U. S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

FORM 10-Q

[ X ] Quarterly Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2011

[ ] Transition Report Pursuant to Section 13

or 15(d) of the Securities Exchange Act of 1934

For the transition period ended

Commission File Number - 000-49898

NORTH STATE BANCORP

(Exact name of small business issuer as specified in its charter)

NORTH CAROLINA		65-1177289
(State or other jurisdiction of		(IRS Employer
incorporation or organization)		Identification Number)

6204 FALLS OF THE NEUSE ROAD, RALEIGH, NORTH CAROLINA 27609

(Address of principal executive office)

(919) 787-9696

(Issuer’s telephone number)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes X No___

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes X No___

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

Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [ ] (Do not check if a smaller reporting company) Smaller reporting company [X]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12 b-2 of the Exchange Act): Yes___ No X

As of August 12, 2011, 7,427,976 shares of the registrant’s common stock, no par value per share, were outstanding. The registrant has no other classes of securities outstanding.

		Page No.
Part I.	FINANCIAL INFORMATION

Item 1 -	Financial Statements (Unaudited)

	Consolidated Balance Sheets
	June 30, 2011 and December 31, 2010	3

	Consolidated Statements of Operations
	Three and Six Months Ended June 30, 2011 and 2010	4

	Consolidated Statements of Comprehensive Income
	Three and Six Months Ended June 30, 2011 and 2010	5

	Consolidated Statement of Shareholders’ Equity
	Six Months Ended June 30, 2011 and 2010	6

	Consolidated Statements of Cash Flows
	Six Months Ended June 30, 2011 and 2010	7

	Notes to Consolidated Financial Statements	8

Item 2 -	Management’s Discussion and Analysis of Financial Condition and Results of Operations	32

Item 3 -	Quantitative and Qualitative Disclosures About Market Risk	47

Item 4 -	Controls and Procedures	47

Part II.	OTHER INFORMATION

Item 6 -	Exhibits	48

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Part I. FINANCIAL INFORMATION

Item 1 - Financial Statements

NORTH STATE BANCORP

CONSOLIDATED BALANCE SHEETS

	June 30, 2011		December 31, 2010
	(unaudited)			*
ASSETS	(Dollars in thousands)

Cash and due from banks	$	8,731	$	5,974
Interest-earning deposits with banks		61,684		43,859
Certificates of deposit with banks		735		198
Investment securities available for sale, at fair value		17,011		9,234
Investment securities held to maturity, at amortized cost		250		250
Loans held for sale		47,182		51,472

Loans		482,721		499,523
Less allowance for loan losses		9,944		9,935
Net loans		472,777		489,588

Accrued interest receivable		1,424		1,654
Stock in the Federal Home Loan Bank of Atlanta, at cost		1,227		1,273
Premises and equipment, net		14,487		14,801
Foreclosed assets		3,121		5,296
Prepaid FDIC insurance		2,991		3,646
Other assets		6,717		6,620

TOTAL ASSETS	$	638,337	$	633,865

LIABILITIES AND SHAREHOLDERS' EQUITY

Deposits:
Demand	$	130,549	$	117,840
Savings, money market and NOW		264,107		250,469
Time		172,218		194,439
Total deposits		566,874		562,748

Accrued interest payable		1,308		1,181
Short-term borrowings		3,461		3,615
Long-term borrowings		27,258		27,269
Accrued expenses and other liabilities		1,304		1,550

TOTAL LIABILITIES		600,205		596,363

Commitments

Shareholders' equity:
Preferred stock, no par value, 1,000,000 shares authorized, none issued		-		-
Common stock, no par value; 10,000,000 shares authorized; 7,427,976 shares issued and outstanding June 30, 2011 and December 31, 2010		21,686		21,636
Retained earnings		16,240		15,926
Accumulated other comprehensive loss		206		(60	)

TOTAL SHAREHOLDERS' EQUITY		38,132		37,502

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY	$	638,337	$	633,865

*Derived from audited consolidated financial statements

See accompanying notes.

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NORTH STATE BANCORP

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)


	Three Months Ended June 30,				Six Months Ended June 30,
	2011		2010		2011		2010
	(Dollars in thousands, except per share data)
INTEREST INCOME
Loans	$	6,156	$	7,108	$	12,816	$	14,209
Loans held for sale		272		298		546		358
Investments		244		181		347		391
Dividends and interest-earning deposits		62		202		105		431
Total interest income		6,734		7,789		13,814		15,389

INTEREST EXPENSE
Savings, money market and NOW		401		521		881		1,066
Time deposits		717		1,215		1,487		2,601
Short-term borrowings		1		7		2		13
Long-term borrowings		230		228		461		448
Total interest expense		1,349		1,971		2,831		4,128

NET INTEREST INCOME		5,385		5,818		10,983		11,261

PROVISION FOR LOAN LOSSES		1,418		1,612		2,433		2,862

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		3,967		4,206		8,550		8,399

NON-INTEREST INCOME
Merchant and other loan fees		27		33		53		63
Service charges and fees on deposits		98		98		196		196
Gain on sale of investment securities		329		-		329		232
Fees from mortgage operations		536		484		1,033		653
Other		175		110		297		167
Total non-interest income		1,165		725		1,908		1,311

