Carolina Bank 10Q 2013 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2013

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

For the transition period from ______________to_________________

Commission File Number:

000-31877

Carolina Bank Holdings, Inc.
(Exact name of registrant as specified in its charter)

North Carolina	56-2215437
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

101 North Spring Street, Greensboro, North Carolina	27401
(Address of principal executive offices)	(Zip Code)

(336) 288-1898
(Registrant’s telephone number, including area code)

n/a
(Former name, former address and former fiscal year, if changed since last report)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes¨No¨

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

Large accelerated filer¨	Accelerated filer¨

Non-accelerated filer¨ (Do not check if a smaller reporting company)	Smaller reporting companyx

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

¨Yesx No

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

There were 3,388,773 shares of the Issuer’s common stock, $1.00 par value, outstanding as of May 11, 2013.

CAROLINA BANK HOLDINGS, INC.

	INDEX
		Page

PART I. FINANCIAL INFORMATION

	Item 1. Financial Statements (unaudited)	2

	Consolidated Balance Sheets as of March 31, 2013 and December 31, 2012	2

	Consolidated Statements of Income for the three months ended March 31, 2013 and 2012	3

	Consolidated Statements of Comprehensive Income for the three months ended March 31, 2013 and 2012	4

	Consolidated Statement of Stockholders’ Equity for the three months ended March 31, 2013	5

	Consolidated Statements of Cash Flows for the three months ended March 31, 2013 and 2012	6

	Notes to Consolidated Financial Statements	7

	Item 2. Management's Discussion and Analysis of Financial Conditionand Results of Operations	29

	Item 4. Controls and Procedures	34

PART II.	OTHER INFORMATION

	Item 1. Legal Proceedings	35

	Item 4. (Reserved)	35

	Item 6. Exhibits	35

	Exhibit 31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act

	Exhibit 31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act

	Exhibit 32.1 Certification Pursuant to 18 U.S.C. Section 1350

ITEM 1. Financial Statements

Carolina Bank Holdings, Inc. and Subsidiary

Consolidated Balance Sheets

	March 31,			December 31,
	2013			2012
	(unaudited)
	(in thousands, except share data)
Assets
Cash and due from banks	$	6,613		$	7,913
Interest-bearing deposits with banks		72,243			7,186
Securities available-for-sale, at fair value		46,931			42,036
Securities held-to-maturity		-			211
Loans held for sale		77,440			131,762
Loans		431,754			461,728
Less allowance for loan losses		(10,239	)		(9,944	)
Net loans		421,515			451,784
Premises and equipment, net		17,551			17,732
Other real estate owned		7,555			5,940
Bank-owned life insurance		10,858			10,765
Other assets		14,058			16,539
Total assets	$	674,764		$	691,868

Liabilities and Stockholders' Equity
Deposits
Non-interest bearing demand	$	74,432		$	73,032
NOW, money market and savings		338,133			343,740
Time		173,389			174,153
Total deposits		585,954			590,925

Advances from the Federal Home Loan Bank		2,958			15,982
Securities sold under agreements to repurchase		3,112			1,950
Subordinated debentures		19,582			19,563
Other liabilities and accrued expenses		7,769			9,586
Total liabilities		619,375			638,006

Commitments and contingencies - Note O

Stockholders' equity
Preferred stock, no par value, authorized 1,000,000 shares; issued and outstanding 16,000 shares		15,677			15,573
Common stock, $1 par value; authorized 20,000,000 shares; issued and outstanding 3,388,773 in 2013 and 3,387,045 in 2012		3,389			3,387
Common stock warrants		1,841			1,841
Additional paid-in capital		15,917			15,906
Retained earnings		16,822			15,408
Stock in directors' rabbi trust		(1,128	)		(1,050	)
Directors' deferred fees obligation		1,128			1,050
Accumulated other comprehensive income		1,743			1,747
Total stockholders’ equity		55,389			53,862
Total liabilities and stockholders’ equity	$	674,764		$	691,868

See accompanying notes to consolidated financial statements.

Carolina Bank Holdings, Inc. and Subsidiary

Consolidated Statements of Income (unaudited)

	Three Months
	Ended March 31,
	2013		2012

	(in thousands, except per share data)
Interest income
Loans	$	6,719	$	7,085
Investment securities, taxable		248		306
Investment securities, non taxable		106		107
Interest from deposits in banks		18		10
Total interest income		7,091		7,508

Interest expense
NOW, money market, savings		320		548
Time deposits		520		709
Other borrowed funds		188		202
Total interest expense		1,028		1,459

Net interest income		6,063		6,049
Provision for loan losses		400		1,460
Net interest income after provision for loan losses		5,663		4,589
Non-interest income
Service charges		252		283
Mortgage banking income		3,895		3,169
Gain on sale of investment securities		22		-
Other		145		167
Total non-interest income		4,314		3,619

Non-interest expense
Salaries and benefits		4,748		4,030
Occupancy and equipment		747		682
Foreclosed property expense		331		399
Professional fees		186		257
Outside data processing		259		206
FDIC insurance		169		215
Advertising and promotion		206		175
Stationery, printing and supplies		153		135
Other		583		411
Total non-interest expense		7,382		6,510

Income before income taxes		2,595		1,698
Income tax expense		877		470
Net income		1,718		1,228
Dividends and accretion on preferred stock		304		302
Net income available to common stockholders	$	1,414	$	926
Net income per common share
Basic	$	0.42	$	0.27
Diluted	$	0.42	$	0.27

See accompanying notes to consolidated financial statements.

Carolina Bank Holdings, Inc. and Subsidiary

Consolidated Statements of Comprehensive Income (unaudited)

	Three Months
	Ended March 31,
	2013			2012
	(in thousands)

Net income	$	1,718		$	1,228

Other comprehensive income (loss):
Investment securities available-for-sale:
Unrealized holding gains		17			537
Tax effect		(6	)		(183	)
Reclassification of gains recognized in net income		(22	)		-
Tax effect		7			-
		(4	)		354

Comprehensive income	$	1,714		$	1,582

See accompanying notes to consolidated financial statements.

Carolina Bank Holdings, Inc. and Subsidiary

Consolidated Statement of Stockholders' Equity (unaudited)

												Stock in			Directors'		Accumulated
					Common		Additional					Directors'			Deferred		Other
	Preferred		Common		Stock		Paid-In		Retained			Rabbi			Fees		Comprehensive
	Stock		Stock		Warrants		Capital		Earnings			Trust			Obligation		Income			Total
	(in thousands)

Balance, December 31, 2012	$	15,573	$	3,387	$	1,841	$	15,906	$	15,408		$	(1,050	)	$	1,050	$	1,747		$	53,862


Net income		-		-		-		-		1,718			-			-		-			1,718
Other comprehensive loss, net of tax		-		-		-		-		-			-			-		(4	)		(4	)

Directors' fees deferred less
payment of deferred fees		-		-		-		-		-			(78	)		78		-			-
Stock options exercised		-		2		-		11		-			-			-		-			13
Amortization of preferred stock discount		104		-		-		-		(104	)		-			-		-			-
Preferred stock dividends		-		-		-		-		(200	)		-			-		-			(200	)

Balance, March 31, 2013	$	15,677	$	3,389	$	1,841	$	15,917	$	16,822		$	(1,128	)	$	1,128	$	1,743		$	55,389

See accompanying notes to consolidated financial statements.

Carolina Bank Holdings, Inc. and Subsidiary

Consolidated Statements of Cash Flows (unaudited)

	Three Months
	Ended March 31,
	2013			2012
Cash flows from operating activities	(in thousands)
Net income	$	1,718		$	1,228
Adjustments to reconcile net income to net cash provided by operating activities
Provision for loan losses		400			1,460
Depreciation		213			219
Increase in cash surrender value of bank-owned life insurance		(93	)		(95	)
Stock-based compensation expense		-			9
Deferred income tax (benefit)		(341	)		(202	)
Amortization (accretion), net		(18	)		(15	)
Amortization of subordinated debt discount		19			18
Decrease in fair value of loans held for sale		633			59
Gain on sale of other real estate owned		(42	)		(48	)
Gain on sale of investments		(22	)		-
Gain on sale of loans held for sale		(4,777	)		(3,189	)
Impairment of other real estate owned		230			296
Proceeds from sale of loans held for sale		348,756			161,520
Originations of loans held for sale		(290,290	)		(147,932	)
(Increase) decrease in other assets		2,824			(258	)
Increase (decrease) in other liabilities and accrued expenses		(996	)		854
Net cash provided by operating activities		58,214			13,924

Cash flows from investing activities
Purchases of investment securities available-for-sale		(5,977	)		(3,778	)
Maturities and calls of securities available-for-sale		105			919
Repayments from mortgage-backed securities available-for-sale		562			690
Repayments from mortgage-backed securities held-to-maturity		46			21
Net decrease in loans		27,927			3,419
Proceeds from sales of investment securities		614			-
Improvements to other real estate owned		-			(44	)
Purchases of premises and equipment		(32	)		(231	)
Proceeds from sales of other real estate owned		139			778
Net cash provided by investing activities		23,384			1,774

Cash flows from financing activities
Net decrease in deposits		(4,971	)		(8,139	)
Net decrease in Federal Home Loan Advances		(13,024	)		(22	)
Increase in securities sold under agreements to repurchase		1,162			382
Proceeds from exercise of stock options		13			-
Dividends paid		(1,021	)		-
Net cash used for financing activities		(17,841	)		(7,779	)

Net increase in cash and cash equivalents		63,757			7,919
Cash and cash equivalents at beginning of period		15,099			13,311
Cash and cash equivalents at end of period	$	78,856		$	21,230

Supplemental disclosure of cash flow information
Cash paid during the period for interest	$	912		$	1,423
Cash paid during the period for income taxes	$	550		$	-
Supplemental disclosure of non-cash transactions
Transfer of loans to other real estate owned	$	1,942		$	1,962
Dividends declared but not paid	$	-		$	206
Accretion of preferred stock discount	$	104		$	96
Change in unrealized gains on securities available-for-sale, net of tax	$	4		$	354

See accompanying notes to consolidated financial statements.

