |   | $             | 427,716      |    |              | 17,536      |    |                               | 8,697    |    |                                         | 453,949 |    |   | 112,714 |   | $ | 566,663 |   |
| Mortgage                    loans available for sale                                                              |   |          | 2,248        |    |              | -           |    |                               | -        |    |                                         | 2,248   |    |   | - |   |   | 2,248 |   |
| Investment                    securities                                                                          |   |          | -            |    |              | 1,753       |    |                               | -        |    |                                         | 1,753   |    |   | 113,405 |   |   | 115,158 |   |
| Federal                    funds sold                                                                             |   |          | 1,347        |    |              | -           |    |                               | -        |    |                                         | 1,347   |    |   | - |   |   | 1,347 |   |
| Interest-bearing                    deposit accounts                                                              |   |          | 1,480        |    |              | -           |    |                               | -        |    |                                         | 1,480   |    |   | - |   |   | 1,480 |   |
| Other                    interest-earning assets                                                                  |   |          | -            |    |              | -           |    |                               | -        |    |                                         | -       |    |   | 5,506 |   |   | 5,506 |   |
|                                                                                                              |   |          |         |    |              |        |    |                               |     |    |                                         |    |    |   |   |   |   |   |   |
| **Total                    interest-earning assets**                                                              |   |          | 432,791      |    |              | 19,289      |    |                               | 8,697    |    |                                         | 460,777 |    |   | 231,625 |   | $ | 692,402 |   |
|                                                                                                              |   |          |         |    |              |        |    |                               |     |    |                                         |    |    |   |   |   |   |   |   |
| **Interest-bearing                    liabilities:**                                                              |   |          |         |    |              |        |    |                               |     |    |                                         |    |    |   |   |   |   |   |   |
| NOW,                    savings, and money market deposits                                                        |   |          | 183,249      |    |              | -           |    |                               | -        |    |                                         | 183,249 |    |   | - |   | $ | 183,249 |   |
| Time                    deposits                                                                                  |   |          | 69,697       |    |              | 42,161      |    |                               | 130,078  |    |                                         | 241,936 |    |   | 63,008 |   |   | 304,944 |   |
| Other                    short term borrowings                                                                    |   |          | 1,474        |    |              | -           |    |                               | -        |    |                                         | 1,474   |    |   | - |   |   | 1,474 |   |
| FHLB                    borrowings                                                                                |   |          | 4,600        |    |              | 2,500       |    |                               | -        |    |                                         | 7,100   |    |   | 64,500 |   |   | 71,600 |   |
| Securities                    sold under agreement to repurchase                                                  |   |          | 981          |    |              | -           |    |                               | -        |    |                                         | 981     |    |   | - |   |   | 981 |   |
| Trust                    preferred securities                                                                     |   |          | -            |    |              | 14,433      |    |                               | -        |    |                                         | 14,433  |    |   | - |   |   | 14,433 |   |
|                                                                                                              |   |          |         |    |              |        |    |                               |     |    |                                         |    |    |   |   |   |   |   |   |
| **Total                    interest-bearing liabilities**                                                         |   |          | 260,001      |    |              | 59,094      |    |                               | 130,078  |    |                                         | 449,173 |    |   | 127,508 |   | $ | 576,681 |   |
|                                                                                                              |   |          |         |    |              |        |    |                               |     |    |                                         |    |    |   |   |   |   |   |   |
| **Interest-sensitive                    gap**                                                                     |   | $             | 172,790      |    |              | (39,805     | )       |                               | (121,381 | )       |                                         | 11,604  |    |   | 104,117 |   | $ | 115,721 |   |
|                                                                                                              |   |          |         |    |              |        |    |                               |     |    |                                         |    |    |   |   |   |   |   |   |
| **Cumulative                    interest-sensitive gap**                                                          |   | $             | 172,790      |    |              | 132,985     |    |                               | 11,604   |    |                                         | 11,604  |    |   | 115,721 |   |   |   |   |
|                                                                                                              |   |          |         |    |              |        |    |                               |     |    |                                         |    |    |   |   |   |   |   |   |
| **Interest-earning                    assets as a percentage of interest-bearing                    liabilities** |   |          | 166.46  |  % |              | 32.64  |  % |                               | 6.69     |  % |                                         | 102.58  |  % |   |   |   |   |   |   |

----

**Analysis        of Financial Condition**

*Investment        Securities. *
*.        *

| **Table                  6 - Summary of Investment Portfolio**    |                                   |   |                                   |   |                                   |    |   |
|-------------------------------------------------------------------|----------------------------------------|--------|----------------------------------------|--------|----------------------------------------|---------|--------|
|                                                              |                                   |   |                                   |   |                                   |    |   |
| **(Dollars                  in Thousands)**                       | **                    2005** |   | **                    2004** |   | **                    2003** |    |
| Obligations                  of United States government          |                                   |   |                                   |   |                                   |    |   |   |   |   |
| agencies                  and corporations                        |                                   | $      | 60,243                                 |   |                                   | 46,570  |   |   | 34,517 |   |
|                                                              |                                   |   |                                   |   |                                   |    |   |   |   |   |
| Obligations                  of states and political subdivisions |                                   |   | 21,609                                 |   |                                   | 20,649  |   |   | 14,950 |   |
|                                                              |                                   |   |                                   |   |                                   |    |   |   |   |   |
| Mortgage                  backed securities                       |                                   |   | 31,004                                 |   |                                   | 36,543  |   |   | 24,920 |   |
|                                                              |                                   |   |                                   |   |                                   |    |   |   |   |   |
| Trust                  preferred securities                       |                                   |   | 1,750                                  |   |                                   | 1,750   |   |   | 5,000 |   |
|                                                              |                                   |   |                                   |   |                                   |    |   |   |   |   |
| Equity                  securities                                |                                   |   | 552                                    |   |                                   | 86      |   |   | 73 |   |
|                                                              |                                   |   |                                   |   |                                   |    |   |   |   |   |
| **Total                  securities**                             |                                   | $      | 115,158                                |   |                                   | 105,598 |   |   | 79,460 |   |

***.***

----

| **Table                  7 - Maturity Distribution and Weighted Average Yield on                  Investments** |       |                                                    |      |                                                |       |                                                |      |                                |       |       |      |
|-----------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|-----------|-----------------------------------------------------|------------|-----------------------------------------------------|-----------|-------------------------------------|------------|------------|-----------|
|                                                                                                            |       |    **One                  Year or Less** |      | **After                  One Year Through 5 Years** |       | **After                  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                                                              |       | $                                                       | -         |                                                |       | -                                                   |      |                                | 36,433     |       |      | 4.27 | % |   | 24,318 |   |   | 4.80 | % |   | - |   |   | - |   | $ | 60,751 |   |   | 4.48 | % |
|                                                                                                            |       |                                                    |      |                                                |       |                                                |      |                                |       |       |      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| States                  and political subdivisions                                                              |       |                                                    | 200       |                                                |       | 7.21                                                | %         |                                | 8,341      |       |      | 5.08 | % |   | 9,329 |   |   | 4.88 | % |   | 3,878 |   |   | 7.04 | % |   | 21,748 |   |   | 5.36 | % |
|                                                                                                            |       |                                                    |      |                                                |       |                                                |      |                                |       |       |      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Mortgage                  backed securities                                                                     |       |                                                    | -         |                                                |       | -                                                   |      |                                | 432        |       |      | 3.74 | % |   | 12,371 |   |   | 3.99 | % |   | 19,063 |   |   | 4.53 | % |   | 31,866 |   |   | 4.31 | % |
|                                                                                                            |       |                                                    |      |                                                |       |                                                |      |                                |       |       |      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Trust                  preferred securities                                                                     |       |                                                    | -         |                                                |       | -                                                   |      |                                | -          |       |      | - |   |   | - |   |   | - |   |   | 1,750 |   |   | 7.16 | % |   | 1,750 |   |   | 7.16 | % |
|                                                                                                            |       |                                                    |      |                                                |       |                                                |      |                                |       |       |      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Equity                  securities                                                                              |       |                                                    | -         |                                                |       | -                                                   |      |                                | -          |       |      | - |   |   | - |   |   | - |   |   | 815 |   |   | 0.21 | % |   | 815 |   |   | 0.21 | % |
|                                                                                                            |       |                                                    |      |                                                |       |                                                |      |                                |       |       |      |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Total                  securities**                                                                           |       | $                                                       | 200       |                                                |       | 7.21                                                | %         |                                | 45,206     |       |      | 4.42 | % |   | 46,018 |   |   | 4.60 | % |   | 25,506 |   |   | 4.95 | % | $ | 116,930 |   |   | 4.61 | % |

*Loans.        *

| **Table                    8 - Loan Portfolio**       |       |     |                              |     |       |     |                              |     |       |     |                              |   |       |   |                              |   |       |   |                              |   |    |
|-------------------------------------------------------|------------|----------|-----------------------------------|----------|------------|----------|-----------------------------------|----------|------------|----------|-----------------------------------|--------|------------|--------|-----------------------------------|--------|------------|--------|-----------------------------------|--------|---------|
|                                                  |       |     |                              |     |       |     |                              |     |       |     |                              |   |       |   |                              |   |       |   |                              |   |    |
|                                                  |       | **2005** |                              | **2004** |       | **2003** |                              | **2002** |       | **2001** |                              |
| **(Dollars                    in Thousands)**         | **Amount** |     | **%                    of Loans** |     | **Amount** |     | **%                    of Loans** |     | **Amount** |     | **%                    of Loans** |   | **Amount** |   | **%                    of Loans** |   | **Amount** |   | **%                    of Loans** |   |
| **Breakdown                    of loan receivables:** |       |     |                              |     |       |     |                              |     |       |     |                              |   |       |   |                              |   |       |   |                              |   |    |   |   |   |   |   |   |   |   |   |   |
| Commercial                                            |       | $        | 79,902                            |     |       | 14.10    | %                                 |     | 79,189     |     |                              | 14.79  | %          |   | 90,558                            |   |       | 16.41  | %                                 |   | 92,141  |   |   | 17.51 | % |   | 102,409 |   |   | 20.87 | % |
| Real                    estate - mortgage             |       |     | 330,227                           |     |       | 58.28    | %                                 |     | 312,988    |     |                              | 58.45  | %          |   | 332,730                           |   |       | 60.26  | %                                 |   | 322,987 |   |   | 61.36 | % |   | 277,737 |   |   | 56.61 | % |
| Real                    estate - construction         |       |     | 141,420                           |     |       | 24.96    | %                                 |     | 127,042    |     |                              | 23.73  | %          |   | 110,392                           |   |       | 19.99  | %                                 |   | 80,552  |   |   | 15.30 | % |   | 82,791 |   |   | 16.88 | % |
| Consumer                                              |       |     | 15,115                            |     |       | 2.66     | %                                 |     | 16,249     |     |                              | 3.03   | %          |   | 18,446                            |   |       | 3.34   | %                                 |   | 30,690  |   |   | 5.83 | % |   | 27,671 |   |   | 5.64 | % |
|                                                  |       |     |                              |     |       |          |                              |     |       |     |                              |        |       |   |                              |   |       |        |                              |   |    |   |   |  |   |   |   |   |   |  |   |
| **Total                    loans**                    |       | $        | 566,664                           |     |       | 100.00   | %                                 |     | 535,468    |     |                              | 100.00 | %          |   | 552,126                           |   |       | 100.00 | %                                 |   | 526,370 |   |   | 100.00 | % |   | 490,608 |   |   | 100.00 | % |
|                                                  |       |     |                              |     |       |     |                              |     |       |     |                              |   |       |   |                              |   |       |   |                              |   |    |   |   |   |   |   |   |   |   |   |   |
| Less:                    Allowance for loan losses    |       |     | 7,425                             |     |       |     |                              |     | 8,049      |     |                              |   |       |   | 9,722                             |   |       |   |                              |   | 7,248   |   |   |   |   |   | 6,091 |   |   |   |   |
|                                                  |       |     |                              |     |       |     |                              |     |       |     |                              |   |       |   |                              |   |       |   |                              |   |    |   |   |   |   |   |   |   |   |   |   |
| **Net                    loans**                      |       | $        | 559,239                           |     |       |     |                              |     | 527,419    |     |                              |   |       |   | 542,404                           |   |       |   |                              |   | 519,122 |   |   |   |   |   | 484,517 |   |   |   |   |