NON-INTEREST EXPENSE
Salaries and employee benefits		2,266		1,956		4,569		3,593
Occupancy and equipment		702		654		1,405		1,365
Professional fees		86		161		168		256
Advertising and promotion		33		24		62		74
Data processing and other outsourced services		443		344		913		697
FDIC insurance		358		353		690		717
Net cost of foreclosed assets		561		464		1,052		791
Other		501		421		1,093		787
Total non-interest expense		4,950		4,377		9,952		8,280

INCOME BEFORE INCOME TAXES		182		554		506		1,430

INCOME TAXES		71		244		192		606

NET INCOME	$	111	$	310	$	314	$	824

NET INCOME PER COMMMON SHARE:
Basic	$	0.01	$	0.04	$	0.04	$	0.11
Diluted	$	0.01	$	0.04	$	0.04	$	0.11

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
Basic		7,427,976		7,337,980		7,427,976		7,298,201
Diluted		7,431,682		7,371,396		7,432,884		7,345,693

See accompanying notes

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NORTH STATE BANCORP

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2011			2010			2011			2010
	(Dollars in thousands)

Net income	$	111		$	310		$	314		$	824

Other comprehensive income (loss):
Securities available for sale:
Unrealized holding gains on available for sale securities		792			171			762			207
Tax effect		(305	)		(66	)		(294	)		(79	)
Reclassification of net gain recognized in net income		(329	)		-			(329	)		(232	)
Tax effect		127			-			127			89

Total other comprehensive income (loss)		285			105			266			(15	)

Comprehensive income	$	396		$	415		$	580		$	809

See accompanying notes.

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NORTH STATE BANCORP

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (Unaudited)

							Accumulated
							other			Total
	Common Stock				Retained		comprehensive			shareholders'
	Shares		Amount		earnings		income (loss)			equity
	(Dollars in thousands)

Balance as of December 31, 2009		7,198,513	$	20,865	$	14,902	$	399		$	36,166
Net income		-		-		824		-			824
Other comprehensive loss, net of tax		-		-		-		(15	)		(15	)
Stock based compensation		-		50		-		-			50
Stock options exercised including income tax benefit of $61		229,463		672		-		-			672

Balance as of June 30, 2010		7,427,976	$	21,587	$	15,726	$	384		$	37,697

Balance as of December 31, 2010		7,427,976	$	21,636	$	15,926	$	(60	)	$	37,502
Net income		-		-		314		-			314
Other comprehensive income, net of tax		-		-		-		266			266
Stock based compensation		-		50		-		-			50

Balance as of June 30, 2011		7,427,976	$	21,686	$	16,240	$	206		$	38,132

See accompanying notes.

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NORTH STATE BANCORP

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

	Six months ended June 30,
	2011			2010
	(Dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	314		$	824
Adjustments to reconcile net income to net cash provided (used) by operating activities:
Provision for loan losses		2,433			2,862
Depreciation and amortization		453			465
Net amortization (accretion) of premiums and discounts on investment securities		1			(12	)
Amortization of investment accounted for under the cost method		40			19
Originations of loans held for sale		(157,799	)		(84,863	)
Proceeds from sales of loans held for sale		161,757			53,651
Net realized gain on sale of investment securities available for sale		(329	)		(232	)
Loss on sale of foreclosed assets		67			24
Provision for foreclosed assets		957			649
Stock based compensation		50			50

Changes in assets and liabilities:
Decrease in other assets		683			2,266
Decrease in accrued interest receivable		230			166
Decrease in accrued expenses and other liabilities		(246	)		(240	)
Increase in accrued interest payable		127			207
Net cash provided (used) by operating activities		8,738			(24,164	)

CASH FLOWS FROM INVESTING ACTIVITIES:
Net change in certificates of deposit with banks		(537	)		14,741
Proceeds from sales of investment securities available for sale		17,785			4,885
Proceeds from maturities and repayments of investment securities available for sale		7,876			2,223
Purchases of investment securities available for sale		(32,677	)		(4,990	)
Sale of FHLB stock		46			-
Net decrease in loans		13,510			6,901
Purchases of premises and equipment		(139	)		(350	)
Proceeds from sales of foreclosed assets		2,090			3,203
Capital expenditures on foreclosed assets		(71	)		(114	)
Net cash provided by investing activities		7,883			26,499

CASH FLOWS FROM FINANCING ACTIVITIES:
Net decrease in short term borrowed funds		(154	)		(720	)
Repayments on long-term borrowings		(11	)		(10	)
Net increase (decrease) in deposit accounts		4,126			(28,888	)
Excess tax benefits from exercise of stock options		-			61
Exercise of stock options		-			611
Net cash provided (used) by financing activities		3,961			(28,946	)

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		20,582			(26,611	)

CASH AND CASH EQUIVALENTS, BEGINNING		49,833			59,083

CASH AND CASH EQUIVALENTS, ENDING	$	70,415		$	32,472

See accompanying notes.

