First Bancorp
Annual Report 2011

Plain-text annual report

93314_BC-FC_Layout 1 3/19/12 12:04 PM Page 2 First Bancorp Annual Report continuing our journey. 93314_Coversx_Layout 1 3/16/12 2:38 PM Page 1 ( Selected Financial Data ) We’re proud to report our 25th consecutive year of profitability since our initial public offering: Change 2010 Years Ended December 31, 2011 2010 to 2011 ($ in thousands except share data) SELECTED INCOME STATEMENT DATA Net interest income $ 132,203 127,354 3.8% Provision for loan losses 41,301 54,562 -24.3% Noninterest income 26,216 29,106 -9.9% Noninterest expenses 96,106 86,956 10.5% Income taxes 7,370 4,960 48.6% Net income 13,642 9,982 36.7% Preferred stock dividends 6,166 4,107 50.1% Net income - common shareholders 7,476 5,875 27.3% PER SHARE DATA Earnings per common share - basic $ 0.44 0.35 25.7% Earnings per common share - diluted 0.44 0.35 25.7% Cash dividends declared - common 0.32 0.32 0.0% Market Price: High 16.89 16.90 0.0% Low 8.05 12.00 -32.9% Close 11.15 15.31 -27.2% Book value - common 16.66 16.64 0.1% Tangible book value - common 12.53 12.45 0.6% SELECTED BALANCE SHEET DATA (at year end) Assets $ 3,290,474 3,278,932 0.4% Loans 2,430,386 2,454,132 -1.0% Deposits 2,755,037 2,652,513 3.9% Shareholders’ Equity 345,150 344,603 0.2% PERFORMANCE RATIOS Return on average assets 0.23% 0.18% 5 bps Return on average common equity 2.59% 2.05% 54 bps NONFINANCIAL DATA Common shares outstanding 16,909,820 16,801,426 Number of branches 97 92 Number of employees - full/part time 812/36 753/41 93314_txt_p01-p05x_Layout 1 3/16/12 3:16 PM Page 1 ( President’s Letter ) Jerry Ocheltree, President Staying the course. Dear Shareholders, Customers and Friends, I am pleased to be able to report to you the 25th consecutive year of profitability for First Bancorp since our initial public offering in 1987. If you follow the performance of other community banks in our market area, you know that profitability has not been a given over the past several years. Our largest market area is in North Carolina, which does not seem to be showing the same signs of economic recovery as much of the rest of the nation. We continue to see high unemployment rates, real estate value declines and difficulties in transitioning from a manufacturing economy. But we are confident that First Bank is uniquely positioned with the right combination of size and dedication to community banking to prosper when conditions improve. Financial Roadmap. For 2011, we earned $7.5 million, or $0.44 per share, for holders of our common stock. This represents a 26% increase from the $5.9 million, or $0.35 per share, earned in 2010. The results for both 2010 and 2011 were significantly impacted by what we consider to be non-core components of earnings, which include a bargain purchase gain in 2011, losses and related indemnification asset income in both 2010 and 2011 related to problem loans and foreclosed properties primarily associated with properties assumed in prior FDIC failed-bank acquisitions, and accelerated accretion of discount on preferred stock in 2011. These items are discussed in detail in the accompanying Form 10-K. Overall, our bank has a profitable core earnings stream. However, the earnings stream has not been as high as it could be due to losses on our non-covered 93314_txt_p01-p05x_Layout 1 3/16/12 2:46 PM Page 2 ( President’s Letter ) loans and foreclosed properties (“non-covered” refers to assets not covered under loss-share agreements with the FDIC). In 2011, our provision for loan losses on non-covered loans was $28.5 million, which was a 15% decline from 2010, but was still significantly higher than we would like. Losses on non-covered foreclosed properties increased from $1.0 million in 2010 to $3.4 million in 2011. Because these types of losses are closely correlated with our level of problem assets, we are eager for our problem asset levels to decline. As I mentioned earlier, there have been signs of economic recovery on a national level. But thus far, it does not seem that our market has participated much in the recovery, and our level of problem assets has remained essentially flat. On the positive side, our net interest margin for 2011 of 4.72% was the highest it has been in many years, exceeding the already strong 4.39% margin realized in 2010. With new regulations pressuring certain sources of noninterest income and increasing our overhead expenses, we know that having a strong net interest margin is very important to the sustained profitability of our company. Driving Growth. While unfavorable economic conditions in our market area have limited the opportunities for organic growth, our company’s financial strength has allowed us the opportunity to seek external acquisition growth. On January 21, 2011, we acquired the Bank of Asheville in an FDIC-assisted transaction, with five branches and $190 million in assets. Like the coast, the mountain region of North Carolina also experienced a real estate bubble and a subsequent bust that led to losses at many banks in that region. But like the coast, this is a very attractive market that we think will recover and experience good growth again. With five branches throughout the city of Asheville, we have the critical mass necessary to support the growth when it eventually returns. ( Board of Directors ) Daniel T. Blue Jr. Virginia C. Thomasson R. Walton Brown James G. Hudson Jr. Thomas F. Phillips R. Winston Dozier Jr. David L. Burns Jack D. Briggs Dennis A. Wicker 93314_txt_p01-p05x_Layout 1 3/16/12 2:46 PM Page 3 ( President’s Letter ) Also, we were able to leverage the knowledge and experience we gained from a 2009 failed-bank acquisition to make this integration faster and smoother. In October 2011, we announced that we had reached an agreement with Waccamaw Bank, Whiteville, North Carolina, to acquire 11 of their coastal branches with total deposits of $180 million. Many of the branches are in towns where we already have a presence and thus we believe there are significant economies of scale that we can leverage. We are awaiting regulatory approval for this transaction. Overall, the growth provided by the Bank of Asheville acquisition essentially offset general declines in loans and deposits caused by normal loan paydowns and a decreased need to rely on higher cost time deposits. At December 31, 2011, we had 97 branches and our total assets amounted to $3.3 billion, making us the fourth largest bank holding company headquartered in North Carolina. Gaining Speed on the Internet. We have fully embraced the ongoing technology revolution. In addition to free debit cards, we offer state-of-the art internet banking, along with online bill pay, cash rewards, mobile banking, e-statements, remote deposit capture, and a comprehensive product called Finance 360, which is a powerful budgeting and financial analysis tool that assists customers in seeing their complete financial picture, including the ability to aggregate accounts held at other firms. For smart phones, we offer our own iPhone® app and our Android™ app is due to be released soon. In 2011, we completed a major upgrade to our website. It is now simpler and faster than ever to use. Please visit us at www.firstbancorp.com. Navigating the Road Ahead. During 2011, we made significant investments in our infrastructure, including personnel, that provide John F. Burns James Crawford III Mary Clara Capel Jerry L. Ocheltree Richard H. Moore John C. Willis George R. Perkins Jr. Frederick L. Taylor, II Not Pictured: Goldie H. Wallace 93314_txt_p01-p05x_Layout 1 3/16/12 3:19 PM Page 4 ( President’s Letter ) Accompanying the mailing of this letter is our proxy statement and the notice of our Annual Shareholders Meeting, which is being held at the James H. Garner Conference Center at 3:00 PM on May 10, 2012. There is important information regarding your company contained within the proxy statement, and I encourage you to read it closely. On the back of the proxy statement is a location map for your convenience. I invite you to attend this meeting, which will give you an opportunity to meet the management and board of directors of your company. Your support is appreciated, and I welcome your comments and suggestions. Jerry L. Ocheltree PRESIDENT AND CHIEF EXECUTIVE OFFICER FIRST BANCORP AND FIRST BANK MARCH 20, 2012 us with the platform to seek growth. We believe it is more important than ever to have enough size to be able to better absorb the higher level of expenses that are needed to comply with new regulations applicable to banks. We believe many smaller banks will come to this same conclusion and will decide they need to partner with a larger bank. With the investments we have made and our track record of being a friendly acquirer, we believe that we can be a good partner. We are also working to grow internally. During 2011, we hired a chief retail banking officer who is working to bring growth to our company with a renewed focus on customer service. Also, we were recently joined by a seasoned executive that will be building out and growing our wealth management capabilities. In addition to our existing banking and property/casualty insurance expertise, we ask that you also consider First Bank for your investment advisory needs. An aspect of internal growth we are working hard to achieve is an increase in our small business lending. During 2011, we were one of a minority of banks that were approved by the US Treasury to participate in the Small Business Lending Fund (SBLF), which involved the issuance of preferred stock to the Treasury that has a dividend rate that can be as low as 1% during the first five years based on increases in our lending to small businesses. Simultaneous with our participation in the SBLF, we were able to redeem all of the preferred stock that we had issued as part of the Capital Purchase Program (also known as “TARP”). Road Well Traveled. In summary, despite the near term challenges, we believe we are well-positioned for a future that is as bright as most of our previous 76 years of service. Our financial position is strong, and we believe we will be the beneficiary of the fallout and consolidation that is expected to continue in the banking industry. 93314_txt_p01-p05x_Layout 1 3/16/12 3:20 PM Page 5 Form 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2011 Commission File Number 0-15572 FIRST BANCORP (Exact Name of Registrant as Specified in its Charter) North Carolina (State of Incorporation) 56-1421916 (I.R.S. Employer Identification Number) 341 North Main Street, Troy, North Carolina (Address of Principal Executive Offices) Registrant’s telephone number, including area code: 27371-0508 (Zip Code) (910) 576-6171 Title of each class Common Stock, No Par Value Name of each exchange on which registered The Nasdaq Global Select Market Securities Registered Pursuant to Section 12(b) of the Act: Securities Registered Pursuant to Section 12(g) of the Act: None Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933. [ ] YES [X] NO Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934. [ ] YES [X] NO Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] YES [ ] NO Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). [X] YES [ ] NO Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to the Form 10-K. [ ] 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 the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one) [ ] Large Accelerated Filer [X] Accelerated Filer [ ] Non-Accelerated Filer [ ] Smaller Reporting Company Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). [ ] YES [X] NO The aggregate market value of the Common Stock, no par value, held by non-affiliates of the registrant, based on the closing price of the Common Stock as of June 30, 2011 as reported by The NASDAQ Global Select Market, was approximately $154,892,268. The number of shares of the registrant’s Common Stock outstanding on February 29, 2012 was 16,935,043. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant’s Proxy Statement to be filed pursuant to Regulation 14A are incorporated herein by reference into Part III. TABLE OF CONTENTS Forward-Looking Statements Item 1 Item 1A Item 1B Item 2 Item 3 Item 4 Business Risk Factors Unresolved Staff Comments Properties Legal Proceedings Mine Safety Disclosures PART I PART II Item 5 Market for Registrant’s Common Stock, Related Shareholder Matters, and Issuer Item 6 Item 7 Purchases of Equity Securities Selected Consolidated Financial Data Management’s Discussion and Analysis of Financial Condition and Results of Operations Overview – 2011 Compared to 2010 Overview – 2010 Compared to 2009 Outlook for 2012 Critical Accounting Policies Merger and Acquisition Activity FDIC Indemnification Asset Statistical Information Net Interest Income Provision for Loan Losses Noninterest Income Noninterest Expenses Income Taxes Stock-Based Compensation Distribution of Assets and Liabilities Securities Loans Nonperforming Assets Allowance for Loan Losses and Loan Loss Experience Deposits and Securities Sold Under Agreements to Repurchase Borrowings Liquidity, Commitments, and Contingencies Capital Resources and Shareholders’ Equity Off-Balance Sheet Arrangements and Derivative Financial Instruments Return on Assets and Equity Interest Rate Risk (Including Quantitative and Qualitative Disclosures about Market Risk) Inflation Current Accounting Matters Item 7A Item 8 Quantitative and Qualitative Disclosures about Market Risk Financial Statements and Supplementary Data: Consolidated Balance Sheets as of December 31, 2011 and 2010 Consolidated Statements of Income for each of the years in the three-year period ended December 31, 2011 Consolidated Statements of Comprehensive Income for each of the years in the three-year period ended December 31, 2011 Consolidated Statements of Shareholders’ Equity for each of the years in the three-year period ended December 31, 2011 3 Begins on Page(s) 5 5 19 24 24 25 25 25, 65 28, 65 29 32 34 35 37 38 40, 66 42, 76 44, 67 45, 68 46, 68 46 49, 69 49, 69 51, 71 52, 73 55, 75 57, 78 58 59, 80 60, 82 62 62, 81 62, 79 64 64 64 84 85 86 87 Consolidated Statements of Cash Flows for each of the years in the three-year period ended December 31, 2011 Notes to the Consolidated Financial Statements Reports of Independent Registered Public Accounting Firm Selected Consolidated Financial Data Quarterly Financial Summary Changes in and Disagreements with Accountants on Accounting and Financial Item 9 Disclosures Item 9A Item 9B Controls and Procedures Other Information PART III Item 10 Item 11 Item 12 Directors, Executive Officers and Corporate Governance Executive Compensation Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters Item 13 Item 14 Certain Relationships and Related Transactions, and Director Independence Principal Accountant Fees and Services Item 15 Exhibits and Financial Statement Schedules PART IV SIGNATURES Begins on Page(s) 88 89 148 65 83 150 150 151 151 151 151 151 151 152 156 * Information called for by Part III (Items 10 through 14) is incorporated herein by reference to the Registrant’s definitive Proxy Statement for the 2012 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission on or before April 29, 2012. 4 FORWARD-LOOKING STATEMENTS This report contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 and the Private Securities Litigation Reform Act of 1995, which statements are inherently subject to risks and uncertainties. Forward-looking statements are statements that include projections, predictions, expectations or beliefs about future events or results or otherwise are not statements of historical fact. Further, forward-looking statements are intended to speak only as of the date made. Such statements are often characterized by the use of qualifying words (and their derivatives) such as “expect,” “believe,” “estimate,” “plan,” “project,” or other statements concerning our opinions or judgment about future events. Our actual results may differ materially from those anticipated in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors which are beyond our control. Factors that could influence the accuracy of such forward-looking statements include, but are not limited to, the financial success or changing strategies of our customers, our level of success in integrating acquisitions, actions of government regulators, the level of market interest rates, and general economic conditions. For additional information about factors that could affect the matters discussed in this paragraph, see the “Risk Factors” section in Item 1A of this report. PART I Item 1. Business General Description First Bancorp (the “Company”) is a bank holding company. Our principal activity is the ownership and operation of First Bank (the “Bank”), a state-chartered bank with its main office in Troy, North Carolina. The Company is also the parent to a series of statutory business trusts organized under the laws of the State of Delaware that were created for the purpose of issuing trust preferred debt securities. Our outstanding debt associated with these trusts was $46.4 million at December 31, 2011 and 2010. The Company was incorporated in North Carolina on December 8, 1983, as Montgomery Bancorp, for the purpose of acquiring 100% of the outstanding common stock of the Bank through a stock-for-stock exchange. On December 31, 1986, the Company changed its name to First Bancorp to conform its name to the name of the Bank, which had changed its name from Bank of Montgomery to First Bank in 1985. The Bank was organized in 1934 and began banking operations in 1935 as the Bank of Montgomery, named for the county in which it operated. The Bank’s main office is in Troy, population 3,500, located in the center of Montgomery County, approximately 60 miles east of Charlotte, 50 miles south of Greensboro, and 80 miles southwest of Raleigh. As of December 31, 2011, we conducted business from 97 branches covering a geographical area from Little River, South Carolina to the southeast, to Wilmington, North Carolina to the east, to Kill Devil Hills, North Carolina to the northeast, to Radford, Virginia to the north, to Wytheville, Virginia to the northwest, and to Asheville, North Carolina to the west. We also have a loan production office in Blacksburg, which is located in southwestern Virginia and represents our furthest location to the north of Troy. Of the Bank’s 97 branches, 82 branches are in North Carolina, nine branches are in South Carolina and six branches are in Virginia (where we operate under the name “First Bank of Virginia”). Ranked by assets, the Bank was the fourth largest bank headquartered in North Carolina as of December 31, 2011. On June 19, 2009, we acquired substantially all of the assets and liabilities of Cooperative Bank, which had been closed earlier that day by regulatory authorities. Cooperative Bank operated through twenty-four branches located primarily in the coastal region of North Carolina. In connection with the acquisition, we assumed assets with a book value of $959 million, including $829 million in loans and $706 million in deposits. The loans and 5 foreclosed real estate purchased in the acquisition are covered by loss share agreements between the Federal Deposit Insurance Corporation (FDIC) and First Bank which affords the Bank significant loss protection. We recorded a gain of $67.9 million as a result of this acquisition. Additional information regarding this transaction is contained in Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 2 to the consolidated financial statements. On January 21, 2011, we acquired substantially all of the assets and liabilities of The Bank of Asheville, which had been closed earlier that day by regulatory authorities. The Bank of Asheville operated through five branches located in or near Asheville, North Carolina. In connection with the acquisition, we assumed assets with a book value of $190 million, including $154 million in loans and $192 million in deposits. Substantially all of the acquired loans and foreclosed real-estate are covered by loss share agreements with the FDIC, which affords the Bank significant loss protection. We recorded a gain of $10.2 million as a result of this acquisition. Additional information regarding this transaction is also contained in Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 2 to the consolidated financial statements. As of December 31, 2011, the Bank had two wholly owned subsidiaries, First Bank Insurance Services, Inc. (“First Bank Insurance”) and First Troy SPE, LLC. First Bank Insurance was acquired as an active insurance agency in 1994 in connection with the Company’s acquisition of a bank that had an insurance subsidiary. On December 29, 1995, the insurance agency operations of First Bank Insurance were divested. From December 1995 until October 1999, First Bank Insurance was inactive. In October 1999, First Bank Insurance began operations again as a provider of non-FDIC insured investments and insurance products. Currently, First Bank Insurance’s primary business activity is the placement of property and casualty insurance coverage. First Troy SPE, LLC, which was organized in December 2009, is a holding entity for certain foreclosed properties. Our principal executive offices are located at 341 North Main Street, Troy, North Carolina 27371-0508, and our telephone number is (910) 576-6171. Unless the context requires otherwise, references to the “Company,” “we,” “our,” or “us” in this annual report on Form 10-K shall mean collectively First Bancorp and its consolidated subsidiaries. General Business We engage in a full range of banking activities, with the acceptance of deposits and the making of loans being our most basic activities. We offer deposit products such as checking, savings, NOW and money market accounts, as well as time deposits, including various types of certificates of deposits (CDs) and individual retirement accounts (IRAs). We provide loans for a wide range of consumer and commercial purposes, including loans for business, agriculture, real estate, personal uses, home improvement and automobiles. We also offer credit cards, debit cards, letters of credit, safe deposit box rentals and electronic funds transfer services, including wire transfers. In addition, we offer internet banking, mobile banking, cash management and bank-by- phone capabilities to our customers, and are affiliated with ATM networks that give our customers access to 67,000 ATMs, with no surcharge fee. In 2007, we introduced remote deposit capture, which provides business customers with a method to electronically transmit checks received from customers into their bank account without having to visit a branch. In 2008, we joined the Certificate of Deposit Account Registry Service (CDARS), which gives our customers the ability to obtain FDIC insurance on deposits of up to $50 million, while continuing to work directly with their local First Bank branch. Because the majority of our customers are individuals and small to medium-sized businesses located in the counties we serve, management does not believe that the loss of a single customer or group of customers would have a material adverse impact on the Bank. There are no seasonal factors that tend to have any material effect on the Bank’s business, and we do not rely on foreign sources of funds or income. Because we operate primarily within North Carolina, southwestern Virginia and northeastern South Carolina, the economic conditions of these 6 areas could have a material impact on the Company. See additional discussion below in the section entitled “Territory Served and Competition.” Beginning in 1999, First Bank Insurance began offering non-FDIC insured investment and insurance products, including mutual funds, annuities, long-term care insurance, life insurance, and company retirement plans, as well as financial planning services (the “investments division”). In May 2001, First Bank Insurance added to its product line when it acquired two insurance agencies that specialized in the placement of property and casualty insurance. In October 2003, the “investments division” of First Bank Insurance became a part of the Bank. The primary activity of First Bank Insurance is now the placement of property and casualty insurance products. In February 2010, First Bank Insurance acquired The Insurance Center, Inc., a Troy-based property and casualty insurance agency with approximately 500 customers. First Bancorp Capital Trust I was organized in October 2002 for the purpose of issuing $20.6 million in debt securities. These debt securities were called by the Company at par on November 7, 2007 and First Bancorp Capital Trust I was dissolved. First Bancorp Capital Trust II and First Bancorp Capital Trust III were organized in December 2003 for the purpose of issuing $20.6 million in debt securities ($10.3 million was issued from each trust). These borrowings are due on January 23, 2034 and are also structured as trust preferred capital securities in order to qualify as regulatory capital. These debt securities are callable by the Company at par on any quarterly interest payment date beginning on January 23, 2009. The interest rate on these debt securities adjusts on a quarterly basis at a weighted average rate of three-month LIBOR plus 2.70%. First Bancorp Capital Trust IV was organized in April 2006 for the purpose of issuing $25.8 million in debt securities. These borrowings are due on June 15, 2036 and are also structured as trust preferred capital securities that qualify as regulatory capital. These debt securities are callable by the Company at par on any quarterly interest payment date beginning on June 15, 2011. The interest rate on these debt securities adjusts on a quarterly basis at a rate of three-month LIBOR plus 1.39%. 7 Territory Served and Competition Our headquarters are located in Troy, Montgomery County, North Carolina. At the end of 2011, we served primarily the south central region (sometimes called the Piedmont region), the central mountain region and the eastern coastal region of North Carolina, with additional operations in northeastern South Carolina and southwestern Virginia. The following table presents, for each county where we operated as of December 31, 2011, the number of bank branches operated by the Company within the county, the approximate amount of deposits with the Company in the county as of December 31, 2011, our approximate deposit market share at June 30, 2011, and the number of bank competitors located in the county at June 30, 2011. County Anson, NC Beaufort, NC Bladen, NC Brunswick, NC Buncombe, NC Cabarrus, NC Carteret, NC Chatham, NC Chesterfield, SC Columbus, NC Dare, NC Davidson, NC Dillon, SC Duplin, NC Florence, SC Guilford, NC Harnett, NC Horry, SC Iredell, NC Lee, NC Montgomery, NC Montgomery, VA Moore, NC New Hanover, NC Onslow, NC Pulaski, VA Randolph, NC Richmond, NC Robeson, NC Rockingham, NC Rowan, NC Scotland, NC Stanly, NC Wake, NC Washington, VA Wythe, VA Brokered & Internet Deposits Total Number of Branches 1 3 1 4 5 2 2 2 3 2 1 3 3 3 2 1 3 1 2 4 5 2 11 5 2 1 4 1 5 1 2 2 4 1 1 2 - 97 Deposits (in millions) $ 12 31 22 76 103 36 20 62 57 29 15 94 67 126 26 55 114 3 32 181 106 58 404 137 43 25 69 16 190 30 50 61 94 17 32 79 183 $ 2,755 Market Share 4.2% 2.8% 9.3% 4.7% 2.9% 2.0% 2.6% 8.7% 16.1% 4.0% 1.2% 3.8% 23.8% 24.9% 1.2% 0.4% 13.0% 0.1% 1.5% 21.5% 39.1% 3.2% 25.7% 3.5% 4.1% 6.9% 3.7% 4.1% 19.7% 2.8% 3.3% 17.5% 9.7% 0.1% 3.0% 13.9% Number of Competitors 5 7 5 11 18 11 8 10 7 6 11 10 3 7 13 21 9 24 23 10 4 13 11 20 9 8 15 6 9 11 13 6 6 31 16 11 Our branches and facilities are primarily located in small communities whose economies are based primarily on services, manufacturing and light industry. Although our market is predominantly small communities and rural areas, the market area is not dependent on agriculture. Textiles, furniture, mobile homes, electronics, plastic and metal fabrication, forest products, food products, chicken hatcheries, and cigarettes are among the leading manufacturing industries in the trade area. Leading producers of lumber and rugs are located in Montgomery 8 County, North Carolina. The Pinehurst area within Moore County, North Carolina, is a widely known golf resort and retirement area. The High Point, North Carolina, area is widely known for its furniture market. New Hanover and Brunswick Counties, located in the southeastern coastal region of North Carolina, are popular with tourists and have significant retirement populations. Buncombe County, located in the western region of North Carolina, is a highly diverse area with industries in manufacturing, service, and tourism. Additionally, several of the communities served by the Company are “bedroom” communities of large cities like Charlotte, Raleigh and Greensboro, while several branches are located in medium-sized cities such as Albemarle, Asheboro, High Point, Southern Pines and Sanford. We also have branches in small communities such as Bennett, Polkton, Vass, and Harmony. Approximately 15% of our deposit base is in Moore County. Accordingly, material changes in competition, the economy or population of Moore County could materially impact the Company. No other county comprises more than 10% of our deposit base. We compete in our various market areas with, among others, several large interstate bank holding companies. These large competitors have substantially greater resources than us, including broader geographic markets, higher lending limits and the ability to make greater use of large-scale advertising and promotions. A significant number of interstate banking acquisitions have taken place in the past decade, thus further increasing the size and financial resources of some of our competitors, three of which are among the largest bank holding companies in the nation. In many of our markets, we also compete against banks that have been organized within the past ten to fifteen years. Until recently, these new banks often focused on loan and deposit balance sheet growth, and not necessarily on earnings profitability, which often resulted in them offering more attractive terms on loans and deposits than we were willing to offer in light of our profitability goals. Due to capital considerations, most of these banks are no longer seeking balance sheet growth. This has increased our ability to compete for loans, but the same banks continue to offer premium rates on deposits, presumably in an effort to maintain maximum liquidity during these challenging economic times. Moore County, which as noted above comprises a disproportionate share of our deposits, is a particularly competitive market, with at least eleven other financial institutions having a physical presence. We compete not only against banking organizations, but also against a wide range of financial service providers, including federally and state-chartered savings and loan institutions, credit unions, investment and brokerage firms and small-loan or consumer finance companies. One of the credit unions in our market area is among the largest in the nation. Competition among financial institutions of all types is virtually unlimited with respect to legal ability and authority to provide most financial services. We also experience competition from internet banks, particularly in the area of time deposits. Despite the competitive market, we believe we have certain advantages over our competition in the areas we serve. We seek to maintain a distinct local identity in each of the communities we serve and we actively sponsor and participate in local civic affairs. Most lending and other customer-related business decisions can be made without the delays often associated with larger institutions. Additionally, employment of local managers and personnel in various offices and low turnover of personnel enable us to establish and maintain long-term relationships with individual and corporate customers. Lending Policy and Procedures Conservative lending policies and procedures and appropriate underwriting standards are high priorities of the Bank. Loans are approved under our written loan policy, which provides that lending officers, principally branch managers, have authority to approve loans of various amounts up to $350,000, with lending limits varying depending upon the experience of the lending officer and whether the loan is secured or unsecured. Each of our regional senior lending officers has discretion to approve secured loans of various principal amounts up to 9 $500,000 and together can approve loans up to $4,000,000. Loans above $4,000,000 must be approved by the Executive Committee of the Company’s board of directors. Our board of directors reviews and approves loans that exceed management’s lending authority, loans to executive officers, directors, and their affiliates and, in certain instances, other types of loans. New credit extensions are reviewed daily by our senior management and at least monthly by our board of directors. We continually monitor our loan portfolio to identify areas of concern and to enable us to take corrective action. Lending officers and the board of directors meet periodically to review past due loans and portfolio quality, while assuring that the Bank is appropriately meeting the credit needs of the communities it serves. Individual lending officers are responsible for pursuing collection of past-due amounts and monitoring any changes in the financial status of borrowers. We also contract with an independent consulting firm to review new loan originations meeting certain criteria, as well as to assign risk grades to existing credits meeting certain thresholds. The consulting firm’s observations, comments, and risk grades, including variances with the Bank’s risk grades, are shared with the audit committee of the Company’s board of directors and are considered by management in setting Bank policy, as well as in evaluating the adequacy of our allowance for loan losses. The consulting firm also provides training on a periodic basis to our lending officers to keep them updated on current developments in the marketplace. For additional information, see “Allowance for Loan Losses and Loan Loss Experience” under Item 7 below. Investment Policy and Procedures We have adopted an investment policy designed to maximize our income from funds not needed to meet loan demand, in a manner consistent with appropriate liquidity and risk objectives. Pursuant to this policy, we may invest in federal, state and municipal obligations, federal agency obligations, public housing authority bonds, industrial development revenue bonds, Federal Home Loan Bank bonds, Fannie Mae bonds, Government National Mortgage Association bonds, Freddie Mac bonds, Small Business Administration bonds, and, to a limited extent, corporate bonds. Except for corporate bonds, our investments must be rated at least Baa by Moody’s or BBB by Standard and Poor’s. Securities rated below A are periodically reviewed for creditworthiness. We may purchase non-rated municipal bonds only if such bonds are in our general market area and we determine these bonds have a credit risk no greater than the minimum ratings referred to above. Industrial development authority bonds, which normally are not rated, are purchased only if they are judged to possess a high degree of credit soundness to assure reasonably prompt sale at a fair value. We are also authorized by our board of directors to invest a portion of our securities portfolio in high quality corporate bonds, with the amount of such bonds not to exceed 15% of the entire securities portfolio. Prior to purchasing a corporate bond, the Company’s management performs due diligence on the issuer of the bond, and the purchase is not made unless we believe that the purchase of the bond bears no more risk to the Company than would an unsecured loan to the same company. Our investment officer implements the investment policy, monitors the investment portfolio, recommends portfolio strategies and reports to the Company’s Investment Committee. The Investment Committee generally meets on a quarterly basis to review investment activity and to assess the overall position of the securities portfolio. The Investment Committee compares our securities portfolio with portfolios of other companies of comparable size. In addition, reports of all purchases, sales, issuer calls, net profits or losses and market appreciation or depreciation of the securities portfolio are reviewed by our board of directors each month. Once a quarter, our interest rate risk exposure is evaluated by our board of directors. Each year, the written investment policy is approved by the board of directors. 10 Mergers and Acquisitions As part of our operations, we have pursued an acquisition strategy over the years to augment our internal growth. We regularly evaluate the potential acquisition of, or merger with, various financial institutions. Our acquisitions have generally fallen into one of three categories - 1) an acquisition of a financial institution or branch thereof within a market in which we operate, 2) an acquisition of a financial institution or branch thereof in a market contiguous or nearly contiguous to a market in which we operate, or 3) an acquisition of a company that has products or services that we do not currently offer. Historically, we have paid for our acquisitions with cash and/or common stock and any operating income or loss has been fully borne by the Company beginning on the closing date of the acquisition. In 2009, FDIC-assisted acquisitions began to occur frequently as banking regulators closed problem banks. In FDIC-assisted transactions, the acquiring bank often does not pay any consideration for the failed bank, and in some cases receives cash from the FDIC as part of the transaction. In addition, the acquiring bank usually enters into one or more loss share agreements with the FDIC, which affords the acquiring bank significant loss protection. As discussed below, we completed FDIC-assisted transactions in 2009 and 2011. We believe that we can enhance our earnings by pursuing these types of acquisition opportunities through any combination or all of the following: 1) achieving cost efficiencies, 2) enhancing the acquiree’s earnings or gaining new customers by introducing a more successful banking model with more products and services to the acquiree’s market base, 3) increasing customer satisfaction or gaining new customers by providing more locations for the convenience of customers, and 4) leveraging the customer base by offering new products and services. There is also the possibility, especially in a FDIC-assisted transaction, to record a gain on the acquisition date arising from the difference between the purchase price and the acquisition date fair value of the acquired assets and liabilities. Since 2000, we have completed acquisitions in each of the three categories described above. We have completed several whole-bank traditional acquisitions in our existing and contiguous markets; we have purchased numerous bank branches from other banks (both in existing market area and in contiguous/nearly contiguous markets) and we have acquired several insurance agencies, which provided us with the ability to offer property and casualty insurance coverage. In addition to the traditional acquisitions discussed above, in both 2009 and 2011 we acquired the operations of failed banks in FDIC-assisted transactions. On June 19, 2009, we acquired substantially all of the assets and liabilities of Cooperative Bank in a FDIC-assisted transaction. Cooperative Bank operated through twenty-one branches in North Carolina and three branches in South Carolina in the same markets in which the Bank was already operating, as well as in several new, mostly contiguous markets. In connection with the acquisition, the Bank assumed assets with a book value of $959 million, including $829 million in loans and $706 million in deposits. See Note 2 to the consolidated financial statements for more information on this acquisition. On January 21, 2011, we acquired substantially all of the assets and liabilities of The Bank of Asheville in a FDIC- assisted transaction. The Bank of Asheville operated through five branches in or near Asheville, North Carolina. This market was a new market for the Bank. In connection with the acquisition, the Bank assumed assets with a book value of $190 million, including $154 million in loans and $192 million in deposits. See Note 2 to the consolidated financial statements for more information on this acquisition. On October 21, 2011, we entered into a Branch Purchase and Assumption Agreement with Waccamaw Bank, in Whiteville, North Carolina, which provides for the Bank to acquire eleven branches from Waccamaw Bank. Deposits for these branches total approximately $180 million and loans total approximately $98 million. See 11 Note 2 to the consolidated financial statements for more information on this pending acquisition, which is currently awaiting regulatory approval. There are many factors that we consider when evaluating how much to offer for potential acquisition candidates (including FDIC-assisted transactions) with a few of the more significant factors being projected impact on earnings per share, projected impact on capital, and projected impact on book value and tangible book value. Significant assumptions that affect this analysis include the estimated future earnings stream of the acquisition candidate, estimated credit and other losses to be incurred, the amount of cost efficiencies that can be realized, and the interest rate earned/lost on the cash received/paid. In addition to these primary factors, we also consider other factors including (but not limited to) marketplace acquisition statistics, location of the candidate in relation to our expansion strategy, market growth potential, management of the candidate, potential integration issues (including corporate culture), and the size of the acquisition candidate. We plan to continue to evaluate acquisition opportunities that could potentially benefit the Company and its shareholders. These opportunities may include acquisitions that do not fit the categories discussed above. For a further discussion of recent acquisition activity, see “Merger and Acquisition Activity” under Item 7 below. Employees As of December 31, 2011, we had 811 full-time and 38 part-time employees. We are not a party to any collective bargaining agreements, and we consider our employee relations to be good. Supervision and Regulation As a bank holding company, we are subject to supervision, examination and regulation by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) and the North Carolina Office of the Commissioner of Banks (the “Commissioner”). The Bank is subject to supervision and examination by the FDIC and the Commissioner. For additional information, see Note 16 to the consolidated financial statements. Supervision and Regulation of the Company The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended. The Company is also regulated by the Commissioner under the North Carolina Bank Holding Company Act of 1984. A bank holding company is required to file quarterly reports and other information regarding its business operations and those of its subsidiaries with the Federal Reserve Board. It is also subject to examination by the Federal Reserve Board and is required to obtain Federal Reserve Board approval prior to making certain acquisitions of other institutions or voting securities. The Federal Reserve Board requires the Company to maintain certain levels of capital - see “Capital Resources and Shareholders’ Equity.” The Federal Reserve Board also has the authority to take enforcement action against any bank holding company that commits any unsafe or unsound practice, or violates certain laws, regulations or conditions imposed in writing by the Federal Reserve Board. The Federal Reserve Board generally prohibits a bank holding company from declaring or paying a cash dividend that would impose undue pressure on the capital of subsidiary banks or would be funded only through borrowing or other arrangements which might adversely affect a bank holding company’s financial position. Under the Federal Reserve Board policy, a bank holding company is not permitted to continue its existing rate of cash dividends on its common stock unless its net income is sufficient to fully fund each dividend and its prospective rate of earnings retention appears consistent with its capital needs, asset quality and overall financial condition. 12 The Commissioner is empowered to regulate certain acquisitions of North Carolina banks and bank holding companies, issue cease and desist orders for violations of North Carolina banking laws, and promulgate rules necessary to effectuate the purposes of the North Carolina Bank Holding Company Act of 1984. Regulatory authorities have cease and desist powers over bank holding companies and their nonbank subsidiaries where their actions would constitute a serious threat to the safety, soundness or stability of a subsidiary bank. Those authorities may compel holding companies to invest additional capital into banking subsidiaries upon acquisitions or in the event of significant loan losses or rapid growth of loans or deposits. The United States Congress and the North Carolina General Assembly have periodically considered and adopted legislation that has impacted the Company. Supervision and Regulation of the Bank Federal banking regulations applicable to all depository financial institutions, among other things: (i) provide federal bank regulatory agencies with powers to prevent unsafe and unsound banking practices; (ii) restrict preferential loans by banks to “insiders” of banks; (iii) require banks to keep information on loans to major shareholders and executive officers and (iv) bar certain director and officer interlocks between financial institutions. As a state-chartered bank, the Bank is subject to the provisions of the North Carolina banking statutes and to regulation by the Commissioner. The Commissioner has a wide range of regulatory authority over the activities and operations of the Bank, and the Commissioner’s staff conducts periodic examinations of the Bank and its affiliates to ensure compliance with state banking regulations and to assess the safety and soundness of the Bank. Among other things, the Commissioner regulates the merger and consolidation of state-chartered banks, the payment of dividends, loans to officers and directors, recordkeeping, types and amounts of loans and investments, and the establishment of branches. The Commissioner also has cease and desist powers over state-chartered banks for violations of state banking laws or regulations and for unsafe or unsound conduct that is likely to jeopardize the interest of depositors. The dividends that may be paid by the Bank to the Company are subject to legal limitations under North Carolina law. In addition, regulatory authorities may restrict dividends that may be paid by the Bank or the Company’s other subsidiaries. The ability of the Company to pay dividends to its shareholders is largely dependent on the dividends paid to the Company by the Bank. The FDIC is authorized to approve conversions, mergers, consolidations and assumptions of deposit liability transactions between insured banks and uninsured banks or institutions, and to prevent capital or surplus diminution in such transactions if the resulting, continuing, or assumed bank is an insured nonmember bank. In addition, the FDIC monitors the Bank’s compliance with several banking statutes, such as the Depository Institution Management Interlocks Act and the Community Reinvestment Act of 1977. The FDIC also conducts periodic examinations of the Bank to assess its safety and soundness and its compliance with banking laws and regulations, and it has the power to implement changes to, or restrictions on, the Bank’s operations if it finds that a violation is occurring or is threatened. U.S. Treasury Capital Purchase Program (TARP) On October 3, 2008, in response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions, the Emergency Economic Stabilization Act of 2008 (the “EESA”) was signed into law. Pursuant to the EESA, the U.S. Treasury was given the 13 authority to, among other things, purchase up to $700 billion of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets. On October 14, 2008, the Secretary of the U.S. Department of the Treasury announced that the Treasury would purchase equity stakes in a wide variety of banks and thrifts. Under the program, known as the Capital Purchase Program (also known as “TARP”), the Treasury made $250 billion of capital available from EESA to U.S. financial institutions in the form of purchases of preferred stock. In addition to the preferred stock, the Treasury received, from participating financial institutions, warrants to purchase common stock with an aggregate market price equal to 15% of the preferred investment. Participating financial institutions were required to adopt the Treasury’s standards for executive compensation and corporate governance for the period during which the Treasury holds equity issued under the Capital Purchase Program. Although we believed that our capital position was sound, we concluded that the Capital Purchase Program would allow us to raise additional capital on favorable terms in comparison with other available alternatives. Accordingly, we applied to participate in the Capital Purchase Program. The Treasury approved our application in December 2008, and we received $65 million in proceeds from the sale of 65,000 shares of Series A cumulative perpetual preferred stock with a liquidation value of $1,000 per share to the Treasury on January 9, 2009. The terms of the preferred stock issued to the Treasury require a dividend of 5% for the first five years and 9% thereafter. As part of the transaction, we also granted the Treasury a ten-year warrant to purchase up to 616,308 shares of our common stock at an exercise price of $15.82 per share. On September 1, 2011, we redeemed the 65,000 shares of outstanding Series A preferred stock from the Treasury for a redemption price of $65 million, plus unpaid dividends. We funded the majority of this transaction by simultaneously issuing Series B preferred stock to the Treasury in connection with our participation in the Small Business Lending Fund (see below). In November 2011, we repurchased the outstanding common stock warrant from the Treasury at a price of $1.50 per common share for a total of $924,000. See Note 19 to the consolidated financial statements for more information on these transactions. Small Business Lending Fund In December 2010, the U.S. Treasury announced the creation of the Small Business Lending Fund (SBLF) program, which was established under the Small Business Jobs Act of 2010. The SBLF was created to encourage lending to small businesses by providing capital to qualified community banks at favorable rates. Interested financial institutions were required to submit an application and a small business lending plan. Less than half of the financial institutions that applied for the SBLF were approved. We were one of the institutions approved, and on September 1, 2011, we completed the sale of $63.5 million of Series B preferred stock to the Treasury under the SBLF. Under the terms of the stock purchase agreement, the Treasury received 63,500 shares of Series B non-cumulative perpetual preferred stock with a liquidation value of $1,000 per share, in exchange for $63.5 million. As noted above, we used the $63.5 million received from this issuance along with $1.5 million of existing Company funds to redeem the $65 million of preferred stock issued to the Treasury as part of the Capital Purchase Program. The initial dividend rate on SBLF preferred stock was 5%. Depending on our success in meeting certain loan growth targets to small businesses, the dividend rate could decrease to as low as 1% for a period of time. See Note 19 to the consolidated financial statements for more information. 14 FDIC Insurance As a member of the FDIC, the Bank’s deposits are insured by the FDIC. For this protection, each member bank pays a quarterly statutory assessment (which was previously based on deposits, but is now based on average total assets less average tangible equity) and is subject to the rules and regulations of the FDIC. In 2009, the FDIC assessed minimum rates ranging from twelve cents to sixteen cents per $100 in deposits. During 2009, we recorded approximately $3.9 million in annual FDIC insurance premium expense (excluding the special assessment discussed below). The FDIC announced on February 27, 2009 an interim rule that imposed a one-time special assessment of seven cents per $100 in insured deposits to be collected on September 30, 2009, which resulted in a $1.6 million expense for the Bank that was recorded in the second quarter of 2009 and paid on September 30, 2009. The interim rule also permits the FDIC to impose emergency special assessments from time to time after June 30, 2009 if the FDIC board believes the deposit insurance fund will fall to a level that would adversely affect public confidence in federal deposit insurance. To date, the FDIC has not imposed additional special assessments, but in December 2009, the FDIC did require banks to prepay their estimated insurance premiums for 2010 through 2012, which resulted in the Bank prepaying approximately $16.9 million in premiums. This prepaid amount is being recorded as expense on our books as it is incurred. We recognized approximately $4.4 million in FDIC insurance expense in 2010. In February 2011, the FDIC announced changes to the deposit insurance program whereby FDIC deposit insurance assessments are based on average total assets less average tangible equity instead of the previous methodology that was based on deposits. Also, new assessment rates were adopted. The new assessment methodology and assessment rates became effective April 1, 2011. These changes were favorable to our insurance rates, and we recognized approximately $3.0 million in FDIC insurance expense in 2011 compared to the previously noted insurance expense of $4.4 million and $3.9 million (excluding the special assessment) in 2010 and 2009, respectively. Legislative and Regulatory Developments Given the ongoing financial crisis and the current presidential administration, legislation that would affect regulation in the banking industry is introduced in most legislative sessions. The most significant recent legislative and regulatory developments impacting the Company were 1) the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, and 2) Automated Overdraft Payment Regulation, each of which is discussed below. Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 On July 21, 2010, the Dodd-Frank Act became law. The Dodd-Frank Act has had and will continue to have a broad impact on the financial services industry, including significant regulatory and compliance changes including, among other things, (cid:120) enhanced authority over troubled and failing banks and their holding companies; (cid:120) increased capital and liquidity requirements; (cid:120) increased regulatory examination fees; (cid:120) specific provisions designed to improve supervision and safety and soundness by imposing restrictions and limitations on the scope and type of banking and financial activities. In addition, the Dodd-Frank Act establishes a new framework for systemic risk oversight within the financial system that will be enforced by new and existing federal regulatory agencies, including the Financial Stability 15 Oversight Council (FSOC), the Federal Reserve Bank (FRB), the Office of Comptroller of the Currency, the FDIC, and the Consumer Financial Protection Bureau (CFPB). The following description briefly summarizes aspects of the Dodd-Frank Act that could impact the Company, both currently and prospectively. Deposit Insurance. The Dodd-Frank Act made permanent the $250,000 deposit insurance limit for insured deposits, which was an increase from the previous limit of $100,000. The Act also provides for unlimited deposit insurance coverage on non-interest bearing transaction accounts at all insured depository institutions effective December 31, 2010 through December 31, 2012. Amendments to the Federal Deposit Insurance Act also revised the assessment base against which an insured depository institution’s deposit insurance premiums paid to the FDIC’s Deposit Insurance Fund (DIF) will be calculated. Under the amendments, which became effective on April 1, 2011, the FDIC assessment base is no longer the institution’s deposit base, but rather its average consolidated total assets less its average tangible equity. The Dodd-Frank Act also changed the minimum designated reserve ratio of the DIF, increasing the minimum from 1.15% to 1.35% of the estimated amount of total insured deposits, and eliminating the requirement that the FDIC pay dividends to depository institutions when the reserve ratio exceeds certain thresholds by September 30, 2020. Interest on Demand Deposits. The Dodd-Frank Act provided that beginning July 21, 2011 depository institutions were permitted to pay interest on business demand deposits with no limit on the number of monthly withdrawals. Prior to July 21, 2011, we entered into securities repurchase agreements with business customers in order to allow them to earn interest on their excess funds. With the prohibition of paying interest now removed, we have been able to pay interest on our customers’ deposits without the need to enter into a securities repurchase agreement. During 2011, approximately $38 million in liabilities previously classified as “securities sold under agreements to repurchase” were moved to the “NOW” deposit account category. At this time, we do not expect a material increase in total interest expense, only an insignificant amount of reclassification among interest expense categories, as a result of these changes. Trust Preferred Securities. The Dodd-Frank Act prohibits bank holding companies from including in their regulatory Tier 1 capital hybrid debt and equity securities issued on or after May 19, 2010. Among the hybrid debt and equity securities included in this prohibition are trust preferred securities, which we have issued in the past in order to raise additional Tier 1 capital and otherwise improve our regulatory capital ratios. Although we may continue to include our existing trust preferred securities as Tier 1 capital, the prohibition on the use of these securities as Tier 1 capital may limit our ability to raise capital in the future. The Consumer Financial Protection Bureau. The Dodd-Frank Act creates a new, independent Consumer Financial Protection Bureau (CFPB) within the FRB. The CFPB’s responsibility is to establish, implement and enforce rules and regulations under certain federal consumer protection laws with respect to the conduct of providers of certain consumer financial products and services. The CFPB has rulemaking authority over many of the statutes that govern products and services banks offer to consumers. In addition, the Dodd-Frank Act permits states to adopt consumer protection laws and regulations that are more stringent than those regulations the CFPB will promulgate and state attorney generals will have the authority to enforce consumer protection rules the CFPB adopts against state-chartered institutions and national banks. Compliance with any such new regulations established by the CFPB and/or states could reduce our revenue, increase our cost of operations, and limit our ability to expand into certain products and services. Debit Card Interchange Fees. The Dodd-Frank Act gives the FRB the authority to establish rules regarding interchange fees charged for electronic debit transactions by payment card issuers having assets over $10 billion and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer. While we are not directly subject to these rules for so long as our assets do not exceed $10 billion, our activities as a debit card issuer may nevertheless be indirectly impacted by the change in the applicable debit card market caused by these regulations, which may require us to match any new lower fee 16 structure implemented by larger financial institutions in order to remain competitive in the future. The new caps on interchange fees for banks with assets greater than $10 billion became effective October 1, 2011. To date, the Company has not noted any significant indirect negative effects of the interchange fee caps that are applicable to the larger financial institutions. Increased Capital Standards and Enhanced Supervision. The Dodd-Frank Act requires the federal banking agencies to establish minimum leverage and risk-based capital requirements for banks and bank holding companies. These new standards will be no less strict than existing regulatory capital and leverage standards applicable to insured depository institutions and may, in fact, become higher once the agencies promulgate the new standards. Compliance with heightened capital standards may reduce our ability to generate or originate revenue-producing assets and thereby restrict revenue generation from banking and non-banking operations. Transactions with Affiliates. The Dodd-Frank Act enhances the requirements for certain transactions with affiliates under Section 23A and 23B of the Federal Reserve Act, including an expansion of the definition of “covered transactions,” and an increase in the amount of time for which collateral requirements regarding covered transactions must be maintained. Transactions with Insiders. The Dodd-Frank Act expands insider transaction limitations through the strengthening of loan restrictions to insiders and the expansion of the types of transactions subject to the various limits, including derivative transactions, repurchase agreements, reverse repurchase agreements and securities lending and borrowing transactions. The Dodd-Frank Act also places restrictions on certain asset sales to and from an insider of an institution, including requirements that such sales be on market terms and, in certain circumstances, receive the approval of the institution’s board of directors. Enhanced Lending Limits. The Dodd-Frank Act strengthens the existing limits on a depository institution’s credit exposure to one borrower. Federal banking law currently limits a national bank’s ability to extend credit to one person or group of related persons to an amount that does not exceed certain thresholds. The Dodd-Frank Act expands the scope of these restrictions to include credit exposure arising from derivative transactions, repurchase agreements and securities lending and borrowing transactions. It also will eventually prohibit state- chartered banks from engaging in derivative transactions unless the state lending limit laws take into account credit exposure to such transactions. Corporate Governance. The Dodd-Frank Act addresses many corporate governance and executive compensation matters that will affect most U.S. publicly traded companies, including the Company. The Dodd-Frank Act: (cid:120) grants shareholders of U.S. publicly traded companies an advisory vote on executive compensation; (cid:120) enhances independence requirements for compensation committee members; (cid:120) requires companies listed on national securities exchanges to adopt clawback policies for incentive- based compensation plans applicable to executive officers; and (cid:120) provides the SEC with authority to adopt proxy access rules that would allow shareholders of publicly traded companies to nominate candidates for election as directors and require such companies to include such nominees in its proxy materials. Many of the requirements of the Dodd-Frank Act will be subject to implementation over the course of several years. While we do not currently expect the final requirements of the Dodd-Frank Act to have a material adverse impact on the Company, we do expect them to negatively impact our profitability, require changes to certain of our business practices, including limitations on fee income opportunities, and impose more stringent capital, liquidity and leverage requirements upon the Company. These changes may also require us to invest significant management attention and resources to evaluate and make any changes necessary to comply with the new statutory and regulatory requirements. 17 Automated Overdraft Payment Regulation In recent years, the Federal Reserve and FDIC have enacted consumer protection regulations related to automated overdraft payment programs offered by financial institutions. In November 2009, the Federal Reserve amended its Regulation E to prohibit financial institutions, including the Company, from charging consumers fees for paying overdrafts on automated teller machine and one-time debit card transactions, unless a consumer consents, or opts in, to the overdraft service for those types of transactions. The Regulation E amendments also require financial institutions to provide consumers with a notice that explains the financial institution’s overdraft services, including the fees associated with the service and the consumer’s choices. We have completed implementation of the changes as required by the Regulation E amendments, which resulted in reductions to overdraft fees that we were able to collect beginning in the second half of 2010. In November 2010, the FDIC supplemented the Regulation E amendments by requiring FDIC-supervised institutions, including the Bank, to implement additional changes relating to automated overdraft payment programs by July 1, 2011. The most significant of these changes require financial institutions to monitor overdraft payment programs for “excessive or chronic” customer use and undertake “meaningful and effective” follow-up action with customers that overdraw their accounts more than six times during a rolling 12-month period. The additional guidance also imposes daily limits on overdraft charges, requires institutions to review and modify check-clearing procedures, prominently distinguish account balances from available overdraft coverage amounts and requires increased board and management oversight regarding overdraft payment programs. We have now implemented the supplemental requirements of the Regulation E amendments, which resulted in further reductions to the amount of overdraft fees we were able to collect beginning in July 2011. Neither the Company nor the Bank can predict what other legislation might be enacted or what other regulations or assessments might be adopted. See “Capital Resources and Shareholders’ Equity” under Item 7 below for a discussion of regulatory capital requirements. Available Information We maintain a corporate Internet site at www.FirstBancorp.com, which contains a link within the “Investor Relations” section of the site to each of our filings with the Securities and Exchange Commission, including our annual reports on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. These filings are available, free of charge, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission. These filings can also be accessed at the Securities and Exchange Commission’s website located at www.sec.gov. Information included on our Internet site is not incorporated by reference into this annual report. 18 Item 1A. Risk Factors An investment in our common stock involves certain risks. Before you invest in our common stock, you should be aware that there are various risks, including those described below, which could affect the value of your investment in the future. The trading price of our common stock could decline due to any of these risks, and you may lose all or part of your investment. The risk factors described in this section, as well as any cautionary language in this report, provide examples of risks, uncertainties and events that could have a material adverse effect on our business, including our operating results and financial condition. In addition to the risks and uncertainties described below, other risks and uncertainties not currently known to us, or that we currently deem to be immaterial, also may materially or adversely affect our business, financial condition, and results of operations. The value or market price of our common stock could decline due to any of these identified or other unidentified risks. Difficult market conditions and economic trends have adversely affected our industry and our business. A general economic downturn began in the latter half of 2007. Dramatic declines in the housing market, with decreasing home prices and increasing delinquencies and foreclosures, have negatively impacted the credit performance of mortgage loans, especially land development loans, and resulted in significant write-downs of assets by many financial institutions. In addition, the value of real estate collateral supporting many loans has declined and may continue to decline. General downward economic trends, reduced availability of commercial credit and high unemployment rates have negatively impacted the credit performance of commercial and consumer credit, resulting in additional write-downs. While there have been recent signs of recovery in the national economy, the economic conditions in our market area do not seem to have improved. We believe that the economic downtrends are largely responsible for the deterioration in loan quality that we experienced over the past three years, including higher levels of loan charge-offs, higher levels of nonperforming assets, and higher provisions for loan losses. Concerns over the stability of the financial markets and the economy have resulted in decreased lending by financial institutions to their customers and to each other. This market turmoil and tightening of credit has led to increased commercial and consumer delinquencies, lack of confidence, increased market volatility and widespread reduction in general business activity. Financial institutions, including us, have experienced a decrease in access to borrowings. The resulting economic pressure on consumers and businesses and the lack of confidence in the financial markets have adversely affected, and may continue to adversely affect, our business, financial condition, results of operations and stock price. As a result of the foregoing factors, there is a potential for new federal or state laws and regulations regarding lending and funding practices and liquidity standards, and bank regulatory agencies are expected to be very aggressive in responding to concerns and trends identified in examinations. This increased governmental action may increase our costs and limit our ability to pursue certain business opportunities. Our ability to assess the creditworthiness of customers and to estimate the losses inherent in our credit exposure is made more complex by these difficult market and economic conditions. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market and economic conditions on us, our customers and the other financial institutions in our market. As a result, we may experience additional increases in foreclosures, delinquencies and customer bankruptcies, as well as more restricted access to funds. We are vulnerable to the economic conditions within the fairly small geographic region in which we operate. Like many businesses, our overall success is partially dependent on the economic conditions in the marketplace where we operate. Our marketplace is predominately concentrated in the central Piedmont and coastal regions of North Carolina. These regions continue to experience recessionary economic conditions, which we believe is a factor in our increases in borrower delinquencies, nonperforming assets, and loan losses during 2009, 2010, 19 and 2011 compared to recent prior years. If economic conditions in our marketplace worsen, it would likely have an adverse impact on us. In particular, if economic conditions related to real estate values in our marketplace were to worsen, our loan losses would likely increase. At December 31, 2011, approximately 90% of our loans were secured by real estate collateral, which means that additional decreases in real estate values would have an adverse impact on our operations. If our goodwill becomes impaired, we may be required to record a significant charge to earnings. We have goodwill recorded on our balance sheet as an asset with a carrying value as of December 31, 2011 of $65.8 million. Under generally accepted accounting principles, goodwill is required to be tested for impairment at least annually and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The test for goodwill impairment involves comparing the fair value of a company’s reporting units to their respective carrying values. For our company, our community banking operation is our only material reporting unit. The price of our common stock is one of several measures available for estimating the fair value of our community banking operations. For much of 2009, 2010 and 2011, the stock market value of our common stock traded below the book value of our company. Subject to the results of other valuation techniques, if this situation persists or worsens, this could indicate that our next test of goodwill will result in a determination that there is impairment. We may be required to record a significant charge to earnings in our financial statements during the period in which any impairment of our goodwill is determined, which could have a negative impact on our results of operations. We may be subject to more stringent capital requirements. We are subject to capital adequacy guidelines and other regulatory requirements specifying minimum amounts and types of capital which we must maintain. From time to time, the regulators implement changes to these regulatory capital adequacy guidelines. If we fail to meet these minimum capital guidelines and other regulatory requirements, our financial condition would be materially and adversely affected. In light of proposed changes to regulatory capital requirements contained in the Dodd-Frank Act and the regulatory accords on international banking institutions formulated by the Basel Committee and implemented by the Federal Reserve, we likely will be required to satisfy additional, more stringent, capital adequacy standards. The ultimate impact of the new capital standards on us cannot be determined at this time and will depend on a number of factors, including the treatment and implementation by U.S. banking regulators. These requirements, however, and any other new regulations, could adversely affect our ability to pay dividends, or could require us to reduce business levels or raise capital, including in ways that may adversely affect our financial condition or results of operations. We might be required to raise additional capital in the future, but that capital may not be available or may not be available on terms acceptable to us when it is needed. We are required to maintain adequate capital levels to support our operations. In the future, we might need to raise additional capital to support growth, absorb loan losses, or meet more stringent capital requirements. Our access to capital markets has remained limited for most of the past three years (excluding the Treasury’s Capital Purchase Program and the Small Business Lending Fund). Our ability to raise additional capital will depend on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, we cannot be certain of our ability to raise additional capital in the future if needed or on terms acceptable to us. If we cannot raise additional capital when needed, our ability to conduct our business could be materially impaired. The soundness of other financial institutions could adversely affect us. Since the middle of 2007, the financial services industry as a whole, as well as the securities markets generally, 20 have been materially adversely affected by substantial declines in the values of nearly all asset classes and by a significant lack of liquidity. Financial institutions, especially in North Carolina and the rest of the Southeast, have been subject to increased volatility and an overall loss in investor confidence. Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services companies are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, and investment banks. Defaults by, or even rumors or questions about, one or more financial services companies, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. We can make no assurance that any such losses would not materially and adversely affect our business, financial condition or results of operations. We are subject to extensive regulation, which could have an adverse effect on our operations. We are subject to extensive regulation and supervision from the North Carolina Commissioner of Banks, the FDIC, and the Federal Reserve Board. This regulation and supervision is intended primarily for the protection of the FDIC insurance fund and our depositors and borrowers, rather than for holders of our equity securities. In the past, our business has been materially affected by these regulations. This trend is likely to continue in the future. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on operations, the classification of our assets and the determination of the level of allowance for loan losses. Changes in the regulations that apply to us, or changes in our compliance with regulations, could have a material impact on our operations. Financial reform legislation enacted by the U.S. Congress, and further changes in regulation to which we are exposed, will result in additional new laws and regulations that are expected to increase our costs of operations. The Dodd-Frank Act has and will continue to significantly change bank regulatory structure and affect lending, deposit, investment, and operating activities of financial institutions and their holding companies. The Dodd- Frank Act requires various federal agencies to adopt a broad range of new rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies are given significant discretion in drafting and implementing the rules and regulations, and consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for many months or years. See “Legislative and Regulatory Developments – Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010” above for additional information regarding the Dodd-Frank Act. The Dodd-Frank Act also created the Consumer Financial Protection Bureau and gave it broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. Additionally, the Consumer Financial Protection Bureau has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. Proposals for further regulation of the financial services industry are continually being introduced in the Congress of the United States of America. The agencies regulating the financial services industry also periodically adopt changes to their regulations. It is possible that additional legislative proposals may be adopted or regulatory changes may be made that would have an adverse effect on our business. In addition, it is expected that such regulatory changes will increase our operating and compliance cost. We can provide no assurance regarding the manner in which new laws and regulations will affect us. 21 We are subject to interest rate risk, which could negatively impact earnings. Net interest income is the most significant component of our earnings. Our net interest income results from the difference between the yields we earn on our interest-earning assets, primarily loans and investments, and the rates that we pay on our interest-bearing liabilities, primarily deposits and borrowings. When interest rates change, the yields we earn on our interest-earning assets and the rates we pay on our interest-bearing liabilities do not necessarily move in tandem with each other because of the difference between their maturities and repricing characteristics. This mismatch can negatively impact net interest income if the margin between yields earned and rates paid narrows. Interest rate environment changes can occur at any time and are affected by many factors that are outside our control, including inflation, recession, unemployment trends, the Federal Reserve’s monetary policy, domestic and international disorder and instability in domestic and foreign financial markets. Our allowance for loan losses may not be adequate to cover actual losses. Like all financial institutions, we maintain an allowance for loan losses to provide for probable losses caused by customer loan defaults. The allowance for loan losses may not be adequate to cover actual loan losses, and in this case additional and larger provisions for loan losses would be required to replenish the allowance. Provisions for loan losses are a direct charge against income. We establish the amount of the allowance for loan losses based on historical loss rates, as well as estimates and assumptions about future events. Because of the extensive use of estimates and assumptions, our actual loan losses could differ, possibly significantly, from our estimate. We believe that our allowance for loan losses is adequate to provide for probable losses, but it is possible that the allowance for loan losses will need to be increased for credit reasons or that regulators will require us to increase this allowance. Either of these occurrences could materially and adversely affect our earnings and profitability. In the normal course of business, we process large volumes of transactions involving millions of dollars. If our internal controls fail to work as expected, if our systems are used in an unauthorized manner, or if our employees subvert our internal controls, we could experience significant losses. We process large volumes of transactions on a daily basis and are exposed to numerous types of operational risk. Operational risk includes the risk of fraud by persons inside or outside the Company, the execution of unauthorized transactions by employees, errors relating to transaction processing and systems and breaches of the internal control system and compliance requirements. This risk also includes potential legal actions that could arise as a result of an operational deficiency or as a result of noncompliance with applicable regulatory standards. We establish and maintain systems of internal operational controls that provide us with timely and accurate information about our level of operational risk. Although not foolproof, these systems have been designed to manage operational risk at appropriate, cost-effective levels. Procedures exist that are designed to ensure that policies relating to conduct, ethics, and business practices are followed. From time to time, losses from operational risk may occur, including the effects of operational errors. In 2011, we experienced a fraud loss of $1 million involving the circumvention of internal controls by an employee. We continually monitor and improve our internal controls, data processing systems, and corporate-wide processes and procedures, but there can be no assurance that future losses will not occur. 22 Negative public opinion regarding our company and the financial services industry in general, could damage our reputation and adversely impact our earnings. Reputation risk, or the risk to our business, earnings and capital from negative public opinion regarding our company and the financial services industry in general, is inherent in our business. Negative public opinion can result from actual or alleged conduct in any number of activities, including lending practices, corporate governance and acquisitions, and from actions taken by government regulators and community organizations in response to those activities. Negative public opinion can adversely affect our ability to keep and attract clients and employees and can expose us to litigation and regulatory action. Although we have taken steps to minimize reputation risk in dealing with our clients and communities, this risk will always be present given the nature of our business. Our reported financial results are impacted by management’s selection of accounting methods and certain assumptions and estimates. Our accounting policies and methods are fundamental to the way we record and report our financial condition and results of operations. Our management must exercise judgment in selecting and applying many of these accounting policies and methods so they comply with generally accepted accounting principles and reflect management’s judgment of the most appropriate manner to report our financial condition and results. In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which may be reasonable under the circumstances, yet may result in reporting materially different results than would have been reported under a different alternative. Certain accounting policies are critical to presenting our financial condition and results. They require management to make difficult, subjective or complex judgments about matters that are uncertain. Materially different amounts could be reported under different conditions or using different assumptions or estimates. These critical accounting policies include: the allowance for loan losses; the valuation of goodwill and other intangible assets; and the accounting for FDIC loss share transactions. There can be no assurance that we will continue to pay cash dividends. Although we have historically paid cash dividends, there is no assurance that we will continue to pay cash dividends. Future payment of cash dividends, if any, will be at the discretion of our board of directors and will be dependent upon our financial condition, results of operations, capital requirements, economic conditions, and such other factors as the board may deem relevant. Our business continuity plans or data security systems could prove to be inadequate, resulting in a material interruption in, or disruption to, our business and a negative impact on our results of operations. We rely heavily on communications and information systems to conduct our business. Our daily operations depend on the operational effectiveness of our technology. We rely on our systems to accurately track and record our assets and liabilities. Any failure, interruption or breach in security of our computer systems or outside technology, due to severe weather, natural disasters, acts of war or terrorism, criminal activity or other factors, could result in failures or disruptions in general ledger, deposit, loan, customer relationship management, and other systems leading to inaccurate financial records. This could materially affect our business operations and financial condition. While we have disaster recovery and other policies and procedures designed to prevent or limit the effect of any failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions, or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to 23 additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our results of operations. In addition, the Bank provides its customers the ability to bank online. The secure transmission of confidential information over the Internet is a critical element of online banking. While we use qualified third party vendors to test and audit our network, our network could become vulnerable to unauthorized access, computer viruses, phishing schemes and other security issues. The Bank may be required to spend significant capital and other resources to alleviate problems caused by security breaches or computer viruses. To the extent that the Bank activities or the activities of its customers involve the storage and transmission of confidential information, security breaches and viruses could expose the Bank to claims, litigation, and other potential liabilities. Any inability to prevent security breaches or computer viruses could also cause existing customers to lose confidence in the Bank’s systems and could adversely affect its reputation and its ability to generate deposits. Our potential inability to integrate companies we may acquire in the future could expose us to financial, execution, and operational risks that could negatively affect our financial condition and results of operations. Acquisitions may be dilutive to common shareholders and FDIC-assisted transactions have additional compliance risk that other acquisitions do not have. On occasion, we may engage in a strategic acquisition when we believe there is an opportunity to strengthen and expand our business. In addition, such acquisitions may involve the issuance of stock, which may have a dilutive effect on earnings per share. To fully benefit from such acquisition, however, we must integrate the administrative, financial, sales, lending, collections, and marketing functions of the acquired company. If we are unable to successfully integrate an acquired company, we may not realize the benefits of the acquisition, and our financial results may be negatively affected. A completed acquisition may adversely affect our financial condition and results of operations, including our capital requirements and the accounting treatment of the acquisition. Completed acquisitions may also lead to exposure from potential asset quality issues, losses of key employees or customers, difficulty and expense of integrating operations and systems, and significant unexpected liabilities after the consummation of these acquisitions. In addition, if we were to conclude that the value of an acquired business had decreased and that the related goodwill had been impaired, that conclusion would result in a goodwill impairment charge, which would adversely affect our results of operations. We may have opportunities to acquire the assets and liabilities of failed banks in FDIC-assisted transactions. Although these transactions typically provide for FDIC assistance to an acquirer to mitigate certain risks, such as sharing exposure to loan losses and providing indemnification against certain liabilities of the failed institution, we are (and would be in future transactions) subject to many of the same risks we would face in acquiring another bank in a negotiated transaction, including risks associated with maintaining customer relationships and failure to realize the anticipated acquisition benefits in the amounts and within the time frames we expect. In addition, ongoing compliance risk under the loss-share agreement with the FDIC is considerable and the event of noncompliance could result in coverage under the loss-share being disallowed, thus increasing the actual losses to the Bank. Our inability to overcome these risks could have a material adverse effect on our business, financial condition and results of operations. Item 1B. Unresolved Staff Comments None Item 2. Properties The main offices of the Company and the Bank are owned by the Bank and are located in a three-story building in the central business district of Troy, North Carolina. The building houses administrative and bank teller 24 facilities. The Bank’s Operations Division, including customer accounting functions, offices for information technology operations, and offices for loan operations, are housed in two one-story steel frame buildings approximately one-half mile west of the main office. Both of these buildings are owned by the Bank. The Company operates 97 bank branches. The Company owns all of its bank branch premises except eight branch offices for which the land and buildings are leased and ten branch offices for which the land is leased but the building is owned. The Company also leases one loan production office. There are no options to purchase or lease additional properties. The Company considers its facilities adequate to meet current needs and believes that lease renewals or replacement properties can be acquired as necessary to meet future needs. Item 3. Legal Proceedings Various legal proceedings may arise in the ordinary course of business and may be pending or threatened against the Company and its subsidiaries. However, neither the Company nor any of its subsidiaries is involved in any pending legal proceedings that management believes could have a material effect on the consolidated financial position of the Company. If an exposure were to be identified, it is the Company’s policy to establish and accrue appropriate reserves during the accounting period in which a loss is deemed to be probable and the amount is determinable. There were no tax shelter penalties assessed by the Internal Revenue Service against the Company during the year ended December 31, 2011. Item 4. Mine Safety Disclosure Not applicable. PART II Item 5. Market for the Registrant’s Common Stock, Related Shareholder Matters, and Issuer Purchases of Equity Securities Our common stock trades on The NASDAQ Global Select Market under the symbol FBNC. Table 22, included in “Management’s Discussion and Analysis” below, sets forth the high and low market prices of our common stock as traded by the brokerage firms that maintain a market in our common stock and the dividends declared for the periods indicated. We paid a cash dividend of $0.08 per share for each quarter of 2011. For the foreseeable future, it is our current intention to continue to pay cash dividends of $0.08 per share on a quarterly basis. See “Business - Supervision and Regulation” above and Note 16 to the consolidated financial statements for a discussion of other regulatory restrictions on the Company’s payment of dividends. As of December 31, 2011, there were approximately 2,600 shareholders of record and another 3,500 shareholders whose stock is held in “street name.” There were no sales of unregistered securities during the year ended December 31, 2011. 25 Additional Information Regarding the Registrant’s Equity Compensation Plans At December 31, 2011, the Company had four equity-based compensation plans, one of which was assumed in a corporate acquisition. The Company’s 2007 Equity Plan is the only one of the four plans under which new grants of equity-based awards are possible. The following table presents information as of December 31, 2011 regarding shares of the Company’s stock that may be issued pursuant to the Company’s equity based compensation plans. The table does not include information with respect to shares subject to outstanding options granted under a stock incentive plan assumed by the Company in connection with the acquisition of the company that originally granted those options. Footnote (2) to the table indicates the total number of shares of common stock issuable upon the exercise of options under the assumed plan as of December 31, 2011, and the weighted average exercise price of those options. No additional options may be granted under the assumed plan. At December 31, 2011, the Company had no warrants or stock appreciation rights outstanding under any compensation plans. (a) (b) (c) As of December 31, 2011 Number of securities to be issued upon exercise of outstanding options, warrants and rights Weighted-average exercise price of outstanding options, warrants and rights Number of securities available for future issuance under equity compensation plans (excluding securities reflected in column (a)) 489,078 $ 18.98 (cid:326) 489,078 (cid:326) $ 18.98 906,268 (cid:326) 906,268 Plan category Equity compensation plans approved by security holders (1) Equity compensation plans not approved by security holders Total (2) (1) Consists of (A) the Company’s 2007 Equity Plan, which is currently in effect; (B) the Company’s 2004 Stock Option Plan; and (C) the Company’s 1994 Stock Option Plan, each of which was approved by our shareholders. (2) The table does not include information for stock incentive plans that the Company assumed in connection with mergers and acquisitions of the companies that originally established those plans. As of December 31, 2011, a total of 4,788 shares of common stock were issuable upon exercise under an assumed plan. The weighted average exercise price of those outstanding options is $12.90 per share. No additional options may be granted under the assumed plan. 26 Performance Graph The performance graph shown below compares the Company’s cumulative total return to shareholders for the five-year period commencing December 31, 2006 and ending December 31, 2011, with the cumulative total return of the Russell 2000 Index (reflecting overall stock market performance of small-capitalization companies), and an index of banks with between $1 billion and $5 billion in assets, as constructed by SNL Securities, LP (reflecting changes in banking industry stocks). The graph and table assume that $100 was invested on December 31, 2006 in each of the Company’s common stock, the Russell 2000 Index, and the SNL Bank Index, and that all dividends were reinvested. First Bancorp Comparison of Five-Year Total Return Performances (1) Five Years Ending December 31, 2011 First Bancorp Russell 2000 SNL Index-Banks between $1 billion and $5 billion 2006 $ 100.00 100.00 100.00 Notes: Total Return Index Values (1) December 31, 2007 2008 2009 89.78 98.43 72.84 91.21 65.18 60.42 70.97 82.89 43.31 2010 79.54 105.14 2011 59.64 100.75 49.09 44.77 (1) Total return indices were provided from an independent source, SNL Securities LP, Charlottesville, Virginia, and assume initial investment of $100 on December 31, 2006, reinvestment of dividends, and changes in market values. Total return index numerical values used in this example are for illustrative purposes only. 27 Issuer Purchases of Equity Securities Pursuant to authorizations by the Company’s board of directors, the Company has from time to time repurchased shares of common stock in private transactions and in open-market purchases. The most recent board authorization was announced on July 30, 2004 and authorized the repurchase of 375,000 shares of the Company’s stock. The Company repurchased approximately 20,000 shares of its common stock during the quarter ended December 31, 2011. Issuer Purchases of Equity Securities Total Number of Shares Purchased (2) Average Price Paid Per Share Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (1) Maximum Number of Shares That May Yet Be Purchased Under the Plans or Programs (1) (cid:326) (cid:326) $ (cid:326) (cid:326) 20,278 20,278 11.24 $ 11.24 (cid:326) (cid:326) (cid:326) (cid:326) 234,667 234,667 214,389 214,389 Period Month #1 (October 1, 2011 to October 31, 2011) Month #2 (November 1, 2011 to November 30, 2011) Month #3 (December 1, 2011 to December 31, 2011) (3) Total Footnotes to the Above Table (1) All shares available for repurchase are pursuant to publicly announced share repurchase authorizations. On July 30, 2004, the Company announced that its board of directors had approved the repurchase of 375,000 shares of the Company’s common stock. The repurchase authorization does not have an expiration date. There are no plans or programs the Company has determined to terminate prior to expiration, or under which the Company does not intend to make further purchases. (2) The table above does not include shares that were used by option holders to satisfy the exercise price of the call options issued by the Company to its employees and directors pursuant to the Company’s stock option plans. There were no such exercises during the three months ended December 31, 2011. (3) The repurchases during December 2011 relate to shares of stock that employees of the Company sold back to the Company in order to fund the taxes due on shares of restricted stock that became fully vested during December 2011. Item 6. Selected Consolidated Financial Data Table 1 on page 65 of this report sets forth the selected consolidated financial data for the Company. 28 Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations Management’s Discussion and Analysis is intended to assist readers in understanding our results of operations and changes in financial position for the past three years. This review should be read in conjunction with the consolidated financial statements and accompanying notes beginning on page 83 of this report and the supplemental financial data contained in Tables 1 through 22 included with this discussion and analysis. Overview - 2011 Compared to 2010 Net income for 2011 increased by 27.3% over 2010. Earnings for 2011 were impacted by a bargain purchase gain and accelerated accretion on our preferred stock discount (see discussion below). Financial Highlights ($ in thousands except per share data) 2011 2010 Change Earnings Net interest income Provision for loan losses – non-covered Provision for loan losses - covered Noninterest income Noninterest expenses Income before income taxes Income tax expense Net income Preferred stock dividends Accretion of preferred stock discount Net income available to common shareholders Net income per common share Basic Diluted At Year End Assets Loans Deposits $ 132,203 28,525 12,776 26,216 96,106 21,012 7,370 13,642 (3,234) (2,932) $ 7,476 127,354 33,646 20,916 29,106 86,956 14,942 4,960 9,982 (3,250) (857) 5,875 3.8% -15.2% -38.9% -9.9% 10.5% 40.6% 48.6% 36.7% 27.3% $ 0.44 0.44 0.35 0.35 25.7% 25.7% $ 3,290,474 2,430,386 2,755,037 3,278,932 2,454,132 2,652,513 0.4% -1.0% 3.9% Ratios Return on average assets Return on average common equity Net interest margin (taxable-equivalent) 0.23% 2.59% 4.72% 0.18% 2.05% 4.39% The following is a more detailed discussion of our results for 2011 compared to 2010: For the year ended December 31, 2011, we reported net income available to common shareholders of $7.5 million compared to $5.9 million reported for 2010. Earnings per diluted common share were $0.44 for the year ended December 31, 2011 compared to $0.35 for 2010. In the first quarter of 2011, we realized a $10.2 million bargain purchase gain related to the acquisition of a failed bank, which is recorded in noninterest income. The after-tax impact of this gain on net income was $6.2 million, or $0.37 per diluted common share. In the third quarter of 2011, we recorded $2.3 million of accelerated accretion of the discount remaining on the preferred stock that was redeemed during the quarter. This stock was originally issued to the U.S. Treasury in January 2009 as part of the program known as TARP. When this preferred stock was redeemed, the remaining discount that was recorded upon the issuance of the stock, which had been on a five year accretion schedule, 29 was immediately accreted as a reduction to net income available to common shareholders. Total discount accretion of the preferred stock for 2011 was $2.9 million, or $0.17 per diluted common share. In both 2011 and 2010, we experienced significant write-downs and losses associated with loans and foreclosed properties that were assumed in two failed bank acquisitions. The amounts of the write-downs and losses were less in 2011 than in 2010, but continued to significantly impact our earnings. We note that our results of operation are significantly affected by the on-going accounting for the two FDIC- assisted failed bank acquisitions that we have completed. In the discussion below, the term “covered” is used to describe assets included as part of FDIC loss share agreements, which generally result in the FDIC reimbursing the Company for 80% of losses incurred. For covered loans that deteriorate in terms of repayment expectations, we record immediate allowances through the provision of loan losses. For covered loans that experience favorable changes in credit quality compared to what was expected at the acquisition date, including loans that payoff, we record positive adjustments to interest income over the life of the respective loan – also referred to as loan discount accretion. For foreclosed properties that are sold at gains or losses or that are written down to lower values, we record gains/losses within noninterest income. The adjustments discussed above are recorded within the income statement line items noted without consideration of the FDIC loss share agreements. Because favorable changes in covered assets result in lower expected FDIC claims, and unfavorable changes in covered assets result in higher expected FDIC claims, the FDIC indemnification asset is adjusted to reflect those expectations. The net increase or decrease in the indemnification asset is reflected within noninterest income. The adjustments noted above can result in volatility within individual income statement line items. Because of the FDIC loss share agreements and the associated indemnification asset, pretax income resulting from amounts recorded as provisions for loan losses on covered loans, discount accretion, and losses from covered foreclosed properties is generally only impacted by 20% due to the corresponding adjustments made to the indemnification asset. Total assets at December 31, 2011 amounted to $3.3 billion, a 0.4% increase from a year earlier. Total loans at December 31, 2011 amounted to $2.4 billion, a 1.0% decrease from a year earlier, and total deposits amounted to $2.8 billion at December 31, 2011, a 3.9% increase from a year earlier. Since the onset of the recession, we have generally experienced declines in loans and deposits. Normal loan paydowns, loan charge-offs, and loan foreclosures have exceeded new loan growth, which has provided the liquidity to lessen our reliance on high cost deposits. However, for the last half of 2011, we experienced modest growth in our non-covered loan portfolio, which increased $28 million from June 30, 2011 through year end. We are actively pursuing lending opportunities in order to improve our asset yields, as well as to potentially decrease the dividend rate on our preferred stock, as discussed in Note 19 to the consolidated financial statements. Brokered deposits remained at a low level at December 31, 2011, comprising just 5.7% of total deposits, with internet deposits comprising an additional 1.1%. Net interest income for the year ended December 31, 2011 amounted to $132.2 million, an increase of $4.8 million, or 3.8%, from 2010. The higher net interest income was primarily caused by an increase in 2011 in the amount of discount accretion on loans purchased in failed bank acquisitions. Loan discount accretion amounted to $11.6 million for 2011 compared to $7.6 million in 2010, an increase of $4 million. As previously discussed, the impact of changes in discount accretion on pretax income is only 20% of the gross amount of the change. See “Net Interest Income” below for additional information. 30 Our net interest margin (tax-equivalent net interest income divided by average earnings assets) for 2011 was 4.72% compared to 4.39% for 2010. The higher margin was primarily due to the aforementioned increase in loan discount accretion, as well as a decline in funding costs. Our provisions for loan losses remain elevated compared to historical levels, primarily due to continued high unemployment rates and ongoing declines in property values in our market area that negatively impact collateral dependent real estate loans. Our provision for loan losses for non-covered loans amounted to $28.5 million for 2011 compared to $33.6 million recorded in 2010. The lower provision in 2011 was primarily due to stabilization in overall loan quality and lower levels of non-covered nonperforming loans. We recorded $12.8 million in provision for loan losses on covered loans during 2011 compared to $20.9 million recorded in 2010. The lower provision in 2011 was due to declines in covered nonperforming loans resulting from the resolution of a significant amount of these loans through a combination of charge-offs and foreclosures. Our non-covered nonperforming assets at December 31, 2011 amounted to $122 million compared to $117 million at December 31, 2010. At December 31, 2011, the ratio of non-covered nonperforming assets to total non-covered assets was 4.30% compared to 4.16% at December 31, 2010. Our covered nonperforming assets at December 31, 2011 amounted to $141 million compared to $168 million at December 31, 2010. Noninterest income for the year ended December 31, 2011 amounted to $26.2 million compared to $29.1 million for 2010. The decline in noninterest income in 2011 is primarily due to lower amounts of indemnification asset income recorded. As previously discussed, when we anticipate receiving additional amounts from the FDIC because of new losses identified in our covered loan and foreclosed property portfolios, we record indemnification asset income for 80% of the expected loss. In 2011, fewer new losses were identified compared to 2010, and thus less indemnification asset income was recorded. Noninterest expenses for the year ended December 31, 2011 amounted to $96.1 million, a 10.5% increase from the $87.0 million recorded in 2010. The majority of the increase relates to personnel expense, which increased partially due to employees joining the Company in the 2011 Bank of Asheville acquisition. We also experienced higher employee medical expense due to higher claims in 2011 compared to 2010. We have also progressively built our infrastructure to manage increased compliance burdens, collection activities and the overall growth of the Company, and to prepare for future growth, which has generally resulted in higher expenses across all categories. Our effective tax rates were 35.1% and 33.2% for the years ended December 31, 2011 and 2010, respectively. 31 Overview – 2010 Compared to 2009 Net income was significantly lower in 2010 than in 2009 primarily due to a gain that resulted from the Cooperative Bank acquisition in June 2009. Most items of income and expense were higher in 2010 than in 2009 as a result of the Cooperative acquisition, which impacted the Company for twelve months in 2010 compared to six months in 2009 beginning with the June acquisition date. In 2010, our provision for loan losses increased significantly due to deterioration of asset quality, which we believe was primarily caused by the recessionary economic environment, including its unfavorable effect on real estate values. Financial Highlights ($ in thousands except per share data) 2010 2009 Change Earnings Net interest income Provision for loan losses – non-covered Provision for loan losses - covered Noninterest income Noninterest expenses Income before income taxes Income tax expense Net income Preferred stock dividends Accretion of preferred stock discount Net income available to common shareholders Net income per common share Basic Diluted At Year End Assets Loans Deposits $ 127,354 33,646 20,916 29,106 86,956 14,942 4,960 9,982 (3,250) (857) $ 5,875 107,096 20,186 (cid:888) 89,518 78,551 97,877 37,618 60,259 (3,169) (803) 56,287 18.9% 66.7% n/m -67.5% 10.7% -84.7% -86.8% -83.4% -89.6% $ 0.35 0.35 3.38 3.37 -89.6% -89.6% $ 3,278,932 2,454,132 2,652,513 3,545,356 2,652,865 2,933,108 -7.5% -7.5% -9.6% Ratios Return on average assets Return on average common equity Net interest margin (taxable-equivalent) 0.18% 2.05% 4.39% 1.82% 22.55% 3.81% The following is a more detailed discussion of our results for 2010 compared to 2009: For the year ended December 31, 2010, we reported net income available to common shareholders of $5.9 million compared to $56.3 million reported for 2009. Earnings per diluted common share were $0.35 for the year ended December 31, 2010 compared to $3.37 for 2009. In the second quarter of 2009, we realized a $67.9 million gain related to the acquisition of a failed bank. The after-tax impact of this gain was $41.1 million, or $2.46 per diluted common share. Earnings reported for 2010 were impacted by write-downs of foreclosed properties that were assumed in our 2009 failed bank acquisition and also by higher provisions for loan losses related both to loans acquired in the failed bank acquisition and to our legacy loans (loans not obtained in the failed bank acquisition). Total assets at December 31, 2010 amounted to $3.3 billion, a 7.5% decrease from a year earlier. Total loans at December 31, 2010 amounted to $2.5 billion, a 7.5% decrease from a year earlier, and total deposits amounted to $2.7 billion at December 31, 2010, a 9.6% decrease from a year earlier. The contraction of our balance sheet was primarily a result of weak loan demand during 2010, which allowed us to lessen our reliance on higher cost 32 sources of funding. We began experiencing a general decline in loans beginning in 2009 as the full effect of the recession took hold. Loans declined approximately $199 million, or 7.5%, in 2010. Our deposits declined $281 million, or 9.6%, in 2010. The decrease was primarily associated with time deposits, which are generally our highest cost source of funds. We also experienced a $70 million decrease in our NOW accounts during 2010, primarily as a result of the expiration of certain provisions of the FDIC transaction account guarantee program. Net interest income for the year ended December 31, 2010 amounted to $127.4 million, an 18.9% increase from 2009. The increase in net interest income was primarily due to 1) a higher net interest margin, and 2) the higher average balances of loans and deposits realized from the June 2009 Cooperative Bank acquisition. Our net interest margin (tax-equivalent net interest income divided by average earnings assets) for 2010 was 4.39% compared to 3.81% for 2009. During 2010, there were no changes in the interest rates set by the Federal Reserve, and we were able to continue to lower rates on our deposits, especially on maturing time deposits that were originated in periods of higher interest rates. Also positively impacting net interest income were purchase accounting adjustments, primarily related to our failed bank acquisition in 2009, including adjustments to loan interest income previously discussed. See “Net Interest Income” below for additional discussion. The economic environment, including its unfavorable effect on real estate values, resulted in an increase in our loan losses and nonperforming assets, which led to significantly higher provisions for loan losses in 2010. Our provision for loan losses amounted to $54.6 million for 2010 compared to $20.2 million recorded in 2009. In 2010, our provision for loan losses was comprised of $33.6 million in provisions related to non-covered loans and $20.9 million related to covered loans, whereas in prior years the provision only related to non-covered loans. We recorded $33.6 million and $20.2 million in provision for loan losses during 2010 and 2009, respectively, for non-covered loans. The higher provisions for loan losses were necessary primarily as a result of higher levels of classified and nonperforming assets and the impact of declining real estate values on our collateral dependent real estate loans. We recorded $20.9 million in provision for loan losses during 2010 related to covered loans that experienced credit quality deterioration. The credit quality deterioration primarily related to collateral dependent loans for which we received updated appraisals during 2010 that reflected lower valuations. Net loan charge-offs for 2010 were $42.5 million compared to $12.1 million in 2009. Net charge-offs increased primarily as a result of declines in real estate values. In 2010, net charge-offs were also impacted by charge-offs of covered loans and the recording of partial charge-offs of non-covered loans, neither of which occurred during 2009. We recorded approximately $9.8 million in charge-offs of covered loans in 2010 compared to none in 2009. Also, we recorded partial charge-offs of non-covered loans amounting to $8.6 million during the fourth quarter of 2010. Previously, we recorded specific reserves on collateral-deficient nonaccrual loans within the allowance for loan losses, but did not record the charge-offs until the loans were foreclosed upon. Our non-covered nonperforming assets at December 31, 2010 amounted to $117 million compared to $92 million at December 31, 2009. At December 31, 2010, the ratio of non-covered nonperforming assets to total non-covered assets was 4.16% compared to 3.10% at December 31, 2009. Our covered nonperforming assets at December 31, 2010 amounted to $168 million compared to $165 million 33 at December 31, 2009. Noninterest income for the year ended December 31, 2010 amounted to $29.1 million compared to $89.5 million for 2009. In 2009, we recorded a $67.9 million bargain purchase gain in connection with the acquisition of a failed bank. In 2010, we recorded $35.5 million in write-downs and losses on foreclosed property, the majority of which related to the market deterioration of foreclosed properties associated with the failed bank acquisition. We recorded $41.8 million in indemnification asset income related to higher than anticipated claims that we will be able to make with the FDIC under the loss share agreements, primarily relating to loan losses and foreclosed property losses and write-downs. Noninterest expenses for the year ended December 31, 2010 amounted to $87.0 million, a 10.7% increase from the $78.6 million recorded in 2009. Incremental operating expenses associated with the failed bank acquisition were the primary reason for the increases in 2010. Included in other operating expenses for 2010 were approximately $2.6 million in costs (net of FDIC reimbursements) associated with collection activities on loans and foreclosed properties covered by FDIC loss share agreements, compared to $0.8 million in 2009. Our effective tax rates were 33.2% and 38.4% for the years ended December 31, 2010 and 2009, respectively. The lower effective tax rate in 2010 was primarily due to increased investment holdings of tax-exempt municipal securities. Outlook for 2012 We expect the banking industry, particularly in our region, to continue to face significant challenges in 2012. While there has been some favorable national economic data reported in recent months, we have seen little, if any, improvement in the unfavorable economic statistics affecting our region. These include unemployment rates, housing starts, home prices, and the number of personal and business bankruptcies. We believe that the Carolinas and Virginia may have been relatively late to experience the downturn in the national economy and that this region is lagging the rest of the country in recovery. Thus, we believe that our loan losses will continue to remain at elevated levels compared to historical norms. We also expect that the weak economy will continue to result in low loan demand. We believe that regulatory reform will negatively impact our earnings. The regulatory climate is not favorable for banks. We expect additional overhead costs will be necessary to comply with all of the new regulations expected to arise directly or indirectly from the Dodd-Frank Act. In 2009 and 2011 we acquired failed banks with approximately $959 and $193 million in assets, respectively. These acquisitions resulted in significant volatility to our earnings in 2009, 2010, and 2011, primarily as a result of the bargain purchase gains recorded on the acquisition dates that increased earnings and write-downs of foreclosed properties in 2010 and 2011 that negatively impacted earnings. While we expect the acquisitions to eventually be accretive to earnings on a consistent basis, we believe that they may continue to add volatility to our reported earnings in 2012. The volatility may be positive to earnings, which would most likely occur if the credit quality of the acquired loans improves, or negative to earnings, which would most likely occur if the credit quality of the acquired loans deteriorates or if the properties we have foreclosed on continue to decline in value. 