M&F BANCORP INC /NC/ - Annual Report: 2010 (Form 10-K)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT UNDER SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2010

Commission file number 027307

(Exact name of registrant as specified in charter)

(919) 687-7800

(Registrant’s Telephone Number, Including Area Code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, no par value

(Title of class)

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

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

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  ¨    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 registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment of this Form 10-K.  x

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

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

The aggregate market value of the registrant’s common stock as of June 30, 2010, held by those persons deemed by the registrant to be non-affiliates was approximately $4,118,580. For purposes of the foregoing calculation only, all directors, executive officers, and 5% stockholders of the registrant have been deemed affiliates.

As of March 25, 2011, there were 2,031,337 shares outstanding of the registrant’s common stock.

DOCUMENTS INCORPORATED BY REFERENCE

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M&F BANCORP, INC. AND SUBSIDIARY

Annual Report on Form 10-K for the Year Ended December 31, 2010

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements represent expectations and beliefs of M&F Bancorp, Inc. (the “Company”) and Mechanics and Farmers Bank (the “Bank”), including but not limited to the Company’s operations, performance, financial condition, growth or strategies. These forward-looking statements are identified by words such as “expects”, “anticipates”, “should”, “estimates”, “believes” and variations of these words and other similar statements. For this purpose, any statements contained in this Annual Report on Form 10-K that are not statements of historical fact may be deemed to be forward-looking statements. Readers should not place undue reliance on forward-looking statements as a number of important factors could cause actual results to differ materially from those in the forward-looking statements. These forward-looking statements involve estimates, assumptions, risks and uncertainties that could cause actual results to differ materially from current projections depending on a variety of important factors, including without limitation:

The Company cautions that the foregoing list of important factors is not exhaustive. See also “Risk Factors” which begins on page 13. The Company undertakes no obligation to update any forward-looking statement, whether written or oral, that may be made from time to time, by or on behalf of the Company.

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PART I

ITEM 1. BUSINESS

GENERAL

Headquartered in Durham, North Carolina (“NC”), M&F Bancorp, Inc. (the “Company”) is a bank holding company incorporated under the laws of NC in 1999, and is registered with the Board of Governors of the Federal Reserve System (the “Federal Reserve”) under the Bank Holding Company Act of 1956, as amended (the “BHCA”). The Company’s primary function is to serve as the holding company for its wholly-owned subsidiary, Mechanics and Farmers Bank (the “Bank”), a NC-chartered commercial bank that was organized in 1907 and began operations in 1908.

As of December 31, 2010, the Company had assets of approximately $312.3 million, with gross loans of approximately $201.8 million and deposits of approximately $269.7 million. The Company’s corporate office is located at 2634 Durham Chapel Hill Boulevard, Durham, NC, 27707, and its telephone number is 919-687-7800. In addition to its corporate office, the Company has seven branch offices in NC: two in Durham, two in Raleigh, one in Charlotte, one in Winston-Salem, and one in Greensboro.

The Company’s principal source of income is from dividends declared and paid by the Bank on its issued and outstanding capital stock. The Company uses such income to pay dividends to stockholders and fund its expenses. The majority of the Company’s operations occur at the Bank level. Throughout this Annual Report on Form 10-K, results of operations will be discussed by referring to the Bank’s operations, unless a specific reference is made to the Company and its operating results apart from those of the Bank.

The Bank is a community bank engaged in the general banking business in Wake, Durham, Guilford, Forsyth, and Mecklenburg Counties and the surrounding areas. Both the Company and the Bank are designated by the United States Department of the Treasury (the “Treasury”) as Community Development Financial Institution (“CDFI”). As defined by the Treasury, a CDFI is a community-based organization that provides credit, financial services, and other related services in low-income urban and rural communities across America. These organizations have a common mission of working toward revitalizing economically depressed communities or communities underserved by mainstream financial institutions and improving the quality of life of those who live and work in these communities. CDFIs operate in communities for the benefit of people who live in them. In turn, CDFIs provide financing to residents who want to buy their first home, individuals who may want to start their own business and owners of existing businesses who would like to expand their businesses (helping to create new jobs). In addition, CDFIs work with individuals on improving their credit ratings or helping them to create monthly budgets.

The Bank offers a full range of banking services, including the following: checking accounts; savings accounts; NOW accounts; money market accounts; certificates of deposit; individual retirement accounts; loans for real estate, construction, businesses, personal use, home improvement and automobiles; equity lines of credit; credit lines; consumer loans; credit cards; safe deposit boxes; bank money orders; internet banking; electronic funds transfer services including wire transfers; traveler’s checks; and notary services. In addition, the Bank provides automated teller machine (“ATM”) access to its customers for cash withdrawals through nationwide ATM networks. At present, the Bank does not provide the services of a trust department.

GENERAL DESCRIPTION OF MARKET AREAS

The Bank has two branch offices in Durham, NC, two offices in Raleigh, NC, one office in Charlotte, NC, one office in Winston-Salem, NC, and one office in Greensboro, NC. All offices are located in metropolitan areas with employment spread primarily among service, health care, education, manufacturing and governmental activities. All offices are located in areas of high competition among financial service providers.

COMPETITION

Commercial banking in North Carolina is extremely competitive. The Bank competes in its market areas with some of the largest banking organizations in the state and the country, other community financial institutions, such as federally and state-chartered savings and loan institutions, credit unions, consumer finance companies, mortgage companies and other lenders engaged in the business of extending credit. Many of the Bank’s competitors have broader geographic markets, easier access to capital, lower cost of funding, and higher lending limits than the Bank, and are able to provide more services, and make greater use of media advertising.

Despite the strong competition in its market areas, the Bank believes that it has certain competitive advantages that distinguish it from its competition. The Bank believes that its primary competitive advantages are its 104-year legacy, strong local identity and affiliation with the communities it serves, and its emphasis on providing specialized services to small- and medium-sized business and special purpose enterprises, and individuals. The Bank offers customers modern, high-tech banking without compromising community values

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such as prompt, personal service and friendliness. The Bank offers personalized services and attracts customers by being responsive and sensitive to their individual needs. The Bank relies on goodwill and referrals from stockholders, board members, employees, and satisfied customers, as well as traditional methods to attract new customers. To enhance a positive image in the communities in which it has branches, the Bank supports and participates in select local events and many of its officers and directors serve on boards of local civic and charitable organizations.

The ability of the Bank to attract and retain deposits generally depends on its ability to provide a rate of return, liquidity and risk comparable to that offered by competing investment opportunities. As of June 30, 2010, based on the Federal Deposit Insurance Corporation (the “FDIC”) Summary of Deposits Report, the Bank’s market share of the total deposits in Durham, NC was approximately 2.62%, and less than one percent in each of Raleigh, Charlotte, Greensboro and Winston-Salem, NC. Management believes that the Company is not dependent upon any single customer, or a few customers, the loss of which would have a material adverse effect on the Company’s operations. However, the Company does serve a specialized niche market (faith-based organizations and not-for-profits), the loss of which could have a material adverse effect on the Company’s operations.

EMPLOYEES

As of December 31, 2010, the Company and the Bank had 81 employees, including 71 full-time equivalent employees. No employees are represented by a collective bargaining unit or agreement. Management considers relations with employees to be good.

EXECUTIVE OFFICERS

Kim D. Saunders serves as President and Chief Executive Officer for the Company and the Bank, overseeing the day-to-day operations of the Bank. Ms. Saunders joined the Company in 2007. She previously served as President and Chief Executive Officer of Consolidated Bank and Trust Company from 2003 to 2007. Lyn Hittle serves as Senior Vice President, Chief Financial Officer and Director of Human Resources (“HR”) for the Company and the Bank, overseeing the financial operations and HR function of the Company and the Bank. Ms. Hittle joined the Company in 2008, before which she was the Chief Accounting Officer of Capital Bank in Raleigh, NC from 2007 to 2008, Vice President Finance/Controller for Eos Airlines from 2006 to 2007, and Chief Financial Officer for Harrington Bank in Chapel Hill, NC from 2001 to 2005.

AVAILABLE INFORMATION

The Company makes its Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports, available free of charge on its internet website www.mfbonline.com, as soon as reasonably practicable after the reports are electronically filed with the Securities and Exchange Commission (“SEC”). Any materials that the Company files with the SEC may be read and/or copied at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. These filings are accessible on the SEC’s website at www.sec.gov.

The Company’s corporate governance policies, including its Codes of Ethics and the charters of the Audit, Compensation, and Corporate Governance and Nominating Committees, may be found under the “Investor Relations” section of the Company’s website. The Company elects to disclose any amendments to or waivers of any provisions of its Code of Ethics applicable to its principal executive officers and senior financial officers on its website. A written copy of the foregoing corporate governance policies is available upon written request to the Company.

SUPERVISION AND REGULATION

Bank holding companies and commercial banks are subject to extensive federal and state governmental regulation and supervision. The following is a brief summary of certain statutes and regulations that apply to the Company and Bank. This summary is qualified in its entirety by reference to the particular statute and regulatory provisions cited below and are not intended to be an exhaustive description of the statutes or regulations applicable to the business of the Company and the Bank. Supervision, regulation and examination of the Company and the Bank by the regulatory agencies are intended primarily for the protection of depositors rather than stockholders of the Company.

Statutes and regulations, which contain wide-ranging proposals for altering the structures, regulations, and competitive relationship of financial institutions are introduced regularly. The Company cannot predict whether or in what form any proposed statute or regulation may be adopted or the extent to which the business of the Company and the Bank may be affected by such statute or regulation.

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Insured depository institutions under common control are required to reimburse the FDIC for any loss suffered by its deposit insurance fund because of the default of a commonly controlled insured depository institution or for any assistance provided by the FDIC to a commonly controlled insured depository institution in danger of default. The FDIC’s claim for damages is superior to claims of stockholders of the insured depository institution or its holding Company but is subordinate to claims of depositors, secured creditors and holders of subordinated debt (other than affiliates) of the commonly controlled insured depository institutions.