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NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE A - BASIS OF PRESENTATION

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 June 30, 2011 and December 31, 2010 and for the three and six-month periods ended June 30, 2011 and 2010, in conformity with accounting principles generally accepted in the United States of America. The consolidated financial statements include the accounts of North State Bancorp (the “Company”) and its wholly-owned subsidiary, North State Bank (the “Bank”). North State Bank Mortgage (“NSB Mortgage”), a division of the Bank, began operations during February 2010 for the purpose of originating and selling single family, residential first mortgage loans.

All significant intercompany transactions and balances have been eliminated in consolidation. The preparation of 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 and six-month periods ended June 30, 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 relevant information are contained in the notes to the consolidated financial statements filed as part of the Company’s 2010 Annual Report on Form 10-K for the year ended December 31, 2010. This quarterly report should be read in conjunction with the Annual Report.

NOTE B – RECENT ACCOUNTING PRONOUNCEMENTS

In April 2011, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update No. 2011-02, A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. The new standard provides additional guidance on a creditor’s evaluation of when a concession on a loan has been granted and whether a debtor is experiencing financial difficulties. A creditor must conclude that both of these conditions exist for the loan to be considered a troubled debt restructuring. This guidance is effective for interim and annual reporting periods beginning after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. The Company expects to adopt the update of this standard during the quarter ending September 30, 2011. The adoption is not expected to have a material impact on the consolidated financial statements.

In April 2011, the FASB issued Accounting Standards Update No. 2011-03, Transfers and Servicing (Topic 860), Reconsideration of Effective Control for Repurchase Agreements. The amendments in this standard remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (2) the collateral maintenance implementation guidance related to that criterion. Other criteria applicable to the assessment of effective control are not changed by the amendments in this Update. The guidance in this Update is effective for the first interim or annual period beginning on or after December 15, 2011. The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. The Company does not anticipate that the adoption of this statement will have a material impact on the consolidated financial statements.

In May 2011, the FASB issued Accounting Standards Update No. 2011-04, Fair Value Measurement. The purpose of the standard is to clarify and combine fair value measurements and disclosure requirements for

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NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE B – RECENT ACCOUNTING PRONOUNCEMENTS (Continued)

U.S. generally accepted accounting principles, or GAAP, and international financial reporting standards, or IFRS. The new standard provides amendments and wording changes used to describe certain requirements for measuring fair value and for disclosing information about fair value measurements. This guidance is effective for interim and annual reporting periods beginning after December 15, 2011, and should be applied prospectively to the beginning of the annual period of adoption. The Company does not anticipate that the adoption of this statement will have a material impact on the consolidated financial statements.

In June 2011, the FASB issued Accounting Standards Update No. 2011-05, Comprehensive Income. The new standard provides guidance and new formats for reporting components of total net income and comprehensive income. The guidance allows the presentation of net income and comprehensive income to be in a single continuous statement or two separate but consecutive statements. This guidance is effective for interim and annual reporting periods beginning after December 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. The Company does not anticipate that the adoption of this statement will have a material impact on the consolidated financial statements.

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

NOTE C - INVESTMENT SECURITIES

Available for sale securities are reported at fair value and consist of debt instruments not classified as trading securities or as held to maturity securities. Unrealized holding gains and losses on available for sale securities are reported, net of related tax effect, in other comprehensive income. Gains and losses on the sale of available for sale securities are determined using the specific-identification method. Bonds and mortgage-backed securities for which the Company has the positive intent and ability to hold to maturity are reported at cost, adjusted for premiums and discounts that are recognized in interest income using a method that approximates the interest method over the period to maturity. Declines in the fair value of available for sale and held to maturity securities below their cost that are other than temporary would result in write-downs of the individual securities to their fair value. If the Company does not intend to sell the security prior to recovery and it is more likely than not the Company will not be required to sell the impaired security prior to recovery, the credit loss portion of the impairment is recognized in earnings and the remaining impairment is recognized in other comprehensive income. Otherwise, the full impairment loss is recognized in earnings. The classification of securities is determined at the date of purchase.

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NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE C - INVESTMENT SECURITIES (Continued)

The amortized cost and fair value of securities available for sale and securities held to maturity, with gross unrealized gains and losses, follows:

	As of June 30, 2011
			Gross		Gross
	Amortized		unrealized		unrealized		Fair
	cost		gains		losses		value
	(Dollars in thousands)
Securities available for sale:
Government-sponsored residential mortgage-backed securities	$	16,672	$	377	$	38	$	17,011
Total securities available for sale	$	16,672	$	377	$	38	$	17,011

Securities held to maturity:
Corporate securities	$	250	$	-	$	46		204
Total securities held to maturity	$	250	$	-	$	46	$	204


	As of December 31, 2010
			Gross		Gross
	Amortized		unrealized		unrealized		Fair
	cost		gains		losses		value
			(Dollars in thousands)
Securities available for sale:
U. S. government securities and obligations of U.S. government agencies	$	5,500	$	-	$	-	$	5,500
Government-sponsored residential mortgage-backed securities		3,829		28		123		3,734
Total securities available for sale	$	9,329	$	28	$	123	$	9,234

Securities held to maturity:
Corporate securities	$	250	$	-	$	39		211
Total securities held to maturity	$	250	$	-	$	39	$	211