34 Critical Accounting Policies The accounting principles we follow and our methods of applying these principles conform with accounting principles generally accepted in the United States of America and with general practices followed by the banking industry. Certain of these principles involve a significant amount of judgment and may involve the use of estimates based on our best assumptions at the time of the estimation. The allowance for loan losses, intangible assets, and the fair value and discount accretion of loans acquired in FDIC-assisted transactions are three policies we have identified as being more sensitive in terms of judgments and estimates, taking into account their overall potential impact to our consolidated financial statements. Allowance for Loan Losses Due to the estimation process and the potential materiality of the amounts involved, we have identified the accounting for the allowance for loan losses and the related provision for loan losses as an accounting policy critical to our consolidated financial statements. The provision for loan losses charged to operations is an amount sufficient to bring the allowance for loan losses to an estimated balance considered adequate to absorb losses inherent in the portfolio. Our determination of the adequacy of the allowance is based primarily on a mathematical model that estimates the appropriate allowance for loan losses. This model has two components. The first component involves the estimation of losses on non-single family home loans or relationships greater than $500,000 that are defined as “impaired loans.” A loan is considered to be impaired when, based on current information and events, it is probable we will be unable to collect all amounts due according to the contractual terms of the loan agreement. The estimated valuation allowance is the difference, if any, between the loan balance outstanding and the value of the impaired loan as determined by either 1) an estimate of the cash flows that we expect to receive from the borrower discounted at the loan’s effective rate, or 2) in the case of a collateral-dependent loan, the fair value of the collateral. The second component of the allowance model is an estimate of losses for impaired single family home loans, impaired loans or relationships less than $500,000, and all loans not considered to be impaired loans. Impaired single family home loans, impaired loans or relationships less than $500,000, and loans that we have classified as having normal credit risk are segregated by loan type, and estimated loss percentages are assigned to each loan type, based on the historical losses, current economic conditions, and operational conditions specific to each loan type. Loans that we have risk graded as having more than “standard” risk but not considered to be impaired are segregated between those relationships with outstanding balances exceeding $500,000 and those that are less than that amount. For those loan relationships with outstanding balances exceeding $500,000, we review the attributes of each individual loan and assign any necessary loss reserve based on various factors including payment history, borrower strength, collateral value, and guarantor strength. For loan relationships less than $500,000 with more than standard risk but not considered to be impaired, loss percentages are based on a multiple of the estimated loss rate for loans of a similar loan type with normal risk. The multiples assigned vary by type of loan, depending on risk, and we have consulted with an external credit review firm in assigning those multiples. The reserve estimated for impaired loans is then added to the reserve estimated for all other loans. This becomes our “allocated allowance.” In addition to the allocated allowance derived from the model, we also evaluate other data such as the ratio of the allowance for loan losses to total loans, net loan growth information, nonperforming asset levels and trends in such data. Based on this additional analysis, we may determine that an additional amount of allowance for loan losses is necessary to reserve for probable losses. This additional amount, if any, is our “unallocated allowance.” The sum of the allocated allowance and the unallocated allowance is compared to the actual allowance for loan losses recorded on our books and any adjustment necessary for the recorded allowance to equal the computed allowance is recorded as a provision for loan 35 losses. The provision for loan losses is a direct charge to earnings in the period recorded. Loans covered under loss share agreements are recorded at fair value at acquisition date. Therefore, amounts deemed uncollectible at acquisition date become a part of the fair value calculation and are excluded from the allowance for loan losses. Subsequent decreases in the amount expected to be collected result in a provision for loan losses with a corresponding increase in the allowance for loan losses. Subsequent increases in the amount expected to be collected are accreted into income over the life of the loan. Proportional adjustments are also recorded to the FDIC indemnification asset. Although we use the best information available to make evaluations, future material adjustments may be necessary if economic, operational, or other conditions change. In addition, various regulatory agencies, as an integral part of their examination process, periodically review our allowance for loan losses. Such agencies may require us to recognize additions to the allowance based on the examiners’ judgment about information available to them at the time of their examinations. For further discussion, see “Nonperforming Assets” and “Summary of Loan Loss Experience” below. Intangible Assets Due to the estimation process and the potential materiality of the amounts involved, we have also identified the accounting for intangible assets as an accounting policy critical to our consolidated financial statements. When we complete an acquisition transaction, the excess of the purchase price over the amount by which the fair market value of assets acquired exceeds the fair market value of liabilities assumed represents an intangible asset. We must then determine the identifiable portions of the intangible asset, with any remaining amount classified as goodwill. Identifiable intangible assets associated with these acquisitions are generally amortized over the estimated life of the related asset, whereas goodwill is tested annually for impairment, but not systematically amortized. Assuming no goodwill impairment, it is beneficial to our future earnings to have a lower amount assigned to identifiable intangible assets and higher amount of goodwill as opposed to having a higher amount considered to be identifiable intangible assets and a lower amount classified as goodwill. The primary identifiable intangible asset we typically record in connection with a whole bank or bank branch acquisition is the value of the core deposit intangible, whereas when we acquire an insurance agency, the primary identifiable intangible asset is the value of the acquired customer list. Determining the amount of identifiable intangible assets and their average lives involves multiple assumptions and estimates and is typically determined by performing a discounted cash flow analysis, which involves a combination of any or all of the following assumptions: customer attrition/runoff, alternative funding costs, deposit servicing costs, and discount rates. We typically engage a third party consultant to assist in each analysis. For the whole bank and bank branch transactions recorded to date, the core deposit intangibles have generally been estimated to have a life ranging from seven to ten years, with an accelerated rate of amortization. For insurance agency acquisitions, the identifiable intangible assets related to the customer lists were determined to have a life of ten to fifteen years, with amortization occurring on a straight-line basis. Subsequent to the initial recording of the identifiable intangible assets and goodwill, we amortize the identifiable intangible assets over their estimated average lives, as discussed above. In addition, on at least an annual basis, goodwill is evaluated for impairment by comparing the fair value of our reporting units to their related carrying value, including goodwill (our community banking operation is our only material reporting unit). If the carrying value of a reporting unit were ever to exceed its fair value, we would determine whether the implied fair value of the goodwill, using a discounted cash flow analysis, exceeded the carrying value of the goodwill. If the carrying value of the goodwill exceeded the implied fair value of the goodwill, an impairment 36 loss would be recorded in an amount equal to that excess. Performing such a discounted cash flow analysis would involve the significant use of estimates and assumptions. At our last goodwill impairment evaluation as of September 30, 2011, we determined the fair value of our community banking operation was approximately $18.50 per common share, or 8% higher, than the $17.08 stated book value of our common stock at the date of valuation. To assist us in computing the fair value of our community banking operation, we engaged a consulting firm who used various valuation techniques as part of their analysis, which resulted in the conclusion of the $18.50 value. We review identifiable intangible assets for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Our policy is that an impairment loss is recognized, equal to the difference between the asset’s carrying amount and its fair value, if the sum of the expected undiscounted future cash flows is less than the carrying amount of the asset. Estimating future cash flows involves the use of multiple estimates and assumptions, such as those listed above. Fair Value and Discount Accretion of Loans Acquired in FDIC-Assisted Transactions We consider the determination of the initial fair value of loans acquired in FDIC-assisted transactions, the initial fair value of the related FDIC indemnification asset, and the subsequent discount accretion of the purchased loans to involve a high degree of judgment and complexity. We determine fair value accounting estimates of newly assumed assets and liabilities in accordance with relevant accounting guidance. However, the amount that we realize on these assets could differ materially from the carrying value reflected in our financial statements, based upon the timing of collections on the acquired loans in future periods. To the extent the actual values realized for the acquired loans are different from the estimates, the FDIC indemnification asset will generally be impacted in an offsetting manner due to the loss-sharing support from the FDIC. Because of the inherent credit losses associated with the acquired loans in a failed bank acquisition, the amount that we record as the fair values for the loans is generally less than the contractual unpaid principal balance due from the borrowers, with the difference being referred to as the “discount” on the acquired loans. We have applied the cost recovery method of accounting to all purchased impaired loans due to the uncertainty as to the timing of expected cash flows. This will result in the recognition of interest income on these impaired loans only when the cash payments received from the borrower exceed the recorded net book value of the related loans. For nonimpaired purchased loans, we accrete the discount over the lives of the loans in a manner consistent with the guidance for accounting for loan origination fees and costs. Merger and Acquisition Activity In both 2009 and 2011 we completed a FDIC-assisted transaction of a failed bank. There were no significant acquisitions in 2010. The results of each acquired company/branch are included in our financial statements beginning on their respective acquisition dates. See Note 2 to the consolidated financial statements for additional information regarding these acquisitions. In October 2011, we announced that we had entered into a Branch Purchase and Assumption Agreement with Waccamaw Bank, headquartered in Whiteville, North Carolina. The agreement provides for First Bank to acquire eleven branches from Waccamaw Bank, which includes assuming all deposits, selected performing loans, and all premises and equipment. Deposits total approximately $180 million and loans total approximately $98 million. This transaction is subject to regulatory approval and other customary conditions. See Note 2 to the consolidated financial statements for additional information. 37 FDIC Indemnification Asset As previously discussed, on June 19, 2009 and January 21, 2011, we acquired substantially all of the assets and liabilities of Cooperative Bank and The Bank of Asheville, respectively, in FDIC-assisted transactions. For each transaction, the loans and foreclosed real estate purchased are covered by two loss share agreements with the FDIC, which afford First Bank significant loss protection. Under the Cooperative Bank loss share agreements, the FDIC will cover 80% of covered loan and foreclosed real estate losses up to $303 million, and 95% of losses in excess of that amount. Under The Bank of Asheville loss share agreements, the FDIC will cover 80% of all covered loan and foreclosed real estate losses. For both transactions, the loss share reimbursements are applicable for ten years for single family home loans and five years for all other loans. We have recorded a FDIC indemnification asset related to the two transactions to account for payments that we expect to receive from the FDIC related to the loss share agreements. The carrying value of this receivable at each period end is the sum of: 1) actual claims that have been submitted to the FDIC for reimbursement that have not yet been received and 2) our estimated amount of loan and other real estate losses covered by the agreements multiplied by the FDIC reimbursement percentage. At December 31, 2011 and 2010, the FDIC indemnification asset was comprised of the following components: ($ in thousands) Receivable related to claims submitted, not yet received Receivable related to estimated future claims on loans Receivable related to estimated future claims on other real estate owned FDIC indemnification asset 2011 $ 13,377 90,275 18,025 $ 121,677 2010 30,201 86,966 6,552 123,719 As of each acquisition date, based on the losses inherent in the covered assets and what we estimated we would receive as payments from the FDIC, we recorded a “FDIC Indemnification Asset.” Since that time, we have recorded adjustments to the indemnification asset as discussed below. The FDIC indemnification asset has been adjusted upwards in the following circumstances: 1) Deterioration of credit quality of covered loans – As of the acquisition dates, we recorded the loans acquired from Cooperative Bank and The Bank of Asheville on our books at a fair value that was $227.9 million and $51.7 million, respectively, less than the contractual amounts due from the borrowers, which was our estimate of the loan losses inherent in the portfolio. As the credit quality of these portfolios change and better information is obtained about likely losses, some loans have better repayment expectations than we originally projected and some loans have worse repayment expectations than originally projected. For loans with worse repayment expectations, we record provisions for loan losses with corresponding increases to the FDIC indemnification asset by recording noninterest income in proportion to the reimbursement percentage. In 2011 and 2010, we recorded provisions for loan losses on covered loans amounting to $12.8 million and $20.9 million, respectively, which resulted in an adjustment to the FDIC indemnification asset of $10.2 million and $16.7 million, respectively. There were no such adjustments in 2009. 2) Write-downs and losses on foreclosed properties – When we foreclose on delinquent borrowers, we initially record the foreclosed property at the lower of book or fair value (based on current appraisals), with any deficiency recorded as a charge-off. Subsequent to the foreclosure, we periodically order updated appraisals and if the appraisal indicates a fair value lower than our carrying value, we must write the property down. Also, periodically we sell foreclosed properties that result in losses. Each of these situations results in the Company recording losses on other real estate owned with a corresponding increase to the FDIC indemnification asset by recording noninterest income in proportion to the reimbursement percentage. In 2011 and 2010, we recorded losses and write downs on covered foreclosed properties amounting to $24.5 million and $34.5 million, 38 respectively, which resulted in upward adjustments to the FDIC indemnification asset of $19.6 million and $27.6 million, respectively. There were no such adjustments in 2009. 3) Expenses incurred related to collection activities on covered assets – As a result of our collection efforts, we incur expenses such as legal fees, property taxes and appraisal costs. Many of these expenses are reimbursable by the FDIC. These expenses are recorded as “other” noninterest expenses and a corresponding increase is made to increase the FDIC indemnification asset by reducing the gross collection expenses by the amount expected to be reimbursed by the FDIC for eligible expenses. In 2011, 2010 and 2009, we incurred $8.5 million, $5.5 million, and $2.1 million in gross collection expenses related to covered assets, respectively, and reduced that amount by $5.7 million, $2.9 million and $1.3 million in FDIC reimbursements, respectively. The FDIC indemnification asset has been adjusted downwards in the following circumstances: 1) Receipt of cash from the FDIC related to claims submitted – On at least a quarterly basis, we submit eligible loss share claims to the FDIC. After reviewing and approving the claims, the FDIC wires us cash, which reduces the amount of the FDIC indemnification asset. In 2011, 2010 and 2009, we received $69.3 million, $46.7 million and $40.5 million in FDIC reimbursements, respectively. 2) Accretion of discount on acquired loans – As noted above, we recorded the acquired loans of the two transactions on our books at a fair value that was $280 million (in total) less than the contractual amounts due from the borrowers (the “discount”), which was our estimate of the loan losses inherent in the portfolio. As the credit quality of this portfolio changes and better information is obtained about likely losses, some loans have better repayment expectations than we originally projected and some loans have worse repayment expectations than originally projected (discussed above). For loans with improved repayment expectations, we are systematically reducing the discount over the life of the loan as it repays. For some loans, we have received complete payoffs at the contractual balance and the discount must be reduced to zero. When we reduce/accrete the discount, we do so by recognizing interest income in that same amount. When the expected losses on loans with improved repayment expectations becomes less than the original estimate, our expected reimbursement from the FDIC declines as well. Accordingly, we reduce the FDIC indemnification asset by the corresponding reimbursement percentage. In 2011, 2010 and 2009, we recorded discount accretion of $11.6 million, $7.6 million, and $1.5 million, respectively, which resulted in a reduction of FDIC indemnification asset of $9.3 million, $6.1 million, and $1.2 million, respectively. In summary, circumstances that result in adjustments to the FDIC indemnification asset are recorded within the income statement line items noted without consideration of the FDIC loss share agreements. Because favorable changes in covered assets result in lower expected FDIC claims, and unfavorable changes in covered assets result in higher expected FDIC claims, the FDIC indemnification asset is adjusted to reflect those expectations. The net increase or decrease in the indemnification asset is reflected within noninterest income. The adjustments can result in volatility within individual income statement line items. Because of the FDIC loss share agreements and the associated indemnification asset, pretax income resulting from amounts recorded as provisions for loan losses, interest income, and losses from foreclosed properties is generally only impacted by 20% due to the corresponding adjustments made to the indemnification asset. 39 The following presents a rollforward of the FDIC indemnification asset since the date of the Cooperative Bank acquisition on June 19, 2009. ($ in thousands) Balance at June 19, 2009 Decrease related to favorable change in loss estimates Increase related to reimbursable expenses Cash received Accretion of loan discount Balance at December 31, 2009 Increase related to unfavorable change in loss estimates Increase related to reimbursable expenses Cash received Accretion of loan discount Balance at December 31, 2010 Increase related to acquisition of The Bank of Asheville Increase related to unfavorable change in loss estimates Increase related to reimbursable expenses Cash received Accretion of loan discount Other Balance at December 31, 2011 $ 185,112 (1,516) 1,300 (40,500) (1,175) 143,221 30,419 2,900 (46,721) (6,100) 123,719 42,218 29,814 5,725 (69,339) (9,278) (1,182) $ 121,677 ANALYSIS OF RESULTS OF OPERATIONS Net interest income, the “spread” between earnings on interest-earning assets and the interest paid on interest- bearing liabilities, constitutes the largest source of our earnings. Other factors that significantly affect operating results are the provision for loan losses, noninterest income such as service fees and noninterest expenses such as salaries, occupancy expense, equipment expense and other overhead costs, as well as the effects of income taxes. Net Interest Income Net interest income on a reported basis amounted to $132.2 million in 2011, $127.4 million in 2010, and $107.1 million in 2009. For internal purposes and in the discussion that follows, we evaluate our net interest income on a tax-equivalent basis by adding the tax benefit realized from tax-exempt securities to reported interest income. Net interest income on a tax-equivalent basis amounted to $133.8 million in 2011, $128.7 million in 2010, and $107.9 million in 2009. Management believes that analysis of net interest income on a tax-equivalent basis is useful and appropriate because it allows a comparison of net interest amounts in different periods without taking into account the different mix of taxable versus non-taxable investments that may have existed during those periods. The following is a reconciliation of reported net interest income to tax-equivalent net interest income. ($ in thousands) Net interest income, as reported Tax-equivalent adjustment Net interest income, tax-equivalent 2011 $ 132,203 1,556 $ 133,759 Year ended December 31, 2010 127,354 1,316 128,670 2009 107,096 818 107,914 Table 2 analyzes net interest income on a tax-equivalent basis. Our net interest income on a tax-equivalent basis increased by 4.0% in 2011 and 19.2% in 2010. There are two primary factors that cause changes in the amount of net interest income we record - 1) changes in our loans and deposits balances, and 2) our net interest margin (tax-equivalent net interest income divided by average interest-earning assets). 40 For 2011, the increase in net interest income over the comparable period in 2010 was due to a higher net interest margin, which was partially offset by a lower level of earning assets due to a contraction of our balance sheet during 2011. In 2010, higher average loan and deposit balances increased net interest income. Also, the positive effects of the increased balances in 2010 were enhanced by a higher net interest margin. Although our acquisition of The Bank of Asheville in early 2011 resulted in the addition of $102 million in loans, our average loan balances declined by $92 million during the year - from $2.55 billion in 2010 to $2.46 billion in 2011. We believe the decline in loans is primarily a direct and indirect result of the weak economy in our market area. During 2011, we charged-off $52 million in loans and foreclosed on another $76 million that reduced our loan balances, with a portion of the charge-off and foreclosure activity relating to our two FDIC failed bank acquisitions. Also, loan demand in most of our market areas remained weak, with the pace of loan principal repayments substantially offsetting new loan originations. With the decline in loans, we were able to lessen our reliance on higher cost sources of funding, including internet deposits and large denomination time deposits, which resulted in lower deposit balances (and, as discussed below, a lower average cost of funds). Although loans and deposits outstanding decreased during calendar year 2010, the average balances of loans and deposits were both higher in 2010 than they were in 2009 as a result of the Cooperative Bank acquisition that occurred in mid-2009. The loans and deposits acquired in this acquisition impacted loan and deposit balances outstanding for all twelve months of 2010 and for the six month period subsequent to the June 2009 acquisition. As illustrated in Table 3, the lower average loan and deposit balances negatively impacted net interest income in 2011, while higher balances positively impacted net interest income in 2010. In 2011, declines in interest- earning assets, primarily loans, resulted in a decrease in interest income of $4.4 million, while lower amounts of interest-bearing liabilities resulted in only $0.4 million of lower interest expense. As a result, the net impact of lower loans and deposits was a decrease in tax-equivalent net interest income of $4.0 million in 2011. In 2010, growth in interest-earning assets resulted in an increase in interest income of $6.1 million, while higher amounts of interest-bearing liabilities only resulted in $0.5 million in increased interest expense. As a result, the higher average balances of loans and deposits resulted in an increase in tax-equivalent net interest income of $5.6 million in 2010. Table 3 also illustrates the impact that changes in the interest rates that we earned/paid had on our net interest income in 2010 and 2011. In both years, lower interest rates on deposits was the primary factor affecting net interest income. Although the prime rate of interest has not changed since 2008, interest rates on U.S. Treasury bonds and other interest-sensitive financial instruments have steadily declined since then, resulting in a generally lower interest rate environment. In both years, the progressively lower interest rate environment gave us the opportunity to reduce rates on matured time deposits, and we were also able to gradually reduce interest rates on demand deposits. In 2010, the lower interest rates reduced interest expense by $17.5 million and in 2011 the lower interest rates reduced interest expense by $7.9 million. The lower interest rate environment had much less impact on our interest income, with the impact of changes in interest rates lowering interest income by $2.3 million in 2010 and increasing it by $1.2 million in 2011. The lesser impact was due to continued use of interest rate floors on loans, as well as the effect of higher levels of loan discount accretion in both 2010 and 2011 (discussed below). Overall, changes in interest rates increased net interest income by $15.2 million in 2010 and $9.1 million in 2011. We measure the spread between the yield on our earning assets and the cost of our funding primarily in terms of the ratio entitled “net interest margin” which is defined as tax-equivalent net interest income divided by average earning assets. Our net interest margin increased 33 basis points in 2011 to 4.72% from 4.39% in 2010. Our net interest margin was 3.81% in 2009. 41 The primary reason for the increases in our net interest margin has been that the yields on interest-earning assets have remained fairly stable over the past three years, ranging from 5.48% to 5.55%, while the cost of interest-bearing liabilities has steadily declined from 1.96% in 2009 to 1.20% in 2010 to 0.90% in 2011. As noted above, our interest-earning asset yields have remained stable because of the continued use of interest rate floors on loans, as well as higher levels of loan discount accretion. Also as noted above, we have been able to lower rates on maturing time deposits that were originated in periods of higher rates throughout 2009, 2010, and 2011. And to a lesser degree, we have been able to progressively lower interest rates on various types of savings, NOW and money market accounts. We have also experienced declines in our levels of higher cost deposit balances, including internet deposits and large denomination time deposits. During each of the past three years, our net interest margin also benefitted from the net accretion of purchase accounting premiums/discounts associated with the Cooperative Bank acquisition in June 2009 and, to a lesser degree, the acquisition of Great Pee Dee Bancorp in April 2008 and The Bank of Asheville in January 2011. For 2011, 2010 and 2009, we recorded $11.6 million, $10.0 million and $5.6 million, respectively, in net accretion of purchase accounting premiums/discounts that increased net interest income. The following table provides detail of the purchase accounting adjustments that impacted net interest income: ($ in thousands) Year Ended December 31, 2011 Year Ended December 31, 2010 Year Ended December 31, 2009 Interest income – reduced by premium amortization on loans Interest income – increased by accretion of loan discount Interest expense – reduced by premium amortization of deposits Interest expense – reduced by premium amortization of borrowings Impact on net interest income $ (453) 11,598 337 146 $ 11,628 (196) 7,607 2,211 341 9,963 (196) 1,469 3,911 464 5,648 The following table presents the purchase accounting entries that we expect to record in 2012. ($ in thousands) Interest income – reduced by premium amortization on loans Interest income – increased by accretion of loan discount Interest expense – reduced by premium amortization of deposits Interest expense – reduced by premium amortization of borrowings Impact on net interest income Expected - 2012 $ (465) See note below 85 30 See note below Note - We cannot determine the amount of interest income, if any, to be recognized from the accretion of the loan discount on Cooperative loans or The Bank of Asheville loans because it is reliant on our ongoing assessment during the year of the repayment period of the loans, which is impacted by any changes in expected credit losses related to the loans. See additional information regarding net interest income in the section entitled “Interest Rate Risk.” Provision for Loan Losses The provision for loan losses charged to operations is an amount sufficient to bring the allowance for loan losses to an estimated balance considered appropriate to absorb probable losses inherent in our loan portfolio. Management’s determination of the adequacy of the allowance is based on the level of loan growth, an evaluation of the portfolio, current economic conditions, historical loan loss experience and other risk factors. Our provisions for loan losses and nonperforming assets remain at what we believe to be elevated levels, primarily due to high unemployment rates and declining property values in our market area that negatively 42 impact collateral dependent real estate loans. For 2011, 2010, and 2009 our total provisions for loan losses were $41.3 million, $54.6 million, and $20.2 million, respectively. The total provision for loan losses is comprised of provision for loan losses for non-covered loans and provision for loan losses for covered loans, as discussed in the following paragraphs. We recorded $28.5 million, $33.6 million, and $20.2 million in provisions for loan losses related to non-covered loans for the years-ended December 31, 2011, 2010, and 2009, respectively. The lower provision for loan losses for non-covered loans in 2011 compared to 2010 was primarily due to stabilization in overall loan quality and lower levels of non-covered nonperforming loans. The higher provision for non-covered loans in 2010 was necessary primarily as a result of higher levels of classified and nonperforming assets and the impact of declining real estate values on our collateral dependent real estate loans. In 2011 and 2010, we recorded $12.8 million and $20.9 million in provisions for loan losses for covered loans, respectively, that experienced credit quality deterioration. The credit quality deterioration primarily related to collateral dependent nonaccrual loans for which we received updated appraisals in 2011 and 2010 that reflected lower valuations. The lower provision for loan losses for covered loans in 2011 compared to 2010 was primarily due to lower levels of nonperforming covered loans. Because of the FDIC loss-share agreements in place for these loans, the FDIC indemnification asset was adjusted upwards by recording noninterest income of $10.2 million and $16.7 million in 2011 and 2010, respectively, or 80% of the amount of the provisions (see discussion above). Total net charge-offs for the years ended December 31, 2011, 2010, and 2009, were $49.3 million, $42.5 million, and $12.1 million, respectively. As discussed further below, the higher net charge-offs in 2010 and 2011 compared to 2009 were primarily a result of worsening economic conditions, especially related to real estate, that resulted in higher levels of borrowers not repaying their loans. Net-charge offs for non-covered loans were $31.2 million, $32.7 million and $12.1 million for 2011, 2010 and 2009 respectively. Net charge-offs of non-covered loans were impacted by $9.0 million and $8.6 million in partial charge-offs of non-covered loans for 2011 and 2010, respectively. Prior to 2010 we recorded specific reserves on collateral-deficient nonaccrual loans within the allowance for loan losses, but did not record charge- offs until the loans had been foreclosed upon. Net charge-offs for covered loans were $18.1 million, $9.8 million, and $0 in for 2011, 2010, and 2009, respectively. The charge-offs of covered loans were primarily a result of declining collateral values on collateral dependent nonaccrual loans. In 2011 and 2010, our provisions for loan losses and net charge-offs were concentrated in loans classified as “real estate – construction, land development & other land loans.” This category of loans is primarily comprised of land acquisition and development loans and other types of lot loans. These types of loans have been particularly hard hit by the decline in real estate development and property values. As can be seen in Table 10, although we have reduced our exposure to this category of loans, we continue to have exposure to this sector and future significant losses could result. Non-covered nonperforming assets at December 31, 2011 amounted to $122 million compared to $117 million and $92 million at December 31, 2010 and 2009, respectively. At December 31, 2011, the ratio of non-covered nonperforming assets to total non-covered assets was 4.30% compared to 4.16% and 3.10% at December 31, 2010 and 2009, respectively. Also see “Nonperforming Assets” below for additional discussion. See the section entitled “Allowance for Loan Losses and Loan Loss Experience” below for a more detailed discussion of the allowance for loan losses. The allowance is monitored and analyzed regularly in conjunction with our loan analysis and grading program, and adjustments are made to maintain an adequate allowance for 43 loan losses. Noninterest Income Our noninterest income amounted to $26.2 million in 2011, $29.1 million in 2010, and $89.5 million in 2009. As shown in Table 4, core noninterest income excludes gains from acquisitions, foreclosed property write-downs and losses, indemnification asset income, securities gains or losses, and other miscellaneous gains and losses. Core noninterest income amounted to $23.2 million in 2011, a 4.7% increase from $22.1 million in 2010. The 2010 core noninterest income of $22.1 million was 1.2% higher than the $21.9 million recorded in 2009. See Table 4 and the following discussion for an understanding of the components of noninterest income. Service charges on deposit accounts in 2011 amounted to $12.0 million, a 2.9% decrease compared to $12.3 million recorded in 2010. The $12.3 million recorded in 2010 was 5.9% less than the 2009 amount of $13.1 million. Legislation that became effective on July 1, 2010 reduced our fees earned on overdrafts in 2010 and 2011, which was the primary reason for the declines in this component of noninterest income. Specifically, the legislation now prohibits us from charging an overdraft fee for paying ATM and one-time debit card transactions that overdraw a consumer’s account, unless the consumer affirmatively consents, or opts in, to our payment of overdrafts for these transactions. Additional regulations on overdraft fees became effective July 1, 2011 that further reduced our overdraft fees, although to a lesser extent than the 2010 changes. In April 2011, we implemented new fees on deposit accounts, such as fees for customers that elect to receive paper statements, that have helped to replace a large portion of the revenue that was lost as a result of the overdraft legislation. Other service charges, commissions and fees amounted to $8.1 million in 2011, a 24.0% increase from the $6.5 million earned in 2010. The 2010 amount of $6.5 million was a 13.6% increase from the $5.7 million earned in 2009. This category of noninterest income includes items such as electronic payment processing revenue (which includes fees related to credit card transactions by merchants and customers and fees earned from debit card transactions), ATM charges, safety deposit box rentals, fees from sales of personalized checks, and check cashing fees. The growth in this category for both years was primarily attributable to increased debit card usage by our customers, as we earn a small fee each time our customers make a debit card transaction. Also, part of the increase in this category is due to the overall growth in our total customer base, including growth achieved from corporate acquisitions. Fees from presold mortgages amounted to $1.6 million in 2011, $1.8 million in 2010, and $1.5 million in 2009. We continue to experience higher mortgage refinance activity due to lower interest rates. Commissions from sales of insurance and financial products amounted to $1.5 million in each of 2011, 2010, and 2009. This line item includes commissions we receive from three sources - 1) sales of credit life insurance associated with new loans, 2) commissions from the sales of investment, annuity, and long-term care insurance products, and 3) commissions from the sale of property and casualty insurance. The following table presents the contribution of each of the three sources to the total amount recognized in this line item: 44 ($ in thousands) Commissions earned from: Sales of credit life insurance Sales of investments, annuities, and long term care insurance Sales of property and casualty insurance Total 2011 2010 2009 $ 70 760 682 $ 1,512 107 531 838 1,476 281 503 740 1,524 Noninterest income not considered to be “core” resulted in a net contribution to total noninterest income of $3.0 million in 2011, $7.0 million in 2010, and $67.6 million in 2009. The components of non-core noninterest income are shown in Table 4 and the significant components thereof are discussed below. In 2011 and 2010, we recorded $27.8 million and $35.5 million in write-downs and losses on foreclosed properties, respectively, of which $24.5 million and $34.5 million related to write-downs on covered properties, respectively. Consistent with the other failed bank accounting adjustments discussed earlier, the bottom line impact to pretax income of these write-downs on covered properties was 20% of the gross write-downs. Indemnification asset income for 2011 and 2010 amounted to $20.5 million and $41.8 million, respectively (with no corresponding amount in 2009). This income primarily relates to upward adjustments to the amount expected to be received from the FDIC under loss share agreements as a result of higher than anticipated loan losses and foreclosed property losses and write-downs, as follows: ($ in millions) Higher expected FDIC claims for covered loans experiencing a deterioration in quality Lower expected FDIC claims for covered loans related to loan discount accretion and principal paydowns/payoffs Foreclosed property losses and write-downs - covered Total adjustment to expected FDIC loss-share claims Expected reimbursement rate Indemnification asset income 2011 $ 12.7 (11.6) 24.5 25.6 80% $ 20.5 2010 $ 20.9 (3.2) 34.5 52.2 80% $ 41.8 In 2011 and 2009, as previously discussed, we realized gains from the FDIC-assisted acquisitions of failed banks amounting to $10.2 million and $67.9 million, respectively, which were the amounts by which the fair value of the assets purchased exceeded the fair value of liabilities assumed in each transaction. The line item “Other gains (losses)” was positively impacted in 2010 by the sale of our merchant credit card processing portfolio, which resulted in a gain of $850,000. Noninterest Expenses Noninterest expenses for 2011 were $96.1 million, compared to $87.0 million in 2010 and $78.6 million in 2009. Table 5 presents the components of our noninterest expense during the past three years. As reflected in the amounts noted above, noninterest expenses increased 10.5% in 2011 and 10.7% in 2010. The increases in noninterest expenses over the past three years have occurred in almost every line item of expense and have been primarily a result of our significant growth. Due to acquisition and internal growth, over the past three years our number of bank branches has increased from 74 to 97, and the number of full time equivalent employees has increased from 650 at December 31, 2008 to 830 at December 31, 2011. Additionally, from December 31, 2008 to December 31, 2011, the amount of loans outstanding increased 9.9% and deposits increased 32.8%. Total personnel expense increased by approximately $6.1 million, or 13.6%, in 2011. Salaries expense 45 comprised $4.7 million of this increase, which was primarily a result of an initiative to progressively build our infrastructure to manage increased compliance burdens, collection activities, and overall growth of the Company, as well as to prepare for future growth. Another factor in the increase in salaries expense in 2011 was the acquisition of The Bank of Asheville in January 2011, which added approximately 35 employees. Higher employee health insurance costs also played a role in the increase in personnel expense in 2011. Employee health insurance expense amounted to $4.4 million in 2011, an increase of $1.3 million over the $3.1 million incurred in 2010. We self-insure our employees’ health care expense; therefore, incurred health care costs directly impact the expense we record. In 2010, salaries expense increased $4.3 million, primarily due to a full year of salaries related to employees assumed in the June 2009 Cooperative acquisition. The increase in salary expense was partially offset by lower health care expenses of $0.4 million and lower pension expense in 2010 of $0.6 million. Pension expense decreased during 2010 primarily due to investment gains experienced by the pension plan’s assets in 2009. In 2011 and 2009, we incurred acquisition expenses of approximately $0.6 million in connection with The Bank of Asheville acquisition and $1.3 million in connection with the Cooperative Bank acquisition, respectively. Acquisition expenses for both periods consisted primarily of professional fees. FDIC deposit insurance expense declined in each of the past two years. In 2009, 2010, and 2011, we incurred approximately $5.5 million, $4.4 million, and $3.0 million, respectively, in FDIC deposit insurance premium expense. The $5.5 million in FDIC insurance expense for 2009 included a special assessment, which applied to all banks, of $1.6 million. As previously discussed, the FDIC changed its premium assessment methodology in April 2011, which was favorable for our company and reduced our expense in 2011. Due to higher levels of delinquencies and foreclosure activity, including those associated with our covered assets, we recorded $5.5 million in repossession and collection expenses, net of FDIC reimbursements, in 2011, compared to $4.8 million in 2010 and $1.7 million in 2009. Within the “non-credit losses” presented in Table 5, we recorded $1 million in 2011 in connection with a fraud loss. Income Taxes The provision for income taxes was $7.4 million in 2011, $5.0 million in 2010, and $37.6 million in 2009. Table 6 presents the components of tax expense and the related effective tax rates. The effective tax rate for 2011 was 35.1% compared to 33.2% in 2010 and 38.4% in 2009. The variances in effective tax rates are primarily due to changes in the proportion of tax-exempt interest income to pretax income. We expect our effective tax rate to be approximately 35% in 2012. Stock-Based Compensation We recorded stock-based compensation expense of $0.9 million, $0.6 million, and $0.4 million for the years ended December 31, 2011, 2010, and 2009, respectively. See Note 15 to the consolidated financial statements for more information regarding stock-based compensation. 46 ANALYSIS OF FINANCIAL CONDITION AND CHANGES IN FINANCIAL CONDITION Overview Over the past two years, our total assets have decreased from $3.5 billion at December 31, 2009 to $3.3 billion at December 31, 2011, which was primarily due to declines in our outstanding loans and deposits. Changes in our loans and deposit balances occur as a result of organic growth or decline, as well as acquisitions. During the first quarter of 2011, we acquired The Bank of Asheville in a FDIC-assisted failed bank transaction. The following table presents detailed information regarding the nature of changes in our loans and deposits in 2010 and 2011: ($ in thousands) 2011 Loans – Non-covered Loans – Covered Total loans Deposits – Noninterest bearing Deposits – NOW Deposits – Money market Deposits – Savings Deposits – Brokered time Deposits – Internet time Deposits – Time >$100,000 - retail Deposits – Time <$100,000 - retail Total deposits 2010 Loans – Non-covered Loans – Covered Total loans Deposits – Noninterest bearing Deposits – NOW Deposits – Money market Deposits – Savings Deposits – Brokered time Deposits – Internet time Deposits – Time >$100,000 - retail Deposits – Time <$100,000 - retail Total deposits Balance at beginning of period Internal growth (1) Growth from Acquisitions Balance at end of period Total percentage growth Internal percentage growth (1) $ 2,083,004 371,128 $ 2,454,132 (13,852) (112,162) (126,014) $ 292,759 292,623 498,312 153,325 143,554 46,801 602,371 622,768 $ 2,652,513 24,276 99,471 (7,661) (10,056) (1,048) (59,819) (40,478) (94,905) (90,220) (cid:1086) 102,268 102,268 18,798 31,358 19,150 3,212 14,902 42,920 13,515 48,889 192,744 $ 2,132,843 520,022 $ 2,652,865 (49,839) (148,894) (198,733) $ 272,422 362,366 496,940 149,338 76,332 128,024 704,128 743,558 $ 2,933,108 20,337 (69,743) 1,372 3,987 67,222 (81,223) (101,757) (120,790) (280,595) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) 2,069,152 361,234 2,430,386 335,833 423,452 509,801 146,481 157,408 29,902 575,408 576,752 2,755,037 2,083,004 371,128 2,454,132 292,759 292,623 498,312 153,325 143,554 46,801 602,371 622,768 2,652,513 -0.7% -2.7% -1.0% 14.7% 44.7% 2.3% -4.5% 9.7% -36.1% -4.5% -7.4% 3.9% -2.3% -28.6% -7.5% 7.5% -19.2% 0.3% 2.7% 88.1% -63.4% -14.5% -16.2% -9.6% -0.7% -30.2% -5.1% 8.3% 34.0% -1.5% -6.6% -0.7% -127.8% -6.7% -15.2% -3.4% -2.3% -28.6% -7.5% 7.5% -19.2% 0.3% 2.7% 88.1% -63.4% -14.5% -16.2% -9.6% (1) Excludes the impact of acquisitions in the year of the acquisition, but includes growth or declines in acquired operations after the date of acquisition. In 2011, as derived from the table above, our total loans declined $24 million, or 1.0%. Positively impacting loans outstanding was our acquisition of The Bank of Asheville on January 21, 2011, which added $102 million in loans. However, this increase was more than offset by loan payoffs, foreclosures and loan charge-offs. During 2011, we charged-off $52 million in loans and foreclosed on another $76 million that reduced our loan balances, with a portion of the charge-off and foreclosure activity relating to our two FDIC failed bank acquisitions. Also, loan demand in most of our market areas has remained weak, with the pace of loan principal repayments substantially offsetting new loan originations. In addition, we have de-emphasized certain types of lending, most notably acquisition and development land loans and non-owner occupied commercial real estate. However, for the first time since our loans outstanding began trending downward in 2008, we experienced sequential quarterly growth in our non-covered loan portfolio during each of the last two quarters of 2011, with 47 non-covered loans increasing by $28 million during the last half of 2011. We are actively pursuing lending opportunities in order to improve asset yields, as well as to potentially decrease the dividend rate on our SBLF preferred stock (see Note 19 to the consolidated financial statements for more information). To start 2011, our total deposits increased by $193 million as a result of the January acquisition of The Bank of Asheville. For the remainder of the year, as our loans declined, we were able to lessen our reliance on higher cost sources of funding, including internet deposits and time deposits, which resulted in generally declining deposit balances. Our lowest cost deposits, noninterest bearing demand accounts and NOW accounts, experienced positive internal growth of $24 million and $99 million, respectively. In addition to our bank-wide emphasis to grow these types of low-rate accounts, the increase in NOW accounts was impacted by $38 million in customer funds that were shifted from repurchase agreements (securities sold under agreements to repurchase) to NOW accounts during late 2011. In July 2011, the Dodd-Frank Act repealed certain sections of the Federal Reserve Act that prohibited payment of interest on commercial demand deposits. With this prohibition removed, we began to pay interest on certain types of commercial demand accounts, and we encouraged our customers with repurchase agreements to switch to commercial NOW accounts, which eliminated the need to sell/pledge our investment securities. For the same reasons as discussed above for 2011, we experienced a decline in loans of 7.5% in 2010. In 2010, we also experienced a decline in deposits of 9.6%, with most of the decline occurring in retail time deposits. Retail time deposits are generally a high cost source of funds for us, and during 2010 we decided not to match promotional time deposit interest rates being offered by several of our local competitors, which we felt were too high compared to alternative funding sources, and consequently we experienced a loss of time deposits. Also declining significantly in 2010 was our level of internet time deposits. Our level of time deposits gathered from internet posting services declined from $128 million at December 31, 2009 to $47 million at December 31, 2010. Substantially all of our internet deposits during 2010 were assumed in the Cooperative acquisition in 2009. Prior to its closing, Cooperative was prohibited from originating or renewing brokered deposits and accordingly, they enhanced liquidity by offering relatively high interest rates on internet posting services. As these time deposits have matured, the internet depositors, mostly credit unions, have elected not to renew the time deposits at the interest rates we have proposed. In 2010, we replaced most of the lost internet deposits with brokered deposits, which had more favorable interest rates. As a result, our brokered deposits increased from $76 million at December 31, 2009 to $144 million at December 31, 2010. We also experienced a $70 million decrease in our NOW accounts during 2010, primarily as a result of two depositors who withdrew their funds in the last week of the year in anticipation of the expiration of certain provisions of the FDIC transaction account guarantee program. This program previously provided unlimited FDIC insurance for interest bearing transaction accounts earning interest rates up to 0.25%. Subsequent to this change, the only accounts with unlimited FDIC insurance are non-interest bearing transaction accounts. Our overall liquidity increased slightly during 2011 compared to 2010. We experienced a $103 million increase in deposits, while loans decreased $24 million. With the excess deposits, we were able to reduce our borrowings by approximately $63 million during 2011. Our liquid assets (cash and securities) as a percentage of our total deposits and borrowings increased from 15.4% at December 31, 2010 to 15.7% at December 31, 2011. Our capital ratios improved in 2011. All of our capital ratios have continually exceeded the regulatory thresholds for “well-capitalized” status for all periods covered by this report. Due to the continued economic slowdown, our asset quality ratios remain at unfavorable levels compared to most of our company’s history. Our non-covered nonperforming assets to total non-covered assets ratio was 4.30% at December 31, 2011 compared to 4.16% at December 31, 2010, and 3.10% at December 31, 2009. For 48 the year ended December 31, 2011, our ratio of net non-covered charge-offs to average non-covered loans was 1.52% compared to 1.55% for 2010, and 0.56% for 2009. Distribution of Assets and Liabilities Table 7 sets forth the percentage relationships of significant components of our balance sheet at December 31, 2011, 2010, and 2009. Our balance sheet distribution has remained relatively stable over the past three years. The increase in NOW deposits discussed earlier resulted in an increase in this category from 9% of total liabilities and shareholders’ equity at December 31, 2010 to 13% in 2011. Also, over the past two years we have experienced a decline in retail time deposits less than $100,000 (“other time deposits”) that has resulted in other time deposits declining from 23% of total liabilities and shareholders’ equity in 2009 to 18% in 2011. Securities Information regarding our securities portfolio as of December 31, 2011, 2010, and 2009 is presented in Tables 8 and 9. The composition of the investment securities portfolio reflects our investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of income. The investment portfolio also provides a balance to interest rate risk and credit risk in other categories of the balance sheet while providing a vehicle for the investment of available funds, furnishing liquidity, and supplying securities to pledge as required collateral for certain deposits. We obtain fair values for the vast majority of our investment securities from a third-party investment recordkeeper, who specializes in securities purchases and sales, recordkeeping, and valuation. This recordkeeper provides us with a third-party report that contains an evaluation of internal controls that includes testwork of securities valuation. We further test the values we receive by comparing the values for a significant sample of securities to another third-party valuation service on a quarterly basis. Total securities amounted to $240.6 million, $235.2 million, and $214.2 million, at December 31, 2011, 2010, and 2009, respectively. The majority of our “government-sponsored enterprise” securities are issued by the Federal Home Loan Bank and carry one maturity date, often with an issuer call feature. At December 31, 2011, of the $35 million (carrying value) in government-sponsored enterprise securities, $21 million were issued by the Federal Home Loan Bank system and the remaining $14 million were issued by the Federal Farm Credit Bank system. Our $124 million of mortgage-backed securities have all been issued by either Freddie Mac, Fannie Mae, Ginnie Mae, or the Small Business Administration, each of which are government-sponsored corporations. We have no “private label” mortgage-backed securities. Mortgage-backed securities vary in their repayment in correlation with the underlying pools of mortgage loans. Included in mortgage-backed securities at December 31, 2011 were collateralized mortgage obligations (“CMOs”) with an amortized cost of $1.5 million and a fair value of $1.5 million. The CMOs that we have invested in are substantially all “early tranche” portions of the CMOs, which minimizes our long-term interest rate risk. 49 At December 31, 2011, our $12.5 million investment in corporate bonds was comprised of the following: Issuer ($ in thousands) First Citizens Bancorp (South Carolina) Bond Bank of America Trust Preferred Security Bank of America Trust Preferred Security First Citizens Bancorp (North Carolina) Trust Preferred Security First Citizens Bancorp (South Carolina) Trust Preferred Security Total investment in corporate bonds S&P Issuer Ratings (1) Not Rated BB BB BB Not Rated Maturity Date 4/1/15 12/11/26 4/15/27 3/1/28 6/15/34 Amortized Cost $ 2,996 2,039 5,046 2,108 1,000 $ 13,189 Market Value 3,102 1,780 4,588 2,278 740 12,488 (1) The ratings are as of January 26, 2012. Substantially all of our investment in equity securities at each year end was comprised of capital stock in the Federal Home Loan Bank of Atlanta (FHLB). The FHLB requires us to purchase their stock in order to borrow from them. The amount they require us to invest is based on our level of borrowings from them. At December 31, 2011, our investment in capital stock of the FHLB amounted to $10.9 million of our total investment in equity securities of $11.4 million. Until February 27, 2009, the FHLB redeemed their stock at par as borrowings were repaid. On February 27, 2009, the FHLB announced that they would no longer automatically redeem their stock when loans are repaid. Instead, they stated that they would evaluate whether they would repurchase stock on a quarterly basis. During 2010 and 2011, the FHLB repurchased $1.8 million and $3.9 million, respectively, of their stock from the Company. The fair value of securities held to maturity, which we carry at amortized cost, was $4,766,000 more than the carrying value at December 31, 2011 and $706,000 less than the carrying value at December 31, 2010. Our $58.0 million in securities held to maturity are comprised almost entirely of municipal bonds issued by state and local governments throughout our market area. We have only two municipal bonds with a denomination greater than $2,000,000 and we have no significant concentration of bond holdings from one government entity, with the single largest exposure to any one entity being $3,700,000. Management evaluated any unrealized losses on individual securities at each year end and determined them to be of a temporary nature and caused by fluctuations in market interest rates, not by concerns about the ability of the issuers to meet their obligations. At December 31, 2011, 2010, and 2009, a net unrealized gain of $3,896,000, $2,478,000, and $1,832,000, respectively, was included in the carrying value of securities classified as available for sale. During the past three years, interest rates have generally declined, which typically increases the value of our investment securities. Management evaluated any unrealized losses on individual securities at each year end and determined them to be of a temporary nature and caused by fluctuations in market interest rates and the overall economic environment, not by concerns about the ability of the issuers to meet their obligations. Net unrealized gains, net of applicable deferred income taxes, of $2,376,000, $1,512,000, and $1,117,000 have been reported as part of a separate component of shareholders’ equity (accumulated other comprehensive income) as of December 31, 2011, 2010, and 2009, respectively. The weighted average taxable-equivalent yield for the securities available for sale portfolio was 3.01% at December 31, 2011. The expected weighted average life of the available for sale portfolio using the call date for above-market callable bonds, the maturity date for all other non-mortgage-backed securities, and the expected life for mortgage-backed securities, was 5.2 years. The weighted average taxable-equivalent yield for the securities held to maturity portfolio was 5.78% at December 31, 2011. The expected weighted average life of the held to maturity portfolio using the call date for above-market callable bonds and the maturity date for all other securities, was 6.6 years. 