UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2012

or

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File No. 0-24753

ECB Bancorp, Inc.

(Exact name of registrant as specified in its charter)

North Carolina	56-2090738
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

Post Office Box 337, Engelhard, North Carolina 27824

(Address of principal executive offices) (Zip Code)

(252) 925-5501

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	¨	Accelerated filer	¨
Non-accelerated filer	¨	Smaller reporting company	x

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

On August 10, 2012, there were 2,849,841 outstanding shares of Registrant’s common stock.

Table of Contents

Index

		Begins on Page
Part 1 – Financial Information
Item 1.	Financial Statements:
Consolidated Balance Sheets at June 30, 2012 (unaudited) and December 31, 2011			3
Consolidated Results of Operations for Three and Six Months Ended June  30, 2012 and 2011 (unaudited)			4
Consolidated Statements of Comprehensive Income for Three and Six Months Ended June  30, 2012 and 2011 (unaudited)			5
Consolidated Statements of Changes in Shareholders’ Equity for Six Months Ended June  30, 2012 and 2011 (unaudited)			6
Consolidated Statements of Cash Flows for Six Months Ended June  30, 2012 and 2011 (unaudited)			7
Notes to Consolidated Financial Statements			8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		39
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		56
Item 4.	Controls and Procedures		56
Part II – Other Information
Item 1.	Legal Proceedings		57
Item 1A.	Risk Factors		57
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		57
Item 3.	Defaults upon Senior Securities		57
Item 4.	Mine Safety Disclosures		57
Item 5.	Other Information		57
Item 6.	Exhibits		57
Signatures			58
Exhibit Index			59
Certifications

2

ECB BANCORP, INC. AND SUBSIDIARY

Consolidated Balance Sheets

June 30, 2012 and December 31, 2011

(Dollars in thousands, except per share data)

	June 30, 2012			December 31, 2011*
	(unaudited)
Assets
Non-interest bearing deposits and cash	$	16,890		$	18,363
Interest bearing deposits		61			63
Overnight investments		7,670			6,305
Total cash and cash equivalents		24,621			24,731
Investment securities
Available-for-sale, at market value (cost of $346,271 and $338,685 at June 30, 2012 and December 31, 2011, respectively)		350,779			339,450
Loans held for sale		3,059			2,866
Loans		506,257			496,542
Allowance for loan losses		(10,780	)		(12,092	)
Loans, net		495,477			484,450
Real estate and repossessions acquired in settlement of loans, net		7,661			6,573
Federal Home Loan Bank common stock, at cost		3,899			3,456
Bank premises and equipment, net		26,111			26,289
Accrued interest receivable		5,030			5,308
Bank owned life insurance		11,981			11,778
Other assets		15,648			16,376
Total	$	944,266		$	921,277
Liabilities and Shareholders’ Equity
Deposits
Demand, noninterest bearing	$	146,326		$	135,732
Demand, interest bearing		305,298			270,119
Savings		58,562			55,517
Time		285,302			336,277
Total deposits		795,488			797,645
Accrued interest payable		469			519
Short-term borrowings		42,101			11,679
Long-term obligations		18,000			25,500
Other liabilities		4,948			5,491
Total liabilities		861,006			840,834
Shareholders’ equity
Preferred stock, Series A		17,536			17,454
Common stock, par value $3.50 per share		9,974			9,974
Capital surplus		25,857			25,873
Warrants		878			878
Retained earnings		26,360			25,926
Accumulated other comprehensive income		2,655			338
Total shareholders’ equity		83,260			80,443
Total	$	944,266		$	921,277
Common shares outstanding		2,849,841			2,849,841
Common shares authorized		50,000,000			50,000,000
Preferred shares outstanding		17,949			17,949
Preferred shares authorized		2,000,000			2,000,000
Non-voting common shares authorized		2,000,000			2,000,000

* Derived from audited consolidated financial statements.

See accompanying notes to consolidated financial statements.

3

ECB BANCORP, INC. AND SUBSIDIARY

Consolidated Results of Operations

For the three and six months ended June 30, 2012 and 2011 (unaudited)

(Dollars in thousands, except per share data)

	Three months ended June 30,					Six months ended June 30,
	2012		2011			2012		2011
Interest income:
Interest and fees on loans	$	6,404	$	7,329		$	12,773	$	14,686
Interest on investment securities:
Interest exempt from federal income taxes		249		117			484		245
Taxable interest income		1,774		2,163			3,656		4,100
Dividend income		14		9			25		18
Other interest income		4		14			6		21
Total interest income		8,445		9,632			16,944		19,070
Interest expense:
Deposits:
Demand accounts		390		505			796		1,062
Savings		60		74			155		127
Time		1,166		1,790			2,436		3,601
Short-term borrowings		95		73			176		142
Long-term obligations		76		145			195		325
Total interest expense		1,787		2,587			3,758		5,257
Net interest income		6,658		7,045			13,186		13,813
Provision for loan losses		866		1,273			866		5,203
Net interest income after provision for loan losses		5,792		5,772			12,320		8,610
Noninterest income:
Service charges on deposit accounts		945		828			1,802		1,593
Other service charges and fees		518		330			847		574
Mortgage origination fees		376		452			782		778
Net gain on sale of securities		279		858			324		884
Income from bank owned life insurance		102		74			203		148
Other operating (expense) income		1		(3	)		2		(7	)
Total noninterest income		2,221		2,539			3,960		3,970
Noninterest expenses:
Salaries		2,865		2,826			5,784		5,390
Retirement and other employee benefits		815		784			1,918		1,460
Occupancy		518		522			1,048		1,005
Equipment		603		513			1,193		1,072
Professional fees		343		271			562		542
Supplies		41		78			115		129
Telephone		184		189			382		358
FDIC insurance		203		201			407		527
Other outside services		92		162			192		343
Data processing and related expenses		346		83			742		153
Net cost of real estate and repossessions acquired in settlement of loans		463		79			1,147		97
Other operating expenses		784		949			1,685		1,825
Total noninterest expenses		7,257		6,657			15,175		12,901
Income (loss) before income taxes		756		1,654			1,105		(321	)
Income tax expense (benefit)		168		509			140		(382	)
Net income		588		1,145			965		61
Preferred stock dividends		225		224			449		448
Accretion of discount		41		41			82		82
Income (loss) available to common shareholders	$	322	$	880		$	434	($	469	)
Net income (loss) per common share—basic	$	0.11	$	0.31		$	0.15	($	0.16	)
Net income (loss) per common share—diluted	$	0.11	$	0.31		$	0.15	($	0.16	)
Weighted average common shares outstanding—basic		2,849,841		2,849,841			2,849,841		2,849,841
Weighted average common shares outstanding—diluted		2,849,841		2,849,841			2,849,841		2,849,841

See accompanying notes to consolidated financial statements.

4

ECB BANCORP, INC. AND SUBSIDIARY

Consolidated Statements of Comprehensive Income (unaudited)

For the three and six months ended June 30, 2012 and 2011

(Dollars in thousands)

	Three months ended June 30,						Six months ended June 30,
	2012			2011			2012			2011
	(Dollars in thousands)
Net income	$	588		$	1,145		$	965		$	61
Other comprehensive income:
Unrealized gains on available for sale securities arising during the period		3,093			4,404			4,067			4,247
Tax related to unrealized gains		(1,175	)		(1,696	)		(1,551	)		(1,635	)
Reclassification to realized gains		(279	)		(858	)		(324	)		(884	)
Tax related to realized gains		107			330			125			340
Defined benefit pension plan:
Prior service cost		—			—			—			7
Net loss arising during period		—			—			—			(116	)
Tax related to defined benefit pension plan		—			—			—			42
Total other comprehensive income		1,746			2,180			2,317			2,001
Total comprehensive income	$	2,334		$	3,325		$	3,282		$	2,062

See accompanying notes to consolidated financial statements.

5

ECB BANCORP, INC. AND SUBSIDIARY

Consolidated Statements of Changes in Shareholders’ Equity

Six months ended June 30, 2012 and 2011 (unaudited)

(Dollars in thousands, except per share data)

	Preferred stock, Series A		Common Stock				Common stock warrants		Capital surplus		Retained earnings			Accumulated other comprehensive income			Total
			Number		Amount
Balance January 1, 2011	$	17,288		2,849,841	$	9,974	$	878	$	25,852	$	28,554		$	(1,652	)	$	80,894
Other comprehensive income		—		—		—		—		—		—			2,001			2,001
Net income		—		—		—		—		—		61						61
Stock based compensation		—		—		—		—		11					—			11
Preferred stock accretion		82		—		—		—		—		(82	)		—			—
Cash dividends on preferred stock		—		—		—		—		—		(448	)		—			(448	)
Cash dividends ($0.07 per share)		—		—		—		—		—		(199	)		—			(199	)
Balance June 30, 2011	$	17,370		2,849,841	$	9,974	$	878	$	25,863	$	27,886		$	349		$	82,320

	Preferred stock, Series A		Common Stock				Common stock warrants		Capital surplus			Retained earnings			Accumulated other comprehensive income		Total
			Number		Amount
Balance January 1, 2012	$	17,454		2,849,841	$	9,974	$	878	$	25,873		$	25,926		$	338	$	80,443
Other comprehensive income		—		—		—		—		—			—			2,317		2,317
Net income		—		—		—		—		—			965			—		965
Stock based compensation		—		—		—		—		(16	)					—		(16	)
Preferred stock accretion		82		—		—		—		—			(82	)		—		—
Cash dividends on preferred stock		—		—		—		—		—			(449	)		—		(449	)
Balance June 30, 2012	$	17,536		2,849,841	$	9,974	$	878	$	25,857		$	26,360		$	2,655	$	83,260

See accompanying notes to consolidated financial statements.

6

ECB BANCORP, INC. AND SUBSIDIARY

Consolidated Statements of Cash Flows

Six months ended June 30, 2012 and 2011 - (unaudited)

(Dollar amounts in thousands)

	Six months ended June 30,
	2012			2011
Cash flows from operating activities:
Net income	$	965		$	61
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		757			724
Amortization of premium on investment securities, net		2,502			1,408
Provision for loan losses		866			5,203
Gain on sale of securities		(324	)		(884	)
Stock based compensation (benefit)		(16	)		11
Decrease in accrued interest receivable		278			736
Impairment of real estate and repossessions acquired in settlement of loans		683			—
Loss on sale of real estate and repossessions acquired in settlement of loans		142			26
Income from Bank owned life insurance		(203	)		(148	)
Originations of mortgage loans held for sale		(31,210	)		(29,425	)
Proceeds from sale of loans held for sale		31,017			32,117
Decrease in other assets		728			1,697
Increase (decrease) in accrued interest payable		(50	)		17
Decrease in other liabilities, net		(1,969	)		(1,993	)
Net cash provided by operating activities		4,166			9,550
Cash flows from investing activities:
Proceeds from sales of investment securities classified as available-for-sale		74,073			56,536
Proceeds from maturities of investment securities classified as available-for-sale		24,049			25,908
Purchases of investment securities classified as available-for-sale		(107,886	)		(104,492	)
Purchases of premises and equipment		(579	)		(828	)
Purchase (sale) of Federal Home Loan Bank common stock		(443	)		539
Proceeds from disposal of real estate and repossessions acquired in settlement of loans and real estate held for sale		909			1,449
Net loan (originations) repayments		(14,715	)		17,953
Net cash used by investing activities		(24,592	)		(2,935	)
Cash flows from financing activities:
Net increase (decrease) in deposits		(2,157	)		26,833
Net increase (decrease) in borrowings		22,922			(4,798	)
Dividends paid to common shareholders		—			(199	)
Dividends paid on preferred stock		(449	)		(448	)
Net cash provided by financing activities		20,316			21,388
Increase (decrease) in cash and cash equivalents		(110	)		28,003
Cash and cash equivalents at beginning of period		24,731			20,166
Cash and cash equivalents at end of period	$	24,621		$	48,169
Cash paid during the period:
Interest	$	3,808		$	5,240
Taxes		—			—
Supplemental disclosures of noncash financing and investing activities:
Unrealized gains on available-for-sale securities, net of deferred taxes	$	2,317		$	2,068
Transfer from loans to real estate and repossessions acquired in settlement of loans		2,822			3,989
Transfer from long-term to short-term borrowings		7,500			7,000

See accompanying notes to consolidated financial statements.

7

ECB BANCORP, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

(1) Basis of Presentation

The consolidated financial statements include the accounts of ECB Bancorp, Inc. (“Bancorp”) and its wholly-owned subsidiary, The East Carolina Bank (the “Bank”) (Bancorp and the Bank are collectively referred to hereafter as the “Company”). The Bank has one wholly-owned subsidiary, ECB Financial Services, Inc., which formerly provided courier services to the Bank but is currently inactive. All intercompany transactions and balances are eliminated in consolidation. The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the balance sheets and the reported amounts of income and expenses for the periods presented. Actual results could differ from those estimates.

Management makes a number of estimates and assumptions relating to reported amounts of assets, liabilities, revenues and expenses in the preparation of the financial statements and disclosures. Estimates and assumptions that are most significant to the Company are related to the determination of the allowance for loan losses, asset impairment valuation, postretirement and benefit plan accounting and income taxes.

All adjustments considered necessary for a fair presentation of the results for the interim periods presented have been included (such adjustments are normal and recurring in nature). The notes to consolidated financial statements in Bancorp’s annual report on Form 10-K should be referenced when reading these unaudited interim financial statements. Operating results for the period ended June 30, 2012, are not necessarily indicative of the results that may be expected for the year ending December 31, 2012 or any other period.

Loans

Loans are generally stated at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses and any deferred fees or costs. Loan origination fees net of certain direct loan origination costs are deferred and amortized as a yield adjustment over the contractual life of the related loans using the level-yield method.

Impaired loans are defined as those which management believes it is probable we will not collect all amounts due according to the contractual terms of the loan agreement, as well as those loans whose terms have been modified in a troubled debt restructuring.

Interest on loans is recorded based on the principal amount outstanding. The Company ceases accruing interest on loans (including impaired loans) when, in management’s judgment, the collection of interest appears doubtful or the loan is past due 90 days or more. All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Management may return a loan classified as nonaccrual to accrual status when the obligation has been brought current, has performed in accordance with its contractual terms over an extended period of time, and the ultimate collectability of the total contractual principal and interest is no longer in doubt.

Troubled debt restructurings (“TDRs”) are loans in which the borrower is experiencing financial difficulty at the time of restructure, and the Company has granted an economic concession to the borrower. Prior to modifying a borrower’s loan terms, the Company performs an evaluation of the borrower’s financial condition and ability to service under the potential modified loan terms. The types of concessions generally granted are extensions of the loan maturity date, reductions in the original contractual interest rate and forgiveness of principal. The Company measures the impairment loss of a TDR using the methodology for individually impaired loans. If a loan is accruing at the time of modification, the loan remains on accrual status and is subject to the Company’s charge-off and nonaccrual policies. If a loan is on nonaccrual before it is determined to be a TDR then the loan remains on nonaccrual. TDRs may be returned to accrual status if there has been at least a six month sustained period of repayment performance by the borrower.

Allowance for Loan Losses

The allowance for loan losses (AFLL) is established through provisions for losses charged against income. Loan amounts deemed to be uncollectible are charged against the AFLL, and subsequent recoveries, if any, are credited to the allowance. The AFLL represents management’s estimate of the amount necessary to absorb estimated probable losses in the loan portfolio. Management’s periodic evaluation of the adequacy of the allowance is based on individual loan reviews, past loan loss experience, economic conditions in the Company’s market areas, the fair value and adequacy of underlying collateral, and the growth and loss attributes of the loan portfolio. This evaluation is inherently subjective as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. Thus, future changes to the AFLL may be necessary based on the impact of changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s AFLL. Such agencies may require the Company to recognize adjustments to the AFLL based on their judgments about information available to them at the time of their examination.

8

In evaluating the allowance for loan losses, the Company prepares an analysis of its current loan portfolio through the use of historical loss rates, homogeneous risk analysis grouping to include probabilities for loss in each group by risk grade, estimation of years to impairment in each homogeneous grouping, analysis of internal credit processes, past due loan portfolio performance and overall economic conditions, both regionally and nationally.

Historical loss calculations for each homogeneous risk group are based on a three year average loss ratio calculation with the most recent quarter’s loss history included in the model. The impact is to more quickly recognize and increase the loss history in a respective grouping. For those groups with little or no loss history, management increases the historical factor through a positive adjustment to more accurately represent current economic conditions and their potential impact on that particular loan group.

Homogeneous loan groups are assigned risk factors based on their perceived loss potential, current economic conditions and on their respective risk ratings. The probability of loss is increased as the risk grade increases within each risk grouping to more accurately reflect the Bank’s exposure in that particular group of loans. The Bank utilizes a system of eight possible risk ratings. The risk ratings are established based on perceived probability of loss. Most loans risk rated “substandard”, “doubtful” and “loss” are removed from their homogeneous group and individually analyzed for impairment. Some smaller loans risk rated “substandard”, “doubtful” and “loss” with balances less than $100 thousand are not removed from their homogeneous group and individually analyzed for impairment. Other groups of loans based on loan size may be selected for impairment review. Loans are considered impaired if, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans is based on either the fair value of the underlying collateral, the present value of the future cash flows discounted at the historical effective interest rate stipulated in the loan agreement, or the estimated market value of the loan. In measuring the fair value of the collateral, management uses a comparison to the recent selling price of similar assets, which is consistent with those that would be utilized by unrelated third parties.

A portion of the Bank’s AFLL is not allocated to any specific category of loans. This general portion of the allowance reflects the elements of imprecision and estimation risk inherent in the calculation of the overall allowance. Due to the subjectivity involved in determining the overall allowance, including the portion determined through general qualitative and quantitative internal and external factors, the general portion may fluctuate from period to period based on management’s evaluation of the factors affecting the assumptions used in calculating the allowance, including historical loss experience, current and expected economic conditions and geographic conditions. While the Company believes that our management uses the best information available to determine the allowance for loan losses, unforeseen market conditions could result in adjustments to the AFLL, and net income could be significantly affected, if circumstances differ substantially from the assumptions used in making the final determination. Because these factors and management’s assumptions are subject to change, the allocation is not necessarily indicative of future loan portfolio performance.

Unsecured loans are charged-off in full against the Company’s AFLL as soon as the loan becomes uncollectible. Unsecured loans are considered uncollectible when no regularly scheduled monthly payment has been made within three months, the loan matured over 90 days ago and has not been renewed or extended or the borrower files for bankruptcy. Secured loans are considered uncollectible when the liquidation of collateral is deemed to be the most likely source of repayment. Once secured loans reach 90 days past due, they are placed into non-accrual status. If the loan is deemed to be collateral dependent, the principal balance is written down immediately to reflect the current market valuation based on current independent appraisal. Included in the write-down is the estimated expense to liquidate the property and typically an additional allowance for the foreclosure discount.

Subsequent Events

In preparing these financial statements, the Company has evaluated events and transactions for potential recognition or disclosure through the date the consolidated financial statements were issued.

(2) Net Income Per Common Share

Basic net income per common share is calculated by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period. For purposes of basic net income per common share, restricted stock is considered “contingently issuable” and is not included in the weighted average number of common shares outstanding.

Diluted net income per common share is computed by assuming the issuance of common shares for all dilutive potential common shares outstanding during the reporting period. Restricted stock is considered outstanding for purposes of diluted net income per common share. The amount of compensation cost attributed to future services and not yet recognized is considered “proceeds” using the treasury stock method. Restricted stock had no dilutive effect on earnings per common share for the six or three-month periods ended June 30, 2012 and June 30, 2011 as there were no shares outstanding during these periods.

9

In computing diluted net income per common share, it is assumed that all dilutive stock options are exercised during the reporting period at their respective exercise prices, with the proceeds from the exercises used by the Company to buy back stock in the open market at the average market price in effect during the reporting period. The difference between the number of shares assumed to be exercised and the number of shares bought back is added to the number of weighted average common shares outstanding during the period. The sum is used as the denominator to calculate diluted net income per common share for the Company. Diluted weighted average shares outstanding did not increase for the six and three months ended June 30, 2012 or June 30, 2011 as there was no dilutive impact of options for the periods. There were 3,500 options outstanding for both the six and three months ended June 30, 2012, that were not included in the computation of diluted net income per share because the exercise price was above the average market value of the Company’s stock for the periods. As of June 30, 2012, the warrant, covering approximately 145 thousand shares, issued to the U.S. Treasury Department was not included in the computation of net income per share for either the six or three-month period because its exercise price exceeded the average market price of the company’s stock for the periods. For the six month period ending June 30, 2011, the warrant, covering approximately 145 thousand shares, issued to the U.S. Treasury Department and 28,513 options were not included in the computation of diluted earnings per common share as the effect would have been anti-dilutive. For the three month period ending June 30, 2011, the warrant, covering approximately 145 thousand shares, issued to the U.S. Treasury Department and 28,513 options were not included in the computation of diluted earnings per common share because the exercise price exceeded the average market price of the Company’s stock for that period.

10

The following is a reconciliation of the numerators and denominators used in computing Basic and Diluted Net Income (Loss) Per Common Share for the six months ended June 30.

	Six months ended June 30, 2012 (dollars in thousands, except per share data)
	Income (Numerator)		Shares (Denominator)		Per Share Amount
Basic net income per common share	$	434		2,849,841	$	0.15
Effect of dilutive securities		—		—
Diluted net income per common share	$	434		2,849,841	$	0.15

	Six months ended June 30, 2011 (dollars in thousands, except per share data)
	Income (Numerator)			Shares (Denominator)		Per Share Amount
Basic net loss per common share	$	(469	)		2,849,841	$	(0.16	)
Effect of dilutive securities		—			—
Diluted net loss per common share	$	(469	)		2,849,841	$	(0.16	)

The following is a reconciliation of the numerators and denominators used in computing Basic and Diluted Net Income Per Common Share for the three months ended June 30.

	Three months ended June 30, 2012 (dollars in thousands, except per share data)
	Income (Numerator)		Shares (Denominator)		Per Share Amount
Basic net income per common share	$	322		2,849,841	$	0.11
Effect of dilutive securities		—		—
Diluted net income per common share	$	322		2,849,841	$	0.11

	Three months ended June 30, 2011 (dollars in thousands, except per share data)
	Income (Numerator)		Shares (Denominator)		Per Share Amount
Basic net income per common share	$	880		2,849,841	$	0.31
Effect of dilutive securities		—		—
Diluted net income per common share	$	880		2,849,841	$	0.31

11

(3) Comprehensive Income

Comprehensive income is defined as the change in equity during a period for non-owner transactions and is divided into net income (loss) and other comprehensive income. Other comprehensive income includes revenues, expenses, gains, and losses that are excluded from earnings under current accounting standards. The components of comprehensive income for the periods have been presented in the consolidated statements of comprehensive income.

(4) Recent Accounting Pronouncements

The following is a summary of recent authoritative pronouncements that could impact the accounting, reporting, and/or disclosure of financial information by the Company.

In April 2011, the criteria used to determine effective control of transferred assets in the Transfers and Servicing topic of the ASC was amended by ASU 2011-03. The requirement for the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms and the collateral maintenance implementation guidance related to that criterion were removed from the assessment of effective control. The other criteria to assess effective control were not changed. The amendments were effective for the Company on January 1, 2012 and had no effect on the Company’s financial statements.

ASU 2011-04 was issued in May 2011 to amend the Fair Value Measurement topic of the ASC by clarifying the application of existing fair value measurement and disclosure requirements and by changing particular principles or requirements for measuring fair value or for disclosing information about fair value measurements. The amendments were effective for the Company beginning January 1, 2012 and are included in Note 9.

The Comprehensive Income topic of the ASC was amended in June 2011 by ASU 2011-05. The amendment eliminates the option to present other comprehensive income as a part of the statement of changes in stockholders’ equity and requires consecutive presentation of the statement of net income and other comprehensive income. The amendments were applicable to the Company on January 1, 2012 and have been applied retrospectively. In December 2011, the topic was further amended to defer the effective date of presenting reclassification adjustments from other comprehensive income to net income on the face of the financial statements. Companies should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect prior to the amendments while FASB redeliberates future requirements.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations and cash flows.

12

(5) Investment Securities

The following is a summary of the securities portfolio by major classification:

	June 30, 2012
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(Dollars in thousands)
Securities available-for-sale:
Obligations of states and political subdivisions	$	36,655	$	1,181	$	(57	)	$	37,779
Mortgage-backed securities		131,169		1,831		(201	)		132,799
SBA-backed securities		137,445		2,270		(113	)		139,602
Corporate bonds		41,002		337		(740	)		40,599
	$	346,271	$	5,619	$	(1,111	)	$	350,779

	December 31, 2011
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(Dollars in thousands)
Securities available-for-sale:
Government-sponsored enterprises and FFCB bonds	$	1,003	$	29	$	—		$	1,032
Obligations of states and political subdivisions		27,855		863		—			28,718
Mortgage-backed securities		130,949		1,460		(117	)		132,292
SBA-backed securities		146,195		774		(332	)		146,637
Corporate bonds		32,683		88		(2,000	)		30,771
	$	338,685	$	3,214	$	(2,449	)	$	339,450

Gross realized gains and losses on sales of securities for the three and six-month periods ended June 30, 2012 and June 30, 2011 were as follows:

	Six months ended June 30,     (Dollars in thousands)
	2012			2011
Gross realized gains	$	433		$	971
Gross realized losses		(109	)		(87	)
Net realized gains	$	324		$	884

	Three months ended June 30, (Dollars in thousands)
	2012			2011
Gross realized gains	$	362		$	945
Gross realized losses		(83	)		(87	)
Net realized gains	$	279		$	858

Analysis of Certain Investments in Debt and Equity Securities for Other Than Temporary Impairment

The following tables set forth the amount of unrealized losses at June 30, 2012 and December 31, 2011 (that is, the amount by which cost or amortized cost exceeds fair value), and the related fair value of investments with unrealized losses, none of which are

13

considered to be other-than-temporarily impaired. The tables are segregated into investments that have been in a continuous unrealized-loss position for less than 12 months from those that have been in a continuous unrealized-loss position for 12 months or longer.

	June 30, 2012
	Less Than 12 Months				12 Months or longer				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(Dollars in thousands)
Obligations of states and political subdivisions	$	5,032	$	57	$	—	$	—	$	5,032	$	57
Mortgage-backed securities		20,968		201		—		—		20,968		201
SBA-backed securities		19,996		113		—		—		19,996		113
Corporate bonds		15,356		252		8,173		488		23,529		740
Total	$	61,352	$	623	$	8,173	$	488	$	69,525	$	1,111

	December 31, 2011
	Less Than 12 Months				12 Months or longer				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(Dollars in thousands)
Mortgage-backed securities	$	25,011	$	81	$	2,880	$	36	$	27,891	$	117
SBA-backed securities		62,543		332		—		—		62,543		332
Corporate bonds		11,824		485		13,755		1,515		25,579		2,000
Total	$	99,378	$	898	$	16,635	$	1,551	$	116,013	$	2,449

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As of June 30, 2012 and December 31, 2011, management concluded that the unrealized losses presented above, which consisted of twenty-five securities at June 30, 2012 and fifty securities at December 31, 2011, are temporary in nature since they are not related to the underlying credit quality of the issuers, and the Bank has the intent to hold these investments for a time necessary to recover their cost and it is not likely that the Bank would be required to sell prior to recovery. The twenty-five securities at June 30, 2012 were comprised of three obligations of states and political subdivisions, five mortgage-backed securities, ten corporate bonds and seven SBA-backed securities. The fifty securities at December 31, 2011 were comprised of twelve mortgage-backed securities, twelve corporate bonds and twenty-six SBA-backed securities. The losses above are on debt securities that have contractual maturity dates and are primarily related to market interest rates. All unrealized losses on investment securities are not considered to be other-than-temporary, because they are related to changes in interest rates, lack of liquidity and demand in the general investment market and do not affect the expected cash flows of the underlying collateral or the issuer. The Bank’s mortgage-backed securities are all backed by government sponsored enterprises or agencies. The Bank does not own any private label mortgage-backed securities.

At June 30, 2012 and December 31, 2011, the balance of Federal Home Loan Bank (“FHLB”) of Atlanta stock held by the Bank was $3.9 million and $3.5 million, respectively. The FHLB paid a dividend for the first quarter of 2012 with an annualized rate of 1.51%. The dividend rate was equal to average three-month LIBOR for the period of January 1, 2012 to March 31, 2012 plus 1.00%, and was applicable to capital stock held during that period. Management believes that its investment in FHLB stock was not other-than-temporarily impaired as of June 30, 2012 or December 31, 2011. However, there can be no assurance that the impact of recent or future legislation on the Federal Home Loan Banks will not also cause a decrease in the value of the FHLB stock held by the Bank.

The aggregate amortized cost and fair value of the available-for-sale securities portfolio at June 30, 2012 by remaining contractual maturity are as follows:

	Amortized Cost		Fair Value
	(Dollars in thousands)
Obligations of states and political subdivisions:
Due in one through five years	$	1,605		1,704
Due in five through ten years		20,196		20,930
Due after ten years		14,854		15,145
Mortgage-backed securities:
Due in one through five years		1,044		1,044
Due in five through ten years		27,230		27,488
Due after ten years		102,896		104,267
SBA-backed securities:
Due in five through ten years		5,190		5,224
Due after ten years		132,255		134,378
Corporate bonds:
Due in one through five years		23,326		23,271
Due in five through ten years		17,675		17,328
Total securities	$	346,271	$	350,779

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Securities with an amortized cost of $186.6 million at June 30, 2012 are pledged as collateral. Of this total, securities with an amortized cost of $60.8 million and fair value of $62.3 million are pledged as collateral for FHLB advances.

The aggregate amortized cost and fair value of the available-for-sale securities portfolio at December 31, 2011 by remaining contractual maturity are as follows:

	Amortized Cost		Fair Value
	(Dollars in thousands)
Government-sponsored enterprises and FFCB bonds:
Due in one through five years	$	3	$	28
Due in five through ten years		1,000		1,004
Obligations of states and political subdivisions:
Due in one year or less		250		252
Due in one through five years		961		1,033
Due in five through ten years		11,768		12,083
Due after ten years		14,876		15,350
Mortgage-backed securities:
Due in five through ten years		7,415		7,490
Due after ten years		123,534		124,802
SBA-backed securities:
Due in five through ten years		2,967		3,007
Due after ten years		143,228		143,630
Corporate bonds:
Due in one year through five years		13,338		13,081
Due in five through ten years		19,345		17,690
Total securities	$	338,685	$	339,450

Securities with an amortized cost of $197.6 million at December 31, 2011 were pledged as collateral. Of this total, securities with an amortized cost of $47.4 million and fair value of $48.0 million were pledged as collateral for FHLB advances.

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(6) Loans

Loans at June 30, 2012 and December 31, 2011 classified by type are as follows:

	June 30, 2012		December 31, 2011
Real estate loans:
Construction and land development	$	63,041	$	67,232
Secured by farmland		27,677		29,947
Secured by residential properties		107,545		110,238
Secured by nonfarm, nonresidential properties		198,221		203,287
Consumer installment		6,028		6,485
Credit cards and related plans		1,723		1,660
Commercial and all other loans:
Commercial and industrial		54,989		45,649
Loans to finance agricultural production		36,840		21,524
All other loans		10,237		10,587
		506,301		496,609
Less deferred fees and costs, net		44		67
	$	506,257	$	496,542
Included in the above:
Nonaccrual loans	$	18,204	$	15,973
Restructured loans 1		10,439		10,138

1. Restructured loans include loans restructured and still accruing. The Company is not committed to advance additional funds on restructured loans.

There were no loans outstanding that were past due ninety days or more that were still accruing at June 30, 2012 or December 31, 2011.

The Company, through its normal lending activity, originates and maintains loans receivable that are substantially concentrated in the Eastern region of North Carolina, where its offices are located. The Company’s policy calls for collateral or other forms of repayment assurance to be received from the borrower at the time of loan origination. Such collateral or other form of repayment assurance is subject to changes in economic value due to various factors beyond the control of the Company, and such changes could be significant.

The Bank’s loan policies and procedures establish the basic guidelines governing its lending operations. The guidelines address the type of loans that the Bank seeks, target markets, underwriting and collateral requirements, terms, interest rate and yield considerations and compliance with laws and regulations. All loans or credit lines are subject to approval procedures and amount limitations. These limitations apply to the borrower’s total outstanding indebtedness to the Bank, including any indebtedness as a guarantor. The policies are reviewed and approved at least annually by the Board of Directors of the Bank. The Bank supplements its own supervision of the loan underwriting and approval process with periodic loan reviews by independent, outside professionals experienced in loan review. On an annual basis, the Board of Directors of the Bank determines officers lending authority. Authorities may include loans, letters of credit, overdrafts, uncollected funds and such other authorities as determined by the Board of Directors.

Responsibility for loan underwriting resides with the Chief Credit Officer position. This position is responsible for loan underwriting and approval. This is accomplished through individual lender approval authorities with supervision by Credit Policy Officers who review and approve loans which exceed the lender’s authority. Also, all Special Mention and Classified loans are reviewed quarterly. Detailed, written action plans are updated by the lenders and those plans are reviewed by a joint committee consisting of Regional Managers, Credit Policy Officers, CCO, Commercial Banking Manager and Special Assets Manager.

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The following describe the risk characteristics relevant to each of the portfolio segments.

Real Estate Loans. Our real estate loan classification includes all loans secured by real estate. Real estate loans include loans made to purchase, construct or improve residential or commercial real estate, and for real estate development purposes. However, many of our real estate loans, while secured by real estate, were made for various other commercial, agricultural and consumer purposes (which may or may not be related to our real estate collateral). This generally reflects our efforts to reduce credit risk by taking real estate as primary or additional collateral, whenever possible, without regard to loan purpose. Substantially all of our real estate loans are secured by real property located in or near our banking markets. We make long-term residential mortgage loans through our mortgage department. These loans are held for sale and we generally hold these loans for a short period of time of approximately ten days. This allows us to make long-term residential loans available to our customers and generate fee income but avoid most risks associated with those loans.

Construction and land development loans involve special risks because loan funds are advanced on the security of houses or other improvements that are under construction and are of uncertain value before construction is complete. For that reason, it is more difficult to evaluate accurately the total loan funds required to complete a project and the related loan-to-value ratios. To reduce these risks, we generally limit loan amounts to 85% of the projected “as built” appraised values of our collateral on completion of construction. For larger projects, we include amounts for contingencies in our construction cost estimates. We generally require a qualified permanent financing commitment from an outside lender unless we have agreed to convert the construction loan to permanent financing ourselves.

Loans secured by farmland are made to agricultural customers for the purpose of acquisition or improvement of farmland. The loans are typically secured by land which is cultivated for primarily row- crop production and related interests, such as grain elevator facilities and farming operations buildings. Repayment of loans secured by farmland may depend on successful crop production or other farm related operations.

Residential loans may be made at fixed or variable interest rates, and they generally have maturities that do not exceed five years and provide for payments based on amortization schedules of less than twenty years. Loans with a maturity of more than five years or that is based on an amortization schedule of more than five years generally will include contractual provisions that allow us to call the loan in full, or provide for a “balloon” payment in full, at the end of a period of no more than five years.

Nonfarm and nonresidential loans typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. Repayment of commercial real estate loans may depend on the successful operation of income producing properties, a business, or a real estate project and, therefore, may, to a greater extent than in the case of other loans, be subject to the risk of adverse conditions in the economy generally or in the real estate market in particular.

Consumer Installment Loans, Credit Cards and Related Plans. Our consumer installment loans consist primarily of loans for various consumer purposes, as well as the outstanding balances of non-real estate secured consumer revolving credit accounts. A majority of these loans are secured by liens on various personal assets of the borrowers, but they also may be made on an unsecured basis. Consumer loans generally are made at fixed interest rates and with maturities or amortization schedules that generally do not exceed five years. Consumer installment loans involve greater risks than other loans, particularly in the case of loans that are unsecured or secured by depreciating assets. When damage or depreciation reduces the value of our collateral below the unpaid balance of a defaulted loan, repossession may not result in repayment of the entire outstanding loan balance. The resulting deficiency may not warrant further substantial collection efforts against the borrower. In connection with consumer lending in general, the success of our loan collection efforts is highly dependent on the continuing financial stability of our borrowers, and our collection of consumer installment loans may be more likely to be adversely affected by a borrower’s job loss, illness, personal bankruptcy or other change in personal circumstances than is the case with other types of loans.

Commercial and Industrial and Agricultural Loans. Our commercial and industrial loan and loans to finance agriculture includes loans to small- and medium-sized businesses and individuals for working capital, equipment purchases and various other business and agricultural purposes. These loans generally are secured by business assets, such as inventory, accounts receivable, equipment or similar assets, but they also may be made on an unsecured basis. Commercial and industrial loans typically are made on the basis of the borrower’s ability to make repayment from business cash flow. As a result, the ability of borrowers to repay commercial loans may be substantially dependent on the success of their businesses, and the collateral for commercial loans may depreciate over time and cannot be appraised with as much precision as real estate.

18

At June 30, 2012 and December 31, 2011, included in mortgage, commercial, and residential loans were loans collateralized by owner-occupied residential real estate of approximately $49.5 million and $53.2 million, respectively.

Loans with a book value of approximately $25.0 million at June 30, 2012 are pledged as eligible collateral for FHLB advances. Loans with a book value of approximately $25.8 million at December 31, 2011 were pledged as eligible collateral for FHLB advances.

19

(7) Credit Quality of Loans and Allowance for Loan Losses

The following tables summarize the balances by loan category of the allowance for loan losses with changes arising from charge-offs, recoveries and provision expense for the six months ending June 30, 2012 and 2011, and the three months ending June 30, 2012 and 2011:

Allowance for Loan Losses

As of and for the Six Months Ended June 30, 2012

Allowance for Credit Losses	Real Estate Construction and Land Development			Real Estate Secured by Farmland			Real Estate Secured by Residential Properties			Real Estate Secured by Nonfarm Nonresidential			Consumer Installment			Credit Cards and Related Plans			Commercial and Industrial			Loans to Finance Agricultural Production			All Other Loans			General Qualitative & Quantitative Portion			Total
	(Dollars in thousands)
Beginning balance	$	3,655		$	15		$	2,418		$	1,740		$	46		$	18		$	555		$	115		$	26		$	3,504		$	12,092
Charge-offs		(913	)		—			(278	)		(892	)		(43	)		(17	)		(421	)		—			(99	)		—			(2,663	)
Recoveries		337			—			47			2			13			3			12			—			71			—			485
Provisions		176			(2	)		202			200			134			65			505			(14	)		41			(441	)		866
Ending Balance	$	3,255		$	13		$	2,389		$	1,050		$	150		$	69		$	651		$	101		$	39		$	3,063		$	10,780
Ending Balance: individually evaluated for impairment	$	575		$	—		$	617		$	180		$	—		$	—		$	20		$	—		$	—		$	—		$	1,392
Ending Balance: collectively evaluated for impairment	$	2,680		$	13		$	1,772		$	870		$	150		$	69		$	631		$	101		$	39		$	3,063		$	9,388
Loans
Ending Balance	$	62,944		$	27,627		$	107,695		$	198,007		$	6,160		$	1,723		$	55,005		$	36,856		$	10,240		$	—		$	506,257
Ending Balance: individually evaluated for impairment	$	8,797		$	356		$	7,614		$	15,093		$	—		$	—		$	417		$	—		$	—		$	—		$	32,277
Ending Balance: collectively evaluated for impairment	$	54,147		$	27,271		$	100,081		$	182,914		$	6,160		$	1,723		$	54,588		$	36,856		$	10,240		$	—		$	473,980

Allowance for Loan Losses

As of and for the Three Months Ended June 30, 2012

Allowance for Credit Losses	Real Estate Construction and Land Development			Real Estate Secured by Farmland			Real Estate Secured by Residential Properties			Real Estate Secured by Nonfarm Nonresidential			Consumer Installment			Credit Cards and Related Plans			Commercial and Industrial			Loans to Finance Agricultural Production			All Other Loans			General Qualitative & Quantitative Portion			Total
	(Dollars in thousands)
Beginning balance	$	3,100		$	15		$	2,486		$	1,565		$	150		$	68		$	505		$	122		$	28		$	3,346		$	11,385
Charge-offs		(694	)		—			(176	)		(654	)		(2	)		(14	)		(64	)		—			(47	)		—			(1,651	)
Recoveries		111			—			20			1			12			3			2			—			31			—			180
Provisions		738			(2	)		59			138			(10	)		12			208			(21	)		27			(283	)		866
Ending Balance	$	3,255		$	13		$	2,389		$	1,050		$	150		$	69		$	651		$	101		$	39		$	3,063		$	10,780
Ending Balance: individually evaluated for impairment	$	575		$	—		$	617		$	180		$	—		$	—		$	20		$	—		$	—		$	—		$	1,392
Ending Balance: collectively evaluated for impairment	$	2,680		$	13		$	1,772		$	870		$	150		$	69		$	631		$	101		$	39		$	3,063		$	9,388
Loans
Ending Balance	$	62,944		$	27,627		$	107,695		$	198,007		$	6,160		$	1,723		$	55,005		$	36,856		$	10,240		$	—		$	506,257
Ending Balance: individually evaluated for impairment	$	8,797		$	356		$	7,614		$	15,093		$	—		$	—		$	417		$	—		$	—		$	—		$	32,277
Ending Balance: collectively evaluated for impairment	$	54,147		$	27,271		$	100,081		$	182,914		$	6,160		$	1,723		$	54,588		$	36,856		$	10,240		$	—		$	473,980

20

Allowance for Loan Losses

As of and for the Six Months Ended June 30, 2011

Allowance for Credit Losses	Real Estate Construction and Land Development			Real Estate Secured by Farmland		Real Estate Secured by Residential Properties			Real Estate Secured by Nonfarm Nonresidential			Consumer Installment			Credit Cards and Related Plans			Commercial and Industrial			Loans to Finance Agricultural Production			All Other Loans			General Qualitative & Quantitative Portion		Total
	(Dollars in thousands)
Beginning balance	$	6,168		$	28	$	3,450		$	1,007		$	12		$	21		$	882		$	18		$	139		$	1,522	$	13,247
Charge-offs		(1,917	)		—		(704	)		(43	)		(15	)		(9	)		(338	)		—			(122	)		—		(3,148	)
Recoveries		6			—		2			—			2			1			78			—			57			—		146
Provisions		3,210			5		1,491			168			31			175			—			(3	)		100			26		5,203
Ending Balance	$	7,467		$	33	$	4,239		$	1,132		$	30		$	188		$	622		$	15		$	174		$	1,548	$	15,448
Ending Balance: individually evaluated for impairment	$	1,931		$	—	$	1,124		$	585		$	—		$	170		$	249		$	—		$	—		$	—	$	4,059
Ending Balance: collectively evaluated for impairment	$	5,536		$	33	$	3,115		$	547		$	30		$	18		$	373		$	15		$	174		$	1,548	$	11,389
Loans
Ending Balance	$	84,291		$	33,641	$	117,458		$	211,556		$	5,191		$	2,422		$	47,780		$	23,715		$	16,633		$	—	$	542,687
Ending Balance: individually evaluated for impairment	$	16,331		$	—	$	8,762		$	5,508		$	—		$	200		$	511		$	—		$	—		$	—	$	31,312
Ending Balance: collectively evaluated for impairment	$	67,960		$	33,641	$	108,696		$	206,048		$	5,191		$	2,222		$	47,269		$	23,715		$	16,633		$	—	$	511,375

Allowance for Loan Losses

As of and for the Three Months Ended June 30, 2011

Allowance for Credit Losses	Real Estate Construction and Land Development			Real Estate Secured by Farmland		Real Estate Secured by Residential Properties			Real Estate Secured by Nonfarm Nonresidential			Consumer Installment			Credit Cards and Related Plans			Commercial and Industrial			Loans to Finance Agricultural Production		All Other Loans			General Qualitative & Quantitative Portion		Total
	(Dollars in thousands)
Beginning balance	$	7,587		$	29	$	4,002		$	1,118		$	16		$	189		$	1,132		$	15	$	130		$	1,001	$	15,219
Charge-offs		(644	)		—		(255	)		(43	)		(6	)		—			(84	)		—		(56	)		—		(1,088	)
Recoveries		6			—		1			—			—			1			15			—		21			—		44
Provisions		518			4		491			57			20			(2	)		(441	)		—		79			547		1,273
Ending Balance	$	7,467		$	33	$	4,239		$	1,132		$	30		$	188		$	622		$	15	$	174		$	1,548	$	15,448
Ending Balance: individually evaluated for impairment	$	1,931		$	—	$	1,124		$	585		$	—		$	170		$	249		$	—	$	—		$	—	$	4,059
Ending Balance: collectively evaluated for impairment	$	5,536		$	33	$	3,115		$	547		$	30		$	18		$	373		$	15	$	174		$	1,548	$	11,389
Loans
Ending Balance	$	84,291		$	33,641	$	117,458		$	211,556		$	5,191		$	2,422		$	47,780		$	23,715	$	16,633		$	—	$	542,687
Ending Balance: individually evaluated for impairment	$	16,331		$	—	$	8,762		$	5,508		$	—		$	200		$	511		$	—	$	—		$	—	$	31,312
Ending Balance: collectively evaluated for impairment	$	67,960		$	33,641	$	108,696		$	206,048		$	5,191		$	2,222		$	47,269		$	23,715	$	16,633		$	—	$	511,375

21

Loans are closely monitored by management for changes in quality. This monitoring includes assessing the appropriateness of the credit quality indicator in relation to the risk of the loan. Management uses the following indicators to grade the risk of each loan based on a system of eight possible ratings. These indicators are included in the Company’s loan policy which is reviewed and updated at least annually.

Pass: Include loans that are risk rated one through three. The primary source of repayment for pass loans is very likely to be sufficient, with secondary sources readily available; strong financial position; minimal risk; profitability, liquidity and capitalization are better than industry norms.

Weak Pass: Include loans that are risk rated four. The asset quality for weak pass assets is generally acceptable. Primary source of loan repayment is acceptable and secondary sources are likely to be realized, if needed; acceptable business credit, but borrowers operations, cash flow, or financial condition evidence more than average risk; requires above average levels of supervision and attention from Loan Officer. The source of increased risk has been identified, can be effectively managed/corrected, and the increased risk is not significant to warrant a more severe rating.

Special Mention: Include loans that are risk rated five. A special mention asset is considered to be high risk due to potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in the deterioration of the repayment prospects for the asset or in the Company’s credit position at some future date. Special mention assets are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification.

Substandard: Include loans that are risk rated six through eight. Loans rated as substandard are considered to be very high risk. A substandard asset is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified must have a well-defined weakness or weakness that jeopardizes the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

The following tables present loans as of June 30, 2012 and December 31, 2011 classified by risk type:

Credit Quality Indicators

As of June 30, 2012

	Pass		Weak Pass		Special Mention		Substandard		Total
	(Dollars in thousands)
Real Estate—Construction and Land Development Loans	$	27,929	$	19,992	$	5,682	$	9,341	$	62,944
Real Estate—Secured by Farmland		21,265		3,326		2,680		356		27,627
Real Estate—Secured by Residential Properties		59,344		29,079		10,488		8,784		107,695
Real Estate—Secured by Nonfarm Nonresidential		87,857		71,532		19,611		19,007		198,007
Consumer Installment		4,071		1,741		284		64		6,160
Credit Cards and Related Plans		871		580		270		2		1,723
Commercial and Industrial		29,978		19,737		3,627		1,663		55,005
Loans to Finance Agriculture Production		28,582		7,917		357		—		36,856
All Other Loans		5,826		4,390		24		—		10,240
Total	$	265,723	$	158,294	$	43,023	$	39,217	$	506,257

22

Credit Quality Indicators

As of December 31, 2011

	Pass		Weak Pass		Special Mention		Substandard		Total
	(Dollars in thousands)
Real Estate—Construction and Land Development Loans	$	27,833	$	23,237	$	4,853	$	11,204	$	67,127
Real Estate—Secured by Farmland		22,008		4,430		3,452		—		29,890
Real Estate—Secured by Residential Properties		60,121		31,146		12,302		6,805		110,374
Real Estate—Secured by Nonfarm Nonresidential		90,099		75,384		18,663		18,917		203,063
Consumer Installment		4,025		2,212		254		129		6,620
Credit Cards and Related Plans		850		529		279		3		1,661
Commercial and Industrial		25,133		16,146		2,686		1,714		45,679
Loans to Finance Agriculture Production		16,473		3,290		584		1,192		21,539
All Other Loans		3,171		7,393		25		—		10,589
Total	$	249,713	$	163,767	$	43,098	$	39,964	$	496,542

The following tables summarize the past due loans by category as of June 30, 2012 and December 31, 2011:

Past Due Loans

As of June 30, 2012

	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days		Total Past Due		Current		Total
	(Dollars in thousands)
Real Estate Construction and Land Development	$	178	$	76	$	5,271	$	5,525	$	57,419	$	62,944
Real Estate Secured by Farmland		—		156		200		356		27,271		27,627
Real Estate Secured by Residential Properties		211		222		2,312		2,745		104,950		107,695
Real Estate Secured by Nonfarm Nonresidential		2,430		210		6,401		9,041		188,966		198,007
Consumer Installment		20		2		7		29		6,131		6,160
Credit Cards and Related Plans		2		—		—		2		1,721		1,723
Commercial and Industrial		101		—		151		252		54,753		55,005
Loans to Finance Agricultural Production		—		—		—		—		36,856		36,856
All Other Loans		—		—		—		—		10,240		10,240
Total	$	2,942	$	666	$	14,342	$	17,950	$	488,307	$	506,257
Non-Accrual Loans Included in above Total	$	1,941	$	529	$	14,342	$	16,812	$	1,392	$	18,204

23

Past Due Loans

As of December 31, 2011

	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days		Total Past Due		Current		Total
	(Dollars in thousands)
Real Estate Construction and Land Development	$	447	$	198	$	6,142	$	6,787	$	60,340	$	67,127
Real Estate Secured by Farmland		—		—		—		—		29,890		29,890
Real Estate Secured by Residential Properties		1,055		993		1,278		3,326		107,048		110,374
Real Estate Secured by Nonfarm Nonresidential		2,357		—		4,446		6,803		196,260		203,063
Consumer Installment		65		—		22		87		6,533		6,620
Credit Cards and Related Plans		2		2		—		4		1,657		1,661
Commercial and Industrial		294		—		205		499		45,180		45,679
Loans to Finance Agricultural Production		—		—		—		—		21,539		21,539
All Other Loans		—		—		—		—		10,589		10,589
Total	$	4,220	$	1,193	$	12,093	$	17,506	$	479,036	$	496,542
Non-Accrual Loans Included in above Total	$	1,426	$	588	$	12,093	$	14,107	$	1,866	$	15,973

24

The following tables summarize impaired loans as of June 30, 2012, June 30, 2011 and December 31, 2011. The recorded investment balance includes the loan balance, deferred fees that have yet to be recognized and accrued interest. The deferred fees that have yet to be recognized are not material amounts.

Impaired Loans

	Balance at June 30, 2012						Six Months Ended June 30, 2012				Three Months Ended June 30, 2012
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
	(Dollars in thousands)
With no related allowance recorded:
Real Estate Construction and Land Development	$	5,750	$	7,219	$	—	$	5,791	$	49	$	5,552	$	22
Real Estate Secured by Farmland		356		356		—		119		3		237		2
Real Estate Secured by Residential Properties		2,180		2,329		—		1,830		28		2,074		14
Real Estate Secured by Nonfarm Nonresidential		11,682		12,835		—		8,227		93		9,303		40
Consumer Installment		—		—		—		—		—		—		—
Credit Cards and Related Plans		—		—		—		—		—		—		—
Commercial and Industrial		219		217		—		300		12		296		9
Loans to Finance Agricultural Production		—		—		—		293		9		—		—
All Other Loans		—		—		—		—		—		—		—
Total impaired loans with no related allowance	$	20,187	$	22,956	$	—	$	16,560	$	194	$	17,462	$	87
With an allowance recorded:
Real Estate Construction and Land Development	$	3,055	$	3,472	$	575	$	3,321	$	28	$	2,738	$	11
Real Estate Secured by Farmland		—		—		—		—		—		—		—
Real Estate Secured by Residential Properties		5,444		5,431		617		5,286		80		5,441		38
Real Estate Secured by Nonfarm Nonresidential		3,430		3,423		180		7,622		87		6,468		27
Consumer Installment		—		—		—		—		—		—		—
Credit Cards and Related Plans		—		—		—		—		—		—		—
Commercial and Industrial		199		199		20		124		5		67		2
Loans to Finance Agricultural Production		—		—		—		—		—		—		—
All Other Loans		—		—		—		—		—		—		—
Total impaired loans with related allowance recorded	$	12,128	$	12,525	$	1,392	$	16,353	$	200	$	14,714	$	78
Total
Construction and Land Development	$	8,805	$	10,691	$	575	$	9,112	$	77	$	8,290	$	33
Residential		7,624		7,760		617		7,116		108		7,515		52
Commercial		15,886		17,030		200		16,685		209		16,371		80
Consumer		—		—		—		—		—		—		—
Total impaired loans	$	32,315	$	35,481	$	1,392	$	32,913	$	394	$	32,176	$	165

Impaired Loans

	Balance at June 30, 2011						Six Months Ended June 30, 2011				Three Months Ended June 30, 2011
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
	(Dollars in thousands)
With no related allowance recorded:
Real Estate Construction and Land Development	$	7,995	$	11,610	$	—	$	7,819	$	82	$	7,105	$	33
Real Estate Secured by Farmland		—		—		—		—		—		—		—
Real Estate Secured by Residential Properties		3,860		4,222		—		3,846		38		3,855		22
Real Estate Secured by Nonfarm Nonresidential		2,501		2,544		—		1,517		24		2,183		17
Consumer Installment		—		—		—				—				—
Credit Cards and Related Plans		—		—		—		—		—		—		—
Commercial and Industrial		175		449		—		366		7		298		2
Loans to Finance Agricultural Production		—		—		—		—		—		—		—
All Other Loans		—		—		—		—		—		—		—
Total impaired loans with no related allowance	$	14,531	$	18,825	$	—	$	13,548	$	151	$	13,441	$	74
With an allowance recorded:
Real Estate Construction and Land Development	$	8,267	$	9,996	$	1,931	$	8,206	$	86	$	8,791	$	40
Real Estate Secured by Farmland		—		—		—		—		—		—		—
Real Estate Secured by Residential Properties		5,042		4,901		1,124		3,912		39		4,904		28
Real Estate Secured by Nonfarm Nonresidential		3,011		3,076		585		3,245		51		3,089		24
Consumer Installment		—		—		—		—		—		—		—
Credit Cards and Related Plans		201		200		170		200		6		200		3
Commercial and Industrial		301		300		249		404		8		358		2
Loans to Finance Agricultural Production		—		—		—		—		—		—		—
All Other Loans		—		—		—		—		—		—		—
Total impaired loans with related allowance recorded	$	16,822	$	18,473	$	4,059	$	15,967	$	190	$	17,342	$	97
Total
Construction and Land Development	$	16,262	$	21,606	$	1,931	$	16,025	$	168	$	15,896	$	73
Residential		8,902		9,123		1,124		7,758		77		8,759		50
Commercial		5,988		6,369		834		5,532		90		5,928		45
Consumer		201		200		170		200		6		200		3
Total impaired loans	$	31,353	$	37,298	$	4,059	$	29,515	$	341	$	30,783	$	171

25

Impaired Loans

As of December 31, 2011

	Recorded Investment		Unpaid Principal Balance		Related Allowance
	(Dollars in thousands)
With no related allowance recorded:
Real Estate Construction and Land Development	$	6,280	$	11,137	$	—
Real Estate Secured by Farmland		—		—		—
Real Estate Secured by Residential Properties		2,135		2,611		—
Real Estate Secured by Nonfarm Nonresidential		7,075		7,484		—
Consumer Installment		—		—		—
Credit Cards and Related Plans		—		—		—
Commercial and Industrial		379		500		—
Loans to Finance Agricultural Production		1,109		1,110		—
All Other Loans		—		—		—
Total impaired loans with no related allowance	$	16,978	$	22,842	$	—
With an allowance recorded:
Real Estate Construction and Land Development	$	3,806	$	3,794	$	637
Real Estate Secured by Farmland		—		—		—
Real Estate Secured by Residential Properties		3,391		3,382		480
Real Estate Secured by Nonfarm Nonresidential		6,976		6,957		1,181
Consumer Installment		—		—		—
Credit Cards and Related Plans		—		—		—
Commercial and Industrial		186		186		165
Loans to Finance Agricultural Production		—		—		—
All Other Loans		—		—		—
Total impaired loans with related allowance recorded	$	14,359	$	14,319	$	2,463
Total
Construction and Land Development	$	10,086	$	14,931	$	637
Residential		5,526		5,993		480
Commercial		15,725		16,237		1,346
Consumer		—		—		—
Total impaired loans	$	31,337	$	37,161	$	2,463

26

The following table presents nonaccrual loans as of June 30, 2012 and December 31, 2011 by loan category:

Nonaccrual Loans

	June 30, 2012		December 31, 2011
	(Dollars in thousands)
Real Estate Construction and Land Development	$	5,716	$	6,795
Real Estate Secured by Farmland		356		—
Real Estate Secured by Residential Properties		2,620		2,113
Real Estate Secured by Nonfarm Nonresidential		9,328		6,767
Consumer Installment		7		22
Credit Cards and Related Plans		—		—
Commercial and Industrial		177		276
Loans to Finance Agricultural Production		—		—
All Other Loans		—		—
Total	$	18,204	$	15,973

Interest income not recognized due to loans being on nonaccrual status during the three and six month period ended June 30, 2012 was approximately $250 thousand and $451 thousand, respectively. Interest income not recognized due to loans being on nonaccrual status during the three and six month period ended June 30, 2011 was approximately $217 thousand and $408 thousand, respectively.

Troubled Debt Restructurings

Loans which management identifies as impaired generally will be nonperforming loans or restructured loans (also known as “troubled debt restructurings” or “TDRs”). As a result of adopting the amendments in ASU 2011-02, the Company reassessed all restructurings that occurred on or after the beginning of the fiscal year of adoption (January 1, 2011) to determine whether they are considered TDRs under the amended guidance. The Company identified no loans as TDRs which the allowance for loan losses had previously been measured under a general allowance methodology. TDRs are treated as impaired loans in determining the adequacy of the allowance for loan loss.

For the three and six months ended June 30, 2012 the following table presents a breakdown of the types of concessions made by loan class. The recorded investment balances presented are balances at the time of concessions.

	Three Months ended June 30, 2012						Six Months ended June 30, 2012
	Number of Loans		Pre-Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment		Number of Loans		Pre-Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment
					(Dollars in thousands)
Below market interest rate:
Real Estate Secured by Residential Properties		—	$	—	$	—		1	$	1,943	$	1,943
Total below market interest rate		—	$	—	$	—		1	$	1,943	$	1,943
Extended payment terms:
Real Estate construction and land development		1	$	503	$	503		1	$	503	$	503
Commercial and Industrial		1		18		18		1		18		18
Total Extended Payment Terms		2	$	521	$	521		2	$	521	$	521
Total		2	$	521	$	521		3	$	2,464	$	2,464

27

The following table presents the successes and failures of the types of modifications within the previous twelve months as of June 30, 2012. The recorded investment balances presented are as of June 30, 2012.

	Paid in Full				Paying as Restructured				Converted to Non-accrual				Foreclosure/Default
	Number of Loans		Recorded Investment		Number of Loans		Recorded Investment		Number of Loans		Recorded Investment		Number of Loans		Recorded Investment
	(Dollars in thousands)
Below market interest rate		—	$	—		3	$	3,202		1	$	617		—	$	—
Extended payment terms		—		—		8		1,858		—		—		—		—
Forgiveness of principal		—		—		—		—		—		—		—		—
Total		—		—		11	$	5,060		1		617		—		—

There was one loan with a recorded investment of $617 thousand that is included in the table above that was placed on non-accrual in a prior period. While the loan was not ninety days past due, it was moved into nonaccrual status due to payment concerns. There were no loans that were restructured during the twelve months ending on June 30, 2012 as a result of payment default.

(8) Benefit Plans

Postretirement Benefits

The Company has a postretirement benefit plan whereby the Company pays postretirement health care benefits for certain of its retirees that have met minimum age and service requirements. Net periodic postretirement benefit cost for the six- and three-month periods ended June 30, 2012 and 2011 includes the following components.

	Six months ended June 30, (Dollars in thousands)
	2012		2011
Components of net periodic cost:
Service cost	$	4	$	4
Interest cost		18		18
Prior service cost		—		—
Amortization of (gain) loss		6		—
Net periodic postretirement benefit cost	$	28	$	22

	Three months ended June 30, (Dollars in thousands)
	2012		2011
Components of net periodic cost:
Service cost	$	2	$	2
Interest cost		9		9
Prior service cost		—		—
Amortization of (gain) loss		3		—
Net periodic postretirement benefit cost	$	14	$	11

28

The Company expects to contribute $56 thousand to its postretirement benefit plan in 2012. No contributions were made in the first six months of 2012. For additional information related to the plan, refer to the Company’s Form 10-K for the year ended December 31, 2011.

Stock Option and Restricted Option Plans

On June 7, 2012, the stockholders of the Company approved amendments to the Company’s 2008 Omnibus Equity Plan (the “Plan”) that would increase by 190,100 the number of shares reserved under the Plan, permit nonemployee directors of the Company to participate in the Plan and increase the types of awards available for approval under the Plan. These types of awards may include restricted stock units, stock appreciation rights or similar forms of equity compensation that are valued by reference to the Company’s common stock.

During the six months ended June 30, 2012, 25,013 stock options were forfeited. During the three months ended June 30, 2012, 5,457 stock options were forfeited. There was no other activity during the quarter.

29

(9) Fair Value Of Financial Instruments

Fair value estimates are made by management at a specific point in time, based on relevant information about the financial instrument and the market. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument nor are potential taxes and other expenses that would be incurred in an actual sale considered. Fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions and/or the methodology used could significantly affect the estimates disclosed. Similarly, the fair values disclosed could vary significantly from amounts realized in actual transactions.

The following presents the carrying amount, fair value, and placement in the fair value hierarchy of the Company’s financial instruments as of June 30, 2012 and December 31, 2011. For short-term financial assets such as cash and cash equivalents, accrued interest receivable and loans held for sale the carrying amount is a reasonable estimate of fair value due to the relatively short time between the origination of the instrument and its expected realization. For financial liabilities such as noninterest-bearing demand, interest-bearing demand, savings deposits, short-term borrowing and accrued interest payable the carrying amount is a reasonable estimate of fair value due to these products having no stated maturity.

The fair value of investment securities available-for-sale are recorded at fair value utilizing Level 1, Level 2 and Level 3 inputs and is described in more detail below.

The fair value of net loans is based on estimated cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. This does not include consideration of liquidity that market participants would use to value such loans. The estimated fair values of time deposits and long-term obligations are based on estimated cash flows discounted at market interest rates.

The fair value of off-balance sheet financial instruments is considered immaterial. These off-balance sheet financial instruments are commitments to extend credit and are either short-term in nature or subject to immediate repricing.

30

The following table presents the carrying values and estimated fair values of the Company’s financial instruments at June 30, 2012 and December 31, 2011:

	June 30, 2012
	Carrying Amount				Fair Value Measurements Using
(Dollars in thousands)			Fair Value		Level 1		Level 2		Level 3
Assets
Cash and cash equivalents	$	24,621	$	24,621	$	24,621	$	—	$	—
Investment securities		350,779		350,779		161,317		187,624		1,838
FHLB stock		3,899		3,899		—		3,899		—
Accrued interest receivable		5,030		5,030		—		5,030		—
Net loans		495,477		492,950		—		—		492,950
Loans held for sale		3,059		3,059		—		3,059		—
Liabilities
Demand, noninterest bearing deposits	$	146,326	$	146,326	$	—	$	146,326	$	—
Demand, interest-bearing deposits		305,298		305,298		—		305,298		—
Savings deposits		58,562		58,562		—		58,562		—
Time deposits		285,302		291,019		—		291,019		—
Accrued interest payable		469		469		—		469		—
Short-term borrowing		42,101		42,101		—		42,101		—
Long-term borrowing		18,000		18,710		—		18,710		—

	December 31, 2011
	Carrying Amount		Fair Value		Fair Value Measurements Using
(Dollars in thousands)					Level 1		Level 2		Level 3
Assets
Cash and cash equivalents	$	24,731	$	24,731	$	24,731	$	—	$	—
Investment securities		339,450		339,450		151,714		186,094		1,642
FHLB stock		3,456		3,456		—		3,456		—
Accrued interest receivable		5,308		5,308		—		5,308		—
Net loans		484,450		482,851		—		—		482,851
Loans held for sale		2,866		2,866		—		2,866		—
Liabilities
Demand, noninterest bearing deposits	$	135,732	$	135,732	$	—	$	135,732	$	—
Demand, interest-bearing deposits		270,119		270,119		—		270,119		—
Savings deposits		55,517		55,517		—		55,517		—
Time deposits		336,277		343,374		—		343,374		—
Accrued interest payable		519		519		—		519		—
Short-term borrowing		11,679		11,679		—		11,679		—
Long-term borrowing		25,500		26,296		—		26,296		—

Fair Value Hierarchy

The Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

Level 1 Valuation is based upon quoted prices for identical instruments traded in active markets.

Level 2 Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

Level 3 Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

31

The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available-for-sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as loans held for sale, loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

There were no changes to the techniques used to measure fair value during the period.

Following is a description of valuation methodologies used for assets recorded at fair value.

Investment Securities Available-for-Sale

Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.

Mortgage Banking Activity

The Company enters into interest rate lock commitments and commitments to sell mortgages. At June 30, 2012 and December 31, 2011, the amount of fair value associated with these interest rate lock commitments was $131 thousand and $76 thousand, respectively, which is included in other assets. Fair value associated with the interest rate lock commitments are classified as Level 3 measurements due to the use of significant management judgment and estimation. Forward loan sale commitments have been deemed insignificant for both periods.

Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment using one of several methods, including collateral value, market price and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At June 30, 2012, the majority of the total impaired loans were evaluated based on the fair value of the collateral. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3. The fair values of impaired loans are generally based on judgment and therefore are considered to be level 3 assets.

Real Estate and Repossessions Acquired in Settlement of Loans

Foreclosed assets are adjusted to fair value upon transfer of the loans to other real estate owned. Real estate acquired in settlement of loans is recorded initially at estimated fair value of the property less estimated selling costs at the date of foreclosure. The initial recorded value may be subsequently reduced by additional allowances, which are charged to earnings if the estimated fair value of the property less estimated selling costs declines below the initial recorded value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3. The fair values of foreclosed assets are generally based on judgment and therefore are considered to be level 3 assets.

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Assets recorded at fair value on a recurring basis

June 30, 2012	Total		Level 1		Level 2		Level 3
	(Dollars in thousands)
Investment Securities Available-for-Sale
Obligations of states and political subdivisions	$	37,779	$	3,903	$	33,876	$	—
Mortgage-backed securities		132,799		19,463		113,336		—
SBA-backed securities		139,602		137,951		1,651		—
Corporate bonds		40,599		—		38,761		1,838
Total Securities		350,779		161,317		187,624		1,838
Interest rate lock commitments		131		—		—		131
Total assets at fair value	$	350,910	$	161,317	$	187,624	$	1,969

December 31, 2011	Total		Level 1		Level 2		Level 3
	(Dollars in thousands)
Investment Securities Available-for-Sale
Government-sponsored enterprises and FFCB bonds	$	1,032	$	—	$	1,032	$	—
Obligations of states and political subdivisions		28,718		6,752		21,966		—
Mortgage-backed securities		132,292		—		132,292		—
SBA-backed securities		146,637		144,962		1,675		—
Corporate bonds		30,771		—		29,129		1,642
Total Securities		339,450		151,714		186,094		1,642
Interest rate lock commitments		76		—		—		76
Total assets at fair value	$	339,526	$	151,714	$	186,094	$	1,718

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Assets recorded at fair value on a nonrecurring basis

June 30, 2012	Total		Level 1		Level 2		Level 3
	(Dollars in thousands)
Impaired Loans
Real estate—construction and land development	$	6,128	$	—	$	—	$	6,128
Real estate—secured by residential properties		5,240		—		—		5,240
Real estate—secured by nonfarm nonresidential properties		7,324		—		—		7,324
Commercial and industrial		179		—		—		179
Total impaired loans		18,871		—		—		18,871
Real estate and repossessions acquired in settlement of loans
Total real estate and repossessions acquired in settlement of loans		7,661		—		—		7,661
Total assets at fair value	$	26,532	$	—	$	—	$	26,532

December 31, 2011	Total		Level 1		Level 2		Level 3
	(Dollars in thousands)
Impaired Loans
Real estate—construction and land development	$	9,169	$	—	$	—	$	9,169
Real estate—secured by residential properties		3,893		—		—		3,893
Real estate—secured by nonfarm nonresidential properties		8,805		—		—		8,805
Commercial and industrial		196		—		—		196
Total impaired loans		22,063		—		—		22,063
Real estate and repossessions acquired in settlement of loans
Real estate and repossessions acquired in settlement of loans		6,573		—		—		6,573
Total assets at fair value	$	28,636	$	—	$	—	$	28,636

34

As of June 30, 2012 there were $6.7 million of Level 2 investment securities available for sale that were reported as Level 1 as of December 31, 2011. These obligations of states and political subdivisions were transferred from Level 1 to Level 2 during the first six months of 2012 because the December 31, 2011 pricing was based on the Company’s actual trades for the securities at initial purchase while the June 30, 2012 pricing was through a pricing system.

During the first six months of 2012 and 2011 there were no investment securities transferred in or out of Level 3. The tables below present a reconciliation for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the three and six month periods of 2012 and 2011.

	Corporate Bonds		Interest Rate Lock Commitments		Total
	(Dollars in thousands)
Balance, December 31, 2011	$	1,642	$	76	$	1,718
Total gains or losses (realized/unrealized):
Included in earnings		—		35		35
Included in other comprehensive income		147		—		147
Purchases, issuances, and settlements		—		—		—
Transfers in to/out of Level 3		—		—		—
Balance, Mach 31, 2012	$	1,789	$	111	$	1,900
Total gains or losses (realized/unrealized):
Included in earnings		—		20		20
Included in other comprehensive income		49		—		49
Purchases, issuances, and settlements		—		—		—
Transfers in to/out of Level 3		—		—		—
Balance, June 30, 2012	$	1,838	$	131	$	1,969

	Corporate Bonds			Interest Rate Lock Commitments			Total
	(Dollars in thousands)
Balance, December 31, 2010	$	1,716		$	101		$	1,817
Total gains or losses (realized/unrealized):
Included in earnings		—			(6	)		(6	)
Included in other comprehensive income		(392	)		—			(392	)
Purchases, issuances, and settlements		—			—			—
Transfers in to/out of Level 3		—			—			—
Balance, Mach 31, 2011	$	1,324		$	95		$	1,419
Total gains or losses (realized/unrealized):
Included in earnings		—			(25	)		(25	)
Included in other comprehensive income		167			—			167
Purchases, issuances, and settlements		—			—			—
Transfers in to/out of Level 3		—			—			—
Balance, June 30, 2011	$	1,491		$	70		$	1,561

35

For Level 3 assets and liabilities measured at fair value on a recurring or non-recurring basis as of June 30, 2012, the significant unobservable inputs used in the fair value measurements were as follows:

Level 3 Assets with Significant Unobservable Inputs	Fair Value At 6/30/2012		Valuation Technique	Significant Unobservable Inputs	Significant Unobservable Input Value
Corporate Bonds	$	965	Fundamental Analysis	Spread	+550 BBB
			Pricing Model		Bank Paper
				Yield	9.89%
Corporate Bonds		873	Fundamental Analysis	Spread	+650 LIBOR
			Pricing Model		Index
				Yield	6.96%
Interest Rate Lock Commitments		131	Pricing Model	Weighted average Closing Ratio	90%
Impaired Loans		18,871	Discounted appraisals (1)	Appraisal adjustments (2)	5% to 85%
OREO		7,661	Discounted appraisals (1)	Appraisal adjustments (2)	5% to 70%

(1) Fair value is generally based on appraisals of the underlying collateral but is also based on discounted cash flows for some loans.

(2) Appraisals may be adjusted by management for customized discounting criteria, estimated sales costs, and proprietary qualitative adjustments.

The significant unobservable inputs used in the fair value measurement of the Company’s Corporate Bonds are the yield expected to be earned on the bonds and the spread. The yield is applied to a discounted cash flow in order to arrive at a price and corresponding market value. A discount margin represents a spread over the floating rate index. Spread represents an additional yield that is applied over a comparable security or curve (such as the treasury curve). Yield of the comparable or curve plus the “spread” in basis points is equal to the yield or discount rate applied in a discounted cash flow in order to arrive at a price and corresponding market value. The spread is based on various factors such as liquidity, earning history and capital ratios.

The significant unobservable input used in the fair value measurement of the Company’s interest rate lock commitments (IRLC) is the closing ratio, which represents the percentage of loans currently in a lock position which management estimates will ultimately close. Generally the fair value of an IRLC is positive if the prevailing interest rate is lower than the IRLC rate. The fair value would be negative if the prevailing rate was higher. When a higher percentage of loans are estimated to close, the increase in the closing ratio will result in a positive effect to fair value. The closing ratio is dependent upon the loan processing stage that a loan is currently in and the change in prevailing interest rates from the time of the rate lock.

Impaired loans and real estate and repossessions acquired in settlement of loans classified as Level 3 are based on management’s judgment and estimation.

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(10) U.S. Treasury’s Troubled Asset Relief Program (TARP) Capital Purchase Program

On January 16, 2009, we issued Series A Preferred Stock in the amount of $17,949,000 and a warrant to purchase 144,984 shares of our common stock to the U.S. Treasury as a participant in the TARP Capital Purchase Program. The Series A Preferred Stock qualifies as Tier 1 capital for purposes of regulatory capital requirements and will pay cumulative dividends at a rate of 5% per annum for the first five years and 9% per annum thereafter. Until the U.S. Treasury ceases to own our securities sold under the TARP Capital Purchase Program, the compensation arrangements for our senior executive officers must comply in all respects with the U.S. Emergency Economic Stabilization Act of 2008 and the rules and regulations thereunder.

(11) Regulatory Matters

Bancorp’s and the Bank’s actual capital ratios for purposes of bank regulatory capital guidelines are presented in the following table:

	Ratio required to be well capitalized under prompt corrective action provisions			Minimum ratio required for capital adequacy purposes			Bancorp’s Ratio			Bank’s Ratio
As of June 30, 2012:
Tier 1 Capital (to Average Assets)		³5.00	%		³3.00	%		8.25	%		8.25	%
Tier 1 Capital (to Risk Weighted Assets)		³6.00	%		³4.00	%		12.09			12.09
Total Capital (to Risk Weighted Assets)		³10.00	%		³8.00	%		13.35			13.35
As of December 31, 2011:
Tier 1 Capital (to Average Assets)		³5.00	%		³3.00	%		8.25	%		8.25	%
Tier 1 Capital (to Risk Weighted Assets)		³6.00	%		³4.00	%		12.59			12.59
Total Capital (to Risk Weighted Assets)		³10.00	%		³8.00	%		13.85			13.85
As of June 30, 2011:
Tier 1 Capital (to Average Assets)		³5.00	%		³3.00	%		8.39	%		8.39	%
Tier 1 Capital (to Risk Weighted Assets)		³6.00	%		³4.00	%		12.20			12.20
Total Capital (to Risk Weighted Assets)		³10.00	%		³8.00	%		13.46			13.46

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During April 2011, the Bank’s Board of Directors adopted a resolution at the request of the Federal Deposit Insurance Corporation to the effect that the Bank, through its management, will take various actions designed to address issues related to the Bank’s operations. The Resolution provides that, among other things, the Bank will (1) establish and continue to maintain an adequate reserve for loan losses, and review the adequacy of the reserve with the Board prior to each quarter-end and make appropriate provisions to the reserve; (2) in order to maintain sufficient capital levels, establish and document a prudent policy regarding cash dividends the Bank pays to Bancorp, document an analysis of amounts to be paid by each quarter-end prior to payment, and not pay any cash dividend to Bancorp without seeking the prior approval of the FDIC and N.C. Commissioner of Banks; (3) implement various recommendations regarding risk management policies and practices for the Bank’s funds management and investment functions; (4) provide for the internal audit program to include a review and coverage of activities sufficient to determine compliance with the Bank’s policies, applicable laws and regulations and sound banking principles, and identification of audit personnel who periodically report directly to the Board; (5) correct or eliminate various credit administration weaknesses and establish an effective credit administration function, and ascertain that all necessary supporting documentation is obtained and evaluated before loans are extended; and (6) correct violations of and ensure further compliance with applicable laws, rules and regulations.

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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

Statements in this Report and its exhibits relating to plans, strategies, economic performance and trends, projections of results of specific activities or investments, expectations or beliefs about future events or results, and other statements that are not descriptions of historical facts, may be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking information is inherently subject to risks and uncertainties, and actual results could differ materially from those currently anticipated due to a number of factors, which include, but are not limited to, risk factors discussed in our Annual Report on Form 10-K and in other documents we file with the Securities and Exchange Commission from time to time. Copies of those reports are available through our Internet website at www.myecb.com or directly through the Commission’s website at www.sec.gov. Forward-looking statements in this Report may be identified by terms such as “may,” “will,” “should,” “could,” “expects,” “plans,” “intends,” “anticipates,” “feels,” “believes,” “estimates,” “predicts,” “forecasts,” “potential” or “continue,” or similar terms or the negative of these terms, or other statements concerning opinions or judgments of our management about future events. Factors that could influence the accuracy of those forward-looking statements include, but are not limited to, (a) pressures on our earnings, capital and liquidity resulting from current and future conditions in the credit and equity markets, (b) continued or unexpected increases in credit losses in our loan portfolio, (c) continued adverse conditions in the economy and in the real estate market in our banking markets (particularly those conditions that affect our loan portfolio, the abilities of our borrowers to repay their loans, and the values of collateral that secures our loans), (d) the financial success or changing strategies of our customers, (e) actions of government regulators, or changes in laws, regulations or accounting standards, that adversely affect our business, (f) changes in the interest rate environment and the level of market interest rates that reduce our net interest margins and/or the values of loans we make and securities we hold, (g) changes in competitive pressures among depository and other financial institutions or in our ability to compete effectively against other financial institutions in our banking markets; (h) weather and similar conditions, particularly the effect of hurricanes on our banking and operations facilities and on our customers and the communities in which we do business; and (i) other developments or changes in our business that we do not expect. Although we believe that the expectations reflected in the forward-looking statements in this Report are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. All forward-looking statements attributable to us are expressly qualified in their entirety by the cautionary statements in this paragraph. We have no obligation, and we do not intend, to update these forward-looking statements.

Executive Summary

ECB Bancorp, Inc. is a bank holding company headquartered in Engelhard, North Carolina. Our wholly owned subsidiary, The East Carolina Bank (the “Bank”), is a state-chartered community bank that was founded in 1919. For the purpose of this discussion, “we,” “us” and “our” refers to the Bank and the bank holding company as a single, consolidated entity unless the context otherwise indicates.

As of June 30, 2012, we had consolidated assets of approximately $944.3 million, total loans of approximately $506.3 million, total deposits of approximately $795.5 million and shareholders’ equity of approximately $83.3 million. For the three months ended June 30, 2012, we had income available to common shareholders of $322 thousand or $0.11 basic and diluted earnings per share, compared to income available to common shareholders of $880 thousand, or $0.31 basic and diluted earnings per share for the three months ended June 30, 2011. For the six months ended June 30, 2012, we had net income available to common shareholders of $434 thousand or $0.15 basic and diluted income per share, compared to a loss attributable to common shareholders of $469 thousand or $0.16 basic and diluted loss per share for the six months ended June 30, 2011.

39

Critical Accounting Policies

The Company’s accounting policies are in accordance with accounting principles generally accepted in the United States and with general practices within the banking industry. Our significant accounting policies are set forth in Note 1 to the Consolidated Financial Statements contained in the Form 10-K Annual Report for the fiscal year ended December 31, 2011. Management makes a number of estimates and assumptions relating to reported amounts of assets, liabilities, revenues and expenses in the preparation of the financial statements and disclosures. Estimates and assumptions that are most significant to the Company are related to the determination of the allowance for loan losses, asset impairment valuations, postretirement and benefit plan accounting and income taxes.

We consider our policy regarding the allowance for loan losses to be our most critical accounting policy, because it requires management’s most subjective and complex judgments. In addition, changes in economic conditions can have a significant impact on the allowance for loan losses and, therefore, the provision for loan losses and results of operations. We have developed policies and procedures for assessing the adequacy of the allowance for loan losses, recognizing that this process requires a number of assumptions and estimates with respect to our loan portfolio. Our assessments may be impacted in future periods by changes in economic conditions, the results of regulatory examinations, and the discovery of information with respect to borrowers that is not currently known to management. For additional discussion concerning our allowance for loan losses and related matters, see “—Asset Quality” and “—Nonperforming Assets.” Other real estate acquired through the settlement of loans is carried at fair value less cost to sell. Management relies on outside appraisals and estimates of costs of disposal in determining this value. The actual disposal value could vary from this fair value estimate.

The determination of retirement plans and other postretirement benefit plans requires the use of estimates and judgments related to the amount and timing of expected future cash out-flows for benefit payments and cash in-flows for maturities. Our retirement plans and other postretirement benefit plans are actuarially determined based on assumptions on the discount rate and the health care cost trend rate. Changes in estimates and assumptions related to mortality rates and future health care costs could have a material impact to our financial condition or results of operations. The discount rate is used to determine the present value of future benefit obligations and the net periodic benefit cost. The discount rate used to value the future benefit obligation as of each year-end is the rate used to determine the periodic benefit cost in the following year.

Management seeks strategies that minimize the tax effect of implementing their business strategies. As such, judgments are made regarding the ultimate consequence of long-term tax planning strategies, including the likelihood of future recognition of deferred tax benefits. The Company’s tax returns are subject to examination by both Federal and State authorities. Such examinations may result in the assessment of additional taxes, interest and penalties. As a result, the ultimate outcome, and the corresponding financial statement impact, can be difficult to predict with accuracy.

Comparison of the Results of Operations for the Three- and Six-Month Periods Ended June 30, 2012 and 2011

The following table summarizes components of income and expense and the changes in those components for the three- and six-month periods ended June 30, 2012 as compared to the same periods in 2011.

Condensed Consolidated Results of Operations

(Dollars in thousands)

	For the Three Months Ended June 30, 2012		Changes from the Prior Year						For the Six Months Ended June 30, 2012		Changes from the Prior Year
			Amount			%					Amount			%
Total interest income	$	8,445	$	(1,187	)		(12.3	)	$	16,944	$	(2,126	)		(11.1	)
Total interest expense		1,787		(800	)		(30.9	)		3,758		(1,499	)		(28.5	)
Net interest income		6,658		(387	)		(5.5	)		13,186		(627	)		(4.5	)
Provision for loan losses		866		(407	)		(32.0	)		866		(4,337	)		(83.4	)
Net interest income after
Provision for loan losses		5,792		20			0.3			12,320		3,710			43.1
Noninterest income		2,221		(318	)		(12.5	)		3,960		(10	)		(0.3	)
Noninterest expense		7,257		600			9.0			15,175		2,274			17.6
Income before income taxes		756		(898	)		(54.3	)		1,105		1,426			(444.2	)
Income tax provision		168		(341	)		(67.0	)		140		522			(136.6	)
Net income		588		(557	)		(48.6	)		965		904			1,482.0
Preferred stock dividend and accretion of discount		266		1			0.4			531		1			0.2
Net income available to common shareholders	$	322	$	(558	)		(63.4	)	$	434	$	903			(192.5	)

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Net Interest Income

Net interest income (the difference between the interest earned on assets, such as loans and investment securities and the interest paid on liabilities, such as deposits and other borrowings) is our primary source of operating income. Net interest income for the three months ended June 30, 2012 was $6.7 million, a decrease of $387 thousand or 5.5% when compared to net interest income of $7.0 million for the three months ended June 30, 2011. For the six months ended June 30, 2012, net interest income was $13.2 million, a decrease of $627 thousand or 4.5% when compared to net interest income of $13.8 million for the same period in 2011.

The level of net interest income is determined primarily by the average balances (volume) of interest-earning assets and interest-bearing liabilities and the various rate spreads between our interest-earning assets and our interest-bearing liabilities. Changes in net interest income from period to period result from increases or decreases in the volume of interest-earning assets and interest-bearing liabilities, increases or decreases in the average interest rates earned and paid on such assets and liabilities, the ability to manage the interest-earning asset portfolio (which includes loans), and the availability of particular sources of funds, such as noninterest bearing deposits.

Interest income decreased $1.2 million or 12.3% for the three months ended June 30, 2012 compared to the same three months of 2011. Interest income decreased $2.1 million or 11.1% for the six months ended June 30, 2012 compared to the same six months in 2011. The decreases for the three and six months ended June 30, 2012 are due to the decreases in the rates earned on our average earning assets and a decrease in the volume of these earning assets. The tax equivalent yield on average earning assets decreased 48 basis points for the quarter ended June 30, 2012 to 4.08% from 4.56% for the same period in 2011. For the first six months of 2012, the yield on average earning assets, on a tax-equivalent basis, decreased 45 basis points to 4.13% compared to 4.58% for the six months ended June 30, 2011. Management attributes the decrease in the yield on our earning assets to the continued low level of market interest rates and the decline in volume of higher yielding loans which were replaced by lower yielding securities. Yields on our taxable securities decreased approximately 78 and 67 basis points for the three- and six-month periods ending June 30, 2012, respectively, as compared to the same periods last year as securities sold, called or matured have been replaced with lower yielding securities.

Our average cost of funds during the second quarter of 2012 was 1.02%, a decrease of 40 basis points when compared to 1.42% for the second quarter of 2011. Average rates paid on bank certificates of deposit decreased 26 basis points from 1.83% for the quarter ended June 30, 2011 to 1.57% for the quarter ended June 30, 2012, while our average cost of borrowed funds decreased 76 basis points during the second quarter of 2012 compared to the same period in 2011. Total interest expense decreased $800 thousand or 30.9% during the second quarter of 2012 compared to the same period in 2011, primarily the result of decreased market rates paid on these liabilities. For the six months ended June 30, 2012, our cost of funds was 1.08%, a decrease of 38 basis points when compared to 1.46% for the same period in 2011. Average rates paid on bank certificates of deposit decreased 27 basis points from 1.86% to 1.59% for the first six months of 2012, while our cost of borrowed funds decreased 72 basis points compared to the same period a year ago. Total interest expense decreased $1.5 million or 28.5% during the six months of 2012 compared to the same period in 2011, primarily the result of decreased market rates paid on these liabilities. The volume of average interest-bearing liabilities decreased approximately $23.3 million for the six months of 2012 compared with the same period in 2011.

The banking industry uses two key ratios to measure profitability of net interest income: net interest rate spread and net interest margin. The net interest rate spread measures the difference between the average yield on earning assets and the average rate paid on interest-bearing liabilities. The net interest rate spread does not consider the impact of non-interest-bearing deposits and gives a direct perspective on the effect of market interest rate movements. The net interest margin is defined as net interest income as a percentage of total average earning assets and takes into account the positive effects of investing non-interest bearing deposits in earning assets.

Our annualized net interest margin, on a tax-equivalent basis, for the three months ended June 30, 2012 was 3.23% compared to 3.35% in the second quarter of 2011, while our net interest spread decreased 7 basis points during the same period. For the six months ended June 30, 2012, our net interest margin, on a tax-equivalent basis, was 3.22% compared to 3.33% in the six months of 2011 while our net interest spread decreased 7 basis points.

Average interest-bearing liabilities, as a percentage of interest-earning assets, for the quarters ended June 30, 2012 and 2011 were 83.7% and 85.8%, respectively. For the six months ended June 30, 2012, average interest-bearing liabilities as a percentage of interest-earning assets were 83.8% compared to 86.1% for the six months ended June 30, 2011.

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Average Consolidated Balance Sheets and Net Interest Analysis Fully on Tax Equivalent Basis

For the three months ended

	June 30, 2012							June 30, 2011
	Average Balance		Yield/ Rate (5)			Income/ Expense		Average Balance		Yield/ Rate (5)			Income/ Expense
	(Dollars in thousands)
Assets
Loans—net (1)	$	488,307		5.26	%	$	6,404	$	530,303		5.54	%	$	7,329
Taxable securities		314,301		2.28	%		1,788		284,997		3.06	%		2,172
Non-taxable securities (2)		33,457		4.52	%		377		11,555		6.15	%		177
Other investments		6,229		0.26	%		4		25,123		0.22	%		14
Total interest-earning assets		842,294		4.08	%	$	8,573		851,978		4.56	%	$	9,692
Cash and due from banks		13,344							12,160
Bank premises and equipment, net		26,267							26,677
Other assets		39,973							36,272
Total assets	$	921,878						$	927,087
Liabilities and Shareholders’ Equity
Interest-bearing deposits	$	646,656		1.00	%	$	1,616	$	685,641		1.39	%	$	2,369
Short-term borrowings		40,291		0.95	%		95		17,544		1.67	%		73
Long-term obligations		18,000		1.69	%		76		27,500		2.11	%		145
Total interest-bearing liabilities		704,947		1.02	%		1,787		730,685		1.42	%		2,587
Non-interest-bearing deposits		129,466							110,824
Other liabilities		5,419							5,358
Shareholders’ equity		82,046							80,220
Total liabilities and Shareholders’ equity	$	921,878						$	927,087
Net interest income and net interest margin (FTE) (3)				3.23	%	$	6,786				3.35	%	$	7,105
Interest rate spread (FTE) (4)				3.06	%						3.14	%

(1) Average loans include non-accruing loans, net of allowance for loan losses and loans held for sale.

(2) Yields on tax-exempt investments have been adjusted to a fully taxable-equivalent basis (FTE) using the federal income tax rate of 34%. The taxable equivalent adjustment was $128 thousand and $60 thousand for periods ended June 30, 2012 and 2011, respectively.

(3) Net interest margin is computed by dividing net interest income by average total earning assets.

(4) Interest rate spread equals the average yield on total earning assets minus the average rate paid on total interest-bearing liabilities.

(5) Annualized

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For the six months ended

	June 30, 2012							June 30, 2011
	Average Balance		Yield/ Rate (5)			Income/ Expense		Average Balance		Yield/ Rate (5)			Income/ Expense
	(Dollars in thousands)
Assets
Loans—net (1)	$	484,947		5.31	%	$	12,773	$	538,722		5.50	%	$	14,686
Taxable securities		317,912		2.33	%		3,681		276,360		3.00	%		4,118
Non-taxable securities (2)		32,796		4.51	%		733		12,098		6.19	%		371
Other investments		4,803		0.25	%		6		18,181		0.23	%		21
Total interest-earning assets		840,458		4.13	%	$	17,193		845,361		4.58	%	$	19,196
Cash and due from banks		13,231							12,736
Bank premises and equipment, net		26,301							26,725
Other assets		39,724							35,363
Total assets	$	919,714						$	920,185
Liabilities and Shareholders’ Equity
Interest-bearing deposits	$	648,781		1.05	%	$	3,387	$	682,103		1.42	%	$	4,790
Short-term borrowings		34,536		1.03	%		176		15,447		1.85	%		142
Long-term obligations		21,049		1.87	%		195		30,141		2.17	%		325
Total interest-bearing liabilities		704,366		1.08	%		3,758		727,691		1.46	%		5,257
Non-interest-bearing deposits		128,092							106,402
Other liabilities		5,625							5,650
Shareholders’ equity		81,631							80,442
Total liabilities and Shareholders’ equity	$	919,714						$	920,185
Net interest income and net interest margin (FTE) (3)				3.22	%	$	13,435				3.33	%	$	13,939
Interest rate spread (FTE) (4)				3.05	%						3.12	%

(1) Average loans include non-accruing loans, net of allowance for loan losses and loans held for sale.

(2) Yields on tax-exempt investments have been adjusted to a fully taxable-equivalent basis (FTE) using the federal income tax rate of 34%. The taxable equivalent adjustment was $249 thousand and $126 thousand for periods ended June 30, 2012 and 2011, respectively.

(3) Net interest margin is computed by dividing net interest income by average total earning assets.

(4) Interest rate spread equals the average yield on total earning assets minus the average rate paid on total interest-bearing liabilities.

(5) Annualized

The following table presents the relative impact on net interest income of average outstanding balances (volume) of earning assets and interest-bearing liabilities and the rates earned and paid by us on such assets and liabilities. Variances resulting from a combination of changes in rate and volume are allocated in proportion to the absolute dollar amount of the change in each category.

43

Change in Interest Income and Expense on Tax Equivalent Basis

For the three months ended June 30, 2012 and 2011

Increase (Decrease) in interest income and expense due to changes in:

	2012 compared to 2011
	Volume (1)			Rate (1)			Net
	(Dollars in thousands)
Loans	$	(566	)	$	(359	)	$	(925	)
Taxable securities		195			(579	)		(384	)
Non-taxable securities (2)		291			(91	)		200
Other investments		(11	)		1			(10	)
Interest income		(91	)		(1,028	)		(1,119	)
Interest-bearing deposits		(116	)		(637	)		(753	)
Short-term borrowings		74			(52	)		22
Long-term obligations		(45	)		(24	)		(69	)
Interest expense		(87	)		(713	)		(800	)
Net interest income	$	(4	)	$	(315	)	$	(319	)

(1) The combined rate/volume variance for each category has been allocated equally between rate and volume variances.

(2) Yields on tax-exempt investments have been adjusted to a fully taxable-equivalent basis (FTE) using the federal income tax rate of 34%. The taxable equivalent adjustment was $128 thousand and $60 thousand for periods ended June 30, 2012 and 2011, respectively.

For the six months ended June 30, 2012 and 2011

Increase (Decrease) in interest income and expense due to changes in:

	2012 compared to 2011
	Volume (1)			Rate (1)			Net
	(Dollars in thousands)
Loans	$	(1,441	)	$	(472	)	$	(1,913	)
Taxable securities		550			(987	)		(437	)
Non-taxable securities (2)		549			(187	)		362
Other investments		(16	)		1			(15	)
Interest income		(358	)		(1,645	)		(2,003	)
Interest-bearing deposits		(204	)		(1,199	)		(1,403	)
Short-term borrowings		136			(102	)		34
Long-term obligations		(91	)		(39	)		(130	)
Interest expense		(159	)		(1,340	)		(1,499	)
Net interest income	$	(199	)	$	(305	)	$	(504	)

(1) The combined rate/volume variance for each category has been allocated equally between rate and volume variances.

(2) Yields on tax-exempt investments have been adjusted to a fully taxable-equivalent basis (FTE) using the federal income tax rate of 34%. The taxable equivalent adjustment was $249 thousand and $126 thousand for periods ended June 30, 2012 and 2011, respectively.

44

Provision for Loan Losses

The provision for loan losses charged to operations during both the three and six months ended June 30, 2012 was $0.9 million. The provision for loan losses charged to operations during the three and six months ended June 30, 2011 was $1.3 million and $5.2 million, respectively. The decrease for the three and six-month periods reflects decrease in total loans outstanding, reduced charge-off levels for the six month period, and adjustments for loan loss migrations within the portfolio as previously announced. The Bank had net charge-offs of $1.5 million for the quarter ended June 30, 2012 compared to net charge-offs of $1.1 million during the second quarter of 2011. For the six-month periods ended June 30, 2012 and 2011, the Bank had net charge-offs of $2.2 million and $3.1 million, respectively. We use the results of our allowance for loan loss model to estimate the dollar amount of provision expense needed to maintain the adequacy of our allowance for loan losses. Our management analyzes the adequacy of the allowance on a monthly basis and adjustments to the provision expense are made as necessary. Additional information regarding our allowance for loan losses is contained in this discussion under the caption “Asset Quality.”

Noninterest Income

Noninterest income, principally charges and fees assessed for the use of our services, is a significant contributor to net income. The following table presents the components of noninterest income for the three- and six-month periods ended June 30, 2012 and 2011.

	For the Three  Months Ended June 30, 2012		Changes from the Prior Year						For the Six  Months Ended June 30, 2012		Changes from the Prior Year
			Amount			%					Amount			%
	(Dollars in thousands)
Service charges on deposit accounts	$	945	$	117			14.1		$	1,802	$	209			13.1
Other service charges and fees		518		188			57.0			847		273			47.6
Mortgage origination fees		376		(76	)		(16.8	)		782		4			0.5
Net gain on sale of securities		279		(579	)		(67.5	)		324		(560	)		(63.3	)
Income from bank owned life insurance		102		28			37.8			203		55			37.2
Other operating expense		1		4			(133.3	)		2		9			(128.6	)
Total noninterest income	$	2,221	$	(318	)		(12.5	)	$	3,960	$	(10	)		(0.3	)

Noninterest income decreased $318 thousand or 12.5% to $2.2 million for the second quarter of this year compared to $2.5 million for the same period in 2011. For the six months ended June 30, 2012 noninterest income decreased $10 thousand or 0.3% to $4.0 million compared to $4.0 million for the same period in 2011. The decrease in noninterest income in the second quarter of 2012 as compared to the same quarter of 2011 is primarily due to a decrease in net gain on sale of securities of $579 thousand. The year to date decrease in noninterest income is primarily the result of a decrease in net gains on the sale of securities of $560 thousand which was offset by increases in service charges on deposit accounts and other service charges and fees. Service charges on deposit accounts increased $117 thousand and $209 thousand, respectively, for the three and six months ended June 30, 2012 as compared to the same periods in 2011 mainly due to an increase in cardholder fees. Other service charges and fees increased $188 thousand and $273 thousand, respectively, for the three and six months ended June 30, 2012 as compared to the same periods in 2011. The primary reason for the increase is an increase in merchant processing fees. Mortgage loan origination fees decreased $76 thousand and increased $4 thousand, respectively, for the three and six months ended June 30, 2012 as compared to the same periods in 2011. Income from bank owned life insurance increased $28 thousand and increased $55 thousand, respectively, for the three and six months ended June 30, 2012 as compared to the same periods in 2011 due to the Bank increasing the investment in bank owned life insurance late in 2011.

45

Noninterest Expense

Noninterest expense increased 9.0% and 17.6%, respectively, for the three and six months ended June 30, 2012, as compared to the same periods in 2011. The following table presents the components of noninterest expense for the three and six months ended June 30, 2012 and dollar and percentage changes from the prior year.

	For the Three Months Ended June 30, 2012		Changes from the Prior Year						For the Six Months Ended June 30, 2012		Changes from the Prior Year
			Amount			%					Amount			%
	(Dollars in thousands)
Salaries	$	2,865	$	39			1.4		$	5,784	$	394			7.3
Retirement and other employee benefits		815		31			4.0			1,918		458			31.4
Occupancy		518		(4	)		(0.8	)		1,048		43			4.3
Equipment		603		90			17.5			1,193		121			11.3
Professional fees		343		72			26.6			562		20			3.7
Supplies		41		(37	)		(47.4	)		115		(14	)		(10.9	)
Communications/Data lines		184		(5	)		(2.6	)		382		24			6.7
FDIC deposit insurance		203		2			1.0			407		(120	)		(22.8	)
Other outside services		92		(70	)		(43.2	)		192		(151	)		(44.0	)
Data processing and related expenses		346		263			316.9			742		589			385.0
Net cost of real estate and repossessions acquired in settlement of loans		463		384			486.1			1,147		1,050			1,082.5
Other operating expenses		784		(165	)		(17.4	)		1,685		(140	)		(7.7	)
Total noninterest expenses	$	7,257	$	600			9.0		$	15,175	$	2,274			17.6

Salary expense for the three and six months ended June 30, 2012 increased $39 thousand and $394 thousand, respectively, compared to the same prior year periods. During 2011, we continued to expand the Bank’s infrastructure to support asset growth as outlined in our five-year strategic plan and implemented several initiatives to improve our customer service delivery. While the following initiatives took place in 2011 their full impact was not reflected in the first six months of 2011. A portion of the increase in salary expense can be attributed to the successful implementation of a fully staffed and functioning Customer Care Center that manages various communication channels and contact points for the customer. This allows customers to utilize phone, email, website and online banking to receive immediate responses to questions they have regarding their Bank accounts or other services offered by the Bank. The Customer Care Center is part of the Bank’s continued development of its Customer Experience strategy designed to focus on improving the experience customers have, whether it be interacting with a branch or the many “banking channels” offered to maintain their banking relationship with ECB. We also made staff additions to our Agriculture Lending business unit during 2011 as we continue to expand our presence and expertise to capture attractive lending opportunities within our eastern North Carolina footprint. Expansion of our Bank support infrastructure came in several forms during 2011, the Bank added additional staff in the areas of Information Technology, Risk Management, Asset Review, Human Resources, Training, Marketing and Special Assets. As of June 30, 2012, we had 249 full time equivalent employees and operated 25 full service banking offices and one mortgage loan origination office. As of June 30, 2011, we had 246 full time equivalent employees and operated 25 full service banking offices and one mortgage loan origination office.

Employee related benefits expense for the three and six months ended June 30, 2012 increased $31 thousand and $458 thousand, respectively, compared to the same prior year periods. The increase is associated with the increase in salaries mentioned above and an increase in supplemental employee retirement plan expense, as a result of a change in the discount rate, during the six month period.

Occupancy expense for the three and six months ended June 30, 2012 decreased $4 thousand and increased $43 thousand, respectively, compared to the same prior year periods. The increase for the six month period is related to increase in janitorial services expense.

Equipment expense for the three and six months ended June 30, 2012 increased $90 thousand and $121 thousand, respectively, compared to the same prior year periods. The increases are related to an increase in equipment and software maintenance expense.

Professional fees, which include consulting, audit and legal fees, increased $72 thousand for the three months ended June 30, 2012 compared to the same period of 2011 and increased $20 thousand when compared on a year to date basis to the prior year period. Consulting expense during the second quarter decreased $59 thousand and, on a year to date basis, consulting expense decreased $24 thousand in 2012 when compared to the same period in 2011. Audit and accounting fees in the second quarter of 2012 increased $88 thousand from the prior year period and for the six-month period ended June 30, 2012 audit fees increased $10 thousand over the prior year six-month period. Legal expense during the second quarter of 2012 increased $43 thousand and, on a year to date basis, legal expense increased $34 thousand as of June 30, 2012 when compared to the same period in 2011.

46

FDIC deposit insurance expenses increased $2 thousand for the three months ended June 30, 2012 compared to the three months ended June 30, 2011. For the six-month period ended June 30, 2012, FDIC deposit insurance expense decreased $120 thousand over the six-month period ended June 30, 2011. The decrease for the six-month period was due to a change made by the FDIC in its assessment calculations in 2011.

Other outside services expense for the three and six months ended June 30, 2012 decreased $70 thousand and $151 thousand, respectively, compared to the same prior year periods.

Data processing services expense, which primarily consist of check and deposit item processing, nightly update of loan, deposit and general ledger balances, ATM/ EFT network management and On-line Banking, for the three months ended June 30, 2012 was $346 thousand compared to $83 thousand for the three months ended June 30, 2011. Data processing services expense for the six months ended June 30, 2012 was $742 thousand compared to $153 thousand for the six months ended June 30, 2011. In May of 2011, the Bank outsourced all of its core bank data processing under agreement with InfoTech Alliance Bank Services (“ITA”) using the FIS integrated HORIZON banking system. Prior to the core system conversion in May, the Bank only outsourced its item processing through ITA while maintaining an in-house core processing system, ATM/EFT network and On-line Banking package. During the three and six month periods ending June 30, 2011, expense related to our On-line Banking totaled approximately $84 thousand and $139 thousand, respectively, and was included in Other Outside Services. Our second quarter 2011 and year-to-date expense as of June 30, 2011 for our ATM/EFT network management totaled approximately $66 thousand and $132 thousand, respectively, and was included in Other Operating Expense. In addition, the Bank implemented a number of ancillary systems including an advanced data reporting interface, customer relationship management system, fraud monitoring system, teller system, and real-time online banking among others. These additional systems also added to the increase in data processing services expense in the three and six month periods ending June 30, 2012 when compared to 2011.

Net cost of real estate and repossessions acquired in the settlement of loans expense for the three and six months ended June 30, 2012 increased $0.4 million and $1.1million compared to the same prior year period. The increases are mainly attributable to impairments of real estate.

Income Taxes

Income tax expense for the three months ended June 30, 2012 and 2011 was $168 thousand and $509 thousand, respectively, resulting in effective tax rates of 22.2% and 30.8%, respectively. For the six-month period ending June 30, 2012, there was a tax expense of $140 thousand compared to an income tax benefit of $382 thousand for the same period of 2011, which resulted in effective tax rates of 12.7% and 119.0%, respectively.

Deferred tax assets are recognized for temporary deductible differences and operating loss and tax credit carryforwards. A valuation allowance is established when it is more likely than not that all or some portion of the deferred tax asset will not be realized. Evaluating the need for and amount of a valuation allowance requires judgment and analysis of the positive and negative evidence. Included in our analysis, which receives significant weight, is the 3-year cumulative loss test. The cumulative loss test calculates the cumulative pre-tax income (loss) over the preceding twelve quarter period. If the Company is in a cumulative loss position, management performs an evaluation of the positive and negative evidence to determine whether a valuation allowance is necessary. As of June 30, 2012, the Company did not pass the cumulative loss test by $2.9 million. Management has evaluated, among other factors, projected future earnings, credit quality trends, taxable temporary differences and the cause and probability of recurrence of those circumstances leading to current taxable losses in evaluating the need for a valuation allowance.

As of June 30, 2012, our recorded net deferred tax asset was $6.8 million and at this time management has concluded that the net deferred tax asset is fully realizable. The Company will continue to monitor deferred tax assets closely to evaluate whether we will be able to realize the full benefit of our net deferred tax asset and need for valuation allowance. Significant negative trends in credit quality, losses from operations, or significant deviations from forecasted future financial results could impact our ability to realize the deferred tax asset in the future.

Financial Condition

Balance Sheet

Our total assets were $944.3 million at June 30, 2012, $921.3 million at December 31, 2011 and $941.5 million at June 30, 2011. Short-term borrowing growth funded our year-over-year asset growth. For the twelve months ended June 30, 2012, our loans declined $36.4 million or 6.7% while our deposits declined by approximately $17.3 million or 2.1%. Year-over-year, our earning assets declined by $9.1 million primarily through reductions in loans and overnight investment which were offset by additions to our available-for-sale investment securities portfolio. For the six months ended June 30, 2012, our loans outstanding increased $9.7 million and deposits decreased by $2.2 million.

47

Loans

As of June 30, 2012, total loans were $506.3 million, up 2.0% from total loans of $496.5 million at December 31, 2011 and down 6.7% from total loans of $542.7 million at June 30, 2011. The decline in loans year-over-year and the limited growth for the six months ending June 30, 2012 can be attributed to continued weak economic conditions. Loans as of June 30, 2012 were up $14.9 million or 3.0% compared to March 31, 2012 which is attributed to an increase of $15.1 in loans to finance agricultural production.

Asset Quality

At June 30, 2012, our allowance for loan losses as a percentage of loans was 2.13%, down from 2.85% at June 30, 2011 and 2.44% at December 31, 2011. The decrease can be attributable to a significant decline in the outstanding balance of construction and land development loans. Additionally, the overall risk grade of the remaining loans within these segments has improved. Given the significance of historical loss rates attributable to these loan segments, the declining loan balances and improved average risk grades had a substantial impact on our general reserves. Also, growth in loans during the second quarter of 2012 was driven by an increase in loans to finance agriculture production which have 0% loss rates over the last two years. In evaluating the allowance for loan losses, we prepare an analysis of our current loan portfolio through the use of historical loss rates, homogeneous risk analysis grouping to include probabilities for loss in each group by risk grade, estimation of years to impairment in each homogeneous grouping, analysis of internal credit processes, past due loan portfolio performance and overall economic conditions, both regionally and nationally.

Historical loss calculations for each homogeneous risk group are based on a three year average loss ratio calculation with the most recent quarter’s loss history included in the model. The impact is to more quickly recognize and increase the loss history in a respective grouping. For those groups with little or no loss history, management increases the historical factor through a positive adjustment to more accurately represent current economic conditions and their potential impact on that particular loan group.

48

Homogeneous loan groups are assigned risk factors based on their perceived loss potential, current economic conditions and on their respective risk ratings. The probability of loss is increased as the risk grade increases within each risk grouping to more accurately reflect the Bank’s exposure in that particular group of loans. The Bank utilizes a system of eight possible risk ratings. The risk ratings are established based on perceived probability of loss. Most loans risk rated “substandard”, “doubtful” and “loss” are removed from their homogeneous group and individually analyzed for impairment. Some smaller loans risk rated “substandard”, “doubtful” and “loss” with balances less than $100 thousand are not removed from their homogeneous group and individually analyzed for impairment. Other groups of loans based on loan size may be selected for impairment review. Loans are considered impaired if, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans is based on either the fair value of the underlying collateral, the present value of the future cash flows discounted at the historical effective interest rate stipulated in the loan agreement, or the estimated market value of the loan. In measuring the fair value of the collateral, management uses a comparison to the recent selling price of similar assets, which is consistent with those that would be utilized by unrelated third parties.

A portion of the Bank’s allowance for loan losses is not allocated to any specific category of loans. This general portion of the allowance reflects the elements of imprecision and estimation risk inherent in the calculation of the overall allowance. Due to the subjectivity involved in determining the overall allowance, including the portion determined through general qualitative and quantitative internal and external factors, the general portion may fluctuate from period to period based on management’s evaluation of the factors affecting the assumptions used in calculating the allowance, including historical loss experience, current and expected economic conditions and geographic conditions. While we believe that our management uses the best information available to determine the allowance for loan losses, unforeseen market conditions could result in adjustments to the allowance for loan losses, and net income could be significantly affected, if circumstances differ substantially from the assumptions used in making the final determination. Because these factors and management’s assumptions are subject to change, the allocation is not necessarily indicative of future loan portfolio performance.

Unsecured loans are charged-off in full against the Bank’s allowance for loan losses as soon as the loan becomes uncollectible. Unsecured loans are considered uncollectible when no regularly scheduled monthly payment has been made within three months, the loan matured over 90 days ago and has not been renewed or extended or the borrower files for bankruptcy. Secured loans are considered uncollectible when the liquidation of collateral is deemed to be the most likely source of repayment. Once secured loans reach 90 days past due, they are placed into non-accrual status. If the loan is deemed to be collateral dependent, the principal balance is written down immediately to reflect the current market valuation based on current independent appraisal. Included in the write-down is the estimated expense to liquidate the property and typically an additional allowance for the foreclosure discount.

49

Net charge-offs for the first six months of 2012 totaled $2.2 million compared to net charge-offs of $3.0 million during the first six months of 2011. The provision for loan losses charged to operations for the six months ended June 30, 2012 and 2011 was $0.9 million and $5.2 million, respectively. The following table presents an analysis of the changes in the allowance for loan losses for the six months ended June 30, 2012 and 2011.

Analysis of Changes in Allowance for Loan Losses

	For the six months Ended June 30,
	2012			2011
	(Dollars in thousands)
Total loans outstanding at end of period-gross	$	506,257		$	542,687
Average loans outstanding-gross	$	494,162		$	551,356
Allowance for loan losses at beginning of period	$	12,092		$	13,247
Loans charged off:
Real estate		(2,083	)		(2,664	)
Installment loans		(43	)		(15	)
Credit cards and related plans		(17	)		(9	)
Demand deposit overdraft program		(99	)		(92	)
Commercial and all other loans		(421	)		(368	)
Total charge-offs		(2,663	)		(3,148	)
Recoveries of loans previously charged off:
Real estate		386			8
Installment loans		13			2
Credit cards and related plans		3			1
Demand deposit overdraft program		71			57
Commercial and all other loans		12			78
Total recoveries		485			146
Net charge offs		(2,178	)		(3,002	)
Provision for loan losses		866			5,203
Allowance for loan losses at end of period	$	10,780		$	15,448

	For the six months Ended June 30,
	2012			2011
Ratios
Annualized net charge offs to average loans during the period		0.88	%		1.09	%
Allowance for loan losses to loans at period end		2.13	%		2.85	%
Allowance for loan losses to nonperforming loans at period end		38	%		61	%
Allowance for loan losses to impaired loans at period end		33.4	%		49.3	%

The ratio of annualized net charge-offs to average loans decreased to 0.88% at June 30, 2012 from 1.09% at June 30, 2011 mainly due to a decrease in real estate related charge-offs. The decrease in the allowance for loan losses to loans to 2.13% at June 30, 2012 from 2.85% at June 30, 2011 reflects the decrease in our historical loss rate as our charge-offs have decreased during the most recent six months ending June 30, 2012. The ratio of our allowance for loan losses to nonperforming loans decreased to 38% as of June 30, 2012 compared to 61% as of June 30, 2011.

This reduction in percent of reserve to non- performing loans resulted from a general improvement of loan quality and the resulting reduction in loan loss reserves that we felt were prudent based on our evaluation of the loan portfolio. The portion of loan reserves represented by the general portion of our loan portfolio reserves contracted from June 30, 2011 to June 30, 2012. This reduction was the direct result of a decline in Classified and Special Mention loans during the twelve month period ended June 30, 2012. Furthermore, the loan portfolio contracted over the twelve months ended June 30, 2012; however the agricultural segment of the portfolio grew. The agricultural segment of our loan portfolio has historically shown a very low charge off history versus other segments of credit in the portfolio. This growth in our strongest segment in the portfolio also contributed to the lower percentage of reserve indicated for our general reserve allowance.

As we have indicated in past discussions we are constantly reviewing and analyzing our assumptions for qualitative calculations related to our general reserve calculations. In the course of these reviews during the last several quarters we have modified some of the time frames the model uses in estimating probable losses from the credit quality migration. In the second quarter we made two adjustments to slightly shorten the loan loss migration periods which our model uses to estimate probable losses. These adjustments also had the effect of slightly reducing the general portion of reserves required in our loan loss reserve.

Construction, land and development (“CLD”) loans made up 12.4% of the Bank’s loan portfolio as of June 30, 2012 down from 15.5% as of June 30, 2011. This sector of the economy has been particularly impacted by declines in housing activity, and has had a disproportionate impact on the credit quality of the Bank. The tables below show trends of CLD loans, along with ratios relating to their relative credit quality for June 30, 2012 and June 30, 2011.

50

	CLD Loans						All Other Loans						Total
	Balance			% of Total			Balance			% of Total			Loans
	(Dollars in thousands)
Balances at June 30, 2012	$	62,944			12.4	%	$	443,313			87.6	%	$	506,257
Impaired loans		8,797			27.3	%		23,480			72.7	%		32,277
Allocated Reserves		3,255			42.2	%		4,462			57.8	%		7,717
YTD Net Charge-offs		576			26.4	%		1,602			73.6	%		2,178
Nonperforming loans (NPL)		7,513			26.2	%		21,130			73.8	%		28,643
NPL as % of loans		11.9	%					4.8	%					5.7	%

While balances of CLD loans make up 12.4% of the Bank’s loan portfolio at June 30, 2012, they represent 27.3% and 26.4% of the Bank’s impaired loans and YTD net charge-offs, respectively. CLD loans represent 26.2% of the Bank’s nonperforming loans and 42.2% of the Bank’s allocated reserves are allocated to CLD loans on June 30, 2012.

	CLD Loans						All Other Loans						Total
	Balance			% of Total			Balance			% of Total			Loans
	(Dollars in thousands)
Balances at June 30, 2011	$	84,291			15.5	%	$	458,396			84.5	%	$	542,687
Impaired loans		16,331			52.2	%		14,981			47.8	%		31,312
Allocated Reserves		7,466			53.7	%		6,434			46.3	%		13,900
YTD Net Charge-offs		1,911			63.7	%		1,091			36.3	%		3,002
Nonperforming loans (NPL)		12,415			49.2	%		12,801			50.8	%		25,216
NPL as % of loans		14.7	%					2.8	%					4.6	%

While balances of CLD loans made up 15.5% of the Bank’s loan portfolio at June 30, 2011, they represented 52.2% and 63.7% of the Bank’s impaired loans and YTD net charge-offs, respectively. CLD loans represented 49.2% of the Bank’s nonperforming loans and 53.7% of the Bank’s allocated reserves were allocated to CLD loans on June 30, 2011.

Nonperforming Assets

The following table summarizes our nonperforming assets and past due loans at the dates indicated.

	June 30, 2012		December 31, 2011
	(Dollars in thousands)
Non-accrual loans	$	18,204	$	15,973
Loans past due 90 days or more still accruing		—		—
Restructured loans		10,439		9,596
Other real estate owned & repossessions		7,661		6,573
Other nonperforming assets (1)		1,427		1,427
Total	$	37,731	$	33,569

(1) The other nonperforming asset of $1.4 million represents the movement of a foreclosed participation loan into a separate LLC for liability purposes. It is a single purpose LLC set up specifically by the lending group to handle the disposition of the property. Proper approvals for this arrangement had to be obtained in advance from the NC Commissioner of Banks.

Nonperforming assets consist of loans not accruing interest, loans past due ninety days and still accruing interest, restructured debt and real estate acquired in settlement of loans and other repossessed collateral. It is our policy to place loans on non-accrual status when any portion of principal or interest becomes 90 days past due, or earlier if full collection of principal and interest becomes doubtful. When loans are placed on nonaccrual status, interest receivable is reversed against interest income in the current period. Interest payments received thereafter are applied as a reduction to the remaining principal balance so long as doubt exists as to the ultimate collection of the principal. Loans are removed from nonaccrual status when they become current as to both principal and interest and when the collectability of principal or interest is no longer doubtful. Nonperforming assets were $37.7 million and $33.6 million, or 4.00% and 3.64% of total assets at June 30, 2012 and December 31, 2011, respectively. On June 30, 2012 and

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December 31, 2011 our nonperforming loans (consisting of non-accruing loans, loans past due ninety days and still accruing interest and restructured loans) amounted to approximately $28.6 million and $25.6 million, respectively. We had $7.7 million in other real estate owned and repossessions at June 30, 2012 compared to $6.6 million at December 31, 2011. We also had $1.4 million in other nonperforming assets at both June 30, 2012 and December 31, 2011 as described above.

Loans Considered Impaired

We review our nonperforming loans and other groups of loans based on loan size or other factors for impairment. At June 30, 2012, we had loans totaling $32.3 million (which includes $27.6 million in nonperforming loans) which were considered to be impaired compared to $31.3 million at December 31, 2011. As discussed under the caption Asset Quality, loans are considered impaired if, based on current information, circumstances or events, it is probable that the Bank will not collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. However, treating a loan as impaired does not necessarily mean that we expect to incur a loss on that loan, and our impaired loans include loans that currently are performing in accordance with their terms. For example, if we believe it is probable that a loan will be collected, but not according to its original agreed upon payment schedule, we may treat that loan as impaired even though we expect that the loan will be repaid or collected in full. As indicated in the table below, when we believe a loss is probable on a non-collateral dependent impaired loan, a portion of our reserve is allocated to that probable loss. If the loan is deemed to be collateral dependent, the principal balance is written down immediately to reflect the current market valuation based on a current independent appraisal.

The following table sets forth the number and volume of loans, net of previous charge-offs, that were considered impaired, and their associated reserve allocation, if any, at June 30, 2012. Twenty-six non-accrual loans with a total balance of approximately $888 thousand and three restructured loans with a balance of $111 thousand were not removed from their homogeneous group and individually analyzed for impairment because their individual loan balances were less than $100 thousand.

	Number of Loans		Loan Balances Outstanding		Allocated Reserves
	(Dollars in millions)
Non-accrual loans		43	$	17.3	$	0.5
Restructured loans		18		10.3		0.8
Total nonperforming loans		61	$	27.6	$	1.3
Other impaired loans with allocated reserves		9		3.1		0.1
Other impaired loans without allocated reserves		4		1.6		—
Total impaired loans		74	$	32.3	$	1.4

Investment Securities and Other Assets

The composition of our securities portfolio reflects our investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of income. Our securities portfolio also provides a balance to interest rate risk and credit risk in other categories of the balance sheet while providing a vehicle for investing available funds, furnishing liquidity and supplying securities to pledge as required collateral for certain deposits and borrowed funds. We use two categories to classify our securities: “held-to-maturity” and “available-for-sale.” Currently, none of our investments are classified as held-to-maturity. While we have no plans to liquidate a significant amount of our securities, the securities classified as available-for-sale may be sold to meet liquidity needs should management deem it to be in our best interest.

Our investment securities totaled $350.8 million at June 30, 2012, $339.5 million at December 31, 2011 and $298.1 million at June 30, 2011. Additions to the investment securities portfolio depend to a large extent on the availability of investable funds that are not otherwise needed to satisfy loan demand. Investable funds not otherwise utilized are temporarily invested as federal funds sold or as interest-bearing balances at other banks, the level of which is affected by such considerations as near-term loan demand and liquidity needs.

At June 30, 2012, the securities portfolio had unrealized net gains of approximately $4.5 million, which are reported in accumulated other comprehensive income on the consolidated statement of changes in shareholders’ equity, net of tax. Our securities portfolio at June 30, 2012 consisted of U.S. government sponsored agencies, collateralized mortgage obligations (CMOs), mortgage-backed securities (MBS), corporate bonds and municipal securities.

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We currently have the ability to hold our available-for-sale investment securities to maturity. However, should conditions change, we may sell unpledged securities. We consider the overall quality of the securities portfolio to be high. As of June 30, 2012, we owned securities from issuers in which the aggregate amortized cost from such issuers exceeded 10% of our common shareholders’ equity. As of June 30, 2012 the amortized cost and market value of the securities from such issuers were as follows:

	Amortized Cost		Fair Value
	(Dollars in thousands)
Federal National Mortgage Corporation	$	84,191	$	85,272
Federal Home Loan Mortgage Corporation		31,664		31,933
Government National Mortgage Association		15,314		15,594
Goldman Sachs Group		7,339		7,172
Morgan Stanley		8,372		8,017
North Carolina		8,839		8,977
Small Business Administration		137,445		139,602
Wake County, North Carolina		8,200		8,325

At June 30, 2012, we held $12.0 million in bank owned life insurance, compared to $11.8 million and $9.1 million at December 31, 2011 and June 30, 2011, respectively.

Deposits and Other Borrowings

Deposits

Deposits totaled $795.5 million as of June 30, 2012 compared to deposits of $797.6 million at December 31, 2011 and down 2.1% compared to deposits of $812.8 million at June 30, 2011. We attribute our deposit decline during the twelve months ended June 30, 2012 to allowing higher priced Time deposits to roll off while focusing on core transaction accounts. We believe that we can improve our core deposit funding by improving our branching network and providing more convenient opportunities for customers to bank with us.

Other Borrowings

Short-term borrowings include sweep accounts and advances from the Federal Home Loan Bank of Atlanta (the “FHLB”) having maturities of one year or less. Our short-term borrowings totaled $42.1 million at June 30, 2012, compared to $11.7 million on December 31, 2011, a net increase of $30.4 million. The increase is mainly the result of management’s decision to allow higher priced time deposits to roll off without being replaced.

The following table details the maturities and rates of our borrowings from the FHLB, as of June 30, 2012

Borrow Date	Type	Principal		Term	Rate	Maturity
(Dollars in thousands)
March 12, 2008	Fixed rate		7,500	5 years	3.54	March 12, 2013
August 17, 2010	Fixed rate		3,000	4 years	1.49	August 18, 2014
August 17, 2010	Fixed rate		4,500	5 years	1.85	August 17, 2015
August 17, 2010	Fixed rate		2,500	6 years	2.21	August 17, 2016
August 20, 2010	Fixed rate		2,000	3 years	1.09	August 20, 2013
August 20, 2010	Fixed rate		3,000	4 years	1.48	August 20, 2014
August 20, 2010	Fixed rate		3,000	5 years	1.83	August 20, 2015
September 1, 2010	Fixed rate		2,000	2 years	0.66	September 4, 2012
June 11, 2012	Fixed rate		21,000	1 month	0.22	July 11, 2012
June 29, 2012	Fixed rate		7,000	1 year	0.38	June 28, 2013

Total Borrowings: $ 55,500             Composite rate: 1.18%

Long-Term Obligations

Long-term obligations consist of advances from FHLB with maturities greater than one year. Our long-term borrowing from the FHLB totaled $18.0 million on June 30, 2012, compared to $25.5 million in FHLB advances on December 31, 2011 and $27.5 million on June 30, 2011. The decrease of $7.5 million in long-term FHLB advances as of June 30, 2012, compared to December 31, 2011 is the result of FHLB advances being reclassed to short-term borrowing because the current time to maturity is less than a year.

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Liquidity

Liquidity refers to our continuing ability to meet deposit withdrawals, fund loan and capital expenditure commitments, maintain reserve requirements, pay operating expenses and provide funds for payment of dividends, debt service and other operational requirements. Liquidity is immediately available from five major sources: (a) cash on hand and on deposit at other banks; (b) the outstanding balance of federal funds sold; (c) lines for the purchase of federal funds from other banks; (d) lines of credit established at the FHLB, less existing advances; and (e) our investment securities portfolio. All our debt securities are of investment grade quality and, if the need arises, can be promptly liquidated on the open market or pledged as collateral for short-term borrowing.

Consistent with our general approach to liquidity management, loans and other assets of the Bank are funded primarily using local core deposits, retail repurchase agreements and the Bank’s capital position. To date, these core funds, supplemented by FHLB advances, institutional deposits obtained through the internet and brokered deposits, have been adequate to fund loan demand in our market areas, while maintaining the desired level of immediate liquidity and an investment securities portfolio available for both immediate and secondary liquidity purposes. It is anticipated that funding sources in the future will include continued use of brokered deposits and institutional deposits obtained through the Internet.

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We are a member of the FHLB. Membership, along with a blanket collateral commitment of our one-to-four family residential mortgage loan portfolio, as well as our commercial real estate loan portfolio, provided us the ability to draw up to $188.9 million, $184.3 million and $188.3 million of advances from the FHLB at June 30, 2012, December 31, 2011 and June 30, 2011, respectively. At June 30, 2012, we had outstanding FHLB advances totaling $53.5 million compared to $34.5 million and $36.0 million at December 31, 2011 and June 30, 2011, respectively.

As a requirement for membership, we invest in stock of the FHLB in the amount of 1% of our outstanding residential loans or 5% of our outstanding advances from the FHLB, whichever is greater. That stock is pledged as collateral for any FHLB advances drawn by us. At June 30, 2012, we owned 38,991 shares of the FHLB’s $100 par value capital stock, compared to 34,558 and 40,320 shares at December 31, 2011 and June 30, 2011, respectively. No ready market exists for such stock, which is carried at cost.

We also had unsecured federal funds lines in the aggregate amount of $36.0 million available to us at June 30, 2012 under which we can borrow funds to meet short-term liquidity needs. At June 30, 2012, we had no borrowings outstanding under these federal funds lines. Another source of funding is loan participations sold to other commercial banks (in which we retain the servicing rights). We believe that our liquidity sources are adequate to meet our operating needs.

Net cash provided by operations during the six months ended June 30, 2012 totaled $4.2 million, compared to net cash provided by operations of $9.5 million for the same period in 2011. Net cash used in investing activities increased to $24.6 million for the six months ended June 30, 2012, as compared to $2.9 million for the same period in 2011. Net cash provided by financing activities was $20.3 million for the first half of 2012, compared to net cash provided of $21.4 million for the same period in 2011. Cash and cash equivalents at June 30, 2012 were $24.6 million compared to $48.2 million at June 30, 2011.

As discussed in Note 11, during April 2011, the Bank’s Board of Directors adopted a resolution at the request of the Federal Deposit Insurance Corporation to the effect that, among other things, the Bank will not pay any cash dividend to us without the approval of the FDIC and N.C. Commissioner of Banks. Dividends we receive from the Bank are our primary source of funds with which we can pay dividends on our outstanding common and preferred stock. As a result, if the Bank’s regulators declined to permit the Bank to dividend funds to us, we would be unable to pay dividends on our common and preferred stock.

Capital Resources

Shareholders’ Equity

As of June 30, 2012, our total shareholders’ equity was $83.3 million (consisting of common shareholders’ equity of $65.7 million and preferred stock of $17.5 million) compared with total shareholders’ equity of $80.4 million as of December 31, 2011 (consisting of common shareholders’ equity of $62.9 million and preferred stock of $17.5 million). Common shareholders’ equity increased by approximately $2.8 million to $65.7 million at June 30, 2012 from $62.9 million at December 31, 2011. We generated net income of $1.0 million, experienced an increase in net unrealized gains on available-for-sale securities of $2.3 million, and recognized stock based compensation benefit of $16 thousand on incentive stock awards. We declared dividends and accretion of discount of $531 thousand on preferred shares during the first six months of 2012.

We are subject to various regulatory capital requirements administered by our federal banking regulators. Failure to meet minimum capital requirements can result in certain mandatory and possibly additional discretionary actions by these regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines involving quantitative measures of our assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Our capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by the FDIC to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of Total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to average assets (each as defined in the regulations). As a bank holding company, we also are subject, on a consolidated basis, to the capital adequacy guidelines of the Federal Reserve Board. The capital requirements of the Federal Reserve Board are similar to those of the FDIC governing the Bank. As of June 30, 2012, we and the Bank met all capital adequacy requirements to which we are subject.

As of June 30, 2012, we experienced a decrease in our capital ratios when compared to the periods ending December 31, 2011 and June 30, 2011. This decrease is primarily due to an increase in our risk weighted assets when compared to the December 31, 2011 period and primarily due to a decrease in Tier 1 capital when compared to the June 30, 2011 period.

Based on the most recent notification from the FDIC, the Bank is well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table below. There are no conditions or events since that notification that management believes have changed the Bank’s category.

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Our and the Bank’s actual capital ratios are presented in the following table:

	Ratio required to be well capitalized under prompt corrective action provisions			Minimum ratio required for capital adequacy purposes			Our Ratio			Bank’s Ratio
As of June 30, 2012:
Tier 1 Capital (to Average Assets)	³	5.00	%	³	3.00	%		8.25	%		8.25	%
Tier 1 Capital (to Risk Weighted Assets)	³	6.00	%	³	4.00	%		12.09			12.09
Total Capital (to Risk Weighted Assets)	³	10.00	%	³	8.00	%		13.35			13.35
As of December 31, 2011:
Tier 1 Capital (to Average Assets)	³	5.00	%	³	3.00	%		8.25	%		8.25	%
Tier 1 Capital (to Risk Weighted Assets)	³	6.00	%	³	4.00	%		12.59			12.59
Total Capital (to Risk Weighted Assets)	³	10.00	%	³	8.00	%		13.85			13.85
As of June 30, 2011:
Tier 1 Capital (to Average Assets)	³	5.00	%	³	3.00	%		8.39	%		8.39	%
Tier 1 Capital (to Risk Weighted Assets)	³	6.00	%	³	4.00	%		12.20			12.20
Total Capital (to Risk Weighted Assets)	³	10.00	%	³	8.00	%		13.46			13.46

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market risk reflects the risk of economic loss resulting from adverse changes in market price and interest rates. This risk of loss can be reflected in diminished current market values and/or reduced potential net interest income in future periods.

Our market risk arises primarily from interest rate risk inherent in its lending and deposit-taking activities. The structure of our loan and deposit portfolios is such that a significant decline in interest rates may adversely impact net market values and net interest income. We do not maintain a trading account nor are we subject to currency exchange risk or commodity price risk. Interest rate risk is monitored as part of our asset/liability management function.

Management does not believe there has been any significant change in the overall analysis of financial instruments considered market risk sensitive, as measured by the factors of contractual maturities, average interest rates and estimated fair values, since the analysis prepared and presented in conjunction with the Form 10-K Annual Report for the fiscal year ended December 31, 2011.

Item 4. Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures in accordance with Rule 13a-15 of the Securities Exchange Act of 1934 (the “Exchange Act”). Based on their evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective to provide reasonable assurance that we are able to record, process, summarize and report in a timely manner the information required to be disclosed in reports we file under the Exchange Act.

We review our disclosure controls and procedures, including our internal control over financial reporting, on an ongoing basis and may from time to time make changes aimed at enhancing their effectiveness. In connection with the above evaluation of our disclosure controls and procedures, no change in our internal control over financial reporting was identified that occurred during the quarterly period ended June 30, 2012, and that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

None.

Item 1A. Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2011, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K above are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Item 5. Other Information

None.

Item 6. Exhibits

An Exhibit Index listing exhibits that are being filed or furnished with, or incorporated by reference into, this Report appears immediately following the signature page and is incorporated herein by reference.

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SIGNATURES

In accordance with the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	ECB BANCORP, INC. (Registrant)
Date: August 14, 2012	By:	/s/    A. Dwight Utz
		A. Dwight Utz
		(President & CEO)
Date: August 14, 2012	By:	/s/    Thomas M. Crowder
		Thomas M. Crowder
		(Executive Vice President & CFO)

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EXHIBIT INDEX

Exhibit Number	Description
10.01	Amended ECB Bancorp, Inc. 2008 Omnibus Equity Plan*
31.01	Certification of Chief Executive Officer required by Rule 13a-14(a) (furnished herewith)
31.02	Certification of Chief Financial Officer required by Rule 13a-14(a) (furnished herewith)
32.01	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 (furnished herewith)
32.02	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 (furnished herewith)
101.0	The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2012, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Results of Operations, (iii) the Consolidated Statements of Comprehensive Income (Loss); (iv) the Consolidated Statement of Changes in Shareholders’ Equity, (v) the Consolidated Statements of Cash Flows and (vi) the Notes to the Consolidated Financial Statements. **

* Management contract or compensatory plan, contract or arrangement.

** Furnished, not filed.

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