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 March 31, 2012

[ ] 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 incorporation or organization)		(IRS Employer 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 May 10, 2012 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 March 31, 2012 and December 31, 2011	3

		Consolidated Statements of Operations Three Months Ended March 31, 2012 and 2011	4

		Consolidated Statements of Comprehensive Income Three Months Ended March 31, 2012 and 2011	5

		Consolidated Statements of Changes in Shareholders’ Equity Three Months Ended March 31, 2012 and 2011	6

		Consolidated Statements of Cash Flows Three Months Ended March 31, 2012 and 2011	7

		Notes to Consolidated Financial Statements	8

Item 2 -	Management’s Discussion and Analysis of Financial Condition and Results of Operations		29

Item 3 -	Quantitative and Qualitative Disclosures About Market Risk		40

Item 4 -	Controls and Procedures		41

Part II.	OTHER INFORMATION

Item 6 -	Exhibits		42

NORTH STATE BANCORP

CONSOLIDATED BALANCE SHEETS

	March 31, 2012		December 31, 2011
	(unaudited)			*
ASSETS	(Dollars in thousands)

Cash and due from banks	$	8,364	$	9,826
Interest-earning deposits with banks		86,679		39,547
Investment securities available for sale, at fair value		11,036		12,917
Investment securities held to maturity, at amortized cost		250		250
Loans held for sale		46,693		49,728

Loans		484,765		490,455
Less allowance for loan losses		9,142		9,906
Net loans		475,623		480,549

Accrued interest receivable		1,253		1,441
Stock in the Federal Home Loan Bank of Atlanta, at cost		1,073		1,073
Premises and equipment, net		13,985		14,159
Foreclosed assets		4,059		2,851
Prepaid FDIC insurance		2,589		2,777
Bank owned life insurance		10,243		10,146
Other assets		7,347		7,626

TOTAL ASSETS	$	669,194	$	632,890

LIABILITIES AND SHAREHOLDERS' EQUITY

Deposits:
Demand	$	155,099	$	145,185
Savings, money market and NOW		282,326		264,304
Time		162,095		154,950
Total deposits		599,520		564,439

Accrued interest payable		895		897
Short-term borrowings		1,045		73
Long-term borrowings		27,241		27,246
Accrued expenses and other liabilities		1,445		1,246

TOTAL LIABILITIES		630,146		593,901

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 March 31, 2012 and December 31, 2011		21,718		21,708
Retained earnings		17,299		17,063
Accumulated other comprehensive income		31		218

TOTAL SHAREHOLDERS' EQUITY		39,048		38,989

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY	$	669,194	$	632,890

* Derived from audited consolidated financial statements.

See accompanying notes.

NORTH STATE BANCORP

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

		Three Months Ended
		March 31,
		2012		2011
		(Dollars in thousands, except per share data)
INTEREST INCOME
Loans		$	6,135	$	6,660
Loans held for sale			230		274
Investments			51		103
Dividends and interest-earning deposits			34		43
	Total interest income		6,450		7,080

INTEREST EXPENSE
Savings, money market and NOW			333		480
Time deposits			538		770
Short-term borrowings			-		1
Long-term borrowings			240		231
	Total interest expense		1,111		1,482

	Net interest income		5,339		5,598

PROVISION FOR LOAN LOSSES			1,531		1,015

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES			3,808		4,583

NON-INTEREST INCOME
Merchant and other loan fees			53		26
Service charges and fees on deposits			98		98
Gain on sale of investment securities			106		-
Fees from mortgage operations			944		497
Fees from wealth management services			67		87
Income from bank owned life insurance			97		-
Other			52		35
	Total non-interest income		1,417		743

NON-INTEREST EXPENSE
Salaries and employee benefits			2,613		2,303
Occupancy and equipment			656		703
Professional fees			96		82
Advertising and promotion			21		29
Data processing and other outsourced services			501		470
FDIC insurance			197		332
Net cost of foreclosed assets			142		491
Telecommunications			73		72
Mortgage processing costs			81		61
Other			540		459
	Total non-interest expense		4,920		5,002

INCOME BEFORE INCOME TAXES			305		324

INCOME TAXES			69		120

NET INCOME		$	236	$	204

NET INCOME PER COMMON SHARE:
Basic		$	0.03	$	0.03
Diluted		$	0.03	$	0.03

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
Basic			7,427,976		7,427,976
Diluted			7,427,976		7,433,773

See accompanying notes.

NORTH STATE BANCORP

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

	Three Months Ended
	March 31,
	2012			2011
	(Dollars in thousands)

Net income	$	236		$	204

Other comprehensive loss:
Securities available for sale:
Unrealized holding losses on available for sale securities		(202	)		(29	)
Tax effect		80			11
Reclassification of net gain recognized in net income		(106	)		-
Tax effect		41			-
Total other comprehensive loss		(187	)		(18	)

Comprehensive income	$	49		$	186

See accompanying notes.

NORTH STATE BANCORP

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)

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

Balance as of December 31, 2010		7,427,976	$	21,636	$	15,926	$	(60	)	$	37,502
Net income		-		-		204		-			204
Other comprehensive loss, net of tax		-		-		-		(18	)		(18	)
Stock based compensation		-		25		-		-			25

Balance as of March 31, 2011		7,427,976	$	21,661	$	16,130	$	(78	)	$	37,713


Balance as of December 31, 2011		7,427,976	$	21,708	$	17,063	$	218		$	38,989
Net income		-		-		236		-			236
Other comprehensive loss, net of tax		-		-		-		(187	)		(187	)
Stock based compensation		-		10		-		-			10

Balance as of March 31, 2012		7,427,976	$	21,718	$	17,299	$	31		$	39,048

See accompanying notes.