50 The following table provides the names of issuers for which the Company has investment securities totaling in excess of 10% of shareholders’ equity and the fair value and amortized cost of these investments as of December 31, 2011. All of these securities are issued by government sponsored corporations. ($ in thousands) Issuer Ginnie Mae Small Business Administration Total Amortized Cost $ 66,888 39,034 $ 105,922 Fair Value 70,016 39,055 109,071 % of Shareholders’ Equity 20.3% 11.3% Loans Table 10 provides a summary of the loan portfolio composition of our total loans at each of the past five year ends. As previously discussed, in our acquisitions of Cooperative Bank and The Bank of Asheville, we entered into loss share agreements with the FDIC, which afford us significant protection from losses on all loans and other real estate acquired in those acquisitions. Because of the loss protection provided by the FDIC, the financial risk of the Cooperative Bank and The Bank of Asheville loans is significantly different from assets not covered under the loss share agreements. Accordingly, we present separately loans subject to the FDIC loss share agreements as “covered loans” and loans that are not subject to the loss share agreements as “non-covered loans.” Table 10a presents a breakout of covered and non-covered loans as of December 31, 2011. The loan portfolio is the largest category of our earning assets and is comprised of commercial loans, real estate mortgage loans, real estate construction loans, and consumer loans. We restrict virtually all of our lending to our 36 county market area, which is located in western, central and eastern North Carolina, four counties in southern Virginia and five counties in northeastern South Carolina. The diversity of the region’s economic base has historically provided a stable lending environment. In 2011, loans outstanding decreased $23.7 million, or 1.0% to $2.43 billion. In 2010, loans outstanding decreased $198.7 million, or 7.5% to $2.45 billion. As previously discussed, the declines for both years were mainly due to loan payoffs and loan foreclosures exceeding new loan growth as loan demand in most of our market areas remained weak. The majority of our loan portfolio over the years has been real estate mortgage loans, with loans secured by real estate consistently comprising 86% to 90% of our outstanding loan balances. Except for real estate construction, land development and other land loans, the majority of our “real estate” loans are personal and commercial loans where cash flow from the borrower’s occupation or business is the primary repayment source, with the real estate pledged providing a secondary repayment source. Table 10 indicates that the two types of loans that have had the largest variances in the amount outstanding as a percent of total loans have been construction/land development loans and residential mortgage loans. In 2005 we expanded our branch network to what was then the fast-growing southeast coast of North Carolina, which had a high demand for construction and land development loans. In 2008, due to recessionary conditions, particularly in the new housing market, loan demand for these types of loans weakened and we tightened our loan underwriting criteria for these types of loans, which reduced growth. Due to economic conditions, for the past three years we have made very few new acquisition and land development loans, and we expect this trend to continue. 51 Our concentration of residential mortgage loans increased in 2009 as a result of the Cooperative acquisition, because Cooperative’s loan portfolio was heavily concentrated in residential mortgages. In 2011, due to The Bank of Asheville acquisition, our percentage of commercial real estate loans increased slightly as that bank’s primary business had been commercial lending. Table 11 provides a summary of scheduled loan maturities over certain time periods, with fixed rate loans and adjustable rate loans shown separately. Approximately 23% of our accruing loans outstanding at December 31, 2011 mature within one year and 67% of total loans mature within five years. As of December 31, 2011, the percentages of variable rate loans and fixed rate loans as compared to total performing loans were 47% and 53%, respectively. We intentionally make a blend of fixed and variable rate loans so as to reduce interest rate risk. Nonperforming Assets Nonperforming assets include nonaccrual loans, troubled debt restructurings, loans past due 90 or more days and still accruing interest, and other real estate. As a matter of policy we place all loans that are past due 90 or more days on nonaccrual basis, and thus there were no loans at any of the past five year ends that were 90 days past due and still accruing interest. Nonaccrual loans are loans on which interest income is no longer being recognized or accrued because management has determined that the collection of interest is doubtful. Placing loans on nonaccrual status negatively impacts earnings because (i) interest accrued but unpaid as of the date a loan is placed on nonaccrual status is reversed and deducted from interest income, (ii) future accruals of interest income are not recognized until it becomes probable that both principal and interest will be paid and (iii) principal charged-off, if appropriate, may necessitate additional provisions for loan losses that are charged against earnings. In some cases, where borrowers are experiencing financial difficulties, loans may be restructured to provide terms significantly different from the originally contracted terms. Table 12 summarizes our nonperforming assets at the dates indicated. Because of the loss protection provided by the FDIC, we present separately nonperforming assets subject to the loss share agreements as “covered” and nonperforming assets that are not subject to the loss share agreements as “non-covered.” Due largely to the economic downturn that began in late 2007 and continued to worsen over the past few years, we have experienced increases in our non-covered nonperforming assets. Our total nonperforming assets were also significantly impacted by the Cooperative acquisition in 2009. Table 12a presents our nonperforming assets at December 31, 2011 by general geographic region and further segregated into “covered” nonperforming assets and “non-covered” nonperforming assets. The majority of our nonperforming assets are located in the Eastern North Carolina region, which has experienced the most negative effects of the recession of any of our regions. Non-covered nonperforming loans totaled $85.2 million, $96.0 million, and $83.5 million, as of December 31, 2011, 2010, and 2009, respectively. Total non-covered nonperforming loans as a percentage of total non- covered loans amounted to 4.12%, 4.61%, and 3.91%, at December 31, 2011, 2010, and 2009, respectively. At December 31, 2011, 2010, and 2009, non-covered troubled debt restructurings amounted to $11.7 million, $33.7 million, and $21.3 million, respectively. The decline in 2011 is primarily a result of troubled debt restructurings that re-defaulted and were placed on nonaccrual status. The increase in 2010 was the result of 52 our initiative to work with borrowers experiencing financial difficulties by modifying certain loan terms. We also had $14.2 million and $14.4 million of covered troubled debt restructurings at December 31, 2011 and 2010, respectively, compared to none in 2009. The following is the composition, by loan type, of all of our nonaccrual loans at each period end, as classified for regulatory purposes: ($ in thousands) Commercial, financial, and agricultural Real estate – construction, land development, and other land loans Real estate – mortgage – residential (1-4 family) first mortgages Real estate – mortgage – home equity loans/lines of credit Real estate – mortgage – commercial and other Installment loans to individuals Total nonaccrual loans (1) Includes both covered and non-covered loans. At December 31, 2011 (1) $ 3,300 48,467 24,133 7,255 28,491 3,392 $ 115,038 At December 31, 2010 (1) 2,595 54,781 36,715 8,584 17,578 539 120,792 The following segregates our nonaccrual loans at December 31, 2011 into covered and non-covered loans, as classified for regulatory purposes: ($ in thousands) Commercial, financial, and agricultural Real estate – construction, land development, and other land loans Real estate – mortgage – residential (1-4 family) first mortgages Real estate – mortgage – home equity loans/lines of credit Real estate – mortgage – commercial and other Installment loans to individuals Total nonaccrual loans Covered Nonaccrual Loans $ 469 21,203 10,134 1,231 8,212 223 $ 41,472 Non-covered Nonaccrual Loans 2,831 27,264 13,999 6,024 20,279 3,169 73,566 Total Nonaccrual Loans 3,300 48,467 24,133 7,255 28,491 3,392 115,038 The following segregates our nonaccrual loans at December 31, 2010 into covered and non-covered loans, as classified for regulatory purposes: ($ in thousands) Commercial, financial, and agricultural Real estate – construction, land development, and other land loans Real estate – mortgage – residential (1-4 family) first mortgages Real estate – mortgage – home equity loans/lines of credit Real estate – mortgage – commercial and other Installment loans to individuals Total nonaccrual loans Covered Nonaccrual Loans $ 163 30,846 16,343 4,059 7,039 16 $ 58,466 Non-covered Nonaccrual Loans 2,432 23,935 20,372 4,525 10,539 523 62,326 Total Nonaccrual Loans 2,595 54,781 36,715 8,584 17,578 539 120,792 The tables above indicate that covered nonaccrual loans declined from $58.5 million at December 31, 2010 to $41.5 million at December 31, 2011. This decrease was primarily a result of many of the nonaccrual loans at December 31, 2010 being either charged-off or being foreclosed upon in 2011 and their balances being transferred to other real estate during the year. Non-covered nonaccrual loans increased from $62.3 million at December 31, 2010 to $73.6 million at December 31, 2011, which was the result of continued economic hardship in our market areas, particularly for the commercial real estate business. If the nonaccrual and restructured loans as of December 31, 2011, 2010 and 2009 had been current in 53 accordance with their original terms and had been outstanding throughout the period (or since origination if held for part of the period), gross interest income in the amounts of approximately $8,724,000, $8,136,000 and $9,800,000 for nonaccrual loans and $1,873,000, $1,943,000 and $1,200,000 for restructured loans would have been recorded for 2011, 2010, and 2009, respectively. Interest income on such loans that was actually collected and included in net income in 2011, 2010 and 2009 amounted to approximately $2,578,000, $3,195,000 and $2,147,000 for nonaccrual loans (prior to their being placed on nonaccrual status), and $1,351,000, $1,342,000, and $866,000 for restructured loans, respectively. At December 31, 2011 and 2010, we had no commitments to lend additional funds to debtors whose loans were nonperforming. Management routinely monitors the status of certain large loans that, in management’s opinion, have credit weaknesses that could cause them to become nonperforming loans. In addition to the nonperforming loan amounts discussed above, management believes that an estimated $5 million of non-covered loans and $16 million of covered loans that were performing in accordance with their contractual terms at December 31, 2011 have the potential to develop problems depending upon the particular financial situations of the borrowers and economic conditions in general. Management has taken these potential problem loans into consideration when evaluating the adequacy of the allowance for loan losses at December 31, 2011 (see discussion below). Loans classified for regulatory purposes as loss, doubtful, substandard, or special mention that have not been disclosed in the problem loan amounts and the potential problem loan amounts discussed above do not represent or result from trends or uncertainties that management reasonably expects will materially impact future operating results, liquidity, or capital resources, or represent material credits about which management is aware of any information that causes management to have serious doubts as to the ability of such borrowers to comply with the loan repayment terms. Other real estate includes foreclosed, repossessed, and idled properties. Non-covered other real estate has increased over the past three years, amounting to $37.0 million at December 31, 2011, $21.1 million at December 31, 2010, and $8.8 million at December 31, 2009. At December 31, 2011, 2010 and 2009, we also held $85.3 million, $94.9 million and $47.4 million, respectively, in other real estate that is subject to loss share agreements with the FDIC. We believe that the fair values of the items of other real estate, less estimated costs to sell, equal or exceed their respective carrying values at the dates presented. The following table presents the detail of our other real estate at each of the past two year ends: Vacant land 1-4 family residential properties Commercial real estate Other Total other real estate (1) Includes both covered and non-covered real estate. At December 31, 2011 (1) $ 76,341 33,724 12,230 – $ 122,295 At December 31, 2010 (1) 81,185 28,146 6,641 – 115,972 54 The following segregates our other real estate at December 31, 2011 into covered and non-covered: Vacant land 1-4 family residential properties Commercial real estate Other Total other real estate Covered Other Real Estate $ 59,994 17,362 7,916 – $ 85,272 Non-covered Other Real Estate 16,347 16,362 4,314 – Total Other Real Estate 76,341 33,724 12,230 – 37,023 122,295 The following segregates our other real estate at December 31, 2010 into covered and non-covered: Vacant land 1-4 family residential properties Commercial real estate Other Total other real estate Allowance for Loan Losses and Loan Loss Experience Covered Other Real Estate $ 72,878 18,691 3,322 – $ 94,891 Non-covered Other Real Estate 8,307 9,455 3,319 – Total Other Real Estate 81,185 28,146 6,641 – 21,081 115,972 The allowance for loan losses is created by direct charges to operations (known as a “provision for loan losses” for the period in which the charge is taken). Losses on loans are charged against the allowance in the period in which such loans, in management’s opinion, become uncollectible. The recoveries realized during the period are credited to this allowance. We consider our procedures for recording the amount of the allowance for loan losses and the related provision for loan losses to be a critical accounting policy. See the heading “Critical Accounting Policies” above for further discussion. The factors that influence management’s judgment in determining the amount charged to operating expense include past loan loss experience, composition of the loan portfolio, evaluation of probable inherent losses and current economic conditions. We use a loan analysis and grading program to facilitate our evaluation of probable inherent loan losses and the adequacy of our allowance for loan losses. In this program, credit risk grades are assigned by management and tested by an independent third party consulting firm. The testing program includes an evaluation of a sample of new loans, loans we identify as having potential credit weaknesses, loans past due 90 days or more, loans originated by new loan officers, nonaccrual loans and any other loans identified during previous regulatory and other examinations. We strive to maintain our loan portfolio in accordance with what management believes are conservative loan underwriting policies that result in loans specifically tailored to the needs of our market areas. Every effort is made to identify and minimize the credit risks associated with such lending strategies. We have no foreign loans, few agricultural loans and do not engage in significant lease financing or highly leveraged transactions. Commercial loans are diversified among a variety of industries. The majority of loans captioned in the tables discussed below as “real estate” loans are personal and commercial loans where real estate provides additional security for the loan. Collateral for virtually all of these loans is located within our principal market area. The allowance for loan losses amounted to $41.4 million at December 31, 2011 compared to $49.4 million at December 31, 2010 and $37.3 million at December 31, 2009. At December 31, 2011 and 2010, $5.8 million and $11.2 million, respectively, of the allowance for loan losses is attributable to covered loans that have exhibited credit quality deterioration due to lower collateral valuations, while the allowance for loan losses for non- covered loans amounted to $35.6 million and $38.3 million at those dates. For all prior periods, the entire 55 allowance for loan losses is attributable to non-covered loans. The ratio of the allowance for non-covered loan losses to non-covered loans was 1.72%, 1.84%, and 1.75%, as of December 31, 2011, 2010, and 2009, respectively. The decrease in the percentage for 2011 is primarily attributable to lower specific reserves at December 31, 2011. The increased allowance percentage in 2010 was necessary due to the higher level of delinquencies and classified and nonperforming loans. Table 13 sets forth the allocation of the allowance for loan losses at the dates indicated. The amount of the unallocated portion of the allowance for loan losses did not vary materially at any of the past three year ends. The allowance for loan losses is available to absorb losses in all categories. Table 13a segregates the allocation of the allowance for loan losses as of December 31, 2011 and 2010 into covered and non-covered categories. As indicated in Tables 13 and 13a, the amount of the allowance allocated to “Real Estate – Construction and Land Development” declined by $5-$6 million from December 31, 2010 to December 31, 2011. This decline was due to charge-offs and the foreclosure and transfer to “other real estate” of a significant amount of covered land development loans. Management considers the allowance for loan losses adequate to cover probable loan losses on the loans outstanding as of each reporting date. It must be emphasized, however, that the determination of the allowance using our procedures and methods rests upon various judgments and assumptions about economic conditions and other factors affecting loans. No assurance can be given that we will not in any particular period sustain loan losses that are sizable in relation to the amount reserved or that subsequent evaluations of the loan portfolio, in light of conditions and factors then prevailing, will not require significant changes in the allowance for loan losses or future charges to earnings. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses and losses on foreclosed real estate. Such agencies may require us to recognize additions to the allowance based on the examiners’ judgments about information available to them at the time of their examinations. For the years indicated, Table 14 summarizes our balances of loans outstanding, average loans outstanding, and a detailed rollforward of the allowance for loan losses. Table 14a presents a detailed rollforward of the 2011 and 2010 activity for the allowance for loan losses segregated into covered and non-covered activity. Net loan charge-offs of non-covered loans amounted to $31.2 million in 2011, $32.7 million in 2010, and $12.1 million in 2009. The elevated amounts in 2010 and 2011 reflect the impact of deteriorating loan quality that has been impacted by the economic downturn. Also in 2010 and 2011, we recorded $8.6 million and $9.0 million, respectively, in partial charge-offs of non-covered loans. Previously, we recorded specific reserves on collateral- deficient nonaccrual loans within the allowance for loans losses, but did not record charge-offs until the loans had been foreclosed upon. Net non-covered charge-offs as a percentage of average non-covered loans represented 1.52%, 1.55%, and 0.56%, during 2011, 2010, and 2009, respectively. We recorded $18.1 million and $9.8 million in charge-offs of covered loans during 2011 and 2010, respectively, primarily related to collateral dependent nonaccrual loans for which we received updated appraisals that reflected lower valuations. 56 Deposits and Securities Sold Under Agreements to Repurchase At December 31, 2011, deposits outstanding amounted to $2.755 billion, an increase of $103 million from December 31, 2010. To begin 2011, deposits initially grew by $193 million as a result of the acquisition of The Bank of Asheville in January 2011. For the remainder of the year, our deposit base declined by $90 million as a lack of loan growth allowed us to reduce our reliance on higher cost deposits. Our NOW deposits increased approximately $131 million during 2011, with $31 million being assumed in The Bank of Asheville acquisition and another $38 million of the growth resulting from customers shifting their funds from securities sold under agreements to repurchase to a commercial interest bearing NOW account (discussed earlier). In 2011, despite the addition of $62 million in time deposits and $43 million in internet deposits from The Bank of Asheville acquisition, we experienced overall net declines in these categories of $73 million and $17 million, respectively, due to our ability to lessen our reliance on these higher cost deposits as a result of weak loan demand and growth in our other lower-cost deposit categories. In 2010, deposits declined from $2.933 billion to $2.653 billion, a decrease of $281 million, or 9.6%, from December 31, 2009. Approximately $237 million, or 84%, of the decline in deposits was attributable to decreases in time deposits. We also experienced a $70 million decrease in our NOW accounts during 2010, primarily as a result of two depositors who withdrew their funds during the last week of the year in anticipation of the expiration of certain provisions of the FDIC transaction account guarantee program. The nature of our deposit growth is illustrated in the table on page 46. The following table reflects the mix of our deposits at each of the past three year ends: Noninterest-bearing deposits NOW deposits Money market deposits Savings deposits Brokered deposits Internet deposits Time deposits > $100,000 - retail Time deposits < $100,000 - retail Total deposits Securities sold under agreements to repurchase 2011 12% 15% 19% 5% 6% 1% 21% 21% 100% 2010 11% 11% 19% 6% 5% 2% 23% 23% 100% 2009 9% 12% 17% 5% 3% 4% 24% 26% 100% as a percent of total deposits 1% 2% 2% The deposit mix remained relatively consistent from 2009 to 2011. Our mix has gradually shifted over the past few years to a heavier concentration in transaction accounts and less concentration in our time deposits. The percentages for retail time deposits have declined because we have chosen not to match certain promotional time deposit interest rates being offered by several of our local competitors, which we felt were too high compared to alternative funding sources. Our growth in other categories of deposits and our weak loan demand eliminated the need to match the higher competitor rates. We routinely engage in activities designed to grow and retain deposits, such as (1) emphasizing relationship banking to new and existing customers, where borrowers are encouraged and normally expected to maintain deposit accounts with us, (2) pricing deposits at rate levels that will attract and/or retain deposits, and (3) continually working to identify and introduce new products that will attract customers or enhance our appeal as a primary provider of financial services. Table 15 presents the average amounts of our deposits and the average yield paid for those deposits for the years ended December 31, 2011, 2010, and 2009. 57 As of December 31, 2011, we held approximately $753.2 million in time deposits of $100,000 or more. Table 16 is a maturity schedule of time deposits of $100,000 or more as of December 31, 2011. This table shows that 66% of our time deposits greater than $100,000 mature within one year. At each of the past three year ends, we have no deposits issued through foreign offices, nor do we believe that we held any deposits by foreign depositors. Borrowings We had borrowings outstanding of $133.9 million at December 31, 2011 compared to $196.9 million at December 31, 2010 and $176.8 million at December 31, 2009. Borrowings decreased from 2010 to 2011 primarily as a result of a decline in loans and growth in deposits that provided funds to pay down our borrowings. During most of 2010, we held a lower level of borrowings until late in the year when we obtained borrowings to offset a portion of the liquidity decline we experienced as a result of the loss of deposits that was previously discussed. Table 2 shows that average borrowings were $122.7 million in 2011 compared to $79.8 million in 2010 and $151.2 million in 2009. At December 31, 2011, the Company had four sources of readily available borrowing capacity – 1) an approximately $389 million line of credit with the FHLB, of which $88 million was outstanding at December 31, 2011 and $62 million was outstanding at December 31, 2010, 2) a $50 million overnight federal funds line of credit with a correspondent bank, of which none was outstanding at December 31, 2011 and $33 million was outstanding at December 31, 2010, 3) an approximately $79 million line of credit through the Federal Reserve Bank of Richmond’s (FRB) discount window, of which none was outstanding at December 31, 2011 and $55 million was outstanding at December 31, 2010, and 4) a $10 million holding company line of credit with a commercial bank (none of which was outstanding at December 31, 2011 or 2010). Our line of credit with the FHLB can be structured as either short-term or long-term borrowings, depending on the particular funding or liquidity need, and is secured by our FHLB stock and a blanket lien on most of our real estate loan portfolio. As of December 31, 2011, none of the $88 million outstanding with the FHLB were overnight borrowings. All the FHLB borrowings were at fixed rates with a weighted average interest rate of 1.36% and maturity dates ranging from April 2012 to June 2014. For the year ended December 31, 2011, the average amount of FHLB borrowings outstanding was approximately $76 million with a weighted average interest rate for the year of 1.49%. The maximum amount of short-term FHLB borrowings outstanding at any month-end during 2011 was $92 million. In addition to the outstanding borrowings from the FHLB that reduce the available borrowing capacity of the line of credit, our borrowing capacity was further reduced by $203 million at December 31, 2011 and 2010 as a result of our pledging letters of credit backed by the FHLB for public deposits at each of those dates. Our correspondent bank relationship allows us to purchase up to $50 million in federal funds on an overnight, unsecured basis (federal funds purchased). We had no borrowings under this line at December 31, 2011. We had $33 million outstanding under this line at December 31, 2010 with a weighted average interest rate of 0.65%. There were no federal funds purchased outstanding at any month-end during 2011. We also have a line of credit with the FRB discount window. This line is secured by a blanket lien on a portion of our commercial and consumer loan portfolio (excluding real estate loans). Based on the collateral that we owned as of December 31, 2011, the available line of credit was approximately $79 million. At December 31, 2011, we had no borrowings outstanding under this line. At December 31, 2010, we had $55 million in borrowings outstanding under this line. There were no FRB borrowings outstanding at any month-end during 2011. 58 At December 31, 2011 and 2010, we had a $10 million holding company line of credit with a correspondent bank that was secured by 100% of the common stock of our bank subsidiary. This line of credit expires and is subject to renewal in March of each year. The line of credit had no outstanding balance at December 31, 2011 or 2010, and was not drawn upon during 2011 or 2010. In addition to the lines of credit described above, in which we had $88 million and $150 million outstanding as of December 31, 2011, and 2010, respectively, we also had a total of $46.4 million in trust preferred security debt outstanding at December 31, 2011 and 2010. We have initiated three trust preferred security issuances since 2002 totaling $67.0 million, with one of those issuances for $20.6 million being redeemed in 2007. These borrowings each have 30 year final maturities and were structured in a manner that allows them to qualify as capital for regulatory capital adequacy requirements. We may call these debt securities at par on any quarterly interest payment date five years after their issue date. We issued $20.6 million of this debt on October 29, 2002 (which we called in 2007), an additional $20.6 million on December 19, 2003, and $25.8 million on April 13, 2006. The interest rate on these debt securities adjusts on a quarterly basis at a rate of three-month LIBOR plus 2.70% for the securities issued in 2003, and three-month LIBOR plus 1.39% for the securities issued in 2006. Liquidity, Commitments, and Contingencies We have a pending agreement to purchase eleven branches of another bank with approximately $180 million in total deposits and $98 million in total loans. See Note 2 to the consolidated financial statements for additional information. Our liquidity is determined by our ability to convert assets to cash or to acquire alternative sources of funds to meet the needs of our customers who are withdrawing or borrowing funds, and our ability to maintain required reserve levels, pay expenses and operate the Company on an ongoing basis. Our primary liquidity sources are net income from operations, cash and due from banks, federal funds sold and other short-term investments. Our securities portfolio is comprised almost entirely of readily marketable securities which could also be sold to provide cash. As noted above, in addition to internally generated liquidity sources, we currently (March 2012) have the ability to obtain borrowings from the following four sources – 1) an approximately $389 million line of credit with the FHLB, 2) a $50 million overnight federal funds line of credit with a correspondent bank, 3) an approximately $79 million line of credit through the FRB’s discount window and 4) a holding company line of credit with a limit of $10 million. Our overall liquidity increased slightly during 2011 compared to 2010. Our loans decreased by $24 million, while our deposits increased by $103 million. As a result, our liquid assets (cash and securities) as a percentage of our total deposits and borrowings increased from 15.4% at December 31, 2010 to 15.7% at December 31, 2011. We continue to believe our liquidity sources, including unused lines of credit, are at an acceptable level and remain adequate to meet our operating needs in the foreseeable future. We will continue to monitor our liquidity position carefully and will explore and implement strategies to increase liquidity if deemed appropriate. In the normal course of business we have various outstanding contractual obligations that will require future cash outflows. In addition, there are commitments and contingent liabilities, such as commitments to extend credit, that may or may not require future cash outflows. Table 18 reflects our contractual obligations and other commercial commitments outstanding as of December 31, 2011. Any of our $88 million in outstanding borrowings with the FHLB may be accelerated immediately by 59 the FHLB in certain circumstances, including material adverse changes in our condition or if our qualifying collateral is less than the amount required under the terms of the borrowing agreement. In the normal course of business there are various outstanding commitments and contingent liabilities such as commitments to extend credit, which are not reflected in the financial statements. The following table presents a summary of our outstanding loan commitments as of December 31, 2011: ($ in millions) Type of Commitment Outstanding closed-end loan commitments Unfunded commitments on revolving lines of credit, credit cards and home equity loans Total Fixed Rate $ 39 32 $ 71 Variable Rate 278 185 463 Total 317 217 534 At December 31, 2011 and 2010, we also had $7.1 million and $7.5 million, respectively, in standby letters of credit outstanding. We had no carrying amount for these standby letters of credit at either of those dates. The nature of the standby letters of credit is that of a guarantee made on behalf of our customers to suppliers of the customers to guarantee payments owed to the supplier by the customer. The standby letters of credit are generally for terms of one year, at which time they may be renewed for another year if both parties agree. The payment of the guarantees would generally be triggered by a continued nonpayment of an obligation owed by the customer to the supplier. The maximum potential amount of future payments (undiscounted) we could be required to make under the guarantees in the event of nonperformance by the parties to whom credit or financial guarantees have been extended is represented by the contractual amount of the financial instruments discussed above. In the event that we are required to honor a standby letter of credit, a note, already executed by the customer, becomes effective providing repayment terms and any collateral. Over the past two years, we have had to honor only a few standby letters of credit, which involved insignificant amounts of funds and have been or are being repaid by the borrower without any loss to us. We expect any draws under existing commitments to be funded through normal operations. It has been our experience that deposit withdrawals are generally replaced with new deposits, thus not requiring any net cash outflow. Based on that assumption, management believes that it can meet its contractual cash obligations and existing commitments from normal operations. We are not involved in any legal proceedings that, in management’s opinion, could have a material effect on the consolidated financial position of the Company. Capital Resources and Shareholders’ Equity Shareholders’ equity at December 31, 2011 amounted to $345.2 million compared to $344.6 million at December 31, 2010. The two basic components that typically have the largest impact on our shareholders’ equity are net income, which increases shareholders’ equity, and dividends declared, which decreases shareholders’ equity. Additionally, any stock issuances can significantly increase shareholders’ equity. In 2011, the most significant factors that impacted our equity were the redemption of $65.0 million of our Series A Preferred Stock issued under the U.S. Treasury’s Capital Purchase Program (also known as TARP) and the simultaneous issuance of $63.5 million of Series B Preferred Stock under the Treasury’s Small Business Lending Fund (SBLF). Net income of $13.6 million for 2011 increased equity, while common stock dividends declared of $5.4 million and preferred stock dividends declared of $3.2 million reduced equity. We also recorded accretion of the discount on preferred stock of $2.9 million due to the redemption of the Series A Preferred Stock. (See Note 19 to the consolidated financial statements for further information on these transactions.) Another significant factor negatively impacting equity in 2011 was a $4.5 million increase in accumulated other 60 comprehensive loss that was caused by an increase in our pension liability. The increase in the pension liability was primarily due to the impact of lower interest rates on the actuarial calculations involved in determining the liability. Our policy is to use the Citigroup Pension Index yield curve in the computation of the pension liability. At December 31, 2011, that index had a weighted average rate of 4.39%, which was a decline from the rate of 5.59% at December 31, 2010. See the Consolidated Statements of Shareholders’ Equity within the consolidated financial statements for disclosure of other less significant items affecting shareholders’ equity. In 2010, the most significant factors that impacted our equity were net income of $10.0 million, which increased equity, and common stock dividends declared of $5.4 million and preferred stock dividends declared of $3.3 million, which reduced equity. See the Consolidated Statements of Shareholders’ Equity within the consolidated financial statements for disclosure of other less significant items affecting shareholders’ equity. In 2009, the most significant item that impacted our equity was our issuance of $65 million in preferred stock to the U.S. Treasury in connection with our participation in the Treasury’s Capital Purchase Program (see Note 19 to the consolidated financial statements). In addition, other significant factors were net income of $60.3 million, which increased equity, and common stock dividends declared of $5.3 million and preferred stock dividends declared of $3.2 million, which reduced equity. See the consolidated financial statements for other less significant factors that impacted equity in 2009. We are not aware of any recommendations of regulatory authorities or otherwise which, if they were to be implemented, would have a material effect on our liquidity, capital resources, or operations. The Company and the Bank must comply with regulatory capital requirements established by the FRB and the FDIC. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. These capital standards require the Company and the Bank to maintain minimum ratios of “Tier 1” capital to total risk-weighted assets (“Tier I Capital Ratio”) and total capital to risk-weighted assets (“Total Capital Ratio”) of 4.00% and 8.00%, respectively. Tier 1 capital is comprised of total shareholders’ equity, excluding unrealized gains or losses from the securities available for sale, less intangible assets, and total capital is comprised of Tier 1 capital plus certain adjustments, the largest of which for the Company and the Bank is the allowance for loan losses. Risk-weighted assets refer to the on- and off-balance sheet exposures of the Company and the Bank, adjusted for their related risk levels using formulas set forth in FRB and FDIC regulations. In addition to the risk-based capital requirements described above, the Company and the Bank are subject to a leverage capital requirement, which calls for a minimum ratio of Tier 1 capital (as defined above) to quarterly average total assets (“Leverage Ratio) of 3.00% to 5.00%, depending upon the institution’s composite ratings as determined by its regulators. The FRB has not advised us of any requirement specifically applicable to the Company. Table 21 presents our regulatory capital ratios as of December 31, 2011, 2010, and 2009. All of our capital ratios have significantly exceeded the minimum regulatory thresholds for all periods covered by this report. In addition to the minimum capital requirements described above, the regulatory framework for prompt corrective action also contains specific capital guidelines for a bank’s classification as “well capitalized.” The specific guidelines are as follows – Tier I Capital Ratio of at least 6.00%, Total Capital Ratio of at least 10.00%, and a Leverage Ratio of at least 5.00%. If a bank falls below “well capitalized” status in any of these three ratios, it must ask for FDIC permission to originate or renew brokered deposits. The Bank’s regulatory ratios exceeded the threshold for “well-capitalized” status at December 31, 2011, 2010, and 2009 – see Note 16 to the consolidated financial statements for a table that presents the Bank’s regulatory ratios. 61 In addition to shareholders’ equity, we have supplemented our capital in past years with trust preferred security debt issuances, which because of their structure qualify as regulatory capital. This was necessary in past years because our balance sheet growth outpaced the growth rate of our capital. Additionally, we have frequently purchased bank branches over the years that resulted in our recording intangible assets, which negatively impacted regulatory capital ratios. As discussed in “Borrowings” above, we have issued a total of $67.0 million in trust preferred securities since 2002, with the most recent issuance being a $25.8 million issuance that occurred in April 2006. We currently have $46.4 million in trust preferred securities outstanding. In this economic environment, our goal is to maintain our capital ratios at levels at least 200 basis points higher than the “well-capitalized” thresholds set for banks. At December 31, 2011, our total risk-based capital ratio was 16.72% compared to the 10.00% “well-capitalized” threshold. In addition to regulatory capital ratios, we also closely monitor our ratio of tangible common equity to tangible assets (“TCE Ratio”). Our TCE ratio was 6.58% at December 31, 2011 compared to 6.52% at December 31, 2010. See “Supervision and Regulation” under “Business” above and Note 16 to the consolidated financial statements for discussion of other matters that may affect our capital resources. Off-Balance Sheet Arrangements and Derivative Financial Instruments Off-balance sheet arrangements include transactions, agreements, or other contractual arrangements pursuant to which we have obligations or provide guarantees on behalf of an unconsolidated entity. We have no off- balance sheet arrangements of this kind other than letters of credit and repayment guarantees associated with our trust preferred securities. Derivative financial instruments include futures, forwards, interest rate swaps, options contracts, and other financial instruments with similar characteristics. We have not engaged in derivatives activities through December 31, 2011 and have no current plans to do so. Return on Assets and Equity Table 20 shows return on assets (net income available to common shareholders divided by average total assets), return on common equity (net income available to common shareholders divided by average common shareholders’ equity), dividend payout ratio (dividends per share divided by net income per common share) and shareholders’ equity to assets ratio (average total shareholders’ equity divided by average total assets) for each of the years in the three-year period ended December 31, 2011. Interest Rate Risk (Including Quantitative and Qualitative Disclosures About Market Risk – Item 7A.) Net interest income is our most significant component of earnings. Notwithstanding changes in volumes of loans and deposits, our level of net interest income is continually at risk due to the effect that changes in general market interest rate trends have on interest yields earned and paid with respect to our various categories of earning assets and interest-bearing liabilities. It is our policy to maintain portfolios of earning assets and interest-bearing liabilities with maturities and repricing opportunities that will afford protection, to the extent practical, against wide interest rate fluctuations. Our exposure to interest rate risk is analyzed on a regular basis by management using standard GAP reports, maturity reports, and an asset/liability software model that simulates future levels of interest income and expense based on current interest rates, expected future interest rates, and various intervals of “shock” interest rates. Over the years, we have been able to maintain a fairly consistent yield on average earning assets (net interest margin). Over the past five calendar years, our net 62 interest margin has ranged from a low of 3.74% (realized in 2008) to a high of 4.72% (realized in 2011). During that five year period, the prime rate of interest has ranged from a low of 3.25% (which was the rate as of December 31, 2011) to a high of 8.25%. The consistency of the net interest margin is aided by the relatively low level of long-term interest rate exposure that we maintain. At December 31, 2011, approximately 82% of our interest-earning assets are subject to repricing within five years (because they are either adjustable rate assets or they are fixed rate assets that mature) and substantially all of our interest-bearing liabilities reprice within five years. Table 17 sets forth our interest rate sensitivity analysis as of December 31, 2011, using stated maturities for all fixed rate instruments except mortgage-backed securities (which are allocated in the periods of their expected payback) and securities and borrowings with call features that are expected to be called (which are shown in the period of their expected call). As illustrated by this table, at December 31, 2011, we had $682 million more in interest-bearing liabilities that are subject to interest rate changes within one year than earning assets. This generally would indicate that net interest income would experience downward pressure in a rising interest rate environment and would benefit from a declining interest rate environment. However, this method of analyzing interest sensitivity only measures the magnitude of the timing differences and does not address earnings, market value, or management actions. Also, interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. In addition to the effects of “when” various rate-sensitive products reprice, market rate changes may not result in uniform changes in rates among all products. For example, included in interest-bearing liabilities subject to interest rate changes within one year at December 31, 2011 are deposits totaling $1.084 billion comprised of NOW, savings, and certain types of money market deposits with interest rates set by management. These types of deposits historically have not repriced with, or in the same proportion, as general market indicators. Overall we believe that in the near term (twelve months), net interest income will not likely experience significant downward pressure from rising interest rates. Similarly, we would not expect a significant increase in near term net interest income from falling interest rates. Generally, when rates change, our interest-sensitive assets that are subject to adjustment reprice immediately at the full amount of the change, while our interest- sensitive liabilities that are subject to adjustment reprice at a lag to the rate change and typically not to the full extent of the rate change. In the short-term (less than six months), this results in us being asset-sensitive, meaning that our net interest income benefits from an increase in interest rates and is negatively impacted by a decrease in interest rates. However, in the twelve-month horizon, the impact of having a higher level of interest- sensitive liabilities lessens the short-term effects of changes in interest rates. The Federal Reserve has made no changes to interest rates since 2008, and since that time the difference between market driven short-term interest rates and longer-term interest rates has generally widened, with short-term interest rates steadily declining and longer term interest rates not declining by as much. The higher long term interest rate environment enhanced our ability to require higher interest rates on loans. As it relates to funding, we have been able to reprice many of our maturing time deposits at lower interest rates. We were also able to generally decrease the rates we paid on other categories of deposits as a result of declining short- term interest rates in the marketplace and an increase in liquidity that lessened our need to offer premium interest rates. Our net interest margin increased throughout 2010 and 2011. Our net interest margin was 4.72% for 2011, a 33 basis point increase from the 4.39% margin realized in 2010. As previously discussed in the section “Net Interest Income,” our net interest income was impacted by certain purchase accounting adjustments related primarily to our acquisitions of Cooperative Bank and The Bank of Asheville. The purchase accounting adjustments related to the premium amortization on loans, deposits and borrowings are based on amortization schedules and are thus systematic and predictable. The accretion of the loan discount on loans acquired from Cooperative Bank and The Bank of Asheville, which amounted to $11.6 million and $7.6 million for 2011 and 2010, respectively, is less predictable and could be materially different 63 among periods. This is because of the magnitude of the discounts that were initially recorded ($280 million in total) and the fact that the accretion being recorded is dependent on both the credit quality of the acquired loans and the impact of any accelerated loan repayments, including payoffs. If the credit quality of the loans declines, some, or all, of the remaining discount will cease to be accreted into income. If the underlying loans experience accelerated paydowns or are paid off, the remaining discount will be accreted into income on an accelerated basis, which in the event of total payoff will result in the remaining discount being entirely accreted into income in the period of the payoff. Each of these factors is difficult to predict and susceptible to volatility. Based on our most recent interest rate modeling, which assumes no changes in interest rates for 2012 (federal funds rate = 0.25%, prime = 3.25%), we project that our net interest margin for 2012 will remain relatively consistent with the net interest margins recently realized. With interest rates having been stable for a relatively long period of time, most of our interest-sensitive assets and interest-sensitive liabilities have been repriced at rates near today’s interest rates. We have no market risk sensitive instruments held for trading purposes, nor do we maintain any foreign currency positions. Table 19 presents the expected maturities of our other than trading market risk sensitive financial instruments. Table 19 also presents the estimated fair values of market risk sensitive instruments as estimated in accordance with relevant accounting guidance. Our assets and liabilities have estimated fair values that do not materially differ from their carrying amounts. See additional discussion regarding net interest income, as well as discussion of the changes in the annual net interest margin, in the section entitled “Net Interest Income” above. Inflation Because the assets and liabilities of a bank are primarily monetary in nature (payable in fixed determinable amounts), the performance of a bank is affected more by changes in interest rates than by inflation. Interest rates generally increase as the rate of inflation increases, but the magnitude of the change in rates may not be the same. The effect of inflation on banks is normally not as significant as its influence on those businesses that have large investments in plant and inventories. During periods of high inflation, there are normally corresponding increases in the money supply, and banks will normally experience above average growth in assets, loans and deposits. Also, general increases in the price of goods and services will result in increased operating expenses. Current Accounting Matters We prepare our consolidated financial statements and related disclosures in conformity with standards established by, among others, the Financial Accounting Standards Board (the “FASB”). Because the information needed by users of financial reports is dynamic, the FASB frequently issues new rules and proposes new rules for companies to apply in reporting their activities. See Note 1(t) to our consolidated financial statements for a discussion of recent rule proposals and changes. Item 7A. Quantitative and Qualitative Disclosures About Market Risk. The information responsive to this Item is found in Item 7 under the caption “Interest Rate Risk.” 64 Table 1 Selected Consolidated Financial Data ($ in thousands, except per share and nonfinancial data) Income Statement Data Interest income Interest expense Net interest income Provision for loan losses Net interest income after provision Noninterest income Noninterest expense Income before income taxes Income taxes Net income Preferred stock dividends Accretion of preferred stock discount Net income available to common shareholders Earnings per common share – basic Earnings per common share – diluted Per Share Data (Common) Cash dividends declared - common Market Price High Low Close Stated book value – common Tangible book value – common Selected Balance Sheet Data (at year end) Total assets Loans – non-covered Loans – covered Total loans Allowance for loan losses Intangible assets Deposits Borrowings Total shareholders’ equity Selected Average Balances Assets Loans – non-covered Loans – covered Total loans Earning assets Deposits Interest-bearing liabilities Shareholders’ equity Ratios Return on average assets Return on average common equity Net interest margin (taxable-equivalent basis) Tangible common equity to tangible assets Loans to deposits at year end Allowance for loan losses to total loans Allowance for loan losses to total loans - non-covered Nonperforming assets to total assets at year end Nonperforming assets to total assets - non-covered Net charge-offs to average total loans Net charge-offs to average total loans - non-covered Nonfinancial Data – number of branches Nonfinancial Data – number of employees (FTEs) 2011 2010 2009 2008 2007 Year Ended December 31, $ 155,768 23,565 132,203 41,301 90,902 26,216 96,106 21,012 7,370 13,642 (3,234) (2,932) 7,476 0.44 0.44 159,261 31,907 127,354 54,562 72,792 29,106 86,956 14,942 4,960 9,982 (3,250) (857) 5,875 155,991 48,895 107,096 20,186 86,910 89,518 78,551 97,877 37,618 60,259 (3,169) (803) 56,287 147,862 61,303 86,559 9,880 76,679 20,657 62,211 35,125 13,120 22,005 — — 22,005 148,942 69,658 79,284 5,217 74,067 17,217 56,324 34,960 13,150 21,810 — — 21,810 0.35 0.35 3.38 3.37 1.38 1.37 1.52 1.51 $ 0.32 0.32 0.32 0.76 0.76 16.89 8.05 11.15 16.66 12.53 $ 3,290,474 2,069,152 361,234 2,430,386 41,418 69,732 2,755,037 133,925 345,150 $ 3,315,045 2,051,677 410,318 2,461,995 2,834,938 2,758,022 2,606,450 353,588 0.23% 2.59% 4.72% 6.58% 89.27% 1.70% 1.72% 8.00% 4.30% 2.00% 1.52% 97 830 65 16.90 12.00 15.31 16.64 12.45 19.00 6.87 13.97 16.59 12.35 20.86 11.25 18.35 13.27 9.18 26.72 16.40 18.89 12.11 8.56 3,278,932 2,083,004 371,128 2,454,132 49,430 70,358 2,652,513 196,870 344,603 3,326,977 2,104,677 449,724 2,554,401 2,927,815 2,807,161 2,655,195 350,908 3,545,356 2,132,843 520,022 2,652,865 37,343 70,948 2,933,108 176,811 342,383 3,097,137 2,176,153 298,892 2,475,045 2,833,167 2,549,709 2,497,304 313,173 2,750,567 2,211,315 (cid:1086) 2,211,315 29,256 67,780 2,074,791 367,275 219,868 2,317,249 1,894,295 (cid:1086) 1,894,295 21,324 51,020 1,838,277 242,394 174,070 2,484,296 2,117,028 — 2,117,028 2,329,025 1,985,332 2,019,256 210,810 2,139,576 1,808,219 — 1,808,219 1,998,428 1,780,265 1,726,002 170,857 0.18% 2.05% 4.39% 6.52% 92.52% 2.01% 1.84% 8.69% 4.16% 1.66% 1.55% 92 774 1.82% 22.55% 3.81% 5.94% 90.45% 1.41% 1.75% 7.27% 3.10% 0.49% 0.56% 91 764 0.89% 10.44% 3.74% 5.67% 106.58% 1.32% 1.32% 1.29% 1.29% 0.24% 0.24% 74 650 1.02% 12.77% 4.00% 5.43% 103.05% 1.13% 1.13% 0.47% 0.47% 0.16% 0.16% 70 614 Table 2 Average Balances and Net Interest Income Analysis 2011 Avg. Rate Interest Earned or Paid Average Volume Year Ended December 31, 2010 2009 Average Volume Avg. Rate Interest Earned or Paid Average Volume Avg. Rate Interest Earned or Paid $2,461,995 175,666 57,478 6.00% 3.23% 6.18% $147,652 5,680 3,556 $2,554,401 160,711 46,807 5.92% $151,292 5,750 3.58% 2,949 6.30% $2,475,045 167,041 23,018 5.98% $148,007 6,580 3.94% 1,677 7.29% 139,799 0.31% 436 165,896 0.35% 586 168,063 0.32% 545 2,834,938 72,628 68,930 338,549 $3,315,045 5.55% 157,324 2,927,815 59,236 56,534 283,392 $3,326,977 5.48% 160,577 2,833,167 42,350 52,789 168,831 $3,097,137 5.53% 156,809 $ 355,979 508,209 152,256 771,165 641,078 0.22% 0.53% 0.48% 1.31% 1.10% $ 776 2,705 731 10,103 7,036 $ 349,501 508,250 156,483 786,257 717,416 0.24% 0.84% 0.81% 1.57% 1.56% $ 834 4,267 1,262 12,374 11,193 $ 244,863 0.29% 1.52% 1.08% 2.54% 2.43% 429,068 137,142 745,159 736,358 $ 720 6,537 1,487 18,908 17,866 2,428,687 0.88% 21,351 2,517,907 1.19% 29,930 2,292,590 1.99% 45,518 55,020 0.33% 122,743 1.65% 184 2,030 57,443 0.52% 298 53,537 1.37% 736 79,845 2.10% 1,679 151,177 1.75% 2,641 2,606,450 0.90% 23,565 2,655,195 1.20% 31,907 2,497,304 1.96% 48,895 329,335 25,672 353,588 289,254 31,620 350,908 257,119 29,541 313,173 $3,315,045 $3,326,977 $3,097,137 $133,759 4.72% 4.65% 3.25% $128,670 4.39% 4.28% 3.25% $107,914 3.81% 3.57% 3.25% ($ in thousands) Assets Loans (1) (2) Taxable securities Non-taxable securities (3) Short-term investments, primarily overnight funds Total interest- earning assets Cash and due from banks Bank premises and equipment, net Other assets Total assets Liabilities and Equity NOW accounts Money market accounts Savings accounts Time deposits >$100,000 Other time deposits Total interest-bearing deposits Securities sold under agreements to repurchase Borrowings Total interest- bearing liabilities Non-interest- bearing deposits Other liabilities Shareholders’ equity Total liabilities and shareholders’ equity Net yield on interest- earning assets and net interest income Interest rate spread Average prime rate (1) Average loans include nonaccruing loans, the effect of which is to lower the average rate shown. Interest earned includes recognized net loan (2) (3) fees (costs) in the amounts of ($101,500), $35,000, and $144,000 for 2011, 2010, and 2009, respectively. Includes accretion of discount on covered loans of $11,598,000, $7,607,000, and $1,469,000 in 2011, 2010, and 2009, respectively. Includes tax-equivalent adjustments of $1,556,000, $1,316,000, and $818,000 in 2011, 2010, and 2009, respectively, to reflect the federal and state tax benefit of the tax-exempt securities (using a 39% combined tax rate), reduced by the related nondeductible portion of interest expense. 