Monetary Policy and Economic Controls

The Company and the Bank are directly affected by governmental policies and regulatory measures affecting the banking industry in general. Of primary importance is the Federal Reserve, whose actions directly affect the money supply, which, in turn, affects banks’ lending abilities by increasing or decreasing the cost and availability of funds to banks. The Federal Reserve regulates the availability of bank credit in order to combat recession and curb inflationary pressures in the economy by open market operations in United States government securities, changes in the discount rate on bank borrowings, changes in reserve requirements against bank deposits, and limitations on interest rates that banks may pay on time and savings deposits.

Deregulation of interest rates paid by banks on deposits and the types of deposits that may be offered by banks has eliminated minimum balance requirements and rate ceilings on various types of time deposit accounts. The effect of these specific actions and, in general, the deregulation of deposit interest rates has generally increased banks’ cost of funds and made them more sensitive to fluctuations in money market rates. In view of the changing conditions in the national economy and money markets, as well as the effect of actions by monetary and fiscal authorities, no prediction can be made as to possible future changes in interest rates, deposit levels, loan demand, or the business and earnings of the Bank or the Company. As a result, banks, including the Bank, face a significant challenge to maintain acceptable net interest margins.

Company Regulation

General. The Company is a bank holding company registered with the Federal Reserve under the BHCA. As such, the Company is subject to the supervision, examination and reporting requirements contained in the BHCA and the regulation of the Federal Reserve. Despite prior approval, the Federal Reserve has the power to order a bank holding company or its subsidiaries to terminate any activity or to terminate its ownership or control of any subsidiary when it believes that continuation of such activity or such ownership or control constitutes a serious risk to the financial safety, soundness or stability of any bank subsidiary of that bank holding company.

Federal Securities Law. The Company’s common stock is registered with the SEC pursuant to Section 12(g) of the Securities Exchange Act of 1934 (the “Act”). As a result, the proxy and tender offer rules, insider trading reporting requirements, annual and periodic reporting and other requirements of the Exchange Act are applicable to the Company. The regulatory compliance burden of being a publicly traded Company has increased significantly over the last several years.

The Gramm-Leach-Bliley Act. The federal Gramm-Leach-Bliley Act (the “GLB Act”) dramatically changed various federal laws governing the banking, securities and insurance industries. The GLB Act expanded opportunities for banks and bank holding companies to provide services and engage in other revenue-generating activities that previously were prohibited to them. However, this expanded authority presents the Company with new challenges, as its larger competitors are able to expand their services and products into areas that are not feasible for smaller, community-oriented financial institutions. The GLB Act has had a significant economic impact on the banking industry and on competitive conditions in the financial services industry generally.

Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act was signed into law in 2002 (“Sarbanes-Oxley”) and became some of the most sweeping federal legislation addressing accounting, corporate governance and disclosure issues. The impact of Sarbanes-Oxley has been wide-ranging as it applies to all public companies and imposes significant new requirements for public Company governance and disclosure requirements. Some of the provisions of Sarbanes-Oxley became effective immediately while other provisions have subsequently been implemented or will be implemented in the future.

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

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The economic and operational effects of this legislation on public companies, including the Company, have been and will continue to be significant in terms of the time, resources and costs associated with complying with its requirements. Because Sarbanes-Oxley, for the most part, applies equally to larger and smaller public companies, the Company will be presented with additional challenges as a smaller financial institution seeking to compete with larger financial institutions in its market. In accordance with the requirements of Section 404(a), management’s report on internal control is included herein as Item 9A. The Dodd-Frank Act permanently exempted smaller companies, such as the Company, from the requirements under Section 404(b) for auditor attestation on internal controls.

Prohibited and Permissible Activities of Bank Holding Companies. The BHCA generally prohibits a bank holding Company, with certain exceptions, from engaging in activities other than banking, or managing or controlling banks or other permissible subsidiaries, and from acquiring or retaining direct or indirect control of any Company engaged in any activities other than those activities determined by the Federal Reserve to be closely related to banking. In determining whether a particular activity is permissible, the Federal Reserve must consider whether the performance of such an activity may be reasonably expected to produce benefits to the public, such as greater convenience, increased competition or gains in efficiency, that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices.

Banking, operating a thrift institution, extending credit or servicing loans, leasing real or personal property, providing securities brokerage services, providing certain data processing services, acting as agent or broker in selling credit life insurance and certain other types of insurance underwriting activities have been determined by regulations of the Federal Reserve to be permissible activities.

Pursuant to delegated authority, the Federal Reserve Bank of Richmond (the “FRB”) has authority to approve certain activities of holding companies within its district, including the Company, provided the nature of the activity has been approved by the Federal Reserve.

Additional Restrictions and Oversight. Subsidiary banks of a bank holding company are subject to certain restrictions imposed by the Federal Reserve on any extensions of credit to the bank holding Company or any of its subsidiaries, investments in the stock or securities thereof and the acceptance of such stock or securities as collateral for loans to any borrower. A bank holding company and its subsidiaries are prevented from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. An example of a prohibited tie-in would be any arrangement that would condition the provision or cost of services on a customer obtaining additional services from the bank holding Company or any of its other subsidiaries.

The Federal Reserve may issue consent orders against bank holding companies and non-bank subsidiaries to stop actions believed to present a serious threat to a subsidiary bank. The Federal Reserve regulates certain debt obligations, changes in control of bank holding companies, and capital requirements.

As a result of the Company’s ownership of the Bank, the Company is registered under the bank holding company laws of NC. Accordingly, the Company is also subject to supervision and regulation by the NC Commissioner of Banks (the “NCCOB”).

Capital Requirements. The Federal Reserve has established risk-based capital guidelines for bank holding companies and banks that are members of the Federal Reserve System. The minimum standard for the ratio of capital to risk-weighted assets (including certain off-balance-sheet obligations, such as standby letters of credit) is eight percent. At least half of this capital must consist of common equity, retained earnings, and a limited amount of perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries, less certain goodwill items and other adjustments (“Tier 1 capital”). The remainder (“Tier 2 capital”) may consist of mandatorily redeemable debt securities, a limited amount of other preferred stock, subordinated debt, and loan loss reserves.

In addition, the Federal Reserve has established minimum leverage ratio guidelines for bank holding companies. These guidelines provide for a minimum leverage ratio (“Leverage Ratio”) of Tier 1 capital to adjusted average quarterly assets less certain amounts equal to three percent for bank holding companies that meet certain specified criteria, including having the highest regulatory rating. All other bank holding companies will generally be required to maintain a Leverage Ratio of between four and five percent.

The guidelines provide that bank holding companies experiencing significant growth, whether through internal expansion or acquisitions, are expected to maintain strong capital ratios well above the minimum supervisory levels without significant reliance on intangible assets. The same heightened requirements apply to bank holding companies with supervisory, financial, operational or managerial weaknesses, as well as to other banking institutions if warranted by particular circumstances or the institution’s risk profile. Furthermore, the guidelines indicate that the Federal Reserve will continue to consider a “tangible Tier 1 Leverage Ratio” (deducting all intangibles) in evaluating proposals for expansion or new activity. The Federal Reserve has not advised the Company of any specific minimum Leverage Ratio or tangible Tier 1 Leverage Ratio applicable to it.

As of December 31, 2010, the Company had Tier 1 risk-adjusted, total regulatory capital and leverage capital of approximately 16.93%, 18.19% and 11.77%, respectively, all in excess of the minimum requirements. Those same ratios as of December 31, 2009 were 14.33%, 15.58% and 13.00%, respectively. As of December 31, 2010, the Bank had a leverage ratio of 10.42%, a Tier 1 capital ratio of 15.59%, and a total risk-based capital ratio of 16.84%. Those same ratios as of December 31, 2009 were 11.30%, 12.86% and 14.11%, respectively.

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In December 2009, the Basel Committee on Banking Supervision (the “BCBS”) released a comprehensive list of proposals for changes to capital, leverage, and liquidity requirements for banks (commonly referred to as “Basel III”). In December 2010, the oversight body of the Basel Committee published the final Basel III rules on capital, leverage, and liquidity.

Dividend and Repurchase Limitations. Under a Memorandum of Understanding (“MOU”) with the FRB executed in August 2010, the Company must obtain FRB approval prior to repurchasing or redeeming any shares of its stock, declaring or paying any dividends or taking dividends or any other form of payment representing a reduction in capital from the Bank.

Federal banking regulations applicable to all bank holding companies separately restrict the Company from repurchasing its common stock for consideration in excess of 10% of its net worth during any 12-month period unless the Company (i) both before and after the redemption satisfies capital requirements for “well capitalized” state bank holding companies; (ii) received a “one” or “two” rating in its last examination; and (iii) is not the subject of any unresolved supervisory issues. In addition, as a bank holding company, the Company is required to adhere to the Federal Reserve’s Policy Statement on Payment of Cash Dividends, which generally requires bank holding companies to act as a source of strength and not place undue burden on subsidiary banks.

Under NC corporation laws, the Company may not pay a dividend or distribution, if after giving its effect, the Company would not be able to pay its debts as they become due in the usual course of business or the Company’s total assets would be less than its liabilities. In general, the Company’s ability to pay cash dividends is dependent upon the amount of dividends paid to the Company by the Bank. NC commercial banks, such as the Bank, are subject to legal limitations on the amounts of dividends they are permitted to pay. For instance, NC commercial banks may only pay dividends from undivided profits, which are determined by deducting and charging certain items against actual profits, including any contributions to surplus required by NC law. In addition, an insured depository institution, such as the Bank, is prohibited from making capital distributions, including the payment of dividends, if, after making such distribution, the institution would become “undercapitalized” (as such term is defined in the applicable law and regulations). Further, under the terms of the MOU entered into by the FDIC, and the NCCOB in April 2010, the Bank may not declare dividends to the Company without prior approval from the FDIC and NCCOB.

Under the Emergency Economic Stabilization Act of 2008 (the “EESA”), as amended, the Treasury implemented the Troubled Asset Relief Program (“TARP”), of which the Capital Purchase Program (the “CPP”) is a part. On June 26, 2009, the Company completed the issuance of 11,735 shares of $1,000 value Series A Fixed Rate Cumulative Perpetual Preferred Stock (“Series A Preferred Stock”) under the CPP.

On August 20, 2010, the Company exchanged the Series A Preferred Stock for an equal number of shares of $1,000 liquidation value, Series B Fixed Rate Cumulative Perpetual Preferred Stock (“Series B Preferred Stock”), under the Community Development Capital Initiative (“CDCI”), also part of the TARP.