----

| **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                                                             |                                                                 | $                                                        | 70,761                                           |                               |   | 8,572  |   |   | 569    |   | $ | 79,902 |   |
| Real                    estate - mortgage                              |                                                                 |                                                     | 245,454                                          |                               |   | 51,624 |   |   | 33,149 |   |   | 330,227 |   |
| Real                    estate - construction                          |                                                                 |                                                     | 131,110                                          |                               |   | 9,373  |   |   | 937    |   |   | 141,420 |   |
| Consumer                                                               |                                                                 |                                                     | 6,624                                            |                               |   | 7,215  |   |   | 1,275  |   |   | 15,114 |   |
|                                                                   |                                                                 |                                                     |                                             |                               |   |   |   |   |   |   |   |   |   |
| **Total                    loans**                                     |                                                                 | $                                                        | 453,949                                          |                               |   | 76,784 |   |   | 35,930 |   | $ | 566,663 |   |
|                                                                   |                                                                 |                                                     |                                             |                               |   |   |   |   |   |   |   |   |   |
| Total                    fixed rate loans                              |                                                                 | $                                                        | 11,316                                           |                               |   | 63,882 |   |   | 35,930 |   | $ | 111,128 |   |
| Total                    floating rate loans                           |                                                                 |                                                     | 442,633                                          |                               |   | 12,902 |   |   | -      |   |   | 455,535 |   |
|                                                                   |                                                                 |                                                     |                                             |                               |   |   |   |   |   |   |   |   |   |
| **Total                    loans**                                     |                                                                 | $                                                        | 453,949                                          |                               |   | 76,784 |   |   | 35,930 |   | $ | 566,663 |   |

*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. |
|--------------------|-----------------------------------------------------------------------------------------------------------------------------|

----

** **
**.**

| **Table                      10 - Loan Risk Grade Analysis** |                                 |                                         |                                 |                                     |                                 |   |                                 |   |   |
|--------------------------------------------------------------|--------------------------------------|----------------------------------------------|--------------------------------------|------------------------------------------|--------------------------------------|--------|--------------------------------------|--------|--------|
|                                                         |                                 |                                         |                                 |                                     |                                 |   |                                 |   |   |
|                                                         |                                 | **Percentage                      of Loans** |                                 | **General                      Reserve** |                                 |
|                                                         |                                 | **By                      Risk Grade**       |                                 | **Percentage**                           |                                 |
| **Risk                      Grade**                          | **                       2005** |                                         | **                       2004** |                                     | **                       2005** |   | **                       2004** |   |
|                                                         |                                 |                                         |                                 |                                     |                                 |   |                                 |   |   |   |   |   |   |
|                                                         |                                 |                                         |                                 |                                     |                                 |   |                                 |   |   |   |   |   |   |
| Risk                      1 (Excellent Quality)              |                                 |                                         | 14.28                                | %                                        |                                 | 13.44  | %                                    |   | 0.15   | % |   | 0.15 | % |
| Risk                      2 (High Quality)                   |                                 |                                         | 18.16                                | %                                        |                                 | 23.03  | %                                    |   | 0.50   | % |   | 0.50 | % |
| Risk                      3 (Good Quality)                   |                                 |                                         | 56.40                                | %                                        |                                 | 53.89  | %                                    |   | 1.00   | % |   | 1.00 | % |
| Risk                      4 (Management Attention)           |                                 |                                         | 8.38                                 | %                                        |                                 | 5.67   | %                                    |   | 2.50   | % |   | 2.50 | % |
| Risk                      5 (Watch)                          |                                 |                                         | 0.88                                 | %                                        |                                 | 0.95   | %                                    |   | 7.00   | % |   | 7.00 | % |
| Risk                      6 (Substandard)                    |                                 |                                         | 0.42                                 | %                                        |                                 | 0.61   | %                                    |   | 12.00  | % |   | 12.00 | % |
| Risk                      7 (Low Substandard)                |                                 |                                         | 0.86                                 | %                                        |                                 | 1.46   | %                                    |   | 25.00  | % |   | 25.00 | % |
| Risk                      8 (Doubtful)                       |                                 |                                         | 0.00                                 | %                                        |                                 | 0.00   | %                                    |   | 50.00  | % |   | 50.00 | % |
| Risk                      9 (Loss)                           |                                 |                                         | 0.00                                 | %                                        |                                 | 0.00   | %                                    |   | 100.00 | % |   | 100.00 | % |

----

| **Table                      11 - Analysis of Allowance for Loan Losses** |   |                                                   |   |   |                                                   |   |   |                                                   |   |   |                                                   |
|---------------------------------------------------------------------------|--------|--------------------------------------------------------|--------|--------|--------------------------------------------------------|--------|--------|--------------------------------------------------------|--------|--------|--------------------------------------------------------|
|                                                                      |   |                                                   |   |   |                                                   |   |   |                                                   |   |   |                                                   |
| **(Dollars                      in Thousands)**                           |   | **                          2005** |   |   | **                          2004** |   |   | **                          2003** |   |   | **                          2002** |   |   | **                          2001** |   |
| Reserve                      for loan losses at beginning                 |   | $                                                      | 8,049  |   |                                                   | 9,722  |   |                                                   | 7,248  |   |                                                   | 6,091 |   |   | 4,713 |   |
|                                                                      |   |                                                   |   |   |                                                   |   |   |                                                   |   |   |                                                   |   |   |   |   |   |
| Loans                      charged off:                                   |   |                                                   |   |   |                                                   |   |   |                                                   |   |   |                                                   |   |   |   |   |   |
| Commercial                                                                |   |                                                   | 293    |   |                                                   | 1,004  |   |                                                   | 1,179  |   |                                                   | 3,737 |   |   | 842 |   |
| Real                      estate - mortgage                               |   |                                                   | 2,141  |   |                                                   | 3,842  |   |                                                   | 2,422  |   |                                                   | 158 |   |   | 790 |   |
| Real                      estate - construction                           |   |                                                   | 1,250  |   |                                                   | 4      |   |                                                   | 251    |   |                                                   | - |   |   | 51 |   |
| Consumer                                                                  |   |                                                   | 516    |   |                                                   | 535    |   |                                                   | 630    |   |                                                   | 546 |   |   | 675 |   |
|                                                                      |   |                                                   |   |   |                                                   |   |   |                                                   |   |   |                                                   |   |   |   |   |   |
| **Total                      loans charged off**                          |   |                                                   | 4,200  |   |                                                   | 5,385  |   |                                                   | 4,482  |   |                                                   | 4,441 |   |   | 2,358 |   |
|                                                                      |   |                                                   |   |   |                                                   |   |   |                                                   |   |   |                                                   |   |   |   |   |   |
| Recoveries                      of losses previously charged off:         |   |                                                   |   |   |                                                   |   |   |                                                   |   |   |                                                   |   |   |   |   |   |
|                                                                      |   |                                                   |   |   |                                                   |   |   |                                                   |   |   |                                                   |   |   |   |   |   |
| Commercial                                                                |   |                                                   | 144    |   |                                                   | 162    |   |                                                   | 36     |   |                                                   | 40 |   |   | 84 |   |
| Real                      estate - mortgage                               |   |                                                   | 162    |   |                                                   | 144    |   |                                                   | 18     |   |                                                   | - |   |   | - |   |
| Real                      estate - construction                           |   |                                                   | -      |   |                                                   | -      |   |                                                   | 1      |   |                                                   | 4 |   |   | 6 |   |
| Consumer                                                                  |   |                                                   | 160    |   |                                                   | 150    |   |                                                   | 157    |   |                                                   | 122 |   |   | 101 |   |
|                                                                      |   |                                                   |   |   |                                                   |   |   |                                                   |   |   |                                                   |   |   |   |   |   |
| **Total                      recoveries**                                 |   |                                                   | 466    |   |                                                   | 456    |   |                                                   | 212    |   |                                                   | 166 |   |   | 191 |   |
|                                                                      |   |                                                   |   |   |                                                   |   |   |                                                   |   |   |                                                   |   |   |   |   |   |
| **Net                      loans charged off**                            |   |                                                   | 3,734  |   |                                                   | 4,929  |   |                                                   | 4,270  |   |                                                   | 4,275 |   |   | 2,167 |   |
|                                                                      |   |                                                   |   |   |                                                   |   |   |                                                   |   |   |                                                   |   |   |   |   |   |
| Provision                      for loan losses                            |   |                                                   | 3,110  |   |                                                   | 3,256  |   |                                                   | 6,744  |   |                                                   | 5,432 |   |   | 3,545 |   |
|                                                                      |   |                                                   |   |   |                                                   |   |   |                                                   |   |   |                                                   |   |   |   |   |   |
| **Reserve                      for loan losses at end of year**           |   | $                                                      | 7,425  |   |                                                   | 8,049  |   |                                                   | 9,722  |   |                                                   | 7,248 |   |   | 6,091 |   |
|                                                                      |   |                                                   |   |   |                                                   |   |   |                                                   |   |   |                                                   |   |   |   |   |   |
| Loans                      charged off net of recoveries, as              |   |                                                   |   |   |                                                   |   |   |                                                   |   |   |                                                   |   |   |   |   |   |
| a                      percent of average loans outstanding               |   |                                                   | 0.68   | %      |                                                   | 0.90   | %      |                                                   | 0.79   | %      |                                                   | 0.84 | % |   | 0.48 | % |

*Non-performing          Assets. *

----

| **Table                      12 - Non-performing Assets**              |                                                   |   |                                                   |   |                                                   |   |                                                   |   |                                                   |   |   |
|------------------------------------------------------------------------|--------------------------------------------------------|--------|--------------------------------------------------------|--------|--------------------------------------------------------|--------|--------------------------------------------------------|--------|--------------------------------------------------------|--------|--------|
|                                                                   |                                                   |   |                                                   |   |                                                   |   |                                                   |   |                                                   |   |   |
| **(Dollars                      in Thousands)**                        | **                          2005** |   | **                          2004** |   | **                          2003** |   | **                          2002** |   | **                          2001** |   |
| Non-accrual                      loans                                 |                                                   | $      | 3,492                                                  |   |                                                   | 5,097  |                                                   |   | 4,343                                                  |   |   | 4,602 |   |   | 3,756 |   |
| Loans                      90 days or more past due and still accruing |                                                   |   | 946                                                    |   |                                                   | 245    |                                                   |   | 271                                                    |   |   | 239 |   |   | 655 |   |
| **Total                      non-performing loans**                    |                                                   |   | 4,438                                                  |   |                                                   | 5,342  |                                                   |   | 4,614                                                  |   |   | 4,841 |   |   | 4,411 |   |
| All                      other real estate owned                       |                                                   |   | 531                                                    |   |                                                   | 682    |                                                   |   | 1,447                                                  |   |   | 240 |   |   | 256 |   |
| All                      other repossessed assets                      |                                                   |   | -                                                      |   |                                                   | -      |                                                   |   | 206                                                    |   |   | 1,538 |   |   | 4 |   |
| **Total                      non-performing assets**                   |                                                   | $      | 4,969                                                  |   |                                                   | 6,024  |                                                   |   | 6,267                                                  |   |   | 6,619 |   |   | 4,671 |   |
|                                                                   |                                                   |   |                                                   |   |                                                   |   |                                                   |   |                                                   |   |   |   |   |   |   |   |
| **As                      a percent of total loans at year end**       |                                                   |   |                                                   |   |                                                   |   |                                                   |   |                                                   |   |   |   |   |   |   |   |
| Non-accrual                      loans                                 |                                                   |   | 0.62                                                   | %      |                                                   | 0.95   | %                                                      |   | 0.79                                                   | %      |   | 0.87 | % |   | 0.77 | % |
| Loans                      90 days or more past due and still accruing |                                                   |   | 0.17                                                   | %      |                                                   | 0.05   | %                                                      |   | 0.05                                                   | %      |   | 0.05 | % |   | 0.13 | % |
| Total                      non-performing assets                       |                                                   |   | 0.88                                                   | %      |                                                   | 1.12   | %                                                      |   | 1.14                                                   | %      |   | 1.26 | % |   | 0.95 | % |

*Deposits.          *
** **

| **Table                      13 - Maturities of Time Deposits over $100,000** |   |     |    |
|-------------------------------------------------------------------------------|--------|----------|---------|
|                                                                          |   |     |    |   |
| **(Dollars                      in Thousands)**                               |   | **2005** |    |
| Three                      months or less                                     |   | $        | 33,040  |   |
| Over                      three months through six months                     |   |     | 28,730  |   |
| Over                      six months through twelve months                    |   |     | 38,760  |   |
| Over                      twelve months                                       |   |     | 51,881  |   |
| **Total**                                                                     |   | $        | 152,411 |   |