66 Table 3 Volume and Rate Variance Analysis ($ in thousands) Interest income (tax-equivalent): Loans Taxable securities Non-taxable securities Short-term investments, primarily overnight funds Total interest income Interest expense: NOW accounts Money Market accounts Savings accounts Time deposits >$100,000 Other time deposits Total interest-bearing deposits Securities sold under agreements to repurchase Borrowings Total interest expense Year Ended December 31, 2011 Year Ended December 31, 2010 Change Attributable to Change Attributable to Changes in Volumes Changes in Rates Total Increase (Decrease) Changes in Volumes Changes in Rates Total Increase (Decrease) $ (5,507) 509 666 (87) (4,419) 15 (cid:1086) (27) (218) (1,014) (1,244) (10) 806 (448) 1,867 (579) (59) (63) 1,166 (73) (1,562) (504) (2,053) (3,143) (7,335) (104) (455) (7,894) (3,640) (70) 607 4,723 (238) 1,616 (150) (3,253) (58) (1,562) (531) (2,271) (4,157) (8,579) (114) 351 (8,342) (7) 6,094 279 936 183 845 (378) 1,865 37 (1,373) 529 (1,438) (592) (344) 48 (2,326) (165) (3,206) (408) (7,379) (6,295) (17,453) (475) 411 (17,517) 3,285 (830) 1,272 41 3,768 114 (2,270) (225) (6,534) (6,673) (15,588) (438) (962) (16,988) Net interest income (tax-equivalent) $ (3,971) 9,060 5,089 5,565 15,191 20,756 Changes attributable to both volume and rate are allocated equally between rate and volume variances. Table 4 Noninterest Income ($ in thousands) Service charges on deposit accounts Other service charges, commissions, and fees Fees from presold mortgages Commissions from sales of insurance and financial products Total core noninterest income Gain from acquisition Foreclosed property losses and write-downs – covered Foreclosed property losses and write-downs – non-covered FDIC Indemnification asset income, net Securities gains (losses), net Other gains (losses), net Total 2011 $ 11,981 8,067 1,609 1,512 23,169 10,196 (24,492) (3,355) 20,481 74 143 $ 26,216 Year Ended December 31, 2010 12,335 6,507 1,813 1,476 22,131 — (34,527) (984) 41,808 26 652 29,106 2009 13,112 5,729 1,505 1,524 21,870 67,894 — — — (104) (142) 89,518 67 Table 5 Noninterest Expenses ($ in thousands) Salaries Employee benefits Total personnel expense Occupancy expense Equipment related expenses Amortization of intangible assets Acquisition expenses FDIC insurance expense Stationery and supplies Telephone Repossession and collection expenses – non-covered Repossession and collection expenses – covered, net of FDIC reimbursement and rental income Non-credit losses Other operating expenses Total Table 6 Income Taxes ($ in thousands) Current - Federal - State Deferred - Federal - State Total Effective tax rate 2011 $ 39,822 11,616 51,438 6,574 4,326 902 636 3,008 2,867 2,127 3,492 1,968 1,276 17,492 $ 96,106 2011 $ 9,204 2,094 (3,234) (694) $ 7,370 Year Ended December 31, 2010 35,076 10,214 45,290 6,799 4,327 874 — 4,387 2,563 2,053 2,138 2,617 489 15,419 86,956 2010 25,353 3,807 (21,092) (3,108) 4,960 2009 30,745 10,843 41,588 6,071 4,334 630 1,343 5,500 2,181 1,847 871 795 254 13,137 78,551 2009 11,190 1,830 20,545 4,053 37,618 35.1% 33.2% 38.4% 68 Table 7 Distribution of Assets and Liabilities 2011 2010 2009 As of December 31, Assets Interest-earning assets Net loans Securities available for sale Securities held to maturity Short term investments Total interest-earning assets Noninterest-earning assets Cash and due from banks Premises and equipment FDIC indemnification asset Other real estate owned Other assets Total assets Liabilities and shareholders’ equity Demand deposits – noninterest bearing NOW deposits Money market deposits Savings deposits Time deposits of $100,000 or more Other time deposits Total deposits Securities sold under agreements to repurchase Borrowings Accrued expenses and other liabilities Total liabilities Shareholders’ equity Total liabilities and shareholders’ equity Table 8 Securities Portfolio Composition ($ in thousands) Securities available for sale: Government-sponsored enterprise securities Mortgage-backed securities Corporate bonds Equity securities Total securities available for sale Securities held to maturity: State and local governments Other Total securities held to maturity 73% 6 2 4 85 2 2 4 4 3 100% 10% 13 16 4 23 18 84 1 4 1 90 10 100% 73% 6 2 5 86 2 2 4 4 2 100% 9% 9 15 5 23 20 81 2 6 1 90 10 100% 74% 5 1 8 88 2 2 4 2 2 100% 8% 10 14 4 23 23 82 2 5 1 90 10 100% 2011 $ 34,665 124,105 12,488 11,368 182,626 57,988 (cid:1086) 57,988 As of December 31, 2010 43,273 107,460 15,330 15,119 181,182 54,011 7 54,018 2009 36,518 111,797 14,436 17,004 179,755 34,394 19 34,413 Total securities $ 240,614 235,200 214,168 Average total securities during year $ 233,144 207,518 190,059 69 Table 9 Securities Portfolio Maturity Schedule ($ in thousands) Securities available for sale: Government-sponsored enterprise securities Due within one year Due after one but within five years Due after five but within ten years Total Mortgage-backed securities (2) Due within one year Due after one but within five years Due after five but within ten years Due after ten years Total Corporate debt securities Due after one but within five years Due after ten years Total Equity securities Total securities available for sale Due within one year Due after one but within five years Due after five but within ten years Due after ten years Equity securities Total Securities held to maturity: State and local governments Due within one year Due after one but within five years Due after five but within ten years Due after ten years Total Total securities held to maturity Due within one year Due after one but within five years Due after five but within ten years Due after ten years Total As of December 31, 2011 Book Value Fair Value Book Yield (1) $ 3,011 28,500 3,000 34,511 1,053 62,754 48,192 8,033 120,032 2,997 10,192 13,189 10,998 4,064 94,251 51,192 18,225 10,998 $ 178,730 $ 626 1,743 23,188 32,431 57,988 626 1,743 23,188 32,431 $ 57,988 3,106 28,558 3,001 34,665 1,074 65,780 48,606 8,645 124,105 3,102 9,386 12,488 11,368 4,180 97,440 51,607 18,031 11,368 182,626 629 1,843 25,201 35,081 62,754 629 1,843 25,201 35,081 62,754 4.15% 1.62% 1.60% 1.84% 4.44% 3.58% 2.08% 4.91% 3.07% 6.83% 7.50% 7.35% 0.79% 4.22% 3.09% 2.05% 6.36% 0.79% 3.01% 5.52% 5.86% 5.85% 5.73% 5.78% 5.52% 5.86% 5.85% 5.73% 5.78% (1) Yields on tax-exempt investments have been adjusted to a taxable equivalent basis using a 39% tax rate. (2) Mortgage-backed securities are shown maturing in the periods consistent with their estimated lives based on expected prepayment speeds. 70 Table 10 Loan Portfolio Composition As of December 31, 2011 2010 2009 2008 2007 % of Total Loans Amount % of Total Loans Amount Amount % of Total Loans Amount % of Total Loans Amount % of Total Loans $ 162,099 7% $ 155,016 6% $ 173,611 7% $ 190,428 9% $ 166,925 9% 363,079 15% 437,700 18% 551,714 21% 481,849 22% 446,437 23% 805,542 33% 802,658 33% 849,875 32% 576,884 26% 456,102 24% 256,509 11% 263,529 11% 270,054 10% 249,764 11% 209,852 11% 762,895 31% 710,337 29% 718,723 27% 620,444 28% 523,008 28% 78,982 2,429,106 3% 100% 83,919 2,453,159 3% 100% 88,514 2,652,491 3% 100% 91,711 2,211,080 4% 100% 91,825 1,894,149 5% 100% 1,280 $2,430,386 973 $2,454,132 374 $2,652,865 235 $2,211,315 146 $1,894,295 ($ in thousands) Commercial, financial, and agricultural Real estate – construction, land development & other land loans Real estate – mortgage – residential (1-4 family) first mortgages Real estate – mortgage – home equity loans / lines of credit Real estate – mortgage – commercial and other Installment loans to individuals Loans, gross Unamortized net deferred loan costs Total loans Table 10a Loan Portfolio Composition – Covered versus Non-covered As of December 31, 2011 Covered Loans (Carrying Value) % of Covered Loans Amount Non-covered Loans % of Non- covered Loans Amount Total Loans % of Total Loans Amount Unpaid Principal Balance of Covered Loans Carrying Value of Covered Loans as a Percent of the Unpaid Balance Amount Percentage $ 9,472 3% $ 152,627 8% $ 162,099 7% $ 12,055 79% 72,096 20% 290,983 14% 363,079 15% 123,994 58% 158,926 44% 646,616 31% 805,542 33% 192,075 83% 23,338 6% 233,171 11% 256,509 11% 29,826 96,013 27% 666,882 32% 762,895 31% 130,436 1,389 361,234 – $ 361,234 0% 100% 77,593 2,067,872 4% 100% 78,982 2,429,106 3% 100% 1,589 $ 489,975 1,280 $ 2,069,152 1,280 $2,430,386 78% 74% 87% 74% ($ in thousands) Commercial, financial, and agricultural Real estate – construction, land development & other land loans Real estate – mortgage – residential (1-4 family) first mortgages Real estate – mortgage – home equity loans / lines of credit Real estate – mortgage – commercial and other Installment loans to individuals Loans, gross Unamortized net deferred loan costs Total loans See Note 4 to the Consolidated Financial Statements for tables showing breakout of covered loans versus non-covered loans at December 31, 2010. 71 Table 11 Loan Maturities ($ in thousands) Variable Rate Loans: Commercial, financial, and agricultural Real estate – construction only Real estate – all other mortgage Installment loans to individuals Total at variable rates Fixed Rate Loans: Commercial, financial, and agricultural Real estate – construction only Real estate – all other mortgage Installment loans to individuals Total at fixed rates Subtotal Nonaccrual loans Total loans As of December 31, 2011 Due within one year Due after one year but within five years Due after five years Total Amount Yield Amount Yield Amount Yield Amount Yield $ 56,973 49,298 150,100 358 256,729 23,830 3,728 233,842 9,184 270,584 527,313 115,038 $ 642,351 5.28% 5.40% 5.29% 5.55% 5.31% 5.85% 5.56% 6.48% 6.92% 6.43% 5.88% $ 28,408 1,698 340,476 9,862 380,444 44,577 2,358 565,095 32,432 644,462 1,024,906 (cid:326) $1,024,906 5.41% 5.10% 5.23% 8.93% 5.34% 6.50% 5.59% 6.12% 9.25% 6.30% 5.94% $ 924 2,449 427,964 5.28% 4.74% 4.50% $ 86,305 53,445 918,540 14,690 446,027 4.88% 4.52% 24,910 1,083,200 9,666 835 303,900 2,701 317,102 763,129 (cid:326) $ 763,129 4.63% 5.72% 5.38% 5.79% 5.36% 4.87% 78,073 6,921 1,102,837 44,317 1,232,148 2,315,348 115,038 $2,430,386 5.32% 5.36% 4.90% 6.49% 4.99% 6.07% 5.59% 6.00% 8.55% 6.09% 5.58% The above table is based on contractual scheduled maturities. Early repayment of loans or renewals at maturity are not considered in this table. 72 Table 12 Nonperforming Assets ($ in thousands) Non-covered nonperforming assets Nonaccrual loans Restructured loans - accruing Accruing loans >90 days past due Total non-covered nonperforming loans Other real estate Total non-covered nonperforming assets Covered nonperforming assets (1) Nonaccrual loans (2) Restructured loans - accruing Accruing loans >90 days past due Total covered nonperforming loans Other real estate Total covered nonperforming assets 2011 2010 As of December 31, 2009 2008 2007 $ 73,566 11,720 (cid:16) 85,286 37,023 $ 122,309 62,326 33,677 (cid:16) 96,003 21,081 117,084 62,206 21,283 (cid:16) 83,489 8,793 92,282 26,600 3,995 (cid:16) 30,595 4,832 35,427 7,807 6 (cid:16) 7,813 3,042 10,855 $ 41,472 14,218 (cid:16) 55,690 85,272 $ 140,962 58,466 14,359 (cid:16) 72,825 94,891 167,716 117,916 (cid:16) (cid:16) 117,916 47,430 165,346 (cid:16) (cid:16) (cid:16) (cid:1086) (cid:16) (cid:1086) (cid:16) (cid:16) (cid:16) (cid:1086) (cid:16) (cid:1086) Total nonperforming assets $ 263,271 284,800 257,628 35,427 10,855 Asset Quality Ratios – All Assets Nonperforming loans to total loans Nonperforming assets to total loans and other real estate Nonperforming assets to total assets Asset Quality Ratios – Based on Non-covered Assets only Non-covered nonperforming loans to non-covered loans Non-covered nonperforming assets to non-covered loans 5.80% 10.31% 8.00% 6.88% 11.08% 8.69% 7.59% 9.51% 7.27% 1.38% 1.60% 1.29% 0.41% 0.57% 0.47% 4.12% 4.61% 3.91% 1.38% 0.41% and non-covered other real estate 5.81% 5.56% 4.31% 1.60% 0.57% Non-covered nonperforming assets to total non-covered assets 4.30% 4.16% 3.10% 1.29% 0.47% (1) Covered nonperforming assets consist of assets that are included in loss-share agreements with the FDIC. (2) At December 31, 2011, 2010 and 2009, the contractual balance of the nonaccrual loans covered by the FDIC loss share agreement was $69.0 million, $86.2 million and $192.1 million, respectively. 73 Table 12a Nonperforming Assets by Geographical Region ($ in thousands) Nonaccrual loans and Troubled Debt Restructurings (1) Eastern Region (NC) Triangle Region (NC) Triad Region (NC) Charlotte Region (NC) Southern Piedmont Region (NC) Western Region (NC) South Carolina Region Virginia Region Other Total nonaccrual loans and troubled debt restructurings Other Real Estate (1) Eastern Region (NC) Triangle Region (NC) Triad Region (NC) Charlotte Region (NC) Southern Piedmont Region (NC) Western Region (NC) South Carolina Region Virginia Region Other Total other real estate As of December 31, 2011 Covered Non-covered Total Total Loans Nonperforming Loans to Total Loans $ 46,179 – – – 180 9,188 143 – – 20,111 23,546 16,854 1,795 3,436 1 13,164 4,950 1,429 66,290 23,546 16,854 1,795 3,616 9,189 13,307 4,950 1,429 $ 535,000 764,000 381,000 97,000 220,000 73,000 148,000 201,000 11,000 $ 55,690 85,286 140,976 $ 2,430,000 12.4% 3.1% 4.4% 1.9% 1.6% 12.6% 9.0% 2.5% 13.0% 5.8% $ 73,110 – – – – 11,810 352 – – $ 85,272 12,102 9,286 7,580 4,585 1,130 – 2,110 230 – 37,023 85,212 9,286 7,580 4,585 1,130 11,810 2,462 230 – 122,295 (1) The counties comprising each region are as follows: Eastern North Carolina Region - New Hanover, Brunswick, Duplin, Dare, Beaufort, Onslow, Carteret Triangle North Carolina Region - Moore, Lee, Harnett, Chatham, Wake Triad North Carolina Region - Montgomery, Randolph, Davidson, Rockingham, Guilford, Stanly Charlotte North Carolina Region - Iredell, Cabarrus, Rowan Southern Piedmont North Carolina Region - Anson, Richmond, Scotland, Robeson, Bladen, Columbus Western North Carolina Region - Buncombe South Carolina Region - Chesterfield, Dillon, Florence, Horry Virginia Region - Wythe, Washington, Montgomery, Pulaski 74 Table 13 Allocation of the Allowance for Loan Losses ($ in thousands) Commercial, financial, and agricultural Real estate – construction, land development Real estate – residential, commercial, home equity, multifamily Installment loans to individuals Total allocated Unallocated Total 2011 2010 As of December 31, 2009 2008 2007 $ 4,443 14,268 5,154 20,065 4,995 9,286 4,913 1,977 3,516 1,827 20,818 1,873 41,402 16 $ 41,418 22,077 1,960 49,256 174 49,430 20,845 1,606 36,732 611 37,343 19,543 2,815 29,248 8 29,256 13,477 2,486 21,306 18 21,324 Table 13a Allocation of the Allowance for Loan Losses – Covered versus Non-covered ($ in thousands) Commercial, financial, and agricultural Real estate – construction, land development Real estate – residential, commercial, home equity, multifamily Installment loans to individuals Total allocated Unallocated Total As of December 31, 2011 Non-covered Total Covered As of December 31, 2010 Covered Non-covered Total $ 663 3,780 4,443 423 4,731 5,154 2,962 11,306 14,268 7,545 12,520 20,065 2,182 1 5,808 (cid:1086) $ 5,808 18,636 1,872 35,594 16 35,610 20,818 1,873 41,402 16 41,418 3,187 (cid:1086) 11,155 (cid:1086) 11,155 18,890 1,960 38,101 174 38,275 22,077 1,960 49,256 174 49,430 75 Table 14 Loan Loss and Recovery Experience ($ in thousands) 2011 2010 As of December 31, 2009 2008 2007 Loans outstanding at end of year $ 2,430,386 2,454,132 2,652,865 2,211,315 1,894,295 Average amount of loans outstanding $ 2,461,995 2,554,401 2,475,045 2,117,028 1,808,219 Allowance for loan losses, at beginning of year Provision for loan losses Additions related to loans assumed in corporate acquisitions Loans charged off: Commercial, financial, and agricultural Real estate – construction, land development & other land loans Real estate – mortgage – residential (1-4 family) first mortgages Real estate – mortgage – home equity loans / lines of credit Real estate – mortgage – commercial and other Installment loans to individuals Total charge-offs Recoveries of loans previously charged-off: Commercial, financial, and agricultural Real estate – construction, land development & other land loans Real estate – mortgage – residential (1-4 family) first mortgages Real estate – mortgage – home equity loans / lines of credit Real estate – mortgage – commercial and other Installment loans to individuals Total recoveries Net charge-offs Allowance for loan losses, at end of year Ratios: Net charge-offs as a percent of average loans Allowance for loan losses as a percent of loans at end of year Allowance for loan losses as a multiple of net charge-offs Provision for loan losses as a percent of net charge-offs Recoveries of loans previously charged-off as a $ 49,430 41,301 37,343 54,562 29,256 20,186 21,324 9,880 18,947 5,217 — 90,731 — 91,905 (2,358) (4,481) (25,604) (22,665) (12,045) (6,032) (3,195) (7,180) (1,600) (51,982) (4,973) (2,916) (2,499) (43,566) 314 919 492 61 113 357 — 49,442 (2,143) (1,716) (4,617) (1,824) (516) (1,973) (12,789) 18 9 184 3,158 34,362 (992) (309) (1,333) (613) (677) (1,714) (5,638) 31 – 86 — 24,164 (982) (180) (305) – (497) (1,213) (3,177) 49 – – 375 119 450 2,669 (49,313) $ 41,418 131 33 396 1,091 (42,475) 49,430 66 129 284 690 (12,099) 37,343 42 136 237 532 (5,106) 29,256 43 23 222 337 (2,840) 21,324 2.00% 1.70% 0.84x 1.66% 2.01% 1.16x 0.49% 1.41% 3.09x 0.24% 1.32% 5.73x 0.16% 1.13% 7.51x 83.75% 128.46% 166.84% 193.50% 183.70% percent of loans charged-off 5.13% 2.50% 5.40% 9.44% 10.61% 76 Table 14a - Loan Loss and Recovery Experience – Covered versus Non-covered ($ in thousands) As of December 31, 2011 Non-covered Covered Total As of December 31, 2010 Non-covered Covered Total Loans outstanding at end of year $ 361,234 2,069,152 2,430,386 371,128 2,083,004 2,454,132 Average amount of loans outstanding $ 410,318 2,051,677 2,461,995 449,724 2,104,677 2,554,401 Allowance for loan losses, at beginning of year Provision for loan losses Loans charged off: Commercial, financial, and agricultural Real estate – construction, land development & other land loans Real estate – mortgage – residential (1-4 family) first mortgages Real estate – mortgage – home equity loans / lines of credit Real estate – mortgage – commercial and other Installment loans to individuals Total charge-offs Recoveries of loans previously charged-off: Commercial, financial, and agricultural Real estate – construction, land development & other land loans Real estate – mortgage – residential (1-4 family) first mortgages Real estate – mortgage – home equity loans / lines of credit Real estate – mortgage – commercial and other Installment loans to individuals Total recoveries Net charge-offs Allowance for loan losses, at end of year Ratios: Net charge-offs as a percent of average loans Allowance for loan losses as a percent of loans at end of year Allowance for loan losses as a multiple of net charge-offs Provision for loan losses as a percent of net charge-offs Recoveries of loans previously charged-off as a percent of loans charged-off $ 11,155 38,275 49,430 (cid:1086) 37,343 37,343 12,776 23,931 28,525 66,800 41,301 90,731 20,916 20,916 33,646 70,989 54,562 91,905 (293) (2,065) (2,358) (cid:1086) (4,481) (4,481) (10,127) (15,477) (25,604) (7,208) (15,457) (22,665) (4,744) (7,301) (12,045) (1,482) (4,550) (6,032) (925) (2,270) (3,195) (332) (4,641) (4,973) (1,908) (126) (18,123) (5,272) (1,474) (33,859) (7,180) (1,600) (51,982) (739) (cid:1086) (9,761) (2,177) (2,499) (33,805) (2,916) (2,499) (43,566) (cid:237) (cid:237) (cid:237) (cid:237) (cid:237) (cid:1086) (cid:1086) (18,123) $ 5,808 314 919 492 375 314 919 492 375 119 450 2,669 (31,190) 35,610 119 450 2,669 (49,313) 41,418 (cid:237) (cid:237) (cid:237) (cid:237) (cid:237) (cid:1086) (cid:1086) (9,761) 11,155 61 113 357 131 61 113 357 131 33 396 1,091 (32,714) 38,275 33 396 1,091 (42,475) 49,430 4.42% 1.61% 0.32x 1.52% 2.00% 1.72% 1.70% 1.14x 0.84x 2.17% 3.01% 1.14x 1.55% 1.66% 1.84% 2.01% 1.17x 1.16x 70.50% 91.46% 83.75% 214.28% 102.85% 128.46% 0% 7.88% 5.13% 0% 3.23% 2.50% Note: There were no covered loan charge-offs or recoveries prior to 2010. 77 Table 15 Average Deposits ($ in thousands) NOW accounts Money market accounts Savings accounts Time deposits >$100,000 Other time deposits Total interest-bearing deposits Noninterest-bearing deposits Total deposits 2011 Year Ended December 31, 2010 2009 Average Amount Average Rate Average Amount Average Rate Average Amount Average Rate $ 355,979 508,209 152,256 771,165 641,078 2,428,687 329,335 $2,758,022 0.22% 0.53% 0.48% 1.31% 1.10% 0.88% (cid:16) 0.77% $ 349,501 508,250 156,483 786,257 717,416 2,517,907 289,254 $2,807,161 0.24% 0.84% 0.81% 1.57% 1.56% 1.19% (cid:16) 1.07% $ 244,863 429,068 137,142 745,159 736,358 2,292,590 257,119 $2,549,709 0.29% 1.52% 1.08% 2.54% 2.43% 1.99% (cid:16) 1.79% Table 16 Maturities of Time Deposits of $100,000 or More ($ in thousands) 3 Months or Less Over 3 to 6 Months As of December 31, 2011 Over 6 to 12 Months Over 12 Months Total Time deposits of $100,000 or more $ 160,668 120,391 214,133 258,041 753,233 78 Table 17 Interest Rate Sensitivity Analysis ($ in thousands) Earning assets: Loans (1) Securities available for sale Securities held to maturity Short-term investments Total earning assets Interest-bearing liabilities: NOW deposits Money market deposits Savings deposits Time deposits of $100,000 or more Other time deposits Securities sold under agreements to repurchase Borrowings Total interest-bearing liabilities Repricing schedule for interest-earning assets and interest-bearing liabilities held as of December 31, 2011 Total Within 12 Months Over 3 to 12 Months Over 12 Months 3 Months or Less Total $ 1,020,605 54,458 733 141,916 $ 1,217,712 $ 423,452 513,832 146,481 160,668 159,572 255,581 27,845 752 (cid:326) 284,178 10.10% 53.39% (cid:326) (cid:326) (cid:326) 334,524 351,679 1,276,186 82,303 1,485 141,916 1,501,890 1,154,200 100,323 56,503 (cid:326) 1,311,026 2,430,386 182,626 57,988 141,916 2,812,916 53.39% 53.39% 46.61% 100.00% 100.00% 100.00% 423,452 513,832 146,481 495,192 511,251 (cid:326) (cid:326) (cid:326) 258,041 70,955 423,452 513,832 146,481 753,233 582,206 17,105 133,925 2,570,234 17,105 46,394 $ 1,467,504 (cid:326) 30,031 716,234 17,105 76,425 2,183,738 (cid:326) 57,500 386,496 Percent of total earning assets Cumulative percent of total earning assets 43.29% 43.29% Percent of total interest-bearing liabilities Cumulative percent of total interest- bearing liabilities Interest sensitivity gap Cumulative interest sensitivity gap Cumulative interest sensitivity gap as a percent of total earning assets Cumulative ratio of interest-sensitive assets to interest-sensitive liabilities 57.10% 27.87% 84.96% 15.04% 100.00% 57.10% 84.96% 84.96% 100.00% 100.00% $ (249,792) (249,792) (432,056) (681,848) (681,848) (681,848) 924,530 242,682 242,682 242,682 (8.88%) (24.24%) (24.24%) 8.63% 8.63% 82.98% 68.78% 68.78% 109.44% 109.44% (1) The three months or less category for loans includes $813,955 in adjustable rate loans that have reached their contractual rate floors. 79 Table 18 Contractual Obligations and Other Commercial Commitments Contractual Obligations As of December 31, 2011 Securities sold under agreements to repurchase Borrowings Operating leases Total contractual cash obligations, excluding deposits Deposits Total contractual cash obligations, Payments Due by Period ($ in thousands) On Demand or Less than 1 Year 1-3 Years 4-5 Years After 5 Years 17,105 30,031 805 (cid:326) 57,500 1,452 (cid:326) (cid:326) 1,125 (cid:326) 46,394 2,143 Total $ 17,105 133,925 5,525 156,555 47,941 58,952 1,125 48,537 2,755,037 2,423,164 227,905 102,465 1,503 including deposits $ 2,911,592 2,471,105 286,857 103,590 50,040 Amount of Commitment Expiration Per Period ($ in thousands) Other Commercial Commitments As of December 31, 2011 Credit cards Lines of credit and loan commitments Standby letters of credit Total commercial commitments Total Amounts Committed $ 27,809 289,788 7,088 $ 324,685 Less than 1 Year 13,904 106,813 6,359 127,076 1-3 Years 4-5 Years 13,905 11,926 729 26,560 (cid:326) 11,491 (cid:326) 11,491 After 5 Years (cid:326) 159,558 (cid:326) 159,558 80 Table 19 Market Risk Sensitive Instruments Expected Maturities of Market Sensitive Instruments Held at December 31, 2011 Occurring in Indicated Year ($ in thousands) 2012 2013 2014 2015 2016 Beyond Total Average Interest Rate Estimated Fair Value Due from banks, interest-bearing Federal funds sold Presold mortgages in process of settlement Debt Securities - at amortized cost (1) (2) Loans – fixed (3) (4) Loans – adjustable (3) (4) Total NOW deposits Money market deposits Savings deposits Time deposits Securities sold under agreements to repurchase Borrowings – fixed (2) Borrowings – adjustable Total $ 135,218 608 6,090 (cid:16) (cid:16) (cid:16) (cid:16) (cid:16) (cid:16) (cid:16) (cid:16) (cid:16) (cid:16) (cid:16) (cid:16) (cid:16) (cid:16) (cid:16) 135,218 608 0.22% 0.22% $ 135,218 608 6,090 4.00% 6,090 50,438 22,188 24,236 271,241 250,627 165,442 263,637 111,407 92,113 67,607 37,121 24,130 90,459 137,311 317,066 82,687 105,008 428,350 $ 727,232 386,270 279,743 197,276 279,440 813,023 225,720 1,232,146 1,083,202 2,682,984 $ 423,452 513,832 146,481 (cid:16) (cid:16) (cid:16) 1,003,566 162,617 (cid:16) (cid:16) (cid:16) 65,288 (cid:16) (cid:16) (cid:16) 64,592 (cid:16) (cid:16) (cid:16) 37,873 (cid:16) (cid:16) (cid:16) 1,503 423,452 513,832 146,481 1,335,439 3.83% 6.09% 4.99% 5.15% 0.19% 0.42% 0.35% 1.06% 234,012 1,227,825 1,041,960 $2,645,713 $ 423,452 513,832 146,481 1,339,906 17,105 30,031 (cid:16) 35,000 – $2,134,467 185,117 100,288 (cid:16) 22,500 – (cid:1086) (cid:16) (cid:16) – 64,592 (cid:16) (cid:16) – 37,873 (cid:16) (cid:16) 46,394 47,897 17,105 87,531 46,394 2,570,234 0.32% 1.36% 2.47% 0.70% 17,105 88,048 18,285 $2,547,109 (1) Tax-exempt securities are reflected at a tax-equivalent basis using a 39% tax rate. (2) Securities and borrowings with call dates within 12 months of December 31, 2011 that have above market interest rates are assumed to mature at their call date for purposes of this table. Mortgage securities are assumed to mature in the period of their expected repayment based on estimated prepayment speeds. (3) Excludes nonaccrual loans. (4) Loans are shown in the period of their contractual maturity, except for home equity lines of credit loans which are assumed to repay on a straight-line basis over five years. Table 20 Return on Assets and Common Equity 2011 For the Year Ended December 31, 2010 2009 Return on assets Return on common equity Dividend payout ratio Average shareholders’ equity to average assets 0.23% 2.59% 72.73% 10.67% 0.18% 2.05% 91.43% 10.55% 1.82% 22.55% 9.47% 10.11% 81 Table 21 Risk-Based and Leverage Capital Ratios ($ in thousands) Risk-Based and Leverage Capital Tier I capital: Shareholders’ equity Trust preferred securities eligible for Tier I capital treatment Intangible assets Accumulated other comprehensive income adjustments Total Tier I leverage capital Tier II capital: Allowable allowance for loan losses Tier II capital additions Total risk-based capital 2011 As of December 31, 2010 2009 $ 345,150 344,603 342,383 45,000 (69,732) 8,682 329,100 45,000 (70,358) 5,085 324,330 45,000 (70,948) 4,427 320,862 26,797 26,797 $ 355,897 26,767 26,767 351,097 28,996 28,996 349,858 Total risk weighted assets $ 2,129,116 2,118,661 2,314,393 Adjusted fourth quarter average assets 3,222,762 3,155,297 3,449,684 Risk-based capital ratios: Tier I capital to Tier I risk adjusted assets Minimum required Tier I capital Total risk-based capital to Tier II risk-adjusted assets Minimum required total risk-based capital Leverage capital ratios: Tier I leverage capital to adjusted fourth quarter average assets Minimum required Tier I leverage capital 15.46% 4.00% 16.72% 8.00% 10.21% 4.00% 15.31% 4.00% 16.57% 8.00% 10.28% 4.00% 13.86% 4.00% 15.12% 8.00% 9.30% 4.00% 82 Table 22 Quarterly Financial Summary (Unaudited) 2011 2010 ($ in thousands except per share data) Income Statement Data Interest income, taxable equivalent Interest expense Net interest income, taxable equivalent Taxable equivalent, adjustment Net interest income Provision for loan losses Net interest income after provision for losses Noninterest income Noninterest expense Income (loss) before income taxes Income taxes (benefit) Net income (loss) Preferred stock dividends and accretion Net income (loss) available to common shareholders Per Common Share Data Earnings (loss) per common share - basic Earnings (loss) per common share - diluted Cash dividends declared Market Price High Low Close Stated book value - common Tangible book value - common Selected Average Balances Assets Loans Earning assets Deposits Interest-bearing liabilities Shareholders’ equity Ratios (annualized where applicable) Return on average assets Return on average common equity Equity to assets at end of period Tangible equity to tangible assets at end of period Tangible common equity to tangible assets at end of period Average loans to average deposits Average earning assets to interest- bearing liabilities Net interest margin Allowance for loan losses to gross loans Nonperforming loans as a percent of Fourth Quarter Third Quarter Second Quarter First Quarter Fourth Quarter Third Quarter Second Quarter First Quarter $ 37,576 5,262 32,314 394 31,920 9,878 22,042 3,423 24,192 1,273 289 984 39,617 5,739 33,878 389 33,489 9,146 24,343 3,486 23,958 3,871 1,314 2,557 40,917 6,049 34,868 388 34,480 10,934 23,546 5,114 22,913 5,747 2,021 3,726 39,214 6,515 40,785 6,854 32,699 385 32,314 11,343 20,971 14,193 25,043 10,121 3,746 6,375 33,931 361 33,570 30,545 3,025 14,918 22,008 (4,065) (1,820) (2,245) 39,140 7,739 31,401 330 31,071 8,391 22,680 3,957 20,711 5,926 2,078 3,848 40,049 8,182 31,867 331 31,536 8,003 23,533 4,537 21,957 6,113 2,172 3,941 40,604 9,132 31,472 295 31,177 7,623 23,554 5,694 22,280 6,968 2,530 4,438 (794) (3,289) (1,041) (1,042) (1,027) (1,027) (1,026) (1,027) 190 (732) 2,685 5,333 (3,272) 2,821 2,915 3,411 $ 0.01 (0.04) 0.01 0.08 13.78 9.36 11.15 16.66 12.53 (0.04) 0.08 11.87 8.05 10.04 17.08 12.93 0.16 0.16 0.08 14.08 9.82 10.24 17.04 12.88 0.32 (0.19) 0.32 0.08 16.89 12.36 13.26 16.90 12.72 (0.19) 0.08 15.83 12.73 15.31 16.64 12.45 0.17 0.17 0.08 16.90 12.00 13.62 17.04 12.83 0.17 0.17 0.08 16.80 13.27 14.49 16.92 12.70 0.20 0.20 0.08 16.00 12.97 13.52 16.76 12.52 $3,292,494 2,432,568 2,816,689 2,730,422 2,577,329 354,206 3,293,758 2,441,486 2,808,205 2,724,418 2,592,873 355,575 3,327,238 2,471,915 2,842,817 2,785,998 2,617,122 352,619 3,346,690 2,502,011 2,872,041 2,791,250 2,638,476 351,952 3,225,655 2,484,684 2,811,988 2,722,162 2,543,070 354,715 3,272,161 3,316,971 2,529,356 2,575,926 2,894,660 2,939,478 2,777,358 2,818,581 2,613,762 2,664,399 349,330 353,061 3,440,537 2,627,638 3,065,134 2,910,543 2,799,549 346,526 0.02% 0.26% 10.49% (0.09%) (1.00%) 10.65% 0.32% 3.74% 10.57% 0.65% 7.54% 10.27% (0.40%) (4.48%) 10.51% 0.34% 3.89% 10.44% 0.35% 4.11% 10.51% 0.40% 4.91% 10.19% 8.55% 8.72% 8.64% 8.37% 8.54% 8.52% 8.56% 8.27% 6.58% 89.09% 6.75% 89.61% 6.65% 88.73% 6.42% 89.64% 6.52% 91.28% 6.55% 91.07% 6.56% 91.39% 6.31% 90.28% 109.29% 4.55% 1.70% 108.30% 4.79% 1.55% 108.62% 4.92% 1.64% 108.85% 4.62% 1.72% 110.57% 4.79% 2.01% 110.75% 4.30% 1.79% 110.32% 4.35% 1.65% 109.49% 4.16% 1.52% total loans 5.80% 5.74% 6.14% 6.52% 6.88% 7.17% 7.86% 7.94% Nonperforming loans as a percent of total loans – non-covered Nonperforming assets as a percent of total assets Nonperforming assets as a percent of total assets – non-covered Net charge-offs as a percent of average total loans Net charge-offs as a percent of average total loans – non-covered 4.12% 4.19% 4.33% 4.35% 4.61% 4.81% 4.46% 4.28% 8.00% 8.39% 8.54% 8.38% 8.69% 8.90% 8.90% 8.43% 4.30% 4.21% 4.25% 4.05% 4.16% 4.16% 3.89% 3.58% 1.00% 1.87% 2.22% 2.92% 4.17% 0.88% 0.85% 0.81% 1.09% 1.26% 1.74% 1.97% 3.10% 1.06% 1.04% 1.01% 83 Item 8. Financial Statements and Supplementary Data First Bancorp and Subsidiaries Consolidated Balance Sheets December 31, 2011 and 2010 ($ in thousands) Assets Cash and due from banks, noninterest-bearing Due from banks, interest-bearing Federal funds sold Total cash and cash equivalents Securities available for sale Securities held to maturity (fair values of $62,754 in 2011 and $53,312 in 2010) Presold mortgages in process of settlement Loans – non-covered Loans – covered by FDIC loss share agreement Total loans Allowance for loan losses – non-covered Allowance for loan losses – covered Total allowance for loan losses Net loans Premises and equipment Accrued interest receivable FDIC indemnification asset Goodwill Other intangible assets Other real estate owned – non-covered Other real estate owned – covered Other assets Total assets Liabilities Deposits: Demand – noninterest-bearing NOW accounts Money market accounts Savings accounts Time deposits of $100,000 or more Other time deposits Total deposits Securities sold under agreements to repurchase Borrowings Accrued interest payable Other liabilities Total liabilities Commitments and contingencies (see Note 13) 2011 2010 $ 80,341 135,218 608 216,167 56,821 154,320 861 212,002 182,626 57,988 6,090 2,069,152 361,234 2,430,386 (35,610) (5,808) (41,418) 2,388,968 69,975 11,779 121,677 65,835 3,897 37,023 85,272 43,177 $ 3,290,474 $ 335,833 423,452 513,832 146,481 753,233 582,206 2,755,037 17,105 133,925 1,872 37,385 2,945,324 181,182 54,018 3,962 2,083,004 371,128 2,454,132 (38,275) (11,155) (49,430) 2,404,702 67,741 13,579 123,719 65,835 4,523 21,081 94,891 31,697 3,278,932 292,759 292,623 500,360 153,325 762,990 650,456 2,652,513 54,460 196,870 2,082 28,404 2,934,329 Shareholders’ Equity Preferred stock, no par value per share. Authorized: 5,000,000 shares Issued & outstanding: 63,500 in 2011 and 65,000 in 2010 Discount on preferred stock Common stock, no par value per share. Authorized: 40,000,000 shares Issued & outstanding: 16,909,820 shares in 2011 and 16,801,426 shares in 2010 Retained earnings Accumulated other comprehensive income (loss) Total shareholders’ equity Total liabilities and shareholders’ equity See accompanying notes to consolidated financial statements. 63,500 (cid:1086) 104,841 185,491 (8,682) 345,150 $ 3,290,474 65,000 (2,932) 104,207 183,413 (5,085) 344,603 3,278,932 84 First Bancorp and Subsidiaries Consolidated Statements of Income Years Ended December 31, 2011, 2010 and 2009 ($ in thousands, except per share data) Interest Income Interest and fees on loans Interest on investment securities: Taxable interest income Tax-exempt interest income Other, principally overnight investments Total interest income Interest Expense Savings, NOW and money market Time deposits of $100,000 or more Other time deposits Securities sold under agreements to repurchase Borrowings Total interest expense Net interest income Provision for loan losses – non-covered Provision for loan losses – covered Total provision for loan losses Net interest income after provision for loan losses Noninterest Income Service charges on deposit accounts Other service charges, commissions and fees Fees from presold mortgage loans Commissions from sales of insurance and financial products Gain from acquisition Foreclosed property losses and write-downs – covered Foreclosed property losses and write-downs – non-covered FDIC indemnification asset income, net Securities gains (losses) Other gains (losses) Total noninterest income Noninterest Expenses Salaries Employee benefits Total personnel expense Occupancy expense Equipment related expenses Intangibles amortization Acquisition expenses Other operating expenses Total noninterest expenses Income before income taxes Income taxes Net income Preferred stock dividends Accretion of preferred stock discount Net income available to common shareholders Earnings per common share: Basic Diluted Dividends declared per common share Weighted average common shares outstanding: Basic Diluted See accompanying notes to consolidated financial statements. 85 2011 2010 2009 $ 147,652 151,292 148,007 5,680 2,000 436 155,768 4,212 10,103 7,036 184 2,030 23,565 132,203 28,525 12,776 41,301 90,902 11,981 8,067 1,609 1,512 10,196 (24,492) (3,355) 20,481 74 143 26,216 39,822 11,616 51,438 6,574 4,326 902 636 32,230 96,106 21,012 7,370 5,750 1,633 586 159,261 6,363 12,374 11,193 298 1,679 31,907 127,354 33,646 20,916 54,562 72,792 12,335 6,507 1,813 1,476 (cid:326) (34,527) (984) 41,808 26 652 29,106 35,076 10,214 45,290 6,799 4,327 874 (cid:326) 29,666 86,956 14,942 4,960 6,580 859 545 155,991 8,744 18,908 17,866 736 2,641 48,895 107,096 20,186 (cid:326) 20,186 86,910 13,112 5,729 1,505 1,524 67,894 (cid:326) (cid:326) (cid:326) (104) (142) 89,518 30,745 10,843 41,588 6,071 4,334 630 1,343 24,585 78,551 97,877 37,618 13,642 9,982 60,259 (3,234) (2,932) (3,250) (857) (3,169) (803) $ 7,476 5,875 56,287 $ 0.44 0.44 $ 0.32 0.35 0.35 0.32 3.38 3.37 0.32 16,856,072 16,883,244 16,764,879 16,793,650 16,648,822 16,686,880 First Bancorp and Subsidiaries Consolidated Statements of Comprehensive Income Years Ended December 31, 2011, 2010 and 2009 ($ in thousands) 2011 2010 2009 Net income Other comprehensive income (loss): Unrealized gains/losses on securities available for sale: Unrealized holding gains arising during the period, pretax Tax expense Reclassification to realized (gains) losses Tax expense (benefit) Postretirement Plans: Net gain (loss) arising during period Tax (expense) benefit Amortization of unrecognized net actuarial loss Tax expense Amortization of prior service cost and transition obligation Tax expense Other comprehensive income (loss) $ 13,642 9,982 60,259 1,492 (583) (74) 29 (7,798) 3,080 393 (155) 32 (13) (3,597) 672 (261) (26) 10 (2,307) 911 531 (210) 35 (13) (658) 1,455 (567) 104 (41) 3,623 (1,397) 869 (339) 36 (14) 3,729 Comprehensive income $ 10,045 9,324 63,988 See accompanying notes to consolidated financial statements. 86 First Bancorp and Subsidiaries Consolidated Statements of Shareholders’ Equity Years Ended December 31, 2011, 2010 and 2009 (In thousands) Preferred Stock Preferred Stock Discount Common Stock Shares Amount Retained Earnings Accumulated Other Comprehensive Income (Loss) Total Share- holders’ Equity Balances, January 1, 2009 $ — — 16,574 $ 96,072 131,952 (8,156) 219,868 Net income Preferred stock issued Common stock warrants issued Common stock issued under stock option plans Common stock issued into dividend reinvestment plan Cash dividends declared ($0.32 per share) Preferred dividends accrued Accretion of preferred stock discount Tax benefit realized from exercise of nonqualified stock options Stock-based compensation Other comprehensive income 65,000 (4,592) 4,592 393 1,112 42 77 803 — 29 73 449 60,259 (5,331) (3,169) (803) 3,729 60,259 60,408 4,592 393 1,112 (5,331) (3,169) –– 73 449 3,729 Balances, December 31, 2009 65,000 (3,789) 16,722 102,691 182,908 (4,427) 342,383 Net income Common stock issued under stock option plans Common stock issued into dividend reinvestment plan Cash dividends declared ($0.32 per share) Preferred dividends accrued Accretion of preferred stock discount Tax benefit realized from exercise of nonqualified stock options Stock-based compensation Other comprehensive (loss) 9,982 (5,370) (3,250) (857) 17 46 171 669 857 — 16 36 640 9,982 171 669 (5,370) (3,250) –– 36 640 (658) (658) Balances, December 31, 2010 65,000 (2,932) 16,801 104,207 183,413 (5,085) 344,603 (65,000) 63,500 Net income Preferred stock redeemed Preferred stock issued Common stock issued under stock option plans Common stock issued into dividend reinvestment plan Repurchases of common stock Repurchase of outstanding common stock warrants Cash dividends declared ($0.32 per share) Preferred dividends Accretion of preferred stock discount Stock-based compensation Other comprehensive (loss) 13,642 (5,398) (3,234) (2,932) 2 71 (20) 30 851 (228) (924) 2,932 56 905 (3,597) 13,642 (65,000) 63,500 30 851 (228) (924) (5,398) (3,234) –– 905 (3,597) Balances, December 31, 2011 $ 63,500 (cid:1086) 16,910 $ 104,841 185,491 (8,682) 345,150 See accompanying notes to consolidated financial statements. 87 First Bancorp and Subsidiaries Consolidated Statements of Cash Flows Years Ended December 31, 2011, 2010 and 2009 ($ in thousands) Cash Flows From Operating Activities Net income Reconciliation of net income to net cash provided by operating activities: Provision for loan losses Net security premium amortization Purchase accounting accretion and amortization, net Gain from acquisition Foreclosed property losses and write-downs Loss (gain) on securities available for sale Other losses (gains) Increase in net deferred loan costs Depreciation of premises and equipment Stock-based compensation expense Amortization of intangible assets Originations of presold mortgages in process of settlement Proceeds from sales of presold mortgages in process of settlement Decrease in accrued interest receivable Decrease (increase) in other assets Decrease in accrued interest payable Increase (decrease) in other liabilities Net cash provided by operating activities Cash Flows From Investing Activities Purchases of securities available for sale Purchases of securities held to maturity Proceeds from sales of securities available for sale Proceeds from maturities/issuer calls of securities available for sale Proceeds from maturities/issuer calls of securities held to maturity Net decrease in loans Proceeds from FDIC loss share agreements Proceeds from sales of foreclosed real estate Purchases of premises and equipment Net cash received (paid) in acquisition Net cash provided by investing activities Cash Flows From Financing Activities Net increase (decrease) in deposits and repurchase agreements Proceeds from (repayments of) borrowings, net Cash dividends paid – common stock Cash dividends paid – preferred stock Proceeds from issuance of preferred stock Proceeds from issuance of common stock Redemption of preferred stock Repurchase of common stock Repurchase of common stock warrants Tax benefit from exercise of nonqualified stock options Net cash used by financing activities Increase (decrease) in Cash and Cash Equivalents Cash and Cash Equivalents, Beginning of Year 2011 2010 2009 $ 13,642 9,982 60,259 41,301 1,373 (11,628) (10,196) 27,847 (74) (143) (307) 4,388 905 902 (76,095) 73,967 1,800 (30,096) (210) (330) 37,046 (75,689) (4,332) 2,518 75,615 1,053 11,912 69,339 43,414 (6,606) 54,037 171,261 (127,253) (66,881) (5,390) (2,847) 63,500 881 (65,000) (228) (924) — (204,142) 4,165 212,002 54,562 1,491 (9,963) — 35,511 (26) (652) (599) 3,993 640 874 (88,665) 88,670 1,204 (32,538) (972) 597 64,109 (99,310) (22,431) — 97,202 2,687 40,306 46,721 24,875 (17,543) (171) 72,336 (287,982) 20,400 (5,359) (3,250) — 840 — — — 36 (275,315) (138,870) 350,872 20,186 1,279 (5,648) (67,894) — 104 142 (139) 3,624 449 630 (93,893) 93,598 1,096 2,306 (3,706) 2,640 15,033 (102,899) (20,300) 44 134,736 1,799 105,007 41,891 4,094 (5,299) 91,696 250,769 153,085 (349,465) (7,145) (2,763) 65,000 1,505 — — — 73 (139,710) 126,092 224,780 Cash and Cash Equivalents, End of Year $ 216,167 212,002 350,872 Supplemental Disclosures of Cash Flow Information: Cash paid during the period for: Interest Income taxes Non-cash investing and financing transactions: Foreclosed loans transferred to other real estate Unrealized gain on securities available for sale, net of taxes See accompanying notes to consolidated financial statements. 88 $ 23,775 14,893 32,879 16,309 52,601 16,474 76,242 864 123,962 395 43,860 951 First Bancorp and Subsidiaries Notes to Consolidated Financial Statements December 31, 2011 Note 1. Summary of Significant Accounting Policies (a) Basis of Presentation (cid:16) The consolidated financial statements include the accounts of First Bancorp (the Company) and its wholly owned subsidiary - First Bank (the Bank). The Bank has two wholly owned subsidiaries that are fully consolidated - First Bank Insurance Services, Inc. (First Bank Insurance) and First Troy SPE, LLC. All significant intercompany accounts and transactions have been eliminated. Subsequent events have been evaluated through the date of filing this Form 10-K. The Company is a bank holding company. The principal activity of the Company is the ownership and operation of the Bank, a state chartered bank with its main office in Troy, North Carolina. The Company is also the parent company for a series of statutory trusts that were formed at various times since 2002 for the purpose of issuing trust preferred debt securities. The trusts are not consolidated for financial reporting purposes; however, notes issued by the Company to the trusts in return for the proceeds from the issuance of the trust preferred securities are included in the consolidated financial statements and have terms that are substantially the same as the corresponding trust preferred securities. The trust preferred securities qualify as capital for regulatory capital adequacy requirements. First Bank Insurance is an agent for property and casualty insurance policies. First Troy SPE, LLC was formed in order to hold and dispose of certain real estate foreclosed upon by the Bank. The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The most significant estimates made by the Company in the preparation of its consolidated financial statements are the determination of the allowance for loan losses, the valuation of other real estate, the accounting and impairment testing related to intangible assets, and the fair value and discount accretion of loans acquired in FDIC-assisted transactions. (b) Cash and Cash Equivalents (cid:16) The Company considers all highly liquid assets such as cash on hand, noninterest-bearing and interest-bearing amounts due from banks and federal funds sold to be “cash equivalents.” (c) Securities (cid:16) Debt securities that the Company has the positive intent and ability to hold to maturity are classified as “held to maturity” and carried at amortized cost. Securities not classified as held to maturity are classified as “available for sale” and carried at fair value, with unrealized gains and losses being reported as other comprehensive income and reported as a separate component of shareholders’ equity. A decline in the market value of any available for sale or held to maturity security below cost that is deemed to be other than temporary results in a reduction in carrying amount to fair value. The impairment is charged to earnings and a new cost basis for the security is established. Any equity security that is in an unrealized loss position for twelve consecutive months is presumed to be other than temporarily impaired and an impairment charge is recorded unless the amount of the charge is insignificant. Gains and losses on sales of securities are recognized at the time of sale based upon the specific identification method. Premiums and discounts are amortized into income on a level yield basis, with premiums being amortized to the earliest call date and discounts being accreted to the stated maturity date. 89 (d) Premises and Equipment (cid:16) Premises and equipment are stated at cost less accumulated depreciation. Depreciation, computed by the straight-line method, is charged to operations over the estimated useful lives of the properties, which range from 2 to 40 years or, in the case of leasehold improvements, over the term of the lease, if shorter. Maintenance and repairs are charged to operations in the year incurred. Gains and losses on dispositions are included in current operations. (e) Loans – Loans are stated at the principal amount outstanding less any partial charge-offs plus deferred origination costs, net of nonrefundable loan fees. Interest on loans is accrued on the unpaid principal balance outstanding. Net deferred loan origination costs/fees are capitalized and recognized as a yield adjustment over the life of the related loan. The Company does not hold any interest-only strips, loans, other receivables, or retained interests in securitizations that can be contractually prepaid or otherwise settled in a way that it would not recover substantially all of its recorded investment. Purchased loans acquired in a business combination, which include loans that were purchased in the 2009 Cooperative Bank acquisition and the 2011 Bank of Asheville acquisition, are recorded at estimated fair value on their purchase date. The purchaser cannot carry over any related allowance for loan losses. The Company follows specific accounting guidance related to purchased impaired loans when purchased loans have evidence of credit deterioration since origination and it is probable at the date of acquisition that the Company will not collect all contractually required principal and interest payments. Evidence of credit quality deterioration as of the purchase date may include statistics such as past due and nonaccrual status. The accounting guidance permits the use of the cost recovery method of income recognition for those purchased impaired loans for which the timing and amount of cash flows expected to be collected cannot be reasonably estimated. Under the cost recovery method of income recognition, all cash receipts are initially applied to principal, with interest income being recorded only after the carrying value of the loan has been reduced to zero. Substantially all of the Company’s purchased impaired loans to date have had uncertain cash flows and thus are accounted for under the cost recovery method of income recognition. For nonimpaired purchased loans, the Company accretes any fair value discount over the life of the loan in a manner consistent with the guidance for accounting for loan origination fees and costs. A loan is placed on nonaccrual status when, in management’s judgment, the collection of interest appears doubtful. The accrual of interest is discontinued on all loans that become 90 days or more past due with respect to principal or interest. The past due status of loans is based on the contractual payment terms. While a loan is on nonaccrual status, the Company’s policy is that all cash receipts are applied to principal. Once the recorded principal balance has been reduced to zero, future cash receipts are applied to recoveries of any amounts previously charged off. Further cash receipts are recorded as interest income to the extent that any interest has been foregone. Loans are removed from nonaccrual status when they become current as to both principal and interest and when concern no longer exists as to the collectability of principal or interest. In some cases, where borrowers are experiencing financial difficulties, loans may be restructured to provide terms significantly different from the originally contracted terms. The nonaccrual policy discussed above applies to all loan classifications. A loan is considered to be impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans are measured using either 1) an estimate of the cash flows that the Company expects to receive from the borrower discounted at the loan’s effective rate, or 2) in the case of a collateral-dependent loan, the fair value of the collateral. Unless restructured, while a loan is considered to be impaired, the Company’s policy is that 90 interest accrual is discontinued and all cash receipts are applied to principal. Once the recorded principal balance has been reduced to zero, future cash receipts are applied to recoveries of any amounts previously charged off. Further cash receipts are recorded as interest income to the extent that any interest has been foregone. Impaired loans that are restructured are returned to accruing status in accordance with the restructured terms if the Company believes that the borrower will be able to meet the obligations of the restructured loan terms. The impairment policy discussed above applies to all loan classifications. (f) Presold Mortgages in Process of Settlement and Loans Held for Sale (cid:16) As a part of normal business operations, the Company originates residential mortgage loans that have been pre-approved by secondary investors to be sold on a best efforts basis. The terms of the loans are set by the secondary investors, and the purchase price that the investor will pay for the loan is agreed to prior to the funding of the loan by the Company. Generally within three weeks after funding, the loans are transferred to the investor in accordance with the agreed-upon terms. The Company records gains from the sale of these loans on the settlement date of the sale equal to the difference between the proceeds received and the carrying amount of the loan. The gain generally represents the portion of the proceeds attributed to service release premiums received from the investors and the realization of origination fees received from borrowers that were deferred as part of the carrying amount of the loan. Between the initial funding of the loans by the Company and the subsequent reimbursement by the investors, the Company carries the loans on its balance sheet at the lower of cost or market. Periodically, the Company originates commercial loans that are intended for resale. The Company carries these loans at the lower of cost or fair value at each reporting date. There were no such loans held for sale as of December 31, 2011 or 2010. (g) Allowance for Loan Losses (cid:16) The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged-off against the allowance for loan losses when management believes that the collectability of the principal is unlikely. The provision for loan losses charged to operations is an amount sufficient to bring the allowance for loan losses to an estimated balance considered adequate to absorb losses inherent in the portfolio. Management’s determination of the adequacy of the allowance is based on several factors, including: 1. Risk grades assigned to the loans in the portfolio, 2. Specific reserves for larger loans with concerns regarding repayment ability, 3. Current economic conditions, including the local, state, and national economic outlook; interest rate risk; trends in loan volume, mix and size of loans; seasoning of the loan portfolio; levels and trends of delinquencies, 4. Historical loan loss experience with the more recent periods carrying a higher weight, and 5. An assessment of the risk characteristics of the Company’s loan portfolio, including industry concentrations, payment structures, and credit administration practices. While management uses the best information available to make evaluations, future adjustments may be necessary if economic and other conditions differ substantially from the assumptions used. For loans covered under loss share agreements, subsequent decreases to the expected cash flows will generally result in additional provisions for loan losses. Subsequent increases in expected cash flows will result in a reversal of the allowance for loan losses to the extent of prior allowance recognition. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based on the examiners’ judgment about information available to them at the time of their examinations. 91 (h) Other Real Estate (cid:16) Other real estate owned consists primarily of real estate acquired by the Company through legal foreclosure or deed in lieu of foreclosure. The property is initially carried at the lower of cost (generally the loan balance plus additional costs incurred for improvements to the property) or the estimated fair value of the property less estimated selling costs. If there are subsequent declines in fair value, which is reviewed routinely by management, the property is written down to its fair value through a charge to expense. Capital expenditures made to improve the property are capitalized. Costs of holding real estate, such as property taxes, insurance and maintenance, less related revenues during the holding period, are recorded as expense. (i) FDIC Indemnification Asset – The FDIC indemnification asset relates to loss share agreements with the FDIC, whereby the FDIC has agreed to reimburse to the Company a percentage of the losses related to loans and other real estate that the Company assumed in the acquisition of two failed banks. This indemnification asset is measured separately from the loan portfolio and other real estate because it is not contractually embedded in the loans and is not transferable with the loans should the Company choose to dispose of them. The carrying value of this receivable at each period end is the sum of: 1) actual claims that have been submitted to the FDIC for reimbursement that have not yet been received and 2) the Company’s estimated amount of loan and other real estate losses covered by the agreements multiplied by the FDIC reimbursement percentage. At December 31, 2011 and 2010, the amount of actual claims that had been submitted to the FDIC for reimbursement but had not yet been received was $13.4 million and $30.2 million, respectively. (j) Income Taxes (cid:16) Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred tax assets are reduced, if necessary, by the amount of such benefits that are not expected to be realized based upon available evidence. The Company’s investment tax credits, which are low income housing tax credits and state historic tax credits, are recorded in the period that they are reflected in the Company’s tax returns. (k) Intangible Assets (cid:16) Business combinations are accounted for using the purchase method of accounting. Identifiable intangible assets are recognized separately and are amortized over their estimated useful lives, which for the Company has generally been seven to ten years and at an accelerated rate. Goodwill is recognized in business combinations to the extent that the price paid exceeds the fair value of the net assets acquired, including any identifiable intangible assets. Goodwill is not amortized, but as discussed in Note 1(p), is subject to fair value impairment tests on at least an annual basis. (l) Other Investments – The Company accounts for investments in limited partnerships, limited liability companies (“LLCs”), and other privately held companies using either the cost or the equity method of accounting. The accounting treatment depends upon the Company’s percentage ownership and degree of management influence. Under the cost method of accounting, the Company records an investment in stock at cost and generally recognizes cash dividends received as income. If cash dividends received exceed the investee’s earnings since the investment date, these payments are considered a return of investment and reduce the cost of the investment. Under the equity method of accounting, the Company records its initial investment at cost. Subsequently, the carrying amount of the investment is increased or decreased to reflect the Company’s share of income or loss of the investee. The Company’s recognition of earnings or losses from an equity method investment is based on 92 the Company’s ownership percentage in the investee and the investee’s earnings on a quarterly basis. The investees generally provide their financial information during the quarter following the end of a given period. The Company’s policy is to record its share of earnings or losses on equity method investments in the quarter the financial information is received. All of the Company’s investments in limited partnerships, LLCs, and other companies are privately held, and their market values are not readily available. The Company’s management evaluates its investments in investees for impairment based on the investee’s ability to generate cash through its operations or obtain alternative financing, and other subjective factors. There are inherent risks associated with the Company’s investments in such companies, which may result in income statement volatility in future periods. At December 31, 2011 and 2010, the Company’s investments in limited partnerships, LLCs and other privately held companies totaled $2.6 million and $2.3 million, respectively, and were included in other assets. (m) Stock Option Plan (cid:16) At December 31, 2011, the Company had four equity-based employee compensation plans, which are described more fully in Note 15. The Company accounts for these plans under the recognition and measurement principles of relevant accounting guidance. (n) Per Share Amounts (cid:16) Basic Earnings Per Common Share is calculated by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted Earnings Per Common Share is computed by assuming the issuance of common shares for all potentially dilutive common shares outstanding during the reporting period. Currently, the Company’s potentially dilutive common stock issuances relate to grants under the Company’s equity-based plans, including 1) stock options, 2) performance units, and 3) restricted stock grants. In computing Diluted Earnings Per Common Share, it is assumed that all dilutive stock options are exercised during the reporting period at their respective exercise prices, with the proceeds from the exercises used by the Company to buy back stock in the open market at the average market price in effect during the reporting period. The difference between the number of shares assumed to be exercised and the number of shares bought back is included in the calculation of dilutive securities. Performance units vest if certain financial goals and service conditions are met. Once vested, one performance unit is equal to one share of common stock. Performance units are included in the calculation of dilutive securities if the financial goals for a measurement period have been met, even if service requirements have not been met. Restricted stock grants issued by the Company vest solely on service conditions, and thus these shares are included in the calculation of dilutive securities. The following is a reconciliation of the numerators and denominators used in computing Basic and Diluted Earnings Per Common Share: ($ in thousands, except per share amounts) Income (Numer- ator) 2011 Shares (Denom- inator) Per Share Amount For the Years Ended December 31, 2010 Shares (Denom- inator) Per Share Amount Income (Numer- ator) Income (Numer- ator) 2009 Shares (Denom- inator) Per Share Amount Basic EPS Net income available to common shareholders Effect of dilutive securities Diluted EPS per common share $ 7,476 16,856,072 $ 0.44 $ 5,875 16,764,879 $ 0.35 $ 56,287 16,648,822 $ 3.38 (cid:16) 27,172 (cid:16) 28,771 (cid:16) 38,058 $ 7,476 16,883,244 $ 0.44 $ 5,875 16,793,650 $ 0.35 $ 56,287 16,686,880 $ 3.37 For the years ended December 31, 2011, 2010, and 2009, there were 396,669 options, 604,752 options and 93 704,018 options, respectively, that were anti-dilutive because the exercise price exceeded the average market price for the year, and thus are not included in the calculation to determine the effect of dilutive securities. In addition, the warrant for 616,308 shares issued to the Treasury in 2009 and repurchased by the Company in 2011 was anti-dilutive for the year ended December 31, 2010 and 2009 – see Note 19 for additional information. (o) Fair Value of Financial Instruments (cid:16) Relevant accounting guidance requires that the Company disclose estimated fair values for its financial instruments. Fair value methods and assumptions are set forth below for the Company’s financial instruments. Cash and Amounts Due from Banks, Federal Funds Sold, Presold Mortgages in Process of Settlement, Accrued Interest Receivable, and Accrued Interest Payable (cid:16) The carrying amounts approximate their fair value because of the short maturity of these financial instruments. Available for Sale and Held to Maturity Securities (cid:16) Fair values are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. Loans (cid:16) Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, financial and agricultural, real estate construction, real estate mortgages and installment loans to individuals. Each loan category is further segmented into fixed and variable interest rate terms. The fair value for each category is determined by discounting scheduled future cash flows using current interest rates offered on loans with similar risk characteristics. Fair values for impaired loans are estimated based on discounted cash flows or underlying collateral values, where applicable. FDIC Indemnification Asset – Fair value is equal to the FDIC reimbursement rate of the expected losses to be incurred and reimbursed by the FDIC and then discounted over the estimated period of receipt. Deposits and Securities Sold Under Agreements to Repurchase (cid:16) The fair value of securities sold under agreements to repurchase and deposits with no stated maturity, such as non-interest-bearing demand deposits, savings, NOW, and money market accounts, is equal to the amount payable on demand as of the valuation date. The fair value of certificates of deposit is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities. Borrowings (cid:16) The fair value of borrowings is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered by the Company’s lenders for debt of similar remaining maturities. Commitments to Extend Credit and Standby Letters of Credit (cid:16) At December 31, 2011 and 2010, the Company’s off-balance sheet financial instruments had no carrying value. The large majority of commitments to extend credit and standby letters of credit are at variable rates and/or have relatively short terms to maturity. Therefore, the fair value for these financial instruments is considered to be immaterial. Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no highly liquid market exists for a significant 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. 94 Fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets and liabilities that are not considered financial assets or liabilities include net premises and equipment, intangible and other assets such as foreclosed properties, deferred income taxes, prepaid expense accounts, income taxes currently payable and other various accrued expenses. In addition, the income tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates. (p) Impairment (cid:16) Goodwill is evaluated for impairment on at least an annual basis by comparing the fair value of the reporting units to their related carrying value. If the carrying value of a reporting unit exceeds its fair value, the Company determines whether the implied fair value of the goodwill, using various valuation techniques, exceeds the carrying value of the goodwill. If the carrying value of the goodwill exceeds the implied fair value of the goodwill, an impairment loss is recorded in an amount equal to that excess. The Company reviews all other long-lived assets, including identifiable intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. The Company’s policy is that an impairment loss is recognized if the sum of the undiscounted future cash flows is less than the carrying amount of the asset. Any long-lived assets to be disposed of are reported at the lower of the carrying amount or fair value, less costs to sell. To date, the Company has not recorded any impairment write-downs of its long-lived assets or goodwill. (q) Comprehensive Income (cid:16) Comprehensive income is defined as the change in equity during a period for non- owner transactions and is divided into net income and other comprehensive income. Other comprehensive income includes revenues, expenses, gains, and losses that are excluded from earnings under current accounting standards. The components of accumulated other comprehensive income (loss) for the Company are as follows: ($ in thousands) Unrealized gain on securities available for sale Deferred tax liability Net unrealized gain on securities available for sale Additional pension liability Deferred tax asset Net additional pension liability December 31, 2011 $ 3,896 (1,520) 2,376 December 31, 2010 2,478 (966) 1,512 December 31, 2009 1,832 (715) 1,117 (18,278) 7,220 (11,058) (10,905) 4,308 (6,597) (9,164) 3,620 (5,544) Total accumulated other comprehensive income (loss) $ (8,682) (5,085) (4,427) (r) Segment Reporting (cid:16) Accounting standards require management to report selected financial and descriptive information about reportable operating segments. The standards also require related disclosures about products and services, geographic areas, and major customers. Generally, disclosures are required for segments internally identified to evaluate performance and resource allocation. The Company’s operations are primarily within the banking segment, and the financial statements presented herein reflect the results of that segment. The Company has no foreign operations or customers. (s) Reclassifications (cid:16) Certain amounts for prior years have been reclassified to conform to the 2011 presentation. The reclassifications had no effect on net income or shareholders’ equity as previously presented, nor did they materially impact trends in financial information. (t) Recent Accounting Pronouncements (cid:16) In July 2010, the Financial Accounting Standards Board (FASB) issued guidance that requires an entity to provide more information about the credit quality of its financing 95 receivables, such as aging information, credit quality indicators and troubled debt restructurings, in the disclosures to its financial statements. The disclosures must be disaggregated by portfolio segment or class. The disaggregation of information is based on how the entity develops its allowance for credit losses and how it manages its credit exposure. Except for disclosures related to troubled debt restructurings (discussed in next paragraph), the required disclosures became effective for periods ending on or after December 15, 2010. The Company is required to include these disclosures in its interim and annual financial statements. See Note 4 for required disclosures. In April 2011, the FASB issued guidance to assist creditors with their determination of when a restructuring is a troubled debt restructuring. The determination is based on whether the restructuring constitutes a concession and whether the debtor is experiencing financial difficulties, as both events must be present. This guidance and the new disclosures related to troubled debt restructurings became effective for reporting periods beginning after June 15, 2011. See Note 4 for required disclosures. In December 2010, the FASB issued amended guidance to modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. Any resulting goodwill impairment should be recorded as a cumulative-effect adjustment to beginning retained earnings upon adoption. Impairments occurring subsequent to adoption should be included in earnings. The amendment was effective for the Company beginning January 1, 2011 and did not impact the Company. In September 2011, the FASB issued additional amended guidance related to goodwill impairment testing. Guidance now permits an entity to consider qualitative factors to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. This amendment will be effective for the Company on January 1, 2012 and is not expected to impact the Company. Also in December 2010, the FASB issued amended guidance specifying that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendment also requires that the supplemental pro forma disclosures include a description of the nature and amount of any material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. This amendment is effective for the Company for business combinations for which the acquisition date is on or after January 1, 2011. The Company does not expect this guidance to have a material impact on its financial statements. In June 2011, the FASB amended the comprehensive income guidance by eliminating the option to present other comprehensive income as a part of the statement of changes in stockholders’ equity. The amendment requires consecutive presentation of the statement of net income and other comprehensive income and requires an entity to present reclassification adjustments from other comprehensive income to net income on the face of the financial statements. In December 2011, the FASB deferred the effective date of presenting reclassification adjustments from other comprehensive income to net income on the face of the financial statements. The remaining amendments of the guidance will be applicable to the Company on January 1, 2012 and will be applied retrospectively. The Company has consistently followed the new requirements in prior filings, and thus this guidance will not change the way the Company has presented its 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. 96 Note 2. Acquisitions – Completed and Pending The Company did not complete any significant acquisitions during 2010. The Company completed the acquisitions described below during 2009 and 2011. The results of each acquired company/branch are included in the Company’s results beginning on its respective acquisition date. (1) On June 19, 2009, the Bank entered into a purchase and assumption agreement with the Federal Deposit Insurance Corporation (FDIC), as receiver for Cooperative Bank, in Wilmington, North Carolina. Earlier that day, the North Carolina Commissioner of Banks issued an order requiring the closure of Cooperative Bank and appointing the FDIC as receiver. According to the terms of the agreement, the Bank acquired all deposits (except certain brokered deposits) and borrowings, and substantially all of the assets of Cooperative Bank and its subsidiary, Lumina Mortgage. All deposits were assumed by the Bank with no losses to any depositor. Cooperative Bank operated through twenty-one branches in North Carolina and three branches in South Carolina, with assets totaling approximately $959 million and approximately 200 employees. The loans and foreclosed real estate purchased are covered by two loss share agreements between the FDIC and the Bank, which affords the Bank significant loss protection. Under the loss share agreements, the FDIC will cover 80% of covered loan and foreclosed real estate losses up to $303 million and 95% of losses in excess of that amount. The term for loss sharing on residential real estate loans is ten years, while the term for loss sharing on non-residential real estate loans is five years in respect to losses and eight years in respect to loss recoveries. The reimbursable losses from the FDIC are based on the book value of the relevant loan as determined by the FDIC at the date of the transaction. New loans made after that date are not covered by the loss share agreements. The Bank received a $123 million discount on the assets acquired and paid no deposit premium. The acquisition was accounted for under the purchase method of accounting in accordance with relevant accounting guidance. The purchased assets and assumed liabilities were recorded at their respective acquisition date fair values, and identifiable intangible assets were recorded at fair value. Fair values were subject to refinement for up to one year after the closing date of the acquisition as information relative to closing date fair values became available. The Company recorded an estimated receivable from the FDIC in the amount of $185.1 million as of June 30, 2009, which represented the FDIC’s portion of the losses that were expected to be incurred and reimbursed to the Company. An acquisition gain totaling $67.9 million resulted from the acquisition and is included as a component of noninterest income in the Company’s statement of income. In the Company’s filings for the second quarter 2009, this gain was reported as being $53.8 million. During the third and fourth quarters of 2009, the Company obtained third-party appraisals for the majority of Cooperative Bank’s collateral dependent problem loans. Overall, the appraised values were higher than the Company’s original estimates made as of the acquisition date. In addition, during the third and fourth quarters of 2009, the Company received payoffs related to certain loans for which losses had been anticipated. Accordingly, as required by accounting guidance, the Company retrospectively adjusted the fair value of the loans acquired for these factors, which resulted in a higher gain being reflected in the second quarter of 2009. The statement of net assets acquired as of June 19, 2009 and the resulting gain (as adjusted) are presented in the following table. 97 ($ in thousands) Assets Cash and cash equivalents Securities Presold mortgages Loans Core deposit intangible FDIC indemnification asset Foreclosed properties Other assets Total Liabilities Deposits Borrowings Other Total Excess of assets received over liabilities Less: Asset discount Cash received from FDIC at closing Total gain recorded Explanation of Fair Value Adjustments As Recorded by Cooperative Bank Fair Value Adjustments As Recorded by the Company $ 66,096 40,189 3,249 828,958 (cid:1086)(cid:3) (cid:1086)(cid:3) 15,993 4,178 958,663 $ 706,139 153,056 2,227 861,422 $ 97,241 (123,000) 25,759 – – – (227,854) (a) 3,798 (b) 185,112 (c) (3,534) (d) (137) (e) (42,615) 5,922 (f) 6,409 (g) 160 (e) 12,491 (55,106) 66,096 40,189 3,249 601,104 3,798 185,112 12,459 4,041 916,048 712,061 159,465 2,387 873,913 42,135 25,759 $ 67,894 (a) This estimated fair value adjustment was necessary as of the acquisition date to write down Cooperative Bank’s book value of loans to the estimated fair value as a result of future expected loan losses. (b) This estimated fair value adjustment represents the value of the core deposit base assumed in the acquisition based on a study performed by an independent consulting firm. This amount was recorded by the Company as an identifiable intangible asset and will be amortized as an expense on a straight-line basis over the average life of the core deposit base, which is estimated to be 8 years. (c) This estimated fair value adjustment represents the amount that the Company will receive from the FDIC under its loss share agreements as a result of future loan losses. (d) This estimated fair value adjustment was necessary to write down Cooperative Bank’s book value of foreclosed real estate properties to their estimated fair value as of the acquisition date. (e) These estimated fair value adjustments are other immaterial adjustments made to acquired assets and assumed liabilities to reflect fair value. (f) This estimated fair value adjustment was recorded because the weighted average interest rate of Cooperative Bank’s time deposits exceeded the cost of similar wholesale funding at the time of the acquisition. This amount was amortized to reduce interest expense on a declining basis over the average life of the portfolio of approximately 15 months. (g) This estimated fair value adjustment was recorded because the interest rates of Cooperative Bank’s fixed rate borrowings exceeded current interest rates on similar borrowings. This amount was realized shortly after the acquisition by prepaying the borrowings at a premium, and thus there will be no future amortization related to this adjustment. 98 The operating results of the Company for the year ended December 31, 2009 include the operating results of the acquired assets and assumed liabilities since the acquisition date of June 19, 2009. (2) On January 21, 2011, the Bank entered into a loss share purchase and assumption agreement with the FDIC, as receiver for The Bank of Asheville, Asheville, North Carolina. Earlier that day, the North Carolina Commissioner of Banks issued an order for the closure of The Bank of Asheville and appointed the FDIC as receiver. According to the terms of the agreement, First Bank acquired substantially all of the assets and liabilities of The Bank of Asheville. All deposits were assumed by First Bank with no losses to any depositor. The Bank of Asheville operated through five branches in Asheville, North Carolina with total assets of approximately $198 million and 50 employees. Substantially all of the loans and foreclosed real estate purchased are covered by loss share agreements between the FDIC and First Bank, which afford First Bank significant loss protection. Under the loss share agreements, the FDIC will cover 80% of covered loan and foreclosed real estate losses. The term for loss sharing on residential real estate loans is ten years, while the term for loss sharing on non-residential real estate loans is five years in respect to losses and eight years in respect to loss recoveries. The reimbursable losses from the FDIC are based on the book value of the relevant loan as determined by the FDIC at the date of the transaction. New loans made after that date are not covered by the loss share agreements. First Bank received a $23.9 million discount on the assets acquired and paid no deposit premium. The acquisition was accounted for under the purchase method of accounting in accordance with relevant accounting guidance. The statement of net assets acquired as of January 21, 2011 and the resulting gain are presented in the following table. The purchased assets and assumed liabilities were recorded at their respective acquisition date fair values, and identifiable intangible assets were recorded at fair value. The Company recorded an estimated receivable from the FDIC in the amount of $42.2 million, which represents the fair value of the FDIC’s portion of the losses that are expected to be incurred and reimbursed to the Company. An acquisition gain totaling $10.2 million resulted from the acquisition and is included as a component of noninterest income in the statement of income. The amount of the gain is equal to the amount by which the fair value of assets purchased exceeded the fair value of liabilities assumed. The statement of net assets acquired as of January 21, 2011 and the resulting gain that was recorded are presented in the following table. 99 ($ in thousands) Assets Cash and cash equivalents Securities Loans Core deposit intangible FDIC indemnification asset Foreclosed properties Other assets Total Liabilities Deposits Borrowings Other Total Excess of liabilities received over assets Less: Asset discount Cash received/receivable from FDIC at closing Total gain recorded As Recorded by The Bank of Asheville $ 27,297 4,461 153,994 (cid:1086)(cid:3) (cid:1086)(cid:3) 3,501 1,146 190,399 $ 192,284 4,004 111 196,399 $ (6,000) (23,940) 29,940 Fair Value Adjustments As Recorded by the Company – – (51,726) (a) 277 (b) 42,218 (c) (2,159) (d) (370) (e) (11,760) 460 (f) 77 (g) 1,447 (h) 1,984 27,297 4,461 102,268 277 42,218 1,342 776 178,639 192,744 4,081 1,558 198,383 (13,744) (19,744) 29,940 $ 10,196 Explanation of Fair Value Adjustments (a) This estimated adjustment is necessary as of the acquisition date to write down The Bank of Asheville’s book value of loans to the estimated fair value as a result of future expected loan losses. (b) This fair value adjustment represents the value of the core deposit base assumed in the acquisition based on a study performed by an independent consulting firm. This amount was recorded by the Company as an identifiable intangible asset and will be amortized as an expense on a straight-line basis over the average life of the core deposit base, which is estimated to be seven years. (c) This adjustment is the estimated fair value of the amount that the Company expects to receive from the FDIC under its loss share agreements as a result of future loan losses. (d) This is the estimated adjustment necessary to write down The Bank of Asheville’s book value of foreclosed real estate properties to their estimated fair value as of the acquisition date. (e) This is an immaterial adjustment made to reflect fair value. (f) This fair value adjustment was recorded because the weighted average interest rate of The Bank of Asheville’s time deposits exceeded the cost of similar wholesale funding at the time of the acquisition. This amount will be amortized to reduce interest expense on a declining basis over the life of the portfolio of approximately 48 months. (g) This fair value adjustment was recorded because the interest rates of The Bank of Asheville’s fixed rate borrowings exceeded current interest rates on similar borrowings. This amount was realized shortly after the acquisition by prepaying the borrowings at a premium and thus there will be no future amortization related to this adjustment. (h) This adjustment relates primarily to the estimate of what the Company will owe to the FDIC at the conclusion of the loss share agreements based on a pre-established formula set forth in those agreements that is based on total expected losses in relation to the amount of the discount bid. 100 The operating results of the Company for the year ended December 31, 2011 include the operating results of the acquired assets and assumed liabilities for the period subsequent to the acquisition date of January 21, 2011. Due primarily to the significant amount of fair value adjustments and the FDIC loss share agreements now in place, historical results of The Bank of Asheville are not believed to be relevant to the Company’s results, and thus no pro forma information is presented. (3) At December 31, 2011, the Company had one pending acquisition. On October 21, 2011, the Company entered into a Branch Purchase and Assumption Agreement (“The Agreement”) with Waccamaw Bankshares, Inc., and its subsidiary, Waccamaw Bank. The Agreement provides for First Bank to acquire eleven branches from Waccamaw Bank, which includes assuming all deposits, selected performing loans, and all premises and equipment. Deposits total approximately $180 million (unaudited) and loans total approximately $98 million (unaudited). The Agreement provides for the deposits to be purchased at a premium that varies by account type. The estimated blended premium is approximately 1.5% of total deposits (unaudited). The Agreement provides for loans to be purchased at par (the amount of principal outstanding and interest receivable) and for premises and equipment to be purchased at net book value. Approximately $31 million of the $98 million (unaudited) in loans being acquired are subject to a provision in the Agreement allowing First Bank to put the loans back to Waccamaw Bank at par value for any reason within 20 months following the closing date of the transaction. The Agreement is subject to regulatory approval and other customary conditions. No assurance can be provided that this Agreement will be approved. Note 3. Securities The book values and approximate fair values of investment securities at December 31, 2011 and 2010 are summarized as follows: ($ in thousands) Securities available for sale: Government-sponsored enterprise securities Mortgage-backed securities Corporate bonds Equity securities Total available for sale Securities held to maturity: State and local governments Other Total held to maturity 2011 2010 Amortized Cost Fair Value Unrealized Gains (Losses) Amortized Cost Fair Value Unrealized Gains (Losses) $ 34,511 120,032 13,189 10,998 $ 178,730 34,665 124,105 12,488 11,368 182,626 170 4,164 279 409 5,022 (16) (91) (980) (39) (1,126) 43,432 104,660 15,754 14,858 178,704 43,273 107,460 15,330 15,119 181,182 214 3,270 35 301 3,820 (373) (470) (459) (40) (1,342) $ 57,988 (cid:326) $ 57,988 62,754 (cid:326) 62,754 4,766 (cid:326) 4,766 (cid:326) (cid:326) (cid:326) 54,011 7 54,018 53,305 7 53,312 517 (cid:326) 517 (1,223) (cid:326) (1,223) Included in mortgage-backed securities at December 31, 2011 were collateralized mortgage obligations with an amortized cost of $1,462,000 and a fair value of $1,515,000. Included in mortgage-backed securities at December 31, 2010 were collateralized mortgage obligations with an amortized cost of $2,644,000 and a fair value of $2,740,000. All of the Company’s mortgage-backed securities, including the collateralized mortgage obligations, were issued by government-sponsored corporations. The Company owned Federal Home Loan Bank (FHLB) stock with a cost and fair value of $10,904,000 at December 31, 2011 and $14,759,000 at December 31, 2010, which is included in equity securities above and serves as part of the collateral for the Company’s line of credit with the FHLB (see Note 10 for additional 101 discussion). The investment in this stock is a requirement for membership in the FHLB system. The following table presents information regarding securities with unrealized losses at December 31, 2011: ($ in thousands) Securities in an Unrealized Loss Position for Less than 12 Months Securities in an Unrealized Loss Position for More than 12 Months Total Government-sponsored enterprise securities Mortgage-backed securities Corporate bonds Equity securities State and local governments Total temporarily impaired securities Fair Value $ 8,984 14,902 4,588 4 (cid:1086) $ 28,478 Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses 16 61 458 2 (cid:1086) 537 – 9,302 2,773 22 – 12,097 – 30 522 37 – 589 8,984 24,204 7,361 26 (cid:1086) 40,575 16 91 980 39 (cid:1086) 1,126 The following table presents information regarding securities with unrealized losses at December 31, 2010: ($ in thousands) Securities in an Unrealized Loss Position for Less than 12 Months Securities in an Unrealized Loss Position for More than 12 Months Total Government-sponsored enterprise securities Mortgage-backed securities Corporate bonds Equity securities State and local governments Total temporarily impaired securities Fair Value $ 18,607 21,741 7,548 3 35,289 $ 83,188 Unrealized Losses Fair Value Unrealized Losses Fair Value Unrealized Losses 373 470 55 1 1,223 2,122 – – 2,900 29 – 2,929 – – 404 39 – 443 18,607 21,741 10,448 32 35,289 86,117 373 470 459 40 1,223 2,565 In the above tables, all of the non-equity securities that were in an unrealized loss position at December 31, 2011 and 2010 are bonds that the Company has determined are in a loss position due to interest rate factors, the overall economic downturn in the financial sector, and the broader economy in general. The Company has evaluated the collectability of each of these bonds and has concluded that there is no other-than-temporary impairment. The Company does not intend to sell these securities, and it is more likely than not that the Company will not be required to sell these securities before recovery of the amortized cost. At December 31, 2011, the Company’s $12.5 million investment in corporate bonds was comprised of the following: ($ in thousands) Issuer First Citizens Bancorp (South Carolina) Bond Bank of America Trust Preferred Security Bank of America Trust Preferred Security First Citizens Bancorp (North Carolina) Trust Preferred Security First Citizens Bancorp (South Carolina) Trust Preferred Security Total investment in corporate bonds (1) The ratings are as of January 26, 2012. S&P Issuer Ratings (1) Not Rated BB+ BB+ BB+ Not Rated Maturity Date 4/1/15 12/11/26 4/15/27 3/1/28 6/15/34 Amortized Cost $ 2,996 2,039 5,046 2,108 1,000 $ 13,189 Market Value 3,102 1,780 4,588 2,278 740 12,488 102 The Company has concluded that each of the equity securities in an unrealized loss position at December 31, 2011 and 2010 was in such a position due to temporary fluctuations in the market prices of the securities. The Company’s policy is to record an impairment charge for any of these equity securities that remains in an unrealized loss position for twelve consecutive months unless the amount is insignificant. The aggregate carrying amount of cost-method investments was $11,368,000 and $14,766,000 at December 31, 2011 and 2010, respectively, which included the Federal Home Loan Bank stock discussed above. The Company determined that none of its cost-method investments were impaired at either year end. The book values and approximate fair values of investment securities at December 31, 2011, by contractual maturity, are summarized in the table below. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. ($ in thousands) Debt securities Due within one year Due after one year but within five years Due after five years but within ten years Due after ten years Mortgage-backed securities Total debt securities Equity securities Total securities Securities Available for Sale Amortized Cost Fair Value Securities Held to Maturity Amortized Cost Fair Value $ 3,011 31,497 3,000 10,192 120,032 167,732 10,998 $ 178,730 3,106 31,660 3,001 9,386 124,105 171,258 11,368 182,626 $ 626 1,743 23,188 32,431 (cid:326) 57,988 (cid:326) $ 57,988 629 1,843 25,201 35,081 (cid:326) 62,754 (cid:326) 62,754 At December 31, 2011 and 2010, investment securities with book values of $47,418,000 and $75,654,000, respectively, were pledged as collateral for public and private deposits and securities sold under agreements to repurchase. There were $2,510,000 in sales of securities in 2011, which resulted in a net gain of $8,000. There were no sales of securities in 2010. There were $44,000 in sales in 2009, which resulted in a net gain of $9,000. In 2011, the Company recorded a net loss of $5,000 related to write-downs of the Company’s equity portfolio and recorded a net gain of $71,000 related to the call of several securities. In 2010, the Company recorded a gain of $26,000 related to the call of several municipal securities. The Company recorded losses of $113,000 related to write- downs of the Company’s equity portfolio in 2009. Note 4. Loans and Asset Quality Information The loans and foreclosed real estate that were acquired in FDIC-assisted transactions are covered by loss share agreements between the FDIC and the Company’s banking subsidiary, First Bank, which afford First Bank significant loss protection. (See Note 2 above for more information regarding these transactions.) Because of the loss protection provided by the FDIC, the risk of the Cooperative Bank and The Bank of Asheville loans and foreclosed real estate are significantly different from those assets not covered under the loss share agreements. Accordingly, the Company presents separately loans subject to the loss share agreements as “covered loans” in the information below and loans that are not subject to the loss share agreements as “non-covered loans.” 103 The following is a summary of the major categories of total loans outstanding: ($ in thousands) All loans (non-covered and covered): Commercial, financial, and agricultural Real estate – construction, land development & other land loans Real estate – mortgage – residential (1-4 December 31, 2011 December 31, 2010 Amount Percentage Amount Percentage $ 162,099 7% $ 155,016 363,079 15% 437,700 family) first mortgages 805,542 33% 802,658 Real estate – mortgage – home equity loans / lines of credit 256,509 11% 263,529 Real estate – mortgage – commercial and other Installment loans to individuals Subtotal Unamortized net deferred loan costs Total loans 762,895 78,982 2,429,106 1,280 $ 2,430,386 31% 3% 100% 710,337 83,919 2,453,159 973 $ 2,454,132 6% 18% 33% 11% 29% 3% 100% As of December 31, 2011 and 2010, net loans include an unamortized premium of $949,000 and $687,000, respectively, related to acquired loans. Loans in the amounts of $2,074,148,000 and $1,708,642,000 as of December 31, 2011 and 2010, respectively, are pledged as collateral for certain borrowings (see Note 10). The loans above also include loans to executive officers and directors serving the Company at December 31, 2011 and to their associates, totaling approximately $6,004,000 and $5,097,000 at December 31, 2011 and 2010, respectively. During 2011, additions to such loans were approximately $1,253,000 and repayments totaled approximately $346,000. These loans were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other non-related borrowers. Management does not believe these loans involve more than the normal risk of collectability or present other unfavorable features. 104 The following is a summary of the major categories of non-covered loans outstanding: ($ in thousands) Non-covered loans: December 31, 2011 December 31, 2010 Amount Percentage Amount Percentage Commercial, financial, and agricultural Real estate – construction, land development & other land loans Real estate – mortgage – residential (1-4 $ 152,627 8% $ 150,545 290,983 14% 344,939 family) first mortgages 646,616 31% 622,353 Real estate – mortgage – home equity loans / lines of credit 233,171 11% 246,418 Real estate – mortgage – commercial and other Installment loans to individuals Subtotal Unamortized net deferred loan costs Total non-covered loans 666,882 77,593 2,067,872 1,280 $ 2,069,152 32% 4% 100% 636,197 81,579 2,082,031 973 $ 2,083,004 7% 17% 30% 12% 30% 4% 100% The carrying amount of the covered loans at December 31, 2011 consisted of impaired and nonimpaired purchased loans, as follows: ($ in thousands) Covered loans: Commercial, financial, and agricultural Real estate – construction, land development & other land loans Real estate – mortgage – residential (1-4 family) first mortgages Real estate – mortgage – home equity loans / lines of credit Real estate – mortgage – commercial and other Installment loans to individuals Total Impaired Purchased Loans – Carrying Value Impaired Purchased Loans – Unpaid Principal Balance Nonimpaired Purchased Loans – Carrying Value Nonimpaired Purchased Loans - Unpaid Principal Balance Total Covered Loans – Carrying Value Total Covered Loans – Unpaid Principal Balance $ 69 319 9,403 11,736 9,472 12,055 3,865 8,505 68,231 115,489 72,096 123,994 1,214 2,639 157,712 189,436 158,926 192,075 127 577 23,211 29,249 23,338 29,826 2,585 4 $ 7,864 4,986 6 17,032 93,428 1,385 353,370 125,450 1,583 472,943 96,013 1,389 361,234 130,436 1,589 489,975 The carrying amount of the covered loans at December 31, 2010 consisted of impaired and nonimpaired purchased loans, as follows: ($ in thousands) Covered loans: Commercial, financial, and agricultural Real estate – construction, land development & other land loans Real estate – mortgage – residential (1-4 family) first mortgages Real estate – mortgage – home equity loans / lines of credit Real estate – mortgage – commercial and other Installment loans to individuals Total Impaired Purchased Loans – Carrying Value Impaired Purchased Loans – Unpaid Principal Balance Nonimpaired Purchased Loans – Carrying Value Nonimpaired Purchased Loans - Unpaid Principal Balance Total Covered Loans – Carrying Value Total Covered Loans – Unpaid Principal Balance $ (cid:1086) (cid:1086) 4,471 5,272 4,471 5,272 1,898 3,328 90,863 147,615 92,761 150,943 (cid:1086) (cid:1086) 2,709 (cid:1086)(cid:3) $ 4,607 (cid:1086) (cid:1086) 3,594 (cid:1086) 6,922 105 180,305 212,826 180,305 212,826 17,111 20,332 17,111 20,332 71,431 2,340 366,521 93,490 2,595 482,130 74,140 2,340 371,128 97,084 2,595 489,052 The following table presents information regarding covered purchased nonimpaired loans since December 31, 2009. The amounts include principal only and do not reflect accrued interest as of the date of the acquisition or beyond. ($ in thousands) Carrying amount of nonimpaired Cooperative Bank loans at December 31, 2009 Principal repayments Transfers to foreclosed real estate Loan charge-offs Accretion of loan discount Carrying amount of nonimpaired Cooperative Bank loans at December 31, 2010 Additions due to acquisition of The Bank of Asheville (at fair value) Principal repayments Transfers to foreclosed real estate Loan charge-offs Accretion of loan discount Carrying amount of nonimpaired covered loans at December 31, 2011 $ 485,572 (43,801) (75,121) (7,736) 7,607 366,521 84,623 (40,576) (53,999) (14,797) 11,598 $ 353,370 As reflected in the table above, the Company accreted $11,598,000 and $7,607,000 of the loan discount on purchased nonimpaired loans into interest income during 2011 and 2010, respectively. As of December 31, 2011, there was remaining loan discount of $89,837,000 related to purchased nonimpaired loans. If these loans continue to be repaid by the borrowers, the Company will accrete the remaining loan discount into interest income over the lives of the respective loans. In such circumstances, a corresponding entry to reduce the indemnification asset will be recorded amounting to 80% of the loan discount accretion, which reduces noninterest income. The following table presents information regarding all purchased impaired loans since December 31, 2009, substantially all of which are covered loans. The Company has applied the cost recovery method to all purchased impaired loans at their respective acquisition dates due to the uncertainty as to the timing of expected cash flows, as reflected in the following table. ($ in thousands) Purchased Impaired Loans Balance at December 31, 2009 Change due to payments received Transfer to foreclosed real estate Change due to loan charge-off Other Balance at December 31, 2010 Additions due to acquisition of The Bank of Asheville Change due to payments received Transfer to foreclosed real estate Change due to loan charge-off Other Balance at December 31, 2011 Fair Market Value Adjustment – Write Down (Nonaccretable Difference) 3,242 2 (225) (625) (65) 2,329 20,807 (327) (9,308) (4,193) 224 9,532 Contractual Principal Receivable $ 39,293 (685) (27,569) (3,149) 190 8,080 38,452 (1,620) (19,881) (7,522) 807 $ 18,316 Carrying Amount 36,051 (687) (27,344) (2,524) 255 5,751 17,645 (1,293) (10,573) (3,329) 583 8,784 Each of the purchased impaired loans are on nonaccrual status and considered to be impaired. Because of the uncertainty of the expected cash flows, the Company is accounting for each purchased impaired loan under the cost recovery method, in which all cash payments are applied to principal. Thus, there is no accretable yield associated with the above loans. During 2011 and 2010, the Company received $0 and $67,000, respectively, in payments that exceeded the initial carrying amount of the purchased impaired loans, which is included in the 106 loan discount accretion amount discussed previously. Nonperforming assets are defined as nonaccrual loans, restructured loans, loans past due 90 or more days and still accruing interest, and other real estate. Nonperforming assets are summarized as follows: ASSET QUALITY DATA ($ in thousands) Non-covered nonperforming assets Nonaccrual loans Restructured loans – accruing Accruing loans > 90 days past due Total non-covered nonperforming loans Other real estate Total non-covered nonperforming assets Covered nonperforming assets Nonaccrual loans (1) Restructured loans – accruing Accruing loans > 90 days past due Total covered nonperforming loans Other real estate Total covered nonperforming assets December 31, 2011 December 31, 2010 $ 73,566 11,720 (cid:16) 85,286 37,023 $ 122,309 $ 41,472 14,218 (cid:16) 55,690 85,272 $ 140,962 62,326 33,677 (cid:16) 96,003 21,081 117,084 58,466 14,359 (cid:16) 72,825 94,891 167,716 Total nonperforming assets $ 263,271 284,800 _________________________________________________________________________________________________________ (1) At December 31, 2011 and December 31, 2010, the contractual balance of the nonaccrual loans covered by FDIC loss share agreements was $69.0 million and $86.2 million, respectively. If the nonaccrual and restructured loans as of December 31, 2011, 2010, and 2009 had been current in accordance with their original terms and had been outstanding throughout the period (or since origination if held for part of the period), gross interest income in the amounts of approximately $8,724,000, $8,136,000 and $9,800,000 for nonaccrual loans and $1,873,000, $1,943,000 and $1,200,000 for restructured loans would have been recorded for 2011, 2010, and 2009, respectively. Interest income on such loans that was actually collected and included in net income in 2011, 2010, and 2009 amounted to approximately $2,578,000, $3,195,000 and $2,147,000 for nonaccrual loans (prior to their being placed on nonaccrual status), and $1,351,000, $1,342,000, and $866,000 for restructured loans, respectively. At December 31, 2011 and 2010, the Company had no commitments to lend additional funds to debtors whose loans were nonperforming. 107 The following table presents information related to the Company’s impaired loans. ($ in thousands) Impaired loans at period end Non-covered Covered Total impaired loans at period end Average amount of impaired loans for period Non-covered Covered Average amount of impaired loans for period – total Allowance for loan losses related to impaired loans at period end Non-covered Covered Allowance for loan losses related to impaired loans - total Amount of impaired loans with no related allowance at period end Non-covered Covered Total impaired loans with no related allowance at period end As of /for the year ended December 31, 2011 As of /for the year ended December 31, 2010 As of /for the year ended December 31, 2009 $ 85,286 55,690 $ 140,976 96,003 72,825 168,828 55,574 94,746 150,320 $ 89,023 63,289 $ 152,312 89,751 95,373 185,124 36,171 34,161 70,332 $ 5,804 5,106 $ 10,910 7,613 11,155 18,768 9,717 (cid:1086) 9,717 $ 35,721 43,702 $ 79,423 42,874 49,991 92,865 30,236 94,746 124,982 All of the impaired loans noted in the table above were on nonaccrual status at each respective period end except for those classified as restructured loans (see table on previous page for balances). The remaining tables in this note present information derived from the Company’s allowance for loan loss model. Relevant accounting guidance requires certain disclosures to be disaggregated based on how the Company develops its allowance for loan losses and manages its credit exposure. This model combines loan types in a different manner than the tables previously presented. The following table presents the Company’s nonaccrual loans as of December 31, 2011. ($ in thousands) Commercial, financial, and agricultural: Commercial - unsecured Commercial - secured Secured by inventory and accounts receivable Real estate – construction, land development & other land loans Real estate – residential, farmland and multi-family Real estate – home equity lines of credit Real estate - commercial Consumer Total Non-covered Covered Total $ 452 2,190 588 22,772 25,430 3,161 16,203 2,770 $ 73,566 (cid:1086) 358 102 21,204 11,050 1,068 7,459 231 41,472 452 2,548 690 43,976 36,480 4,229 23,662 3,001 115,038 108 The following table presents the Company’s nonaccrual loans as of December 31, 2010. ($ in thousands) Commercial, financial, and agricultural: Commercial - unsecured Commercial - secured Secured by inventory and accounts receivable Real estate – construction, land development & other land loans Real estate – residential, farmland and multi-family Real estate – home equity lines of credit Real estate - commercial Consumer Total Non-covered Covered Total $ 64 1,566 802 22,654 27,055 2,201 7,461 523 $ 62,326 160 3 (cid:1086) 30,847 19,716 685 7,039 16 58,466 224 1,569 802 53,501 46,771 2,886 14,500 539 120,792 The following table presents an analysis of the payment status of the Company’s loans as of December 31, 2011. ($ in thousands) Non-covered loans Commercial, financial, and agricultural: Commercial - unsecured Commercial - secured Secured by inventory and accounts receivable Real estate – construction, land development & other land loans Real estate – residential, farmland, and multi-family Real estate – home equity lines of credit Real estate - commercial Consumer Total non-covered Unamortized net deferred loan costs Total non-covered loans 30-59 Days Past Due $ 67 672 247 1,250 9,751 1,126 2,620 657 $ 16,390 60-89 Days Past Due Nonaccrual Loans Current Total Loans Receivable 591 207 (cid:1086) 452 2,190 588 37,668 108,682 20,993 38,778 111,751 21,828 1,411 4,259 237 1,006 286 7,997 22,772 221,372 246,805 25,430 756,215 795,655 3,161 202,912 207,436 16,203 567,354 587,183 2,770 73,566 54,723 1,969,919 58,436 2,067,872 1,280 $ 2,069,152 Covered loans Total loans $ 6,511 3,388 41,472 309,863 361,234 $ 22,901 11,385 115,038 2,279,782 2,430,386 The Company had no non-covered or covered loans that were past due greater than 90 days and accruing interest at December 31, 2011. 