Participation in the CDCI places restrictions on the Company’s ability to declare or pay dividends or distributions on, or purchase, redeem or otherwise acquire for consideration, shares of its capital stock, including restrictions against the Company (i) increasing dividends payable on its common stock from the last quarterly cash dividend per share ($0.05) declared on the common stock prior to November 17, 2008; (ii) increasing its aggregate per share dividends and distributions above the aggregate dividends and distributions paid for the immediately prior fiscal year; and (iii) declaring or paying dividends or distributions on, or repurchasing, redeeming or otherwise acquiring for consideration, shares of its capital stock in the event that the Company fails to declare and pay full dividends (or declare and set aside a sum sufficient for payment thereof) on the Series B Preferred Stock. These restrictions will continue until all of the Series B Preferred Stock has been redeemed in full.

Bank Regulation

The Bank is subject to numerous state and federal statutes and regulations that affect its business, activities, and operations, and is supervised and examined by the NCCOB and the FDIC. The FDIC and the NCCOB regularly examine the operations of banks over which they exercise jurisdiction. They have the authority to approve or disapprove the establishment or closing of branches, mergers, consolidations and other similar corporate actions. They have authority to prevent the continuance or development of unsafe or unsound banking practices and other violations of law. The FDIC and the NCCOB regulate and monitor all areas of the operations of banks and their subsidiaries, including loans, mortgages, capital adequacy, loss reserves and compliance with the Community Reinvestment Act (“CRA”) as well as other laws and regulations. Interest and certain other charges collected and contracted for by banks are subject to state usury laws and certain federal laws concerning interest rates.

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Federal Deposit Insurance. The Deposit Insurance Fund (“DIF”) of the Federal Deposit Insurance Corporation (the “FDIC”) insures deposit accounts in the Bank up to a maximum amount per separately insured depositor. Under the Dodd-Frank Act, the maximum amount of federal deposit insurance coverage permanently increased from $100,000 to $250,000 per depositor, per institution. On November 9, 2010, the FDIC issued a final rule to implement a provision of the Dodd-Frank Act that provides temporary unlimited deposit insurance coverage for noninterest-bearing transaction accounts at all FDIC-insured depository institutions. Institutions cannot opt out of this coverage, nor will the FDIC charge a separate assessment for the insurance. On December 29, 2010, President Obama signed into law an amendment to the Federal Deposit Insurance Act to include Interest on Lawyers Trust Accounts (“IOLTA”) within the definition of noninterest-bearing transaction accounts. This amendment will provide IOLTAs with the same temporary, unlimited insurance coverage afforded to noninterest-bearing transaction accounts under the Dodd-Frank Act. This unlimited coverage for noninterest-bearing transaction accounts became effective on December 31, 2010 and terminates on December 31, 2012.

The FDIC did not extend its Transaction Account Guarantee Program beyond its sunset date of December 31, 2010, which provided a full guarantee of certain Negotiable Order of Withdrawal accounts (“NOW accounts”). The FDIC insures NOW accounts up to the standard maximum deposit insurance amount as noted above.

FDIC-insured depository institutions are required to pay deposit insurance premiums based on the risk an institution poses to the DIF. In order to restore reserves and ensure that the DIF will adequately cover losses from future bank failures, the FDIC approved new deposit insurance rules in November 2009. These new rules required insured depository institutions to prepay their estimated quarterly risk-based assessments for all of 2010, 2011, and 2012. The Bank requested and received an exemption from the prepayment of assessments.

As required by the Dodd-Frank Act, on February 7, 2011, the FDIC finalized new rules, which would redefine the assessment base as “average consolidated total assets minus average tangible equity.” The new rate schedule and other revisions to the assessment rules will become effective April 1, 2011, and used to calculate the June 2011 assessments, which will be due in September 2011. Institutions, such as the Bank, with less than $1 billion in average total assets will share a more proportionate FDIC assessment under the new rules. We continue to assess the impact that these changes will have on our deposit insurance premiums in future periods.

Under the Federal Deposit Insurance Corporation Improvement Act of 1991, (“FDICIA”) the federal banking agencies possess broad powers to take prompt corrective action to resolve problems of insured depository institutions. FDICIA identifies five capital categories for insured depository institutions: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized.” Under regulations established by the federal banking agencies, a “well capitalized” institution must have a Tier 1 Capital Ratio of at least 6%, a Total Capital Ratio of at least 10%, a Tier 1 Leverage Ratio of at least 5%, and not be subject to a capital directive order. As of December 31, 2010, the Bank was classified as “well capitalized.” The classification of a depository institution under FDICIA is primarily for the purpose of applying the federal banking agencies’ prompt corrective action provisions, and is not intended to be, nor should it be interpreted as, a representation of the overall financial condition or the prospects of any financial institution.

Community Reinvestment and Consumer Protection Laws In connection with its lending activities, the Bank is subject to a number of federal laws designed to protect borrowers and promote lending to various sectors of the economy and population. These include the Equal Credit Opportunity Act, the Truth-in-Lending Act, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, and the Community Reinvestment Act (the “CRA”). In addition, federal banking regulators, pursuant to the Gramm-Leach-Bliley Act, have enacted regulations limiting the ability of banks and other financial institutions to disclose nonpublic consumer information to non-affiliated third parties. The regulations require disclosure of privacy policies and allow consumers to prevent certain personal information from being shared with non-affiliated third parties.

The CRA requires the appropriate federal banking agency, in connection with its examination of a bank, to assess the bank’s record in meeting the credit needs of the communities served by the bank, including low and moderate income neighborhoods. Under the CRA, institutions are assigned a rating of “outstanding,” “satisfactory,” “needs to improve,” or “substantial non-compliance.” The Bank received an “outstanding” rating in its most recent CRA evaluation.

The Dodd-Frank Act created a new Bureau of Consumer Financial Protection (the “CFPB”) that will take over responsibility for the federal consumer financial protection laws. The CFPB is an independent bureau within the FRB that will have broad rule-making, supervisory and examination authority to set and enforce rules in the consumer protection area over financial institutions that have assets of $10 billion or more. The Dodd-Frank Act also gives the CFPB expanded data-collecting powers for fair lending purposes for both small business and mortgage loans, as well as expanded authority to prevent unfair, deceptive and abusive practices. It is anticipated that certain of the CFPB’s rules will be indirectly applied to the Bank, through their adoption by the Bank’s regulators as “best practices.”

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Amendments to Regulation E, which implement the Electronic Fund Transfer Act (the “EFTA”), involve changes to the way banks with assets in excess of $10 billion may charge overdraft fees by limiting their ability to charge an overdraft fee for ATM and one-time debit card transactions that overdraw a consumer’s account, unless the consumer affirmatively consents to payment of overdraft fees for those transactions. Additional amendments to the EFTA include the “Durbin Act,” which mandates limiting debit card interchange fees that larger banks may charge merchants. Notwithstanding that these new laws do not apply directly to the Bank, it is anticipated that smaller financial institutions, such as the Bank, will come under competitive pressure to reduce their fees accordingly.

Bank Secrecy Act / Anti-Money Laundering Laws The Bank is subject to the Bank Secrecy Act and other anti-money laundering laws and regulations, including the USA PATRIOT Act of 2001. The USA PATRIOT Act substantially broadened the scope of U.S. anti-money laundering laws and regulations by creating new laws, regulations, and penalties, imposing significant new compliance and due diligence obligations, and expanding the extra-territorial jurisdiction of the U.S. These laws and regulations require the Bank to implement policies, procedures, and controls to detect, prevent, and report potential money laundering and terrorist financing and to verify the identity of their customers. Violations of these requirements can result in substantial civil and criminal sanctions. In addition, provisions of the USA PATRIOT Act require the federal banking agencies to consider the effectiveness of a financial institution’s anti-money laundering activities when reviewing bank mergers and bank holding company acquisitions.

Other Safety and Soundness Regulations As required by FDICIA, the federal banking agencies’ prompt corrective action powers impose progressively more restrictive constraints on operations, management and capital distributions, depending on the category in which an institution is classified. These actions can include: requiring an insured depository institution to adopt a capital restoration plan guaranteed by the institution’s parent company; placing limits on asset growth and restrictions on activities, including restrictions on transactions with affiliates; restricting the interest rates the institution may pay on deposits; prohibiting the payment of principal or interest on subordinated debt; prohibiting the holding company from making capital distributions without prior regulatory approval; and, ultimately, appointing a receiver for the institution.

The federal banking agencies also have adopted guidelines prescribing safety and soundness standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, and compensation and benefits. The federal regulatory agencies may take action against a financial institution that does not meet such standards.

Capital Requirements for the Bank. The Bank, as a NC commercial bank, is required to maintain a surplus account equal to 50% or more of its paid-in capital stock. As a NC chartered, FDIC-insured commercial bank, which is not a member of the Federal Reserve System, the Bank is also subject to capital requirements imposed by the FDIC. Under the FDIC’s regulations, state nonmember banks that (i) receive the highest rating during the examination process and (ii) are not anticipating or experiencing any significant growth, are required to maintain a minimum leverage ratio of 3% of total consolidated assets; all other banks are required to maintain a minimum ratio of 1% or 2% above the stated minimum, with a minimum leverage ratio of not less than 4%. The Bank exceeded all applicable capital requirements as of December 31, 2010.

Federal Home Loan Bank System. The Federal Home Loan Bank system provides a central credit facility for member institutions. As a member of the Federal Home Loan Bank of Atlanta (“FHLB”), the Bank is required to own capital stock in the FHLB in an amount at least equal to 0.15% (or 15 basis points) of the Bank’s total assets at the end of each calendar year, plus 4.5% of its outstanding advances (borrowings) from the FHLB under the new activity-based stock ownership requirement. On December 31, 2010, the Bank was in compliance with this requirement.

Restrictions on Transactions with Affiliates. The Bank is subject to the provisions of Sections 23A and 23B of the Federal Reserve Act and Regulation W. Section 23A places limits on the amount of:

The total amount of the above transactions is limited in amount, as to any one affiliate, to 10% of a bank’s capital and surplus and, as to all affiliates combined, to 20% of a bank’s capital and surplus. In addition to the limitation on the amount of these transactions, each of the above transactions must meet specified collateral requirements. The Bank must comply with other provisions designed to avoid the transfer of low-quality assets from an affiliate.