*Borrowed          Funds. *
** **

----

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

*Contractual          Obligations and Off-Balance Sheet Arrangements. *

| **Table                    14 - 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                                     |   |                                       | 2,500  |                                      |   | 17,000    |   |   | 45,000 |   | $ | 67,000 |   |
| Junior                    subordinated debentures                                                                                                       |                                   |   | -                                         |   |                                       | -      |                                      |   | -         |   |   | 14,433 |   |   | 14,433 |   |
| Operating                    lease obligations                                                                                                          |                                   |   | 985                                       |   |                                       | 1,935  |                                      |   | 1,447     |   |   | 4,232 |   |   | 8,599 |   |
|                                                                                                                                                    |                                   |   |                                      |   |                                       |   |                                      |   |      |   |   |   |   |   |   |   |
| **Total**                                                                                                                                               |                                   | $      | 3,485                                     |   |                                       | 4,435  |                                      |   | 18,447    |   |   | 63,665 |   | $ | 90,032 |   |
|                                                                                                                                                    |                                   |   |                                      |   |                                       |   |                                      |   |      |   |   |   |   |   |   |   |
| **Other                    Commitments**                                                                                                                |                                   |   |                                      |   |                                       |   |                                      |   |      |   |   |   |   |   |   |   |
| Commitments                    to extend credit                                                                                                         |                                   | $      | 46,450                                    |   |                                       | 23,217 |                                      |   | 9,472     |   |   | 54,270 |   | $ | 133,409 |   |
| Standby                    letters of credit                                                                                                            |                                   |   |                                      |   |                                       |   |                                      |   |      |   |   |   |   |   |   |   |
| and                    financial guarantees written                                                                                                     |                                   |   | 2,607                                     |   |                                       | 85     |                                      |   | -         |   |   | - |   |   | 2,692 |   |
|                                                                                                                                                    |                                   |   |                                      |   |                                       |   |                                      |   |      |   |   |   |   |   |   |   |
| **Total**                                                                                                                                               |                                   | $      | 49,057                                    |   |                                       | 23,302 |                                      |   | 9,472     |   |   | 54,270 |   | $ | 136,101 |   |
|                                                                                                                                                    |                                   |   |                                      |   |                                       |   |                                      |   |      |   |   |   |   |   |   |   |
| *Excludes                    $4.6 million adjustable rate credit due to the FHLB, which matured                    in                    February 2006. |                                   |   |                                      |   |                                       |   |                                      |

----

*Capital          Resources. *

----

| **Table                      15 - Equity Ratios**     |   |                                                                     |   |   |                                                                     |   |   |
|-------------------------------------------------------|--------|--------------------------------------------------------------------------|--------|--------|--------------------------------------------------------------------------|--------|--------|
|                                                  |   |                                                                     |   |   |                                                                     |   |   |
|                                                  |   | **                             2005** |   |   | **                             2004** |   |   | **                             2003** |   |
| Return                      on average assets         |   |                                                                     | 0.90   | %      |                                                                     | 0.65   | %      |   | 0.30 | % |
| Return                      on average equity         |   |                                                                     | 11.31  | %      |                                                                     | 8.52   | %      |   | 4.01 | % |
| Dividend                      payout ratio            |   |                                                                     | 22.34  | %      |                                                                     | 28.37  | %      |   | 62.56 | % |
| Average                      equity to average assets |   |                                                                     | 7.92   | %      |                                                                     | 7.59   | %      |   | 7.56 | % |
|                                                  |   |                                                                     |   |   |                                                                     |   |   |   |   |   |

*Quarterly          Financial Data. *

| **Table                      16 - Quarterly Financial Data**                                      |      |     |       |     |      |   |       |   |      |   |       |   |      |   |       |   |   |
|---------------------------------------------------------------------------------------------------|-----------|----------|------------|----------|-----------|--------|------------|--------|-----------|--------|------------|--------|-----------|--------|------------|--------|--------|
|                                                                                              |      |     |       |     |      |   |       |   |      |   |       |   |      |   |       |   |   |
|                                                                                              |      | **2005** |       | **2004** |      |
| **(Dollars                      in thousands, except****per                      share amounts)** | **First** |     | **Second** |     | **Third** |   | **Fourth** |   | **First** |   | **Second** |   | **Third** |   | **Fourth** |   |
|                                                                                              |      |     |       |     |      |   |       |   |      |   |       |   |      |   |       |   |   |   |   |   |   |   |   |   |   |
| Total                      interest income                                                        |      | $        | 9,581      |     |      | 10,349 |       |   | 11,352    |   |       | 12,089 |      |   | 8,936      |   |   | 8,847 |   |   | 9,135 |   |   | 9,374 |   |
| Total                      interest expense                                                       |      |     | 3,346      |     |      | 3,686  |       |   | 3,978     |   |       | 4,418  |      |   | 3,066      |   |   | 3,002 |   |   | 3,103 |   |   | 3,164 |   |
|                                                                                              |      |     |       |     |      |   |       |   |      |   |       |   |      |   |       |   |   |   |   |   |   |   |   |   |   |
| **Net                      interest income**                                                      |      |     | 6,235      |     |      | 6,663  |       |   | 7,374     |   |       | 7,671  |      |   | 5,870      |   |   | 5,845 |   |   | 6,032 |   |   | 6,210 |   |
|                                                                                              |      |     |       |     |      |   |       |   |      |   |       |   |      |   |       |   |   |   |   |   |   |   |   |   |   |
| Provision                      for loan losses                                                    |      |     | 690        |     |      | 723    |       |   | 930       |   |       | 767    |      |   | 859        |   |   | 868 |   |   | 931 |   |   | 598 |   |
| Other                      income                                                                 |      |     | 1,638      |     |      | 1,842  |       |   | 1,795     |   |       | 1,421  |      |   | 1,500      |   |   | 1,531 |   |   | 1,549 |   |   | 1,440 |   |
| Other                      expense                                                                |      |     | 5,259      |     |      | 5,301  |       |   | 5,388     |   |       | 5,869  |      |   | 4,720      |   |   | 4,873 |   |   | 4,990 |   |   | 5,474 |   |
|                                                                                              |      |     |       |     |      |   |       |   |      |   |       |   |      |   |       |   |   |   |   |   |   |   |   |   |   |
| **Income                      before income taxes**                                               |      |     | 1,924      |     |      | 2,481  |       |   | 2,851     |   |       | 2,456  |      |   | 1,791      |   |   | 1,635 |   |   | 1,660 |   |   | 1,578 |   |
| Income                      taxes                                                                 |      |     | 647        |     |      | 873    |       |   | 1,010     |   |       | 851    |      |   | 613        |   |   | 547 |   |   | 552 |   |   | 521 |   |
|                                                                                              |      |     |       |     |      |   |       |   |      |   |       |   |      |   |       |   |   |   |   |   |   |   |   |   |   |
| **Net                      earnings**                                                             |      | $        | 1,277      |     |      | 1,608  |       |   | 1,841     |   |       | 1,605  |      |   | 1,178      |   |   | 1,088 |   |   | 1,108 |   |   | 1,057 |   |
|                                                                                              |      |     |       |     |      |   |       |   |      |   |       |   |      |   |       |   |   |   |   |   |   |   |   |   |   |
| **Basic                      earnings per share**                                                 |      | $        | 0.37       |     |      | 0.47   |       |   | 0.53      |   |       | 0.47   |      |   | 0.34       |   |   | 0.31 |   |   | 0.32 |   |   | 0.31 |   |
| **Diluted                      earnings per share**                                               |      | $        | 0.36       |     |      | 0.46   |       |   | 0.52      |   |       | 0.46   |      |   | 0.34       |   |   | 0.31 |   |   | 0.32 |   |   | 0.30 |   |

----

**QUANTATIVE          AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

** **

| Table                  17 - Market Risk Table |                                                                                            |   |
|-----------------------------------------------|-------------------------------------------------------------------------------------------------|--------|
|                                          |                                                                                            |   |
| (Dollars                  In Thousands)       | Principal/Notional                  Amount Maturing in Year Ended December                  31, |

| **Loans                      Receivable**                          |   | **2006** |    |   | **2007** |    |   | **2008** |   |   | **2009                      & 2010** |   |   | **Thereafter** |    |   | **Total** |    |   | **Fair                      Value** |    |
|--------------------------------------------------------------------|--------|----------|---------|--------|----------|---------|--------|----------|--------|--------|------------------------------------------|--------|--------|----------------|---------|--------|-----------|---------|--------|-------------------------------------|---------|
| Fixed                      rate                                    |   | $        | 19,131  |   |     | 16,117  |   |     | 14,695 |   |                                     | 31,070 |   |           | 30,114  |   | $         | 111,128 |   | $                                   | 111,049 |   |
| Average                      interest rate                         |   |     | 7.93    | %      |     | 7.28    | %      |     | 6.80   | %      |                                     | 6.83   | %      |           | 6.92    | %      |      |    |   |                                |    |   |
| Variable                      rate                                 |   | $        | 169,488 |   |     | 66,448  |   |     | 38,876 |   |                                     | 74,198 |   |           | 106,526 |   | $         | 455,535 |   | $                                   | 455,498 |   |
| Average                      interest rate                         |   |     | 7.82    | %      |     | 7.97    | %      |     | 8.05   | %      |                                     | 7.89   | %      |           | 7.65    | %      |      |    |   |                                |    |   |
|                                                               |   |     |    |   |     |    |   |     |   |   |                                     |   |   |           |    |   | $         | 566,663 |   | $                                   | 566,547 |   |
| **Investment                      Securities**                     |   | .        |    |   |     |    |   |     |   |   |                                     |   |   |           |    |   |      |    |   |                                |    |
| Interest                      bearing cash                         |   | $        | -       |   |     | -       |   |     | -      |   |                                     | -      |   |           | 1,480   |   | $         | 1,480   |   | $                                   | 1,480   |   |
| Average                      interest rate                         |   |     | -       |   |     | -       |   |     | -      |   |                                     | -      |   |           | 3.64    | %      |      |    |   |                                |    |   |
| Federal                      funds sold                            |   | $        | 1,347   |   |     | -       |   |     | -      |   |                                     | -      |   |           | -       |   | $         | 1,347   |   | $                                   | 1,347   |   |
| Average                      interest rate                         |   |     | 3.80    | %      |     | -       |   |     | -      |   |                                     | -      |   |           | -       |   |      |    |   |                                |    |   |
| Securities                      available for sale                 |   | $        | 1,535   |   |     | 5,485   |   |     | 16,725 |   |                                     | 25,708 |   |           | 65,705  |   | $         | 115,158 |   | $                                   | 115,158 |   |
| Average                      interest rate                         |   |     | 4.41    | %      |     | 4.57    | %      |     | 4.29   | %      |                                     | 4.18   | %      |           | 3.88    | %      |      |    |   |                                |    |   |
| Nonmarketable                      equity securities               |   | $        | -       |   |     | -       |   |     | -      |   |                                     | -      |   |           | 3,735   |   | $         | 3,735   |   | $                                   | 5,506   |   |
| Average                      interest rate                         |   |     | -       |   |     | -       |   |     | -      |   |                                     | -      |   |           | 3.97    | %      |      |    |   |                                |    |   |
|                                                               |   |     |    |   |     |    |   |     |   |   |                                     |   |   |           |    |   |      |    |   |                                |    |   |
| **Debt                      Obligations**                          |   |     |    |   |     |    |   |     |   |   |                                     |   |   |           |    |   |      |    |   |                                |    |
| Deposits                                                           |   | $        | 230,683 |   |     | 101,307 |   |     | 46,232 |   |                                     | 37,888 |   |           | 166,744 |   | $         | 582,854 |   | $                                   | 583,312 |   |
| Average                      interest rate                         |   |     | 3.36    | %      |     | 4.10    | %      |     | 4.05   | %      |                                     | 3.77   | %      |           | 1.05    | %      |      |    |   |                                |    |   |
| Advances                      from FHLB                            |   | $        | 47,100  |   |     | 7,500   |   |     | -      |   |                                     | 17,000 |   |           | -       |   | $         | 71,600  |   | $                                   | 71,843  |   |
| Average                      interest rate                         |   |     | 3.62    | %      |     | 3.99    | %      |     | -      |   |                                     | 5.35   | %      |           | -       |   |      |    |   |                                |    |   |
| Demand                      notes payable to U.S. Treasury         |   | $        | 1,474   |   |     | -       |   |     | -      |   |                                     | -      |   |           | -       |   | $         | 1,474   |   | $                                   | 1,474   |   |
| Average                      interest rate                         |   |     | 3.79    | %      |     | -       |   |     | -      |   |                                     | -      |   |           | -       |   |      |    |   |                                |    |   |
| Securities                      sold under agreement to repurchase |   | $        | 981     |   |     | -       |   |     | -      |   |                                     | -      |   |           | -       |   | $         | 981     |   | $                                   | 981     |   |
| Average                      interest rate                         |   |     | 3.14    | %      |     | -       |   |     | -      |   |                                     | -      |   |           | -       |   |      |    |   |                                |    |   |
| Junior                      subordinated debentures                |   | $        | -       |   |     | -       |   |     | -      |   |                                     | -      |   |           | 14,433  |   | $         | 14,433  |   | $                                   | 14,433  |   |
| Average                      interest rate                         |   |     | -       |   |     | -       |   |     | -      |   |                                     | -      |   |           | 7.11    | %      |      |    |   |                                |    |   |
|                                                               |   |     |    |   |     |    |   |     |   |   |                                     |   |   |           |    |   |      |    |   |                                |    |   |
| **Derivative                      Instruments (notional amount)**  |   |     |    |   |     |    |   |     |   |   |                                     |   |   |           |    |   |      |    |   |                                |    |
| Interest                      rate floor contracts                 |   | $        | -       |   |     | -       |   |     | 70,000 |   |                                     | -      |   |           | -       |   | $         | 70,000  |   | $                                   | 176     |   |
| Average                      interest rate                         |   |     | -       |   |     | -       |   |     | 6.63   | %      |                                     | -      |   |           | -       |   |      |    |   |                                |    |   |

