8-K/A

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 8-K/A

CURRENT REPORT

Pursuant to Section 13 or 15(d) of the

Securities Exchange Act of 1934

Date of Report: July 1, 2011

(Date of earliest event reported)

AMERICAN NATIONAL BANKSHARES INC.

(Exact name of registrant as specified in its charter)

Virginia	0-12820	54-1284688
(State or other jurisdiction of incorporation)	(Commission File Number)	(IRS Employer Identification No.)

628 Main Street

Danville, Virginia 24541

(Address of principal executive offices, including Zip Code)

Registrant’s telephone number, including area code: (434) 792-5111

Not Applicable

(Former name or former address, if changed since last report)

Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions (see General Instruction A.2. below):

¨ Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425)

¨ Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12)

¨ Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b))

¨ Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c))

On July 5, 2011, American National Bankshares Inc. (“American”) filed a Form 8-K reporting the completion of its acquisition of MidCarolina Financial Corporation (“MidCarolina”) on July 1, 2011. In that filing, American indicated that it would amend the Form 8-K at a later date to include the financial information required by Item 9.01. This amendment to American’s July 5, 2011 Form 8-K is being filed to provide such financial information, which is attached to this report as Exhibits 99.1, 99.2 and 99.3.

Item 9.01 Financial Statements and Exhibits.

(a)     Financial statements of businesses acquired.

(i) The audited consolidated statements of financial condition of MidCarolina as of December 31, 2010 and 2009, and the related consolidated statements of operations, comprehensive income, changes in shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2010, and the related notes and report of independent auditors thereto, are attached hereto as Exhibit 99.1 and incorporated by reference herein (collectively, the “MidCarolina Audited Information”).

(ii) The unaudited consolidated balance sheet of MidCarolina as of March 31, 2011, the unaudited consolidated statements of operations for the three months ended March 31, 2011 and 2010, the unaudited consolidated statements of comprehensive income (loss) for the three months ended March 31, 2011 and 2010, the unaudited consolidated statement of shareholders’ equity for the three months ended March 31, 2011 and the unaudited consolidated statements of cash flows for the three months ended March 31, 2011 and 2010, and the related notes thereto, are attached hereto as Exhibit 99.2 and incorporated by reference herein (collectively, the “MidCarolina Unaudited Information”).

(b)     Pro forma financial information.

American and MidCarolina unaudited pro forma condensed combined balance sheet as of March 31, 2011, and the unaudited pro forma condensed combined statements of income for the three months ended March 31, 2011 and for the year ended December 31, 2010, and the related notes to the unaudited pro forma condensed combined financial information, are attached hereto as Exhibit 99.3 and incorporated by reference herein (collectively, the “American-MidCarolina Pro Forma Financial Information”).

(d)     Exhibits.

The following exhibits are filed herewith:

Exhibit No.	Description of Exhibit
23.1	Consent of Dixon Hughes Goodman, LLP.
99.1	MidCarolina Audited Information.
99.2	MidCarolina Unaudited Information.
99.3	American-MidCarolina Pro Forma Financial Information.

2

SIGNATURES

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

AMERICAN NATIONAL BANKSHARES INC.
By:	/s/ William W. Traynham
	William W. Traynham
	Senior Vice President and
	Chief Financial Officer

Date: August 1, 2011

3

EXHIBIT INDEX

Exhibit No.	Description of Exhibit
23.1	Consent of Dixon Hughes Goodman, LLP.
99.1	MidCarolina Audited Information.
99.2	MidCarolina Unaudited Information.
99.3	American-MidCarolina Pro Forma Financial Information.

EX-23.1

Exhibit 23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholder of MidCarolina Bank

Burlington, North Carolina

We consent to the incorporation by reference in the Registration Statements for American National Bankshares, Inc. (No. 333-164977 on Form S-3, No. 333-174473 on Form S-3D, No. 333-151277 on Form S-8, and No. 333-35783 on Form S-8) of our report dated March 15, 2011, relating to our audit of the consolidated financial statements of MidCarolina Financial Corporation and Subsidiary as of December 31, 2010 and 2009, and for each of the three years in the period ended December 31, 2010, included in this Form 8-K/A.

/s/ Dixon Hughes Goodman LLP

Raleigh, North Carolina

July 29, 2011

EX-99.1

Exhibit 99.1

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders

MidCarolina Financial Corporation and Subsidiary

Burlington, North Carolina

We have audited the accompanying consolidated statements of financial condition of MidCarolina Financial Corporation and Subsidiary (hereinafter referred to as the “Company”) as of December 31, 2010 and 2009, and the related consolidated statements of operations, comprehensive income, changes in shareholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2010. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of MidCarolina Financial Corporation and Subsidiary as of December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note C to the consolidated financial statements, effective January 1, 2009 the Company changed its method of accounting for other-than-temporary impairment of debt securities as a result of adopting new accounting guidance.

/s/ Dixon Hughes PLLC

Raleigh, North Carolina

March 15, 2011

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

December 31, 2010 and 2009

	2010			2009
	(Amounts in thousands, except share data)
Assets
Cash and due from banks	$	1,510		$	1,581
Federal funds sold and interest-earning deposits		12,196			7,848
Investment securities:
Available for sale		90,152			70,719
Loans held for sale		2,958			228
Loans		399,829			438,087
Allowance for loan losses		(9,226	)		(7,307	)
Net loans		390,603			430,780
Investment in stock of Federal Home Loan Bank of Atlanta		2,075			2,322
Investment in life insurance		8,514			8,179
Premises and equipment, net		6,652			7,063
Other assets		16,540			12,284
Total assets	$	531,200		$	541,004
Liabilities and Shareholders’ Equity
Deposits:
Noninterest-bearing demand deposits	$	38,951		$	41,655
Interest-bearing demand deposits		227,944			144,839
Savings		14,197			8,266
Time		184,781			270,260
Total deposits		465,873			465,020
Short-term borrowings		—			520
Long-term debt		23,764			33,764
Accrued expenses and other liabilities		1,139			1,515
Total liabilities		490,776			500,819
Shareholders’ equity:
Noncumulative, perpetual preferred stock, no par value, liquidation value of $1,000 per share, 20,000,000 shares authorized; 5,000 shares issued and outstanding at December 31, 2010 and 2009, respectively		4,819			4,819
Common stock, no par value; 80,000,000 shares authorized; 4,927,828 shares issued and outstanding at December 31, 2010 and 2009, respectively		15,162			14,958
Retained earnings		21,418			20,805
Accumulated other comprehensive loss		(975	)		(397	)
Total shareholders’ equity		40,424			40,185
Total liabilities and shareholders’ equity	$	531,200		$	541,004

See accompanying notes to consolidated financial statements.

2

CONSOLIDATED STATEMENTS OF OPERATIONS

Years Ended December 31, 2010, 2009 and 2008

	2010			2009			2008
	(Amounts in thousands, except per share data)
Interest Income
Loans	$	22,943		$	24,160		$	25,763
Investment securities:
Taxable		1,539			2,248			2,725
Tax-exempt		1,167			1,130			836
Federal funds sold and interest-earning deposits		48			21			131
Other		29			24			161
Total interest income		25,726			27,583			29,616
Interest Expense
Demand deposits		2,733			1,510			1,275
Savings deposits		78			20			29
Time deposits		4,344			7,648			12,192
Short-term borrowings		—			15			288
Long-term debt		968			1,247			1,510
Total interest expense		8,123			10,440			15,294
Net Interest Income		17,603			17,143			14,322
Provision for loan losses		6,418			4,455			1,665
Net interest income after provision for loan losses		11,185			12,688			12,657
Noninterest Income
Service charges on deposit accounts		712			910			1,152
Mortgage operations		786			800			571
Investment services		248			245			300
Increase in cash surrender value of life insurance		335			286			299
Gain on sale of available for sale investments		51			189			29
Impairment on nonmarketable investments		—			(126	)		—
Total other-than-temporary impairment loss		(110	)		(456	)		(490	)
Portion of loss recognized in other comprehensive income		81			308			—
Net impairment loss recognized in earnings		(29	)		(148	)		(490	)
Other		556			631			359
Total noninterest income		2,659			2,787			2,220
Noninterest Expense
Salaries and employee benefits		5,261			5,626			5,387
Occupancy and equipment		1,506			1,582			1,133
Other outside services		742			374			307
Data processing		1,209			931			787
Office supplies and postage		346			341			350
Deposit and other insurance		1,253			1,280			432
Professional and other services		498			734			550
Advertising		328			338			387
Other real estate owned related costs, net		734			349			(536	)
Other		1,004			726			972
Total noninterest expense		12,881			12,281			9,462
Income before income taxes		963			3,194			5,415
Provision for income tax expense (benefit)		(14	)		818			1,741
Net income		977			2,376			3,674
Dividends on preferred stock		(364	)		(417	)		(417	)
Net income available to common shareholders	$	613		$	1,959		$	3,257
Net Income Per Common Share:
Basic	$	.12		$	.40		$	.66
Diluted	$	.12		$	.40		$	.66

See accompanying notes to consolidated financial statements.

3

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

Years Ended December 31, 2010, 2009 and 2008

	2010			2009			2008
	(Amounts in thousands)
Net income	$	977		$	2,376		$	3,674
Other comprehensive income (loss):
Securities available for sale:
Change in unrealized holding gains (losses) on available for sale securities, net of actual gains		(839	)		1,485			(1,350	)
Tax effect		324			(573	)		521
Reclassification of impairment on private label collateralized mortgage obligations		29			148			490
Tax effect		(11	)		(57	)		(189	)
Reclassification of gains recognized in net income		(51	)		(189	)		(29	)
Tax effect		20			73			10
Portion of other-than-temporary impairment loss recognized in other comprehensive income		(81	)		(308	)		—
Tax effect		31			119			—
Total other comprehensive income (loss)		(578	)		698			(547	)
Comprehensive income	$	399		$	3,074		$	3,127

See accompanying notes to consolidated financial statements.

4

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

Years Ended December 31, 2010, 2009 and 2008

	Preferred stock				Common stock				Retained earnings			Accumulated other com- prehensive loss			Total shareholders’ equity
	Shares		Amount		Shares		Amount
					(Amounts in thousands, except share data)
Balance at December 31, 2007		5,000	$	4,819		4,618,528	$	13,290	$	15,378		$	(337	)	$	33,150
Net income		—		—		—		—		3,674			—			3,674
Other comprehensive loss		—		—		—		—		—			(547	)		(547	)
Preferred dividends paid		—		—		—		—		(417	)		—			(417	)
Stock options exercised		—		—		309,300		792		—			—			792
Current income tax benefit		—		—		—		498		—			—			498
Expense recognized in connection with stock awards and stock options		—		—		—		46		—			—			46
Balance at December 31, 2008		5,000		4,819		4,927,828		14,626		18,635			(884	)		37,196
Cumulative effect of accounting method change		—		—		—		—		211			(211	)		—
Net income		—		—		—		—		2,376			—			2,376
Other comprehensive income		—		—		—		—		—			698			698
Preferred dividends paid		—		—		—		—		(417	)		—			(417	)
Expense recognized in connection with stock awards and stock options		—		—		—		332		—			—			332
Balance at December 31, 2009		5,000		4,819		4,927,828		14,958		20,805			(397	)		40,185
Net income		—		—		—		—		977			—			977
Other comprehensive loss		—		—		—		—		—			(578	)		(578	)
Preferred dividends paid		—		—		—		—		(364	)		—			(364	)
Expense recognized in connection with stock awards and stock options		—		—		—		204		—			—			204
Balance at December 31, 2010		5,000	$	4,819		4,927,828	$	15,162	$	21,418		$	(975	)	$	40,424

See accompanying notes to consolidated financial statements.

5

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years Ended December 31, 2010, 2009 and 2008

	2010			2009			2008
	(Amounts in thousands)
Operating Activities
Net income	$	977		$	2,376		$	3,674
Depreciation and amortization		758			567			481
Provision for loan losses		6,418			4,455			1,665
Stock option expense		204			332			46
Deferred income tax benefit		(1,201	)		(1,114	)		(573	)
Impairment of nonmarketable investments		—			126			—
Gain on sale of investment securities available for sale		(51	)		(189	)		(29	)
Impairment of investment securities available for sale		29			148			490
Other real estate owned related costs, net		734			349			(536	)
Gain on sale of loans		(786	)		(800	)		(571	)
Origination of loans held for sale		(35,779	)		(42,750	)		(21,489	)
Proceeds from sales of loans held for sale		33,835			43,322			22,883
Increase in cash surrender value life insurance		(335	)		(286	)		(299	)
Changes in assets and liabilities:
Prepayment of FDIC insurance assessment		1,029			(2,654	)		—
Decrease in other assets		296			124			572
Increase (decrease) in accrued expenses and other liabilities		12			(731	)		(93	)
Net cash provided by operating activities		6,116			3,275			6,221
Investing Activities
Purchases of investment securities available for sale		(86,008	)		(44,174	)		(51,091	)
Maturities and calls of investment securities available for sale		5,060			8,855			25
Principal paydowns on investment securities available for sale		7,493			750			4,793
Sales of investment securities available for sale		52,901			36,162			44,570
Net (increase) decrease in loans from originations and principal repayments		25,613			(10,187	)		(65,347	)
(Purchase) redemption of FHLB stock		247			(353	)		997
Purchases of premises and equipment		(146	)		(185	)		(1,065	)
Improvement costs on other real estate owned		—			(134	)		(16	)
Proceeds from sale of other real estate owned		3,032			2,511			1,112
Net cash provided (used) by investing activities		8,192			6,755			(66,022	)
Financing Activities
Net increase (decrease) in deposits		853			(2,928	)		94,051
Net increase (decrease) in short-term borrowings		(520	)		520			(19,000	)
Proceeds from (repayment of) long-term debt		(10,000	)		—			(5,000	)
Non-cumulative perpetual preferred stock dividends paid		(364	)		(417	)		(417	)
Proceeds from stock options exercised		—			—			792
Tax benefit from exercise of stock options		—			—			498
Net cash provided (used) by financing activities		(10,031	)		(2,825	)		70,924
Net increase (decrease) in cash and cash equivalents		4,277			(6,305	)		11,123
Cash and cash equivalents, beginning of year		9,429			15,734			4,611
Cash and cash equivalents, end of year	$	13,706		$	9,429		$	15,734
Supplemental Cash Flow Disclosure
Interest paid on deposits and borrowed funds	$	8,265		$	10,697		$	15,305
Income taxes paid		1,096			1,621			2,349
Summary of Noncash Investing and Financing Activities
Unrealized gain (loss) on investment securities available for sale, net of tax effect	$	(578	)	$	698		$	(547	)
Transfer of loans to other real estate owned		8,146			3,982			1,904

See accompanying notes to consolidated financial statements.

6

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

Note A - Organization and Operations

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

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

Note B - Summary of Significant Accounting Policies

Basis of Consolidation

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

Use of Estimates

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

Cash and Cash Equivalents

For the purpose of presentation in the consolidated statements of cash flows, cash and cash equivalents include cash and due from banks, federal funds sold and interest-earning deposits. Federal regulations require institutions to set aside specified amounts of cash as reserves against transactions and time deposits. As of December 31, 2010, the daily average gross reserve requirement was $139,000. Due from bank balances are maintained in other financial institutions. Federal funds sold are generally purchased and sold for one-day periods, but may from time to time have longer terms.

Investment Securities

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

7

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

Loans and Interest Income

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their unpaid principal balances, less unearned income and net of any deferred loan origination fees and costs. Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield of the related loan. Interest income is recorded as earned on an accrual basis. The Company discontinues the recognition of interest income when, in the opinion of management, collection of such interest is doubtful. It is the general policy of the Company to discontinue the accrual of interest on loans, including loans impaired when principal or interest payments are contractually delinquent 90 days or more. Any unpaid amounts previously accrued on these loans are reversed from income. 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.

A loan is considered impaired when, in management’s judgment, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Management determines when loans become impaired through its normal loan administration and review functions. Loans identified as troubled debt restructurings (TDRs) are considered impaired. Loans identified as substandard or doubtful as a result of the loan review process are potentially impaired loans. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired, provided that management expects to collect all amounts due, including interest accrued at the contractual interest rate for the period of delay. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent. Interest revenue on impaired loans is discontinued when the loans meet the criteria for nonaccrual status described above.

Loans Held for Sale

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

Allowance for Loan Losses

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

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.

8

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

The Company’s allowance for possible loan losses consists of three elements: (i) specific valuation allowance determined in accordance with ASC Topic 310 based on probable losses on specific loans; (ii) historical valuation allowances determined in accordance with ASC Topic 450 based on historical loan loss experience for similar loans with similar characteristics and trends, adjusted, as necessary, to reflect the impact of current conditions; and (iii) general valuation allowances determined in accordance with ASC Topic 450 based on general conditions and other qualitative risk factors both internal and external to the Company.

The general reserves are determined by applying loss percentages to the portfolio that are based on recent historical loss experience and management’s evaluation and “risk grading” of the loan portfolio. The historical loss experience is a weighted average calculation using a rolling 12-quarters worth of net charge-offs and weighted to the most recent quarter using the sum of the year’s digits. Additionally, the general economic and business conditions affecting key lending areas, credit quality trends, collateral values, loan volumes and concentrations, seasoning of the loan portfolio, the findings of internal and external credit reviews and results from external bank regulatory examinations are included in this evaluation. The specific reserves are determined on a loan-by-loan basis based on management’s evaluation of the Company’s exposure for each credit, given the current payment status of the loan and the value of any underlying collateral. These are loans classified by management as doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan.

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

Premises and Equipment

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

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

Other Real Estate Owned

Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less estimated costs to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management to ensure the assets are carried at fair value less cost to sell. If there are subsequent declines in fair value, the assets are written down to its then current fair value through a charge to operations. Revenue and expenses from operations and the impact of any subsequent changes in the carrying value are included in other noninterest expense.

Stock in Federal Home Loan Bank of Atlanta

As a requirement for membership, the Company invests in stock of the Federal Home Loan Bank of Atlanta (“FHLB”). At December 31, 2010 and 2009, the balance of FHLB stock held by the Company was $2.1 million and $2.3 million, respectively. Due to the redemption provisions of the FHLB, the Company estimated that fair value equals cost and that this investment was not impaired at December 31, 2010.

9

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

Income Taxes

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

Accumulated Other Comprehensive Income (Loss)

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

Accumulated other comprehensive income (loss) at December 31, 2010 and 2009 consists of the following:

	2010			2009
	(Amounts in thousands)
Unrealized holding losses - securities available for sale	$	(1,587	)	$	(645	)
Deferred income taxes		612			248
Net unrealized holding losses - securities available for sale		(975	)		(397	)
Total other accumulated other comprehensive loss	$	(975	)	$	(397	)

Stock Compensation Plans

U.S. Generally Accepted Accounting Principals (GAAP) requires recognition of the cost of employee services received in exchange for an award of equity instruments in the financial statements over the period the employee is required to perform the services in exchange for the award (usually the vesting period). SFAS No. 123R also requires measurement of the cost of employee services received in exchange for an award based on the grant-date fair value of the award. GAAP also requires that excess tax benefits be reported as financing cash inflows, rather than as a reduction of taxes paid, which is included within operating cash flows.