The Bank is subject to the provisions of Section 23B of the Federal Reserve Act which, among other things, prohibits a bank from engaging in the above transactions with its affiliates unless the transactions are on terms substantially the same, or at least as favorable to the bank or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.

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

Emergency Economic Stabilization Act of 2008. Under the EESA, the Treasury implemented the TARP, of which the CPP is a part. Under the CPP, certain U.S. qualifying financial institutions sold senior preferred stock and warrants to the Treasury. Eligible institutions generally applied to issue preferred stock to the Treasury in aggregate amounts between 1% and 3% of the institution’s risk-weighted assets. Smaller community banks and bank holding companies, such as the Company, were later allowed to issue preferred stock up to 5% of the institution’s risk weighted assets. At the 2009 annual meeting of the stockholders, the Company’s stockholders approved an amendment to the Company’s articles of incorporation authorizing the issuance of shares of preferred stock, and so enabling the Company to participate in the CPP.

The Treasury was given discretion to exempt certain financial institutions from having to issue warrants. The Treasury elected to exercise its discretion in favor of those financial institutions that are certified as CDFIs, and for whom the CPP investment was $50 million or less. Accordingly, because the Bank is a CDFI, the Company was exempted from issuing warrants.

On June 26, 2009, the Company completed the issuance of 11,735 shares of Series A Preferred Stock under the CPP as a part of the TARP.

On February 3, 2010, the Obama Administration announced final terms for a new TARP program designed for CDFIs. Under the CDCI, eligible CDFIs currently participating in the CPP would be permitted to exchange the preferred stock issued under the CPP for preferred stock to be issued under the CDCI. Under the CDCI program, an initial dividend rate of 2% would apply for a period of eight years, as opposed to the original CPP terms of 5% for five years, thereafter moving to 9%.

On August 20, 2010, the Company completed an exchange of the Series A Preferred Stock for an equal amount of Series B Preferred Stock, under the CDCI.

Executive Compensation. The EESA, as amended by the American Recovery and Reinvestment Act (“ARRA”), which was signed into law on February 17, 2009, introduced extensive restrictions on executive compensation arrangements of financial institutions participating in TARP programs, including the CPP and the CDCI. On June 15, 2009, the Treasury published the Interim Final Rules in the Federal Register, which further supplement these executive compensation restrictions.

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

The Secure and Fair Enforcement for Mortgage Licensing Act of 2008 (“SAFE Act”).

The SAFE Act was enacted to enhance consumer protection and reduce fraud by setting minimum standards for the licensing and registration of mortgage loan originators. The Act requires mortgage loan originators employed by federally insured depository institutions or their subsidiaries to register with the Nationwide Mortgage Licensing System and Registry and to maintain current registration in that system. Financial institutions are required by the SAFE Act to maintain adequate policies and practices which will ensure that all employees acting in the capacity of mortgage loan originators register in the Nationwide Mortgage Licensing System and update their registration annually during the annual renewal period in November and December of each year.

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

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

Under Chapter 53 of the NC General Statutes, if the capital stock of a NC commercial bank is impaired by losses or otherwise, the NCCOB is authorized to require payment of the deficiency by assessment upon the bank’s stockholders.

ITEM 1A. RISK FACTORS

An investment in the Company’s common stock is subject to risks inherent in the Company’s business. The material risks and uncertainties that management believes affect the Company are described below. Before making an investment decision, you should carefully consider these risks and uncertainties, together with all of the other information included or incorporated by reference in this Annual Report on Form 10-K. These risks and uncertainties are not the only ones facing the Company. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair the Company’s business operations. This report is qualified in its entirety by these risk factors.

If any of the following risks actually occur, the Company’s financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of the Company’s common stock could decline significantly, and you could lose all or part of your investment.

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

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

Financial reform legislation recently enacted by Congress will result in new laws and regulations that are expected to increase our costs of operations. Congress recently enacted the Dodd-Frank Act. This new law will significantly change the current bank regulatory structure and affect the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies are given significant discretion in drafting the implementing rules and regulations, 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.

Certain provisions of the Dodd-Frank Act are expected to have a near term effect on us. For example, effective one year after the date of enactment, is a provision that eliminates the federal prohibitions on paying interest on demand deposits, thus allowing businesses to have interest bearing checking accounts. Depending on competitive responses, this significant change to existing law could have an adverse effect on our interest expense.

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

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

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

It is difficult to predict at this time what specific impact the Dodd-Frank Act and the yet to be written implementing rules and regulations will have on community banks. However, it is expected that at a minimum they will increase our operating and compliance costs and could increase our interest expense.

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

The soundness of other financial institutions could adversely affect us. Since mid-2007, the financial services industry as a whole, as well as the securities markets generally, have been materially and adversely affected by significant declines in the values of nearly all asset classes and by a serious lack of liquidity. Financial institutions in particular have been subject to increased volatility and an overall loss in investor confidence. The Company’s ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services companies are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, and other institutional clients. As a result, 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. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized or is liquidated at prices not sufficient to recover the full amount of the loan due us. There is no assurance that any such losses would not materially and adversely affect our businesses, financial condition or results of operations.

Increases in FDIC insurance premiums may adversely affect the Company’s net income and profitability. Since 2008, higher levels of bank failures have dramatically increased resolution costs of the FDIC and depleted the DIF. Deposit accounts are permanently insured up to $250,000 per customer and noninterest-bearing transactional accounts are currently fully insured (unlimited coverage). These programs have placed additional stress on the deposit insurance fund. In order to maintain a strong funding position and restore reserve ratios of the DIF, the FDIC has increased assessment rates of insured institutions. The Company is generally unable to control the amount of premiums that the Bank is required to pay for FDIC insurance. If there are additional bank or financial institution failures, or the cost of resolving prior failures exceeds expectations, the Bank may be required to pay even higher FDIC premiums than the recently increased levels. These announced increases and any future increases or required prepayments of FDIC insurance premiums may adversely impact the Company’s earnings and financial condition.

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On November 9, 2010, the FDIC published a rulemaking proposal under the Dodd-Frank Act that would alter the way an institution’s assessment base is calculated. Under the proposal, an institution’s assessment base will be its average consolidated total assets less its average tangible equity. In addition, certain current rate adjustments will be modified or eliminated, and a new rate adjustment will be established. The proposal will not become effective before the second quarter of 2011.

Additional requirements under our regulatory framework, especially those imposed under Dodd-Frank, ARRA, EESA or other legislation or regulations intended to strengthen the U.S. financial system, could adversely affect us. Recent government efforts to strengthen the U.S. financial system, including the passage of the Dodd-Frank Act, implementation of ARRA, EESA, the TLGP and special assessments imposed by the FDIC, subject participants to additional regulatory fees and requirements, including corporate governance requirements, executive compensation restrictions, restrictions on declaring or paying dividends, restrictions on share repurchases, limits on executive compensation tax deductions and prohibitions against golden parachute payments. These requirements, and any other requirements that may be subsequently imposed, may have a material and adverse affect on our business, financial condition, and results of operations.

Our participation in the CDCI imposes restrictions and obligations on us that limit our ability to increase dividends, repurchase shares of our common stock and access the capital markets. On August 20, 2010, the Company issued 11,735 shares of Series B Preferred Stock pursuant to the CDCI, a TARP program. Participation in the CDCI places restrictions on the Company’s ability to declare or pay dividends or distributions on, or purchase, redeem or otherwise acquire for consideration, shares of its capital stock, including restrictions against the Company (i) increasing dividends payable on its common stock from the last quarterly cash dividend per share ($0.05) declared on the common stock prior to November 17, 2008; (ii) increasing its aggregate per share dividends and distributions above the aggregate dividends and distributions paid for the immediately prior fiscal year; and (iii) declaring or paying dividends or distributions on, or repurchasing, redeeming or otherwise acquiring for consideration, shares of its capital stock in the event that the Company fails to declare and pay full dividends (or declare and set aside a sum sufficient for payment thereof) on the Series B Preferred Stock. The holders of these shares of Series B Preferred Stock also have certain registration rights which, in certain circumstances, impose lock-up periods during which we would be unable to issue equity securities. These restrictions will continue until all of the Series B Preferred Stock has been redeemed in full. In addition, unless we are able to redeem the Series B Preferred Stock during the first eight years, the dividends on this capital will increase substantially at that point, from 2% to 9%, and no further common stock dividends will be allowed until the preferred stock has been fully redeemed. Depending on market conditions at the time, this increase in preferred stock dividends could significantly impact our liquidity.

The limitations on incentive compensation contained in the ARRA and subsequent regulations may adversely affect our ability to retain our highest performing employees. In the case of a company such as the Company that received TARP funds, the ARRA, and subsequent regulations issued by Treasury, contain restrictions on bonus and other incentive compensation payable to the company’s senior executive officers. As a consequence, we may be unable to create a compensation structure that permits us to retain our highest performing employees and attract new employees of a high caliber. If this were to occur, our businesses and results of operations could be adversely affected.

The Company is subject to extensive governmental regulation, which could have an adverse impact on our operations. The banking industry is extensively regulated and supervised under both federal and state law. Current and future legislation and the policies established by federal and state regulatory authorities will affect the Company’s operations. The Company is subject to supervision and periodic examination by the Federal Reserve and the NCCOB. The Bank, as a state chartered non-member commercial bank, receives regulatory scrutiny from the FDIC and the NCCOB. Banking regulations, designed primarily for the protection of depositors, may limit our growth and the return to you as an investor in the Company, by restricting the Company’s activities, such as: the Company cannot predict what changes, if any, will be made to existing federal and state legislation and regulations or the effect that such changes may have on its business. Given the recent disruption in the financial markets and regulatory initiatives that have been proposed by the Obama administration and Congress, new regulations and laws that may affect us are increasingly likely. Compliance with such regulation may increase our costs and limit our ability to pursue business opportunities. In addition, participation in additional programs may subject us to additional restrictions. We cannot assure you that such modifications or new laws will not adversely affect:

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Our regulatory position is discussed in greater detail under Item 1. “Business—Supervision and Regulation” of this Annual Report on Form 10-K. In addition, the Company will be required to pay significantly higher FDIC premiums because market developments have significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured deposits.

