Midcarolina Financial (MCFI) 10-Q 2008 Q3 Quarterly report

United States

Securities and Exchange Commission

Washington, D.C. 20549

Form 10-Q

x Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2008

¨ Transition Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period ended                        

Commission File Number 000-49848

MidCarolina Financial Corporation

(Exact name of registrant as specified in its charter)

North Carolina	55-6144577
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

3101 South Church Street Burlington, North Carolina	27216
(Address of principal executive offices)	(Zip Code)

(336) 538-1600

(Registrant’s telephone number, including area code)

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

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

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

Indicated by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    ¨  yes    no  x

As of November 11, 2008, the registrant had outstanding 4,919,661 shares of Common Stock, no par value.

		Page No.
Part I.	FINANCIAL INFORMATION
Item 1 -	Financial Statements (Unaudited)
	Consolidated Balance Sheets
	September 30, 2008 and December 31, 2007	3
	Consolidated Statements of Operations
	Three Months and Nine Months Ended September 30, 2008 and 2007	4
	Consolidated Statements of Comprehensive Income
	Three Months and Nine Months Ended September 30, 2008 and 2007	5
	Consolidated Statement of Shareholders’ Equity
	Nine Months Ended September 30, 2008	6
	Consolidated Statements of Cash Flows
	Nine Months Ended September 30, 2008 and 2007	7
	Notes to Consolidated Financial Statements	8
Item 2 -	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13
Item 3 -	Quantitative and Qualitative Disclosures About Market Risk	18
Item 4 -	Controls and Procedures	18
Part II.	Other Information
Item 1 -	Legal Proceedings	19
Item 6 -	Exhibits	19

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Part I. FINANCIAL INFORMATION

Item 1 - Financial Statements

MIDCAROLINA FINANCIAL CORPORATION

CONSOLIDATED BALANCE SHEETS

	September 30, 2008 (Unaudited)			December 31, 2007(*)
	(Dollars in thousands except Share data)
ASSETS
Cash and due from banks	$	1,403		$	1,632
Federal funds sold and interest-earning deposits		12,492			2,979
Investment securities:
Available for sale		69,975			70,801
Loans held for sale		304			823
Loans		418,928			371,714
Allowance for loan losses		(5,372	)		(4,462	)
NET LOANS		413,556			367,252
Investment in stock of Federal Home Loan Bank of Atlanta		2,329			2,966
Investment in life insurance		7,821			7,594
Premises and equipment, net		7,067			6,834
Other assets		6,676			6,305
TOTAL ASSETS	$	521,623		$	467,186
LIABILITIES AND SHAREHOLDERS’ EQUITY
LIABILITIES
Noninterest-bearing demand deposits	$	41,844		$	30,568
Interest-bearing demand deposits		69,205			74,913
Savings		6,053			5,462
Time		326,318			262,954
TOTAL DEPOSITS		443,420			373,897
Short-term borrowings		8,000			19,000
Long-term borrowings		33,764			38,764
Accrued expenses and other liabilities		1,054			2,375
TOTAL LIABILITIES		486,238			434,036
Shareholders’ equity:
Noncumulative, perpetual preferred stock, no par value, 20,000,000 shares authorized; 5,000 shares issued and outstanding at September 30, 2008 and December 31, 2007		4,819			4,819
Common stock, no par value; 80,000,000 shares authorized; 4,919,661 and 4,618,528 shares issued and outstanding at September 30, 2008 December 31, 2007, respectively		14,576			13,290
Retained earnings		18,290			15,378
Accumulated other comprehensive loss		(2,300	)		(337	)
TOTAL SHAREHOLDERS’ EQUITY		35,385			33,150
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	521,623			467,186

* Derived from audited consolidated financial statements.

See accompanying notes.

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MIDCAROLINA FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

