Ecb Bancorp (ECBE) 10-Q 2010 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2010

or

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from            to            

Commission File No. 0-24753

ECB Bancorp, Inc.

(Exact name of registrant as specified in its charter)

North Carolina	56-2090738
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

Post Office Box 337, Engelhard, North Carolina 27824

(Address of principal executive offices) (Zip Code)

(252) 925-9411

(Registrant’s telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    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 (Section 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 whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	¨	Accelerated filer	¨
Non-accelerated filer	¨	Smaller reporting company	x

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

On November 5, 2010, there were 2,849,841 outstanding shares of Registrant’s common stock.

This Form 10-Q has 45 pages.

Table of Contents

Index

		Begins on Page
Part 1 – Financial Information
Item 1. Financial Statements:
	Consolidated Balance Sheets at September 30, 2010 (unaudited) and December 31, 2009		3
	Consolidated Income Statements for Three and Nine Months Ended September 30, 2010 and 2009 (unaudited)		4
	Consolidated Statements of Changes in Shareholders’ Equity for Nine Months Ended September  30, 2010 and 2009 (unaudited)		5
	Consolidated Statements of Cash Flows for Nine Months Ended September 30, 2010 and 2009 (unaudited)		6
	Notes to Consolidated Financial Statements		7
Item  2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			22
Item 3. Quantitative and Qualitative Disclosures About Market Risk			37
Item 4. Controls and Procedures			38
Part II – Other Information
Item 1. Legal Proceedings			38
Item 1A. Risk Factors			38
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			39
Item 3. Defaults upon Senior Securities			39
Item 4. Removed and Reserved			39
Item 5. Other Information			39
Item 6. Exhibits			39
Signatures			40
Exhibit Index			41

2

ECB BANCORP, INC. AND SUBSIDIARY

Consolidated Balance Sheets

September 30, 2010 and December 31, 2009

(Dollars in thousands, except per share data)

	September 30, 2010			December 31, 2009*
	(unaudited)
Assets
Non-interest bearing deposits and cash	$	8,666		$	9,076
Interest bearing deposits		20			870
Overnight investments		31,720			7,865
Total cash and cash equivalents		40,406			17,811
Investment securities
Available-for-sale, at market value (cost of $258,148 and $237,594 at September 30, 2010 and December 31, 2009, respectively)		263,946			239,332
Loans held for sale		2,103			—
Loans		575,003			577,791
Allowance for loan losses		(13,187	)		(9,725	)
Loans, net		561,816			568,066
Real estate and repossessions acquired in settlement of loans, net		5,253			5,443
Federal Home Loan Bank common stock, at cost		4,749			5,116
Bank premises and equipment, net		25,897			25,329
Accrued interest receivable		5,176			4,967
Bank owned life insurance		8,880			8,657
Other assets		13,983			13,999
Total	$	932,209		$	888,720
Liabilities and Shareholders’ Equity
Deposits
Demand, noninterest bearing	$	105,628		$	93,492
Demand, interest bearing		215,346			141,956
Savings		25,972			19,595
Time		443,646			499,687
Total deposits		790,592			754,730
Accrued interest payable		982			1,121
Short-term borrowings		13,534			22,910
Long-term obligations		34,500			21,000
Other liabilities		4,969			4,584
Total liabilities		844,577			804,345
Shareholders’ equity
Preferred stock, Series A		17,246			17,122
Common stock, par value $3.50 per share		9,974			9,968
Capital surplus		25,844			25,803
Warrant		878			878
Retained earnings		30,144			29,555
Accumulated other comprehensive income		3,546			1,049
Total shareholders’ equity		87,632			84,375
Total	$	932,209		$	888,720
Common shares outstanding		2,849,841			2,847,881
Common shares authorized		10,000,000			10,000,000
Preferred shares outstanding		17,949			17,949
Preferred shares authorized		2,000,000			2,000,000

* Derived from audited consolidated financial statements.

3

ECB BANCORP, INC. AND SUBSIDIARY

Consolidated Income Statements

For the three and nine months ended September 30, 2010 and 2009

(Dollars in thousands, except per share data)

	Three months ended September 30,						Nine months ended September 30,
	2010			2009			2010		2009
	(unaudited)			(unaudited)			(unaudited)		(unaudited)
Interest income:
Interest and fees on loans	$	7,640		$	7,807		$	23,062	$	22,820
Interest on investment securities:
Interest exempt from federal income taxes		385			354			1,337		1,005
Taxable interest income		1,949			2,122			5,519		6,959
Dividend income		6			37			40		67
Other interest income		2			—			9		3
Total interest income		9,982			10,320			29,967		30,854
Interest expense:
Deposits:
Demand accounts		406			224			1,045		609
Savings		25			12			52		34
Time		2,347			2,742			7,248		9,510
Short-term borrowings		66			95			183		403
Long-term obligations		161			171			434		538
Other interest expense		—			—			—		30
Total interest expense		3,005			3,244			8,962		11,124
Net interest income		6,977			7,076			21,005		19,730
Provision for loan losses		3,863			2,675			8,643		5,425
Net interest income after provision for loan losses		3,114			4,401			12,362		14,305
Noninterest income:
Service charges on deposit accounts		842			932			2,558		2,724
Other service charges and fees		470			330			1,168		947
Mortgage origination brokerage fees		351			153			856		680
Net gain on sale of securities		2,030			444			3,471		1,032
Income from bank owned life insurance		75			82			223		246
Other operating income		32			(15	)		58		(4	)
Total noninterest income		3,800			1,926			8,334		5,625
Noninterest expenses:
Salaries		2,548			2,061			7,193		6,135
Retirement and other employee benefits		740			416			2,182		1,869
Occupancy		480			474			1,384		1,403
Equipment		589			465			1,542		1,284
Professional fees		187			123			686		522
Supplies		45			53			165		164
Telephone		147			168			487		458
FDIC insurance		355			306			1,033		1,216
Other outside services		123			98			351		338
Net cost of real estate and repossessions acquired in settlement of loans		112			1,081			493		1,187
Other operating expenses		1,053			890			3,017		2,459
Total noninterest expenses		6,379			6,135			18,533		17,035
Income before income taxes		535			192			2,163		2,895
Income tax expense (benefit)		(5	)		(154	)		179		496
Net income		540			346			1,984		2,399
Preferred stock dividends		225			224			673		630
Accretion of discount		42			39			124		108
Income available to common shareholders	$	273		$	83		$	1,187	$	1,661
Net income per share - basic	$	0.10		$	0.03		$	0.42	$	0.58
Net income per share - diluted	$	0.10		$	0.03		$	0.42	$	0.58
Weighted average shares outstanding - basic		2,849,841			2,845,343			2,849,511		2,843,962
Weighted average shares outstanding - diluted		2,849,841			2,847,053			2,849,554		2,845,630

4

ECB BANCORP, INC. AND SUBSIDIARY

Consolidated Statements of Changes in Shareholders’ Equity

Nine months ended September 30, 2010 and 2009

(Dollars in thousands, except per share data)

	Preferred stock, Series A			Common Stock				Common stock warrant			Capital surplus		Retained earnings			Accumulated other comprehensive income		Comprehensive income		Total
				Number		Amount
Balance January 1, 2009	$	—			2,844,489	$	9,956		—		$	25,707	$	31,026		$	1,254			$	67,943
Unrealized loss, net of income tax expense of $1,080																	1,726	$	1,726		1,726
Net income														2,399					2,399		2,399
Total comprehensive income																		$	4,125
Issuance of preferred stock in connection with Capital Purchase Program, net of discount on preferred stock		17,067																			17,067
Issuance of common stock warrants in connection with Capital Purchase Program									882												882
Costs associated with issuance of preferred stock and common warrants		(95	)						(4	)											(99	)
Stock based compensation												50									50
Stock options exercised					1,892		7					16									23
Issuance of restricted stock					1,500		5					19									24
Preferred stock accretion		108												(108	)						—
Cash dividends on preferred stock														(521	)						(521	)
Cash dividends ($0.5475 per share)														(1,558	)						(1,558	)
Balance September 30, 2009	$	17,080			2,847,881	$	9,968	$	878		$	25,792	$	31,238		$	2,980			$	87,936
	Preferred stock, Series A							Common stock warrant			Capital surplus		Retained earnings			Accumulated other comprehensive income		Comprehensive income		Total
				Common Stock
				Number		Amount
Balance January 1, 2010	$	17,122			2,847,881	$	9,968	$	878		$	25,803	$	29,555		$	1,049			$	84,375
Unrealized gain, net of income tax expense of $ 1,563																	2,497	$	2,497		2,497
Net income														1,984					1,984		1,984
Total comprehensive income																		$	4,481
Stock based compensation												28									28
Stock options exercised					1,960		6					13									19
Preferred stock accretion		124												(124	)						—
Cash dividends on preferred stock														(673	)						(673	)
Cash dividends ($0.21 per share)														(598	)						(598	)
Balance September 30, 2010	$	17,246			2,849,841	$	9,974	$	878		$	25,844	$	30,144		$	3,546			$	87,632

5

ECB BANCORP, INC. AND SUBSIDIARY

Consolidated Statements of Cash Flows

Nine months ended September 30, 2010 and 2009

(Dollar amounts in thousands)

	Nine months ended September 30,
	2010			2009
Cash flows from operating activities:
Net income	$	1,984		$	2,399
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		999			1,022
Amortization of premium on investment securities, net		1,284			725
Provision for loan losses		8,643			5,425
Gain on sale of securities		(3,471	)		(1,032	)
Stock based compensation		28			74
Impairment on equity investment		—			37
Increase in accrued interest receivable		(209	)		(419	)
Loss on disposal of premises and equipment		—			15
Loss on sale of real estate and repossessions acquired in settlement of loans		478			1,052
Income from Bank owned life insurance		(223	)		(246	)
Origination of loans held for sale		(18,485	)		—
Proceeds from sale of loans held for sale		16,382			—
Decrease (increase) in other assets		266			(1,412	)
Decrease in accrued interest payable		(139	)		(1,423	)
Decrease in other liabilities, net		(859	)		(1,092	)
Net cash provided by operating activities		6,678			5,125
Cash flows from investing activities:
Proceeds from sales of investment securities classified as available-for-sale		96,858			67,850
Proceeds from maturities of investment securities classified as available-for-sale		36,981			45,508
Purchases of investment securities classified as available-for-sale		(152,456	)		(142,553	)
Redemption (purchase) of Federal Home Loan Bank common stock		367			(1,257	)
Proceeds from disposal of premises and equipment		—			11
Purchases of premises and equipment		(1,169	)		(711	)
Proceeds from disposal of real estate and repossessions acquired in settlement of loans and real estate held for sale		2,357			1,297
Net loan originations		(5,436	)		(43,221	)
Net cash (used) by investing activities		(22,498	)		(73,076	)
Cash flows from financing activities:
Net increase in deposits		35,862			67,481
Net increase (decrease) in borrowings		4,124			(15,727	)
Dividends paid to common shareholders		(917	)		(1,558	)
Dividends paid on preferred stock		(673	)		(521	)
Net proceeds from issuance of common stock		19			23
Net proceeds from issuance of preferred stock		—			17,850
Repurchase of common stock		—			—
Net cash provided by financing activities		38,415			67,548
Increase (decrease) in cash and cash equivalents		22,595			(403	)
Cash and cash equivalents at beginning of period		17,811			16,799
Cash and cash equivalents at end of period	$	40,406		$	16,396
Cash paid during the period:
Interest	$	9,101		$	12,547
Taxes		746			2,583
Supplemental disclosures of noncash financing and investing activities:
Cash dividends declared but not paid	$	199		$	519
Unrealized gains on available-for-sale securities, net of deferred taxes		2,497			1,726
Transfer from loans to real estate and repossessions acquired in settlement of loans		3,043			916
Transfer from long-term to short-term borrowings		6,500			5,000
Payable, settlement for securities purchased		—			53,000
Transfer from investments to other assets		250			—
Transfer from real estate and repossessions acquired in settlement of loans to bank premises and equipment		398			—

See accompanying notes to consolidated financial statements.