We may need to raise additional capital in the future and such capital may not be available when needed or at all. We may need additional capital in the future to provide us with sufficient capital resources and liquidity to meet our commitments and business needs. Our ability to raise additional capital, if needed, will depend on, among other things, conditions in the capital markets at that time, which are outside of our control, and our financial performance. The ongoing liquidity crisis and the loss of confidence in financial institutions may increase our cost of funding and limit our access to some of our customary sources of capital, including, but not limited to, inter-bank borrowings, repurchase agreements and borrowings from the discount window of the Federal Reserve. We cannot assure you that such capital will be available to us on acceptable terms or at all. Any occurrence that may limit our access to the capital markets, such as a decline in the confidence of debt purchasers, depositors of the Bank or counterparties participating in the capital markets may adversely affect our capital costs and our ability to raise capital and, in turn, our liquidity. An inability to raise additional capital on acceptable terms when needed could have a materially adverse effect on our businesses, financial condition and results of operations.

The Company relies on dividends from the Bank for most of its revenue. The Company is a separate and distinct legal entity from the Bank. It receives substantially all of its revenue from dividends received from the Bank. These dividends are the principal source of funds to pay dividends on the Company’s common and preferred stock. Current the regulators have restricted the Bank from up-streaming dividends to the Company without prior approval by the FDIC, NCCOB and the FRB, which is discussed in greater detail under Item 1. “Business—Supervision and Regulation” of this Annual Report on Form 10-K. Absent the current MOUs, various federal and/or state laws, regulations, and agreements, limit the amount of dividends that the Bank may pay to the Company. In the event the Bank is unable to pay dividends to the Company, the Company may not be able to service debt, pay obligations, or pay dividends on the Company’s common and preferred stock. The inability to receive dividends from the Bank could have a material adverse effect on the Company’s business, financial condition and results of operations. See Item 1 “Business — Supervision and Regulation.”

The Bank may have higher loan losses than the Bank’s allowance for loan losses. The Bank maintains an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense that represents management’s best estimate of inherent risks of loss, as well as probable losses that will be incurred within the existing portfolio of loans. The level of the allowance reflects management’s continuing evaluation of industry concentrations; specific loan risks; credit loss experience; current loan portfolio quality; present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires management to make significant estimates of current loan risks and future trends, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of the Bank’s control, may require an increase in the allowance for loan losses. Repayment of commercial loans is generally considered more subject to market risk than residential mortgage loans. Bank regulatory agencies periodically review the Bank’s allowance for loan losses and may require an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance for loan losses, the Bank will need additional provisions to increase the allowance for loan losses. Any increases in the allowance for loan losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on the Company’s financial condition and results of operations. See Provision and Allowance for Loan Losses in the accompanying Management’s Discussion and Analysis of Financial Condition and Results of Operations for further discussion related to the Bank’s process for determining the appropriate level of the allowance for loan losses.

Our commercial real estate lending may expose us to a greater risk of loss and hurt our earnings and profitability. Our business strategy involves making loans secured by commercial real estate. These types of loans generally have higher risk-adjusted returns and shorter maturities than traditional one-to-four family residential mortgage loans. At December 31, 2010, our real estate secured commercial and faith based loans totaled $137.0 million, which represented 67.99% of total loans. Such loans increase our credit risk profile relative to other financial institutions that have higher concentrations of one to four family residential mortgage loans. Further, loans secured by commercial real estate properties are generally for larger amounts and involve a greater degree of risk than one to four family residential mortgage loans. Payments on loans secured by these properties are often dependent on the income produced by the underlying properties which, in turn, depends on the successful operation and management of the properties. Accordingly, repayment of these loans is subject to adverse conditions in the real estate market or the local economy. In addition, many economists believe that deterioration in income producing commercial real estate is likely to worsen as vacancy rates continue to rise and absorption rates of existing square footage continue to decline. In our niche market, faith-based and non-profit, payments on loans are dependent on voluntary contributions, which may be adversely affected during high unemployment periods, such as the economic conditions since late 2008. Because of the current general economic slowdown, these loans represent higher risk, could result in an increase in our total net-charge offs and could require us to increase our allowance for loan losses, which could have a material adverse effect on our financial condition or results of operations. For the year ended December 31, 2010, we had net charge-offs of $0.2 million, a decrease of $1.1 million when compared to the $1.3 million net charge-offs for the year ended December 31, 2009. While we seek to minimize loan loss risks in a variety of ways, there can be no assurance that these measures will protect against credit-related losses.

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Our faith-based and non-profit lending may expose us to a greater risk of loss and adversely impact our earnings and profitability. Our niche market is faith-based and non-profit lending. This specialization has historically experienced minimal losses, however, when unemployment is high, individuals may be unable to donate to support the missions of these organizations. In addition, many of the real estate secured properties are deemed to be special purpose structures that may not be conducive to other types of commercial activities, were foreclosure or sale necessary to enable principal and interest repayment. The Company has experienced recent deterioration in the credit quality of many of the loans in this niche market, and while we seek to minimize these risks in a variety of ways, there may be no assurance that these measures will protect against loan losses. At December 31, 2010, our loans secured by faith-based and non-profit entities totaled $91.4 million, which totaled 45.33% of total loans as compared to $82.0 million, which totaled 39.02% of total loans at December 31, 2009. Such loans increase our credit risk profile relative to other financial institutions that have higher concentrations of one to four family residential loans.

The Company’s growth strategy may not be successful. As a strategy, the Company seeks to increase the size of its franchise by pursuing business development opportunities, which include expanding deposit relationships, lending activity, and possible strategic expansion and/or acquisitions in new or existing markets. The Company can provide no assurance that it will be successful in increasing the volume of the Company’s loans and deposits at acceptable risk levels and upon acceptable terms, expanding its asset base while managing the costs and implementation risks associated with this growth strategy. There can be no assurance that any expansion will be profitable or that the Company will be able to sustain its growth, either through internal growth or through successful expansions of its banking markets, that regulatory approval would be forthcoming for such growth, or that the Company will be able to maintain capital sufficient to support its continued growth.

The Bank is subject to interest rate risk. The Bank’s earnings and cash flows are largely dependent upon its net interest income. Net interest income is the difference between interest income earned on interest-earning assets such as loans and investment securities, and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond the Bank’s control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Reserve. Changes in monetary policy, including changes in interest rates, could influence not only the interest the Bank receives on loans and investment securities and the amount of interest it pays on deposits and borrowings, but such changes could also affect (i) the Bank’s ability to originate loans and obtain deposits, (ii) the fair value of the Bank’s financial assets and liabilities, and (iii) the average duration of certain of the Bank’s interest-rate sensitive assets and liabilities. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, the Bank’s net interest income and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings. In addition, there are costs associated with the Bank’s risk management techniques, and these costs could be material. Fluctuations in interest rates are not predictable or controllable and, therefore, there can be no assurances of the Bank’s ability to continue to maintain a consistent, positive spread between the interest earned on the Bank’s earning assets and the interest paid on the Bank’s interest-bearing liabilities. See Asset/Liability Management in the accompanying Management’s Discussion and Analysis of Financial Condition and Results of Operations located elsewhere in this report for further discussion related to the Company’s management of interest rate risk.

If our investment in the common stock of the FHLB of Atlanta is classified as other-than-temporarily impaired or as permanently impaired, our earnings and stockholders’ equity could decrease. We own common stock of the FHLB of Atlanta. We hold this stock to qualify for membership in the FHLB System and to be eligible to borrow funds under the FHLB of Atlanta’s advance program. The aggregate cost and fair value of our FHLB of Atlanta common stock as of December 31, 2010 was $0.9 million based on its par value. There is no market for our FHLB of Atlanta common stock.

Published reports indicate that certain member banks of the FHLB System may be subject to accounting rules and asset quality risks that could result in materially lower regulatory capital levels. In an extreme situation, it is possible that the capital of an FHLB, including the FHLB of Atlanta, could be substantially diminished or reduced to zero. Consequently, we believe that there is a risk that our investment in FHLB of Atlanta common stock could be impaired at some time in the future, and if this occurs, it would cause our earnings and stockholders’ equity to decrease by the after-tax amount of the impairment charge.

If the Bank loses key employees with significant business contacts in its market areas, its business may suffer. The Bank’s success is largely dependent on the personal contacts of our officers and employees in its market areas. If the Bank loses key employees temporarily or permanently, this could have a material adverse effect on the business. The Bank could be particularly hurt if its key employees go to work for competitors. The Bank’s future success depends on the continued contributions of its existing senior management personnel, many of whom have significant local experience and contacts in its market areas.

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The Company’s operating results and financial condition would likely suffer if there is continued deterioration in the general economic condition of the areas in which the Bank does business. Unlike larger national or other regional banks that are more geographically diversified, the Bank primarily provides services to customers located in the Raleigh, Durham, Winston-Salem, Greensboro, and Charlotte areas of NC. Because the Bank’s lending and deposit-gathering activities are concentrated in these markets, the Bank will be affected by the business activity, population, income levels, deposits and real estate activity in these markets. Adverse developments in local industries have had and could continue to have a negative effect on the Bank’s financial condition and results of operations. Even though the Bank’s customers’ business and financial interests may extend well beyond these market areas, adverse economic conditions that affect these market areas could reduce the Bank’s growth rate, affect the ability of the Bank’s customers to repay their loans and generally affect the Company’s financial condition and results of operations. A significant further decline in general economic conditions in the Bank’s market areas, or the entire country, caused by inflation, recession, unemployment or other factors which are beyond the Bank’s control, would also impact these local economic conditions and could have an adverse affect on the Company’s financial condition and results of operations.