----

| **Table                      18 - Interest Rate Risk**                                          |   |                                                                         |   |   |                              |
|-------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------|--------|--------|-----------------------------------|
| **(Dollars                      in thousands)**                                                 |   |                                                                         |   |   |                              |
|                                                                                            |   | **Estimated                      Resulting Theoretical Net Interest Income** |   |
| **Hypothetical                      rate change****(ramp                      over 12 months)** |   | **Amount**                                                                   |   |   | **%                      Change** |   |
| +2%                                                                                             |   | $                                                                            | 33,409 |   |                              | 7.68 | % |
| +1%                                                                                             |   | $                                                                            | 32,216 |   |                              | 3.83 | % |
|                        0%                                                                  |   | $                                                                            | 31,028 |   |                              | 0.00 | % |
| -1%                                                                                             |   | $                                                                            | 29,952 |   |                              | -3.47 | % |
| -2%                                                                                             |   | $                                                                            | 29,052 |   |                              | -6.37 | % |
|                                                                                            |   |                                                                         |   |   |                              |   |   |
|                                                                                            |   |                                                                         |   |   |                              |   |   |
|                                                                                            |   |                                                                         |   |   |                              |   |   |

|                                                                                              |   | **Estimated                      Resulting Theoretical****Market Value                      of Equity** |   |
|---------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------------|--------|
| **Hypothetical                      rate change**** (immediate                      shock)** |   |  **Amount**                                                                                             |   |  **%                      Change** |   |
| +2%                                                                                               |   | $                                                                                                            | 48,424 |   |   | -8.63 | % |
| +1%                                                                                               |   | $                                                                                                            | 50,588 |   |   | -4.54 | % |
|                        0%                                                                    |   | $                                                                                                            | 52,995 |   |   | 0.00 | % |
| -1%                                                                                               |   | $                                                                                                            | 55,686 |   |   | 5.08 | % |
| -2%                                                                                               |   | $                                                                                                            | 58,725 |   |   | 10.81 | % |
|                                                                                              |   |                                                                                                         |   |   |   |   |   |

----

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

**AND          RELATED SHAREHOLDER MATTERS**

** **

| **Table                        19 - Market and Dividend Data** |   |                               |   |   |                                |   |   |                                                                         |   |   |
|----------------------------------------------------------------|--------|------------------------------------|--------|--------|-------------------------------------|--------|--------|------------------------------------------------------------------------------|--------|--------|
| **2005**                                                       |   | **Low                        Bid** |   |   | **High                        Bid** |   |   | **Cash                        Dividend****Per                        Share** |   |
| First                        Quarter                           |   | $                                  | 17.75  |   |                                | 22.27  |   |                                                                         | 0.10   |   |
|                                                           |   |                               |   |   |                                |   |   |                                                                         |   |   |
| Second                        Quarter                          |   | $                                  | 17.25  |   |                                | 22.00  |   |                                                                         | 0.10   |   |
|                                                           |   |                               |   |   |                                |   |   |                                                                         |   |   |
| Third                        Quarter                           |   | $                                  | 18.16  |   |                                | 22.27  |   |                                                                         | 0.10   |   |
|                                                           |   |                               |   |   |                                |   |   |                                                                         |   |   |
| Fourth                        Quarter                          |   | $                                  | 19.47  |   |                                | 24.00  |   |                                                                         | 0.11   |   |
|                                                           |   |                               |   |   |                                |   |   |                                                                         |   |   |
|                                                           |   |                               |   |   |                                |   |   |                                                                         |   |   |
| **2004**                                                       |   | **Low                        Bid** |   |   | **High                        Bid** |   |   | **Cash                        Dividend****Per                        Share** |   |
| First                        Quarter                           |   | $                                  | 15.84  |   |                                | 18.25  |   |                                                                         | 0.09   |   |
|                                                           |   |                               |   |   |                                |   |   |                                                                         |   |   |
| Second                        Quarter                          |   | $                                  | 16.09  |   |                                | 17.95  |   |                                                                         | 0.09   |   |
|                                                           |   |                               |   |   |                                |   |   |                                                                         |   |   |
| Third                        Quarter                           |   | $                                  | 16.54  |   |                                | 18.09  |   |                                                                         | 0.09   |   |
|                                                           |   |                               |   |   |                                |   |   |                                                                         |   |   |
| Fourth                        Quarter                          |   | $                                  | 16.39  |   |                                | 18.18  |   |                                                                         | 0.09   |   |

----

**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**

----

**REPORT          OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

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

----

| **PEOPLES                  BANCORP OF NORTH CAROLINA, INC. AND                  SUBSIDIARIES** |
|------------------------------------------------------------------------------------------------|
|                                                                                           |   |   |   |   |   |
| **Consolidated                  Balance Sheets**                                               |
|                                                                                           |   |   |   |   |   |
| **December                  31, 2005 and 2004**                                                |
|                                                                                           |   |   |   |   |   |
| Assets                                                                                         |   | 2005 |   | 2004 |   |
|                                                                                           |   |   |   |   |   |   |   |
|                                                                                           |   |   |   |   |   |   |   |
| Cash                  and due from banks, including reserve requirements                       |   | $ | 18,468,999 |   |   | 15,067,871 |   |
| of                  $5,229,000 and $4,643,000                                                  |   |   |   |   |   |   |   |
| Federal                  funds sold                                                            |   |   | 1,347,000 |   |   | 1,723,000 |   |
| Cash                  and cash equivalents                                                     |   |   | 19,815,999 |   |   | 16,790,871 |   |
|                                                                                           |   |   |   |   |   |   |   |
| Investment                  securities available for sale                                      |   |   | 115,158,184 |   |   | 105,598,106 |   |
| Other                  investments                                                             |   |   | 5,810,749 |   |   | 5,396,959 |   |
| Total                  securities                                                              |   |   | 120,968,933 |   |   | 110,995,065 |   |
|                                                                                           |   |   |   |   |   |   |   |
| Mortgage                  loans held for sale                                                  |   |   | 2,247,900 |   |   | 3,783,175 |   |
|                                                                                           |   |   |   |   |   |   |   |
| Loans                                                                                          |   |   | 566,663,416 |   |   | 535,467,733 |   |
| Less                  allowance for loan losses                                                |   |   | (7,424,782 | ) |   | (8,048,627 | ) |
| Net                  loans                                                                     |   |   | 559,238,634 |   |   | 527,419,106 |   |
|                                                                                           |   |   |   |   |   |   |   |
| Premises                  and equipment, net                                                   |   |   | 12,662,153 |   |   | 12,742,730 |   |
| Cash                  surrender value of life insurance                                        |   |   | 6,311,757 |   |   | 6,034,188 |   |
| Accrued                  interest receivable and other assets                                  |   |   | 9,034,239 |   |   | 8,582,937 |   |
| Total                  assets                                                                  |   | $ | 730,279,615 |   |   | 686,348,072 |   |
|                                                                                           |   |   |   |   |   |   |   |
| Liabilities                  and Shareholders' Equity                                          |   |   |   |   |   |   |   |
|                                                                                           |   |   |   |   |   |   |   |
| Deposits:                                                                                      |   |   |   |   |   |   |   |
| Non-interest                  bearing demand                                                   |   | $ | 94,660,721 |   |   | 78,024,194 |   |
| NOW,                  MMDA & savings                                                       |   |   | 183,248,699 |   |   | 193,917,507 |   |
| Time,                  $100,000 or more                                                        |   |   | 152,410,976 |   |   | 154,300,926 |   |
| Other                  time                                                                    |   |   | 152,533,265 |   |   | 130,279,446 |   |
| Total                  deposits                                                                |   |   | 582,853,661 |   |   | 556,522,073 |   |
|                                                                                           |   |   |   |   |   |   |   |
| Demand                  notes payable to U.S. Treasury                                         |   |   | 1,473,693 |   |   | 1,184,392 |   |
| Securities                  sold under agreement to repurchase                                 |   |   | 981,050 |   |   | -                      |   |
| FHLB                  borrowings                                                               |   |   | 71,600,000 |   |   | 59,000,000 |   |
| Junior                  subordinated debentures                                                |   |   | 14,433,000 |   |   | 14,433,000 |   |
| Accrued                  interest payable and other liabilities                                |   |   | 4,585,217 |   |   | 4,270,755 |   |
| Total                  liabilities                                                             |   |   | 675,926,621 |   |   | 635,410,220 |   |
|                                                                                           |   |   |   |   |   |   |   |
| 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                  3,440,805 shares in 2005                                          |   |   |   |   |   |   |   |
| and                  3,135,074 shares in 2004                                                  |   |   | 41,096,500 |   |   | 35,040,390 |   |
| Retained                  earnings                                                             |   |   | 14,656,160 |   |   | 16,018,206 |   |
| Accumulated                  other comprehensive income (loss)                                 |   |   | (1,399,666 | ) |   | (120,744 | ) |
| Total                  shareholders' equity                                                    |   |   | 54,352,994 |   |   | 50,937,852 |   |
|                                                                                           |   |   |   |   |   |   |   |
| Total                  liabilities and shareholders' equity                                    |   | $ | 730,279,615 |   |   | 686,348,072 |   |
|                                                                                           |   |   |   |   |   |   |   |
| 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, 2005, 2004 and                  2003**     |
|                                                                                           |   |   |   |   |   |   |   |
|                                                                                           |   | 2005 |   | 2004 |   | 2003 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Interest                  income:                                                              |   |   |   |   |   |   |   |   |   |   |
| Interest                  and fees on loans                                                    |   | $ | 38,609,667 |   |   | 32,290,835 |   |   | 31,612,448 |   |
| Interest                  on federal funds sold                                                |   |   | 72,578 |   |   | 35,236 |   |   | 58,384 |   |
| Interest                  on investment securities:                                            |   |   |   |   |   |   |   |   |   |   |
| U.S.                  Government agencies                                                      |   |   | 3,584,755 |   |   | 2,903,865 |   |   | 2,244,375 |   |
| States                  and political subdivisions                                             |   |   | 735,892 |   |   | 660,227 |   |   | 577,339 |   |
| Other                                                                                          |   |   | 367,875 |   |   | 402,080 |   |   | 441,958 |   |
| Total                  interest income                                                         |   |   | 43,370,767 |   |   | 36,292,243 |   |   | 34,934,504 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Interest                  expense:                                                             |   |   |   |   |   |   |   |   |   |   |
| NOW,                  MMDA & savings deposits                                              |   |   | 2,644,413 |   |   | 1,899,249 |   |   | 1,318,820 |   |
| Time                  deposits                                                                 |   |   | 8,923,488 |   |   | 7,145,486 |   |   | 8,157,388 |   |
| FHLB                  borrowings                                                               |   |   | 2,888,785 |   |   | 2,602,866 |   |   | 2,597,043 |   |
| Junior                  subordinated debentures                                                |   |   | 938,145 |   |   | 676,547 |   |   | 667,526 |   |
| Other                                                                                          |   |   | 33,790 |   |   | 10,518 |   |   | 7,891 |   |
| Total                  interest expense                                                        |   |   | 15,428,621 |   |   | 12,334,666 |   |   | 12,748,668 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Net                  interest income                                                           |   |   | 27,942,146 |   |   | 23,957,577 |   |   | 22,185,836 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Provision                  for loans losses                                                    |   |   | 3,110,000 |   |   | 3,256,000 |   |   | 6,743,900 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Net                  interest income after provision for loan losses                           |   |   | 24,832,146 |   |   | 20,701,577 |   |   | 15,441,936 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Other                  income:                                                                 |   |   |   |   |   |   |   |   |   |   |
| Service                  charges                                                               |   |   | 3,779,933 |   |   | 3,434,544 |   |   | 3,266,949 |   |
| Other                  service charges and fees                                                |   |   | 1,141,879 |   |   | 677,191 |   |   | 610,591 |   |
| Loss                  on sale of securities                                                    |   |   | (729,727 | ) |   | (63,688 | ) |   | (52,855 | ) |
| Mortgage                  banking income                                                       |   |   | 469,109 |   |   | 356,782 |   |   | 604,568 |   |
| Insurance                  and brokerage commissions                                           |   |   | 386,662 |   |   | 429,788 |   |   | 420,762 |   |
| Loss                  on sale of repossessed assets                                            |   |   | (37,811 | ) |   | (179,886 | ) |   | (746,543 | ) |
| Gain                  on sale of loans                                                         |   |   | -                      |   |   | -                      |   |   | 478,759 |   |
| Miscellaneous                                                                                  |   |   | 1,686,334 |   |   | 1,365,397 |   |   | 1,262,883 |   |
| Total                  other income                                                            |   |   | 6,696,379 |   |   | 6,020,128 |   |   | 5,845,114 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Other                  expense:                                                                |   |   |   |   |   |   |   |   |   |   |
| Salaries                  and employee benefits                                                |   |   | 12,350,119 |   |   | 11,477,495 |   |   | 10,099,811 |   |
| Occupancy                                                                                      |   |   | 3,948,694 |   |   | 3,672,051 |   |   | 3,389,857 |   |
| Other                                                                                          |   |   | 5,517,832 |   |   | 4,907,923 |   |   | 4,738,253 |   |
| Total                  other expenses                                                          |   |   | 21,816,645 |   |   | 20,057,469 |   |   | 18,227,921 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Earnings                  before income taxes                                                  |   |   | 9,711,880 |   |   | 6,664,236 |   |   | 3,059,129 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Income                  taxes                                                                  |   |   | 3,380,900 |   |   | 2,233,300 |   |   | 1,055,538 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Net                  earnings                                                                  |   | $ | 6,330,980 |   |   | 4,430,936 |   |   | 2,003,591 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Basic                  earnings per share                                                      |   | $ | 1.84 |   |   | 1.28 |   |   | 0.58 |   |
| Diluted                  earnings per share                                                    |   | $ | 1.80 |   |   | 1.26 |   |   | 0.58 |   |
| Cash                  dividends declared per share                                             |   | $ | 0.41 |   |   | 0.36 |   |   | 0.36 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| 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, 2005, 2004 and                  2003** |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                       |   |   |   |   |   |   |   | Accumulated |   |   |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   | Other |   |   |   |   |
|                                                                                       |   |   | Common                  Stock  |   |   | Retained |   |   | Comprehensive |   |   |   |   |
|                                                                                       |   |   | Shares |   |   | Amount |   |   | Earnings |   |   | Income                  (Loss) |   |   | Total |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Balance,                  December 31, 2002                                                |   |   | 3,133,547 |   | $ | 35,097,773 |   |   | 12,094,363 |   |   | 1,412,597 |   |   | 48,604,733 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash                  dividends declared                                                   |   |   | -                      |   |   | -                      |   |   | (1,253,430 | ) |   | -                      |   |   | (1,253,430 | ) |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Exercise                  of stock options                                                 |   |   | 1,655 |   |   | 23,737 |   |   | - |   |   | -                      |   |   | 23,737 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net                  earnings                                                              |   |   | -                      |   |   | -                      |   |   | 2,003,591 |   |   | -                      |   |   | 2,003,591 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Change                  in accumulated other                                               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| comprehensive                  income (loss), net of tax                                   |   |   | -                      |   |   | -                      |   |   | -                      |   |   | (824,735 | ) |   | (824,735 | ) |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 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 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| 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, 2005, 2004 and                  2003**     |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
|                                                                                           |   |   | 2005 |   |   | 2004 |   |   | 2003 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Net                  earnings                                                                  |   | $ | 6,330,980 |   |   | 4,430,936 |   |   | 2,003,591 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Other                  comprehensive income (loss):                                            |   |   |   |   |   |   |   |   |   |   |
| Unrealized                  holding gains (losses) on securities                               |   |   |   |   |   |   |   |   |   |   |
| available                  for sale                                                            |   |   | (3,045,565 | ) |   | 30,988 |   |   | (419,147 | ) |
| Reclassification                  adjustment for losses on                                     |   |   |   |   |   |   |   |   |   |   |
| sales                  of securities available for sale included                               |   |   |   |   |   |   |   |   |   |   |
| in                  net earnings                                                               |   |   | 729,727 |   |   | 63,688 |   |   | 52,855 |   |
| Unrealized                  holding losses on derivative                                       |   |   |   |   |   |   |   |   |   |   |
| financial                  instruments qualifying as cash flow                                 |   |   |   |   |   |   |   |   |   |   |
| hedges                                                                                         |   |   | (283,493 | ) |   | (702,000 | ) |   | (284,000 | ) |
| Reclassification                  adjustment for losses (gains) on                             |   |   |   |   |   |   |   |   |   |   |
| derivative                  financial instruments qualifying as                                |   |   |   |   |   |   |   |   |   |   |
| cash                  flow hedges included in net earnings                                     |   |   | 483,715 |   |   | (553,375 | ) |   | (700,626 | ) |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Total                  other comprehensive income (loss),                                      |   |   |   |   |   |   |   |   |   |   |
| before                  income taxes                                                           |   |   | (2,115,616 | ) |   | (1,160,699 | ) |   | (1,350,918 | ) |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Income                  tax expense (benefit) related to other                                 |   |   |   |   |   |   |   |   |   |   |
| comprehensive                  income:                                                         |   |   |   |   |   |   |   |   |   |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Unrealized                  holding gains (losses) on securities                               |   |   |   |   |   |   |   |   |   |   |
| available                  for sale                                                            |   |   | (1,186,248 | ) |   | 12,070 |   |   | (163,258 | ) |
| Reclassification                  adjustment for losses on                                     |   |   |   |   |   |   |   |   |   |   |
| sales                  of securities available for sale included                               |   |   |   |   |   |   |   |   |   |   |
| in                  net earnings                                                               |   |   | 284,229 |   |   | 24,806 |   |   | 20,587 |   |
| Unrealized                  holding losses on derivative                                       |   |   |   |   |   |   |   |   |   |   |
| financial                  instruments qualifying as cash flow                                 |   |   |   |   |   |   |   |   |   |   |
| hedges                                                                                         |   |   | (123,082 | ) |   | (273,429 | ) |   | (110,618 | ) |
| Reclassification                  adjustment for losses (gains) on                             |   |   |   |   |   |   |   |   |   |   |
| derivative                  financial instruments qualifying as                                |   |   |   |   |   |   |   |   |   |   |
| cash                  flow hedges included in net earnings                                     |   |   | 188,407 |   |   | (215,540 | ) |   | (272,894 | ) |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Total                  income tax expense (benefit) related to                                 |   |   |   |   |   |   |   |   |   |   |
| other                  comprehensive income                                                    |   |   | (836,694 | ) |   | (452,093 | ) |   | (526,183 | ) |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Total                  other comprehensive income (loss),                                      |   |   |   |   |   |   |   |   |   |   |
| net                  of tax                                                                    |   |   | (1,278,922 | ) |   | (708,606 | ) |   | (824,735 | ) |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Total                  comprehensive income                                                    |   | $ | 5,052,058 |   |   | 3,722,330 |   |   | 1,178,856 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| See                  accompanying notes to consolidated financial statements.                  |   |   |   |   |   |   |   |   |   |   |