NORTH STATE BANCORP

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

	Three Months Ended
	March 31,
	2012			2011
	(Dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	236		$	204
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		1,531			1,015
Depreciation and amortization		206			231
Net amortization of premiums and discounts on investment securities		3			-
Originations of mortgage loans held for sale		(135,104	)		(76,535	)
Proceeds from sales of loans held for sale		137,230			115,462
Net realized gain on sale of investment securities available for sale		(106	)		-
Income from bank owned life insurance		(97	)		-
Loss on sale of foreclosed assets		58			28
Provision for foreclosed assets		38			470
Stock based compensation		10			25
Changes in assets and liabilities:
Decrease in other assets		1,497			946
Decrease in accrued interest receivable		188			94
Increase (decrease) in accrued expenses and other liabilities		199			(230	)
Decrease in accrued interest payable		(2	)		(123	)
Net cash provided by operating activities		5,887			41,587

CASH FLOWS FROM INVESTING ACTIVITIES:
Net change in certificates of deposit with banks		-			198
Proceeds from sales of investment securities available for sale		9,422			-
Proceeds from maturities and repayments of investment securities available for sale		458			5,811
Purchases of investment securities available for sale		(8,204	)		(26,626	)
Net decrease in loans		1,107			17,335
Purchases of premises and equipment		(32	)		(90	)
Proceeds from sales of foreclosed assets		984			438
Capital expenditures on foreclosed assets		-			(63	)
Net cash provided (used) by investing activities		3,735			(2,997	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in short-term borrowings		972			909
Repayments on long-term borrowings		(5	)		(6	)
Net increase in deposit accounts		35,081			14,958
Net cash provided by financing activities		36,048			15,861

NET INCREASE IN CASH AND CASH EQUIVALENTS		45,670			54,451

CASH AND CASH EQUIVALENTS, BEGINNING		49,373			49,833

CASH AND CASH EQUIVALENTS, ENDING	$	95,043		$	104,284

See accompanying notes.

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

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 March 31, 2012 and December 31, 2011 and for the three-month periods ended March 31, 2012 and 2011, in conformity with accounting principles generally accepted in the United States of America. The accompanying consolidated financial statements include the accounts and transactions of North State Bancorp (the “Company”) and its wholly-owned subsidiary, North State Bank (the “Bank”).

The Bank was incorporated May 25, 2000 and began banking operations on June 1, 2000. The Bank is engaged in general commercial and retail banking in central North Carolina, principally in Wake County, and in southeast North Carolina in New Hanover County, operating under the banking laws of North Carolina and under the rules and regulations of the Federal Deposit Insurance Corporation and the North Carolina Commissioner of Banks. The Bank undergoes periodic examinations by those regulatory authorities. The Bank’s wholly-owned subsidiary, North State Wealth Advisors, Inc. offers wealth management and brokerage services. 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. In June 2011, the Bank established another wholly-owned subsidiary, North State Title, LLC, which owns 67% of Title Group, LLC, a title insurance agency.

All significant intercompany transactions and balances are 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-month period ended March 31, 2012 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2012.

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 2011 Annual Report on Form 10-K for the year ended December 31, 2011. This quarterly report should be read in conjunction with the Annual Report.

NOTE B – RECENT ACCOUNTING PRONOUCEMENTS

In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-04, Fair Value Measurement. The purpose of the standard is to clarify and combine fair value measurements and disclosure requirements for 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 adopted this statement during the quarter ended March 31, 2012, which resulted in additional disclosures related to fair value.

ASU No. 2011-11, amendments to ASC 210-20, Balance Sheet: Disclosures about Offsetting Assets and Liabilities was issued by FASB during the quarter ended December 2011. The amendments in this update require an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. This update affects all entities that have financial instruments and derivative instruments that are either (1) offset in accordance with either Section 210-20-45 or Section 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement. This information is intended to enable users of an entity’s financial statements to evaluate the effect or potential effect of netting arrangements on an entity’s financial position, including the effect or potential effect of rights to setoff associated with certain financial instruments and derivative instruments in the scope of this update. The amendments are effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. The adoption of this statement is not expected to have a material impact on the Company’s consolidated financial statements.

The FASB issued ASU No. 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in ASU No. 2011-05, to indefinitely defer the effective date of the requirement to present reclassification adjustments from other comprehensive income to net income by component under ASU No. 2011-05, Presentation of Comprehensive Income, to allow time for reconsideration of these provisions. The Company adopted ASU No. 2011-05 as of December 31, 2011with no material impact to its 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.

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

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.

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 March 31, 2012
			Gross		Gross
	Amortized		unrealized		unrealized		Fair
	cost		gains		losses		value
	(Dollars in thousands)
Securities available for sale:
Government-sponsored residential mortgage-backed securities	$	10,986	$	50	$	-	$	11,036
Total securities available for sale	$	10,986	$	50	$	-	$	11,036

Securities held to maturity:
Corporate securities	$	250	$	-	$	50	$	200
Total securities held to maturity	$	250	$	-	$	50	$	200


	As of December 31, 2011
			Gross		Gross
	Amortized		unrealized		unrealized		Fair
	cost		gains		losses		value
	(Dollars in thousands)
Securities available for sale:
Government-sponsored residential mortgage-backed securities	$	12,559	$	358	$	-		12,917
Total securities available for sale	$	12,559	$	358	$	-	$	12,917

Securities held to maturity:
Corporate securities	$	250	$	-	$	49	$	201
Total securities held to maturity	$	250	$	-	$	49	$	201

The following table shows as of March 31, 2012 and 2011 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. As of March 31, 2012 and December 31, 2011, the Company did not hold any available for sale securities with unrealized losses. The unrealized losses on held to maturity securities as of March 31, 2012 and December 31, 2011 relate to one corporate security. All unrealized losses on investment securities are not considered to be other-than-temporary, because they are related to changes in interest rates, lack of liquidity and demand in the general investment market and do not affect the expected cash flows of the underlying collateral or the issuer. Since the Company does not intend to sell the impaired corporate bond prior to recovery and it is more likely than not the Company will not be required to sell this imparied security prior to recovery, it is not deemed to be other than temporarily impaired.