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NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE C - INVESTMENT SECURITIES (Continued)

The following table shows as of June 30, 2011 and December 31, 2010 gross unrealized losses on and fair values of the Company’s investments, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position. All unrealized losses on investment securities are considered by management to be temporary given the credit ratings on these investment securities and the Company’s intent and ability to hold its securities to maturity. The unrealized losses as of June 30, 2011 and December 31, 2010 relate to one government-sponsored residential mortgage-backed security. The unrealized losses on held to maturity corporate securities as of June 30, 2011 and December 31, 2010 relate to one corporate security. The unrealized losses are not likely to reverse unless and until market interest rates and/or spreads decline to the levels that existed when the securities were purchased. Since the Company does not intend to sell the securities prior to recovery and it is more likely than not the Company will not be required to sell the impaired securities prior to recovery, none of the securities are deemed to be other than temporarily impaired.

	As of June 30, 2011
	Less than 12 months				12 months of more				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
	Value		Losses		Value		Losses		Value		Losses
	(Dollars in thousands)
Securities available for sale:
Government-sponsored residential mortgage-backed securities	$	2,964	$	38	$	-	$	-	$	2,964	$	38
Total temporarily impaired securities	$	2,964	$	38	$	-	$	-	$	2,964	$	38

Securities held to maturity:
Corporate securities	$	-	$	-	$	204	$	46	$	204	$	46
Total securities held to maturity	$	-	$	-	$	204	$	46	$	204	$	46


	As of December 31, 2010
	Less than 12 months				12 months of more				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
	Value		Losses		Value		Losses		Value		Losses
	(Dollars in thousands)
Securities available for sale:
Government-sponsored residential mortgage-backed securities	$	2,879	$	123	$	-	$	-	$	2,879	$	123
Total temporarily impaired securities	$	2,879	$	123	$	-	$	-	$	2,879	$	123

Securities held to maturity:
Corporate securities	$	-	$	-	$	211	$	39	$	211	$	39
Total securities held to maturity	$	-	$	-	$	211	$	39	$	211	$	39

The amortized cost and fair values of securities available for sale and securities held to maturity as of June 30, 2011 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

	As of June 30, 2011
	Amortized		Fair
	Cost		Value
	(Dollars in thousands)
Securities available for sale:
Government-sponsored residential mortgage-backed securities
Due within one year	$	288	$	292
Due after one but within five years		193		202
Due after five but within ten years		4,760		4,818
Due after ten years		11,431		11,699
	$	16,672	$	17,011
Securities held to maturity:
Corporate Securities
Due after five but within ten years	$	250	$	204
	$	250	$	204

Securities with a carrying value of $6.3 million and $8.8 million as of June 30, 2011 and December 31, 2010, respectively, were pledged to secure securities sold under agreements to repurchase and public deposits.

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NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE C - INVESTMENT SECURITIES (Continued)

For the three and six months ended June 30, 2011 proceeds from sales of investment securities of $17.8 million resulted in gross gains of $329,000. There were no sales of investment securities for the three months ended June 30, 2010. For the six months ended June 30, 2010 proceeds from sales of investment securities of $4.9 million resulted in gross gains of $232,000.

NOTE D - COMMITMENTS

As of June 30, 2011, loan commitments were as follows:

	June 30, 2011
	(Dollars in thousands)

Commitments to extend credit	$	27,246
Undisbursed lines of credit		14,416
Letters of credit		1,955
Commitments to originate mortgage loans, fixed and variable		102,491
	$	146,108

NOTE E – LOANS

Following is a summary of loans segregated by category:

	June 30, 2011					December 31, 2010
			% of					% of
			Total					Total
	Amount		Loans			Amount		Loans
	(Dollars in thousands)
Real estate loans:
Residential - construction	$	37,036		7.6	%	$	51,058		10.2	%
Commercial - construction		76,627		15.9	%		82,010		16.4	%
Residential - other		121,485		25.2	%		98,324		19.7	%
Commercial - other		207,159		42.9	%		221,603		44.4	%
		442,307		91.6	%		452,995		90.7	%
Non-real estate loans:
Commercial and industrial		37,127		7.7	%		42,884		8.6	%
Consumer and other		3,287		0.7	%		3,644		0.7	%
		40,414		8.4	%		46,528		9.3	%
Total loans	$	482,721		100.0	%	$	499,523		100.0	%

Loans are primarily funded in Wake County and New Hanover County in North Carolina. Real estate loans can be affected by the condition of the local real estate market. Commercial and installment loans can be affected by local, regional and national economic conditions.

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NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE E – LOANS (Continued)

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

Real estate construction

Commercial and residential construction loans are underwritten utilizing independent appraisal reviews, sensitivity analysis of absorption and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of costs and value associated with the project as completed. 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, 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, general economic conditions, availability of long-term financing and government regulation of real property. As of June 30, 2011 and December 31, 2010, residential construction and commercial construction loans represented 7.6% and 15.9% and 10.2% and 16.4%, respectively, of the Company’s loans outstanding.