----

| **PEOPLES                  BANCORP OF NORTH CAROLINA, INC.**                               |
|--------------------------------------------------------------------------------------------|
|                                                                                       |   |   |   |   |   |   |   |
| **Consolidated                  Statements of Cash Flows**                                 |
|                                                                                       |   |   |   |   |   |   |   |
| **For                  the Years Ended December 31, 2005, 2004 and                  2003** |
|                                                                                       |   |   |   |   |   |   |   |
|                                                                                       |   | 2005 |   | 2004 |   | 2003 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |
| Cash                  flows from operating activities:                                     |   |   |   |   |   |   |   |   |   |   |
| Net                  earnings                                                              |   | $ | 6,330,980 |   |   | 4,430,936 |   |   | 2,003,591 |   |
| Adjustments                  to reconcile net earnings to                                  |   |   |   |   |   |   |   |   |   |   |
| net                  cash provided by operating activities:                                |   |   |   |   |   |   |   |   |   |   |
| Depreciation,                  amortization and accretion                                  |   |   | 1,643,459 |   |   | 1,563,245 |   |   | 1,963,995 |   |
| Provision                  for loan losses                                                 |   |   | 3,110,000 |   |   | 3,256,000 |   |   | 6,743,900 |   |
| Deferred                  income taxes                                                     |   |   | 332,806 |   |   | 341,441 |   |   | (1,526,062 | ) |
| Loss                  on sale of investment securities                                     |   |   | 729,727 |   |   | 63,688 |   |   | 52,855 |   |
| Recognition                  of gain (loss) on sale of                                     |   |   |   |   |   |   |   |   |   |   |
| derivative                  instruments                                                    |   |   | 483,715 |   |   | (553,375 | ) |   | (700,626 | ) |
| Gain                  on sale of loans                                                     |   |   | -                      |   |   | -                      |   |   | (478,759 | ) |
| Amortization                  of deferred gain on sale of premises                         |   |   | (21,984 | ) |   | (22,412 | ) |   | -                      |   |
| Loss                  (gain) on sale of repossessed assets                                 |   |   | (2,189 | ) |   | 15,412 |   |   | 262,840 |   |
| Writedown                  of other real estate and repossessions                          |   |   | 40,000 |   |   | 164,474 |   |   | 483,703 |   |
| Change                  in:                                                                |   |   |   |   |   |   |   |   |   |   |
| Mortgage                  loans held for sale                                              |   |   | 1,535,275 |   |   | (3,195,680 | ) |   | 4,477,140 |   |
| Cash                  surrender value of life insurance                                    |   |   | (277,569 | ) |   | (988,739 | ) |   | (216,741 | ) |
| Other                  assets                                                              |   |   | 462,686 |   |   | (3,442,472 | ) |   | 377,900 |   |
| Other                  liabilities                                                         |   |   | 651,204 |   |   | 1,470,823 |   |   | (4,582 | ) |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |
| Net                  cash provided by operating activities                                 |   |   | 15,018,110 |   |   | 3,103,341 |   |   | 13,439,154 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |
| Cash                  flows from investing activities:                                     |   |   |   |   |   |   |   |   |   |   |
| Purchases                  of investment securities available for sale                     |   |   | (49,431,813 | ) |   | (48,667,610 | ) |   | (55,439,455 | ) |
| Proceeds                  from calls and maturities of investment securities               |   |   |   |   |   |   |   |   |   |   |
| available                  for sale                                                        |   |   | 9,655,995 |   |   | 19,413,975 |   |   | 27,158,675 |   |
| Proceeds                  from sales of investment securities available                    |   |   |   |   |   |   |   |   |   |   |
| for                  sale                                                                  |   |   | 27,768,392 |   |   | 2,986,313 |   |   | 19,896,324 |   |
| Purchases                  of other investments                                            |   |   | (5,367,790 | ) |   | (4,822,500 | ) |   | (925,000 | ) |
| Proceeds                  from sale of other investments                                   |   |   | 4,239,000 |   |   | 3,642,514 |   |   | 953,600 |   |
| Net                  change in loans                                                       |   |   | (35,062,738 | ) |   | 12,578,820 |   |   | (31,533,937 | ) |
| Proceeds                  from sale of loans                                               |   |   | -                      |   |   | -                      |   |   | 4,207,206 |   |
| Purchases                  of premises and equipment                                       |   |   | (1,373,019 | ) |   | (1,502,346 | ) |   | (1,913,876 | ) |
| Proceeds                  from sale of premises and equipment                              |   |   | 1,750 |   |   | -                      |   |   | -                      |   |
| Proceeds                  from sale of repossessed assets                                  |   |   | 246,218 |   |   | 2,153,103 |   |   | 1,502,891 |   |
| Purchases                  of derivative financial instruments                             |   |   | (364,000 | ) |   | -                      |   |   | -                      |   |
| Proceeds                  from (payment on) settlement of                                  |   |   |   |   |   |   |   |   |   |   |
| derivative                  financial instruments                                          |   |   | (870,000 | ) |   | -                      |   |   | 1,254,000 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |
| Net                  cash used by investing activities                                     |   |   | (50,558,005 | ) |   | (14,217,731 | ) |   | (34,839,572 | ) |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |
| Cash                  flows from financing activities:                                     |   |   |   |   |   |   |   |   |   |   |
| Net                  change in deposits                                                    |   |   | 26,331,588 |   |   | 6,719,841 |   |   | 34,063,277 |   |
| Net                  change in demand notes payable to U.S. Treasury                       |   |   | 289,301 |   |   | 741,008 |   |   | (1,156,616 | ) |
| Net                  change in securities sold under agreement to repurchase               |   |   | 981,050 |   |   | -                      |   |   | -                      |   |
| Proceeds                  from FHLB borrowings                                             |   |   | 162,300,000 |   |   | 95,850,000 |   |   | 46,650,000 |   |
| Repayments                  of FHLB borrowings                                             |   |   | (149,700,000 | ) |   | (94,850,000 | ) |   | (51,721,429 | ) |
| Proceeds                  from exercise of stock options                                   |   |   | 96,773 |   |   | 209,706 |   |   | 23,737 |   |
| Common                  stock repurchased                                                  |   |   | (314,750 | ) |   | (290,826 | ) |   | -                      |   |
| Cash                  paid in lieu of fractional shares                                    |   |   | (4,700 | ) |   | -                      |   |   | -                      |   |
| Cash                  dividends paid                                                       |   |   | (1,414,239 | ) |   | (1,257,254 | ) |   | (1,253,430 | ) |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |
| Net                  cash provided by financing activities                                 |   |   | 38,565,023 |   |   | 7,122,475 |   |   | 26,605,539 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |
| Net                  change in cash and cash equivalent                                    |   |   | 3,025,128 |   |   | (3,991,915 | ) |   | 5,205,121 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |
| Cash                  and cash equivalents at beginning of period                          |   |   | 16,790,871 |   |   | 20,782,786 |   |   | 15,577,665 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |
| Cash                  and cash equivalents at end of period                                |   | $ | 19,815,999 |   |   | 16,790,871 |   |   | 20,782,786 |   |