The Company is subject to security and operational risks related to the technology the Company uses that could result in a loss of customers, increased costs and other damages which could be material. The Company depends on data processing, software, and communication and information exchange on a variety of platforms, networks and over the internet. Despite safeguards, the Company cannot be certain that all of its systems are entirely free from vulnerability to attack or other technological difficulties or failures. Any failure, interruptions, or breach of security of these systems could result in failures or disruptions in its customer relationships, general ledger, deposits and servicing or loan origination systems. The occurrence of any such failures or difficulties could result in a loss of customer business, damage the Bank’s reputation, subject the Bank to additional regulatory scrutiny or expose the Bank to civil litigation and possible financial liability, any of which could have a material adverse effect on the Company’s results of operations and financial condition.

The Bank faces strong competition in our market areas, which may limit our asset growth and profitability. The banking business in the Bank’s market areas is very competitive, and the level of competition facing the Bank may increase further, which may limit the Bank’s asset growth and/or profitability. The Bank experiences competition in both lending and attracting deposits from other banks and nonbank financial institutions located within its market areas, some of which are significantly larger institutions and may have more financial resources than the Bank. Such competitors primarily include national, regional and local financial institutions within the Bank’s market areas. Additionally, various out-of-state banks have begun to enter or have announced plans to enter the market areas in which the Bank currently operates. Nonbank competitors for deposits and deposit-type accounts include savings associations, credit unions, savings banks, securities firms, money market funds, life insurance companies and the mutual funds industry. For loans, the Bank encounters competition from other banks, savings associations, finance companies, mortgage bankers and brokers, insurance companies, small loan and credit card companies, credit unions, pension trusts, securities firms and major retail stores that offer competing financial services. Many of these competitors have fewer regulatory constraints and may have lower cost structures. Additionally, due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products and services as well as better pricing for those products and services than the Bank can offer.

The Bank is exposed to risks in connection with the loans it makes. A significant source of risk for the Company and the Bank arises from the possibility that losses will be sustained by the Bank because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loans. The Bank has underwriting and credit monitoring procedures and credit policies, including the establishment and review of the allowance for loan losses, that it believes are appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance and diversifying its loan portfolio. Such policies and procedures, however, may not prevent unexpected losses that could adversely affect the Bank’s results of operations.

The Bank is subject to environmental liability risk associated with lending activities. A significant portion of the Company’s loan portfolio is secured by real property. During the ordinary course of business, the Bank may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, the Bank may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require the Bank to incur substantial expenses and may materially reduce the affected property’s value or limit the Bank’s ability to use or sell the affected property. In addition, future laws or more stringent interpretations of enforcement policies with respect to existing laws may increase the Bank’s exposure to environmental liability. Although the Bank has policies and procedures to perform an environmental review before initiating any foreclosure action on real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on the Company’s financial condition and results of operations.

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

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

Liquidity risk could impair our ability to fund operations and jeopardize our financial condition, results of operations and cash flows. Liquidity is essential to our business. Our ability to implement our business strategy will depend on our ability to obtain funding for loan originations, working capital and other general corporate purposes. An inability to raise funds through deposits, borrowings, securities sold under repurchase agreements, the sale of loans and other sources could have a substantial negative effect on our liquidity. We do not anticipate that our retail and commercial deposits will be sufficient to meet our funding needs in the foreseeable future. We therefore rely on Certificate of Deposit Account Registry Service® (“CDARS®”) reciprocal deposits, FHLB advances, and other wholesale funding sources to obtain the funds necessary to implement our growth strategy.

Our access to funding sources in amounts adequate to finance our activities or on terms which are acceptable to us could be impaired by factors that affect us specifically, the financial services industry, or the economy in general, including a decrease in the level of our business activity as a result of a downturn in the markets in which our loans are concentrated or adverse regulatory action against us. Our ability to borrow could be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry in light of the recent turmoil faced by banking organizations and the continued deterioration in credit markets. To the extent we are not successful in obtaining such funding, we will be unable to implement our strategy as planned which could have a material adverse effect on our financial condition, results of operations and cash flows.

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

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

Technological advances impact the Company’s business. The banking industry continues to undergo technological changes with frequent introductions of new technology-driven products and services. In addition to improving customer services, the effective use of technology increases efficiency and enables financial institutions to reduce costs. The Company’s future success will depend, in part, on our ability to address the needs of the Bank’s customers by using technology to provide products and services that will satisfy customer demands for convenience as well as to create additional efficiencies in operations. Many competitors have substantially greater resources to invest in technological improvements. The Bank may not be able to effectively implement new technology-driven products and services or successfully market such products and services to its customers.

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

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Unpredictable catastrophic events could have a material adverse effect on the Company. The occurrence of catastrophic events such as hurricanes, tropical storms, earthquakes, pandemic disease, windstorms, floods, severe winter weather (including snow, freezing water, ice storms and blizzards), fires, and other catastrophes could adversely affect the Company’s consolidated financial condition or results of operations. Unpredictable natural and other disasters could have an adverse effect on the Bank in that such events could materially disrupt its operations or the ability or willingness of its customers to access the financial services offered by the Bank. The incidence and severity of catastrophes are inherently unpredictable. Although the Bank carries insurance to mitigate its exposure to certain catastrophic events, these events could nevertheless reduce the Company’s earnings, cause volatility in its financial results for any fiscal quarter or year, and have a material adverse effect on the Company’s financial condition and/or results of operations.

The Company’s trading volume is low compared with larger national and regional banks. The Company’s common stock is quoted on the Over The Counter Bulletin Board. The trading volume of the Company’s common stock is low when compared with more seasoned companies listed on the NASDAQ, the NYSE, other consolidated reporting systems, or stock exchanges. Thus, the market in the Company’s common stock is limited in scope relative to other larger companies. In addition, the Company cannot say with any certainty that a more active and liquid trading market for its common stock will develop.

The Company has issued preferred stock, which ranks senior to our common stock. The Company has issued 11,735 shares of Series B Preferred Stock. This Series B Preferred Stock ranks senior to shares of our common stock. As a result, the Company must make dividend payments on the preferred stock before any dividends may be paid on the common stock and, in the event of our bankruptcy, dissolution or liquidation, the holders of the preferred stock must be satisfied before any distributions can be made on the common stock. If the Company does not remain current in the payment of dividends on the Series B Preferred Stock, no dividends may be paid on the common stock.

Our preferred stock reduces net income available to holders of our common stock and earnings per common share. The dividends declared on our preferred stock reduce any net income available to holders of common stock and our earnings per common share. The preferred stock will receive preferential treatment in the event of sale, merger, liquidation, dissolution or winding up of our company.

There may be future sales of additional common stock or preferred stock or other dilution of our equity, which may adversely affect the market price of our common stock. We are not restricted from issuing additional common stock or preferred stock, including any securities that are convertible into or exchangeable for, or that represent the right to receive, common stock or preferred stock or any substantially similar securities. The market value of our common stock could decline as a result of sales by us of a large number of shares of common stock or preferred stock or similar securities in the market or the perception that such sales could occur.

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

The Bank has credit risks with some of its deposits. The Bank holds deposits that exceed the FDIC federally insured balance at certain financial institutions. The Bank may lose all uninsured balances if one of the correspondent banks fails without warning. As of December 31, 2010, the Bank has deposits with one correspondent institution that exceed the federally insured limit by $0.6 million.

Consumer protection initiatives related to the foreclosure process could affect our remedies as a creditor. Consumer protection initiatives proposed related to the foreclosure process, including voluntary and/or mandatory programs intended to permit or require lenders to consider loan modifications or other alternatives to foreclosure, could increase our loan losses or increase our expense in pursuing our remedies as a creditor.

Item 1B. UNRESOLVED STAFF COMMENTS

None

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At December 31, 2010, the Company conducted its business from its corporate office in Durham, NC, and its seven branch offices in Durham, Raleigh, Charlotte, Greensboro and Winston-Salem, NC.

The following table sets forth certain information regarding the Bank’s properties as of December 31, 2010. Rent expense incurred by the Bank under ongoing leases totaled approximately $46 thousand for the year ended December 31, 2009. Total rent expense for the year ended December 31, 2010 totaled $47 thousand, which included an off-site ATM.

Management considers all of these properties to be in good condition and adequately covered by insurance. Additional information about the Company’s property is set forth in Notes 7 and 9 to the Consolidated Financial Statements, included in Item 8 herein.

ITEM 3. LEGAL PROCEEDINGS

In the ordinary course of operations, the Company and the Bank are often involved in legal proceedings. In the opinion of management, neither the Company nor the Bank is a party to, nor is their property the subject of, any material pending legal proceedings, other than ordinary routine litigation incidental to their business, nor has any such proceeding been terminated during the fourth quarter of the Company’s fiscal year ended December 31, 2010.

ITEM 4. N/A

PART II

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

The Company’s common stock is quoted on the OTC Bulletin Board under the symbol “MFBP”.

As of March 15, 2011, there were 2,031,337 shares of the Company’s common stock outstanding, held by approximately 990 stockholders of record (not including persons or entities whose stock is held in nominee or ‘street’ name through various brokerage firms or banks). The following table shows the high and low sale price of the Company’s common stock for the previous eight quarters, as well as the per share amount of cash dividends paid per share for the same periods. These quotations reflect inter-dealer prices, without retail mark up, mark down or commission and may not represent actual transactions. No stock dividend was declared or paid during any of the fiscal quarters listed.

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Dividends. See “Item 1. Description of Business – Supervision and Regulation – Dividend and Repurchase Limitations” above for regulatory and TARP restrictions, which limit the ability of the Company to pay dividends.

Dividend Policy. The Company’s stockholders are entitled to receive such dividends or distributions as declared from time to time by the Board of Directors. During fiscal year 2010, the Company declared and paid to its stockholders dividends totaling $0.10 per share (see chart above for declared quarterly dividends). Subject to the regulatory and TARP restrictions discussed in “Item 1 Dividend and Repurchase Limitations”, the Company may continue to pay stockholders in the form of annual cash dividends, if doing so is considered to be in the best interest of the Company and consistent with maintaining the Company’s status as a “well capitalized” institution under applicable banking laws and regulations, and the regulators are in agreement thereof. In 2010, the dividends awarded to stockholders accounted for 83.0% of fully diluted earnings per share available to common shareholders.

Recent Sales of Unregistered Securities. Except for the sale of preferred stock to the Treasury in 2009 and the exchange thereof in 2010, the Company did not sell any securities within the last three fiscal years that were not registered under the Securities Act.