Commercial and residential real estate

Commercial and residential real estate secured loans are subject to underwriting similar to real estate construction loans. These loans are either cash flow loans or development loans paid from the real estate sale and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher risk and 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 Company’s commercial real estate portfolio are principally secured by owner-occupied buildings including professional practices, office and church properties and single family rental properties. Management monitors and evaluates commercial real estate loans based on collateral, market area and risk grade criteria. As a general rule, the Company avoids non-owner occupied commercial 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 within its market areas. Residential real estate properties are typically secured by the primary residence of the borrower and the combined loan-to-value ratio is usually 90% or less. As of June 30, 2011 and December 31, 2010, commercial and residential real estate represented 42.9% and 25.2% and 44.4% and 19.7%, respectively, of our loans outstanding.

Commercial and industrial

Non-real estate secured 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. Management examines current and projected cash flows of the borrower to determine the ability of the borrower to repay their obligations as agreed. Commercial and industrial loans are primarily made based on the indentified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower and tertiary, as applicable, the guarantors. The cash flows of borrowers, however, may not materialize 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 guaranty. In the case of loans secured by accounts receivable, the availability of the funds for repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. As of June 30, 2011 and December 31, 2010, commercial and industrial loans represented 7.7% and 8.6%, respectively, of the Company’s loans outstanding.

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NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE E – LOANS (Continued)

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

The Company also originates single-family, residential mortgage loans that have been approved by secondary investors which are included on the consolidated balance sheet under the caption “loans held for sale.” The Company recognizes certain origination and service release fees from sale, which are included in non-interest income on the consolidated statements of operations. As of June 30, 2011 and December 31, 2010 mortgage loans held for sale were $47.2 million and $51.5 million, respectively.

Nonperforming assets and potential problem loans

A summary of total nonperforming assets and detail of nonaccrual loans, troubled debt restructured (“TDR”) loans, foreclosed assets and potential problem loans by loan category as of June 30, 2011 and December 31, 2010 are as follows:

	June 30, 2011				December 31, 2010
	(Dollars in thousands)

Nonaccrual loans	$	21,978			$	10,972
TDR nonaccrual loans		4,776				520
Total nonaccrual loans		26,754				11,492

Foreclosed assets		3,122				5,296
Total nonperforming assets	$	29,876			$	16,788

Accruing loans past due 90 days or more	$	133			$	131
TDR accruing loans	$	7,113			$	11,741
Potential problem loans	$	-			$	1,184
Allowance for loan losses	$	9,944			$	9,935

Nonaccrual loans to period end loans		5.54	%			2.30	%
Allowance for loan losses to period end loans		2.06	%			1.99	%
Nonperforming assets to total assets		4.68	%			2.65	%
Ratio of allowance for loan losses to nonaccrual loans		0.37		x		0.86	x

-14-

NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE E – LOANS (Continued)

	As of June 30, 2011
	Nonaccrual		Nonaccrual TDR		Total Nonaccrual		Foreclosed Assets		Total Nonperforming Assets		Potential Problem Loans		Accruing TDR
	(Dollars in thousands)

Commercial and industrial	$	423	$	461	$	884	$	-	$	884	$	-	$	64
Commercial real estate loans:
Construction		7,288		2,888		10,176		1,218		11,394		-		568
Other		2,642		914		3,556		846		4,402		-		3,272
		9,930		3,802		13,732		2,064		15,796		-		3,840
Residential real estate loans:
Construction		8,614		-		8,614		816		9,430		-		2,021
Other		2,997		468		3,465		242		3,707		-		1,171
		11,611		468		12,079		1,058		13,137		-		3,192

Consumer		14		45		59		-		59		-		17
	$	21,978	$	4,776	$	26,754	$	3,122	$	29,876	$	-	$	7,113



	As of December 31, 2010
	Nonaccrual		Nonaccrual TDR			Total Nonaccrual		Foreclosed Assets		Total Nonperforming Assets		Potential Problem Loans	Accruing TDR
	(Dollars in thousands)

Commercial and industrial	$	1,544	$	54	$	1,598	$	-	$	1,598	$	461	$	1,078
Commercial real estate loans:
Construction		2,875		-		2,875		1,484		4,359		523		4,752
Other		255		-		255		1,868		2,123		-		3,870
		3,130		-		3,130		3,352		6,482		523		8,622
Residential real estate loans:
Construction		4,056		-		4,056		813		4,869		-		2,021
Other		2,231		466		2,697		1,131		3,828		200		-
		6,287		466		6,753		1,944		8,697		200		2,021

Consumer		11		-		11		-		11		-		20
	$	10,972	$	520	$	11,492	$	5,296	$	16,788	$	1,184	$	11,741

All classes of loans are classified as nonaccrual if they are past due as to maturity or payment of principal or interest for a period of more than 90 days, unless such loans are well-secured and in the process of collection. Loans that are current or past due less than 90 days may also be classified as nonaccrual if repayment in full of principal and/or interest is in doubt (as determined by the contractual terms of the note). Loans may be returned to accrual status when all principal and interest amounts contractually due (including arrearages) are reasonably assured of repayment within an acceptable period of time, and there is a sustained period of repayment performance (generally a minimum of six months) by the borrower, in accordance with the contractual terms.