----

| **PEOPLES                  BANCORP OF NORTH CAROLINA, INC.**                               |
|--------------------------------------------------------------------------------------------|
|                                                                                       |   |   |   |   |   |   |   |
| **Consolidated                  Statements of Cash Flows, continued**                      |
|                                                                                       |   |   |   |   |   |   |   |
| **For                  the Years ended December 31, 2005, 2004 and                  2003** |
|                                                                                       |   |   |   |   |   |   |   |
|                                                                                       |   |   |   |   |   |   |   |
|                                                                                       |   |   | 2005 |   |   | 2004 |   |   | 2003 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |
| Supplemental                  disclosures of cash flow information:                        |   |   |   |   |   |   |   |   |   |   |
| Cash                  paid during the year for:                                            |   |   |   |   |   |   |   |   |   |   |
| Interest                                                                                   |   | $ | 15,189,559 |   |   | 11,833,234 |   |   | 12,975,587 |   |
| Income                  taxes                                                              |   | $ | 2,245,000 |   |   | 2,483,394 |   |   | 2,093,000 |   |
|                                                                                       |   |   |   |   |   |   |   |   |   |   |
| Noncash                  investing and financing activities:                               |   |   |   |   |   |   |   |   |   |   |
| Change                  in unrealized gain (loss) on investment securities                 |   |   |   |   |   |   |   |   |   |   |
| available                  for sale, net                                                   |   | $ | (1,413,819 | ) |   | 57,800 |   |   | (223,621 | ) |
| Change                  in unrealized gain (loss) on derivative financial                  |   |   |   |   |   |   |   |   |   |   |
| instruments,                  net                                                          |   | $ | 134,897 |   |   | (766,406 | ) |   | (601,114 | ) |
| Transfer                  of loans to other real estate and repossessions                  |   | $ | 133,210 |   |   | 1,362,138 |   |   | 3,382,633 |   |
| Financed                  portion of sale of other real estate                             |   | $ | -                     |   |   | 2,212,142 |   |   | 1,258,500 |   |
| Financed                  portion of sale of premises and equipment                        |   | $ | -                     |   |   | -                      |   |   | 3,729,932 |   |
| 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 |

----

|                                          |                                     |   | 2005      |   | 2004      |   | 2003      |
|-----------------------------------------------|------------------------------------------|--------|-----------|--------|-----------|--------|-----------|
|                                          |                                     |   |      |   |      |   |      |
| Net                    earnings               | As                    reported           | $      | 6,330,980 |   | 4,430,936 |   | 2,003,591 |
|                                          | Effect                    of grants      |   | (143,747) |   | (312,444) |   | -         |
|                                          | Effect                    of forfeitures |   | 5,253     |   | 14,092    |   | -         |
|                                          |                                     |   |      |   |      |   |      |
|                                          | Proforma                                 | $      | 6,192,486 |   | 4,132,584 |   | 2,003,591 |
|                                          |                                     |   |      |   |      |   |      |
| Basic                    earnings per share   | As                    reported           | $      | 1.84      |   | 1.28      |   | 0.58      |
|                                          | Proforma                                 | $      | 1.79      |   | 1.19      |   | 0.58      |
|                                          |                                     |   |      |   |      |   |      |
| Diluted                    earnings per share | As                    reported           | $      | 1.80      |   | 1.26      |   | 0.58      |
|                                          | Proforma                                 | $      | 1.76      |   | 1.18      |   | 0.58      |

| For                    the year ended December 31, 2005: |   |  Net                    Earnings   |   | Common Shares               |   |   | Per                    Share Amount |
|----------------------------------------------------------|--------|-----------------------------------------|--------|----------------------------------|--------|--------|-------------------------------------|
| Basic                    earnings per share              | $      | 6,330,980                               |   | 3,449,873                        |   | $      | 1.84                                |
| Effect                    of dilutive securities:        |   |                                    |   |                             |   |   |                                |
| Stock                    options                         |   | -                        |   | 60,655                           |   |   |                                |
| Diluted                    earnings per share            | $      | 6,330,980                               |   | 3,510,528                        |   | $      | 1.80                                |
|                                                     |   |                                    |   |                             |   |   |                                |
| For                    the year ended December 31, 2004: |   |  Net                    Earnings   |   | Common                    Shares |   |   | Per                    Share Amount |
|                                                     |   |                                    |   |                             |   |   |                                |
| Basic                    earnings per share              | $      | 4,430,936                               |   | 3,459,379                        |   | $      | 1.28                                |
| Effect                    of dilutive securities:        |   |                                    |   |                             |   |   |                                |
| Stock                    options                         |   | -                        |   | 47,604                           |   |   |                                |
| Diluted                    earnings per share            | $      | 4,430,936                               |   | 3,506,983                        |   | $      | 1.26                                |

----

| For                    the year ended December 31, 2003: |   |  Net                    Earnings   |   | Common                    Shares |   |   | Per                    Share Amount |
|----------------------------------------------------------|--------|-----------------------------------------|--------|----------------------------------|--------|--------|-------------------------------------|
| Basic                    earnings per share              | $      | 2,003,591                               |   | 3,447,056                        |   | $      | 0.58                                |
| Effect                    of dilutive securities:        |   |                                    |   |                             |   |   |                                |
| Stock                    options                         |   | -                        |   | 29,703                           |   |   |                                |
| Diluted                    earnings per share            | $      | 2,003,591                               |   | 3,476,759                        |   | $      | 0.58                                |

**(2)**
**Investment        Securities**

|                                                |   | December                    31, 2005 |
|-----------------------------------------------------|--------|--------------------------------------|
|                                                |   |                                 |   | Gross  |   | Gross  |   |   |
|                                                |   |  Amortized                      |   | Unrealized  |   | Unrealized  |   |  Estimated                    Fair |
|                                                |   |  Cost                           |   | Gains  |   | Losses  |   |  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, 2004 |
|                                                |   |                                 |   | Gross  |   | Gross  |   |   |
|                                                |   |  Amortized                      |   | Unrealized  |   | Unrealized  |   |  Estimated                    Fair |
|                                                |   |  Cost                           |   | Gains  |   | Losses  |   |  Value |
|                                                |   |                                 |   |   |   |   |   |   |
| Mortgage-backed                    securities       | $      | 36,492,826                           |   | 188,816 |   | 138,443 |   | 36,543,199 |
| U.S.                    government agencies         |   | 46,498,958                           |   | 170,574 |   | 99,195 |   | 46,570,337 |
| State                    and political subdivisions |   | 20,212,105                           |   | 546,905 |   | 110,189 |   | 20,648,821 |
| Trust                    preferred securities       |   | 1,750,000                            |   | -                        |   | -                        |   | 1,750,000 |
| Equity                    securities                |   | 99,995                               |   | -                        |   | 14,246 |   | 85,749 |
|                                                |   |                                 |   |   |   |   |   |   |
| Total                                               | $      | 105,053,884                          |   | 906,295 |   | 362,073 |   | 105,598,106 |

----

|                                                |   | December                    31, 2005    |
|-----------------------------------------------------|--------|-----------------------------------------|
|                                                |   | Less                    than 12 Months  |   | 12                    Months or More |   | Total |
|                                                |   |                                    |   | Unrealized  |   |   |   | Unrealized  |   |   |   |  Unrealized |
|                                                |   | Fair                    Value           |   | Losses  |   | Fair                    Value |   | Losses  |   |  Fair                    Value |   |  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 |
|                                                |   |                                    |   |   |   |   |   |   |   |   |   |   |
|                                                |   | December                    31, 2004    |
|                                                |   | Less                    than 12 Months  |   | 12                    Months or More |   | Total |
|                                                |   |                                    |   | Unrealized  |   |   |   | Unrealized  |   |   |   | Unrealized  |
|                                                |   |  Fair                    Value     |   | Losses  |   |  Fair                    Value |   | Losses  |   |  Fair                    Value |   |  Losses |
|                                                |   |                                    |   |   |   |   |   |   |   |   |   |   |
| Mortgage-backed                    securities       | $      | 9,706,756                               |   | 100,854 |   | 2,625,755 |   | 37,589 |   | 12,332,511 |   | 138,443 |
| U.S.                    government agencies         |   | 14,910,156                              |   | 85,488 |   | 2,986,293 |   | 13,707 |   | 17,896,449 |   | 99,195 |
| State                    and political subdivisions |   | 7,118,463                               |   | 110,189 |   | -                        |   | -                        |   | 7,118,463 |   | 110,189 |
| Equity                    securities                |   | -                        |   | -                        |   | 85,749 |   | 14,246 |   | 85,749 |   | 14,246 |
|                                                |   |                                    |   |   |   |   |   |   |   |   |   |   |
| Total                                               | $      | 31,735,375                              |   | 296,531 |   | 5,697,797 |   | 65,542 |   | 37,433,172 |   | 362,073 |

|                                          |   | Amortized                    Cost |   | Estimated                    Fair Value |
|-----------------------------------------------|--------|-----------------------------------|--------|-----------------------------------------|
|                                          |   |                              |   |                                    |
| Due                    within one year        | $      | 200,172                           |   | 201,026                                 |
| Due                    from one to five years |   | 44,773,905                        |   | 44,213,108                              |
| Due                    from five to ten years |   | 33,646,742                        |   | 33,398,366                              |
| Due                    after ten years        |   | 5,628,439                         |   | 5,790,075                               |
| Mortgage-backed                    securities |   | 31,865,547                        |   | 31,003,964                              |
| Equity                    securities          |   | 814,995                           |   | 551,645                                 |
|                                          |   |                              |   |                                    |
| Total                                         | $      | 116,929,800                       |   | 115,158,184                             |

----

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

|                                              |   |                           2005 |   |                           2004 |
|---------------------------------------------------|--------|--------------------------------------------------------------|--------|--------------------------------------------------------------|
|                                              |   |                                                         |   |                                                         |
| Commercial                                        | $      | 79,902,157                                                   |   | 79,189,073                                                   |
| Real                    estate - mortgage         |   | 330,226,315                                                  |   | 312,988,293                                                  |
| Real                    estate - construction     |   | 141,420,338                                                  |   | 127,041,980                                                  |
| Consumer                                          |   | 15,114,606                                                   |   | 16,248,387                                                   |
|                                              |   |                                                         |   |                                                         |
| Total                    loans                    |   | 566,663,416                                                  |   | 535,467,733                                                  |
|                                              |   |                                                         |   |                                                         |
| Less                    allowance for loan losses |   | 7,424,782                                                    |   | 8,048,627                                                    |
|                                              |   |                                                         |   |                                                         |
| Total                    net loans                | $      | 559,238,634                                                  |   | 527,419,106                                                  |

|                                                            |   |                           2005 |   |                           2004 |   |                           2003 |
|-----------------------------------------------------------------|--------|--------------------------------------------------------------|--------|--------------------------------------------------------------|--------|--------------------------------------------------------------|
|                                                            |   |                                                         |   |                                                         |   |                                                         |
| Balance                    at beginning of year                 | $      | 8,048,627                                                    |   | 9,722,267                                                    |   | 7,247,906                                                    |
| Amounts                    charged off                          |   | (4,199,650)                                                  |   | (5,385,199)                                                  |   | (4,481,548)                                                  |
| Recoveries                    on amounts previously charged off |   | 465,805                                                      |   | 455,559                                                      |   | 212,009                                                      |
| Provision                    for loan losses                    |   | 3,110,000                                                    |   | 3,256,000                                                    |   | 6,743,900                                                    |
|                                                            |   |                                                         |   |                                                         |   |                                                         |
| Balance                    at end of year                       | $      | 7,424,782                                                    |   | 8,048,627                                                    |   | 9,722,267                                                    |