	Three Months Ended September 30,				Nine Months Ended September 30,
	2008		2007		2008		2007
	(Amounts in thousands, except per share data)
INTEREST INCOME
Loans and loan fees	$	6,515	$	7,057	$	19,473	$	19,967
Investment securities:
Taxable		706		664		2,011		1,915
Tax-exempt		208		236		631		806
Federal funds sold and interest-earning deposits		31		53		109		206
Other		42		44		154		134
TOTAL INTEREST INCOME		7,502		8,054		22,378		23,028
INTEREST EXPENSE
Demand deposits		272		753		977		2,151
Savings		6		14		24		46
Time		2,877		3,315		9,281		9,113
Short-term borrowings		50		210		270		757
Long-term borrowings		355		349		1,141		1,050
TOTAL INTEREST EXPENSE		3,560		4,641		11,693		13,117
NET INTEREST INCOME		3,942		3,413		10,685		9,911
PROVISION FOR LOAN LOSSES		705		—		1,155		—
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		3,237		3,413		9,530		9,911
NON-INTEREST INCOME
Service charges on deposits accounts		299		263		871		753
Mortgage operations		117		146		512		485
Income from brokerage activities		69		82		239		237
Increase in cash surrender value of life insurance		77		74		227		215
Gain on sale of investments		2		3		29		3
Gain (loss) on sale of other real estate		536		—		536		(45	)
Other (Note E)		92		89		265		300
TOTAL NON-INTEREST INCOME		1,192		657		2,679		1,948
NON-INTEREST EXPENSE
Salaries and employee benefits		1,399		1,349		4,113		4,075
Occupancy and equipment		266		274		813		882
Data processing and other outside services		260		288		818		887
Office supplies and postage		82		87		251		236
Deposit and other insurance		122		124		311		251
Professional and other services		190		46		361		213
Advertising		71		23		241		156
Other (Note E)		181		134		489		426
TOTAL NON-INTEREST EXPENSE		2,571		2,325		7,397		7,126
INCOME BEFORE INCOME TAXES		1,858		1,745		4,812		4,733
INCOME TAXES		615		540		1,587		1,444
NET INCOME		1,243		1,205		3,225		3,289
Dividends on preferred stock		104		104		313		313
Net income available to common shareholders	$	1,139	$	1,101	$	2,912	$	2,976
NET INCOME PER COMMON SHARE
Basic	$	.23	$	.24	$	.59	$	.66
Diluted	$	.23	$	.23	$	.59	$	.61

See accompanying notes.

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MIDCAROLINA FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2008			2007			2008			2007
	(Dollars in thousands)
Net income	$	1,243		$	1,205		$	3,225		$	3,289
Other comprehensive income (loss):
Securities available for sale:
Unrealized holding gains (losses) on available-for-sale securities		(2,238	)		906			(3,165	)		(515	)
Tax effect		863			(349	)		1,220			199
Reclassification of gains recognized in net income		(2	)		(3	)		(29	)		(3	)
Tax effect		1			1			11			1
Total other comprehensive income (loss)		(1,376	)		555			(1,963	)		(318	)
COMPREHENSIVE INCOME (LOSS)	$	(133	)	$	1,760		$	1,262		$	2,971

See accompanying notes.

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MIDCAROLINA FINANCIAL CORPORATION

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (Unaudited)

	Preferred stock			Common stock			Retained			Accumulated other comprehensive			Total shareholders’
	Shares	Amount		Shares	Amount		earnings			loss			equity
	(Amounts in thousands, except share data)
Balance at December 31, 2007	5,000	$	4,819	4,618,528	$	13,290	$	15,378		$	(337	)	$	33,150
Net income	—		—	—		—		3,225			—			3,225
Other comprehensive income (loss)	—		—	—		—		—			(1,963	)		(1,963	)
Stock based compensation	—		—	—		26		—			—			26
Stock options exercised	—		—	301,133		762		—			—			762
Current income tax benefit	—		—	—		498		—			—			498
Preferred dividends paid	—		—	—		—		(313	)		—			(313	)
Balance at September 30, 2008	5,000	$	4,819	4,919,661	$	14,576	$	18,290		$	(2,300	)	$	35,385

See accompanying notes.

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MIDCAROLINA FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

	Nine Months Ended September 30,
	2008			2007
	(Dollars in thousands)
Operating Activities
Net income	$	3,225		$	3,289
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		330			375
Accretion on securities		(163	)		(1	)
Provision for loan losses		1,155			—
Gain on sale of investment securities available for sale		(29	)		(3	)
Deferred tax benefit		(1,231	)		(200	)
Gain on sale of loans		(512	)		(485	)
Origination of loans held for sale		(19,364	)		(22,774	)
Proceeds from sales of loans held for sale		20,395			24,316
Increase in cash surrender value life insurance		(227	)		(215	)
Net (gain) loss on sale of other real estate owned		(536	)		45
Stock based compensation expense		26			2
Changes in assets and liabilities:
Decrease in other assets		527			284
Increase in accrued expenses and other liabilities		1,141			1,752
NET CASH PROVIDED BY OPERATING ACTIVITIES		4,737			6,365
Investing Activities
Purchases of investment securities available for sale		(38,311	)		(21,834	)
Maturities and calls of investment securities available for sale		25			1,389
Principal paydowns on investment securities available for sale		3,562			2,674
Sales of investment securities available for sale		32,548			20,714
Net increase in loans from originations and principal repayments		(48,939	)		(49,129	)
Redemption of FHLB stock		637			340
Purchases of premises and equipment		(557	)		(562	)
Proceeds from sale of foreclosed assets		1,112			381
NET CASH USED BY INVESTING ACTIVITIES		(49,923	)		(46,027	)
Financing Activities
Net increase in deposits		69,523			45,304
Net decrease in short-term borrowings		(11,000	)		(10,000	)
Net increase (decrease) in long-term borrowings		(5,000	)		2,000
Non-cumulative perpetual preferred stock dividends paid		(313	)		(313	)
Proceeds from common stock issue		—			2
Proceeds from stock options exercised		762			192
Tax benefit from exercise of stock options		498			—
Purchase of fractional shares		—			(10	)
NET CASH PROVIDED BY FINANCING ACTIVITIES		54,470			37,175
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		9,284			(2,487	)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		4,611			12,438
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	13,895		$	9,951

See accompanying notes.

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MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

NOTE A - BASIS OF PRESENTATION

The consolidated financial statements include the accounts and transactions of MidCarolina Financial Corporation (the “Company”) and its wholly-owned subsidiary MidCarolina Bank (the “Bank”). All intercompany transactions and balances have been eliminated in consolidation. 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 September 30, 2008 and for the three month and nine month periods ended September 30, 2008 and 2007, in conformity with accounting principles generally accepted in the United States of America.

The preparation of the consolidated financial statements requires management to make estimates and assumptions that affect reported amounts of assets and liabilities at the date of the financial statements, as well as the amounts of income and expense during the reporting period. Actual results could differ from those estimates. Operating results for the three month and nine month periods ended September 30, 2008 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2008.

The organization and business of the Company, accounting policies followed by the Company and other information are contained in the notes to the consolidated financial statements filed as part of the Company’s annual report on Form 10-K. This quarterly report should be read in conjunction with such annual report.

NOTE B - COMMITMENTS

At September 30, 2008, loan commitments were as follows (in thousands):

Commitments to extend credit	$	39,308
Undisbursed lines of credit		35,262
Standby letters of credit		3,991
Commitments to sell loans held for sale		304

NOTE C - PER SHARE DATA

Diluted earnings per share reflect additional shares of common stock that would have been outstanding if dilutive potential shares had been issued. For the three month period ended September 30, 2008 there were 148,241 options that were antidilutive. For the nine month period ended September 30, 2008 there were 148,223 options that were antidilutive. For the three month and nine month periods ended September 30, 2007, there were 10,000 options that were antidilutive.

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MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

NOTE C - PER SHARE DATA (Continued)

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

	Three Months Ended September 30,		Nine Months Ended September 30,
	2008	2007	2008	2007
Weighted average number of shares used in computing basic net income per share	4,919,532	4,547,515	4,911,631	4,532,192
Effect of dilutive stock options	2,770	320,198	18,570	336,038
Weighted average number of common shares and dilutive potential common shares used in computing diluted net income per share	4,922,302	4,867,713	4,930,201	4,868,230

NOTE D - LOANS

Following is a summary of loans at each of the balance sheet dates presented (Dollars in thousands):

	At September 30, 2008					At December 31, 2007
	Amount			Percent of Total		Amount			Percent of Total
	(In thousands)
Real estate loans	$	354,553		84.63	%	$	319,070		85.83	%
Commercial and industrial loans		59,721		14.25	%		46,893		12.61	%
Loans to individuals		4,704		1.12	%		5,796		1.56	%
Subtotal		418,978		100.00	%		371,759		100.00	%
Net deferred loan fees		(50	)				(45	)
Loans	$	418,928				$	371,714

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MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

NOTE D - LOANS (Continued)

An analysis of the allowance for loan losses is as follows:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2008			2007			2008			2007
	(In thousands)
Balance at beginning of period	$	4,824		$	4,226		$	4,462		$	4,222
Provision charged to operations		705			—			1,155			—
Charge-offs		(163	)		(115	)		(277	)		(134	)
Recoveries		6			31			32			54
Net charge-offs		(157	)		(84	)		(245	)		(80	)
Balance at end of period	$	5,372		$	4,142		$	5,372		$	4,142

The following is a summary of nonperforming assets for the periods ended as presented:

	September 30, 2008		December 31, 2007
	(In thousands)
Nonaccrual loans	$	2,586	$	700
Foreclosed assets		1,187		264
Total	$	3,773	$	964

NOTE E - NON-INTEREST INCOME AND NON-INTEREST EXPENSE

The major components of other non-interest income are as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2008		2007		2008		2007
	(In thousands)
Debit card income	$	55	$	45	$	158	$	126
ATM interchange income		2		2		6		7
Safe deposit rent		4		3		10		9
Check upcharge		8		7		17		19
Income from rental property		5		13		26		46
Other		18		19		48		93
Total	$	92	$	89	$	265	$	300

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MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

NOTE E - NON-INTEREST INCOME AND NON-INTEREST EXPENSE (Continued)

The major components of other non-interest expense are as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2008		2007		2008			2007
	(In thousands)
Travel	$	19	$	21	$	57		$	74
Contributions		1		11		20			33
Director fees		37		32		101			92
Dues and memberships		10		17		19			31
Credit reports and filing fees		4		10		12	��		26
Franchise tax		31		—		99			44
Appraisals		3		7		18			19
Deposit charge offs		11		3		29			15
Loan collection expense		1		19		21			52
Oreo – charge off		40		—		40			—
Other		24		14		73			40
Total	$	181	$	134	$	489		$	426

NOTE F - IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS

The Company adopted Statement of Financial Accounting Standards No. 157Fair Value Measurements (“SFAS 157”), effective January 1, 2008.SFAS 157 defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. 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. 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 and other certain assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting write-downs of individual assets.

The following is a description of valuation methodologies used for assets and liabilities recorded at fair value.

Investment Securities Available-for-Sale

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

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MIDCAROLINA FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

NOTE F - IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS (Continued)

Loans Held for Sale

Loans held for sale are carried at the lower of cost or market value. The fair value of loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics. As such, the Company classifies loans subject to nonrecurring fair value adjustments as Level 2.

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 in accordance with SFAS 114, “Accounting by Creditors for Impairment of Loans,” (SFAS 114). The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value 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. As of September 30, 2008, the Bank identified $3.6 million in impaired loans. Of these impaired loans, $3.5 million were identified to have impairment of $541 thousand. The determination of impairment was based on the fair market value of collateral for each loan, which is considered to be a Level 3 input.

The following table summarizes quantitative disclosures about the fair value measurement for each category of assets carried at fair value as of September 30, 2008 (Dollars in thousands):

Description	September 30, 2008		Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
Available for sale securities	$	69,975		69,625	350
Impaired loans		2,983			2,983
Loans held for sale		304			304

In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161,Disclosures about Derivative Instruments and Hedging Activities (“SFAS 161”). SFAS 161 changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under FASB Statement No. 133,Accounting for Derivative Instruments and Hedging Activities, and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS 161 is effective for fiscal years and interim periods beginning after November 15, 2008 and requires comparative disclosures only for periods subsequent to initial adoption. The adoption of the provisions of SFAS 161 is not anticipated to materially impact the Company’s consolidated balance sheets and results of operations.

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

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 as defined in 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, 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 directly through the SEC’s Internet website atwww.sec.gov or through our Internet website atwww.midcarolinabank.com. Forward-looking statements may be identified by terms such as “may,” “will,” “should,” “could,” “expects,” “plans,” “intends,” “anticipates,” “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 forward-looking statements include, but are not limited to, (a)pressures onthe earnings, capital and liquidity offinancial institutions resulting from current and future adverse conditions in the credit and capital markets and the banking industry in general, (b)the financial success or changing strategies of our customers,(c)actions of government regulators, the level of market interest rates, and changes in general economic conditions and real estate values in our banking market (particularly changes that affect our loan portfolio, the abilities of our borrowers to repay their loans, and the values of loan collateral). Although we believe that the expectations reflected in the forward-looking statements are reasonable, they represent our management’s judgments only as of the date they are made, and we cannot guarantee future results, levels of activity, performance or achievements. As a result, readers are cautioned not to place undue reliance on these forward-looking statements. 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 do not intend, to update these forward-looking statements.

In response to the challenges facing the financial services sector, several regulatory and governmental actions have recently been announced, including:

• The Emergency Economic Stabilization Act, approved by Congress and signed by President Bush on October 3, 2008, which, among other provisions, allowed the U.S. Treasury to purchase troubled assets from banks, authorized the Securities and Exchange Commission to suspend the application of mark-to market accounting, and temporarily raised the basic limit of FDIC deposit insurance from $100,000 to $250,000 (with a return to the $100,000 limit on December 31, 2009;

• On October 7, 2008, the FDIC approved a plan to increase the rates banks pay for deposit insurance:

• On October 14, 2008, the U.S. Treasury announced the creation of a new program, the TARP Capital Purchase Program, that encourages and allows financial institutions to build capital through the sale of senior preferred shares to the U.S. Treasury on terms that are non-negotiable;

• On October 14, 2008, the FDIC announced the creation of the Temporary Liquidity Guarantee Program (TLGP), which seeks to strengthen confidence and encourage liquidity in the banking system, and which has two primary components that are available on a voluntary basis to financial institutions, including:

• Guarantee of newly-issued senior unsecured debt issued on or before June 30, 2009 (subject to certain limits) and which would be in effect until June 30, 2012; issuers electing to participate would pay a 75 basis point fee for the guarantee;

• Unlimited deposit insurance for non-interest bearing deposit transaction accounts; financial institutions electing to participate will pay a 10 basis point premium in addition to the insurance premiums paid for standard deposit insurance;

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The Company is currently evaluating the programs outlined above and the impact they may have on the organization. As a result of the enhancements to deposit insurance protection and the expectation that there will be demands on the FDIC’s deposit insurance fund, it is clear that our deposit insurance costs will increase significantly during 2009.

Although it is unknown whether further regulatory actions will arise as the Federal government attempts to address the economic situation, management is not aware of any further recommendations by regulatory authorities that, if implemented, would have or would be reasonably likely to have a material effect on liquidity, capital ratios or results of operations.

Financial Condition at September 30, 2008 and December 31, 2007

During the three-month period ending September 30, 2008, our total assets increased by $54.4 million to $521.6 million from $467.2 million at December 31, 2007. At September 30, 2008, loans totaled $418.9 million, an increase of $47.2 million, or 12.70%, for the nine months, as loan demand continues to be strong in our markets. Our loan portfolio experienced increases in real estate and commercial loans in the amount of $35.5 million and $12.8 million, respectively. Consumer loans decreased by $1.1 million to $4.7 million. Federal funds sold and interest-earning deposits increased by $9.5 million, to $12.5 million.

Our total liquid assets, which include cash and due from banks, federal funds sold and interest-earning deposits at Federal Home Loan Bank (“FHLB”) of Atlanta, investment securities and loans held for sale increased by $7.9 million during the nine months, to $84.2 million or 16.13% of total assets at September 30, 2008 versus $76.2 million, or 16.31% of total assets, at December 31, 2007. At September 30, 2008, investment securities available for sale totaled $70.0 million, a decrease of $826,000, or 1.17% compared to December 31, 2007.

Deposits continue to be our primary funding source. At September 30, 2008, deposits totaled $443.4 million, an increase of $69.5 million, or 18.59%, from year-end 2007. Included in the deposit balances are $123.2 million of brokered certificates of deposit, an increase of $35.5 million, or 40.47%, from year-end. We also utilize borrowings from the FHLB to support balance sheet management and growth. Borrowings from the FHLB decreased by $16.0 million, or 32.65%, to $33.0 million at September 30, 2008.

Our capital position remains strong, with all of our regulatory capital ratios at levels that make us “well capitalized” under federal bank regulatory capital guidelines. At September 30, 2008, our shareholders’ equity totaled $35.4 million, an increase of $2.2 million from the December 31, 2007 balance. This increase resulted from net income available to common shareholders of $2.9 million for the nine month period, proceeds from the exercise of stock options in the amount of $762,000 and a current income tax benefit associated with the exercise of stock options in the amount of $498,000. Accumulated other comprehensive loss increased in the amount of $2.0 million for the nine-month period ended September 30, 2008 resulting from the illiquid securities markets affecting the Company’s unrealized loss on available-for-sale Municipal securities and Mortgage Backed securities portfolios.

Comparison of Results of Operations for the

Three Months Ended September 30, 2008 and 2007

Net Income. Our net income available for common shareholders for the three months ended September 30, 2008 was $1.139 million, an increase of $38,000, or 3.45%, from net income available to common shareholders of $1.101 million for the same three-month period in 2007. Net income per diluted share of

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$0.23 remained unchanged when compared to the prior period. We have experienced strong balance sheet growth, with total assets averaging $515.7 million during the current three-month period compared to $456.0 million in the comparative prior year period, an increase of 13.10%. Our interest rate spread and net yield on average interest-earning assets increased 24 basis points and 7 basis points respectively. Net interest income increased $529,000, non-interest income for the quarter ended September 30, 2008 increased in the amount of $495,000, the provision for loan losses increased $705,000, and non-interest expenses increased $206,000 for the comparative period.

Net Interest Income. Net interest income increased by $529,000, or 15.50%, to $3.9 million for the three months ended September 30, 2008. Our total interest income benefited from growth in the level of average earning assets offset by a decrease in asset yields caused by decreases in interest rates charged on loans. The rates earned on a significant portion of our loans adjust immediately when index rates such as prime rate change. Conversely, most of our interest-bearing liabilities, including certificates of deposit and borrowings, have rates fixed until maturity. As a result, interest rate reductions will generally result in an immediate drop in our interest income on loans, with a more delayed impact on interest expense because reductions in interest costs will only occur upon renewals of certificates of deposit or fixed rate FHLB advances. Conversely, interest rate increases should result in an immediate increase in our interest income on loans, with a more delayed impact on interest expense because increases in interest costs will occur upon renewals of certificates of deposits or borrowings. Average interest-earning assets during the third quarter of 2008 increased $59.4 million, or 13.37%, as compared with the same period in 2007. Our average yield on total interest-earning assets decreased by 127 basis points from 7.20% to 5.93%. Our average total interest-bearing liabilities increased by $49.4 million, or 12.75%. Our average cost of total interest-bearing liabilities decreased 151 basis points from 4.75% to 3.24%. Our markets are extremely competitive for deposits. For the three months ended September 30, 2008, our net interest spread was 2.69% and our net interest margin was 3.12%. For the three months ended September 30, 2007, our net interest rate spread was 2.45% and our net interest margin was 3.05%.

Provision for Loan Losses. Based on the uncertainty of the local and national economy, trends in the level of delinquent and classified loans as well as the over all growth of the loan portfolio, the Bank made a $705,000 provision for loan losses during the three months ended September 30, 2008. No provision was made for loan losses during the three months ended September 30, 2007. Provisions for loan losses are charged to income to maintain the allowance for loan losses at a level deemed appropriate by management. Loan recoveries of previously charged-off loans were $6,000 during the three months ended September 30, 2008, offset by $163,000 of loan charge-offs. At September 30, 2008, we had non-accrual loans in the amount of $2.6 million of which $2.2 million is related to an independent retail grocer and meat market, while the allowance for loan losses increased $548,000 to $5.4 million, or 1.28% of total loans. At September 30, 2007, we had non-accrual loans in the amount of $266,000, while the allowance for loan losses decreased $80,000 to $4.1 million, or 1.14% of total loans. The Bank holds secured positions in these non-accrual loans. At December 31, 2007, the Bank had non-accrual loans in the amount of $700,000, while the allowance for loan losses stood at $4.5 million, or 1.20% of total loans.

Non-Interest Income. For the third quarter of 2008, non-interest income increased $495,000, or 75.34%, to $1,152,000 from $657,000 for the same period the prior year. Changes for the three months ended September 30, 2008 include an increase of $36,000 in service charges and fees on deposits, an increase of $536,000 in gain on sale of other real estate realized substantially from the re-sale of property originally foreclosed during 2004 from a single borrower, an increase in cash value of life insurance of $3,000, a decrease in gain on sale of investments of $1,000, a decrease in mortgage brokerage activities of $29,000, a decrease in income from brokerage services of $13,000 and an increase in all other non-interest income of $3,000.

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Non-Interest Expense. We strive to maintain levels of non-interest expense that we believe are appropriate given the nature of our operations and the investments in personnel and facilities that have been necessary to generate growth. For the three-months ended September 30, 2008, total non-interest expense increased $246,000 from the prior year period. Salary and employee benefit expenses increased $50,000, reflecting staffing changes undertaken during the period. Deposit and other insurance expense decreased $2,000. Occupancy and equipment costs decreased $8,000 reflecting decreased depreciation expenses and the termination of an automobile lease, advertising expense increased $7,000 due to an increase in our advertising and marketing budget. Professional and other services and data processing and other outside services increased a combined $116,000 primarily due to increases in legal services.

Provision for Income Taxes.Our provision for income taxes, as a percentage of income before income taxes, was 33.10% and 30.94%, respectively, for the three months ended September 30, 2008 and 2007. The increase in the tax rate accrual is due to a decrease in tax-free federal and state income.

Comparison of Results of Operations for the

Nine Months Ended September 30, 2008 and 2007

Net Income. Our net income available for common shareholders for the nine months ended September 30, 2008 was $2.912 million, a decrease of $64,000, or 2.15%, from net income available to common shareholders of $2.976 million for the same nine-month period in 2007. Net income per diluted share of $0.59 decreased $0.02 per diluted share compared to the prior period. We have experienced strong balance sheet growth, with total assets averaging $498.3 million during the current nine-month period compared to $441.3 million in the comparative prior year period, an increase of 12.91%. Our interest rate spread and net yield on average interest-earning assets decreased 6 basis points and 17 basis points respectively. Net interest income increased $774,000, non-interest income for the nine months ended September 30, 2008 increased in the amount of $691,000, the provision for loan losses increased $1,155,000, and non-interest expenses increased by $231,000 for the comparative period.

Net Interest Income. Net interest income increased by $774,000, or 7.81%, to $10.7 million for the nine months ended September 30, 2008. Our total interest income benefited from growth in the level of average earning assets which was offset by a decrease in asset yields caused by decreases in interest rates charged on loans. The rates earned on a significant portion of our loans adjust immediately when index rates such as our prime rate change. Conversely, most of our interest-bearing liabilities, including certificates of deposit and borrowings, have rates fixed until maturity. As a result, interest rate reductions will generally result in an immediate drop in our interest income on loans, with a more delayed impact on interest expense because reductions in interest costs will only occur upon renewals of certificates of deposit or fixed rate FHLB advances. Conversely, interest rate increases should result in an immediate increase in our interest income on loans, with a more delayed impact on interest expense because increases in interest costs will occur upon renewals of certificates of deposits or borrowings. Average interest-earning assets during the first nine months of 2008 increased $59.0 million, or 13.93%, as compared with the same period in 2007. Our average yield on total interest-earning assets decreased by 107 basis points from 7.27% to 6.20%. Our average total interest-bearing liabilities increased by $50.9 million, or 13.59%. Our average cost of total interest-bearing liabilities decreased 101 basis points from 4.68% to 3.67%. Our markets are extremely competitive for deposits. For the nine months ended September 30, 2008, our net interest spread was 2.53% and our net interest margin was 2.96%. For the nine months ended September 30, 2007, our net interest rate spread was 2.59% and our net interest margin was 3.13%.

Provision for Loan Losses. Based on the uncertainty of the local and national economy, trends in the level of delinquent and classified loans as well as the over all growth of the loan portfolio, the Bank made a $1,155,000 provision for loan losses during the nine months ended September 30, 2008. No

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provision was made for loan losses during the nine months ended September 30, 2007. Provisions for loan losses are charged to income to maintain the allowance for loan losses at a level deemed appropriate by management. Loan recoveries of previously charged-off loans were $32,000 during the nine months ended September 30, 2008, offset by $277,000 of loan charge-offs. At September 30, 2008, we had non-accrual loans in the amount of $2.6 million of which $2.2 million is related to an independent retail grocer and meat market, while the allowance for loan losses increased $910,000 to $5.4 million, or 1.28% of total loans. At September 30, 2007, we had non-accrual loans in the amount of $266,000, while the allowance for loan losses decreased $80,000 to $4.1 million, or 1.14% of total loans. The Bank holds secured positions in these non-accrual loans. At December 31, 2007, the Bank had non-accrual loans in the amount of $700,000, while the allowance for loan losses stood at $4.5 million, or 1.20% of total loans.

Non-Interest Income. For the third quarter of 2008, non-interest income increased $731,000, or 37.53%, to $2.7 million from $1.9 million for the same period the prior year. Changes for the nine months ended September 30, 2008 include an increase of $118,000 in service charges and fees on deposits, an increase of $2,000 in brokerage related income, an increase in gain on sale of other real estate of $581,000 realized substantially from the re-sale of property originally foreclosed during 2004 from a single borrower, an increase in cash value of life insurance of $12,000, an increase in gain on sale of investments of $26,000, an increase in mortgage brokerage activities of $27,000 and a decrease in all other non-interest income of $35,000.

Non-Interest Expense. We strive to maintain levels of non-interest expense that we believe are appropriate given the nature of our operations and the investments in personnel and facilities that have been necessary to generate growth. For the nine-months ended September 30, 2008, total non-interest expense increased $271,000 from the prior period. Salary and employee benefit expenses increased $38,000. Deposit and other insurance expense increased $60,000 as a result in increases charged by the FDIC for deposit insurance. Occupancy and equipment costs decreased $69,000 reflecting decreased depreciation expenses and the termination of an automobile lease, advertising expense increased $85,000. Office supplies and postage increased $15,000. Professional and other services increased $148,000 primarily due to increases in legal services and data processing and other outside services decreased $69,000 reflecting cost reductions gained in contract renegotiations and less reliance on outside information technology technicians.

Provision for Income Taxes.Our provision for income taxes, as a percentage of income before income taxes, was 32.98% and 30.50%, respectively, for the nine months ended September 30, 2008 and 2007. The increase in the tax rate accrual is due to a decrease in tax-free federal and state income.

Liquidity and Capital Resources

Market and public confidence in our financial strength and in the strength of financial institutions in general will largely determine our access to appropriate levels of liquidity. This confidence is significantly dependent on our ability to maintain sound asset quality and appropriate levels of capital resources.

Liquidity is defined as our ability to meet anticipated customer demands for funds under credit commitments and deposit withdrawals at a reasonable cost and on a timely basis. Management measures our liquidity position by giving consideration to both on-and off-balance sheet sources of, and demands for, funds on a daily and weekly basis.

Sources of liquidity include cash and cash equivalents, net of federal requirements to maintain reserves against deposit liabilities; investment securities eligible for pledging to secure borrowings from dealers and customers pursuant to securities sold under repurchase agreements; investments available for sale;

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loan repayments; loan sales; deposits; and borrowings from the FHLB and from correspondent banks under overnight federal funds credit lines. In addition to interest rate-sensitive deposits, the Bank’s primary demand for liquidity is anticipated fundings under credit commitments to customers.

We have maintained an adequate position of liquidity in the form of cash, interest-bearing bank deposits, federal funds sold, investment securities and loans held for sale. These aggregated $84.2 million at September 30, 2008 compared to $76.2 million at December 31, 2007. Supplementing customer deposits as a source of funding, we have the ability to borrow up to $92.0 million from the FHLB, subject to collateral constraints, with $33.0 million outstanding at September 30, 2008 and $49.0 million at December 31, 2007. All borrowings with FHLB must be adequately collateralized. We believe that our combined aggregate liquidity position is sufficient to meet the funding requirements of loan demand and deposit maturities and withdrawals in the near term.

At September 30, 2008, the Company’s average equity to average asset ratio was 7.13%, and all of the Bank’s capital ratios exceeded the minimums established for a well-capitalized bank by regulatory measures. The Bank’s tier I risk-based capital ratio at September 30, 2008 was 10.20%.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We believe there has not 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 the difference between estimated fair values and book values, since the analysis prepared and presented in conjunction with our Annual Report on Form 10-K for the fiscal year ended December 31, 2007.

Item 4. Controls and Procedures

MidCarolina Financial Corporation’s management, with the participation of the Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures as of September 30, 2008. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures where effective, as of September 30, 2008, to provide reasonable assurance that information required to be disclosed by the Company in the reports filed or submitted by it under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

In conjunction 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, 2008, and that has materially affected, or that is reasonably likely to materially affect, our internal control over financial reporting.

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Part II. OTHER INFORMATION

Item 1. Legal Proceedings

As previously disclosed in the Company’s Report on Form 10-Q for the quarterly period ended June 30, 2008, on July 22, 2008, the Company and the Bank filed a civil action in the Superior Court of Alamance County, North Carolina, against their former President and Chief Executive Officer whose employment terminated during August 2007. The lawsuit alleges claims (which involve amounts that are not material to the Company’s financial condition or results of operations) for fraud and misrepresentation, conversion of funds and breach of fiduciary duty as a director and officer. On July 24, 2008, the former officer filed a claim for arbitration pursuant to his employment agreement with the Bank, disputing that there was cause for the termination of his employment and seeking to be paid additional salary and benefits under the agreement and other compensatory agreements between him and the Bank. The Bank will vigorously defend its position that the former officer was discharged for cause and is not entitled to any additional compensation or benefits, and that he is obligated to repay the Bank for certain personal expenses and excesses incurred while he served as an officer.

Item 6. Exhibits

Exhibit 31.1	Rule 13a-14(a)/15d-14(a) Certification by Chief Executive Officer (filed herewith)
Exhibit 31.2	Rule 13a-14(a)/15d-14(a) Certification by Chief Financial Officer (filed herewith)
Exhibit 32	Section 1350 Certifications (filed herewith)

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SIGNATURES

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

	MIDCAROLINA FINANCIAL CORPORATION
Date: November 12, 2008	By:	/s/ Charles T. Canaday, Jr.
		Charles T. Canaday, Jr.
		President and Chief Executive Officer
Date: November 12, 2008	By:	/s/ Christopher B. Redcay
		Christopher B. Redcay
		Chief Financial Officer

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Exhibit Index

Exhibit 31.1	Rule 13a-14(a)/15d-14(a) Certification by Chief Executive Officer (filed herewith)
Exhibit 31.2	Rule 13a-14(a)/15d-14(a) Certification by Chief Financial Officer (filed herewith)
Exhibit 32	Section 1350 Certifications (filed herewith)