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

NOTE C - INVESTMENT SECURITIES (Continued)

	As of March 31, 2012
	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 held to maturity:
Corporate securities	$	-	$	-	$	200	$	50	$	200	$	50
Total securities held to maturity	$	-	$	-	$	200	$	50	$	200	$	50


	As of December 31, 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 held to maturity:
Corporate securities	$	-	$	-	$	201	$	49	$	201	$	49
Total securities held to maturity	$	-	$	-	$	201	$	49	$	201	$	49

The amortized cost and fair values of securities available for sale and securities held to maturity as of March 31, 2012 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 March 31, 2012
	Amortized		Fair
	Cost		Value
	(Dollars in thousands)
Securities available for sale:
Government-sponsored residential mortgage-backed securities
Due after ten years	$	10,986	$	11,036
	$	10,986	$	11,036

Securities held to maturity:
Corporate securities
Due after five but within ten years	$	250	$	200
	$	250	$	200

Securities with a carrying value of $2.4 million and $1.7 million as of March 31, 2012 and December 31, 2011, respectively, were pledged to secure securities sold under agreements to repurchase and public deposits.

During the three-month period ended March 31, 2012, proceeds from the sales of investment securities of $9.4 million resulted in gross gains of $106,000. There was no security sales during the three-month period ended March 31, 2011.

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

NOTE D - COMMITMENTS

A summary of the contract amount of the Company’s exposure to off-balance sheet credit risk as of March 31, 2012 is as follows:

	March 31, 2012
	(Dollars in thousands)

Financial instruments whose contract amounts represent credit risk:
Undisbursed lines of credit	$	29,417
Other commitments to extend credit		11,417
Letters of credit		1,373
Commitments to originate mortgage loans, fixed and variable		70,983
	$	113,190

NOTE E - LOANS

The following is a summary of loans segregated by loan category:

	March 31, 2012					December 31, 2011
			% of					% of
			Total					Total
	Amount		Loans			Amount		Loans
	(Dollars in thousands)
Real estate secured loans:
Residential construction	$	28,568		5.9	%	$	27,323		5.6	%
Commercial construction, all land development and land loans		43,468		9.0	%		47,524		9.7	%
Residential properties		104,019		21.5	%		105,226		21.5	%
Residential mortgage (1)		50,484		10.4	%		39,829		8.1	%
Commercial real estate - other		219,327		45.2	%		228,256		46.5	%
Total real estate secured loans		445,866		92.0	%		448,158		91.4	%

Other non-real estate loans:
Commercial and industrial		35,060		7.2	%		38,435		7.8	%
Consumer and other		3,839		0.8	%		3,862		0.8	%
Total loans held for investment	$	484,765		100.0	%	$	490,455		100.0	%

Single-family residential mortgages held for sale	$	46,693				$	49,728

(1) Single-family residential mortgages originated through NSB Mortgage held for investment.

Included in the table above are net unamortized loan costs of $703,000 and $500,000 as of March 31, 2012 and December 31, 2011, respectively. 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 economic conditions. Commercial construction and land development loans decreased $4.1 million from year-end 2011 as loans were paid off, charged-off or completed and moved to longer-term financing and new lending for these classes was minimized. Retained residential mortgages originated through NSB Mortgage increased $10.7 million over year-end 2011. Commercial real-estate secured loans decreased $13.0 million from year-end 2011.

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

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

NOTE E – LOANS (Continued)

Real estate construction loans:

Residential construction

The Company provides financing to builders for the construction of speculative and pre-sold custom homes, and from time to time, financing for custom homes where the home buyer is the borrower. Residential construction loans typically are for periods of 12 months or less and the homes are sold to consumers who obtain permanent financing. The loans are underwritten utilizing independent appraisals, sensitivity analysis of absorption and financial analysis of the borrower.

Commercial construction

Commercial real estate construction and land development loans are also underwritten utilizing independent appraisals, sensitivity analysis of absorption and financial analysis of the general contractors and borrowers. Commercial construction loans are generally based upon estimates of costs and value associated with the as-completed project. These estimates may be inaccurate. The 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 or sales of developed property.

All construction 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, government regulation of real property, general economic conditions and the availability of long-term financing.

Residential properties

Residential real estate secured loans are subject to underwriting based on the purpose of the loan. Residential real estate properties secured by income-producing property typically have a loan-to-value ratio of 85% or less. Residential real estate properties secured by the primary residence of the borrower typically have a loan-to-value ratio less than 90%. Also included are loans that are underwritten and secured by second liens and home equity lines of credit which are revolving extensions of credit that are secured by first or second liens on owner-occupied residential real estate.

Residential mortgage

Residential mortgage loans represent single-family mortgage loans originated through NSB Mortgage and selected by the Company to be retained in its portfolio. These loans are subject to strict underwriting standards which are at a minimum per the FREDDIE MAC guidelines and typically have terms within 10 to 15 years with moderate loan-to-value ratios, typically less than 70% and with credit scores typically exceeding 740.

Commercial real estate - other

Commercial real estate secured loans are subject to underwriting standards similar to those for commercial construction loans. These loans are either cash flow loans or 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. For these loans, the Company also utilizes third-party experts to provide insight and guidance about economic conditions and trends within its market areas.

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 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. 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.

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

NOTE E – LOANS (Continued)

Consumer and other

Consumer and other loans include automobile loans, boat and recreational vehicle financing, other secured or unsecured loans and loans to tax exempt entities. Consumer loans generally carry greater risk than other loans, even if secured, if the collateral consists of rapidly depreciating assets such as automobiles and equipment. Consumer loan collections are sensitive to job loss, illness and other personal factors. The Company manages risks inherent in consumer and other lending by following established credit guidelines and underwriting practices designed to minimize the risk of loans.

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 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 have 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 March 31, 2012 and December 31, 2011, mortgage loans held for sale were $46.7 million and $49.7 million, respectively.

Nonperforming assets

Nonperforming assets include nonaccrual loans, troubled debt restructured loans, or “TDR” (nonaccrual and accrual), and foreclosed assets.