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

|                                                |   |                          2005 |   |                          2004 |
|-----------------------------------------------------|--------|--------------------------------------------------------|--------|--------------------------------------------------------|
|                                                |   |                                                   |   |                                                   |
| Land                                                | $      | 2,187,254                                              |   | 2,170,514                                              |
| Buildings                    and improvements       |   | 10,405,684                                             |   | 10,138,526                                             |
| Furniture                    and equipment          |   | 12,743,224                                             |   | 11,679,698                                             |
|                                                |   |                                                   |   |                                                   |
| Total                    premises and equipment     |   | 25,336,162                                             |   | 23,988,738                                             |
|                                                |   |                                                   |   |                                                   |
| Less                    accumulated depreciation    |   | 12,674,009                                             |   | 11,246,008                                             |
|                                                |   |                                                   |   |                                                   |
| Total                    net premises and equipment | $      | 12,662,153                                             |   | 12,742,730                                             |

----

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

| 2006                                   |   | $      | 241,930,881 |
|----------------------------------------|--------|--------|-------------|
| 2007                                   |   |   | 46,248,980  |
| 2008                                   |   |   | 6,666,780   |
| 2009                                   |   |   | 7,034,324   |
| 2010                    and thereafter |   |   | 3,063,276   |
|                                   |   |   |        |
| Total                                  |   | $      | 304,944,241 |

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

| Maturity                    Date    | Call                    Date                          | Rate   | Rate                    Type  |   | Amount     |
|-------------------------------------|-------------------------------------------------------|--------|-------------------------------|--------|------------|
|                                |                                                  |   |                          |   |       |
| February                    5, 2006 | N/A                                                   | 4.440% | Daily                    Rate | $      | 4,600,000  |
|                                |                                                  |   |                          |   |       |
| March                    30, 2010   | March                    30, 2001 and every three     |   |                          |   |       |
|                                | months                    thereafter                  | 6.020% | Convertible                   |   | 5,000,000  |
|                                |                                                  |   |                          |   |       |
| 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                    10, 2011 | January                    10, 2002 and every three   |   |                          |   |       |
|                                | months                    thereafter                  | 4.200% | Convertible                   |   | 5,000,000  |
|                                |                                                  |   |                          |   |       |
| May                    2, 2011      | May                    2, 2002 and every three        |   |                          |   |       |
|                                | months                    thereafter                  | 4.055% | Convertible                   |   | 30,000,000 |
|                                |                                                  |   |                          |   |       |
| January                    26, 2006 | N/A                                                   | 3.280% | Adjustable                    |   | 2,500,000  |
|                                |                                                  |   |                          |   |       |
| January                    25, 2007 | N/A                                                   | 4.220% | Adjustable                    |   | 2,500,000  |
|                                |                                                  |   |                          |   |       |
| June                    24, 2015    | June                    24, 2010                      | 3.710% | Convertible                   |   | 5,000,000  |
|                                |                                                  |   |                          |   |       |
| June                    24, 2010    | June                    24, 2006                      | 3.879% | Convertible                   |   | 5,000,000  |
|                                |                                                  |   |                          |   |       |
| July                    23, 2012    | July                    23, 2007                      | 3.870% | Convertible                   |   | 5,000,000  |
|                                |                                                  |   |                          |   |       |
|                                |                                                  |   |                          | $      | 71,600,000 |

----

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

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

|     |   | 2005      |   | 2004      |   | 2003        |
|----------|--------|-----------|--------|-----------|--------|-------------|
| Current  | $      | 3,048,094 |   | 1,891,859 |   | 2,581,600   |
| Deferred |   | 332,806   |   | 341,441   |   | (1,526,062) |
| Total    | $      | 3,380,900 |   | 2,233,300 |   | 1,055,538   |

|                                                        |   | 2005      |   | 2004      |   | 2003      |
|-------------------------------------------------------------|--------|-----------|--------|-----------|--------|-----------|
| Pre-tax                    income at statutory rates (34%)  | $      | 3,302,039 |   | 2,265,840 |   | 1,040,104 |
| Differences:                                                |   |      |   |      |   |      |
| Tax                    exempt interest income               |   | (263,555) |   | (243,346) |   | (216,431) |
| Nondeductible                    interest and other expense |   | 30,511    |   | 21,588    |   | 18,668    |
| Cash                    surrender value of life insurance   |   | (73,973)  |   | (65,871)  |   | (73,692)  |
| State                    taxes, net of federal benefits     |   | 363,264   |   | 236,544   |   | 270,493   |
| Other,                    net                               |   | 22,614    |   | 18,545    |   | 16,396    |
| Total                                                       | $      | 3,380,900 |   | 2,233,300 |   | 1,055,538 |

----

|                                                                 |   | 2005      |   | 2004                                    |
|----------------------------------------------------------------------|--------|-----------|--------|-----------------------------------------|
| Deferred                    tax assets:                              |   |      |   |                                    |
| Allowance                    for loan losses                         | $      | 2,862,550 |   | 3,103,068                               |
| Amortizable                    intangible assets                     |   | 141,010   |   | 173,548                                 |
| Accrued                    retirement expense                        |   | 533,155   |   | 454,446                                 |
| Income                    from non-accrual loans                     |   | 9,639     |   | 23,309                                  |
| Deferred                    gain on sale of premises                 |   | 220,876   |   | 228,932                                 |
| Unrealized                    loss on cash flow hedges               |   | 223,684   |   | 289,009                                 |
| Unrealized                    loss on available for sale securities  |   | 690,044   |   | -                        |
| Other                                                                |   | 33,578    |   | 28,965                                  |
| Total                    gross deferred tax assets                   |   | 4,714,536 |   | 4,301,277                               |
|                                                                 |   |      |   |                                    |
| Deferred                    tax liabilities:                         |   |      |   |                                    |
| Unrealized                    gains on available for sale securities |   | -         |   | 211,974                                 |
| Deferred                    loan fees                                |   | 1,135,448 |   | 1,060,798                               |
| Premises                    and equipment                            |   | 545,570   |   | 477,285                                 |
| Deferred                    income from servicing rights             |   | 87,330    |   | 108,920                                 |
| Total                    gross deferred tax liabilities              |   | 1,768,348 |   | 1,858,977                               |
| Net                    deferred tax asset                            | $      | 2,946,188 |   | 2,442,300                               |

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

| Beginning                    balance |   | $      | 8,404,828 |
|--------------------------------------|--------|--------|-----------|
| New                    loans         |   |   | 2,229,878 |
| Repayments                           |   |   | 3,413,977 |
|                                 |   |   |      |
| Ending                    balance    |   | $      | 7,220,729 |

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

| Year                                        |   |      |      |
|---------------------------------------------|--------|-----------|-----------|
| 2006                                        |   | $         | 984,858   |
| 2007                                        |   |      | 983,386   |
| 2008                                        |   |      | 952,257   |
| 2009                                        |   |      | 793,700   |
| 2010                                        |   |      | 652,643   |
| Thereafter                                  |   |      | 4,232,256 |
|                                        |   |      |      |
| Total                    minimum obligation | $      | 8,599,100 |

----

|                                                                                  |   |   | Contractual                    Amount |
|---------------------------------------------------------------------------------------|--------|--------|---------------------------------------|
|                                                                                  |   |   | 2005                                  |   | 2004 |
| Financial                    instruments whose contract amount represent credit risk: |   |   |                                  |   |   |
|                                                                                  |   |   |                                  |   |   |
| Commitments                    to extend credit                                       |   | $      | 133,409,227                           |   | 123,093,680 |
|                                                                                  |   |   |                                  |   |   |
| Standby                    letters of credit and financial guarantees written         |   | $      | 2,692,192                             |   | 3,278,326 |

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

----

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

|                                                             |   | 2005     |   | 2004     |
|------------------------------------------------------------------|--------|----------|--------|----------|
|                                                             |   |     |   |     |
| Accumulated                    postretirement benefit obligation | $      | 244,304  |   | 215,985  |
| Unrecognized                    gain (loss)                      |   | (80,495) |   | (49,038) |
|                                                             |   |     |   |     |
| Net                    liability recognized                      | $      | 163,809  |   | 166,947  |

----

|                                                |   | 2005   |                                    | 2004   |   | 2003                                  |   |
|-----------------------------------------------------|--------|--------|-----------------------------------------|--------|--------|---------------------------------------|--------|
|                                                |   |   |                                    |   |   |                                  |   |   |   |   |   |   |   |
|                                                |   |   |                                    |   |   | Weighted                         |   |   |   |   |   | Weighted  |   |   |   |   |   | Weighted  |   |
|                                                |   |   |                                    |   |   | Average                          |   |   |   |   |   | Average  |   |   |   |   |   | Average  |   |
|                                                |   |   |                                    |   |   | Option                    Price  |   |   |   |   |   | Option                    Price  |   |   |   |   |   | Option                    Price  |   |
|                                                |   |   | Shares                             |   |   | Per                    Share     |   |   | Shares  |   |   | Per                    Share  |   |   | Shares  |   |   | Per                    Share  |   |
| Outstanding,                    beginning of period |   |   | 202,401                                 |   | $      | 13.39                                 |   |   | 216,726 |   |   | 13.26 |   |   | 218,545 |   |   | 13.25 |   |
| Granted                    during the period        |   |   | -                        |   | $      | -                           |   |   | 4,400 |   |   | 17.22 |   |   | -                        |   |   | -                        |   |
| Forfeited                    during the period      |   |   | (1,194                                  | )      | $      | 12.82                                 |   |   | (2,260 | ) |   | 13.19 |   |   | -                        |   |   | -                        |   |
| Exercised                    during the period      |   |   | (7,464                                  | )      | $      | 12.97                                 |   |   | (16,465 | ) |   | 12.73 |   |   | (1,819 | ) |   | 13.04 |   |
|                                                |   |   |                                    |   |   |                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Outstanding,                    end of period       |   |   | 193,743                                 |   | $      | 13.41                                 |   |   | 202,401 |   |   | 13.39 |   |   | 216,726 |   |   | 13.26 |   |
|                                                |   |   |                                    |   |   |                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Number                    of shares exercisable     |   |   | 190,809                                 |   | $      | 13.35                                 |   |   | 173,609 |   |   | 13.37 |   |   | 140,035 |   |   | 13.17 |   |

|                                                |   | 2005         |                                    | 2004                                |   | 2003          |   |
|-----------------------------------------------------|--------|--------------|-----------------------------------------|-------------------------------------|--------|---------------|--------|
|                                                |   |         |                                    |                                |   |          |   |   |   |   |   |   |   |
|                                                |   |         |                                    |  Weighted                      |   |          |   |  Weighted |   |   |   |  Weighted |   |
|                                                |   |         |                                    |  Average                       |   |          |   |  Average |   |   |   |  Average |   |
|                                                |   |         |                                    |  Price                    of   |   |          |   |  Price                    of |   |   |   |  Price                    of |   |
|                                                |   |         |                                    |  Book                    Value |   |          |   |  Book                    Value |   |   |   |  Book                    Value |   |
|                                                |   |  Shares |                                    |  Shares                        |   |  Shares  |   |  Shares |   |  Shares |   |  Shares |   |
| Outstanding,                    beginning of period |   |         | 70,819                                  |                                | $      | 11.88         |   |   | 53,114 |   |   | 10.67 |   |   | 59,015 |   |   | 10.64 |   |
| Granted                    during the period        |   |         | -                        |                                | $      | -   |   |   | 23,606 |   |   | 14.25 |   |   | -                        |   |   | -                        |   |
| Forfeited                    during the period      |   |         | -                        |                                | $      | -   |   |   | (1,180 | ) |   | 10.41 |   |   | (5,902 | ) |   | 10.41 |   |
| Exercised                    during the period      |   |         | (11,802                                 | )                                   | $      | 10.41         |   |   | (4,721 | ) |   | 10.41 |   |   | -                        |   |   | -                        |   |
|                                                |   |         |                                    |                                |   |          |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Outstanding,                    end of period       |   |         | 59,017                                  |                                | $      | 12.18         |   |   | 70,819 |   |   | 11.88 |   |   | 53,114 |   |   | 10.67 |   |
|                                                |   |         |                                    |                                |   |          |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Number                    of shares exercisable     |   |         | 40,127                                  |                                | $      | 11.20         |   |   | 45,733 |   |   | 10.63 |   |   | 40,717 |   |   | 10.58 |   |