Past due loans

An aged analysis of past due loans segregated by loan category as of June 30, 2011 and December 31, 2010 are as follows:

-15-

NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE E – LOANS (Continued)

	As of June 30, 2011
											Accruing
											Loans 90 or
	30 - 89 Days		Over 90		Total Past				Total		More Days
	Past Due (1)		Days (2)		Due		Current (3)		Loans		Past Due (2)
	(Dollars in thousands)

Commercial and industrial	$	155	$	1,485	$	1,640	$	35,487	$	37,127	$	-
Commercial real estate loans:
Construction		2,267		8,126		10,393		66,234		76,627		-
Other		908		3,138		4,046		203,113		207,159		-
		3,175		11,264		14,439		269,347		283,786		-
Residential real estate loans:
Construction		-		9,169		9,169		27,867		37,036		-
Other		345		2,505		2,850		118,635		121,485		133
		345		11,674		12,019		146,502		158,521		133

Consumer		-		45		45		2,860		2,905		-
Other		-		-		-		382		382		-
Total	$	3,675	$	24,468	$	28,143	$	454,578	$	482,721	$	133

(1) Total loans past due 30 – 89 days includes approximately $1.7 million of loans in nonaccrual status.

(2) All loans past due 90 days or more are in nonaccrual status with the exception of one accruing loan past due more than 90 days for $133,000.

(3) Includes approximately $420,000 of loans that are in nonaccrual status and not past due 30 days or more.

	As of December 31, 2010
											Accruing
											Loans 90 or
	30 - 89 Days		Over 90		Total Past				Total		More Days
	Past Due (1)		Days (2)		Due		Current (3)		Loans		Past Due (2)
	(Dollars in thousands)

Commercial and industrial	$	1,797	$	602	$	2,399	$	40,485	$	42,884	$	-
Commercial real estate loans:
Construction		4,801		2,462		7,263		74,747		82,010		-
Other		1,554		438		1,992		219,611		221,603		-
		6,355		2,900		9,255		294,358		303,613		-
Residential real estate loans:
Construction		1,274		3,079		4,353		46,705		51,058		-
Other		2,510		1,863		4,373		93,951		98,324		131
		3,784		4,942		8,726		140,656		149,382		131

Consumer		11		-		11		3,165		3,176		-
Other		-		-		-		468		468		-
Total	$	11,947	$	8,444	$	20,391	$	479,132	$	499,523	$	131

(1) Total loans past due 30 – 89 days includes approximately $2.5 million of loans in nonaccrual status.

(2) All loans past due 90 days or more are in nonaccrual status with the exception of one accruing loan past due more than 90 days for $131,000.

(3) Includes approximately $690,000 of loans that are in nonaccrual status and not past due 30 days or more.

Impaired loans

For all classes of impaired loans, interest payments are applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Accrual of interest is continued for restructured loans when the borrower is performing prior to the loan restructuring and there is reasonable assurance of repayment and continued performance under the modified terms. Accrual of interest on restructured loans in nonaccrual status is resumed when the

-16-

NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE E – LOANS (Continued)

borrower has established a sustained period of performance under the restructured terms of at least six months. Information regarding impaired loans segregated by loan category as of and for the three and six months ended June 30, 2011 and year ended December 31, 2010 are as follows.

							For the three months ended				For the six months ended
	As of June 30, 2011						June 30, 2011				June 30, 2011
			Unpaid				Average		Interest		Average		Interest
	Recorded		Principal		Related		Recorded		Income		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized		Investment		Recognized
	(Dollars in thousands)
Impaired with no related allowance recorded:
Commercial and industrial	$	100	$	384	$	-	$	163	$	-	$	206	$	-
Commercial real estate loans:
Construction		5,818		6,167		-		5,212		-		3,855		-
Other		1,325		1,520		-		1,122		-		929		-
		7,143		7,687		-		6,334		-		4,784		-
Residential real estate loans:
Construction		4,930		5,171		-		5,105		-		4,461		-
Other		2,103		3,444		-		2,222		-		2,254		-
		7,033		8,615		-		7,327		-		6,715		-

Consumer		14		28		-		17		-		13		-
Total	$	14,290	$	16,714	$	-	$	13,841	$	-	$	11,718	$	-

Impaired performing restructured loans with no related allowance recorded:
Commercial and industrial	$	64	$	64	$	-	$	112	$	2	$	200	$	3
Commercial real estate loans:
Construction		571		568		-		1,177		3		1,812		33
Other		3,282		3,272		-		3,391		32		3,608		73
		3,853		3,840		-		4,568		35		5,420		106
Residential real estate loans:
Construction		2,028		2,021		-		2,021		14		2,021		41
Other		1,172		1,171		-		1,174		6		929		31
		3,200		3,192		-		3,195		20		2,950		72

Consumer		17		17		-		18		1		19		1
Total	$	7,134	$	7,113	$	-	$	7,893	$	58	$	8,589	$	182