Nonaccrual loans

Nonaccrual loans as of March 31, 2012 were $21.8 million compared to $24.0 million as of December 31, 2011. For all classes of loans, 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 age analysis of past due loans segregated by loan class as of March 31, 2012 and December 31, 2011 are as follows:

	As of March 31, 2012
	30 - 89 Days Past Due (1)		Over 90 Days (2)		Total Past Due		Current (3)		Total Loans		Accruing Loans 90 or More Days Past Due
	(Dollars in thousands)
Real estate secured loans:
Residential construction	$	-	$	6,957	$	6,957	$	21,611	$	28,568	$	-
Commercial construction, all land development and land loans		956		6,463		7,419		36,049		43,468		-
Residential properties		1,246		1,706		2,952		101,067		104,019		-
Residential mortgage (4)		582		-		582		49,902		50,484		-
Commercial real estate - other		-		1,264		1,264		218,063		219,327		-
Total real estate secured loans		2,784		16,390		19,174		426,692		445,866		-

Other non-real estate loans:
Commercial and industrial		11		514		525		34,535		35,060		-
Consumer and other		-		-		-		3,839		3,839		-
Total loans held for investment	$	2,795	$	16,904	$	19,699	$	465,066	$	484,765	$	-

(1)	Includes one $131,000 commercial construction loan in nonaccrual status.
(2)	All loans past due 90 days or more in nonaccrual status.
(3)	Includes approximately $3.2 million residential constuction, $300,000 commercial construction, $594,000 residential properties and $644,000 other commercial real estate loans in nonaccrual status and $173,000 residential properties and $275,000 other commercial real estate loans considered potential problem loans.
(4)	Single-family residential mortgages originated through NSB Mortgage, held for investment.

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

NOTE E – LOANS (Continued)

	As of December 31, 2011
	30 - 89 Days Past Due (1)		Over 90 Days (2)		Total Past Due		Current (3)		Total Loans		Accruing Loans 90 or more Days Past Due
	(Dollars in thousands)
Real estate secured loans:
Residential construction	$	2,020	$	6,986	$	9,006	$	18,317	$	27,323	$	-
Commercial construction, all land development and land loans		1,194		9,107		10,301		37,223		47,524		-
Residential properties		605		1,629		2,234		102,992		105,226		-
Residential mortgage (4)		-		-		-		39,829		39,829		-
Commercial real estate - other		314		1,850		2,164		226,092		228,256		-
Total real estate secured loans		4,133		19,572		23,705		424,453		448,158		-

Other non-real estate loans:
Commercial and industrial		93		464		557		37,878		38,435		-
Consumer and other		-		-		-		3,862		3,862		-
Total loans held for investment	$	4,226	$	20,036	$	24,262	$	466,193	$	490,455	$	-

(1)	Includes approximately $3.0 million of loans in nonaccrual status of which approximately $2.0 million are residential construction, $896,000 are commercial construction and $113,000 are residential properties. Includes approximately $1.6 million of potential problem loans of which approximately $1.3 million are residential construction and $275,000 are residential properties.
(2)	All loans past due 90 days or more are in nonaccrual status.
(3)	Includes approximately $955,000 of loans in nonaccrual status of which approximately $250,000 are commercial construction and $705,000 are residential properties. Includes approximately $281,000 of potential problem loans of which approximately $174,000 are residential properties, $93,000 are commercial real estate-other and $14,000 are consumer.
(4)	Single-family residential mortgages originated through NSB Mortgage, held for investment.

Impaired loans

For all classes of loans, interest payments on impaired loans 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 TDR loans when the borrower was performing prior to the restructuring and there is reasonable assurance of repayment and continued performance under the modified terms. Accrual of interest on TDR loans in nonaccrual status is resumed when the borrower has established a sustained period of performance under the restructured terms of at least six months.

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

NOTE E – LOANS (Continued)

Information regarding impaired loans segregated by loan class as of and for the three months ended March 31, 2012 and as of and for the year ended December 31, 2011 is as follows.

										For the three months ended
	As of March 31, 2012									March 31, 2012
	Unpaid Principal Balance		Partial Charge-offs			Recorded Investment		Related Allowance		Average Recorded Investment		Interest Income Recognized
	(Dollars in thousands)
Impaired with no related allowance recorded:
Real estate secured loans:
Residential construction	$	9,204	$	(1,035	)	$	8,169	$	-	$	8,539	$	17
Commercial construction, all land development and land loans		6,807		(224	)		6,583		-		6,559		24
Residential properties		4,602		(589	)		4,013		-		3,704		17
Commercial real estate - other		5,454		(1,075	)		4,379		-		4,396		32
Total real estate secured loans		26,067		(2,923	)		23,144		-		23,198		90

Other non-real estate loans:
Commercial and industrial		109		(39	)		70		-		64		-
Consumer and other		12		-			12		-		13		-
Total loans held for investment	$	26,188	$	(2,962	)	$	23,226	$	-	$	23,275	$	90

Impaired with a related allowance recorded:
Real estate secured loans:
Residential construction	$	3,231	$	-		$	3,231	$	473	$	1,077	$	-
Commercial construction, all land development and land loans		3,111		(489	)		2,622		768		2,509		-
Residential properties		63		-			63		17		63		-
Commercial real estate - other		619		-			619		211		619		-
Total real estate secured loans		7,024		(489	)		6,535		1,469		4,268		-

Other non-real estate loans:
Commercial and industrial		461		-			461		200		461		-
Consumer and other		-		-			-		-		-		-
Total loans held for investment	$	7,485	$	(489	)	$	6,996	$	1,669	$	4,729	$	-

Total impaired:
Commercial	$	16,561	$	(1,827	)	$	14,734	$	1,179	$	14,608	$	56
Residential		17,100		(1,624	)		15,476		490		13,383		34
Consumer		12		-			12		-		13		-
Total loans held for investment	$	33,673	$	(3,451	)	$	30,222	$	1,669	$	28,004	$	90

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

NOTE E – LOANS (Continued)

										For the year ended
	As of December 31, 2011									December 31, 2011
	Unpaid Principal Balance		Partial Charge-offs			Recorded Investment		Related Allowance		Average Recorded Investment		Interest Income Recognized
	(Dollars in thousands)
Impaired with no related allowance recorded:
Real estate secured loans:
Residential construction	$	5,789	$	(1,166	)	$	4,636	$	-	$	7,183	$	131
Commercial construction, all land development and land loans		8,680		(1,666	)		7,030		-		6,207		158
Residential properties		6,517		(2,161	)		4,359		-		4,303		83
Commercial real estate - other		6,686		(2,445	)		4,250		-		5,128		153
Total real estate secured loans		27,672		(7,438	)		20,275		-		22,821		525

Other non-real estate loans:
Commercial and industrial		593		(574	)		20		-		231		4
Consumer and other		-		-			-		-		13		1
Total	$	28,265	$	(8,012	)	$	20,295	$	-	$	23,065	$	530

Impaired with a related allowance recorded:
Real estate secured loans:
Residential construction	$	7,543	$	(72	)	$	7,475	$	756	$	3,513	$	79
Commercial construction, all land development and land loans		6,230		(379	)		5,851		1,370		4,539		14
Residential properties		66		-			66		17		69		-
Commercial real estate - other		621		-			621		211		623		-
Total real estate secured loans		14,460		(451	)		14,013		2,354		8,744		93

Other non-real estate loans:
Commercial and industrial		461		-			461		200		422		-
Consumer and other		-		-			-		-		-		-
Total	$	14,921	$	(451	)	$	14,474	$	2,554	$	9,166	$	93

Total impaired:
Commercial	$	23,271	$	(5,064	)	$	18,233	$	1,781	$	17,150	$	329
Residential		19,915		(3,399	)		16,536		773		15,068		293
Consumer		-		-			-		-		13		1
Total	$	43,186	$	(8,463	)	$	34,769	$	2,554	$	32,231	$	623

Each loan risk rated “substandard”, “doubtful” and “loss” is reviewed to determine if it is an impaired loan. 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 allocated 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.

Total impaired loans as of March 31, 2012 include $8.4 million of restructured but still accruing loans and $12.2 million of restructured nonaccrual loans. Nonaccrual TDRs are up $1.6 million over year-end 2011 as approximately $1.7 million of accruing TDRs as of year-end 2011 declined to nonaccrual status as of March 31, 2012. In total, TDRs represent $20.6 million of March 31, 2012 impaired loans. The loans were restructured for various concessions due to financial difficulties of the borrower such as forgiveness of accrued interest, below market interest rate or extended payment terms. In addition, there were two potential problem loans outstanding as of March 31, 2012 with loan balances of $448,000 and secured by residential and commercial real-estate.

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

NOTE E – LOANS (Continued)

The determination for the potential problem loans primarily was the result of information regarding possible, although not probable, credit problems of the related borrowers. Potential problem loans are not included in the table above. Although these loans are not currently impaired, they have been considered by management in assessing the adequacy of its allowance for loan losses as of March 31, 2012 and have been allocated specific reserves of $30,700 included in the allowance for loan losses as of March 31, 2012 for one of the potential problem loans with an outstanding loan balance of $173,300. Both potential problem loans were current and not past due as of March 31, 2012. Of the $1.9 million potential problem loans as of year-end 2011, the largest loan of $1.4 million was downgraded to nonaccrual status while a partial charge-off of $173,000 was recorded on another potential problem loan during the first three months of 2012.

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 rating, 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 if left uncorrected could result in deterioration or (2) were classified as substandard accruing or substandard nonaccruing have made improvements to their financial profile but do not yet meet the definition of a pass grade.

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 weakness 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, any guarantors or of the collateral pledged. These loans are individually analyzed for impairment.

Doubtful – These loans have all the weaknesses of substandard, nonaccruing 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 this worthless loan even though partial recovery may be affected in the future.

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

NOTE E – LOANS (Continued)

Information regarding the Company’s credit risk by internally assigned risk grades as of March 31, 2012 and December 31, 2011 follows:

	As of March 31, 2012
	Real Estate Loans										Non-Real Estate Loans
	Construction				Residential		Residential				Commercial &		Consumer &
	Residential		Commercial		Properties		Mortgage (1)		Commercial		Industrial		Other		Total
	(Dollars in thousands)

Pass	$	9,909	$	26,662	$	85,502	$	50,484	$	201,749	$	31,973	$	3,827	$	410,106
Special mention		4,825		4,455		8,358		-		11,829		2,459		12		31,938
Substandard accruing		3,646		5,457		7,859		-		3,841		114		-		20,917
Substandard nonaccruing		10,188		5,059		2,300		-		1,908		514		-		19,969
Doubtful		-		1,835		-		-		-		-		-		1,835
Loss		-		-		-		-		-		-		-		-
Total by exposure	$	28,568	$	43,468	$	104,019	$	50,484	$	219,327	$	35,060	$	3,839	$	484,765

(1) Single-family residential mortgages originated through NSB Mortgage, held for investment.

	As of December 31, 2011
	Real Estate Loans										Non-Real Estate Loans
	Construction				Residential		Residential				Commercial &		Consumer &
	Residential		Commercial		Properties		Mortgage (1)		Commercial		Industrial		Other		Total
	(Dollars in thousands)

Pass	$	7,048	$	28,632	$	85,956	$	39,829	$	210,446	$	35,301	$	3,848	$	411,060
Special mention		4,410		4,489		8,378		-		12,098		2,509		14		31,898
Substandard accruing		6,858		3,920		8,541		-		3,862		161		-		23,342
Substandard nonaccruing		9,007		10,252		2,351		-		1,850		464		-		23,924
Doubtful		-		231		-		-		-		-		-		231
Loss		-		-		-		-		-		-		-		-
Total by exposure	$	27,323	$	47,524	$	105,226	$	39,829	$	228,256	$	38,435	$	3,862	$	490,455

(1) Single-family residential mortgages originated through NSB Mortgage, held for investment.

As discussed above, TDR loans generally occur when a borrower is experiencing, or is expected to experience, financial difficulties in the near-term. As a result, a concessionary modification with more favorable terms that would not otherwise be considered may be granted to the borrower with the intent to prevent further difficulties and improve the likelihood of recovery of the loan. The modifications resulting in a TDR have generally involved a reduction of interest rate or extension of term of the loan or a combination of both. We do not generally forgive principal as part of a loan modification. Also when possible, additional collateral or guarantor support is obtained when modifying the loan. All TDRs are individually reviewed and analyzed for impairment during management’s monthly evaluation of the allowance for loan losses. The specific allowance is based on the present value of expected cash flows or the fair value of the collateral or the loan’s observable market price.

For the three months ended March 31, 2012, the following table presents a breakdown of the types of concessions made by loan class. TDR below market interest rate concessions may also have had an extension of term granted as well.

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

NOTE E – LOANS (Continued)

	Troubled Debt Restructured Loans
	Three Months Ended March 31, 2012
	Number of loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
			(Dollars in thousands)
Extended payment terms:
Real estate secured loans:
Residential construction		1	$	1,356	$	1,356

Total		1	$	1,356	$	1,356

The following table presents loans that were modified as troubled debt restructurings within the previous 12 months and for which there was a payment default where payment under the modified terms had been 30 days or more past due at any month end during the three months ended March 31, 2012.

	Troubled Debt Restructured Loans
	March 31, 2012
	Number of loans		Recorded Investment
	(Dollars in thousands)
Below market interest rate:
Real estate secured loans:
Commercial construction, all land development and land loans		1	$	2,036
Residential properties		1		199
Commercial real estate - other		1		644
Total		3		2,879

Extended payment terms:
Real estate secured loans:
Residential construction		4		4,448
Commercial construction, all land development and land loans		1		300
Residential properties		2		416
Total		7		5,164

Below market rate and extended payment terms:
Real estate secured loans:
Residential properties		1		442
Commercial real estate - other		1		331
Total		2		773

Refinance for interest carry and cash out:
Real estate secured loans:
Residential properties		1		312
Total		1		312

Total		13	$	9,128

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

NOTE E – LOANS (Continued)

The following table presents the successes and failures of the types of modifications within the previous 12 months as of March 31, 2012.

	Paid in full				Paying as restructured				Converted to non-accrual				Foreclosure/Default				Total
	Number of loans		Recorded Investment		Number of loans		Recorded Investment		Number of loans		Recorded Investment		Number of loans		Recorded Investment		Number of loans		Recorded Investment
	(Dollars in thousands)

Below market interest rate		-	$	-		-	$	-		1	$	644		2	$	2,235		3	$	2,879
Extended payment terms		-		-		-		-		5		3,703		2		1,461		7		5,164
Below market rate and extended payment terms		-		-		-		-		-		-		2		773		2		773
Refinace for interest carry and cash out		-		-		1		289		1		312		-		-		2		601
Total		-	$	-		1	$	289		7	$	4,659		6	$	4,469		14	$	9,417

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. Overall, the allowance for loan losses declined $764,000 from the 2011 year-end amount of $9.9 million. Impairment reserves decreased $885,000 while the general reserve increased approximately $121,000 over year-end 2011 primarily due to a higher potential charge-off rate applied to the general commercial loan portfolio. The allowance for loan losses as a percentage of loans outstanding decreased to 1.89% as of March 31, 2012 from 2.02% from year-end 2011. 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 financial statements contained in the Company’s 2011 Annual Report on Form 10-K.

The table below details activity in the allowance for probable loan losses by segregated loan category for the three months ended March 31, 2012 and 2011. Allocation of a portion of the allowance to one class of loan does not preclude its availability to absorb losses in other classes.

	For the Three Months Ended March 31, 2012
	Real Estate Loans													Non-Real Estate Loans
	Construction						Residential			Residential				Commercial &			Consumer &
	Residential			Commercial			Properties			Mortgage (1)		Commercial		Industrial			Other		Total
	(Dollars in thousands)
Allowance for loan losses:
Beginning balance	$	1,497		$	2,783		$	1,608		$	40	$	3,179	$	763		$	36	$	9,906
Charge-offs		(839	)		(1,279	)		(174	)		-		-		(41	)		-		(2,333	)
Recoveries		6			17			8			-		5		2			-		38
Provision		573			795			105			11		29		15			3		1,531
Ending balance	$	1,237		$	2,316		$	1,547		$	51	$	3,213	$	739		$	39	$	9,142
Ending balance, individually evaluated for impairment	$	473		$	768		$	17		$	-	$	211	$	200		$	-	$	1,669
Ending balance, collectively evaluated for impairment	$	764		$	1,548		$	1,530		$	51	$	3,002	$	539		$	39	$	7,473

Loans:
Ending balance	$	28,568		$	43,468		$	104,019		$	50,484	$	219,327	$	35,060		$	3,839	$	484,765
Ending balance, individually evaluated for impairment	$	11,400		$	9,205		$	4,076		$	-	$	4,998	$	531		$	12	$	30,222
Ending balance, collectively evaluated for impairment	$	17,168		$	34,263		$	99,943		$	50,484	$	214,329	$	34,529		$	3,827	$	454,543

(1) Single-family residential mortgages originated through NSB Mortgage, held for investment.

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

NOTE F - ALLOWANCE FOR LOAN LOSSES (Continued)

	For the Three Months Ended March 31, 2011
	Real Estate Loans												Non-Real Estate Loans
	Construction						Residential						Commercial &			Consumer &
	Residential			Commercial			Properties			Commercial			Industrial			Other			Total
	(Dollars in thousands)
Allowance for loan losses:
Beginning balance	$	1,475		$	2,269		$	2,339		$	2,464		$	1,354		$	34		$	9,935
Charge-offs		(118	)		(96	)		(873	)		(468	)		(177	)		(11	)		(1,743	)
Recoveries		12			-			1			11			88			27			139
Provision		(145	)		(21	)		549			603			4			25			1,015
Ending balance	$	1,224		$	2,152		$	2,016		$	2,610		$	1,269		$	75		$	9,346

Ending balance, individually evaluated for impairment	$	122		$	190		$	588		$	401		$	715		$	45		$	2,061

Ending balance, collectively evaluated for impairment	$	1,102		$	1,962		$	1,428		$	2,209		$	554		$	30		$	7,285

Loans:
Ending balance	$	47,240		$	74,621		$	105,940		$	212,353		$	36,666		$	3,345		$	480,165
Ending balance, individually evaluated for impairment	$	10,374		$	9,548		$	3,652		$	5,831		$	2,188		$	74		$	31,667
Ending balance, collectively evaluated for impairment	$	36,866		$	65,073		$	102,288		$	206,522		$	34,478		$	3,271		$	448,498

NOTE G – NET INCOME PER SHARE

Basic earnings per share represents income available to common shareholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares 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. Potential common shares that may be issued by the Company relate to outstanding stock options. Basic and diluted net income per common share have been computed based upon net income 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.

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

	Three Months Ended
	March 31,
	2012		2011

Weighted average number of common shares used in computing basic net income per share		7,427,976		7,427,976

Effect of dilutive stock options
		-		5,797
Weighted average number of common shares and dilutive potential shares used in computing diluted net income per share		7,427,976		7,433,773

Due to the exercise price exceeding the average market price, the following anti-dilutive shares were excluded from the calculation of total dilutive weighted average shares. Anti-dilutive shares for the three months ended March 31, 2012 and 2011 were 125,503 and 105,787, respectively.

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

NOTE H - FAIR VALUE MEASUREMENTS

The Company estimates fair value for certain financial assets and liabilities based on fair value accounting guidance. Fair value measurements are based on the inputs used in valuation, gives priority to quoted prices in active markets, and requires that observable inputs be used in the valuations when available. The disclosure of fair value estimates in the fair value accounting guidance hierarchy is based on whether the significant inputs into the valuation are observable. In determining the level of the hierarchy in which the estimate is disclosed, the highest priority is given to unadjusted quoted prices in active markets and the lowest priority to unobservable inputs that reflect the Company’s significant market assumptions. The level in the fair value hierarchy within which the fair value measurement is reported is based on the lowest level input that is significant to the measurement in its entirety. The Company groups its financial assets and financial liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

●

Level 1 – Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange. Level 1 also includes U.S. Treasury, other U.S. government and agency mortgage-backed securities that are traded by dealers or brokers in active markets. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

●	Level 2 – Valuations for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained from third party services for identical or comparable assets or liabilities.

●

Level 3 – Valuations for assets and liabilities that are derived from other valuation methodologies, including option pricing models, discounted cash flow models and similar techniques, and not based on market exchange, dealer, or brokered traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities.

Valuation of Assets and Liabilities Reported at Fair Value in Financial Statements

The fair value of a financial instrument is the estimated amount at which the instrument could be exchanged in an orderly transaction between knowledgeable, unrelated, willing parties. The estimated fair value of a financial instrument may differ from the amount that could be realized if sold in an immediate sale such as a forced transaction. Additionally, the valuation of investments is more subjective when markets are less liquid due to the lack of market based inputs, which may increase the potential that the estimated fair value of an investment is not reflective of the price at which an actual transaction would occur.

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

The following is a description of valuation methodologies used by the Company 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 the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, 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 and corporate debt securities.

Mortgage Banking Activity

The Company enters into written loan commitments and commitments to sell mortgages. Changes in the written loan commitments subjected to recurring fair value adjustments are affected by the changes in the balances of locked mortgage loan commitments, changes in the fall out rates and changes in the prevailing secondary market prices for like-kind mortgage loans. The fall out rate measures the likelihood that an interest rate lock commitment will ultimately not become a closed loan held for sale. Factors contributing to the fall out rate include changes in prevailing interest rates from the time of the interest rate lock commitment as well as other factors such as lower than anticipated appraised values. As of March 31, 2012 the fall out rate averaged 33.4%. As of March 31, 2012, the amount of fair value associated with these written loan commitments was $530,000, which was included in other assets. As of December 31, 2011, fall out rates averaged 33.6% and the amount of fair value associated with written loan commitments was $946,000. The fair value of interest rate lock commitments is based on servicing rate premium, origination income

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

NOTE H - FAIR VALUE MEASUREMENTS (Continued)

net of originations costs, and changes in loan pricing between the commitment date and period end, typically month end. The fair value of forward sales commitments is based on changes in loan pricing between the commitment date and period end. The commitments to sell mortgages are generally equal and offsetting to the interest rate lock commitment, both of whose fair values are deemed to be immaterial as of March 31, 2012 and December 31, 2011.

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 the impairment in accordance with accounting standards. 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, or 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 March 31, 2012, the majority of the Company’s impaired loans were evaluated based on the fair value of the collateral. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value due to factors such as current market price corrections, the number of qualifying buyers available, or the level of inventory of like property and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3. The unobservable inputs include collateral discounts in a range of 5 – 40% of appraised value. The valuation techniques for the level 3 impaired loans are consistent with techniques used in prior periods.

Foreclosed Assets

Foreclosed assets are adjusted to fair value, less cost to sale, upon transfer of the loans to foreclosed assets. Subsequently, foreclosed assets are carried at fair value less costs to sell. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value due to factors such as current market price corrections, the number of qualifying buyers available, or the level of inventory of like property and there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3. The unobservable inputs include collateral discounts in a range of 5 – 40% to appraised values as well as a general cost of sales rate of 6%. The valuation techniques for the level 3 impaired loans are consistent with techniques used in prior periods.

The table below presents the balances of assets and liabilities measured at fair value on a recurring basis.

	As of March 31, 2012
	Total		Level 1		Level 2		Level 3
	(Dollars in thousands)
Securities available for sale:
Government-sponsored residential mortgage-backed securities	$	11,036	$	-	$	11,036	$	-
Written loan commitments		530		-		-		530
Total	$	11,566	$	-	$	11,036	$	530


	As of December 31, 2011
	Total		Level 1		Level 2		Level 3
	(Dollars in thousands)
Securities available for sale:
Government-sponsored residential mortgage-backed securities	$	12,917	$	-	$	12,917	$	-
Written loan commitments		946		-		-		946
Total	$	13,863	$	-	$	12,917	$	946

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

NOTE H - FAIR VALUE MEASUREMENTS (Continued)

Valuation of Assets and Liabilities Reported at Fair Value in Financial Statements (Continued)

The table below presents a reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the three-month periods ended March 31, 2012 and 2011.