Carolina Bank Holdings, Inc. and Subsidiary

Notes to Consolidated Financial Statements

Note A – Summary

Carolina Bank Holdings, Inc. (the “Holding Company” or the “Company”) is a North Carolina corporation organized in 2000. In August 2000, pursuant to the plan of exchange approved by the shareholders of Carolina Bank (the “Bank”), all of the outstanding shares of common stock of the Bank were exchanged for shares of common stock of the Holding Company. The Holding Company presently has no employees.

The Bank was incorporated in August 1996, and began banking operations in November 1996. It is engaged in lending and deposit gathering activities in Guilford, Alamance, Randolph and Forsyth Counties, North Carolina and operates under the laws of North Carolina, the rules and regulations of the Federal Deposit Insurance Corporation and the North Carolina Commissioner of Banks. The Bank has eight full-service banking locations, comprised of four in Greensboro and one in each of Asheboro, Burlington, High Point, and Winston-Salem. A wholesale mortgage division is located at the Greensboro corporate headquarters, and retail residential mortgage loan production offices are located in Burlington, Hillsborough, and Raleigh. The Raleigh loan production office was expanded in the first quarter of 2013, and a lease was signed to open a loan production office in Chapel Hill in the second quarter of 2013. All offices, except the Raleigh, Hillsborough, and Chapel Hill loan production offices, are in the Piedmont Triad region of North Carolina.

The Holding Company files periodic reports with the Securities and Exchange Commission and is also subject to regulation by the Federal Reserve Board.

Note B – Consolidation

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, the Bank. TheBank also owns two limited liability companies for the purpose of holding foreclosed real estate, the assets and operations of which are consolidated into Carolina Bank and included herein. All significant inter-company transactions and balances have been eliminated.

Note C – Basis of presentation

In management’s opinion, the financial information, which is unaudited, reflects all adjustments (consisting solely of normal recurring adjustments) necessary for a fair presentation of the financial information as of and for the three months ended March 31, 2013 and 2012, in conformity with accounting principles generally accepted in the United States of America. Operating results for the three months ended March 31, 2013 and 2012 are not necessarily indicative of the results that may be expected for future annual periods.

The Company’s financial statements are presented in accordance with Accounting Standards Codification (“ASC”) Topic 105, “The FASB Accounting Standards CodificationandThe Hierarchy of Generally Accepted Accounting Principles”, which codifies generally accepted accounting principles (GAAP) in the United States.

The organization and business of the Company, accounting policies followed, and other information are contained in the notes to the financial statements of the Company as of and for the years ended December 31, 2012 and 2011, filed with the Securities and Exchange Commission as part of the Company’s annual report on Form 10-K. These financial statements should be read in conjunction with the annual financial statements.

Note D - Use of estimates

The financial statements are prepared in accordance with accounting principles generally accepted in the United States of America which require management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. 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 the valuation of other real estate owned.

Note E - Stock compensation plans

The Company’s shareholders approved the 2009 Omnibus Stock Ownership and Long Term Incentive Plan (“Omnibus Plan”) in 2009 to replace three expired stock option plans, a nonqualified plan for directors (Director Plan) and two incentive stock option plans for management and employees (Employee Plans). The Omnibus Plan provides for the grant of incentive stock options, non-qualified stock options, restricted stock, long-term incentive compensation units and stock appreciation rights to employees and directors. An aggregate of 500,000 shares of the Company’s common stock have been reserved for issuance under the terms of the Omnibus Plan.

There were no stock option grants in 2012 or the first three months of 2013. The fair value of employee plan options granted in December 2007 was $178,000 and expensed over a five year vesting period. Total expense related to the 2007 grants was $0 and $9,000 in the first three months of 2013 and 2012, respectively. At March 31, 2013, there was no unrecognized compensation cost related to unvested share-based compensation.

1,728 new shares of common stock were issued in the first quarter of 2013 as a result of the exercise of incentive stock options.

Note F - Earnings per share

Earnings per share has been determined on a basic basis and a diluted basis which considers potential stock issuances. For the quarters ended March 31, 2013 and 2012, basic earnings per share has been computed based upon the weighted average common shares outstanding of 3,387,813 and 3,387,045, respectively.

The only potential issuances of Company stock are stock options granted to various officers of the Bank and a warrant to purchase common stock executed in conjunction with the issuance of preferred stock to the U.S. Treasury in 2009. The warrant was repurchased from the U.S. Treasury in April 2013 and cancelled. The following is a summary of the diluted earnings per share calculation for the three months ended March 31, 2013 and 2012.

	Three Months Ended
	March 31,
	2013		2012
	(in thousands, except per share data)

Net income available to common stockholders	$	1,414	$	926

Weighted average outstanding shares - basic		3,388		3,387
Dilutive effect of stock options and warrants		10		-
Weighted average shares - diluted		3,398		3,387

Diluted net income per share	$	0.42	$	0.27

For the three months ended March 31, 2013 and 2012, there were stock options and warrants covering 426,981 and 520,390 shares, respectively, that were excluded in computing diluted common shares outstanding given that they were anti-dilutive since the exercise price exceeded the average market price for the period.

Note G – Preferred stock and common stock warrants

In December 2008, the shareholders of the Company approved an amendment to the Articles of Incorporation authorizing the issuance of up to 1,000,000 shares of preferred stock, no par value. In January 2009, the Company issued 16,000 shares of preferred stock to the U.S. Treasury and received $16 million under the Capital Purchase Program. The Company granted a warrant to purchase 357,675 shares of common stock at a price of $6.71 per share to the U.S. Treasury as part of the preferred stock transaction. In accordance with accounting principles, the preferred stock and common stock warrant were valued independently and their relative fair market values were allocated to the $16 million received. Under the relative value method, $14,159,000 was allocated to the preferred stock and $1,841,000 to the common stock warrant. The discount of $1,841,000 on the preferred stock is accreted over five years using the effective yield method, thereby increasing preferred stock dividends. The accretion of the discount was $104,000 and $96,000 for the first three months of 2013 and 2012, respectively. Dividends at 5% per annum are payable quarterly for the first five years; the dividend increases to 9% per annum after the fifth year.

The warrant to the U.S. Treasury was repurchased by the Company for $1,800,000 in April 2013 and cancelled. The Company also paid out $1,021,000 in preferred stock dividends during the first quarter of 2013 which represented the current quarter dividend of $200,000 plus four quarters of dividends that had been deferred due to regulatory guidance. Regulatory approval is no longer required for the payment of preferred stock dividends.

Note H – Subordinated debentures

In December 2004, the Company issued $10,310,000 of unsecured junior subordinated debentures which accrue and pay interest quarterly at three month LIBOR plus 2% per annum. These debentures were issued to Carolina Capital Trust (“Carolina Trust”), a wholly owned subsidiary of the Company which is not consolidated in these consolidated financial statements pursuant to accounting principles governingConsolidated Variable Interest Entities. Carolina Trust acquired these debentures using the proceeds of its offerings of common securities to the Company and $10 million of Trust Preferred Securities to outside investors. The Trust Preferred Securities qualify as Tier 1 capital under current Federal Reserve Board guidelines, but a recent proposal would phase out Tier 1 capital treatment over ten years.The Company has entered into contractual arrangements which, in the aggregate, constitute a full, irrevocable and unconditional guarantee on a subordinated basis by the Company of the obligations of Carolina Trust under the Trust Preferred Securities. The Trust Preferred Securities are redeemable upon maturity of the debentures on January 7, 2035, or upon earlier redemption as provided in the indenture. The Company has the right to redeem the debentures purchased by Carolina Trust in whole or in part at any time.

In the third quarter of 2008, Carolina Bank issued $9,300,000 of unsecured junior subordinated notes to outside investors which accrue and pay interest quarterly at three month LIBOR plus 4% per annum. The notes, net of unamortized expenses associated with the offering, equal $9,272,000 and $9,253,000 at March 31, 2013 and December 31, 2012, respectively and qualify as Tier 2 capital for the Bank. The notes are redeemable upon maturity on September 30, 2018, or earlier at the Bank’s option, in whole or part subject to regulatory approval, beginning September 30, 2013. The expenses of the offering of $373,000 were capitalized at issue and are being amortized over sixty months. The notes are subordinate to the rights of payment to depositors, bankers acceptances, letters of credit and general creditors.

Note I – Operating segments

The Company is considered to have three principal business segments in 2013 and 2012, the Commercial/Retail Bank, the Mortgage Division, and the Holding Company. The Mortgage Division began originating home mortgage loans through third parties and selling these loans to investors in late 2007. A retail mortgage operation was added to the mortgage division in July 2010. Financial performance, reflective of inter-company eliminations, for the three months ended March 31, 2013 and 2012, and selected balance sheet information, reflective of inter-company eliminations, at March 31, 2013 and 2012 for each segment is as follows:

	Three months ended March 31, 2013
	Commercial/Retail		Mortgage		Holding
	Bank		Division		Company			Total
	(in thousands)
Interest income	$	6,300	$	789	$	2		$	7,091
Interest expense		180		789		59			1,028
Net interest income (loss)		6,120		-		(57	)		6,063
Provision for loan losses		400		-		-			400
Net interest income (loss) after provision for loan losses		5,720		-		(57	)		5,663
Non-interest income		419		3,895		-			4,314
Non-interest expense		4,540		2,752		90			7,382
Income (loss) before income taxes		1,599		1,143		(147	)		2,595
Income tax (benefit) expense		471		456		(50	)		877
Net income (loss)	$	1,128	$	687	$	(97	)	$	1,718

Total assets	$	594,809	$	79,615	$	340		$	674,764
Net loans		421,515		77,440		-			498,955
Equity		1,128		687		53,574			55,389

	Three months ended March 31, 2012
	Commercial/Retail		Mortgage			Holding
	Bank		Division			Company			Total
	(in thousands)
Interest income	$	6,795	$	711		$	2		$	7,508
Interest expense		680		713			66			1,459
Net interest income (loss)		6,115		(2	)		(64	)		6,049
Provision for loan losses		1,460		-			-			1,460
Net interest income (loss) after provision for loan losses		4,655		(2	)		(64	)		4,589
Non-interest income		450		3,169			-			3,619
Non-interest expense		4,383		2,106			21			6,510
Income (loss) before income taxes		722		1,061			(85	)		1,698
Income tax (benefit) expense		80		419			(29	)		470
Net income (loss)	$	642	$	642		$	(56	)	$	1,228

Total assets	$	584,438	$	83,216		$	355		$	668,009
Net loans		468,397		81,497			-			549,894
Equity		642		642			46,659			47,943

The Mortgage Division has experienced strong growth in originations since its establishment in 2007 due to low interest rates and due to the purchase of a retail loan production office in July of 2010. Originations and related fee income increased in the first three months of 2013 over 2012 due to lower interest rates in 2013, continued refinancing by borrowers, and expansion of staff to manage the additional volume. Interest rate risk has been minimized by obtaining optional loan sales commitments when loan origination commitments are made or by entering into hedging transactions whereby mortgage backed securities are sold for the estimated closing value of loan commitments. Borrower fraud is a risk that has been minimized by prudent underwriting and by obtaining indemnification from the originating bank or broker for the risks the Company assumes. Warranty provisions and related warranty liabilities were established in 2009 to provide for potential claims that might arise from borrower fraud or underwriting errors. Warranty expenses were $209,000 and $128,000 for the three months ended March 31, 2013 and 2012, respectively. The warranty liability, which is available to fund future warranty claims, was $1,808,000 and $1,624,000 at March 31, 2013 and December 31, 2012, respectively. Ten warranty claims totaling $643,000 have been paid since establishment of the mortgage division in 2007. In addition, six loans with a total current principal balance of $1,532,000 and fair value of $1,377,000 have been repurchased and are included in loans held for sale at fair value. Other real estate owned includes three residential properties valued at $536,000 which were repurchased due to warranty claims.

Note J - Securities

A summary of the amortized cost, gross unrealized gains and losses and estimated fair values of securities available-for-sale and held-to-maturity follows:

			Gross		Gross		Estimated
	Amortized		Unrealized		Unrealized		Fair
	Cost		Gains		Losses		Value
			(in thousands)
March 31, 2013

Available for sale
Municipal securities	$	20,818	$	1,432	$	28	$	22,222
FNMA, FHLMC, and GNMA
mortgage-backed securities		9,143		773		-		9,916
Corporate securities		14,063		250		20		14,293
Unrestricted stock		266		234		-		500
	$	44,290	$	2,689	$	48	$	46,931

December 31, 2012

Available for sale
Municipal securities	$	16,938	$	1,414	$	5	$	18,347
FNMA, FHLMC, and GNMA
mortgage-backed securities		10,127		876		-		11,003
Corporate securities		12,059		264		92		12,231
Unrestricted stock		266		189		-		455
	$	39,390	$	2,743	$	97	$	42,036

Held to maturity
FNMA and GNMA
mortgage-backed securities		211		14		-		225
	$	211	$	14	$	-	$	225

The scheduled maturities of debt securities available-for-sale at March 31, 2013 were as follows:

	Available for Sale
			Estimated
	Amortized		Fair
	Cost		Value
	(in thousands)
Due in one year or less	$	950	$	963
Due from one to five years		9,697		9,886
Due from five to ten years		7,770		8,322
Over ten years		16,464		17,344
Mortgage-backed securities		9,143		9,916
	$	44,024	$	46,431

The Company sold its remaining held-to-maturity securities with a book value of $165,000 at a $10,000 gain during the first quarter of 2013. The securities, which were mortgage-backed securities, were sold in accordance with investment policy since the remaining par value at the date of sale was less than 15% of purchased par value.

Investments are periodically evaluated for any impairment which would be deemed other than temporary. Based upon these evaluations, the Company did not deem any debt securities to be impaired during 2012 or the first three months of 2013. The deterioration in value is primarily attributable to changes in market demand for municipal and corporate securities, not changes in the credit risk of the corporate issuers, and the Company expects these securities to be paid in full and that any temporary impairment will be fully recoverable prior to or at maturity. The Company has the ability and intent to hold the investment securities for a reasonable period of time sufficient for a forecasted recovery or until maturity. Information pertaining to temporarily impaired securities with gross unrealized losses at March 31, 2013 and December 31, 2012, by category and length of time that individual securities have been in a continuous loss position follows:

	Less Than 12 Months						12 Months or Greater						Total
	Number				Gross		Number				Gross		Number				Gross
	of		Fair		Unrealized		of		Fair		Unrealized		of		Fair		Unrealized
	Securities		Value		Losses		Securities		Value		Losses		Securities		Value		Losses
	(dollars in thousands)
March 31, 2013:
Municipal securities		2	$	2,572	$	28		0	$	-	$	-		2	$	2,572	$	28
Corporate securities		2		1,480		20		0		-		-		2		1,480		20
Total		4	$	4,052	$	48		0	$	-	$	-		4	$	4,052	$	48

December 31, 2012:
Municipal securities		1	$	598	$	5		0	$	-	$	-		1	$	598	$	5
Corporate securities		3		2,378		92		0		-		-		3		2,378		92
Total		4	$	2,976	$	97		0	$	-	$	-		4	$	2,976	$	97

Note K - Loans and allowance for loan losses

The activity in the allowance for loan losses for the first three months of 2013 and 2012 and related asset balances at March 31, 2013 and December 31, 2012 is summarized as follows:

	Construction &			Commercial			Home Equity			Residential			Commercial			Consumer
	Development			Real Estate			Lines			Real Estate			& Industrial			& Other			Unallocated		Total
Allowance for loan losses:	(in thousands)
2013
Beginning of year balance	$	2,349		$	4,068		$	609		$	863		$	1,885		$	133		$	37	$	9,944
Provision for loan losses		(148	)		592			29			132			(580	)		28			347		400
Charge-offs		(73	)		(71	)		(32	)		(8	)		(1	)		(5	)		-		(190	)
Recoveries		-			5			-			13			45			22			-		85
Balance at March 31,	$	2,128		$	4,594		$	606		$	1,000		$	1,349		$	178		$	384	$	10,239
2012
Beginning of year balance	$	2,948		$	3,690		$	1,126		$	994		$	2,985		$	46		$	4	$	11,793
Provision for loan losses		(450	)		1,592			(198	)		357			920			106			33		2,360
Charge-offs		(159	)		(1,318	)		(324	)		(498	)		(2,142	)		(20	)		-		(4,461	)
Recoveries		10			104			5			10			122			1			-		252
Balance at December 31,	$	2,349		$	4,068		$	609		$	863		$	1,885		$	133		$	37	$	9,944

Balances at March 31, 2013
Allowance for loan losses:
Balance at March 31,	$	2,128		$	4,594		$	606		$	1,000		$	1,349		$	178		$	384	$	10,239
Ending balance individually evaluated for impairment	$	-		$	2,595		$	227		$	275		$	89		$	48		$	-	$	3,234
Ending balance collectively evaluated for impairment	$	2,128		$	1,999		$	379		$	725		$	1,260		$	130		$	384	$	7,005
Loans Outstanding:
Balance at March 31,	$	56,291		$	193,119		$	65,970		$	49,708		$	60,670		$	5,996		$	-	$	431,754
Ending balance individually evaluated for impairment	$	2,222		$	19,177		$	751		$	4,124		$	1,014		$	50		$	-	$	27,338
Ending balance collectively evaluated for impairment	$	54,069		$	173,942		$	65,219		$	45,584		$	59,656		$	5,946		$	-	$	404,416

Balances at December 31, 2012
Allowance for loan losses:
Balance at December 31,	$	2,349		$	4,068		$	609		$	863		$	1,885		$	133		$	37	$	9,944
Ending balance individually evaluated for impairment	$	-		$	1,309		$	187		$	134		$	95		$	50		$	-	$	1,775
Ending balance collectively evaluated for impairment	$	2,349		$	2,759		$	422		$	729		$	1,790		$	83		$	37	$	8,169
Loans Outstanding:
Balance at December 31,	$	64,669		$	215,258		$	66,523		$	48,857		$	61,251		$	5,170		$	-	$	461,728
Ending balance individually evaluated for impairment	$	1,942		$	19,724		$	778		$	4,416		$	1,198		$	52		$	-	$	28,110
Ending balance collectively evaluated for impairment	$	62,727		$	195,534		$	65,745		$	44,441		$	60,053		$	5,118		$	-	$	433,618

A loan is past due when the borrower has not made a payment by the contractual due date. The following table presents the carrying value of loans that are past due thirty days or more. Loans which are ninety days or more past due are generally on non-accrual status, at which time all accrued interest is removed from interest income, as shown in the following table:

													Loans Past
	Number of Days Past Due												Due 90 Days
					90 Days		Total				Total		or More
	30-59 Days		60-89 Days		or More		Past Due		Current		Loans		& Accruing
At March 31, 2013	(in thousands)
Real Estate Loans:
Construction & development	$	368	$	-	$	2,070	$	2,438	$	53,853	$	56,291	$	-
Commercial real estate		1,100		363		6,515		7,978		185,141		193,119		-
Home equity lines		29		200		624		853		65,117		65,970		-
Residential real estate		92		-		634		726		48,982		49,708		-
Total real estate		1,589		563		9,843		11,995		353,093		365,088		-
Commercial & industrial		-		-		915		915		59,755		60,670		-
Consumer & other		-		-		48		48		5,948		5,996		-
Total loans	$	1,589	$	563	$	10,806	$	12,958	$	418,796	$	431,754	$	-

At December 31, 2012
Real Estate Loans:
Construction & development	$	-	$	-	$	1,778	$	1,778	$	62,891	$	64,669	$	-
Commercial real estate		-		-		7,908		7,908		207,350		215,258		-
Home equity lines		27		-		654		681		65,842		66,523		-
Residential real estate		665		-		1,584		2,249		46,608		48,857		33
Total real estate		692		-		11,924		12,616		382,691		395,307		33
Commercial & industrial		67		-		1,126		1,193		60,058		61,251		-
Consumer & other		1		-		50		51		5,119		5,170		-
Total loans	$	760	$	-	$	13,100	$	13,860	$	447,868	$	461,728	$	33

Loans are determined to be impaired when, based on current information and events, it is probable that all amounts will not be collected when due according to the contractual terms of the original loan agreement. At March 31, 2013 and December 31, 2012, the total recorded investment in impaired loans amounted to approximately $27,338,000 and $28,110,000, respectively. Of these impaired loans, $10,806,000 and $13,067,000 were on non-accrual at March 31, 2013 and December 31, 2012, respectively.

The recorded investment and related information for impaired loans is summarized as follows:

	Impaired Loans
	At end of period						For Period Ended
			Unpaid		Related		Average		Interest
	Recorded		Principal		Loan Loss		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
March 31, 2013	(in thousands)
With no related allowance recorded
Real Estate Loans:
Construction & development	$	2,222	$	2,357	$	-	$	2,249	$	5
Commercial real estate		11,032		12,886		-		12,904		77
Home equity lines		240		414		-		414		4
Residential real estate		2,631		2,926		-		2,937		25
Total real estate		16,125		18,583		-		18,504		111
Commercial & industrial		874		1,416		-		1,418		15
Consumer & other		1		1		-		2		-
Total loans		17,000		20,000		-		19,924		126
With an allowance recorded
Real Estate Loans:
Construction & development		-		-		-		-		-
Commercial real estate		8,145		8,377		2,596		8,394		103
Home equity lines		511		544		227		544		2
Residential real estate		1,493		1,587		274		1,593		14
Total real estate		10,149		10,508		3,097		10,531		119
Commercial & industrial		140		150		89		153		2
Consumer & other		49		50		48		50		2
Total loans		10,338		10,708		3,234		10,734		123
Total impaired loans	$	27,338	$	30,708	$	3,234	$	30,658	$	249
December 31, 2012
With no related allowance recorded
Real Estate Loans:
Construction & development	$	1,942	$	2,074	$	-	$	2,114	$	53
Commercial real estate		16,547		18,009		-		18,335		785
Home equity lines		414		608		-		608		17
Residential real estate		3,800		4,111		-		4,151		155
Total real estate		22,703		24,802		-		25,208		1,010
Commercial & industrial		1,103		1,697		-		2,170		42
Consumer & other		2		2		-		4		-
Total loans		23,808		26,501		-		27,382		1,052
With an allowance recorded
Real Estate Loans:
Construction & development		-		-		-		-		-
Commercial real estate		3,177		3,180		1,309		3,181		177
Home equity lines		364		395		187		395		16
Residential real estate		616		631		134		656		38
Total real estate		4,157		4,206		1,630		4,232		231
Commercial & industrial		95		104		95		118		7
Consumer & other		50		50		50		50		3
Total loans		4,302		4,360		1,775		4,400		241
Total impaired loans	$	28,110	$	30,861	$	1,775	$	31,782	$	1,293

Loans that are past due 90 days or more or where there is serious doubt as to collectability are placed on non-accrual status. Non-accrual loans are not returned to accrual status unless principal and interest are current and borrowers have demonstrated the ability to make contractual payments. Accrued interest is reversed through a charge to income when loans are placed on non-accrual and future payments on non-accrual loans are generally applied to principal. The following is a summary of non-accrual loans at March 31, 2013 and December 31, 2012:

	March 31,		December 31,
	2013		2012
	(in thousands)
Real Estate Loans:
Construction & development	$	2,070	$	1,778
Commercial real estate		6,515		7,908
Home equity lines		624		654
Residential real estate		634		1,551
Total real estate		9,843		11,891
Commercial & industrial		915		1,126
Consumer & other		48		50
Total loans	$	10,806	$	13,067

Loans are graded according to an internal loan rating classification system when originated. Loan grades are periodically re-evaluated during servicing, internal loan reviews, and external loan reviews. The general categories of the internal loan rating classification are:

Pass - Acceptable loans

Special Mention - Loans with potential identified weaknesses in administration or servicing.

Criticized - Adversely classified loans with identified weaknesses, and potential or identified losses of principal and/or interest due.

The following is a breakdown of loans by the general categories of the internal rating system:

	Outstanding Loans at March 31, 2013 and December 31, 2012
	Construction & Development				Commercial				Home Equity
	Development				Real Estate				Lines of Credit
	2013		2012		2013		2012		2013		2012
	(in thousands)
Pass	$	52,424	$	60,928	$	162,561	$	182,314	$	63,537	$	64,042
Special Mention		-		-		7,714		8,641		539		588
Criticized		3,867		3,741		22,844		24,303		1,894		1,893
TOTAL	$	56,291	$	64,669	$	193,119	$	215,258	$	65,970	$	66,523

	Residential				Commercial &				Consumer
	Real Estate				Industrial				& Other
	2013		2012		2013		2012		2013		2012
	(in thousands)
Pass	$	44,291	$	43,042	$	58,294	$	58,454	$	5,942	$	5,101
Special Mention		933		391		153		400		6		7
Criticized		4,484		5,424		2,223		2,397		48		62
TOTAL	$	49,708	$	48,857	$	60,670	$	61,251	$	5,996	$	5,170

During 2013 and 2012, the Company restructured certain loans to improve the likelihood that the loans would be repaid in full under the modified terms in accordance with reasonable repayment schedules. Management evaluates each of these loans in accordance with generally accepted accounting principles to determine whether they should be reported as troubled debt restructurings.

The Company offers a variety of modifications to borrowers. The modification categories offered can generally be described in the following categories:

Rate Modification - A modification in which the interest rate is changed.

Term Modification - A modification in which the maturity date, timing of payments, or frequency of payments is changed.

Interest Only Modification– A modification in which the loan is converted to interest only payments for a period of time.

Payment Modification – A modification in which the dollar amount of the payment is changed, other than an interest only modification described above.

Combination Modification– Any other type of modification, including the use of multiple categories above.

There was $142,000 of available commitments for troubled debt restructurings outstanding at March 31, 2013.

The following tables present troubled debt restructurings as of March 31, 2013 and December 31, 2012:

Troubled Debt Restructurings
	March 31, 2013
					Non-Accrual				Total
	Accrual Status				Status				Modifications
	#		Amount		#		Amount		#		Amount
	($ in thousands)
Real Estate Loans:
Construction & development		1	$	153		1	$	1,791		2	$	1,944
Commercial real estate		14		11,185		6		2,589		20		13,774
Home equity lines		0		-		1		150		1		150
Residential real estate		16		2,982		1		11		17		2,993
Total real estate		31		14,320		9		4,541		40		18,861
Commercial & industrial		2		70		3		910		5		980
Consumer & other		1		1		1		48		2		49
Total loans		34	$	14,391		13	$	5,499		47	$	19,890

	December 31, 2012
					Non-Accrual				Total
	Accrual Status				Status				Modifications
	#		Amount		#		Amount		#		Amount
	($ in thousands)
Real Estate Loans:
Construction & development		1	$	165		7	$	1,606		8	$	1,771
Commercial real estate		14		11,235		8		3,936		22		15,171
Home equity lines		0		-		1		150		1		150
Residential real estate		15		2,350		3		685		18		3,035
Total real estate		30		13,750		19		6,377		49		20,127
Commercial & industrial		2		70		5		1,066		7		1,136
Consumer & other		1		2		0		-		1		2
Total loans		33	$	13,822		24	$	7,443		57	$	21,265

The Bank’s policy is that loans placed on non-accrual will typically remain on non-accrual status until all principal and interest payments are brought current and the prospect for future payment in accordance with the loan agreement appears relatively certain. The Bank’s policy generally refers to six months of payment performance as sufficient to warrant a return to accrual status.

Troubled debt restructurings are classified as impaired loans when modified, and fair value calculations are performed to determine the specific reserves required in the allowance for loan losses related to these loans. Troubled debt restructurings can be removed from such status and returned to non-impaired status in years subsequent to restructure if the interest rate charged at restructure was greater than or equal to the rate charged for a new extension of credit with comparable risk and if the loan is performing and there is no available information to indicated that performance will not continue.

The following tables present newly restructured loans that occurred during the three months ended March 31, 2013 and 2012, respectively:

	New Troubled Debt Restructurings
	Three Months Ended March 31, 2013
	Rate				Term				Payment				Combination				Total
	Modifications				Modifications				Modifications				Modifications				Modifications
	#		Amount		#		Amount		#		Amount		#		Amount		#		Amount
	($ in thousands)
Pre-Modification Outstanding Recorded Investment:
Real Estate Loans:
Construction & development		0	$	-		0	$	-		1	$	-		0	$	-		1	$	-
Total real estate		0		-		0		-		1		-		0		-		1		-
Consumer & other		0		-		0		-		0		-		1		50		1		50
Total loans		0	$	-		0	$	-		1	$	-		1	$	50		2	$	50

Post-Modification Outstanding Recorded Investment:
Real Estate Loans:
Construction & development		0	$	-		0	$	-		1	$	161		0	$	-		1	$	161
Total real estate		0		-		0		-		1		161		0		-		1		161
Consumer & other		0		-		0		-		0		-		1		48		1		48
Total loans		0	$	-		0	$	-		1	$	161		1	$	48		2	$	209

	Three Months Ended March 31, 2012
Pre-Modification Outstanding Recorded Investment:
Real Estate Loans:
Commercial real estate		0	$	-	0	$	-	1	$	123	0	$	-	1	$	123
Home equity lines		0		-	0		-	0		-	0		-	0		-
Total real estate		0		-	0		-	1		123	0		-	1		123
Commercial & industrial		0		-	0		-	1		835	0		-	1		835
Total loans		0	$	-	0	$	-	2	$	958	0	$	-	2	$	958

Post-Modification Outstanding Recorded Investment:
Real Estate Loans:
Commercial real estate		0	$	-	0	$	-	1	$	122	0	$	-	1	$	122
Total real estate		0		-	0		-	1		122	0		-	1		122
Commercial & industrial		0		-	0		-	1		829	0		-	1		829
Total loans		0	$	-	0	$	-	2	$	951	0	$	-	2	$	951

The following tables represent financing receivables modified as troubled debt restructurings and with a payment default, with the payment default occurring within 12 months of the restructure date, and the payment default occurring during the three months ended March 31, 2013 and 2012, respectively:

TDRs with a payment default occurring within 12 months of restructure

	During the three months ended
	March 31, 2013				March 31, 2012
	#		Amount		#		Amount
	($ in thousands)
Real Estate Loans:
Commercial real estate		1	$	119		5	$	7,134
Residential real estate		0		-		0		-
Total real estate		1		119		5		7,134
Commercial & industrial		0		-		3		1,606
Total loans		1	$	119		8	$	8,740

Troubled debt restructuring defaults can result in a higher allowance for loan losses and a corresponding higher provision for loan losses because defaults generally negatively impact the timing of and expected collections from these impaired loans. Impaired loans, which include troubled debt restructurings, are evaluated for specific additions to the allowance for loan losses by subtracting the recorded investment in these impaired loans from their fair values. Fair value is generally determined by the present value of future cash flows, collateral value, or liquidation value. Defaults generally reduce the present value of the future cash flows and can negatively impact the collateral values if declining real estate values are impacting the sale of collateral.

Note L – Fair value measurements

The Company has adopted the accounting standards within FASB AccountingStandards Codification (ASC) 820 “Fair Value Measurements and Disclosures”,which provides a framework for measuring fair value under GAAP and enhances disclosures about fair value measurements. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company utilizes fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. The Company has not elected the fair value option to value liabilities. Securities available-for-sale and loans held for sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as impaired loans 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.

When measuring fair value, valuation techniques should be appropriate in the circumstances and consistently applied. A hierarchy is used to prioritize valuation inputs into the following three levels to determine fair value:

Level 1 – quoted prices (unadjusted) in active markets for identical assets or liabilities.

Level 2 – observable inputs other than the quoted prices included in Level 1.

Level 3 – unobservable inputs.

Fair Value on a Recurring Basis. The Company measures certain assets at fair value on a recurring basis and the following is a general description of the methods used to value such assets.

Investment Securities Available-for-Sale

Investment securities available-for-sale are recorded at fair value. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities and certain corporate bonds 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 most corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.

Loans Held for Sale

The Company opted to account for loans held for sale at fair value which is measured based on what secondary markets are currently offering for portfolios with similar characteristics. As such, the Company classifies loans subjected to recurring fair value adjustments as Level 2 valuation.

Interest Rate Lock Commitments

The Mortgage Division of the Company hedges some of its residential mortgage loans held for sale by selling mortgage backed securities on a forward basis. The forward sale mortgage backed securities are later purchased or closed when mandatory loan sales are consummated for the related mortgages that are originated. The value of the estimated loan commitments and open hedges are marked to market through the income statement. The significant unobservable input used in the Level 3 fair value measurement of the Company’s Interest Rate Lock Commitments (IRLCs) on hedged loans held for sale is the closing ratio, which represents the percentage of loans currently in a lock position which management estimates will ultimately close. Generally, the fair value of an IRLC is positive (negative) if the prevailing interest rate is lower (higher) than the IRLC rate. Therefore, an increase in the closing ratio (i.e., higher percentage of loans are estimated to close) will result in the fair value of the IRLC to increase if in a gain position, or decrease if in a loss position. The closing ratio is largely dependent on the loan processing stage that a loan is currently in and the change in prevailing interest rates from the time of the rate lock. The closing ratio is computed by management using historical data.

The fair value of interest rate lock commitments is based on servicing rate premium, origination income net of origination costs, fall out rates and changes in loan pricing between the commitment date and period end, typically month end. The Company classifies interest rate lock commitments as Level 3. Gain or loss on interest rate lock commitments for the period is included in mortgage banking income of non-interest income on the Consolidated Statements of Income. There have been no changes in valuation techniques for the three months ended March 31, 2012; however, the Mortgage Division discontinued hedging during the first quarter of 2013 due to economic factors. All loans are currently sold on a “best efforts” basis where optional commitments are made with investors to sell loans shortly after optional commitments are consummated to originate loans with borrowers. Below is a summary of activity related to interest rate lock commitments for the three months ending March 31, 2013 and 2012.

	Interest Rate Lock Commitments
	Level 3
	Fair Value			Fair Value
	(in thousands)

Balance, December 31, 2012 and 2011	$	56		$	47
Gains (losses) included in other income		(56	)		112
Transfers in and out		-			-
Balance, March 31, 2013 and 2012	$	-		$	159

Assets measured at fair value on a recurring basis at March 31, 2013 and December 31, 2012 are summarized below:

	Assets
	Measured at		Fair Value Measured Using
Description	Fair Value		Level 1		Level 2		Level 3
	(in thousands)

At March 31, 2013:
Securities available-for-sale:
Municipal securities	$	22,222	$	-	$	22,222	$	-
Mortgage-backed securities		9,916		-		9,916		-
Corporate securities		14,293		9,842		4,451		-
Unrestricted stock		500		500		-		-
Total available-for-sale securities		46,931		10,342		36,589		-
Loans held for sale		77,440		-		77,440		-
Total	$	124,371	$	10,342	$	114,029	$	-

At December 31, 2012:
Securities available-for-sale:
Municipal securities	$	18,347	$	-	$	18,347	$	-
Mortgage-backed securities		11,003		-		11,003		-
Corporate securities		12,231		6,891		5,340		-
Unrestricted stock		455		455		-		-
Total available-for-sale securities		42,036		7,346		34,690		-
Loans held for sale		131,762		-		131,762		-
Interest rate lock commitments		56		-		-		56
Total	$	173,854	$	7,346	$	166,452	$	56

Fair Value on a Non-recurring Basis. The Company measures certain assets at fair value on a non-recurring basis and the following is a general description of the methods used to value such assets.

Impaired 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. Impaired loans are recorded at fair value less estimated selling costs. Once a loan is identified as individually impaired, the Company measures impairment. Fair values of impaired loans are generally estimated using one of several methods, including collateral value, liquidation value, discounted cash flows and, in rare cases, the market value of the note. Those impaired loans not requiring an allowance represent loans for which the net present value of the expected cash flows or fair value of the collateral less costs to sell exceed the recorded investments in such loans. At March 31, 2013 and December 31, 2012, a majority of the total impaired loans were evaluated based on the fair value of the collateral. When the fair value of the collateral is based on an executed sales contract with an independent third party, the Company records the impaired loans as nonrecurring Level 1. If the collateral is based on another observable market price or a current appraised value, the Company records the impaired loans as nonrecurring Level 2. When an appraised value is not available or the Company determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3. Impaired loans can also be evaluated for impairment using the present value of expected future cash flows discounted at the loan’s effective interest rate. The measurement of impaired loans using future cash flows discounted at the loan’s effective interest rate rather than the market rate of interest is not a fair value measurement and is therefore excluded from fair value disclosure requirements. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly.

Other Real Estate Owned and Repossessed Assets

Properties acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less costs to sell at the date of foreclosure. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying value or the new fair value less estimated selling costs. Fair value is generally based upon current appraisals, comparable sales, and other estimates of value obtained principally from independent sources, adjusted for selling costs. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the asset as nonrecurring Level 2. However, the Company also considers other factors or recent developments which could result in adjustments to the collateral value estimates indicated in the appraisals such as changes in absorption rates or market conditions from the time of valuation. In situations where an appraisal less estimated selling costs is used to determine fair value, management adjustments are significant to the fair value measurements, or other means are used to estimate fair value in the absence of an appraisal, the Company records the impaired loan as nonrecurring Level 3 within the valuation hierarchy.

Securities Held to Maturity

The fair values of securities held to maturity are recorded on a non-recurring basis when an impairment in value that is deemed to be other than temporary occurs. 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. At March 31, 2013, the Company had no securities held to maturity.

Assets measured at fair value on a non-recurring basis at March 31, 2013 and December 31, 2012 are summarized below:

	Assets
	Measured at		Fair Value Measured Using
Description	Fair Value		Level 1		Level 2		Level 3
	(in thousands)

At March 31, 2013:
Impaired loans	$	24,104	$	-	$	-	$	24,104
Other real estate owned		7,555		-		-		7,555

At December 31, 2012:
Impaired loans	$	26,335	$	-	$	-	$	26,335
Other real estate owned		5,940		-		-		5,940

Fair Value on a Recurring or Non-recurring Basis – Unobservable Inputs for Level 3.For Level 3 assets and liabilities measured at fair value on a recurring or non-recurring basis as of March 31, 2013, the significant unobservable inputs used in the fair value measurements were as follows:

Significant

Fair Value at

Valuation

Unobservable

Description

March 31, 2013

Technique

Inputs

Input Value

($ in thousands)

Impaired loans

24,104

Appraised Value / Discounted Cash Flows / Market Value of Note

Appraisals and/or sales of comparable properties / Independent quotes

n/a

Other real estate owned

7,555

Appraised Value / Comparable Sales / Other Estimates from Independent Sources

Appraisals and/or sales of comparable properties / Independent quotes/bids / Forward sale contract values

n/a

Fair Value of items not valued as such. The Company measures certain financial assets and liabilities at fair value for disclosure purposes only. The assumptions used in estimating the fair value of these financial instruments are detailed below:

Net non-impaired loans held for investment: For variable rate loans, fair values are based on carrying values. Fixed rate commercial, other installment, and certain real estate mortgage loans are valued using discounted cash flows. The discount rates used to determine the present value of these loans are based on interest rates currently being charged by the Company on comparable loans as to credit risk and term.

Time deposits: Discounted cash flows have been used to value fixed rate and variable rate term deposits. The discount rate used is based on interest rates currently being offered by the Company on comparable deposits as to amount and term.

Trust preferred subordinated debt: The fair value of trust preferred debt was determined by discounting cash flows using a rate 3% higher than the actual current rate over an estimated remaining term of 10.75 years in 2013 and eleven years in 2012. The trust preferred debt was issued at favorable rates in 2004, and current rates for subordinated debt with less favorable capital treatment is approximately 3% higher. Regulations have been proposed that would phase out our ability to include trust preferred debt in Tier 1 capital; however, final regulations have not been issued and any disallowed amounts for inclusion in Tier 1 capital would likely qualify for inclusion in Tier 2 capital.

The following presents the carrying amount, fair value, and placement in the fair value hierarchy of financial instruments at March 31, 2013 and December 31, 2012. This table excludes financial instruments for which the carrying amount approximates fair value. For short-term financial assets such as cash and due from banks and interest-bearing deposits with banks, the carrying amount is a reasonable estimate of fair value due to the relatively short time between the origination of the instrument and its expected realization. For financial liabilities such as non-interest bearing demand deposits, NOW, money market and savings deposits, the carrying amount is a reasonable estimate of fair value due to these products having no stated maturity.

					Fair Value Measurements
					Quoted
					Prices in
					Active Markets		Significant
					for Identical		Other		Significant
					Assets or		Observable		Unobservable
	Carrying		Fair		Liabilities		Inputs		Inputs
	Amount		Value		(Level 1)		(Level 2)		(Level 3)
March 31, 2013	(in thousands)
Financial Instruments - Assets
Net non-impaired loans held for investment	$	397,411	$	399,812	$	-	$	-	$	399,812

Financial Instruments - Liabilities
Time deposits		173,389		175,054		-		-		175,054
Trust preferred subordinated debt		10,310		7,875		-		-		7,875

December 31, 2012
Financial Instruments - Assets
Investment securities held-to-maturity	$	211	$	225	$	-	$	225	$	-
Net non-impaired loans held for investment		425,449		427,484		-		-		427,484

Financial Instruments - Liabilities
Time deposits		174,153		175,729		-		-		175,729
Trust preferred subordinated debt		10,310		7,833		-		-		7,833

Note M – Derivatives and financial instruments

A derivative is a financial instrument that derives its cash flows and value by reference to an underlying instrument, index or referenced interest rate. These instruments are designed to hedge exposures to interest rate risk or for speculative purposes.

Accounting guidance requires an entity to recognize all derivatives as either assets or liabilities in the balance sheet, and measure those instruments at fair value. Changes in the fair value of those derivatives are reported in current earnings or other comprehensive income depending on the purpose for which the derivative is held and whether the derivative qualifies for hedge accounting.

The Mortgage Division of the Company began hedging its governmental mortgage loans, primarily FHA and VA loans, in October 2010 by selling mortgage backed securities on a forward basis. The forward sale mortgage backed securities are later purchased or closed when mandatory loan sales are consummated for the related mortgages that are originated. The value of the estimated loan commitments and open hedges are marked to market through the income statement.

The table below provides the carrying values of derivative instruments at December 31, 2012:

	Carrying Value		Carrying Value		Gain (Loss)			Notional Amount
Derivatives designated as	of Assets		of Liabilities		in Income			of Derivative
hedging instruments:	(in thousands)

At December 31, 2012:
Mortgage loan rate lock commitments	$	56	$	-	$	56		$	-

Mortgage-backed securities forward sales	$	-	$	16	$	(16	)	$	5,250

Prior to October 2010, the Company sold mortgage loans on a best efforts basis whereby optional commitments to sell mortgage loans were consummated at approximately the same time that optional commitments were given to borrowers to originate the loans. The Company changed from hedging a small portion of its loans in 2012 to complete best efforts sales in the first quarter of 2013. The below presents the aggregate fair value and aggregate unpaid principal of loans held for sale at March 31, 2013 and December 31, 2012;

March 31, 2013

December 31, 2012

Aggregate Fair

Value Less

Aggregate

Unpaid

Aggregate

Unpaid

Fair Value

Principal

Fair Value

Principal

(in thousands)

Loans held for sale, at fair value

77,440

76,849

591

131,762

130,539

1,223

Interest income on loans held for sale is recognized based on contractual rates and is reflected in interest income on loans in the consolidated statements of income. The following table details net (losses) resulting from changes in fair value of these loans which were recorded in mortgage banking income in the consolidated statements of income during the three months ended March 31, 2013 and 2012, respectively. These changes in fair value are mostly offset by economic hedging activities and also fluctuate based on the change in the aggregate loan principal outstanding. An immaterial portion of these amounts was attributable to changes in instrument-specific credit risk.

	Loans Held for Sale, At Fair Value
	Three Months Ended March 31,
	2013			2012
	(in thousands)
Net gains (losses) resulting from changes in fair value	$	(633	)	$	(59	)

Note N – Impact of recently adopted accounting standards

In April 2011, the FASB issued ASU No. 2011-03,Reconsideration of Effective Control for Repurchase Agreements. The Update amends existing guidance to remove from the assessment of effective control, the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms and the collateral maintenance implementation guidance related to that criterion. The other criteria to assess effective control were not changed. The amendments were effective for the Company on January 1, 2012 and had no effect on the Company’s consolidated financial statements.

In May 2011, the FASB issued ASU No. 2011-04,Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. The Update amends existing guidance by clarifying the application of existing fair value measurement and disclosure requirements and by changing particular principles or requirements for measuring fair value or for disclosing information about fair value measurements. The amendments were effective for the Company beginning January 1, 2012. The adoption of this guidance has resulted in expanded narrative and tabular disclosures regarding fair value measurements in the Company’s consolidated financial statements, as reflected in Note L.

In June 2011, the FASB issued ASU No. 2011-05,Presentation of Comprehensive Income. The amendment eliminated the option to present other comprehensive income as a part of the statement of changes in stockholders’ equity and required consecutive presentation of the statement of net income and other comprehensive income. The Company implemented this guidance in the period ended December 31, 2011. The adoption of these amendments, which are applied retrospectively, affected the presentation of the Company’s consolidated financial statements, but did not change the items that are reported in other comprehensive income. In December 2011, the FASB further amended this topic with ASU No. 2011-12 to defer the effective date of presenting reclassification adjustments from other comprehensive income to net income on the face of the financial statements while the FASB redeliberated the presentation requirements for the reclassification adjustments. In February 2013, the FASB further amended the Comprehensive Income topic with ASU No. 2013-02 to clarify the conclusions from such redeliberations. Specifically, the amendments do not change the current requirements for reporting net income or other comprehensive income in financial statements. However, the amendments do require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, in certain circumstances an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income. The amendments were effective for the Company on a prospective basis beginning January 1, 2013. These amendments did not have a material effect on the Company’s consolidated financial statements.

In December 2011, the FASB issued ASU No. 2011-11,Disclosures about Offsetting Assets and Liabilities, for companies with financial instruments and derivative instruments that offset or are subject to a master netting agreement. The amendments require disclosure of both gross information and net information about instruments and transactions eligible for offset or subject to an agreement similar to a master netting agreement. The amendments were effective for reporting periods beginning on or after January 1, 2013 and required retrospective presentation for all comparative periods presented. Additionally, in January 2013, the FASB further amended this topic with ASU No. 2013-01 to clarify that the amendments apply only to derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either offset in accordance with specific criteria contained in U.S. GAAP or subject to an enforceable master netting arrangement or similar agreement. These amendments did not have a material impact on the Company’s consolidated financial statements.

Several other accounting standards have been issued or proposed by the FASB or other standards-setting bodies during the periods presented or will be effective subsequent to March 31, 2013. None of these new standards had or is expected to have a material impact on the Company’s consolidated financial statements.

Note O - Commitments

In the normal course of business there are outstanding commitments for the extension of credit which are not reflected in the financial statements. At March 31, 2013 and December 31, 2012, pre-approved but unused lines of credit for loans totaled approximately $138,409,000 and $118,608,000, respectively. In addition, we had $1,694,000 and $1,904,000 in standby letters of credit at March 31, 2013 and December 31, 2012, respectively. These commitments represent no more than the normal lending risk that we commit to borrowers. If these commitments are drawn, we will obtain collateral if it is deemed necessary based on our credit evaluation of the counter-party. We believe these commitments can be funded through normal operations.

We are committed for future lease payments on our Friendly Center office, the land for our Greensboro headquarters, our office in Winston-Salem, and mortgage loan offices in Burlington, Hillsborough, Raleigh, and Chapel Hill. Total future minimum lease payments, excluding renewal options, at March 31, 2013 under the leases are as follows:

	(in thousands)
Due in one year	$	505
Due in Years 2 and 3		912
Due in Years 4 and 5		475
Due after Year 5		2,852
	$	4,744

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

The following discussion is intended to assist in understanding our financial condition and results of operations. Because we have no material operations and conduct no business on our own other than owning our subsidiaries, Carolina Bank and Carolina Capital Trust, and because Carolina Capital Trust has no operations other than the issuance of its trust preferred securities, the discussion contained in this Management’s Discussion and Analysis concerns primarily the business of Carolina Bank. However, for ease of reading and because the financial statements are presented on a consolidated basis, Carolina Bank Holdings, Inc. and Carolina Bank are collectively referred to herein as “we”, “our” or “us” unless otherwise noted.

Forward-looking Statements

This report contains forward-looking statements with respect to our financial condition and results of operations and business. These forward-looking statements involve risks and uncertainties and are based on our beliefs and assumptions and on information available at the time these statements and disclosures were prepared. Factors that may cause actual results to differ materially from those expected include the following:

General economic conditions may deteriorate and negatively impact the ability of our borrowers to repay loans and our depositors to maintain balances.

Changes in interest rates could reduce our net interest income.

Competitive pressures among financial institutions may increase.

Legislative or regulatory changes, including changes in accounting standards, may adversely affect the businesses in which we are engaged.

New products developed and new methods of delivering products could result in a reduction in our business and income.

Increases in interest rates, changes in quantitative easing by the Federal Reserve, increases in warranty losses, or changes in the securitization of mortgages could negatively impact our mortgage banking income.

Adverse changes may occur in the securities market.

Local, state or federal taxing authorities may take tax positions that are adverse to us.

Unpredictable natural and other disasters could have an adverse effect on our operations or on the willingness of our customers to access our financial services.

Comparison of Financial Condition

Assets.Our total assets decreased by $17.1 million, or 2.5%, from $691.9 million at December 31, 2012, to $674.8 million at March 31, 2013. During the three months ended March 31, 2013, cash and due from banks, interest-bearing deposits with banks and investment securities increased by $68.4 million while loans held for sale decreased $54.3 million, and loans held for investment decreased $30.0 million. The decrease in loans held for sale was expected as loans outstanding had risen to above targeted levels at December 31, 2012 due to delays in processing loan sales prior to yearend. We experienced slowing commercial and consumer loan demand in our primary lending markets, Guilford, Randolph, Alamance and Forsyth Counties, North Carolina in 2010, 2011, 2012, and the first three months of 2013. The slowing demand in 2013 was partially due to increased competition.

Liabilities. Total deposits decreased by $5.0 million, or 0.8%, from $590.9 million at December 31, 2012, to $586.0 million at March 31, 2013. Due to the decline in loans and excess liquidity, deposits were not promoted during the quarter. Our branching activities are designed to enhance customer convenience and related deposit gathering activities as well as provide new sources for loans. While deposit growth has been an ongoing goal, wholesale sources of funding such as Federal Home Loan Bank (“FHLB’) advances and repurchase borrowings, may be utilized where cost beneficial and when necessary to meet liquidity requirements. Retail repurchase agreements increased $1.2 million and FHLB advances were down $13 million in the first three months of 2013. The decrease in FHLB advances represented short term advances that had been used to fund the increase in loans held for sale at December 31, 2012. We had approximately $32.5 million in out-of-market time deposits from other institutions and $17.4 million in brokered deposits at March 31, 2013, a decrease of $0.2 million in these two types of accounts from December 31, 2012.

Stockholders’ Equity. Total stockholders’ equity increased $1.5 million at March 31, 2013 to $55.4 million from $53.9 million at December 31, 2012, due primarily to retained net income.

Comparison of Results of Operations for the Three Months Ended March 31, 2013 and 2012

General. Net income was $1,718,000 and $1,228,000 for the first quarter of 2013 and 2012, respectively. Net income available to common stockholders was $1,414,000, or $0.42 per diluted share, for the three months ended March 31, 2013 compared to $926,000, or $0.27 per diluted share, for the three months ended March 31, 2012. Net income available to common stockholders represents net income less preferred stock dividends and related discount accretion. Higher net income in 2013 resulted primarily from a decline in the provision for loan losses. Our primary markets in the Triad of North Carolina experienced deteriorating economic conditions in 2009 through 2011 which negatively impacted our borrowers as evidenced by increasing defaults and loan charge-offs. While economic conditions have not improved substantially since 2011 in our primary markets, loan charge-offs have declined and the risk in the loan portfolio has declined as evidenced by a decrease in impaired loans.

Net interest income. Net interest income of $6,063,000 for the three months ended March 31, 2013 increased $14,000 from the first quarter of 2012. The net yield on interest earning assets, adjusted to a fully taxable basis, decreased to 3.94% in the first quarter of 2013 from 3.98% in the first quarter of 2012. The decrease in the net yield on interest earning assets of 4 basis points in 2013 was offset by an increase in average interest-earning assets by $13.6 million. The increase in interest-earning assets was primarily due to growth in non-interest-bearing demand deposits. The decline in the net yield on interest-earning assets is expected to continue into the second quarter of 2013 due to the decline in loans in the first quarter of 2013 and due to increased competitive pressures for loans in our markets. The table below provides an analysis of effective yields and rates on categories of interest-earning assets and interest-bearing liabilities for the three months ended March 31, 2013 and 2012.

Net Interest Income and Average Balance Analysis

	For the Three Months Ended March 31,
	2013							2012
	Average		Interest		Average			Average		Interest		Average
	Balance (1.)		Inc./Exp.		Yield/Cost			Balance (1.)		Inc./Exp.		Yield/Cost
	(Dollars in thousands)

Interest-earning assets
Interest bearing deposits	$	45,549	$	18		0.16	%	$	20,163	$	10		0.20	%
Non-taxable investments (2.)		11,448		158		5.60	%		11,107		160		5.79	%
Taxable investments		31,147		248		3.23	%		32,626		306		3.77	%
Loans held for sale		91,839		789		3.48	%		73,084		711		3.91	%
Loans (3.)		449,704		5,931		5.35	%		479,121		6,374		5.35	%
Interest-earning assets		629,687		7,144					616,101		7,561
Interest-earning assets						4.60	%						4.94	%

Non interest-earning assets		48,686							47,831

Total assets	$	678,373						$	663,932

Interest-bearing liabilities
Interest checking	$	41,130	$	13		0.13	%	$	35,193	$	22		0.25	%
Money market and savings		297,956		307		0.42	%		286,638		526		0.74	%
Time certificates and IRAs		173,476		520		1.22	%		207,574		709		1.37	%
Other borrowings		27,741		188		2.75	%		24,530		202		3.31	%
Total interest-bearing liabilities		540,303		1,028					553,935		1,459
Cost on average
Interest-bearing liabilities						0.77	%						1.06	%
Non-interest-bearing liabilities
Demand deposits		76,952							57,446
Other liabilities		6,449							5,350
Total non-interest-bearing Liabilities		83,401							62,796
Total liabilities		623,704							616,731
Stockholders' equity		54,669							47,201
Total liabilities and equity	$	678,373						$	663,932
Net interest income			$	6,116						$	6,102
Net yield on average interest-earning assets						3.94	%						3.98	%
Interest rate spread						3.83	%						3.88	%

(1.)	Average balances are computed on a daily basis.
(2.)	Interest income and yields related to certain investment securities exempt from federal income tax are stated on a fully taxable basis using a 34% federal tax rate, reduced by the nondeductible portion of interest expense.
(3.)	Nonaccrual loans are included in the average loan balance.

Provision for loan losses.The provision for loan losses amounted to $400,000 and $1,460,000 for the three months ended March 31, 2013 and 2012, respectively. The amount of the provision for loan losses decreased in 2013 primarily because of a decrease in loans outstanding and a decline in net loan charge-offs which positively impacted the historical losses used to calculate the allowance for loan losses on non-impaired loans. We believe the allowance for loan losses is appropriate based on asset quality indicators and other factors.

Non-interest income.Total non-interest income amounted to $4,314,000 for the three months ended March 31, 2013, as compared to $3,619,000 for the three months ended March 31, 2012. Service charges decreased $31,000, or 11.0%, and mortgage banking income increased $726,000, or 22.9%, during the first quarter of 2013 compared to the first quarter of 2012.

Non-interest expense.Total non-interest expense amounted to $7,382,000 and $6,510,000 for the three months ended March 31, 2013 and 2012, respectively. Salaries and employee benefits increased $718,000, or 17.8%, primarily from expansion of our Mortgage Division and related support staff, and from merit increases. The number of full-time equivalent employees increased to 215 at March 31, 2013 from 184 at March 31, 2012. Other expenses were $172,000 higher in 2013 due to increased loan related charges, primarily for the mortgage division. Lower expenses were incurred in the first quarter of 2013 in the areas of foreclosed property expense, professional fees, and FDIC insurance.

Income taxes.Income tax expense was $877,000, or 33.8% of net income before income taxes, for the three month period ended March 31, 2013, as compared to $470,000, or 27.7% of net income before income taxes, for the three month period ended March 31, 2012. Non-taxable income was a higher percentage of pre-tax income in 2012 which accounted for the lower effective tax rate in 2012.

Asset Quality

Non-performing assets, composed of other real estate owned and non-accrual loans, totaled $18,361,000 at March 31, 2013, compared to $19,007,000 at December 31, 2012. Non-performing assets, as a percentage of total assets, was 2.72% at March 31, 2013, compared to 2.75% at December 31, 2012. There were $0 and $33,000 loans 90 days or more past due and still accruing interest at March 31, 2013 and December 31, 2012, respectively. Other real estate owned was $7,555,000 at March 31, 2013 and $5,940,000 at December 31, 2012. Although non-performing assets were stable during the first quarter of 2013, they declined substantially during 2011 and 2012 due to success in disposing of problem loans and assets, from reduction in new additions to non-performing assets, and from an improved economy. The economic conditions in our primary markets in North Carolina, while improved, continued to be stressed during 2013 and 2012 with elevated unemployment levels. The seasonally adjusted unemployment rate in North Carolina decreased to 9.2% in March 2013 from 9.4% in December 2012 and 10.4% in December 2011. North Carolina’s seasonally adjusted unemployment rate of 9.2% compares unfavorably to 7.6% for the United States. A large portion of our loans are made to businesses and real estate developers and are secured by real estate. Due to the slow economic conditions, it has been difficult for borrowers to sell businesses or real estate properties as needed to pay off their loans.

Our allowance for loan losses is composed of two parts, a specific portion related to non-performing loans and performing impaired loans and a general section related to non-impaired loans. The specific portion of our allowance for loan losses, which relates to impaired loans, increased to $3,234,000 at March 31, 2013 from $1,775,000 at December 31, 2012, and impaired loans decreased to $27,338,000 at March 31, 2013 from $28,110,000 at December 31, 2012. The specific portion of our allowance relating to impaired loans increased in 2013 primarily because we utilized more conservative assumptions in calculating the present value of future cash flows related to the impairment on several loans to one borrower. The general portion of our allowance for loan losses decreased to $7,005,000 on non-impaired loans of $404,416,000 at March 31, 2013 from $8,169,000 on non-impaired loans of $433,615,000 at December 31, 2012. The general portion of our allowance applies to non-impaired loans and was determined by applying estimated loss ratios inherent in the loan portfolio, ranging from 0.20% on loans secured by multi-family properties to 3.94% on construction and development loans, to categories of non-impaired loans at each period end. The general section of our allowance also includes a qualitative component which is calculated based on nine environmental factors such as the changes in economic and business conditions that affect the collectability of the loan portfolio and changes in the value of collateral dependent loans. The qualitative component of the general section of our allowance for loan losses, including an unallocated allowance, decreased from $1,207,000 at December 31, 2012 to $622,000 at March 31, 2013 because of continued improvement in delinquency trends, lower levels of non-accruing loans, and lower loan charge-offs.

The allowance for loan losses is increased by direct charges to operating expense, the provision for loan losses. Losses on loans or charge-offs are deducted from the allowance in the period that loans are deemed to become uncollectible or in the period that updated appraisals indicate a loss in value of non-performing, collateral dependent, real estate loans. Recoveries of previously charged-off loans are added back to the allowance. Net loan charge-offs (charge-offs minus recoveries) totaled $105,000 for the three months ended March 31, 2013 compared to $762,000 for the same period in 2012.

Liquidity and Capital Resources

The objective of our liquidity management is to ensure the availability of sufficient cash flows to meet all financial commitments and to capitalize on opportunities for expansion. Liquidity management addresses our ability to meet deposit withdrawals on demand or at contractual maturity, to repay borrowings as they mature, and to fund new loans and investments as opportunities arise.

Our primary sources of internally generated funds are principal and interest payments on loans receivable and cash flows generated from operations. External sources of funds include increases in deposits, repurchase agreements, lines of credit from banks, including the Federal Reserve, and advances from the Federal Home Loan Bank of Atlanta (“FHLB”).

Carolina Bank is required under applicable federal regulations to maintain specified levels of liquid investments in qualifying types of investments. Cash and due from banks, interest-bearing deposits in banks, investment securities available-for-sale, and loans held for sale by our mortgage division are the primary liquid assets of Carolina Bank. We regularly monitor Carolina Bank’s liquidity position to ensure its liquidity is sufficient to meet its needs. During the first three months of 2013, we increased our levels of short-term liquidity due to a decrease in our loans held for sale and loans held for investment. Short-term liquidity in the form of cash and due from banks and interest-bearing deposits in banks, increased to $78.9 million at March 31, 2013 from $15.1 million at December 31, 2012. We also have substantial secondary sources of liquidity in the form of unused secured lines of credit from the FHLB and the Federal Reserve of approximately $171 million at March 31, 2013.

We are subject to various regulatory capital requirements administered by the banking regulatory agencies. Failure to meet minimum capital requirements can initiate mandatory and possibly discretionary actions by the regulators that, if undertaken, could have a direct material effect on our financial condition. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. Our capital amounts and classifications are subject to qualitative judgments by the regulators about components, risk-weightings, and other factors. As of March 31, 2013 and December 31, 2012, our levels of capital exceeded all applicable published regulatory requirements. Carolina Bank continued to exceed its internal goal of maintaining Tier 1 capital to average assets of 8% in 2013 through earnings. Tier 1 capital to average assets for Carolina Bank was 9.34% at March 31, 2013 compared to 9.23% at December 31, 2012. Carolina Bank Holdings, Inc. is current on its preferred stock dividends and on its trust preferred interest payments.

Due to our strong growth in recent years and our anticipation of continued growth, we increased our capital in January 2009 by issuing $16 million in preferred stock to the United States Treasury under the Capital Purchase Program. Carolina Bank also issued approximately $9.3 million in subordinated debt through a private placement in the third quarter of 2008 to increase capital at the bank level. The Treasury sold our preferred stock to private investors in the first quarter of 2013, and we re-purchased and cancelled a warrant to purchase our common stock from the Treasury for $1,800,000 in April 2013.

ITEM 4. Controls and Procedures

Our Chief Executive Officer and Chief Financial Officer have conducted an evaluation of our disclosure controls and procedures as of March 31, 2013. Based on their evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time period specified in the applicable Securities and Exchange Commission Rules and Forms. There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the most recent evaluation of these controls by our Chief Executive Officer and Chief Financial Officer.

Management of the Company has evaluated, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, changes in the Company's internal controls over financial reporting (as defined in Rule 13a−15(f) and 15d−15(f) of the Exchange Act) during the first quarter of 2013. In connection with such evaluation, the Company has determined that there have been no changes in internal control over financial reporting during the first quarter that have materially affected or are reasonably likely to materially affect, the Company's internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

There are various claims and lawsuits in which the Company and the Bank are periodically involved incidental to their business. In the opinion of management, no material loss is expected from any of such pending claims or lawsuits.

Item 4. (Reserved)

Item 6. Exhibits

Exhibit No		Description of Exhibit
31.1		Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.

31.2		Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.

32.1		Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act.

101		Interactive data files providing financial information from the Registrant’s Quarterly report on Form 10-Q for the quarterly period ended March 31, 2013, in XBRL (eXetensible Business Reporting Language). *

Pursuant to Regulation 406T of Regulation S-T, these interactive data files are furnished and not filed or part of a registration statement or prospectus for the purposes of section 11 or 12 of the Securities Act of 1933 , as amended, or section 18 of the Securities Exchange Act of 1934, as amended, and are otherwise not subject to liability.

SIGNATURES

Pursuant to 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.

	Carolina Bank Holdings, Inc.

Date: May 14, 2013	By:	/s/ Robert T. Braswell
		Robert T. Braswell
		President and Chief Executive Officer

Date: May 14, 2013	By:	/s/ T. Allen Liles
		T. Allen Liles
		Chief Financial and Principal Accounting Officer

Exhibit Index

Exhibit No.		Description of Exhibit
31.1		Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.

31.2		Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.

32.1		Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act.

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Carolina Bank (CLBH) Inactive 10-Q2013 Q1 Quarterly report

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