Purchases of Equity Securities by the Issuer and Affiliated Purchasers. The Company did not repurchase any shares of its common stock in 2010.

Equity Compensation Plan. The Company’s stock option plan, and all options granted thereunder, expired as of or before December 31, 2009.

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ITEM 6. SELECTED FINANCIAL DATA

The following table sets forth selected financial information for the Company, including balance sheets and operational data as of and for the years ended December 31, 2010, 2009, and 2008, portions of which have been derived from, and are qualified by reference to, and should be read in conjunction with, the Consolidated Financial Statements and notes thereto included elsewhere in this report. The comparability of financial data for these periods has been impacted by the acquisition of Mutual Community Savings Bank, Inc., SSB (“MCSB”) in March, 2008.

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

INTRODUCTION

The following discussion and analysis is intended to aid the reader in understanding and evaluating the Company’s consolidated results of operations and financial condition. This discussion is designed to provide more comprehensive information about the major components of the Company’s results of operations, financial condition, liquidity, and capital resources than may be obtained from reading the financial statements alone. This discussion should be read in conjunction with, and is qualified in its entirety by reference to, the Company’s Consolidated Financial Statements, including the related notes thereto presented elsewhere in this report. This discussion may contain forward-looking statements that involve risks and uncertainties. Our actual results could differ significantly from those anticipated in forward-looking statements as a result of various factors. See Item 1A “Risk Factors” and the cautionary statement on page 2 of this Annual Report on Form 10-K, entitled “Forward-looking Statements.”

OVERVIEW

The Bank is a full-service NC state-chartered bank conducting business in the five largest urban areas of NC: Raleigh, the State’s capitol, Durham, Winston-Salem, Greensboro, and Charlotte. Beginning in 2007, the Bank celebrated the 100^th anniversary of its founding in 1907 and the opening of its first branch in 1908 on Parrish Street in Durham where the Bank continues to operate a branch. In 1999, the Company was created as a bank holding company. As of December 31, 2010, the Company conducted no business other than providing services and assistance to the Bank, its wholly owned subsidiary.

On March 28, 2008, the Company completed the acquisition of MCSB, which had opened its original operation in a teller window of the Bank 84 years previously.

The Bank’s business consists principally of attracting deposits from the general public and investing these funds in loans secured by commercial real estate, secured and unsecured commercial and consumer loans, single-family residential mortgage loans, and home equity lines. As a community bank, the Bank’s profitability depends primarily upon its levels of net interest income, which is the difference between interest income from interest-earning assets and interest expense on interest-bearing liabilities. When earnings from interest-earning assets approximate or exceed expenses for interest-bearing liabilities, any positive interest rate spread will generate net interest income. The Bank’s profitability is affected by its provision for loan losses, noninterest income, and other operating expenses. Noninterest income primarily consists of service charges, ATM fees, rental income, and the increase in cash surrender value of bank-owned life insurance. Operating expenses primarily consist of compensation and benefits, occupancy related expenses, marketing, data processing, professional fees, telecommunication, FDIC insurance expense, expenses related to foreclosed properties from defaulted loans, and other non-interest expenses.

The Bank’s operations are influenced significantly by local economic conditions and by policies of financial institution regulatory authorities. The Bank’s costs of funds are influenced by interest rates on deposits and borrowing rates offered by competing financial institutions in our market area, as well as general market interest rates. Lending activities are affected by the demand for financing, which in turn is affected by the prevailing interest rates, as well as the borrower’s credit and risk profiles established under the Bank’s lending policies.

EXECUTIVE SUMMARY

Impact of Recent Developments on the Banking Industry

Congress enacted the Dodd-Frank Act on July 21, 2010. This new law will significantly change the current bank regulatory structure and affect the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act is a significant piece of legislation that will have major effects on the financial services industry, including the Company, and the financial condition and operations of banks and bank holding companies, including the Bank. Management is currently evaluating the impact of the Dodd-Frank Act; however, uncertainty remains as to its operational impact, which could have a material adverse impact on the Company’s and the Bank’s business, results of operations and financial condition. Many of the provisions of the Dodd-Frank Act are focused on financial institutions that are significantly larger than the Company and the Bank. As rules and regulations are promulgated by the agencies responsible for implementing and enforcing the Dodd-Frank Act, the Company and the Bank will have to address each to ensure compliance with applicable provisions of the Act and compliance costs are expected to increase.

It is difficult to predict at this time what specific impact the Dodd-Frank Act and the yet to be written rules and regulations will have on community banks. However, it is expected that at a minimum they will increase our operating and compliance costs and could increase our interest expense.

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The banking industry, including the Company, is operating in a challenging and volatile economic environment. The effects of the downturn in the housing market have adversely impacted credit markets, consumer confidence and the broader economy. Although the Bank remains profitable, it has not been immune to the impact of the current recession or the increased focus of banking regulators upon capital and liquidity levels.

As discussed in more detail below, the following is a brief summary of the Company’s significant results for the year ended December 31, 2010.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The following discussion and analysis of the Company’s financial condition and results of operations are based on the Company’s Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of these financial statements requires the Company to make estimates and judgments regarding uncertainties that affect the reported amounts of assets, liabilities, revenues, and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, the Company evaluates its estimates, including those related to the allowance for loan losses, investment values, income taxes, contingencies, and litigation. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. However, because future events and their effects cannot be determined with certainty, actual results may differ from these estimates under different assumptions or conditions, and the Company may be exposed to gains or losses that could be material.

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The Bank’s significant accounting policies are discussed below and in Item 8. Financial Statements and Supplementary Data — Notes to Consolidated Financial Statements – Note 1. Significant Accounting Policies. Management believes that the following accounting policies are the most critical to aid in fully understanding and evaluating the Company’s reported financial results, and they require management’s most difficult, subjective or complex judgments, resulting from the need to make estimates about the effect of matters that are inherently uncertain. Management has reviewed these critical accounting policies and related disclosures with the Audit Committee of the Board of Directors.

The fair value hierarchy defines Level 1 and 2 valuations as those that are based on quoted prices for identical instruments traded in active markets and quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. Level 3 valuations are based on model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that we believe market participants would use in pricing the asset or liability. Financial assets that are recorded at fair value on a recurring basis include available-for-sale investment securities, mortgage servicing rights, and investments related to deferred compensation arrangements.

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RESULTS OF OPERATIONS

Year Ended December 31, 2010 Compared with Year Ended December 31, 2009

Net Interest Income. Net interest income, the difference between total interest income from loans and investments, and total interest expenses from deposits and borrowings, is the Company’s principal source of earnings. The amount of net interest income is determined by the volume of interest-earning assets, the level of rates earned on those assets, and the volume and cost of underlying funding from deposits and borrowings. Net interest income before the provision for loan losses decreased $0.2 million, or 1.73%, from $11.2 million for the year ended December 31, 2009, to $11.0 million for the year ended December 31, 2010. Net interest spread is the difference between rates earned on interest-earning assets and the interest paid on deposits and borrowed funds. Net interest margin is the total of net interest income divided by average earning assets. Average earning assets for the year ended December 31, 2010 were $274.3 million, up 11.06% compared to $247.0 million for the year ended December 31, 2009. On a fully TE basis, net interest margin was 4.09% and 4.66% for the years ended December 31, 2010 and 2009, respectively. The net interest spread decreased 42 bps to 3.82% for the year ended December 31, 2010, from 4.24% for the year ended December 31, 2009. The yield on average interest-earning assets was 4.84% and 5.80% for the years ended December 31, 2010 and 2009, respectively, a decrease of 96 bps, while the interest rate on average interest-bearing liabilities for those periods was 1.02% and 1.56%, respectively, a decrease of 54 bps due to the ongoing low interest rate environment.

The Company’s balance sheet remains asset sensitive and, as a result, interest-earning assets are repricing faster than interest-bearing liabilities. As time deposits mature and reprice, the margin may be negatively impacted based on competitive pricing to retain these deposits.

Interest income decreased 7.46% for the year ended December 31, 2010 to $13.1 million, from $14.2 million for the year ended December 31, 2009. The average balances of loans, which had overall yields of 5.94% for the year ended December 31, 2010 and 6.21% for the year ended December 31, 2009, respectively, decreased from $211.0 million for the year ended December 31, 2009 to $207.0 million for the year ended December 31, 2010. The average balance of investment securities decreased $5.4 million from $23.4 million for the year ended December 31, 2009 to $18.0 million for the year ended December 31, 2010. The TE yield on investment securities decreased from 5.55% for the year ended December 31, 2009 to 4.95% for the year ended December 31, 2010. The rate decreases have been driven by the economy and market conditions. The average balances of federal funds and other short-term investments increased from $12.6 million for the year ended December 31, 2009 to $49.3 million for the year ended December 31, 2010, and the average yield in this category decreased 4 bps from 0.24% to 0.20% over the same time period resulting from the decrease in short-term interest rates. The increase in federal funds sold and other short-term investments has resulted from the decrease in loans and the increase in deposits during 2010.

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Interest expense decreased 29.45% for the year ended December 31, 2010, to $2.1 million, from $2.9 million for the year ended December 31, 2009. Average total interest-bearing deposits, including savings, interest-bearing demand deposits and time deposits increased from $179.2 million for the year ended December 31, 2009, to $202.0 million for the year ended December 31, 2010. The average rate paid on interest-bearing deposits decreased 57 bps from 1.59% for the year ended December 31, 2009 to 1.02% for the year ended December 31, 2010, primarily in response to the decreases in rates paid on time deposits.

The average rate on borrowings decreased from 0.81% for the year ended December 31, 2009 to 0.34% for the year ended December 31, 2010. The average borrowings outstanding decreased from $8.6 million for the year ended December 31, 2009 to $1.1 million for the year ended December 31, 2010. The interest expense on borrowed funds decreased by $66 thousand in 2010 from $70 thousand in 2009 to $4 thousand, reflecting lower rates and lower average balances. In early 2010, the Company repaid a short-term borrowing at the FHLB, and took advantage of the opportunity to pay off another long term borrowing without a prepayment penalty. Other than periodic testing of the Bank’s federal funds lines with correspondent banks, there was only one long term, small balance loan outstanding for the balance of 2010.

