North State Bancorp (NSBC) 10-Q 2007 Q2 Quarterly report

U. S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2007

or

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

For the transition period ended            

Commission File Number - 000-49898

NORTH STATE BANCORP

(Exact name of small business issuer as specified in its charter)

NORTH CAROLINA	65-1177289
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification Number)

4270 THE CIRCLE AT NORTH HILLS, RALEIGH, NORTH CAROLINA 27609

(Address of principal executive office)

(919) 787-9696

(Issuer’s telephone number)

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act):

Large accelerated filer  ¨    Accelerated filer  ¨    Non-accelerated filer  x

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

As of August 10, 2007, 6,971,326 shares of the registrant’s common stock, no par value per share, were outstanding. The registrant has no other classes of securities outstanding.

		Page No.
Part I.	FINANCIAL INFORMATION
Item 1 -	Financial Statements (Unaudited)
	Consolidated Balance Sheets June 30, 2007 and December 31, 2006	3
	Consolidated Statements of Operations Three Months and Six Months Ended June 30, 2007 and 2006	4
	Consolidated Statements of Comprehensive Income Three Months and Six Months Ended June 30, 2007 and 2006	5
	Consolidated Statement of Shareholders’ Equity Six Months Ended June 30, 2007	6
	Consolidated Statements of Cash Flows Six Months Ended June 30, 2007 and 2006	7
	Notes to Consolidated Financial Statements	8
Item 2 -	Management’s Discussion and Analysis of Financial Condition and Results of Operations	11
Item 3 -	Quantitative and Qualitative Disclosures About Market Risk	18
Item 4T -	Controls and Procedures	19
Part II.	OTHER INFORMATION
Item 4 -	Submission of Matters to a Vote of Security Holders	20
Item 6 -	Exhibits	21

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Part I. FINANCIAL INFORMATION

Item 1—Financial Statements

NORTH STATE BANCORP

CONSOLIDATED BALANCE SHEETS

	June 30, 2007 (Unaudited)			December 31, 2006*
	(Amounts in thousands)
ASSETS
Cash and due from banks	$	19,336		$	12,189
Interest-earning deposits with banks		1,209			1,249
Federal funds sold		44,480			44,059
Investment securities available for sale, at fair value		40,341			41,932
Loans		387,153			345,943
Less allowance for loan losses		(4,103	)		(3,983	)
NET LOANS		383,050			341,960
Accrued interest receivable		1,827			1,754
Stock in the Federal Home Loan Bank of Atlanta, at cost		993			939
Premises and equipment, net		9,884			7,810
Other assets		3,591			3,585
TOTAL ASSETS	$	504,711		$	455,477
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits:
Demand	$	127,529		$	105,228
Savings, money market and NOW		188,467			154,400
Time deposits		136,447			142,450
TOTAL DEPOSITS		452,443			402,078
Accrued interest payable		2,583			2,297
Short-term borrowings		7,514			10,670
Long-term debt		11,187			11,196
Accrued expenses and other liabilities		2,723			2,639
TOTAL LIABILITIES		476,450			428,880
Commitments (Note C)
Shareholders’ equity:
Preferred stock, no par value, 1,000,000 shares authorized, none issued		—			—
Common stock, no par value as of May 3, 2007; prior to May 3, 2007 $1 par value; 10,000,000 shares authorized 4,599,810 and 4,542,061 shares issued and outstanding at June 30, 2007 and December 31, 2006, respectively		18,890			4,542
Additional paid-in capital		—			14,002
Retained earnings		9,898			8,344
Accumulated other comprehensive loss		(527	)		(291	)
TOTAL SHAREHOLDERS’ EQUITY		28,261			26,597
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	504,711		$	455,477

* Derived from audited consolidated financial statements.

See accompanying notes.

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NORTH STATE BANCORP

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

	Three Months Ended June 30,				Six Months Ended June 30,
	2007		2006		2007		2006
	(Amounts in thousands, except share and per share data)
INTEREST INCOME
Loans	$	7,055	$	5,701	$	13,817	$	10,907
Investments		423		447		869		851
Federal funds sold and interest-earning deposits		439		205		779		460
TOTAL INTEREST INCOME		7,917		6,353		15,465		12,218
INTEREST EXPENSE
Money market, NOW and savings deposits		1,670		1,221		3,197		2,256
Time deposits		1,744		1,173		3,506		2,285
Short-term borrowings		46		110		98		162
Long-term debt		203		197		405		375
TOTAL INTEREST EXPENSE		3,663		2,701		7,206		5,078
NET INTEREST INCOME		4,254		3,652		8,259		7,140
PROVISION FOR LOAN LOSSES		211		223		422		376
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		4,043		3,429		7,837		6,764
NON-INTEREST INCOME
Fees from mortgage operations		67		91		109		176
Service charges and fees on deposit accounts		183		186		354		374
Other		53		18		90		30
TOTAL NON-INTEREST INCOME		303		295		553		580
NON-INTEREST EXPENSE
Salaries and employee benefits		1,582		1,341		3,094		2,716
Occupancy and equipment		475		375		936		752
Professional fees		65		70		120		95
Postage, printing and office supplies		36		31		87		64
Data processing and other outsourced services		149		125		307		252
Advertising		52		50		103		97
Other		578		535		1,194		1,073
TOTAL NON-INTEREST EXPENSE		2,937		2,527		5,841		5,049
INCOME BEFORE INCOME TAXES		1,409		1,197		2,549		2,295
INCOME TAXES		563		446		995		853
NET INCOME	$	846	$	751	$	1,554	$	1,442
NET INCOME PER COMMON SHARE
Basic	$	.12	$	.12	$	.23	$	.22
Diluted	$	.12	$	.11	$	.21	$	.20
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
Basic		6,889,775		6,512,074		6,867,118		6,500,243
Diluted		7,338,636		7,090,729		7,335,313		7,087,489

See accompanying notes.

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NORTH STATE BANCORP

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
	2007			2006			2007			2006
	(In thousands)						(In thousands)
Net income	$	846		$	751		$	1,554		$	1,442
Other comprehensive loss:
Securities available for sale:
Unrealized holding losses on available for sale securities		(378	)		(182	)		(218	)		(213	)
Tax effect		146			69			84			81
Net of tax amount		(232	)		(113	)		(134	)		(132	)
Cash flow hedging activities:
Unrealized holding losses on hedging activities		(228	)		—			(178	)		—
Tax effect		88			—			76			—
Net of tax amount		(140	)		—			(102	)		—
Total other comprehensive loss		(372	)		(113	)		(236	)		(132	)
Comprehensive income	$	474		$	638		$	1,318		$	1,310

See accompanying notes.

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NORTH STATE BANCORP

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (Unaudited)

	Common stock			Additional paid-in capital			Retained earnings		Accumulated other comprehensive loss			Total shareholders’ equity
	Shares	Amount
	(Amounts in thousands, except share data)
Balance at December 31, 2006	4,542,061	$	4,542	$	14,002		$	8,344	$	(291	)	$	26,597
Comprehensive income	—		—		—			1,554		(236	)		1,318
Stock based compensation	—		43		—			—		—			43
Stock options exercised for $1 par value common stock including tax benefit of $67	56,749		124		175			—		—			299
Change in par value of common stock	—		14,177		(14,177	)		—		—			—
Stock options exercised for no par value common stock	1,000		4		—			—		—			4
Balance at June 30, 2007	4,599,810	$	18,890	$	—		$	9,898	$	(527	)	$	28,261

See accompanying notes.

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NORTH STATE BANCORP

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

	Six Months Ended June 30,
	2007			2006
	(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	1,554		$	1,442
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		336			244
Net amortization of discounts on investment securities		(10	)		19
Provision for loan losses		422			376
Stock based compensation		43			25
Change in assets and liabilities:
Increase in accrued interest receivable		(73	)		(90	)
Increase in other assets		(22	)		(414	)
Increase in accrued interest payable		286			231
Increase in accrued expenses and other liabilities		84			67
NET CASH PROVIDED BY OPERATING ACTIVITIES		2,620			1,900
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of investment securities available for sale		(5,192	)		(6,873	)
Proceeds from maturities and repayments of investment securities available for sale		6,573			6,283
Purchases of premises and equipment		(2,410	)		(1,223	)
Net increase in loans		(41,512	)		(26,713	)
Purchase of Federal Home Loan Bank Stock		(54	)		(161	)
NET CASH USED BY INVESTING ACTIVITIES		(42,595	)		(28,687	)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits		50,365			37,437
Net increase (decrease) in short-term borrowings		(3,156	)		1,025
Exercise of stock options		236			322
Excess tax benefits from exercise of stock options		67			319
Net decrease in long-term debt		(9	)		(9	)
NET CASH PROVIDED BY FINANCING ACTIVITIES		47,503			39,094
NET INCREASE IN CASH AND CASH EQUIVALENTS		7,528			12,307
CASH AND CASH EQUIVALENTS, BEGINNING		57,497			40,720
CASH AND CASH EQUIVALENTS, ENDING	$	65,025		$	53,027