**(13)**
**Regulatory        Matters**

----

|                                                        |                              |   |                             |   |  To                    Be Well        |
|-------------------------------------------------------------|---------------------------------------------|--------|--------------------------------------------|--------|--------------------------------------------|
|                                                        |                                        |   |                                       |   |                                       |   |  Capitalized                    Under |
|                                                        |                                        |   |                                       |   |  For                    Capital       |   |  Prompt                    Corrective |
|                                                        |  Actual                                |   |  Adequacy                    Purposes |   |  Action                    Provisions |
|                                                        |                                        |   |                                       |   |                                       |   |   |   |   |   |   |
|                                                        | Amount                                      |   | Ratio                                      |   | Amount                                     |   | Ratio |   | Amount |   | Ratio |
|                                                        | *(dollars                    in thousands)* |
|                                                        |                                        |   |                                       |   |                                       |   |   |   |   |   |   |
| 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% |
|                                                        |                                        |   |                                       |   |                                       |   |   |   |   |   |   |
| As                    of December 31, 2004:                 |                                        |   |                                       |   |                                       |   |   |   |   |   |   |
|                                                        |                                        |   |                                       |   |                                       |   |   |   |   |   |   |
| Total                    Capital (to Risk-Weighted Assets)  |                                        |   |                                       |   |                                       |   |   |   |   |   |   |
| Consolidated                                                | $                    72,410                 |   | 12.22%                                     |   | 47,407                                     |   | 8.00% |   | N/A |   | N/A |
| Bank                                                        | $                    68,503                 |   | 11.60%                                     |   | 47,240                                     |   | 8.00% |   | 59,050 |   | 10.00% |
| Tier                    1 Capital (to Risk-Weighted Assets) |                                        |   |                                       |   |                                       |   |   |   |   |   |   |
| Consolidated                                                | $                    65,021                 |   | 10.97%                                     |   | 23,704                                     |   | 4.00% |   | N/A |   | N/A |
| Bank                                                        | $                    61,114                 |   | 10.35%                                     |   | 23,620                                     |   | 4.00% |   | 35,430 |   | 6.00% |
| Tier                    1 Capital (to Average Assets)       |                                        |   |                                       |   |                                       |   |   |   |   |   |   |
| Consolidated                                                | $                    65,021                 |   | 9.50%                                      |   | 27,374                                     |   | 4.00% |   | N/A |   | N/A |
| Bank                                                        | $                    61,114                 |   | 8.95%                                      |   | 27,328                                     |   | 4.00% |   | 34,161 |   | 5.00% |

**(14)**
**Shareholders’        Equity**

----

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

|        |   | 2005    |   | 2004    |   | 2003    |
|-------------|--------|---------|--------|---------|--------|---------|
|        |   |    |   |    |   |    |
| Advertising | $      | 656,184 |   | 619,731 |   | 540,970 |

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

----

|                                                        |   | 2005                                        |   | 2004                                                       |
|-------------------------------------------------------------|--------|---------------------------------------------|--------|------------------------------------------------------------|
|                                                        |   | Carrying                    Amount          |   | Estimated                    Fair                    Value |   | Carrying                    Amount |   | Estimated                    Fair                    Value |
|                                                        |   | *(dollars                    in thousands)* |
|                                                        |   |                                        |   |                                                       |   |   |   |   |
| Assets:                                                     |   |                                        |   |                                                       |   |   |   |   |
| Cash                    and cash equivalents                | $      | 19,816                                      |   | 19,816                                                     |   | 16,791 |   | 16,791 |
| Investment                    securities available for sale | $      | 115,158                                     |   | 115,158                                                    |   | 105,598 |   | 105,598 |
| Other                    investments                        | $      | 5,811                                       |   | 5,811                                                      |   | 5,397 |   | 5,397 |
| Mortgage                    loans held for sale             | $      | 2,248                                       |   | 2,248                                                      |   | 3,783 |   | 3,783 |
| Loans,                    net                               | $      | 559,239                                     |   | 559,122                                                    |   | 527,419 |   | 525,818 |
| Cash                    surrender value of life insurance   | $      | 6,312                                       |   | 6,312                                                      |   | 6,034 |   | 6,034 |
| Mortgage                    servicing rights                | $      | 227                                         |   | 227                                                        |   | 283 |   | 283 |
| Derivative                    instruments                   | $      | 176                                         |   | 176                                                        |   | - |   | - |
|                                                        |   |                                        |   |                                                       |   |   |   |   |
| Liabilities:                                                |   |                                        |   |                                                       |   |   |   |   |
| Deposits                    and demand notes payable        | $      | 584,327                                     |   | 584,786                                                    |   | 557,706 |   | 556,993 |
| FHLB                    advances                            | $      | 71,600                                      |   | 71,804                                                     |   | 59,000 |   | 61,637 |
| Junior                    subordinated debentures           | $      | 14,433                                      |   | 14,433                                                     |   | 14,433 |   | 14,433 |
| Derivative                    instruments                   | $      | -                                           |   | -                                                          |   | 742 |   | 742 |

----

**(17)**
**Peoples Bancorp of North Carolina, Inc. (Parent        Company        Only) Condensed Financial Statements**

| **Balance                    Sheets**                                                          |
|------------------------------------------------------------------------------------------------|
|                                                                                           |   |   |   |   |   |   |   |
| **December                    31, 2005 and 2004**                                              |
|                                                                                           |   |   |   |   |   |   |   |
| Assets                                                                                         |   |   |   | 2005 |   | 2004 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Cash                                                                                           |   |   |   |   | $ | 519,089 |   |   | 517,652 |   |
| Interest-bearing                    time deposit                                               |   |   |   |   |   | 2,000,000 |   |   | 2,000,000 |   |
| Investment                    in subsidiaries                                                  |   |   |   |   |   | 65,057,096 |   |   | 61,463,299 |   |
| Investment                    securities available for sale                                    |   |   |   |   |   | 451,651 |   |   | -                        |   |
| Other                    investments                                                           |   |   |   |   |   | 349,994 |   |   | 1,050,749 |   |
| Other                    assets                                                                |   |   |   |   |   | 683,493 |   |   | 613,727 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Total                    assets                                                                |   |   |   |   | $ | 69,061,323 |   |   | 65,645,427 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Liabilities                    and Shareholders' Equity                                        |   |   |   |   |   |   |   |   |   |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Accrued                    expenses                                                            |   |   |   |   | $ | 275,329 |   |   | 274,575 |   |
| Junior                    subordinated debentures                                              |   |   |   |   |   | 14,433,000 |   |   | 14,433,000 |   |
| Shareholders'                    equity                                                        |   |   |   |   |   | 54,352,994 |   |   | 50,937,852 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Total                    liabilities and shareholders' equity                                  |   |   |   |   | $ | 69,061,323 |   |   | 65,645,427 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| **Statements                    of Earnings**                                                  |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| **For                    the Years Ended December 31, 2005, 2004 and                    2003** |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Revenues:                                                                                      |   |   | 2005 |   |   | 2004 |   |   | 2003 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Dividends                    from subsidiaries                                                 |   | $ | 2,375,042 |   |   | 1,962,551 |   |   | 3,948,455 |   |
| Interest                    and dividend income                                                |   |   | 83,632 |   |   | 63,875 |   |   | 43,684 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Total                    revenues                                                              |   |   | 2,458,674 |   |   | 2,026,426 |   |   | 3,992,139 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Expenses:                                                                                      |   |   |   |   |   |   |   |   |   |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Interest                                                                                       |   |   | 938,145 |   |   | 676,547 |   |   | 667,526 |   |
| Other                    operating expenses                                                    |   |   | 289,691 |   |   | 280,002 |   |   | 211,788 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Total                    expenses                                                              |   |   | 1,227,836 |   |   | 956,549 |   |   | 879,314 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Earnings                    before income tax benefit and equity in                            |   |   |   |   |   |   |   |   |   |   |
| undistributed                    earnings of subsidiaries                                      |   |   | 1,230,838 |   |   | 1,069,877 |   |   | 3,112,825 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Income                    tax benefit                                                          |   |   | 379,500 |   |   | 296,700 |   |   | 277,200 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Earnings                    before undistributed earnings in subsidiaries                      |   |   | 1,610,338 |   |   | 1,366,577 |   |   | 3,390,025 |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Equity                    in undistributed earnings in subsidiaries                            |   |   | 4,720,642 |   |   | 3,064,359 |   |   | -                        |   |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Dividends                    paid in excess in earnings                                        |   |   | -                        |   |   | -                        |   |   | (1,386,434 | ) |
|                                                                                           |   |   |   |   |   |   |   |   |   |   |
| Net                    earnings                                                                |   | $ | 6,330,980 |   |   | 4,430,936 |   |   | 2,003,591 |   |

----

| **Statements                    of Cash Flows**                             |   |
|-----------------------------------------------------------------------------|--------|
|                                                                        |   |   |   |   |   |   |   |
| **For                    the Years Ended December 31, 2005, 2004 and 2003** |   |
|                                                                        |   |   |   |   |   |   |   |
|                                                                        |   | 2005 |   | 2004 |   | 2003 |   |
| Cash                    flows from operating activities:                    |   |   |   |   |   |   |   |   |   |   |
|                                                                        |   |   |   |   |   |   |   |   |   |   |
| Net                    earnings                                             |   | $ | 6,330,980 |   |   | 4,430,936 |   |   | 2,003,591 |   |
| Adjustments                    to reconcile net earnings to net             |   |   |   |   |   |   |   |   |   |   |
| cash                    provided by operating activities:                   |   |   |   |   |   |   |   |   |   |   |
| Amortization                                                                |   |   | 17,742 |   |   | 17,742 |   |   | 17,742 |   |
| Book                    value shares accrual                                |   |   | 21,818 |   |   | 66,933 |   |   | 47,078 |   |
| Equity                    in undistributed earnings of subsidiaries         |   |   | (4,720,642 | ) |   | (3,064,359 | ) |   | 1,386,434 |   |
| Deferred                    income tax benefit                              |   |   | (8,412 | ) |   | (25,806 | ) |   | (19,173 | ) |
| Change                    in:                                               |   |   |   |   |   |   |   |   |   |   |
| Accrued                    income                                           |   |   | 17,930 |   |   | (9,033 | ) |   | -                        |   |
| Accrued                    expense                                          |   |   | (21,063 | ) |   | -                        |   |   | 7,814 |   |
|                                                                        |   |   |   |   |   |   |   |   |   |   |
| Net                    cash provided by operating activities                |   |   | 1,638,353 |   |   | 1,416,413 |   |   | 3,443,486 |   |
|                                                                        |   |   |   |   |   |   |   |   |   |   |
| Cash                    flows from investing activities:                    |   |   |   |   |   |   |   |   |   |   |
|                                                                        |   |   |   |   |   |   |   |   |   |   |
| Net                    change in interest-bearing time deposit              |   |   | -                        |   |   | -                        |   |   | (2,000,000 | ) |
| Purchases                    of investment securities available for sale    |   |   | -                        |   |   | (250,000 | ) |   | -                        |   |
|                                                                        |   |   |   |   |   |   |   |   |   |   |
| Net                    cash used by investing activities                    |   |   | -                        |   |   | (250,000 | ) |   | (2,000,000 | ) |
|                                                                        |   |   |   |   |   |   |   |   |   |   |
| Cash                    flows from financing activities:                    |   |   |   |   |   |   |   |   |   |   |
|                                                                        |   |   |   |   |   |   |   |   |   |   |
| Cash                    dividends paid                                      |   |   | (1,414,239 | ) |   | (1,257,254 | ) |   | (1,253,430 | ) |
| Cash                    paid in lieu of fractional shares                   |   |   | (4,700 | ) |   | -                        |   |   | -                        |   |
| Common                    stock repurchased                                 |   |   | (314,750 | ) |   | (290,826 | ) |   | -                        |   |
| Proceeds                    from exercise of stock options                  |   |   | 96,773 |   |   | 209,706 |   |   | 23,737 |   |
|                                                                        |   |   |   |   |   |   |   |   |   |   |
| Net                    cash provided (used) by financing activities         |   |   | (1,636,916 | ) |   | (1,338,374 | ) |   | (1,229,693 | ) |
|                                                                        |   |   |   |   |   |   |   |   |   |   |
| Net                    change in cash                                       |   |   | 1,437 |   |   | (171,961 | ) |   | 213,793 |   |
|                                                                        |   |   |   |   |   |   |   |   |   |   |
| Cash                    at beginning of year                                |   |   | 517,652 |   |   | 689,613 |   |   | 475,820 |   |
|                                                                        |   |   |   |   |   |   |   |   |   |   |
| Cash                    at end of year                                      |   | $ | 519,089 |   |   | 517,652 |   |   | 689,613 |   |

----