109 The following table presents an analysis of the payment status of the Company’s loans as of December 31, 2010. ($ in thousands) 30-59 Days Past Due 60-89 Days Past Due Nonaccrual Loans Current Total Loans Receivable Non-covered loans Commercial, financial, and agricultural: Commercial - unsecured Commercial - secured Secured by inventory and accounts receivable Real estate – construction, land development & other land loans Real estate – residential, farmland, and multi-family Real estate – home equity lines of credit Real estate - commercial Consumer Total non-covered Unamortized net deferred loan costs Total non-covered loans Total covered loans Total loans $ 225 1,165 100 2,951 10,290 496 2,581 595 $ 18,403 92 195 (cid:1086) 7,022 2,942 253 1,193 297 11,994 64 1,566 802 41,564 102,657 21,369 41,945 105,583 22,271 22,654 270,892 303,519 27,055 726,456 766,743 2,201 213,984 216,934 7,461 552,020 563,255 523 62,326 60,366 1,989,308 61,781 2,082,031 973 $ 2,083,004 $ 6,713 4,127 58,466 301,822 371,128 $ 25,116 16,121 120,792 2,291,130 2,454,132 The Company had no non-covered or covered loans that were past due greater than 90 days and accruing interest at December 31, 2010. 110 The following table presents the activity in the allowance for loan losses for non-covered loans for the year ended December 31, 2011. ($ in thousands) Real Estate – Construction, Land Development, & Other Land Loans Real Estate – Residential, Farmland, and Multi- family Real Estate – Home Equity Lines of Credit Commercial, Financial, and Agricultural As of and for the year ended December 31, 2011 Real Estate – Commercial and Other Consumer Unallo- cated Total Beginning balance Charge-offs Recoveries Provisions Ending balance $ 4,731 (2,703) 389 1,363 $ 3,780 12,520 (16,240) 1,142 13,884 11,306 11,283 (9,045) 719 10,575 13,532 3,634 (1,147) 107 (904) 1,690 3,972 (3,355) 37 2,760 3,414 1,961 (845) 182 574 1,872 174 (524) 93 273 16 38,275 (33,859) 2,669 28,525 35,610 Ending balances as of December 31, 2011: Allowance for loan losses Individually evaluated for impairment Collectively evaluated for impairment Loans acquired with deteriorated credit quality $ 60 607 150 (cid:1086) 200 (cid:1086) (cid:1086) 1,017 $ 3,720 10,699 13,382 1,690 3,214 1,872 16 34,593 (cid:936)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) Loans receivable as of December 31, 2011: Ending balance – total $ 172,357 246,805 795,655 207,436 587,183 58,436 (cid:1086) 2,067,872 Ending balances as of December 31, 2011: Loans Individually evaluated for impairment Collectively evaluated for impairment Loans acquired with deteriorated credit quality $ 2,526 34,750 11,880 527 30,846 12 (cid:1086) 80,541 $ 169,831 212,055 783,775 206,909 556,337 58,424 (cid:1086) 1,987,331 (cid:936)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:1086)(cid:3) 920 (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) 920 111 The following table presents the activity in the allowance for loan losses for non-covered loans for the year ended December 31, 2010. ($ in thousands) Real Estate – Construction, Land Development, & Other Land Loans Real Estate – Residential, Farmland, and Multi- family Real Estate – Home Equity Lines of Credit Commercial, Financial, and Agricultural As of and for the year ended December 31, 2010 Real Estate – Commercial and Other Consumer Unallo- cated Total Beginning balance Charge-offs Recoveries Provisions Ending balance $ 4,992 (4,691) 145 4,285 $ 4,731 9,286 (15,721) 130 18,825 12,520 10,779 (6,962) 548 6,918 11,283 3,228 (2,490) 59 2,837 3,634 6,839 (2,354) 38 (551) 3,972 1,610 (1,587) 171 1,767 1,961 609 (cid:1086) (cid:1086) (435) 174 37,343 (33,805) 1,091 33,646 38,275 Ending balances as of December 31, 2010: Allowance for loan losses Individually evaluated for impairment Collectively evaluated for impairment Loans acquired with deteriorated credit quality $ 867 3,740 1,070 269 611 (cid:1086) (cid:1086) 6,557 $ 3,864 8,780 10,213 3,365 3,361 1,961 174 31,718 (cid:936)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) Loans receivable as of December 31, 2010: Ending balance – total $ 169,799 303,519 766,743 216,934 563,255 61,781 (cid:1086) 2,082,031 Ending balances as of December 31, 2010: Loans Individually evaluated for impairment Collectively evaluated for impairment Loans acquired with deteriorated credit quality $ 3,487 64,549 15,786 1,223 25,213 28 (cid:1086) 110,286 $ 166,312 238,970 750,957 215,711 538,042 61,753 (cid:1086) 1,971,745 (cid:936)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:1086)(cid:3) 1,144 (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) 1,144 112 The following table presents the activity in the allowance for loan losses for covered loans for the year ended December 31, 2011. ($ in thousands) Covered Loans As of and for the year ended December 31, 2011 Beginning balance Charge-offs Recoveries Provisions Ending balance $ 11,155 (18,123) (cid:1086) 12,776 $ 5,808 Ending balances as of December 31, 2011: Allowance for loan losses Individually evaluated for impairment Collectively evaluated for impairment Loans acquired with deteriorated credit quality $ 5,481 (cid:1086) 327 Loans receivable as of December 31, 2011: Ending balance – total $ 361,234 Ending balances as of December 31, 2011: Loans Individually evaluated for impairment Collectively evaluated for impairment Loans acquired with deteriorated credit quality $ 44,723 316,511 7,864 The following table presents the activity in the allowance for loan losses for covered loans for the year ended December 31, 2010. ($ in thousands) Covered Loans As of and for the year ended December 31, 2010 Beginning balance Charge-offs Recoveries Provisions Ending balance $ (cid:1086) (9,761) (cid:1086) 20,916 $ 11,155 Ending balances as of December 31, 2010: Allowance for loan losses Individually evaluated for impairment Collectively evaluated for impairment Loans acquired with deteriorated credit quality $ 11,155 (cid:1086) (cid:1086) Loans receivable as of December 31, 2010: Ending balance – total $ 371,128 Ending balances as of December 31, 2010: Loans Individually evaluated for impairment Collectively evaluated for impairment Loans acquired with deteriorated credit quality $ 72,690 298,438 4,607 113 The following table presents the Company’s impaired loans as of December 31, 2011. ($ in thousands) Recorded Investment Unpaid Principal Balance Related Allowance Average Recorded Investment Non-covered loans with no related allowance recorded: Commercial, financial, and agricultural: Commercial - unsecured Commercial - secured Secured by inventory and accounts receivable (cid:936)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:1086) 295 27 (cid:1086) 478 493 Real estate – construction, land development & other land loans 15,105 20,941 Real estate – residential, farmland, and multi-family 3,442 4,741 Real estate – home equity lines of credit 46 300 Real estate – commercial 16,794 18,817 Consumer Total non-covered impaired loans with no allowance 12 $ 35,721 39 45,809 Total covered impaired loans with no allowance $ 43,702 78,578 Total impaired loans with no allowance recorded $ 79,423 124,387 Non-covered loans with an allowance recorded: Commercial, financial, and agricultural: Commercial - unsecured Commercial - secured Secured by inventory and accounts receivable $ 452 1,895 561 454 1,899 571 Real estate – construction, land development & other land loans 10,360 12,606 Real estate – residential, farmland, and multi-family 24,460 26,153 Real estate – home equity lines of credit Real estate – commercial Consumer Total non-covered impaired loans with allowance 3,115 5,965 2,757 $ 49,565 3,141 6,421 2,759 54,004 (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) 59 295 156 2,244 2,169 117 283 481 5,804 (cid:1086) 504 124 17,876 5,278 79 13,359 15 37,235 49,030 86,265 226 1,427 391 15,782 22,487 2,544 6,602 2,329 51,788 Total covered impaired loans with allowance $ 11,988 15,670 5,106 14,259 Total impaired loans with an allowance recorded $ 61,553 69,674 10,910 66,047 Interest income recorded on non-covered and covered impaired loans during the year ended December 31, 2011 is considered insignificant. The related allowance listed above includes both reserves on loans specifically reviewed for impairment and general reserves on impaired loans that were not specifically reviewed for impairment. 114 The following table presents the Company’s impaired loans as of December 31, 2010. Recorded Investment Unpaid Principal Balance Related Allowance Average Recorded Investment ($ in thousands) Non-covered loans: With no related allowance recorded: Commercial, financial, and agricultural: Commercial - unsecured Commercial - secured Secured by inventory and accounts receivable (cid:936)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:1086) 902 240 (cid:1086) 967 650 Real estate – construction, land development & other land loans 22,026 26,012 Real estate – residential, farmland, and multi-family 8,269 9,447 Real estate – home equity lines of credit 302 502 Real estate – commercial 11,115 11,321 Consumer Total non-covered impaired loans with no allowance 20 $ 42,874 40 48,939 Total covered impaired loans with no allowance $ 49,991 77,321 Total impaired loans with no allowance recorded $ 92,865 126,260 Non-covered loans: With an allowance recorded: Commercial, financial, and agricultural: Commercial - unsecured Commercial - secured Secured by inventory and accounts receivable $ 124 579 1,026 124 579 1,026 Real estate – construction, land development & other land loans 17,540 19,926 Real estate – residential, farmland, and multi-family 23,012 23,012 Real estate – home equity lines of credit Real estate – commercial Consumer Total non-covered impaired loans with allowance 2,148 8,013 687 $ 53,129 2,223 8,088 687 55,665 (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) 24 88 609 3,932 1,820 357 497 286 7,613 138 758 186 15,639 7,437 381 7,284 46 31,869 83,955 115,824 243 1,385 613 21,362 22,166 1,928 9,275 910 57,882 Total covered impaired loans with allowance $ 22,834 27,105 11,155 11,418 Total impaired loans with an allowance recorded $ 75,963 82,770 18,768 69,300 Interest income recorded on non-covered and covered impaired loans during the year ended December 31, 2010 is considered insignificant. The related allowance listed above includes both reserves on loans specifically reviewed for impairment and general reserves on impaired loans that were not specifically reviewed for impairment. 115 The Company tracks credit quality based on its internal risk ratings. Upon origination a loan is assigned an initial risk grade, which is generally based on several factors such as the borrower’s credit score, the loan-to-value ratio, the debt-to-income ratio, etc. Loans that are risk-graded as substandard during the origination process are declined. After loans are initially graded, they are monitored monthly for credit quality based on many factors, such as payment history, the borrower’s financial status, and changes in collateral value. Loans can be downgraded or upgraded depending on management’s evaluation of these factors. Internal risk-grading policies are consistent throughout each loan type. The following describes the Company’s internal risk grades in ascending order of likelihood of loss: Numerical Risk Grade Description Pass: Weak Pass: Watch or Standard: Special Mention: Classified: 1 2 3 4 9 5 6 7 8 Cash secured loans. Non-cash secured loans that have no minor or major exceptions to the lending guidelines. Non-cash secured loans that have no major exceptions to the lending guidelines. Non-cash secured loans that have minor or major exceptions to the lending guidelines, but the exceptions are properly mitigated. Loans that meet the guidelines for a Risk Graded 5 loan, except the collateral coverage is sufficient to satisfy the debt with no risk of loss under reasonable circumstances. This category also includes all loans to insiders and any other loan that management elects to monitor on the watch list. Existing loans with major exceptions that cannot be mitigated. Loans that have a well-defined weakness that may jeopardize the liquidation of the debt if deficiencies are not corrected. Loans that have a well-defined weakness that make the collection or liquidation improbable. Loans that are considered uncollectible and are in the process of being charged- off. 116 The following table presents the Company’s recorded investment in loans by credit quality indicators as of December 31, 2011. ($ in thousands) Non-covered loans: Commercial, financial, and agricultural: Commercial - unsecured Commercial - secured Secured by inventory and accounts receivable Real estate – construction, land development & other land loans Real estate – residential, farmland, and multi-family Real estate – home equity lines of credit Credit Quality Indicator (Grouped by Internally Assigned Grade) Special Mention Loans (Grade 5) Classified Loans (Grades 6, 7, & 8) Watch or Standard Loans (Grade 9) Weak Pass (Grade 4) Nonaccrual Loans Total Pass (Grades 1, 2, & 3) $ 13,516 36,587 23,735 66,105 13 1,912 3,756 16,197 282 217 2,196 756 845 2,761 249 452 2,190 38,778 111,751 588 21,828 37,596 156,651 6,490 9,903 13,393 22,772 246,805 257,163 456,188 10,248 17,687 28,939 25,430 795,655 130,913 67,606 2,422 1,868 1,466 3,161 207,436 Real estate - commercial 140,577 372,614 30,722 11,502 15,565 16,203 587,183 Consumer Total Unamortized net deferred loan costs Total non-covered loans 30,693 $650,801 23,550 1,182,646 67 52,156 368 44,497 988 64,206 2,770 73,566 58,436 2,067,872 1,280 $2,069,152 Total covered loans $ 62,052 161,508 (cid:1086) 8,033 88,169 41,472 361,234 Total loans $712,853 1,344,154 52,156 52,530 152,375 115,038 2,430,386 At December 31, 2011, there was an insignificant amount of non-covered loans that were graded “8” with an accruing status. At December 31, 2011, there were no covered loans that were graded “8” with an accruing status. 117 The following table presents the Company’s recorded investment in loans by credit quality indicators as of December 31, 2010. ($ in thousands) Non-covered loans: Commercial, financial, and agricultural: Commercial – unsecured Commercial – secured Secured by inventory and accounts receivable Real estate – construction, land development & other land loans Real estate – residential, farmland, and multi-family Real estate – home equity lines of credit Credit Quality Indicator (Grouped by Internally Assigned Grade) Special Mention Loans (Grade 5) Classified Loans (Grades 6, 7, & 8) Watch or Standard Loans (Grade 9) Weak Pass (Grade 4) Nonaccrual Loans Total Pass (Grades 1, 2, & 3) $ 14,850 40,995 25,992 55,918 (cid:1086) 2,100 6,364 14,165 (cid:1086) 332 2,774 873 707 2,230 64 1,566 41,945 105,583 67 802 22,271 66,321 162,147 7,649 13,971 30,777 22,654 303,519 302,594 376,187 15,808 22,196 22,903 27,055 766,743 137,674 68,876 3,001 3,060 2,122 2,201 216,934 Real estate – commercial 190,284 301,828 33,706 11,915 18,061 7,461 563,255 Consumer Total Unamortized net deferred loan costs Total non-covered loans 34,600 $793,682 24,783 1,029,896 140 62,404 408 55,529 1,327 78,194 523 62,326 61,781 2,082,031 973 $2,083,004 Total covered loans $ 37,973 187,526 (cid:1086) 7,461 79,702 58,466 371,128 Total loans $831,655 1,217,422 62,404 62,990 157,896 120,792 2,454,132 At December 31, 2010, there was an insignificant amount of non-covered and covered loans that were graded “8” with an accruing status. Troubled Debt Restructurings The restructuring of a loan is considered a “troubled debt restructuring” if both (i) the borrower is experiencing financial difficulties and (ii) the creditor has granted a concession. Concessions may include interest rate reductions or below market interest rates, principal forgiveness, restructuring amortization schedules and other actions intended to minimize potential losses. The vast majority of the Company’s troubled debt restructurings modified during the year ended December 31, 2011 related to interest rate reductions combined with restructured amortization schedules. The Company does not grant principal forgiveness. All loans classified as troubled debt restructurings are considered to be impaired and are evaluated as such for determination of the allowance for loan losses. The Company’s troubled debt restructurings can be classified as either nonaccrual or accruing based on the loan’s payment status. The troubled debt restructurings that are nonaccrual are reported within the nonaccrual loan totals presented previously. 118 The following table presents information related to loans modified in a troubled debt restructuring during the year ended December 31, 2011. ($ in thousands) Non-covered TDRs – Accruing Real estate – construction, land development & other land loans Real estate – residential, farmland, and multi-family Real estate - commercial Non-covered TDRs - Nonaccrual Real estate – construction, land development & other land loans Real estate – residential, farmland, and multi-family Real estate - commercial Total non-covered TDRs arising during period Total covered TDRs arising during period– Accruing Total covered TDRs arising during period – Nonaccrual Total TDRs arising during period For the year ended December 31, 2011 Number of Contracts Restructured Balances 2 5 4 1 3 4 19 37 8 64 $ 543 1,645 1,871 357 438 1,408 $ 6,262 $ 6,528 1,472 $ 14,262 Accruing restructured loans that defaulted during the year ended December 31, 2011 are presented in the table below. The Company considers a loan to have defaulted when it becomes 90 or more days delinquent under the modified terms, has been transferred to nonaccrual status, or has been transferred to other real estate owned. ($ in thousands) Non-covered accruing TDRs that subsequently defaulted Real estate – construction, land development & other land loans Real estate – residential, farmland, and multi-family Real estate - commercial Total non-covered TDRs that subsequently defaulted Total accruing covered TDRs that subsequently defaulted Total accruing TDRs that subsequently defaulted For the year ended December 31, 2011 Number of Contracts Recorded Investment 8 5 10 23 40 63 $ 13,688 1,281 7,005 $ 21,974 $ 18,203 $ 40,177 119 Note 5. Premises and Equipment Premises and equipment at December 31, 2011 and 2010 consisted of the following: ($ in thousands) 2011 2010 Land Buildings Furniture and equipment Leasehold improvements Total cost Less accumulated depreciation and amortization Net book value of premises and equipment Note 6. FDIC Indemnification Asset $ 22,700 53,818 31,618 2,003 110,139 (40,164) $ 69,975 22,069 50,456 29,563 2,003 104,091 (36,350) 67,741 As discussed in Note 1(i), the FDIC indemnification asset is the estimated amount that the Company will receive from the FDIC under loss share agreements associated with two FDIC-assisted failed bank acquisitions. December 31, 2011 and 2010, the FDIC indemnification asset was comprised of the following components: At ($ in thousands) Receivable related to claims submitted, not yet received Receivable related to estimated future claims on loans Receivable related to estimated future claims on other real estate owned FDIC indemnification asset 2011 $ 13,377 90,275 18,025 $ 121,677 2010 30,201 86,966 6,552 123,719 The following presents a rollforward of the FDIC indemnification asset since the date of the Cooperative Bank acquisition on June 19, 2009. ($ in thousands) Balance at June 19, 2009 Decrease related to favorable change in loss estimates Increase related to reimbursable expenses Cash received Accretion of loan discount Balance at December 31, 2009 Increase related to unfavorable change in loss estimates Increase related to reimbursable expenses Cash received Accretion of loan discount Balance at December 31, 2010 Increase related to acquisition of The Bank of Asheville Increase related to unfavorable change in loss estimates Increase related to reimbursable expenses Cash received Accretion of loan discount Other Balance at December 31, 2011 $ 185,112 (1,516) 1,300 (40,500) (1,175) 143,221 30,419 2,900 (46,721) (6,100) $ 123,719 42,218 29,814 5,725 (69,339) (9,278) (1,182) $ 121,677 Note 7. Goodwill and Other Intangible Assets The following is a summary of the gross carrying amount and accumulated amortization of amortized intangible assets as of December 31, 2011 and December 31, 2010 and the carrying amount of unamortized intangible assets as of those same dates. In 2011, the Company recorded a core deposit premium intangible of $277,000 in connection with the acquisition of The Bank of Asheville, which is being amortized on a straight-line basis over 120 the estimated life of the related deposits of seven years. ($ in thousands) Amortized intangible assets: Customer lists Core deposit premiums Total Unamortized intangible assets: Goodwill December 31, 2011 December 31, 2010 Gross Carrying Amount Accumulated Amortization Gross Carrying Amount Accumulated Amortization $ 678 7,867 $ 8,545 357 4,291 4,648 678 7,590 8,268 298 3,447 3,745 $ 65,835 65,835 Amortization expense totaled $902,000, $874,000 and $630,000 for the years ended December 31, 2011, 2010 and 2009, respectively. Goodwill is evaluated for impairment on at least an annual basis – see Note 1(p). For each of the years presented, the Company’s evaluation indicated that there was no goodwill impairment. The following table presents the estimated amortization expense for intangible assets for each of the five calendar years ending December 31, 2016 and the estimated amount amortizable thereafter. These estimates are subject to change in future periods to the extent management determines it is necessary to make adjustments to the carrying value or estimated useful lives of amortized intangible assets. ($ in thousands) Estimated Amortization Expense 2012 2013 2014 2015 2016 Thereafter Total $ 892 781 678 622 555 369 $ 3,897 Note 8. Income Taxes Total income taxes for the years ended December 31, 2011, 2010 and 2009 were allocated as follows: ($ in thousands) 2011 2010 2009 Allocated to net income Allocated to stockholders’ equity, for unrealized holding gain/loss on debt and equity securities for financial reporting purposes Allocated to stockholders’ equity, for tax benefit of pension liabilities Total income taxes $ 7,370 4,960 37,618 554 (2,912) $ 5,012 251 (688) 4,523 610 1,750 39,978 The components of income tax expense (benefit) for the years ended December 31, 2011, 2010 and 2009 are as follows: ($ in thousands) Current - Federal - State Deferred - Federal - State Total 2011 2010 2009 $ 9,204 2,094 (3,234) (694) $ 7,370 25,353 3,807 (21,092) (3,108) 4,960 11,190 1,830 20,545 4,053 37,618 121 The sources and tax effects of temporary differences that give rise to significant portions of the deferred tax assets (liabilities) at December 31, 2011 and 2010 are presented below: ($ in thousands) 2011 2010 Deferred tax assets: Allowance for loan losses Excess book over tax SERP retirement plan cost Deferred compensation State net operating loss carryforwards Accruals, book versus tax Pension liability adjustments Unrealized gain on securities available for sale Basis differences in assets acquired in FDIC transactions All other Gross deferred tax assets Less: Valuation allowance Net deferred tax assets Deferred tax liabilities: Loan fees Excess tax over book pension cost Depreciable basis of fixed assets Amortizable basis of intangible assets Accruals, book versus tax Unrealized gain on securities available for sale FHLB stock dividends Basis differences in assets acquired in FDIC transactions All other Gross deferred tax liabilities Net deferred tax asset (liability) - included in other assets $ 16,458 2,378 138 62 329 7,220 (cid:1086) 771 3,086 30,442 (81) 30,361 (1,217) (219) (2,372) (8,334) (cid:1086) (1,520) (437) (cid:1086) (198) (14,297) $ 16,064 $ 20,020 2,150 148 62 (cid:1086) 4,308 (cid:1086) (cid:1086) 2,225 28,913 (86) 28,827 (1,003) (61) (1,300) (7,423) (66) (966) (436) (7,520) (274) (19,049) $ 9,778 A portion of the annual change in the net deferred tax asset relates to unrealized gains and losses on securities available for sale. The related 2011 and 2010 deferred tax expense (benefit) of approximately $554,000 and $251,000 respectively, has been recorded directly to shareholders’ equity. Additionally, a portion of the annual change in the net deferred tax asset relates to pension adjustments. The related 2011 and 2010 deferred tax expense (benefit) of ($2,912,000) and ($688,000), respectively, has been recorded directly to shareholders’ equity. Purchase acquisitions also increased the net deferred tax asset by approximately $4,005,000 in 2011. The balance of the 2011 increase in the net deferred tax asset of $3,928,000 is reflected as a deferred income tax benefit, and the balance of the 2010 increase in the net deferred tax asset of $24,200,000 is reflected as a deferred income tax benefit in the consolidated statement of income. The valuation allowances for 2011 and 2010 relate primarily to state net operating loss carryforwards. It is management’s belief that the realization of the remaining net deferred tax assets is more likely than not. The Company had no significant uncertain tax positions, and thus no reserve for uncertain tax positions has been recorded. Additionally, the Company determined that it has no material unrecognized tax benefits that if recognized would affect the effective tax rate. The Company’s general policy is to record tax penalties and interest as a component of “other operating expenses”. The Company’s tax returns are subject to income tax audit by federal and state agencies beginning with the year 2008. Retained earnings at December 31, 2011 and 2010 includes approximately $6,869,000 representing pre-1988 tax bad debt reserve base year amounts for which no deferred income tax liability has been provided since these reserves are not expected to reverse or may never reverse. Circumstances that would require an accrual of a portion or all of this unrecorded tax liability are a reduction in qualifying loan levels relative to the end of 1987, failure to meet the definition of a bank, dividend payments in excess of accumulated tax earnings and profits, or 122 other distributions in dissolution, liquidation or redemption of the Bank’s stock. The following is a reconcilement of federal income tax expense at the statutory rate of 35% to the income tax provision reported in the financial statements. ($ in thousands) 2011 2010 2009 Tax provision at statutory rate Increase (decrease) in income taxes resulting from: Tax-exempt interest income Low income housing tax credits Non-deductible interest expense State income taxes, net of federal benefit Change in valuation allowance Other, net Total $ 7,354 $ 5,230 $ 34,257 (852) (163) 33 910 (5) 93 $ 7,370 (726) (143) 37 454 (145) 253 $ 4,960 (459) (114) 38 3,824 3 69 $ 37,618 Note 9. Time Deposits, Securities Sold Under Agreements to Repurchase, and Related Party Deposits At December 31, 2011, the scheduled maturities of time deposits were as follows: ($ in thousands) 2012 2013 2014 2015 2016 Thereafter $ 1,003,566 162,617 65,288 64,592 37,873 1,503 $ 1,335,439 For the years ended December 31, 2011, 2010, and 2009, the Company recorded amortization of deposit premiums amounting to $337,000, $2,211,000 and $3,911,000, respectively, which reduced interest expense. The deposit premiums related to the Company’s acquisitions are discussed in Note 2. The Company has $123,000 remaining in unamortized deposit premiums at December 31, 2011. Securities sold under agreements to repurchase represent short-term borrowings by the Company with maturities less than one year and are collateralized by a portion of the Company’s securities portfolio, which have been delivered to a third-party custodian for safekeeping. At December 31, 2011, securities with an amortized cost of $17,184,000 and a market value of $17,155,000 were pledged to secure securities sold under agreements to repurchase. The following table presents certain information for securities sold under agreements to repurchase: ($ in thousands) Balance at December 31 Weighted average interest rate at December 31 Maximum amount outstanding at any month-end during the year Average daily balance outstanding during the year Average annual interest rate paid during the year 2011 $ 17,105 0.32% $ 72,926 $ 55,011 0.33% 2010 $ 54,460 0.36% $ 68,157 $ 57,443 0.52% Deposits received from executive officers and directors and their associates totaled approximately $30,764,000 and $27,607,000 at December 31, 2011 and 2010, respectively. These deposit accounts have substantially the same terms, including interest rates, as those prevailing at the time for comparable transactions with other non- related depositors. 123 Note 10. Borrowings and Borrowings Availability The following tables present information regarding the Company’s outstanding borrowings at December 31, 2011 and 2010: Description - 2011 Due date Call Feature 2011 Amount Interest Rate 4/20/12 Quarterly by FHLB, beginning 4/20/09 $ 7,500,000 4.51% fixed FHLB Term Note FHLB Term Note FHLB Term Note FHLB Term Note FHLB Term Note FHLB Term Note FHLB Term Note Trust Preferred Securities 6/28/12 12/28/12 6/28/2013 12/30/13 1/13/14 6/30/14 1/23/34 Trust Preferred Securities 6/15/36 Total borrowings/ weighted average rate None None None None None None Quarterly by Company beginning 1/23/09 Quarterly by Company beginning 6/15/11 15,000,000 0.69% fixed 7,500,000 0.91% fixed 15,000,000 0.72% fixed 7,500,000 1.50% fixed 20,000,000 1.38% fixed 15,000,000 1.21% fixed 20,620,000 25,774,000 3.13% at 12/31/11 adjustable rate 3 month LIBOR + 2.70% 1.94% at 12/31/11 adjustable rate 3 month LIBOR + 1.39% 133,894,000 1.74% Unamortized fair market value adjustment recorded in acquisition Total borrowings as of December 31, 2011 31,000 $ 133,925,000 124 Description - 2010 Due date Call Feature FHLB Overnight Borrowings Federal Funds Purchased Line of Credit with Federal Reserve Bank 1/1/11, renewable daily 1/1/11, renewable daily 1/1/11, renewable daily FHLB Term Note 8/1/11 None None None None 2010 Amount $20,000,000 33,000,000 55,000,000 3,000,000 Interest Rate 0.47% subject to change daily 0.65% subject to change daily 0.75% subject to change daily 0.29% at 12/31/10 Adjustable rate based on 3 month LIBOR 12/12/11 Quarterly by FHLB, beginning 6/12/08 1,800,000 4.21% fixed 4/20/12 Quarterly by FHLB, beginning 4/20/09 7,500,000 4.51% fixed FHLB Term Note FHLB Term Note FHLB Term Note FHLB Term Note FHLB Term Note 6/28/12 12/28/12 12/30/13 Trust Preferred Securities 1/23/34 Trust Preferred Securities 6/15/36 None None None Quarterly by Company beginning 1/23/09 Quarterly by Company beginning 6/15/11 Total borrowings/ weighted average rate Unamortized fair market value adjustment recorded in acquisition Total borrowings as of December 31, 2010 15,000,000 0.69% fixed 7,500,000 0.91% fixed 7,500,000 1.50% fixed 2.99% at 12/31/10 adjustable rate 3 month LIBOR + 2.70% 1.69% at 12/31/10 adjustable rate 3 month LIBOR + 1.39% 1.26% (1.98% excluding overnight borrowings) 20,620,000 25,774,000 196,694,000 176,000 $ 196,870,000 As noted in the table above, at December 31, 2011 and 2010, borrowings outstanding included $31,000 and $176,000, respectively, in unamortized premium on borrowings acquired from a 2008 acquisition. The originally recorded premium was $1,328,000, of which $145,000, $341,000, and $464,000 was amortized in 2011, 2010, and 2009, respectively, as a reduction of interest expense. All outstanding FHLB borrowings may be accelerated immediately by the FHLB in certain circumstances, including material adverse changes in the condition of the Company or if the Company’s qualifying collateral amounts to less than that required under the terms of the FHLB borrowing agreement. In the above tables, the $20.6 million in borrowings due on January 23, 2034 relate to borrowings structured as trust preferred capital securities that were issued by First Bancorp Capital Trusts II and III ($10.3 million by each trust), which are unconsolidated subsidiaries of the Company, on December 19, 2003 and qualify as capital for regulatory capital adequacy requirements. These unsecured debt securities are callable by the Company at par on any quarterly interest payment date beginning on January 23, 2009. The interest rate on these debt securities adjusts on a quarterly basis at a rate of three-month LIBOR plus 2.70%. The Company incurred approximately $580,000 of debt issuance costs related to the issuance that were recorded as prepaid expenses and are included in the “Other Assets” line item of the consolidated balance sheet. These debt issuance costs were amortized as interest expense until the earliest possible call date of January 23, 2009. In the above tables, the $25.8 million in borrowings due on June 15, 2036 relate to borrowings structured as trust preferred capital securities that were issued by First Bancorp Capital Trust IV, an unconsolidated subsidiary 125 of the Company, on April 13, 2006 and qualify as capital for regulatory capital adequacy requirements. These unsecured debt securities are callable by the Company at par on any quarterly interest payment date beginning on June 15, 2011. The interest rate on these debt securities adjusts on a quarterly basis at a rate of three-month LIBOR plus 1.39%. The Company incurred no debt issuance costs related to the issuance. At December 31, 2011, the Company had four sources of readily available borrowing capacity – 1) an approximately $389 million line of credit with the FHLB, of which $88 million was outstanding at December 31, 2011 and $62 million was outstanding at December 31, 2010, 2) a $50 million overnight federal funds line of credit with a correspondent bank, of which none was outstanding at December 31, 2011 and $33 million was outstanding at December 31, 2010, 3) an approximately $79 million line of credit through the Federal Reserve Bank of Richmond’s (FRB) discount window, of which none was outstanding at December 31, 2011 and $55 million was outstanding at December 31, 2010, and 4) a $10 million holding company line of credit with a commercial bank, of which none was outstanding at December 31, 2011 or 2010. The Company’s line of credit with the FHLB totaling approximately $389 million can be structured as either short-term or long-term borrowings, depending on the particular funding or liquidity needs and is secured by the Company’s FHLB stock and a blanket lien on most of its real estate loan portfolio. In addition to the outstanding borrowings from the FHLB that reduce the available borrowing capacity of the line of credit, the borrowing capacity was further reduced by $203 million at December 31, 2011 and 2010, as a result of the Company pledging letters of credit for public deposits at each of those dates. Accordingly, the Company’s unused FHLB line of credit was $98 million at December 31, 2011. The Company’s correspondent bank relationship allows the Company to purchase up to $50 million in federal funds on an overnight, unsecured basis (federal funds purchased). The Company had no borrowings outstanding under this line at December 31, 2011 and $33 million in borrowings outstanding at December 31, 2010. The Company has a line of credit with the FRB discount window. This line is secured by a blanket lien on a portion of the Company’s commercial and consumer loan portfolio (excluding real estate). Based on the collateral owned by the Company as of December 31, 2011, the available line of credit was approximately $79 million. The Company had no borrowings outstanding under this line of credit at December 31, 2011 and $55 million in borrowings outstanding at December 31, 2010. At December 31, 2011 and 2010, the Company had a $10 million line of credit with a correspondent bank that was secured by 100% of the common stock of the Bank. This line of credit expires and is subject to renewal in March of each year. The line of credit was not drawn at December 31, 2011 or 2010. Note 11. Leases Certain bank premises are leased under operating lease agreements. Generally, operating leases contain renewal options on substantially the same basis as current rental terms. Rent expense charged to operations under all operating lease agreements was $1,226,000 in 2011, $2,076,000 in 2010, and $1,978,000 in 2009. 126 Future obligations for minimum rentals under noncancelable operating leases at December 31, 2011 are as follows: ($ in thousands) Year ending December 31: 2012 2013 2014 2015 2016 Later years Total $ 805 751 701 612 513 2,143 $ 5,525 Note 12. Employee Benefit Plans 401(k) Plan. The Company sponsors a retirement savings plan pursuant to Section 401(k) of the Internal Revenue Code. Employees who have completed one year of service are eligible to participate in the plan. New employees, who have met the service requirement, are automatically enrolled in the plan at a 2% deferral rate, which can be modified by the employee at any time. An eligible employee may contribute up to 15% of annual salary to the plan. The Company contributes an amount equal to 75% of the first 6% of the employee’s salary contributed. Participants vest in Company contributions at the rate of 20% after one year of service, and 20% for each additional year of service, with 100% vesting after five years of service. The Company’s matching contribution expense was $1,198,000, $1,107,000, and $933,000, for the years ended December 31, 2011, 2010, and 2009, respectively. Additionally, the Company made additional discretionary matching contributions to the plan of $200,000 in 2009. The Company did not make a discretionary contribution in 2011 or 2010. The Company’s matching and discretionary contributions are made in the form of Company stock, which can be transferred by the employee into other investment options offered by the plan at any time. Employees are not permitted to invest their own contributions in Company stock. Pension Plan. The Company sponsors a noncontributory defined benefit retirement plan (the “Pension Plan”), which is intended to qualify under Section 401(a) of the Internal Revenue Code. Employees who have attained age 21 and completed one year of service are eligible to participate in the Pension Plan. The Pension Plan provides for a monthly payment, at normal retirement age of 65, equal to one-twelfth of the sum of (i) 0.75% of Final Average Annual Compensation (5 highest consecutive calendar years’ earnings out of the last 10 years of employment) multiplied by the employee’s years of service not in excess of 40 years, and (ii) 0.65% of Final Average Annual Compensation in excess of “covered compensation” multiplied by years of service not in excess of 35 years. “Covered compensation” means the average of the social security taxable wage base during the 35 year period ending with the year the employee attains social security retirement age. Early retirement, with reduced monthly benefits, is available at age 55 after 15 years of service. The Pension Plan provides for 100% vesting after 5 years of service, and provides for a death benefit to a vested participant’s surviving spouse. The costs of benefits under the Pension Plan, which are borne by the Company, are computed actuarially and defrayed by earnings from the Pension Plan’s investments. The compensation covered by the Pension Plan includes total earnings before reduction for contributions to a cash or deferred profit-sharing plan (such as the 401(k) plan described above) and amounts used to pay group health insurance premiums and includes bonuses (such as amounts paid under the incentive compensation plan). Compensation for the purposes of the Pension Plan may not exceed statutory limits; such limits were $245,000 in 2011, $245,000 in 2010 and $235,000 in 2009. During the second quarter of 2009, the Company amended the Pension Plan to prohibit new entrants into the plan. The Company’s contributions to the Pension Plan are based on computations by independent actuarial consultants and are intended to provide the Company with the maximum deduction for income tax purposes. 127 The contributions are invested to provide for benefits under the Pension Plan. The Company expects that it will contribute $2,500,000 to the Pension Plan in 2012. The following table reconciles the beginning and ending balances of the Pension Plan’s benefit obligation, as computed by the Company’s independent actuarial consultants, and its plan assets, with the difference between the two amounts representing the funded status of the Pension Plan as of the end of the respective year. ($ in thousands) Change in benefit obligation Projected benefit obligation at beginning of year Service cost Interest cost Actuarial (gain) loss Benefits paid Projected benefit obligation at end of year Change in plan assets Plan assets at beginning of year Actual return on plan assets Employer contributions Benefits paid Plan assets at end of year 2011 2010 2009 $ 31,140 1,782 1,638 6,004 (480) 40,084 22,431 15 2,500 (480) 24,466 25,395 1,754 1,555 2,830 (394) 31,140 17,793 2,532 2,500 (394) 22,431 24,039 1,687 1,360 (1,309) (382) 25,395 13,065 3,610 1,500 (382) 17,793 Funded status at end of year $ (15,618) (8,709) (7,602) The accumulated benefit obligation related to the Pension Plan was $29,641,000, $22,124,000, and $18,413,000 at December 31, 2011, 2010, and 2009, respectively. The following table presents information regarding the amounts recognized in the consolidated balance sheets at December 31, 2011 and 2010 as it relates to the Pension Plan, excluding the related deferred tax assets. ($ in thousands) 2011 2010 Other assets – prepaid pension asset Other liabilities $ 671 (16,289) $ (15,618) 270 (8,979) (8,709) The following table presents information regarding the amounts recognized in accumulated other comprehensive income (AOCI) at December 31, 2011 and 2010, as it relates to the Pension Plan. ($ in thousands) 2011 2010 Net loss Net transition obligation Prior service cost Amount recognized in AOCI before tax effect Tax benefit Net amount recognized as reduction to AOCI $ 16,213 32 44 16,289 (6,434) $ 9,855 8,889 34 56 8,979 (3,547) 5,432 128 The following table reconciles the beginning and ending balances of accumulated other comprehensive income (AOCI) at December 31, 2011 and 2010, as it relates to the Pension Plan: ($ in thousands) Accumulated other comprehensive loss at beginning of fiscal year Net loss arising during period Amortization of unrecognized actuarial loss Amortization of prior service cost and transition obligation Tax benefit of changes during the year, net Accumulated other comprehensive loss at end of fiscal year 2011 2010 $ 5,432 7,707 (382) (13) (2,889) $ 9,855 4,639 1,777 (450) (15) (519) 5,432 The following table reconciles the beginning and ending balances of the prepaid pension cost related to the Pension Plan: ($ in thousands) 2011 2010 Prepaid pension cost as of beginning of fiscal year Net periodic pension cost for fiscal year Actual employer contributions Prepaid pension asset as of end of fiscal year $ 270 (2,099) 2,500 $ 671 65 (2,295) 2,500 270 Net pension cost for the Pension Plan included the following components for the years ended December 31, 2011, 2010, and 2009: ($ in thousands) 2011 2010 2009 Service cost – benefits earned during the period Interest cost on projected benefit obligation Expected return on plan assets Net amortization and deferral Net periodic pension cost $ 1,782 1,638 (1,716) 395 $ 2,099 1,754 1,555 (1,479) 465 2,295 1,687 1,360 (998) 780 2,829 The estimated net loss, transition obligation, and prior service cost that will be amortized from accumulated other comprehensive income into net periodic pension cost over the next fiscal year are $1,070,000, $2,000, and $12,000, respectively. The following table is an estimate of the benefits that will be paid in accordance with the Pension Plan during the indicated time periods: ($ in thousands) Year ending December 31, 2012 Year ending December 31, 2013 Year ending December 31, 2014 Year ending December 31, 2015 Year ending December 31, 2016 Years ending December 31, 2017-2021 Estimated benefit payments $ 661 827 1,017 1,065 1,384 8,945 For each of the years ended December 31, 2011, 2010, and 2009, the Company used an expected long-term rate-of-return-on-assets assumption of 7.75%. The Company arrived at this rate based primarily on a third-party investment consulting firm’s historical analysis of investment returns, which indicated that the mix of the Pension Plan’s assets (generally 75% equities and 25% fixed income) can be expected to return approximately 7.75% on a long term basis. 129 Funds in the Pension Plan are invested in a mix of investment types in accordance with the Pension Plan’s investment policy, which is intended to provide an average annual rate of return of 7% to 10%, while maintaining proper diversification. Except for Company stock, all of the Pension Plan’s assets are invested in an unaffiliated bank money market account or mutual funds. The investment policy of the Pension Plan does not permit the use of derivatives, except to the extent that derivatives are used by any of the mutual funds invested in by the Pension Plan. The following table presents the targeted mix of the Pension Plan’s assets as of December 31, 2011, as set out by the Plan’s investment policy: Investment type Fixed income investments Cash/money market account US government bond fund US corporate bond fund US corporate high yield bond fund Equity investments Large cap value fund Large cap growth fund Mid cap equity fund Small cap growth fund Foreign equity fund Company stock Targeted % of Total Assets Acceptable Range % of Total Assets 2% 10% 10% 5% 20% 20% 10% 8% 10% 5% 1%-5% 10%-20% 5%-15% 0%-10% 20%-30% 20%-30% 5%-15% 5%-15% 5%-15% 0%-10% The Pension Plan’s investment strategy contains certain investment objectives and risks for each permitted investment category. To ensure that risk and return characteristics are consistently followed, the Pension Plan’s investments are reviewed at least semi-annually and rebalanced within the acceptable range. Performance measurement of the investments employs the use of certain investment category and peer group benchmarks. The investment category benchmarks as of December 31, 2011 are as follows: Investment Category Investment Category Benchmark Range of Acceptable Deviation from Investment Category Benchmark Fixed income investments Cash/money market account US government bond fund US corporate bond fund US corporate high yield bond fund Equity investments Large cap value fund Large cap growth fund Mid cap equity fund Small cap growth fund Foreign equity fund Company stock Citigroup Treasury Bill Index – 3 month Barclays Intermediate Government Bond Index Barclays Aggregate Index Barclays High Yield Index Russell 1000 Value Index Russell 1000 Growth Index Russell Mid Cap Index Russell 2000 Growth Index MSCI EAFE Index Russell 2000 Index 0-50 basis points 0-200 basis points 0-200 basis points 0-200 basis points 0-300 basis points 0-300 basis points 0-300 basis points 0-300 basis points 0-300 basis points 0-300 basis points Each of the investment fund’s average annualized return over a three-year period should be within the range of acceptable deviation from the benchmarked index shown above. In addition to the investment category benchmarks, the Pension Plan also utilizes certain Peer Group benchmarks, based on Morningstar percentile rankings for each investment category. Funds are generally considered to be underperformers if their category ranking is below the 75th percentile for the trailing one-year period; the 50th percentile for the trailing three-year period; and the 25th percentile for the trailing five-year period. The Pension Plan invests in various investment securities which are exposed to various risks such as interest rate, market, and credit risks. All of these risks are monitored and managed by the Company. No significant 130 concentration of risk exists within the plan assets at December 31, 2011. The fair values of the Company’s pension plan assets at December 31, 2011, by asset category, are as follows: ($ in thousands) Total Fair Value at December 31, 2011 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Fixed income investments Money market funds US government bond fund US corporate bond fund US corporate high yield bond fund Equity investments Large cap value fund Large cap growth fund Small cap growth fund Mid cap growth fund Foreign equity fund Company stock Total $ 831 2,356 2,331 1,195 5,194 4,883 2,030 2,491 2,328 827 $ 24,466 (cid:1086)(cid:3)(cid:3)(cid:3)(cid:3) 2,356 2,331 1,195 5,194 4,883 2,030 2,491 2,328 827 23,635 831 (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) 831 (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) The fair values of the Company’s pension plan assets at December 31, 2010, by asset category, are as follows: ($ in thousands) Total Fair Value at December 31, 2010 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Fixed income investments Money market funds US government bond fund US corporate bond fund US corporate high yield bond fund Equity investments Large cap value fund Large cap growth fund Small cap growth fund Mid cap growth fund Foreign equity fund Company stock Total $ 525 1,987 2,038 1,147 4,634 4,623 2,106 2,523 2,286 562 $ 22,431 (cid:1086)(cid:3)(cid:3)(cid:3)(cid:3) 1,987 2,038 1,147 4,634 4,623 2,106 2,523 2,286 562 21,906 525 (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) 525 (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) (cid:1086) The following is a description of the valuation methodologies used for assets measured at fair value. There have been no changes in the methodologies used at December 31, 2011 and 2010. - Money market fund: valued on the active market on which it is traded; at amortized cost, which approximates fair value. - Mutual funds, common stocks: valued at the closing price reported on the active market on which the individual securities are traded. Supplemental Executive Retirement Plan. The Company sponsors a Supplemental Executive Retirement Plan (the “SERP”) for the benefit of certain senior management executives of the Company. The purpose of the SERP is to provide additional monthly pension benefits to ensure that each such senior management executive would receive lifetime monthly pension benefits equal to 3% of his or her final average compensation multiplied by his or her years of service (maximum of 20 years) to the Company or its subsidiaries, subject to a maximum of 60% 131 of his or her final average compensation. The amount of a participant’s monthly SERP benefit is reduced by (i) the amount payable under the Company’s qualified Pension Plan (described above), and (ii) 50% of the participant’s primary social security benefit. Final average compensation means the average of the 5 highest consecutive calendar years of earnings during the last 10 years of service prior to termination of employment. The SERP is an unfunded plan. Payments are made from the general assets of the Company. The following table reconciles the beginning and ending balances of the SERP’s benefit obligation, as computed by the Company’s independent actuarial consultants: ($ in thousands) Change in benefit obligation Projected benefit obligation at beginning of year Service cost Interest cost Actuarial (gain) loss Benefits paid Projected benefit obligation at end of year Plan assets Funded status at end of year 2011 2010 2009 $ 7,433 292 351 93 (105) 8,064 (cid:326) $ (8,064) 6,222 408 377 531 (105) 7,433 (cid:326) (7,433) 5,239 464 328 296 (105) 6,222 (cid:326) (6,222) The accumulated benefit obligation related to the SERP was $7,199,000, $5,623,000, and $4,882,000 at December 31, 2011, 2010, and 2009, respectively. The following table presents information regarding the amounts recognized in the consolidated balance sheets at December 31, 2011 and 2010 as it relates to the SERP, excluding the related deferred tax assets. ($ in thousands) Other assets – prepaid pension asset (liability) Other liabilities 2011 2010 $ (6,075) (1,989) $ (8,064) (5,507) (1,926) (7,433) The following table presents information regarding the amounts recognized in AOCI at December 31, 2011 and 2010. ($ in thousands) Net (gain)/loss Prior service cost Amount recognized in AOCI before tax effect Tax benefit Net amount recognized as reduction to AOCI 2011 2010 $ 1,887 102 1,989 (786) $ 1,203 1,805 121 1,926 (761) 1,165 The following table reconciles the beginning and ending balances of accumulated other comprehensive income (AOCI) at December 31, 2011 and 2010, as it relates to the SERP: ($ in thousands) Accumulated other comprehensive loss at beginning of fiscal year Net loss arising during period Amortization of unrecognized actuarial loss Amortization of prior service cost and transition obligation Tax benefit of changes during the year, net Accumulated other comprehensive loss at end of fiscal year 2011 2010 $ 1,165 93 (12) (19) (24) $ 1,203 906 530 (81) (19) (171) 1,165 132 The following table reconciles the beginning and ending balances of the prepaid pension cost related to the SERP: ($ in thousands) Prepaid pension cost (liability) as of beginning of fiscal year Net periodic pension cost for fiscal year Benefits paid Prepaid pension cost (liability) as of end of fiscal year 2011 2010 $ (5,507) (673) 105 $ (6,075) (4,727) (885) 105 (5,507) Net pension cost for the SERP included the following components for the years ended December 31, 2011, 2010, and 2009: ($ in thousands) 2011 2010 2009 Service cost – benefits earned during the period Interest cost on projected benefit obligation Net amortization and deferral Net periodic pension cost $ 292 351 30 $ 673 408 377 100 885 464 328 125 917 The estimated net loss and prior service cost that will be amortized from accumulated other comprehensive income into net periodic pension cost over the next fiscal year are $135,000 and $19,000, respectively. The following table is an estimate of the benefits that will be paid in accordance with the SERP during the indicated time periods: ($ in thousands) Year ending December 31, 2012 Year ending December 31, 2013 Year ending December 31, 2014 Year ending December 31, 2015 Year ending December 31, 2016 Years ending December 31, 2017-2021 Estimated benefit payments $ 230 326 321 315 436 2,494 The following assumptions were used in determining the actuarial information for the Pension Plan and the SERP for the years ended December 31, 2011, 2010, and 2009: 2011 2010 2009 Pension Plan SERP Pension Plan SERP Pension Plan Discount rate used to determine net periodic pension cost 5.59% 5.59% 6.00% 6.00% 5.75% Discount rate used to calculate end of year liability disclosures Expected long-term rate of return on assets Rate of compensation increase 4.39% 7.75% 5.00% 4.39% n/a 5.00% 5.59% 7.75% 5.00% 5.59% n/a 5.00% 6.00% 7.75% 5.00% SERP 5.75% 6.00% n/a 5.00% The Company’s discount rate policy is based on a calculation of the Company’s expected pension payments, with those payments discounted using the Citigroup Pension Index yield curve. 133 Note 13. Commitments, Contingencies, and Concentrations of Credit Risk See Note 2 for discussion regarding a pending purchase of eleven bank branches from another bank. See Note 11 with respect to future obligations under noncancelable operating leases. In the normal course of the Company’s business, there are various outstanding commitments and contingent liabilities such as commitments to extend credit that are not reflected in the financial statements. The following table presents the Company’s outstanding loan commitments at December 31, 2011. ($ in millions) Type of Commitment Outstanding closed-end loan commitments Unfunded commitments on revolving lines of credit, credit cards and home equity loans Total Fixed Rate $ 39 32 $ 71 Variable Rate 278 185 463 Total 317 217 534 At December 31, 2011 and 2010, the Company had $7.1 million and $7.5 million, respectively, in standby letters of credit outstanding. The Company has no carrying amount for these standby letters of credit at either of those dates. The nature of the standby letters of credit is a guarantee made on behalf of the Company’s customers to suppliers of the customers to guarantee payments owed to the supplier by the customer. The standby letters of credit are generally for terms for one year, at which time they may be renewed for another year if both parties agree. The payment of the guarantees would generally be triggered by a continued nonpayment of an obligation owed by the customer to the supplier. The maximum potential amount of future payments (undiscounted) the Company could be required to make under the guarantees in the event of nonperformance by the parties to whom credit or financial guarantees have been extended is represented by the contractual amount of the standby letter of credit. In the event that the Company is required to honor a standby letter of credit, a note, already executed with the customer, is triggered which provides repayment terms and any collateral. Over the past two years, the Company has had to honor several insignificant standby letters of credit, which have been or are being repaid by the borrower without any loss to the Company. Management expects any draws under existing commitments to be funded through normal operations. The Company is not involved in any legal proceedings which, in management’s opinion, could have a material effect on the consolidated financial position of the Company. The Bank grants primarily commercial and installment loans to customers throughout its market area, which consists of Anson, Beaufort, Bladen, Brunswick, Buncombe, Cabarrus, Carteret, Chatham, Columbus, Dare, Davidson, Duplin, Guilford, Harnett, Iredell, Lee, Montgomery, Moore, New Hanover, Onslow, Randolph, Richmond, Robeson, Rockingham, Rowan, Scotland, Stanly and Wake Counties in North Carolina, Chesterfield, Dillon, Florence and Horry Counties in South Carolina, and Montgomery, Pulaski, Washington and Wythe Counties in Virginia. The real estate loan portfolio can be affected by the condition of the local real estate market. The commercial and installment loan portfolios can be affected by local economic conditions. The Company’s loan portfolio is not concentrated in loans to any single borrower or to a relatively small number of borrowers. Additionally, management is not aware of any concentrations of loans to classes of borrowers or industries that would be similarly affected by economic conditions. In addition to monitoring potential concentrations of loans to particular borrowers or groups of borrowers, industries and geographic regions, the Company monitors exposure to credit risk that could arise from potential concentrations of lending products and practices such as loans that subject borrowers to substantial payment increases (e.g. principal deferral periods, loans with initial interest-only periods, etc), and loans with high loan- 134 to-value ratios. Additionally, there are industry practices that could subject the Company to increased credit risk should economic conditions change over the course of a loan’s life. For example, the Company makes variable rate loans and fixed rate principal-amortizing loans with maturities prior to the loan being fully paid (i.e. balloon payment loans). These loans are underwritten and monitored to manage the associated risks. The Company has determined that there is no concentration of credit risk associated with its lending policies or practices. The Company’s investment portfolio consists principally of obligations of government-sponsored enterprises, mortgage-backed securities guaranteed by government-sponsored enterprises, corporate bonds, FHLB stock and general obligation municipal securities. The following are the fair values at December 31, 2011 of available for sale and held to maturity securities to any one issuer/guarantor that exceed $2.0 million, with such amounts representing the maximum amount of credit risk that the Company would incur if the issuer did not repay the obligation. ($ in thousands) Issuer Ginnie Mae - mortgage-backed securities Small Business Administration - pooled bonds Federal Home Loan Bank System - bonds Federal Farm Credit bonds Federal Home Loan Bank of Atlanta - common stock Fannie Mae - mortgage-backed securities Bank of America - trust preferred securities Freddie Mac - mortgage-backed securities Craven County, North Carolina municipal bond First Citizens Bancorp (South Carolina) – bond / trust preferred securities Spartanburg, South Carolina Sanitary Sewer District municipal bond Richmond County, North Carolina municipal bond South Carolina State municipal bond Virginia State Housing Authority municipal bond First Citizens Bancorp (North Carolina) - trust preferred security Amortized Cost $ 66,888 39,034 20,511 14,000 10,904 9,422 7,085 4,688 3,665 3,996 3,301 2,610 2,124 2,194 2,108 Fair Value 70,016 39,055 20,655 14,010 10,904 10,045 6,368 4,939 4,041 3,842 3,628 2,793 2,338 2,304 2,278 Until February 27, 2009, the FHLB redeemed their stock at par as borrowings were repaid. On February 27, 2009, the FHLB announced that they would no longer automatically redeem their stock when loans are repaid. Instead, they stated that they would evaluate whether they would repurchase stock on a quarterly basis. During the second half of 2010, the FHLB repurchased $1.8 million of stock from the Company. During 2011, the FHLB repurchased $4.4 million of stock from the Company. The Company places its deposits and correspondent accounts with the Federal Home Loan Bank of Atlanta, the Federal Reserve Bank, and Bank of America and sells its federal funds to Bank of America. At December 31, 2011, the Company had deposits in the Federal Home Loan Bank of Atlanta totaling $17.6 million, deposits of $117.6 million in the Federal Reserve Bank, and deposits of $54.9 million in Bank of America and federal funds sold to Bank of America of $0.6 million. None of the deposits held at the Federal Home Loan Bank of Atlanta, the Federal Reserve Bank, or the federal funds sold to Bank of America are FDIC-insured, however the Federal Reserve Bank is a government entity and therefore risk of loss is minimal. The deposits held at Bank of America are fully guaranteed by the FDIC under its Temporary Liquidity Guarantee Program which guarantees, until December 31, 2013, an unlimited amount of non-interest bearing deposits. 135 Note 14. Fair Value of Financial Instruments As discussed in Note 1(o), the Company is required to disclose estimated fair values for its financial instruments. Fair value estimates as of December 31, 2011 and 2010 and limitations thereon are set forth below for the Company’s financial instruments. See Note 1(o) for a discussion of fair value methods and assumptions, as well as fair value information for off-balance sheet financial instruments. ($ in thousands) Cash and due from banks, noninterest-bearing Due from banks, interest-bearing Federal funds sold Securities available for sale Securities held to maturity Presold mortgages in process of settlement Loans - non-covered, net of allowance Loans - covered, net of allowance FDIC indemnification asset Accrued interest receivable Deposits Securities sold under agreements to repurchase Borrowings Accrued interest payable December 31, 2011 Carrying Amount Estimated Fair Value $ 80,341 135,218 608 182,626 57,988 6,090 2,033,542 355,426 121,677 11,779 80,341 135,218 608 182,626 62,754 6,090 1,987,979 355,426 121,004 11,779 December 31, 2010 Carrying Amount 56,821 154,320 861 181,182 54,018 3,962 2,044,729 359,973 123,719 13,579 Estimated Fair Value 56,821 154,320 861 181,182 53,312 3,962 2,020,109 359,973 122,351 13,579 2,755,037 2,759,504 2,652,613 2,657,214 17,105 133,925 1,872 17,105 106,333 1,872 54,460 196,870 2,082 54,460 168,508 2,082 Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no highly liquid market exists for a significant 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. Fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets and liabilities that are not considered financial assets or liabilities include net premises and equipment, intangible and other assets such as foreclosed properties, deferred income taxes, prepaid expense accounts, income taxes currently payable and other various accrued expenses. In addition, the income tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates. Relevant accounting guidance establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The guidance describes three levels of inputs that may be used to measure fair value: Level 1: Quoted prices (unadjusted) of identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date. Level 2: Quoted prices for similar instruments in active or non-active markets and model-derived valuations in which all significant inputs are observable in active markets. 136 Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability. The following table summarizes the Company’s financial instruments that were measured at fair value on a recurring and nonrecurring basis at December 31, 2011. Fair Value at December 31, 2011 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) ($ in thousands) Description of Financial Instruments Recurring Securities available for sale: Government-sponsored enterprise securities Mortgage-backed securities Corporate bonds Equity securities Total available for sale securities $ 34,665 124,105 12,488 11,368 $ 182,626 Nonrecurring Impaired loans – covered Impaired loans – non-covered Other real estate – covered Other real estate – non-covered $ 55,690 85,286 85,272 37,023 — — — 398 398 — — — — 34,665 124,105 12,488 10,969 182,227 55,690 85,286 85,272 37,023 — — — — — — — — — The following table summarizes the Company’s financial instruments that were measured at fair value on a recurring and nonrecurring basis at December 31, 2010. ($ in thousands) Description of Financial Instruments Recurring Securities available for sale: Government-sponsored enterprise securities Mortgage-backed securities Corporate bonds Equity securities Total available for sale securities Nonrecurring Impaired loans – covered Impaired loans – non-covered Other real estate – covered Other real estate – non-covered Fair Value at December 31, 2010 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) $ 43,273 107,460 15,330 15,119 $ 181,182 $ 72,825 96,003 94,891 21,081 — — — 360 360 — — — — 43,273 107,460 15,330 14,759 180,822 72,825 96,003 94,891 21,081 — — — — — — — — — The following is a description of the valuation methodologies used for instruments measured at fair value. Securities — When quoted market prices are available in an active market, the securities are classified as Level 1 in the valuation hierarchy. Level 1 securities for the Company include certain equity securities. If quoted market prices are not available, but fair values can be estimated by observing quoted prices of securities with similar characteristics, the securities are classified as Level 2 on the valuation hierarchy. For the Company, Level 2 securities include mortgage-backed securities, collateralized mortgage obligations, government-sponsored entity securities, and corporate bonds. In cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy. 137 Impaired loans — Fair values for impaired loans in the above table are collateral dependent and are estimated based on underlying collateral values, which are then adjusted for the cost related to liquidation of the collateral. Other real estate – Other real estate, consisting of properties obtained through foreclosure or in satisfaction of loans, is reported at the lower of cost or fair value, determined on the basis of current appraisals, comparable sales, and other estimates of value obtained principally from independent sources, adjusted for estimated selling costs. At the time of foreclosure, any excess of the loan balance over the fair value of the real estate held as collateral is treated as a charge against the allowance for loan losses. There were no transfers to or from Level 1 and 2 during the year ended December 31, 2011. For the year ended December 31, 2011, the increase in the fair value of securities available for sale was $1,418,000, which is included in other comprehensive income (net of taxes of $554,000). For the year ended December 31, 2010, the increase in the fair value of securities available for sale was $646,000, which is included in other comprehensive income (net of taxes of $251,000). Fair value measurement methods at December 31, 2011 and 2010 are consistent with those used in prior reporting periods. Note 15. Equity-Based Compensation Plans At December 31, 2011, the Company had the following equity-based compensation plans: the First Bancorp 2007 Equity Plan, the First Bancorp 2004 Stock Option Plan, the First Bancorp 1994 Stock Option Plan, and one plan that was assumed from an acquired entity. The Company’s shareholders approved all equity-based compensation plans, except for those assumed from acquired companies. The First Bancorp 2007 Equity Plan became effective upon the approval of shareholders on May 2, 2007. As of December 31, 2011, the First Bancorp 2007 Equity Plan was the only plan that had shares available for future grants. The First Bancorp 2007 Equity Plan is intended to serve as a means to attract, retain and motivate key employees and directors and to associate the interests of the plans’ participants with those of the Company and its shareholders. The First Bancorp 2007 Equity Plan allows for both grants of stock options and other types of equity-based compensation, including stock appreciation rights, restricted stock, restricted performance stock, unrestricted stock, and performance units. Prior to the June 17, 2008 grant (discussed below), stock option grants to employees generally had five-year vesting schedules (20% vesting each year) and had been irregular, usually falling into three categories - 1) to attract and retain new employees, 2) to recognize changes in responsibilities of existing employees, and 3) to periodically reward exemplary performance. Compensation expense associated with these types of grants is recorded pro-ratably over the vesting period. As it relates to directors, until 2010 the Company had historically granted 2,250 vested stock options to each of the Company’s non-employee directors in June of each year. In June 2011 and 2010, the Company granted 1,414 common shares and 1,039 common shares, respectively, to each non-employee director, which had approximately the same value as 2,250 stock options. Compensation expense associated with these director grants is recognized on the date of grant since there are no vesting conditions. The June 17, 2008 grant of a combination of performance units and stock options have both performance conditions (earnings per share targets) and service conditions that must be met in order to vest. The 262,599 stock options and 81,337 performance units represented the maximum number of options and performance units that could have vested if the Company were to achieve specified maximum goals for earnings per share during the three annual performance periods ending on December 31, 2008, 2009, and 2010. Up to one-third of 138 the total number of options and performance units granted were subject to vesting annually as of December 31 of each year beginning in 2010, if (1) the Company achieved specific earnings per share (EPS) goals during the corresponding performance period and (2) the executive or key employee continued employment for a period of two years beyond the corresponding performance period. Compensation expense for this grant was recorded over the various service periods based on the estimated number of options and performance units that were probable to vest. No compensation cost is recognized for awards that do not vest and any previously recognized compensation cost will be reversed. The Company did not achieve the minimum earnings per share performance goal for 2008 or 2010, and thus two-thirds of the above grant was permanently forfeited. As a result of the significant acquisition gain realized in June 2009 related to a failed bank acquisition, the Company achieved the EPS goal for 2009 and the related awards fully vested on December 31, 2011 for each grantee that remained employed through that date. The Company recorded compensation expense of $299,000 in each of 2009, 2010 and 2011 related to the vesting of these awards. The Company granted long-term restricted shares of common stock to senior executives on December 11, 2009 and February 24, 2011, with vesting terms in accordance with the minimum rules for long-term equity grants for companies participating in the U.S. Treasury’s Troubled Asset Relief Program (TARP). These rules require that the vesting of the stock be tied to repayment of the financial assistance, with a two year minimum vesting period. The Company originally projected the repayment to occur five years after the date of the TARP issuance, and thus the amortization schedule for the expense was based on a repayment date of January 9, 2014. However, the Company redeemed 100% of the TARP preferred stock on September 1, 2011. Therefore, the Company recast the amortization schedule for both grants to be based on the vesting date two years after the grant. The total compensation expense associated with the December 11, 2009 grant was $398,000 and was being initially amortized over a four-year period at approximately $100,000 per year. Due to the TARP repayment, the 2009 grant fully vested on December 11, 2011. Accordingly, the Company accelerated the expense amortization and recorded a total of $298,000 for 2011. The total compensation expense associated with the February 24, 2011 grant was $105,500 and was being initially amortized over a three-year period at approximately $35,000 per year. Due to the TARP repayment, the 2011 grant will fully vest on February 24, 2013. Accordingly, the Company accelerated the expense amortization and recorded a total of $42,000 in 2011. See Note 19 for further information related to the Company’s participation in the TARP. Under the terms of the Predecessor Plans and the First Bancorp 2007 Equity Plan, options can have a term of no longer than ten years, and all options granted thus far under these plans have had a term of ten years. The Company’s options provide for immediate vesting if there is a change in control (as defined in the plans). At December 31, 2011, there were 489,062 options outstanding related to the three First Bancorp plans, with exercise prices ranging from $14.35 to $22.12. At December 31, 2011, there were 906,268 shares remaining available for grant under the First Bancorp 2007 Equity Plan. The Company also has a stock option plan as a result of a corporate acquisition. At December 31, 2011, there were 4,788 stock options outstanding in connection with the acquired plan, with option prices ranging from $10.66 to $15.22. The Company issues new shares of common stock when options are exercised. The Company measures the fair value of each option award on the date of grant using the Black-Scholes option- pricing model. The Company determines the assumptions used in the Black-Scholes option pricing model as follows: the risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of the grant; the dividend yield is based on the Company’s dividend yield at the time of the grant (subject to adjustment if the dividend yield on the grant date is not expected to approximate the dividend yield over the expected life of the option); the volatility factor is based on the historical volatility of the Company’s stock (subject to adjustment if future volatility is reasonably expected to differ from the past); and the weighted-average expected life is based on the historical behavior of employees related to exercises, forfeitures and cancellations. 139 The Company’s equity grants for the year ended December 31, 2011 were the issuance of 1) 7,259 shares of long-term restricted stock to certain senior executives on February 24, 2011, at a fair market value of $14.54 per share, which was the closing price of the Company’s common stock on that date, and 2) 21,210 shares of common stock to non-employee directors on June 1, 2011 (1,414 shares per director), at a fair market value of $11.39 per share, which was the closing price of the Company’s common stock on that date. The Company’s only equity grants for the year ended December 31, 2010 were the issuance of 15,585 shares of common stock to non-employee directors on June 1, 2010 (1,039 shares per director). The fair market value of the Company’s common stock on the grant date was $15.51 per share, which was the closing price of the Company’s common stock on that date. The per share weighted-average fair value of options granted during 2009 was $6.06 on the date of the grant using the Black-Scholes option pricing model with the following weighted-average assumptions: Expected dividend yield Risk-free interest rate Expected life Expected volatility 2009 2.23% 3.28% 7 years 46.32% The Company recorded total stock-based compensation expense of $905,000, $640,000 and $449,000 for the years ended December 31, 2011, 2010 and 2009, respectively. Of the $905,000 in expense that was recorded in 2011, approximately $242,000 related to the June 1, 2011 director grants, which is classified as “other operating expenses” in the Consolidated Statements of Income. The remaining $663,000 in expense relates the employee grants discussed above and is recorded as “salaries expense.” Stock based compensation is reflected as an adjustment to cash flows from operating activities on the Company’s Consolidated Statement of Cash Flows. The Company recognized $353,000, $250,000, and $180,000 of income tax benefits related to stock based compensation expense in the income statement for the years ended December 31, 2011, 2010, and 2009, respectively. As noted above, certain of the Company’s stock option grants contain terms that provide for a graded vesting schedule whereby portions of the award vest in increments over the requisite service period. The Company has elected to recognize compensation expense for awards with graded vesting schedules on a straight-line basis over the requisite service period for the entire award. Compensation expense is based on the estimated number of stock options and awards that will ultimately vest. Over the past five years, there have only been minimal amounts of forfeitures, and therefore the Company assumes that all options granted without performance conditions will become vested. 140 The following table presents information regarding the activity since December 31, 2008 related to all of the Company’s stock options outstanding: Options Outstanding Weighted- Average Exercise Price Weighted- Average Contractual Term (years) Aggregate Intrinsic Value Number of Shares Balance at December 31, 2008 828,876 $ 17.21 Granted Exercised Forfeited Expired 27,000 (73,843) (cid:1086)(cid:3)(cid:3)(cid:3) (28,917) 14.35 13.14 (cid:1086) 11.52 Balance at December 31, 2009 753,116 $ 17.73 Granted Exercised Forfeited Expired (cid:1086)(cid:3)(cid:3)(cid:3) (18,667) (87,536) (4,500) (cid:1086) 10.46 16.53 15.69 Balance at December 31, 2010 642,413 $ 18.11 Granted Exercised Forfeited Expired (cid:1086)(cid:3)(cid:3)(cid:3) (2,300) (cid:1086)(cid:3)(cid:3)(cid:3) (146,247) (cid:1086) 13.30 (cid:1086) 15.47 $ 251,000 $ 97,940 $ 6,949 Outstanding at December 31, 2011 493,866 $ 18.92 3.7 $ 1,337 Exercisable at December 31, 2011 420,936 $ 19.31 3.3 $ 1,337 The Company received $30,000, $171,000, and $393,000 as a result of stock option exercises during the years ended December 31, 2011, 2010, and 2009, respectively. The Company recorded $0, $36,000, and $73,000 in associated tax benefits from the exercise of nonqualified stock options during the years ended December 31, 2011, 2010, and 2009, respectively. The following table summarizes information about the stock options outstanding at December 31, 2011: Range of Exercise Prices $8.85 to $11.06 $11.06 to $13.27 $13.27 to $15.48 $15.48 to $17.70 $17.70 to $19.91 $19.91 to $22.12 Options Outstanding Weighted- Average Remaining Contractual Life Weighted- Average Exercise Price Number Outstanding at 12/31/11 Options Exercisable Number Exercisable at 12/31/11 Weighted- Average Exercise Price 2,447 (cid:1086)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3) 54,107 171,582 56,250 209,480 493,866 0.5 (cid:1086) 3.9 4.8 3.7 2.9 3.7 $ 10.66 (cid:1086) 14.85 16.61 19.65 21.76 $ 18.92 2,447 (cid:1086)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3) 54,107 100,652 56,250 207,480 420,936 $ 10.66 (cid:1086) 14.85 16.66 19.65 21.77 $ 19.31 As discussed above, the Company granted 81,337 performance units to 19 senior officers on June 17, 2008. Each performance unit represents the right to acquire one share of the Company’s common stock upon satisfaction of the vesting conditions (discussed above). The fair market value of the Company’s common stock on the grant date was $16.53 per share. One-third of this grant was forfeited on December 31, 2008 and another one-third 141 was forfeited on December 31, 2010 because the Company failed to meet the minimum performance goal required for vesting. Also, as discussed above, the Company granted 29,267 and 7,259 long-term restricted shares of common stock to certain senior executives on December 11, 2009 and February 24, 2011, respectively. The following table presents information regarding the activity during 2009, 2010, and 2011 related to the Company’s outstanding performance units and restricted stock: Nonvested Performance Units Long-Term Restricted Stock Weighted- Average Grant-Date Fair Value Weighted- Average Grant-Date Fair Value Number of Units Number of Units Nonvested at December 31, 2008 54,225 $ 16.53 – $ – Granted during the period Vested during the period Forfeited or expired during the period – – – – – – 29,267 – – $ 13.59 – – Nonvested at December 31, 2009 54,225 $ 16.53 29,267 $ 13.59 Granted during the period Vested during the period – – – – Forfeited or expired during the period (27,112) 16.53 – – – – – – Nonvested at December 31, 2010 27,113 $ 16.53 29,267 $ 13.59 Granted during the period Vested during the period Forfeited or expired during the period – (27,022) (91) – 16.53 16.53 7,259 (29,267) – 14.54 13.59 – Nonvested at December 31, 2011 (cid:1086) (cid:936)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:3)(cid:1086) 7,259 $ 14.54 Note 16. Regulatory Restrictions The Company is regulated by the Federal Reserve Board and is subject to securities registration and public reporting regulations of the Securities and Exchange Commission. The Bank is regulated by the FDIC and the North Carolina Commissioner of Banks. The primary source of funds for the payment of dividends by the Company is dividends received from its subsidiary, the Bank. The Bank, as a North Carolina banking corporation, may pay dividends only out of undivided profits as determined pursuant to North Carolina General Statutes Section 53-87. As of December 31, 2011, the Bank had undivided profits of approximately $197,681,000 which were available for the payment of dividends (subject to remaining in compliance with regulatory capital requirements). As of December 31, 2011, approximately $199,512,000 of the Company’s investment in the Bank is restricted as to transfer to the Company without obtaining prior regulatory approval. The average reserve balance maintained by the Bank under the requirements of the Federal Reserve Board was approximately $410,000 for the year ended December 31, 2011. The Company and the Bank must comply with regulatory capital requirements established by the Federal Reserve Board and FDIC. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for 142 prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s and Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. These capital standards require the Company and the Bank to maintain minimum ratios of “Tier 1” capital to total risk- weighted assets (“Tier I Capital Ratio”) and total capital to risk-weighted assets of 4.00% and 8.00% (“Total Capital Ratio”), respectively. Tier 1 capital is comprised of total shareholders’ equity, excluding unrealized gains or losses from the securities available for sale, less intangible assets, and total capital is comprised of Tier 1 capital plus certain adjustments, the largest of which for the Company and the Bank is the allowance for loan losses. Risk-weighted assets refer to the on- and off-balance sheet exposures of the Company and the Bank, adjusted for their related risk levels using formulas set forth in Federal Reserve Board and FDIC regulations. In addition to the risk-based capital requirements described above, the Company and the Bank are subject to a leverage capital requirement, which calls for a minimum ratio of Tier 1 capital (as defined above) to quarterly average total assets (“Leverage Ratio) of 3.00% to 5.00%, depending upon the institution’s composite ratings as determined by its regulators. The Federal Reserve Board has not advised the Company of any requirement specifically applicable to it. In addition to the minimum capital requirements described above, the regulatory framework for prompt corrective action also contains specific capital guidelines applicable to banks for classification as “well capitalized,” which are presented with the minimum ratios, the Company’s ratios and the Bank’s ratios as of December 31, 2011 and 2010 in the following table. Based on the most recent notification from its regulators, the Bank is well capitalized under the framework. There are no conditions or events since that notification that management believes have changed the Company’s classification. Also see Note 19 for discussion of preferred stock transactions that have affected the Company’s capital ratios. ($ in thousands) As of December 31, 2011 Total Capital Ratio Company Bank Tier I Capital Ratio Company Bank Leverage Ratio Company Bank As of December 31, 2010 Total Capital Ratio Company Bank Tier I Capital Ratio Company Bank Leverage Ratio Company Bank Actual Amount Ratio For Capital Adequacy Purposes Amount Ratio (must equal or exceed) To Be Well Capitalized Under Prompt Corrective Action Provisions Amount Ratio (must equal or exceed) $ 355,897 354,235 16.72% 16.65% $ 170,329 170,180 8.00% 8.00% $ N/A 212,725 N/A 10.00% 329,100 327,461 329,100 327,461 15.46% 15.39% 10.21% 10.17% 85,165 85,090 128,910 128,831 $ 351,097 330,560 16.57% 15.62% $ 169,493 169,340 324,330 303,817 324,330 303,817 15.31% 14.35% 10.28% 9.63% 84,746 84,670 126,212 126,228 4.00% 4.00% 4.00% 4.00% 8.00% 8.00% 4.00% 4.00% 4.00% 4.00% N/A 127,635 N/A 161,039 $ N/A 211,675 N/A 127,005 N/A 157,785 N/A 6.00% N/A 5.00% N/A 10.00% N/A 6.00% N/A 5.00% 143 Note 17. Supplementary Income Statement Information Components of other noninterest income/expense exceeding 1% of total income for any of the years ended December 31, 2011, 2010, and 2009 are as follows: ($ in thousands) 2011 2010 2009 Other service charges, commissions, and fees – debit interchange income Other service charges, commissions, and fees – other interchange income $ 4,757 1,033 Other operating expenses – interchange expense Other operating expenses – stationery and supplies Other operating expenses – telephone expense Other operating expenses – FDIC insurance expense Other operating expenses – repossession and collection – non-covered Other operating expenses – repossession and collection – covered, net of FDIC reimbursement and rental income Other operating expenses – outside consultants 2,042 2,867 2,127 3,008 3,492 1,968 1,842 3,608 912 1,736 2,563 2,053 4,387 2,138 2,617 1,185 2,823 980 1,561 2,181 1,847 5,500 871 795 808 Note 18. Condensed Parent Company Information Condensed financial data for First Bancorp (parent company only) follows: CONDENSED BALANCE SHEETS ($ in thousands) Assets Cash on deposit with bank subsidiary Investment in wholly-owned subsidiaries, at equity Premises and Equipment Other assets Total assets Liabilities and shareholders’ equity Trust preferred securities Other liabilities Total liabilities Shareholders’ equity Total liabilities and shareholders’ equity As of December 31, 2011 2010 $ 3,324 388,528 161 1,633 $ 393,646 $ 46,394 2,102 48,496 345,150 $ 393,646 21,826 369,107 172 1,660 392,765 46,394 1,768 48,162 344,603 392,765 CONDENSED STATEMENTS OF INCOME ($ in thousands) Year Ended December 31, 2011 2010 2009 Dividends from wholly-owned subsidiaries Earnings of wholly-owned subsidiaries, net of dividends Interest expense All other income and expenses, net Net income Preferred stock dividends and accretion $ 9,500 5,862 (1,041) (679) 13,642 (6,166) 26,250 (14,536) (1,054) (678) 9,982 (4,107) 13,250 49,024 (1,356) (659) 60,259 (3,972) Net income available to common shareholders $ 7,476 5,875 56,287 144 CONDENSED STATEMENTS OF CASH FLOWS ($ in thousands) Operating Activities: Net income Equity in undistributed earnings of subsidiaries Dividend from subsidiaries in excess of earnings Decrease in other assets Increase (decrease) in other liabilities Total – operating activities Investing Activities: Downstream cash investment in subsidiary Cash proceeds from dissolution of subsidiary Total – investing activities Financing Activities: Repayments of borrowings, net Payment of preferred and common cash dividends Proceeds from issuance of preferred stock Redemption of preferred stock Proceeds from issuance of common stock Repurchases of common stock Repurchase of common stock warrants Total - financing activities Net increase (decrease) in cash Cash, beginning of year Cash, end of year 2011 Year Ended December 31, 2010 2009 $ 13,642 (5,862) (cid:326) 38 (62) 7,756 (16,250) (cid:326) (16,250) (cid:326) (8,237) 63,500 (65,000) 881 (228) (924) (10,008) (18,502) 21,826 $ 3,324 9,982 (cid:1086) 14,536 32 17 24,567 (cid:326) 706 706 (cid:326) (8,609) (cid:326) (cid:326) 840 (cid:326) (cid:326) (7,769) 17,504 4,322 21,826 60,259 (49,024) (cid:1086) 72 (349) 10,958 (45,000) (cid:326) (45,000) (20,000) (9,908) 65,000 (cid:326) 1,505 (cid:326) (cid:326) 36,597 2,555 1,767 4,322 Note 19. Participation in the U.S. Treasury Capital Purchase Program and Small Business Lending Fund U.S. Treasury Capital Purchase Program On January 9, 2009, the Company completed the sale of $65 million of Series A preferred stock to the United States Treasury Department (Treasury) under the Treasury’s Capital Purchase Program. The program was designed to attract broad participation by healthy banking institutions to help stabilize the financial system and increase lending for the benefit of the U.S. economy. Under the terms of the stock purchase agreement, the Treasury received (i) 65,000 shares of fixed rate cumulative perpetual preferred stock with a liquidation value of $1,000 per share and (ii) a warrant to purchase 616,308 shares of the Company’s common stock, no par value, in exchange for $65 million. As discussed below, the Company redeemed this preferred stock in the third quarter of 2011 and repurchased the common stock warrant in the fourth quarter of 2011. The Series A preferred stock qualified as Tier 1 capital and its terms required cumulative dividends at a rate of 5% for the first five years, and 9% thereafter. The warrant had a 10-year term and became immediately exercisable upon its issuance, with an exercise price equal to $15.82 per share. 145 The Company allocated the $65 million in proceeds to the preferred stock and the common stock warrant based on their relative fair values. To determine the fair value of the preferred stock, the Company used a discounted cash flow model that assumed redemption of the preferred stock at the end of year five. The discount rate utilized was 13% and the estimated fair value was determined to be $36.2 million. The fair value of the common stock warrant was estimated to be $2.8 million using the Black-Scholes option pricing model with the following assumptions: Expected dividend yield Risk-free interest rate Expected life Expected volatility Weighted average fair value 4.83% 2.48% 10 years 35.00% $ 4.47 The aggregate fair value result for both the preferred stock and the common stock warrant was determined to be $39.0 million, with 7% of this aggregate total attributable to the warrant and 93% attributable to the preferred stock. Therefore, the $65 million issuance was allocated with $60.4 million being assigned to the preferred stock and $4.6 million being assigned to the common stock warrant. The $4.6 million difference between the $65 million face value of the preferred stock and the $60.4 million allocated to it upon issuance was recorded as a discount on the preferred stock. Until the Company redeemed the preferred stock in the third quarter of 2011 (discussed below), the $4.6 million discount was being accreted, using the effective interest method, as a reduction in net income available to common shareholders over a five- year period at approximately $0.8 million to $1.0 million per year. On September 1, 2011, the Company redeemed the 65,000 shares of outstanding Series A preferred stock from the U.S. Treasury for a redemption price of $65 million, plus unpaid dividends. The Company funded the majority of this transaction by simultaneously issuing Series B preferred stock to the Treasury as part of the Small Business Lending Fund (see below). Due to the redemption of the preferred stock, the Company accreted the remaining discount of $2.3 million during the third quarter of 2011, which resulted in total discount accretion for 2011 of $2.9 million, which compared to $0.9 million recorded in 2010 and $0.8 million in 2009. Preferred stock discount accretion is deducted from net income in computing “Net income available to common shareholders.” In November 2011, the Company repurchased the outstanding common stock warrant from the Treasury for $1.50 per common share, or a total of $924,000. Small Business Lending Fund On September 1, 2011, the Company completed the sale of $63.5 million of Series B preferred stock to the Secretary of the Treasury under the Small Business Lending Fund (SBLF). The fund was established under the Small Business Jobs Act of 2010 that was created to encourage lending to small businesses by providing capital to qualified community banks with assets less than $10 billion. Under the terms of the stock purchase agreement, the Treasury received 63,500 shares of non-cumulative perpetual preferred stock with a liquidation value of $1,000 per share, in exchange for $63.5 million. The Series B preferred stock qualifies as Tier 1 capital. The dividend rate, as a percentage of the liquidation amount, can fluctuate on a quarterly basis during the first 10 quarters during which the Series B preferred stock is outstanding, based upon changes in the level of “Qualified Small Business Lending” or “QBSL”. For the first nine quarters after issuance, the dividend rate can range from one percent (1%) to five percent (5%) per annum based upon the increase in QBSL as compared to the baseline. For the two quarters subsequent to the issuance in 2011, the Company paid a dividend rate of 5%. Based upon an increase in the level of QBSL over the baseline 146 level calculated under the terms of the related purchase agreement, the dividend rate for the next dividend period (which will end on March 31, 2012) is expected to be 4.8%, subject to confirmation by Treasury. For the tenth calendar quarter through four and one half years after issuance, the dividend rate will be fixed at between one percent (1%) and seven percent (7%) based upon the level of QBSL compared to the baseline. After four and one half years from the issuance, the dividend rate will increase to nine percent (9%). Subject to regulatory approval, the Company is generally permitted to redeem the Series B preferred shares at par plus unpaid dividends. There was no discount recorded related to the SBLF preferred stock (because no warrants were issued in connection with this preferred stock issuance), and therefore there will be no future amounts recorded for preferred stock discount accretion. 147 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders First Bancorp Troy, North Carolina We have audited the accompanying consolidated balance sheets of First Bancorp and subsidiaries (the “Company”) as of December 31, 2011 and 2010, and the related consolidated statements of income, comprehensive income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 2011. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of First Bancorp and subsidiaries as of December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2011 in conformity with accounting principles generally accepted in the United States of America. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 14, 2012 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting. Greenville, South Carolina March 14, 2012 /s/ Elliott Davis, PLLC 148 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders First Bancorp Troy, North Carolina We have audited the internal control over financial reporting of First Bancorp and subsidiaries (the “Company”) as of December 31, 2011, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO criteria”). The Company’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (a) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (b) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (c) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on the COSO criteria. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of the Company as of December 31, 2011 and 2010 and the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2011 and our report dated March 14, 2012 expressed an unqualified opinion thereon. Greenville, South Carolina March 14, 2012 /s/ Elliott Davis, PLLC 149 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures None. Item 9A. Controls and Procedures Evaluation of Disclosure Controls and Procedures As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures, which are our controls and other procedures that are designed to ensure that information required to be disclosed in our periodic reports with the SEC is recorded, processed, summarized and reported within the required time periods. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed is communicated to our management to allow timely decisions regarding required disclosure. Based on the evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures are effective in allowing timely decisions regarding disclosure to be made about material information required to be included in our periodic reports with the SEC. Management’s Report On Internal Control Over Financial Reporting Management of First Bancorp and its subsidiaries (the “Company”) is responsible for establishing and maintaining effective internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Under the supervision and with the participation of management, including the principal executive officer and principal financial officer, the Company conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation under the framework in Internal Control – Integrated Framework, management of the Company has concluded the Company maintained effective internal control over financial reporting, as such term is defined in Securities Exchange Act of 1934 Rules 13a-15(f), as of December 31, 2011. Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting can also be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk. Management is also responsible for the preparation and fair presentation of the consolidated financial statements and other financial information contained in this report. The accompanying consolidated financial statements were prepared in conformity with U.S. generally accepted accounting principles and include, as necessary, best estimates and judgments by management. Elliott Davis, PLLC, an independent, registered public accounting firm, has audited the Company’s consolidated financial statements as of and for the year ended December 31, 2011, and audited the Company’s effectiveness 150 of internal control over financial reporting as of December 31, 2011, as stated in their report, which is included in Item 8 hereof. Changes in Internal Controls There were no changes in our internal control over financial reporting that occurred during, or subsequent to, the fourth quarter of 2011 that were reasonably likely to materially affect our internal control over financial reporting. Item 9B. Other Information Not applicable. PART III Item 10. Directors, Executive Officers and Corporate Governance Incorporated herein by reference is the information under the captions “Directors, Nominees and Executive Officers,” “Section 16(a) Beneficial Ownership Reporting Compliance,” “Corporate Governance Policies and Practices” and “Board Committees, Attendance and Compensation” from the Company’s definitive proxy statement to be filed pursuant to Regulation 14A. Item 11. Executive Compensation Incorporated herein by reference is the information under the captions “Executive Compensation” and “Board Committees, Attendance and Compensation” from the Company’s definitive proxy statement to be filed pursuant to Regulation 14A. Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters Incorporated herein by reference is the information under the captions “Principal Holders of First Bancorp Voting Securities” and “Directors, Nominees and Executive Officers” from the Company’s definitive proxy statement to be filed pursuant to Regulation 14A. See also “Additional Information Regarding the Registrant’s Equity Compensation Plans” in Item 5 of this report. Item 13. Certain Relationships and Related Transactions, and Director Independence Incorporated herein by reference is the information under the caption “Certain Transactions” and “Corporate Governance Policies and Practices” from the Company’s definitive proxy statement to be filed pursuant to Regulation 14A. Item 14. Principal Accountant Fees and Services Incorporated herein by reference is the information under the caption “Audit Committee Report” from the Company’s definitive proxy statement to be filed pursuant to Regulation 14A. 151 PART IV Item 15. Exhibits and Financial Statement Schedules (a) 1. Financial Statements - See Item 8 and the Cross Reference Index on page 3 for information concerning the Company’s consolidated financial statements and report of independent auditors. 2. Financial Statement Schedules - not applicable 3. Exhibits The following exhibits are filed with this report or, as noted, are incorporated by reference. Management contracts, compensatory plans and arrangements are marked with an asterisk (*). 3.a Articles of Incorporation of the Company and amendments thereto were filed as Exhibits 3.a.i through 3.a.v to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2002, and are incorporated herein by reference. Articles of Amendment to the Articles of Incorporation were filed as Exhibits 3.1 and 3.2 to the Company’s Current Report on Form 8-K filed on January 13, 2009, and are incorporated herein by reference. Articles of Amendment to the Articles of Incorporation were filed as Exhibit 3.1.b to the Company’s Registration Statement on Form S-3D filed on June 29, 2010, and are incorporated herein by reference. Articles of Amendment to the Articles of Incorporation were filed as Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on September 6, 2011, and are incorporated herein by reference. 3.b Amended and Restated Bylaws of the Company were filed as Exhibit 3.1 to the Company's Current Report on Form 8-K filed on November 23, 2009, and are incorporated herein by reference. 4.a Form of Common Stock Certificate was filed as Exhibit 4 to the Company’s Quarterly Report on Form 10- Q for the quarter ended June 30, 1999, and is incorporated herein by reference. 4.b Form of Certificate for Series B Preferred Stock was filed as Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on September 6, 2011, and is incorporated herein by reference. 10 Material Contracts 10.a First Bancorp Annual Incentive Plan was filed as Exhibit 10(a) to the Form 8-K filed on February 2, 2007 and is incorporated herein by reference. (*) 10.b Indemnification Agreement between the Company and its Directors and Officers was filed as Exhibit 10(t) to the Registrant's Registration Statement Number 33-12692, and is incorporated herein by reference. 10.c First Bancorp Senior Management Supplemental Executive Retirement Plan was filed as Exhibit 10.1 to the Company's Form 8-K filed on December 22, 2006, and is incorporated herein by reference. (*) 10.d First Bancorp 1994 Stock Option Plan was filed as Exhibit 10(f) to the Company's Annual Report on Form 10-K for the year ended December 31, 2001, and is incorporated herein by reference. (*) 10.e First Bancorp 2004 Stock Option Plan was filed as Exhibit B to the Registrant's Form Def 14A filed on March 30, 2004 and is incorporated herein by reference. (*) 152 10.f First Bancorp 2007 Equity Plan was filed as Appendix B to the Registrant's Form Def 14A filed on March 27, 2007 and is incorporated herein by reference. (*) 10.g Employment Agreement between the Company and Anna G. Hollers dated August 17, 1998 was filed as Exhibit 10(m) to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998, and is incorporated by reference (Commission File Number 000-15572). (*) 10.h 10.i 10.j 10.k 10.l Employment Agreement between the Company and Teresa C. Nixon dated August 17, 1998 was filed as Exhibit 10(n) to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998, and is incorporated by reference (Commission File Number 000-15572). (*) Employment Agreement between the Company and Eric P. Credle dated August 17, 1998 was filed as Exhibit 10(p) to the Company's Annual Report on Form 10-K for the year ended December 31, 1998, and is incorporated herein by reference (Commission File Number 333-71431).(*) Employment Agreement between the Company and John F. Burns dated September 14, 2000 was filed as Exhibit 10.w to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2000 and is incorporated herein by reference. (*) Employment Agreement between the Company and R. Walton Brown dated January 15, 2003 was filed as Exhibit 10(b) to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003 and is incorporated herein by reference. (*) Amendment to the employment agreement between the Company and R. Walton Brown dated March 8, 2005 was filed as Exhibit 10.n to the Company's Annual Report on Form 10-K for the year ended December 31, 2004 and is incorporated herein by reference. (*) 10.m Employment Agreement between the Company and Jerry L. Ocheltree was filed as Exhibit 10.1 to the Form 8-K filed on January 25, 2006, and is incorporated herein by reference. (*) 10.n First Bancorp Long Term Care Insurance Plan was filed as Exhibit 10(o) to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2004, and is incorporated by reference. (*) 10.o Advances and Security Agreement with the Federal Home Loan Bank of Atlanta dated February 15, 2005 was attached as Exhibit 99(a) to the Form 8-K filed on February 22, 2005, and is incorporated herein by reference. 10.p Form of Stock Option and Performance Unit Award Agreement was filed as Exhibit 10 to the Company’s Form 8-K filed on June 23, 2008 and is incorporated herein by reference. (*) 10.q Description of Director Compensation pursuant to Item 601(b)(10)(iii)(A) of Regulation S-K . 10.r Purchase and Assumption Agreement among Federal Deposit Insurance Corporation, Receiver of Cooperative Bank, Federal Deposit Insurance Corporation and First Bank dated as of June 19, 2009 was filed as Exhibit 10.1 to the Company’s Form 8-K filed on June 24, 2009, and is incorporated herein by reference. 10.s Form of Restricted Stock Award Agreement under the First Bancorp 2007 Equity Plan was filed as Exhibit 10.u to the Company's Annual Report on Form 10-K for the year ended December 31, 2009 and is incorporated herein by reference. (*) 153 10.t 10.u 10.v First Bancorp Employees’ Pension Plan, including amendments, was filed as Exhibit 10.v to the Company's Annual Report on Form 10-K for the year ended December 31, 2009 and is incorporated herein by reference. (*) Purchase and Assumption Agreement among Federal Deposit Insurance Corporation, Receiver of The Bank of Asheville, Federal Deposit Insurance Corporation and First Bank, dated as of January 21, 2011, was filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on January 26, 2011, and is incorporated herein by reference. Securities Purchase Agreement, dated September 1, 2011, between First Bancorp and the Secretary of the Treasury, with respect to the issuance and sale of Series B Preferred Stock, was filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on September 6, 2011, and is incorporated herein by reference. 10.w Repurchase Letter Agreement, dated September 1, 2011, between First Bancorp and the United States Department of the Treasury, with respect to the repurchase and redemption of the Series A Preferred Stock, was filed as Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on September 6, 2011 and is incorporated herein by reference. 10.x 12 21 Purchase and Assumption Agreement among Waccamaw Bank and Waccamaw Bankshares, Inc. and First Bank, dated as of October 21, 2011, was filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on October 26, 2011, and is incorporated herein by reference. Computation of Ratio of Earnings to Fixed Charges. List of Subsidiaries of Registrant was filed as Exhibit 21 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 and is incorporated herein by reference. (*) 23 Consent of Independent Registered Public Accounting Firm, Elliott Davis, PLLC 31.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302(a) of the Sarbanes- Oxley Act of 2002. 31.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302(a) of the Sarbanes- Oxley Act of 2002. 32.1 Chief Executive Officer Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 101 Chief Financial Officer Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. The following financial information from the Company’s Quarterly Report on Form 10-K for the year ended December 31, 2011, formatted in eXtensible Business Reporting Language (XBRL): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Shareholders’ Equity, (v) the Consolidated Statements of Cash Flows, and (vi) the Notes to Consolidated Financial Statements. (1) ______________ (b) Exhibits - see (a)(3) above (c) No financial statement schedules are filed herewith. 154 Copies of exhibits are available upon written request to: First Bancorp, Anna G. Hollers, Executive Vice President, P.O. Box 508, Troy, NC 27371 ______________________________________________________________________________________ (1) As provided in Rule 406T of Regulation S-T, this information shall not be deemed “filed” for purposes of Section 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934 or otherwise subject to liability under those sections. 155 Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, FIRST BANCORP has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Troy, and State of North Carolina, on the 15th day of March 2012. SIGNATURES First Bancorp By: /s/ Jerry L. Ocheltree Jerry L. Ocheltree President, Chief Executive Officer and Treasurer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed on behalf of the Company by the following persons and in the capacities and on the dates indicated. Executive Officers /s/ Jerry L. Ocheltree Jerry L. Ocheltree President, Chief Executive Officer and Treasurer /s/ Anna G. Hollers Anna G. Hollers Executive Vice President Chief Operating Officer / Secretary March 15, 2012 Board of Directors /s/ Thomas F. Phillips Thomas F. Phillips Chairman of the Board Director March 15, 2012 /s/ Daniel T. Blue, Jr. Daniel T. Blue, Jr. Director March 15, 2012 /s/ Jack D. Briggs Jack D. Briggs Director March 15, 2012 /s/ R. Walton Brown R. Walton Brown Director March 15, 2012 /s/ David L. Burns David L. Burns Director March 15, 2012 156 /s/ Eric P. Credle Eric P. Credle Executive Vice President Chief Financial Officer (Principal Accounting Officer) March 15, 2012 /s/ James G. Hudson, Jr. James G. Hudson, Jr. Director March 15, 2012 /s/ Richard H. Moore Richard H. Moore Director March 15, 2012 /s/ Jerry L. Ocheltree Jerry L. Ocheltree Director March 15, 2012 /s/ George R. Perkins, Jr. George R. Perkins, Jr. Director March 15, 2012 /s/ Frederick L. Taylor II Frederick L. Taylor II Director March 15, 2012 /s/ John F. Burns John F. Burns Director March 15, 2012 /s/ Mary Clara Capel Mary Clara Capel Director March 15, 2012 /s/ James C. Crawford, III James C. Crawford, III Director March 15, 2012 /s/ R. Winston Dozier, Jr. R. Winston Dozier, Jr. Director March 15, 2012 /s/ Virginia C. Thomasson Virginia C. Thomasson Director March 15, 2012 ________________ Goldie H. Wallace Director March 15, 2012 /s/ Dennis A. Wicker Dennis A. Wicker Director March 15, 2012 /s/ John C. Willis John C. Willis Director March 15, 2012 157 AR_11_Covers_Layout 1 3/15/12 6:11 AM Page 2 ( Shareholder Information ) Corporate Office 341 North Main Street P.O. Box 508 Troy, NC 27371 910-576-6171 800-548-9377 Fax 910-576-0662 www.FirstBancorp.com Independent Auditors Elliott Davis, PLLC Greenville, SC Corporate Counsel Robinson, Bradshaw & Hinson, PA Charlotte, NC Transfer Agent Registrar & Transfer Co., Inc. 10 Commerce Drive Cranford, NJ 07016-3572 800-368-5948 www.rtco.com Shareholders’ Meeting The Annual Meeting will be held on May 10, 2012 at 3:00 pm at the James H. Garner Conference Center, 211 Burnette Street, Troy, North Carolina. Common Stock Information The Company’s common stock is traded on the NASDAQ Global Select Market under the symbol FBNC. There were 16,909,820 shares outstanding as of December 31, 2011 with 2,574 shareholders of record and approximately 3,500 additional shareholders that held their shares in “street name.” Direct Deposit With Direct Deposit, shareholders may enjoy the convenience of having dividends directly deposited into their checking or savings account. There is no cost for this service. Shareholders may obtain further information about Direct Deposit by calling us toll- free at 800-548-9377 and asking for Shareholder Services. Shareholder Services First Bancorp now offers online access to your First Bancorp Stock Account, including your account balance, certificate history, dividend reinvestment plan information and more. Choose About Us at www.FirstBancorp.com and select Shareholder Access. First Bancorp now offers online access to all financial publications, including annual reports and quarterly reports filed with the Securities and Exchange Commission, at www.FirstBancorp.com. Choose About Us and select SEC Filings. For more information or shareholder assistance, call us toll-free at 800-548-9377 and ask for Shareholder Services. Copies of Form 10-K Copies of the First Bancorp Annual Report on Form 10-K filed with the Securities and Exchange Commission may be obtained at no cost by contacting: Investor Relations Anna Hollers P.O. Box 508 Troy, NC 27371-0508 800-548-9377 or by visiting our corporate website at www.FirstBancorp.com Dividend Reinvestment Registered holders of First Bancorp stock are eligible to participate in the Company’s Dividend Reinvestment Plan, a convenient and economical way to purchase additional shares of First Bancorp common stock without payment of brokerage commissions. For an information folder and authorization form, or to receive additional information on this plan, contact: Investor Relations Anna Hollers P.O. Box 508 Troy, NC 27371-0508 800-548-9377 or Registrar & Transfer Co., Inc. Dividend Reinvestment Section 10 Commerce Drive Cranford, NJ 07016-3572 800-368-5948 or info@rtco.com 93314_BC-FC_Layout 1 3/19/12 12:04 PM Page 1 FIRST BANCORP 341 N. Main Street P.O. Box 508 Troy, NC 27371- 0508 www.FirstBancorp.com 

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