6

ECB BANCORP, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

(1) Basis of Presentation

The consolidated financial statements include the accounts of ECB Bancorp, Inc. (“Bancorp”) and its wholly-owned subsidiary, The East Carolina Bank (the “Bank”) (Bancorp and the Bank are collectively referred to hereafter as the “Company”). The Bank has one wholly-owned subsidiary, ECB Financial Services, Inc., which formerly provided courier services to the Bank but is currently inactive. All intercompany transactions and balances are eliminated in consolidation. The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect reported amounts of assets and liabilities, disclosure of contingent assets and liabilities as of the date of the balance sheets, and the reported amounts of income and expenses for the periods presented. Actual results could differ from those estimates.

Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for loan losses and retirement plan costs. In connection with the determination of the allowance for loan losses, management obtains independent appraisals for significant properties held as collateral for loans. The Company’s retirement plans and other post-retirement benefit costs are actuarially determined based on assumptions of the discount rate, estimated future return on plan assets and the health care cost trend rate.

All adjustments considered necessary for a fair presentation of the results for the interim periods presented have been included (such adjustments are normal and recurring in nature). The notes to consolidated financial statements in Bancorp’s annual report on Form 10-K should be referenced when reading these unaudited interim consolidated financial statements. Operating results for the period ended September 30, 2010, are not necessarily indicative of the results that may be expected for the year ending December 31, 2010.

Reclassification

Certain reclassifications have been made to the prior period’s financial statements to place them on a comparable basis with the current year. Net income and shareholders’ equity previously reported were not affected by these reclassifications.

Subsequent Events

In preparing these financial statements, the Company has evaluated events and transactions for potential recognition or disclosure through the date the consolidated financial statements were issued.

ECB announced on August 12, 2010, that it has signed an extensive agreement with InfoTech Alliance Bank Services to implement the FIS integrated HORIZON banking system. HORIZON is a highly flexible core banking solution featuring open architecture and advanced technology that involves minimal risk and disruption to business operations and customers.

InfoTech Alliance currently provides item processing services for ECB. After conducting a complete evaluation of its core systems, the Bank decided to extend its relationship with InfoTech Alliance to include HORIZON core account processing services and a host of other integrated technology solutions.

As a result of this decision, it has been determined that several existing multi year support and maintenance agreements with current vendors will be terminated early resulting in early termination fees that will be expensed once contract termination agreements have been entered into with the current third party service providers. While the exact dollar amount of these fees have not been agreed upon by both parties at this time, it is expected to range from $1.1 million to $1.3 million.

Although this termination expense will be recognized in the fourth quarter 2010, our agreement with Info Tech Alliance includes discounts to their standard fees for services that will begin in May of 2011 when the conversion is implemented. These discounted fees for their services will occur and be recognized over the entire length of the contract with estimated total savings representing approximately $1.3 million.

7

(2) Net Income Per Share

Basic net income per share is calculated by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period. For purposes of basic net income per share, restricted stock is considered “contingently issuable” and is not included in the weighted average number of common shares outstanding.

Diluted net income per share is computed by assuming the issuance of common shares for all dilutive potential common shares outstanding during the reporting period. Restricted stock is considered outstanding for purposes of diluted net income per share. The amount of compensation cost attributed to future services and not yet recognized is considered “proceeds” using the treasury stock method. Restricted stock had no dilutive effect on earnings per share for the nine- or three-month periods ended September 30, 2010 and September 30, 2009.

In computing diluted net income per share, it is assumed that all dilutive stock options are exercised during the reporting period at their respective exercise prices, with the proceeds from the exercises used by the Company to buy back stock in the open market at the average market price in effect during the reporting period. The difference between the number of shares assumed to be exercised and the number of shares bought back is added to the number of weighted average common shares outstanding during the period. The sum is used as the denominator to calculate diluted net income per share for the Company. For the nine months ended September 30, 2010 and 2009, diluted weighted average shares outstanding increased by 43 and 1,668, respectively, due to the dilutive impact of options. Stock options had no impact on diluted weighted average shares for the three months ended September 30, 2010. Stock options increased diluted weighted average shares by 1,710 for the three months ended September 30, 2009. There were 28,513 and 53,675 anti-dilutive (not in the money) options outstanding for the nine months ended September 30, 2010 and 2009, respectively. There were 28,513 and 53,675 anti-dilutive (not in the money) options outstanding for the three months ended September 30, 2010 and 2009, respectively. As of September 30, 2010 and 2009 the warrant, consisting of 144,984 shares issued to the U.S. Treasury Department was not included in the computation of net income per share for either the nine or three-month period because its exercise price exceeded the market price of the Company’s stock on that date.

The following is a reconciliation of the numerators and denominators used in computing Basic and Diluted Net Income Per Share for the nine months ended September 30.

	Nine months ended September 30, 2010 (Dollars in thousands, except per share data)
	Income (Numerator)		Shares (Denominator)		Per Share Amount
Basic net income	$	1,187		2,849,511	$	0.42
Effect of dilutive securities		—		43
Diluted net income	$	1,187		2,849,554	$	0.42
	Nine months ended September 30, 2009 (Dollars in thousands, except per share data)
	Income (Numerator)		Shares (Denominator)		Per Share Amount
Basic net income	$	1,661		2,843,962	$	0.58
Effect of dilutive securities		—		1,668
Diluted net income	$	1,661		2,845,630	$	0.58

8

The following is a reconciliation of the numerators and denominators used in computing Basic and Diluted Net Income Per Share for the three months ended September 30.

	Three months ended September 30, 2010 (Dollars in thousands, except per share data)
	Income (Numerator)		Shares (Denominator)		Per Share Amount
Basic net income	$	273		2,849,841	$	0.10
Effect of dilutive securities		—		—
Diluted net income	$	273		2,849,841	$	0.10
	Three months ended September 30, 2009 (Dollars in thousands, except per share data)
	Income (Numerator)		Shares (Denominator)		Per Share Amount
Basic net income	$	83		2,845,343	$	0.03
Effect of dilutive securities		—		1,710
Diluted net income	$	83		2,847,053	$	0.03

(3) Stock Compensation Plan

During 2008, the Company adopted the 2008 Omnibus Equity Plan (the “Plan”) which replaced the expired 1998 Omnibus Stock Ownership and Long-Term Incentive Plan. The Plan provides for the issuance of up to an aggregate of 200,000 shares of common stock of the Company in the form of stock options, restricted stock awards and performance share awards.

Stock based compensation is accounted for in accordance with FASB ASC Topic 718. Compensation cost charged to income was approximately $28 thousand and $74 thousand for the nine months ended September 30, 2010 and 2009, respectively. Compensation cost charged to income was approximately $8 thousand and $35 thousand for the three months ended September 30, 2010 and 2009, respectively. No income tax benefit was recognized for stock based compensation, as the Company does not have any outstanding nonqualified stock options.

Stock Options

Under the Plan, stock options may be issued to employees as incentive stock options which qualify for special tax treatment under the Internal Revenue Code, or as nonqualified stock options. The terms and exercise prices of options, and the dates or schedules on which options vest or become exercisable, are established at the time the options are granted and may be different for each option. However, the term of an option may not exceed ten years, and the exercise price of each option may not be less than the fair market value of a share of common stock on the date the option is granted. It is the Company’s policy to issue new shares of stock to satisfy option exercises.

The weighted-average fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The weighted-average estimated fair values of stock option grants and the

9

assumptions that were used in calculating such fair values are based on estimates at the date of grant. There were no options granted during the nine-month period ending September 30, 2010 and September 30, 2009.

A summary of option activity under the Plan as of September 30, 2010, and changes during the nine-month period ended September 30, 2010 is presented below:

	Options Outstanding		Weighted Average Exercise Price		Average Remaining Contractual Term		Aggregate Intrinsic Value
	(Dollars in thousands, except per share data)
Outstanding at December 31, 2009		57,335	$	28.31
Granted		—	$	—
Forfeited		—	$	—
Expired		26,862	$	30.04
Exercised		1,960	$	10.00
Outstanding at September 30, 2010		28,513	$	27.94		5.73 years	$	—
Exercisable at September 30, 2010		15,149	$	27.69		4.77 years	$	—

1,960 options were exercised during the first nine months of 2010. Cash received for options exercised in 2010 was $19 thousand with an intrinsic value of $3 thousand. There were 1,892 shares exercised during the nine-month period ended September 30, 2009. The intrinsic value of options exercised during the nine months ended September 30, 2009 was $9 thousand and $23 thousand was received for options exercised. There were 26,862 options that expired in 2010.

Restricted Stock Awards

Restricted stock awards are subject to restrictions and the risk of forfeiture if conditions stated in the award agreement are not satisfied at the end of a restriction period. During the restriction period, restricted stock covered by the award will be held by the Company. If the conditions stated in the award agreement are satisfied at the end of the restriction period, the restricted stock will become unrestricted and the certificate evidencing the stock will be delivered to the employee.

There were no shares of non-vested restricted stock as of September 30, 2010 or December 31, 2009.

Unrecognized Compensation Cost

Anticipated total unrecognized compensation cost related to outstanding non-vested stock options will be recognized over the following periods:

10

	Stock Options
	(Dollars in thousands)
October 1 – December 31, 2010	$	7
2011		21
2012		8
2013		2
Total	$	38

(4) Postretirement Benefits

The Company has a postretirement benefit plan whereby the Company pays postretirement health care benefits for certain of its retirees that have met minimum age and service requirements. Net periodic postretirement benefit cost for the nine- and three-month periods ended September 30, 2010 and 2009 includes the following components.

	Nine months ended September 30, (Dollars in thousands)
	2010			2009
Components of net periodic cost:
Service cost	$	3		$	3
Interest cost		32			36
Prior service cost		(6	)		(6	)
Net periodic postretirement benefit cost	$	29		$	33
	Three months ended September 30, (Dollars in thousands)
	2010			2009
Components of net periodic cost:
Service cost	$	1		$	1
Interest cost		11			12
Prior service cost		(2	)		(2	)
Net periodic postretirement benefit cost	$	10		$	11

The Company expects to contribute $38 thousand to its postretirement benefit plan in 2010. No contributions were made in the first nine months of 2010. For additional information related to the plan, refer to the Company’s Form 10-K for the year ended December 31, 2009.