The Company awarded 99,500 options in 2009 and recognized stock compensation expense of $332,000. No stock options were exercised during 2009 or 2010. Cash flows provided by financing activities from the exercise of stock options amounted to $1.3 million for the year ended December 31, 2008. There were no cash flows provided by financing activities from the exercise of stock options for the years ended December 31, 2010 and 2009.

Net Income Per Common Share

Basic and diluted net income per share has been computed based on the weighted average number of shares outstanding during each period after retroactively adjusting for all applicable declared stock splits effected in the form of stock dividends. Diluted net income per share reflect additional shares of common stock that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Stock options that have exercise prices greater than the average market price of the common shares are considered antidilutive. At December 31, 2010, 2009 and 2008 there were 371,504, 269,774 and 148,228 antidilutive options respectively.

10

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

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

	2010		2009		2008
Weighted average number of common shares used in computing basic net income per share		4,927,828		4,927,828		4,915,350
Effect of dilutive stock options		—		2,482		1,526
Weighted average number of common shares and dilutive potential common shares used in computing diluted net income per share		4,927,828		4,930,310		4,916,876

Segment Reporting

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

Reclassification

There were no reclassifications made to prior period amounts in order to conform to reclassifications used in 2010.

Recent Accounting Pronouncements

In June 2009, the FASB issued SFAS No. 166, Accounting for Transfers of Financial Assets — an amendment of FASB Statement No. 140, which was subsequently codified by the FASB under ASC Topic 860 (“Topic 860”). Topic 860 seeks to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. Specifically, Topic 860 eliminates the concept of a qualifying special-purpose entity, creates more stringent conditions for reporting a transfer of a portion of a financial asset as a sale, clarifies other sale-accounting criteria, and changes the initial measurement of a transferor’s interest in transferred financial assets. SFAS No. 166 as codified under ASC Topic 860 is effective for financial asset transfers occurring after the beginning of fiscal years beginning after November 15, 2009. The adoption of this statement did not have a material impact on the Company’s consolidated financial statements.

In June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R), which was subsequently codified by the FASB as ASC Topic 810 (“Topic 810-10”). Topic 810 amends FASB Interpretation No. 46(R), Variable Interest Entities, for determining whether an entity is a variable interest entity (“VIE”) and requires an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a VIE. Under Topic 810, an enterprise has a controlling financial interest when it has (a) the power to direct the activities of a VIE that most significantly impact the entity’s economic performance, and (b) the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the VIE. Topic 810 also requires an enterprise to assess whether it has an implicit financial responsibility to ensure that a VIE operates as designed when determining whether it has power to direct the activities of the VIE that most significantly impact the entity’s economic performance. Topic 810 also requires ongoing assessments of whether an enterprise is the primary beneficiary of a VIE, requires enhanced disclosures and

11

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

eliminates the scope exclusion for qualifying special-purpose entities. SFAS No. 167 as codified under ASC Topic 810 is effective as of the beginning of fiscal years beginning after November 15, 2009, and is applied using a cumulative effect adjustment to retained earnings for any carrying amount adjustments. The adoption of this statement did not have a material impact on the Company’s consolidated financial statements.

In January 2010, the FASB issued Accounting Standards Update No. 2010-06, Fair Value Measurements Disclosures, which amends Subtopic 820-10 of the FASB Accounting Standards Codification to require new disclosures for fair value measurements and provides clarification for existing disclosures requirements. More specifically, this update will require (a) an entity to disclose separately the amounts of significant transfers in and out of Levels 1 and 2 fair value measurements and to describe the reasons for the transfers; and (b) information about purchases, sales, issuances and settlements to be presented separately (i.e. present the activity on a gross basis rather than net) in the reconciliation for fair value measurements using significant unobservable inputs (Level 3 inputs). This update clarifies existing disclosure requirements for the level of disaggregation used for classes of assets and liabilities measured at fair value and requires disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements using Level 2 and Level 3 inputs. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The Company has included the required disclosures within the consolidated financial statements

In July 2010, the FASB issued Accounting Standards Update No 2010-20, Receivables (“ASC 310-30”): Disclosure about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. The objective of this ASU is for an entity to provide disclosures that facilitate financial statement users’ evaluation of the following:

• The nature of credit risk inherent in the entity’s portfolio of financing receivables;

• How that risk is analyzed and assessed in arriving at the allowance for credit losses; and

• The changes and reasons for those changes in the allowance for credit losses.

To achieve these objectives, an entity should provide disclosures on a disaggregated basis on two defined levels: (1) portfolio segment; and (2) class of financing receivable. The ASU makes changes to existing disclosure requirements and includes additional disclosure requirements about financing receivables, including:

• Credit quality indicators of financing receivables at the end of the reporting period by class of financing receivables;

• The aging of past due financing receivables at the end of the reporting period by class of financing receivables; and

• The nature and extent of troubled debt restructurings that occurred during the period by class of financing receivables and their effect on the allowance for credit losses.

For public entities, the disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. These disclosures have been included in year-end 2010 reporting as applicable.

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

12

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

Note C - Investment Securities

The following is a summary of investment securities by major classification at December 31, 2010 and 2009:

	December 31, 2010
	Amortized cost		Gross unrealized gains		Gross unrealized losses		Fair value
	(Amounts in thousands)
Securities available for sale:
U.S. government agency securities	$	10,590	$	45	$	130	$	10,505
Mortgage-backed securities		39,278		299		363		39,214
GSE CMO’s		8,757		29		93		8,693
Private label CMO’s		810		—		84		726
State and municipal		31,804		72		1,172		30,704
Subordinated debentures		500		—		190		310
Total	$	91,739	$	446	$	2,032	$	90,152
	December 31, 2009
	Amortized cost		Gross unrealized gains		Gross unrealized losses		Fair value
	(Amounts in thousands)
Securities available for sale:
U.S. government agency securities	$	12,113	$	13	$	69	$	12,057
Mortgage-backed securities		23,690		1,246		19		24,917
Private label CMO’s		5,683		6		713		4,976
State and municipal		29,379		191		1,121		28,449
Subordinated debentures		500		—		180		320
Total	$	71,365	$	1,456	$	2,102	$	70,719

Information pertaining to securities with gross unrealized losses at December 31, 2010 and 2009, aggregated by investment category and length of time that individual securities have been in a continuous loss position follows:

13

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

	2010
	Less Than 12 Months				12 Months or More				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
	value		losses		value		losses		value		losses
	(Amounts in thousands)
Securities available for sale:
U.S. government agency securities	$	7,434	$	130	$	—	$	—	$	7,434	$	130
Mortgage-backed securities		17,236		363		—		—		17,236		363
GSE CMO’s		4,031		93		—		—		4,031		93
Private label CMO’s		—		—		—		—		—		—
State and municipal		23,177		811		2,415		361		25,592		1,172
Subordinated debentures		—		—		310		190		310		190
Total temporarily impaired securities	$	51,878	$	1,397	$	2,725	$	551	$	54,603	$	1,948
Other than temporary impairment
Private label CMO’s	$	—	$	—	$	726	$	84	$	726	$	84
Total other than temporarily impaired securities	$	—	$	—	$	726	$	84	$	726	$	84
	2009
	Less Than 12 Months				12 Months or More				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
	value		losses		value		losses		value		losses
	(Amounts in thousands)
Securities available for sale:
U.S. government agency securities	$	7,095	$	69	$	—	$	—	$	7,095	$	69
Mortgage-backed securities		2,039		19		—		—		2,039		19
Private label CMO’s		—		—		2,295		405		2,295		405
State and municipal		9,042		273		7,384		848		16,426		1,121
Subordinated debentures		—		—		320		180		320		180
Total temporarily impaired securities	$	18,176	$	361	$	9,999	$	1,433	$	28,175	$	1,794
Other than temporary impairment
Private label CMO’s	$	1,051	$	153	$	729	$	155	$	1,780	$	308
Total other than temporarily impaired securities	$	1,051	$	153	$	729	$	155	$	1,780	$	308

The Company had 54 securities with gross unrealized losses at December 31, 2010. These securities include four U.S. government agency bonds, nine mortgage-backed securities, three government sponsored enterprise collateralized mortgage obligations, one private label collateralized mortgage obligation, 36 state and municipal securities and one subordinated debenture. The government sponsored enterprise collateralized mortgage obligations were comprised of GNMA issues. Management feels that the unrealized loss is attributable to a limited market for trading these types of securities and the interest rate spreads. None of the unrealized losses identified on temporarily impaired securities as of December 31, 2010 or 2009 relate to the issuer’s ability to honor redemption obligations or the marketability of the securities. The bond ratings of the municipal securities include two AAA rated bonds, twenty-nine AA rated bonds and five A rated bonds. No municipal securities have a rating below A. The municipal

14

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

securities portfolio is geographically diversified. It is not more likely than not that these securities will have to be sold prior to recovery.

The aggregate amortized cost and fair value of debt securities at December 31, 2010, by remaining contractual maturity, are shown below. Actual expected maturities for may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

	Available for Sale
	Amortized		Fair
	cost		value
	(Amounts in thousands)
U.S. agency securities:
Due in 1 year or less	$	6,566	$	6,451
Due in 1 year through 5 years		3,024		3,075
Due after 5 years through 10 years		1,000		979
Due after 10 years		—		—
State and municipal securities:
Due in 1 year or less		—		—
Due in 1 year through 5 years		7,398		7,178
Due after 5 years through 10 years		11,638		11,474
Due after 10 years		12,768		12,052
Subordinated debentures:
Due after 5 years through 10 years		500		310
Other equity securities		—		—
Government service enterprise CMO’s		8,757		8,693
Private label CMO’s		810		726
Mortgage-backed securities		39,278		39,214
Total	$	91,739	$	90,152

Proceeds from sales of investment securities available for sale amounted to $52.9 million, $36.2 million and $44.6 million for the years ended December 31, 2010, 2009 and 2008, respectively. Aggregate gross realized gains from the sales of investment securities available for sale amounted to $954,000, $406,000 and $29,000 for the years ended December 31, 2010, 2009 and 2008, respectively. Gross realized losses from the sale of investment securities available for sale amounted to $903,000, $217,000, and $0 for the years ended December 31, 2010, 2009 and 2008. Realized losses from the impairment of private label mortgage backed securities amounted to $29,000 for the year ended December 31, 2010, $148,000 for the year ended December 31 2009 and $490,000 for the year ended December 31, 2008, resulting from increased default rates on underlying collateral payments and credit rating deterioration.

Debt securities were divided into two groups, those rated investment grade by at least one nationally-recognized rating agency and those rated below investment grade by all nationally-recognized agencies. Impairment of debt securities consistently rated investment grade is considered temporary unless specific contrary information is identified. None of the debt securities consistently rated investment grade were considered to be other-than-temporarily impaired at December 31, 2010 and December 31, 2009.

At December 31, 2010 approximately $1.3 million (based on amortized cost before impairment charges) of our taxable portfolio, (consisting of one private label mortgage-backed security and one subordinated debenture) was rated below investment grade by all nationally-recognized rating agencies. At December 31, 2010, the aggregate unrealized loss on the private label mortgage-backed security and subordinated debenture totaled $274,000 before recognition of any other-than-temporary impairment charges. Impairment of securities rated below investment grade were evaluated to determine if we expect to recover the entire amortized cost basis of the security. This evaluation for the private label CMO was based on projections of estimated cash flows based on individual loans underlying

15

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

each security using current and anticipated increases in unemployment and default rates, decreases in housing prices and increases in loss severity at foreclosure. The evaluation of the subordinated debentures was based on an analysis of the issuer’s financial statements, debt service reserves, past debt service performance as well as other factors.

The primary assumptions used in this evaluation were:

Prepayments - starting with current refinancing and payoff prepayment vector statistics based on information derived from the trustee. The bond’s prepayment vector (VPR) anticipates 6 VPR for 2 months and then returns to historical norms of 4 VPR to maturity.

Default rate – The model takes the consumer default rate from the mortgage backed bond’s 2 month average default rate from 5.4% and ramps it up to 17.5% over the next 12 months, where it remains for another 12 months and down to 4.0% through maturity.

Loss severity – Recoveries on liquidation collateral for this bond have been relatively high for Alternative A collateral in the current economic environment, most likely due to the low initial loan-to-value and geographic diversity in this deal. During the past two quarters severity was 37%, therefore, estimated foreclosure rate assumptions are 35% over the life of the instrument. Loss severity includes estimated holding and disposal expenses.

Discount rates – estimated cash flows were discounted at 6.00% based on our purchase yield of the private label CMO analyzed.

The evaluation uses an adjusted loan to value ratio as part of our evaluation of whether the unrealized losses on this security are temporary or other-than-temporary. The adjusted loan to value ratio is based on the original loan to value ratio inherent in the security, adjusted for changes in housing prices, prepayment speeds, default rates and credit enhancements. A higher adjusted loan to value ratio indicates a greater likelihood that projected cash flows may result in losses. A shortfall between our current amortized cost and the present value of expected cash flows we are likely to collect, based on all available information, is referred to as the credit loss, which is the amount recognized in net income.

The evaluation of previously recognized other-than-temporary impairment at December 31, 2008 was $490,000. In accordance with the provision set forth in ASC 320-10-65-1 of the other-than-temporary impairment charge recognized in 2008, $343,000 was determined to relate to other non-credit-related factors in the market place. This resulted in an adjustment to the opening balance of retained earnings with a corresponding adjustment to accumulated other comprehensive income in the amount of $211,000, net of tax effect.

Based on our evaluation, one security was identified with other-than-temporary impairment at December 31, 2010. For the year-ended December 31, 2010 total other than temporary impairment losses totaled $110,000 and of this amount estimated credit losses totaled $29,000 on this security, which was charged against earnings. For the year-ended December 31, 2009 total other than temporary impairment losses totaled $456,000 and of this amount estimated credit losses totaled $148,000 on this security, which was charged against earnings. The difference between total unrealized losses and estimated credit losses on these securities was charged against accumulated other comprehensive income, net of deferred taxes.

The following table shows a roll forward of the amount related to credit losses recognized on debt securities held by the Company for which a portion of an other-than-temporary impairment was recognized in other comprehensive income.

16

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

	Twelve Months Ended December 31,
	2010		2009
	(Amounts in thousands)
Balance of credit losses on debt securities at the beginning of the period	$	148	$	—
Additional increase related to the credit loss for which an other-than-temporary impairment was previously recognized		29		148
Balance of credit losses on debt securities at the end of the current period	$	177	$	148

At December 31, 2010, the balance of Federal Home Loan Bank (“FHLB”) of Atlanta stock held by the Company is $2.2 million. On May 11, 2010, the FHLB announced that it would pay a dividend for the first quarter of 2010. On June 30, 2010, the FHLB also announced its intentions of repurchasing up to $300 million of its stockholders’ capital that its “members” owned in excess of amounts the members are required to own. This repurchase was transacted on July 15, 2010. On July 29, 2010, the FHLB announced that it would pay a dividend for the second quarter of 2010. On October 29, 2010, the FHLB announced that it would pay a dividend for the third quarter of 2010. The FHLB also announced on October 29, 2010 its intentions of repurchasing up to $300 million of its stockholders’ capital that its “members” owned in excess of amounts the members are required to own. This repurchase did take place on November 15, 2010. Given this, management believes that its investment in FHLB stock was not other-than-temporarily impaired as of December 31, 2010. However, there can be no assurance that the impact of recent or future legislation on the Federal Home Loan Banks will not cause a decrease in the value of the FHLB stock held by the Company.

Investment securities with amortized cost of $25.0 million and fair value of $24.7 million at December 31, 2010 were pledged to secure both financing from the FHLB and for public monies on deposit as required by law.

Note D - Loans

Following is a summary of loans at December 31, 2010 and 2009:

	2010		2009
	(Amounts in thousands)
Real estate:
Construction loans	$	43,934	$	67,635
Commercial mortgage loans		173,275		174,926
Home equity lines of credit		43,611		44,627
Residential mortgage loans		72,370		81,377
Total real estate loans		333,190		368,565
Commercial and industrial loans		61,230		64,173
Loans to individuals for household, family and other personal expenditures		5,398		5,383
Unamortized net deferred loan origination (fees) costs		11		(34	)
Total loans	$	399,829	$	438,087

The recorded investment in loans on nonaccrual status was $7.5 million and $7.3 million as of December 31, 2010 and 2009, respectively. At December 31, 2010 and 2009, the recorded investment in loans considered impaired totaled $20.2 million and $11.0 million, respectively. Impaired loans of $6.7 million and $8.2 million at December 31, 2010 and 2009 had corresponding valuation allowances of $695,000 and $1.2 million, respectively. At December 31, 2010, $4.6 million of the $20.2 million of impaired loans was attributed to twelve troubled debt restructurings (TDRs) and represented $273,000 of the $695,000 valuation allowance. Eight of the twelve TDRs are accruing interest as of December 31, 2010. At December 31, 2009, $2.6 million of the $11.0 million of impaired loans was attributed to two troubled debt restructurings (TDRs) and represented $597,000 of the $1.2 valuation allowance. The two TDRs are accruing interest as of December 31, 2009. Impaired loans of $13.4 million and $2.8

17

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

million at December 31, 2010 and 2009 had no valuation allowances. For the years ended December 31, 2010, 2009 and 2008, the average recorded investment in impaired loans was approximately $23.1 million, $5.7 million and $2.9 million, respectively. The amount of interest recognized on impaired loans during the portion of the year that they were impaired was $1.0 million for 2010 and was not material for 2009 and 2008.

Loan Origination/Risk Management. The Company has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions.

Commercial and industrial loans are underwritten after evaluating and understanding the borrowers’ ability to operate profitably and prudently expand its business. Underwriting standards are designed to promote relationship banking rather than transactional banking. Once it is determined that the borrower’s management possesses sound ethics and solid business acumen, the Company’s management examines current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable, inventory or equipment and usually incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of the funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

Commercial real estate and commercial mortgage loans are subject to underwriting standards and processes similar to commercial and industrial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in real estate markets or the general economy. The properties securing the Corporation’s commercial real estate portfolio are diverse in terms of type. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. As a general rule, the Company avoids financing single-purpose projects unless other underwriting factors are present to help mitigate risk. The Company also utilizes third-party experts to provide insight and guidance about economic conditions and trends affecting market areas it serves. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. At December 31, 2010, approximately 22.1% of the outstanding principal balance of the Company’s commercial real estate loans were secured by owner-occupied properties.

With respect to loans to developers and builders that are secured by non-owner occupied properties that the Corporation may originate from time to time, the Company generally requires the borrower to have an existing relationship with Company and have a proven record of success. Commercial and Residential Construction loans are underwritten utilizing independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with the repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

Most residential mortgage loans originated by the Company are sold into the secondary market adhering to secondary market underwriting requirements. However, residential mortgage loans retained in-house are

18

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

underwritten with a bias toward first liens against the borrowers’ primary residence, generally located in the Company’s target market area. In-house residential mortgages must meet loan-to-value appraisal and debt ratio guidelines.

The Company originates consumer loans utilizing a computer based credit score analysis to supplement the underwriting process. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed, jointly by line and staff personnel. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimize risk. Additionally, trend and outlook reports are viewed by management on a regular basis.

Underwriting standards for home equity loans are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage of 90%, collection remedies, the number of such loans a borrower can have at one time and documentation requirements.

The Company maintains an independent loan review function that reviews and validates the credit risk program on a periodic basis. Results of these reviews are presented to management. The loan review process compliments and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Company’s policies and procedures.

Concentrations of Credit. Most of the Company’s lending activity occurs within the counties of Alamance and Guilford counties in the state of North Carolina as well as other markets. The majority of the Company’s loan portfolio consists of commercial and industrial and commercial real estate loans. As of December 31, 2010 and 2009, there was no concentration of loans related to any single industry in excess of 11% of total loans.

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

Balance at December 31, 2009	$	9,659
New loans		3,190
Principal repayments		(2,694	)
Balance at December 31, 2010	$	10,155

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

Non-Accrual and Past Due Loans. The following past due and nonaccrual policy applies to all classes of loans. 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 principal and interest amounts contractually are brought current and future payments are reasonably assured.

Charge-off of Uncollectible Loans. When any loan or portion thereof becomes uncollectible, the loan will be charged down or charged off against the allowance for loan and lease losses. Residential mortgages are charged-off or written down to fair value when the loan has been foreclosed and the balance exceeds the market value of the collateral. Home equity lines of credit are either charged-off or written down to fair value, when determined that there is not sufficient equity in the loan to cover the Company’s exposure. Loans in any portfolio may be charged-off prior to the policies described above when a loss confirming event occurred, such as bankruptcy (unsecured),

19

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

continued delinquency, or receipt of an asset valuation indicating collateral deficiency for an asset serving as sole source of repayment.

Age Analysis of Past Due Loans

As of December 31, 2010 (in thousands)

	30-89 Days Past Due		Greater than 90 Days Past Due (1)		Total Past Due		Current		Total Loans		Recorded Investment  > 90 Days and Accruing
Loans:
Commercial construction loans	$	195	$	—	$	195	$	9,214	$	9,409	$	—
Commercial mortgage loans		362		4,868		5,230		168,045		173,275		—
Commercial and industrial loans		311		99		410		60,820		61,230		—
Residential construction loans		—		3,383		3,383		31,142		34,525		—
Residential mortgage loans		807		455		1,262		71,119		72,381		—
Consumer loans		184		53		237		5,161		5,398		—
Home equity lines of credit		33		221		254		43,357		43,611		—
Total	$	1,892	$	9,079	$	10,971	$	388,858	$	399,829	$	—

(1) As the Company has no loans past due 90 or more days and still accruing, this category only includes non-accrual loans.

Impaired Loans. The following impaired loan policy applies to all classes of loans. Impaired loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectable. Year-end impaired loans are set forth in the following table.

For the twelve months ended December 31, 2010 (in thousands)

	Unpaid						Average		Interest
	Principal		Recorded		Related		Recorded		Income
	Balance		Investment		Allowance		Investment		Recognized
With no related allowance recorded:
Commercial construction loans	$	—	$	—	$	—	$	—	$	—
Commercial mortgage loans		6,382		6,382		—		7,332		289
Commercial and industrial loans		3,365		3,365		—		4,549		144
Residential construction loans		3,013		3,013		—		3,635		172
Residential mortgage loans		362		362		—		402		26
Consumer loans		75		75		—		69		5
Home equity lines of credit		223		223		—		446		20
Subtotal		13,420		13,420		—		16,433		656
With a related allowance recorded:
Commercial construction loans		—		—		—		—		—
Commercial mortgage loans		1,907		1,907		352		1,796		92
Commercial and Industrial loans		1,640		1,640		40		1,784		98
Residential construction loans		2,032		2,032		253		2,038		100
Residential mortgage loans		1,152		1,152		46		1,059		72
Consumer loans		7		7		4		—		—
Home equity lines of credit		—		—		—		—		—
Subtotal		6,738		6,738		695		6,677		362
Totals
Commercial construction loans		—		—		—		—		—
Commercial mortgage loans		8,289		8,289		352		9,129		381
Commercial and Industrial loans		5,005		5,005		40		6,333		242
Residential construction loans		5,045		5,045		253		5,673		272
Residential mortgage loans		1,514		1,514		46		1,461		98
Consumer loans		82		82		4		69		5
Home equity lines of credit		223		223		—		445		20
Grand total	$	20,158	$	20,158	$	695	$	23,110	$	1,018

20

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

Of the $13.4 million of impaired loans with no related allowance recorded, $7.0 million is recorded at fair value after previous recognition of $2.1 million of charge-offs prior to year-end.

Credit Quality Indicators. As part of the on-going monitoring of the credit quality of the Company’s loan portfolio, management tracks certain credit quality indicators including trends related to (i) the weighted –average risk grade commercial loans, (ii) the level of classified commercial loans, (iii) net charge-offs, (iv) non-performing loans (see details above) and (v) the general economic conditions in the state of North Carolina.

The Company utilizes a risk grading matrix to assign a risk grade to each of its commercial loans. Loans are graded on a scale of 1 to 9. A description of the general characteristics of the 9 grades is as follows:

• Grade 1– Virtually no risk – Credits in this grade are virtually risk-free. Credits are secured by assignment of certificates of deposits issued by the Company, US Treasury notes or properly margined, readily marketable securities. Positive control must be maintained by the Company. The repayment program is well-defined and achievable and repayment sources numerous.

• Grade 2 – Minimal credit risk – This grade is reserved for new and existing loans where the borrower has documented significant overall financial strength. A liquid financial statement with substantial liquid assets, particularly relative to the debts. Borrowers are required to show excellent sources of repayment, with no significant identifiable risk of collection.

• Grade 3 – Average credit risk – These loans have excellent sources of repayment, with no significant identifiable risk of collection. The borrowers have documented historical cash flow that meets or exceeds required minimum Company’s guidelines. The borrower must have adequate secondary sources to liquidate the debt, or liquidation value for the net worth of the borrower or guarantor.

• Grade 4 – Average credit risk – These loans have adequate sources of repayment, with little identifiable risk of collection.

• Grade 5 – Above average credit risk – These loans show signs of weakness in either adequate sources of repayment or collateral, but have demonstrated mitigating factors that minimize the risk of delinquency or loss.

• Grade 6 – Special mention – These loans have clearly defined weaknesses in primary source of repayment that, if not corrected, could cause a loss to the Company. The loans constitute an undue and unwarranted credit risk to the Company, but are not considered so severe as to meet the definition of Substandard.

• Grade 7 – Substandard – This grade includes loans that are inadequately protected by the current net worth and paying capacity of the obligator or of the collateral pledged. The loans have well defined weaknesses that jeopardize the liquidation of the debt and are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

• Grade 8 – Doubtful – This category has the weaknesses inherent in substandard loans and the added characteristic that the weaknesses make collection or liquidation in full highly questionable and improbable. The loans are not yet graded as loss because certain events may occur that could salvage the outstanding debt such as the injection of capital, alternative financing is obtained, or the pledging of additional collateral. Doubtful is a temporary grade where loss is anticipated but is not quantified with any degree of accuracy.

• Grade 9 – Loss – These loans are considered uncollectable and of such little value that their continuance as a bankable asset is not warranted. “Loss” is not intended to imply that the loan or some portion of it will never be paid, nor does it in any way imply that there has been a forgiveness of debt.

21

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

Commercial Credit Exposure

Credit Risk Profile by Internally Assigned Grade

Code	Commercial Construction		Commercial Mortgage		Commercial and Industrial
Virtually no credit risk	$	—	$	—	$	692
Minimal credit risk		—		—		983
Good credit risk		—		11,364		9,808
Acceptable credit risk		2,061		94,969		30,997
Above average credit risk		3,954		43,906		13,857
Special mention		1,567		12,911		3,443
Substandard		1,827		10,125		1,450
Doubtful		—		—		—
Loss		—		—		—
	$	9,409	$	173,275	$	61,230

Consumer Credit Exposure

Credit Risk Profile by Creditworthiness Category

Grade	Residential Construction		Residential Mortgage		Consumer		Home Equity Lines of Credit
Virtually no credit risk	$	—	$	—	$	—	$	—
Minimal credit risk		—		639		70		26
Good credit risk		967		708		207		444
Acceptable credit risk		6,300		43,131		4,800		40,660
Above average credit risk		12,644		21,407		294		1,886
Special mention		8,575		4,496		26		456
Substandard		6,039		1,989		1		139
Doubtful		—		—		—		—
Loss		—		—		—		—
	$	34,525	$	72,370	$	5,398	$	43,611

Consumer and Commercial Credit Exposure

Credit Risk Profile Based on Payment History

Status	Construction		Commercial Mortgage		Home Equity Lines of Credit		Residential Mortgage		Commercial and Industrial		Consumer
Performing	$	40,551	$	168,407	$	43,390	$	71,915	$	61,131	$	5,345
Nonperforming		3,383		4,868		221		455		99		53
	$	43,934	$	173,275	$	43,611	$	72,370	$	61,230	$	5,398

22

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

Note E - Allowance for Loan Losses

The allowance for loan losses is a reserve established through a provision for possible loan losses charged to expense, which represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The Company’s allowance for possible loss methodology includes allowance allocations calculated in accordance with ASC Topic 310, Receivables and allowance allocations calculated in accordance with ASC Topic 450, Contingencies. Accordingly, the methodology is based on historical loss experience by type of credit and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions. The corporation’s process for determining the appropriate level of the allowance for possible loan losses is designed to account for credit deterioration as it occurs. The provision for possible loan losses reflects loan quality trends, including the levels of and trends related to non-accrual loans, past due loans, potential problem loans, criticized loans and net charge-offs or recoveries, among other factors. The provision for possible loan losses also reflects the totality of actions taken on all loans for a particular period. In other words, the amount of the provision reflects not only the necessary increases in the allowance for possible loan losses related to newly identified criticized loans, but it also reflects actions taken related to other loans including among other things, any necessary increases or decreases in required allowances for specific loans or loan pools.

The level of the allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, resent economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Company’s control, including, among other things, the performance of the Company’s loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.

The Company’s allowance for possible loan losses consists of three elements: (i) specific valuation allowance determined in accordance with ASC Topic 310 based on probable losses on specific loans; (ii) historical valuation allowances determined in accordance with ASC Topic 450 based on historical loan loss experience for similar loans with similar characteristics and trends, adjusted, as necessary, to reflect the impact of current conditions; and (iii) general valuation allowances determined in accordance with ASC Topic 450 based on general conditions and other qualitative risk factors both internal and external to the Company.

The allowance established for probable losses on specific loans are based on a regular analysis and evaluation of problem loans. Loans are classified based on an internal credit risk grading process that evaluates, among other things; (i) obligor’s ability to repay; (ii) the underlying collateral, if any; and (iii) the economic environment and industry in which the borrower operates. This analysis is performed at the relationship manager level for all commercial loans. When a loan has a calculated grade of 7 or higher a special assets officer analyzes the loan to determine whether the loan is impaired and, if impaired, the need to specifically allocate a portion of the allowance for possible loan losses to the loan. Specific valuation allowances are determined by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies, the relative risk grade of the loan and economic conditions affecting the borrower’s industry, among other things.

Historical valuation allowances are calculated based on the historical loss experience of specific types of loans and the internal risk grade of such loans at the time they were charged-off. The Company calculates historical loss ratios for pools of similar loans with similar characteristics based on the proportion of actual charge-offs experienced to the total population of loans in the pool. The historical loss ratios are periodically updated based on actual charge-off experience. A historical valuation allowance is established for each pool of similar loans based on the product of the historical loss ratio and the total dollar amount of the loans in the pool. The Company’s pools of similar loans

23

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

include similar risk-graded groups of commercial and industrial loans, commercial real estate loans, consumer real estate loans and consumer and other loans.

General valuation allowances are based on general economic conditions and other qualitative risk factors both internal and external to the Company. In general, such valuation allowances are determined by evaluating among other things; (i) the experience, ability and effectiveness of the Bank’s lending management and staff; (ii) the effectiveness of the Company’s loan policies, procedures and internal controls; (iii) changes in asset quality; (iv) changes in loan portfolio volume; (v) the composition and concentrations of credit; (vi) the impact of competition on loan structuring and pricing; (vii) the effectiveness of the internal loan review function; (viii) the impact of environmental risks on portfolio risks: and (ix) the impact of rising interest rates on portfolio risk. Management evaluates the degree of risk that each one of these components has on the quality of the loan portfolio on a quarterly basis. Each component is determined to have either a high, moderate or low degree of risk. The results are then input into a “general allocation matrix” to determine an appropriate general valuation allowance.

Included in the general valuation allowances are allocations for groups of similar loans with risk characteristics that exceed certain concentration limits established by management. Concentration risk limits have been established, among other things, for certain industry concentrations, large balance and highly leveraged credit relationships that exceed specified risk grades, and loans originated with policy exceptions that exceed specified risk grades.

Loans identified as losses by management, internal loan review and/or bank examiners are charged-off. Furthermore, consumer loan accounts are charged-off automatically based on regulatory requirement.

An analysis of activity in the allowance for loan losses for the years ended December 31, 2010, 2009 and 2008 follows:

	2010			2009			2008
	(Amounts in thousands)
Balance at beginning of year	$	7,307		$	5,632		$	4,462
Provision for loan losses		6,418			4,455			1,665
Charge-offs		(4,810	)		(3,025	)		(533	)
Recoveries		311			245			38
Net charge-offs		(4,499	)		(2,780	)		(495	)
Balance at end of year	$	9,226		$	7,307		$	5,632

24

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

Allowance for Loan Losses and Recorded Investment in Loans

For the Twelve Months Ended December 31, 2010 (in thousands)

			Real Estate
	Construction Loans		Commercial Mortgage Loans		Home Equity Lines of Credit		Residential Mortgage Loans		Commercial and Industrial Loans		Consumer Loans		Total
Allowance for loan losses
Beginning balance	$	1,127	$	2,918	$	744	$	1,358	$	1,071	$	89	$	7,307
Charge-offs		2,388		965		319		462		611		65		4,810
Recoveries		131		2		—		25		103		50		311
Provision		3,209		1,284		385		642		834		64		6,418
Ending balance	$	2,079	$	3,239	$	810	$	1,563	$	1,397	$	138	$	9,226
Portion of ending balance:
Individually evaluated for impairment	$	253	$	352	$	—	$	46	$	40	$	4	$	695
Collectively evaluated for impairment		1,826		2,887		810		1,517		1,357		134		8,531
Total loans evaluated for impairment	$	2,079	$	3,239	$	810	$	1,563	$	1,397	$	138	$	9,226
Loans
Ending balance	$	43,934	$	173,275	$	43,611	$	72,381	$	61,230	$	5,398	$	399,829
Portion of ending balance:
Individually evaluated for impairment	$	5,045	$	8,289	$	223	$	1,514	$	5,005	$	82	$	20,158
Collectively evaluated for impairment		38,889		164,986		43,388		70,867		56,225		5,316		379,671
Total loans evaluated for impairment	$	43,934	$	173,275	$	43,611	$	72,381	$	61,230	$	5,398	$	399,829

Note F - Premises and Equipment

The following is a summary of premises and equipment:

	2010		2009
	(Amounts in thousands)
Land	$	1,864	$	1,864
Buildings and leasehold improvements		5,458		5,458
Furniture and equipment		2,485		2,338
		9,807		9,660
Less accumulated depreciation		3,155		(2,597	)
Total	$	6,652	$	7,063

Depreciation expense for the years ended December 31, 2010, 2009 and 2008 amounted to approximately $557,000, $577,000 and $444,000, respectively.

25

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

Note G - Time Deposits

Time deposits in denominations of $100,000 or more were $158.8 million and $227.9 million at December 31, 2010 and 2009, respectively. Interest expense on such deposits aggregated approximately $3.9 million and $6.6 million in 2010 and 2009, respectively. Related party deposits totaled $5.5 million at December 31, 2010 and $8.0 million at December 31, 2009. Time deposits in denominations of $100,000 or more, maturing subsequent to December 31, 2010 are as follows (amounts in thousands):

2011	$	110,349
2012		39,138
2013		5,340
2014		4,000
	$	158,827

Note H - Leases

As of December 31, 2010, the Company leases office space under non-cancelable operating leases. Future minimum lease payments required under the leases are as follows (amounts in thousands):

Year Ending December 31,
2011	$	417
2012		408
2013		400
2014		364
2015		364
Thereafter		987
	$	2,940

The leases contain options for renewals after the expiration of the current lease terms. The cost of such rentals is not included above. Total rent expense for the years ended December 31, 2010, 2009 and 2008 amounted to $430,000, $387,000 and $189,000, respectively.

Note I - Borrowings

Short-term borrowings

The Company has remaining credit availability totaling approximately $150.5 million from the FHLB, with no short term outstanding balances at December 31, 2010 or December 31, 2009. The Company also has credit availability totaling approximately $50.5 million from the Federal Reserve Bank (“FRB”), with no short term outstanding balances at December 31, 2010 or December 31, 2009. Any outstanding borrowings held by the Bank are appropriately collateralized. The Company had no short-term balances outstanding at December 31, 2010. The Company had $520,000 short-term borrowings at the daily rate of 0.25% with Pacific Coast Bankers Bank at December 31, 2009. The balance was outstanding for one day.

26

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

Long-term debt

The Company is a member of the FHLB. As a member, the Company is required to invest in the stock of the FHLB. The stock is carried at cost since it has no quoted fair value. All stock in the FHLB, together with various investment securities and a blanket lien of $110.8 million on qualifying loans, are pledged as collateral to secure any borrowings. At December 31, there were the following borrowings:

Maturity	Fixed Interest Rate			2010		2009
				(Amounts in thousands)
March 17, 2010		5.92	%	$	—	$	1,500
March 17, 2010		5.71	%		—		2,500
September 21, 2010		3.98	%		—		6,000
February 28, 2011		2.37	%		5,000		5,000
November 30, 2017		2.98	%		10,000		10,000
				$	15,000	$	25,000

At December 31, 2010 and 2009, the weighted average interest rates on the above advances were 2.78% and 3.54%, respectively. The above borrowings have been classified as long-term debt in the balance sheet.

The Company has issued $8.8 million of Junior Subordinated debentures to its wholly owned capital trusts, MidCarolina I and MidCarolina Trust II, to fully and unconditionally guarantee the preferred securities issued by the Trusts. These long term obligations, which currently qualify as Tier I capital for the Company, constitute a full and unconditional guarantee by the Company of the Trusts’ obligations under the Capital Trust Securities. The trusts are not consolidated in the Company’s financial statements.

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

	Date of Issuance		Interest Rate	Maturity Date		(Amounts in thousands) Principal Amount
Issuing Entity						2010		2009
MidCarolina I		10/29/2002	Libor plus 3.45%		11/07/2032	$	5,155	$	5,155
MidCarolina Trust II		12/03/2003	Libor plus 2.90%		10/07/2033		3,609		3,609
						$	8,764	$	8,764

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

Note J - Income Taxes

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

	2010			2009			2008
	(Amounts in thousands)
Current tax provision:
Federal	$	905		$	1,521		$	1,836
State		282			411			478
		1,187			1,932			2,314
Deferred tax provision (benefit):
Federal		(989	)		(927	)		(458	)
State		(212	)		(187	)		(115	)
		(1,201	)		(1,114	)		(573	)
Net provision for income taxes	$	(14	)	$	818		$	1,741

27

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

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

	2010			2009			2008
	(Amounts in thousands)
Income tax at statutory rate	$	327		$	1,086		$	1,841
Increase (decrease) in income tax resulting from:
State income taxes, net of federal tax effect		46			148			240
Income from bank-owned life insurance		(114	)		(97	)		(102	)
Nontaxable interest		(366	)		(349	)		(246	)
Other		92			30			7
Provision for income taxes	$	(14	)	$	818		$	1,741

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

	2010			2009
	(Amounts in thousands)
Deferred tax assets relating to:
Allowance for loan losses	$	3,495		$	2,709
Deferred compensation		575			496
Impairment of investment securities		125			114
Write-downs of other real estate owned		272			114
Nonqualified stock options		175			108
Other		45			37
Unrealized holding losses on investment securities available for sale		612			248
Total deferred tax assets		5,299			3,826
Deferred tax liabilities relating to:
Property and equipment		(61	)		(127	)
Deferred loan fees		(137	)		(163	)
Total deferred tax liabilities		(198	)		(290	)
Net recorded deferred tax asset	$	5,101		$	3,536

It is the Bank’s policy to recognize interest and penalties associated with uncertain tax positions as components of income taxes. There were no interest or penalties accrued during the year. The Bank’s federal and state income tax returns are subject to examination for fiscal years ending on or after December 31, 2007.

28

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

Note K - Noncumulative Perpetual Preferred Stock

On August 15, 2005, the Company issued $4.8 million of noncumulative, perpetual preferred stock, with no par value and liquidation preference of $1,000. The preferred stock is non-voting, other than having class voting rights on certain matters, and pays noncumulative dividends quarterly at a fixed rate of 8.432% through August 15, 2010 and then floats, based upon the London Interbank Offered Rate (“LIBOR”) plus 3.75%. Liquidation is restricted for the first five years. Beginning on August 15, 2010 the preferred stock is callable based upon the following table:

Redemption During the 12-Month Period Beginning August 15	Percentage of Principal  Amount
2010		105.0	%
2011		104.5
2012		104.0
2013		103.5
2014		103.0
2015		102.5
2016		102.0
2017		101.5
2018		101.0
2019		100.5
2020		100.0

Note L - Savings Plan

The Company maintains a contributory savings plan under Section 401(k) of the Internal Revenue Code covering all employees who have completed three months of service and are at least eighteen years of age. Under the plan, employee contributions are matched by the Company in an amount equal to 100% of the first 6% of compensation contributed by the employee. Total savings plan expense for the years ended December 31, 2010, 2009 and 2008 was $107,000, $114,000 and $223,000, respectively.

Note M - Stock Options

During 2008, the Board of Directors and shareholders of the Bank approved a Non-Qualified Stock Option Plan for certain original directors of the Bank and 250,000 shares of authorized and unissued stock were reserved for award.

In 2008, the Board of Directors and shareholders of the Bank amended the Incentive Stock Option Plan for officers and key employees, originally approved in 2004, to increase the number of shares available for award by 159,571. Under the provisions of the Plan, grants are made at the discretion of an administrative committee appointed by the Board of Directors at the fair value of the stock on the date of grant. The Board originally reserved 326,700 shares of authorized and unissued stock for grant.

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

29

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

A summary of the Company’s stock option activity and related information for the year ended December 31, 2010:

	Outstanding Options				Exercisable Options
	Number shares		Average Exercise Price		Number shares		Aggregate Exercise Price
At December 31, 2009		395,429	$	8.59		308,790	$	8.70
Options granted/vested		—		—		—		—
Options exercised		—		—		—		—
Options forfeited		23,925		6.97		—		—
Outstanding at December 31, 2010		371,504	$	8.70		308,790	$	8.82

	Number of shares		Weighted Average Grant Date Fair Value
Non vested shares at December 31, 2009		86,657	$	8.22
Options vested		1,496		8.82
Options exercised		—		—
Options forfeited		23,925		6.97
Non vested shares at December 31, 2010		61,236	$	8.08

The weighted average remaining contractual term of options outstanding and options exercisable at December 31, 2010 and 2009 is 6.14 years and 6.93 years, respectively.

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

	2010		2009		2008
Estimated fair value of options granted	$	—	$	2.87	$	3.16

The risk-free interest rate is based upon a U.S. Treasury instrument with a life that is similar to the expected life of the option grant. Expected volatility is based upon the historical volatility of the Company based upon the previous 3 years trading history. The expected term of the options is based upon the average life of previously issued stock options. The expected dividend yield is based upon current yield on date of grant. No post-vesting restrictions exist for these options. The following table illustrates the assumptions for the Black-Scholes model used in determining the fair value of options granted to employees in the year ended December 31, 2009 and 2008.

The estimated average per share fair value of options granted, using the Black-Scholes methodology, together with the assumptions used in estimating those fair values, are displayed below.

	2009			2008
Assumptions in estimating option values:
Risk-free rate		2.40	%		3.22	%
Dividend yield		0	%		0	%
Volatility		30.13	%		29.26	%
Expected life		8.0 years			6.5 years

30

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

For the years ended December 31, 2010, 2009 and 2008, the intrinsic value of options exercised was approximately:

2010	2009		2008
$—	$	—	$	2.6 million

There were no options exercised during 2010 or 2009. Cash received from options exercised under all share-based payment arrangements for year ended December 31, 2008 was approximately $792,000. The actual tax benefit in shareholders equity realized for the tax deduction from option exercise in the share-based payment arrangements totaled $498,000 for the year ended December 31, 2008.

The unrecognized compensation expense for outstanding options at December 31, 2010 was $588,000 which will be recognized over the service period to vesting of each award.

Note N - Officers’ Deferred Compensation

In 2002, the Company implemented a non-qualifying deferred compensation plan for certain key executive officers. The Company has purchased life insurance policies on the participating officers in order to offset the cost of benefit payments. Benefits for each officer participating in the plan will accrue and vest during the period of employment, and will be paid in monthly benefit payments over the participant’s life after retirement. The plan also provides for payment of disability or death benefits in the event a participating officer becomes permanently disabled or dies while employed at the Bank. Provisions of $205,000 in 2010, $192,000 in 2009 and $180,000 in 2008 were expensed for future benefits to be provided under this plan. The total liability under this plan was $ 1.3 million at December 31, 2009 and $1.1 million at December 31, 2008, and is included in accrued expenses and other liabilities in the accompanying consolidated statements of financial condition.

Note O - Employment Agreement

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

Note P - Contingent Liabilities and Commitments

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

A summary of the Company’s commitments and contingent liabilities at December 31, 2010 is as follows (amounts in thousands):

	2010
Unfunded commitments to extend credit under existing equity line and commercial lines of credit	$	54,378
Commitments to sell loans held for sale		2,958
Financial standby letters of credit, net		2,138

Commitments to originate new loans or extend credit and letters of credit all include exposure to some credit loss in the event of nonperformance by the customer. The Company’s credit policies and procedures for credit commitments are the same as those for extensions of credit that are recorded in the balance sheets. Because these instruments have fixed maturity dates, and because many of them expire without being drawn upon, they do not generally present any significant liquidity risk to the Company. The Company has not incurred any losses on its commitments in 2010, 2009 or 2008.

31

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

The capital and credit markets have experienced volatility for more than a year. More recently, the volatility and disruption has increased, and the markets have produced a downward pressure on stock prices and credit availability for many issuers without regard to their underlying financial strength. This has been particularly the case with respect to financial institutions, and the market prices of the stock of financial services companies in general, including the Company’s, are at their lowest levels in recent history. If current levels of market disruption and volatility continue or worsen, there can be no assurance that we will not experience an adverse effect, which may be material, on the Company’s ability to access capital and on our business, financial condition and results of operations.

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

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

Note Q - Shareholders’ Equity

Regulatory Matters

During June 2010, the Bank’s Board of Directors entered into an agreement called a Memorandum of Understanding (the “Memorandum”) with the FDIC and North Carolina Commissioner of Banks under which the Bank will move in good faith to take various actions designed to improve the Bank’s lending procedures and other conditions related to its operations. The Memorandum provides for the Board to (i) review and formulate objectives relative to liquidity and growth, including a reduction in reliance on volatile liabilities, (ii) formulate plans for the reduction and improvement in adversely classified assets, (iii) review compliance with and, as necessary, modify written policies regarding asset/liability, investment and funds management, (iv) oversee and enforce loan underwriting procedures and implement policies regarding other real estate and an effective loan documentation system, (v) not pay any dividend without the approval of the regulators, (vi) review officer performance and consider additional staffing needs, and (vii) provide progress reports and submit various other information to the regulators.

During October 2010, the Company’s Board of Directors entered into a separate Memorandum of Understanding with the Federal Reserve Bank of Richmond (the “FRB”) under which the Company may not receive dividends from the Bank, pay dividends on the Company’s common or preferred stock or payments on its trust preferred securities, incur additional debt, or redeem any outstanding stock, without prior regulatory approval.

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

The Bank is subject to the capital requirements of the FDIC. The FDIC requires the Bank to maintain minimum ratios of Tier I capital to total risk-weighted assets and total capital to risk-weighted assets of 4% and 8%, respectively. 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 Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. To be “well-capitalized,” the FDIC requires ratios of Tier I capital to risk-weighted assets and total capital to risk-weighted assets of 6% and 10%, respectively. Tier I capital consists of total shareholders’ equity calculated in accordance with accounting principles generally accepted in the United States of America less intangible assets, and total capital is comprised of Tier I capital plus certain adjustments, the only one of which applicable to the Bank is

32

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

the allowance for loan losses. Risk-weighted assets refer to the on- and off-balance sheet exposures of the Bank adjusted for their relative risk levels using formulas set forth in FDIC regulations. The Bank is also subject to a FDIC leverage capital requirement, which calls for a minimum ratio of Tier I capital to quarterly average total assets of 4% and a ratio of 5% to be “well-capitalized.”

As of December 31, 2010 and 2009, the Bank’s capital ratios exceeded levels deemed “well-capitalized” under the regulatory framework for prompt corrective action. There are no events or conditions since the notification that management believes have changed the Bank’s category. However, the Bank is subject to discretionary actions by regulators. Currently the Company may not receive dividends from the Bank, pay dividends on the Company’s common or preferred stock or payments on its trust preferred securities, incur additional debt, or redeem any outstanding stock, without prior regulatory approval.

	For the Bank					Minimum Requirements
	Capital Amount		Capital Ratio			For Capital Adequacy			To Be Well Capitalized
	(Dollars in thousands)
As of December 31, 2010
Tier I capital (to risk-weighted assets)	$	49,321		11.77	%		4.00	%		6.00	%
Total capital - Tier II capital (to risk-weighted assets)		54,609		13.03	%		8.00	%		10.00	%
Leverage - Tier I capital (to average assets)		49,321		9.03	%		4.00	%		5.00	%
As of December 31, 2009
Tier I capital (to risk-weighted assets)	$	48,436		10.54	%		4.00	%		6.00	%
Total capital - Tier II capital (to risk-weighted assets)		54,197		11.80	%		8.00	%		10.00	%
Leverage - Tier I capital (to average assets)		48,436		8.67	%		4.00	%		5.00	%

The Company is also subject to these capital requirements except for the prompt corrective action requirements of the FDIC.

Note R - Fair Value of Financial Instruments

ASC 820, Fair Value Measurements and Disclosures, requires a company to disclose the fair value of its financial instruments, whether or not recognized in the balance sheet, where it is practical to estimate that value.

Fair value estimates are made at a specific point in time based on relevant market information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holding of a particular financial instrument. In cases where quoted market prices are not available, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates. Finally, the fair value estimates presented herein are based on pertinent information available to management as of December 31, 2010 and 2009, respectively.

33

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

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

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

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

Investment Securities

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

Loans Held for Sale

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

Loans

For certain homogeneous categories of loans, such as residential mortgages, fair value is estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. However, the values derived likely do not represent exit prices due to the distressed market conditions; therefore, incremental market risks and liquidity discounts of approximately 8% were subtracted to reflect the illiquid and distressed conditions at December 31, 2010 and 2009.

Investment in Life Insurance

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

Deposits, Short-term Borrowings and Long-term Debt

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

Accrued Interest Receivable and Accrued Interest Payable

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

Financial Instruments with Off-Balance Sheet Risk

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

34

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

The following table presents the carrying values and estimated fair values of the Company’s financial instruments at December 31, 2010 and 2009:

	Carrying value		Estimated fair value
	(Amounts in thousands)
As of December 31, 2010
Financial assets:
Cash and cash equivalents	$	13,706	$	13,706
Investment securities available for sale		90,152		90,152
Loans held for sale		2,958		2,958
Loans, net		390,603		367,483
Federal Home Loan Bank stock		2,075		2,075
Investment in life insurance		8,514		8,514
Accrued interest receivable		1,801		1,801
Financial liabilities:
Deposits	$	465,873	$	461,447
Short-term borrowings		—		—
Long-term debt		23,764		24,124
Accrued interest payable		279		279
As of December 31, 2009
Financial assets:
Cash and cash equivalents	$	9,429	$	9,429
Investment securities available for sale		70,719		70,719
Loans held for sale		228		228
Loans, net		430,780		402,646
Federal Home Loan Bank stock		2,322		2,322
Investment in life insurance		8,179		8,179
Accrued interest receivable		2,150		2,150
Financial liabilities:
Deposits	$	465,020	$	462,740
Short-term borrowings		520		520
Long-term debt		33,674		34,684
Accrued interest payable		485		485

35

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

Note S - FAIR VALUE MEASUREMENTS

The Company adopted FASB’s Accounting Standards Codification (ASC) Topic 820, Fair Value Measurements and Disclosures, effective January 1, 2009, which defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available-for-sale are recorded at fair value on a recurring basis. From time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as loans held for sale and other real estate owned. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting write-downs of individual assets.

The following is a description of valuation methodologies used for assets and liabilities recorded at fair value.

Investment Securities Available-for-Sale

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

Securities classified as Level 3 include asset-backed securities and corporate debt securities in less liquid markets.

Loans Held for Sale

Loans held for sale are carried at the lower of cost or market value. The fair value of loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics. As such, the Company classifies loans subject to nonrecurring fair value adjustments as Level 2.

Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as impaired, management measures impairment on an individual basis. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. As of December 31, 2010, the Bank identified $20.2 million in impaired loans. Of these impaired loans, $9.1 million required a specific reserve of $2.1 million, which was charged off prior to year-end resulting in a net fair value of $7.0 million, in addition to $6.7 million in impaired loans maintaining a specific reserve of $695,000 at year-end, for a net fair value of impaired loans of $13.0 million. As of December 31, 2009, the Bank identified $11.0 million in impaired loans. Of these impaired loans, $8.2 million were identified to have impairment of $1.2 million for a net fair value of $7.0 million. The determination of impairment was based on the estimated fair market value of collateral for each loan determined through the use of appraisals and subjected to further discounts by management, which is considered to be a Level 3 input.

Other Real Estate Owned

Other real estate owned is adjusted to fair value at the date of transfer subject to future impairment. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When fair value of the collateral is based on an observable market price or a current appraised value, the Company records the other real estate owned as nonrecurring Level 2. When an appraised value is not available

36

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the other real estate owned as nonrecurring Level 3.

There were no transfers between Level 1 and Level 2 for the year-ended December 31, 2010. The following table summarizes quantitative disclosures about the fair value measurement for each category of assets carried at fair value as of December 31, 2010 (Dollars in thousands):

Description	December 31, 2010		Quoted Prices in Active  Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Available for sale securities:
U.S. Agency securities	$	10,505	$	—	$	10,505	$	—
Mortgage backed securities		39,214		—		39,214		—
Government enterprise CMO’s		8,693		—		8,693		—
Private label CMO’s		726		—		726		—
State and municipal securities		30,704		—		30,704		—
Subordinated debenture		310		—		—		310
		90,152		—		89,842		310
Impaired loans		13,037		—		—		13,037
Other real estate owned		7,244		—		—		7,244

The following table summarizes quantitative disclosures about the fair value measurement for each category of assets carried at fair value as of December 31, 2009 (Dollars in thousands):

Description	December 31, 2009		Quoted Prices in Active  Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Available for sale securities:
U.S. Agency securities	$	12,057	$	—	$	12,057	$	—
Mortgage backed securities		24,917		—		24,917		—
Private label CMO’s		4,976		—		4,976		—
State and municipal securities		28,449		—		28,449		—
Subordinated debenture		320		—		—		320
		70,719		—		70,399		320
Impaired loans		7,042		—		—		7,042
Other real estate owned		2,876		—		—		2,876

37

The table below presents reconciliation for the period of December 31, 2009 to December 31, 2010 for all Level 3 assets that are measured at fair value on a recurring basis. At December 31, 2009, $2.3 million of securities were transferred from Level 3 to Level 2 resulting from enhanced measurement capabilities of third party valuations.

	Available-for-sale securities
	(Dollars in thousands)
Beginning Balance December 31, 2009	$	320
Total realized and unrealized gains or losses:
Included in earnings		—
Included in other comprehensive income		(10	)
Purchases, issuances and settlements		—
Transfers in (out) of Level 3		—
Ending Balance December 31, 2010	$	310

Note T - Parent Company Financial Data

The Company’s condensed statement of financial condition as of December 31, 2010 and 2009, and its related condensed statements of operations and cash flows for the three year period ended December 31, 2010, are as follows:

Condensed Statement of Financial Condition

December 31, 2010 and 2009

(Amounts in thousands)

	2010			2009
Assets:
Cash in banks	$	446		$	—
Investment in subsidiaries		48,610			48,302
Other assets		186			698
Total assets	$	49,242		$	49,000
Liabilities and Shareholders’ Equity:
Liabilities:
Junior subordinated debentures	$	8,764		$	8,764
Other liabilities		54			51
Total liabilities		8,818			8,815
Shareholders’ Equity:
Preferred stock		4,819			4,819
Common stock		15,162			14,958
Retained earnings		21,418			20,805
Accumulated other comprehensive loss		(975	)		(397	)
Total shareholders’ equity		40,424			40,185
Total liabilities and shareholders’ equity	$	49,242		$	49,000

38

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010, 2009 and 2008

Condensed Statements of Operations

Years ended December 31, 2010, 2009 and 2008

(Amounts in thousands)

	2010			2009			2008
Undistributed earnings of subsidiaries	$	682		$	1,755		$	3,105
Subsidiary dividend income		615			980			1,140
Interest expense		(320	)		(359	)		(571	)
Income tax benefit		—			—			—
Net income		977			2,376			3,674
Dividends on preferred stock		(364	)		(417	)		(417	)
Net income available to common shareholders	$	613		$	1,959		$	3,257

Condensed Statements of Cash Flow

Years ended December 31, 2010, 2009 and 2008

(Amounts in thousands)

	2010			2009			2008
Cash flows from operating activities:
Net income	$	977		$	2,376			3,674
Adjustments to reconcile net income to net cash used by operating activities:
Equity in undistributed earnings of subsidiaries		(682	)		(1,755	)		(3,105	)
Stock compensation expense		204			332			46
Amortization		9			9			9
Increase in other assets		(512	)		(157	)		(144	)
Increase (decrease) in other liabilities		(6	)		(55	)		(18	)
Net cash provided by operating activities		810			750			462
Cash flows from investing activities:
Capital contributions to bank subsidiary		(204	)		(333	)		(1,335	)
Net cash used by investing activities		(204	)		(333	)		(1,335	)
Cash flows from financing activities:
Proceeds from exercise of stock options		—			—			792
Tax benefit from exercise of stock options		—			—			498
Non-cumulative perpetual preferred stock dividends paid		(364	)		(417	)		(417	)
Net cash (used) provided by financing activities		(160	)		(417	)		873
Net increase in cash and cash equivalents		446			—			—
Cash and cash equivalents, beginning		—			—			—
Cash and cash equivalents, ending	$	446		$	—		$

39

EX-99.2

Exhibit 99.2

MIDCAROLINA FINANCIAL CORPORATION

CONSOLIDATED BALANCE SHEETS

	March 31, 2011 (Unaudited)			December 31, 2010(*)
	(Dollars in thousands, except Share data)
ASSETS
Cash and due from banks	$	1,666		$	1,510
Federal funds sold and interest-earning deposits		28,088			12,196
Investment securities available for sale		88,100			90,152
Loans held for sale		683			2,958
Loans		386,873			399,829
Allowance for loan losses		(9,691	)		(9,226	)
NET LOANS		377,182			390,603
Investment in stock of Federal Home Loan Bank of Atlanta		2,075			2,075
Investment in life insurance		8,592			8,514
Premises and equipment, net		6,536			6,652
Foreclosed real estate		10,201			7,244
Other assets		8,963			9,296
TOTAL ASSETS	$	532,086		$	531,200
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits:
Noninterest-bearing demand deposits	$	54,291		$	38,951
Interest-bearing demand deposits		230,453			227,944
Savings		14,436			14,197
Time		172,631			184,781
TOTAL DEPOSITS		471,811			465,873
Long-term debt		18,764			23,764
Accrued expenses and other liabilities		897			1,139
TOTAL LIABILITIES		491,472			490,776
Shareholders’ equity:
Noncumulative, perpetual preferred stock, no par value, liquidation value of $1,000 per share, 20,000,000 shares authorized; 5,000 shares issued and outstanding at March 31, 2011 and December 31, 2010, respectively		4,819			4,819
Common stock, no par value; 80,000,000 shares authorized; 4,927,828 shares issued and outstanding at March 31, 2011 and December 31, 2010, respectively		15,215			15,162
Retained earnings		21,660			21,418
Accumulated other comprehensive loss		(1,080	)		(975	)
TOTAL SHAREHOLDERS’ EQUITY		40,614			40,424
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	532,086		$	531,200

* Derived from audited consolidated financial statements.

See accompanying notes.

MIDCAROLINA FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

	Three Months Ended March 31,
	2011			2010
	(Amounts in thousands, except per share data)
INTEREST INCOME
Loans and loan fees	$	5,294		$	5,856
Investment securities:
Taxable		373			442
Tax-exempt		294			301
Federal funds sold and interest-earning deposits		15			5
TOTAL INTEREST INCOME		5,976			6,604
INTEREST EXPENSE
Demand deposits		518			617
Savings		19			13
Time		802			1,270
Long-term borrowings		168			290
TOTAL INTEREST EXPENSE		1,507			2,190
NET INTEREST INCOME		4,469			4,414
PROVISION FOR LOAN LOSSES		1,200			2,600
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		3,269			1,814
NON-INTEREST INCOME
Service charges on deposits accounts		150			194
Gain on sale of loans		116			118
Income from brokerage activities		69			60
Increase in cash surrender value of life insurance		78			99
Gain on sale of available for sale investments		-			45
Total other-than-temporary impairment loss		(50	)		(443	)
Portion of loss recognized in other comprehensive income		50			425
Net impairment loss recognized in earnings		-			(18	)
Other (Note G)		127			183
TOTAL NON-INTEREST INCOME		540			681
NON-INTEREST EXPENSE
Salaries and employee benefits		1,332			1,280
Occupancy and equipment		380			380
Other outside services		184			122
Data processing		302			260
Office supplies and postage		45			99
Deposit and other insurance		339			215
Professional and other services		86			197
Advertising		49			87
Loss on sale and costs of foreclosed real estate		229			9
Other (Note G)		477			193
TOTAL NON-INTEREST EXPENSE		3,423			2,842
INCOME BEFORE INCOME TAXES		386			(347	)
INCOME TAXES		94			(113	)
NET INCOME (LOSS)		292			(234	)
Dividends on preferred stock		(50	)		(104	)
Net income (loss) available to common shareholders	$	242		$	(338	)
NET INCOME (LOSS) PER COMMON SHARE
Basic	$	.05		$	(.07	)
Diluted	$	.05		$	(.07	)

See accompanying notes.

2

MIDCAROLINA FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited)

	Three Months Ended March 31,
	2011			2010
	(Dollars in thousands)
Net income (loss)	$	292		$	(234	)
Other comprehensive income (loss):
Securities available for sale:
Unrealized holding gains (losses) on available-for-sale securities		(121	)		216
Tax effect		47			(83	)
Reclassification of net (gains) losses recognized in net income		-			(45	)
Tax effect		-			17
Reclassification of impairment loss recognized in net income		-			18
Tax effect		-			(7	)
Portion of other-than-temporary impairment loss recognized in other comprehensive income		(50	)		(425	)
Tax effect		19			164
Total other comprehensive income (loss)		(105	)		(145	)
COMPREHENSIVE INCOME (LOSS)	$	187		$	(379	)

See accompanying notes.

3

MIDCAROLINA FINANCIAL CORPORATION

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (Unaudited)

	Preferred stock				Common stock				Retained			Accumulated other com- prehensive			Total shareholders’
	Shares		Amount		Shares		Amount		earnings			income (loss)			equity
	(Amounts in thousands, except share data)
Balance at December 31, 2010		5,000	$	4,819		4,927,828	$	15,162	$	21,418		$	(975	)	$	40,424
Net income		-		-		-		-		292			-			292
Other comprehensive income		-		-		-		-		-			(105	)		(105	)
Stock based compensation		-		-		-		53		-			-			53
Preferred dividends paid		-		-		-		-		(50	)		-			(50	)
Balance at March 31, 2011		5,000	$	4,819		4,927,828	$	15,215	$	21,660		$	(1,080	)	$	40,614

See accompanying notes.

4

MIDCAROLINA FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

	Three Months Ended March 31,
	2011			2010
	(Dollars in thousands)
Operating Activities
Net income (loss)	$	292		$	(234	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		116			226
Amortization on investment securities available for sale		103			-
Provision for loan losses		1,200			2,600
Gain on sale of investment securities available for sale		-			(45	)
Other-than-temporary impairment on investment securities available for sale		-			18
Deferred tax expense (benefit)		(66	)		(91	)
Gain on sale of loans		(116	)		(118	)
Origination of loans held for sale		(5,881	)		(6,511	)
Proceeds from sales of loans held for sale		8,272			5,764
Increase in cash surrender value life insurance		(78	)		(99	)
Loss on sale and costs of foreclosed real estate		229			9
Stock based compensation expense		53			57
Changes in assets and liabilities:
(Increase) decrease in other assets		397			(342	)
Increase (decrease) in accrued expenses and other liabilities		(176	)		(93	)
NET CASH PROVIDED BY OPERATING ACTIVITIES		4,345			1,141
Investing Activities
Purchases of investment securities available for sale		-			(21,772	)
Principal paydowns on investment securities available for sale		1,780			2,015
Sales of investment securities available for sale		-			18,666
Net (increase) decrease in loans from originations and principal repayments		7,587			3,331
Purchases of premises and equipment		-			(27	)
Proceeds from sale of foreclosed real estate		1,448			214
NET CASH PROVIDED BY INVESTING ACTIVITIES		10,815			2,427
Financing Activities
Net increase in deposits		5,938			29,210
Net decrease in short-term borrowings		-			(520	)
Net decrease in long-term borrowings		(5,000	)		(4,000	)
Preferred stock dividends paid		(50	)		(104	)
NET CASH PROVIDED BY FINANCING ACTIVITIES		888			24,586
NET INCREASE IN CASH AND CASH EQUIVALENTS		16,048			28,154
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		13,706			9,429
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	29,754		$	37,583
Supplemental disclosure of cash flow information
Cash paid for interest	$	1,713		$	2,175
Loans transferred to foreclosed real estate	$	4,634		$	406

See accompanying notes.

5

MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

NOTE A - BASIS OF PRESENTATION

The consolidated financial statements include the accounts and transactions of MidCarolina Financial Corporation (the “Company”) and its wholly-owned subsidiary MidCarolina Bank (the “Bank”). All intercompany transactions and balances have been eliminated in consolidation. In management’s opinion, the financial information, which is unaudited, reflects all adjustments (consisting solely of normal recurring adjustments) necessary for a fair presentation of the financial information as of March 31, 2011 and for the three month periods ended March 31, 2011 and 2010, in conformity with accounting principles generally accepted in the United States of America.

The preparation of the consolidated financial statements requires management to make estimates and assumptions that affect reported amounts of assets and liabilities at the date of the financial statements, as well as the amounts of income and expense during the reporting period. Actual results could differ from those estimates. Operating results for the three month period ended March 31, 2011 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2011.

The organization and business of the Company, accounting policies followed by the Company and other information are contained in the notes to the consolidated financial statements filed as part of the Company’s annual report on Form 10-K. This quarterly report should be read in conjunction with such annual report.

NOTE B - COMMITMENTS

At March 31, 2011, loan commitments were as follows (in thousands):

Commitments to extend credit	$	25,944
Undisbursed lines of credit		32,032
Standby letters of credit		2,187
Commitments to sell loans held for sale		683

NOTE C - PER SHARE DATA

Diluted earnings per share reflect additional shares of common stock that would have been outstanding if dilutive potential shares had been issued. For the three-month period ended March 31, 2011 there were 346,116 options that were antidilutive due to the average share price for the quarter being in excess of the grant price. For the three-month period ended March 31, 2010 all options were antidilutive due to the net loss.

6

MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

NOTE C - PER SHARE DATA (Continued)

The weighted average number of shares of common stock outstanding or assumed to be outstanding are summarized below:

	Three Months Ended March 31,
	2011		2010
Weighted average number of common shares used in computing basic net income per share		4,927,828		4,927,828
Effect of dilutive stock options		3,986		-
Weighted average number of common shares and dilutive potential common shares used in computing diluted net income per share		4,931,814		4,927,828

NOTE D - INVESTMENT SECURITIES

The following is a summary of investment securities by major classification at March 31, 2011 and December 31, 2010:

	March 31, 2011
	Amortized cost		Gross unrealized gains		Gross unrealized losses		Fair value
	(Amounts in thousands)
Securities available for sale:
U.S. government agency securities	$	10,564	$	38	$	136	$	10,466
Mortgage-backed securities		38,118		118		465		37,771
GSE CMO’s		8,092		40		56		8,076
Private Label CMO’s		792		-		50		742
State and municipal		31,792		94		1,156		30,730
Subordinated debentures		500		-		185		315
Total	$	89,858	$	290	$	2,048	$	88,100
	December 31, 2010
	Amortized cost		Gross unrealized gains		Gross unrealized losses		Fair value
	(Amounts in thousands)
Securities available for sale:
U.S. government agency securities	$	10,590	$	45	$	130	$	10,505
Mortgage-backed securities		39,278		299		363		39,214
GSE CMO’s		8,757		29		93		8,693
Private label CMO’s		810		-		84		726
State and municipal		31,804		72		1,172		30,704
Subordinated debentures		500		-		190		310
Total	$	91,739	$	446	$	2,032	$	90,152

7

MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

NOTE D - INVESTMENT SECURITIES (Continued)

The following tables show investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, at March 31, 2011 and December 31, 2010. The Company had 53 securities with gross unrealized losses at March 31, 2011. These securities include three US Agency securities, twelve mortgaged-backed securities, one private label collateralized mortgage obligation, three government sponsored enterprise (GSE) collateralized mortgage obligations, thirty three state and municipal securities and one subordinated debenture. The Company had 54 securities with gross unrealized losses at December 31, 2010. These securities include three U.S. government agency securities, twelve mortgage-backed securities, three government sponsored enterprise (GSE) collateralized mortgage obligations, one private label collateralized mortgage obligations, thirty three state and municipal securities and one subordinated debenture. The GSE collateralized mortgage obligations were comprised of three GNMA securities. Management feels that the unrealized loss is attributable to a limited market for trading these types of securities and the interest rate spreads. None of the unrealized losses identified as temporarily impaired securities as of March 31, 2011 or December 31, 2010 relate to the issuers’ ability to honor redemption obligations or the marketability of the securities. The bond ratings of the municipal securities include two AAA-rated bonds, twenty-six AA-rated bonds and five A-rated securities. No municipal securites have a rating below A. The municipal securites portfolio is geographically diversified. Management believes it is more likely than not that these securities will not need to be sold prior to recovery.

	March 31, 2011
	Less Than 12 Months				12 Months or More				Total
	Fair value		Unrealized losses		Fair value		Unrealized losses		Fair value		Unrealized losses
	(Amounts in thousands)
Securities available for sale:
U.S. government agency securities	$	5,382	$	136	$	-	$	-	$	5,382	$	136
Mortgage-backed securities		21,081		465		-		-		21,081		465
GSE CMO’s		3,994		56		-		-		3,994		56
State and municipal.		20,993		658		2,282		498		23,275		1,156
Subordinated debentures		-		-		315		185		315		185
Total temporarily impaired securities	$	51,450	$	1,315	$	2,597	$	683	$	54,047	$	1,998
Other than temporary impairment Private label CMO’s	$	-	$	-	$	742	$	50	$	742	$	50
Total other than temporarily impaired securities	$	-	$	-	$	742	$	50	$	742	$	50

8

MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

NOTE D - INVESTMENT SECURITIES (Continued)

	December 31, 2010
	Less Than 12 Months				12 Months or More				Total
	Fair value		Unrealized losses		Fair value		Unrealized losses		Fair value		Unrealized losses
	(Amounts in thousands)
Securities available for sale:
U.S. government agency securities	$	7,434	$	130	$	-	$	-	$	7,434	$	130
Mortgage-backed securities		17,236		363		-		-		17,236		363
GSE CMO’s		4,031		93		-		-		4,031		93
State and municipal		23,177		811		2,415		361		25,592		1,172
Subordinated debentures		-		-		310		190		310		190
Total temporarily impaired securities	$	51,878	$	1,397	$	2,725	$	551	$	54,603	$	1,948
Other than temporary impairment Private label CMO’s	$	-	$	-	$	726	$	84	$	726	$	84
Total other than temporarily impaired securities	$	-	$	-	$	726	$	84	$	726	$	84

The aggregate amortized cost and fair value of debt securities at March 31, 2011, by remaining contractual maturity, are shown below. Actual expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations.

	Available for Sale
	Amortized cost		Fair value
	(Amounts in thousands)
U.S. Agency securities:
Due within 1 year	$	4,544	$	4,453
Due in 1 year through 5 years		5,020		5,041
Due after 5 years through 10 years		1,000		972
Due after 10 years		-		-
State and municipal securities:
Due within 1 year		-		-
Due in 1 year through 5 years		7,871		7,746
Due after 5 years through 10 years		12,143		12,091
Due after 10 years		11,778		10,893
Other:
Due in 5 year through 10		500		315
Due after 10 years		-		-
GSE CMOs		8,092		8,076
Private label CMOs		792		742
Mortgage-backed securities		38,118		37,771
Total	$	89,858	$	88,100

9

MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

NOTE D - INVESTMENT SECURITIES (Continued)

There were no sales of investment securities in the three month period ended March 31, 2011 and $18.7 million for the three months ended March 31, 2010. Gross realized gains from the sale of investment securities available for sale amounted to $45,000 for the three months ended March 31, 2010. Net realized gains from the sales of securities available for sale amounted to $45,000 for the three months ended March 31, 2010. Realized losses from the impairment of private label mortgage backed securities amounted to $18,000 for the three months ended March 31, 2010 resulting from increased default rates on underlying collateral payments and credit rating deterioration. There was no impairment related to credit losses on private label mortgage backed securities for the three months ended March 31, 2011.

Investment securities with amortized cost of $29.1 million and fair value of $28.8 million at March 31, 2011 were pledged to secure public monies on deposit as required by law.

Debt securities were divided into two groups: those rated investment grade by at least one nationally-recognized rating agency and those rated below investment grade by all nationally-recognized agencies. Impairment of debt securities consistently rated investment grade is considered temporary unless specific contrary information is identified. None of the debt securities consistently rated investment grade were considered to be other-than-temporarily impaired at March 31, 2011. One debt security rated below investment grade (a private label collateralized mortgage obligation) was considered to be other-than-temporarily impaired at March 31, 2011.

At March 31, 2011, the aggregate unrealized loss on the private label collateralized mortgage obligation totaled $50,000 before recognition of any other-than-temporary impairment charges. Impairment of this security was evaluated to determine if we expect to not recover the entire amortized cost basis of the security. This evaluation was based on projections of estimated cash flows on individual loans underlying each security using current and anticipated changes in unemployment and default rates, decreases in housing prices and increases in loss severity at foreclosure. No impairment charges related to credit were recognized in the statements of operations for the three month period ended March 31, 2011.

The primary assumptions used in this evaluation were:

Prepayment - starting with current refinancing and payoff prepayment vector statistics based on information derived from the trustee. The bond’s prepayment vector anticipates a VPR for 9 months and then returning to historical norms of 4 VPR to maturity

Loss severity - the estimated foreclosure rate is 45% through 2011 and 35% thereafter, through maturity. Loss severity includes estimated holding and disposal expenses.

Default rate - The model takes the consumer default rate from the mortgage backed bond’s 2 month average default rate from 16.5% over the next 24 months and down to 4% through maturity.

10

MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

NOTE D - INVESTMENT SECURITIES (Continued)

Discount rate - estimated cash flows were discounted at 6.00% based on our purchase yield.

The evaluation uses an adjusted loan-to-value ratio as part of our evaluation of whether the unrealized losses on these securities are temporary or other-than-temporary. The adjusted loan to value ratio is based on the original loan to value ratio inherent in the security, adjusted for changes in housing prices, prepayment speeds, default rates and credit enhancements. A higher adjusted loan to value ratio indicates a greater likelihood that projected cash flows may result in losses. A shortfall between our current amortized cost and the present value of expected cash flows we are likely to collect, based on all available information, is referred to as the credit loss, which is the amount recognized in net income.

Based on our evaluation, no portion of the unrealized loss for the security was identified as credit impairment and charged to earnings for the three months ended March 31, 2011.

The following table shows a roll forward of the amount related to credit losses recognized on debt securities held by the Company for which a portion of an other-than-temporary impairment was recognized in other comprehensive income.

	Three Months Ended March 31,
	2011		2010
	(Amounts in thousands)
Balance of credit losses on debt securities at the beginning of the period	$	177	$	148
Additional increase related to the credit loss for which an other-than-temporary impairment was previously recognized		-		18
Balance of credit losses on debt securities at the end of the current period	$	177	$	166

At March 31, 2011, the balance of Federal Home Loan Bank (“FHLB”) of Atlanta stock held by the Company is $2.1 million. On May 11, 2010 the FHLB announced that it would pay a dividend for the first quarter of 2010. On June 30, 2010, the FHLB also announced its intentions of repurchasing up to $300 million of its stockholders’ capital that its “members” owned in excess of amounts the members are required to own. This repurchase was transacted on July 15, 2010. On July 29, 2010 the FHLB announced that it would pay a dividend for the second quarter of 2010. On October 29, 2010 the FHLB announced that it would pay a dividend for the third quarter of 2010. The FHLB also announced on October 29, 2010 its intentions of repurchasing up to $300 million of its stockholders’ capital that its “members” owned in excess of amounts the members are required to own. This repurchase did take place on November 15, 2010. On March 29, 2011 a dividend in the amount of $4,000 was paid for the 4^th quarter of 2010. On April 8, 2011 the FHLB redeemed $105,000 of its outstanding stock representing excess capital. Given this, management believes that its investment in FHLB stock was not other-than-temporarily impaired as of March 31, 2011. However, there can be no assurance that the impact of recent or future legislation on the Federal Home Loan Banks will not also cause a change in the value of the FHLB stock held by the Company.

11

MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

NOTE E - LOANS

Following is a summary of loans at March 31, 2011 and December 31, 2010:

	March 31, 2011		December 31, 2010
	(Amounts in thousands)
Real estate:
Construction loans	$	38,155	$	43,934
Commercial mortgage loans		166,416		173,275
Home equity lines of credit		43,075		43,611
Residential mortgage loans		75,026		72,370
Total real estate loans		322,672		333,190
Commercial and industrial loans		59,808		61,230
Loans to individuals for household, family and other personal expenditures		4,374		5,398
Unamortized net deferred loan origination (fees) costs		19		11
Total loans	$	386,873	$	399,829

The recorded investment in loans on nonaccrual status was $3.9 million as of March 31, 2011 and $9.1 million as of December 31, 2010. At March 31, 2011 the recorded investment in loans considered impaired totaled $14.2 million. At December 31, 2010 the recorded investment in loans considered impaired totaled $20.2 million. Impaired loans of $7.7 million at March 31, 2011 had corresponding valuation allowances of $810,000. Impaired loans of $6.7 million at December 31, 2010 had corresponding valuation allowances of $695,000. At March 31, 2011, $4.2 million of the $14.2 million of impaired loans was attributed to ten troubled debt restructurings (TDRs) and represented $113,000 of the $810,000 valuation allowance. Eight of the ten TDRs were accruing interest as of March 31, 2011. At December 31, 2010 $4.6 million of the $20.2 million of impaired loans was attributed to twelve TDRs and represented $273,000 of the $695,000 valuation allowance. Eight of the twelve TDRs were accruing interest as of December 31, 2010. Impaired loans of $6.5 million at March 31, 2011 had no valuation allowances. Impaired loans of $13.4 million at December 31, 2010 had no valuation allowances.

Loan Origination/Risk Management. The Company has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions.

Commercial and industrial loans are underwritten after evaluating and understanding the borrowers’ ability to operate profitably and prudently expand its business. Underwriting standards are designed to promote relationship banking rather than transactional banking. Once it is determined that the borrower’s management possesses sound ethics and solid business acumen, the Company’s management examines current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable, inventory or equipment and usually incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of the funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

12

MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

NOTE E - LOANS (Continued)

Commercial real estate and commercial mortgage loans are subject to underwriting standards and processes similar to commercial and industrial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in real estate markets or the general economy. The properties securing the Corporation’s commercial real estate portfolio are diverse in terms of type. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. As a general rule, the Company avoids financing single-purpose projects unless other underwriting factors are present to help mitigate risk. The Company also utilizes third-party experts to provide insight and guidance about economic conditions and trends affecting market areas it serves. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. At March 31, 2011, approximately 50.3% of the outstanding principal balance of the Company’s commercial real estate loans were secured by owner-occupied properties.

With respect to loans to developers and builders that are secured by non-owner occupied properties that the Company may originate from time to time, the Company generally requires the borrower to have an existing relationship with Company and have a proven record of success. Commercial and Residential Construction loans are underwritten utilizing independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with the repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation, general economic conditions and the availability of long-term financing.

Most residential mortgage loans originated by the Company are sold into the secondary market adhering to secondary market underwriting requirements. However, residential mortgage loans retained in-house are underwritten with a preference for first liens against the borrowers’ primary residence, generally located in the Company’s target market area. In-house residential mortgages must meet loan-to-value appraisal and debt ratio guidelines.

The Company originates consumer loans utilizing a computer-based credit score analysis to supplement the underwriting process. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed, jointly by line and staff personnel. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimize risk. Additionally, trend and outlook reports are reviewed by management on a regular basis.

Underwriting standards for home equity loans are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage of 90%, collection remedies, the number of such loans a borrower can have at one time and documentation requirements.

The Company maintains an independent loan review function that reviews and validates the credit risk program on a periodic basis. Results of these reviews are presented to management. The loan review process compliments and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Company’s policies and procedures.

Concentrations of Credit. Most of the Company’s lending activity occurs within Alamance and Guilford Counties and surrounding areas in the state of North Carolina. The majority of the Company’s loan portfolio consists of commercial and industrial and commercial real estate loans. As of March 31, 2011, there was one concentration of loans related to a single industry, residential real estate, in excess of 11% of total loans.

13

MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

NOTE E - LOANS (Continued)

The Company had loan and deposit relationships with most of its directors and executive officers and with companies with which certain directors and executive officers are associated. The following is a reconciliation of loans directly outstanding to executive officers, directors and their affiliates (amounts in thousands):

Balance at December 31, 2009	$	9,659
New loans		3,190
Principal repayments		(2,694	)
Balance at December 31, 2010		10,155
New loans		-
Principal repayments		(290	)
Balance at March 31, 2011	$	9,865

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

Non-Accrual and Past Due Loans. The following past due and nonaccrual policy applies to all classes of loans. 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 principal and interest amounts contractually are brought current and future payments are reasonably assured.

Charge-off of Uncollectible Loans. When any loan or portion thereof becomes uncollectible, the loan will be charged down or charged off against the allowance for loan and lease losses. Residential mortgages are charged-off or written down to fair value when the loan has been foreclosed and the balance exceeds the market value of the collateral. Home equity lines of credit are either charged-off or written down to fair value, when it is determined that there is not sufficient equity in the loan to cover the Company’s exposure. Loans in any portfolio may be charged-off prior to the policies described above when a loss confirming event occurred, such as bankruptcy (unsecured), continued delinquency, or receipt of an asset valuation indicating collateral deficiency for an asset serving as the sole source of repayment.

Age Analysis of Past Due Loans

As of March 31, 2011 (in thousands)

	30 - 89 Days Past Due		Greater than 90 Days Past Due (1)		Total Past Due		Current		Total Loans		Recorded Investment > 90 Days and Accruing
Loans
Commercial construction loans	$	120	$	801	$	921	$	7,998	$	8,919	$	-
Commercial mortgage loans		456		1,780		2,236		164,199		166,435		-
Commercial and industrial loans		396		186		583		59,226		59,808		-
Residential construction loans		-		245		245		28,991		29,236		-
Residential mortgage loans		350		713		1,063		73,963		75,026		-
Consumer loans		74		32		106		4,268		4,374		-
Home equity lines of credit		631		174		805		42,270		43,075		-
Total	$	2,027	$	3,931	$	5,958	$	380,915	$	386,873	$	-

(1) As the Company had no loans past due 90 or more days and still accruing, this category only includes non-accrual loans.

14

MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

NOTE E - LOANS (Continued)

Age Analysis of Past Due Loans

As of December 31, 2010 (in thousands)

	30 - 89 Days Past Due		Greater than 90 Days Past Due (1)		Total Past Due		Current		Total Loans		Recorded Investment > 90 Days and Accruing
Loans:
Commercial construction loans	$	195	$	-	$	195	$	9,214	$	9,409	$	-
Commercial mortgage loans		362		4,868		5,230		168,045		173,275		-
Commercial and industrial loans		311		99		410		60,820		61,230		-
Residential construction loans		-		3,383		3,383		31,142		34,525		-
Residential mortgage loans		807		455		1,262		71,119		72,381		-
Consumer loans		184		53		237		5,161		5,398		-
Home equity lines of credit		33		221		254		43,357		43,611		-
Total	$	1,892	$	9,079	$	10,971	$	388,858	$	399,829	$	-

(1) As the Company had no loans past due 90 or more days and still accruing, this category only includes non-accrual loans.

Impaired Loans. The following impaired loan policy applies to all classes of loans. Impaired loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectable. Year-end impaired loans are set forth in the following tables.

For the three months ended March 31, 2011 (in thousands)

	Unpaid Principal Balance		Recorded Investment		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial construction loans	$	245	$	245	$	-	$	123	$	-
Commercial mortgage loans		2,491		2,491		-		4,437		10
Commercial and industrial loans		1,002		1,002		-		2,184		13
Residential construction loans		1,990		1,990		-		2,501		-
Residential mortgage loans		585		585		-		473		-
Consumer loans		11		11		-		43		-
Home equity lines of credit		143		143		-		183		-
Subtotal		6,467		6,467		-		9,944		23
With a related allowance recorded:
Commercial construction loans		909		909		5		454		10
Commercial mortgage loans		2,496		2,496		267		2,201		34
Commercial and Industrial loans		83		83		20		862		-
Residential construction loans		2,929		2,929		448		2,481		35
Residential mortgage loans		1,205		1,205		58		1,179		5
Consumer loans		-		-		-		3		-
Home equity lines of credit		74		74		12		37		12
Subtotal		7,696		7,696		810		7,217		96
Totals
Commercial construction loans		1,154		1,154		5		577		10
Commercial mortgage loans		4,987		4,987		267		6,638		44
Commercial and Industrial loans		1,085		1,085		20		3,046		13
Residential construction loans		4,919		4,919		448		4,982		35
Residential mortgage loans		1,790		1,790		58		1,652		5
Consumer loans		11		11		-		46		-
Home equity lines of credit		217		217		12		220		12
Grand total	$	14,163	$	14,163	$	810	$	17,161	$	119

15

MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

NOTE E - LOANS (Continued)

Of the $6.5 million of impaired loans with no related allowance recorded, $1.0 million was recorded at fair value after previous recognition of $717,000 of charge-offs prior to quarter-end.

For the twelve months ended December 31, 2010 (in thousands)

	Unpaid Principal Balance		Recorded Investment		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial construction loans	$	-	$	-	$	-	$	-	$	-
Commercial mortgage loans		6,382		6,382		-		7,332		289
Commercial and industrial loans		3,365		3,365		-		4,549		144
Residential construction loans		3,013		3,013		-		3,635		172
Residential mortgage loans		362		362		-		402		26
Consumer loans		75		75		-		69		5
Home equity lines of credit		223		223		-		446		20
Subtotal		13,420		13,420		-		16,433		656
With a related allowance recorded:
Commercial construction loans		-		-		-		-		-
Commercial mortgage loans		1,907		1,907		352		1,796		92
Commercial and Industrial loans		1,640		1,640		40		1,784		98
Residential construction loans		2,032		2,032		253		2,038		100
Residential mortgage loans		1,152		1,152		46		1,059		72
Consumer loans		7		7		4		-		-
Home equity lines of credit		-		-		-		-		-
Subtotal		6,738		6,738		695		6,677		362
Totals
Commercial construction loans		-		-		-		-		-
Commercial mortgage loans		8,289		8,289		352		9,129		381
Commercial and Industrial loans		5,005		5,005		40		6,333		242
Residential construction loans		5,045		5,045		253		5,673		272
Residential mortgage loans		1,514		1,514		46		1,461		98
Consumer loans		82		82		4		69		5
Home equity lines of credit		223		223		-		445		20
Grand total	$	20,158	$	20,158	$	695	$	23,110	$	1,018

Of the $13.4 million of impaired loans with no related allowance recorded, $7.0 million was recorded at fair value after previous recognition of $2.1 million of charge-offs prior to year-end.

Credit Quality Indicators. As part of the on-going monitoring of the credit quality of the Company’s loan portfolio, management tracks certain credit quality indicators including trends related to (i) the weighted–average risk grade of commercial loans, (ii) the level of classified commercial loans, (iii) net charge-offs, (iv) non-performing loans (see details above) and (v) the general economic conditions in the state of North Carolina.

The Company utilizes a risk grading matrix to assign a risk grade to each of its commercial loans. Loans are graded on a scale of 1 to 9. A description of the general characteristics of the 9 grades is as follows:

• Grade 1 – Virtually no risk – Credits in this grade are virtually risk-free. Credits are secured by assignment of certificates of deposits issued by the Company, US Treasury notes or properly margined, readily marketable securities. Positive control must be maintained by the Company. The repayment program is well-defined and achievable and repayment sources numerous.

• Grade 2 – Minimal credit risk – This grade is reserved for new and existing loans where the borrower has documented significant overall financial strength. A liquid financial statement with substantial liquid assets, particularly relative to the debts. Borrowers are required to show excellent sources of repayment, with no significant identifiable risk of collection.

• Grade 3 – Average credit risk – These loans have excellent sources of repayment, with no significant identifiable risk of collection. The borrowers have documented historical cash flow that meets or exceeds required minimum Company’s guidelines. The borrower must have adequate secondary sources to liquidate the debt, or liquidation value for the net worth of the borrower or guarantor.

16

MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

NOTE E - LOANS (Continued)

• Grade 4 – Average credit risk – These loans have adequate sources of repayment, with little identifiable risk of collection.

• Grade 5 – Above average credit risk – These loans show signs of weakness in either adequate sources of repayment or collateral, but have demonstrated mitigating factors that minimize the risk of delinquency or loss.

• Grade 6 – Special mention – These loans have clearly defined weaknesses in primary source of repayment that, if not corrected, could cause a loss to the Company. The loans constitute an undue and unwarranted credit risk to the Company, but are not considered so severe as to meet the definition of Substandard.

• Grade 7 – Substandard – This grade includes loans that are inadequately protected by the current net worth and paying capacity of the obligator or of the collateral pledged. The loans have well defined weaknesses that jeopardize the liquidation of the debt and are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

• Grade 8 – Doubtful – This category has the weaknesses inherent in substandard loans and the added characteristic that the weaknesses make collection or liquidation in full highly questionable and improbable. The loans are not yet graded as loss because certain events may occur that could salvage the outstanding debt such as the injection of capital, alternative financing is obtained, or the pledging of additional collateral. Doubtful is a temporary grade where loss is anticipated but is not quantified with any degree of accuracy.

• Grade 9 – Loss – These loans are considered uncollectable and of such little value that their continuance as a bankable asset is not warranted. “Loss” is not intended to imply that the loan or some portion of it will never be paid, nor does it in any way imply that there has been a forgiveness of debt.

Commercial Credit Exposure

Credit Risk Profile by Internally Assigned Grade

For the three months ended March 31, 2011 (in thousands)

Grade	Commercial Construction		Commercial Mortgage		Commercial and Industrial
Virtually no credit risk	$	-	$	-	$	835
Minimal credit risk		-		-		1,671
Good credit risk		-		10,153		6,183
Acceptable credit risk		1,741		89,977		32,643
Above average credit risk		3,942		52,141		12,093
Special mention		1,508		10,035		5,129
Substandard		1,728		4,129		1,254
Doubtful		-		-		-
Loss		-		-		-
	$	8,919	$	166,435	$	59,808

17

MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

NOTE E - LOANS (Continued)

Consumer Credit Exposure

Credit Risk Profile by Creditworthiness Category

For the three months ended March 31, 2011 (in thousands)

Grade	Residential Construction		Residential Mortgage		Consumer		Home Equity Lines of Credit
Virtually no credit risk	$	-	$	-	$	-	$	-
Minimal credit risk		-		626		67		25
Good credit risk		884		3,962		224		538
Acceptable credit risk		4,732		41,375		3,539		39,998
Above average credit risk		10,968		22,644		517		1,950
Special mention		6,809		4,381		17		468
Substandard		5,843		2,038		10		96
Doubtful		-		-		-		-
Loss		-		-		-		-
	$	29,236	$	75,026	$	4,374	$	43,075

Consumer and Commercial Credit Exposure

Credit Risk Profile Based on Payment History

For the three months ended March 31, 2011 (in thousands)

Status	Construction		Commercial Mortgage		Home Equity Lines of Credit		Residential Mortgage		Commercial and Industrial		Consumer
Performing	$	37,109	$	164,655	$	42,901	$	74,313	$	59,622	$	4,342
Nonperforming		1,046		1,780		174		713		186		32
	$	38,155	$	166,435	$	43,075	$	75,026	$	59,808	$	4,374

Commercial Credit Exposure

Credit Risk Profile by Internally Assigned Grade

For the twelve months ended December 31, 2010 (in thousands)

Code	Commercial Construction		Commercial Mortgage		Commercial and Industrial
Virtually no credit risk	$	-	$	-	$	692
Minimal credit risk		-		-		983
Good credit risk		-		11,364		9,808
Acceptable credit risk		2,061		94,969		30,997
Above average credit risk		3,954		43,906		13,857
Special mention		1,567		12,911		3,443
Substandard		1,827		10,125		1,450
Doubtful		-		-		-
Loss		-		-		-
	$	9,409	$	173,275	$	61,230

18

MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

NOTE E - LOANS (Continued)

Consumer Credit Exposure

Credit Risk Profile by Creditworthiness Category

For the twelve months ended December 31, 2010 (in thousands)

Grade	Residential Construction		Residential Mortgage		Consumer		Home Equity Lines of Credit
Virtually no credit risk	$	-	$	-	$	-	$	-
Minimal credit risk		-		639		70		26
Good credit risk		967		708		207		444
Acceptable credit risk		6,300		43,149		4,800		40,660
Above average credit risk		12,644		21,407		294		1,886
Special mention		8,575		4,496		26		456
Substandard		6,039		1,989		1		139
Doubtful		-		-		-		-
Loss		-		-		-		-
	$	34,525	$	72,389	$	5,398	$	43,611

Consumer and Commercial Credit Exposure

Credit Risk Profile Based on Payment History

For the twelve months ended December 31, 2010 (in thousands)

Status	Construction		Commercial Mortgage		Home Equity Lines of Credit		Residential Mortgage		Commercial and Industrial		Consumer
Performing	$	40,551	$	168,407	$	43,390	$	71,915	$	61,131	$	5,345
Nonperforming		3,383		4,868		221		455		99		53
	$	43,934	$	173,275	$	43,611	$	72,370	$	61,230	$	5,398

19

MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

NOTE F - ALLOWANCE FOR LOAN LOSSES

The allowance for loan losses is a reserve established through a provision for possible loan losses charged to expense, which represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The Company’s allowance for possible loss methodology includes allowance allocations calculated in accordance with ASC Topic 310, Receivables, and loan allowance allocations calculated in accordance with ASC Topic 450, Contingencies. Accordingly, the methodology is based on historical loss experience by type of credit and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions. The Company’s process for determining the appropriate level of the allowance for possible loan losses is designed to account for credit deterioration as it occurs. The provision for possible loan losses reflects loan quality trends, including the levels of and trends related to non-accrual loans, past due loans, potential problem loans, criticized loans and net charge-offs or recoveries, among other factors. The provision for possible loan losses also reflects the totality of actions taken on all loans for a particular period. In other words, the amount of the provision reflects not only the necessary increases in the allowance for possible loan losses related to newly identified criticized loans, but it also reflects actions taken related to other loans including among other things, any necessary increases or decreases in required allowances for specific loans or loan pools.

The level of the allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Company’s control, including, among other things, the performance of the Company’s loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.

The Company’s allowance for possible loan losses consists of three elements: (i) specific valuation allowance determined in accordance with ASC Topic 310 based on probable losses on specific loans; (ii) historical valuation allowances determined in accordance with ASC Topic 450 based on historical loan loss experience for similar loans with similar characteristics and trends, adjusted, as necessary, to reflect the impact of current conditions; and (iii) general valuation allowances determined in accordance with ASC Topic 450 based on general conditions and other qualitative risk factors both internal and external to the Company.

The allowance established for probable losses on specific loans are based on a regular analysis and evaluation of problem loans. Loans are classified based on an internal credit risk grading process that evaluates, among other things; (i) obligor’s ability to repay; (ii) the underlying collateral, if any; and (iii) the economic environment and industry in which the borrower operates. This analysis is performed at the relationship manager level for all commercial loans. When a loan has a calculated grade of 7 or higher a special assets officer analyzes the loan to determine whether the loan is impaired and, if impaired, the need to specifically allocate a portion of the allowance for possible loan losses to the loan. Specific valuation allowances are determined by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies, the relative risk grade of the loan and economic conditions affecting the borrower’s industry, among other things.

Historical valuation allowances are calculated based on the historical loss experience of specific types of loans and the internal risk grade of such loans at the time they were charged-off. The Company calculates historical loss ratios for pools of similar loans with similar characteristics based on the proportion of actual charge-offs experienced to the total population of loans in the pool. The historical loss ratios are periodically updated based on actual charge-off experience. A historical valuation allowance is established for each pool of similar loans based on the product of the historical loss ratio and the total dollar amount of the loans in the pool. The Company’s pools of similar loans include similar risk-graded groups of commercial and industrial loans, commercial real estate loans, consumer real estate loans and consumer and other loans.

20

MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

NOTE F - ALLOWANCE FOR LOAN LOSSES (Continued)

General valuation allowances are based on general economic conditions and other qualitative risk factors both internal and external to the Company. In general, such valuation allowances are determined by evaluating among other things; (i) the experience, ability and effectiveness of the Bank’s lending management and staff; (ii) the effectiveness of the Company’s loan policies, procedures and internal controls; (iii) changes in asset quality; (iv) changes in loan portfolio volume; (v) the composition and concentrations of credit; (vi) the impact of competition on loan structuring and pricing; (vii) the effectiveness of the internal loan review function; (viii) the impact of environmental risks on portfolio risks: and (ix) the impact of rising interest rates on portfolio risk. Management evaluates the degree of risk that each one of these components has on the quality of the loan portfolio on a quarterly basis. Each component is determined to have either a high, moderate or low degree of risk. The results are then input into a “general allocation matrix” to determine an appropriate general valuation allowance.

Included in the general valuation allowances are allocations for groups of similar loans with risk characteristics that exceed certain concentration limits established by management. Concentration risk limits have been established, among other things, for certain industry concentrations, large balance and highly leveraged credit relationships that exceed specified risk grades, and loans originated with policy exceptions that exceed specified risk grades.

Loans identified as losses by management, internal loan review and/or bank examiners are charged-off. Furthermore, consumer loan accounts are charged-off automatically based on regulatory requirements.

An analysis of activity in the allowance for loan losses for the three months ended March 31, 2011 and 2010 follows:

	Three Months ended
	March 31, 2011			March 31, 2010
	(Amounts in thousands)
Balance at beginning of year	$	9,226		$	7,307
Provision for loan losses		1,200			2,600
Charge-offs		(785	)		(1,734	)
Recoveries		50			52
Net charge-offs		(735	)		(1,682	)
Balance at end of year	$	9,691		$	8,225

21

MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

NOTE F - ALLOWANCE FOR LOAN LOSSES (Continued)

Allowance for Loan Losses and Recorded Investment in Loans

For the Three Months Ended March 31, 2011 (in thousands)

	Real Estate
	Construction Loans			Commercial Mortgage Loans			Home Equity Lines of Credit			Residential Mortgage Loans			Commercial and Industrial Loans			Consumer Loans			Total
Allowance for loan losses
Beginning balance	$	2,079		$	3,239		$	810		$	1,563		$	1,397		$	138		$	9,226
Charge-offs		(231	)		(320	)		(64	)		(48	)		(112	)		(10	)		(785	)
Recoveries		2			4			-			22			19			3			50
Provision		600			240			72			120			156			12			1,200
Ending balance	$	2,450		$	3,163		$	818		$	1,657		$	1,460		$	143		$	9,691
Portion of ending balance:
Individually evaluated for impairment	$	452		$	267		$	12		$	59		$	20		$	-		$	810
Collectively evaluated for impairment		1,998			2,896			806			1,598			1,440			143			8,881
Total loans evaluated for impairment	$	2,450		$	3,163		$	818		$	1,657		$	1,460		$	143		$	9,691
Loans
Ending balance	$	38,155		$	166,435		$	43,075		$	75,026		$	59,808		$	4,374		$	386,873
Portion of ending balance:
Individually evaluated for impairment	$	6,073		$	4,988		$	216		$	1,790		$	1,085		$	11		$	14,163
Collectively evaluated for impairment		32,082			161,447			42,859			73,236			58,723			4,363			372,710
Total loans evaluated for impairment	$	38,155		$	166,435		$	43,075		$	75,026		$	59,808		$	4,374		$	386,873

22

MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

NOTE F - ALLOWANCE FOR LOAN LOSSES (Continued)

Allowance for Loan Losses and Recorded Investment in Loans

For the Twelve Months Ended December 31, 2010 (in thousands)

	Real Estate
	Construction Loans			Commercial Mortgage Loans			Home Equity Lines of Credit			Residential Mortgage Loans			Commercial and Industrial Loans			Consumer Loans			Total
Allowance for loan losses
Beginning balance	$	1,127		$	2,918		$	744		$	1,358		$	1,071		$	89		$	7,307
Charge-offs		(2,388	)		(965	)		(319	)		(462	)		(611	)		(65	)		(4,810	)
Recoveries		131			2			-			25			103			50			311
Provision		3,209			1,284			385			642			834			64			6,418
Ending balance	$	2,079		$	3,239		$	810		$	1,563		$	1,397		$	138		$	9,226
Portion of ending balance:
Individually evaluated for impairment	$	253		$	352		$	-		$	46		$	40		$	4		$	695
Collectively evaluated for impairment		1,826			2,887			810			1,517			1,357			134			8,531
Total loans evaluated for impairment	$	2,079		$	3,239		$	810		$	1,563		$	1,397		$	138		$	9,226
Loans
Ending balance	$	43,934		$	173,275		$	43,611		$	72,381		$	61,230		$	5,398		$	399,829
Portion of ending balance:
Individually evaluated for impairment	$	5,045		$	8,289		$	223		$	1,514		$	5,005		$	82		$	20,158
Collectively evaluated for impairment		38,889			164,986			43,388			70,867			56,225			5,316			379,671
Total loans evaluated for impairment	$	43,934		$	173,275		$	43,611		$	72,381		$	61,230		$	5,398		$	399,829

NOTE G - NON-INTEREST INCOME AND NON-INTEREST EXPENSE

The major components of other non-interest income are as follows:

	Three Months Ended March 31,
	2011		2010
	(In thousands)
Debit card income	$	76	$	63
ATM interchange income		2		1
Safe deposit rent		4		3
Check upcharge		7		7
Income from rental property		9		13
Insurance claim proceeds		-		80
Other		29		16
Total	$	127	$	183

23

MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

NOTE G - NON-INTEREST INCOME AND NON-INTEREST EXPENSE (Continued)

The major components of other non-interest expense are as follows:

	Three Months Ended March 31,
	2011		2010
	(In thousands)
Travel	$	9	$	12
Contributions		4		10
Director fees		43		46
Dues and memberships		4		3
Credit reports and filing fees		4		5
Franchise tax		30		30
Appraisals		70		20
Deposit charge offs		8		1
Loan collection expense		267		46
CDARS expense		15		18
Other		23		2
Total	$	477	$	193

NOTE H - FAIR VALUE MEASUREMENTS

The Company adopted FASB’s Accounting Standards Codification (ASC) Topic 820, Fair Value Measurements and Disclosures, effective January 1, 2009, which defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available-for-sale are recorded at fair value on a recurring basis. From time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as loans held for sale and other certain assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting write-downs of individual assets.

The following is a description of valuation methodologies used for assets and liabilities recorded at fair value.

Investment Securities Available-for-Sale

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

Loans Held for Sale

Loans held for sale are carried at the lower of cost or market value. The fair value of loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics. As such, the Company classifies loans subject to nonrecurring fair value adjustments as Level 2.

24

MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

NOTE H - FAIR VALUE MEASUREMENTS (Continued)

Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as impaired, management measures impairment on an individual basis. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At March 31, 2011, the Company identified impaired loans of $14.2 million. Of this total, $1.8 million required a specific allowance totaling $717,000, which was charged off resulting in a net fair value of $1.0 million, in addition to $7.7 million in impaired loans maintaining a specific reserve of $810,000 at quarter end for a combined net fair value of impaired loans of $7.9 million. At December 31, 2010, the Company identified impaired loans of $20.2 million. Of this total, $9.1 million required a specific allowance totaling $2.1 million, which was charged off prior to year-end resulting in a net fair value of $7.0 million, in addition to $6.7 million in impaired loans maintaining a specific reserve of $695,000 at year-end for a net fair value of impaired loans of $13.0 million. The determination of impairment was based on the estimated fair market value of collateral for each loan determined through the use of appraisals and subjected to further discounts by management for age of appraisals, geography of the collateral and historical experience in selling similar types of collateral, which are considered to be Level 3 inputs.

Foreclosed Real Estate

Foreclosed real estate is initially recorded at the lesser of fair value or the balance of the foreclosed loan, less cost to sell, at the date of foreclosure. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed real estate as nonrecurring Level 2. In situations where current appraised values are unavailable or it is determined that the fair value of the collateral is further impaired below the appraised value and there is no observable market price, management will rely on significant discounts to account for the age of the most current appraised value available, geography of the foreclosed real estate and historical experience in selling similar types of foreclosed real estate. The Company records the foreclosed real estate under these significant unobservable inputs as nonrecurring Level 3.

Their were no significant transfers between the valuation of financial assets or liabilities between Levels 1 and 2 in the valuation hierarchy below. The following table summarizes quantitative disclosures about the fair value measurement for each category of assets carried at fair value as of March 31, 2011 (in thousands):

			Fair Value Measurements at March 31, 2011
Description	March 31, 2011		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Input (Level 2)		Significant Unobservable Inputs (Level 3)
Available for sale securities:
U.S Agency securities	$	10,466	$	-	$	10,466	$	-
Mortgage backed securities		37,771		-		37,771		-
GSE CMO’s		8,076		-		8,076		-
Private label CMO’s		742		-		742		-
State and municipal securities		30,730		-		30,730		-
Subordinated debenture		315				-		315
		88,100		-		87,785		315
Impaired loans		7,938		-		-		7,938
Foreclosed real estate		10,201		-		-		10,201

25

MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

NOTE H - FAIR VALUE MEASUREMENTS (Continued)

There were no transfers between Level 1 and Level 2 for the year-ended December 31, 2010. The following table summarizes quantitative disclosures about the fair value measurement for each category of assets carried at fair value as of December 31, 2010 (in thousands):

			Fair Value Measurements at December 31, 2010
Description	December 31, 2010		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Input (Level 2)		Significant Unobservable Inputs (Level  3)
Available for sale securities:
U.S. Agency securities	$	10,505	$	-	$	10,505	$	-
Mortgage backed securities		39,214		-		39,214		-
Government enterprise CMO’s		8,693		-		8,693		-
Private label CMO’s		726		-		726		-
State and municipal securities		30,704		-		30,704		-
Subordinated debenture		310		-		-		310
		90,152		-		89,842		310
Impaired loans		13,037		-		-		13,037
Other real estate owned		7,244		-		-		7,244

The table below presents reconciliation for the three months ended March 31, 2011 and 2010 for all Level 3 assets that are measured at fair value on a recurring basis.

	Available-for-sale Securities
	2011		2010
	(Dollars in thousands)
Beginning Balance	$	310	$	148
Total realized and unrealized gains or (losses):
Included in earnings		-		-
Included in other comprehensive income		5		18
Purchases, issuances and settlements		-		-
Transfers in (out) of Level 3		-		-
Ending Balance	$	315	$	166

26

MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

NOTE I - FAIR VALUE OF FINANCIAL INSTRUMENTS

ASC Topic 825 Financial Instruments, requires a company to disclose on an interim and annual basis the fair value of its financial instruments whether or not recognized in the balance sheet, where it is practical to estimate that value.

Fair value estimates are made at a specific point in time based on relevant market information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holding of a particular financial instrument. In cases where quoted market prices are not available, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates. Finally, the fair value estimates presented herein are based on pertinent information available to management as of March 31, 2011 and December 31, 2010, respectively.

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

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

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

Investment Securities

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

Loans Held for Sale

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

Loans

For certain homogeneous categories of loans, such as residential mortgages, fair value is estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. However, the values derived likely do not represent exit prices due to the distressed market conditions; therefore, incremental market risks and liquidity discounts of approximately 8% were subtracted to reflect the illiquid and distressed conditions at March 31, 2011 and December 31, 2010.

Investment in Life Insurance

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

Deposits, Short-term Borrowings and Long-term Debt

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

27

MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

NOTE I - FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)

Accrued Interest Receivable and Accrued Interest Payable

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

Financial Instruments with Off-Balance Sheet Risk

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

The following table presents the carrying values and estimated fair values of the Company’s financial instruments at March 31, 2011 and December 31, 2010:

	Carrying value		Estimated fair value
	(Amounts in thousands)
As of March 31, 2011
Financial assets:
Cash and cash equivalents	$	29,754	$	29,754
Investment securities available for sale		88,100		88,100
Loans held for sale		683		683
Loans, net of allowance		377,182		347,007
Federal Home Loan Bank stock		2,075		2,075
Investment in life insurance		8,592		8,592
Accrued interest receivable		1,746		1,746
Financial liabilities:
Deposits	$	471,811	$	458,992
Long-term debt		18,764		18,984
Accrued interest payable		185		185
As of December 31, 2010
Financial assets:
Cash and cash equivalents	$	13,706	$	13,706
Investment securities available for sale		90,152		90,152
Loans held for sale		2,958		2,958
Loans, net		390,603		367,483
Federal Home Loan Bank stock		2,075		2,075
Investment in life insurance		8,514		8,514
Accrued interest receivable		1,801		1,801
Financial liabilities:
Deposits	$	465,873	$	461,447
Long-term debt		23,764		24,124
Accrued interest payable		279		279

28

MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

NOTE J - RECENT ACCOUNTING PRONOUNCEMENTS

The FASB has issued ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. This ASU requires some new disclosures and clarifies some existing disclosure requirements about fair value measurement as set forth in Codification Subtopic 820-10. The FASB’s objective is to improve these disclosures and, thus, increase the transparency in financial reporting. Specifically, ASU 2010-06 amends Codification Subtopic 820-10 to now require:

• A reporting entity to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers; and

• In the reconciliation for fair value measurements using significant unobservable inputs, a reporting entity should present separately information about purchases, sales, issuances, and settlements.

In addition, ASU 2010-06 clarifies the requirements of the following existing disclosures:

• For purposes of reporting fair value measurement for each class of assets and liabilities, a reporting entity needs to use judgment in determining the appropriate classes of assets and liabilities; and

• A reporting entity should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements.

ASU 2010-06 is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. Early adoption is permitted. The adoption of this standard did not have an impact on our financial position or results of operations.

ASU 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses, will help investors assess the credit risk of a company’s receivables portfolio and the adequacy of its allowance for credit losses held against the portfolios by expanding credit risk disclosures. This ASU requires more information about the credit quality of financing receivables in the disclosures to financial statements, such as aging information and credit quality indicators. Both new and existing disclosures must be disaggregated by portfolio segment or class. The disaggregation of information is based on how a company develops its allowance for credit losses and how it manages its credit exposure.

The amendments in this update apply to all public and nonpublic entities with financing receivables. Financing receivables include loans and trade accounts receivable. However, short-term trade accounts receivable, receivables measured at fair value or lower of cost or fair value, and debt securities are exempt from these disclosure amendments. The effective date of ASU 2010-20 differs for public and nonpublic companies. For public companies, the amendments that require disclosures as of the end of a reporting period are effective for periods ending on or after December 15, 2010. The amendments that require disclosures about activity that occurs during a reporting period are effective for periods beginning on or after December 15, 2010. The Company has fully adopted all of the provisions within this standard and has provided all required credit quality disclosures as of the end of this reporting period March 31, 2011.

On April 5, 2011, FASB issued ASU 2011-02, Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring, which amends Subtopic 310-40, Receivables: Troubled Debt Restructurings by Creditors. The objective of this ASU is to provide greater clarity and guidance to assist creditors in determining whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring constitutes a troubled debt restructuring. For public entities, the amendments in this ASU are effective for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption.

The ASU also states that as a result of applying these amendments, an entity may identify receivables that are newly considered impaired. For purposes of measuring impairment of those receivables, an entity should apply the amendments prospectively for the first interim or annual period beginning on or after June 15, 2011. An entity should disclose the total amount of receivables and the allowance for credit losses as of the end of the period of

29

MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

NOTE J - RECENT ACCOUNTING PRONOUNCEMENTS (Continued)

adoption related to those receivables that are newly considered impaired under Section 310-10-35 for which impairment was previously measured under Subtopic 450-20, Contingencies: Loss Contingencies. An entity should disclose certain information required by and previously deferred by ASU 2011-01, for interim and annual periods beginning on or after June 15, 2011. The Company is currently evaluating the impact of this standard on the financial statements and related disclosures.

NOTE K - SHAREHOLDERS’ EQUITY

During June 2010, the Bank’s Board of Directors entered into an agreement called a Memorandum of Understanding (the “Memorandum”) with the FDIC and North Carolina Commissioner of Banks under which the Bank will move in good faith to take various actions designed to improve the Bank’s lending procedures and other conditions related to its operations. The Memorandum provides for the Board to (i) review and formulate objectives relative to liquidity and growth, including a reduction in reliance on volatile liabilities, (ii) formulate plans for the reduction and improvement in adversely classified assets, (iii) review compliance with and, as necessary, modify written policies regarding asset/liability, investment and funds management, (iv) oversee and enforce loan underwriting procedures and implement policies regarding other real estate and an effective loan documentation system, (v) not pay any dividend without the approval of the regulators, (vi) review officer performance and consider additional staffing needs, and (vii) provide progress reports and submit various other information to the regulators.

During October 2010, the Company’s Board of Directors entered into a separate Memorandum of Understanding with the Federal Reserve Bank of Richmond (the “FRB”) under which the Company agreed, among other things, that it will not receive dividends from the Bank, pay dividends on the Company’s common or preferred stock or payments on its trust preferred securities, incur additional debt, or redeem any outstanding stock, without the FRB’s prior written approval.

30

EX-99.3

Exhibit 99.3

UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION

The following unaudited pro forma combined financial information is designed to show how the merger of American National Bankshares Inc. (“American”) and MidCarolina Financial Corporation (“MidCarolina”) might have affected historical financial statements if the merger had been completed at an earlier time and was prepared based on the historical financial results reported by American and disclosed by MidCarolina in other public filings.

The unaudited pro forma balance sheet data assumes that the merger took place on March 31, 2011 and combines American’s consolidated balance sheet as of March 31, 2011 with MidCarolina’s consolidated balance sheet as of March 31, 2011. The unaudited pro forma statements of income for the three months ended March 31, 2011 and the year ended December 31, 2010 give effect to the merger as if it occurred at the beginning of each applicable period. The unaudited pro forma financial statements give effect to the proposed merger under the acquisition method of accounting.

The unaudited pro forma combined financial information, while helpful in illustrating the financial characteristics of the combined company under one set of assumptions, does not reflect the benefits of expected cost savings or opportunities to earn additional revenue and, accordingly, does not attempt to predict or suggest future results. It also is not necessarily indicative of the financial condition or results of operations of future periods or the financial condition or results of operations that actually would have been realized had the companies been combined during these periods.

The unaudited pro forma combined consolidated financial statements are based on, and should be read together with, the historical consolidated financial statements and related notes of American contained in its Annual Report on Form 10-K for the year ended December 31, 2010 and its Quarterly Report on Form 10-Q for the quarter ended March 31, 2011, and of MidCarolina, contained in its Annual Report on Form 10-K for the fiscal year ended December 31, 2010, and its Quarterly Report on Form 10-Q for the quarter ended March 31, 2011.

In December 2007, the Financial Accounting Standards Board issued Statement of Financial Standards (“SFAS”) No. 141(R) (ASC Topic 805) (“ASC Topic 805”), which replaced SFAS 141, “Business Combinations,” for periods beginning on or after December 15, 2008, but retains the fundamental requirements in SFAS 141, that the acquisition method of accounting (which SFAS 141 called the purchase method) be used for all business combinations and for an acquirer to be identified for each business combination.

AMERICAN NATIONAL BANKSHARES INC. AND MIDCAROLINA FINANCIAL CORP.

Unaudited Pro Forma Condensed Combined Consolidated Balance Sheet

March 31, 2011

(dollars in thousands, except per share data)

	American Historical		MidCarolina Historical			Pro Forma Adjustments			Pro Forma Combined
ASSETS
Cash and due from banks	$	14,248	$	1,666		$	—		$	15,914
Federal funds and Interest-bearing deposits in		25,397		28,088			—			53,485
Total cash and cash equivalents		39,645		29,754			—			69,399
Securities held to maturity		3,146		—			—			3,146
Securities available for sale, at fair value		226,171		88,100			—			314,271
Mortgage loans held for sale		1,309		683			—			1,992
Loans, net of unearned income		516,629		386,873			(35,209	) (2)		868,293
Less allowance for loan losses		8,257		9,691			(9,691	) (3)		8,257
Net loans		508,372		377,182			(25,518	)		860,036
Premises and equipment, net		19,308		6,536			400	(4)		26,244
Other real estate owned		3,532		10,201			(6,631	) (5)		7,102
Core deposit intangibles		1,226		—			7,603	(6)		8,829
Goodwill		22,468		—			15,888	(7)		38,356
Bank-owned life insurance		4,137		8,592			—			12,729
Restricted stock		4,062		2,075			—			6,137
Deferred income tax		1,506		4,534			8,119	(8)		15,459
		—		—			1,300	(1)		—
Other assets		10,356		4,429			—			14,785
Total assets	$	845,238	$	532,086		$	1,162		$	1,378,486
LIABILITIES
Noninterest-bearing deposits	$	117,260	$	54,291		$	—		$	171,551
Interest-bearing deposits:
Interest bearing transaction accounts		96,686		230,453			—			327,139
Money market accounts		57,530		—			—			57,530
Savings accounts		63,236		14,436			—			77,672
Time deposits		328,771		81,421			1,398	(9)		411,590
Brokered deposits		—		91,210			—			91,210
Total interest-bearing deposits		546,223		417,520			1,398			965,141
Total deposits		663,483		471,811			1,398			1,136,692
Securities sold under agreements to repurchase		43,871		—			—			43,871
Other short-term borrowings		—		—			—			—
Long-term borrowings		4,450		10,000			(170	) (10)		14,280
Trust Preferred capital notes		20,619		8,764			(2,177	) (11)		27,206
Other liabilities		3,443		897			5,300	(1)		9,640
Total liabilities		735,866		491,472			4,351			1,231,689
Commitments and contingencies
STOCKHOLDERS’ EQUITY
Preferred stock		—		4,819			—	(12)		4,819
Common stock		6,153		15,215			(13,589	) (12)		7,779
Surplus		27,541		—			34,979	(12)		62,520
Retained earnings		75,214		21,660			(21,660	) (12)		71,214
		—		—			(4,000	) (1)		—
Accumulated other comprehensive income (loss)		464		(1,080	)		1,080	(12)		464
Total stockholders’ equity		109,372		40,614			(3,190	)		146,796
Total liabilities and stockholders’ equity	$	845,238	$	532,086		$	1,162		$	1,378,486

The accompanying notes are an integral part of the unaudited pro forma condensed combined consolidated financial information. Certain reclassifications have been made to MidCarolina’s balance sheet to conform with American’s presentation.

2

Notes to Unaudited Pro Forma Condensed Combined Consolidated Balance Sheet at March 31, 2011

Under acquisition accounting MidCarolina’s assets and liabilities and any identifiable intangible assets are required to be stated at their estimated fair values. American has engaged a competent third party valuation specialist to assist in the valuation of the major financial assets and liabilities of the acquired bank. Pro form adjustments reflected herein present preliminary estimates based on initial work by the valuation specialist and American and is preliminary and subject to adjustment and may vary from the actual purchase price allocation that will be recorded based on the actual balance sheet at the acquisition date.

(1) Adjustment to record estimated one-time merger related expenses totaling $5.3 million ($4.0 million net of taxes at a 35% tax rate.)

(2) Management has not finalized the amounts of those loans with evidence of deterioration of credit quality since origination and where it is probable that the collection of all contractually required payments receivable would not occur and thus within the scope of ASC 310-30 (formerly SOP 03-3). However, initial estimates are $88.3 million of unpaid principal balance will apply. The contractually required payments receivable related to these loans is approximately $93.3 million with expected cash flow to be collected of $80.3 million. The estimated fair value of such loans is $71.7 million, with a nonaccretable difference of $12.9 million and accretable yield of $8.6 million. For purposes of these pro formas, management is recognizing income on the related interest mark of $3.5 million over five years, the expected life of the loans, using the sum of the years digits method as an approximation of the level yield method.

For the remaining portfolio of approximately $298.6 million that is not within the scope of ASC 310-30, the Company will accrete the estimated fair value adjustment of $18.6 million over the estimated life of the loans of five years using the sum of the years digits method as an approximation of the level yield method, based upon the guidance for accounting for loan origination fees and costs under ASC 310-20 (formerly SFAS 91).

(3) Elimination of MidCarolina’s allowance for loan losses.

(4) Adjustment to premises and equipment to reflect increased value of real estate as provided by a preliminary valuation.

(5) Adjustment to reflect fair value of other real estate as provided by a preliminary valuation.

(6) Estimation of fair value of core deposit intangible (“CDI”). The estimated CDI represents the estimated future economic benefit resulting from the acquired customer balances and relationships. This value was estimated based on similar transactions while the final value will be determined based upon an independent appraisal at the date of the acquisition. For pro forma purposes, we are amortizing the CDI using the sum-of-the-years-digits method, as a proxy for accelerated amortization, and an estimated life of seven years.

3

(7) Estimated amount of goodwill to be recorded in the acquisition of MidCarolina, less amounts allocated to the fair value of tangible and specifically identified intangible assets acquired. The purchase price and purchase price allocation are as follows:

Allocation of Purchase Price
Total consideration
Preferred stock	$	4,819
Common stock (1,626,183 @ $22.51, March 31, 2011 closing price for American)		36,605
Total consideration (Purchase Price)			$	41,424
Net assets acquired (book value)				40,614
Purchase price greater than book value				810
Allocated to:
Core deposit intangible				7,603
Eliminate existing allowance for loan losses				9,691
Fair value adjustment on loans				(35,209	)
Premises and equipment				400
Deposits				(1,398	)
Long term borrowings (FHLB advances)				170
Trust preferred capital notes				2,177
Other real estate owned				(6,631	)
Deferred income tax asset				8,119
Total allocations				(15,078	)
Purchase price less allocation to identifiable asset and liabilities (goodwill)			$	15,888

(8) Estimated deferred tax asset arising from the credit quality fair value adjustment on loans and other fair value adjustments of assets and liabilities, less deferred tax liabilities arising from the core deposit intangible and other fair value adjustments of assets and liabilities, all at a 35% tax rate.

(9) Fair value adjustment on time deposits at current market rates for similar products. This adjustment will be accreted into income over the estimated lives of the time deposits. Due to the very short estimated lives of these deposits, American expects that the adjustment accretion will reduce interest expense over the first year of the merger. This amount will be adjusted to actual based on a final valuation as of the merger date.

(10) Fair value adjustment of borrowings at current interest rates for similar borrowings. This adjustment amortization will increase interest expense over the estimated remaining five year life of the borrowings. Estimated amortization was determined using the straight line method, which should approximate the level yield method, as these borrowings are due at maturity. We are in the process of conducting a merger date independent valuation of these amounts.

(11) Fair value adjustment of borrowings at current interest rates for similar borrowings. This adjustment amortization will increase interest expense over the estimated remaining 20 year life of the borrowings. Estimated amortization was determined using the straight line method, which should approximate the level yield method, as their borrowings are due at maturity. We are in the process of conducting a merger date independent valuation of these amounts.

(12) Elimination of MidCarolina stockholders’ equity as part of the acquisition accounting adjustments representing the conversion of all MidCarolina common shares into American common shares and the conversion of MidCarolina preferred into American preferred. MidCarolina common shares convert at a ratio of 0.33 American shares for each share of MidCarolina. MidCarolina preferred shares will be converted with the same terms and conditions as they had originally.

4

AMERICAN NATIONAL BANKSHARES INC. AND MIDCAROLINA FINANCIAL CORP.

Unaudited Pro Forma Condensed Combined Consolidated Statements of Income

For the Quarter Ended March 31, 2011

(dollars in thousands, except per share data)

	American Historical		MidCarolina Historical		Pro Forma Adjustment			Pro Forma Combined
Interest Income
Interest and fees on loans	$	6,679	$	5,294	$	1,854	(1)	$	13,827
Interest on federal funds sold and deposits in other banks		70		9		—			79
Dividends		27		6		—			33
Interest and dividends on securities:
Taxable		1,169		373		104	(2)		1,646
Nontaxable		716		294		—			1,010
Total interest and dividend income		8,661		5,976		1,957			16,594
Interest Expense
Interest on deposits		1,580		1,339		(350	) (3)		2,569
Interest on trust preferred capital notes		343		—		—			343
Interest on securities sold under agreement to repurchase		80		—		—			80
Interest on long-term borrowings		53		168		36	(4)		257
Total interest expense		2,056		1,507		(314	)		3,249
Net interest income		6,605		4,469		2,271			13,345
Provision for loan losses		337		1,200		—			1,537
Net interest income after provision for loan losses		6,268		3,269		2,271			11,808
Noninterest Income
Trust fees and brokerage		928		69		—			997
Service charges on deposit accounts		421		150		—			571
Other service charges, commissions and fees		316		—		—			316
Mortgage banking income		147		116		—			263
Gains on securities transactions, net		1		—		—			1
Other-than-temporary impairment of securities available for sale		—		—		—			—
Increase in cash surrender value of life insurance		34		78		—			112
Other operating income		124		127		—			251
Total noninterest income		1,971		540		—			2,511
Noninterest Expense
Salaries and benefits		3,026		1,332		—			4,358
Occupancy expenses		699		380		5	(5)		1,084
FDIC assessment		205		318		—			523
Bank franchise tax		175		30		—			205
Amortization of core deposit premiums		94		—		475	(6)		569
Losses on sales of other real estate owned and bank premises, net		22		229					251
Merger related expenses		309		108		(417	) (7)		—
Other expenses		1,249		1,026					2,275
Total noninterest expenses		5,779		3,423		63			9,265
Income before income taxes		2,460		386		2,208			5,054
Income tax expense		682		94		662	(8)		1,438
Net income	$	1,778	$	292	$	1,546		$	3,616
Dividends paid and accumulated on preferred stock		—		50		—			50
Net income available to common stockholders		1,778		242		1,546			3,566
Earnings per common share, basic	$	0.29	$	0.05				$	0.46
Earnings per common share, diluted	$	0.29	$	0.05				$	0.46
Weighted average shares outstanding – Basic		6,143,602		4,927,828		1,626,183	(9)		7,769,785
Weighted average shares outstanding – Diluted		6,152,738		4,931,814		1,626,183			7,778,921

The accompanying notes are an integral part of the unaudited pro forma condensed combined consolidated financial information. Certain reclassifications have been made to MidCarolina’s income statement to conform with American’s presentation.

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AMERICAN NATIONAL BANKSHARES INC. AND MIDCAROLINA FINANCIAL CORP.

Unaudited Pro Forma Condensed Combined Consolidated Statements of Income

For the Year Ended December 31, 2010

(dollars in thousands, except per share data)

	American Historical			MidCarolina Historical			Pro Forma Adjustment			Pro Forma Combined
Interest Income
Interest and fees on loans	$	28,148		$	22,943		$	7,414	(1)	$	58,505
Interest on federal funds sold and deposits in other banks		360			48			—			408
Dividends		95			29			—			124
Interest and dividends on securities:
Taxable		5,042			1,539			415	(2)		6,996
Nontaxable		2,288			1,167			—			3,455
Total interest and dividend income		35,933			25,726			7,829			69,488
Interest Expense
Interest on deposits		6,708			7,155			(1,398	) (3)		12,465
Interest on trust preferred capital notes		1,373			320			—			1,693
Interest on securities sold under agreement to repurchase		382			—			—			382
Interest on long-term borrowings		256			648			143	(4)		1,047
Total interest expense		8,719			8,123			(1,255	)		15,587
Net interest income		27,214			17,603			9,085			53,902
Provision for loan losses		1,490			6,418			—			7,908
Net interest income after provision for loan losses		25,724			11,185			9,085			45,994
Noninterest Income
Trust fees and brokerage		3,391			248			—			3,639
Service charges on deposit accounts		1,897			712			—			2,609
Other service charges, commissions and fees		1,163			—			—			1,163
Mortgage banking income		1,560			786			—			2,346
Gains on securities transactions, net		157			51			—			208
Other-than-temporary impairment of securities available for sale		(31	)		(29	)		—			(60	)
Increase in cash surrender value of life insurance		137			335			—			472
Other operating income		840			556			—			1,396
Total noninterest income		9,114			2,659			—			11,773
Noninterest Expense
Salaries and benefits		12,505			5,261			—			17,766
Occupancy expenses		2,936			1,506			20	(5)		4,462
FDIC assessment		795			1,085			—			1,880
Bank franchise tax		670			121			—			791
Amortization of core deposit premiums		378			—			1,901	(6)		2,279
Losses on sales of other real estate owned and bank premises, net		583			110						693
Merger related expenses		358			108			(466	) (7)		—
Other expenses		5,154			4,690			—			9,844
Total noninterest expenses		23,379			12,881			1,455			37,715
Income before income taxes		11,459			963			7,630			20,052
Income tax expense		3,181			(14	)		2,289	(8)		5,456
Net income	$	8,278		$	977		$	5,341		$	14,596
Dividends paid and accumulated on preferred stock		—			364			—			364
Net income available to common stockholders		8,278			613			5,341			14,232
Earnings per common share, basic	$	1.35		$	0.12					$	1.84
Earnings per common share, diluted	$	1.35		$	0.12					$	1.83
Weighted average shares outstanding – Basic		6,123,870			4,927,828			1,626,183	(9)		7,750,053
Weighted average shares outstanding – Diluted		6,131,650			4,927,828			1,626,183			7,757,833

The accompanying notes are an integral part of the unaudited pro forma condensed combined consolidated financial information. Certain reclassifications have been made to MidCarolina’s income statement to conform with American’s presentation.

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Notes to Unaudited Pro Forma Condensed Combined Consolidated Statements of Operations for the three months ended March 31, 2011 and the year ended December 31, 2010

(1) Reflects estimated accretion of the fair value adjustments to loans over the expected life of five years, using the sum of years digits method as an approximation of the level yield method.

(2) All investments were identified as available for sale and recorded at fair value. The available for sale discount of $1.6 million accreted into income over an estimated life of seven years, computed using the sum of years digits method as an approximation of the level yield method.

(3) Reflects estimated accretion of the fair value adjustments to time deposits over their expected life of one year.

(4) Reflects the estimated amortization of the fair value adjustments to FHLB borrowings over the expected life of five years and the fair value adjustment of trust preferred notes over the expected life of 20 years. All this debt is payable at maturity and amortization is computed on a straight line basis, as an approximation of the level yield method.

(5) Amount represents estimated additional depreciation from fair value adjustment to real estate assets, computed over an estimated 20 year life on a straight line basis.

(6) Amount represents CDI amortization computed using the sum of years digits method as a proxy for accelerated amortization, over an estimated life of seven years.

(7) Adjustment to remove merger related expenses from pro forma income statement.

(8) The effective tax rate for American is less than 28%. For purposes of this pro forma we are estimating the combined effective tax rate at 30%.

(9) The pro forma number of shares issued by American was computed by multiplying 4.9 million MidCarolina shares outstanding by the fixed exchange ratio of 0.33.

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