	Written Loan Commitments
	For the three months ended March 31,
	2012			2011
	(Dollars in thousands)

Balance, beginning of period	$	946		$	411
Gains (losses) included in other income		(416	)		52
Balance, end of period	$	530		$	463

The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period.

The table below presents the balances of assets and liabilities measured at fair value on a nonrecurring basis.

	As of March 31, 2012
	Total		Level 1		Level 2		Level 3
	(Dollars in thousands)

Impaired loans	$	12,430	$	-	$	606	$	11,824
Foreclosed assets	$	4,059	$	-	$	331	$	3,728


	As of December 31, 2011
	Total		Level 1		Level 2		Level 3
	(Dollars in thousands)

Impaired loans	$	16,309	$	-	$	9,628	$	6,681
Foreclosed assets	$	2,851	$	-	$	886	$	1,965

As of March 31, 2012, all level 2 nonrecurring impaired loans and foreclosed assets have sales contracts or commitments to purchase. No further market driven discounts were applied to the December 31, 2011 impaired loans that required transfers between Level 2 and Level 3 as of March 31, 2012 other than one foreclosed property for $25,000 which was transferred to Level 3 as of March 31, 2012, which we consider as immaterial.

Financial Assets and Liabilities Disclosed, but Not Carried, at Fair Value in Financial Statements

Financial instruments include cash and due from banks, interest-bearing deposits with banks, investments, accrued interest, loans, written loan commitments, bank owned life insurance, deposit accounts and borrowings. The Company has recorded certain assets at fair value as required by accounting standards on the proper disclosure of fair value of financial instruments. Fair value estimates are made at a specific moment in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no active market readily exists for a portion of the Company’s financial instruments, 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.

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

NOTE H - FAIR VALUE MEASUREMENTS (Continued)

Valuation of Assets and Liabilities Reported at Fair Value in Financial Statements (Continued)

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 and Interest-Earning Deposits With Banks

The carrying amounts are a reasonable estimate of fair value for cash and due from banks and interest-earning deposits with banks because of the short maturities of those instruments.

Investment Securities

Fair value for investment securities available for sale equals 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 fair values are based on market observable inputs and are disclosed at Level 2 hierarchy. Fair value for investment securities held to maturity is determined internally based on a discounted cash flow valuation technique utilizing a discount rate based on the three-month LIBOR rate. Estimates of fair value developed internally are disclosed at Level 3 of the hierarchy. The valuation technique for the level 3 securities is consistent with techniques used in prior periods.

Loans and Loans Held for Sale

The fair value of loans is based on estimated cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities, less a credit component and are carried at Level 3 of the hierarchy. The fair value of impaired loans measured on a nonrecurring basis are determined internally utilizing one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value or discounted cash flows. A portion of the Company’s March 31, 2012 impaired loans was evaluated based on the fair value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2 of the hierarchy. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as a nonrecurring Level 3. The carrying amount of loans held for sale is a reasonable estimate of fair value since they will be sold in a short period and are carried at Level 3 of the hierarchy. This does not include consideration of liquidity that market participants would use to value such loans.

Stock in Federal Home Loan Bank of Atlanta

The fair value for FHLB stock approximates carrying value, based on the redemption provisions of the Federal Home Loan Bank and is carried at Level 2 of the hierarchy.

Bank Owned Life Insurance

The carrying value of life insurance approximates fair value as this investment is carried at cash surrender value as determined by the insurer and is carried at Level 2 of the hierarchy.

Deposits

The fair value of demand, savings, money market and NOW deposits is the amount payable on demand at the reporting date. The fair value of time deposits and borrowings is estimated by discounting expected cash flows using the rates currently offered for instruments of similar remaining maturities and are carried at Level 3 of the hierarchy.

Borrowings

The fair values are based on discounting expected cash flows at the interest rate for debt with the same or similar remaining maturities and collateral requirements and are carried at Level 3 of the hierarchy.

Accrued Interest

The carrying amounts of accrued interest approximate fair value and is carried at Level 3 of the hierarchy.

Financial Instruments with Off-Balance Sheet Risk

With regard to financial instruments with off-balance sheet risk discussed in Note D, the estimated fair value of future financing commitments is not deemed material.

The following table presents the carrying value and estimated fair value of the Company's financial assets and liabilities disclosed, but not carried, at fair value as of March 31, 2012 and the level within the fair value hierarchy at which such financial instruments are measured on a recurring and non-recurring basis.

NORTH STATE BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

NOTE H - FAIR VALUE MEASUREMENTS (Continued)

Financial Assets and Liabilities Disclosed, but Not Carried, at Fair Value in Financial Statements (Continued)

	March 31, 2012
	Carrying Amount		Estimated Fair Value		Level 1		Level 2		Level 3
	(Dollars in thousands)
Financial assets:
Cash and due from banks	$	8,364	$	8,364	$	8,364	$	-	$	-
Interest-earning deposits with banks		86,679		86,679		86,679		-		-
Investment securities available for sale		11,036		11,036		-		11,036		-
Investment securities held to maturity		250		200		-		-		200
Loans held for sale		46,693		46,693		-		-		46,693
Loans, net		475,623		481,905		-		606		481,299
Accrued interest receivable		1,253		1,253		-		-		1,253
Stock in the Federal Home Loan Bank		1,073		1,073		-		-		1,073
Bank owned life insurance		10,243		10,243		-		10,243		-
Written loan commitments		530		530		-		-		530

Financial liabilities:
Deposits	$	599,520	$	600,437	$	-	$	-	$	600,437
Short-term borrowings		1,045		1,045		-		-		1,045
Long-term borrowings		27,241		27,238		-		-		27,238
Accrued interest payable		895		895		-		-		895

The Company did not have any transfers between Level 1 and Level 2. The following table presents the carrying values and estimated fair values of the Company's financial instruments disclosed, but not carried, at fair value as of December 31, 2011.

		December 31, 2011
		Carrying Amount				Estimated Fair Value
		(Dollars in thousands)

NORTH STATE BANCORP 10-Q