11

(5) Investment Securities

The following is a summary of the securities portfolio by major classification:

	September 30, 2010
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(Dollars in thousands)
Securities available-for-sale:
Government-sponsored enterprises and FFCB bonds	$	23,539	$	1,255	$	—		$	24,794
Obligations of states and political subdivisions		21,685		1,226		—			22,911
Mortgage-backed securities		150,625		2,625		(174	)		153,076
SBA backed securities		46,324		842		(3	)		47,163
Corporate Bonds		15,975		226		(199	)		16,002
	$	258,148	$	6,174	$	(376	)	$	263,946
	December 31, 2009
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(Dollars in thousands)
Securities available-for-sale:
Government-sponsored enterprises and FFCB bonds	$	36,141	$	69	$	(367	)	$	35,843
Obligations of states and political subdivisions		45,242		997		(217	)		46,022
Mortgage-backed securities		116,829		1,844		(537	)		118,136
SBA backed securities		32,338		359		(32	)		32,665
Corporate Bonds		6,044		—		(184	)		5,860
Equity securities		1,000		—		(194	)		806
	$	237,594	$	3,269	$	(1,531	)	$	239,332

Gross realized gains and losses on sales of securities for the three- and nine-month periods ended September 30, 2010 and September 30, 2009 were as follows:

	Nine months ended September 30, (Dollars in thousands)
	2010			2009
Gross realized gains	$	3,519		$	1,045
Gross realized losses		(48	)		(13	)
Net realized gains	$	3,471		$	1,032

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	Three months ended September 30, (Dollars in thousands)
	2010			2009
Gross realized gains	$	2,062		$	444
Gross realized losses		(32	)		(0	)
Net realized gains	$	2,030		$	444

Analysis of Certain Investments in Debt and Equity Securities for Other Than Temporary Impairment

The following table sets forth the amount of unrealized losses (that is, the amount by which cost or amortized cost exceeds fair value), and the related fair value of investments with unrealized losses, none of which are considered to be other than temporarily impaired. The table is segregated into investments that have been in continuous unrealized-loss position for less than 12 months from those that have been in a continuous unrealized-loss position for more than 12 months, as of September 30, 2010 and December 31, 2009:

September 30, 2010

	Less Than 12 Months				12 Months or longer				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(Dollars in thousands)
Mortgage-backed securities	$	23,736	$	174	$	—	$	—	$	23,736	$	174
SBA backed securities		905		3		—		—		905		3
Corporate bonds		—		—		1,801		199		1,801		199
Total	$	24,641	$	177	$	1,801	$	199	$	26,442	$	376

December 31, 2009

	Less Than 12 Months				12 Months or longer				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(Dollars in thousands)
Government-sponsored enterprises and FFCB bonds	$	18,431	$	367	$	—	$	—	$	18,431	$	367
Obligations of states and political subdivisions		7,315		96		3,118		121		10,433		217
Mortgage-backed securities		46,771		536		102		1		46,873		537
SBA backed securities		9,688		32		—		—		9,688		32
Corporate bonds		3,354		154		2,505		30		5,859		184
Equity securities		—		—		806		194		806		194

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	Less Than 12 Months				12 Months or longer				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Total	$	85,559	$	1,185	$	6,531	$	346	$	92,090	$	1,531

As of September 30, 2010 and December 31, 2009, management concluded that the unrealized losses presented above are temporary in nature since they are not related to the underlying credit quality of the issuers, and the Company has the intent and ability to hold these investments for a time necessary to recover their cost. The losses above, except for equity securities, are on debt securities that have contractual maturity dates and are primarily related to market interest rates. Municipal losses as of December 31, 2009 were also related to lack of liquidity and demand in the general investment market. All unrealized losses on investment securities are not considered to be other-than-temporary, because they are related to changes in interest rates, lack of liquidity and demand in the general investment market and do not affect the expected cash flows of the underlying collateral or the issuer. The Bank’s mortgage-backed securities are all backed by government sponsored enterprises or agencies. The Bank does not own any private label mortgage-backed securities.

At September 30, 2010 and December 31, 2009, the balance of Federal Home Loan Bank (“FHLB”) of Atlanta stock held by the Company was $4.7 million and $5.1 million, respectively. The FHLB paid a dividend for the second quarter of 2010 with an annualized rate of 0.44%. The dividend rate was equal to average three month LIBOR for the period of April 1, 2010 to June 30, 2010, and was applicable to capital stock held during that period. Management believes that its investment in FHLB stock was not other-than-temporarily impaired as of September 30, 2010 or December 31, 2009. However, there can be no assurance that the impact of recent or future legislation on the Federal Home Loan Banks will not also cause a decrease in the value of the FHLB stock held by the Company.

The aggregate amortized cost and fair value of the available-for-sale securities portfolio at September 30, 2010 by remaining contractual maturity are as follows:

	Amortized Cost		Fair Value
	(Dollars in thousands)
Government-sponsored enterprises and FFCB bonds:
Due in one through five years	$	2,480	$	2,489
Due in five through ten years		18,955		20,040
Due after ten years		2,104		2,265
Obligations of states and political subdivisions:
Due in one year or less		977		994
Due in one through five years		3,878		4,096
Due in five through ten years		9,294		9,827
Due after ten years		7,536		7,994
Mortgage-backed securities:
Due in five through ten years		4,811		5,097
Due after ten years		145,814		147,979

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	Amortized Cost		Fair Value
SBA backed securities:
Due in five through ten years		8,157		8,232
Due after ten years		38,167		38,931
Corporate Bonds:
Due in one through five years		6,084		6,128
Due in five through ten years		9,891		9,874
Total securities	$	258,148	$	263,946

Securities with an amortized cost of $162.7 million at September 30, 2010 are pledged as collateral. Of this total, amortized cost of $29.4 million and fair value of $29.8 million are pledged as collateral for FHLB advances.

The aggregate amortized cost and fair value of the available-for-sale securities portfolio at December 31, 2009 by remaining contractual maturity are as follows:

	Amortized Cost		Fair Value
	(Dollars in thousands)
Government-sponsored enterprises and FFCB bonds:
Due in one through five years	$	7,152	$	7,166
Due in five through ten years		20,610		20,392
Due after ten years		8,379		8,285
Obligations of states and political subdivisions:
Due in one year or less		870		876
Due in one through five years		7,006		7,343
Due in five through ten years		17,997		18,448
Due after ten years		19,369		19,355
Mortgage-backed securities:
Due in five through ten years		7,942		8,296
Due after ten years		108,887		109,840
SBA backed securities:
Due in five through ten years		6,505		6,506
Due after ten years		25,833		26,159
Corporate Bonds:
Due in five through ten years		6,044		5,860

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	Amortized Cost		Fair Value
Equity securities:		1,000		806
Total securities	$	237,594	$	239,332

Securities with an amortized cost of $142.4 million at December 31, 2009 were pledged as collateral. Of this total, amortized cost of $55.6 million and fair value of $56.6 million were pledged as collateral for FHLB advances.

(6) Comprehensive Income (Loss)

A summary of comprehensive income (loss) is as follows:

	Three months ended September 30,						Nine months ended September 30,
	2010			2009			2010			2009
	(Dollars in thousands)
Net income	$	540		$	346		$	1,984		$	2,399
Other comprehensive income:
Unrealized gains arising during the period		2,990			4,483			7,531			3,837
Tax expense		(1,150	)		(1,727	)		(2,899	)		(1,478	)
Reclassification to realized gains		(2,030	)		(444	)		(3,471	)		(1,032	)
Tax expense		780			173			1,336			399
Other comprehensive income		590			2,485			2,497			1,726
Total comprehensive income	$	1,130		$	2,831		$	4,481		$	4,125

(7) Recent Accounting Pronouncements

The following is a summary of recent authoritative pronouncements that could impact the accounting, reporting, and/or disclosure of financial information by the Company.

In March 2010, guidance related to derivatives and hedging was amended to exempt embedded credit derivative features related to the transfer of credit risk from potential bifurcation and separate accounting. Embedded features related to other types of risk and other embedded credit derivative features are not exempt from potential bifurcation and separate accounting. The amendments were effective for the Company on July 1, 2010. These amendments will have no impact on the financial statements.

In July 2010, the Receivables topic of the ASC was amended to require expanded disclosures related to a company’s allowance for credit losses and the credit quality of its financing receivables. The amendments will require the allowance disclosures to be provided on a disaggregated basis. The Company is required to begin to comply with the disclosures in its financial statements for the year ended December 31, 2010.

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which significantly changes the regulation of financial institutions and the financial services industry. The Dodd-Frank Act includes several provisions that will affect how community banks, thrifts, and small bank and thrift holding companies will be regulated in the future. Among other things, these

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provisions abolish the Office of Thrift Supervision and transfer its functions to the other federal banking agencies, relax rules regarding interstate branching, allow financial institutions to pay interest on business checking accounts, change the scope of federal deposit insurance coverage, and impose new capital requirements on bank and thrift holding companies. The Dodd-Frank Act also establishes the Bureau of Consumer Financial Protection as an independent entity within the Federal Reserve, which will be given the authority to promulgate consumer protection regulations applicable to all entities offering consumer financial services or products, including banks. Additionally, the Dodd-Frank Act includes a series of provisions covering mortgage loan origination standards affecting originator compensation, minimum repayment standards, and pre-payments. Management is actively reviewing the provisions of the Dodd-Frank Act and assessing its probable impact on our business, financial condition, and results of operations.

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

(8) Fair Value of Financial Instruments

Fair value estimates are made by management at a specific point in time, based on relevant information about the financial instrument and the market. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument nor are potential taxes and other expenses that would be incurred in an actual sale considered. Fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions and/or the methodology used could significantly affect the estimates disclosed. Similarly, the fair values disclosed could vary significantly from amounts realized in actual transactions.

The following table presents the carrying values and estimated fair values of the Company’s financial instruments at September 30, 2010 and December 31, 2009:

	September 30, 2010				December 31, 2009
	Carrying Value		Estimated Fair Value		Carrying Value		Estimated Fair Value
	(Dollars in thousands)
Financial assets:
Cash and cash equivalents	$	40,406	$	40,406	$	17,811	$	17,811
Investment securities		263,946		263,946		239,332		239,332
FHLB stock		4,749		4,749		5,116		5,116
Accrued interest receivable		5,176		5,176		4,967		4,967
Net loans		561,816		557,939		568,066		565,178
Loans held for sale		2,103		2,103		—		—
Financial liabilities:
Deposits	$	790,592	$	794,486	$	754,730	$	759,647
Short-term borrowings		13,534		13,534		22,910		22,910
Accrued interest payable		982		982		1,121		1,121
Long-term obligations		34,500		35,721		21,000		21,210

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The estimated fair values of net loans, deposits and long-term obligations are based on estimated cash flows discounted at market interest rates. The fair value of off-balance sheet financial instruments is considered immaterial. These off-balance sheet financial instruments are commitments to extend credit and are either short-term in nature or subject to immediate repricing.

Fair Value Hierarchy

The Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

Level 1	Valuation is based upon quoted prices for identical instruments traded in active markets.
Level 2	Valuation is based upon 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	Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

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

There were no changes to the techniques used to measure fair value during the period.

Following is a description of valuation methodologies used for assets recorded at fair value.

Investment Securities Available-for-Sale

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

Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment using one of several methods, including collateral value, market price and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At September 30, 2010, the majority of impaired loans were evaluated based on the fair value of the collateral. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further

18

impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3.

Real Estate and Repossessions Acquired in Settlement of Loans

Foreclosed assets are adjusted to fair value upon transfer of the loans to other real estate owned. Real estate acquired in settlement of loans is recorded initially at estimated fair value of the property less estimated selling costs at the date of foreclosure. The initial recorded value may be subsequently reduced by additional allowances, which are charged to earnings if the estimated fair value of the property less estimated selling costs declines below the initial recorded value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3.

Assets recorded at fair value on a recurring basis

September 30, 2010	Total		Level 1		Level 2		Level 3
	(Dollars in thousands)
Investment Securities Available-for-Sale
Government-sponsored enterprises and FFCB bonds	$	24,794	$	—	$	24,794	$	—
Obligations of states and political subdivisions		22,911		—		22,911		—
Mortgage-backed securities		153,076		—		153,076		—
SBA backed securities		47,163		42,883		4,280		—
Corporate bonds		16,002		—		14,201		1,801
Total Securities	$	263,946	$	42,883	$	219,262	$	1,801
Total assets at fair value	$	263,946	$	42,883	$	219,262	$	1,801

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December 31, 2009	Total		Level 1		Level 2		Level 3
	(Dollars in thousands)
Investment Securities Available-for-Sale
Government-sponsored enterprises and FFCB bonds	$	35,843	$	8,626	$	24,737	$	2,480
Obligations of states and political subdivisions		46,022		4,506		41,516		—
Mortgage-backed securities		118,136		9,361		108,775		—
SBA backed securities		32,665		26,363		6,302		—
Corporate bonds		5,860		—		3,989		1,871
Equity securities		806		806		—		—
Total Securities	$	239,332	$	49,662	$	185,319	$	4,351
Total assets at fair value	$	239,332	$	49,662	$	185,319	$	4,351

Assets recorded at fair value on a nonrecurring basis

September 30, 2010	Total		Level 1		Level 2		Level 3
	(Dollars in thousands)
Impaired Loans
Real estate—construction and land development	$	8,990	$	—	$	6,558	$	2,432
Real estate—commercial, residential and other		4,676		—		4,113		563
Commercial and all other loans		67		—		—		67
Total impaired loans	$	13,733	$	—	$	10,671	$	3,062
Real estate and repossessions acquired in settlement of loans
Total real estate and repossessions acquired in settlement of loans	$	5,253	$	—	$	1,644	$	3,609
Total assets at fair value	$	18,986	$	—	$	12,315	$	6,671
December 31, 2009 (Dollars in thousands)	Total		Level 1		Level 2		Level 3
	(Dollars in thousands)
Impaired Loans
Real estate—construction and land development	$	6,882	$	—	$	5,510	$	1,372
Real estate—commercial, residential and other		3,389		—		2,205		1,184
Commercial and all other loans		2,304		—		—		2,304
Total impaired loans	$	12,575	$	—	$	7,715	$	4,860
Real estate and repossessions acquired in settlement of loans
Real estate and repossessions acquired in settlement of loans	$	5,438	$	606	$	1,657	$	3,175
Total assets at fair value	$	18,013	$	606	$	9,372	$	8,035

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As of September 30, 2010 there were $14.7 million of Level 2 investment securities available for sale that were reported as Level 1 as of December 31, 2009. The bonds were transferred from Level 1 to Level 2 during the first nine months of 2010 because the December 31, 2009 pricing was based on the Company’s actual trades for the securities at initial purchase while the September 30, 2010 pricing was through a pricing system. The table below presents a reconciliation for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during 2010 and 2009.

	Government- sponsored enterprises and FFCB bonds			Corporate Bonds			Available-for Sale Debt Securities
	(Dollars in thousands)
Balance, December 31, 2009	$	2,480		$	1,871		$	4,351
Total gains or losses (realized/unrealized):
Included in earnings		—			—			—
Included in other comprehensive income		—			(70	)		(70	)
Purchases, issuances, and settlements		—			—			—
Transfers in to/out of Level 3		(2,480	)		—			(2,480	)
Balance, September 30, 2010	$	—		$	1,801		$	1,801

	Obligations of states and political subdivisions			Mortgage- backed securities			Corporate Bonds			Available-for Sale Debt Securities
	(Dollars in thousands)
Balance, December 31, 2008	$	698		$	8,374		$	2,000		$	11,072
Total gains or losses (realized/unrealized):
Included in earnings		—			—			—			—
Included in other comprehensive income		—			—			(162	)		(162	)
Purchases, issuances, and settlements		—			—			—			—
Transfers in to/out of Level 3		(698	)		(8,374	)		—			(9,072	)
Balance, September 30, 2009	$	—		$	—		$	1,838		$	1,838

(9) U.S. Treasury’s Troubled Asset Relief Program (TARP) Capital Purchase Program

On January 16, 2009, the Company issued Series A Preferred Stock in the amount of $17,949,000 and a warrant to purchase 144,984 shares of common stock with an exercise price of $18.57 to the U.S. Treasury as a participant in the TARP Capital Purchase Program. The Series A Preferred Stock qualifies as Tier 1 capital for purposes of regulatory capital requirements and will pay cumulative dividends at a rate of 5% per annum for the first five years and 9% per annum thereafter. Prior to January 16, 2012, unless the Company has redeemed all of this preferred stock or the U.S. Treasury has transferred all of this preferred stock to a third party, the consent of the U.S.

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Treasury will be required to, among other things, increase common stock dividend above $0.1825 per share or repurchase common stock except in limited circumstances. In addition, until the U.S. Treasury ceases to own these securities sold under the TARP Capital Purchase Program, the compensation arrangements for senior executive officers must comply in all respects with the U.S. Emergency Economic Stabilization Act of 2008 and the rules and regulations thereunder.

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

Statements in this Report and its exhibits relating to plans, strategies, economic performance and trends, projections of results of specific activities or investments, expectations or beliefs about future events or results, and other statements that are not descriptions of historical facts, may be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking information is inherently subject to risks and uncertainties, and actual results could differ materially from those currently anticipated due to a number of factors, which include, but are not limited to, risk factors discussed in our Annual Report on Form 10-K and in other documents we file with the Securities and Exchange Commission from time to time. Copies of those reports are available through our Internet website atwww.myecb.comor directly through the Commission’s website atwww.sec.gov.Forward-looking statements in this Report may be identified by terms such as “may,” “will,” “should,” “could,” “expects,” “plans,” “intends,” “anticipates,” “feels,” “believes,” “estimates,” “predicts,” “forecasts,” “potential” or “continue,” or similar terms or the negative of these terms, or other statements concerning opinions or judgments of our management about future events. Factors that could influence the accuracy of those forward-looking statements include, but are not limited to, (a) pressures on our earnings, capital and liquidity resulting from current and future conditions in the credit and equity markets, (b) continued or unexpected increases in credit losses in our loan portfolio, (c) continued adverse conditions in the economy and in the real estate market in our banking markets (particularly those conditions that affect our loan portfolio, the abilities of our borrowers to repay their loans, and the values of collateral that secures our loans), (d) the financial success or changing strategies of our customers, (e) actions of government regulators, or changes in laws, regulations or accounting standards, that adversely affect our business, (f) changes in the interest rate environment and the level of market interest rates that reduce our net interest margins and/or the values of loans we make and securities we hold, (g) changes in competitive pressures among depository and other financial institutions or in our ability to compete effectively against other financial institutions in our banking markets; (h) weather and similar conditions, particularly the effect of hurricanes on our banking and operations facilities and on our customers and the communities in which we do business; and (i) other developments or changes in our business that we do not expect. Although we believe that the expectations reflected in the forward-looking statements in this Report are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. All forward-looking statements attributable to us are expressly qualified in their entirety by the cautionary statements in this paragraph. We have no obligation, and we do not intend, to update these forward-looking statements.

Executive Summary

ECB Bancorp, Inc. is a bank holding company headquartered in Engelhard, North Carolina. Our wholly owned subsidiary, The East Carolina Bank (the “Bank”), is a state-chartered community bank that was founded in 1919. For the purpose of this discussion, “we,” “us” and “our” refers to the Bank and the bank holding company as a single, consolidated entity unless the context otherwise indicates.

As of September 30, 2010, we had consolidated assets of approximately $932.2 million, total loans of approximately $575.0 million, total deposits of approximately $790.6 million and shareholders’ equity of approximately $87.6 million. For the three months ended September 30, 2010, we had income available to common shareholders of $273 thousand or $0.10 basic and diluted earnings per share, compared to income available to common shareholders of $83 thousand or $0.03 basic and diluted earnings per share for the three months ended September 30, 2009. For the nine months ended September 30, 2010, we had income available to common shareholders of $1.2 million or $0.42 basic and diluted earnings per share, compared to income available to common

22

shareholders of $1.7 million or $0.58 basic and diluted earnings per share for the nine months ended September 30, 2009.

Critical Accounting Policies

The Company’s significant accounting policies are set forth in Note 1 to the Consolidated Financial Statements contained in the Form 10-K Annual Report for the fiscal year ended December 31, 2009. Of these significant accounting policies, the Company considers its policy regarding the allowance for loan losses to be its most critical accounting policy, because it requires management’s most subjective and complex judgments. In addition, changes in economic conditions can have a significant impact on the allowance for loan losses and therefore the provision for loan losses and results of operations. The Company has developed appropriate policies and procedures for assessing the adequacy of the allowance for loan losses, recognizing that this process requires a number of assumptions and estimates with respect to its loan portfolio. The Company’s assessments may be impacted in future periods by changes in economic conditions, the results of regulatory examinations, and the discovery of information with respect to borrowers that is not known to management at the time of the issuance of the consolidated financial statements. For additional discussion concerning the Company’s allowance for loan losses and related matters, see “Asset Quality”.

We also consider our determination of retirement plans and other postretirement benefit cost to be a critical accounting estimate as it requires the use of estimates and judgments related to the amount and timing of expected future cash out-flows for benefit payments and cash in-flows for maturities and return on plan assets. Our retirement plans and other post-retirement benefit costs are actuarially determined based on assumptions on the discount rate, estimated future return on plan assets and the health care cost trend rate. Changes in estimates and assumptions related to mortality rates and future health care costs could have a material impact on our financial condition or results of operations. The discount rate is used to determine the present value of future benefit obligations and the net periodic benefit cost. The discount rate used to value the future benefit obligation as of each year-end is the rate used to determine the periodic benefit cost in the following year. For additional discussion concerning our retirement plans and other postretirement benefits refer to Note 8 to the Consolidated Financial Statements contained in our Form 10-K Annual Report for the fiscal year ended December 31, 2009.

Comparison of the Results of Operations for the Three- and Nine-Month Periods Ended September 30, 2010 and 2009

Results of Operations

The following table summarizes components of income and expense and the changes in those components for the three- and nine-month periods ended September 30, 2010 as compared to the same periods in 2009.

Condensed Consolidated Statements of Income

	For the Three Months Ended September 30, 2010		Changes from the Prior Year						For the Nine Months Ended September 30, 2010		Changes from the Prior Year
			Amount			%					Amount			%
	(Dollars in thousands)
Total interest income	$	9,982	$	(338	)		(3.3	)	$	29,967	$	(887	)		(2.9	)
Total interest expense		3,005		(239	)		(7.4	)		8,962		(2,162	)		(19.4	)
Net interest income		6,977		(99	)		(1.4	)		21,005		1,275			6.5
Provision for loan losses		3,863		1,188			44.4			8,643		3,218			59.3
Net interest income after
Provision for loan losses		3,114		(1,287	)		(29.2	)		12,362		(1,943	)		(13.6	)

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Noninterest income		3,800			1,874	97.3		8,334		2,709		48.2
Noninterest expense		6,379			244	4.0		18,533		1,498		8.8
Income before income taxes		535			343	178.6		2,163		(732	)	(25.3	)
Income tax provision		(5	)		149	96.7		179		(317	)	(63.9	)
Net income		540			194	56.1		1,984		(415	)	(17.3	)
Preferred stock dividend and accretion of discount		267			4	1.5		797		59		8.0
Net income available to common shareholders	$	273		$	190	228.9	$	1,187	$	(474	)	(28.5	)

Net Interest Income

Net interest income (the difference between the interest earned on assets, such as loans and investment securities, and the interest paid on liabilities, such as deposits and other borrowings) is our primary source of operating income. Net interest income for the three months ended September 30, 2010 was $7.0 million, a decrease of $99 thousand or 1.4% when compared to net interest income of $7.1 million for the three months ended September 30, 2009. For the nine months ended September 30, 2010, net interest income was $21.0 million, an increase of $1.3 million or 6.5% when compared to net interest income of $19.7 million for the period in 2009.

The level of net interest income is determined primarily by the average balances (volume) of interest-earning assets and interest-bearing liabilities and the various rate spreads between our interest-earning assets and our interest-bearing liabilities. Changes in net interest income from period to period result from increases or decreases in the volume of interest-earning assets and interest-bearing liabilities, increases or decreases in the average interest rates earned and paid on such assets and liabilities, the ability to manage the interest-earning asset portfolio (which includes loans), and the availability of particular sources of funds, such as non-interest-bearing deposits.

Interest income decreased $338 thousand or 3.3% for the three months ended September 30, 2010 compared to the same three months of 2009. Interest income decreased $887 thousand or 2.9% for the nine months ended September 30, 2010 compared to the same nine months in 2009. The decreases for the three and nine months ended September 30, 2010 are due to the decrease in the rates earned on our average earning assets which were partially offset by increases in the volume of these earning assets. The tax equivalent yield on average earning assets decreased 50 basis points for the quarter ended September 30, 2010 to 4.69% from 5.19% for the same period in 2009. For the first nine months of 2010, the yield on average earning assets, on a tax-equivalent basis, decreased 31 basis points to 4.89% compared to 5.20% at September 30, 2009. Management attributes the decrease in the yield on our earning assets to the continued low level of short-term market interest rates. Yields on our taxable securities decreased approximately 99 basis points for the first nine months of 2010 as compared to the same period last year as securities sold, called or matured have been replaced with lower yielding securities

Our average cost of funds during the third quarter of 2010 was 1.64%, a decrease of 26 basis points when compared to 1.90% for the third quarter of 2009. Average rates paid on bank certificates of deposit decreased 24 basis points from 2.31% for the quarter ended September 30, 2009 to 2.07% for the quarter ended September 30, 2010, while our average cost of borrowed funds increased 64 basis points during the third quarter of 2010 compared to the same period in 2009. Total interest expense decreased $239 thousand or 7.4% during the third quarter of 2010 compared to the same period in 2009, primarily the result of decreased market rates paid on these liabilities. For the nine months ended September 30, 2010, our cost of funds was 1.68% a decrease of 50 basis points when compared to 2.18% for the same period in 2009. Average rates paid on bank certificates of deposit decreased 62 basis points from 2.70% to 2.08% for the first nine months of 2010, while our cost of borrowed funds increased 71 basis points compared to the same period a year ago. The increase in the average cost of borrowed funds for both the three- and nine- month periods is the result of a decrease in the volume of lower cost short term borrowings. Total interest

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expense decreased $2.2 million or 19.4% during the first nine months of 2010 compared to the same period in 2009, primarily the result of decreased market rates paid on these liabilities. The volume of average interest-bearing liabilities increased approximately $31.8 million for the first nine months of 2010 compared with the same period in 2009.

The banking industry uses two key ratios to measure profitability of net interest income: net interest rate spread and net interest margin. The net interest rate spread measures the difference between the average yield on earning assets and the average rate paid on interest-bearing liabilities. The net interest rate spread does not consider the impact of non-interest-bearing deposits and gives a direct perspective on the effect of market interest rate movements. The net interest margin is defined as net interest income as a percentage of total average earning assets and takes into account the positive effects of investing non-interest bearing deposits in earning assets.

Our annualized net interest margin, on a tax-equivalent basis, for the three months ended September 30, 2010 was 3.31% compared to 3.58% in the third quarter of 2009 while our net interest spread decreased 24 basis points during the same period. For the nine months ended September 30, 2010, our net interest margin, on a tax-equivalent basis, was 3.46% compared to 3.36% in the first nine months of 2009 while our net interest spread increased 19 basis points.

Average interest-bearing liabilities, as a percentage of interest-earning assets for the quarters ended September 30, 2010 and 2009 were 84.5% and 84.2%, respectively. For the nine months ended September 30, 2010, average interest-bearing liabilities as a percentage of interest-earning assets were 85.2% compared to 84.7% for the nine months ended September 30, 2009.

Average Consolidated Balance Sheets and Net Interest Analysis on Fully Tax Equivalent Basis

For the three months ended September 30, 2010 and 2009

	Average Balance		2010 Yield/ Rate(5)			Income/ Expense		Average Balance		2009 Yield/ Rate(5)			Income/ Expense
	(Dollars in thousands)
Assets
Loans – net (1)	$	564,526		5.37	%	$	7,640	$	563,923		5.49	%	$	7,807
Taxable securities		247,596		3.13	%		1,955		189,796		4.51	%		2,159
Non-taxable securities (2)		38,220		6.06	%		583		37,044		5.74	%		536
Other investments		10,013		0.08	%		2		12,791		—	%		—
Total interest- earning assets		860,355		4.69	%	$	10,180		803,554		5.19	%	$	10,502
Cash and due from banks		11,955							11,459
Bank premises and equipment, net		25,622							25,490
Other assets		27,433							24,672
Total assets	$	925,365						$	865,175
Liabilities and Shareholders’ Equity
Interest-bearing deposits	$	684,890		1.61	%	$	2,778	$	606,512		1.95	%	$	2,978
Short-term borrowings		18,351		1.43	%		66		49,343		0.76	%		95
Long-term obligations		23,812		2.68	%		161		21,000		3.23	%		171
Total interest- bearing liabilities		727,052		1.64	%		3,005		676,855		1.90	%		3,244
Non-interest-bearing deposits		108,111							97,068
Other liabilities		1,792							4,014

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Shareholders’ equity		88,410						87,238
Total liabilities and Shareholders’ equity	$	925,365					$	865,175
Net interest income and net interest margin (FTE) (3)			3.31	%	$	7,175			3.58	%	$	7,258
Interest rate spread (FTE) (4)			3.05	%					3.29	%

(1) Average loans include non-accruing loans, net of allowance for loan losses, and loans held for sale.

(2) Yields on tax-exempt investments have been adjusted to a fully taxable-equivalent basis (FTE) using the federal income tax rate of 34%. The taxable equivalent adjustment was $198 thousand and $182 thousand for periods ended September 30, 2010 and 2009, respectively.

(3) Net interest margin is computed by dividing net interest income by total earning assets.

(4) Interest rate spread equals the earning asset yield minus the interest-bearing liability rate.

(5) Annualized

For the nine months ended September 30, 2010 and 2009

	Average Balance		2010 Yield/ Rate(5)			Income/ Expense		Average Balance		2009 Yield/ Rate(5)			Income/ Expense
	(Dollars in thousands)
Assets
Loans – net (1)	$	566,824		5.44	%	$	23,062	$	552,479		5.52	%	$	22,820
Taxable securities		213,564		3.48	%		5,559		210,383		4.47	%		7,026
Non-taxable securities (2)		44,461		6.09	%		2,026		35,280		5.77	%		1,523
Other investments		14,129		0.09	%		9		8,024		0.05	%		3
Total interest- earning assets		838,978		4.89	%	$	30,656		806,166		5.20	%	$	31,372
Cash and due from banks		11,395							10,538
Bank premises and equipment, net		25,321							25,528
Other assets		27,032							23,808
Total assets	$	902,726						$	866,040
Liabilities and Shareholders’ Equity
Interest-bearing deposits	$	677,946		1.65	%	$	8,345	$	598,681		2.27	%	$	10,153
Short-term borrowings		17,113		1.43	%		183		61,370		0.94	%		433
Long-term obligations		19,384		2.99	%		434		22,630		3.18	%		538
Total interest- bearing liabilities		714,443		1.68	%		8,962		682,681		2.18	%		11,124
Non-interest-bearing deposits		101,202							88,959
Other liabilities		708							8,175
Shareholders’ equity		86, 373							86, 225
Total liabilities and Shareholders’ equity	$	902,726						$	866,040

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Net interest income and net interest margin (FTE) (3)	3.46	%	$	21,694	3.36	%	$	20,248
Interest rate spread (FTE) (4)	3.21	%			3.02	%

(1) Average loans include non-accruing loans, net of allowance for loan losses, and loans held for sale.

(2) Yields on tax-exempt investments have been adjusted to a fully taxable-equivalent basis (FTE) using the federal income tax rate of 34%. The taxable equivalent adjustment was $689 thousand and $518 thousand for periods ended September 30, 2010 and 2009, respectively.

(3) Net interest margin is computed by dividing net interest income by total earning assets.

(4) Interest rate spread equals the earning asset yield minus the interest-bearing liability rate.

(5) Annualized

The following table presents the relative impact on net interest income of average outstanding balances (volume) of earning assets and interest-bearing liabilities and the rates earned and paid by us on such assets and liabilities. Variances resulting from a combination of changes in rate and volume are allocated in proportion to the absolute dollar amount of the change in each category.

Change in Interest Income and Expense on Tax Equivalent Basis

For the three months ended September 30, 2010 and 2009

Increase (Decrease) in interest income and expense due to changes in:

	2010 compared to 2009
	Volume (1)			Rate (1)			Net
	(Dollars in thousands)
Loans	$	8		$	(175	)	$	(167	)
Taxable securities		557			(761	)		(204	)
Non-taxable securities (2)		17			30			47
Other investments		—			2			2
Interest income		582			(904	)		(322	)
Interest-bearing deposits		351			(551	)		(200	)
Short-term borrowings		(86	)		57			(29	)
Long-term obligations		21			(31	)		(10	)
Interest expense		286			(525	)		(239	)
Net interest income	$	296		$	(379	)	$	(83	)

(1) The combined rate/volume variance for each category has been allocated equally between rate and volume variances.

(2) Yields on tax-exempt investments have been adjusted to a fully taxable-equivalent basis (FTE) using the federal income tax rate of 34%. The taxable equivalent adjustment was $198 thousand and $182 thousand for periods ended September 30, 2010 and 2009, respectively.

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For the nine months ended September 30, 2010 and 2009

Increase (Decrease) in interest income and expense due to changes in:

	2010 compared to 2009
	Volume (1)			Rate (1)			Net
	(Dollars in thousands)
Loans	$	588		$	(346	)	$	242
Taxable securities		95			(1,562	)		(1,467	)
Non-taxable securities (2)		407			96			503
Other investments		3			3			6
Interest income		1,093			(1,809	)		(716	)
Interest-bearing deposits		1,160			(2,968	)		(1,808	)
Short-term borrowings		(393	)		143			(250	)
Long-term obligations		(75	)		(28	)		(103	)
Interest expense		692			(2,853	)		(2,161	)
Net interest income	$	401		$	1,044		$	1,445

(1) The combined rate/volume variance for each category has been allocated equally between rate and volume variances.

(2) Yields on tax-exempt investments have been adjusted to a fully taxable-equivalent basis (FTE) using the federal income tax rate of 34%. The taxable equivalent adjustment was $689 thousand and $518 thousand for periods ended September 30, 2010 and 2009, respectively.

Provision for Loan Losses

The provision for loan losses charged to operations during the three and nine months ended September 30, 2010 was $3.9 million and $8.6 million, respectively. The provision for loan losses charged to operations during the three and nine months ended September 30, 2009 was $2.7 million and $5.4 million, respectively. The increase reflects higher historical loss rates, additional impaired loans and management’s response to the current economic environment. The Bank had net charge-offs of $1.1 million for the quarter ended September 30, 2010 compared to net charge-offs of $663 thousand during the third quarter of 2009. For the nine-month periods ended September 30, 2010 and 2009, the Bank had net charge-offs of $5.2 million and $3.6 million, respectively.

We use the results of our allowance for loan loss model to estimate the dollar amount of provision expense needed to maintain the adequacy of our allowance for loan losses. Our management analyzes the adequacy of the allowance on a monthly basis and adjustments to the provision expense are made as necessary. Additional information regarding our allowance for loan losses is contained in this discussion under the caption “Asset Quality.”

Noninterest Income

Noninterest income, principally charges and fees assessed for the use of our services, is a significant contributor to net income. The following table presents the components of noninterest income for the three- and nine-month periods ended September 30, 2010 and 2009.

	For the Three Months Ended September 30, 2010		Changes from the Prior Year						For the Nine Months Ended September 30, 2010		Changes from the Prior Year
			Amount			%					Amount			%
	(Dollars in thousands)
Service charges on deposit accounts	$	842	$	(90	)		(9.7	)	$	2,558	$	(166	)		(6.1	)
Other service charges and fees		470		140			42.4			1,168		221			23.3
Mortgage origination brokerage fees		351		198			129.4			856		176			25.9
Net gain on sale of securities		2,030		1,586			357.2			3,471		2,439			236.3
Income from bank owned life insurance		75		(7	)		(8.5	)		223		(23	)		(9.3	)
Other operating income		32		47			(313.3	)		58		62			NM

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Total noninterest income $ 3,800 $ 1,874 97.3 $ 8,334 $ 2,709 48.2

Noninterest income increased $1.9 million or 97.3% to $3.8 million for the third quarter of this year compared to $1.9 million for the same period in 2009. For the nine months ended September 30, 2010 noninterest income increased $2.7 million or 48.2% to $8.3 million compared to $5.6 million for the same period in 2009. The increase in noninterest income in the third quarter of 2010 is primarily due to an increase in gains on the sale of securities. The year to date increase in noninterest income is also the result of gains on the sale of securities of $3.5 million in the first nine months of 2010 compared to $1.0 million in the nine-month period ended September 30, 2009. Service charges on deposit accounts decreased $90 thousand and $166 thousand, respectively, for the three and nine months ended September 30, 2010 as compared to the same periods in 2009 mainly due to a decrease in overdraft protection fees. Other service charges and fees increased $140 thousand and $221 thousand, respectively for the three and nine months ended September 30, 2010 as compared to the same periods in 2009. The primary reason for the increase is that brokerage investment service fees were up during both periods. Mortgage loan origination brokerage fees increased $198 thousand compared to the previous year three-month period and $176 thousand for the nine months ended September 30, 2010 as compared to the same period in 2009. Other operating income increased $47 thousand for the three-month period ended September 30, 2010 as compared to the same period in 2009 mainly due to an increase of $36 thousand in SBIC income. Other operating income increased $62 thousand for the nine-month period ending September 30, 2010 due to a gain on mortgage loan commitments.

Noninterest Expense

Noninterest expense increased 4.0% and 8.8%, respectively for the three and nine months ended September 30, 2010, as compared to the same periods in 2009. The following table presents the components of noninterest expense for the three and nine months ended September 30, 2010 and dollar and percentage changes from the prior year.

	For the Three Months Ended September 30, 2010		Changes from the Prior Year						For the Nine Months Ended September 30, 2010		Changes from the Prior Year
			Amount			%					Amount			%
	(Dollars in thousands)
Salaries	$	2,548	$	487			23.6		$	7,193	$	1,058			17.2
Retirement and other employee benefits		740		324			77.9			2,182		313			16.7
Occupancy		480		6			1.3			1,384		(19	)		(1.4	)
Equipment		589		124			26.7			1,542		258			20.1
Professional fees		187		64			52.0			686		164			31.4
Supplies		45		(8	)		(15.1	)		165		1			0.6
Telephone		147		(21	)		(12.5	)		487		29			6.3
FDIC deposit insurance		355		49			16.0			1,033		(183	)		(15.0	)
Other outside Services		123		25			25.5			351		13			3.8
Net cost of real estate and repossessions acquired in settlement of loans		112		(969	)		(89.6	)		493		(694	)		(58.5	)
Other operating expenses		1,053		163			18.3			3,017		558			22.7
Total noninterest expenses	$	6,379	$	244			4.0		$	18,533	$	1,498			8.8

Salary expense for the three and nine months ended September 30, 2010 increased $487 thousand and $1.1 million, respectively, compared to the same prior year periods. The increase is primarily the result of additions made to senior management and other management positions during the past twelve months.

29

Employee related benefits expense for the three and nine months ended September 30, 2010 increased $324 thousand and $313 thousand, respectively, over the same prior year periods. The increase for the three months ended September 30, 2010 is primarily the result of $200 thousand in employee incentive that was reversed out of the prior year’s third quarter because certain goals set by the board under the Company’s incentive plan were not expected to be met. For the nine months ending September 30, 2010 the increase is mainly the result of increased supplemental retirement benefit expense. As of September 30, 2010, we had 236 full time equivalent employees and operated 24 full service banking offices and one mortgage loan origination office.

Equipment expense for the three and nine months ended September 30, 2010 increased $124 thousand and $258 thousand, respectively, compared to the same prior year periods. The three and nine month increase is primarily the result of an increase in equipment maintenance expense.

Professional fees, which include consulting, audit and legal fees, increased $64 thousand for the three months ended September 30, 2010 compared to the same period of 2009 and increased $164 thousand when compared on a year to date basis to the prior year period. Consulting expense during the third quarter increased $26 thousand and, on a year to date basis, consulting expense increased $37 thousand in 2010 when compared to the same periods in 2009. Audit expense during the third quarter decreased $13 thousand and, on a year to date basis, audit expense decreased $28 thousand in 2010 when compared to the same periods in 2009. Legal expense during the third quarter increased $51 thousand and, on a year to date basis, legal expense increased $131 thousand in 2010 when compared to the same period in 2009.

FDIC deposit insurance expenses increased $49 thousand for the three months ended September 30, 2010 compared to the three months ended September 30, 2009. For the nine-month period ended September 30, 2010, FDIC deposit insurance expense decreased $183 thousand over the nine-month period ended September 30, 2009. The decrease for the nine-month period is related to the special assessment that was levied on all banks by the FDIC in 2009.

Income Taxes

Income tax benefit for the three months ended September 30, 2010 was $5 thousand compared to an income tax benefit of $154 thousand for the three months ended September 30, 2009, resulting in effective tax rates of (0.9)% and (80.2)%, respectively. The effective tax rates for the quarters ended September 30, 2010 and September 30, 2009 were negative principally due to a larger percentage of tax exempt income to taxable income during the periods. For the nine-month period ending September 30, 2010, tax expense was $179 thousand compared to $496 thousand for the same period of 2009, which resulted in effective tax rates of 8.3% and 17.1%, respectively. The effective tax rates in both years differ from the federal statutory rate of 34.0% primarily due to tax-exempt interest income.

Balance Sheet

Our total assets were $932.2 million at September 30, 2010, $888.7 million at December 31, 2009 and $858.7 million at September 30, 2009. Deposit growth primarily funded our year-over-year asset growth. For the twelve months ended September 30, 2010, we grew our loans $1.2 million or 0.2% while our deposits grew by approximately $94.0 million or 13.5%. Year-over-year, our earning assets grew by $77.5 million mainly through additions to our available-for-sale investment securities portfolio. For the nine months ended September 30, 2010, loans decreased by $2.8 million while deposits increased by $35.9 million.

Loans

As of September 30, 2010, total loans decreased to $575.0 million, down 0.5% from total loans of $577.8 million at December 31, 2009 and up 0.2% from total loans of $573.8 million at September 30, 2009. The decline in loans for the nine months ending September 30, 2010 can be attributed to continued weak economic conditions.

Asset Quality

At September 30, 2010, our allowance for loan losses as a percentage of loans was 2.29%, up from 1.68% at December 31, 2009. The increase from December 31, 2009 in part reflects the increase in our historical loss rate as

30

our charge-offs have increased during the past year. Also, the increase reflects the recognition of additional loans identified as being impaired. In evaluating the allowance for loan losses, we prepare an analysis of our current loan portfolio in total through the use of historical loss rates, homogeneous risk analysis grouping to include probabilities for loss in each group by risk grade, estimation of years to impairment in each homogeneous grouping, analysis of internal credit processes, past due loan portfolio performance and overall economic conditions, both regionally and nationally.

Historical loss calculations for each homogeneous risk group are based on a three year average loss ratio calculation with the most recent quarter’s loss history included in the model. The impact is to more quickly recognize and increase the loss history in a respective grouping. For those groups with little or no loss history, management increases the historical factor through a positive adjustment to more accurately represent current economic conditions and their potential impact on that particular loan group.

Homogeneous loan groups are assigned risk factors based on their perceived loss potential, current economic conditions and on their respective risk ratings. The probability of loss is increased as the risk grade increases within each risk grouping to more accurately reflect the Bank’s exposure in that particular group of loans. The Bank utilizes a system of eight possible risk ratings. The risk ratings are established based on perceived probability of loss. All loans risk rated “substandard”, “doubtful” and “loss” are removed from their homogeneous group and individually analyzed for impairment. Other groups of loans based on loan size may be selected for impairment review. Loans are considered impaired if, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans is based on either the fair value of the underlying collateral, the present value of the future cash flows discounted at the historical effective interest rate stipulated in the loan agreement, or the estimated market value of the loan. In measuring the fair value of the collateral, management uses a comparison to the recent selling price of similar assets, which is consistent with those that would be utilized by unrelated third parties.

A portion of the Bank’s allowance for loan losses is not allocated to any specific category of loans. This general portion of the allowance reflects the elements of imprecision and estimation risk inherent in the calculation of the overall allowance. Due to the subjectivity involved in determining the overall allowance, including the unallocated portion, the portion of the allowance considered unallocated may fluctuate from period to period based on management’s evaluation of the factors affecting the assumptions used in calculating the allowance, including historical loss experience, current and expected economic conditions and geographic conditions. The Bank has identified an acceptable range for this unallocated portion to be 5% to 15% of the total reserve. While we believe that our management uses the best information available to determine the allowance for loan losses, unforeseen market conditions could result in adjustments to the allowance for loan losses, and net income could be significantly affected, if circumstances differ substantially from the assumptions used in making the final determination. Because these factors and management’s assumptions are subject to change, the allocation is not necessarily indicative of future loan portfolio performance.

Unsecured loans are charged-off against the Bank’s allowance for loan losses as soon as the loan becomes uncollectible. Unsecured loans are considered uncollectible when no regularly scheduled monthly payment has been made within three months, the loan matured over 90 days ago and has not been renewed or extended or the borrower files for bankruptcy. Secured loans are considered uncollectible when the liquidation of collateral is deemed to be the most likely source of repayment. Once secured loans reach 90 days past due, they are placed into non-accrual status. If the loan is deemed to be collateral dependent, the principal balance is written down immediately to reflect the current market valuation based on current independent appraisal. Included in the write-down is the estimated expense to liquidate the property and typically an additional allowance for the foreclosure discount. Generally, if the loan is unsecured the loan must be charged-off in full while if it is secured the loan is charged down to the net liquidation value of the collateral.

Net charge-offs for the first nine months of 2010 totaled $5.2 million compared to net charge-offs of $3.6 million during the first nine months of 2009. The provision for loan losses charged to operations for the nine months ended September 30, 2010 and 2009 was $8.6 million and $5.4 million, respectively. The following table presents an analysis of the changes in the allowance for loan losses for the nine months ended September 30, 2010 and 2009.

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Analysis of Changes in Allowance for Loan Losses

	For the nine months Ended September 30,
	2010			2009
	(Dollars in thousands)
Total loans outstanding at end of period-gross	$	575,003		$	573,837
Average loans outstanding-gross	$	576,497		$	557,984
Allowance for loan losses at beginning of period	$	9,725		$	5,931
Loans charged off:
Real estate		(4,230	)		(3,395	)
Installment loans		(37	)		(13	)
Demand Deposit overdraft program		(165	)		(153	)
Commercial and all other loans		(992	)		(158	)
Total charge-offs		(5,424	)		(3,719	)
Recoveries of loans previously charged off:
Real estate		120			—
Installment loans		6			5
Credit cards and related plans		1			—
Demand Deposit overdraft program		97			90
Commercial and all other loans		19			68
Total recoveries		243			163
Net charge-offs		(5,181	)		(3,556	)
Provision for loan losses		8,643			5,425
Allowance for loan losses at end of period	$	13,187		$	7,800
Ratios
Annualized net charge-offs to average loans during the period		1.20	%		0.85	%
Allowance for loan losses to loans at period end		2.29	%		1.36	%
Allowance for loan losses to nonperforming loans at period end		63.9	%		62.4	%
Allowance for loan losses to impaired loans at period end		37.9	%		34.5	%

The ratio of annualized net charge-offs to average loans increased to 1.20% at September 30, 2010 from 0.85% at September 30, 2009 mainly due to an increase in real estate and commercial related charge-offs. Declining economic conditions, particularly in our southern coastal markets, resulted in an increased number of impaired collateral dependant loans which resulted in a portion of these loans being charged-off. The increase in the allowance for loan losses to loans to 2.29% at September 30, 2010 from 1.36% at September 30, 2009 reflects the increase in our historical loss rate as our charge-offs have increased during the past year. Also, the increase reflects the recognition of additional loans identified as being impaired. The ratio of our allowance for loan losses to nonperforming loans increased slightly to 63.9% as of September 30, 2010 compared to 62.4% at September 30, 2009.

Construction, land and development (“CLD”) loans make up 17.1% of the Bank’s loan portfolio. This sector of the economy has been particularly impacted by declines in housing activity, and has had a disproportionate impact on the credit quality of the Company. The table below shows trends of CLD loans, along with ratios relating to their relative credit quality.

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	CLD Loans						All Other Loans						Total Loans
	Balance			% of Total			Balance			% of Total
	(Dollars in thousands)
Balances at September 30, 2010	$	98,608			17.1	%	$	476,395			82.9	%	$	575,003
Impaired loans(1)		18,187			52.2	%		16,639			47.8	%		34,826
Allocated Reserves		7,379			60.7	%		4,782			39.3	%		12,161
YTD Net Charge-offs		2,330			45.0	%		2,851			55.0	%		5,181
Nonperforming loans (NPL)		12,805			62.0	%		7,842			38.0	%		20,647
NPL as % of loans		13.0	%					1.6	%					3.6	%

(1) Impaired loans include nonperforming loans.

While balances of CLD loans make up 17.1% of the Bank’s loan portfolio, they represent 52.2% and 45.0% of the Bank’s impaired loans and YTD net charge-offs, respectively. CLD loans represent 62.0% of the Bank’s nonperforming loans and 60.7% of the Bank’s allowance for loan loss is allocated to CLD loans.

Nonperforming Assets

Nonperforming assets consist of loans not accruing interest, restructured debt and real estate acquired in settlement of loans and other repossessed collateral. It is our policy to place loans on nonaccrual status when any portion of principal or interest becomes 90 days past due, or earlier if full collection of principal and interest becomes doubtful. When loans are placed on nonaccrual status, interest receivable is reversed against interest income in the current period. Interest payments received thereafter are applied as a reduction to the remaining principal balance so long as doubt exists as to the ultimate collection of the principal. Loans are removed from nonaccrual status when they become current as to both principal and interest and when the collectability of principal or interest is no longer doubtful. Nonperforming assets were $25.9 million and $20.1 million, or 2.78% and 2.26% of total assets at September 30, 2010 and December 31, 2009, respectively. On September 30, 2010, our nonperforming loans (consisting of nonaccruing and restructured loans) amounted to approximately $20.6 million compared to $14.7 million as of December 31, 2009. We had $5.3 million in other real estate owned and repossessions at September 30, 2010 compared to $5.4 million at December 31, 2009.

Loans Considered Impaired

We review our nonperforming loans and other groups of loans based on loan size or other factors for impairment. At September 30, 2010, we had loans totaling $34.8 million (which includes $20.6 million in nonperforming loans) which were considered to be impaired compared to $23.9 million at December 31, 2009. As discussed in Asset Quality, loans are considered impaired if, based on current information, circumstances or events, it is probable that the Bank will not collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. However, treating a loan as impaired does not necessarily mean that we expect to incur a loss on that loan, and our impaired loans include loans that currently are performing in accordance with their terms. For example, if we believe it is probable that a loan will be collected, but not according to its original agreed upon payment schedule, we may treat that loan as impaired even though we expect that the loan will be repaid or collected in full. As indicated in the table below, when we believe a loss is probable on a non-collateral dependent impaired loan, a portion of our reserve is allocated to that probable loss. If the loan is deemed to be collateral dependent, the principal balance is written down immediately to reflect the current market valuation based on current independent appraisal.

The following table sets forth the number and volume of loans considered impaired and their associated reserve allocation, if any, at September 30, 2010.

	Number of Loans		Loan Balances Outstanding		Allocated Reserves
	(Dollars in millions)
Non-accrual loans		55	$	16.5	$	1.9
Restructured loans		5		4.1		1.1
Total nonperforming loans		60	$	20.6	$	3.0
Other impaired loans with allocated reserves		19		5.3		2.2

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Impaired loans without allocated reserves	19		8.9		—
Total impaired loans	98	$	34.8	$	5.2

Investment Securities and Other Assets

The composition of our securities portfolio reflects our investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of income. Our securities portfolio also provides a balance to interest rate risk and credit risk in other categories of the balance sheet while providing a vehicle for investing available funds, furnishing liquidity and supplying securities to pledge as required collateral for certain deposits and borrowed funds. We use two categories to classify our securities: “held-to-maturity” and “available-for-sale.” Currently, none of our investments are classified as held-to-maturity.

Our investment securities totaled $263.9 million at September 30, 2010, $239.3 million at December 31, 2009 and $218.6 million at September 30, 2009. Additions to the investment securities portfolio depend to a large extent on the availability of investable funds that are not otherwise needed to satisfy loan demand. Investable funds not otherwise utilized are temporarily invested as federal funds sold or as interest-bearing balances at other banks, the level of which is affected by such considerations as near-term loan demand and liquidity needs.

At September 30, 2010, the securities portfolio had unrealized net gains of approximately $5.8 million, which are reported in accumulated other comprehensive income on the consolidated statement of shareholders’ equity, net of tax. Our securities portfolio at September 30, 2010 consisted of U.S. government sponsored agency securities, collateralized mortgage obligations (CMOs), mortgage-backed securities (MBS), corporate bonds, and tax-exempt municipal securities.

We currently have the ability to hold our available-for-sale investment securities to maturity. However, should conditions change, we may sell unpledged securities. We consider the overall quality of the securities portfolio to be high. As of September 30, 2010, we owned securities from issuers in which the aggregate amortized cost from such issuers exceeded 10% of our common shareholders’ equity. As of September 30, 2010 the amortized cost and market value of the securities from such issuers were as follows:

	Amortized Cost		Market Value
	(Dollars in thousands)
Federal National Mortgage Corporation	$	87,950	$	89,252
Federal Home Loan Mortgage Corporation		34,229		34,925
Federal Home Loan Banks		12,429		13,208
Government National Mortgage Association		35,530		36,165
Small Business Administration		46,324		47,163

At September 30, 2010, we held $8.9 million in bank owned life insurance, compared to $8.7 million at December 31, 2009 and $8.6 million at September 30, 2009.

Deposits and Other Borrowings

Deposits

Deposits totaled $790.6 million as of September 30, 2010 compared to deposits of $754.7 million at December 31, 2009 and $696.6 million at September 30, 2009, which reflects a year-over-year increase of 13.5%. We attribute our deposit growth during the nine months and twelve months ended September 30, 2010 mainly to an increase in public funds in money market accounts and an increase in noninterest bearing demand accounts. We believe that we can improve our core deposit funding by improving our branching network and providing more convenient opportunities for customers to bank with us.

Other Borrowings

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Short-term borrowings include sweep accounts, advances from the Federal Home Loan Bank of Atlanta (the “FHLB”) having maturities of one year or less, Federal Funds purchased and repurchase agreements. Our short-term borrowings totaled $13.5 million at September 30, 2010, compared to $22.9 million on December 31, 2009 and $47.0 million at September 30, 2009, a year-over-year decrease of $33.5 million.

The following table details the maturities and rates of our borrowings from the Federal Home Loan Bank of Atlanta (“FHLB”), as of September 30, 2010.

Borrow Date	Type	Principal		Term	Rate			Maturity
(Dollars in thousands)
February 29, 2008	Fixed rate		5,000	4 years		3.18		February 29, 2012
March 12, 2008	Fixed rate		6,500	3 years		2.89		March 14, 2011
March 12, 2008	Fixed rate		2,000	4 years		3.25		March 12, 2012
March 12, 2008	Fixed rate		7,500	5 years		3.54		March 12, 2013
August 17, 2010	Fixed rate		3,000	4 years		1.49		August 18, 2014
August 17, 2010	Fixed rate		4,500	5 years		1.85		August 17, 2015
August 17, 2010	Fixed rate		2,500	6 years		2.21		August 17, 2016
August 20, 2010	Fixed rate		2,000	3 years		1.09		August 20, 2013
August 20, 2010	Fixed rate		3,000	4 years		1.48		August 20, 2014
August 20, 2010	Fixed rate		3,000	5 years		1.83		August 20, 2015
August 31, 2010	Fixed rate		1,500	1 years		0.36		August 31, 2011
September 1, 2010	Fixed rate		2,000	2 years		0.66		September 4, 2012
	Total Borrowings:	$	42,500	Composite rate:		2.35	%

Long-Term Obligations

Long-term obligations consist of advances from FHLB with maturities greater than one year. Our long-term borrowing from the FHLB totaled $34.5 million on September 30, 2010, compared to $21.0 million of FHLB advances on both December 31, 2009 and September 30, 2009. The increase of $13.5 million in long-term FHLB advances as of September 30, 2010, is the result of using long-term FHLB advances for funding of an earning growth strategy that was completed in the third quarter of 2010.

Liquidity

Liquidity refers to our continuing ability to meet deposit withdrawals, fund loan and capital expenditure commitments, maintain reserve requirements, pay operating expenses and provide funds for payment of dividends, debt service and other operational requirements. Liquidity is immediately available from five major sources: (a) cash on hand and on deposit at other banks; (b) the outstanding balance of federal funds sold; (c) lines for the purchase of federal funds from other banks; (d) lines of credit established at the FHLB, less existing advances; and (e) our investment securities portfolio. All our debt securities are of investment grade quality and, if the need arises, can be promptly liquidated on the open market or pledged as collateral for short-term borrowing.

Consistent with our general approach to liquidity management, loans and other assets of the Bank are funded primarily using a core of local deposits, retail repurchase agreements and the Bank’s capital position. To date, these core funds, supplemented by FHLB advances and a modest amount of brokered deposits, have been adequate to fund loan demand in our market areas, while maintaining the desired level of immediate liquidity and an investment securities portfolio available for both immediate and secondary liquidity purposes. It is anticipated that funding sources in the future will include continued use of brokered deposits and, additionally, institutional deposits obtained through the Internet.

We are a member of the FHLB. Membership, along with a blanket collateral commitment of our one-to-four family residential mortgage loan portfolio, as well as our commercial real estate loan portfolio, provided us the ability to draw up to $186.4 million, $177.7 million and $171.9 million of advances from the FHLB at September 30,

35

2010, December 31, 2009 and September 30, 2009, respectively. At September 30, 2010, we had outstanding FHLB advances totaling $42.5 million compared to $41.0 million and $56.0 million at December 31, 2009 and September 30, 2009, respectively.

As a requirement for membership, we invest in stock of the FHLB in the amount of 1% of our outstanding residential loans or 5% of our outstanding advances from the FHLB, whichever is greater. That stock is pledged as collateral for any FHLB advances drawn by us. At September 30, 2010, we owned 47,494 shares of the FHLB’s $100 par value capital stock, compared to 51,160 shares at both December 31, 2009 and September��30, 2009. No ready market exists for such stock, which is carried at cost.

We also had unsecured federal funds lines in the aggregate amount of $41 million available to us at September 30, 2010 under which we can borrow funds to meet short-term liquidity needs. At September 30, 2010 we had no borrowings outstanding under these federal funds lines. Another source of funding is loan participations sold to other commercial banks (in which we retain the servicing rights). We believe that our liquidity sources are adequate to meet our operating needs.

Net cash provided by operations during the nine months ended September 30, 2010 totaled $6.7 million, compared to net cash provided by operations of $5.1 million for the same period in 2009. Net cash used in investing activities totaled $22.5 million for the nine months ended September 30, 2010, as compared to $73.1 million for the same period in 2009. Net cash provided by financing activities was $38.4 million for the first nine months of 2010, compared to net cash provided of $67.5 million for the same period in 2009. Cash and cash equivalents at September 30, 2010 were $40.4 million compared to $16.4 million at September 30, 2009.

Capital Resources

Shareholders’ Equity

As of September 30, 2010, our total shareholders’ equity was $87.6 million (consisting of common shareholders’ equity of $70.4 million and preferred stock of $17.2 million) compared with total shareholders’ equity of $84.4 million as of December 31, 2009 (consisting of common shareholders’ equity of $67.3 million and preferred stock of $17.1 million).

Common shareholders’ equity increased by approximately $3.1 million to $70.4 million at September 30, 2010 from $67.3 million at December 31, 2009. We generated net income of $2.0 million, experienced an increase in net unrealized gains on available-for-sale securities of $2.5 million and recognized stock based compensation of $28 thousand on incentive stock awards. We declared cash dividends of $598 thousand on our common shares or $0.21 per share during the first nine months of 2010 and dividends and accretion of discount of $673 thousand on preferred shares.

We are subject to various regulatory capital requirements administered by our federal banking regulators. Failure to meet minimum capital requirements can result in certain mandatory and possibly additional discretionary actions by these regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines involving quantitative measures of our assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Our capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by the FDIC to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of Total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to average assets (each as defined in the regulations). As a bank holding company, we also are subject, on a consolidated basis, to the capital adequacy guidelines of the Federal Reserve Board. The capital requirements of the Federal Reserve Board are similar to those of the FDIC governing the Bank. As of September 30, 2010, we and the Bank met all capital adequacy requirements to which we are subject.

36

As of September 30, 2010, we experienced a decrease in our capital ratios when compared to the periods ending December 31, 2009 and September 30, 2009. This decrease is primarily due to an increase in risk weighted assets and a reduction in capital caused by an increase in disallowed deferred tax assets.

Based on the most recent notification from the FDIC, the Bank is well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table below. There are no conditions or events since that notification that management believes have changed the Bank’s category.

Our and the Bank’s actual capital ratios are presented in the following table:

	To be well capitalized under prompt corrective action provisions Ratio			Minimum required for capital adequacy purposes Ratio			Our Ratio			Bank’s Ratio
As of September 30, 2010:
Tier 1 Capital (to Average Assets)	³	5.00	%	³	3.00	%		8.79	%		6.85	%
Tier 1 Capital (to Risk Weighted Assets)	³	6.00	%	³	4.00	%		12.38			9.65
Total Capital (to Risk Weighted Assets)	³	10.00	%	³	8.00	%		13.64			10.91
As of December 31, 2009:
Tier 1 Capital (to Average Assets)	³	5.00	%	³	3.00	%		9.59	%		7.53	%
Tier 1 Capital (to Risk Weighted Assets)	³	6.00	%	³	4.00	%		12.77			10.03
Total Capital (to Risk Weighted Assets)	³	10.00	%	³	8.00	%		14.02			11.28
As of September 30, 2009:
Tier 1 Capital (to Average Assets)	³	5.00	%	³	3.00	%		9.81	%		7.74	%
Tier 1 Capital (to Risk Weighted Assets)	³	6.00	%	³	4.00	%		13.16			10.39
Total Capital (to Risk Weighted Assets)	³	10.00	%	³	8.00	%		14.37			11.60

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market risk reflects the risk of economic loss resulting from adverse changes in market price and interest rates. This risk of loss can be reflected in diminished current market values and/or reduced potential net interest income in future periods.

The Company’s market risk arises primarily from interest rate risk inherent in its lending and deposit-taking activities. The structure of the Company’s loan and deposit portfolios is such that a significant decline in interest rates may adversely impact net market values and net interest income. The Company does not maintain a trading account nor is the Company subject to currency exchange risk or commodity price risk. Interest rate risk is monitored as part of the Company’s asset/liability management function.

Management does not believe there has been any significant change in the overall analysis of financial instruments considered market risk sensitive, as measured by the factors of contractual maturities, average interest rates and estimated fair values, since the analysis prepared and presented in conjunction with the Form 10-K Annual Report for the fiscal year ended December 31, 2009.

37

Item 4. Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures in accordance with Rule 13a-15 of the Securities Exchange Act of 1934 (the “Exchange Act”). Based on their evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective to provide reasonable assurance that we are able to record, process, summarize and report in a timely manner the information required to be disclosed in reports we file under the Exchange Act.

We review our disclosure controls and procedures, including our internal control over financial reporting, on an ongoing basis and may from time to time make changes aimed at enhancing their effectiveness. In connection with the above evaluation of our disclosure controls and procedures, no change in our internal control over financial reporting was identified that occurred during the quarterly period ended September 30, 2010, and that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

None.

Item 1A. Risk Factors

The Dodd-Frank Act and related regulations may adversely affect our business, financial condition, liquidity or results of operations.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 was enacted on July 21, 2010. The Dodd-Frank Act creates a new Consumer Financial Protection Bureau with power to promulgate and enforce consumer protection laws. Smaller depository institutions (those with $10 billion or less in assets) will be subject to the Consumer Financial Protection Bureau’s rule-writing authority, and existing depository institution regulatory agencies will retain examination and enforcement authority for such institutions. The Dodd-Frank Act also establishes a Financial Stability Oversight Council chaired by the Secretary of the Treasury with authority to identify institutions and practices that might pose a systemic risk and, among other things, includes provisions affecting (1) corporate governance and executive compensation of all companies whose securities are registered with the SEC, (2) FDIC insurance assessments, (3) interchange fees for debit cards, which would be set by the Federal Reserve under a restrictive “reasonable and proportional cost” per transaction standard, (4) minimum capital levels for bank holding companies, subject to a grandfather clause for financial institutions with less than $15 billion in assets, (5) derivative and proprietary trading by financial institutions, and (6) the resolution of large financial institutions.

At this time, it is difficult to predict the extent to which the Dodd-Frank Act or the resulting regulations may adversely impact us. However, compliance with these new laws and regulations may increase our costs, limit our ability to pursue attractive business opportunities, cause us to modify our strategies and business operations and increase our capital requirements and constraints, any of which may have a material adverse impact on our business, financial condition, liquidity or results of operations.

In addition to the risk factor mentioned above and other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2009, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K and mentioned above are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults upon Senior Securities

None.

Item 4. Removed and Reserved

Item 5. Other Information

None.

Item 6. Exhibits

An Exhibit Index listing exhibits that are being filed or furnished with, or incorporated by reference into, this Report appears immediately following the signature page and is incorporated herein by reference.

39

SIGNATURES

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

.	ECB BANCORP, INC.
	(Registrant)
Date: November 12, 2010	By:	/s/    A. Dwight Utz
		A. Dwight Utz
		(President & CEO)
Date: November 12, 2010	By:	/s/    Thomas M. Crowder
		Thomas M. Crowder
		(Executive Vice President & CFO)

40

EXHIBIT INDEX

Exhibit Number	Description
31.01	Certification of Chief Executive Officer required by Rule 13a-14(a)
	(furnished herewith)
31.02	Certification of Chief Financial Officer required by Rule 13a-14(a)
	(furnished herewith)
32.01	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350
	(furnished herewith)
32.02	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350
	(furnished herewith)

41