Impaired with a related allowance recorded:
Commercial and industrial	$	784	$	784	$	300	$	784	$	-	$	707	$	-
Commercial real estate loans:
Construction		4,358		4,393		740		4,081		-		4,016		-
Other		2,231		3,035		861		2,218		-		2,006		-
		6,589		7,428		1,601		6,299		-		6,022		-
Residential real estate loans:
Construction		3,684		3,684		92		3,684		-		2,756		-
Other		1,362		1,362		341		1,181		-		868		-
		5,046		5,046		433		4,865		-		3,624		-

Consumer		45		45		45		45		-		37		-
Total	$	12,464	$	13,303	$	2,379	$	11,993	$	-	$	10,390	$	-

Total impaired
Commercial	$	18,533	$	20,187	$	1,901	$	18,260	$	37	$	17,339	$	109
Residential		15,279		16,853		433		15,387		20		13,289		72
Consumer		76		90		45		80		1		69		1
Total	$	33,888	$	37,130	$	2,379	$	33,727	$	58	$	30,697	$	182

-17-

NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE E – LOANS (Continued)

	As of and for the year ended December 31, 2010
			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
	(Dollars in thousands)
Impaired with no related allowance recorded:
Commercial and industrial	$	54	$	204	$	-	$	130	$	-
Commercial real estate loans:
Construction		2,554		2,589		-		1,980		-
Other		54		54		-		48		-
		2,608		2,643		-		2,028		-

Residential real estate loans:
Construction		1,350		1,433		-		1,013		-
Other		989		989		-		873		-
		2,339		2,422		-		1,886		-

Consumer		11		25		-		17		-
Total	$	5,012	$	5,294	$	-	$	4,061	$	-


Impaired accruing restructured loans with no related allowance recorded:
Commercial and industrial	$	1,089	$	1,078	$	-	$	1,081	$	56
Commercial real estate loans:
Construction		4,787		4,752		-		4,760		204
Other		3,879		3,870		-		4,451		217
		8,666		8,622		-		9,211		421

Residential real estate loans:
Construction		2,025		2,021		-		2,020		96
Other		-		-		-		-		-
		2,025		2,021		-		2,020		96

Consumer		20		20		-		22		2
Total	$	11,800	$	11,741	$	-	$	12,334	$	575

Impaired with a related allowance recorded:
Commercial and industrial	$	1,544	$	1,934	$	697	$	845	$	-
Commercial real estate loans:
Construction		321		321		96		350		-
Other		201		201		111		98		-
		522		522		207		448		-

Residential real estate loans:
Construction		2,706		2,763		188		2,283		-
Other		1,708		1,708		1,009		875		-
		4,414		4,471		1,197		3,158		-
Consumer		-		-		-		-		-
Total	$	6,480	$	6,927	$	2,101	$	4,451	$	-

Total impaired
Commercial	$	14,483	$	15,003	$	904	$	13,743	$	477
Residential		8,778		8,914		1,197		7,064		96
Consumer		31		45		-		39		2
Total	$	23,292	$	23,962	$	2,101	$	20,846	$	575

-18-

NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE E – LOANS (Continued)

All loans risk rated “substandard”, “doubtful” and “loss” are reviewed to determine if they are impaired loans. If a loan is determined to be impaired it is removed from its homogeneous group and individually analyzed for impairment. Other groups of loans based on facts and circumstances may also be selected for impairment review. If a loan is impaired, a specific reserve allowance is established if necessary. Interest payments on impaired loans are typically applied to principal. Impaired loans are charged off in full or in part when losses are confirmed.

As of June 30, 2011, the recorded investment in loans considered impaired totaled $33.9 million. Additions to impaired loans since December 31, 2010 include approximately $6.4 million and $2.6 million, respectively, of residential and commercial construction loans. As of June 30, 2011, the Company provided specific reserves of $2.4 million for probable losses on impaired loan balances of $12.5 million. Management analyzed $14.3 million of impaired loans and determined the collateral to be adequate and no additional specific reserve allowance necessary after recording approximately $424,000 in partial charge-offs related to loan balances of approximately $1.7 million. Also included in the impaired loans as of June 30, 2011 are $7.1 million of restructured but still accruing loans and 12 restructured nonaccrual loans for $4.8 million, for a TDR balance amounting to $11.9 million. The loans were primarily restructured to forgive accrued interest due to financial difficulties of the borrower. There were no potential problem loans outstanding as of June 30, 2011 because potential problem loans at year-end have been charged off or are currently nonaccrual. The determination that there were no potential problem loans as of June 30, 2011 is further supported by the $8.3 million decline in 30 - 89 day past due loans.

As of December 31, 2010, the recorded investment in loans that management considered impaired totaled $23.3 million including $11.8 million of restructured but still accruing loans and six restructured nonaccrual loans for $520,000, for a TDR balance of $12.3 million. The Company provided for probable losses through specific reserve allowances of $2.1 million with corresponding outstanding loan balances of $6.5 million. There was no corresponding allowance with the remaining $740,000 of loan balances analyzed for impairment after recording approximately $366,000 in related charge-offs. In addition, the Company identified $1.2 million of potential problem loans with $290,000 in allocated reserves included in the allowance for loan losses.

Credit Quality Indicators

As part of the on-going monitoring of the credit quality of the Company’s loan portfolio, management examines certain credit quality indicators which consider the risk of payment performance, overall portfolio quality utilizing weighted-average risk ratings, general economic factors, net charge-offs, non-performing loans and the level of classified loans. All loans risk rated “substandard”, “doubtful” and “loss” are reviewed on an individual basis for probable losses.

A description of our credit quality indicators follows:

Pass – loans with acceptable credit quality and moderate risk.

Special mention – This grade is intended to be temporary and includes loans (1) with potential weaknesses which if left uncorrected could result in deterioration or (2) classified as substandard accruing or substandard nonaccruing where the borrowers made improvements to their financial profile but do not yet meet the definition of a pass grade.

-19-

NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE E – LOANS (Continued)

Substandard, accruing – These loans have a well defined weakness where the accrual of interest has not been stopped. The defined weakness may make default or principal exposure likely but not certain. These loans are likely to be dependent on collateral liquidation or a secondary source of repayment.

Substandard, nonaccruing – These assets have well defined weaknesses that jeopardize the liquidation of the debt and are past due over 90 days. The institution may sustain loss if the weaknesses are not corrected. These loans are inadequately protected by the paying capacity of the borrower and/or any guarantors or by the pledged collateral. These loans are individually analyzed for impairment.

Doubtful – These loans have all the weaknesses of substandard, nonaccruing loans plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values highly questionable and improbable.

Loss – These loans are considered uncollectable and of such little value that their continuance as a bankable asset is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off these loans even though partial recovery may be affected in the future.

Information regarding the Company’s credit risk by internally assigned risk grades as of June 30, 2011 and December 31, 2010 follows:

	As of June 30, 2011
	Real Estate Loans								Non-Real Estate Loans
	Construction								Commercial &
	Residential		Commercial		Residential		Commercial		Industrial		Consumer		Other		Total
	(Dollars in thousands)

Pass	$	18,844	$	51,737	$	103,619	$	192,995	$	33,779	$	2,819	$	382	$	404,175
Special mention		2,564		11,162		8,677		3,754		2,255		27		-		28,439
Substandard accruing		7,014		3,854		5,724		6,854		209		-		-		23,655
Substandard nonaccruing		8,614		9,634		3,443		3,556		884		59		-		26,190
Doubtful		-		240		22		-		-		-		-		262
Loss		-		-		-		-		-		-		-		-
Total by exposure	$	37,036	$	76,627	$	121,485	$	207,159	$	37,127	$	2,905	$	382	$	482,721

	As of December 31, 2010
	Real Estate Loans								Non-Real Estate Loans
	Construction								Commercial &
	Residential		Commercial		Residential		Commercial		Industrial		Consumer		Other		Total
	(Dollars in thousands)

Pass	$	28,520	$	59,122	$	86,364	$	210,371	$	38,616	$	3,066	$	468	$	426,527
Special mention		4,424		8,171		6,532		3,013		1,366		28		-		23,534
Substandard accruing		14,058		11,842		2,240		7,817		1,075		71		-		37,103
Substandard nonaccruing		4,056		2,875		2,697		255		1,598		11		-		11,492
Doubtful		-		-		491		147		180		-		-		818
Loss		-		-		-		-		49		-		-		49
Total by exposure	$	51,058	$	82,010	$	98,324	$	221,603	$	42,884	$	3,176	$	468	$	499,523

-20-

NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE F – ALLOWANCE FOR LOAN LOSSES

The allowance for loan losses is a reserve established through a provision for loan losses charged to expense for estimated loan losses inherent in the loan portfolio. The allowance is maintained at a level which management considers adequate to provide for probable loan losses based on our assessment of various factors affecting the loan portfolio. Additional information regarding the Company’s policies and methodology used to estimate the allowance for possible loan losses is presented in Note B- Summary of Significant Accounting Policies of the Company’s 2010 Annual Report on Form 10-K.

The tables below detail activity in the allowance for loan losses by segregated loan category for the three and six months ended June 30, 2011 and year ended December 31, 2010. Allocation of a portion of the allowance to one class of loan does not preclude its availability to absorb losses in other categories.

	For the Three Months Ended June 30, 2011
	Real Estate Loans											Non-Real Estate Loans
	Construction											Commercial &
	Residential			Commercial		Residential			Commercial			Industrial			Consumer			Other		Total
	(Dollars in thousands)
Allowance for loan losses:
Beginning balance	$	1,224		$	2,152	$	2,016		$	2,610		$	1,269		$	72		$	3	$	9,346
Charge-offs		(46	)		-		(469	)		(141	)		(190	)		-			-		(846	)
Recoveries		18			-		-			5			2			1			-		26
Provision		(225	)		836		470			479			(137	)		(5	)		-		1,418
Ending balance	$	971		$	2,988	$	2,017		$	2,953		$	944		$	68		$	3	$	9,944

Ending balance, individually evaluated for impairment	$	92		$	740	$	341		$	861		$	300		$	45		$	-	$	2,379

Ending balance, collectively evaluated for impairment	$	879		$	2,248	$	1,676		$	2,092		$	644		$	23		$	3	$	7,565

NORTH STATE BANCORP 10-Q