The following table, Average Balances, Interest Earned or Paid, and Interest Yields/Rates reflects the Company’s effective yield on earning assets and cost of funds. Yields and costs are computed by dividing income or expense for the year by the respective daily average asset or liability balance. Changes in net interest income from year to year can be explained in terms of fluctuations in volume and rate. In the tables, the amount earned on nontaxable securities is reflected as actual, whereas the rate on nontaxable securities is stated at the TE rate.

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Average Balances, Interest Earned or Paid, and Interest Yields/Rates

For the Years Ended December 31, 2010 and 2009

The following table, Rate and Volume Variance Analysis, presents further information on those changes. For each category of interest-earning asset and interest-bearing liability, we have provided information on changes attributable to:

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Rate and Volume Variance Analysis

Noninterest Income. Noninterest income decreased 15.19% to $2.2 million from $2.6 million for years ended December 31, 2010 and 2009, respectively. In the year ended December 31, 2009, the Bank sold two bank-owned facilities, a closed branch in Durham, NC and a parcel of land that was originally acquired with another branch, for a net gain on sale of $0.3 million, which accounted for the majority of the decrease in noninterest income in 2010. In 2009, the Bank realized an additional $0.1 million in gain on sale of securities and disposal of assets. The additional $0.2 million in realized gains improved other noninterest income in 2009.

Noninterest Expense. Noninterest expense represents the costs of operating the Company and the Bank. Management regularly monitors all categories of noninterest expense with the goal of improving productivity and operating performance. Noninterest expense increased 5.28% to $11.8 million for the year ended December 31, 2010 from $11.3 million for the year ended December 31, 2009. The largest impacts to noninterest expense were increases in OREO expense, FDIC insurance expense, and information technology expense.

Salary and employee benefits expenses for the years ended December 31, 2010 and 2009 were $5.2 million and $5.5 million, respectively. The full time equivalent employees increased from 74 as of December 31, 2009 to 77 as of December 31, 2010. The increase in staff during 2010 occurred in the second half of the year, mitigating the effect on overall salaries and wages expenses for 2010. Benefits decreased $0.1 million in 2010 compared to 2009, primarily due to decreased retirement benefit costs associated with the Company’s 401k and pension plans. The Company incurred $0.1 million in severance expenses in 2009 related to the reductions in workforce of the Bank’s employees associated with branch closures and corporate office staff reductions.

Occupancy expense decreased $0.2 million in the year ended December 31, 2010 from the same period in 2009. Depreciation and amortization expenses decreased $0.1 million to $0.4 million for the year ended December 31, 2010 from $0.5 million for the year ended December 31, 2009, primarily due to assets fully depreciating in 2009 and not being replaced. Building repairs and maintenance expense declined $0.1 million, following the 2009 branch closures. Real estate taxes, utilities, and other equipment expense decreased a combined total of $43 thousand in 2010.

Data processing and communications costs increased from $0.7 million in 2009 to $0.8 million in 2010, mainly due to increased core processing charges of $0.1 million associated with the increase in total assets.

Directors and advisory board fees were basically flat at $0.3 million for 2009 and 2010. Professional fees increased $38 thousand in 2010 above 2009. Consultant costs increased $0.1 million, temporary help decreased $35 thousand, legal fees remained flat, and audit costs decreased $0.1 million in 2010 from 2009 levels as the result of cost containment measures.

In 2010, FDIC insurance premiums increased $0.2 million due to an increase in our insurance rate and overall deposits.

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Other expenses increased $0.2 million for the year ended December 31, 2010 from the year ended December 31, 2009. Increases in contributions, franchise tax, and appraisal fees led to the majority of the $0.2 million increase over prior year.

Provision for Income Taxes. The Company recorded an income tax expense of $0.1 million for the years ended December 31, 2010 and December 31, 2009. The overall effective rate decreased from a tax expense of 12.81% in 2009 to a tax expense of 9.86% in 2010.

ASSET QUALITY

Provision and Allowance for Loan Losses. The provision for loan losses is the amount charged against earnings, to establish an adequate allowance for loan losses. Loan losses and recoveries are charged to or credited to this allowance, rather than reported as a direct expense or recovery. As of December 31, 2010, the allowance for loan losses was $3.9 million compared to $3.6 million for the year ended December 31, 2009, an increase of $0.3 million, which represented approximately 1.91% and 1.70% of total loans outstanding on those respective dates. Nonperforming assets, defined as non-accruing loans plus foreclosed properties, at December 31, 2010 were 4.07% of total assets compared to 2.13% at December 31, 2009. Nonperforming loans as percentage of total loans at the end of 2010 was 6.23% compared to 5.32% at December 31, 2009.

Of the non-accruing loans totaling $12.6 million at December 31, 2010, 90.6% of the outstanding balance is secured by real estate, which management believes mitigates the risk of loss. Troubled debt restructurings (“TDRs”) in compliance with the modified terms totaled $3.19 million or 37.7% of total TDRs at December 31, 2010. GAAP does not provide specific guidance on when a loan may be returned to accrual status. Federal banking regulators have provided guidance that interest on impaired loans, including TDRs, should only be recorded when there has been a sustained period of repayment performance, the loan is well secured, and collection under any revised terms is assessed as probable. The Company currently uses this Federal banking regulators guidance.

In analyzing its allowance for loan losses, the Company tracks its net loan loss history by loan type. The quantitative net loss history utilizes the prior two year period by loan type for the reserve. The quantitative loss experience by loan type is then applied against the unimpaired loan balances and homogenous impaired balances to determine the quantitative reserve. Under Accounting Standards Codification (“ASC”) Section 310 Receivables (“ASC 310”), the non-homogenous impaired loans, homogenous small balance real estate secured loans in process of foreclosure, and TDRs, are reviewed individually for impairment. The second piece of the calculation is based on qualitative factors, including (i) policy, underwriting, charge-off and collection (ii) national and local economic conditions, (iii) nature and volume of the portfolio, (iv) experience, ability, and depth of lending team, (v) trends of past due, classified loans, and restructurings, (vi) quality of loan review and board oversight, (vii) existence, levels, and effect of loan concentrations and (viii) effects of external factors such as competition and regulatory oversight, are adjusted quarterly based on historical information for any quantifiable factors, and applied in total to each loan balance by loan type. The Company continues to enhance its modeling of the portfolio and underlying risk factors through quarterly analytical reviews with the goal of ensuring it captures all pertinent factors contributing to risk of loss inherent in the loan portfolio. The Company applies additional qualitative factors for classified loans including special mention, substandard, and doubtful loans not identified as impaired, when the loan has a loan to value exceeding 50% of the outstanding balance and is not current in its payments.

Management also considers trends in internally risk-rated exposures, criticized exposures, cash-basis loans, and historical and forecasted write-offs. In addition to a review of industry, geographic, and portfolio concentrations, including current developments within those segments, management considers the current business strategy and credit process, including credit-limit setting and compliance, credit approvals, loan underwriting criteria and loan workout procedures. The quantitative portion of the allowance for loan losses is adjusted for qualitative factors to account for model imprecision and to incorporate the range of probable outcome inherent in the estimates used for the allowance. The qualitative portion of the allowance attempts to incorporate the risks inherent in the portfolio, economic uncertainties, competition, regulatory requirements and other factors including industry trends, changes in underwriting standards, decline in the value of collateral for collateral dependent loans and existence of concentrations.

Loans are generally placed on non-accrual status when the scheduled payments reach 90 days past due. Loans are charged-off, with Board approval, when the Chief Credit Officer and his staff determine that all reasonable means of collection of the outstanding balances, except through foreclosure, have been exhausted. The Company continues its collection efforts subsequent to charge-off, which results in some recoveries each year.

For all classes of commercial loans, a quarterly evaluation of specific individual borrowers is performed to identify impaired loans. The identification of specific borrowers for review is based on a review of non-accrual loans as well as those loans specifically identified by management as exhibiting above average levels of risk. The allowance for loan and lease losses attributed to impaired loans considers all available evidence, including as appropriate, the probability that a specific loan will default, the expected exposure of a loan in default, an estimate of loss given default, the present value of expected future cash flows discounted using the loan’s contractual effective rate, the secondary market value of the loan and the fair value of collateral.

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When a loan has been identified as being impaired, the allowance attributed considers all available evidence as appropriate, the probability that a specific loan will default, the expected exposure of a loan in default, an estimate of loss given default, the present value of expected future cash flows discounted using the loan’s contractual effective rate, the secondary market value of the loan and the fair value of collateral. If the measurement of the impaired loan is less than the recorded investment in the loan (including accrued interest, net of deferred loan fees or costs and unamortized premiums or discounts), an impairment is recognized by creating or adjusting an existing allocation of the allowance, or by recording a partial charge-off of the loan to its fair value. Interest payments made on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest income maybe accrued or recognized on a cash basis.

In 2010 the provision for loan losses decreased to $0.5 million from the 2009 level of $1.9 million. In 2009, two TDR loans to one borrower were determined to be permanently impaired for $0.8 million, and the carrying values of the loans were decreased accordingly. In addition, the carrying values of loans to two other borrowers whose loans were not TDRs, were decreased a total of $0.4 million in 2009. These TDR and non-TDR principal write-downs contributed to the larger provision in 2009 versus that of 2010.

Loans net of deferred fees and costs at year end were as follows:

Activity in the allowance for loan losses was as follows:

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In 2010, management changed its loan-related disclosure classifications in its financial reports to present portfolio segments. A portfolio segment is defined as the level at which an entity develops and documents a systematic methodology to determine its allowance for loan losses. The following table presents the allowance for loan losses and the reported investment in loans net of deferred fees and costs by portfolio segment and based on impairment method as of December 31, 2010:

The Company experienced $0.2 million in net loans charged-off for the year ended December 31, 2010 compared to $1.3 million in net loan charge-offs for the year ended December 31, 2009. Net loan charge-offs as a percent of average loan balances outstanding decreased from 0.59% for the year ended December 31, 2009 to 0.11% for the year ended December 31, 2010.

The unpaid principal balance for impaired loans, excluding troubled debt restructures were as follows:

There was no interest income recognized while the loans were impaired.

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The following table presents loans individually evaluated for impairment, excluding TDRs by class of loans as of December 31, 2010: