10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended: December 31, 2012

Peoples Bancorp of North Carolina, Inc.

(Exact Name of Registrant as Specified in Its Charter)

North Carolina

(State or Other Jurisdiction of Incorporation)

000-27205	56-2132396
(Commission File No.)	(IRS Employer Identification No.)

518 West C Street, Newton, North Carolina	28658
(Address of Principal Executive Offices)	(Zip Code)

(828) 464-5620

(Registrant’s Telephone Number, Including Area Code)

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

Securities Registered Pursuant to Section 12(g) of the Act:

Common Stock, no par value

(title of class)

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

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

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

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 (§ 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 þ   No o

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.

Large Accelerated FileroAccelerated FileroNon-Accelerated FileroSmaller Reporting Companyþ

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

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked prices of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter. $34,030,624 based on the closing price of such common stock on June 30, 2012, which was $7.95 per share.

Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date.

5,613,495 shares of common stock, outstanding at February 28, 2013.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Annual Report of Peoples Bancorp of North Carolina, Inc. for the year ended December 31, 2012 (the “Annual Report”), which will be included as Appendix A to the Proxy Statement for the 2013 Annual Meeting of Shareholders, are incorporated by reference into Part I and Part II and included as Exhibit 13 to the Form 10-K.

Portions of the Proxy Statement for the 2013 Annual Meeting of Shareholders of Peoples Bancorp of North Carolina, Inc. to be held on May 2, 2013 (the “Proxy Statement”), are incorporated by reference into Part III.

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

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PEOPLES BANCORP OF NORTH CAROLINA, INC

FORM 10-K CROSS REFERENCE INDEX

		2012 Form 10-K	Notice of 2013 Annual Meeting, Proxy Statement and Annual Report
		Page	Page
PART I
Item 1 -	Business	4 - 12	N/A
Item 1A -	Risk Factors	12 - 20	N/A
Item 1B -	Unresolved Staff Comments	20	N/A
Item 2 -	Properties	21	N/A
Item 3 -	Legal Proceedings	21	N/A
Item 4 -	Mine Safety Disclosures	21	N/A
PART II
Item 5 -	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	22 - 24	N/A
Item 6 -	Selected Financial Data	24	A-3
Item 7 -	Management’s Discussion and Analysis of Financial Condition and Results of Operations	24	A-4 - A-27
Item 7A -	Quantitative and Qualitative Disclosures About Market Risk	25	A-26 - A-27
Item 8 -	Financial Statements and Supplementary Data	25	A-28 - A-64
Item 9 -	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	25	N/A
Item 9A -	Controls and Procedures	25	N/A
Item 9B -	Other Information	26	N/A
PART III
Item 10 -	Directors and Executive Officers and Corporate Governance	26	A-65
Item 11 -	Executive Compensation	26	20 - 27
Item 12 -	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	27 - 27	5 - 7
Item 13 -	Certain Relationships and Related Transactions and Director Independence	27	27 - 28
Item 14 -	Principal Accountant Fees and Services	27	29 - 30
PART IV
Item 15 -	Exhibits and Financial Statement Schedules	28 -  31	N/A
Signatures		32	N/A

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PART I

ITEM 1.  BUSINESS

General

Peoples Bancorp of North Carolina, Inc. (the “Company”), was formed in 1999 to serve as the holding company for Peoples Bank (the “Bank”). The Company is a bank holding company registered with the Board of Governors of the Federal Reserve System (the “Federal Reserve”) under the Bank Holding Company Act of 1956, as amended (the “BHCA”).  The Company’s principal source of income is dividends declared and paid by the Bank on its capital stock, if any. The Company has no operations and conducts no business of its own other than owning the Bank and Community Bank Real Estate Solutions, LLC (“CBRES”). Accordingly, the discussion of the business which follows concerns the business conducted by the Bank, unless otherwise indicated.

The Bank, founded in 1912, is a state-chartered commercial bank serving the citizens and business interests of the Catawba Valley and surrounding communities through 22 banking offices located in Lincolnton, Newton, Denver, Catawba, Conover, Maiden, Claremont, Hiddenite, Hickory, Charlotte, Monroe, Cornelius, Mooresville and Raleigh, North Carolina. The Bank also operates a loan production office in Denver, North Carolina. At December 31, 2012, the Company had total assets of $1.0 billion, net loans of $605.6 million, deposits of $781.5 million, total securities of $303.4 million, and shareholders’ equity of $97.7 million.

The Bank operates four offices focused on the Latino population under the name Banco de la Gente (“Banco”). These offices are operated as a division of the Bank. Banco offers normal and customary banking services as are offered in the Bank’s other branches such as the taking of deposits and the making of loans and therefore is not considered a reportable segment of the Company.

The Bank has a diversified loan portfolio, with no foreign loans and few agricultural loans.  Real estate loans are predominately variable rate commercial property loans, which include residential development loans to commercial customers. Commercial loans are spread throughout a variety of industries with no one particular industry or group of related industries accounting for a significant portion of the commercial loan portfolio. The majority of the Bank’s deposit and loan customers are individuals and small to medium-sized businesses located in the Bank’s market area. The Bank’s loan portfolio also includes Individual Taxpayer Identification Number (ITIN) mortgage loans generated thorough the Bank’s Banco offices.  Additional discussion of the Bank’s loan portfolio and sources of funds for loans can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” on pages A-4 through A-27 of the Annual Report, which is included in this Form 10-K as Exhibit (13).

The operations of the Bank and depository institutions in general are significantly influenced by general economic conditions and by related monetary and fiscal policies of depository institution regulatory agencies, including the Federal Reserve, the Federal Deposit Insurance Corporation (the “FDIC”) and the North Carolina Commissioner of Banks (the “Commissioner”).

The Company’s fiscal year ends December 31. This Form 10-K is also being used as the Bank’s Annual Disclosure Statement under FDIC Regulations. This Form 10-K has not been reviewed, or confirmed for accuracy or relevance by the FDIC.

At December 31, 2012, the Company employed 247 full-time employees and 38 part-time employees, which equated to 273 full-time equivalent employees.

Subsidiaries

The Bank is a subsidiary of the Company. The Bank has two subsidiaries, Peoples Investment Services, Inc. and Real Estate Advisory Services, Inc. Through a relationship with Raymond James Financial Services, Inc., Peoples Investment Services, Inc. provides the Bank’s customers access to investment counseling and non-deposit investment products such as stocks, bonds, mutual funds, tax deferred annuities, and related brokerage services. Real Estate Advisory Services, Inc. provides real estate appraisal and real estate brokerage services.

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In June 2006, the Company formed a wholly owned Delaware statutory trust, PEBK Capital Trust II (“PEBK Trust II”), which issued $20.0 million of guaranteed preferred beneficial interests in the Company’s junior subordinated deferrable interest debentures.  All of the common securities of PEBK Trust II are owned by the Company. The proceeds from the issuance of the common securities and the trust preferred securities were used by PEBK Trust II to purchase $20.6 million of junior subordinated debentures of the Company, which pay a floating rate equal to three-month LIBOR plus 163 basis points. The proceeds received by the Company from the sale of the junior subordinated debentures were used in December 2006 to repay the trust preferred securities issued in December 2001 by PEBK Capital Trust, a wholly owned Delaware statutory trust of the Company, and for general purposes. The debentures represent the sole asset of PEBK Trust II.  PEBK Trust II is not included in the consolidated financial statements.

The trust preferred securities issued by PEBK Trust II accrue and pay quarterly at a floating rate of three-month LIBOR plus 163 basis points. The Company has guaranteed distributions and other payments due on the trust preferred securities to the extent PEBK Trust II does not have funds with which to make the distributions and other payments. The net combined effect of the trust preferred securities transaction is that the Company is obligated to make the distributions and other payments required on the trust preferred securities.

These trust preferred securities are mandatorily redeemable upon maturity of the debentures on June 28, 2036, or upon earlier redemption as provided in the indenture. The Company has the right to redeem the debentures purchased by PEBK Trust II, in whole or in part, which became effective on June 28, 2011. As specified in the indenture, if the debentures are redeemed prior to maturity, the redemption price will be the principal amount plus any accrued but unpaid interest.

The Company established a new subsidiary, CBRES, in 2009. CBRES serves as a “clearing-house” for appraisal services for community banks. Other banks are able to contract with CBRES to find and engage appropriate appraisal companies in the area where the property is located. This type of service ensures that the appraisal process remains independent from the financing process within the bank.

Market Area

The Bank’s primary market consists of the communities in an approximate 50-mile radius around its headquarters office in Newton, North Carolina. This area includes Catawba County, Alexander County, Lincoln County, Iredell County and portions of northeast Gaston County. The Bank is located only 40 miles north of Charlotte, North Carolina and the Bank’s primary market area is and will continue to be significantly affected by its close proximity to this major metropolitan area.  The Bank has two Banco offices in Mecklenburg County, one Banco office in Union County and one Banco office in Wake County specifically designed to serve the growing Latino market.

Employment in the Bank’s primary market area is diversified among manufacturing, retail and wholesale trade, technology, services and utilities. Catawba County’s largest employers include Catawba County Schools, Frye Regional Medical Center, Catawba Valley Medical Center, Merchant Distributors, Inc (wholesale food distributor), Catawba County, CommScope, Inc. (manufacturer of fiber optic cable and accessories), Corning Cable Systems (manufacturer of fiber optic cable and accessories), Ethan Allen (furniture manufacturer), CV Industries (furniture manufacturer) and Hickory Public Schools.

Competition

The Bank has operated in the Catawba Valley region for over 100 years and is the only financial institution headquartered in Newton. Nevertheless, the Bank faces strong competition both in attracting deposits and making loans. Its most direct competition for deposits has historically come from other commercial banks, credit unions and brokerage firms located in its primary market area, including large financial institutions.  One national money center commercial bank is headquartered in Charlotte, North Carolina. Based upon June 30, 2012 comparative data, the Bank had 21.90% of the deposits in Catawba County, placing it second in deposit size among a total of 13 banks with branch offices in Catawba County; 14.67% of the deposits in Lincoln County, placing it third in deposit size among a total of ten banks with branch offices in Lincoln County; and 13.15% of the deposits in Alexander County, placing it fifth in deposit size among a total of seven banks with branch offices in Alexander County.

The Bank also faces additional significant competition for investors’ funds from short-term money market securities and other corporate and government securities. The Bank’s core deposit base has grown principally due to economic growth in the Bank’s market area coupled with the implementation of new and competitive deposit products. The ability of the Bank to attract and retain deposits depends on its ability to generally provide a rate of return, liquidity and risk comparable to that offered by competing investment opportunities.

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The Bank experiences strong competition for loans from commercial banks and mortgage banking companies. The Bank competes for loans primarily through the interest rates and loan fees it charges and the efficiency and quality of services it provides to borrowers. Competition is increasing as a result of the continuing reduction of restrictions on the interstate operations of financial institutions.

Supervision and Regulation

Bank holding companies and commercial banks are extensively regulated under both federal and state law.  The following is a brief summary of all material statutes and rules and regulations that affect or will affect the Company, the Bank and any subsidiaries.  Supervision, regulation and examination of the Company and the Bank by the regulatory agencies are intended primarily for the protection of depositors rather than shareholders of the Company.  Statutes and regulations which contain wide-ranging proposals for altering the structures, regulations and competitive relationship of financial institutions are introduced regularly. The Company cannot predict whether or in what form any proposed statute or regulation will be adopted or the extent to which the business of the Company and the Bank may be affected by such statute or regulation.

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

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

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

Emergency Economic Stabilization Act of 2008. The Emergency Economic Stabilization Act of 2008 (“EESA”) gave the U.S. Department of Treasury (“UST”) authority to take certain actions to restore liquidity and stability to the U.S. banking markets. Based upon its authority in the EESA, a number of programs to implement EESA have been announced.  The first program implemented by the UST was the Capital Purchase Program (“CPP”). Pursuant to this program, the UST, on behalf of the U.S. government, was authorized to purchase preferred stock, along with warrants to purchase common stock, from certain financial institutions, including bank holding companies, savings and loan holding companies and banks or savings associations not controlled by a holding company. The investments have a dividend rate of 5% per year, until the fifth anniversary of the UST’s investment and a dividend of 9% thereafter. During the time the UST holds securities issued pursuant to this program, participating financial institutions are required to comply with certain provisions regarding executive compensation and corporate governance.  Participation in this program also imposes certain restrictions upon an institution’s dividends to common shareholders and stock repurchase activities. As described further herein, the Company elected to participate in the CPP and received $25.1 million pursuant to the program in December 2008.  The UST sold all of the Company’s CPP preferred stock in a public auction during the second quarter of 2012, and, as a result, the Company is no longer subject to the executive compensation and corporate governance standards imposed on participants in the CPP.

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American Recovery and Reinvestment Act of 2009.The American Recovery and Reinvestment Act of 2009 (“ARRA”) includes a wide variety of programs intended to stimulate the economy and provide for extensive infrastructure, energy, health, and education needs.  In addition, ARRA imposes certain new executive compensation and corporate governance obligations on all current and future CPP recipients, including the Company, until the institution has redeemed the preferred stock, which CPP recipients are now permitted to do under ARRA without regard to the three-year holding period and without the need to raise new capital but subject to approval of its primary federal regulator.

Additionally, ARRA amends Section 111 of EESA to require the UST to adopt additional standards with respect to executive compensation and corporate governance for CPP recipients, which are set forth in the TARP Standards for Compensation and Corporate Governance: Interim Final Rule (“Interim Final Rule”), adopted by the UST on June 15, 2009.  Among the executive compensation and corporate governance provisions included in ARRA and the Interim Final Rule are the following:

·   an incentive compensation “clawback” provision to cover “senior executive officers” (defined in this instance and below to mean the “named executive officers” for whom compensation disclosure is provided in the Company’s proxy statement) and the next 20 most highly compensated employees;

·   a prohibition on certain golden parachute payments to cover any payment related to a departure for any reason (with limited exceptions) made to any senior executive officer (as defined above) and the next five most highly compensated employees;

·   a limitation on incentive compensation paid or accrued to the five most highly compensated employees of the financial institution, subject to limited exceptions for pre-existing arrangements set forth in written employment contracts executed on or prior to February 11, 2009, and certain awards of restricted stock, which may not exceed one-third of annual compensation, are subject to a two-year holding period and cannot be transferred until the UST’s preferred stock is redeemed in full;

·   a requirement that a company’s chief executive officer and chief financial officer provide in annual securities filings, a written certification of compliance with the executive compensation and corporate governance provisions of the Interim Final Rule;

·   an obligation for the compensation committee of the board of directors to evaluate with a company’s chief risk officer certain compensation plans to ensure that such plans do not encourage unnecessary or excessive risks or the manipulation of reported earnings;

·   a requirement that companies adopt a company-wide policy regarding excessive or luxury expenditures;

·   a requirement that companies permit a separate, non-binding shareholder vote to approve the compensation of executives; and

·   a provision that allows the UST to review compensation paid prior to enactment of ARRA to senior executive officers and the next 20 most highly-compensated employees to determine whether any payments were inconsistent with the executive compensation restrictions of EESA, CPP or otherwise contrary to the public interest.

The UST sold all of the Company’s CPP preferred stock in a public auction during the second quarter of 2012, and, as a result, the Company is no longer subject to the executive compensation and corporate governance standards imposed on participants in the CPP.

Dodd-Frank Wall Street Reform and Consumer Protection Act. On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law. The Dodd-Frank Act was intended primarily to overhaul the financial regulatory framework following the global financial crisis and has impacted, and will continue to impact, all financial institutions including the Company and the Bank. The Dodd-Frank Act contains provisions that have, among other things, established a Bureau of Consumer Financial Protection, established a systemic risk regulator, consolidated certain federal bank regulators and imposed increased corporate governance and executive compensation requirements.  The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations and to prepare numerous studies and reports for the U.S. Congress. The federal agencies are given significant discretion in drafting and implementing regulations. Although some of these regulations have been promulgated, many additional regulations are expected to be issued in 2013 and thereafter.  Consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for many months or years.

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Capital Adequacy Guidelines for Holding Companies. The Federal Reserve has adopted capital adequacy guidelines for bank holding companies and banks that are members of the Federal Reserve System and have consolidated assets of $150 million or more.  Bank holding companies subject to the Federal Reserve’s capital adequacy guidelines are required to comply with the Federal Reserve’s risk-based capital guidelines. Under these regulations, the minimum ratio of total capital to risk-weighted assets is 8%.  At least half of the total capital is required to be “Tier I capital,” principally consisting of common stockholders’ equity, noncumulative perpetual preferred stock, and a limited amount of cumulative perpetual preferred stock, less certain goodwill items.  The remainder (“Tier II capital”) may consist of a limited amount of subordinated debt, certain hybrid capital instruments and other debt securities, perpetual preferred stock, and a limited amount of the general loan loss allowance.  In addition to the risk-based capital guidelines, the Federal Reserve has adopted a minimum Tier I capital (leverage) ratio, under which a bank holding company must maintain a minimum level of Tier I capital to average total consolidated assets of at least 3% in the case of a bank holding company which has the highest regulatory examination rating and is not contemplating significant growth or expansion.  All other bank holding companies are expected to maintain a Tier I capital (leverage) ratio of at least 1% to 2% above the stated minimum. The Company exceeded all applicable capital adequacy guidelines as of December 31, 2012.  At December 31, 2012, the Company’s Tier I risk-based capital and total risk-based capital were 16.04% and 17.34%, respectively.

Capital Requirements for the Bank. As a North Carolina chartered, FDIC-insured commercial bank which is not a member of the Federal Reserve System, the Bank is subject to capital requirements imposed by the FDIC.  Under the FDIC's regulations, state nonmember banks that (a) receive the highest rating during the examination process and (b) are not anticipating or experiencing any significant growth, are required to maintain a minimum leverage ratio of 3% of total consolidated assets; all other banks are required to maintain a minimum ratio of 1% or 2% above the stated minimum, with a minimum leverage ratio of not less than 4%.  The Bank exceeded all applicable capital adequacy guidelines as of December 31, 2012.  At December 31, 2012, the Bank’s Tier I risk-based capital and total risk-based capital were 15.54% and 16.84%, respectively.

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

Neither the Commissioner nor the FDIC have promulgated any regulations specifically limiting the right of the Company to pay dividends and repurchase shares. However, the ability of the Company to pay dividends or repurchase shares may be dependent upon the Company’s receipt of dividends from the Bank.

Dividends may be paid by the Bank from undivided profits, which are determined by deducting and charging certain items against actual profits.  An insured depository institution, such as the Bank, is prohibited from making capital distributions, including the payment of dividends, if, after making such distribution, the institution would become “undercapitalized” (as such term is defined in the applicable law and regulations).

Deposit Insurance.  The Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund (“DIF”) of the FDIC. The Bank’s deposits, therefore, are subject to FDIC deposit insurance assessment.

On February 27, 2009, the FDIC adopted a final rule modifying the risk-based assessment system and setting initial base assessment rates beginning April 1, 2009, at 12 to 45 basis points; and due to extraordinary circumstances, extended the time within which the reserve ratio must be returned to 1.15 percent from five to seven years. The Bank’s base assessment averaged 12.94 basis points in 2009.  On May 22, 2009, the FDIC adopted a final rule imposing a 5 basis point special assessment on each insured depository institution’s assets minus Tier 1 capital as of June 30, 2009. The Bank incurred an expense of $453,000 in 2009 as a result of the special assessment.

On November 12, 2009, the FDIC amended its regulations requiring certain insured institutions to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011, and 2012. The Bank’s prepaid assessment for these periods was $5.0 million and was paid on December 30, 2009, along with its regular quarterly risk-based deposit insurance assessment for the third quarter of 2009. The prepayment has been treated as a prepaid expense on the books of the Bank, and recognized as an expense in the period for which the assessment is effective. The remaining balance of this prepaid expense was $1.6 million as of December 31, 2012.

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The Dodd-Frank Act permanently increases the maximum deposit insurance amount for banks, savings institutions and credit unions to $250,000 per depositor, and extended unlimited deposit insurance to non-interest bearing transaction accounts through December 31, 2012. The Dodd-Frank Act also broadens the base for FDIC insurance assessments. Assessments will now be based on the average consolidated total assets less tangible equity capital of a financial institution.  The Dodd-Frank Act requires the FDIC to increase the reserve ratio of the DIF from 1.15% to 1.35% of insured deposits by 2020 and eliminates the requirement that the FDIC pay dividends to insured depository institutions when the reserve ratio exceeds certain thresholds.  

FDIC Temporary Liquidity Guarantee Program.  On October 14, 2008, the FDIC announced its Temporary Liquidity Guarantee Program (“TLGP”), which is comprised of the Debt Guarantee Program (“DGP”) and the Transaction Account Guarantee Program (“TAGP”).

The TAGP provided unlimited deposit insurance coverage through December 31, 2009, for non-interest bearing transaction accounts and certain interest-bearing accounts (negotiable order of withdrawal (“NOW”) accounts with interest rates of 0.50% or less and lawyers trust accounts) at FDIC-insured depository institutions. Depository institutions participating in the TAGP are assessed, on a quarterly basis, an annualized 10 basis points fee on the balance of each covered account in excess of the existing FDIC deposit insurance limit of $250,000 that was established on a temporary basis, through December 31, 2009. The $250,000 deposit insurance coverage limit was scheduled to return to $100,000 on January 1, 2010, but was extended by congressional action until December 31, 2013. The TLGP was extended to cover debt of FDIC-insured institutions issued through December 31, 2010, and the TAGP was extended through December 31, 2010. The Company has participated in the TAGP since its beginning, and elected to continue its participation during the extension period.

The DGP provides an FDIC guarantee of certain senior unsecured debt of FDIC-insured institutions and their holding companies. The unsecured debt must be issued on or after October 14, 2008 and not later than October 31, 2009, and the guarantee is effective through the earlier of the maturity date or June 30, 2012. The DGP coverage limit is generally 125% of the eligible entity’s eligible debt outstanding on September 30, 2008 and scheduled to mature on or before June 30, 2009 or, for certain insured institutions, 2% of their liabilities as of September 30, 2008. The proceeds of debt guaranteed under the DGP may not be used to prepay debt that is not guaranteed by the FDIC.  Depending on the term of the debt maturity, the nonrefundable DGP fee ranges from 50 to 100 basis points (annualized) for covered debt outstanding until the earlier of maturity or June 30, 2012. The Company was eligible to participate in the DGP although it chose not to issue any debt under this program.

Federal Home Loan Bank System.  The Federal Home Loan Bank (“FHLB”) system provides a central credit facility for member institutions. As a member of the FHLB of Atlanta, the Bank is required to own capital stock in the FHLB of Atlanta in an amount at least equal to 0.20% (or 20 basis points) of the Bank’s total assets at the end of each calendar year, plus 4.5% of its outstanding advances (borrowings) from the FHLB of Atlanta under the new activity-based stock ownership requirement.  On December 31, 2012, the Bank was in compliance with this requirement.

Community Reinvestment. Under the Community Reinvestment Act (“CRA”), as implemented by regulations of the FDIC, an insured institution has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions, nor does it limit an institution’s discretion to develop, consistent with the CRA, the types of products and services that it believes are best suited to its particular community. The CRA requires the federal banking regulators, in connection with their examinations of insured institutions, to assess the institutions’ records of meeting the credit needs of their communities, using the ratings of  “outstanding,” “satisfactory,” “needs to improve,” or “substantial noncompliance,” and to take that record into account in its evaluation of certain applications by those institutions. All institutions are required to make public disclosure of their CRA performance ratings. The Bank received a “satisfactory” rating in its last CRA examination, which was conducted during July 2010.

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Prompt Corrective Action.The FDIC has broad powers to take corrective action to resolve the problems of insured depository institutions. The extent of these powers will depend upon whether the institution in question is “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized.”  Under the regulations, an institution is considered: (A) “well capitalized” if it has (i) a total risk-based capital ratio of 10% or greater, (ii) a Tier I risk-based capital ratio of 6% or greater, (iii) a leverage ratio of 5% or greater and (iv) is not subject to any order or written directive to meet and maintain a specific capital level for any capital measure; (B) “adequately capitalized” if it has (i) a total risk-based capital ratio of 8% or greater, (ii) a Tier I risk-based capital ratio of 4% or greater and (iii) a leverage ratio of 4% or greater (or 3% or greater in the case of an institution with the highest examination rating); (C) “undercapitalized” if it has (i) a total risk-based capital ratio of less than 8%, (ii) a Tier I risk-based capital ratio of less than 4% or (iii) a leverage ratio of less than 4% (or 3% in the case of an institution with the highest examination rating); (D) “significantly undercapitalized” if it has (i) a total risk-based capital ratio of less than 6%, or (ii) a Tier I risk-based capital ratio of less than 3% or (iii) a leverage ratio of less than 3%; and (E) “critically undercapitalized” if the institution has a ratio of tangible equity to total assets equal to or less than 2%. At December 31, 2012, the Bank has requisite capital levels to qualify as “well capitalized”.

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

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

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

Loans to One Borrower.The Bank is subject to the Commissioner’s loans-to-one-borrower limits which are substantially the same as those applicable to national banks. Under these limits, no loans and extensions of credit to any borrower outstanding at one time and not fully secured by readily marketable collateral shall exceed 15% of the Bank’s total equity capital.  At December 31, 2012, this limit was $17.1 million. This limit is increased by an additional 10% of the Bank’s total equity capital, or $11.4 million as of December 31, 2012, for loans and extensions of credit that are fully secured by readily marketable collateral.

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

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

Interstate Banking and Branching.  The BHCA was amended by the Interstate Banking Act.  The Interstate Banking Act provides that adequately capitalized and managed financial and bank holding companies are permitted to acquire banks in any state.

State law prohibiting interstate banking or discriminating against out-of-state banks are preempted.  States are not permitted to enact laws opting out of this provision; however, states are allowed to adopt a minimum age restriction requiring that target banks located within the state be in existence for a period of years, up to a maximum of five years, before a bank may be subject to the Interstate Banking Act.  The Interstate Banking Act, as amended by the Dodd-Frank Act, establishes deposit caps which prohibit acquisitions that result in the acquiring company controlling 30% or more of the deposits of insured banks and thrift institutions held in the state in which the target maintains a breach or 10% or more of the deposits nationwide.  States have the authority to waive the 30% deposit cap.  State-level deposit caps are not preempted as long as they do not discriminate against out-of-state companies, and the federal deposit caps apply only to initial entry acquisitions.

Under the Dodd-Frank Act, national banks and state banks are able to establish branches in any state if that state would permit the establishment of the branch by a state bank chartered in that state.  North Carolina law permits a state bank to establish a branch of the bank anywhere in the state.  Accordingly, under the Dodd-Frank Act, a bank with its headquarters outside the State of North Carolina may establish branches anywhere within North Carolina.

Sarbanes-Oxley Act of 2002.  The Sarbanes-Oxley Act of 2002 is federal legislation issued to address accounting, corporate governance and disclosure issues. The impact of the Sarbanes-Oxley Act has been wide-ranging as it applied to all public companies and imposed significant new requirements for public company governance and disclosure requirements.

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

The economic and operational effects of this legislation on public companies, including us, have been significant in terms of the time, resources and costs associated with complying with the law.

Government Monetary Policies and Economic Controls. Our earnings and growth, as well as the earnings and growth of the banking industry, are affected by the credit policies of monetary authorities, including the Federal Reserve. An important function of the Federal Reserve is to regulate the national supply of bank credit in order to combat recession and curb inflationary pressures. Among the instruments of monetary policy used by the Federal Reserve to implement these objectives are open market operations in U.S. government securities, changes in reserve requirements against member bank deposits, and changes in the Federal Reserve discount rate. These means are used in varying combinations to influence overall growth of bank loans, investments, and deposits, and may also affect interest rates charged on loans or paid for deposits. The monetary policies of the Federal Reserve authorities have had a significant effect on the operating results of commercial banks in the past and are expected to continue to have such an effect in the future.

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In view of changing conditions in the national economy and in money markets, as well as the effect of credit policies by monetary and fiscal authorities, including the Federal Reserve, no prediction can be made as to possible future changes in interest rates, deposit levels, and loan demand, or their effect on our business and earnings or on the financial condition of our various customers.

Limits on Rates Paid on Deposits and Brokered Deposits.  FDIC regulations limit the ability of insured depository institutions to accept, renew or roll-over deposits by offering rates of interest which are significantly higher than the prevailing rates of interest on deposits offered by other insured depository institutions having the same type of charter in such depository institution’s normal market area.  Under these regulations, “well capitalized” depository institutions may accept, renew or roll-over such deposits without restriction, “adequately capitalized” depository institutions may accept, renew or roll-over such deposits with a waiver from the FDIC (subject to certain restrictions on payments of rates) and “undercapitalized” depository institutions may not accept, renew, or roll-over such deposits. Definitions of “well capitalized,” “adequately capitalized” and “undercapitalized” are the same as the definitions adopted by the FDIC to implement the prompt corrective action provisions discussed above.

Other. Additional regulations require annual examinations of all insured depository institutions by the appropriate federal banking agency, with some exceptions for small, well-capitalized institutions and state chartered institutions examined by state regulators.  Additional regulations also establish operational and managerial, asset quality, earnings and stock valuation standards for insured depository institutions, as well as compensation standards.

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

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

Future Requirements. Statutes and regulations, which contain wide-ranging proposals for altering the structures, regulations and competitive relationships of financial institutions, are introduced regularly.  Neither the Company nor the Bank can predict whether or what form any proposed statute or regulation will be adopted or the extent to which the business of the Company or the Bank may be affected by such statute or regulation.

ITEM 1A.   RISK FACTORS

The following are potential risks that management considers material and that could affect the future operating results and financial condition of the Bank and the Company.  The risks are not listed in any particular order of importance, and there is the potential that there are other risks that have either not been identified or that management believed to be immaterial but which could in fact adversely affect the Bank’s operating results and financial condition.

 Risks Related to Recent Economic Conditions and Governmental Response:

Our business has been and may continue to be adversely affected by current conditions in the financial markets and economic conditions generally.

The global, U.S. and North Carolina economies are continuing to experience significantly reduced business activity and consumer spending as a result of, among other factors, disruptions in the capital and credit markets that first occurred during 2008. Since 2008, dramatic declines in the housing market, with falling home prices and increasing foreclosures and unemployment, have resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities and major commercial and investment banks. A sustained weakness or weakening in business and economic conditions generally or specifically in the principal markets in which we do business could have one or more of the following adverse effects on our business: 

• a decrease in the demand for loans or other products and services offered by us;

• a decrease in the value of our loans or other assets secured by consumer or commercial real estate;

• a decrease in deposit balances due to overall reductions in the accounts of customers;

• an impairment of certain intangible assets or investment securities;

• a decreased ability to raise additional capital on terms acceptable to us or at all; or

• an increase in the number of borrowers who become delinquent, file for protection under bankruptcy laws or default on their loans or other obligations to us. An increase in the number of delinquencies, bankruptcies or defaults could result in a higher level of nonperforming assets, net charge-offs and provision for credit losses, which would reduce our earnings.

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Until conditions improve, we expect our business, financial condition and results of operations to continue to be adversely affected.

Financial reform legislation enacted by Congress and resulting regulations have increased, and are expected to continue to increase our costs of operations.

Congress enacted the Dodd-Frank Act in 2010. This law has significantly changed the structure of the bank regulatory system and affects the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies are given significant discretion in drafting the implementing rules and regulations.  Although some of these regulations have been promulgated, many additional regulations are expected to be issued in 2013 and thereafter. Consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for many months or years.

Certain provisions of the Dodd-Frank Act are having an effect on us. For example, a provision eliminates the federal prohibitions on paying interest on demand deposits, thus allowing businesses to have interest-bearing checking accounts. Although not currently quantifiable, this significant change to existing law could have an adverse effect on our interest expense.

The Dodd-Frank Act also broadens the base for FDIC insurance assessments. Assessments are now based on the average consolidated total assets less tangible equity capital of a financial institution. The Dodd-Frank Act also permanently increases the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2008, and non-interest bearing transaction accounts had unlimited deposit insurance through December 31, 2012.

The Dodd-Frank Act requires publicly traded companies to give stockholders a non-binding vote on executive compensation and so-called “golden parachute” payments, and authorizes the SEC to promulgate rules that would allow stockholders to nominate their own candidates using a company’s proxy materials. The legislation also directs the Federal Reserve to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded or not.

The Dodd-Frank Act created the Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection laws. The Bureau has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. It also has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. Banks and savings institutions with $10 billion or less in assets will be examined by their applicable bank regulators. The Dodd-Frank Act also weakens the federal preemption rules that have been applicable for national banks and federal savings associations, and gives state attorneys general the ability to enforce federal consumer protection laws.

It is difficult to quantify what specific impact the Dodd-Frank Act and related regulations have had on the Company to date and what impact yet to be written regulations will have on us in the future. However, it is expected that at a minimum they will increase our operating and compliance costs and could increase our interest expense.

Increases in FDIC insurance premiums may adversely affect our net income and profitability.

Since 2008, higher levels of bank failures have dramatically increased resolution costs of the FDIC and depleted the DIF. In order to maintain a strong funding position and restore reserve ratios of the DIF, the FDIC has increased assessment rates of insured institutions. In addition, on November 12, 2009, the FDIC adopted a rule requiring banks to prepay three years’ worth of estimated deposit insurance premiums by December 31, 2009.  The Company is generally unable to control the amount of premiums that the Bank is required to pay for FDIC insurance. If there are additional bank or financial institution failures, or the cost of resolving prior failures exceeds expectations, the Bank may be required to pay higher FDIC premiums than those currently in force. Any future increases or required prepayments of FDIC insurance premiums may adversely impact the Company’s earnings and financial condition.

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The capital and credit markets have experienced unprecedented levels of volatility.

During the economic downturn, the capital and credit markets experienced extended volatility and disruption. In some cases, the markets produced downward pressure on financial institution stock prices and credit capacity for certain issuers without regard to those issuers’ underlying financial strength. If these levels of market disruption and volatility continue, worsen or abate and then arise at a later date, the Company’s ability to access capital could be materially impaired. The Company’s inability to access the capital markets could constrain the Bank’s ability to make new loans, to meet the Bank’s existing lending commitments and, ultimately jeopardize the Bank’s overall liquidity and capitalization.

Additional requirements under our regulatory framework, especially those imposed under ARRA, EESA or other legislation or regulations intended to strengthen the U.S. financial system, could adversely affect us.

Government efforts to strengthen the U.S. financial system, including the implementation of ARRA, EESA, the TLGP and special assessments imposed by the FDIC, subject participants to additional regulatory fees and requirements, including corporate governance requirements, executive compensation restrictions, restrictions on declaring or paying dividends, restrictions on share repurchases, limits on executive compensation tax deductions and prohibitions against golden parachute payments. These requirements, and any other requirements that may be subsequently imposed, may have a material and adverse affect on our business, financial condition, and results of operations.

The soundness of other financial institutions could adversely affect us.

Since 2008, the financial services industry as a whole, as well as the securities markets generally, have been materially and adversely affected by significant declines in the values of nearly all asset classes and by a serious lack of liquidity. Financial institutions in particular have been subject to increased volatility and an overall loss in investor confidence.

Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services companies are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, and other institutional clients.

From time to time, we may utilize derivative financial instruments, primarily to hedge our exposure to changes in interest rates, but also to hedge cash flow. By entering into these transactions and derivative instrument contracts, we expose ourselves to counterparty credit risk in the event of default of our counterparty or client. When the fair value of a derivative contract is in an asset position, the counterparty has a liability to us, which creates credit risk for us. We attempt to minimize this risk by selecting counterparties with investment grade credit ratings, limiting our exposure to any single counterparty and regularly monitoring our market position with each counterparty. Nonetheless, defaults by, or even rumors or questions about, one or more financial services companies, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized or is liquidated at prices not sufficient to recover the full amount of the loan due us. There is no assurance that any such losses would not materially and adversely affect our businesses, financial condition or results of operations.

Market developments may adversely affect our industry, business and results of operations.

Significant declines in the housing market, with falling home prices and increasing foreclosures and unemployment, have resulted in significant write-downs of asset values by many financial institutions, including government-sponsored entities and major commercial and investment banks. These write-downs, initially of mortgage-backed securities but spreading to credit default swaps and other derivative securities, caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail. As a consequence, the Company has experienced significant challenges, its credit quality deteriorated and its net income and results of operations were adversely impacted. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced, and in some cases, ceased to provide funding to borrowers including other financial institutions. Although to date the Company and the Bank remain “well capitalized,” we are part of the financial system and a systemic lack of available credit, a lack of confidence in the financial sector, increased volatility in the financial markets and/or reduced business activity could materially adversely affect our business, financial condition and results of operations.

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Risks Related to Our Business:

Loss of key personnel could adversely impact results.

The success of the Bank has been and will continue to be greatly influenced by the ability to retain the services of existing senior management.  The Bank has benefited from consistency within its senior management team, with its top five executives averaging over 19 years of service with the Bank.  The Company has entered into employment contracts with each of these top management officials.  Nevertheless, the unexpected loss of the services of any of the key management personnel, or the inability to recruit and retain qualified personnel in the future, could have an adverse impact on the business and financial results of the Bank.

A significant amount of the Bank’s business is concentrated in lending which is secured by property located in the Catawba Valley and surrounding areas.

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

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

Our allowance for loan losses may be insufficient and could therefore reduce earnings.

The risk of credit losses on loans varies with, among other things, general economic conditions, the creditworthiness of the borrower over the term of the loan and, in the case of a collateralized loan, the value and marketability of the collateral for the loan. Management maintains an allowance for loan losses based upon, among other things, historical experience, an evaluation of economic conditions and regular reviews of delinquencies and loan portfolio quality. Management believes it has established the allowance in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”) and in consideration of the current economic environment. Although management uses the best information available to make evaluations, significant future additions to the allowance may be necessary based on changes in economic and other conditions, thus adversely affecting the operating results of the Company. If management’s assumptions and judgments prove to be incorrect and the allowance for loan losses is inadequate to absorb future losses, or if the bank regulatory authorities require the Bank to increase the allowance for loan losses as a part of their examination process, the Bank’s earnings and capital could be significantly and adversely affected.  For further discussion related to our process for determining the appropriate level of the allowance for loan losses, see “Allowance for Loan Losses” within “Item 7. Management’s Discussion and Analysis of Financial Condition and Results and Operation” of this Annual Report, which is included in this Form 10-K as Exhibit (13).

Changes in interest rates affect profitability and assets.

Changes in prevailing interest rates may hurt the Bank’s business. The Bank derives its income primarily from the difference or “spread” between the interest earned on loans, securities and other interest-earning assets, and interest paid on deposits, borrowings and other interest-bearing liabilities. In general, the larger the spread, the more the Bank earns. When market rates of interest change, the interest the Bank receives on its assets and the interest the Bank pays on its liabilities will fluctuate. This can cause decreases in the “spread” and can adversely affect the Bank’s income. Changes in market interest rates could reduce the value of the Bank’s financial assets. Fixed-rate investments, mortgage-backed and related securities and mortgage loans generally decrease in value as interest rates rise. In addition, interest rates affect how much money the Bank lends. For example, when interest rates rise, the cost of borrowing increases and the loan originations tend to decrease. If the Bank is unsuccessful in managing the effects of changes in interest rates, the financial condition and results of operations could suffer.

We measure interest rate risk under various rate scenarios using specific criteria and assumptions. A summary of this process, along with the results of our net interest income simulations, is presented within “Item 7A. Quantitative and Qualitative Disclosures About Market Risk” of this Annual Report which is included in this Form 10-K as Exhibit (13).

The Company’s business may be adversely affected by conditions in the financial markets and economic conditions.

Since December 2007, business activity across a wide range of industries and regions  has been greatly reduced and local governments and many businesses are in serious difficulty due to the lack of consumer spending and the lack of liquidity in the credit markets. Unemployment has increased significantly since that time.

During these challenging economic conditions, the financial services industry and the securities markets generally were materially and adversely affected by significant declines in the values of nearly all asset classes and by a serious lack of liquidity. This was initially triggered by declines in home prices and the values of subprime mortgages, but spread to all mortgage and real estate asset classes, to leveraged bank loans and to nearly all asset classes, including equities. The global markets have been characterized by substantially increased volatility and short-selling and an overall loss of investor confidence, initially in financial institutions, but more recently in companies in a number of other industries and in the broader markets.

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Market conditions have also led to the failure or merger of a number of prominent financial institutions. Financial institution failures or near-failures have resulted in further losses as a consequence of defaults on securities issued by them and defaults under contracts entered into with such entities as counterparties. Furthermore, declining asset values, defaults on mortgages and consumer loans, and the lack of market and investor confidence, as well as other factors, have all combined to increase credit default swap spreads, to cause rating agencies to lower credit ratings, and to otherwise increase the cost and decrease the availability of liquidity, despite very significant declines in Federal Reserve borrowing rates and other government actions. Some banks and other lenders have suffered significant losses and have become reluctant to lend, even on a secured basis, due to the increased risk of default and the impact of declining asset values. The foregoing has significantly weakened the strength and liquidity of some financial institutions worldwide. In 2008, the U.S. government, the Federal Reserve and other regulators took numerous steps to increase liquidity and to restore investor confidence, including investing approximately $200 billion in the equity of other banking organizations, but asset values have continued to decline and access to liquidity continues to be limited.

The Company’s financial performance generally, and in particular the ability of borrowers to pay interest on and repay principal of outstanding loans and the value of collateral securing those loans, is highly dependent on the business environment in the markets where the Company operates, in the State of North Carolina and in the United States as a whole. A favorable business environment is generally characterized by, among other factors, economic growth, efficient capital markets, low inflation, high business and investor confidence, and strong business earnings. Unfavorable or uncertain economic and market conditions can be caused by: declines in economic growth, business activity or investor or business confidence; limitations on the availability or increases in the cost of credit and capital; increases in inflation or interest rates; natural disasters; or a combination of these or other factors.

Overall, during 2010, 2011 and 2012, the business environment has been detrimental to the ability to generate income for many households and businesses in the United States and worldwide. It is expected that the business environment in the State of North Carolina will continue to have an adverse impact on many households and businesses for the foreseeable future. Such conditions could adversely affect the credit quality of the Company’s loans, results of operations and financial condition.

The Bank faces strong competition from other banks and financial institutions which can hurt its business.

The financial services industry is highly competitive.  The Bank competes against commercial banks, savings banks, savings and loan associations, credit unions, mortgage banks, brokerage firms, investment advisory firms, insurance companies and other financial institutions. Many of these entities are larger organizations with significantly greater financial, management and other resources than the Bank has.  Moreover, one national money center commercial bank is headquartered in Charlotte, North Carolina, only 40 miles from the Bank’s primary market area.

While management believes it can and does successfully compete with other financial institutions in our market, we may face a competitive disadvantage as a result of our smaller size and lack of geographic diversification.

Changes in technology may impact the Bank’s business.

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

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

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

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Changes in our accounting policies or in accounting standards could materially affect how we report our financial results and condition.

Our accounting policies are fundamental to understanding our financial results and condition. Some of these policies require use of estimates and assumptions that may affect the value of our assets or liabilities and financial results. Some of our accounting policies are critical because they require management to make difficult, subjective and complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions.

From time to time the Financial Accounting Standards Board (“FASB”) and the SEC change the financial accounting and reporting standards or the interpretation of those standards that govern the preparation of our external financial statements. These changes are beyond our control, can be hard to predict and could materially impact how we report our results of operations and financial condition. We could be required to apply a new or revised standard retroactively, resulting in our restating prior period financial statements in material amounts.

Our internal controls may be ineffective.

Management regularly reviews and updates our internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations, and financial condition.

Impairment of investment securities or deferred tax assets could require charges to earnings, which could result in a negative impact on our results of operations.

In assessing the impairment of investment securities, management considers the length of time and extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issues, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery of fair value in the near term. In assessing the future ability of the Company to realize the deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. The impact of each of these impairment matters could have a material adverse effect on our business, results of operations, and financial condition.

We rely on other companies to provide key components of our business infrastructure.

Third party vendors provide key components of our business infrastructure such as internet connections, network access and core application processing. While we have selected these third party vendors carefully, we do not control their actions. Any problems caused by these third parties, including as a result of their not providing us their services for any reason or their performing their services poorly, could adversely affect our ability to deliver products and services to our customers and otherwise to conduct our business. Replacing these third party vendors could also entail significant delay and expense.

Our information systems may experience an interruption or breach in security.

We rely heavily on communications and information systems to conduct our business. Any failure, interruption, or breach in security or operational integrity of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan, and other systems. We have policies and procedures designed with the intention to prevent or limit the effect of the failure, interruption, or security breach of our information systems. The occurrence of any failures, interruptions, or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition, results of operations and business.

Liquidity is essential to our businesses.

Our liquidity could be impaired by an inability to access the capital markets or unforeseen outflows of cash. This situation may arise due to circumstances that we may be unable to control, such as a general market disruption or an operational problem that affects third parties or us. Our credit ratings are important to our liquidity. A reduction in our credit ratings could adversely affect our liquidity and competitive position, increase our borrowing costs, limit our access to the capital markets or trigger unfavorable contractual obligations.

17

Negative publicity could damage our reputation.

Reputation risk, or the risk to our earnings and capital from negative public opinion, is inherent in our business. Negative public opinion could adversely affect our ability to keep and attract customers and expose us to adverse legal and regulatory consequences. Negative public opinion could result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance, regulatory compliance, mergers and acquisitions, and disclosure, sharing or inadequate protection of customer information, and from actions taken by government regulators and community organizations in response to that conduct.

Financial services companies depend on the accuracy and completeness of information about customers and counterparties.

In deciding whether to extend credit or enter into other transactions, we may rely on information furnished by or on behalf of customers and counterparties, including financial statements, credit reports, and other financial information. We may also rely on representations of those customers, counterparties, or other third parties, such as independent auditors, as to the accuracy and completeness of that information. Reliance on inaccurate or misleading financial statements, financial advisors and consultants, credit reports, or other financial information could cause us to enter into unfavorable transactions, which could have a material adverse effect on our financial condition and results of operations.

If our non-performing assets increase, our earnings will suffer.

At December 31, 2012, our non-performing assets (which consist of non-accruing loans, loans 90+ days delinquent, and foreclosed real estate assets) totaled $26.3 million or 2.60% of total assets, compared to $32.1 million or 3.01% of total assets at December 31, 2011 and $46.9 million or 4.40% of total assets at December 31, 2010.  Our non-performing assets adversely affect our net income in various ways.  We do not record interest income on non-accrual loans or real estate owned.  We must reserve for probable losses, which is established through a current period charge to the provision for loan losses as well as from time to time, as appropriate, the write down of the value of properties in our other real estate owned portfolio to reflect changing market values.  Additionally, there are legal fees associated with the resolution of problem assets as well as carrying costs such as taxes, insurance and maintenance related to our other real estate owned.  Further, the resolution of non-performing assets requires the active involvement of management, which can distract them from more profitable activity.  Finally, if our estimate for the recorded allowance for loan losses proves to be incorrect and our allowance is inadequate, we will have to increase the allowance accordingly.

Our loan portfolio includes loans with a higher risk of loss.

We originate commercial real estate loans, commercial loans, construction and land development loans, and residential mortgage loans primarily within our market area.  Commercial real estate, commercial, and construction and land development loans tend to involve larger loan balances to a single borrower or groups of related borrowers and are most susceptible to a risk of loss during a downturn in the business cycle.  These loans also have historically had greater credit risk than other loans for the following reasons:

·   Commercial Real Estate Loans.  Repayment is dependent on income being generated in amounts sufficient to cover operating expenses and debt service.  These loans also involve greater risk because they are generally not fully amortizing over a loan period, but rather have a balloon payment due at maturity.  A borrower’s ability to make a balloon payment typically will depend on being able to either refinance the loan or timely sell the underlying property.  As of December 31, 2012, commercial real estate loans, including multi-family loans, comprised approximately 32% of our total loan portfolio.

·   Commercial Loans.  Repayment is generally dependent upon the successful operation of the borrower’s business.  In addition, the collateral securing the loans may depreciate over time, be difficult to appraise, be illiquid, or fluctuate in value based on the success of the business.  As of December 31, 2012, commercial loans comprised approximately 10% of our total loan portfolio.

·   Construction and land development loans. The risk of loss is largely dependent on our initial estimate of whether the property’s value at completion equals or exceeds the cost of property construction and the availability of take-out financing.  During the construction phase, a number of factors can result in delays or cost overruns.  If our estimate is inaccurate or if actual construction costs exceed estimates, the value of the property securing our loan may be insufficient to ensure full repayment when completed through a permanent loan, sale of the property, or by seizure of collateral.  As of December 31, 2012, construction and land development loans comprised approximately 12% of our total loan portfolio.

·   Single-family residential loans.  Declining home sales volumes, decreased real estate values and higher than normal levels of unemployment could contribute to losses on these loans.  As of December 31, 2012, single-family residential loans comprised approximately 40% of the Bank’s total loan portfolio, including Banco de la Gente single-family residential stated income loans amounting to approximately 8% of the Bank’s total loan portfolio.

18

Because we engage in lending secured by real estate and may be forced to foreclose on the collateral property and own the underlying real estate, we may be subject to the increased costs associated with the ownership of real property, which could result in reduced net income.

Since we originate loans secured by real estate, we may have to foreclose on the collateral property to protect our investment and may thereafter own and operate such property, in which case we are exposed to the risks inherent in the ownership of real estate.

The amount that we, as a mortgagee, may realize after a default is dependent upon factors outside of our control, including, but not limited to:

·   general or local economic conditions;

·   environmental cleanup liability;

·   neighborhood values;

·   interest rates;

·   real estate tax rates;

·   operating expenses of the mortgaged properties;

·   supply of and demand for rental units or properties;

·   ability to obtain and maintain adequate occupancy of the properties;

·   zoning laws;

·   governmental rules, regulations and fiscal policies; and

·   acts of God.

Certain expenditures associated with the ownership of real estate, principally real estate taxes and maintenance costs, may adversely affect the income from the real estate. Therefore, the cost of operating real property may exceed the rental income earned from such property, and we may have to advance funds in order to protect our investment or we may be required to dispose of the real property at a loss.

Risks Related to Our Common Stock:

The trading volume in our common stock is less than that of larger public companies which can cause price volatility.

The trading history of our common stock has been characterized by relatively low trading volume. The value of a shareholder’s investment may be subject to sudden decreases due to the volatility of the price of our common stock, which trades on the NASDAQ Global Market.

The market price of our common stock may be volatile and subject to fluctuations in response to numerous factors, including, but not limited to, the factors discussed in other risk factors and the following:

·   actual or anticipated fluctuation in our operating results;

·   changes in interest rates;

·   changes in the legal or regulatory environment in which we operate;

·   press releases, announcements or publicity relating to us or our competitors or relating to trends in our industry;

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

·   future sales of our common stock;

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

·   other developments affecting our competitors or us.

These factors may adversely affect the trading price of our common stock, regardless of our actual operating performance, and could prevent a shareholder from selling common stock at or above the current market price.  In addition, the Company cannot say with any certainty that a more active and liquid trading market for its common stock will develop.

19

Our stock price can be volatile.

Stock price volatility may make it more difficult for you to resell your common stock when you want and at prices you find attractive.  Our stock price can fluctuate significantly in response to a variety of factors including, among other things:

·   actual or anticipated variations in quarterly results of operations;

·   recommendations by securities analysts;

·   operating results and stock price performance of other companies that investors deem comparable to us;

·   news reports relating to trends, concerns, and other issues in the financial services industry;

·   perceptions in the marketplace regarding us and/or our competitors;

·   new technology used or services offered by competitors;

·   significant acquisitions or business combinations, strategic partnerships, joint ventures, or capital commitments by or involving us or our competitors; and

·   changes in government regulations.

Our common stock is not FDIC insured.

The Company’s common stock is not a savings or deposit account or other obligation of any bank and is not insured by the FDIC or any other governmental agency and is subject to investment risk, including the possible loss of principal.  Investment in our common stock is inherently risky for the reasons described in this “Risk Factors” section and elsewhere in this report and is subject to the same market forces that affect the price of common stock in any company.  As a result, holders of our common stock may lose some or all of their investment.

We may reduce or eliminate dividends on our common stock.

Although we have historically paid a quarterly cash dividend to the holders of our common stock, holders of our common stock are not entitled to receive dividends. Downturns in the domestic and global economies could cause our Board of Directors to consider, among other things, reducing or eliminating dividends paid on our common stock.  This could adversely affect the market price of our common stock. Furthermore, as a bank holding company, our ability to pay dividends is subject to the guidelines of the Federal Reserve regarding capital adequacy and dividends before declaring or paying any dividends.  Dividends also may be limited as a result of safety and soundness considerations.

Our articles of incorporation, as amended, amended and restated bylaws, and certain banking laws may have an anti-takeover effect.

Provisions of our articles of incorporation, as amended, amended and restated bylaws, and federal banking laws, including regulatory approval requirements, could make it more difficult for a third party to acquire us, even if doing so would be perceived to be beneficial to our shareholders. The combination of these provisions may prohibit a non-negotiated merger or other business combination, which, in turn, could adversely affect the market price of our common stock.

ITEM 1B.  UNRESOLVED STAFF COMMENTS

Not applicable.

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ITEM 2.  PROPERTIES

At December 31, 2012, the Company and the Bank conducted their business from the headquarters office in Newton, North Carolina, its Banco administrative office and its 22 other branch offices in Lincolnton, Hickory, Newton, Catawba, Conover, Claremont, Maiden, Denver, Triangle, Hiddenite, Charlotte, Monroe, Cornelius, Mooresville and Raleigh, North Carolina.  The Bank also operates a loan production office in Denver, North Carolina.  The following table sets forth certain information regarding the Bank’s properties at December 31, 2012.

  Owned Corporate Office 518 West C Street Newton, North Carolina  28658   420 West A Street Newton, North Carolina 28658   2619 North Main Avenue Newton, North Carolina  28658   213 1st Street, West Conover, North Carolina  28613   3261 East Main Street Claremont, North Carolina  28610   6125 Highway 16 South Denver, North Carolina  28037   5153 N.C. Highway 90E Hiddenite, North Carolina  28636   200 Island Ford Road Maiden, North Carolina  28650   3310 Springs Road NE Hickory, North Carolina  28601   142 South Highway 16 Denver, North Carolina  28037   106 North Main Street Catawba, North Carolina 28609   2050 Catawba Valley Boulevard Hickory, North Carolina  28601   800 E. Arrowood Road Charlotte, NC  28217   1074 River Highway Mooresville, NC, 28117   Leased 1333 2nd Street NE Hickory, North Carolina  28601   1910 East Main Street Lincolnton, North Carolina  28092 760 Highway 27 West Lincolnton, North Carolina 28092   102 Leonard Avenue Newton, North Carolina 28658   6300 South Boulevard Suite 100 Charlotte, North Carolina 28217   4451 Central Avenue Suite A Charlotte, North Carolina  28205   3752/3754 Highway 16 North Denver, North Carolina  28037   501 West Roosevelt Boulevard Monroe, NC  28110   9624-I Bailey Road Cornelius, North Carolina  28031   4011 Capital Boulevard Raleigh, NC  27604   125-E Trade Court Mooresville, NC 28117

ITEM 3.  LEGAL PROCEEDINGS

In the opinion of management, the Company is not involved in any material pending legal proceedings other than routine proceedings occurring in the ordinary course of business.

ITEM 4.  MINE SAFETY DISCLOSURES

Not applicable.

21

PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The Company’s common stock is listed on the NASDAQ Global Market, under the symbol “PEBK.”  Market makers for the Company’s shares include Scott and Stringfellow, Inc. and Sterne Agee & Leach.

Although the payment of dividends by the Company is subject to certain requirements and limitations of North Carolina corporate law, neither the Commissioner nor the FDIC have promulgated any regulations specifically limiting the right of the Company to pay dividends and repurchase shares.  However, the ability of the Company to pay dividends and repurchase shares may be dependent upon, among other things, the Company’s receipt of dividends from the Bank.  The Bank’s ability to pay dividends is limited. North Carolina commercial banks, such as the Bank, are subject to legal limitations on the amount of dividends they are permitted to pay. Dividends may be paid by the Bank from undivided profits, which are determined by deducting and charging certain items against actual profits, including any contributions to surplus required by North Carolina law. Also, an insured depository institution, such as the Bank, is prohibited from making capital distributions, including the payment of dividends, if, after making such distribution, the institution would become “undercapitalized” (as such term is defined in the applicable law and regulations). Based on its current financial condition, the Bank does not expect that this provision will have any impact on the Bank’s ability to pay dividends. See Supervision and Regulation under Item 1 Business.

As of March 15, 2013, the Company had 721 shareholders of record, not including the number of persons or entitieswhose stock is held in nominee or street name through various brokerage firms or banks. The market price for the Company’s common stock was $11.50 on March 15, 2013.

The following table presents certain market and dividend information for the last two fiscal years.  Over-the-counter quotations reflect inter-dealer prices, without retail mark-up, mark down or commission and may not necessarily represent actual transactions.

						Cash Dividend
2012		Low Bid		High Bid		Per Share
	First Quarter	$	5.16		8.76		0.07
	Second Quarter	$	7.01		9.00		0.02
	Third Quarter	$	7.88		10.44		0.02
	Fourth Quarter	$	8.59		10.50		0.07

						Cash Dividend
2011		Low Bid		High Bid		Per Share
	First Quarter	$	5.20		7.27		0.02
	Second Quarter	$	5.55		7.20		0.02
	Third Quarter	$	4.22		6.68		0.02
	Fourth Quarter	$	4.11		5.96		0.02

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STOCK PERFORMANCE GRAPH

The following graph compares the Company’s cumulative shareholder return on its common stock with a NASDAQ index and with a southeastern bank index. The graph was prepared by SNL Securities, L.C., Charlottesville, Virginia, using data as of December 31, 2012.

COMPARISON OF SIX-YEAR CUMULATIVE TOTAL RETURNS

Performance Report for

Peoples Bancorp of North Carolina, Inc.

Peoples Bancorp of North Carolina, Inc.

	Period Ending
Index	12/31/07		12/31/08		12/31/09		12/31/10		12/31/11		12/31/12
Peoples Bancorp of North Carolina, Inc.		100.00		63.81		35.93		38.70		41.02		69.52
NASDAQ Composite		100.00		60.02		87.24		103.08		102.26		120.42
SNL Southeast Bank		100.00		40.48		40.65		39.47		23.09		38.36

Source : SNL Financial LC, Charlottesville, VA

© 2013

www.snl.com

23

The information required by Item 201(d) concerning securities authorized for issuance under equity compensation plans is set forth in Item 12 hereof.

ISSUER PURCHASES OF EQUITY SECURITIES
Period	Total Number of Shares Purchased			Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
January 1 - 31, 2012		-		$	-		-		-
February 1 - 29, 2012		2,000	(1)		6.92		-		-
March 1 - 31, 2012		1,350	(1)		8.03		-		-
April 1 - 30, 2012		-			-		-		-
May 1 - 31, 2012		2,100	(1)		8.16		-		-
June 1 - 30, 2012		12,530	(2)		966.36		-		-
July 1 - 31, 2012		-			-		-		-
August 1 - 31, 2012		357,234	(3)		1.19		-		-
September 1 - 30, 2012		5,050	(1)		9.50		-		-
October 1 - 31, 2012		-			-		-		-
November 1 - 30, 2012		1,880	(1)		10.17		-		-
December 1 - 31, 2012		765	(1)		10.03		-		-
Total		382,909		$	33.04		-		-

(1)  The Company purchased 13,145 shares on the open market in the year ended December 31, 2012 for its deferred compensation plan.  All purchases were funded by participant contributions to the plan.

(2)  On June 28, 2012, the Company purchased 12,530 shares of the Company’s 25,054 outstanding shares of preferred stock from the UST, which was issued to the UST in connection with the Company’s participation in the CPP under the TARP in 2008.

(3)  On August 8, 2012, the Company completed its repurchase of the Warrant to purchase 357,234 shares of the Company's common stock that was issued to the UST on December 23, 2008, as part of the CPP under TARP.  The Company repurchased the Warrant for a total price of $425,000.

ITEM 6.  SELECTED FINANCIAL DATA

The information required by this Item is set forth in the table captioned "Selected Financial Data" on page A-3 of the Annual Report, which Annual Report is included in this Form 10-K as Exhibit (13).

ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The information required by this Item is set forth in the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations” on pages A-4 through A-27 of the Annual Report, which section is included in this Form 10-K as Exhibit (13).

24

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The information required by this Item is set forth in the section captioned “Quantitative and Qualitative Disclosures About Market Risk” on page A-26 of the Annual Report, which Annual Report is included in this Form 10-K as Exhibit (13).

ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The consolidated financial statements of the Company and supplementary data are set forth on pages A-28 through A-64 of the Annual Report, which Annual Report is included in this Form 10-K as Exhibit (13).

ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

Not applicable.

ITEM 9A.  CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

The Company’s management, under the supervision and with the participation of the Chief Executive Officer and the Chief Financial Officer of the Company, has concluded, based on their evaluation as of the end of the period covered by this Report, that the Company’s disclosure controls and procedures (as defined in Rule 13A-15(e) promulgated under the Exchange Act) are effective to ensure that information required to be disclosed by the Company in the reports filed or submitted by it under the  Exchange Act  is recorded, processed, summarized and reported within the time periods specified in the applicable rules and forms and include controls and procedures designed to ensure that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company’s management including the Chief Executive Officer and the Chief Financial Officer of the Company as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Controls over Financial Reporting

There have been no changes in internal control over financial reporting during the quarter ended December 31, 2012 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Management’s Annual Report on Internal Controls over Financial Reporting

The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting.  Internal control over financial reporting is defined in Rule 13a-15(f) promulgated under the Securities Exchange Act of 1934.  The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.  Internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company, (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the Company and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.

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

Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2012.  In making this assessment, management used the criteria established in “Internal Control – Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission.  Based on our assessment and those criteria, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2012.

25

This annual report does not include an attestation report of the Company’s registered independent public accounting firm regarding internal control over financial reporting.  Management’s report was not subject to attestation by the Company’s registered independent public accounting firm pursuant to rules that permit the Company to provide only management’s report in this annual report.

ITEM 9B.   OTHER INFORMATION

None

PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The information required by this Item regarding directors and executive officers of the Company is set forth under the sections captioned “Nominees”, “Our Board of Directors and Its Committees”; “Executive Committee”, “Governance Committee”, “Audit and Risk Management Committee”, “Compensation Committee”, “Board Leadership and Structure and Risk Oversight” contained in the Proxy Statement, which sections are incorporated herein by reference.

The information required by this Item regarding compliance with Section 16(a) of the Exchange Act is set forth under the section captioned “Section 16(a) Beneficial Ownership Reporting Compliance” contained in the Proxy Statement, which section is incorporated herein by reference.

The information required by this Item regarding identification of members of the Company’s Audit Committee is set forth under the section captioned “Audit and Risk Management Committee” contained in the Proxy Statement, which section is incorporated herein by reference.

The Company has adopted a Code of Ethics that applies to the Company’s employees, including the principal executive officer and principal financial officer.  The Company has also adopted a written charter for the Audit Committee, which is reviewed annually, and amended as needed, by the Committee. These documents are available on the Bank’s website (www.peoplesbanknc.com) under “Investor Relations.”

ITEM 11.  EXECUTIVE COMPENSATION

The information required by this Item is set forth under the section captioned “Management Compensation” contained in the Proxy Statement, which section is incorporated herein by reference.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

For the information required by the Item see the section captioned “Security Ownership of Certain Beneficial Owners and Management” contained in the Proxy Statement, which section is incorporated herein by reference.

The following table presents the number of shares of Company common stock to be issued upon the exercise of outstanding options, warrants and rights; the weighted-average price of the outstanding options, warrants and rights and the number of options, warrants and rights remaining that may be issued under the Company’s Omnibus Plan described under the section captioned “Omnibus Stock Option and Long Term Incentive Plan” contained in the Proxy Statement .

26

Plan Category	Number of securities to be issued upon exercise of outstanding option, warrants and rights (1), (2)		Weighted-average exercise price of outstanding options, warrants and rights (3)		Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) (4)
	(a)		(b)		(c)
Equity compens ation  plans approved by s ecurity holders		33,144	$	9.23		330,486
Equity compens ation  plans  not approved by s ecurity holders		-		-		-
Total		33,144	$	9.23		330,486

(1)  Includes 3,630 stock  options issued on May 6, 2004 under the 1999 Omnibus Stock  Option and  Long Term Incentive Plan (the "1999 Omnibus Plan"), which are fully vested as of December 31, 2012.

(2)  Includes 24,159 restricted stock  units granted on March 22, 2012 and  5,355 restricted stock units granted on July 26, 2012 under the February 19, 2009 Omnibus Stock Ownership and Long Term Incentive Plan (the "2009 Omnibus Plan"). These restricted stock grants cliff vest five years after issuance.

(3)  The exercise price for the grant of stock options under the 1999 Omnibus Plan on May  6, 2004 is $10.31. Exercise price and shares have been adjusted for the 10% stock dividends paid March 16, 2005 and June 16, 2006 and the three-for-two stock split paid June 15, 2007. The exercise price used for the grants of restricted stock units under the 2009 Omnibus Plan is $9.10, the closing price for the Company’s stock on December 31, 2012.

(4)  Reflects shares currently reserved for  possible issuance under the 2009 Omnibus Plan.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE

See the section captioned “Indebtedness of and Transactions with Management and Directors” contained in the Proxy Statement, which section is incorporated herein by reference.

ITEM 14.  PRINCIPAL ACCOUNTANT FEES AND SERVICES

See the section captioned “Proposal 4 - Ratification of Selection of Independent Auditor” contained in the Proxy Statement, which section is incorporated herein by reference.

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PART IV

ITEM 15.   EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

15(a)1. Consolidated Financial Statements (contained in the Annual Report attached hereto as Exhibit (13) and incorporated herein by reference)

(a) Report of Independent Registered Public Accounting Firm

(b) Consolidated Balance Sheets as of December 31, 2012 and 2011

(c) Consolidated Statements of Earnings for the Years Ended December 31, 2012, 2011 and 2010

(d) Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2012, 2011 and 2010

(e) Consolidated Statements of Changes in Shareholders’ Equity for the Years Ended December 31, 2012, 2011 and 2010

(f) Consolidated Statements of Cash Flows for the Years Ended December 31, 2012, 2011 and 2010

(g) Notes to Consolidated Financial Statements

15(a)2. Consolidated Financial Statement Schedules

                         All schedules have been omitted, as the required information is either inapplicable or included in the Notes to Consolidated Financial Statements.

15(a)3. Exhibits

  Exhibit (3)(1) Articles of Amendment dated December 19, 2008, regarding the Series A Preferred Stock, incorporated by reference to Exhibit (3)(1) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008

  Exhibit (3)(2) Articles of Amendment dated February 26, 2010 incorporated by reference to Exhibit (3)(2) to the Form 10-K filed with the Securities and Exchange Commission on March 25, 2010

  Exhibit (3)(i) Articles of Incorporation of the Registrant, incorporated by reference to Exhibit (3)(i) to the Form 8-A filed with the Securities and Exchange Commission on September 2, 1999

  Exhibit (3)(ii) Amended and Restated Bylaws of the Registrant incorporated by reference to Exhibit (3)(ii) to the Form 10-K filed with the Securities and Exchange Commission on March 25, 2010

  Exhibit (4) Specimen Stock Certificate, incorporated by reference to Exhibit (4) to the Form 8-A filed with the Securities and Exchange Commission on September 2, 1999

  Exhibit (4)(1) Form of Certificate for the Series A Preferred Stock, incorporated by reference to Exhibit (4)(1) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008

28

  Exhibit (4)(2) Warrant dated December 23, 2008, for the purchase of shares of Common Stock, incorporated by reference to Exhibit (4)(2) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008

  Exhibit (10)(1) Letter Agreement dated December 23, 2008 between the Registrant and the United States Department of the Treasury, incorporated by reference to Exhibit (10)(1) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008

  Exhibit (10)(a)(i) Employment Letter Agreement dated December 23, 2008 between the Registrant and Tony W. Wolfe, incorporated by reference to Exhibit (10)(a)(i) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008

  Exhibit (10)(a)(ii) Amendment to Employment Agreement between Peoples Bank and Tony W. Wolfe dated December 18, 2008, incorporated by reference to Exhibit (10)(a)(ii) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008

  Exhibit (10)(a)(iii) Amended and Restated Executive Salary Continuation Agreement between Peoples Bank and Tony W. Wolfe dated December 18, 2008, incorporated by reference to Exhibit (10)(a)(iii) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008

  Exhibit (10)(b)(i) Employment Letter Agreement dated December 23, 2008 between the Registrant and Joseph F. Beaman, Jr., incorporated by reference to Exhibit (10)(b)(i) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008

  Exhibit (10)(b)(ii) Amendment to Employment Agreement between Peoples Bank and Joseph F. Beaman, Jr. dated December 18, 2008, incorporated by reference to Exhibit (10)(b)(ii) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008

  Exhibit (10)(b)(iii) Amended and Restated Executive Salary Continuation Agreement between Peoples Bank and Joseph F. Beaman, Jr. dated December 18, 2008, incorporated by reference to Exhibit (10)(b)(iii) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008

  Exhibit (10)(c)(i) Employment Letter Agreement dated December 23, 2008 between the Registrant and William D. Cable, Sr., incorporated by reference to Exhibit (10)(c)(i) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008

  Exhibit (10)(c)(ii) Amendment to Employment Agreement between Peoples Bank and William D. Cable, Sr. dated December 18, 2008, incorporated by reference to Exhibit (10)(c)(ii) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008

  Exhibit (10)(c)(iii) Amended and Restated Executive Salary Continuation Agreement between Peoples Bank and William D. Cable, Sr. dated December 18, 2008, incorporated by reference to Exhibit (10)(c)(iii) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008

  Exhibit (10)(d)(i) Employment Letter Agreement dated December 23, 2008 between the Registrant and Lance A. Sellers, incorporated by reference to Exhibit (10)(d)(i) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008

29

  Exhibit (10)(d)(ii) Amendment to Employment Agreement between Peoples Bank and Lance A. Sellers dated December 18, 2008, incorporated by reference to Exhibit (10)(d)(ii) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008

  Exhibit (10)(d)(iii) Amended and Restated Executive Salary Continuation Agreement between Peoples Bank and Lance A. Sellers dated December 18, 2008, incorporated by reference to Exhibit (10)(d)(iii) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008

  Exhibit (10)(e) Peoples Bancorp of North Carolina, Inc. Omnibus Stock Ownership and Long Term Incentive Plan incorporated by reference to Exhibit (10)(f) to the Form 10-K filed with the Securities and Exchange Commission on March 30, 2000

  Exhibit (10)(e)(i) Amendment No. 1 to the Peoples Bancorp of North Carolina, Inc. Omnibus Stock Ownership and Long Term Incentive Plan incorporated by reference to Exhibit (10)(e)(i) to the Form 10-K filed with the Securities and Exchange Commission on March 15, 2007

  Exhibit (10)(f)(i) Employment Letter Agreement dated December 23, 2008 between the Registrant and A. Joseph Lampron, Jr,, incorporated by reference to Exhibit (10)(f)(i) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008

  Exhibit (10)(f)(ii) Amendment to Employment Agreement between Peoples Bank and A. Joseph Lampron, Jr. dated March 18, 2010 incorporated by reference to Exhibit (10)(f)(ii) to the Form 10-K filed with the Securities and Exchange Commission on March 25, 2010

  Exhibit (10)(f)(iii) Amended and Restated Executive Salary Continuation Agreement between Peoples Bank and A. Joseph Lampron, Jr. dated December 18, 2008, incorporated by reference to Exhibit (10)(f)(iii) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008

  Exhibit (10)(g) Peoples Bank Directors’ and Officers’ Deferral Plan, incorporated by reference to Exhibit (10)(h) to the Form 10-K filed with the Securities and Exchange Commission on March 28, 2002

  Exhibit (10)(h) Rabbi Trust for the Peoples Bank Directors’ and Officers’ Deferral Plan, incorporated by reference to Exhibit (10)(i) to the Form 10-K filed with the Securities and Exchange Commission on March 28, 2002

  Exhibit (10)(i) Description of Service Recognition Program maintained by Peoples Bank, incorporated by reference to Exhibit (10)(i) to the Form 10-K filed with the Securities and Exchange Commission on March 27, 2003

  Exhibit (10)(j) Capital Securities Purchase Agreement dated as of June 26, 2006, by and among the Registrant, PEBK Capital Trust II and Bear, Sterns Securities Corp., incorporated by reference to Exhibit (10)(j) to the Form 10-Q filed with the Securities and Exchange Commission on November 13, 2006

  Exhibit (10)(k) Amended and Restated Trust Agreement of PEBK Capital Trust II, dated as of June 28, 2006, incorporated by reference to Exhibit (10)(k) to the Form 10-Q filed with the Securities and Exchange Commission on November 13, 2006

  Exhibit (10)(l) Guarantee Agreement of the Registrant dated as of June 28, 2006, incorporated by reference to Exhibit (10)(l) to the Form 10-Q filed with the Securities and Exchange Commission on November 13, 2006

30

  Exhibit (10)(m) Indenture, dated as of June 28, 2006, by and between the Registrant and LaSalle Bank National Association, as Trustee, relating to Junior Subordinated Debt Securities Due September 15, 2036, incorporated by reference to Exhibit (10)(m) to the Form 10-Q filed with the Securities and Exchange Commission on November 13, 2006

  Exhibit (10)(n) Form of Amended and Restated Director Supplemental Retirement Agreement between Peoples Bank and Directors Robert C. Abernethy, James S. Abernethy, Douglas S. Howard, John W. Lineberger, Jr., Gary E. Matthews, Dr. Billy L Price, Jr., Larry E Robinson, W. Gregory Terry, Dan Ray Timmerman, Sr., and Benjamin I. Zachary, incorporated by reference to Exhibit (10)(n) to the Form 8-K filed with the Securities and Exchange Commission on December 29, 2008

  Exhibit (10)(o) 2009 Omnibus Stock Ownership and Long Term Incentive Plan incorporated by reference to Exhibit (10)(o) to the Form 10-K filed with the Securities and Exchange Commission on March 20, 2009

  Exhibit (10)(p) Underwriting Agreement with Merrill Lynch, Pierce, Fenner & Smith Incorporated and Sandler O’Neill & Partners, L.P., as representatives of the several underwriters listed on Schedule A thereto and the UST incorporated by reference to Exhibit 1.1 to the Form 8-K filed with the Securities and Exchange Commission on June 29, 2012

  Exhibit (11) Statement regarding computation of per share earnings

  Exhibit (12) Statement regarding computation of ratios

  Exhibit (13) 2012 Annual Report of Peoples Bancorp of North Carolina, Inc.

  Exhibit (14) Code of Business Conduct and Ethics of Peoples Bancorp of North Carolina, Inc., incorporated by reference to Exhibit (14) to the Form 10-K filed with the Securities and Exchange Commission on March 25, 2005

  Exhibit (21) Subsidiaries of the Registrant

  Exhibit (23) Consent of Porter Keadle Moore, LLC

  Exhibit (31)(a) Certification of principal executive officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002

  Exhibit (31)(b) Certification of principal financial officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002

  Exhibit (32) Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

  Exhibit (99)(a) Certification of the Principal Executive Officer Pursuant to Section 111 of the Emergency Economic Stabilization Act of 2008

  Exhibit (99)(b) Certification of the Principal Financial Officer Pursuant to Section 111 of the Emergency Economic Stabilization Act of 2008

  Exhibit (101) The following materials from the Company’s 10-K Report for the annual period ended December 31, 2012, formatted in XBRL: (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Income, (iii) the Condensed Consolidated Statements of Changes in Shareholders’ Equity, (iv) the Condensed Consolidated Statements of Cash Flows, and (v) the Notes to the Condensed Consolidated Financial Statements, tagged as blocks of text.*   *Furnished, not filed.

31

SIGNATURES

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

PEOPLES BANCORP OF NORTH CAROLINA, INC. (Registrant)
By:	/s/ Lance A. Sellers
	Lance A. Sellers
	President and Chief Executive Officer
	Date:  March 22, 2013

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:

Signature	Title	Date
/s/ Lance A. Sellers	President and Chief Executive Officer	March 22, 2013
Lance A. Sellers	(Principal Executive Officer)
/s/ James S. Abernethy	Director	March 22, 2013
James S. Abernethy
/s/ Robert C. Abernethy	Chairman of the Board and Director	March 22, 2013
Robert C. Abernethy
/s/ Douglas S. Howard	Director	March 22, 2013
Douglas S. Howard
/s/ A. Joseph Lampron, Jr.	Executive Vice President and Chief	March 22, 2013
A. Joseph Lampron, Jr.	Financial Officer (Principal Financial
	and Principal Accounting Officer)
/s/ John W. Lineberger, Jr.	Director	March 22, 2013
John W. Lineberger, Jr.
/s/ Gary E. Matthews	Director	March 22, 2013
Gary E. Matthews
/s/ Billy L. Price, Jr., M.D.	Director	March 22, 2013
Billy L. Price, Jr., M.D.
/s/ Larry E. Robinson	Director	March 22, 2013
Larry E. Robinson
/s/ William Gregory Terry	Director	March 22, 2013
William Gregory Terry
/s/ Dan Ray Timmerman, Sr.	Director	March 22, 2013
Dan Ray Timmerman, Sr.
/s/ Benjamin I. Zachary	Director	March 22, 2013
Benjamin I. Zachary

32

EX-11

EXHIBIT (11)

STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS

The computation of earnings per share is contained in Note 1 of the Notes to Consolidated Financial Statements and is incorporated herein by reference.

EX-12

EXHIBIT (12)

STATEMENT REGARDING COMPUTATION OF RATIOS

The averages used in computing the performance ratios provided in Item 6 represent average daily balances.

EX-13

EXHIBIT (13)

The Annual Report to Security Holders is Appendix A to the Proxy Statement for the 2013 Annual Meeting of Shareholders and is incorporated herein by reference.

APPENDIX A

ANNUAL REPORT

OF

PEOPLES BANCORP OF NORTH CAROLINA, INC.

PEOPLES BANCORP OF NORTH CAROLINA, INC.

General Description of Business

Peoples Bancorp of North Carolina, Inc. (the “Company”), was formed in 1999 to serve as the holding company for Peoples Bank (the “Bank”).  The Company is a bank holding company registered with the Board of Governors of the Federal Reserve System (the “Federal Reserve”) under the Bank Holding Company Act of 1956, as amended (the “BHCA”).  The Company’s principal source of income is dividends declared and paid by the Bank on its capital stock, if any.  The Company has no operations and conducts no business of its own other than owning the Bank and Community Bank Real Estate Solutions, LLC (“CBRES”).  Accordingly, the discussion of the business which follows concerns the business conducted by the Bank, unless otherwise indicated.

The Bank, founded in 1912, is a state-chartered commercial bank serving the citizens and business interests of the Catawba Valley and surrounding communities through 22 banking offices located in Lincolnton, Newton, Denver, Catawba, Conover, Maiden, Claremont, Hiddenite, Hickory, Charlotte, Monroe, Cornelius, Mooresville and Raleigh, North Carolina.  The Bank also operates a loan production office in Denver, North Carolina.  At December 31, 2012, the Company had total assets of $1.0 billion, net loans of $605.6 million, deposits of $781.5 million, total securities of $303.4 million, and shareholders’ equity of $97.7 million.

The Bank operates four offices focused on the Latino population under the name Banco de la Gente (“Banco”).  These offices are operated as a division of the Bank.  Banco offers normal and customary banking services as are offered in the Bank’s other branches such as the taking of deposits and the making of loans and therefore is not considered a reportable segment of the Company.

The Bank has a diversified loan portfolio, with no foreign loans and few agricultural loans.  Real estate loans are predominately variable rate commercial property loans, which include residential development loans to commercial customers.  Commercial loans are spread throughout a variety of industries with no one particular industry or group of related industries accounting for a significant portion of the commercial loan portfolio.  The majority of the Bank’s deposit and loan customers are individuals and small to medium-sized businesses located in the Bank’s market area.  The Bank’s loan portfolio also includes Individual Taxpayer Identification Number (ITIN) mortgage loans generated thorough the Bank’s Banco offices.  Additional discussion of the Bank’s loan portfolio and sources of funds for loans can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” on pages A-4 through A-27 of the Annual Report, which is included in this Form 10-K as Exhibit (13).

The operations of the Bank and depository institutions in general are significantly influenced by general economic conditions and by related monetary and fiscal policies of depository institution regulatory agencies, including the Federal Reserve, the Federal Deposit Insurance Corporation (the “FDIC”) and the North Carolina Commissioner of Banks (the “Commissioner”).

At December 31, 2012, the Company employed 247 full-time employees and 38 part-time employees, which equated to 273 full-time equivalent employees.

Subsidiaries

The Bank is a subsidiary of the Company.  The Bank has two subsidiaries, Peoples Investment Services, Inc. and Real Estate Advisory Services, Inc. Through a relationship with Raymond James Financial Services, Inc., Peoples Investment Services, Inc. provides the Bank’s customers access to investment counseling and non-deposit investment products such as stocks, bonds, mutual funds, tax deferred annuities, and related brokerage services.  Real Estate Advisory Services, Inc. provides real estate appraisal and real estate brokerage services.

In June 2006, the Company formed a wholly owned Delaware statutory trust, PEBK Capital Trust II (“PEBK Trust II”), which issued $20.0 million of guaranteed preferred beneficial interests in the Company’s junior subordinated deferrable interest debentures.  All of the common securities of PEBK Trust II are owned by the Company.  The proceeds from the issuance of the common securities and the trust preferred securities were used by PEBK Trust II to purchase $20.6 million of junior subordinated debentures of the Company, which pay a floating rate equal to three-month LIBOR plus 163 basis points.  The proceeds received by the Company from the sale of the junior subordinated debentures were used in December 2006 to repay the trust preferred securities issued in December 2001 by PEBK Capital Trust, a wholly owned Delaware statutory trust of the Company, and for general purposes.  The debentures represent the sole asset of PEBK Trust II.  PEBK Trust II is not included in the consolidated financial statements.

The trust preferred securities issued by PEBK Trust II accrue and pay quarterly at a floating rate of three-month LIBOR plus 163 basis points.  The Company has guaranteed distributions and other payments due on the trust preferred securities to the extent PEBK Trust II does not have funds with which to make the distributions and other payments.  The net

A-1

combined effect of the trust preferred securities transaction is that the Company is obligated to make the distributions and other payments required on the trust preferred securities.

These trust preferred securities are mandatorily redeemable upon maturity of the debentures on June 28, 2036, or upon earlier redemption as provided in the indenture.  The Company has the right to redeem the debentures purchased by PEBK Trust II, in whole or in part, which became effective on June 28, 2011.  As specified in the indenture, if the debentures are redeemed prior to maturity, the redemption price will be the principal amount plus any accrued but unpaid interest.

The Company established a new subsidiary, CBRES, in 2009. CBRES serves as a “clearing-house” for appraisal services for community banks.  Other banks are able to contract with CBRES to find and engage appropriate appraisal companies in the area where the property is located.  This type of service ensures that the appraisal process remains independent from the financing process within the bank.

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

A-2

SELECTED FINANCIAL DATA

Dollars in Thousands Except Per Share Amounts
	2012		2011	2010			2009	2008
Summary of Operations
Interest income	$	39,245	45,259		47,680		50,037	56,322
Interest expense		7,696	10,946		14,348		17,187	23,526
Net interest earnings		31,549	34,313		33,332		32,850	32,796
Provision for loan losses		4,924	12,632		16,438		10,535	4,794
Net interest earnings after provision
for loan losses		26,625	21,681		16,894		22,315	28,002
Non-interest income		12,537	14,513		13,884		11,823	10,495
Non-interest expense		31,782	29,572		28,948		29,883	28,893
Earnings before taxes		7,380	6,622		1,830		4,255	9,604
Income taxes		1,587	1,463		(11	)	1,339	3,213
Net earnings		5,793	5,159		1,841		2,916	6,391
Dividends and accretion of preferred stock		1,010	1,393		1,394		1,246	-
Net earnings available to common
shareholders	$	4,783	3,766		447		1,670	6,391
Selected Year-End Balances
Assets	$	1,013,516	1,067,063		1,067,652		1,048,494	968,762
Available for sale securities		297,823	321,388		272,449		195,115	124,916
Loans, net		605,551	653,893		710,667		762,643	770,163
Mortgage loans held for sale		6,922	5,146		3,814		2,840	-
Interest-earning assets		931,738	1,004,131		1,010,983		988,017	921,101
Deposits		781,525	827,111		838,712		809,343	721,062
Interest-bearing liabilities		770,546	820,452		850,233		826,838	758,334
Shareholders' equity	$	97,747	103,027		96,858		99,223	101,128
Shares outstanding		5,613,495	5,544,160		5,541,413		5,539,056	5,539,056
Selected Average Balances
Assets	$	1,029,612	1,074,250		1,078,136		1,016,257	929,799
Available for sale securities		289,010	295,413		219,797		161,135	115,853
Loans		648,595	697,527		757,532		782,464	747,203
Interest-earning assets		965,994	1,015,451		999,054		956,680	876,425
Deposits		786,976	835,550		840,343		772,075	720,918
Interest-bearing liabilities		770,546	836,382		849,870		796,260	740,478
Shareholders' equity	$	103,805	102,568		101,529		101,162	76,241
Shares outstanding		5,559,401	5,542,548		5,539,308		5,539,056	5,588,314
Profitability Ratios
Return on average total assets		0.56%	0.48%		0.17%		0.29%	0.69%
Return on average shareholders' equity		5.58%	5.03%		1.81%		2.88%	8.38%
Dividend payout ratio*		20.96%	11.78%		100.11%		86.22%	41.93%
Liquidity and Capital Ratios (averages)
Loan to deposit		82.42%	83.48%		90.15%		101.35%	103.65%
Shareholders' equity to total assets		10.08%	9.55%		9.42%		9.95%	8.20%
Per share of Common Stock
Basic net income	$	0.86	0.68		0.08		0.30	1.14
Diluted net income	$	0.86	0.68		0.08		0.30	1.13
Cash dividends	$	0.18	0.08		0.08		0.26	0.48
Book value	$	15.18	14.06		12.96		13.39	13.73

*As a percentage of net earnings available to common shareholders.

A-3

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

The following is a discussion of our financial position and results of operations and should be read in conjunction with the information set forth under Item 1A Risk Factors and the Company’s consolidated financial statements and notes thereto on pages A-28  through A-64.

Introduction

Management’s discussion and analysis of earnings and related data are presented to assist in understanding the consolidated financial condition and results of operations of the Company, for the years ended December 31, 2012, 2011 and 2010.  The Company is a registered bank holding company operating under the supervision of the Federal Reserve Board and the parent company of Peoples Bank (the “Bank”). The Bank is a North Carolina-chartered bank, with offices in Catawba, Lincoln, Alexander, Mecklenburg, Iredell, Union and Wake counties, operating under the banking laws of North Carolina and the rules and regulations of the Federal Deposit Insurance Corporation (the “FDIC”).

Overview

Our business consists principally of attracting deposits from the general public and investing these funds in commercial loans, real estate mortgage loans, real estate construction loans and consumer loans. Our profitability depends primarily on our net interest income, which is the difference between the income we receive on our loan and investment securities portfolios and our cost of funds, which consists of interest paid on deposits and borrowed funds. Net interest income also is affected by the relative amounts of our interest-earning assets and interest-bearing liabilities. When interest-earning assets approximate or exceed interest-bearing liabilities, a positive interest rate spread will generate net interest income. Our profitability is also affected by the level of other income and operating expenses. Other income consists primarily of miscellaneous fees related to our loans and deposits, mortgage banking income and commissions from sales of annuities and mutual funds. Operating expenses consist of compensation and benefits, occupancy related expenses, federal deposit and other insurance premiums, data processing, advertising and other expenses.

Our operations are influenced significantly by local economic conditions and by policies of financial institution regulatory authorities. The earnings on our assets are influenced by the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System (the “Federal Reserve”), inflation, interest rates, market and monetary fluctuations.  Lending activities are affected by the demand for commercial and other types of loans, which in turn is affected by the interest rates at which such financing may be offered.  Our cost of funds is influenced by interest rates on competing investments and by rates offered on similar investments by competing financial institutions in our market area, as well as general market interest rates. These factors can cause fluctuations in our net interest income and other income. In addition, local economic conditions can impact the credit risk of our loan portfolio, in that (1) local employers may be required to eliminate employment positions of individual borrowers, and (2) small businesses and commercial borrowers may experience a downturn in their operating performance and become unable to make timely payments on their loans. Management evaluates these factors in estimating the allowance for loan losses and changes in these economic factors could result in increases or decreases to the provision for loan losses.

The unfavorable economic conditions experienced from 2008 to 2010 moderated in 2011 and 2012 but continue to have a negative impact on our financial condition and results of operations.  Unfavorable economic indicators, such as high unemployment, falling real estate prices and higher than normal levels of loan defaults demonstrate the difficult business conditions that are affecting the general economy and therefore our operating results.  The unemployment rates in our primary market area continued to be higher than state and national averages throughout 2012.

Although we are unable to control the external factors that influence our business, by maintaining high levels of balance sheet liquidity, managing our interest rate exposures and by actively monitoring asset quality, we seek to minimize the potentially adverse risks of unforeseen and unfavorable economic trends.

Our business emphasis has been to operate as a well-capitalized, profitable and independent community-oriented financial institution dedicated to providing quality customer service. We are committed to meeting the financial needs of the communities in which we operate. We believe that we can be more effective in serving our customers than many of our non-local competitors because of our ability to quickly and effectively provide senior management responses to customer needs and inquiries. Our ability to provide these services is enhanced by the stability of our senior management team.

A-4

The Federal Reserve has maintained the Federal Funds Rate at 0.25% since December 31, 2008.  This has had a negative impact on 2010, 2011 and 2012 earnings and will continue to have a negative impact on the Bank’s net interest income in the future periods.  The negative impact from the Federal Funds Rate has been partially offset by the increase in earnings realized on interest rate contracts, including interest rate swaps and interest rate floors, utilized by the Bank.  Additional information regarding the Bank’s interest rate contracts is provided below in the section entitled “Asset Liability and Interest Rate Risk Management.”

On December 23, 2008, the Company entered into a Securities Purchase Agreement (“Purchase Agreement”) with the U.S. Department of the Treasury  (“UST”) pursuant to the Capital Purchase Program (“CPP”) under the Troubled Asset Relief Program (“TARP”).  Under the Purchase Agreement, the Company agreed to issue and sell 25,054 shares of Series A preferred stock and a Warrant to purchase 357,234 shares of the Company’s common stock.  Proceeds from this issuance of Series A preferred shares were allocated between preferred stock and the Warrant based on their relative fair values at the time of the sale.  Of the $25.1 million in proceeds, $24.4 million was allocated to the Series A preferred stock and $704,000 was allocated to the Warrant.  The discount recorded on the Series A preferred stock that resulted from allocating a portion of the proceeds to the Warrant was being accreted directly to retained earnings over a five-year period applying a level yield.  As of December 31, 2012, the Company had accreted a total of $478,000 of the discount related to the Series A preferred stock.

The Series A preferred stock qualifies as Tier 1 capital and will pay cumulative dividends at a rate of 5% per annum for the first five years and 9% per annum thereafter.  The Series A preferred stock may be redeemed at the stated amount of $1,000 per share plus any accrued and unpaid dividends.  Under the terms of the original Purchase Agreement, the Company could not redeem the Series A preferred shares until December 23, 2011 unless the total amount of the issuance, $25.1 million, was replaced with the same amount of other forms of capital that would qualify as Tier 1 capital. However, with the enactment of the American Recovery and Reinvestment Act of 2009 (“ARRA”), the Company can now redeem the Series A preferred shares at any time, if approved by the Company’s primary regulator.  The Series A preferred stock is non-voting except for class voting rights on matters that would adversely affect the rights of the holders of the Series A preferred stock.

The UST sold all of the Company’s CPP preferred stock in a public auction in June 2012, and, as a result, the Company is no longer subject to the executive compensation and corporate governance standards imposed by TARP.  The Company purchased 12,530 shares of the Company’s 25,054 outstanding shares of  Series A preferred stock from the UST, which was issued to the UST in connection with the Company’s participation in the CPP under TARP in 2008.  The shares were purchased for $933.36 per share, for a total purchase price of $11,778,576, including $83,575 accrued and unpaid dividends on the Series A preferred stock.  The Company retired the 12,530 shares purchased.  The $834,999 difference between the $12,530,000 face value of the Series A preferred stock retired and the $11,695,001 purchase price of the Series A preferred stock retired was credited to retained earnings effective June 30, 2012.  Remaining Series A preferred shares are redeemable at any time at par.  The Company expects to be able to repurchase the shares from future earnings, however, there are no immediate plans to repurchase these shares.

During the third quarter of 2012, the Company completed its repurchase of the Warrant to purchase 357,234 shares of the Company's common stock that was issued to the UST on December 23, 2008, as part of the CPP under TARP.  The Company repurchased the Warrant for a total price of $425,000.  The exercise price of the Warrant was $10.52 per common share and was exercisable at anytime on or before December 18, 2018.

Management expects to look for branching opportunities in nearby markets in the future but there are no additional offices planned in 2013.

Summary of Significant Accounting Policies

The consolidated financial statements include the financial statements of the Company and its wholly owned subsidiaries, the Bank and Community Bank Real Estate Solutions, LLC, along with the Bank’s wholly owned subsidiaries, Peoples Investment Services, Inc. and Real Estate Advisory Services, Inc.  All significant intercompany balances and transactions have been eliminated in consolidation.

The Company’s accounting policies are fundamental to understanding management’s discussion and analysis of results of operations and financial condition.  Many of the Company’s accounting policies require significant judgment regarding valuation of assets and liabilities and/or significant interpretation of specific accounting guidance.  The following is a summary of some of the more subjective and complex accounting policies of the Company.  A more complete description of the Company’s significant accounting policies can be found in Note 1 of the Notes to Consolidated Financial Statements in the Company’s 2012 Annual Report to Shareholders which is Appendix A to the Proxy Statement for the May 2, 2013 Annual Meeting of Shareholders.

A-5

Many of the Company’s assets and liabilities are recorded using various techniques that require significant judgment as to recoverability.  The collectability of loans is reflected through the Company’s estimate of the allowance for loan losses.  The Company performs periodic and systematic detailed reviews of its lending portfolio to assess overall collectability.  In addition, certain assets and liabilities are reflected at their estimated fair value in the consolidated financial statements.  Such amounts are based on either quoted market prices or estimated values derived from dealer quotes used by the Company, market comparisons or internally generated modeling techniques.  The Company’s internal models generally involve present value of cash flow techniques.  The various techniques are discussed in greater detail elsewhere in management’s discussion and analysis and the Notes to Consolidated Financial Statements.

There are other complex accounting standards that require the Company to employ significant judgment in interpreting and applying certain of the principles prescribed by those standards.  These judgments include, but are not limited to, the determination of whether a financial instrument or other contract meets the definition of a derivative in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”).

The disclosure requirements for derivatives and hedging activities have the intent to provide users of financial statements with an enhanced understanding of: (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. The disclosure requirements include qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about the fair value of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative instruments.

The Company records all material derivatives on the balance sheet at fair value.  The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting, and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge.  The Company may enter into derivative contracts that are intended to economically hedge certain of its risks, even though hedge accounting does not apply or the Company elects not to apply hedge accounting.

The Company has an overall interest rate risk management strategy that incorporates the use of derivative instruments to minimize significant unplanned fluctuations in earnings that are caused by interest rate volatility.  By using derivative instruments, the Company is exposed to credit and market risk.  If the counterparty fails to perform, credit risk is equal to the extent of the fair-value gain in the derivative.  The Company minimizes the credit risk in derivative instruments by entering into transactions with high-quality counterparties that are reviewed periodically by the Company. The Company had an interest rate swap contract that expired in June 2011.  The Company did not have any interest rate derivatives outstanding as of December 31, 2012.

The Company’s objectives in using interest rate derivatives are to add stability to interest income and expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company primarily uses interest rate swaps and floors as part of its interest rate risk management strategy.  For hedges of the Company’s variable-rate loan assets, interest rate swaps designated as cash flow hedges involve the receipt of fixed-rate amounts from a counterparty in exchange for the Company making variable-rate payments over the life of the agreements without exchange of the underlying notional amount.  For hedges of the Company’s variable-rate loan assets, the interest rate floor designated as a cash flow hedge involves the receipt of variable-rate amounts from a counterparty if interest rates fall below the strike rate on the contract in exchange for an up front premium.

The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in Accumulated Other Comprehensive Income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. During 2011 and 2010, such derivatives were used to hedge the variable cash inflows associated with existing pools of prime-based loan assets.  The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings.  The Company’s derivatives did not have any hedge ineffectiveness recognized in earnings during the years ended December 31, 2011 and 2010.

A-6

The tables below present the effect of the Company’s derivative financial instruments on the Consolidated Statement of Earnings for the years ended December 31, 2012 and 2011.

(Dollars in thousands)

	Amount of Gain (Loss) Recognized in Accumulated OCI on Derivatives					Location of Gain (Loss) Reclassified from Accumulated OCI into Income	Amount of Gain (Loss) Reclassified from Accumulated OCI into Income
	Years ended December 31,						Years ended December 31,
	2012		2011				2012		2011
Interest rate derivative contracts	$	-	$	(20	)	Interest income	$	-	$	628

GAAP establishes a framework for measuring fair value and expands disclosures about fair value measurements. There is a three-level fair value hierarchy for fair value measurements.  Level 1 inputs are quoted prices in active markets for identical assets or liabilities that a company has the ability to access at the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs for the asset or liability.  The table below presents the balance of securities available for sale, which are measured at fair value on a recurring basis by level within the fair value hierarchy as of December 31, 2012 and 2011.

(Dollars in thousands)
	December 31, 2012
	Fair Value Measurements		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
Mortgage-backed securities	$	148,024		-		148,024		-
U.S. Government
sponsored enterprises	$	18,837		-		18,837		-
State and political subdivisions	$	125,658		-		125,658		-
Corporate bonds	$	2,586		-		2,586		-
Trust preferred securities	$	1,250		-		-		1,250
Equity securities	$	1,468		1,468		-		-

(Dollars in thousands)
	December 31, 2011
	Fair Value Measurements		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
Mortgage-backed securities	$	213,693		-		208,349		5,344
U.S. Government
sponsored enterprises	$	7,694		-		7,694		-
State and political subdivisions	$	97,097		-		97,097		-
Corporate bonds	$	543		-		543		-
Trust preferred securities	$	1,250		-		-		1,250
Equity securities	$	1,111		1,111		-		-

Fair values of investment securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges when available.  If quoted prices are not available, fair value is determined using matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities.

The following is an analysis of fair value measurements of investment securities available for sale using Level 3, significant unobservable inputs, for the year ended December 31, 2012.  Transfers out of Level 3 during the year ended December 31, 2012 are attributable to one available for sale security reported in Level 3 at December 31, 2011 because market pricing was unavailable from the Bank’s third party bond accounting provider at that time.  This security was reported in Level 2 at December 31, 2012, as the market valuation was provided by the Bank’s third party bond accounting provider.

A-7

(Dollars in thousands)
	Investment Securities Available for Sale
	Level 3 Valuation
Balance, beginning of period	$	6,594
Change in book value		-
Change in gain/(loss) realized and unrealized		-
Purchases/(sales)		-
Transfers in and/or (out) of Level 3		(5,344	)
Balance, end of period	$	1,250
Change in unrealized gain/(loss) for assets still held in Level 3	$	-

The Bank’s December 31, 2012 and 2011 fair value measurements for impaired loans and other real estate on a non-recurring basis are presented below.  The fair value measurement process uses certified appraisals and other market-based information; however, in many cases, it also requires significant input based on management’s knowledge of and judgment about current market conditions, specific issues relating to the collateral, and other matters.  As a result, all fair value measurements for impaired loans and other real estate are considered Level 3.

(Dollars in thousands)
	Fair Value Measurements December 31, 2012		Level 1 Valuation	Level 2 Valuation	Level 3 Valuation	Total Gains/(Losses) for the Year Ended December 31, 2012
Impaired loans	$	46,738	-	-	46,738	(7,986)
Other real estate	$	6,254	-	-	6,254	(1,136)

(Dollars in thousands)
	Fair Value Measurements December 31, 2011		Level 1 Valuation	Level 2 Valuation	Level 3 Valuation	Total Gains/(Losses) for the Year Ended December 31, 2011
Impaired loans	$	49,901	-	431	49,470	(11,864)
Other real estate	$	7,576	-	-	6,673	(1,322)

At each reporting period, the Bank determines which loans are impaired.  Accordingly, the Bank’s impaired loans are reported at their estimated fair value on a non-recurring basis.  An allowance for each impaired loan that is collateral-dependent is calculated based on the fair value of its collateral.  The fair value of the collateral is based on appraisals performed by REAS, a subsidiary of the Bank.  REAS is staffed by certified appraisers that also perform appraisals for other companies.  Factors including the assumptions and techniques utilized by the appraiser are considered by management.  If the recorded investment in the impaired loan exceeds the measure of fair value of the collateral, a valuation allowance is recorded as a component of the allowance for loan losses.  An allowance for each impaired loan that is non-collateral dependent is calculated based on the present value of projected cash flows.  If the recorded investment in the impaired loan exceeds the present value of projected cash flows, a valuation allowance is recorded as a component of the allowance for loan losses.  Impaired loans under $250,000 are not individually evaluated for impairment, with the exception of the Bank’s troubled debt restructured (“TDR”) loans in the residential mortgage loan portfolio, which are individually evaluated for impairment.  Accruing impaired loans were $30.6 million at December 31, 2012 and 2011.  Interest income recognized on accruing impaired loans was $1.5 million and $1.7 million for the years ended December 31, 2012 and 2011, respectively.  No interest income is recognized on non-accrual impaired loans subsequent to their classification as non-accrual.

A-8

The following tables present the Bank’s impaired loans as of December 31, 2012 and 2011:

December 31, 2012
(Dollars in thousands)
	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Recorded Investment in Impaired Loans		Related Allowance		Average Outstanding Impaired Loans
Real estate loans
Construction and land development	$	17,738		11,795		680		12,475		61		12,810
Single-family residential		9,099		766		7,799		8,565		177		7,590
Single-family residential -
Banco de la Gente stated income		21,806		-		21,000		21,000		1,278		21,158
Commercial		5,830		4,569		467		5,036		6		5,433
Multifamily and farmland		193		-		193		193		1		200
Total impaired real estate loans		54,666		17,130		30,139		47,269		1,523		47,191
Commercial loans (not secured by real estate)		983		347		592		939		12		1,125
Consumer loans (not secured by real estate)		68		-		66		66		1		41
Total impaired loans	$	55,717		17,477		30,797		48,274		1,536		48,357

December 31, 2011
(Dollars in thousands)
	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Recorded Investment in Impaired Loans		Related Allowance		Average Outstanding Impaired Loans
Real estate loans
Construction and land development	$	28,721		14,484		6,098		20,582		3,264		17,848
Single-family residential		6,361		969		5,117		6,086		131		6,324
Single-family residential -
Banco de la Gente stated income		20,021		-		19,602		19,602		1,296		18,778
Commercial		7,717		3,845		3,139		6,984		77		4,518
Multifamily and farmland		209		-		209		209		1		214
Total impaired real estate loans		63,029		19,298		34,165		53,463		4,769		47,682
Commercial loans (not secured by real estate)		1,111		-		1,083		1,083		26		1,485
Consumer loans (not secured by real estate)		157		-		152		152		2		140
Total impaired loans	$	64,297		19,298		35,400		54,698		4,797		49,307

In January 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2013-01, Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities. ASU No. 2013-01 provides additional guidance to clarify the intended scope of ASU No. 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities.  ASU No. 2013-01 is effective for fiscal years beginning on or after January 1, 2013, and interim periods within those annual periods.  The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.

In February 2013, FASB issued ASU No. 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.  The objective of ASU No. 2013-02 is to improve the reporting of significant reclassifications out of accumulated other comprehensive income.  For public entities, ASU No. 2013-02 is effective for reporting periods beginning after December 15, 2012.  The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.

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 results of operations, financial position or disclosures.

Management of the Company has made a number of estimates and assumptions relating to reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare the accompanying consolidated financial statements in conformity with GAAP.  Actual results could differ from those estimates.

The remainder of management’s discussion and analysis of the Company’s results of operations and financial position should be read in conjunction with the Consolidated Financial Statements and related Notes presented on pages A-28 through A-64.

A-9

Results of Operations

Summary.  The Company reported earnings of $5.8 million in 2012, or $1.04 basic and diluted net earnings per share, before adjustment for preferred stock dividends and accretion, as compared to $5.2 million, or $0.93 basic and diluted net earnings per share, for the same period one year ago.  After adjusting for dividends and accretion on preferred stock, net earnings available to common shareholders for the year ended December 31, 2012 were $4.8 million, or $0.86 basic and diluted net earnings per common share, as compared to $3.8 million, or $0.68 basic and diluted net earnings per common share, for the same period one year ago.  The increase in year-to-date earnings is primarily attributable to a decrease in the provision for loan losses, which was partially offset by aggregate decreases in net interest income and non-interest income and aggregate increases in non-interest expense.

Net earnings for 2011 represented an increase of 180% as compared to 2010 net earnings of $1.8 million, or $0.33 basic and diluted net earnings per common share.  The increase in 2011 net earnings was primarily attributable to aggregate increases in net interest income and non-interest income and a decrease in the provision for loan losses, which were partially offset by an increase in non-interest expense.

The return on average assets in 2012 was 0.56%, compared to 0.48% in 2011 and 0.17% in 2010. The return on average shareholders’ equity was 5.58% in 2012 compared to 5.03% in 2011 and 1.81% in 2010.

Net Interest Income.  Net interest income, the major component of the Company’s net income, is the amount by which interest and fees generated by interest-earning assets exceed the total cost of funds used to carry them.  Net interest income is affected by changes in the volume and mix of interest-earning assets and interest-bearing liabilities, as well as changes in the yields earned and rates paid.  Net interest margin is calculated by dividing tax-equivalent net interest income by average interest-earning assets, and represents the Company’s net yield on its interest-earning assets.

Net interest income for 2012 decreased to $31.5 million compared to $34.3 million in 2011.  This decrease is primarily attributable to a decrease in interest income resulting from decreases in loans and investment securities and a decrease in the yield on earning assets, which were partially offset by a decrease in interest expense due to a reduction in the cost of funds and a reduction in interest-bearing liabilities.  Net interest income increased slightly in 2011 from $33.3 million in 2010.

Table 1 sets forth for each category of interest-earning assets and interest-bearing liabilities, the average amounts outstanding, the interest incurred on such amounts and the average rate earned or incurred for the years ended December 31, 2012, 2011 and 2010. The table also sets forth the average rate earned on total interest-earning assets, the average rate paid on total interest-bearing liabilities, and the net yield on average total interest-earning assets for the same periods.  Yield information does not give effect to changes in fair value that are reflected as a component of shareholders’ equity.  Yields and interest income on tax-exempt investments have been adjusted to tax equivalent basis using an effective tax rate of 38.55% for securities that are both federal and state tax exempt, an effective tax rate of 31.65% for federal tax exempt securities and an effective tax rate of 6.90% for state tax exempt securities.  Non-accrual loans and the interest income that was recorded on these loans, if any, are included in the yield calculations for loans in all periods reported.

A-10

Table 1- Average Balance Table
	December 31, 2012								December 31, 2011							December 31, 2010
(Dollars in thousands)	Average Balance			Interest		Yield / Rate			Average Balance		Interest		Yield / Rate			Average Balance		Interest		Yield / Rate
Interest-earning assets:
Interest and fees on loans	$	648,595			32,758		5.05	%	697,527			36,374		5.21	%	757,532			40,204		5.31	%
Investments - taxable		187,060			2,851		1.52	%	173,766			4,688		2.70	%	119,841			3,593		3.00	%
Investments - nontaxable*		108,363			5,248		4.84	%	128,543			5,865		4.56	%	109,353			5,096		4.66	%
Other		21,977			51		0.23	%	15,615			33		0.21	%	12,328			63		0.51	%
Total interest-earning assets		965,995			40,908		4.23	%	1,015,451			46,960		4.62	%	999,054			48,956		4.90	%
Cash and due from banks		24,760							23,844							46,124
Other assets		55,618							50,829							49,765
Allowance for loan losses		(16,760	)						(15,874	)						(16,807	)
Total assets	$	1,029,613							1,074,250							1,078,136
Interest-bearing liabilities:
NOW, MMDA & savings deposits	$	351,748			1,180		0.34	%	344,860			2,263		0.66	%	312,155			3,472		1.11	%
Time deposits		282,218			3,205		1.14	%	357,094			5,035		1.41	%	405,300			6,786		1.67	%
FHLB / FRB borrowings		70,350			2,744		3.90	%	70,027			2,956		4.22	%	71,989			3,285		4.56	%
Trust preferred securities		20,619			438		2.12	%	20,619			407		1.97	%	20,619			411		1.99	%
Other		45,611			129		0.28	%	43,782			285		0.65	%	39,807			394		0.99	%
Total interest-bearing liabilities		770,546			7,696		1.00	%	836,382			10,946		1.31	%	849,870			14,348		1.69	%
Demand deposits		153,009							133,596							122,887
Other liabilities		4,746							4,174							3,513
Shareholders' equity		103,805							102,568							101,529
Total liabilities and shareholder's equity	$	1,032,106							1,076,720							1,077,799
Net interest spread				$	33,212		3.23	%				36,014		3.31	%				34,608		3.21	%
Net yield on interest-earning assets							3.44	%						3.55	%						3.46	%
Taxable equivalent adjustment
Investment securities				$	1,663							1,701							1,276
Net interest income				$	31,549							34,313							33,332

*Includes U.S. government agency securities that are non-taxable for state income tax purposes of $5.3 million in 2012, $39.0 million in 2011 and $50.3 million in 2010.  An effective tax rate of 6.90% was used to calculate the tax equivalent yield on these securities.

Changes in interest income and interest expense can result from variances in both volume and rates.  Table 2 describes the impact on the Company’s tax equivalent net interest income resulting from changes in average balances and average rates for the periods indicated.  The changes in interest due to both volume and rate have been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the changes in each.

A-11

Table 2 - Rate/Volume Variance Analysis-Tax Equivalent Basis
	December 31, 2012									December 31, 2011
(Dollars in thousands)	Changes in average volume			Changes in average rates			Total Increase (Decrease)			Changes in average volume			Changes in average rates			Total Increase (Decrease)
Interest income:
Loans: Net of unearned income	$	(2,512	)		(1,104	)		(3,616	)		(3,157	)		(673	)		(3,830	)
Investments - taxable		281			(2,118	)		(1,837	)		1,564			(469	)		1,095
Investments - nontaxable		(949	)		332			(617	)		885			(116	)		769
Other		15			3			18			12			(42	)		(30	)
Total interest income		(3,165	)		(2,887	)		(6,052	)		(696	)		(1,300	)		(1,996	)
Interest expense:
NOW, MMDA & savings deposits		34			(1,117	)		(1,083	)		289			(1,498	)		(1,209	)
Time deposits		(953	)		(877	)		(1,830	)		(744	)		(1,007	)		(1,751	)
FHLB / FRB Borrowings		13			(225	)		(212	)		(86	)		(243	)		(329	)
Trust Preferred Securities		-			31			31			-			(4	)		(4	)
Other		9			(165	)		(156	)		33			(142	)		(109	)
Total interest expense		(897	)		(2,353	)		(3,250	)		(508	)		(2,894	)		(3,402	)
Net interest income	$	(2,268	)		(534	)		(2,802	)		(188	)		1,594			1,406

Net interest income on a tax equivalent basis totaled $31.5 million in 2012 as compared to $34.3 million in 2011.  The interest rate spread, which represents the rate earned on interest-earning assets less the rate paid on interest-bearing liabilities, was 3.23% in 2012, a decrease from the 2011 net interest spread of 3.31%.  The net yield on interest-earning assets in 2012 decreased to 3.44% from the 2011 net yield on interest-earning assets of 3.55%.

Tax equivalent interest income decreased $6.1 million or 13% in 2012 due to decreases in loans and investment securities and a decrease in the yield on earning assets.  The yield on interest-earning assets decreased to 4.23% in 2012 from 4.62% in 2011.  Average interest-earning assets decreased $49.5 million primarily as the result of a $48.9 million decrease in the average outstanding balance of loans.  All other interest-earning assets including federal funds sold were $22.0 million in 2012 and $22.5 million in 2011.

Interest expense decreased $3.3 million or 30% in 2012 primarily due to a decrease in the average rate paid on interest-bearing liabilities.  The cost of funds decreased to 1.00% in 2012 from 1.31% in 2011.  This decrease in the cost of funds was primarily attributable to decreases in the average rate paid on interest-bearing checking and savings accounts and certificates of deposit.  The $65.8 million decrease in average interest-bearing liabilities in 2012 was primarily attributable to a $74.9 million decrease in certificates of deposit, which was partially offset by a $6.9 million increase in interest-bearing checking and savings accounts.

In 2011 net interest income on a tax equivalent basis increased to $34.3 million from $33.3 million in 2010.  The interest rate spread was 3.31% in 2011, an increase from the 2010 net interest spread of 3.21%.  The net yield on interest-earning assets in 2011 increased to 3.55% from the 2010 net yield on interest-earning assets of 3.46%.

Provision for Loan Losses.  Provisions for loan losses are charged to income in order to bring the total allowance for loan losses to a level deemed appropriate by management of the Company based on factors such as management’s judgment as to losses within the Bank’s loan portfolio, including the valuation of impaired loans, loan growth, net charge-offs, changes in the composition of the loan portfolio, delinquencies and management’s assessment of the quality of the loan portfolio and general economic climate.

The provision for loan losses was $4.9 million, $12.6 million, and $16.4 million for the years ended December 31, 2012, 2011 and 2010, respectively.  The decrease in the provision for loan losses is primarily attributable to a $4.4 million decrease in net charge-offs during the year ended December 31, 2012 compared to the same period one year ago and a $4.2 million reduction in non-accrual loans from December 31, 2011 to December 31, 2012.  Please see the section below entitled “Allowance for Loan Losses” for a more complete discussion of the Bank’s policy for addressing potential loan losses.

A-12

Non-Interest Income.  Non-interest income for 2012 totaled $12.5 million, a decrease of $2.0 million or 14% from non-interest income of $14.5 million for 2011.  This decrease is primarily attributable to $3.2 million decrease in the gains on sale of securities, which was partially offset by a $472,000 increase in mortgage banking income and a $362,000 increase in income from the Company’s appraisal management company subsidiary, for the year ended December 31, 2012, as compared to the year ended December 31, 2011.

Non-interest income for 2011 increased $629,000 or 5% from non-interest income of $13.9 million for 2010. The increase in non-interest income for 2011 is primarily due to an increase in gains on the sale of securities, which was partially offset by a reduction in service charges and fees.

The Company periodically evaluates its investments for any impairment which would be deemed other-than-temporary.   No investment impairments were deemed other-than-temporary in 2012.  As part of its evaluation in 2011, the Company determined that the fair value of one equity security was less than the original cost of the investment and that the decline in fair value was not temporary in nature.  As a result, the Company wrote down its investment by $144,000.  The remaining fair value of the investment at December 31, 2011 was approximately $264,000.  Similarly, as part of its evaluation in 2010, the Company wrote down two equity securities by $291,000.  The remaining fair value of the investments at December 31, 2010 was $409,000.

Net losses on other real estate and repossessed assets were $1.2 million, $1.3 million and $704,000 for 2012, 2011 and 2010, respectively.  The increased level of net losses on other real estate and repossessed assets during 2012 and 2011 were primarily attributable to increased write-downs on foreclosed property during the years ended December 31, 2012 and 2011.  Management determined that the market value of these assets had decreased significantly and charges were appropriate in 2012 and 2011.

Table 3 presents a summary of non-interest income for the years ended December 31, 2012, 2011 and 2010.

Table 3 - Non-Interest Income
(Dollars in thousands)	2012			2011			2010
Service charges	$	4,764		$	5,106		$	5,626
Other service charges and fees		1,940			2,090			2,195
Other than temporary impairment losses		-			(144	)		(291	)
Gain on sale of securities		1,218			4,406			3,348
Mortgage banking income		1,229			757			532
Insurance and brokerage commissions		517			471			390
Loss on sale and write-down of other real estate		(1,136	)		(1,322	)		(704	)
Visa debit card income		2,092			1,783			150
Net appraisal management fee income		737			375			326
Miscellaneous		1,176			991			2,312
Total non-interest income	$	12,537		$	14,513		$	13,884

Non-Interest Expense.  Total non-interest expense amounted to $31.8 million for 2012, an increase of 7% from 2011 primarily due to an increase in salaries and employee benefits expense.  Non-interest expense for 2011 increased 2% to $29.6 million from non-interest expense of $28.9 million for 2010.

Salary and employee benefit expense was $16.4 million in 2012, compared to $14.8 million during 2011, an increase of $1.7 million or 11%, following a $642,000 or 5% increase in salary and employee benefit expense in 2011 from 2010.  The increase in salary and employee benefits in 2012 was primarily due to salary increases and bonuses accrued in 2012, along with an increase in commissions on mortgage and real estate appraisal sales.  The increase in salary and employee benefits in 2011 was primarily due to salary increases given in 2011 along with an increase in commissions on mortgage, real estate and investment sales.

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Table 4 presents a summary of non-interest expense for the years ended December 31, 2012, 2011 and 2010.

Table 4 - Non-Interest Expense
(Dollars in thousands)	2012		2011		2010
Salaries and wages	$	12,762	$	12,003	$	11,408
Employee benefits		3,664		2,763		2,716
Total personnel expense		16,426		14,766		14,124
Occupancy expense		5,236		5,339		5,436
Office supplies		369		403		391
FDIC deposit insurance		894		1,061		1,434
Visa debit card expense		729		658		606
Professional services		560		428		467
Postage		284		326		352
Telephone		554		605		629
Director fees and expense		266		223		263
Advertising		695		660		714
Consulting fees		499		316		288
Taxes and licenses		325		289		320
Foreclosure/OREO expense		677		904		569
Internet banking expense		593		509		445
Other operating expense		3,675		3,085		2,910
Total non-interest expense	$	31,782	$	29,572	$	28,948

Income Taxes.  The Company reported income tax expense of $1.6 million and $1.5 million for the years ended December 31, 2012 and 2011, respectively.  The Company reported an income tax benefit of $11,000 for the year ended December 31, 2010.  The Company’s effective tax rates were 21.50%, 22.09% and -0.60% in 2012, 2011 and 2010, respectively.  The 2012, 2011 and 2010 effective tax rates are lower than historical levels due to increases in tax exempt investment income, which had a greater impact on the effective tax rate at the reduced level of earnings before income taxes as experienced in 2012, 2011 and 2010.

Liquidity. The objectives of the Company’s liquidity policy are to provide for the availability of adequate funds to meet the needs of loan demand, deposit withdrawals, maturing liabilities and to satisfy regulatory requirements.  Both deposit and loan customer cash needs can fluctuate significantly depending upon business cycles, economic conditions and yields and returns available from alternative investment opportunities.  In addition, the Company’s liquidity is affected by off-balance sheet commitments to lend in the form of unfunded commitments to extend credit and standby letters of credit.  As of December 31, 2012, such unfunded commitments to extend credit were $133.9 million, while commitments in the form of standby letters of credit totaled $3.3 million.

The Company uses several funding sources to meet its liquidity requirements.  The primary funding source is core deposits, which includes demand deposits, savings accounts and non-brokered certificates of deposits of denominations less than $100,000.  The Company considers these to be a stable portion of the Company’s liability mix and the result of on-going consumer and commercial banking relationships.  As of December 31, 2012, the Company’s core deposits totaled $646.4 million, or 83% of total deposits.

The other sources of funding for the Company are through large denomination certificates of deposit, including brokered deposits, federal funds purchased, securities under agreement to repurchase and Federal Home Loan Bank (“FHLB”) borrowings.  The Bank is also able to borrow from the Federal Reserve Bank (“FRB”) on a short-term basis.  The Bank’s policies include the ability to access wholesale funding up to 40% of total assets.  The Bank’s wholesale funding includes FHLB borrowings, FRB borrowings, brokered deposits and internet certificates of deposit.  The Company’s ratio of wholesale funding to total assets was 9% as of December 31, 2012.

At December 31, 2012, the Bank had a significant amount of deposits in amounts greater than $100,000, including brokered deposits of $21.4 million, which have an average original term of 10 months.  Brokered deposits include certificates of deposit participated through the Certificate of Deposit Account Registry Service (“CDARS”) on behalf of local customers.  CDARS balances totaled $20.1 million as of December 31, 2012.  The balance and cost of brokered deposits are more susceptible to changes in the interest rate environment than other deposits.   Access to the brokered deposit market could be restricted if the Bank were to fall below the well capitalized level.  For additional information, please see the section below entitled “Deposits.”

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The Bank has a line of credit with the FHLB equal to 20% of the Bank’s total assets, with an outstanding balance of $70.0 million at December 31, 2012.  At December 31, 2012, the carrying value of loans pledged as collateral totaled approximately $138.7 million.  As additional collateral, the Bank has pledged securities to the FHLB.  At December 31, 2012, the market value of securities pledged to the FHLB totaled $17.8 million.  The remaining availability under the line of credit with the FHLB was $20.4 million at December 31, 2012.  The Bank had no borrowings from the FRB at December 31, 2012.  The FRB borrowings are collateralized by a blanket assignment on all qualifying loans that the Bank owns which are not pledged to the FHLB.  At December 31, 2012, the carrying value of loans pledged as collateral to the FRB totaled approximately $313.7 million.

The Bank also had the ability to borrow up to $47.5 million for the purchase of overnight federal funds from five correspondent financial institutions as of December 31, 2012.

The liquidity ratio for the Bank, which is defined as net cash, interest-bearing deposits with banks, federal funds sold and certain investment securities, as a percentage of net deposits and short-term liabilities was 35.14% at December 31, 2012, 32.19% at December 31, 2011 and 25.87% at December 31, 2010.  The minimum required liquidity ratio as defined in the Bank’s Asset/Liability and Interest Rate Risk Management Policy for on balance sheet liquidity is 10%.

As disclosed in the Company’s Consolidated Statements of Cash Flows included elsewhere herein, net cash provided by operating activities was approximately $19.0 million during 2012.  Net cash provided in investing activities of $64.8 million consisted primarily of purchases of available for sale investments totaling $88.3 million, which were offset by maturities, calls and sales of available for sale investments, which totaled $110.3 million.  Net cash used by financing activities amounted to $64.2 million, primarily due to a $45.6 million net decrease in deposits and a $12.1 million decrease in preferred stock.

Asset Liability and Interest Rate Risk Management.  The objective of the Company’s Asset Liability and Interest Rate Risk strategies is to identify and manage the sensitivity of net interest income to changing interest rates and to minimize the interest rate risk between interest-earning assets and interest-bearing liabilities at various maturities.  This is done in conjunction with the need to maintain adequate liquidity and the overall goal of maximizing net interest income. Table 5 presents an interest rate sensitivity analysis for the interest-earning assets and interest-bearing liabilities for the year ended December 31, 2012.

Table 5 - Interest Sensitivity Analysis
(Dollars in thousands)	Immediate			1-3 months		4-12 months		Total Within One Year		Over One Year & Non-sensitive	Total
Interest-earning assets:
Loans	$	305,809		3,390		17,251		326,450		293,524	619,974
Mortgage loans held for  sale		6,922		-		-		6,922		-	6,922
Investment securities available for sale		-		14,090		34,130		48,220		249,603	297,823
Interest-bearing deposit accounts		16,226		-		-		16,226		-	16,226
Other interest-earning assets		-		-		-		-		6,218	6,218
Total interest-earning assets		328,957		17,480		51,381		397,818		549,345	947,163
Interest-bearing liabilities:
NOW, savings, and money market deposits		371,719		-		-		371,719		-	371,719
Time deposits		30,334		39,302		88,071		157,707		90,516	248,223
FHLB borrowings		-		-		-		-		70,000	70,000
Securities sold under
agreement to repurchase		34,578		-		-		34,578		-	34,578
Trust preferred securities		-		20,619		-		20,619		-	20,619
Total interest-bearing liabilities		436,631		59,921		88,071		584,623		160,516	745,139
Interest-sensitive gap	$	(107,674	)	(42,441	)	(36,690	)	(186,805	)	388,829	202,024
Cumulative interest-sensitive gap	$	(107,674	)	(150,115	)	(186,805	)	(186,805	)	202,024
Interest-earning assets as a percentage of interest-bearing liabilities		75.34%		29.17%		58.34%		68.05%		342.24%

The Company manages its exposure to fluctuations in interest rates through policies established by the Asset/Liability Committee (“ALCO”) of the Bank.  The ALCO meets quarterly and has the responsibility for approving asset/liability management policies, formulating and implementing strategies to improve balance sheet positioning and/or

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earnings and reviewing the interest rate sensitivity of the Company.  ALCO tries to minimize interest rate risk between interest-earning assets and interest-bearing liabilities by attempting to minimize wide fluctuations in net interest income due to interest rate movements.  The ability to control these fluctuations has a direct impact on the profitability of the Company. Management monitors this activity on a regular basis through analysis of its portfolios to determine the difference between rate sensitive assets and rate sensitive liabilities.

The Company’s rate sensitive assets are those earning interest at variable rates and those with contractual maturities within one year.  Rate sensitive assets therefore include both loans and available-for-sale securities.  Rate sensitive liabilities include interest-bearing checking accounts, money market deposit accounts, savings accounts, time deposits and borrowed funds.  Rate sensitive assets at December 31, 2012 totaled $947.2 million, exceeding rate sensitive liabilities of $745.1 million by $202.1 million.

Included in the rate sensitive assets are $324.8 million in variable rate loans indexed to prime rate subject to immediate repricing upon changes by the Federal Open Market Committee (“FOMC”).  The Bank utilizes interest rate floors on certain variable rate loans to protect against further downward movements in the prime rate.  At December 31, 2012, the Bank had $245.5 million in loans with interest rate floors.  The floors were in effect on $242.8 million of these loans pursuant to the terms of the promissory notes on these loans.   The weighted average rate on these loans is 1.11% higher than the indexed rate on the promissory notes without interest rate floors.

The Company has an overall interest rate risk management strategy that incorporates the use of derivative instruments to minimize significant unplanned fluctuations in earnings that are caused by interest rate volatility.  By using derivative instruments, the Company is exposed to credit and market risk.  If the counterparty fails to perform, credit risk is equal to the extent of the fair-value gain in the derivative.  The Company minimizes the credit risk in derivative instruments by entering into transactions with high-quality counterparties that are reviewed periodically by the Company. The Company did not have any interest rate derivatives outstanding as of December 31, 2012.

An analysis of the Company’s financial condition and growth can be made by examining the changes and trends in interest-earning assets and interest-bearing liabilities.  A discussion of these changes and trends follows.

Analysis of Financial Condition

Investment Securities.  The composition of the investment securities portfolio reflects the Company’s investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of income.  The investment portfolio also provides a balance to interest rate risk and credit risk in other categories of the balance sheet while providing a vehicle for the investment of available funds, furnishing liquidity, and supplying securities to pledge as required collateral for certain deposits.

All of the Company’s investment securities are held in the available for sale (“AFS”) category. At December 31, 2012, the market value of AFS securities totaled $297.8 million, compared to $321.4 million and $272.4 million at December 31, 2011 and 2010, respectively.  The decrease in 2012 AFS securities reflects maturities, calls and sales of available for sale investments exceeding purchases of available for sale investments during 2012.  Table 6 presents the market value of the AFS securities held at December 31, 2012, 2011 and 2010.

Table 6 - Summary of Investment Portfolio
(Dollars in thousands)	2012		2011		2010
U. S. Government sponsored enterprises	$	18,837	$	7,694	$	42,640
State and political subdivisions		125,658		97,097		87,829
Mortgage-backed securities		148,024		213,693		139,361
Corporate bonds		2,586		543		-
Trust preferred securities		1,250		1,250		1,250
Equity securities		1,468		1,111		1,369
Total securities	$	297,823	$	321,388	$	272,449

The Company’s investment portfolio consists of U.S. Government sponsored enterprise securities, municipal securities, U.S. Government enterprise sponsored mortgage-backed securities, corporate bonds, trust preferred securities and equity securities.  AFS securities averaged $289.0 million in 2012, $295.4 million in 2011 and $219.8 million in 2010.  Table 7 presents the amortized cost of AFS securities held by the Company by maturity category at December 31, 2012.   Yield information does not give effect to changes in fair value that are reflected as a component of shareholders’ equity.  Yields are calculated on a tax equivalent basis.  Yields and interest income on tax-exempt investments have been adjusted to a tax equivalent basis using an effective tax rate 38.55% for securities that are both federal and state tax exempt, an effective tax rate of 31.65% for federal tax exempt securities and an effective tax rate of 6.90% for state tax exempt securities.

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Table 7 - Maturity Distribution and Weighted Average Yield on Investments
						After One Year					After 5 Years
	One Year or Less					Through 5 Years					Through 10 Years					After 10 Years					Totals
(Dollars in thousands)	Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield
Book value:
U.S. Government
sponsored enterprises	$	442		2.57	%		3,136		3.35	%		2,774		2.57	%		12,485		2.57	%		18,837		2.86	%
State and political subdivisions		3,721		3.40	%		10,635		3.24	%		100,883		3.31	%		10,419		3.88	%		125,658		3.41	%
Mortgage-backed securities		44,080		2.12	%		71,144		2.25	%		15,514		2.55	%		17,286		2.42	%		148,024		2.23	%
Corporate bonds		-		-			997		1.64	%		1,589		3.40	%		-		-			2,586		2.32	%
Trust preferred securities		-		-			-		-			1,000		4.54	%		250		5.38	%		1,250		5.05	%
Equity securities		-		-			-		-			-		-			1,468		0.00	%		1,468		0.00	%
Total securities	$	48,243		2.29	%		85,912		2.50	%		121,760		2.87	%		41,908		2.95	%		297,823		2.64	%

Loans.  The loan portfolio is the largest category of the Company’s earning assets and is comprised of commercial loans, real estate mortgage loans, real estate construction loans and consumer loans. The Bank grants loans and extensions of credit primarily within the Catawba Valley region of North Carolina, which encompasses Catawba, Alexander, Iredell and Lincoln counties and also in Mecklenburg, Union and Wake counties in North Carolina.

Although the Bank has a diversified loan portfolio, a substantial portion of the loan portfolio is collateralized by real estate, which is dependent upon the real estate market.  Real estate mortgage loans include both commercial and residential mortgage loans.  At December 31, 2012, the Bank had $108.4 million in residential mortgage loans, $86.9 million in home equity loans and $261.5 million in commercial mortgage loans, which include $209.6 million using commercial property as collateral and $51.9 million using residential property as collateral.   Residential mortgage loans include $56.0 million made to customers in the Bank’s traditional banking offices and $52.4 million in mortgage loans originated in the Bank’s Latino banking operations.  All residential mortgage loans are originated as fully amortizing loans, with no negative amortization.

At December 31, 2012, the Bank had $73.2 million in construction and land development loans.  Table 8 presents a breakout of these loans.

Table 8 - Construction and Land Development Loans
(Dollars in thousands)	Number of Loans	Balance Outstanding		Non-accrual Balance
Land acquisition and development - commercial purposes	68	$	15,874	$	1,671
Land acquisition and development - residential purposes	308		48,872		6,825
1 to 4 family residential construction	24		3,864		757
Commercial construction	5		4,566		-
Total acquisition, development and construction	405	$	73,176	$	9,253

The mortgage loans originated in the traditional banking offices are generally 15 to 30 year fixed rate loans with attributes that  prevent the loans from being sellable in the secondary market.  These factors may include higher loan-to-value ratio, limited documentation on income, non-conforming appraisal or non-conforming property type.  These loans are generally made to existing Bank customers and have been originated throughout the Bank’s five county service area, with no geographic concentration.  At December 31, 2012, there were 29 mortgage loans originated in the traditional banking offices with an outstanding balance of $3.0 million that were 30 days or more past due and 14 loans with an outstanding balance of $1.1 million in non-accrual.

Banco de la Gente single family residential stated income loans originated from 2005 to 2009 were primarily adjustable rate mortgage loans that adjust annually after the end of the first five years of the loan.  The loans are tied to the one-year T-Bill index and, if they were to adjust at December 31, 2012, would have a reduction in the interest rate on the loan.  The underwriting on these loans includes both full income verification and no income verification, with loan-to-value ratios of up to 95% without private mortgage insurance.  A majority of these loans would be considered subprime loans, as they were underwritten using stated income rather than fully documented income verification.  No other loans in the Bank’s portfolio would be considered subprime.  The majority of these loans have been originated within the Charlotte, North Carolina metro area (Mecklenburg County).  At this time, Charlotte has experienced a decline in values within the residential real estate market.  At December 31, 2012, there were 153 loans with an outstanding balance of

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$14.7 million 30 days or more past due and 24 loans with an outstanding balance of $2.2 million in non-accrual.  Total losses on this portfolio, since the first loans were originated in 2004, have amounted to approximately $3.3 millionthrough December 31, 2012.

The composition of the Bank’s loan portfolio is presented in Table 9.

Table 9 - Loan Portfolio
	2012				2011			2010			2009			2008
(Dollars in thousands)	Amount		% of Loans		Amount	% of Loans		Amount	% of Loans		Amount	% of Loans		Amount	% of Loans
Real estate loans
Construction and land development	$	73,176	11.80	%	93,812	13.99	%	124,048	17.08	%	169,680	21.81	%	216,188	27.67	%
Single-family residential		195,003	31.45	%	212,993	31.77	%	232,294	31.99	%	226,651	29.13	%	198,779	25.45	%
Single-family residential- Banco de la
Gente stated income		52,019	8.39	%	54,058	8.06	%	55,013	7.58	%	55,035	7.07	%	57,907	7.41	%
Commercial		200,633	32.36	%	214,415	31.98	%	213,487	29.40	%	224,975	28.92	%	211,835	27.12	%
Multifamily and farmland		8,951	1.44	%	4,793	0.71	%	6,456	0.89	%	6,302	0.81	%	6,232	0.80	%
Total real estate loans		529,782	85.45	%	580,071	86.51	%	631,298	86.94	%	682,643	87.74	%	690,941	88.45	%
Commercial loans (not secured by real estate)		64,295	10.38	%	60,646	9.05	%	60,994	8.40	%	67,487	8.67	%	76,842	9.82	%
Farm loans (not secured by real estate)		11	0.00	%	-	0.00	%	-	0.00	%	-	0.00	%	81	0.01	%
Consumer loans (not secured by real estate)		10,148	1.64	%	10,490	1.56	%	11,500	1.58	%	12,943	1.66	%	12,088	1.55	%
All other loans (not secured by real estate)		15,738	2.54	%	19,290	2.88	%	22,368	3.08	%	14,983	1.93	%	1,236	0.16	%
Total loans		619,974	100.00	%	670,497	100.00	%	726,160	100.00	%	778,056	100.00	%	781,188	100.00	%
Less: Allowance for loan losses		14,423			16,604			15,493			15,413			11,025
Net loans	$	605,551			653,893			710,667			762,643			770,163

As of December 31, 2012, gross loans outstanding were $620.0 million, a decrease of $50.5 million from the December 31, 2011 balance of $670.5 million.  This decrease was primarily due to a $50.3 million reduction in real estate loans.  Loans originated or renewed during the year ended December 31, 2012 were $86.2 million and were offset by paydowns, payoffs and charge-offs of existing loans.  Average loans represented 67% and 69% of total earning assets for the years ended December 31, 2012 and 2011, respectively.  The Bank had $6.9 million and $5.1 million in mortgage loans held for sale as of December 31, 2012 and 2011, respectively.

At December 31, 2012, TDR loans amounted to $23.9 million, including $2.0 million in performing TDR loans. Effective March 31, 2012, performing TDR balances reflect current year TDR loans only, in accordance with GAAP.  Previously reported TDR amounts reflect cumulative TDR loans from prior periods in addition to current year TDR loans.  At December 31, 2011, TDR loans were $44.1 million, including $15.1 million in performing TDR loans.   The terms of these loans have been renegotiated to provide a reduction in principal or interest as a result of the deteriorating financial position of the borrower.

Table 10 identifies the maturities of all loans as of December 31, 2012 and addresses the sensitivity of these loans to changes in interest rates.

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Table 10 - Maturity and Repricing Data for Loans
(Dollars in thousands)	Within one year or less		After one year through five years	After five years	Total loans
Real estate loans
Construction and land development	$	58,954	9,185	5,037	73,176
Single-family residential		101,249	55,091	38,663	195,003
Single-family residential- Banco de la Gente
stated income		20,583	-	31,436	52,019
Commercial		116,000	63,221	21,412	200,633
Multifamily and farmland		4,094	4,491	366	8,951
Total real estate loans		300,880	131,988	96,914	529,782
Commercial loans (not secured by real estate)		51,110	9,364	3,821	64,295
Farm loans (not secured by real estate)		-	11	-	11
Consumer loans (not secured by real estate)		4,690	5,242	216	10,148
All other loans (not secured by real estate)		11,017	2,976	1,745	15,738
Total loans	$	367,697	149,581	102,696	619,974
Total fixed rate loans	$	41,247	129,137	102,696	273,080
Total floating rate loans		326,450	20,444	-	346,894
Total loans	$	367,697	149,581	102,696	619,974

In the normal course of business, there are various commitments outstanding to extend credit that are not reflected in the financial statements. At December 31, 2012, outstanding loan commitments totaled $133.9 million.  Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the commitment contract.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since many of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  Additional information regarding commitments is provided below in the section entitled “Contractual Obligations” and in Note 10 to the Consolidated Financial Statements.

Allowance for Loan Losses.  The allowance for loan losses reflects management’s assessment and estimate of the risks associated with extending credit and its evaluation of the quality of the loan portfolio.  The Bank periodically analyzes the loan portfolio in an effort to review asset quality and to establish an allowance for loan losses that management believes will be adequate in light of anticipated risks and loan losses.  In assessing the adequacy of the allowance, size, quality and risk of loans in the portfolio are reviewed. Other factors considered are:

·   the Bank’s loan loss experience;

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

·   specific known risks;

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

·   underlying estimated values of collateral securing loans;

·   current and anticipated economic conditions; and

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

Management uses several measures to assess and monitor the credit risks in the loan portfolio, including a loan grading system that begins upon loan origination and continues until the loan is collected or collectibility becomes doubtful. Upon loan origination, the Bank’s originating loan officer evaluates the quality of the loan and assigns one of nine risk grades. The loan officer monitors the loan’s performance and credit quality and makes changes to the credit grade as conditions warrant. When originated or renewed, all loans over a certain dollar amount receive in-depth reviews and risk assessments by the Bank’s Credit Administration. Before making any changes in these risk grades, management considers assessments as determined by the third party credit review firm (as described below), regulatory examiners and the Bank’s Credit Administration. Any issues regarding the risk assessments are addressed by the Bank’s senior credit administrators and factored into management’s decision to originate or renew the loan. The Bank’s Board of Directors reviews, on a monthly basis, an analysis of the Bank’s reserves relative to the range of reserves estimated by the Bank’s Credit Administration.

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As an additional measure, the Bank engages an independent third party to review the underwriting, documentation and risk grading analyses. This independent third party reviews and evaluates loan relationships greater than $1.0 million, excluding loans in default, loans in process of litigation or liquidation and loans that have been reviewed by regulatory examiners within six months prior to the independent third party review.  The third party’s evaluation and report is shared with management and the Bank’s Board of Directors.

Management considers certain commercial loans with weak credit risk grades to be individually impaired and measures such impairment based upon available cash flows and the value of the collateral. Allowance or reserve levels are estimated for all other graded loans in the portfolio based on their assigned credit risk grade, type of loan and other matters related to credit risk.

Management uses the information developed from the procedures described above in evaluating and grading the loan portfolio. This continual grading process is used to monitor the credit quality of the loan portfolio and to assist management in estimating the allowance for loan losses.

The allowance for loan losses is comprised of three components: specific reserves, general reserves and unallocated reserves.  After a loan has been identified as impaired, management measures impairment.  When the measure of the impaired loan is less than the recorded investment in the loan, the amount of the impairment is recorded as a specific reserve. These specific reserves are determined on an individual loan basis based on management’s current evaluation of the Bank’s loss exposure for each credit, given the appraised value of any underlying collateral. Loans for which specific reserves are provided are excluded from the general allowance calculations as described below.

The general allowance reflects reserves established under GAAP for collective loan impairment.  These reserves are based upon historical net charge-offs using the greater of the last two or three years’ loss experience.  This charge-off experience may be adjusted to reflect the effects of current conditions.  The Bank considers information derived from its loan risk ratings and external data related to industry and general economic trends in establishing reserves.

The unallocated allowance is determined through management’s assessment of probable losses that are in the portfolio but are not adequately captured by the other two components of the allowance, including consideration of current economic and business conditions and regulatory requirements. The unallocated allowance also reflects management’s acknowledgement of the imprecision and subjectivity that underlie the modeling of credit risk.  Due to the subjectivity involved in determining the overall allowance, including the unallocated portion, the unallocated portion may fluctuate from period to period based on management’s evaluation of the factors affecting the assumptions used in calculating the allowance.

Management considers the allowance for loan losses adequate to cover the estimated losses inherent in the Bank’s loan portfolio as of the date of the financial statements. Management believes it has established the allowance in accordance with GAAP and in consideration of the current economic environment. Although management uses the best information available to make evaluations, significant future additions to the allowance may be necessary based on changes in economic and other conditions, thus adversely affecting the operating results of the Company.

There were no significant changes in the estimation methods or fundamental assumptions used in the evaluation of the allowance for loan losses for the year ended December 31, 2012 as compared to the year ended December 31, 2011.   Revisions, estimates and assumptions may be made in any period in which the supporting factors indicate that loss levels may vary from the previous estimates.

Effective December 31, 2012, stated income mortgage loans from the Banco de la Gente division of the Bank were analyzed separately from other single family residential loans in the Bank’s loan portfolio.  These loans are first mortgage loans made to the Latino market, primarily in Mecklenburg and surrounding counties.  These loans are non-traditional mortgages in that the customer normally did not have a credit history, so all credit information was accumulated by the loan officers.  These loans were made as stated income loans rather than full documentation loans because the customer may not have had complete documentation on the income supporting the loan.

Various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. Such agencies may require adjustments to the allowance based on their judgments of information available to them at the time of their examinations.  Management believes it has established the allowance for credit losses pursuant to GAAP, and has taken into account the views of its regulators and the current economic environment.

Net charge-offs for 2012 were $7.1 million.  The ratio of net charge-offs to average total loans was 1.10%in 2012, 1.65% in 2011 and 2.16% in 2010.  The Bank strives to proactively work with its customers to identify potential

A-20

problems.  If found, the Bank works to quickly recognize identifiable losses and to establish a plan, with the borrower, if possible, to have the loans paid off.  This process increased the levels of charge-offs and provision for loan losses in 2010, 2011 and 2012 as compared to historical periods prior to 2009.  Management expects the ratio of net charge-offs to average total loans to remain at a level above historical norms in 2013 due to current economic conditions and the decrease in real estate values after four years of declining new home sales.   The allowance for loan losses was $14.4 million or 2.33% of total loans outstanding at December 31, 2012.  For December 31, 2011 and 2010, the allowance for loan losses amounted to $16.6 million or 2.48% of total loans outstanding and $15.5 million, or 2.13% of total loans outstanding, respectively.

Table 11 presents the percentage of loans assigned to each risk grade along with the general reserve percentage applied to loans in each risk grade at December 31, 2012 and 2011.

Table 11 - Loan Risk Grade Analysis
	Percentage of Loans
	By Risk Grade
Risk Grade	2012	2011
Risk Grade 1 (Excellent Quality)	2.93%	3.12%
Risk Grade 2 (High Quality)	16.94%	16.58%
Risk Grade 3 (Good Quality)	47.74%	49.30%
Risk Grade 4 (Management Attention)	20.70%	19.65%
Risk Grade 5 (Watch)	5.07%	4.76%
Risk Grade 6 (Substandard)	6.26%	6.21%
Risk Grade 7 (Low Substandard)	0.00%	0.00%
Risk Grade 8 (Doubtful)	0.00%	0.00%
Risk Grade 9 (Loss)	0.00%	0.00%

Table 12 presents an analysis of the allowance for loan losses, including charge-off activity.

Table 12 - Analysis of Allowance for Loan Losses
(Dollars in thousands)	2012		2011		2010	2009	2008
Allowance for loan losses at beginning	$	16,604	$	15,493	15,413	11,025	9,103
Loans charged off:
Commercial		555		314	1,730	697	249
Real estate - mortgage		2,491		4,196	4,194	3,384	1,506
Real estate - construction		4,728		7,164	10,224	1,754	644
Consumer		557		586	763	835	748
Total loans charged off		8,331		12,260	16,911	6,670	3,147
Recoveries of losses previously charged off:
Commercial		104		121	62	111	87
Real estate - mortgage		446		225	162	161	8
Real estate - construction		528		241	89	36	30
Consumer		148		152	240	215	150
Total recoveries		1,226		739	553	523	275
Net loans charged off		7,105		11,521	16,358	6,147	2,872
Provision for loan losses		4,924		12,632	16,438	10,535	4,794
Allowance for loan losses at end of year	$	14,423	$	16,604	15,493	15,413	11,025
Loans charged off net of recoveries, as
a percent of average loans outstanding		1.10%		1.65%	2.16%	0.79%	0.38%
Allowance for loan losses as a percent
of total loans outstanding at end of year		2.33%		2.48%	2.13%	1.98%	1.41%

Non-performing Assets.  Non-performing assets totaled $26.3 million at December 31, 2012 or 2.60% of total assets, compared to $32.1 million at December 31, 2011, or 3.01% of total assets.  Non-accrual loans were $17.6 million at December 31, 2012 and $21.8 million at December 31, 2011.  As a percentage of total loans outstanding, non-accrual loans were 2.84% at December 31, 2012 compared to 3.25% at December 31, 2011.  Non-performing loans include $9.2 million in construction and land development loans, $10.4 million in commercial and residential mortgage loans and

A-21

$416,000 in other loans at December 31, 2012, as compared to $13.2 million in construction and land development loans, $10.7 million in commercial and residential mortgage loans and $555,000 in other loans as of December 31, 2011.  The Bank had loans 90 days past due and still accruing totaling $2.4 million and $2.7 million as of December 31, 2012 and December 31, 2011, respectively.  Other real estate owned totaled $6.3 million as of December 31, 2012 as compared to $7.6 million at December 31, 2011. The Bank had repossessed assets amounting to $10,000 as of December 31, 2012 and no repossessed assets as of December 31, 2011.

At December 31, 2012, the Bank had non-performing loans, defined as non-accrual and accruing loans past due more than 90 days, of $20.0 million or 3.23% of total loans.  Non-performing loans at December 31, 2011 were $24.5 million, or 3.65% of total loans.

Management continually monitors the loan portfolio to ensure that all loans potentially having a material adverse impact on future operating results, liquidity or capital resources have been classified as non-performing.  Should economic conditions deteriorate, the inability of distressed customers to service their existing debt could cause higher levels of non-performing loans.  Management anticipates little growth in the housing market, which combined with the current economic conditions could result in non-performing loans remaining at a level above historical norms in 2013.

It is the general policy of the Bank to stop accruing interest income when a loan is placed on non-accrual status and any interest previously accrued but not collected is reversed against current income.  Generally a loan is placed on non-accrual status when it is over 90 days past due and there is reasonable doubt that all principal will be collected.

A summary of non-performing assets at December 31 for each of the years presented is shown in Table 13.

Table 13 - Non-performing Assets
(Dollars in thousands)	2012		2011		2010		2009		2008
Non-accrual loans	$	17,630		21,785		40,062		22,789		11,815
Loans 90 days or more past due and still accruing		2,403		2,709		210		1,977		514
Total non-performing loans		20,033		24,494		40,272		24,766		12,329
All other real estate owned		6,254		7,576		6,673		3,997		1,867
Repossessed assets		10		-		-		-		-
Total non-performing assets	$	26,297		32,070		46,945		28,763		14,196
As a percent of total loans at year end
Non-accrual loans		2.84%		3.25%		5.52%		2.93%		1.51%
Loans 90 days or more past due and still accruing		0.39%		0.40%		0.03%		0.25%		0.07%
Total non-performing assets		4.24%		4.78%		6.46%		3.70%		1.82%
Total non-performing assets
as a percent of total assets at year end		2.60%		3.01%		4.40%		2.74%		1.47%
Total non-performing loans
as a percent of total loans at year-end		3.23%		3.65%		5.55%		3.18%		1.58%

Deposits.  The Company primarily uses deposits to fund its loan and investment portfolios. The Company offers a variety of deposit accounts to individuals and businesses. Deposit accounts include checking, savings, money market and time deposits. As of December 31, 2012, total deposits were $781.5 million, compared to $827.1 million at December 31, 2011. Core deposits, which include demand deposits, savings accounts and non-brokered certificates of deposits of denominations less than $100,000, amounted to $646.4 million at December 31, 2012, compared to $633.0 million at December 31, 2011.

Time deposits in amounts of $100,000 or more totaled $134.7 million and $193.0 million at December 31, 2012 and 2011, respectively.  At December 31, 2012, brokered deposits amounted to $21.4 million as compared to $47.0 million at December 31, 2011.  CDARS balances included in brokered deposits amounted to $20.1 million and $28.6 million as of December 31, 2012 and 2011, respectively.  Brokered deposits are generally considered to be more susceptible to withdrawal as a result of interest rate changes and to be a less stable source of funds, as compared to deposits from the local market.  Brokered deposits outstanding as of December 31, 2012 have a weighted average rate of 0.29% with a weighted average original term of ten months.

A-22

Table 14 is a summary of the maturity distribution of time deposits in amounts of $100,000 or more as of December 31, 2012.

Table 14 - Maturities of Time Deposits over $100,000
(Dollars in thousands)	2012
Three months or less	$	39,434
Over three months through six months		15,310
Over six months through twelve months		29,932
Over twelve months		50,057
Total	$	134,733

Borrowed Funds. The Company has access to various short-term borrowings, including the purchase of federal funds and borrowing arrangements from the FHLB and other financial institutions.  At December 31, 2012 and 2011, FHLB borrowings totaled $70.0 million. Average FHLB borrowings for 2012 and 2011 were $70.0 million. The maximum amount of outstanding FHLB borrowings was $82.5 million in 2012 and $75.0 million in 2011.The FHLB borrowings outstanding at December 31, 2012 had interest rates ranging from 2.23% to 4.45%.  At December 31, 2012, all of the Bank’s FHLB borrowings had maturities exceeding one year. Additional information regarding FHLB borrowings is provided in Note 6 to the Consolidated Financial Statements.

The Bank had no borrowings from the FRB at December 31, 2012 and 2011.  FRB borrowings are collateralized by a blanket assignment on all qualifying loans that the Bank owns which are not pledged to the FHLB.  At December 31, 2012, the carrying value of loans pledged as collateral totaled approximately $313.7 million.

Securities sold under agreements to repurchase amounted to $34.6 million and $39.6 million as of December 31, 2012 and 2011, respectively.

Junior Subordinated Debentures (related to Trust Preferred Securities).  In June 2006, the Company formed a wholly owned Delaware statutory trust, PEBK Capital Trust II (“PEBK Trust II”), which issued $20.0 million of guaranteed preferred beneficial interests in the Company’s junior subordinated deferrable interest debentures.  All of the common securities of PEBK Trust II are owned by the Company.  The proceeds from the issuance of the common securities and the trust preferred securities were used by PEBK Trust II to purchase $20.6 million of junior subordinated debentures of the Company, which pay a floating rate equal to three-month LIBOR plus 163 basis points.  The proceeds received by the Company from the sale of the junior subordinated debentures were used to repay in December 2006 the trust preferred securities issued in December 2001 by PEBK Capital Trust, a wholly owned Delaware statutory trust of the Company, and for general purposes.  The debentures represent the sole asset of PEBK Trust II.  PEBK Trust II is not included in the Consolidated Financial Statements.

The trust preferred securities issued by PEBK Trust II accrue and pay quarterly at a floating rate of three-month LIBOR plus 163 basis points.  The Company has guaranteed distributions and other payments due on the trust preferred securities to the extent PEBK Trust II does not have funds with which to make the distributions and other payments.  The net combined effect of the trust preferred securities transaction is that the Company is obligated to make the distributions and other payments required on the trust preferred securities.

These trust preferred securities are mandatorily redeemable upon maturity of the debentures on June 28, 2036, or upon earlier redemption as provided in the indenture.  The Company has the right to redeem the debentures purchased by PEBK Trust II, in whole or in part, which became effective on June 28, 2011.  As specified in the indenture, if the debentures are redeemed prior to maturity, the redemption price will be the principal amount and any accrued but unpaid interest.

Contractual Obligations and Off-Balance Sheet Arrangements.  The Company’s contractual obligations and other commitments as of December 31, 2012 are summarized in Table 15 below.  The Company’s contractual obligations include the repayment of principal and interest related to FHLB advances and junior subordinated debentures, as well as certain payments under current lease agreements.  Other commitments include commitments to extend credit.  Because not all of these commitments to extend credit will be drawn upon, the actual cash requirements are likely to be significantly less than the amounts reported for other commitments below.

A-23

Table 15 - Contractual Obligations and Other Commitments
(Dollars in thousands)	Within One Year		One to Three Years	Three to Five Years	Five Years or More	Total
Contractual Cash Obligations
Long-term borrowings	$	-	10,000	25,000	35,000	70,000
Junior subordinated debentures		-	-	-	20,619	20,619
Operating lease obligations		542	998	910	1,667	4,117
Total	$	542	10,998	25,910	57,286	94,736
Other Commitments
Commitments to extend credit	$	42,875	6,432	8,877	75,735	133,919
Standby letters of credit
and financial guarantees written		3,297	-	-	-	3,297
Total	$	46,172	6,432	8,877	75,735	137,216

The Company enters into derivative contracts to manage various financial risks.  A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to an underlying instrument, index or referenced interest rate.  Derivative contracts are carried at fair value on the consolidated balance sheet with the fair value representing the net present value of expected future cash receipts or payments based on market interest rates as of the balance sheet date.  Derivative contracts are written in amounts referred to as notional amounts, which only provide the basis for calculating payments between counterparties and are not a measure of financial risk.  Therefore, the derivative amounts recorded on the balance sheet do not represent the amounts that may ultimately be paid under these contracts.  Further discussions of derivative instruments are included above in the section entitled “Asset Liability and Interest Rate Risk Management” beginning on page A-15 and in Notes 1, 10, 11 and 16 to the Consolidated Financial Statements.

Capital Resources.  Shareholders’ equity at December 31, 2012 was $97.7 million compared to $103.0 million at December 31, 2011.  This decrease was primarily attributable to the Company’s repurchase and retirement of a portion of its preferred shares.  The Company purchased 12,530 shares of the Company’s 25,054 outstanding shares of Series A preferred stock from the UST, which was issued to the UST in connection with the Company’s participation in the CPP under TARP in 2008.  The shares were purchased for $933.36 per share, for a total purchase price of $11,778,576, including $83,575 accrued and unpaid dividends on the Series A preferred stock.  The Company retired the 12,530 shares purchased.  The $834,999 difference between the $12,530,000 face value of the Series A preferred stock retired and the $11,695,001 purchase price of the Series A preferred stock retired was credited to retained earnings effective June 30, 2012.  Remaining Series A preferred shares are redeemable at any time at par.  The Company expects to be able to repurchase the shares from future earnings, however, there are no immediate plans to repurchase these shares.

During the third quarter of 2012, the Company completed its repurchase of the Warrant to purchase 357,234 shares of the Company's common stock that was issued to the UST on December 23, 2008 as part of the CPP under TARP.  The Company repurchased the Warrant for a total price of $425,000.

Common stock at December 31, 2012 was $48.1 million compared to $48.3 million at December 31, 2011.  This decrease is due to the Company’s repurchase of the Warrant associated with the preferred stock that was issued to the UST, which was partially offset by stock options exercised during 2012.

Average shareholders’ equity as a percentage of total average assets is one measure used to determine capital strength.   Average shareholders’ equity as a percentage of total average assets was 10.08%, 9.55% and 9.42% for 2012, 2011 and 2010.   The return on average shareholders’ equity was 5.58% at December 31, 2012 as compared to 5.03% and 1.81% as of December 31, 2011 and December 31, 2010, respectively.  Total cash dividends paid on common stock amounted to $1.0 million, $443,000 and $447,000 during 2012, 2011 and 2010, respectively.  The Company paid dividends totaling $1.0 million, $1.3 million and $1.3 million on preferred stock during 2012, 2011 and 2010, respectively.

The Board of Directors, at its discretion, can issue shares of preferred stock up to a maximum of 5,000,000 shares.  The Board is authorized to determine the number of shares, voting powers, designations, preferences, limitations and relative rights.

A-24

Under regulatory capital guidelines, financial institutions are currently required to maintain a total risk-based capital ratio of 8.0% or greater, with a Tier 1 risk-based capital ratio of 4.0% or greater.  Tier 1 capital is generally defined as shareholders’ equity and trust preferred securities less all intangible assets and goodwill.  Tier 1 capital at December 31, 2012, 2011 and 2010 includes $20.0 million in trust preferred securities. The Company’s Tier 1 capital ratio was 16.04%, 16.10% and 14.24% at December 31, 2012, 2011 and 2010, respectively.  Total risk-based capital is defined as Tier 1 capital plus supplementary capital.  Supplementary capital, or Tier 2 capital, consists of the Company’s allowance for loan losses, not exceeding 1.25% of the Company’s risk-weighted assets. Total risk-based capital ratio is therefore defined as the ratio of total capital (Tier 1 capital and Tier 2 capital) to risk-weighted assets.  The Company’s total risk-based capital ratio was 17.34%, 17.38% and 15.51% at December 31, 2012, 2011 and 2010, respectively.  In addition to the Tier 1 and total risk-based capital requirements, financial institutions are also required to maintain a leverage ratio of Tier 1 capital to total average assets of 4.0% or greater.  The Company’s Tier 1 leverage capital ratio was 11.12%, 11.06% and 10.70% at December 31, 2012, 2011 and 2010, respectively.

The Bank’s Tier 1 risk-based capital ratio was 15.54%, 13.76% and 11.87% at December 31, 2012, 2011 and 2010, respectively.  The total risk-based capital ratio for the Bank was 16.84%, 15.04% and 13.15% at December 31, 2012, 2011 and 2010, respectively.   The Bank’s Tier 1 leverage capital ratio was 10.76%, 9.44% and 8.91% at December 31, 2012, 2011 and 2010, respectively.

A bank is considered to be “well capitalized” if it has a total risk-based capital ratio of 10.0 % or greater, a Tier 1 risk-based capital ratio of 6.0% or greater, and has a leverage ratio of 5.0% or greater.  Based upon these guidelines, the Bank was considered to be “well capitalized” at December 31, 2012, 2011 and 2010.

The Company’s key equity ratios as of December 31, 2012, 2011 and 2010 are presented in Table 16.

Table 16 - Equity Ratios
	2012	2011	2010
Return on average assets	0.56%	0.48%	0.17%
Return on average equity	5.58%	5.03%	1.81%
Dividend payout ratio *	20.96%	11.78%	100.11%
Average equity to average assets	10.08%	9.55%	9.42%

* As a percentage of net earnings available to common shareholders.

Quarterly Financial Data.  The Company’s consolidated quarterly operating results for the years ended December 31, 2012 and 2011 are presented in Table 17.

Table 17 - Quarterly Financial Data
	2012					2011
(Dollars in thousands, except per share amounts)	First		Second	Third	Fourth	First		Second		Third	Fourth
Total interest income	$	10,362	9,835	9,655	9,393	$	11,558	11,422		11,291	10,988
Total interest expense		2,218	1,987	1,842	1,649		3,044	2,809		2,673	2,420
Net interest income		8,144	7,848	7,813	7,744		8,514	8,613		8,618	8,568
Provision for loan losses		2,049	1,603	761	511		2,950	3,368		3,378	2,936
Other income		3,380	3,593	2,886	2,678		3,602	2,736		3,722	4,453
Other expense		7,271	7,843	8,156	8,512		7,400	7,408		7,164	7,600
Income before income taxes		2,204	1,995	1,782	1,399		1,766	573		1,798	2,485
Income taxes		545	486	369	187		405	(56	)	406	708
Net earnings		1,659	1,509	1,413	1,212		1,361	629		1,392	1,777
Dividends and accretion of preferred stock		348	348	157	157		348	348		348	349
Net earnings available
to common shareholders	$	1,311	1,161	1,256	1,055	$	1,013	281		1,044	1,428
Basic and diluted
earnings per common share	$	0.24	0.21	0.23	0.18	$	0.18	0.05		0.19	0.26

A-25

QUANTATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

The Company’s market risk arises primarily from interest rate risk inherent in its lending and deposit taking activities. The structure of the Company’s loan and deposit portfolios is such that a significant decline (increase) in interest rates may adversely (positively)impact net market values and interest income. Management seeks to manage the risk through the utilization of its investment securities and off-balance sheet derivative instruments. During the years ended December 31, 2012, 2011 and 2010, the Company used interest rate contracts to manage market risk as discussed above in the section entitled “Asset Liability and Interest Rate Risk Management.”

Table 18 presents in tabular form the contractual balances and the estimated fair value of the Company’s on-balance sheet financial instruments at their expected maturity dates for the period ended December 31, 2012. The expected maturity categories take into consideration historical prepayment experience as well as management’s expectations based on the interest rate environment at December 31, 2012.  For core deposits without contractual maturity (i.e. interest-bearing checking, savings, and money market accounts), the table presents principal cash flows based on management’s judgment concerning their most likely runoff or repricing behaviors.

Table 18 - Market Risk Table
(Dollars in thousands)	Principal/Notional Amount Maturing in Year Ended December 31,
Loans Receivable	2013		2014	2015	2016 & 2017	Thereafter	Total	Fair Value
Fixed rate	$	53,603	46,611	34,379	53,710	91,699	280,002	274,447
Average interest rate		5.40%	5.57%	5.89%	5.27%	5.81%
Variable rate	$	90,305	60,744	41,926	47,497	106,422	346,894	346,894
Average interest rate		4.78%	4.72%	4.85%	4.73%	4.46%
							626,896	621,341
Investment Securities		.
Interest bearing cash	$	16,226	-	-	-	-	16,226	16,226
Average interest rate		0.23%	-	-	-	-
Securities available for sale	$	38,195	21,612	15,706	23,521	198,789	297,823	297,823
Average interest rate		3.93%	4.89%	4.89%	4.73%	4.82%
Nonmarketable equity securities	$	-	-	-	-	5,599	5,599	5,599
Average interest rate		-	-	-	-	1.61%
Debt Obligations
Deposits	$	157,879	33,639	36,066	20,871	533,070	781,525	780,662
Average interest rate		0.65%	1.10%	1.15%	1.27%	0.29%
Advances from FHLB	$	-	5,000	5,000	25,000	35,000	70,000	76,375
Average interest rate		-	-	3.71%	4.21%	3.72%
Securities sold under agreement to repurchase	$	34,578					34,578	34,578
Average interest rate		0.24%
Junior subordinated debentures	$	-	-	-	-	20,619	20,619	20,619
Average interest rate		-	-	-	-	1.92%

A-26

Table 19 presents the simulated impact to net interest income under varying interest rate scenarios and the theoretical impact of rate changes over a twelve-month period referred to as “rate ramps.”  The table shows the estimated theoretical impact on the Company’s tax equivalent net interest income from hypothetical rate changes of plus and minus 1%, 2% and 3% as compared to the estimated theoretical impact of rates remaining unchanged.  The table also shows the simulated impact to market value of equity under varying interest rate scenarios and the theoretical impact of immediate and sustained rate changes referred to as “rate shocks” of plus and minus 1%, 2% and 3% as compared to the theoretical impact of rates remaining unchanged.  The prospective effects of the hypothetical interest rate changes are based upon various assumptions, including relative and estimated levels of key interest rates.  This type of modeling has limited usefulness because it does not allow for the strategies management would utilize in response to sudden and sustained rate changes.  Also, management does not believe that rate changes of the magnitude presented are likely in the forecast period presented.

Table 19 - Interest Rate Risk
(Dollars in thousands)
	Estimated Resulting Theoretical Net Interest Income
Hypothetical rate change (ramp over 12 months)	Amount		% Change
+3%	$	32,967	4.44	%
+2%	$	32,292	2.30	%
+1%	$	31,701	0.43	%
0%	$	31,566	0.00	%
-1%	$	31,036	-1.68	%
-2%	$	30,247	-4.18	%
-3%	$	29,640	-6.10	%

	Estimated Resulting Theoretical Market Value of Equity
Hypothetical rate change (immediate shock)	Amount		% Change
+3%	$	104,438	14.37	%
+2%	$	105,504	15.54	%
+1%	$	101,969	11.67	%
0%	$	91,312	0.00	%
-1%	$	79,237	-13.22	%
-2%	$	73,426	-19.59	%
-3%	$	75,453	-17.37	%

A-27

PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES

Consolidated Financial Statements

December 31, 2012, 2011 and 2010

INDEX

	PAGE(S)
Report of Independent Registered Public Accounting Firm on the Consolidated Financial Statements		A-29
Financial Statements
Consolidated Balance Sheets at December 31, 2012 and 2011		A-30
Consolidated Statements of Earnings for the years ended December 31, 2012, 2011 and 2010		A-31
Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2012, 2011 and 2010		A-32
Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 2012, 2011 and 2010		A-33
Consolidated Statements of Cash Flows for the years ended December 31, 2012, 2011 and 2010		A-34 - A-35
Notes to Consolidated Financial Statements		A-36 - A-64

A-28

A-29

PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

December 31, 2012 and 2011

(Dollars in thousands)

Assets	2012			2011
Cash and due from banks, including reserve requirements	$	32,617		22,532
of $9,625 and $8,492
Interest-bearing deposits		16,226		6,704
Cash and cash equivalents		48,843		29,236
Investment securities available for sale		297,823		321,388
Other investments		5,599		5,712
Total securities		303,422		327,100
Mortgage loans held for sale		6,922		5,146
Loans		619,974		670,497
Less allowance for loan losses		(14,423	)	(16,604	)
Net loans		605,551		653,893
Premises and equipment, net		15,874		16,896
Cash surrender value of life insurance		13,273		12,835
Other real estate		6,254		7,576
Accrued interest receivable and other assets		13,377		14,381
Total assets	$	1,013,516		1,067,063
Liabilities and Shareholders' Equity
Deposits:
Non-interest bearing demand	$	161,582		136,878
NOW, MMDA & savings		371,719		366,133
Time, $100,000 or more		134,733		193,045
Other time		113,491		131,055
Total deposits		781,525		827,111
Securities sold under agreements to repurchase		34,578		39,600
FHLB borrowings		70,000		70,000
Junior subordinated debentures		20,619		20,619
Accrued interest payable and other liabilities		9,047		6,706
Total liabilities		915,769		964,036
Commitments
Shareholders' equity:
Series A preferred stock, $1,000 stated value; authorized
5,000,000 shares; issued and outstanding
12,524 shares in 2012 and 25,054 shares in 2011		12,524		24,758
Common stock, no par value; authorized
20,000,000 shares; issued and outstanding
5,613,495 shares in 2012 and 5,544,160 shares in 2011		48,133		48,298
Retained earnings		31,478		26,895
Accumulated other comprehensive income		5,612		3,076
Total shareholders' equity		97,747		103,027
Total liabilities and shareholders' equity	$	1,013,516		1,067,063

See accompanying Notes to Consolidated Financial Statements.

A-30

PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES

Consolidated Statements of Earnings

For the Years Ended December 31, 2012, 2011 and 2010

(Dollars in thousands, except per share amounts)

	2012			2011		2010
Interest income:
Interest and fees on loans	$	32,758		36,374		40,204
Interest on due from banks		51		33		63
Interest on investment securities:
U.S. Government sponsored enterprises		2,746		5,414		5,035
States and political subdivisions		3,403		3,180		2,173
Other		287		258		205
Total interest income		39,245		45,259		47,680
Interest expense:
NOW, MMDA & savings deposits		1,180		2,263		3,472
Time deposits		3,205		5,035		6,786
FHLB borrowings		2,744		2,956		3,285
Junior subordinated debentures		438		407		411
Other		129		285		394
Total interest expense		7,696		10,946		14,348
Net interest income		31,549		34,313		33,332
Provision for loan losses		4,924		12,632		16,438
Net interest income after provision for loan losses		26,625		21,681		16,894
Non-interest income:
Service charges		4,764		5,106		5,626
Other service charges and fees		1,940		2,090		2,195
Other than temporary impairment losses		-		(144	)	(291	)
Gain on sale of securities		1,218		4,406		3,348
Mortgage banking income		1,229		757		532
Insurance and brokerage commissions		517		471		390
Loss on sale and write-down of other real estate		(1,136	)	(1,322	)	(704	)
Miscellaneous		4,005		3,149		2,788
Total non-interest income		12,537		14,513		13,884
Non-interest expense:
Salaries and employee benefits		16,426		14,766		14,124
Occupancy		5,236		5,339		5,436
Other		10,120		9,467		9,388
Total non-interest expense		31,782		29,572		28,948
Earnings before income taxes		7,380		6,622		1,830
Income tax expense (benefit)		1,587		1,463		(11	)
Net earnings		5,793		5,159		1,841
Dividends and accretion of preferred stock		1,010		1,393		1,394
Net earnings available to common shareholders	$	4,783		3,766		447
Basic and diluted net earnings per common share	$	0.86		0.68		0.08
Cash dividends declared per common share	$	0.18		0.08		0.08

See accompanying Notes to Consolidated Financial Statements.

A-31

PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (Loss)

For the Years Ended December 31, 2012, 2011 and 2010

(Dollars in thousands)

	2012			2011		2010
Net earnings	$	5,793		5,159		1,841
Other comprehensive income (loss):
Unrealized holding gains on securities available for sale		5,371		9,316		46
Reclassification adjustment for other than temporary impairment losses included in net earnings		-		144		291
Reclassification adjustment for gains on securities available for sale included in net earnings		(1,218	)	(4,406	)	(3,348	)
Unrealized holding losses on derivative financial instruments qualifying as cash flow hedges		-		(648	)	(1,114	)
Total other comprehensive income (loss),
before income taxes		4,153		4,406		(4,125	)
Income tax expense (benefit) related to other comprehensive income (loss):
Unrealized holding gains on securities available for sale		2,091		3,629		18
Reclassification adjustment for gains on securities available for sale included in net earnings		(474	)	(1,660	)	(1,191	)
Unrealized holding losses on derivative financial instruments qualifying as cash flow hedges		-		(252	)	(434	)
Total income tax expense (benefit) related to other comprehensive income (loss)		1,617		1,717		(1,607	)
Total other comprehensive income (loss), net of tax		2,536		2,689		(2,518	)
Total comprehensive income (loss)	$	8,329		7,848		(677	)

See accompanying Notes to Consolidated Financial Statements.

A-32

PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders' Equity

For the Years Ended December 31, 2012, 2011 and 2010

(Dollars in thousands)

											Accumulated
											Other
	Stock Shares			Stock Amount					Retained		Comprehensive
	Preferred		Common	Preferred			Common		Earnings		Income		Total
Balance, December 31, 2009	25,054		5,539,056	$	24,476		48,269		23,573		2,905		99,223
Accretion of Series A
preferred stock	-		-		141		-		(141	)	-		-
Cash dividends declared on
Series A preferred stock	-		-		-		-		(1,253	)	-		(1,253	)
Cash dividends declared on
common stock	-		-		-		-		(447	)	-		(447	)
Restricted stock payout	-		2,357		-		12		-		-		12
Net earnings	-		-		-		-		1,841		-		1,841
Change in accumulated other
comprehensive income,
net of tax	-		-		-		-		-		(2,518	)	(2,518	)
Balance, December 31, 2010	25,054		5,541,413	$	24,617		48,281		23,573		387		96,858
Accretion of Series A
preferred stock	-		-		141		-		(141	)	-		-
Cash dividends declared on
Series A preferred stock	-		-		-		-		(1,253	)	-		(1,253	)
Cash dividends declared on
common stock	-		-		-		-		(443	)	-		(443	)
Restricted stock payout	-		2,747		-		17		-		-		17
Net earnings	-		-		-		-		5,159		-		5,159
Change in accumulated other
comprehensive income,
net of tax	-		-		-		-		-		2,689		2,689
Balance, December 31, 2011	25,054		5,544,160	$	24,758		48,298		26,895		3,076		103,027
Accretion of Series A
preferred stock	-		-		70		-		(70	)	-		-
Preferred stock and
warrant repurchase	(12,530	)	-		(12,304	)	(704	)	886		-		(12,122	)
Cash dividends declared on
Series A preferred stock	-		-		-		-		(1,023	)	-		(1,023	)
Cash dividends declared on
common stock	-		-		-		-		(1,003	)	-		(1,003	)
Stock options exercised	-		69,335		-		539		-		-		539
Net earnings	-		-		-		-		5,793		-		5,793
Change in accumulated other
comprehensive income,
net of tax	-		-		-		-		-		2,536		2,536
Balance, December 31, 2012	12,524		5,613,495	$	12,524		48,133		31,478		5,612		97,747

See accompanying Notes to Consolidated Financial Statements.

A-33

PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

For the Years Ended December 31, 2012, 2011 and 2010

(Dollars in thousands)

	2012			2011		2010
Cash flows from operating activities:
Net earnings	$	5,793		5,159		1,841
Adjustments to reconcile net earnings to
net cash provided by operating activities:
Depreciation, amortization and accretion		8,876		6,226		4,971
Provision for loan losses		4,924		12,632		16,438
Deferred income taxes		(213	)	(678	)	(523	)
Gain on sale of investment securities		(1,218	)	(4,406	)	(3,348	)
Write-down of investment securities		-		144		291
Loss/(Gain) on sale of other real estate		98		272		(191	)
Write-down of other real estate		1,038		1,050		895
Restricted stock expense		-		7		10
Change in:
Mortgage loans held for sale		(1,776	)	(1,332	)	(974	)
Cash surrender value of life insurance		(438	)	(296	)	(257	)
Other assets		(399	)	2,644		(2,316	)
Other liabilities		2,342		930		961
Net cash provided by operating activities		19,027		22,352		17,798
Cash flows from investing activities:
Net change in certificates of deposit		-		735		2,610
Purchases of investment securities available for sale		(88,304	)	(208,863	)	(232,915	)
Proceeds from calls, maturities and paydowns of investment securities
available for sale		63,225		54,041		86,935
Proceeds from sales of investment securities available for sale		47,076		110,978		65,774
Purchases of other investments		(493	)	(215	)	-
Proceeds from sale of other investments		606		290		585
Net change in loans		38,170		38,561		28,703
Purchases of premises and equipment		(917	)	(1,601	)	(1,441	)
Purchases of bank owned life insurance		-		(5,000	)	-
Proceeds from sale of other real estate and repossessions		5,434		3,355		5,725
Net cash provided (used) by investing activities		64,797		(7,719	)	(44,024	)
Cash flows from financing activities:
Net change in deposits		(45,586	)	(11,601	)	29,369
Net change in demand notes payable to U.S. Treasury		-		(1,600	)	964
Net change in securities sold under agreement to repurchase		(5,022	)	5,506		(2,782	)
Proceeds from FHLB borrowings		25,400		40,000		-
Repayments of FHLB borrowings		(25,400	)	(40,000	)	(7,000	)
Proceeds from FRB borrowings		2		1		-
Repayments of FRB borrowings		(2	)	(1	)	-
Preferred stock and warrant repurchase		(12,122	)	-		-
Restricted stock payout		-		17		12
Stock options exercised		539		-		-
Cash dividends paid on Series A preferred stock		(1,023	)	(1,253	)	(1,253	)
Cash dividends paid on common stock		(1,003	)	(443	)	(447	)
Net cash (used) provided by financing activities		(64,217	)	(9,374	)	18,863
Net change in cash and cash equivalent		19,607		5,259		(7,363	)
Cash and cash equivalents at beginning of period		29,236		23,977		31,340
Cash and cash equivalents at end of period	$	48,843		29,236		23,977

A-34

PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows, continued

For the Years Ended December 31, 2012, 2011 and 2010

(Dollars in thousands)

	2012		2011		2010
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest	$	7,838	10,900		14,419
Income taxes	$	2,013	283		1,700
Noncash investing and financing activities:
Change in unrealized gain on investment securities
available for sale, net	$	2,536	(3,087	)	1,838
Change in unrealized gain on derivative financial
instruments, net	$	-	398		680
Transfer of loans to other real estate and repossessions	$	6,323	10,787		9,105
Financed portion of sale of other real estate	$	1,076	5,208		2,270
Accretion of Series A preferred stock	$	70	141		141
Discount on preferred stock	$	835	-		-

See accompanying Notes to Consolidated Financial Statements.

A-35

PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(1)   Summary of Significant Accounting Policies

Organization

Peoples Bancorp of North Carolina, Inc. (“Bancorp”) received regulatory approval to operate as a bank holding company on July 22, 1999, and became effective August 31, 1999.  Bancorp is primarily regulated by the Board of Governors of the Federal Reserve System, and serves as the one-bank holding company for Peoples Bank (the “Bank”).

The Bank commenced business in 1912 upon receipt of its banking charter from the North Carolina State Banking Commission (the “SBC”). The Bank is primarily regulated by the SBC and the Federal Deposit Insurance Corporation (the “FDIC”) and undergoes periodic examinations by these regulatory agencies. The Bank, whose main office is in Newton, North Carolina, provides a full range of commercial and consumer banking services primarily in Catawba, Alexander, Lincoln, Mecklenburg, Iredell, Union and Wake counties in North Carolina.

Peoples Investment Services, Inc. is a wholly-owned subsidiary of the Bank and began operations in 1996 to provide investment and trust services through agreements with an outside party.

Real Estate Advisory Services, Inc. (“REAS”) is a wholly-owned subsidiary of the Bank and began operations in 1997 to provide real estate appraisal and property management services to individuals and commercial customers of the Bank.

Community Bank Real Estate Solutions, LLC is a wholly-owned subsidiary of Bancorp and began operations in 2009 as a “clearing house” for appraisal services for community banks.  Other banks are able to contract with Community Bank Real Estate Solutions, LLC to find and engage appropriate appraisal companies in the area where the property is located.

Principles of Consolidation

The consolidated financial statements include the financial statements of Bancorp and its wholly-owned subsidiaries, the Bank and Community Bank Real Estate Solutions, LLC, along with the Bank’s wholly-owned subsidiaries, Peoples Investment Services, Inc. and REAS (collectively called the “Company”).  All significant intercompany balances and transactions have been eliminated in consolidation.

Basis of Presentation

The accounting principles followed by the Company, and the methods of applying these principles, conform with accounting principles generally accepted in the United States of America (“GAAP”) and with general practices in the banking industry. In preparing the financial statements in conformity with GAAP, management is required to make estimates and assumptions that affect the reported amounts in the financial statements. Actual results could differ significantly from these estimates. Material estimates common to the banking industry that are particularly susceptible to significant change in the near term include, but are not limited to, the determination of the allowance for loan losses and valuation of real estate acquired in connection with or in lieu of foreclosure on loans.

Cash and Cash Equivalents

Cash, due from banks and interest-bearing deposits are considered cash and cash equivalents for cash flow reporting purposes.

Investment Securities

There are three classifications the Company is able to classify its investment securities: trading, available for sale, or held to maturity. Trading securities are bought and held principally for sale in the near term. Held to maturity securities are those securities for which the Company has the ability and intent to hold until maturity. All other securities not included in trading or held to maturity are classified as available for sale. At December 31, 2012 and 2011, the Company classified all of its investment securities as available for sale.

Available for sale securities are recorded at fair value. Unrealized holding gains and losses, net of the related tax effect, are excluded from earnings and are reported as a separate component of shareholders’ equity until realized.

Management evaluates investment securities for other-than-temporary impairment on an annual basis. A decline in the market value of any investment below cost that is deemed other-than-temporary is charged to earnings for

A-36

the decline in value deemed to be credit related and a new cost basis in the security is established. The decline in value attributed to non-credit related factors is recognized in comprehensive income.

Premiums and discounts are amortized or accreted over the life of the related security as an adjustment to the yield.  Realized gains and losses for securities classified as available for sale are included in earnings and are derived using the specific identification method for determining the cost of securities sold.

Other Investments

Other investments include equity securities with no readily determinable fair value. These investments are carried at cost.

Mortgage Loans Held for Sale

Mortgage loans held for sale are carried at lower of aggregate cost or market value. The cost of mortgage loans held for sale approximates the market value.

Loans

Loans that management has the intent and ability to hold for the foreseeable future or until maturity are reported at the principal amount outstanding, net of the allowance for loan losses. Interest on loans is calculated by using the simple interest method on daily balances of the principal amount outstanding. The recognition of certain loan origination fee income and certain loan origination costs is deferred when such loans are originated and amortized over the life of the loan.

A loan is impaired when, based on current information and events, it is probable that all amounts due according to the contractual terms of the loan will not be collected.  Impaired loans are measured based on the present value of expected future cash flows, discounted at the loan’s effective interest rate, or at the loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent.

Accrual of interest is discontinued on a loan when management believes, after considering economic conditions and collection efforts, that the borrower’s financial condition is such that collection of interest is doubtful. Interest previously accrued but not collected is reversed against current period earnings.

Allowance for Loan Losses

The allowance for loan losses reflects management’s assessment and estimate of the risks associated with extending credit and its evaluation of the quality of the loan portfolio. The Bank periodically analyzes the loan portfolio in an effort to review asset quality and to establish an allowance for loan losses that management believes will be adequate in light of anticipated risks and loan losses. In assessing the adequacy of the allowance, size, quality and risk of loans in the portfolio are reviewed. Other factors considered are:

●   the Bank’s loan loss experience;

●   the amount of past due and non-performing loans;

●   specific known risks;

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

●   underlying estimated values of collateral securing loans;

●   current and anticipated economic conditions; and

●   other factors which management believes affect the allowance for potential credit losses.

The allowance for loan losses is comprised of three components: specific reserves, general reserves and unallocated reserves. After a loan has been identified as impaired, management measures impairment. When the measure of the impaired loan is less than the recorded investment in the loan, the amount of the impairment is recorded as a specific reserve. These specific reserves are determined on an individual loan basis based on management’s current evaluation of the Bank’s loss exposure for each credit, given the appraised value of any underlying collateral or the present value of projected cash flows for non-collateral dependent loans. Loans for which specific reserves are provided are excluded from the general allowance calculations as described below.

The general allowance reflects reserves established under GAAP for collective loan impairment. These reserves are based upon historical net charge-offs using the greater of the last two or three years’ loss experience.  This charge-off experience may be adjusted to reflect the effects of current conditions.  The Bank considers information derived from its loan risk ratings and external data related to industry and general economic trends in establishing reserves.

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The unallocated allowance is determined through management’s assessment of probable losses that are in the portfolio but are not adequately captured by the other two components of the allowance, including consideration of current economic and business conditions and regulatory requirements. The unallocated allowance also reflects management’s acknowledgement of the imprecision and subjectivity that underlie the modeling of credit risk.  Due to the subjectivity involved in determining the overall allowance, including the unallocated portion, this unallocated portion may fluctuate from period to period based on management’s evaluation of the factors affecting the assumptions used in calculating the allowance.

Management considers the allowance for loan losses adequate to cover the estimated losses inherent in the Bank’s loan portfolio as of the date of the financial statements. Management believes it has established the allowance in accordance with GAAP and in consideration of the current economic environment. Although management uses the best information available to make evaluations, significant future additions to the allowance may be necessary based on changes in economic and other conditions, thus adversely affecting the operating results of the Company.

There were no significant changes in the estimation methods or fundamental assumptions used in the evaluation of the allowance for loan losses for the year ended December 31, 2012 as compared to the year ended December 31, 2011.   Revisions, estimates and assumptions may be made in any period in which the supporting factors indicate that loss levels may vary from the previous estimates.

Effective December 31, 2012, stated income mortgage loans from the Banco de la Gente division of the Bank were analyzed separately from other single family residential loans in the Bank’s loan portfolio.  These loans are first mortgage loans made to the Latino market, primarily in Mecklenburg and surrounding counties.  These loans are non-traditional mortgages in that the customer normally did not have a credit history, so all credit information was accumulated by the loan officers.  These loans were made as stated income loans rather than full documentation loans because the customer may not have had complete documentation on the income supporting the loan.

Various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. Such agencies may require adjustments to the allowance based on their judgments of information available to them at the time of their examinations.  Also, an independent loan review process further assists with evaluating credit quality and assessing potential performance issues.

Mortgage Banking Activities

Mortgage banking income represents net gains from the sale of mortgage loans and fees received from borrowers and loan investors related to the Bank’s origination of single-family residential mortgage loans.

Mortgage loans serviced for others are not included in the accompanying balance sheets. The unpaid principal balances of mortgage loans serviced for others was approximately $3.1 million, $4.0 million and $5.3 million at December 31, 2012, 2011 and 2010, respectively.

The Bank originates certain fixed rate mortgage loans and commits these loans for sale.  The commitments to originate fixed rate mortgage loans and the commitments to sell these loans to a third party are both derivative contracts.  The fair value of these derivative contracts is immaterial and has no effect on the recorded amounts in the financial statements.

Premises and Equipment

Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed primarily using the straight-line method over the estimated useful lives of the assets. When assets are retired or otherwise disposed, the cost and related accumulated depreciation are removed from the accounts, and any gain or loss is reflected in earnings for the period. The cost of maintenance and repairs that do not improve or extend the useful life of the respective asset is charged to earnings as incurred, whereas significant renewals and improvements are capitalized. The range of estimated useful lives for premises and equipment are generally as follows:

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

Other Real Estate

Foreclosed assets include all assets received in full or partial satisfaction of a loan.  Foreclosed assets are reported at fair value less estimated selling costs.  Any write-downs at the time of foreclosure are charged to the allowance for loan losses.  Subsequent to foreclosure, valuations are periodically performed by management, and a valuation allowance is established if fair value declines below carrying value.  Costs relating to the development and

A-38

improvement of the property are capitalized.  Revenues and expenses from operations are included in other expenses.  Changes in the valuation allowance are included in loss on sale and write-down of other real estate.  The balance of other real estate owned was $6.3 million and $7.6 million at December 31, 2012 and 2011, respectively.

Income Taxes

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Additionally, the recognition of future tax benefits, such as net operating loss carryforwards, is required to the extent that the realization of such benefits is more likely than not to occur. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which the assets and liabilities are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income tax expense in the period that includes the enactment date.

In the event the future tax consequences of differences between the financial reporting bases and the tax bases of the Company’s assets and liabilities results in a deferred tax asset, an evaluation of the probability of being able to realize the future benefits indicated by such asset is required. A valuation allowance is provided for the portion of the deferred tax asset when it is more likely than not that some portion or all of the deferred tax asset will not be realized. In assessing the realizability of a deferred tax asset, management considers the scheduled reversals of deferred tax liabilities, projected future taxable income, and tax planning strategies.

Tax effects from an uncertain tax position can be recognized in the financial statements only when it is more likely than not that the tax position will be sustained upon examination by the appropriate taxing authority that would have full knowledge of all relevant information.  A tax position that meets the more likely than not recognition threshold is measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement.  Previously recognized tax positions that no longer meet the more likely than not recognition threshold should be derecognized in the first subsequent financial reporting period in which that threshold is no longer met.  The Company assessed the impact of this guidance and determined that it did not have a material impact on the Company’s financial position, results of operations or disclosures.

Derivative Financial Instruments and Hedging Activities

In the normal course of business, the Company enters into derivative contracts to manage interest rate risk by modifying the characteristics of the related balance sheet instruments in order to reduce the adverse effect of changes in interest rates. All material derivative financial instruments are recorded at fair value in the financial statements.  The fair value of derivative contracts related to the origination of fixed rate mortgage loans and the commitments to sell these loans to a third party is immaterial and has no effect on the recorded amounts in the financial statements.

The disclosure requirements for derivatives and hedging activities have the intent to provide users of financial statements with an enhanced understanding of: (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows.  The disclosure requirements include qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about the fair value of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative instruments.

On the date a derivative contract is entered into, the Company designates the derivative as a fair value hedge, a cash flow hedge, or a trading instrument. Changes in the fair value of instruments used as fair value hedges are accounted for in the earnings of the period simultaneous with accounting for the fair value change of the item being hedged. Changes in the fair value of the effective portion of cash flow hedges are accounted for in other comprehensive income rather than earnings. Changes in fair value of instruments that are not intended as a hedge are accounted for in the earnings of the period of the change.

If a derivative instrument designated as a fair value hedge is terminated or the hedge designation removed, the difference between a hedged item’s then carrying amount and its face amount is recognized into income over the original hedge period. Likewise, if a derivative instrument designated as a cash flow hedge is terminated or the hedge designation removed, related amounts accumulated in other accumulated comprehensive income are reclassified into earnings over the original hedge period during which the hedged item affects income.

The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives

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designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge.  The Company may enter into derivative contracts that are intended to economically hedge certain of its risks, even though hedge accounting does not apply or the Company elects not to apply hedge accounting.

The Company formally documents all hedging relationships, including an assessment that the derivative instruments are expected to be highly effective in offsetting the changes in fair values or cash flows of the hedged items.

Advertising Costs

Advertising costs are expensed as incurred.

Stock-Based Compensation

The Company has an Omnibus Stock Ownership and Long Term Incentive Plan (the “1999 Plan”) whereby certain stock-based rights, such as stock options, restricted stock units, performance units, stock appreciation rights, or book value shares, may be granted to eligible directors and employees.  The 1999 Plan expired on May 13, 2009.

Under the 1999 Plan, the Company granted incentive stock options to certain eligible employees in order that they may purchase Company stock at a price equal to the fair market value on the date of the grant.  The options granted in 1999 vested over a five-year period.  Options granted subsequent to 1999 vest over a three-year period.

 All options expire ten years after the date of grant.  A summary of the stock option activity in the 1999 Plan is presented below:

Stock Option Activity
For the Years Ended December 31, 2012, 2011 and 2010
	Shares		Weighted Average Option Price Per Share		Weighted Average Remaining Contractual Term (in years)
Outstanding, December 31, 2009	169,462		$	8.17
Granted during the period	-		$	-
Expired during the period	(19,391	)	$	6.99
Exercised during the period	-		$	-
Outstanding, December 31, 2010	150,071		$	8.32
Granted during the period	-		$	-
Expired during the period	(71,054	)	$	8.71
Exercised during the period	-		$	-
Outstanding, December 31, 2011	79,017		$	7.97
Granted during the period	-		$	-
Expired during the period	-		$	-
Forfeited during the period	(6,052	)	$	8.89
Exercised during the period	(69,335	)	$	7.77
Outstanding, December 31, 2012	3,630		$	10.31	1.35
Exercisable, December 31, 2012	3,630		$	10.31	1.35

Options outstanding at December 31, 2012 are exercisable at $10.31.  As of December 31, 2012, the exercise price on options outstanding is more than the current market value; therefore, options outstanding as of December 31, 2012 have no intrinsic value.  Such options have a weighted average remaining contractual life of

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approximately one year.  No options were granted during the years ended December 31, 2012, 2011 and 2010. 69,335 options were exercised during the year ended December 31, 2012.  No options were exercised during the years ended December 31,  2011 and 2010.

The Company granted 3,000 restricted stock units in 2007 under the 1999 Plan at a grant date fair value of $17.40 per share. The Company granted 1,750 restricted stock unitsunder the 1999 Plan at a grant date fair value of $12.80 per share during the third quarter of 2008 and 2,000 restricted stock units under the 1999 Plan at a fair value of $11.37 per share during the fourth quarter of 2008. The Company recognizes compensation expense on the restricted stock units over the period of time the restrictions are in place (three years from the grant date for the grants to date under the 1999 Plan).  The amount of expense recorded each period reflects the changes in the Company’s stock price during the period.  As of December 31, 2012, there was no unrecognized compensation cost related to the 2007 and 2008 restricted stock unit grants.

The Company also has an Omnibus Stock Ownership and Long Term Incentive Plan that was approved by its shareholders’ on May 7, 2009 (the “2009 Plan”) whereby certain stock-based rights, such as stock options, restricted stock, restricted stock units, performance units, stock appreciation rights, or book value shares, may be granted to eligible directors and employees.  A total of 330,486 shares are currently reserved for possible issuance under the 2009 Plan.   All rights must be granted or awarded within ten years from the May 7, 2009 effective date of the 2009 Plan.

The Company granted 29,514 restricted stock units under the 2009 Plan  at a grant date fair value of $7.90 per share during the first quarter of 2012.  5,355 restricted stock units were forfeited by the executive officers of the Company as required by the agreement with the U.S. Department of the Treasury (“UST”) in conjunction with the Company’s participation in the Capital Purchase Program (“CPP”) under the Troubled Asset Relief Program (“TARP”) in 2008.  In July 2012, the Company granted 5,355 restricted stock units at a grant date fair value of $8.25. The Company recognizes compensation expense on the restricted stock units over the period of time the restrictions are in place (five years from the grant date for the grants to date under the 2009 Plan). The amount of expense recorded each period reflects the changes in the Company’s stock price during the period.  As of December 31, 2012, the total unrecognized compensation cost related to the 2012 restricted stock unit grants was $227,000.

The Company recognized compensation expense for restricted stock awards of $42,000, $7,000 and $10,000 for the years ended December 31, 2012, 2011 and 2010, respectively.

Net Earnings Per Share

Net earnings per common share is based on the weighted average number of common shares outstanding during the period while the effects of potential common shares outstanding during the period are included in diluted earnings per common share. The average market price during the year is used to compute equivalent shares.

The reconciliations of the amounts used in the computation of both “basic earnings per common share” and “diluted earnings per common share” for the years ended December 31, 2012, 2011 and 2010 are as follows:

For the year ended December 31, 2012:	Net Earnings Available to Common Shareholders (Dollars in thousands)		Common Shares		Per Share Amount
Basic earnings per common share	$	4,783		5,559,401	$	0.86
Effect of dilutive securities:
Stock options		-		3,206
Diluted earnings per common share	$	4,783		5,562,607	$	0.86

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For the year ended December 31, 2011:	Net Earnings Available to Common Shareholders (Dollars in thousands)		Common Shares		Per Share Amount
Basic earnings per common share	$	3,766		5,542,548	$	0.68
Effect of dilutive securities:
Stock options		-		1,301
Diluted earnings per common share	$	3,766		5,543,849	$	0.68

For the year ended December 31, 2010:	Net Earnings Available to Common Shareholders (Dollars in thousands)		Common Shares		Per Share Amount
Basic earnings per common share	$	447		5,539,308	$	0.08
Effect of dilutive securities:
Stock options		-		4,107
Diluted earnings per common share	$	447		5,543,415	$	0.08

Recent Accounting Pronouncements

In January 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2013-01, Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities. ASU No. 2013-01 provides additional guidance to clarify the intended scope of ASU No. 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities.  ASU No. 2013-01 is effective for fiscal years beginning on or after January 1, 2013, and interim periods within those annual periods. The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position ordisclosures.

In February 2013, FASB issued ASU No. 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. The objective of ASU No. 2013-02 is to improve the reporting of significant reclassifications out of accumulated other comprehensive income.  For public entities, ASU No. 2013-02 is effective for reporting periods beginning after December 15, 2012.  The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position ordisclosures.

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

(2)   Investment Securities

Investment securities available for sale at December 31, 2012 and 2011 are as follows:

(Dollars in thousands)
	December 31, 2012
	Amortized Cost		Gross Unrealized Gains	Gross Unrealized Losses	Estimated Fair Value
Mortgage-backed securities	$	146,755	1,875	606	148,024
U.S. Government
sponsored enterprises		18,714	203	80	18,837
State and political subdivisions		118,591	7,171	104	125,658
Corporate bonds		2,571	19	4	2,586
Trust preferred securities		1,250	-	-	1,250
Equity securities		748	720	-	1,468
Total	$	288,629	9,988	794	297,823

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(Dollars in thousands)
	December 31, 2011
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
Mortgage-backed securities	$	213,378		1,371		1,056		213,693
U.S. Government
sponsored enterprises		7,429		265		-		7,694
State and political subdivisions		92,996		4,157		56		97,097
Corporate bonds		546		-		3		543
Trust preferred securities		1,250		-		-		1,250
Equity securities		748		363		-		1,111
Total	$	316,347		6,156		1,115		321,388

The current fair value and associated unrealized losses on investments in debt securities with unrealized losses at December 31, 2012 and 2011 are summarized in the tables below, with the length of time the individual securities have been in a continuous loss position.

(Dollars in thousands)
	December 31, 2012
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair  Value		Unrealized Losses		Fair  Value		Unrealized Losses
Mortgage-backed securities		48,126		468		12,913		138		61,039		606
U.S. Government
sponsored enterprises		3,402		80		-		-		3,402		80
State and political subdivisions		9,490		104		-		-		9,490		104
Corporate bonds		1,035		4		-		-		1,035		4
Total		62,053		656		12,913		138		74,966		794

(Dollars in thousands)
	December 31, 2011
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Mortgage-backed securities	$	95,122		991		4,125		65		99,247		1,056
State and political subdivisions		4,444		56		-		-		4,444		56
Corporate bonds		542		3		-		-		542		3
Total	$	100,108		1,050		4,125		65		104,233		1,115

At December 31, 2012, unrealized losses in the investment securities portfolio relating to debt securities totaled $794,000. The unrealized losses on these debt securities arose due to changing interest rates and are considered to be temporary.  At December 31, 2012, ten out of 151 securities issued by state and political subdivisions contained unrealized losses, 36 out of 90 securities issued by U.S. Government sponsored enterprises, including mortgage-backed securities, contained unrealized losses and two out of four securities issued by corporations contained unrealized losses. These unrealized losses are considered temporary because of acceptable investment grades on each security and the repayment sources of principal and interest are government backed.

The Company periodically evaluates its investments for any impairment which would be deemed other-than-temporary. No investment impairments were deemed other-than-temporary in 2012. As part of its evaluation in 2011, the Company determined that the fair value of one equity security was less than the original cost of the investment and that the decline in fair value was not temporary in nature.  As a result, the Company wrote down its investment by $144,000. The remaining fair value of the investment at December 31, 2011 was approximately $264,000.  Similarly, as part of its evaluation in 2010, the Company wrote down two equity securities by $291,000.  The remaining fair value of the investments at December 31, 2010 was $409,000.

The amortized cost and estimated fair value of investment securities available for sale at December 31, 2012, by contractual maturity, are shown below. Expected maturities of mortgage-backed securities will differ from

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contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties.

(Dollars in thousands)
	Amortized Cost		Estimated Fair Value
Due within one year	$	4,139		4,163
Due from one to five years		14,285		14,768
Due from five to ten years		100,595		106,246
Due after ten years		22,107		23,154
Mortgage-backed securities		146,755		148,024
Equity securities		748		1,468
Total	$	288,629		297,823

Proceeds from sales of securities available for sale during 2012 were $47.1 million and resulted in gross gains of $1.3 million and gross losses of $103,000.  During 2011, the proceeds from sales of securities available for sale were $111.0 million and resulted in gross gains of $4.4 million and gross losses of $9,000. During 2010, the proceeds from sales of securities available for sale were $65.8 million and resulted in gross gains of $3.3 million.

Securities with a fair value of approximately $73.9 million and $83.6 million at December 31, 2012 and 2011, respectively, were pledged to secure public deposits, Federal Home Loan Bank of Atlanta (“FHLB”) borrowings and for other purposes as required by law.

GAAP establishes a framework for measuring fair value and expands disclosures about fair value measurements. There is a three-level fair value hierarchy for fair value measurements.  Level 1 inputs are quoted prices in active markets for identical assets or liabilities that a company has the ability to access at the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs for the asset or liability. The table below presents the balance of securities available for sale, which are measured at fair value on a recurring basis by level within the fair value hierarchy as of December 31, 2012 and 2011.

(Dollars in thousands)
	December 31, 2012
	Fair Value Measurements		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
Mortgage-backed securities	$	148,024		-		148,024		-
U.S. Government
sponsored enterprises	$	18,837		-		18,837		-
State and political subdivisions	$	125,658		-		125,658		-
Corporate bonds	$	2,586		-		2,586		-
Trust preferred securities	$	1,250		-		-		1,250
Equity securities	$	1,468		1,468		-		-

(Dollars in thousands)
	December 31, 2011
	Fair Value Measurements		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
Mortgage-backed securities	$	213,693		-		208,349		5,344
U.S. Government
sponsored enterprises	$	7,694		-		7,694		-
State and political subdivisions	$	97,097		-		97,097		-
Corporate bonds	$	543		-		543		-
Trust preferred securities	$	1,250		-		-		1,250
Equity securities	$	1,111		1,111		-		-

Fair values of investment securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges when available.  If quoted prices are not available, fair value is determined using matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities.

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The following is an analysis of fair value measurements of investment securities available for sale using Level 3, significant unobservable inputs, for the year ended December 31, 2012.  Transfers out of Level 3 during the year ended December 31, 2012 are attributable to one available for sale security reported in Level 3 at December 31, 2011 because market pricing was unavailable from the Bank’s third party bond accounting provider at that time.  This security was reported in Level 2 at December 31, 2012, as the market valuation was provided by the Bank’s third party bond accounting provider.

(Dollars in thousands)
	Investment Securities Available for Sale
	Level 3 Valuation
Balance, beginning of period	$	6,594
Change in book value		-
Change in gain/(loss) realized and unrealized		-
Purchases/(sales)		-
Transfers in and/or (out) of Level 3		(5,344	)
Balance, end of period	$	1,250
Change in unrealized gain/(loss) for assets still held in Level 3	$	-

(3)   Loans

Major classifications of loans at December 31, 2012 and 2011 are summarized as follows:

(Dollars in thousands)
	December 31, 2012		December 31, 2011
Real estate loans
Construction and land development	$	73,176	93,812
Single-family residential		195,003	212,993
Single-family residential -
Banco de la Gente stated income		52,019	54,058
Commercial		200,633	214,415
Multifamily and farmland		8,951	4,793
Total real estate loans		529,782	580,071
Commercial loans (not secured by real estate)		64,295	60,646
Farm loans (not secured by real estate)		11	-
Consumer loans (not secured by real estate)		10,148	10,490
All other loans (not secured by real estate)		15,738	19,290
Total loans		619,974	670,497
Less allowance for loan losses		14,423	16,604
Total net loans	$	605,551	653,893

The Bank grants loans and extensions of credit primarily within the Catawba Valley region of North Carolina, which encompasses Catawba, Alexander, Iredell and Lincoln counties and also in Mecklenburg, Union and Wake counties of North Carolina.  Although the Bank has a diversified loan portfolio, a substantial portion of the loan portfolio is collateralized by improved and unimproved real estate, the value of which is dependent upon the real estate market.  Risk characteristics of the major components of the Bank’s loan portfolio are discussed below:

●   Construction and land development loans – The risk of loss is largely dependent on the initial estimate of whether the property’s value at completion equals or exceeds the cost of property construction and the availability of take-out financing.  During the construction phase, a number of factors can result in delays or cost overruns.  If the estimate is inaccurate or if actual construction costs exceed estimates, the value of the property securing our loan may be insufficient to ensure full repayment when completed through a permanent loan, sale of the property, or by seizure of collateral. As of December 31, 2012, construction and land development loans comprised approximately 12% of the Bank’s total loan portfolio.

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●   Single-family residential loans – Declining home sales volumes, decreased real estate values and higher than normal levels of unemployment could contribute to losses on these loans.  As of December 31, 2012, single-family residential loans comprised approximately 40% of the Bank’s total loan portfolio, including Banco de la Gente single-family residential stated income loans amounting to approximately 8% of the Bank’s total loan portfolio.

●   Commercial real estate loans – Repayment is dependent on income being generated in amounts sufficient to cover operating expenses and debt service.  These loans also involve greater risk because they are generally not fully amortizing over a loan period, but rather have a balloon payment due at maturity.  A borrower’s ability to make a balloon payment typically will depend on being able to either refinance the loan or timely sell the underlying property.  As of December 31, 2012, commercial real estate loans comprised approximately 32% of the Bank’s total loan portfolio.

●   Commercial loans – Repayment is generally dependent upon the successful operation of the borrower’s business.   In addition, the collateral securing the loans may depreciate over time, be difficult to appraise, be illiquid, or fluctuate in value based on the success of the business.  As of December 31, 2012, commercial loans comprised approximately 10% of the Bank’s total loan portfolio.

Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

The following tables present an age analysis of past due loans, by loan type, as of December 31, 2012 and 2011:

December 31, 2012
(Dollars in thousands)
	Loans 30-89 Days Past  Due		Loans 90 or More Days Past Due	Total Past Due Loans	Total Current Loans	Total Loans	Accruing Loans 90 or More Days Past Due
Real estate loans
Construction and land development	$	1,280	6,858	8,138	65,038	73,176	-
Single-family residential		4,316	1,548	5,864	189,139	195,003	-
Single-family residential -
Banco de la Gente stated income		11,077	3,659	14,736	37,283	52,019	2,378
Commercial		1,720	1,170	2,890	197,743	200,633	-
Multifamily and farmland		7	-	7	8,944	8,951	-
Total real estate loans		18,400	13,235	31,635	498,147	529,782	2,378
Commercial loans (not secured by real estate)		888	66	954	63,341	64,295	23
Farm loans (not secured by real estate)		-	-	-	11	11	-
Consumer loans (not secured by real estate)		250	10	260	9,888	10,148	2
All other loans (not secured by real estate)		-	-	-	15,738	15,738	-
Total loans	$	19,538	13,311	32,849	587,125	619,974	2,403

December 31, 2011
(Dollars in thousands)
	Loans 30-89 Days Past Due		Loans 90 or More Days Past Due	Total Past Due Loans	Total Current Loans	Total Loans	Accruing Loans 90 or More Days Past Due
Real estate loans
Construction and land development	$	10,033	3,338	13,371	80,441	93,812	-
Single-family residential		4,612	1,434	6,046	206,947	212,993	107
Single-family residential -
Banco de la Gente stated income		11,924	4,755	16,679	37,379	54,058	2,602
Commercial		1,002	958	1,960	212,455	214,415	-
Multifamily and farmland		13	-	13	4,780	4,793	-
Total real estate loans		27,584	10,485	38,069	542,002	580,071	2,709
Commercial loans (not secured by real estate)		576	9	585	60,061	60,646	-
Consumer loans (not secured by real estate)		116	36	152	10,338	10,490	-
All other loans (not secured by real estate)		-	-	-	19,290	19,290	-
Total loans	$	28,276	10,530	38,806	631,691	670,497	2,709

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The following tables present the Bank’s non-accrual loans as of December 31, 2012 and 2011:

(Dollars in thousands)
	December 31, 2012		December 31, 2011
Real estate loans
Construction and land development	$	9,253	13,257
Single-family residential		2,491	2,380
Single-family residential -
Banco de la Gente stated income		2,232	3,142
Commercial		3,263	2,451
Total real estate loans		17,239	21,230
Commercial loans (not secured by real estate)		344	403
Consumer loans (not secured by real estate)		47	152
Total	$	17,630	21,785

At each reporting period, the Bank determines which loans are impaired.  Accordingly, the Bank’s impaired loans are reported at their estimated fair value on a non-recurring basis.  An allowance for each impaired loan that is collateral-dependent is calculated based on the fair value of its collateral.  The fair value of the collateral is based on appraisals performed by REAS, a subsidiary of the Bank.  REAS is staffed by certified appraisers that also perform appraisals for other companies.  Factors including the assumptions and techniques utilized by the appraiser are considered by management.  If the recorded investment in the impaired loan exceeds the measure of fair value of the collateral, a valuation allowance is recorded as a component of the allowance for loan losses.  An allowance for each impaired loan that is non-collateral dependent is calculated based on the present value of projected cash flows.  If the recorded investment in the impaired loan exceeds the present value of projected cash flows, a valuation allowance is recorded as a component of the allowance for loan losses.  Impaired loans under $250,000 are not individually evaluated for impairment, with the exception of the Bank’s troubled debt restructured (“TDR”) loans in the residential mortgage loan portfolio, which are individually evaluated for impairment.  Accruing impaired loans were $30.6 million at December 31, 2012 and 2011.  Interest income recognized on accruing impaired loans was $1.5 million and $1.7 million for the years ended December 31, 2012 and 2011, respectively.  No interest income is recognized on non-accrual impaired loans subsequent to their classification as non-accrual.

The following tables present the Bank’s impaired loans as of December 31, 2012 and 2011:

December 31, 2012
(Dollars in thousands)
	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance	Recorded Investment With Allowance	Recorded Investment in Impaired Loans	Related Allowance	Average Outstanding Impaired Loans
Real estate loans
Construction and land development	$	17,738	11,795	680	12,475	61	12,810
Single-family residential		9,099	766	7,799	8,565	177	7,590
Single-family residential -
Banco de la Gente stated income		21,806	-	21,000	21,000	1,278	21,158
Commercial		5,830	4,569	467	5,036	6	5,433
Multifamily and farmland		193	-	193	193	1	200
Total impaired real estate loans		54,666	17,130	30,139	47,269	1,523	47,191
Commercial loans (not secured by real estate)		983	347	592	939	12	1,125
Consumer loans (not secured by real estate)		68	-	66	66	1	41
Total impaired loans	$	55,717	17,477	30,797	48,274	1,536	48,357

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December 31, 2011
(Dollars in thousands)
	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance	Recorded Investment With Allowance	Recorded Investment in Impaired Loans	Related Allowance	Average Outstanding Impaired Loans
Real estate loans
Construction and land development	$	28,721	14,484	6,098	20,582	3,264	17,848
Single-family residential		6,361	969	5,117	6,086	131	6,324
Single-family residential -
Banco de la Gente stated income		20,021	-	19,602	19,602	1,296	18,778
Commercial		7,717	3,845	3,139	6,984	77	4,518
Multifamily and farmland		209	-	209	209	1	214
Total impaired real estate loans		63,029	19,298	34,165	53,463	4,769	47,682
Commercial loans (not secured by real estate)		1,111	-	1,083	1,083	26	1,485
Consumer loans (not secured by real estate)		157	-	152	152	2	140
Total impaired loans	$	64,297	19,298	35,400	54,698	4,797	49,307

The Bank’s December 31, 2012 and 2011 fair value measurements for impaired loans and other real estate on a non-recurring basis are presented below.  The fair value measurement process uses certified appraisals and other market-based information; however, in many cases, it also requires significant input based on management’s knowledge of and judgment about current market conditions, specific issues relating to the collateral, and other matters.  As a result, all fair value measurements for impaired loans and other real estate are considered Level 3.

(Dollars in thousands)
	Fair Value Measurements December 31, 2012		Level 1 Valuation	Level 2 Valuation	Level 3 Valuation	Total Gains/(Losses) for the Year Ended December 31, 2012
Impaired loans	$	46,738	-	-	46,738	(7,986	)
Other real estate	$	6,254	-	-	6,254	(1,136	)

(Dollars in thousands)
	Fair Value Measurements December 31, 2011		Level 1 Valuation	Level 2 Valuation	Level 3 Valuation	Total Gains/(Losses) for the Year Ended December 31, 2011
Impaired loans	$	49,901	-	-	49,901	(11,864	)
Other real estate	$	7,576	-	-	7,576	(1,322	)

Changes in the allowance for loan losses for the year ended December 31, 2012 were as follows:

Year ended December 31, 2012
(Dollars in thousands)
	Real Estate Loans
	Construction and Land Development			Single-Family Residential		Single-Family Residential - Banco de la Gente Stated Income		Commercial		Multifamily and Farmland	Commercial		Farm	Consumer and All Other		Unallocated	Total
Allowance for loan losses:
Beginning balance	$	7,182		3,253		2,104		1,731		13	1,029		-	255		1,037	16,604
Charge-offs		(4,728	)	(886	)	(668	)	(937	)	-	(555	)	-	(557	)	-	(8,331	)
Recoveries		528		72		-		374		-	104		-	148		-	1,226
Provision		1,417		792		562		881		15	510		-	399		348	4,924
Ending balance	$	4,399		3,231		1,998		2,049		28	1,088		-	245		1,385	14,423
Ending balance: individually
evaluated for impairment	$	24		84		1,254		-		-	-		-	-		-	1,362
Ending balance: collectively
evaluated for impairment		4,375		3,147		744		2,049		28	1,088		-	245		1,385	13,061
Ending balance	$	4,399		3,231		1,998		2,049		28	1,088		-	245		1,385	14,423
Loans:
Ending balance	$	73,176		195,003		52,019		200,633		8,951	64,295		11	25,886		-	619,974
Ending balance: individually
evaluated for impairment	$	11,961		3,885		20,024		4,569		-	346		-	-		-	40,785
Ending balance: collectively
evaluated for impairment	$	61,215		191,118		31,995		196,064		8,951	63,949		11	25,886		-	579,189

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Changes in the allowance for loan losses for the year ended December 31, 2011 were as follows:

Year ended December 31, 2011
(Dollars in thousands)
	Real Estate Loans
	Construction and Land Development			Single- Family Residential		Single- Family Residential - Banco de la Gente Stated Income		Commercial		Multifamily and Farmland		Commercial		Consumer and All Other		Unallocated	Total
Allowance for loan losses:
Beginning balance	$	5,774		3,992		2,105		1,409		17		1,174		430		592	15,493
Charge-offs		(7,164	)	(2,233	)	(692	)	(1,271	)	-		(314	)	(586	)	-	(12,260	)
Recoveries		241		184		17		24		-		121		152		-	739
Provision		8,331		1,310		674		1,569		(4	)	48		259		445	12,632
Ending balance	$	7,182		3,253		2,104		1,731		13		1,029		255		1,037	16,604
Ending balance: individually
evaluated for impairment	$	1,250		46		1,243		-		-		-		-		-	2,539
Ending balance: collectively
evaluated for impairment		5,932		3,207		861		1,731		13		1,029		255		1,037	14,065
Ending balance	$	7,182		3,253		2,104		1,731		13		1,029		255		1,037	16,604
Loans:
Ending balance	$	93,812		212,993		54,058		214,415		4,793		60,646		29,780		-	670,497
Ending balance: individually
evaluated for impairment	$	20,280		2,352		18,309		3,845		-		-		-		-	44,786
Ending balance: collectively
evaluated for impairment	$	73,532		210,641		35,749		210,570		4,793		60,646		29,780		-	625,711

Changes in the allowance for loan losses for the year ended December 31, 2010 were as follows:

(Dollars in thousands)
	2010
Balance at beginning of year	$	15,413
Amounts charged off		(16,911	)
Recoveries on amounts previously charged off		553
Provision for loan losses		16,438
Balance at end of year	$	15,493

The Bank utilizes an internal risk grading matrix to assign a risk grade to each of its loans.  Loans are graded on a scale of 1 to 9.  These risk grades are evaluated on an ongoing basis.  A description of the general characteristics of the nine risk grades is as follows:

●   Risk Grade 1 – Excellent Quality: Loans are well above average quality and a minimal amount of credit risk exists.  CD or cash secured loans or properly margined actively traded stock or bond secured loans would fall in this grade.

●   Risk Grade 2 – High Quality: Loans are of good quality with risk levels well within the Company’s range of acceptability.  The organization or individual is established with a history of successful performance though somewhat susceptible to economic changes.

●   Risk Grade 3 – Good Quality: Loans of average quality with risk levels within the Company’s range of acceptability but higher than normal. This may be a new organization or an existing organization in a transitional phase (e.g. expansion, acquisition, market change).

●   Risk Grade 4 – Management Attention: These loans have higher risk and servicing needs but still are acceptable. Evidence of marginal performance or deteriorating trends is observed.  These are not problem credits presently, but may be in the future if the borrower is unable to change its present course.

●   Risk Grade 5 – Watch: These loans are currently performing satisfactorily, but there has been some recent past due history on repayment and there are potential weaknesses that may, if not corrected, weaken the asset or inadequately protect the Company’s position at some future date.

●   Risk Grade 6 – Substandard: A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the obligor or the collateral pledged (if there is any).  There is a well-defined weakness or weaknesses that jeopardize the liquidation of the debt.  There is a distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

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·   Risk Grade 7 – Low Substandard: These loans have the general characteristics of a Grade 6 Substandard loan, with heightened potential concerns.  The exact amount of loss is not yet known because neither the liquidation value of the collateral nor the borrower’s predicted repayment ability is known with confidence.

·   Risk Grade 8 – Doubtful: Loans classified as Doubtful have all the weaknesses inherent in loans classified Substandard, plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values highly questionable and improbable.  Doubtful is a temporary grade where a loss is expected but is presently not quantified with any degree of accuracy. Once the loss position is determined, the amount is charged off.

·   Risk Grade 9 – Loss: Loans classified as Loss are considered uncollectable and of such little value that their continuance as bankable assets is not warranted.  This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this worthless loan even though partial recovery may be realized in the future.  Loss is a temporary grade until the appropriate authority is obtained to charge the loan off.

The following tables present the credit risk profile of each loan type based on internally assigned risk grade as of December 31, 2012 and 2011.

December 31, 2012
(Dollars in thousands)
	Real Estate Loans
	Construction and Land Development		Single- Family Residential	Single- Family Residential - Banco de la Gente Stated Income	Commercial	Multifamily and Farmland	Commercial	Farm	Consumer	All Other	Total
1- Excellent Quality	$	11	24,662	-	-	-	672	-	1,239	-	26,584
2- High Quality		4,947	56,829	-	27,511	32	9,260	-	4,122	2,317	105,018
3- Good Quality		24,952	62,018	24,724	114,001	4,975	40,814	11	4,186	13,416	289,097
4- Management Attention		18,891	35,727	11,366	47,603	3,039	11,844	-	392	5	128,867
5- Watch		9,580	9,504	3,597	6,911	712	976	-	134	-	31,414
6- Substandard		14,795	6,263	12,332	4,607	193	729	-	70	-	38,989
7- Low Substandard		-	-	-	-	-	-	-	-	-	-
8- Doubtful		-	-	-	-	-	-	-	-	-	-
9- Loss		-	-	-	-	-	-	-	5	-	5
Total	$	73,176	195,003	52,019	200,633	8,951	64,295	11	10,148	15,738	619,974

December 31, 2011
(Dollars in thousands)
	Real Estate Loans
	Construction and Land Development		Single- Family Residential	Single- Family Residential - Banco de la Gente Stated Income	Commercial	Multifamily and Farmland	Commercial	Consumer	All Other	Total
1- Excellent Quality	$	197	25,474	-	-	-	715	1,344	-	27,730
2- High Quality		5,183	64,817	-	25,506	50	8,801	4,070	2,774	111,201
3- Good Quality		27,675	74,824	25,564	136,137	3,448	36,585	4,259	16,509	325,001
4- Management Attention		28,138	35,233	15,020	40,312	358	12,882	429	7	132,379
5- Watch		15,923	6,141	5,626	2,795	728	622	89	-	31,924
6- Substandard		16,696	6,504	7,848	9,665	209	1,041	154	-	42,117
7- Low Substandard		-	-	-	-	-	-	-	-	-
8- Doubtful		-	-	-	-	-	-	-	-	-
9- Loss		-	-	-	-	-	-	145	-	145
Total	$	93,812	212,993	54,058	214,415	4,793	60,646	10,490	19,290	670,497

At December 31, 2012, TDR loans amounted to $23.9 million, including $2.0 million in performing TDR loans. Effective March 31, 2012, performing TDR balances reflect current year TDR loans only, in accordance with GAAP.  Previously reported TDR amounts reflect cumulative TDR loans from prior periods in addition to current year TDR loans.  At December 31, 2011, TDR loans were $44.1 million, including $15.1 million in performing

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TDR loans.   The terms of these loans have been renegotiated to provide a reduction in principal or interest as a result of the deteriorating financial position of the borrower.

The following table presents an analysis of TDR loans by loan type as of December 31, 2012.

December 31, 2012
(Dollars in thousands)
	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Real estate loans
Construction and land development	11	$	10,465	6,633
Single-family residential	33		3,014	4,084
Single-family residential -
Banco de la Gente stated income	122		13,459	12,170
Commercial	4		1,457	682
Total real estate TDR loans	170		28,395	23,569
Commercial loans (not secured by real estate)	9		511	368
Consumer loans (not secured by real estate)	1		2	-
Total TDR loans	180	$	28,908	23,937

The following table presents an analysis of 2012 loan modifications included in the December 31, 2012 TDR table above.

December 31, 2012
(Dollars in thousands)
	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Real estate loans
Single-family residential	5	$	674	673
Single-family residential -
Banco de la Gente stated income	20		2,046	1,992
Total real estate TDR loans	25		2,720	2,665
Commercial loans (not secured by real estate)	1		14	13
Total TDR loans	26	$	2,734	2,678

The following table presents an analysis of TDR loans by loan type as of December 31, 2011.

December 31, 2011
(Dollars in thousands)
	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Real estate loans
Construction and land development	29	$	19,762	12,840
Single-family residential	48		4,684	5,244
Single-family residential -
Banco de la Gente stated income	193		20,857	19,602
Commercial	15		7,200	5,013
Multifamily and farmland	1		322	209
Total real estate TDR loans	286		52,825	42,908
Commercial loans (not secured by real estate)	21		1,711	1,083
Consumer loans (not secured by real estate)	8		124	142
Total TDR loans	315	$	54,660	44,133

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(4)   Premises and Equipment

Major classifications of premises and equipment are summarized as follows:

(Dollars in thousands)
	2012		2011
Land	$	3,657	3,581
Buildings and improvements		14,815	14,771
Furniture and equipment		17,660	16,874
Total premises and equipment		36,132	35,226
Less accumulated depreciation		20,258	18,330
Total net premises and equipment	$	15,874	16,896

Depreciation expense was approximately $1.9 million for the year ended December 31, 2012.  The Company recognized approximately $2.0 and $2.1 million in depreciation expense for the years ended December 31, 2011 and 2010, respectively.

(5)   Time Deposits

At December 31, 2012, the scheduled maturities of time deposits are as follows:

(Dollars in thousands)
2013	$	157,707
2014		33,579
2015		36,066
2016		10,269
2017 and thereafter		10,603
Total	$	248,224

At December 31, 2012 and 2011, the Company had approximately $21.4 million and $47.0 million, respectively, in time deposits purchased through third party brokers, including certificates of deposit participated through the Certificate of Deposit Account Registry Service (“CDARS”) on behalf of local customers.  CDARS balances totaled $20.1 million and $28.6 million as of December 31, 2012 and 2011, respectively.  The weighted average rate of brokered deposits as of December 31, 2012 and 2011 was 0.29% and 0.99%, respectively.

(6)   Federal Home Loan Bank and Federal Reserve Bank Borrowings

The Bank has borrowings from the FHLB with monthly or quarterly interest payments at December 31, 2012.  The FHLB borrowings are collateralized by a blanket assignment on all residential first mortgage loans, home equity lines of credit and loans secured by multi-family real estate that the Bank owns.  At December 31, 2012, the carrying value of loans pledged as collateral totaled approximately $138.7 million.  As additional collateral, the Bank has pledged securities to the FHLB.  At December 31, 2012, the market value of securities pledged to the FHLB totaled $17.8 million.

Borrowings from the FHLB outstanding at December 31, 2012 consist of the following:

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(Dollars in thousands)
Maturity Date	Call Date	Rate	Rate Type	Amount
June 24, 2015	N/A	3.710%	Convertible	$	5,000
March 25, 2019	N/A	4.260%	Convertible		5,000
October 5, 2016	N/A	4.450%	Convertible		5,000
November 12, 2014	N/A	2.230%	Fixed Rate Hybrid		5,000
November 13, 2017	N/A	4.260%	Fixed Rate Hybrid		15,000
October 17, 2016	N/A	3.820%	Adjustable Rate Hybrid		5,000
October 17, 2018	N/A	3.500%	Adjustable Rate Hybrid		5,000
October 17, 2018	N/A	3.740%	Adjustable Rate Hybrid		15,000
October 17, 2018	N/A	3.515%	Adjustable Rate Hybrid		5,000
October 17, 2018	N/A	3.570%	Adjustable Rate Hybrid		5,000
				$	70,000

The Bank is required to purchase and hold certain amounts of FHLB stock in order to obtain FHLB borrowings. No ready market exists for the FHLB stock, and it has no quoted market value. The stock is redeemable at $100 per share subject to certain limitations set by the FHLB. The Bank owned $4.7 million and $4.9 million of FHLB stock at December 31, 2012 and 2011, respectively.

As of December 31, 2012 and 2011, the Bank had no borrowings from the Federal Reserve Bank (“FRB”).  FRB borrowings are collateralized by a blanket assignment on all qualifying loans that the Bank owns which are not pledged to the FHLB.  At December 31, 2012, the carrying value of loans pledged as collateral totaled approximately $313.7 million.

(7)   Junior Subordinated Debentures

In June 2006, the Company formed a second wholly-owned Delaware statutory trust, PEBK Capital Trust II (“PEBK Trust II”), which issued $20.0 million of guaranteed preferred beneficial interests in the Company’s junior subordinated deferrable interest debentures.  All of the common securities of PEBK Trust II are owned by the Company.  The proceeds from the issuance of the common securities and the trust preferred securities were used by PEBK Trust II to purchase $20.6 million of junior subordinated debentures of the Company.  The proceeds received by the Company from the sale of the junior subordinated debentures were used to repay in December 2006 the trust preferred securities issued in December 2001 by PEBK Capital Trust, a wholly-owned Delaware statutory trust of the Company, and for general purposes.  The debentures represent the sole assets of PEBK Trust II.  PEBK Trust II is not included in the consolidated financial statements.

The trust preferred securities issued by PEBK Trust II accrue and pay interest quarterly at a floating rate of three-month LIBOR plus 163 basis points.  The Company has guaranteed distributions and other payments due on the trust preferred securities to the extent PEBK Trust II has funds with which to make the distributions and other payments.  The net combined effect of all the documents entered into in connection with the trust preferred securities is that the Company is liable to make the distributions and other payments required on the trust preferred securities.

These trust preferred securities are mandatorily redeemable upon maturity of the debentures on June 28, 2036, or upon earlier redemption as provided in the indenture.  The Company has the right to redeem the debentures purchased by PEBK Trust II, in whole or in part, which became effective on June 28, 2011.  As specified in the indenture, if the debentures are redeemed prior to maturity, the redemption price will be the principal amount plus any accrued but unpaid interest.

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(8)   Income Taxes

The provision for income taxes in summarized as follows:

(Dollars in thousands)
	2012			2011		2010
Current	$	1,800		2,141		512
Deferred		(213	)	(678	)	(523	)
Total	$	1,587		1,463		(11	)

The differences between the provision for income taxes and the amount computed by applying the statutory federal income tax rate to earnings before income taxes are as follows:

(Dollars in thousands)
	2012			2011		2010
Pre-tax income at statutory rate (34%)	$	2,509		2,251		622
Differences:
Tax exempt interest income		(1,168	)	(1,052	)	(721	)
Nondeductible interest and other expense		52		62		58
Cash surrender value of life insurance		(149	)	(101	)	(87	)
State taxes, net of federal benefits		324		233		(8	)
Nondeductible capital losses		-		49		99
Other, net		19		21		26
Total	$	1,587		1,463		(11	)

The following summarizes the tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities.  The net deferred tax asset is included as a component of other assets at December 31, 2012 and 2011.

(Dollars in thousands)
Deferred tax assets:	2012		2011
Allowance for loan losses	$	5,560	6,401
Accrued retirement expense		1,409	1,213
Other real estate		628	454
Other		362	204
Total gross deferred tax assets		7,959	8,272
Deferred tax liabilities:
Deferred loan fees		794	1,082
Premises and equipment		417	655
Unrealized gain on available for sale securities		3,581	1,964
Total gross deferred tax liabilities		4,792	3,701
Net deferred tax asset	$	3,167	4,571

(9)    Related Party Transactions

The Company conducts transactions with its directors and executive officers, including companies in which they have beneficial interests, in the normal course of business. It is the policy of the  Bank that loan transactions with directors and officers are made on substantially the same terms as those prevailing at the time made for comparable loans to other persons. The following is a summary of activity for related party loans for 2012:

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(Dollars in thousands)
Beginning balance	$	6,123
New loans		4,520
Repayments		(5,258	)
Ending balance	$	5,385

At December 31, 2012 and 2011, the Bank had deposit relationships with related parties of approximately $13.9 million and $15.1 million, respectively.

(10)   Commitments and Contingencies

The Company leases various office spaces for banking and operational facilities and equipment under operating lease arrangements. Future minimum lease payments required for all operating leases having a remaining term in excess of one year at December 31, 2012 are as follows:

(Dollars in thousands)
Year ending December 31,
2013	$	542
2014		516
2015		482
2016		482
2017		428
Thereafter		1,667
Total minimum obligation	$	4,117

Total rent expense was approximately $643,000, $735,000 and $815,000 for the years ended December 31, 2012, 2011 and 2010, respectively.

The Bank is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments include commitments to extend credit, standby letters of credit and financial guarantees.  Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet.  The contract amounts of those instruments reflect the extent of involvement the Bank has in particular classes of financial instruments.

The exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit and financial guarantees written is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.

In most cases, the  Bank requires collateral or other security to support financial instruments with credit risk.

(Dollars in thousands)
	Contractual Amount
	2012		2011
Financial instruments whose contract amount represent credit risk:
Commitments to extend credit	$	133,919	131,565
Standby letters of credit and financial guarantees written	$	3,297	3,288

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates and because they may expire without being drawn upon, the total commitment amount of $137.2 million does not necessarily represent future cash requirements.

Standby letters of credit and financial guarantees written are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to businesses in

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the Bank’s delineated market area. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank holds real estate, equipment, automobiles and customer deposits as collateral supporting those commitments for which collateral is deemed necessary.

In the normal course of business, the Company is a party (both as plaintiff and defendant) to a number of lawsuits. In the opinion of management and counsel, none of these cases should have a material adverse effect on the financial position of the  Company.

Bancorp and the Bank have employment agreements with certain key employees. The agreements, among other things, include salary, bonus, incentive stock option, and change in control provisions.

The Company has $47.5 million available for the purchase of overnight federal funds from five correspondent financial institutions.

(11)   Derivative Financial Instruments and Hedging Transactions

Risk Management Objective of Using Derivatives

The Company has an overall interest rate risk management strategy that incorporates the use of derivative instruments to minimize significant unplanned fluctuations in earnings that are caused by interest rate volatility.  By using derivative instruments, the Company is exposed to credit and market risk.  If the counterparty fails to perform, credit risk is equal to the extent of the fair-value gain in the derivative.  The Company minimizes the credit risk in derivative instruments by entering into transactions with high-quality counterparties that are reviewed periodically by the Company.  The Company had an interest rate swap contract that expired in June 2011.  The Company did not have any interest rate derivatives outstanding as of December 31, 2012.

Cash Flow Hedges of Interest Rate Risk

The Company’s objectives in using interest rate derivatives are to add stability to interest income and expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company primarily uses interest rate swaps and floors as part of its interest rate risk management strategy.  For hedges of the Company’s variable-rate loan assets, interest rate swaps designated as cash flow hedges involve the receipt of fixed-rate amounts from a counterparty in exchange for the Company making variable-rate payments over the life of the agreements without exchange of the underlying notional amount.  For hedges of the Company’s variable-rate loan assets, the interest rate floors designated as a cash flow hedge involves the receipt of variable-rate amounts from a counterparty if interest rates fall below the strike rate on the contract in exchange for an up front premium.  The Company had an interest rate swap contract that expired in June 2011.  The Company did not have any interest rate derivatives outstanding as of December 31, 2012.

The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in Accumulated Other Comprehensive Income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings.  During 2011 and 2010, such derivatives were used to hedge the variable cash inflows associated with existing pools of prime-based loan assets.  The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings.  The Company’s derivatives did not have any hedge ineffectiveness recognized in earnings during the years ended December 31, 2011 and 2010.

Effect of Derivative Instruments on the Statement of Earnings

The table below presents the effect of the Company’s derivative financial instruments on the Consolidated Statement of Earnings for the years ended December 31, 2012 and 2011.

(Dollars in thousands)	Amount of Gain (Loss) Recognized in Accumulated OCI on Derivatives					Location of Gain (Loss) Reclassified from Accumulated OCI into Income	Amount of Gain (Loss) Reclassified from Accumulated OCI into Income
	Years ended December 31,						Years ended December 31,
	2012		2011				2012		2011
Interest rate derivative contracts	$	-	$	(20	)	Interest income	$	-	$	628

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(12)   Employee and Director Benefit Programs

The Company has a profit sharing and 401(k) plan for the benefit of substantially all employees subject to certain minimum age and service requirements. Under the 401(k) plan, the Company matched employee contributions to a maximum of 3.50% of annual compensation in 2012 and 2.50% of annual compensation in 2011 and 2010.  The Company’s contribution pursuant to this formula was approximately $345,000, $219,000 and $208,000 for the years 2012, 2011 and 2010, respectively.  Investments of the 401(k) plan are determined by the compensation committee consisting of selected outside directors and senior executive officers.  No investments in Company stock have been made by the 401(k) plan. The vesting schedule for the 401(k) plan begins at 20 percent after two years of employment and graduates 20 percent each year until reaching 100 percent after six years of employment.

In December 2001, the Company initiated a postretirement benefit plan to provide retirement benefits to key officers and its Board of Directors and to provide death benefits for their designated beneficiaries.  Under the postretirement benefit plan, the Company purchased life insurance contracts on the lives of the key officers and each director.  The increase in cash surrender value of the contracts constitutes the Company’s contribution to the postretirement benefit plan each year.  Postretirement benefit plan participants are to be paid annual benefits for a specified number of years commencing upon retirement. Expenses incurred for benefits relating to the postretirement benefit plan were approximately $546,000, $355,000 and $279,000 for the years 2012, 2011 and 2010, respectively.

The Company is currently paying medical benefits for certain retired employees. Postretirement medical benefits expense, including amortization of the transition obligation, as applicable, was approximately $24,000 for the year ended December 31, 2012 and approximately $23,000 for each of the years ended December 31, 2011 and 2010.

The following table sets forth the change in the accumulated benefit obligation for the Company’s two postretirement benefit plans described above:

(Dollars in thousands)
	2012			2011
Benefit obligation at beginning of period	$	2,923			2,607
Service cost		430			303
Interest cost		89			64
Benefits paid		(60	)		(51	)
Benefit obligation at end of period	$	3,382			2,923

The amounts recognized in the Company’s Consolidated Balance Sheet as of December 31, 2012 and 2011 are shown in the following two tables:

(Dollars in thousands)
	2012		2011
Benefit obligation	$	3,382		2,923
Fair value of plan assets		-		-

(Dollars in thousands)
	2012			2011
Funded status	$	(3,382	)		(2,923	)
Unrecognized prior service cost/benefit		-			-
Unrecognized net actuarial loss		-			-
Net amount recognized	$	(3,382	)		(2,923	)
Unfunded accrued liability	$	(3,382	)		(2,923	)
Intangible assets		-			-
Net amount recognized	$	(3,382	)		(2,923	)

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Net periodic benefit cost of the Company’s post retirement benefit plans for the years ended December 31, 2012 and 2011 consisted of the following:

(Dollars in thousands)
	2012		2011
Service cost	$	430	303
Interest cost		89	64
Net periodic cost	$	519	367
Weighted average discount rate assumption used to
determine benefit obligation		5.43%	6.59%

During the year ended December 31, 2012, the Company paid benefits under the two postretirement plans totaling $60,000.  Information about the expected benefit payments for the Company’s two postretirement benefit plans is as follows:

(Dollars in thousands)
Year ending December 31,
2013	$	130
2014	$	219
2015	$	250
2016	$	251
2017	$	283
Thereafter	$	8,944

(13)   Regulatory Matters

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

Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios of capital in relation to both on- and off-balance sheet items at various risk weights. Total capital consists of two tiers of capital. Tier 1 Capital includes common shareholders’ equity and trust preferred securities less adjustments for intangible assets. Tier 2 Capital consists of the allowance for loan losses, up to 1.25% of risk-weighted assets and other adjustments.  Management believes, as of December 31, 2012, that the Company and the Bank meet all capital adequacy requirements to which they are subject.

As of December 31, 2012, the most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the table below. There have been no conditions or events since that notification that management believes have changed the Bank’s category.

A-58

The Company’s and the Bank’s actual capital amounts and ratios are presented below:

(Dollars in thousands)
	Actual			For Capital Adequacy Purposes		To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio	Amount	Ratio	Amount	Ratio
As of December 31, 2012:
Total Capital (to Risk-Weighted Assets)
Consolidated	$	121,246	17.34%	55,928	8.00%	N/A	N/A
Bank	$	117,453	16.84%	55,784	8.00%	69,730	10.00%
Tier 1 Capital (to Risk-Weighted Assets)
Consolidated	$	112,135	16.04%	27,964	4.00%	N/A	N/A
Bank	$	108,379	15.54%	27,892	4.00%	41,838	6.00%
Tier 1 Capital (to Average Assets)
Consolidated	$	112,135	11.12%	40,342	4.00%	N/A	N/A
Bank	$	108,379	10.76%	40,302	4.00%	50,377	5.00%
As of December 31, 2011:
Total Capital (to Risk-Weighted Assets)
Consolidated	$	129,495	17.38%	59,607	8.00%	N/A	N/A
Bank	$	111,807	15.04%	59,463	8.00%	74,329	10.00%
Tier 1 Capital (to Risk-Weighted Assets)
Consolidated	$	119,950	16.10%	29,804	4.00%	N/A	N/A
Bank	$	102,264	13.76%	29,731	4.00%	44,597	6.00%
Tier 1 Capital (to Average Assets)
Consolidated	$	119,950	11.06%	43,379	4.00%	N/A	N/A
Bank	$	102,264	9.44%	43,328	4.00%	54,160	5.00%

(14)   Shareholders’ Equity

Shareholders’ equity at December 31, 2012 was $97.7 million compared to $103.0 million at December 31, 2011. This decrease was primarily attributable to the Company’s repurchase and retirement of a portion of its preferred shares.  The Company purchased 12,530 shares of the Company’s 25,054 outstanding shares of preferred stock from the UST, which was issued to the UST in connection with the Company’s participation in the CPP under TARP in 2008.  The shares were purchased for $933.36 per share, for a total purchase price of $11,778,576, including $83,575 accrued and unpaid dividends on the preferred stock.  The Company retired the 12,530 shares purchased.  The $834,999 difference between the $12,530,000 face value of the preferred stock retired and the $11,695,001 purchase price of the preferred stock retired was credited to retained earnings effective June 30, 2012.  Remaining preferred shares are redeemable at any time at par.  The Company expects to be able to repurchase the shares from future earnings, however, there are no immediate plans to repurchase these shares.

During the third quarter of 2012, the Company completed its repurchase of the Warrant to purchase 357,234 shares of the Company's common stock that was issued to the UST on December 23, 2008 as part of the CPP under TARP.  The Company repurchased the Warrant for a total price of $425,000.

Common stock at December 31, 2012 was $48.1 million compared to $48.3 million at December 31, 2011.  This decrease is due to the Company’s repurchase of the Warrant associated with the preferred stock that was issued to the UST, which was partially offset by stock options exercised during 2012.

The Board of Directors, at its discretion, can issue shares of preferred stock up to a maximum of 5,000,000 shares. The Board of Directors is authorized to determine the number of shares, voting powers, designations, preferences, limitations and relative rights.

A-59

(15)   Other Operating Income and Expense

Other operating income for the years ended December 31, 2012, 2011 and 2010 included the following items that exceeded one percent of total revenues at some point during the following three-year period:

(Dollars in thousands)
	2012		2011		2010
Visa debit card income	$	2,092		1,783		1,570
Net appraisal management fee income	$	737		375		326

Other operating expense for the years ended December 31, 2012, 2011 and 2010 included the following items that exceeded one percent of total revenues at some point during the following three-year period:

(Dollars in thousands)
	2012		2011		2010
Advertising	$	695		660		714
FDIC insurance	$	894		1,061		1,434
Visa debit card expense	$	729		658		606
Telephone	$	554		605		629
Foreclosure/OREO expense	$	677		904		569
Internet banking expense	$	593		509		445

(16)   Fair Value of Financial Instruments

The Company is required to disclose fair value information about financial instruments, whether or not recognized on the face of the balance sheet, for which it is practicable to estimate that value. The assumptions used in the estimation of the fair value of the Company’s financial instruments are detailed below. Where quoted prices are not available, fair values are based on estimates using discounted cash flows and other valuation techniques. The use of discounted cash flows can be significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The following disclosures should not be considered a surrogate of the liquidation value of the Company, but rather a good faith estimate of the increase or decrease in the value of financial instruments held by the Company since purchase, origination, or issuance.

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.

Cash and Cash Equivalents

For cash, due from banks and interest-bearing deposits, the carrying amount is a reasonable estimate of fair value.

Investment Securities Available for Sale

Fair values of investment securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges when available. If quoted prices are not available, fair value is determined using matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities.  Fair values for investment securities with quoted market prices are reported in the Level 1 fair value category. Fair value measurements obtained from independent pricing services are reported in the Level 2 fair value category. All other fair value measurements are reported in the Level 3 fair value category.

A-60

Other Investments

For other investments, the carrying value is a reasonable estimate of fair value.

Mortgage Loans Held for Sale

Mortgage loans held for sale are carried at lower of aggregate cost or market value.  The cost of mortgage loans held for sale approximates the market value.  Mortgage loans held for sale are reported  in the Level 3 fair value category.

Loans

The fair value of fixed rate loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings. For variable rate loans, the carrying amount is a reasonable estimate of fair value.  Impaired loans with current certified appraisals are included in the Level 2 fair value category.  All other loans are included in the Level 3 fair value category, as the pricing of loans is more subjective than the pricing of other financial instruments.

Cash Surrender Value of Life Insurance

For cash surrender value of life insurance, the carrying value is a reasonable estimate of fair value.

Other Real Estate

The fair value of other real estate is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral.  Other real estate is reported in the Level 3 fair value category.

Deposits

The fair value of demand deposits, interest-bearing demand deposits and savings is the amount payable on demand at the reporting date. The fair value of certificates of deposit is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities.

Securities Sold Under Agreements to Repurchase

For securities sold under agreements to repurchase, the carrying value is a reasonable estimate of fair value.

FHLB Borrowings

The fair value of FHLB borrowings is estimated based upon discounted future cash flows using a discount rate comparable to the current market rate for such borrowings.

Junior Subordinated Debentures

Because the Company’s junior subordinated debentures were issued at a floating rate, the carrying amount is a reasonable estimate of fair value.

Commitments to Extend Credit and Standby Letters of Credit

Commitments to extend credit and standby letters of credit are generally short-term and at variable interest rates. Therefore, both the carrying value and estimated fair value associated with these instruments are immaterial.

Limitations

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on many judgments. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets and liabilities that are not considered financial instruments include deferred income taxes and premises and equipment. In addition, the tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.

A-61

The carrying amount and estimated fair value of the Company’s financial instruments at December 31, 2012 and 2011 are as follows:

(Dollars in thousands)
			Fair Value Measurements at December 31, 2012
	Carrying Amount		Level 1		Level 2		Level 3		Total
Assets:
Cash and cash equivalents	$	48,843		48,843		-		-		48,843
Investment securities available for sale		297,823		1,468		295,105		1,250		297,823
Other investments		5,599		-		-		5,599		5,599
Mortgage loans held for sale		6,922		-		-		6,922		6,922
Loans, net		605,551		-		-		599,996		599,996
Cash surrender value of life insurance		13,273		-		13,273		-		13,273
Liabilities:
Deposits	$	781,525		-		780,662		-		780,662
Securities sold under agreements
to repurchase		34,578		-		34,578		-		34,578
FHLB borrowings		70,000		-		76,375		-		76,375
Junior subordinated debentures		20,619		-		20,619		-		20,619

(Dollars in thousands)
	December 31, 2011
	Carrying Amount		Estimated Fair Value
Assets:
Cash and cash equivalents	$	29,236		29,236
Investment securities available for sale		321,388		321,388
Other investments		5,712		5,712
Mortgage loans held for sale		5,146		5,146
Loans, net		653,893		648,640
Cash surrender value of life insurance		12,835		12,835
Liabilities:
Deposits and demand notes payable	$	827,111		826,810
Securities sold under agreements
to repurchase		39,600		39,600
FHLB borrowings		70,000		75,046
Junior subordinated debentures		20,619		20,619

A-62

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

Balance Sheets

December 31, 2012 and 2011

(Dollars in thousands)

Assets	2012		2011
Cash	$	324		316
Interest-bearing time deposit		800		15,000
Investment in subsidiaries		115,386		106,469
Investment securities available for sale		1,596		1,520
Other assets		260		341
Total assets	$	118,366		123,646
Liabilities and Shareholders' Equity
Junior subordinated debentures	$	20,619		20,619
Shareholders' equity		97,747		103,027
Total liabilities and shareholders' equity	$	118,366		123,646

Statements of Earnings

For the Years Ended December 31, 2012, 2011 and 2010

(Dollars in thousands)

Revenues:	2012			2011			2010
Interest and dividend income	$	113			226			311
Impairment of securities		-			(144	)		(291	)
Total revenues		113			82			20
Expenses:
Interest		438			407			411
Other operating expenses		476			190			191
Total expenses		914			597			602
Loss before income tax benefit and equity in
undistributed earnings of subsidiaries		(801	)		(515	)		(582	)
Income tax benefit		166			56			24
Loss before equity in undistributed
earnings of subsidiaries		(635	)		(459	)		(558	)
Equity in undistributed earnings of subsidiaries		6,428			5,618			2,399
Net earnings	$	5,793			5,159			1,841

A-63

Statements of Cash Flows

For the Years Ended December 31, 2012, 2011 and 2010

(Dollars in thousands)

	2012			2011			2010
Cash flows from operating activities:
Net earnings	$	5,793			5,159			1,841
Adjustments to reconcile net earnings to net
cash used by operating activities:
Equity in undistributed earnings of subsidiaries		(6,428	)		(5,618	)		(2,399	)
Impairment of investment securities		-			144			291
Change in:
Other assets		-			112			(66	)
Accrued income		11			(11	)		-
Accrued expense		41			(216	)		147
Net cash used by operating activities		(583	)		(430	)		(186	)
Cash flows from investing activities:
Purchases of investment securities available for sale		-			-			(36,000	)
Proceeds from maturities of investment securities available for sale		-			-			36,000
Net change in interest-bearing time deposit		14,200			2,000			2,000
Net cash provided by investing activities		14,200			2,000			2,000
Cash flows from financing activities:
Cash dividends paid on Series A preferred stock		(1,023	)		(1,253	)		(1,253	)
Cash dividends paid on common stock		(1,003	)		(443	)		(448	)
Preferred stock and warrant repurchase		(12,122	)		-			-
Restricted stock payout		-			17			12
Proceeds from exercise of stock options		539			-			-
Net cash used by financing activities		(13,609	)		(1,679	)		(1,689	)
Net change in cash		8			(109	)		125
Cash at beginning of year		316			425			300
Cash at end of year	$	324			316			425
Noncash investing and financing activities:
Change in unrealized gain on investment securities
available for sale, net	$	(46	)		(3	)		(172	)

A-64

DIRECTORS AND OFFICERS OF THE COMPANY

DIRECTORS

Robert C. Abernethy – Chairman

Chairman of the Board, Peoples Bancorp of North Carolina, Inc. and Peoples Bank;

President, Secretary and Treasurer, Carolina Glove Company, Inc. (glove manufacturer)

Secretary and Assistant Treasurer, Midstate Contractors, Inc. (paving company)

James S. Abernethy

Vice President, Carolina Glove Company, Inc. (glove manufacturer)

President and Assistant Secretary, Midstate Contractors, Inc. (paving company)

Vice President, Secretary and Chairman of the Board of Directors, Alexander Railroad Company

Douglas S. Howard

Vice President, Secretary and Treasurer, Denver Equipment of Charlotte, Inc.

John W. Lineberger, Jr.

President, Lincoln Bonded Warehouse Company (commercial warehousing facility)

Gary E. Matthews

President and Director, Matthews Construction Company, Inc. (general contractor)

Billy L. Price, Jr. MD

Managing Partner and Practitioner of Internal Medicine, Catawba Valley Internal Medicine, PA

Larry E. Robinson

President and Chief Executive Officer, The Blue Ridge Distributing Co., Inc. (beer and wine distributor)

Partner and Chief Operating Officer, United Beverages of North Carolina, LLC (beer distributor)

William Gregory (Greg) Terry

Executive Vice President, Drum & Willis-Reynolds Funeral Homes and Crematory

Dan Ray Timmerman, Sr.

President and Chief Executive Officer, Timmerman Manufacturing, Inc. (wrought iron furniture, railings and gates manufacturer)

Benjamin I. Zachary

President, Treasurer, General Manager and Director, Alexander Railroad Company

OFFICERS

Lance A. Sellers

President and Chief Executive Officer

A. Joseph Lampron, Jr.

Executive Vice President, Chief Financial Officer and Corporate Treasurer

William D. Cable, Sr.

Executive Vice President, Assistant Corporate Treasurer and Assistant Corporate Secretary

Joseph F. Beaman, Jr.

Executive Vice President and Corporate Secretary

A-65

EX-21

EXHIBIT (21)

SUBSIDIARIES OF THE REGISTRANT

A list of subsidiaries is contained in Part I, Item 1 Business, Subsidiaries and is incorporated herein by reference.

EX-23

EXHIBIT (23)

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We have issued our report, dated March 22, 2013, accompanying the consolidated financial statements incorporated by reference in the Annual Report of Peoples Bancorp of North Carolina, Inc. on Form 10-K for the year ended December 31, 2012. We hereby consent to the incorporation by reference of said report in the Registration Statement of Peoples Bancorp of North Carolina, Inc. on Form S-3 (File No. 333-43426, effective August 10, 2000), and on Form S-8 (File No. 333-46860, effective September 28, 2000).

	/s/ PORTER KEADLE MOORE, LLC
Atlanta, Georgia March 22, 2013

EX-31.A

EXHIBIT (31)(a)

CERTIFICATIONS

I, Lance A. Sellers, certify that:

1.   I have reviewed this annual report on Form 10-K of Peoples Bancorp of North Carolina, Inc.;

2.   Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.   Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.   The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a)   designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

b)   designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c)   evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d)   disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect the registrant’s internal control over financial reporting; and

5.   The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

a)   all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information;  and

b)   any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

March 22, 2013	/s/ Lance A. Sellers
Date	Lance A. Sellers President and Chief Executive Officer (Principal Executive Officer)

EX-31.B

EXHIBIT (31)(b)

CERTIFICATIONS

I, A. Joseph Lampron, Jr., certify that:

1.   I have reviewed this annual report on Form 10-K of Peoples Bancorp of North Carolina, Inc.;

2.   Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.   Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.   The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a)   designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

b)   designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c)   evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation ; and

d)   disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect the registrant’s internal control over financial reporting; and

5.   The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

a)   all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information;  and

b)   any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

March 22, 2013	/s/ A. Joseph Lampron, Jr.
Date	A. Joseph Lampron, Jr. Executive Vice President and Chief Financial Officer (Principal Financial and Principal Accounting Officer)

EX-32

EXHIBIT (32)

CERTIFICATION PURSUANT TO

18 U.S.C. § 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of Peoples Bancorp of North Carolina, Inc. (the “Company”) on Form 10-K for the period ending December 31, 2012, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), each of the undersigned certifies, pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best knowledge of the undersigned:

(1)           The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2)           The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

March 22, 2013	/s/ Lance A. Sellers
Date	Lance A. Sellers Chief Executive Officer

March 22, 2013	/s/ A. Joseph Lampron, Jr.
Date	A. Joseph Lampron, Jr. Chief Financial Officer

EX-99.A

EXHIBIT (99)(a)

CERTIFICATION PURSUANT TO

THE EMERGENCY ECONOMIC STABILIZATION ACT OF 2008, AS AMENDED

BY THE AMERICAN RECOVERY AND REINVESTMENT ACT OF 2009.

I, Lance A. Sellers, President and Chief Executive Officer of Peoples Bancorp of North Carolina (the “Company”), certify, based on my knowledge, that:

(i)The compensation committee of the Company has discussed, reviewed, and evaluated with senior risk officers at least every six months during any part of the most recently completed fiscal year that was a TARP period, senior executive officer (“SEO”) compensation plans and employee compensation plans and the risks these plans pose to the Company;

(ii)The compensation committee of the Company has identified and limited during any part of the most recently completed fiscal year that was a TARP period any features of the SEO compensation plans that could lead SEOs to take unnecessary and excessive risks that could threaten the value of the Company and has identified any features of the employee compensation plans that pose risks to the Company and has limited those features to ensure that the Company is not unnecessarily exposed to risks;

(iii)The compensation committee has reviewed, at least every six months during any part of the most recently completed fiscal year that was a TARP period, the terms of each employee compensation plan and identified any features of the plan that could encourage the manipulation of reported earnings of the Company to enhance the compensation of an employee, and has limited any such features;

(iv)The compensation committee of the Company will certify to the reviews of the SEO compensation plans and employee compensation plans required under (i) and (iii) above;

(v)The compensation committee of the Company will provide a narrative description of how it limited during any part of the most recently completed fiscal year that was a TARP period the features in:

a.   SEO compensation plans that could lead SEOs to take unnecessary and excessive risks that could threaten the value of the Company

b.   Employee compensation plans that unnecessarily expose the Company to risks; and

c.   Employee compensation plans that could encourage the manipulation of reported earnings of the Company to enhance the compensation of an employee;

(vi)The Company has required that bonus payments to SEOs or any of the next twenty most highly compensated employees, as defined in the regulations and guidance established under section 111 of EESA (bonus payments), be subject to a recovery or “clawback” provision during any part of the most recently completed fiscal year that was a TARP period if the bonus payments were based on materially inaccurate financial statements or any other materially inaccurate performance metric criteria;

(vii)The Company has prohibited any golden parachute payment, as defined in the regulations and guidance established under section 111 of EESA, to a SEO or any of the next five most highly compensated employees during any part of the most recently completed fiscal year that was a TARP period;

(viii)The Company has limited bonus payments to its applicable employees in accordance with section 111 of EESA and the regulations and guidance established thereunder during any part of the most recently completed fiscal year that was a TARP period;

(ix)The Company and its employees have complied with the excessive or luxury expenditures policy, as defined in the regulations and guidance established under section 111 of EESA, during any part of the most recently completed fiscal year that was a TARP period; and any expenses that, pursuant to the policy, required approval of the board of directors, a committee of the board of directors, an SEO, or an executive officer with a similar level of responsibility were properly approved;

(x)The Company will disclose the amount, nature, and justification for the offering, during any part of the most recently completed fiscal year that was a TARP period, of any perquisites, as defined in the regulations and guidance established under section 111 of EESA, whose total value exceeds $25,000 for any employee who is subject to the bonus payment limitations identified in paragraph (viii);

(xi)The Company will disclose whether the Company, the board of directors of the Company, or the compensation committee of the Company has engaged during any part of the most recently completed fiscal year that was a TARP period a compensation consultant; and the services the compensation consultant or any affiliate of the compensation consultant provided during this period;

(xii)The Company has prohibited the payment of any gross-ups, as defined in the regulations and guidance established under section 111 of EESA, to the SEOs and the next twenty most highly compensated employees during any part of the most recently completed fiscal year that was a TARP period;

(xiii)The Company has substantially complied with all other requirements related to employee compensation that are provided in the agreement between the Company and Treasury, including any amendments;

(xiv)I understand that a knowing and willful false or fraudulent statement made in connection with this certification may be punished by fine, imprisonment, or both. (See, for example, 18 USC 1001.)

March 22, 2013	/s/ Lance A. Sellers
Date	Lance A. Sellers President and Chief Executive Officer (Principal Executive Officer)

EX-99.B

EXHIBIT (99)(b)

CERTIFICATION PURSUANT TO

THE EMERGENCY ECONOMIC STABILIZATION ACT OF 2008, AS AMENDED

BY THE AMERICAN RECOVERY AND REINVESTMENT ACT OF 2009.

I, A. Joseph Lampron, Jr., Executive Vice President and Chief Financial Officer of Peoples Bancorp of North Carolina (the “Company”), certify, based on my knowledge, that:

(i)The compensation committee of the Company has discussed, reviewed, and evaluated with senior risk officers at least every six months during any part of the most recently completed fiscal year that was a TARP period, senior executive officer (“SEO”) compensation plans and employee compensation plans and the risks these plans pose to the Company;

(ii)The compensation committee of the Company has identified and limited during any part of the most recently completed fiscal year that was a TARP period any features of the SEO compensation plans that could lead SEOs to take unnecessary and excessive risks that could threaten the value of the Company and has identified any features of the employee compensation plans that pose risks to the Company and has limited those features to ensure that the Company is not unnecessarily exposed to risks;

(iii)The compensation committee has reviewed, at least every six months during any part of the most recently completed fiscal year that was a TARP period, the terms of each employee compensation plan and identified any features of the plan that could encourage the manipulation of reported earnings of the Company to enhance the compensation of an employee, and has limited any such features;

(iv)The compensation committee of the Company will certify to the reviews of the SEO compensation plans and employee compensation plans required under (i) and (iii) above;

(v)The compensation committee of the Company will provide a narrative description of how it limited during any part of the most recently completed fiscal year that was a TARP period the features in:

a.   SEO compensation plans that could lead SEOs to take unnecessary and excessive risks that could threaten the value of the Company

b.   Employee compensation plans that unnecessarily expose the Company to risks; and

c.   Employee compensation plans that could encourage the manipulation of reported earnings of the Company to enhance the compensation of an employee;

(vi)The Company has required that bonus payments to SEOs or any of the next twenty most highly compensated employees, as defined in the regulations and guidance established under section 111 of EESA (bonus payments), be subject to a recovery or “clawback” provision during any part of the most recently completed fiscal year that was a TARP period if the bonus payments were based on materially inaccurate financial statements or any other materially inaccurate performance metric criteria;

(vii)The Company has prohibited any golden parachute payment, as defined in the regulations and guidance established under section 111 of EESA, to a SEO or any of the next five most highly compensated employees during any part of the most recently completed fiscal year that was a TARP period;

(viii)The Company has limited bonus payments to its applicable employees in accordance with section 111 of EESA and the regulations and guidance established thereunder during any part of the most recently completed fiscal year that was a TARP period;

(ix)The Company and its employees have complied with the excessive or luxury expenditures policy, as defined in the regulations and guidance established under section 111 of EESA, during any part of the most recently completed fiscal year that was a TARP period; and any expenses that, pursuant to the policy, required approval of the board of directors, a committee of the board of directors, an SEO, or an executive officer with a similar level of responsibility were properly approved;

(x)The Company will disclose the amount, nature, and justification for the offering, during any part of the most recently completed fiscal year that was a TARP period, of any perquisites, as defined in the regulations and guidance established under section 111 of EESA, whose total value exceeds $25,000 for any employee who is subject to the bonus payment limitations identified in paragraph (viii);

(xi)The Company will disclose whether the Company, the board of directors of the Company, or the compensation committee of the Company has engaged during any part of the most recently completed fiscal year that was a TARP period a compensation consultant; and the services the compensation consultant or any affiliate of the compensation consultant provided during this period;

(xii)The Company has prohibited the payment of any gross-ups, as defined in the regulations and guidance established under section 111 of EESA, to the SEOs and the next twenty most highly compensated employees during any part of the most recently completed fiscal year that was a TARP period;

(xiii)The Company has substantially complied with all other requirements related to employee compensation that are provided in the agreement between the Company and Treasury, including any amendments;

(xiv)I understand that a knowing and willful false or fraudulent statement made in connection with this certification may be punished by fine, imprisonment, or both. (See, for example, 18 USC 1001.)

March 22, 2013	/s/ A. Joseph Lampron, Jr.
Date	A. Joseph Lampron, Jr. Executive Vice President and Chief Financial Officer (Principal Financial and Principal Accounting Officer)

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16. Fair Value of Financial Instruments (Tables)

12 Months Ended

Dec. 31, 2012

Fair Value Disclosures [Abstract]

Carrying amount and estimated fair value of the Company’s financial instruments

(Dollars in thousands)
			Fair Value Measurements at December 31, 2012
	Carrying Amount		Level 1		Level 2		Level 3		Total
Assets:
Cash and cash equivalents	$	48,843		48,843		-		-		48,843
Investment securities available for sale		297,823		1,468		295,105		1,250		297,823
Other investments		5,599		-		-		5,599		5,599
Mortgage loans held for sale		6,922		-		-		6,922		6,922
Loans, net		605,551		-		-		599,996		599,996
Cash surrender value of life insurance		13,273		-		13,273		-		13,273
Liabilities:
Deposits	$	781,525		-		780,662		-		780,662
Securities sold under agreements
to repurchase		34,578		-		34,578		-		34,578
FHLB borrowings		70,000		-		76,375		-		76,375
Junior subordinated debentures		20,619		-		20,619		-		20,619

(Dollars in thousands)
	December 31, 2011
	Carrying Amount		Estimated Fair Value
Assets:
Cash and cash equivalents	$	29,236		29,236
Investment securities available for sale		321,388		321,388
Other investments		5,712		5,712
Mortgage loans held for sale		5,146		5,146
Loans, net		653,893		648,640
Cash surrender value of life insurance		12,835		12,835
Liabilities:
Deposits and demand notes payable	$	827,111		826,810
Securities sold under agreements
to repurchase		39,600		39,600
FHLB borrowings		70,000		75,046
Junior subordinated debentures		20,619		20,619

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3. Loans (Details Narrative) (USD $)	12 Months Ended
	Dec. 31, 2012	Dec. 31, 2011
Loans Details Narrative
Percentage of construction and land development loans in Bank's loan portfolio	12.00%
Percentage of single-family residential loans in Bank's loan portfolio	40.00%
Percentage of Single-family residential - Banco de la Gente stated income loans in Bank's loan portfolio	8.00%
Percentage of commercial real estate loans in Bank's loan portfolio	32.00%
Percentage of commercial loans in Bank's loan portfolio	10.00%
Accruing impaired loans	$ 30,600,000	$ 30,600,000
Interest income recognized on accruing impaired loans	1,500,000	1,700,000
TDR loan amounts	23,937,000	44,133,000
Amount of performing TDR loans included	$ 2,000,000	$ 15,100,000

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3. Loans, Impaired (Details) (USD $) In Thousands, unless otherwise specified	Dec. 31, 2012	Dec. 31, 2011
Impaired loans
Unpaid Contractual Principal Balance	$ 55,717	$ 64,297
Recorded Investment With No Allowance	17,477	19,298
Recorded Investment With Allowance	30,797	35,400
Recorded Investment in Impaired Loans	48,274	54,698
Related Allowance	1,536	4,797
Average Outstanding Impaired Loans	48,357	49,307
Construction and land development
Impaired loans
Unpaid Contractual Principal Balance	17,738	28,721
Recorded Investment With No Allowance	11,795	14,484
Recorded Investment With Allowance	680	6,098
Recorded Investment in Impaired Loans	12,475	20,582
Related Allowance	61	3,264
Average Outstanding Impaired Loans	12,810	17,848
Single-family residential
Impaired loans
Unpaid Contractual Principal Balance	9,099	6,361
Recorded Investment With No Allowance	766	969
Recorded Investment With Allowance	7,799	5,117
Recorded Investment in Impaired Loans	8,565	6,086
Related Allowance	177	131
Average Outstanding Impaired Loans	7,590	6,324
Single-family residential - Banco de la Gente stated income
Impaired loans
Unpaid Contractual Principal Balance	21,806	20,021
Recorded Investment With No Allowance	0	0
Recorded Investment With Allowance	21,000	19,602
Recorded Investment in Impaired Loans	21,000	19,602
Related Allowance	1,278	1,296
Average Outstanding Impaired Loans	21,158	18,778
Commercial Real Estate
Impaired loans
Unpaid Contractual Principal Balance	5,830	7,717
Recorded Investment With No Allowance	4,569	3,845
Recorded Investment With Allowance	467	3,139
Recorded Investment in Impaired Loans	5,036	6,984
Related Allowance	6	77
Average Outstanding Impaired Loans	5,433	4,518
Multifamily and Farmland
Impaired loans
Unpaid Contractual Principal Balance	193	209
Recorded Investment With No Allowance	0	0
Recorded Investment With Allowance	193	209
Recorded Investment in Impaired Loans	193	209
Related Allowance	1	1
Average Outstanding Impaired Loans	200	214
Total real estate loans
Impaired loans
Unpaid Contractual Principal Balance	54,666	63,029
Recorded Investment With No Allowance	17,130	19,298
Recorded Investment With Allowance	30,139	34,165
Recorded Investment in Impaired Loans	47,269	53,463
Related Allowance	1,523	4,769
Average Outstanding Impaired Loans	47,191	47,682
Commercial loans (not secured by real estate)
Impaired loans
Unpaid Contractual Principal Balance	983	1,111
Recorded Investment With No Allowance	347	0
Recorded Investment With Allowance	592	1,083
Recorded Investment in Impaired Loans	939	1,083
Related Allowance	12	26
Average Outstanding Impaired Loans	1,125	1,485
Consumer loans (not secured by real estate)
Impaired loans
Unpaid Contractual Principal Balance	68	157
Recorded Investment With No Allowance	0	0
Recorded Investment With Allowance	66	152
Recorded Investment in Impaired Loans	66	152
Related Allowance	1	2
Average Outstanding Impaired Loans	$ 41	$ 140

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12. Employee and Director Benefit Programs (Details 1) (USD $) In Thousands, unless otherwise specified	Dec. 31, 2012	Dec. 31, 2011	Dec. 31, 2010
Employee And Director Benefit Programs Details 1
Benefit obligation	$ 3,382	$ 2,923	$ 2,607
Fair value of plan assets	0	0
Funded status	(3,382)	(2,923)
Net amount recognized	(3,382)	(2,923)
Unfunded accrued liability	(3,382)	(2,923)
Net amount recognized in balance sheet	$ (3,382)	$ (2,923)

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4. Premises and Equipment (Details) (USD $) In Thousands, unless otherwise specified	Dec. 31, 2012	Dec. 31, 2011
Premises And Equipment Details
Land	$ 3,657	$ 3,581
Buildings and improvements	14,815	14,771
Furniture and equipment	17,660	16,874
Total premises and equipment	36,132	35,226
Less accumulated depreciation	20,258	18,330
Total net premises and equipment	$ 15,874	$ 16,896

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17. Peoples Bancorp of North Carolina, Inc. (Parent Company Only) Condensed Financial Statements (Details) (USD $) In Thousands, unless otherwise specified	12 Months Ended
	Dec. 31, 2012	Dec. 31, 2011	Dec. 31, 2010
Assets
Interest-bearing time deposit	$ 16,226	$ 6,704
Investment securities available for sale	297,823	321,388
Total assets	1,013,516	1,067,063
Liabilities and Shareholders' Equity
Junior subordinated debentures	20,619	20,619
Shareholders' equity	97,747	103,027
Total liabilities and shareholders' equity	1,013,516	1,067,063
Revenues:
Interest and dividend income	39,245	45,259	47,680
Other than temporary impairment losses	0	(144)	(291)
Expenses:
Interest	7,696	10,946	14,348
Loss before income tax benefit and equity in undistributed earnings of subsidiaries	7,380	6,622	1,830
Income tax benefit	1,587	1,463	(11)
Net earnings	5,793	5,159	1,841
Cash flows from operating activities:
Net earnings	5,793	5,159	1,841
Adjustments to reconcile net earnings to net cash used by operating activities:
Impairment of investment securities	0	(144)	(291)
Change in:
Other assets	399	(2,644)	2,316
Net cash provided (used by) operating activities	19,027	22,352	17,798
Cash flows from investing activities:
Purchases of investment securities available for sale	(88,304)	(208,863)	(232,915)
Proceeds from maturities of investment securities available for sale	63,225	54,041	86,935
Net change in interest-bearing time deposit	0	735	2,610
Net cash provided (used) by investing activities	64,797	(7,719)	(44,024)
Cash flows from financing activities:
Cash dividends paid on Series A preferred stock	(1,023)	(1,253)	(1,253)
Preferred stock and warrant repurchase	(12,122)	0	0
Restricted stock payout	0	17	12
Proceeds from exercise of stock options	539	0	0
Net cash (used) provided by financing activities	(64,217)	(9,374)	18,863
Net change in cash and cash equivalent	19,607	5,259	(7,363)
Noncash investing and financing activities:
Change in unrealized gain on investment securities available for sale, net	(2,536)	3,087	(1,838)
Parent Company
Assets
Cash	324	316	425
Interest-bearing time deposit	800	15,000
Investment in subsidiaries	115,386	106,469
Investment securities available for sale	1,596	1,520
Other assets	260	341
Total assets	118,366	123,646
Liabilities and Shareholders' Equity
Junior subordinated debentures	20,619	20,619
Shareholders' equity	97,747	103,027
Total liabilities and shareholders' equity	118,366	123,646
Revenues:
Interest and dividend income	113	226	311
Other than temporary impairment losses	0	(144)	(291)
Total revenues	113	82	20
Expenses:
Interest	438	407	411
Other operating expenses	476	190	191
Total expenses	914	597	602
Loss before income tax benefit and equity in undistributed earnings of subsidiaries	(801)	(515)	(582)
Income tax benefit	166	56	24
Loss before equity in undistributed earnings of subsidiaries	(635)	(459)	(558)
Equity in undistributed earnings of subsidiaries	6,428	5,618	2,399
Net earnings	5,793	5,159	1,841
Cash flows from operating activities:
Net earnings	5,793	5,159	1,841
Adjustments to reconcile net earnings to net cash used by operating activities:
Equity in undistributed earnings of subsidiaries	(6,428)	(5,618)	(2,399)
Impairment of investment securities	0	(144)	(291)
Change in:
Other assets	0	112	(66)
Accrued income	11	(11)	0
Accrued expense	41	(216)	147
Net cash provided (used by) operating activities	(583)	(430)	(186)
Cash flows from investing activities:
Purchases of investment securities available for sale	0	0	(36,000)
Proceeds from maturities of investment securities available for sale	0	0	36,000
Net change in interest-bearing time deposit	14,200	2,000	2,000
Net cash provided (used) by investing activities	14,200	2,000	2,000
Cash flows from financing activities:
Cash dividends paid on Series A preferred stock	(1,023)	(1,253)	(1,253)
Cash dividends paid on common stock	(1,003)	(443)	(448)
Preferred stock and warrant repurchase	(12,122)	0	0
Restricted stock payout	0	17	12
Proceeds from exercise of stock options	539	0	0
Net cash (used) provided by financing activities	(13,609)	(1,679)	(1,689)
Net change in cash and cash equivalent	8	(109)	125
Cash at beginning of year	316	425	300
Cash at end of year	324	316	425
Noncash investing and financing activities:
Change in unrealized gain on investment securities available for sale, net	$ (46)	$ (3)	$ (172)

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3. Loans, Past Due (Details) (USD $) In Thousands, unless otherwise specified	Dec. 31, 2012	Dec. 31, 2011
Past due loans
Loans 30-89 Days Past Due	$ 19,538	$ 28,276
Loans 90 or More Days Past Due	13,311	10,530
Total Past Due Loans	32,849	38,806
Total Current Loans	587,125	631,691
Total loans	619,974	670,497
Accruing Loans 90 or More Days Past Due	2,403	2,709
Construction and land development
Past due loans
Loans 30-89 Days Past Due	1,280	10,033
Loans 90 or More Days Past Due	6,858	3,338
Total Past Due Loans	8,138	13,371
Total Current Loans	65,038	80,441
Total loans	73,176	93,812
Accruing Loans 90 or More Days Past Due	0	0
Single-family residential
Past due loans
Loans 30-89 Days Past Due	4,316	4,612
Loans 90 or More Days Past Due	1,548	1,434
Total Past Due Loans	5,864	6,046
Total Current Loans	189,139	206,947
Total loans	195,003	212,993
Accruing Loans 90 or More Days Past Due	0	107
Single-family residential - Banco de la Gente stated income
Past due loans
Loans 30-89 Days Past Due	11,077	11,924
Loans 90 or More Days Past Due	3,659	4,755
Total Past Due Loans	14,736	16,679
Total Current Loans	37,283	37,379
Total loans	52,019	54,058
Accruing Loans 90 or More Days Past Due	2,378	2,602
Commercial Real Estate
Past due loans
Loans 30-89 Days Past Due	1,720	1,002
Loans 90 or More Days Past Due	1,170	958
Total Past Due Loans	2,890	1,960
Total Current Loans	197,743	212,455
Total loans	200,633	214,415
Accruing Loans 90 or More Days Past Due	0	0
Multifamily and Farmland
Past due loans
Loans 30-89 Days Past Due	7	13
Loans 90 or More Days Past Due	0	0
Total Past Due Loans	7	13
Total Current Loans	8,944	4,780
Total loans	8,951	4,793
Accruing Loans 90 or More Days Past Due	0	0
Total real estate loans
Past due loans
Loans 30-89 Days Past Due	18,400	27,584
Loans 90 or More Days Past Due	13,235	10,485
Total Past Due Loans	31,635	38,069
Total Current Loans	498,147	542,002
Total loans	529,782	580,071
Accruing Loans 90 or More Days Past Due	2,378	2,709
Commercial loans (not secured by real estate)
Past due loans
Loans 30-89 Days Past Due	888	576
Loans 90 or More Days Past Due	66	9
Total Past Due Loans	954	585
Total Current Loans	63,341	60,061
Total loans	64,295	60,646
Accruing Loans 90 or More Days Past Due	23	0
Farm loans (not secured by real estate)
Past due loans
Loans 30-89 Days Past Due	0
Loans 90 or More Days Past Due	0
Total Past Due Loans	0
Total Current Loans	11
Total loans	11	0
Accruing Loans 90 or More Days Past Due	0
Consumer loans (not secured by real estate)
Past due loans
Loans 30-89 Days Past Due	250	116
Loans 90 or More Days Past Due	10	36
Total Past Due Loans	260	152
Total Current Loans	9,888	10,338
Total loans	10,148	10,490
Accruing Loans 90 or More Days Past Due	2	0
All other loans (not secured by real estate)
Past due loans
Loans 30-89 Days Past Due	0	0
Loans 90 or More Days Past Due	0	0
Total Past Due Loans	0	0
Total Current Loans	15,738	19,290
Total loans	15,738	19,290
Accruing Loans 90 or More Days Past Due	$ 0	$ 0

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9. Related Party Transactions (Tables)

12 Months Ended

Dec. 31, 2012

Related Party Transactions [Abstract]

Summary of activity for related party loans

(Dollars in thousands)
Beginning balance	$	6,123
New loans		4,520
Repayments		(5,258	)
Ending balance	$	5,385

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12. Employee and Director Benefit Programs (Details Narrative) (USD $)	12 Months Ended
	Dec. 31, 2012	Dec. 31, 2011	Dec. 31, 2010
Employee And Director Benefit Programs Details Narrative
Expenses incurred for benefits relating to the postretirement benefit	$ 546,000	$ 335,000	$ 279,000
Postretirement medical benefits expense, including amortization of the transition obligation	24,000	23,000	23,000
Benefits paid	$ 60,000

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5. Time Deposits (Details) (USD $) In Thousands, unless otherwise specified	Dec. 31, 2012
Time Deposits Details
2013	$ 157,707
2014	33,579
2015	36,066
2016	10,269
2017 and thereafter	10,603
Total	$ 248,224

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15. Other Operating Income and Expense (Details) (USD $) In Thousands, unless otherwise specified	12 Months Ended
	Dec. 31, 2012	Dec. 31, 2011	Dec. 31, 2010
Other Operating Income And Expense Details
Visa debit card income	$ 2,092	$ 1,783	$ 1,570
Net appraisal management fee income	737	375	326
Advertising	695	660	714
FDIC insurance	894	1,061	1,434
Visa debit card expense	729	658	606
Telephone	554	605	629
Foreclosure/OREO expense	677	904	569
Internet banking expense	$ 593	$ 509	$ 445

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16. Fair Value of Financial Instruments (Details) (USD $) In Thousands, unless otherwise specified	Dec. 31, 2012	Dec. 31, 2011
Carrying Amount
Assets:
Cash and cash equivalents	$ 48,843	$ 29,236
Investment securities available for sale	297,823	321,388
Other investments	5,599	5,712
Mortgage loans held for sale	6,922	5,146
Loans, net	605,551	653,893
Cash surrender value of life insurance	13,273	12,835
Liabilities:
Deposits and demand notes payable	781,525	827,111
Securities sold under agreements to repurchase	34,578	39,600
FHLB borrowings	70,000	70,000
Junior subordinated debentures	20,619	20,619
Fair Value, Inputs, Level 1 [Member]
Assets:
Cash and cash equivalents	48,843
Investment securities available for sale	1,468
Other investments	0
Mortgage loans held for sale	0
Loans, net	0
Cash surrender value of life insurance	0
Liabilities:
Deposits and demand notes payable	0
Securities sold under agreements to repurchase	0
FHLB borrowings	0
Junior subordinated debentures	0
Fair Value, Inputs, Level 2 [Member]
Assets:
Cash and cash equivalents	0
Investment securities available for sale	295,105
Other investments	0
Mortgage loans held for sale	0
Loans, net	0
Cash surrender value of life insurance	13,273
Liabilities:
Deposits and demand notes payable	780,662
Securities sold under agreements to repurchase	34,578
FHLB borrowings	76,375
Junior subordinated debentures	20,619
Fair Value, Inputs, Level 3 [Member]
Assets:
Cash and cash equivalents	0
Investment securities available for sale	1,250
Other investments	5,599
Mortgage loans held for sale	6,922
Loans, net	599,996
Cash surrender value of life insurance	0
Liabilities:
Deposits and demand notes payable	0
Securities sold under agreements to repurchase	0
FHLB borrowings	0
Junior subordinated debentures	0
Estimated Fair Value
Assets:
Cash and cash equivalents	48,843	29,236
Investment securities available for sale	297,823	321,388
Other investments	5,599	5,712
Mortgage loans held for sale	6,922	5,146
Loans, net	599,996	648,640
Cash surrender value of life insurance	13,273	12,835
Liabilities:
Deposits and demand notes payable	780,662	826,810
Securities sold under agreements to repurchase	34,578	39,600
FHLB borrowings	76,375	75,046
Junior subordinated debentures	$ 20,619	$ 20,619

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12. Employee and Director Benefit Programs (Details 2) (USD $) In Thousands, unless otherwise specified	12 Months Ended
	Dec. 31, 2012	Dec. 31, 2011
Employee And Director Benefit Programs Details 2
Service cost	$ 430	$ 303
Interest cost	89	64
Net periodic cost	$ 519	$ 367
Weighted average discount rate assumption used to determine benefit obligation	5.43%	6.59%

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1. Summary of Significant Accounting Policies (Policies)

12 Months Ended

Dec. 31, 2012

Accounting Policies [Abstract]

Organization

Organization

Peoples Bancorp of North Carolina, Inc. (“Bancorp”) received regulatory approval to operate as a bank holding company on July 22, 1999, and became effective August 31, 1999.  Bancorp is primarily regulated by the Board of Governors of the Federal Reserve System, and serves as the one-bank holding company for Peoples Bank (the “Bank”).

The Bank commenced business in 1912 upon receipt of its banking charter from the North Carolina State Banking Commission (the “SBC”). The Bank is primarily regulated by the SBC and the Federal Deposit Insurance Corporation (the “FDIC”) and undergoes periodic examinations by these regulatory agencies. The Bank, whose main office is in Newton, North Carolina, provides a full range of commercial and consumer banking services primarily in Catawba, Alexander, Lincoln, Mecklenburg, Iredell, Union and Wake counties in North Carolina.

Peoples Investment Services, Inc. is a wholly-owned subsidiary of the Bank and began operations in 1996 to provide investment and trust services through agreements with an outside party.

Real Estate Advisory Services, Inc. (“REAS”) is a wholly-owned subsidiary of the Bank and began operations in 1997 to provide real estate appraisal and property management services to individuals and commercial customers of the Bank.

Community Bank Real Estate Solutions, LLC is a wholly-owned subsidiary of Bancorp and began operations in 2009 as a “clearing house” for appraisal services for community banks.  Other banks are able to contract with Community Bank Real Estate Solutions, LLC to find and engage appropriate appraisal companies in the area where the property is located.

Principles of Consolidation

Principles of Consolidation

The consolidated financial statements include the financial statements of Bancorp and its wholly-owned subsidiaries, the Bank and Community Bank Real Estate Solutions, LLC, along with the Bank’s wholly-owned subsidiaries, Peoples Investment Services, Inc. and REAS (collectively called the “Company”).  All significant intercompany balances and transactions have been eliminated in consolidation.

Basis of Presentation

Basis of Presentation

The accounting principles followed by the Company, and the methods of applying these principles, conform with accounting principles generally accepted in the United States of America (“GAAP”) and with general practices in the banking industry. In preparing the financial statements in conformity with GAAP, management is required to make estimates and assumptions that affect the reported amounts in the financial statements. Actual results could differ significantly from these estimates. Material estimates common to the banking industry that are particularly susceptible to significant change in the near term include, but are not limited to, the determination of the allowance for loan losses and valuation of real estate acquired in connection with or in lieu of foreclosure on loans.

Cash and Cash Equivalents

Cash and Cash Equivalents

Cash, due from banks and interest-bearing deposits are considered cash and cash equivalents for cash flow reporting purposes.

Investment Securities

Investment Securities

There are three classifications the Company is able to classify its investment securities: trading, available for sale, or held to maturity. Trading securities are bought and held principally for sale in the near term. Held to maturity securities are those securities for which the Company has the ability and intent to hold until maturity. All other securities not included in trading or held to maturity are classified as available for sale. At December 31, 2012 and 2011, the Company classified all of its investment securities as available for sale.

Available for sale securities are recorded at fair value. Unrealized holding gains and losses, net of the related tax effect, are excluded from earnings and are reported as a separate component of shareholders’ equity until realized.

Management evaluates investment securities for other-than-temporary impairment on an annual basis. A decline in the market value of any investment below cost that is deemed other-than-temporary is charged to earnings for the decline in value deemed to be credit related and a new cost basis in the security is established. The decline in value attributed to non-credit related factors is recognized in comprehensive income.

Premiums and discounts are amortized or accreted over the life of the related security as an adjustment to the yield.  Realized gains and losses for securities classified as available for sale are included in earnings and are derived using the specific identification method for determining the cost of securities sold.

Other Investments

Other Investments

Other investments include equity securities with no readily determinable fair value. These investments are carried at cost.

Mortgage Loans Held for Sale

Mortgage Loans Held for Sale

Mortgage loans held for sale are carried at lower of aggregate cost or market value. The cost of mortgage loans held for sale approximates the market value.

Loans

Loans

Loans that management has the intent and ability to hold for the foreseeable future or until maturity are reported at the principal amount outstanding, net of the allowance for loan losses. Interest on loans is calculated by using the simple interest method on daily balances of the principal amount outstanding. The recognition of certain loan origination fee income and certain loan origination costs is deferred when such loans are originated and amortized over the life of the loan.

A loan is impaired when, based on current information and events, it is probable that all amounts due according to the contractual terms of the loan will not be collected.  Impaired loans are measured based on the present value of expected future cash flows, discounted at the loan’s effective interest rate, or at the loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent.

Accrual of interest is discontinued on a loan when management believes, after considering economic conditions and collection efforts, that the borrower’s financial condition is such that collection of interest is doubtful. Interest previously accrued but not collected is reversed against current period earnings.

Allowance for Loan Losses

Allowance for Loan Losses

The allowance for loan losses reflects management’s assessment and estimate of the risks associated with extending credit and its evaluation of the quality of the loan portfolio. The Bank periodically analyzes the loan portfolio in an effort to review asset quality and to establish an allowance for loan losses that management believes will be adequate in light of anticipated risks and loan losses. In assessing the adequacy of the allowance, size, quality and risk of loans in the portfolio are reviewed. Other factors considered are:

·   the Bank’s loan loss experience;

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

·   specific known risks;

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

·   underlying estimated values of collateral securing loans;

·   current and anticipated economic conditions; and

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

The allowance for loan losses is comprised of three components: specific reserves, general reserves and unallocated reserves. After a loan has been identified as impaired, management measures impairment. When the measure of the impaired loan is less than the recorded investment in the loan, the amount of the impairment is recorded as a specific reserve. These specific reserves are determined on an individual loan basis based on management’s current evaluation of the Bank’s loss exposure for each credit, given the appraised value of any underlying collateral or the present value of projected cash flows for non-collateral dependent loans. Loans for which specific reserves are provided are excluded from the general allowance calculations as described below.

The general allowance reflects reserves established under GAAP for collective loan impairment. These reserves are based upon historical net charge-offs using the greater of the last two or three years’ loss experience.  This charge-off experience may be adjusted to reflect the effects of current conditions.  The Bank considers information derived from its loan risk ratings and external data related to industry and general economic trends in establishing reserves.

The unallocated allowance is determined through management’s assessment of probable losses that are in the portfolio but are not adequately captured by the other two components of the allowance, including consideration of current economic and business conditions and regulatory requirements. The unallocated allowance also reflects management’s acknowledgement of the imprecision and subjectivity that underlie the modeling of credit risk.  Due to the subjectivity involved in determining the overall allowance, including the unallocated portion, this unallocated portion may fluctuate from period to period based on management’s evaluation of the factors affecting the assumptions used in calculating the allowance.

Management considers the allowance for loan losses adequate to cover the estimated losses inherent in the Bank’s loan portfolio as of the date of the financial statements. Management believes it has established the allowance in accordance with GAAP and in consideration of the current economic environment. Although management uses the best information available to make evaluations, significant future additions to the allowance may be necessary based on changes in economic and other conditions, thus adversely affecting the operating results of the Company.

There were no significant changes in the estimation methods or fundamental assumptions used in the evaluation of the allowance for loan losses for the year ended December 31, 2012 as compared to the year ended December 31, 2011.   Revisions, estimates and assumptions may be made in any period in which the supporting factors indicate that loss levels may vary from the previous estimates.

Effective December 31, 2012, stated income mortgage loans from the Banco de la Gente division of the Bank were analyzed separately from other single family residential loans in the Bank’s loan portfolio.  These loans are first mortgage loans made to the Latino market, primarily in Mecklenburg and surrounding counties.  These loans are non-traditional mortgages in that the customer normally did not have a credit history, so all credit information was accumulated by the loan officers.  These loans were made as stated income loans rather than full documentation loans because the customer may not have had complete documentation on the income supporting the loan.

Various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. Such agencies may require adjustments to the allowance based on their judgments of information available to them at the time of their examinations.  Also, an independent loan review process further assists with evaluating credit quality and assessing potential performance issues.

Mortgage Banking Activities

Mortgage Banking Activities

Mortgage banking income represents net gains from the sale of mortgage loans and fees received from borrowers and loan investors related to the Bank’s origination of single-family residential mortgage loans.

Mortgage loans serviced for others are not included in the accompanying balance sheets. The unpaid principal balances of mortgage loans serviced for others was approximately $3.1 million, $4.0 million and $5.3 million at December 31, 2012, 2011 and 2010, respectively.

The Bank originates certain fixed rate mortgage loans and commits these loans for sale.  The commitments to originate fixed rate mortgage loans and the commitments to sell these loans to a third party are both derivative contracts.  The fair value of these derivative contracts is immaterial and has no effect on the recorded amounts in the financial statements.

Premises and Equipment

Premises and Equipment

Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed primarily using the straight-line method over the estimated useful lives of the assets. When assets are retired or otherwise disposed, the cost and related accumulated depreciation are removed from the accounts, and any gain or loss is reflected in earnings for the period. The cost of maintenance and repairs that do not improve or extend the useful life of the respective asset is charged to earnings as incurred, whereas significant renewals and improvements are capitalized. The range of estimated useful lives for premises and equipment are generally as follows:

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

Other Real Estate

Other Real Estate

Foreclosed assets include all assets received in full or partial satisfaction of a loan.  Foreclosed assets are reported at fair value less estimated selling costs.  Any write-downs at the time of foreclosure are charged to the allowance for loan losses.  Subsequent to foreclosure, valuations are periodically performed by management, and a valuation allowance is established if fair value declines below carrying value.  Costs relating to the development and improvement of the property are capitalized.  Revenues and expenses from operations are included in other expenses.  Changes in the valuation allowance are included in loss on sale and write-down of other real estate.  The balance of other real estate owned was $6.3 million and $7.6 million at December 31, 2012 and 2011, respectively.

Income Taxes

Income Taxes

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Additionally, the recognition of future tax benefits, such as net operating loss carryforwards, is required to the extent that the realization of such benefits is more likely than not to occur. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which the assets and liabilities are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income tax expense in the period that includes the enactment date.

In the event the future tax consequences of differences between the financial reporting bases and the tax bases of the Company’s assets and liabilities results in a deferred tax asset, an evaluation of the probability of being able to realize the future benefits indicated by such asset is required. A valuation allowance is provided for the portion of the deferred tax asset when it is more likely than not that some portion or all of the deferred tax asset will not be realized. In assessing the realizability of a deferred tax asset, management considers the scheduled reversals of deferred tax liabilities, projected future taxable income, and tax planning strategies.

Tax effects from an uncertain tax position can be recognized in the financial statements only when it is more likely than not that the tax position will be sustained upon examination by the appropriate taxing authority that would have full knowledge of all relevant information.  A tax position that meets the more likely than not recognition threshold is measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement.  Previously recognized tax positions that no longer meet the more likely than not recognition threshold should be derecognized in the first subsequent financial reporting period in which that threshold is no longer met.  The Company assessed the impact of this guidance and determined that it did not have a material impact on the Company’s financial position, results of operations or disclosures.

Derivative Financial Instruments and Hedging Activities

Derivative Financial Instruments and Hedging Activities

In the normal course of business, the Company enters into derivative contracts to manage interest rate risk by modifying the characteristics of the related balance sheet instruments in order to reduce the adverse effect of changes in interest rates. All material derivative financial instruments are recorded at fair value in the financial statements.  The fair value of derivative contracts related to the origination of fixed rate mortgage loans and the commitments to sell these loans to a third party is immaterial and has no effect on the recorded amounts in the financial statements.

The disclosure requirements for derivatives and hedging activities have the intent to provide users of financial statements with an enhanced understanding of: (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows.  The disclosure requirements include qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about the fair value of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative instruments.

On the date a derivative contract is entered into, the Company designates the derivative as a fair value hedge, a cash flow hedge, or a trading instrument. Changes in the fair value of instruments used as fair value hedges are accounted for in the earnings of the period simultaneous with accounting for the fair value change of the item being hedged. Changes in the fair value of the effective portion of cash flow hedges are accounted for in other comprehensive income rather than earnings. Changes in fair value of instruments that are not intended as a hedge are accounted for in the earnings of the period of the change.

If a derivative instrument designated as a fair value hedge is terminated or the hedge designation removed, the difference between a hedged item’s then carrying amount and its face amount is recognized into income over the original hedge period. Likewise, if a derivative instrument designated as a cash flow hedge is terminated or the hedge designation removed, related amounts accumulated in other accumulated comprehensive income are reclassified into earnings over the original hedge period during which the hedged item affects income.

The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge.  The Company may enter into derivative contracts that are intended to economically hedge certain of its risks, even though hedge accounting does not apply or the Company elects not to apply hedge accounting.

The Company formally documents all hedging relationships, including an assessment that the derivative instruments are expected to be highly effective in offsetting the changes in fair values or cash flows of the hedged items.

Advertising Costs

Advertising Costs

Advertising costs are expensed as incurred.

Stock-Based Compensation

Stock-Based Compensation

The Company has an Omnibus Stock Ownership and Long Term Incentive Plan (the “1999 Plan”) whereby certain stock-based rights, such as stock options, restricted stock units, performance units, stock appreciation rights, or book value shares, may be granted to eligible directors and employees.  The 1999 Plan expired on May 13, 2009.

Under the 1999 Plan, the Company granted incentive stock options to certain eligible employees in order that they may purchase Company stock at a price equal to the fair market value on the date of the grant.  The options granted in 1999 vested over a five-year period.  Options granted subsequent to 1999 vest over a three-year period.

All options expire ten years after the date of grant.  A summary of the stock option activity in the 1999 Plan is presented below:

Stock Option Activity
For the Years Ended December 31, 2012, 2011 and 2010
	Shares			Weighted Average Option Price Per Share		Weighted Average Remaining Contractual Term (in years)
Outstanding, December 31, 2009		169,462		$	8.17
Granted during the period		-		$	-
Expired during the period		(19,391	)	$	6.99
Exercised during the period		-		$	-
Outstanding, December 31, 2010		150,071		$	8.32
Granted during the period		-		$	-
Expired during the period		(71,054	)	$	8.71
Exercised during the period		-		$	-
Outstanding, December 31, 2011		79,017		$	7.97
Granted during the period		-		$	-
Expired during the period		-		$	-
Forfeited during the period		(6,052	)	$	8.89
Exercised during the period		(69,335	)	$	7.77
Outstanding, December 31, 2012		3,630		$	10.31	1.35
Exercisable, December 31, 2012		3,630		$	10.31	1.35

Options outstanding at December 31, 2012 are exercisable at $10.31.  As of December 31, 2012, the exercise price on options outstanding is more than the current market value; therefore, options outstanding as of December 31, 2012 have no intrinsic value.  Such options have a weighted average remaining contractual life of approximately one year.  No options were granted during the years ended December 31, 2012, 2011 and 2010. 69,335 options were exercised during the year ended December 31, 2012.  No options were exercised during the years ended December 31,  2011 and 2010.

The Company granted 3,000 restricted stock units in 2007 under the 1999 Plan at a grant date fair value of $17.40 per share. The Company granted 1,750 restricted stock units under the 1999 Plan at a grant date fair value of $12.80 per share during the third quarter of 2008 and 2,000 restricted stock units under the 1999 Plan at a fair value of $11.37 per share during the fourth quarter of 2008. The Company recognizes compensation expense on the restricted stock units over the period of time the restrictions are in place (three years from the grant date for the grants to date under the 1999 Plan).  The amount of expense recorded each period reflects the changes in the Company’s stock price during the period.  As of December 31, 2012, there was no unrecognized compensation cost related to the 2007 and 2008 restricted stock unit grants.

The Company also has an Omnibus Stock Ownership and Long Term Incentive Plan that was approved by its shareholders’ on May 7, 2009 (the “2009 Plan”) whereby certain stock-based rights, such as stock options, restricted stock, restricted stock units, performance units, stock appreciation rights, or book value shares, may be granted to eligible directors and employees.  A total of 330,486 shares are currently reserved for possible issuance under the 2009 Plan.   All rights must be granted or awarded within ten years from the May 7, 2009 effective date of the 2009 Plan.

The Company granted 29,514 restricted stock units under the 2009 Plan  at a grant date fair value of $7.90 per share during the first quarter of 2012.  5,355 restricted stock units were forfeited by the executive officers of the Company as required by the agreement with the U.S. Department of the Treasury (“UST”) in conjunction with the Company’s participation in the Capital Purchase Program (“CPP”) under the Troubled Asset Relief Program (“TARP”) in 2008.  In July 2012, the Company granted 5,355 restricted stock units at a grant date fair value of $8.25. The Company recognizes compensation expense on the restricted stock units over the period of time the restrictions are in place (five years from the grant date for the grants to date under the 2009 Plan). The amount of expense recorded each period reflects the changes in the Company’s stock price during the period.  As of December 31, 2012, the total unrecognized compensation cost related to the 2012 restricted stock unit grants was $227,000.

The Company recognized compensation expense for restricted stock awards of $42,000, $7,000 and $10,000 for the years ended December 31, 2012, 2011 and 2010, respectively.

Net Earnings Per Share

Net Earnings Per Share

Net earnings per common share is based on the weighted average number of common shares outstanding during the period while the effects of potential common shares outstanding during the period are included in diluted earnings per common share. The average market price during the year is used to compute equivalent shares.

The reconciliations of the amounts used in the computation of both “basic earnings per common share” and “diluted earnings per common share” for the years ended December 31, 2012, 2011 and 2010 are as follows:

For the year ended December 31, 2012:	Net Earnings Available to Common Shareholders (Dollars in thousands)		Common Shares		Per Share Amount
Basic earnings per common share	$	4,783		5,559,401	$	0.86
Effect of dilutive securities:
Stock options		-		3,206
Diluted earnings per common share	$	4,783		5,562,607	$	0.86

For the year ended December 31, 2011:	Net Earnings Available to Common Shareholders (Dollars in thousands)		Common Shares		Per Share Amount
Basic earnings per common share	$	3,766		5,542,548	$	0.68
Effect of dilutive securities:
Stock options		-		1,301
Diluted earnings per common share	$	3,766		5,543,849	$	0.68

For the year ended December 31, 2010:	Net Earnings Available to Common Shareholders (Dollars in thousands)		Common Shares		Per Share Amount
Basic earnings per common share	$	447		5,539,308	$	0.08
Effect of dilutive securities:
Stock options		-		4,107
Diluted earnings per common share	$	447		5,543,415	$	0.08

Recent Accounting Pronouncements

Recent Accounting Pronouncements

In January 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2013-01, Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities. ASU No. 2013-01 provides additional guidance to clarify the intended scope of ASU No. 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities.  ASU No. 2013-01 is effective for fiscal years beginning on or after January 1, 2013, and interim periods within those annual periods. The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.

In February 2013, FASB issued ASU No. 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. The objective of ASU No. 2013-02 is to improve the reporting of significant reclassifications out of accumulated other comprehensive income.  For public entities, ASU No. 2013-02 is effective for reporting periods beginning after December 15, 2012.  The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.

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

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3. Loans, Allowance for Loan Losses (Details) (USD $) In Thousands, unless otherwise specified	12 Months Ended
	Dec. 31, 2012	Dec. 31, 2011	Dec. 31, 2010
Allowance for loan losses
Beginning balance	$ 16,604	$ 15,493	$ 15,413
Charge-offs	(8,331)	(12,260)	(16,911)
Recoveries	1,226	739	553
Provision	4,924	12,632	16,438
Ending balance	14,423	16,604	15,493
Ending balance: individually evaluated for impairments	1,362	2,539
Ending balance: collectively evaluated for impairments	13,061	14,065
Ending balance	14,423	16,604	15,493
Loans
Ending balance	619,974	670,497
Ending balance: individually evaluated for impairment	40,785	44,786
Ending balance: collectively evaluated for impairment	579,189	625,711
Construction and land development
Allowance for loan losses
Beginning balance	7,182	5,774
Charge-offs	(4,728)	(7,164)
Recoveries	528	241
Provision	1,417	8,331
Ending balance	4,399	7,182
Ending balance: individually evaluated for impairments	24	1,250
Ending balance: collectively evaluated for impairments	4,375	5,932
Ending balance	4,399	7,182
Loans
Ending balance	73,176	93,812
Ending balance: individually evaluated for impairment	11,961	20,280
Ending balance: collectively evaluated for impairment	61,215	73,532
Single-family residential
Allowance for loan losses
Beginning balance	3,253	3,992
Charge-offs	(886)	(2,233)
Recoveries	72	184
Provision	792	1,310
Ending balance	3,231	3,253
Ending balance: individually evaluated for impairments	84	46
Ending balance: collectively evaluated for impairments	3,147	3,207
Ending balance	3,231	3,253
Loans
Ending balance	195,003	212,993
Ending balance: individually evaluated for impairment	3,885	2,352
Ending balance: collectively evaluated for impairment	191,118	210,641
Single-family residential - Banco de la Gente stated income
Allowance for loan losses
Beginning balance	2,104	2,105
Charge-offs	(668)	(692)
Recoveries	0	17
Provision	562	674
Ending balance	1,998	2,104
Ending balance: individually evaluated for impairments	1,254	1,243
Ending balance: collectively evaluated for impairments	744	861
Ending balance	1,998	2,104
Loans
Ending balance	52,019	54,058
Ending balance: individually evaluated for impairment	20,024	18,309
Ending balance: collectively evaluated for impairment	31,995	35,749
Commercial Real Estate
Allowance for loan losses
Beginning balance	1,731	1,409
Charge-offs	(937)	(1,271)
Recoveries	374	24
Provision	881	1,569
Ending balance	2,049	1,731
Ending balance: individually evaluated for impairments	0	0
Ending balance: collectively evaluated for impairments	2,049	1,731
Ending balance	2,049	1,731
Loans
Ending balance	200,633	214,415
Ending balance: individually evaluated for impairment	4,569	3,845
Ending balance: collectively evaluated for impairment	196,064	210,570
Multifamily and Farmland
Allowance for loan losses
Beginning balance	13	17
Charge-offs	0	0
Recoveries	0	0
Provision	15	(4)
Ending balance	28	13
Ending balance: individually evaluated for impairments	0	0
Ending balance: collectively evaluated for impairments	28	13
Ending balance	28	13
Loans
Ending balance	8,951	4,793
Ending balance: individually evaluated for impairment	0	0
Ending balance: collectively evaluated for impairment	8,951	4,793
Commercial loans (not secured by real estate)
Allowance for loan losses
Beginning balance	1,029	1,174
Charge-offs	(555)	(314)
Recoveries	104	121
Provision	510	48
Ending balance	1,088	1,029
Ending balance: individually evaluated for impairments	0	0
Ending balance: collectively evaluated for impairments	1,088	1,029
Ending balance	1,088	1,029
Loans
Ending balance	64,295	60,646
Ending balance: individually evaluated for impairment	346	0
Ending balance: collectively evaluated for impairment	63,949	60,646
Farm loans (not secured by real estate)
Allowance for loan losses
Charge-offs	0
Recoveries	0
Provision	0
Ending balance: individually evaluated for impairments	0
Ending balance: collectively evaluated for impairments	0
Ending balance	0	0
Loans
Ending balance	11
Ending balance: individually evaluated for impairment	0
Ending balance: collectively evaluated for impairment	11
Consumer And All Other Loans
Allowance for loan losses
Beginning balance	255	430
Charge-offs	(557)	(586)
Recoveries	148	152
Provision	399	259
Ending balance	245	255
Ending balance: individually evaluated for impairments	0	0
Ending balance: collectively evaluated for impairments	245	255
Ending balance	245	255
Loans
Ending balance	25,886	29,780
Ending balance: individually evaluated for impairment	0	0
Ending balance: collectively evaluated for impairment	25,886	29,780
Unallocated
Allowance for loan losses
Beginning balance	1,037	592
Charge-offs	0	0
Recoveries	0	0
Provision	348	445
Ending balance	1,385	1,037
Ending balance: individually evaluated for impairments	0	0
Ending balance: collectively evaluated for impairments	1,385	1,037
Ending balance	1,385	1,037
Loans
Ending balance	0	0
Ending balance: individually evaluated for impairment	0	0
Ending balance: collectively evaluated for impairment	$ 0	$ 0

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1. Summary of Significant Accounting Policies (Details Narrative) (USD $)	12 Months Ended
	Dec. 31, 2012	Dec. 31, 2011	Dec. 31, 2010
Summary Of Significant Accounting Policies Details Narrative
Unpaid principal balances of mortgage loans serviced for others	$ 3,100,000	$ 4,000,000	$ 5,300,000
Balance of other real estate owned	6,254,000	7,576,000
Compensation expense for restricted stock awards	$ 42,000	$ 7,000	$ 10,000

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14. Shareholders’ Equity (Details Narrative) (USD $) In Thousands, unless otherwise specified	Dec. 31, 2012	Dec. 31, 2011
Shareholders Equity Details Narrative
Shareholders' equity	$ 97,747	$ 103,027
Common stock	$ 48,133	$ 48,298

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13. Regulatory Matters (Tables)

12 Months Ended

Dec. 31, 2012

Banking and Thrift [Abstract]

Company’s and the Bank’s actual capital amounts and ratios

(Dollars in thousands)
	Actual					For Capital Adequacy Purposes					To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of December 31, 2012:
Total Capital (to Risk-Weighted Assets)
Consolidated	$	121,246		17.34	%		55,928		8.00	%		N/A		N/A
Bank	$	117,453		16.84	%		55,784		8.00	%		69,730		10.00	%
Tier 1 Capital (to Risk-Weighted Assets)
Consolidated	$	112,135		16.04	%		27,964		4.00	%		N/A		N/A
Bank	$	108,379		15.54	%		27,892		4.00	%		41,838		6.00	%
Tier 1 Capital (to Average Assets)
Consolidated	$	112,135		11.12	%		40,342		4.00	%		N/A		N/A
Bank	$	108,379		10.76	%		40,302		4.00	%		50,377		5.00	%
As of December 31, 2011:
Total Capital (to Risk-Weighted Assets)
Consolidated	$	129,495		17.38	%		59,607		8.00	%		N/A		N/A
Bank	$	111,807		15.04	%		59,463		8.00	%		74,329		10.00	%
Tier 1 Capital (to Risk-Weighted Assets)
Consolidated	$	119,950		16.10	%		29,804		4.00	%		N/A		N/A
Bank	$	102,264		13.76	%		29,731		4.00	%		44,597		6.00	%
Tier 1 Capital (to Average Assets)
Consolidated	$	119,950		11.06	%		43,379		4.00	%		N/A		N/A
Bank	$	102,264		9.44	%		43,328		4.00	%		54,160		5.00	%

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3. Loans, TDR (Details) (USD $) In Thousands, except Share data, unless otherwise specified	Dec. 31, 2012	Dec. 31, 2011
TDR Loans
Number of Contracts	180	315
Pre-Modification Outstanding Recorded Investment	$ 28,908	$ 54,660
Post-Modification Outstanding Recorded Investment	23,937	44,133
Construction and land development
TDR Loans
Number of Contracts	11	29
Pre-Modification Outstanding Recorded Investment	10,465	19,762
Post-Modification Outstanding Recorded Investment	6,633	12,840
Single-family residential
TDR Loans
Number of Contracts	33	48
Pre-Modification Outstanding Recorded Investment	3,014	4,684
Post-Modification Outstanding Recorded Investment	4,084	5,244
Single-family residential - Banco de la Gente stated income
TDR Loans
Number of Contracts	122	193
Pre-Modification Outstanding Recorded Investment	13,459	20,857
Post-Modification Outstanding Recorded Investment	12,170	19,602
Commercial Real Estate
TDR Loans
Number of Contracts	4	15
Pre-Modification Outstanding Recorded Investment	1,457	7,200
Post-Modification Outstanding Recorded Investment	682	5,013
Multifamily and Farmland
TDR Loans
Number of Contracts	0	1
Pre-Modification Outstanding Recorded Investment	0	322
Post-Modification Outstanding Recorded Investment	0	209
Total real estate loans
TDR Loans
Number of Contracts	170	286
Pre-Modification Outstanding Recorded Investment	28,395	52,825
Post-Modification Outstanding Recorded Investment	23,569	42,908
Commercial loans (not secured by real estate)
TDR Loans
Number of Contracts	9	21
Pre-Modification Outstanding Recorded Investment	511	1,711
Post-Modification Outstanding Recorded Investment	368	1,083
Consumer loans (not secured by real estate)
TDR Loans
Number of Contracts	1	8
Pre-Modification Outstanding Recorded Investment	2	124
Post-Modification Outstanding Recorded Investment	$ 0	$ 142

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10. Commitments and Contingencies (Details Narrative) (USD $)	12 Months Ended
	Dec. 31, 2012	Dec. 31, 2011	Dec. 31, 2010
Commitments And Contingencies Details Narrative
Rent expense	$ 643,000	$ 735,000	$ 815,000

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8. Income Taxes (Details 1) (USD $) In Thousands, unless otherwise specified	12 Months Ended
	Dec. 31, 2012	Dec. 31, 2011	Dec. 31, 2010
Income Taxes Details 1
Pre-tax income at statutory rate (34%)	$ 2,509	$ 2,251	$ 622
Differences:
Tax exempt interest income	(1,168)	(1,052)	(721)
Nondeductible interest and other expense	52	62	58
Cash surrender value of life insurance	(149)	(101)	(87)
State taxes, net of federal benefits	324	233	(8)
Nondeductible capital losses	0	49	99
Other, net	19	21	26
Total	$ 1,587	$ 1,463	$ (11)

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3. Loans, Nonaccrual (Details) (USD $) In Thousands, unless otherwise specified	Dec. 31, 2012	Dec. 31, 2011
Non-accrual loans
Non-accrual loans	$ 17,630	$ 21,785
Construction and land development
Non-accrual loans
Non-accrual loans	9,253	13,257
Single-family residential
Non-accrual loans
Non-accrual loans	2,491	2,380
Single-family residential - Banco de la Gente stated income
Non-accrual loans
Non-accrual loans	2,232	3,142
Commercial Real Estate
Non-accrual loans
Non-accrual loans	3,263	2,451
Total real estate loans
Non-accrual loans
Non-accrual loans	17,239	21,230
Commercial loans (not secured by real estate)
Non-accrual loans
Non-accrual loans	344	403
Consumer loans (not secured by real estate)
Non-accrual loans
Non-accrual loans	$ 47	$ 152

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2. Investment Securities

12 Months Ended

Dec. 31, 2012

Investments, Debt and Equity Securities [Abstract]

Investment Securities

(2) Investment Securities

Investment securities available for sale at December 31, 2012 and 2011 are as follows:

(Dollars in thousands)
	December 31, 2012
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
Mortgage-backed securities	$	146,755		1,875		606		148,024
U.S. Government
sponsored enterprises		18,714		203		80		18,837
State and political subdivisions		118,591		7,171		104		125,658
Corporate bonds		2,571		19		4		2,586
Trust preferred securities		1,250		-		-		1,250
Equity securities		748		720		-		1,468
Total	$	288,629		9,988		794		297,823

(Dollars in thousands)
	December 31, 2011
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
Mortgage-backed securities	$	213,378		1,371		1,056		213,693
U.S. Government
sponsored enterprises		7,429		265		-		7,694
State and political subdivisions		92,996		4,157		56		97,097
Corporate bonds		546		-		3		543
Trust preferred securities		1,250		-		-		1,250
Equity securities		748		363		-		1,111
Total	$	316,347		6,156		1,115		321,388

The current fair value and associated unrealized losses on investments in debt securities with unrealized losses at December 31, 2012 and 2011 are summarized in the tables below, with the length of time the individual securities have been in a continuous loss position.

(Dollars in thousands)
	December 31, 2012
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair  Value		Unrealized Losses		Fair  Value		Unrealized Losses
Mortgage-backed securities		48,126		468		12,913		138		61,039		606
U.S. Government
sponsored enterprises		3,402		80		-		-		3,402		80
State and political subdivisions		9,490		104		-		-		9,490		104
Corporate bonds		1,035		4		-		-		1,035		4
Total		62,053		656		12,913		138		74,966		794

(Dollars in thousands)
	December 31, 2011
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Mortgage-backed securities	$	95,122		991		4,125		65		99,247		1,056
State and political subdivisions		4,444		56		-		-		4,444		56
Corporate bonds		542		3		-		-		542		3
Total	$	100,108		1,050		4,125		65		104,233		1,115

At December 31, 2012, unrealized losses in the investment securities portfolio relating to debt securities totaled $794,000. The unrealized losses on these debt securities arose due to changing interest rates and are considered to be temporary.  At December 31, 2012, ten out of 151 securities issued by state and political subdivisions contained unrealized losses, 36 out of 90 securities issued by U.S. Government sponsored enterprises, including mortgage-backed securities, contained unrealized losses and two out of four securities issued by corporations contained unrealized losses. These unrealized losses are considered temporary because of acceptable investment grades on each security and the repayment sources of principal and interest are government backed.

The Company periodically evaluates its investments for any impairment which would be deemed other-than-temporary. No investment impairments were deemed other-than-temporary in 2012. As part of its evaluation in 2011, the Company determined that the fair value of one equity security was less than the original cost of the investment and that the decline in fair value was not temporary in nature.  As a result, the Company wrote down its investment by $144,000. The remaining fair value of the investment at December 31, 2011 was approximately $264,000.  Similarly, as part of its evaluation in 2010, the Company wrote down two equity securities by $291,000.  The remaining fair value of the investments at December 31, 2010 was $409,000.

The amortized cost and estimated fair value of investment securities available for sale at December 31, 2012, by contractual maturity, are shown below. Expected maturities of mortgage-backed securities will differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties.

(Dollars in thousands)
	Amortized Cost		Estimated Fair Value
Due within one year	$	4,139		4,163
Due from one to five years		14,285		14,768
Due from five to ten years		100,595		106,246
Due after ten years		22,107		23,154
Mortgage-backed securities		146,755		148,024
Equity securities		748		1,468
Total	$	288,629		297,823

Proceeds from sales of securities available for sale during 2012 were $47.1 million and resulted in gross gains of $1.3 million and gross losses of $103,000.  During 2011, the proceeds from sales of securities available for sale were $111.0 million and resulted in gross gains of $4.4 million and gross losses of $9,000. During 2010, the proceeds from sales of securities available for sale were $65.8 million and resulted in gross gains of $3.3 million.

Securities with a fair value of approximately $73.9 million and $83.6 million at December 31, 2012 and 2011, respectively, were pledged to secure public deposits, Federal Home Loan Bank of Atlanta (“FHLB”) borrowings and for other purposes as required by law.

GAAP establishes a framework for measuring fair value and expands disclosures about fair value measurements. There is a three-level fair value hierarchy for fair value measurements.  Level 1 inputs are quoted prices in active markets for identical assets or liabilities that a company has the ability to access at the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs for the asset or liability. The table below presents the balance of securities available for sale, which are measured at fair value on a recurring basis by level within the fair value hierarchy as of December 31, 2012 and 2011.

(Dollars in thousands)
	December 31, 2012
	Fair Value Measurements		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
Mortgage-backed securities	$	148,024		-		148,024		-
U.S. Government
sponsored enterprises	$	18,837		-		18,837		-
State and political subdivisions	$	125,658		-		125,658		-
Corporate bonds	$	2,586		-		2,586		-
Trust preferred securities	$	1,250		-		-		1,250
Equity securities	$	1,468		1,468		-		-

(Dollars in thousands)
	December 31, 2011
	Fair Value Measurements		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
Mortgage-backed securities	$	213,693		-		208,349		5,344
U.S. Government
sponsored enterprises	$	7,694		-		7,694		-
State and political subdivisions	$	97,097		-		97,097		-
Corporate bonds	$	543		-		543		-
Trust preferred securities	$	1,250		-		-		1,250
Equity securities	$	1,111		1,111		-		-

Fair values of investment securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges when available.  If quoted prices are not available, fair value is determined using matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities.

The following is an analysis of fair value measurements of investment securities available for sale using Level 3, significant unobservable inputs, for the year ended December 31, 2012.  Transfers out of Level 3 during the year ended December 31, 2012 are attributable to one available for sale security reported in Level 3 at December 31, 2011 because market pricing was unavailable from the Bank’s third party bond accounting provider at that time.  This security was reported in Level 2 at December 31, 2012, as the market valuation was provided by the Bank’s third party bond accounting provider.

(Dollars in thousands)
	Investment Securities Available for Sale
	Level 3 Valuation
Balance, beginning of period	$	6,594
Change in book value		-
Change in gain/(loss) realized and unrealized		-
Purchases/(sales)		-
Transfers in and/or (out) of Level 3		(5,344	)
Balance, end of period	$	1,250
Change in unrealized gain/(loss) for assets still held in Level 3	$	-

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8. Income Taxes (Details 2) (USD $) In Thousands, unless otherwise specified	Dec. 31, 2012	Dec. 31, 2011
Deferred tax assets:
Allowance for loan losses	$ 5,560	$ 6,401
Accrued retirement expense	1,409	1,213
Other real estate	628	454
Other	362	204
Total gross deferred tax assets	7,959	8,272
Deferred tax liabilities:
Deferred loan fees	794	1,082
Premises and equipment	417	655
Unrealized gain on available for sale securities	3,581	1,964
Total gross deferred tax liabilities	4,792	3,701
Net deferred tax asset	$ 3,167	$ 4,571

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2. Investment Securities (Details) (USD $) In Thousands, unless otherwise specified	12 Months Ended
	Dec. 31, 2012	Dec. 31, 2011
Investment securities available for sale
Estimated Fair Value	$ 297,823	$ 321,388
Amortized Cost
Due within one year	4,139
Due from one to five years	14,285
Due from five to ten years	100,595
Due after ten years	22,107
Mortgage-backed securities	146,755
Equity securities	748
Total	288,629
Estimated Fair Value
Due within one year	4,163
Due from one to five years	14,768
Due from five to ten years	106,246
Due after ten years	23,154
Mortgage-backed securities	148,024
Equity securities	1,468
Total	297,823
Fair value measurements
Estimated Fair Value	297,823	321,388
Investment Securities Available for Sale Level 3 Valuation
Balance, beginning of period	6,594
Transfers in and/or (out) of Level 3	(5,344)
Balance, end of period	1,250
Mortgage-backed securities
Investment securities available for sale
Amortized Cost	146,755	213,378
Gross Unrealized Gains	1,875	1,371
Gross Unrealized Losses	606	1,056
Estimated Fair Value	148,024	213,693
Investment securities with continuous unrealized loss position
Less than 12 Months, Fair Value	48,126	95,122
Less than 12 Months, Unrealized Losses	468	991
12 Months or More, Fair Value	12,913	4,125
12 Months or More, Unrealized Losses	138	65
Total, Fair Value	61,039	99,247
Total, Unrealized Losses	606	1,056
Fair value measurements
Estimated Fair Value	148,024	213,693
Level 1 valuation	0	0
Level 2 valuation	148,024	208,349
Level 3 valuation	0	5,344
U.S. Government sponsored enterprises
Investment securities available for sale
Amortized Cost	18,714	7,429
Gross Unrealized Gains	203	265
Gross Unrealized Losses	80	0
Estimated Fair Value	18,837	7,694
Investment securities with continuous unrealized loss position
Less than 12 Months, Fair Value	3,402
Less than 12 Months, Unrealized Losses	80
12 Months or More, Fair Value	0
12 Months or More, Unrealized Losses	0
Total, Fair Value	3,402
Total, Unrealized Losses	80
Fair value measurements
Estimated Fair Value	18,837	7,694
Level 1 valuation	0	0
Level 2 valuation	18,837	7,694
Level 3 valuation	0	0
State and political subdivisions
Investment securities available for sale
Amortized Cost	118,591	92,996
Gross Unrealized Gains	7,171	4,157
Gross Unrealized Losses	104	56
Estimated Fair Value	125,658	97,097
Investment securities with continuous unrealized loss position
Less than 12 Months, Fair Value	9,490	4,444
Less than 12 Months, Unrealized Losses	104	56
12 Months or More, Fair Value	0	0
12 Months or More, Unrealized Losses	0	0
Total, Fair Value	9,490	4,444
Total, Unrealized Losses	104	56
Fair value measurements
Estimated Fair Value	125,658	97,097
Level 1 valuation	0	0
Level 2 valuation	125,658	97,097
Level 3 valuation	0	0
Corporate bonds
Investment securities available for sale
Amortized Cost	2,571	546
Gross Unrealized Gains	19	0
Gross Unrealized Losses	4	3
Estimated Fair Value	2,586	543
Investment securities with continuous unrealized loss position
Less than 12 Months, Fair Value	1,035	542
Less than 12 Months, Unrealized Losses	4	3
12 Months or More, Fair Value	0	0
12 Months or More, Unrealized Losses	0	0
Total, Fair Value	1,035	542
Total, Unrealized Losses	4	3
Fair value measurements
Estimated Fair Value	2,586	543
Level 1 valuation	0	0
Level 2 valuation	2,586	543
Level 3 valuation	0	0
Trust preferred securities
Investment securities available for sale
Amortized Cost	1,250	1,250
Gross Unrealized Gains	0	0
Gross Unrealized Losses	0	0
Estimated Fair Value	1,250	1,250
Fair value measurements
Estimated Fair Value	1,250	1,250
Level 1 valuation	0	0
Level 2 valuation	0	0
Level 3 valuation	1,250	1,250
Equity securities
Investment securities available for sale
Amortized Cost	748	748
Gross Unrealized Gains	720	363
Gross Unrealized Losses	0	0
Estimated Fair Value	1,468	1,111
Fair value measurements
Estimated Fair Value	1,468	1,111
Level 1 valuation	1,468	1,111
Level 2 valuation	0	0
Level 3 valuation	0	0
Total
Investment securities available for sale
Amortized Cost	288,629	316,347
Gross Unrealized Gains	9,988	6,156
Gross Unrealized Losses	794	1,115
Estimated Fair Value	297,823	321,388
Investment securities with continuous unrealized loss position
Less than 12 Months, Fair Value	62,053	100,108
Less than 12 Months, Unrealized Losses	656	1,050
12 Months or More, Fair Value	12,913	4,125
12 Months or More, Unrealized Losses	138	65
Total, Fair Value	74,966	104,233
Total, Unrealized Losses	794	1,115
Fair value measurements
Estimated Fair Value	$ 297,823	$ 321,388

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4. Premises and Equipment (Tables)

12 Months Ended

Dec. 31, 2012

Property, Plant and Equipment [Abstract]

Premises and Equipment

(Dollars in thousands)
	2012		2011
Land	$	3,657		3,581
Buildings and improvements		14,815		14,771
Furniture and equipment		17,660		16,874
Total premises and equipment		36,132		35,226
Less accumulated depreciation		20,258		18,330
Total net premises and equipment	$	15,874		16,896

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3. Loans (Tables)

12 Months Ended

Dec. 31, 2012

Loans Tables

Major classifications of loans

(Dollars in thousands)
	December 31, 2012		December 31, 2011
Real estate loans
Construction and land development	$	73,176		93,812
Single-family residential		195,003		212,993
Single-family residential -
Banco de la Gente stated income		52,019		54,058
Commercial		200,633		214,415
Multifamily and farmland		8,951		4,793
Total real estate loans		529,782		580,071
Commercial loans (not secured by real estate)		64,295		60,646
Farm loans (not secured by real estate)		11		-
Consumer loans (not secured by real estate)		10,148		10,490
All other loans (not secured by real estate)		15,738		19,290
Total loans		619,974		670,497
Less allowance for loan losses		14,423		16,604
Total net loans	$	605,551		653,893

Age analysis of past due loans, by loan type

December 31, 2012
(Dollars in thousands)
	Loans 30-89 Days Past Due		Loans 90 or More Days Past Due		Total Past Due Loans		Total Current Loans		Total Loans		Accruing Loans 90 or More Days Past Due
Real estate loans
Construction and land development	$	1,280		6,858		8,138		65,038		73,176		-
Single-family residential		4,316		1,548		5,864		189,139		195,003		-
Single-family residential -
Banco de la Gente stated income		11,077		3,659		14,736		37,283		52,019		2,378
Commercial		1,720		1,170		2,890		197,743		200,633		-
Multifamily and farmland		7		-		7		8,944		8,951		-
Total real estate loans		18,400		13,235		31,635		498,147		529,782		2,378
Commercial loans (not secured by real estate)		888		66		954		63,341		64,295		23
Farm loans (not secured by real estate)		-		-		-		11		11		-
Consumer loans (not secured by real estate)		250		10		260		9,888		10,148		2
All other loans (not secured by real estate)		-		-		-		15,738		15,738		-
Total loans	$	19,538		13,311		32,849		587,125		619,974		2,403

December 31, 2011
(Dollars in thousands)
	Loans 30-89 Days Past Due		Loans 90 or More Days Past Due		Total Past Due Loans		Total Current Loans		Total Loans		Accruing Loans 90 or More Days Past Due
Real estate loans
Construction and land development	$	10,033		3,338		13,371		80,441		93,812		-
Single-family residential		4,612		1,434		6,046		206,947		212,993		107
Single-family residential -
Banco de la Gente stated income		11,924		4,755		16,679		37,379		54,058		2,602
Commercial		1,002		958		1,960		212,455		214,415		-
Multifamily and farmland		13		-		13		4,780		4,793		-
Total real estate loans		27,584		10,485		38,069		542,002		580,071		2,709
Commercial loans (not secured by real estate)		576		9		585		60,061		60,646		-
Consumer loans (not secured by real estate)		116		36		152		10,338		10,490		-
All other loans (not secured by real estate)		-		-		-		19,290		19,290		-
Total loans	$	28,276		10,530		38,806		631,691		670,497		2,709

Non-accrual loans

(Dollars in thousands)
	December 31, 2012		December 31, 2011
Real estate loans
Construction and land development	$	9,253		13,257
Single-family residential		2,491		2,380
Single-family residential -
Banco de la Gente stated income		2,232		3,142
Commercial		3,263		2,451
Total real estate loans		17,239		21,230
Commercial loans (not secured by real estate)		344		403
Consumer loans (not secured by real estate)		47		152
Total	$	17,630		21,785

Impaired loans

December 31, 2012
(Dollars in thousands)
	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Recorded Investment in Impaired Loans		Related Allowance		Average Outstanding Impaired Loans
Real estate loans
Construction and land development	$	17,738		11,795		680		12,475		61		12,810
Single-family residential		9,099		766		7,799		8,565		177		7,590
Single-family residential -
Banco de la Gente stated income		21,806		-		21,000		21,000		1,278		21,158
Commercial		5,830		4,569		467		5,036		6		5,433
Multifamily and farmland		193		-		193		193		1		200
Total impaired real estate loans		54,666		17,130		30,139		47,269		1,523		47,191
Commercial loans (not secured by real estate)		983		347		592		939		12		1,125
Consumer loans (not secured by real estate)		68		-		66		66		1		41
Total impaired loans	$	55,717		17,477		30,797		48,274		1,536		48,357

December 31, 2011
(Dollars in thousands)
	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Recorded Investment in Impaired Loans		Related Allowance		Average Outstanding Impaired Loans
Real estate loans
Construction and land development	$	28,721		14,484		6,098		20,582		3,264		17,848
Single-family residential		6,361		969		5,117		6,086		131		6,324
Single-family residential -
Banco de la Gente stated income		20,021		-		19,602		19,602		1,296		18,778
Commercial		7,717		3,845		3,139		6,984		77		4,518
Multifamily and farmland		209		-		209		209		1		214
Total impaired real estate loans		63,029		19,298		34,165		53,463		4,769		47,682
Commercial loans (not secured by real estate)		1,111		-		1,083		1,083		26		1,485
Consumer loans (not secured by real estate)		157		-		152		152		2		140
Total impaired loans	$	64,297		19,298		35,400		54,698		4,797		49,307

(Dollars in thousands)
	Fair Value Measurements December 31, 2012		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation		Total Gains/(Losses) for the Year Ended December 31, 2012
Impaired loans	$	46,738		-		-		46,738		(7,986	)
Other real estate	$	6,254		-		-		6,254		(1,136	)

(Dollars in thousands)
	Fair Value Measurements December 31, 2011		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation		Total Gains/(Losses) for the Year Ended December 31, 2011
Impaired loans	$	49,901		-		-		49,901		(11,864	)
Other real estate	$	7,576		-		-		7,576		(1,322	)

Changes in the allowance for loan losses

Year ended December 31, 2012
(Dollars in thousands)
	Real Estate Loans
	Construction and Land Development			Single-Family Residential			Single-Family Residential - Banco de la Gente Stated Income			Commercial			Multifamily and Farmland		Commercial			Farm		Consumer and All Other			Unallocated		Total
Allowance for loan losses:
Beginning balance	$	7,182			3,253			2,104			1,731			13		1,029			-		255			1,037		16,604
Charge-offs		(4,728	)		(886	)		(668	)		(937	)		-		(555	)		-		(557	)		-		(8,331	)
Recoveries		528			72			-			374			-		104			-		148			-		1,226
Provision		1,417			792			562			881			15		510			-		399			348		4,924
Ending balance	$	4,399			3,231			1,998			2,049			28		1,088			-		245			1,385		14,423
Ending balance: individually
evaluated for impairment	$	24			84			1,254			-			-		-			-		-			-		1,362
Ending balance: collectively
evaluated for impairment		4,375			3,147			744			2,049			28		1,088			-		245			1,385		13,061
Ending balance	$	4,399			3,231			1,998			2,049			28		1,088			-		245			1,385		14,423
Loans:
Ending balance	$	73,176			195,003			52,019			200,633			8,951		64,295			11		25,886			-		619,974
Ending balance: individually
evaluated for impairment	$	11,961			3,885			20,024			4,569			-		346			-		-			-		40,785
Ending balance: collectively
evaluated for impairment	$	61,215			191,118			31,995			196,064			8,951		63,949			11		25,886			-		579,189

Year ended December 31, 2011
(Dollars in thousands)
		Real Estate Loans
		Construction and Land Development		Single-Family Residential		Single-Family Residential - Banco de la Gente Stated Income		Commercial		Multifamily and Farmland		Commercial		Consumer and All Other		Unallocated	Total
Allowance for loan losses:
Beginning balance	$	5,774		3,992		2,105		1,409		17		1,174		430		592	15,493
Charge-offs		(7,164	)	(2,233	)	(692	)	(1,271	)	—		(314	)	(586	)	—	(12,260	)
Recoveries		241		184		17		24		—		121		152		—	739
Provision		8,331		1,310		674		1,569		(4	)	48		259		445	12,632
Ending balance	$	7,182		3,253		2,104		1,731		13		1,029		255		1,037	16,604
Ending balance: individually
evaluated for impairment	$	1,250		46		1,243		—		—		—		—		—	2,539
Ending balance: collectively
evaluated for impairment		5,932		3,207		861		1,731		13		1,029		255		1,037	14,065
Ending balance	$	7,182		3,253		2,104		1,731		13		1,029		255		1,037	16,604
Loans:
Ending balance	$	93,812		212,993		54,058		214,415		4,793		60,646		29,780		—	670,497
Ending balance: individually
evaluated for impairment	$	20,280		2,352		18,309		3,845		—		—		—		—	44,786
Ending balance: collectively
evaluated for impairment	$	73,532		210,641		35,749		210,570		4,793		60,646		29,780		—	625,711

(Dollars in thousands)
	2010
Balance at beginning of year	$	15,413
Amounts charged off		(16,911	)
Recoveries on amounts previously charged off		553
Provision for loan losses		16,438
Balance at end of year	$	15,493

Credit risk profile of each loan type based on internally assigned risk grade

December 31, 2012
(Dollars in thousands)
	Real Estate Loans
	Construction and Land Development		Single-Family Residential		Single-Family Residential - Banco de la Gente Stated Income		Commercial		Multifamily and Farmland		Commercial		Farm		Consumer		All Other		Total
1- Excellent Quality	$	11		24,662		-		-		-		672		-		1,239		-		26,584
2- High Quality		4,947		56,829		-		27,511		32		9,260		-		4,122		2,317		105,018
3- Good Quality		24,952		62,018		24,724		114,001		4,975		40,814		11		4,186		13,416		289,097
4- Management Attention		18,891		35,727		11,366		47,603		3,039		11,844		-		392		5		128,867
5- Watch		9,580		9,504		3,597		6,911		712		976		-		134		-		31,414
6- Substandard		14,795		6,263		12,332		4,607		193		729		-		70		-		38,989
7- Low Substandard		-		-		-		-		-		-		-		-		-		-
8- Doubtful		-		-		-		-		-		-		-		-		-		-
9- Loss		-		-		-		-		-		-		-		5		-		5
Total	$	73,176		195,003		52,019		200,633		8,951		64,295		11		10,148		15,738		619,974

December 31, 2011
(Dollars in thousands)
	Real Estate Loans
	Construction and Land Development		Single-Family Residential		Single-Family Residential - Banco de la Gente Stated Income		Commercial		Multifamily and Farmland		Commercial		Consumer		All Other		Total
1- Excellent Quality	$	197		25,474		-		-		-		715		1,344		-		27,730
2- High Quality		5,183		64,817		-		25,506		50		8,801		4,070		2,774		111,201
3- Good Quality		27,675		74,824		25,564		136,137		3,448		36,585		4,259		16,509		325,001
4- Management Attention		28,138		35,233		15,020		40,312		358		12,882		429		7		132,379
5- Watch		15,923		6,141		5,626		2,795		728		622		89		-		31,924
6- Substandard		16,696		6,504		7,848		9,665		209		1,041		154		-		42,117
7- Low Substandard		-		-		-		-		-		-		-		-		-
8- Doubtful		-		-		-		-		-		-		-		-		-
9- Loss		-		-		-		-		-		-		145		-		145
Total	$	93,812		212,993		54,058		214,415		4,793		60,646		10,490		19,290		670,497

Analysis of TDR loans by loan type

December 31, 2012
(Dollars in thousands)
	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Real estate loans
Construction and land development		11	$	10,465		6,633
Single-family residential		33		3,014		4,084
Single-family residential -
Banco de la Gente stated income		122		13,459		12,170
Commercial		4		1,457		682
Total real estate TDR loans		170		28,395		23,569
Commercial loans (not secured by real estate)		9		511		368
Consumer loans (not secured by real estate)		1		2		-
Total TDR loans		180	$	28,908		23,937

December 31, 2012
(Dollars in thousands)
	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Real estate loans
Single-family residential		5	$	674		673
Single-family residential -
Banco de la Gente stated income		20		2,046		1,992
Total real estate TDR loans		25		2,720		2,665
Commercial loans (not secured by real estate)		1		14		13
Total TDR loans		26	$	2,734		2,678

December 31, 2011
(Dollars in thousands)
	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Real estate loans
Construction and land development		29	$	19,762		12,840
Single-family residential		48		4,684		5,244
Single-family residential -
Banco de la Gente stated income		193		20,857		19,602
Commercial		15		7,200		5,013
Multifamily and farmland		1		322		209
Total real estate TDR loans		286		52,825		42,908
Commercial loans (not secured by real estate)		21		1,711		1,083
Consumer loans (not secured by real estate)		8		124		142
Total TDR loans		315	$	54,660		44,133

XML

4. Premises and Equipment (Details Narrative) (USD $) In Millions, unless otherwise specified	12 Months Ended
	Dec. 31, 2012	Dec. 31, 2011
Premises And Equipment Details Narrative
Depreciation expense	$ 1.9	$ 2.0

XML

2. Investment Securities (Details Narrative) (USD $) In Thousands, unless otherwise specified	12 Months Ended
	Dec. 31, 2012	Dec. 31, 2011	Dec. 31, 2010
Investment Securities Details Narrative
Unrealized losses in the investment securites portfolio relating to debt securities	$ 794
Other than temporary write downs	0	144	291
Remaining value of impaired investments		264	409
Proceeds from sales of investment securities available for sale	47,076	110,978	65,774
Gains on sales of available-to-sale securities	1,300	4,400	3,300
Securities pledged to secure public deposits	$ 73,900	$ 83,600

XML

5. Time Deposits (Tables)

12 Months Ended

Dec. 31, 2012

Banking and Thrift [Abstract]

Scheduled maturities of time deposits

(Dollars in thousands)
2013	$	157,707
2014		33,579
2015		36,066
2016		10,269
2017 and thereafter		10,603
Total	$	248,224

XML

6. Federal Home Loan Bank and Federal Reserve Bank Borrowings (Tables)

12 Months Ended

Dec. 31, 2012

Banking and Thrift [Abstract]

Borrowings from the FHLB outstanding

(Dollars in thousands)
Maturity Date	Call Date		Rate			Rate Type	Amount
June 24, 2015		N/A		3.710	%	Convertible	$	5,000
March 25, 2019		N/A		4.260	%	Convertible		5,000
October 5, 2016		N/A		4.450	%	Convertible		5,000
November 12, 2014		N/A		2.230	%	Fixed Rate Hybrid		5,000
November 13, 2017		N/A		4.260	%	Fixed Rate Hybrid		15,000
October 17, 2016		N/A		3.820	%	Adjustable Rate Hybrid		5,000
October 17, 2018		N/A		3.500	%	Adjustable Rate Hybrid		5,000
October 17, 2018		N/A		3.740	%	Adjustable Rate Hybrid		15,000
October 17, 2018		N/A		3.515	%	Adjustable Rate Hybrid		5,000
October 17, 2018		N/A		3.570	%	Adjustable Rate Hybrid		5,000
							$	70,000

XML

1. Summary of Significant Accounting Policies

12 Months Ended

Dec. 31, 2012

Accounting Policies [Abstract]

1. Summary of Significant Accounting Policies

(1) Summary of Significant Accounting Policies

Organization

Peoples Bancorp of North Carolina, Inc. (“Bancorp”) received regulatory approval to operate as a bank holding company on July 22, 1999, and became effective August 31, 1999.  Bancorp is primarily regulated by the Board of Governors of the Federal Reserve System, and serves as the one-bank holding company for Peoples Bank (the “Bank”).

The Bank commenced business in 1912 upon receipt of its banking charter from the North Carolina State Banking Commission (the “SBC”). The Bank is primarily regulated by the SBC and the Federal Deposit Insurance Corporation (the “FDIC”) and undergoes periodic examinations by these regulatory agencies. The Bank, whose main office is in Newton, North Carolina, provides a full range of commercial and consumer banking services primarily in Catawba, Alexander, Lincoln, Mecklenburg, Iredell, Union and Wake counties in North Carolina.

Peoples Investment Services, Inc. is a wholly-owned subsidiary of the Bank and began operations in 1996 to provide investment and trust services through agreements with an outside party.

Real Estate Advisory Services, Inc. (“REAS”) is a wholly-owned subsidiary of the Bank and began operations in 1997 to provide real estate appraisal and property management services to individuals and commercial customers of the Bank.

Community Bank Real Estate Solutions, LLC is a wholly-owned subsidiary of Bancorp and began operations in 2009 as a “clearing house” for appraisal services for community banks.  Other banks are able to contract with Community Bank Real Estate Solutions, LLC to find and engage appropriate appraisal companies in the area where the property is located.

Principles of Consolidation

The consolidated financial statements include the financial statements of Bancorp and its wholly-owned subsidiaries, the Bank and Community Bank Real Estate Solutions, LLC, along with the Bank’s wholly-owned subsidiaries, Peoples Investment Services, Inc. and REAS (collectively called the “Company”).  All significant intercompany balances and transactions have been eliminated in consolidation.

Basis of Presentation

The accounting principles followed by the Company, and the methods of applying these principles, conform with accounting principles generally accepted in the United States of America (“GAAP”) and with general practices in the banking industry. In preparing the financial statements in conformity with GAAP, management is required to make estimates and assumptions that affect the reported amounts in the financial statements. Actual results could differ significantly from these estimates. Material estimates common to the banking industry that are particularly susceptible to significant change in the near term include, but are not limited to, the determination of the allowance for loan losses and valuation of real estate acquired in connection with or in lieu of foreclosure on loans.

Cash and Cash Equivalents

Cash, due from banks and interest-bearing deposits are considered cash and cash equivalents for cash flow reporting purposes.

Investment Securities

There are three classifications the Company is able to classify its investment securities: trading, available for sale, or held to maturity. Trading securities are bought and held principally for sale in the near term. Held to maturity securities are those securities for which the Company has the ability and intent to hold until maturity. All other securities not included in trading or held to maturity are classified as available for sale. At December 31, 2012 and 2011, the Company classified all of its investment securities as available for sale.

Available for sale securities are recorded at fair value. Unrealized holding gains and losses, net of the related tax effect, are excluded from earnings and are reported as a separate component of shareholders’ equity until realized.

Management evaluates investment securities for other-than-temporary impairment on an annual basis. A decline in the market value of any investment below cost that is deemed other-than-temporary is charged to earnings for the decline in value deemed to be credit related and a new cost basis in the security is established. The decline in value attributed to non-credit related factors is recognized in comprehensive income.

Premiums and discounts are amortized or accreted over the life of the related security as an adjustment to the yield.  Realized gains and losses for securities classified as available for sale are included in earnings and are derived using the specific identification method for determining the cost of securities sold.

Other Investments

Other investments include equity securities with no readily determinable fair value. These investments are carried at cost.

Mortgage Loans Held for Sale

Mortgage loans held for sale are carried at lower of aggregate cost or market value. The cost of mortgage loans held for sale approximates the market value.

Loans

Loans that management has the intent and ability to hold for the foreseeable future or until maturity are reported at the principal amount outstanding, net of the allowance for loan losses. Interest on loans is calculated by using the simple interest method on daily balances of the principal amount outstanding. The recognition of certain loan origination fee income and certain loan origination costs is deferred when such loans are originated and amortized over the life of the loan.

A loan is impaired when, based on current information and events, it is probable that all amounts due according to the contractual terms of the loan will not be collected.  Impaired loans are measured based on the present value of expected future cash flows, discounted at the loan’s effective interest rate, or at the loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent.

Accrual of interest is discontinued on a loan when management believes, after considering economic conditions and collection efforts, that the borrower’s financial condition is such that collection of interest is doubtful. Interest previously accrued but not collected is reversed against current period earnings.

Allowance for Loan Losses

The allowance for loan losses reflects management’s assessment and estimate of the risks associated with extending credit and its evaluation of the quality of the loan portfolio. The Bank periodically analyzes the loan portfolio in an effort to review asset quality and to establish an allowance for loan losses that management believes will be adequate in light of anticipated risks and loan losses. In assessing the adequacy of the allowance, size, quality and risk of loans in the portfolio are reviewed. Other factors considered are:

·   the Bank’s loan loss experience;

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

·   specific known risks;

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

·   underlying estimated values of collateral securing loans;

·   current and anticipated economic conditions; and

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

The allowance for loan losses is comprised of three components: specific reserves, general reserves and unallocated reserves. After a loan has been identified as impaired, management measures impairment. When the measure of the impaired loan is less than the recorded investment in the loan, the amount of the impairment is recorded as a specific reserve. These specific reserves are determined on an individual loan basis based on management’s current evaluation of the Bank’s loss exposure for each credit, given the appraised value of any underlying collateral or the present value of projected cash flows for non-collateral dependent loans. Loans for which specific reserves are provided are excluded from the general allowance calculations as described below.

The general allowance reflects reserves established under GAAP for collective loan impairment. These reserves are based upon historical net charge-offs using the greater of the last two or three years’ loss experience.  This charge-off experience may be adjusted to reflect the effects of current conditions.  The Bank considers information derived from its loan risk ratings and external data related to industry and general economic trends in establishing reserves.

The unallocated allowance is determined through management’s assessment of probable losses that are in the portfolio but are not adequately captured by the other two components of the allowance, including consideration of current economic and business conditions and regulatory requirements. The unallocated allowance also reflects management’s acknowledgement of the imprecision and subjectivity that underlie the modeling of credit risk.  Due to the subjectivity involved in determining the overall allowance, including the unallocated portion, this unallocated portion may fluctuate from period to period based on management’s evaluation of the factors affecting the assumptions used in calculating the allowance.

Management considers the allowance for loan losses adequate to cover the estimated losses inherent in the Bank’s loan portfolio as of the date of the financial statements. Management believes it has established the allowance in accordance with GAAP and in consideration of the current economic environment. Although management uses the best information available to make evaluations, significant future additions to the allowance may be necessary based on changes in economic and other conditions, thus adversely affecting the operating results of the Company.

There were no significant changes in the estimation methods or fundamental assumptions used in the evaluation of the allowance for loan losses for the year ended December 31, 2012 as compared to the year ended December 31, 2011.   Revisions, estimates and assumptions may be made in any period in which the supporting factors indicate that loss levels may vary from the previous estimates.

Effective December 31, 2012, stated income mortgage loans from the Banco de la Gente division of the Bank were analyzed separately from other single family residential loans in the Bank’s loan portfolio.  These loans are first mortgage loans made to the Latino market, primarily in Mecklenburg and surrounding counties.  These loans are non-traditional mortgages in that the customer normally did not have a credit history, so all credit information was accumulated by the loan officers.  These loans were made as stated income loans rather than full documentation loans because the customer may not have had complete documentation on the income supporting the loan.

Various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. Such agencies may require adjustments to the allowance based on their judgments of information available to them at the time of their examinations.  Also, an independent loan review process further assists with evaluating credit quality and assessing potential performance issues.

Mortgage Banking Activities

Mortgage banking income represents net gains from the sale of mortgage loans and fees received from borrowers and loan investors related to the Bank’s origination of single-family residential mortgage loans.

Mortgage loans serviced for others are not included in the accompanying balance sheets. The unpaid principal balances of mortgage loans serviced for others was approximately $3.1 million, $4.0 million and $5.3 million at December 31, 2012, 2011 and 2010, respectively.

The Bank originates certain fixed rate mortgage loans and commits these loans for sale.  The commitments to originate fixed rate mortgage loans and the commitments to sell these loans to a third party are both derivative contracts.  The fair value of these derivative contracts is immaterial and has no effect on the recorded amounts in the financial statements.

Premises and Equipment

Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed primarily using the straight-line method over the estimated useful lives of the assets. When assets are retired or otherwise disposed, the cost and related accumulated depreciation are removed from the accounts, and any gain or loss is reflected in earnings for the period. The cost of maintenance and repairs that do not improve or extend the useful life of the respective asset is charged to earnings as incurred, whereas significant renewals and improvements are capitalized. The range of estimated useful lives for premises and equipment are generally as follows:

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

Other Real Estate

Foreclosed assets include all assets received in full or partial satisfaction of a loan.  Foreclosed assets are reported at fair value less estimated selling costs.  Any write-downs at the time of foreclosure are charged to the allowance for loan losses.  Subsequent to foreclosure, valuations are periodically performed by management, and a valuation allowance is established if fair value declines below carrying value.  Costs relating to the development and improvement of the property are capitalized.  Revenues and expenses from operations are included in other expenses.  Changes in the valuation allowance are included in loss on sale and write-down of other real estate.  The balance of other real estate owned was $6.3 million and $7.6 million at December 31, 2012 and 2011, respectively.

Income Taxes

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Additionally, the recognition of future tax benefits, such as net operating loss carryforwards, is required to the extent that the realization of such benefits is more likely than not to occur. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which the assets and liabilities are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income tax expense in the period that includes the enactment date.

In the event the future tax consequences of differences between the financial reporting bases and the tax bases of the Company’s assets and liabilities results in a deferred tax asset, an evaluation of the probability of being able to realize the future benefits indicated by such asset is required. A valuation allowance is provided for the portion of the deferred tax asset when it is more likely than not that some portion or all of the deferred tax asset will not be realized. In assessing the realizability of a deferred tax asset, management considers the scheduled reversals of deferred tax liabilities, projected future taxable income, and tax planning strategies.

Tax effects from an uncertain tax position can be recognized in the financial statements only when it is more likely than not that the tax position will be sustained upon examination by the appropriate taxing authority that would have full knowledge of all relevant information.  A tax position that meets the more likely than not recognition threshold is measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement.  Previously recognized tax positions that no longer meet the more likely than not recognition threshold should be derecognized in the first subsequent financial reporting period in which that threshold is no longer met.  The Company assessed the impact of this guidance and determined that it did not have a material impact on the Company’s financial position, results of operations or disclosures.

Derivative Financial Instruments and Hedging Activities

In the normal course of business, the Company enters into derivative contracts to manage interest rate risk by modifying the characteristics of the related balance sheet instruments in order to reduce the adverse effect of changes in interest rates. All material derivative financial instruments are recorded at fair value in the financial statements.  The fair value of derivative contracts related to the origination of fixed rate mortgage loans and the commitments to sell these loans to a third party is immaterial and has no effect on the recorded amounts in the financial statements.

The disclosure requirements for derivatives and hedging activities have the intent to provide users of financial statements with an enhanced understanding of: (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows.  The disclosure requirements include qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about the fair value of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative instruments.

On the date a derivative contract is entered into, the Company designates the derivative as a fair value hedge, a cash flow hedge, or a trading instrument. Changes in the fair value of instruments used as fair value hedges are accounted for in the earnings of the period simultaneous with accounting for the fair value change of the item being hedged. Changes in the fair value of the effective portion of cash flow hedges are accounted for in other comprehensive income rather than earnings. Changes in fair value of instruments that are not intended as a hedge are accounted for in the earnings of the period of the change.

If a derivative instrument designated as a fair value hedge is terminated or the hedge designation removed, the difference between a hedged item’s then carrying amount and its face amount is recognized into income over the original hedge period. Likewise, if a derivative instrument designated as a cash flow hedge is terminated or the hedge designation removed, related amounts accumulated in other accumulated comprehensive income are reclassified into earnings over the original hedge period during which the hedged item affects income.

The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge.  The Company may enter into derivative contracts that are intended to economically hedge certain of its risks, even though hedge accounting does not apply or the Company elects not to apply hedge accounting.

The Company formally documents all hedging relationships, including an assessment that the derivative instruments are expected to be highly effective in offsetting the changes in fair values or cash flows of the hedged items.

Advertising Costs

Advertising costs are expensed as incurred.

Stock-Based Compensation

The Company has an Omnibus Stock Ownership and Long Term Incentive Plan (the “1999 Plan”) whereby certain stock-based rights, such as stock options, restricted stock units, performance units, stock appreciation rights, or book value shares, may be granted to eligible directors and employees.  The 1999 Plan expired on May 13, 2009.

Under the 1999 Plan, the Company granted incentive stock options to certain eligible employees in order that they may purchase Company stock at a price equal to the fair market value on the date of the grant.  The options granted in 1999 vested over a five-year period.  Options granted subsequent to 1999 vest over a three-year period.

All options expire ten years after the date of grant.  A summary of the stock option activity in the 1999 Plan is presented below:

Stock Option Activity
For the Years Ended December 31, 2012, 2011 and 2010
	Shares			Weighted Average Option Price Per Share		Weighted Average Remaining Contractual Term (in years)
Outstanding, December 31, 2009		169,462		$	8.17
Granted during the period		-		$	-
Expired during the period		(19,391	)	$	6.99
Exercised during the period		-		$	-
Outstanding, December 31, 2010		150,071		$	8.32
Granted during the period		-		$	-
Expired during the period		(71,054	)	$	8.71
Exercised during the period		-		$	-
Outstanding, December 31, 2011		79,017		$	7.97
Granted during the period		-		$	-
Expired during the period		-		$	-
Forfeited during the period		(6,052	)	$	8.89
Exercised during the period		(69,335	)	$	7.77
Outstanding, December 31, 2012		3,630		$	10.31	1.35
Exercisable, December 31, 2012		3,630		$	10.31	1.35

Options outstanding at December 31, 2012 are exercisable at $10.31.  As of December 31, 2012, the exercise price on options outstanding is more than the current market value; therefore, options outstanding as of December 31, 2012 have no intrinsic value.  Such options have a weighted average remaining contractual life of approximately one year.  No options were granted during the years ended December 31, 2012, 2011 and 2010. 69,335 options were exercised during the year ended December 31, 2012.  No options were exercised during the years ended December 31,  2011 and 2010.

The Company granted 3,000 restricted stock units in 2007 under the 1999 Plan at a grant date fair value of $17.40 per share. The Company granted 1,750 restricted stock units under the 1999 Plan at a grant date fair value of $12.80 per share during the third quarter of 2008 and 2,000 restricted stock units under the 1999 Plan at a fair value of $11.37 per share during the fourth quarter of 2008. The Company recognizes compensation expense on the restricted stock units over the period of time the restrictions are in place (three years from the grant date for the grants to date under the 1999 Plan).  The amount of expense recorded each period reflects the changes in the Company’s stock price during the period.  As of December 31, 2012, there was no unrecognized compensation cost related to the 2007 and 2008 restricted stock unit grants.

The Company also has an Omnibus Stock Ownership and Long Term Incentive Plan that was approved by its shareholders’ on May 7, 2009 (the “2009 Plan”) whereby certain stock-based rights, such as stock options, restricted stock, restricted stock units, performance units, stock appreciation rights, or book value shares, may be granted to eligible directors and employees.  A total of 330,486 shares are currently reserved for possible issuance under the 2009 Plan.   All rights must be granted or awarded within ten years from the May 7, 2009 effective date of the 2009 Plan.

The Company granted 29,514 restricted stock units under the 2009 Plan  at a grant date fair value of $7.90 per share during the first quarter of 2012.  5,355 restricted stock units were forfeited by the executive officers of the Company as required by the agreement with the U.S. Department of the Treasury (“UST”) in conjunction with the Company’s participation in the Capital Purchase Program (“CPP”) under the Troubled Asset Relief Program (“TARP”) in 2008.  In July 2012, the Company granted 5,355 restricted stock units at a grant date fair value of $8.25. The Company recognizes compensation expense on the restricted stock units over the period of time the restrictions are in place (five years from the grant date for the grants to date under the 2009 Plan). The amount of expense recorded each period reflects the changes in the Company’s stock price during the period.  As of December 31, 2012, the total unrecognized compensation cost related to the 2012 restricted stock unit grants was $227,000.

The Company recognized compensation expense for restricted stock awards of $42,000, $7,000 and $10,000 for the years ended December 31, 2012, 2011 and 2010, respectively.

Net Earnings Per Share

Net earnings per common share is based on the weighted average number of common shares outstanding during the period while the effects of potential common shares outstanding during the period are included in diluted earnings per common share. The average market price during the year is used to compute equivalent shares.

The reconciliations of the amounts used in the computation of both “basic earnings per common share” and “diluted earnings per common share” for the years ended December 31, 2012, 2011 and 2010 are as follows:

For the year ended December 31, 2012:	Net Earnings Available to Common Shareholders (Dollars in thousands)		Common Shares		Per Share Amount
Basic earnings per common share	$	4,783		5,559,401	$	0.86
Effect of dilutive securities:
Stock options		-		3,206
Diluted earnings per common share	$	4,783		5,562,607	$	0.86

For the year ended December 31, 2011:	Net Earnings Available to Common Shareholders (Dollars in thousands)		Common Shares		Per Share Amount
Basic earnings per common share	$	3,766		5,542,548	$	0.68
Effect of dilutive securities:
Stock options		-		1,301
Diluted earnings per common share	$	3,766		5,543,849	$	0.68

For the year ended December 31, 2010:	Net Earnings Available to Common Shareholders (Dollars in thousands)		Common Shares		Per Share Amount
Basic earnings per common share	$	447		5,539,308	$	0.08
Effect of dilutive securities:
Stock options		-		4,107
Diluted earnings per common share	$	447		5,543,415	$	0.08

Recent Accounting Pronouncements

In January 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2013-01, Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities. ASU No. 2013-01 provides additional guidance to clarify the intended scope of ASU No. 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities.  ASU No. 2013-01 is effective for fiscal years beginning on or after January 1, 2013, and interim periods within those annual periods. The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.

In February 2013, FASB issued ASU No. 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. The objective of ASU No. 2013-02 is to improve the reporting of significant reclassifications out of accumulated other comprehensive income.  For public entities, ASU No. 2013-02 is effective for reporting periods beginning after December 15, 2012.  The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.

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

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8. Income Taxes (Tables)

12 Months Ended

Dec. 31, 2012

Income Tax Disclosure [Abstract]

Provision for income taxes

(Dollars in thousands)
	2012			2011			2010
Current	$	1,800			2,141			512
Deferred		(213	)		(678	)		(523	)
Total	$	1,587			1,463			(11	)

Federal income tax rate to earnings reconciliation

(Dollars in thousands)
	2012			2011			2010
Pre-tax income at statutory rate (34%)	$	2,509			2,251			622
Differences:
Tax exempt interest income		(1,168	)		(1,052	)		(721	)
Nondeductible interest and other expense		52			62			58
Cash surrender value of life insurance		(149	)		(101	)		(87	)
State taxes, net of federal benefits		324			233			(8	)
Nondeductible capital losses		-			49			99
Other, net		19			21			26
Total	$	1,587			1,463			(11	)

Deferred tax assets and deferred tax liabilities

Deferred tax assets:
Allowance for loan losses	$	5,560	6,401
Accrued retirement expense		1,409	1,213
Other real estate		628	454
Other		362	204
Total gross deferred tax assets		7,959	8,272
Deferred tax liabilities:
Deferred loan fees		794	1,082
Premises and equipment		417	655
Unrealized gain on available for sale securities		3,581	1,964
Total gross deferred tax liabilities		4,792	3,701
Net deferred tax asset	$	3,167	4,571

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1. Summary of Significant Accounting Policies (Details) (USD $)	12 Months Ended
	Dec. 31, 2012	Dec. 31, 2011	Dec. 31, 2010
Number of Options
Number of Options Outstanding, Beginning	79,017	150,071	169,462
Number of Options Granted	0	0	0
Number of Options Expired/Forfeited	(6,052)	(71,054)	(19,391)
Number of Options Exercised	(69,335)	0	0
Number of Options Outstanding, Ending	3,630	79,017	150,071
Exercisable, December 31, 2012	3,630
Weighted Average Exercise Price
Weighted Average Exercise Price Outstanding, Beginning	$ 7.97	$ 8.32	$ 8.17
Weighted Average Exercise Price Granted	$ 0	$ 0	$ 0
Weighted Average Exercise Price Expired/Forfeited	$ 8.89	$ 8.71	$ 6.99
Weighted Average Exercise Price Exercised	$ 7.77	$ 0	$ 0
Weighted Average Exercise Price Outstanding, Ending	$ 10.31	$ 7.97	$ 8.32
Weighted Average Exercise Price Exercisable, December 31, 2012	$ 10.31
Weighted Average Remaining Contractual Life (in years)
Weighted Average Remaining Contractual Term (in years) Outstanding	1 year 4 months 6 days
Weighted Average Remaining Contractual Term (in years) Exercisable, December 31, 2012	1 year 4 months 6 days

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3. Loans, TDR (Details 2) (USD $) In Thousands, except Share data, unless otherwise specified	Dec. 31, 2012	Dec. 31, 2011
TDR Loans
Number of Contracts	180	315
Pre-Modification Outstanding Recorded Investment	$ 28,908	$ 54,660
Post-Modification Outstanding Recorded Investment	23,937	44,133
Single-family residential TDR loans
TDR Loans
Number of Contracts	5
Pre-Modification Outstanding Recorded Investment	674
Post-Modification Outstanding Recorded Investment	673
Single-family residential- Banco de la Gente stated income
TDR Loans
Number of Contracts	20
Pre-Modification Outstanding Recorded Investment	2,046
Post-Modification Outstanding Recorded Investment	1,992
Total real estate TDR loans
TDR Loans
Number of Contracts	25
Pre-Modification Outstanding Recorded Investment	2,720
Post-Modification Outstanding Recorded Investment	2,665
TDR Commercial loans (not secured by real estate)
TDR Loans
Number of Contracts	1
Pre-Modification Outstanding Recorded Investment	14
Post-Modification Outstanding Recorded Investment	13
Total TDR Loans
TDR Loans
Number of Contracts	26
Pre-Modification Outstanding Recorded Investment	2,734
Post-Modification Outstanding Recorded Investment	$ 2,678

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12. Employee and Director Benefit Programs (Details 3) (USD $)	Dec. 31, 2012
Employee And Director Benefit Programs Details 3
2013	$ 130
2014	219
2015	250
2016	251
2017	283
Thereafter	$ 8,944

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Consolidated Balance Sheets (USD $) In Thousands, unless otherwise specified	Dec. 31, 2012	Dec. 31, 2011
Assets
Cash and due from banks, including reserve requirements of $9,625 and $8,492	$ 32,617	$ 22,532
Interest bearing deposits	16,226	6,704
Cash and cash equivalents	48,843	29,236
Investment securities available for sale	297,823	321,388
Other investments	5,599	5,712
Total securities	303,422	327,100
Mortgage loans held for sale	6,922	5,146
Loans	619,974	670,497
Less allowance for loan losses	(14,423)	(16,604)
Net loans	605,551	653,893
Premises and equipment, net	15,874	16,896
Cash surrender value of life insurance	13,273	12,835
Other real estate	6,254	7,576
Accrued interest receivable and other assets	13,377	14,381
Total assets	1,013,516	1,067,063
Deposits:
Non-interest bearing demand	161,582	136,878
NOW, MMDA & savings	371,719	366,133
Time, $100,000 or more	134,733	193,045
Other time	113,491	131,055
Total deposits	781,525	827,111
Securities sold under agreements to repurchase	34,578	39,600
FHLB borrowings	70,000	70,000
Junior subordinated debentures	20,619	20,619
Accrued interest payable and other liabilities	9,047	6,706
Total liabilities	915,769	964,036
Commitments
Shareholders' equity:
Series A preferred stock, $1,000 stated value; authorized 5,000,000 shares; issued and outstanding 12,524 shares in 2012 and 25,054 shares in 2011	12,524	24,758
Common stock, no par value; authorized 20,000,000 shares; issued and outstanding 5,613,495 shares in 2012 and 5,544,160 shares in 2011	48,133	48,298
Retained earnings	31,478	26,895
Accumulated other comprehensive income	5,612	3,076
Total shareholders' equity	97,747	103,027
Total liabilities and shareholders' equity	$ 1,013,516	$ 1,067,063

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3. Loans (Details) (USD $) In Thousands, unless otherwise specified	Dec. 31, 2012	Dec. 31, 2011	Dec. 31, 2010	Dec. 31, 2009
Major classifications
Total Loans	$ 619,974	$ 670,497
Less allowance for loan losses	14,423	16,604	15,493	15,413
Net loans	605,551	653,893
Construction and land development
Major classifications
Total Loans	73,176	93,812
Single-family residential
Major classifications
Total Loans	195,003	212,993
Single-family residential - Banco de la Gente stated income
Major classifications
Total Loans	52,019	54,058
Commercial Real Estate
Major classifications
Total Loans	200,633	214,415
Multifamily and Farmland
Major classifications
Total Loans	8,951	4,793
Total real estate loans
Major classifications
Total Loans	529,782	580,071
Commercial loans (not secured by real estate)
Major classifications
Total Loans	64,295	60,646
Farm loans (not secured by real estate)
Major classifications
Total Loans	11	0
Consumer loans (not secured by real estate)
Major classifications
Total Loans	10,148	10,490
All other loans (not secured by real estate)
Major classifications
Total Loans	$ 15,738	$ 19,290

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Consolidated Statements of Changes in Shareholders' Equity (USD $) In Thousands, except Share data	Preferred Stock	Common Stock	Retained Earnings	Accumulated Other Comprehensive Income	Total
Beginning Balance, Amount at Dec. 31, 2009	$ 24,476	$ 48,269	$ 23,573	$ 2,905	$ 99,223
Beginning Balance, Shares at Dec. 31, 2009	25,054	5,539,056
Accretion of Series A preferred stock	141		(141)		0
Cash dividends declared on Series A preferred stock			(1,253)		(1,253)
Cash dividends declared on common stock			(447)		(447)
Restricted stock payout, Shares		2,357
Restricted stock payout, Amount		12			12
Stock options exercised, Shares					0
Net earnings			1,841		1,841
Change in accumulated other comprehensive income, net of tax				(2,518)	(2,518)
Ending Balance, Amount at Dec. 31, 2010	24,617	48,281	23,573	387	96,858
Ending Balance, Shares at Dec. 31, 2010	25,054	5,541,413
Accretion of Series A preferred stock	141		(141)		0
Cash dividends declared on Series A preferred stock			(1,253)		(1,253)
Cash dividends declared on common stock			(443)		(443)
Restricted stock payout, Shares		2,747
Restricted stock payout, Amount		17			17
Stock options exercised, Shares					0
Net earnings			5,159		5,159
Change in accumulated other comprehensive income, net of tax				2,689	2,689
Ending Balance, Amount at Dec. 31, 2011	24,758	48,298	26,895	3,076	103,027
Ending Balance, Shares at Dec. 31, 2011	25,054	5,544,160
Accretion of Series A preferred stock	70		(70)		0
Preferred stock and warrant repurchase, Shares	(12,530)
Preferred stock and warrant repurchase, Amount	(12,304)	(704)	886		(12,122)
Cash dividends declared on Series A preferred stock			(1,023)		(1,023)
Cash dividends declared on common stock			(1,003)		(1,003)
Restricted stock payout, Amount					0
Stock options exercised, Shares		69,335			(69,335)
Stock options exercised, Amount		539			539
Net earnings			5,793		5,793
Change in accumulated other comprehensive income, net of tax				2,536	2,536
Ending Balance, Amount at Dec. 31, 2012	$ 12,524	$ 48,133	$ 31,478	$ 5,612	$ 97,747
Ending Balance, Shares at Dec. 31, 2012	12,524	5,613,495

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6. Federal Home Loan Bank and Federal Reserve Bank Borrowings (Details Narrative) (USD $) In Millions, unless otherwise specified	Dec. 31, 2012	Dec. 31, 2011
Federal Home Loan Bank And Federal Reserve Bank Borrowings Details Narrative
Loans pledged as collateral to the FHLB	$ 138.7
Market value of securities pledged to the FHLB	17.8
FLHB stock owned	4.7	4.9
Carrying values of loans pledged as collateral to the FHLB	$ 313.7

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11. Derivative Financial Instruments and Hedging Transactions (Tables)

12 Months Ended

Dec. 31, 2012

Notes to Financial Statements

Company’s derivative financial instruments

	Amount of Gain (Loss) Recognized in Accumulated OCI on Derivatives					Location of Gain (Loss) Reclassified from Accumulated OCI into Income	Amount of Gain (Loss) Reclassified from Accumulated OCI into Income
	Years ended December 31,						Years ended December 31,
	2012		2011				2012		2011
Interest rate derivative contracts	$	-	$	(20	)	Interest income	$	-	$	628

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10. Commitments and Contingencies (Details) (USD $) In Thousands, unless otherwise specified	Dec. 31, 2012
Commitments And Contingencies Details
2013	$ 542
2014	516
2015	482
2016	482
2017	428
Thereafter	1,667
Total minimum obligation	$ 4,117

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15. Other Operating Income and Expense

12 Months Ended

Dec. 31, 2012

Other Income and Expenses [Abstract]

Other Operating Income and Expense

(15) Other Operating Income and Expense

Other operating income for the years ended December 31, 2012, 2011 and 2010 included the following items that exceeded one percent of total revenues at some point during the following three-year period:

(Dollars in thousands)
	2012		2011		2010
Visa debit card income	$	2,092		1,783		1,570
Net appraisal management fee income	$	737		375		326

Other operating expense for the years ended December 31, 2012, 2011 and 2010 included the following items that exceeded one percent of total revenues at some point during the following three-year period:

(Dollars in thousands)
	2012		2011		2010
Advertising	$	695		660		714
FDIC insurance	$	894		1,061		1,434
Visa debit card expense	$	729		658		606
Telephone	$	554		605		629
Foreclosure/OREO expense	$	677		904		569
Internet banking expense	$	593		509		445

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12. Employee and Director Benefit Programs (Tables)

12 Months Ended

Dec. 31, 2012

Compensation and Retirement Disclosure [Abstract]

Accumulated benefit obligation for the Company’s two postretirement benefit plans

(Dollars in thousands)
	2012			2011
Benefit obligation at beginning of period	$	2,923			2,607
Service cost		430			303
Interest cost		89			64
Benefits paid		(60	)		(51	)
Benefit obligation at end of period	$	3,382			2,923

Amounts recognized in the Company’s Consolidated Balance Sheet

(Dollars in thousands)
	2012		2011
Benefit obligation	$	3,382		2,923
Fair value of plan assets		-		-

(Dollars in thousands)
	2012			2011
Funded status	$	(3,382	)		(2,923	)
Unrecognized prior service cost/benefit		-			-
Unrecognized net actuarial loss		-			-
Net amount recognized	$	(3,382	)		(2,923	)
Unfunded accrued liability	$	(3,382	)		(2,923	)
Intangible assets		-			-
Net amount recognized	$	(3,382	)		(2,923	)

Net periodic benefit cost of the Company’s post retirement benefit plans

(Dollars in thousands)
	2012			2011
Service cost	$	430			303
Interest cost		89			64
Net periodic cost	$	519			367
Weighted average discount rate assumption used to
determine benefit obligation		5.43	%		6.59	%

Expected benefit payments for the Company’s two postretirement benefit plans

(Dollars in thousands)
Year ending December 31,
2013	$	130
2014	$	219
2015	$	250
2016	$	251
2017	$	283
Thereafter	$	8,944

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

12 Months Ended

Dec. 31, 2012

Condensed Financial Information of Parent Company Only Disclosure [Abstract]

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

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

Assets	2012		2011
Cash	$	324		316
Interest-bearing time deposit		800		15,000
Investment in subsidiaries		115,386		106,469
Investment securities available for sale		1,596		1,520
Other assets		260		341
Total assets	$	118,366		123,646
Liabilities and Shareholders' Equity
Junior subordinated debentures	$	20,619		20,619
Shareholders' equity		97,747		103,027
Total liabilities and shareholders' equity	$	118,366		123,646

Revenues:	2012			2011			2010
Interest and dividend income	$	113			226			311
Impairment of securities		-			(144	)		(291	)
Total revenues		113			82			20
Expenses:
Interest		438			407			411
Other operating expenses		476			190			191
Total expenses		914			597			602
Loss before income tax benefit and equity in
undistributed earnings of subsidiaries		(801	)		(515	)		(582	)
Income tax benefit		166			56			24
Loss before equity in undistributed
earnings of subsidiaries		(635	)		(459	)		(558	)
Equity in undistributed earnings of subsidiaries		6,428			5,618			2,399
Net earnings	$	5,793			5,159			1,841

	2012			2011			2010
Cash flows from operating activities:
Net earnings	$	5,793			5,159			1,841
Adjustments to reconcile net earnings to net
cash used by operating activities:
Equity in undistributed earnings of subsidiaries		(6,428	)		(5,618	)		(2,399	)
Impairment of investment securities		-			144			291
Change in:
Other assets		-			112			(66	)
Accrued income		11			(11	)		-
Accrued expense		41			(216	)		147
Net cash used by operating activities		(583	)		(430	)		(186	)
Cash flows from investing activities:
Purchases of investment securities available for sale		-			-			(36,000	)
Proceeds from maturities of investment securities available for sale		-			-			36,000
Net change in interest-bearing time deposit		14,200			2,000			2,000
Net cash provided by investing activities		14,200			2,000			2,000
Cash flows from financing activities:
Cash dividends paid on Series A preferred stock		(1,023	)		(1,253	)		(1,253	)
Cash dividends paid on common stock		(1,003	)		(443	)		(448	)
Preferred stock and warrant repurchase		(12,122	)		-			-
Restricted stock payout		-			17			12
Proceeds from exercise of stock options		539			-			-
Net cash used by financing activities		(13,609	)		(1,679	)		(1,689	)
Net change in cash		8			(109	)		125
Cash at beginning of year		316			425			300
Cash at end of year	$	324			316			425
Noncash investing and financing activities:
Change in unrealized gain on investment securities
available for sale, net	$	(46	)		(3	)		(172	)

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11. Derivative Financial Instruments and Hedging Transactions (Details) (Interest rate derivative contracts (located in Interest income portion of OCI), USD $) In Thousands, unless otherwise specified	12 Months Ended
	Dec. 31, 2012	Dec. 31, 2011
Interest rate derivative contracts (located in Interest income portion of OCI)
Amount of Gain (Loss) Recognized in Accumulated OCI on Derivatives	$ 0	$ (20)
Amount of Gain (Loss) Reclassified from Accumulated OCI into Income	$ 0	$ 628

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Consolidated Statements of Cash Flows (USD $) In Thousands, unless otherwise specified	12 Months Ended
	Dec. 31, 2012	Dec. 31, 2011	Dec. 31, 2010
Cash flows from operating activities:
Net earnings	$ 5,793	$ 5,159	$ 1,841
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation, amortization and accretion	8,876	6,226	4,971
Provision for loan losses	4,924	12,632	16,438
Deferred income taxes	(213)	(678)	(523)
Gain on sale of investment securities	(1,218)	(4,406)	(3,348)
Write-down of investment securities	0	144	291
Loss/(Gain) on sale of other real estate	98	272	(191)
Write-down of other real estate	1,038	1,050	895
Restricted stock expense	0	7	10
Change in:
Mortgage loans held for sale	(1,776)	(1,332)	(974)
Cash surrender value of life insurance	(438)	(296)	(257)
Other assets	(399)	2,644	(2,316)
Other liabilities	2,342	930	961
Net cash provided (used by) operating activities	19,027	22,352	17,798
Cash flows from investing activities:
Net change in certificates of deposit	0	735	2,610
Purchases of investment securities available for sale	(88,304)	(208,863)	(232,915)
Proceeds from calls, maturities and paydowns of investment securities available for sale	63,225	54,041	86,935
Proceeds from sales of investment securities available for sale	47,076	110,978	65,774
Purchases of other investments	(493)	(215)	0
Proceeds from sale of other investments	606	290	585
Net change in loans	38,170	38,561	28,703
Purchases of premises and equipment	(917)	(1,601)	(1,441)
Purchases of bank owned life insurance	0	(5,000)	0
Proceeds from sale of other real estate and repossessions	5,434	3,355	5,725
Net cash provided (used) by investing activities	64,797	(7,719)	(44,024)
Cash flows from financing activities:
Net change in deposits	(45,586)	(11,601)	29,369
Net change in demand notes payable to U.S. Treasury	0	(1,600)	964
Net change in securities sold under agreement to repurchase	(5,022)	5,506	(2,782)
Proceeds from FHLB borrowings	25,400	40,000	0
Repayments of FHLB borrowings	(25,400)	(40,000)	(7,000)
Proceeds from FRB borrowings	2	1	0
Repayments of FRB borrowings	(2)	(1)	0
Preferred stock and warrant repurchase	(12,122)	0	0
Restricted stock payout	0	17	12
Stock options exercised	539	0	0
Cash dividends paid on Series A preferred stock	(1,023)	(1,253)	(1,253)
Cash dividends paid on common stock	(1,003)	(443)	(447)
Net cash (used) provided by financing activities	(64,217)	(9,374)	18,863
Net change in cash and cash equivalent	19,607	5,259	(7,363)
Cash and cash equivalents at beginning of period	29,236	23,977	31,340
Cash and cash equivalents at end of period	48,843	29,236	23,977
Cash paid during the year for:
Interest	7,838	10,900	14,419
Income taxes	2,013	283	1,700
Noncash investing and financing activities:
Change in unrealized gain on investment securities available for sale, net	2,536	(3,087)	1,838
Change in unrealized gain on derivative financial instruments, net	0	398	680
Transfer of loans to other real estate and repossessions	6,323	10,787	9,105
Financed portion of sale of other real estate	1,076	5,208	2,270
Accretion of Series A preferred stock	70	141	141
Discount on preferred stock	$ 835	$ 0	$ 0

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Consolidated Balance Sheets (Parenthetical) (USD $) In Thousands, except Share data, unless otherwise specified	Dec. 31, 2012	Dec. 31, 2011
Assets
Cash and due from banks, reserve requirements	$ 9,625	$ 8,492
Shareholders' equity:
Series A preferred stock, stated value (in dollars per share)	$ 1,000	$ 1,000
Series A preferred stock, shares authorized (in shares)	5,000,000	5,000,000
Series A preferred stock, shares issued (in shares)	12,524	25,054
Series A preferred stock, shares outstanding (in shares)	12,524	25,054
Common stock, par value (in dollars per share)	$ 0	$ 0
Common stock, shares authorized (in shares)	20,000,000	20,000,000
Common stock, shares issued (in shares)	5,613,495	5,544,160
Common stock, shares outstanding (in shares)	5,613,495	5,544,160

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10. Commitments and Contingencies

12 Months Ended

Dec. 31, 2012

Commitments and Contingencies Disclosure [Abstract]

10. Commitments and Contingencies

(10) Commitments and Contingencies

The Company leases various office spaces for banking and operational facilities and equipment under operating lease arrangements. Future minimum lease payments required for all operating leases having a remaining term in excess of one year at December 31, 2012 are as follows:

(Dollars in thousands)
Year ending December 31,
2013	$	542
2014		516
2015		482
2016		482
2017		428
Thereafter		1,667
Total minimum obligation	$	4,117

Total rent expense was approximately $643,000, $735,000 and $815,000 for the years ended December 31, 2012, 2011 and 2010, respectively.

The Bank is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments include commitments to extend credit, standby letters of credit and financial guarantees.  Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet.  The contract amounts of those instruments reflect the extent of involvement the Bank has in particular classes of financial instruments.

The exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit and financial guarantees written is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.

In most cases, the  Bank requires collateral or other security to support financial instruments with credit risk.

(Dollars in thousands)
	Contractual Amount
	2012		2011
Financial instruments whose contract amount represent credit risk:
Commitments to extend credit	$	133,919		131,565
Standby letters of credit and financial guarantees written	$	3,297		3,288

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates and because they may expire without being drawn upon, the total commitment amount of $137.2 million does not necessarily represent future cash requirements.

Standby letters of credit and financial guarantees written are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to businesses in the Bank’s delineated market area. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank holds real estate, equipment, automobiles and customer deposits as collateral supporting those commitments for which collateral is deemed necessary.

In the normal course of business, the Company is a party (both as plaintiff and defendant) to a number of lawsuits. In the opinion of management and counsel, none of these cases should have a material adverse effect on the financial position of the  Company.

Bancorp and the Bank have employment agreements with certain key employees. The agreements, among other things, include salary, bonus, incentive stock option, and change in control provisions.

The Company has $47.5 million available for the purchase of overnight federal funds from five correspondent financial institutions.

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Document and Entity Information (USD $)	12 Months Ended
	Dec. 31, 2012	Feb. 28, 2013	Jun. 30, 2012
Document And Entity Information
Entity Registrant Name	PEOPLES BANCORP OF NORTH CAROLINA INC
Entity Central Index Key	0001093672
Document Type	10-K
Document Period End Date	Dec. 31, 2012
Amendment Flag	false
Current Fiscal Year End Date	--12-31
Is Entity a Well-known Seasoned Issuer?	No
Is Entity a Voluntary Filer?	No
Is Entity's Reporting Status Current?	Yes
Entity Filer Category	Smaller Reporting Company
Entity Public Float			$ 34,030,624
Entity Common Stock, Shares Outstanding		5,613,495
Document Fiscal Period Focus	FY
Document Fiscal Year Focus	2012

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11. Derivative Financial Instruments and Hedging Transactions

12 Months Ended

Dec. 31, 2012

Notes to Financial Statements

11. Derivative Financial Instruments and Hedging Transactions

(11) Derivative Financial Instruments and Hedging Transactions

Risk Management Objective of Using Derivatives

The Company has an overall interest rate risk management strategy that incorporates the use of derivative instruments to minimize significant unplanned fluctuations in earnings that are caused by interest rate volatility.  By using derivative instruments, the Company is exposed to credit and market risk.  If the counterparty fails to perform, credit risk is equal to the extent of the fair-value gain in the derivative.  The Company minimizes the credit risk in derivative instruments by entering into transactions with high-quality counterparties that are reviewed periodically by the Company.  The Company had an interest rate swap contract that expired in June 2011.  The Company did not have any interest rate derivatives outstanding as of December 31, 2012.

Cash Flow Hedges of Interest Rate Risk

The Company’s objectives in using interest rate derivatives are to add stability to interest income and expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company primarily uses interest rate swaps and floors as part of its interest rate risk management strategy.  For hedges of the Company’s variable-rate loan assets, interest rate swaps designated as cash flow hedges involve the receipt of fixed-rate amounts from a counterparty in exchange for the Company making variable-rate payments over the life of the agreements without exchange of the underlying notional amount.  For hedges of the Company’s variable-rate loan assets, the interest rate floors designated as a cash flow hedge involves the receipt of variable-rate amounts from a counterparty if interest rates fall below the strike rate on the contract in exchange for an up front premium.  The Company had an interest rate swap contract that expired in June 2011.  The Company did not have any interest rate derivatives outstanding as of December 31, 2012.

The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in Accumulated Other Comprehensive Income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings.  During 2011 and 2010, such derivatives were used to hedge the variable cash inflows associated with existing pools of prime-based loan assets.  The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings.  The Company’s derivatives did not have any hedge ineffectiveness recognized in earnings during the years ended December 31, 2011 and 2010.

Effect of Derivative Instruments on the Statement of Earnings

The table below presents the effect of the Company’s derivative financial instruments on the Consolidated Statement of Earnings for the years ended December 31, 2012 and 2011.

	Amount of Gain (Loss) Recognized in Accumulated OCI on Derivatives					Location of Gain (Loss) Reclassified from Accumulated OCI into Income	Amount of Gain (Loss) Reclassified from Accumulated OCI into Income
	Years ended December 31,						Years ended December 31,
	2012		2011				2012		2011
Interest rate derivative contracts	$	-	$	(20	)	Interest income	$	-	$	628

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Consolidated Statements of Earnings (USD $) In Thousands, except Per Share data, unless otherwise specified	12 Months Ended
	Dec. 31, 2012	Dec. 31, 2011	Dec. 31, 2010
Interest income:
Interest and fees on loans	$ 32,758	$ 36,374	$ 40,204
Interest on due from banks	51	33	63
Interest on investment securities:
U.S. Government sponsored enterprises, including mortgage-backed securities	2,746	5,414	5,035
States and political subdivisions	3,403	3,180	2,173
Other	287	258	205
Total interest income	39,245	45,259	47,680
Interest expense:
NOW, MMDA & savings deposits	1,180	2,263	3,472
Time deposits	3,205	5,035	6,786
FHLB borrowings	2,744	2,956	3,285
Junior subordinated debentures	438	407	411
Other	129	285	394
Total interest expense	7,696	10,946	14,348
Net interest income	31,549	34,313	33,332
Provision for loan losses	4,924	12,632	16,438
Net interest income after provision for loan losses	26,625	21,681	16,894
Non-interest income:
Service charges	4,764	5,106	5,626
Other service charges and fees	1,940	2,090	2,195
Other than temporary impairment losses	0	(144)	(291)
Gain on sale of securities	1,218	4,406	3,348
Mortgage banking income	1,229	757	532
Insurance and brokerage commissions	517	471	390
Loss on sale and write-down of other real estate	(1,136)	(1,322)	(704)
Miscellaneous	4,005	3,149	2,788
Total non-interest income	12,537	14,513	13,884
Non-interest expense:
Salaries and employee benefits	16,426	14,766	14,124
Occupancy	5,236	5,339	5,436
Other	10,120	9,467	9,388
Total non-interest expense	31,782	29,572	28,948
Earnings before income taxes	7,380	6,622	1,830
Income tax expense (benefit)	1,587	1,463	(11)
Net earnings	5,793	5,159	1,841
Dividends and accretion on preferred stock	1,010	1,393	1,394
Net earnings available to common shareholders	$ 4,783	$ 3,766	$ 447
Basic and diluted net earnings per common share (in dollars per share)	$ 0.86	$ 0.68	$ 0.08
Cash dividends declared per common share (in dollars per share)	$ 0.18	$ 0.08	$ 0.08

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5. Time Deposits

12 Months Ended

Dec. 31, 2012

Banking and Thrift [Abstract]

Time Deposits

(5) Time Deposits

At December 31, 2012, the scheduled maturities of time deposits are as follows:

(Dollars in thousands)
2013	$	157,707
2014		33,579
2015		36,066
2016		10,269
2017 and thereafter		10,603
Total	$	248,224

At December 31, 2012 and 2011, the Company had approximately $21.4 million and $47.0 million, respectively, in time deposits purchased through third party brokers, including certificates of deposit participated through the Certificate of Deposit Account Registry Service (“CDARS”) on behalf of local customers.  CDARS balances totaled $20.1 million and $28.6 million as of December 31, 2012 and 2011, respectively.  The weighted average rate of brokered deposits as of December 31, 2012 and 2011 was 0.29% and 0.99%, respectively.

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4. Premises and Equipment

12 Months Ended

Dec. 31, 2012

Property, Plant and Equipment [Abstract]

4. Premises and Equipment

(4) Premises and Equipment

Major classifications of premises and equipment are summarized as follows:

(Dollars in thousands)
	2012		2011
Land	$	3,657		3,581
Buildings and improvements		14,815		14,771
Furniture and equipment		17,660		16,874
Total premises and equipment		36,132		35,226
Less accumulated depreciation		20,258		18,330
Total net premises and equipment	$	15,874		16,896

Depreciation expense was approximately $1.9 million for the year ended December 31, 2012.  The Company recognized approximately $2.0 and $2.1 million in depreciation expense for the years ended December 31, 2011 and 2010, respectively.

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16. Fair Value of Financial Instruments

12 Months Ended

Dec. 31, 2012

Fair Value Disclosures [Abstract]

Fair Value of Financial Instruments

(16) Fair Value of Financial Instruments

The Company is required to disclose fair value information about financial instruments, whether or not recognized on the face of the balance sheet, for which it is practicable to estimate that value. The assumptions used in the estimation of the fair value of the Company’s financial instruments are detailed below. Where quoted prices are not available, fair values are based on estimates using discounted cash flows and other valuation techniques. The use of discounted cash flows can be significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The following disclosures should not be considered a surrogate of the liquidation value of the Company, but rather a good faith estimate of the increase or decrease in the value of financial instruments held by the Company since purchase, origination, or issuance.

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.

Cash and Cash Equivalents

For cash, due from banks and interest-bearing deposits, the carrying amount is a reasonable estimate of fair value.

Investment Securities Available for Sale

Fair values of investment securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges when available. If quoted prices are not available, fair value is determined using matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities.  Fair values for investment securities with quoted market prices are reported in the Level 1 fair value category. Fair value measurements obtained from independent pricing services are reported in the Level 2 fair value category. All other fair value measurements are reported in the Level 3 fair value category.

Other Investments

For other investments, the carrying value is a reasonable estimate of fair value.

Mortgage Loans Held for Sale

Mortgage loans held for sale are carried at lower of aggregate cost or market value.  The cost of mortgage loans held for sale approximates the market value.  Mortgage loans held for sale are reported  in the Level 3 fair value category.

Loans

The fair value of fixed rate loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings. For variable rate loans, the carrying amount is a reasonable estimate of fair value.  Impaired loans with current certified appraisals are included in the Level 2 fair value category.  All other loans are included in the Level 3 fair value category, as the pricing of loans is more subjective than the pricing of other financial instruments.

Cash Surrender Value of Life Insurance

For cash surrender value of life insurance, the carrying value is a reasonable estimate of fair value.

Other Real Estate

The fair value of other real estate is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral.  Other real estate is reported in the Level 3 fair value category.

Deposits

The fair value of demand deposits, interest-bearing demand deposits and savings is the amount payable on demand at the reporting date. The fair value of certificates of deposit is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities.

Securities Sold Under Agreements to Repurchase

For securities sold under agreements to repurchase, the carrying value is a reasonable estimate of fair value.

FHLB Borrowings

The fair value of FHLB borrowings is estimated based upon discounted future cash flows using a discount rate comparable to the current market rate for such borrowings.

Junior Subordinated Debentures

Because the Company’s junior subordinated debentures were issued at a floating rate, the carrying amount is a reasonable estimate of fair value.

Commitments to Extend Credit and Standby Letters of Credit

Commitments to extend credit and standby letters of credit are generally short-term and at variable interest rates. Therefore, both the carrying value and estimated fair value associated with these instruments are immaterial.

Limitations

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on many judgments. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets and liabilities that are not considered financial instruments include deferred income taxes and premises and equipment. In addition, the tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.

The carrying amount and estimated fair value of the Company’s financial instruments at December 31, 2012 and 2011 are as follows:

(Dollars in thousands)
			Fair Value Measurements at December 31, 2012
	Carrying Amount		Level 1		Level 2		Level 3		Total
Assets:
Cash and cash equivalents	$	48,843		48,843		-		-		48,843
Investment securities available for sale		297,823		1,468		295,105		1,250		297,823
Other investments		5,599		-		-		5,599		5,599
Mortgage loans held for sale		6,922		-		-		6,922		6,922
Loans, net		605,551		-		-		599,996		599,996
Cash surrender value of life insurance		13,273		-		13,273		-		13,273
Liabilities:
Deposits	$	781,525		-		780,662		-		780,662
Securities sold under agreements
to repurchase		34,578		-		34,578		-		34,578
FHLB borrowings		70,000		-		76,375		-		76,375
Junior subordinated debentures		20,619		-		20,619		-		20,619

(Dollars in thousands)
	December 31, 2011
	Carrying Amount		Estimated Fair Value
Assets:
Cash and cash equivalents	$	29,236		29,236
Investment securities available for sale		321,388		321,388
Other investments		5,712		5,712
Mortgage loans held for sale		5,146		5,146
Loans, net		653,893		648,640
Cash surrender value of life insurance		12,835		12,835
Liabilities:
Deposits and demand notes payable	$	827,111		826,810
Securities sold under agreements
to repurchase		39,600		39,600
FHLB borrowings		70,000		75,046
Junior subordinated debentures		20,619		20,619

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12. Employee and Director Benefit Programs

12 Months Ended

Dec. 31, 2012

Compensation and Retirement Disclosure [Abstract]

Employee and Director Benefit Programs

(12) Employee and Director Benefit Programs

The Company has a profit sharing and 401(k) plan for the benefit of substantially all employees subject to certain minimum age and service requirements. Under the 401(k) plan, the Company matched employee contributions to a maximum of 3.50% of annual compensation in 2012 and 2.50% of annual compensation in 2011 and 2010.  The Company’s contribution pursuant to this formula was approximately $345,000, $219,000 and $208,000 for the years 2012, 2011 and 2010, respectively.  Investments of the 401(k) plan are determined by the compensation committee consisting of selected outside directors and senior executive officers.  No investments in Company stock have been made by the 401(k) plan. The vesting schedule for the 401(k) plan begins at 20 percent after two years of employment and graduates 20 percent each year until reaching 100 percent after six years of employment.

In December 2001, the Company initiated a postretirement benefit plan to provide retirement benefits to key officers and its Board of Directors and to provide death benefits for their designated beneficiaries.  Under the postretirement benefit plan, the Company purchased life insurance contracts on the lives of the key officers and each director.  The increase in cash surrender value of the contracts constitutes the Company’s contribution to the postretirement benefit plan each year.  Postretirement benefit plan participants are to be paid annual benefits for a specified number of years commencing upon retirement. Expenses incurred for benefits relating to the postretirement benefit plan were approximately $546,000, $355,000 and $279,000 for the years 2012, 2011 and 2010, respectively.

The Company is currently paying medical benefits for certain retired employees. Postretirement medical benefits expense, including amortization of the transition obligation, as applicable, was approximately $24,000 for the year ended December 31, 2012 and approximately $23,000 for each of the years ended December 31, 2011 and 2010.

The following table sets forth the change in the accumulated benefit obligation for the Company’s two postretirement benefit plans described above:

(Dollars in thousands)
	2012			2011
Benefit obligation at beginning of period	$	2,923			2,607
Service cost		430			303
Interest cost		89			64
Benefits paid		(60	)		(51	)
Benefit obligation at end of period	$	3,382			2,923

The amounts recognized in the Company’s Consolidated Balance Sheet as of December 31, 2012 and 2011 are shown in the following two tables:

(Dollars in thousands)
	2012		2011
Benefit obligation	$	3,382		2,923
Fair value of plan assets		-		-

(Dollars in thousands)
	2012			2011
Funded status	$	(3,382	)		(2,923	)
Unrecognized prior service cost/benefit		-			-
Unrecognized net actuarial loss		-			-
Net amount recognized	$	(3,382	)		(2,923	)
Unfunded accrued liability	$	(3,382	)		(2,923	)
Intangible assets		-			-
Net amount recognized	$	(3,382	)		(2,923	)

Net periodic benefit cost of the Company’s post retirement benefit plans for the years ended December 31, 2012 and 2011 consisted of the following:

(Dollars in thousands)
	2012			2011
Service cost	$	430			303
Interest cost		89			64
Net periodic cost	$	519			367
Weighted average discount rate assumption used to
determine benefit obligation		5.43	%		6.59	%

During the year ended December 31, 2012, the Company paid benefits under the two postretirement plans totaling $60,000.  Information about the expected benefit payments for the Company’s two postretirement benefit plans is as follows:

(Dollars in thousands)
Year ending December 31,
2013	$	130
2014	$	219
2015	$	250
2016	$	251
2017	$	283
Thereafter	$	8,944

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8. Income Taxes

12 Months Ended

Dec. 31, 2012

Income Tax Disclosure [Abstract]

8. Income Taxes

(8) Income Taxes

The provision for income taxes in summarized as follows:

(Dollars in thousands)
	2012			2011			2010
Current	$	1,800			2,141			512
Deferred		(213	)		(678	)		(523	)
Total	$	1,587			1,463			(11	)

The differences between the provision for income taxes and the amount computed by applying the statutory federal income tax rate to earnings before income taxes are as follows:

(Dollars in thousands)
	2012			2011			2010
Pre-tax income at statutory rate (34%)	$	2,509			2,251			622
Differences:
Tax exempt interest income		(1,168	)		(1,052	)		(721	)
Nondeductible interest and other expense		52			62			58
Cash surrender value of life insurance		(149	)		(101	)		(87	)
State taxes, net of federal benefits		324			233			(8	)
Nondeductible capital losses		-			49			99
Other, net		19			21			26
Total	$	1,587			1,463			(11	)

The following summarizes the tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities.  The net deferred tax asset is included as a component of other assets at December 31, 2012 and 2011.

Deferred tax assets:
Allowance for loan losses	$	5,560	6,401
Accrued retirement expense		1,409	1,213
Other real estate		628	454
Other		362	204
Total gross deferred tax assets		7,959	8,272
Deferred tax liabilities:
Deferred loan fees		794	1,082
Premises and equipment		417	655
Unrealized gain on available for sale securities		3,581	1,964
Total gross deferred tax liabilities		4,792	3,701
Net deferred tax asset	$	3,167	4,571

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8. Income Taxes (Details) (USD $) In Thousands, unless otherwise specified	12 Months Ended
	Dec. 31, 2012	Dec. 31, 2011	Dec. 31, 2010
Income Taxes Details
Current	$ 1,800	$ 2,141	$ 512
Deferred	(213)	(678)	(523)
Total	$ 1,587	$ 1,463	$ (11)

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6. Federal Home Loan Bank and Federal Reserve Bank Borrowings

12 Months Ended

Dec. 31, 2012

Banking and Thrift [Abstract]

6. Federal Home Loan Bank and Federal Reserve Bank Borrowings

(6) Federal Home Loan Bank and Federal Reserve Bank Borrowings

The Bank has borrowings from the FHLB with monthly or quarterly interest payments at December 31, 2012.  The FHLB borrowings are collateralized by a blanket assignment on all residential first mortgage loans, home equity lines of credit and loans secured by multi-family real estate that the Bank owns.  At December 31, 2012, the carrying value of loans pledged as collateral totaled approximately $138.7 million.  As additional collateral, the Bank has pledged securities to the FHLB.  At December 31, 2012, the market value of securities pledged to the FHLB totaled $17.8 million.

Borrowings from the FHLB outstanding at December 31, 2012 consist of the following:

(Dollars in thousands)
Maturity Date	Call Date		Rate			Rate Type	Amount
June 24, 2015		N/A		3.710	%	Convertible	$	5,000
March 25, 2019		N/A		4.260	%	Convertible		5,000
October 5, 2016		N/A		4.450	%	Convertible		5,000
November 12, 2014		N/A		2.230	%	Fixed Rate Hybrid		5,000
November 13, 2017		N/A		4.260	%	Fixed Rate Hybrid		15,000
October 17, 2016		N/A		3.820	%	Adjustable Rate Hybrid		5,000
October 17, 2018		N/A		3.500	%	Adjustable Rate Hybrid		5,000
October 17, 2018		N/A		3.740	%	Adjustable Rate Hybrid		15,000
October 17, 2018		N/A		3.515	%	Adjustable Rate Hybrid		5,000
October 17, 2018		N/A		3.570	%	Adjustable Rate Hybrid		5,000
							$	70,000

The Bank is required to purchase and hold certain amounts of FHLB stock in order to obtain FHLB borrowings. No ready market exists for the FHLB stock, and it has no quoted market value. The stock is redeemable at $100 per share subject to certain limitations set by the FHLB. The Bank owned $4.7 million and $4.9 million of FHLB stock at December 31, 2012 and 2011, respectively.

As of December 31, 2012 and 2011, the Bank had no borrowings from the Federal Reserve Bank (“FRB”).  FRB borrowings are collateralized by a blanket assignment on all qualifying loans that the Bank owns which are not pledged to the FHLB.  At December 31, 2012, the carrying value of loans pledged as collateral totaled approximately $313.7 million.

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7. Junior Subordinated Debentures

12 Months Ended

Dec. 31, 2012

Debt Disclosure [Abstract]

7. Junior Subordinated Debentures

(7) Junior Subordinated Debentures

In June 2006, the Company formed a second wholly-owned Delaware statutory trust, PEBK Capital Trust II (“PEBK Trust II”), which issued $20.0 million of guaranteed preferred beneficial interests in the Company’s junior subordinated deferrable interest debentures.  All of the common securities of PEBK Trust II are owned by the Company.  The proceeds from the issuance of the common securities and the trust preferred securities were used by PEBK Trust II to purchase $20.6 million of junior subordinated debentures of the Company.  The proceeds received by the Company from the sale of the junior subordinated debentures were used to repay in December 2006 the trust preferred securities issued in December 2001 by PEBK Capital Trust, a wholly-owned Delaware statutory trust of the Company, and for general purposes.  The debentures represent the sole assets of PEBK Trust II.  PEBK Trust II is not included in the consolidated financial statements.

The trust preferred securities issued by PEBK Trust II accrue and pay interest quarterly at a floating rate of three-month LIBOR plus 163 basis points.  The Company has guaranteed distributions and other payments due on the trust preferred securities to the extent PEBK Trust II has funds with which to make the distributions and other payments.  The net combined effect of all the documents entered into in connection with the trust preferred securities is that the Company is liable to make the distributions and other payments required on the trust preferred securities.

These trust preferred securities are mandatorily redeemable upon maturity of the debentures on June 28, 2036, or upon earlier redemption as provided in the indenture.  The Company has the right to redeem the debentures purchased by PEBK Trust II, in whole or in part, which became effective on June 28, 2011.  As specified in the indenture, if the debentures are redeemed prior to maturity, the redemption price will be the principal amount plus any accrued but unpaid interest.

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9. Related Party Transactions

12 Months Ended

Dec. 31, 2012

Related Party Transactions [Abstract]

Related Party Transactions

(9)  Related Party Transactions

The Company conducts transactions with its directors and executive officers, including companies in which they have beneficial interests, in the normal course of business. It is the policy of the  Bank that loan transactions with directors and officers are made on substantially the same terms as those prevailing at the time made for comparable loans to other persons. The following is a summary of activity for related party loans for 2012:

(Dollars in thousands)
Beginning balance	$	6,123
New loans		4,520
Repayments		(5,258	)
Ending balance	$	5,385

At December 31, 2012 and 2011, the Bank had deposit relationships with related parties of approximately $13.9 million and $15.1 million, respectively.

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9. Related Party Transactions (Details Narrative) (USD $) In Millions, unless otherwise specified	Dec. 31, 2012	Dec. 31, 2011
Related Party Transactions Details Narrative
Related party deposits	$ 13.9	$ 15.1

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10. Commitments and Contingencies (Details 1) (USD $) In Thousands, unless otherwise specified	Dec. 31, 2012	Dec. 31, 2011
Commitments and contingencies
Commitments to extend credit
Commitments and contingencies	133,919	131,565
Standby letters of credit and financial guarantees written
Commitments and contingencies	$ 3,297	$ 3,288

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9. Related Party Transactions (Details) (USD $) In Thousands, unless otherwise specified	12 Months Ended
	Dec. 31, 2012
Related Party Transactions Details
Beginning balance	$ 6,123
New loans	4,520
Repayments	(5,258)
Ending balance	$ 5,385

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10. Commitments and Contingencies (Tables)

12 Months Ended

Dec. 31, 2012

Commitments and Contingencies Disclosure [Abstract]

Future minimum lease payments required for all operating leases

(Dollars in thousands)
Year ending December 31,
2013	$	542
2014		516
2015		482
2016		482
2017		428
Thereafter		1,667
Total minimum obligation	$	4,117

Required collateral or other security to support financial instruments with credit risk

(Dollars in thousands)
	Contractual Amount
	2012		2011
Financial instruments whose contract amount represent credit risk:
Commitments to extend credit	$	133,919		131,565
Standby letters of credit and financial guarantees written	$	3,297		3,288

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3. Loans, Credit Risk (Details) (USD $) In Thousands, unless otherwise specified	Dec. 31, 2012	Dec. 31, 2011
Credit risk profile
Total Loans	$ 619,974	$ 670,497
Construction and land development
Credit risk profile
Total Loans	73,176	93,812
Single-family residential
Credit risk profile
Total Loans	195,003	212,993
Single-family residential - Banco de la Gente stated income
Credit risk profile
Total Loans	52,019	54,058
Commercial Real Estate
Credit risk profile
Total Loans	200,633	214,415
Multifamily and Farmland
Credit risk profile
Total Loans	8,951	4,793
Commercial loans (not secured by real estate)
Credit risk profile
Total Loans	64,295	60,646
Farm loans (not secured by real estate)
Credit risk profile
Total Loans	11	0
Consumer loans (not secured by real estate)
Credit risk profile
Total Loans	10,148	10,490
All other loans (not secured by real estate)
Credit risk profile
Total Loans	15,738	19,290
Construction and land development
Credit risk profile
Total Loans	73,176	93,812
Construction and land development | 1- Excellent Quality
Credit risk profile
Total Loans	11	197
Construction and land development | 2- High Quality
Credit risk profile
Total Loans	4,947	5,183
Construction and land development | 3- Good Quality
Credit risk profile
Total Loans	24,952	27,675
Construction and land development | 4- Management Attention
Credit risk profile
Total Loans	18,891	28,138
Construction and land development | 5- Watch
Credit risk profile
Total Loans	9,580	15,923
Construction and land development | 6- Substandard
Credit risk profile
Total Loans	14,795	16,696
Construction and land development | 7- Low Substandard
Credit risk profile
Total Loans	0	0
Construction and land development | 8- Doubtful
Credit risk profile
Total Loans	0	0
Construction and land development | 9- Loss
Credit risk profile
Total Loans	0	0
Single-family residential
Credit risk profile
Total Loans	195,003	212,993
Single-family residential | 1- Excellent Quality
Credit risk profile
Total Loans	24,662	25,474
Single-family residential | 2- High Quality
Credit risk profile
Total Loans	56,829	64,817
Single-family residential | 3- Good Quality
Credit risk profile
Total Loans	62,018	74,824
Single-family residential | 4- Management Attention
Credit risk profile
Total Loans	35,727	35,233
Single-family residential | 5- Watch
Credit risk profile
Total Loans	9,504	6,141
Single-family residential | 6- Substandard
Credit risk profile
Total Loans	6,263	6,504
Single-family residential | 7- Low Substandard
Credit risk profile
Total Loans	0	0
Single-family residential | 8- Doubtful
Credit risk profile
Total Loans	0	0
Single-family residential | 9- Loss
Credit risk profile
Total Loans	0	0
Single-family residential - Banco de la Gente stated income
Credit risk profile
Total Loans	52,019	54,058
Single-family residential - Banco de la Gente stated income | 1- Excellent Quality
Credit risk profile
Total Loans	0	0
Single-family residential - Banco de la Gente stated income | 2- High Quality
Credit risk profile
Total Loans	0	0
Single-family residential - Banco de la Gente stated income | 3- Good Quality
Credit risk profile
Total Loans	24,724	25,564
Single-family residential - Banco de la Gente stated income | 4- Management Attention
Credit risk profile
Total Loans	11,366	15,020
Single-family residential - Banco de la Gente stated income | 5- Watch
Credit risk profile
Total Loans	3,597	5,626
Single-family residential - Banco de la Gente stated income | 6- Substandard
Credit risk profile
Total Loans	12,332	7,848
Single-family residential - Banco de la Gente stated income | 7- Low Substandard
Credit risk profile
Total Loans	0	0
Single-family residential - Banco de la Gente stated income | 8- Doubtful
Credit risk profile
Total Loans	0	0
Single-family residential - Banco de la Gente stated income | 9- Loss
Credit risk profile
Total Loans	0	0
Commercial Real Estate
Credit risk profile
Total Loans	200,633	214,415
Commercial Real Estate | 1- Excellent Quality
Credit risk profile
Total Loans	0	0
Commercial Real Estate | 2- High Quality
Credit risk profile
Total Loans	27,511	25,506
Commercial Real Estate | 3- Good Quality
Credit risk profile
Total Loans	114,001	136,137
Commercial Real Estate | 4- Management Attention
Credit risk profile
Total Loans	47,603	40,312
Commercial Real Estate | 5- Watch
Credit risk profile
Total Loans	6,911	2,795
Commercial Real Estate | 6- Substandard
Credit risk profile
Total Loans	4,607	9,665
Commercial Real Estate | 7- Low Substandard
Credit risk profile
Total Loans	0	0
Commercial Real Estate | 8- Doubtful
Credit risk profile
Total Loans	0	0
Commercial Real Estate | 9- Loss
Credit risk profile
Total Loans	0	0
Multifamily and Farmland
Credit risk profile
Total Loans	8,951	4,793
Multifamily and Farmland | 1- Excellent Quality
Credit risk profile
Total Loans	0	0
Multifamily and Farmland | 2- High Quality
Credit risk profile
Total Loans	32	50
Multifamily and Farmland | 3- Good Quality
Credit risk profile
Total Loans	4,975	3,448
Multifamily and Farmland | 4- Management Attention
Credit risk profile
Total Loans	3,039	358
Multifamily and Farmland | 5- Watch
Credit risk profile
Total Loans	712	728
Multifamily and Farmland | 6- Substandard
Credit risk profile
Total Loans	193	209
Multifamily and Farmland | 7- Low Substandard
Credit risk profile
Total Loans	0	0
Multifamily and Farmland | 8- Doubtful
Credit risk profile
Total Loans	0	0
Multifamily and Farmland | 9- Loss
Credit risk profile
Total Loans	0	0
Commercial loans (not secured by real estate)
Credit risk profile
Total Loans	64,295	60,646
Commercial loans (not secured by real estate) | 1- Excellent Quality
Credit risk profile
Total Loans	672	715
Commercial loans (not secured by real estate) | 2- High Quality
Credit risk profile
Total Loans	9,260	8,801
Commercial loans (not secured by real estate) | 3- Good Quality
Credit risk profile
Total Loans	40,814	36,585
Commercial loans (not secured by real estate) | 4- Management Attention
Credit risk profile
Total Loans	11,844	12,882
Commercial loans (not secured by real estate) | 5- Watch
Credit risk profile
Total Loans	976	622
Commercial loans (not secured by real estate) | 6- Substandard
Credit risk profile
Total Loans	729	1,041
Commercial loans (not secured by real estate) | 7- Low Substandard
Credit risk profile
Total Loans	0	0
Commercial loans (not secured by real estate) | 8- Doubtful
Credit risk profile
Total Loans	0	0
Commercial loans (not secured by real estate) | 9- Loss
Credit risk profile
Total Loans	0	0
Farm loans (not secured by real estate)
Credit risk profile
Total Loans	11
Farm loans (not secured by real estate) | 1- Excellent Quality
Credit risk profile
Total Loans	0
Farm loans (not secured by real estate) | 2- High Quality
Credit risk profile
Total Loans	0
Farm loans (not secured by real estate) | 3- Good Quality
Credit risk profile
Total Loans	11
Farm loans (not secured by real estate) | 4- Management Attention
Credit risk profile
Total Loans	0
Farm loans (not secured by real estate) | 5- Watch
Credit risk profile
Total Loans	0
Farm loans (not secured by real estate) | 6- Substandard
Credit risk profile
Total Loans	0
Farm loans (not secured by real estate) | 7- Low Substandard
Credit risk profile
Total Loans	0
Farm loans (not secured by real estate) | 8- Doubtful
Credit risk profile
Total Loans	0
Farm loans (not secured by real estate) | 9- Loss
Credit risk profile
Total Loans	0
Consumer loans (not secured by real estate) | 1- Excellent Quality
Credit risk profile
Total Loans	1,239	1,344
Consumer loans (not secured by real estate) | 2- High Quality
Credit risk profile
Total Loans	4,122	4,070
Consumer loans (not secured by real estate) | 3- Good Quality
Credit risk profile
Total Loans	4,186	4,259
Consumer loans (not secured by real estate) | 4- Management Attention
Credit risk profile
Total Loans	392	429
Consumer loans (not secured by real estate) | 5- Watch
Credit risk profile
Total Loans	134	89
Consumer loans (not secured by real estate) | 6- Substandard
Credit risk profile
Total Loans	70	154
Consumer loans (not secured by real estate) | 7- Low Substandard
Credit risk profile
Total Loans	0	0
Consumer loans (not secured by real estate) | 8- Doubtful
Credit risk profile
Total Loans	0	0
Consumer loans (not secured by real estate) | 9- Loss
Credit risk profile
Total Loans	5	145
All other loans (not secured by real estate) | 1- Excellent Quality
Credit risk profile
Total Loans	0	0
All other loans (not secured by real estate) | 2- High Quality
Credit risk profile
Total Loans	2,317	2,774
All other loans (not secured by real estate) | 3- Good Quality
Credit risk profile
Total Loans	13,416	16,509
All other loans (not secured by real estate) | 4- Management Attention
Credit risk profile
Total Loans	5	7
All other loans (not secured by real estate) | 5- Watch
Credit risk profile
Total Loans	0	0
All other loans (not secured by real estate) | 6- Substandard
Credit risk profile
Total Loans	0	0
All other loans (not secured by real estate) | 7- Low Substandard
Credit risk profile
Total Loans	0	0
All other loans (not secured by real estate) | 8- Doubtful
Credit risk profile
Total Loans	0	0
All other loans (not secured by real estate) | 9- Loss
Credit risk profile
Total Loans	$ 0	$ 0

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14. Shareholders’ Equity

12 Months Ended

Dec. 31, 2012

Equity [Abstract]

Shareholders’ Equity

(14) Shareholders’ Equity

Shareholders’ equity at December 31, 2012 was $97.7 million compared to $103.0 million at December 31, 2011. This decrease was primarily attributable to the Company’s repurchase and retirement of a portion of its preferred shares.  The Company purchased 12,530 shares of the Company’s 25,054 outstanding shares of preferred stock from the UST, which was issued to the UST in connection with the Company’s participation in the CPP under TARP in 2008.  The shares were purchased for $933.36 per share, for a total purchase price of $11,778,576, including $83,575 accrued and unpaid dividends on the preferred stock.  The Company retired the 12,530 shares purchased.  The $834,999 difference between the $12,530,000 face value of the preferred stock retired and the $11,695,001 purchase price of the preferred stock retired was credited to retained earnings effective June 30, 2012.  Remaining preferred shares are redeemable at any time at par.  The Company expects to be able to repurchase the shares from future earnings, however, there are no immediate plans to repurchase these shares.

During the third quarter of 2012, the Company completed its repurchase of the Warrant to purchase 357,234 shares of the Company's common stock that was issued to the UST on December 23, 2008 as part of the CPP under TARP.  The Company repurchased the Warrant for a total price of $425,000.

Common stock at December 31, 2012 was $48.1 million compared to $48.3 million at December 31, 2011.  This decrease is due to the Company’s repurchase of the Warrant associated with the preferred stock that was issued to the UST, which was partially offset by stock options exercised during 2012.

The Board of Directors, at its discretion, can issue shares of preferred stock up to a maximum of 5,000,000 shares. The Board of Directors is authorized to determine the number of shares, voting powers, designations, preferences, limitations and relative rights.

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1. Summary of Significant Accounting Policies (Tables)

12 Months Ended

Dec. 31, 2012

Accounting Policies [Abstract]

Summary of the stock option activity

Stock Option Activity
For the Years Ended December 31, 2012, 2011 and 2010
	Shares			Weighted Average Option Price Per Share		Weighted Average Remaining Contractual Term (in years)
Outstanding, December 31, 2009		169,462		$	8.17
Granted during the period		-		$	-
Expired during the period		(19,391	)	$	6.99
Exercised during the period		-		$	-
Outstanding, December 31, 2010		150,071		$	8.32
Granted during the period		-		$	-
Expired during the period		(71,054	)	$	8.71
Exercised during the period		-		$	-
Outstanding, December 31, 2011		79,017		$	7.97
Granted during the period		-		$	-
Expired during the period		-		$	-
Forfeited during the period		(6,052	)	$	8.89
Exercised during the period		(69,335	)	$	7.77
Outstanding, December 31, 2012		3,630		$	10.31	1.35
Exercisable, December 31, 2012		3,630		$	10.31	1.35

Reconciliations of the amounts used in the computation of both “basic earnings per common share” and “diluted earnings per common share

For the year ended December 31, 2012:	Net Earnings Available to Common Shareholders (Dollars in thousands)		Common Shares		Per Share Amount
Basic earnings per common share	$	4,783		5,559,401	$	0.86
Effect of dilutive securities:
Stock options		-		3,206
Diluted earnings per common share	$	4,783		5,562,607	$	0.86

For the year ended December 31, 2011:	Net Earnings Available to Common Shareholders (Dollars in thousands)		Common Shares		Per Share Amount
Basic earnings per common share	$	3,766		5,542,548	$	0.68
Effect of dilutive securities:
Stock options		-		1,301
Diluted earnings per common share	$	3,766		5,543,849	$	0.68

For the year ended December 31, 2010:	Net Earnings Available to Common Shareholders (Dollars in thousands)		Common Shares		Per Share Amount
Basic earnings per common share	$	447		5,539,308	$	0.08
Effect of dilutive securities:
Stock options		-		4,107
Diluted earnings per common share	$	447		5,543,415	$	0.08

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3. Loans, Impaired (Details 2) (USD $) In Thousands, unless otherwise specified	Dec. 31, 2012	Dec. 31, 2011
Impaired loans	$ 46,738	$ 49,901
Other real estate	6,254	7,576
Level 1
Impaired loans	0	0
Other real estate	0	0
Level 2
Impaired loans	0	0
Other real estate	0	0
Level 3
Impaired loans	46,738	49,901
Other real estate	6,254	7,576
Total gains losses for the year ended
Impaired loans	(7,986)	(11,864)
Other real estate	$ (1,136)	$ (1,322)

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1. Summary of Significant Accounting Policies (Details 1) (USD $) In Thousands, except Share data, unless otherwise specified	12 Months Ended
	Dec. 31, 2012	Dec. 31, 2011	Dec. 31, 2010
Net Earnings Available to Common Shareholders
Basic earnings per common share	$ 4,783	$ 3,766	$ 447
Effect of dilutive securities, Stock options	0	0	0
Diluted earnings per common share	$ 4,783	$ 3,766	$ 447
Common Shares
Basic earnings per common share (in shares)	5,559,401	5,542,548	5,539,308
Effect of dilutive securities, Stock options (in shares)	3,206	1,301	4,107
Diluted earnings per common share (in shares)	5,562,607	5,543,849	5,543,415
Per Share Amount
Basic earnings per common share (in dollars per share)	$ 0.86	$ 0.68	$ 0.08
Diluted earnings per common share (in dollars per share)	$ 0.86	$ 0.68	$ 0.08

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Consolidated Statements of Comprehensive Income (Loss) (USD $) In Thousands, unless otherwise specified	12 Months Ended
	Dec. 31, 2012	Dec. 31, 2011	Dec. 31, 2010
Consolidated Statements Of Comprehensive Income Loss
Net earnings	$ 5,793	$ 5,159	$ 1,841
Other comprehensive income (loss):
Unrealized holding gains on securities available for sale	5,371	9,316	46
Reclassification adjustment for other than temporary impairment losses included in net earnings	0	144	291
Reclassification adjustment for gains on securities available for sale included in net earnings	(1,218)	(4,406)	(3,348)
Unrealized holding losses on derivative financial instruments qualifying as cash flow hedges	0	(648)	(1,114)
Total other comprehensive income (loss), before income taxes	4,153	4,406	(4,125)
Income tax expense (benefit) related to other comprehensive income (loss):
Unrealized holding gains on securities available for sale	2,091	3,629	18
Reclassification adjustment for gains on securities available for sale included in net earnings	(474)	(1,660)	(1,191)
Unrealized holding losses on derivative financial instruments qualifying as cash flow hedges	0	(252)	(434)
Total income tax expense (benefit) related to other comprehensive income (loss)	1,617	1,717	(1,607)
Total other comprehensive income (loss), net of tax	2,536	2,689	(2,518)
Total comprehensive income (loss)	$ 8,329	$ 7,848	$ (677)

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3. Loans

12 Months Ended

Dec. 31, 2012

Receivables [Abstract]

Loans

(3) Loans

Major classifications of loans at December 31, 2012 and 2011 are summarized as follows:

(Dollars in thousands)
	December 31, 2012		December 31, 2011
Real estate loans
Construction and land development	$	73,176		93,812
Single-family residential		195,003		212,993
Single-family residential -
Banco de la Gente stated income		52,019		54,058
Commercial		200,633		214,415
Multifamily and farmland		8,951		4,793
Total real estate loans		529,782		580,071
Commercial loans (not secured by real estate)		64,295		60,646
Farm loans (not secured by real estate)		11		-
Consumer loans (not secured by real estate)		10,148		10,490
All other loans (not secured by real estate)		15,738		19,290
Total loans		619,974		670,497
Less allowance for loan losses		14,423		16,604
Total net loans	$	605,551		653,893

The Bank grants loans and extensions of credit primarily within the Catawba Valley region of North Carolina, which encompasses Catawba, Alexander, Iredell and Lincoln counties and also in Mecklenburg, Union and Wake counties of North Carolina.  Although the Bank has a diversified loan portfolio, a substantial portion of the loan portfolio is collateralized by improved and unimproved real estate, the value of which is dependent upon the real estate market.  Risk characteristics of the major components of the Bank’s loan portfolio are discussed below:

·   Construction and land development loans – The risk of loss is largely dependent on the initial estimate of whether the property’s value at completion equals or exceeds the cost of property construction and the availability of take-out financing.  During the construction phase, a number of factors can result in delays or cost overruns.  If the estimate is inaccurate or if actual construction costs exceed estimates, the value of the property securing our loan may be insufficient to ensure full repayment when completed through a permanent loan, sale of the property, or by seizure of collateral. As of December 31, 2012, construction and land development loans comprised approximately 12% of the Bank’s total loan portfolio.

·   Single-family residential loans – Declining home sales volumes, decreased real estate values and higher than normal levels of unemployment could contribute to losses on these loans.  As of December 31, 2012, single-family residential loans comprised approximately 40% of the Bank’s total loan portfolio, including Banco de la Gente single-family residential stated income loans amounting to approximately 8% of the Bank’s total loan portfolio.

·   Commercial real estate loans – Repayment is dependent on income being generated in amounts sufficient to cover operating expenses and debt service.  These loans also involve greater risk because they are generally not fully amortizing over a loan period, but rather have a balloon payment due at maturity.  A borrower’s ability to make a balloon payment typically will depend on being able to either refinance the loan or timely sell the underlying property.  As of December 31, 2012, commercial real estate loans comprised approximately 32% of the Bank’s total loan portfolio.

·   Commercial loans – Repayment is generally dependent upon the successful operation of the borrower’s business.   In addition, the collateral securing the loans may depreciate over time, be difficult to appraise, be illiquid, or fluctuate in value based on the success of the business.  As of December 31, 2012, commercial loans comprised approximately 10% of the Bank’s total loan portfolio.

Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

The following tables present an age analysis of past due loans, by loan type, as of December 31, 2012 and 2011:

December 31, 2012
(Dollars in thousands)
	Loans 30-89 Days Past Due		Loans 90 or More Days Past Due		Total Past Due Loans		Total Current Loans		Total Loans		Accruing Loans 90 or More Days Past Due
Real estate loans
Construction and land development	$	1,280		6,858		8,138		65,038		73,176		-
Single-family residential		4,316		1,548		5,864		189,139		195,003		-
Single-family residential -
Banco de la Gente stated income		11,077		3,659		14,736		37,283		52,019		2,378
Commercial		1,720		1,170		2,890		197,743		200,633		-
Multifamily and farmland		7		-		7		8,944		8,951		-
Total real estate loans		18,400		13,235		31,635		498,147		529,782		2,378
Commercial loans (not secured by real estate)		888		66		954		63,341		64,295		23
Farm loans (not secured by real estate)		-		-		-		11		11		-
Consumer loans (not secured by real estate)		250		10		260		9,888		10,148		2
All other loans (not secured by real estate)		-		-		-		15,738		15,738		-
Total loans	$	19,538		13,311		32,849		587,125		619,974		2,403

December 31, 2011
(Dollars in thousands)
	Loans 30-89 Days Past Due		Loans 90 or More Days Past Due		Total Past Due Loans		Total Current Loans		Total Loans		Accruing Loans 90 or More Days Past Due
Real estate loans
Construction and land development	$	10,033		3,338		13,371		80,441		93,812		-
Single-family residential		4,612		1,434		6,046		206,947		212,993		107
Single-family residential -
Banco de la Gente stated income		11,924		4,755		16,679		37,379		54,058		2,602
Commercial		1,002		958		1,960		212,455		214,415		-
Multifamily and farmland		13		-		13		4,780		4,793		-
Total real estate loans		27,584		10,485		38,069		542,002		580,071		2,709
Commercial loans (not secured by real estate)		576		9		585		60,061		60,646		-
Consumer loans (not secured by real estate)		116		36		152		10,338		10,490		-
All other loans (not secured by real estate)		-		-		-		19,290		19,290		-
Total loans	$	28,276		10,530		38,806		631,691		670,497		2,709

The following tables present the Bank’s non-accrual loans as of December 31, 2012 and 2011:

(Dollars in thousands)
	December 31, 2012		December 31, 2011
Real estate loans
Construction and land development	$	9,253		13,257
Single-family residential		2,491		2,380
Single-family residential -
Banco de la Gente stated income		2,232		3,142
Commercial		3,263		2,451
Total real estate loans		17,239		21,230
Commercial loans (not secured by real estate)		344		403
Consumer loans (not secured by real estate)		47		152
Total	$	17,630		21,785

At each reporting period, the Bank determines which loans are impaired.  Accordingly, the Bank’s impaired loans are reported at their estimated fair value on a non-recurring basis.  An allowance for each impaired loan that is collateral-dependent is calculated based on the fair value of its collateral.  The fair value of the collateral is based on appraisals performed by REAS, a subsidiary of the Bank.  REAS is staffed by certified appraisers that also perform appraisals for other companies.  Factors including the assumptions and techniques utilized by the appraiser are considered by management.  If the recorded investment in the impaired loan exceeds the measure of fair value of the collateral, a valuation allowance is recorded as a component of the allowance for loan losses.  An allowance for each impaired loan that is non-collateral dependent is calculated based on the present value of projected cash flows.  If the recorded investment in the impaired loan exceeds the present value of projected cash flows, a valuation allowance is recorded as a component of the allowance for loan losses.  Impaired loans under $250,000 are not individually evaluated for impairment, with the exception of the Bank’s troubled debt restructured (“TDR”) loans in the residential mortgage loan portfolio, which are individually evaluated for impairment.  Accruing impaired loans were $30.6 million at December 31, 2012 and 2011.  Interest income recognized on accruing impaired loans was $1.5 million and $1.7 million for the years ended December 31, 2012 and 2011, respectively.  No interest income is recognized on non-accrual impaired loans subsequent to their classification as non-accrual.

The following tables present the Bank’s impaired loans as of December 31, 2012 and 2011:

December 31, 2012
(Dollars in thousands)
	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Recorded Investment in Impaired Loans		Related Allowance		Average Outstanding Impaired Loans
Real estate loans
Construction and land development	$	17,738		11,795		680		12,475		61		12,810
Single-family residential		9,099		766		7,799		8,565		177		7,590
Single-family residential -
Banco de la Gente stated income		21,806		-		21,000		21,000		1,278		21,158
Commercial		5,830		4,569		467		5,036		6		5,433
Multifamily and farmland		193		-		193		193		1		200
Total impaired real estate loans		54,666		17,130		30,139		47,269		1,523		47,191
Commercial loans (not secured by real estate)		983		347		592		939		12		1,125
Consumer loans (not secured by real estate)		68		-		66		66		1		41
Total impaired loans	$	55,717		17,477		30,797		48,274		1,536		48,357

December 31, 2011
(Dollars in thousands)
	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Recorded Investment in Impaired Loans		Related Allowance		Average Outstanding Impaired Loans
Real estate loans
Construction and land development	$	28,721		14,484		6,098		20,582		3,264		17,848
Single-family residential		6,361		969		5,117		6,086		131		6,324
Single-family residential -
Banco de la Gente stated income		20,021		-		19,602		19,602		1,296		18,778
Commercial		7,717		3,845		3,139		6,984		77		4,518
Multifamily and farmland		209		-		209		209		1		214
Total impaired real estate loans		63,029		19,298		34,165		53,463		4,769		47,682
Commercial loans (not secured by real estate)		1,111		-		1,083		1,083		26		1,485
Consumer loans (not secured by real estate)		157		-		152		152		2		140
Total impaired loans	$	64,297		19,298		35,400		54,698		4,797		49,307

The Bank’s December 31, 2012 and 2011 fair value measurements for impaired loans and other real estate on a non-recurring basis are presented below.  The fair value measurement process uses certified appraisals and other market-based information; however, in many cases, it also requires significant input based on management’s knowledge of and judgment about current market conditions, specific issues relating to the collateral, and other matters.  As a result, all fair value measurements for impaired loans and other real estate are considered Level 3.

(Dollars in thousands)
	Fair Value Measurements December 31, 2012		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation		Total Gains/(Losses) for the Year Ended December 31, 2012
Impaired loans	$	46,738		-		-		46,738		(7,986	)
Other real estate	$	6,254		-		-		6,254		(1,136	)

(Dollars in thousands)
	Fair Value Measurements December 31, 2011		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation		Total Gains/(Losses) for the Year Ended December 31, 2011
Impaired loans	$	49,901		-		-		49,901		(11,864	)
Other real estate	$	7,576		-		-		7,576		(1,322	)

Changes in the allowance for loan losses for the year ended December 31, 2012 were as follows:

Year ended December 31, 2012
(Dollars in thousands)
	Real Estate Loans
	Construction and Land Development			Single-Family Residential			Single-Family Residential - Banco de la Gente Stated Income			Commercial			Multifamily and Farmland		Commercial			Farm		Consumer and All Other			Unallocated		Total
Allowance for loan losses:
Beginning balance	$	7,182			3,253			2,104			1,731			13		1,029			-		255			1,037		16,604
Charge-offs		(4,728	)		(886	)		(668	)		(937	)		-		(555	)		-		(557	)		-		(8,331	)
Recoveries		528			72			-			374			-		104			-		148			-		1,226
Provision		1,417			792			562			881			15		510			-		399			348		4,924
Ending balance	$	4,399			3,231			1,998			2,049			28		1,088			-		245			1,385		14,423
Ending balance: individually
evaluated for impairment	$	24			84			1,254			-			-		-			-		-			-		1,362
Ending balance: collectively
evaluated for impairment		4,375			3,147			744			2,049			28		1,088			-		245			1,385		13,061
Ending balance	$	4,399			3,231			1,998			2,049			28		1,088			-		245			1,385		14,423
Loans:
Ending balance	$	73,176			195,003			52,019			200,633			8,951		64,295			11		25,886			-		619,974
Ending balance: individually
evaluated for impairment	$	11,961			3,885			20,024			4,569			-		346			-		-			-		40,785
Ending balance: collectively
evaluated for impairment	$	61,215			191,118			31,995			196,064			8,951		63,949			11		25,886			-		579,189

Changes in the allowance for loan losses for the year ended December 31, 2011 were as follows:

Year ended December 31, 2011
(Dollars in thousands)
	Real Estate Loans
	Construction and Land Development			Single-Family Residential			Single-Family Residential - Banco de la Gente Stated Income			Commercial			Multifamily and Farmland			Commercial			Consumer and All Other			Unallocated		Total
Allowance for loan losses:
Beginning balance	$	5,774			3,992			2,105			1,409			17			1,174			430			592		15,493
Charge-offs		(7,164	)		(2,233	)		(692	)		(1,271	)		-			(314	)		(586	)		-		(12,260	)
Recoveries		241			184			17			24			-			121			152			-		739
Provision		8,331			1,310			674			1,569			(4	)		48			259			445		12,632
Ending balance	$	7,182			3,253			2,104			1,731			13			1,029			255			1,037		16,604
Ending balance: individually
evaluated for impairment	$	1,250			46			1,243			-			-			-			-			-		2,539
Ending balance: collectively
evaluated for impairment		5,932			3,207			861			1,731			13			1,029			255			1,037		14,065
Ending balance	$	7,182			3,253			2,104			1,731			13			1,029			255			1,037		16,604
Loans:
Ending balance	$	93,812			212,993			54,058			214,415			4,793			60,646			29,780			-		670,497
Ending balance: individually
evaluated for impairment	$	20,280			2,352			18,309			3,845			-			-			-			-		44,786
Ending balance: collectively
evaluated for impairment	$	73,532			210,641			35,749			210,570			4,793			60,646			29,780			-		625,711

 Changes in the allowance for loan losses for the year ended December 31, 2010 were as follows:

(Dollars in thousands)
	2010
Balance at beginning of year	$	15,413
Amounts charged off		(16,911	)
Recoveries on amounts previously charged off		553
Provision for loan losses		16,438
Balance at end of year	$	15,493

The Bank utilizes an internal risk grading matrix to assign a risk grade to each of its loans.  Loans are graded on a scale of 1 to 9.  These risk grades are evaluated on an ongoing basis.  A description of the general characteristics of the nine risk grades is as follows:

·   Risk Grade 1 – Excellent Quality: Loans are well above average quality and a minimal amount of credit risk exists.  CD or cash secured loans or properly margined actively traded stock or bond secured loans would fall in this grade.

·   Risk Grade 2 – High Quality: Loans are of good quality with risk levels well within the Company’s range of acceptability.  The organization or individual is established with a history of successful performance though somewhat susceptible to economic changes.

·   Risk Grade 3 – Good Quality: Loans of average quality with risk levels within the Company’s range of acceptability but higher than normal. This may be a new organization or an existing organization in a transitional phase (e.g. expansion, acquisition, market change).

·   Risk Grade 4 – Management Attention: These loans have higher risk and servicing needs but still are acceptable. Evidence of marginal performance or deteriorating trends is observed.  These are not problem credits presently, but may be in the future if the borrower is unable to change its present course.

·   Risk Grade 5 – Watch: These loans are currently performing satisfactorily, but there has been some recent past due history on repayment and there are potential weaknesses that may, if not corrected, weaken the asset or inadequately protect the Company’s position at some future date.

·   Risk Grade 6 – Substandard: A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the obligor or the collateral pledged (if there is any).  There is a well-defined weakness or weaknesses that jeopardize the liquidation of the debt.  There is a distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

·   Risk Grade 7 – Low Substandard: These loans have the general characteristics of a Grade 6 Substandard loan, with heightened potential concerns.  The exact amount of loss is not yet known because neither the liquidation value of the collateral nor the borrower’s predicted repayment ability is known with confidence.

·   Risk Grade 8 – Doubtful: Loans classified as Doubtful have all the weaknesses inherent in loans classified Substandard, plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values highly questionable and improbable.  Doubtful is a temporary grade where a loss is expected but is presently not quantified with any degree of accuracy. Once the loss position is determined, the amount is charged off.

·   Risk Grade 9 – Loss: Loans classified as Loss are considered uncollectable and of such little value that their continuance as bankable assets is not warranted.  This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this worthless loan even though partial recovery may be realized in the future.  Loss is a temporary grade until the appropriate authority is obtained to charge the loan off.

The following tables present the credit risk profile of each loan type based on internally assigned risk grade as of December 31, 2012 and 2011.

December 31, 2012
(Dollars in thousands)
	Real Estate Loans
	Construction and Land Development		Single-Family Residential		Single-Family Residential - Banco de la Gente Stated Income		Commercial		Multifamily and Farmland		Commercial		Farm		Consumer		All Other		Total
1- Excellent Quality	$	11		24,662		-		-		-		672		-		1,239		-		26,584
2- High Quality		4,947		56,829		-		27,511		32		9,260		-		4,122		2,317		105,018
3- Good Quality		24,952		62,018		24,724		114,001		4,975		40,814		11		4,186		13,416		289,097
4- Management Attention		18,891		35,727		11,366		47,603		3,039		11,844		-		392		5		128,867
5- Watch		9,580		9,504		3,597		6,911		712		976		-		134		-		31,414
6- Substandard		14,795		6,263		12,332		4,607		193		729		-		70		-		38,989
7- Low Substandard		-		-		-		-		-		-		-		-		-		-
8- Doubtful		-		-		-		-		-		-		-		-		-		-
9- Loss		-		-		-		-		-		-		-		5		-		5
Total	$	73,176		195,003		52,019		200,633		8,951		64,295		11		10,148		15,738		619,974

December 31, 2011
(Dollars in thousands)
	Real Estate Loans
	Construction and Land Development		Single-Family Residential		Single-Family Residential - Banco de la Gente Stated Income		Commercial		Multifamily and Farmland		Commercial		Consumer		All Other		Total
1- Excellent Quality	$	197		25,474		-		-		-		715		1,344		-		27,730
2- High Quality		5,183		64,817		-		25,506		50		8,801		4,070		2,774		111,201
3- Good Quality		27,675		74,824		25,564		136,137		3,448		36,585		4,259		16,509		325,001
4- Management Attention		28,138		35,233		15,020		40,312		358		12,882		429		7		132,379
5- Watch		15,923		6,141		5,626		2,795		728		622		89		-		31,924
6- Substandard		16,696		6,504		7,848		9,665		209		1,041		154		-		42,117
7- Low Substandard		-		-		-		-		-		-		-		-		-
8- Doubtful		-		-		-		-		-		-		-		-		-
9- Loss		-		-		-		-		-		-		145		-		145
Total	$	93,812		212,993		54,058		214,415		4,793		60,646		10,490		19,290		670,497

At December 31, 2012, TDR loans amounted to $23.9 million, including $2.0 million in performing TDR loans. Effective March 31, 2012, performing TDR balances reflect current year TDR loans only, in accordance with GAAP.  Previously reported TDR amounts reflect cumulative TDR loans from prior periods in addition to current year TDR loans.  At December 31, 2011, TDR loans were $44.1 million, including $15.1 million in performing TDR loans.   The terms of these loans have been renegotiated to provide a reduction in principal or interest as a result of the deteriorating financial position of the borrower.

The following table presents an analysis of TDR loans by loan type as of December 31, 2012.

December 31, 2012
(Dollars in thousands)
	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Real estate loans
Construction and land development		11	$	10,465		6,633
Single-family residential		33		3,014		4,084
Single-family residential -
Banco de la Gente stated income		122		13,459		12,170
Commercial		4		1,457		682
Total real estate TDR loans		170		28,395		23,569
Commercial loans (not secured by real estate)		9		511		368
Consumer loans (not secured by real estate)		1		2		-
Total TDR loans		180	$	28,908		23,937

The following table presents an analysis of 2012 loan modifications included in the December 31, 2012 TDR table above.

December 31, 2012
(Dollars in thousands)
	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Real estate loans
Single-family residential		5	$	674		673
Single-family residential -
Banco de la Gente stated income		20		2,046		1,992
Total real estate TDR loans		25		2,720		2,665
Commercial loans (not secured by real estate)		1		14		13
Total TDR loans		26	$	2,734		2,678

The following table presents an analysis of TDR loans by loan type as of December 31, 2011.

December 31, 2011
(Dollars in thousands)
	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Real estate loans
Construction and land development		29	$	19,762		12,840
Single-family residential		48		4,684		5,244
Single-family residential -
Banco de la Gente stated income		193		20,857		19,602
Commercial		15		7,200		5,013
Multifamily and farmland		1		322		209
Total real estate TDR loans		286		52,825		42,908
Commercial loans (not secured by real estate)		21		1,711		1,083
Consumer loans (not secured by real estate)		8		124		142
Total TDR loans		315	$	54,660		44,133

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5. Time Deposits (Details Narrative) (USD $) In Millions, unless otherwise specified	Dec. 31, 2012	Dec. 31, 2011
Time Deposits Details Narrative
Time deposits purchased through third party brokers, including certificates of deposit participated through the Certificate of Deposit Account Registry Service ("CDARS") on behalf of local customers	$ 21.4	$ 47.0
CDARS balances	$ 20.1	$ 28.6
Weighted average rate of brokered deposits	0.29%	0.99%

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12. Employee and Director Benefit Programs (Details) (USD $) In Thousands, unless otherwise specified	12 Months Ended
	Dec. 31, 2012	Dec. 31, 2011
Employee And Director Benefit Programs Details
Benefit obligation at beginning of period	$ 2,923	$ 2,607
Service cost	430	303
Interest cost	89	64
Benefits paid	(60)	(51)
Benefit obligation at end of period	$ 3,382	$ 2,923

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2. Investment Securities (Tables)

12 Months Ended

Dec. 31, 2012

Investment Securities Tables

Investment securities available for sale

(Dollars in thousands)
	December 31, 2012
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
Mortgage-backed securities	$	146,755		1,875		606		148,024
U.S. Government
sponsored enterprises		18,714		203		80		18,837
State and political subdivisions		118,591		7,171		104		125,658
Corporate bonds		2,571		19		4		2,586
Trust preferred securities		1,250		-		-		1,250
Equity securities		748		720		-		1,468
Total	$	288,629		9,988		794		297,823

(Dollars in thousands)
	December 31, 2011
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
Mortgage-backed securities	$	213,378		1,371		1,056		213,693
U.S. Government
sponsored enterprises		7,429		265		-		7,694
State and political subdivisions		92,996		4,157		56		97,097
Corporate bonds		546		-		3		543
Trust preferred securities		1,250		-		-		1,250
Equity securities		748		363		-		1,111
Total	$	316,347		6,156		1,115		321,388

Current fair value and associated unrealized losses on investments in securities with unrealized losses

(Dollars in thousands)
	December 31, 2012
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair  Value		Unrealized Losses		Fair  Value		Unrealized Losses
Mortgage-backed securities		48,126		468		12,913		138		61,039		606
U.S. Government
sponsored enterprises		3,402		80		-		-		3,402		80
State and political subdivisions		9,490		104		-		-		9,490		104
Corporate bonds		1,035		4		-		-		1,035		4
Total		62,053		656		12,913		138		74,966		794

(Dollars in thousands)
	December 31, 2011
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Mortgage-backed securities	$	95,122		991		4,125		65		99,247		1,056
State and political subdivisions		4,444		56		-		-		4,444		56
Corporate bonds		542		3		-		-		542		3
Total	$	100,108		1,050		4,125		65		104,233		1,115

Amortized cost and fair value of investment securities by contractual maturity

(Dollars in thousands)
	Amortized Cost		Estimated Fair Value
Due within one year	$	4,139		4,163
Due from one to five years		14,285		14,768
Due from five to ten years		100,595		106,246
Due after ten years		22,107		23,154
Mortgage-backed securities		146,755		148,024
Equity securities		748		1,468
Total	$	288,629		297,823

Available for sale securities measured at fair value on a recurring basis

(Dollars in thousands)
	December 31, 2012
	Fair Value Measurements		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
Mortgage-backed securities	$	148,024		-		148,024		-
U.S. Government
sponsored enterprises	$	18,837		-		18,837		-
State and political subdivisions	$	125,658		-		125,658		-
Corporate bonds	$	2,586		-		2,586		-
Trust preferred securities	$	1,250		-		-		1,250
Equity securities	$	1,468		1,468		-		-

(Dollars in thousands)
	December 31, 2011
	Fair Value Measurements		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
Mortgage-backed securities	$	213,693		-		208,349		5,344
U.S. Government
sponsored enterprises	$	7,694		-		7,694		-
State and political subdivisions	$	97,097		-		97,097		-
Corporate bonds	$	543		-		543		-
Trust preferred securities	$	1,250		-		-		1,250
Equity securities	$	1,111		1,111		-		-

(Dollars in thousands)
	Investment Securities Available for Sale
	Level 3 Valuation
Balance, beginning of period	$	6,594
Change in book value		-
Change in gain/(loss) realized and unrealized		-
Purchases/(sales)		-
Transfers in and/or (out) of Level 3		(5,344	)
Balance, end of period	$	1,250
Change in unrealized gain/(loss) for assets still held in Level 3	$	-

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13. Regulatory Matters (Details) (USD $)	Dec. 31, 2012	Dec. 31, 2011
Total capital (to Risk-Weighted Assets) | Consolidated
Actual, amount	$ 121,246	$ 129,495
Actual, ratio	17.34%	17.38%
For Capital Adequacy Purposes, amount	55,928	59,607
For Capital Adequacy Purposes, ratio	8.00%	8.00%
To Be Well Capitalized Under Prompt Corrective Action Provisions, amount
To Be Well Capitalized Under Prompt Corrective Action Provisions, ratio
Total capital (to Risk-Weighted Assets) | Bank
Actual, amount	117,453	111,807
Actual, ratio	16.84%	15.04%
For Capital Adequacy Purposes, amount	55,784	59,463
For Capital Adequacy Purposes, ratio	8.00%	8.00%
To Be Well Capitalized Under Prompt Corrective Action Provisions, amount	69,730	74,329
To Be Well Capitalized Under Prompt Corrective Action Provisions, ratio	10.00%	10.00%
Tier 1 Capital (to Risk- Weighted Assets) | Consolidated
Actual, amount	112,135	119,950
Actual, ratio	16.04%	16.10%
For Capital Adequacy Purposes, amount	27,964	29,804
For Capital Adequacy Purposes, ratio	4.00%	4.00%
To Be Well Capitalized Under Prompt Corrective Action Provisions, amount
To Be Well Capitalized Under Prompt Corrective Action Provisions, ratio
Tier 1 Capital (to Risk- Weighted Assets) | Bank
Actual, amount	108,379	102,264
Actual, ratio	15.54%	13.76%
For Capital Adequacy Purposes, amount	27,892	29,731
For Capital Adequacy Purposes, ratio	4.00%	4.00%
To Be Well Capitalized Under Prompt Corrective Action Provisions, amount	41,838	44,597
To Be Well Capitalized Under Prompt Corrective Action Provisions, ratio	6.00%	6.00%
Tier 1 Capital (Average Assets) | Consolidated
Actual, amount	112,135	119,950
Actual, ratio	11.12%	11.06%
For Capital Adequacy Purposes, amount	40,342	43,379
For Capital Adequacy Purposes, ratio	4.00%	4.00%
To Be Well Capitalized Under Prompt Corrective Action Provisions, amount
To Be Well Capitalized Under Prompt Corrective Action Provisions, ratio
Tier 1 Capital (Average Assets) | Bank
Actual, amount	108,379	102,264
Actual, ratio	10.76%	9.44%
For Capital Adequacy Purposes, amount	40,302	43,328
For Capital Adequacy Purposes, ratio	4.00%	4.00%
To Be Well Capitalized Under Prompt Corrective Action Provisions, amount	$ 50,377	$ 54,160
To Be Well Capitalized Under Prompt Corrective Action Provisions, ratio	5.00%	5.00%

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15. Other Operating Income and Expense (Tables)

12 Months Ended

Dec. 31, 2012

Other Income and Expenses [Abstract]

Other operating income/expense that exceeded one percent of total revenues

(Dollars in thousands)
	2012		2011		2010
Visa debit card income	$	2,092		1,783		1,570
Net appraisal management fee income	$	737		375		326

Other operating expense for the years ended December 31, 2012, 2011 and 2010 included the following items that exceeded one percent of total revenues at some point during the following three-year period:

(Dollars in thousands)
	2012		2011		2010
Advertising	$	695		660		714
FDIC insurance	$	894		1,061		1,434
Visa debit card expense	$	729		658		606
Telephone	$	554		605		629
Foreclosure/OREO expense	$	677		904		569
Internet banking expense	$	593		509		445

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13. Regulatory Matters

12 Months Ended

Dec. 31, 2012

Banking and Thrift [Abstract]

Regulatory Matters

(13) Regulatory Matters

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

Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios of capital in relation to both on- and off-balance sheet items at various risk weights. Total capital consists of two tiers of capital. Tier 1 Capital includes common shareholders’ equity and trust preferred securities less adjustments for intangible assets. Tier 2 Capital consists of the allowance for loan losses, up to 1.25% of risk-weighted assets and other adjustments.  Management believes, as of December 31, 2012, that the Company and the Bank meet all capital adequacy requirements to which they are subject.

As of December 31, 2012, the most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the table below. There have been no conditions or events since that notification that management believes have changed the Bank’s category.

The Company’s and the Bank’s actual capital amounts and ratios are presented below:

(Dollars in thousands)
	Actual					For Capital Adequacy Purposes					To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of December 31, 2012:
Total Capital (to Risk-Weighted Assets)
Consolidated	$	121,246		17.34	%		55,928		8.00	%		N/A		N/A
Bank	$	117,453		16.84	%		55,784		8.00	%		69,730		10.00	%
Tier 1 Capital (to Risk-Weighted Assets)
Consolidated	$	112,135		16.04	%		27,964		4.00	%		N/A		N/A
Bank	$	108,379		15.54	%		27,892		4.00	%		41,838		6.00	%
Tier 1 Capital (to Average Assets)
Consolidated	$	112,135		11.12	%		40,342		4.00	%		N/A		N/A
Bank	$	108,379		10.76	%		40,302		4.00	%		50,377		5.00	%
As of December 31, 2011:
Total Capital (to Risk-Weighted Assets)
Consolidated	$	129,495		17.38	%		59,607		8.00	%		N/A		N/A
Bank	$	111,807		15.04	%		59,463		8.00	%		74,329		10.00	%
Tier 1 Capital (to Risk-Weighted Assets)
Consolidated	$	119,950		16.10	%		29,804		4.00	%		N/A		N/A
Bank	$	102,264		13.76	%		29,731		4.00	%		44,597		6.00	%
Tier 1 Capital (to Average Assets)
Consolidated	$	119,950		11.06	%		43,379		4.00	%		N/A		N/A
Bank	$	102,264		9.44	%		43,328		4.00	%		54,160		5.00	%