See accompanying notes.

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NORTH STATE BANCORP

Notes to Consolidated Financial Statements

NOTE A—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 June 30, 2007 and for the three and six-month periods ended June 30, 2007 and 2006, in conformity with accounting principles generally accepted in the United States of America. The consolidated financial statements include the accounts of North State Bancorp (the “Company”) and its wholly-owned subsidiary, North State Bank (the “Bank”). All significant intercompany transactions and balances have been eliminated in consolidation.

The preparation of 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 and six-month periods ended June 30, 2007 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2007.

The organization and business of the Company, accounting policies followed by the Company and other relevant information are contained in the notes to the consolidated financial statements filed as part of the Company’s 2006 Annual Report on Form 10-KSB for the year ended December 31, 2006. This quarterly report should be read in conjunction with the Annual Report.

During the quarter, shareholders approved the amendment of our Articles of Incorporation to decrease the par value of our common stock from $1.00 per share to no par value per share.

NOTE B—RECENT ACCOUNTING PRONOUCEMENTS

The Company and its wholly-owned subsidiary the Bank are subject to U.S. federal income tax and North Carolina income tax. The Company’s primary business is the ownership and operation of the Bank. The Company’s 2003 through 2006 U.S. federal income tax returns remain open for examination by the Internal Revenue Service. The Company’s North Carolina state income tax returns remain open for the tax years 2003 through 2006 for examination by the North Carolina Department of Revenue. As of June 30, 2007, no authorities had commenced income tax examinations.

In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes” (“SFAS 109”). This Interpretation prescribes a recognition threshold of more-likely-than-not, and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company adopted the provisions of FIN 48 on January 1, 2007. Management has evaluated the Company’s tax positions and has concluded that the Company has no uncertain tax positions for which the Company should not recognize a tax benefit. The adoption of this statement had no material effect on the Company’s financial position or results of operations.

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NOTE B—RECENT ACCOUNTING PRONOUCEMENTS (Continued)

The Company adopted the provisions of FASB Statement No. 155, “Accounting for Certain Hybrid Financial Instruments” (“SFAS 155”), effective January 1, 2007. The adoption of the provisions of SFAS 155 had no material effect on the Company’s consolidated financial position or results of operations.

The provisions of FASB Statement No. 156, “Accounting for Servicing of Financial Assets—an amendment of FASB Statement No. 140” (“SFAS 156”), were effective beginning January 1, 2007. The adoption of the provisions of SFAS 156 had no effect on the Company’s consolidated financial position or results of operations.

FASB Statement 157, “Fair Value Measurements” (“SFAS 157”), defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. The Company is in the process of evaluating the impact of the adoption of SFAS 157 on its consolidated financial position and results of operations.

FASB Statement 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”), permits an entity to choose to measure many financial instruments and certain other items at fair value. The fair value option permits companies to choose to measure eligible items at fair value at specified election dates. Companies will report unrealized gains and losses on items for which the fair value option has been elected in earnings after adoption. SFAS 159 requires additional disclosures related to the fair value measurements included in the companies financial statements. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007. Early adoption is permitted; however, the Company will adopt SFAS 159 effective January 1, 2008. The Company is evaluating the impact of SFAS 159 on its consolidated financial position and results of operations.

NOTE C—COMMITMENTS

At June 30, 2007, loan commitments were as follows (in thousands):

Commitments to extend credit	$	61,668
Undisbursed lines of credit		23,906
Letters of credit		2,057

NOTE D—NET INCOME PER SHARE

Basic earnings per share represents income available to common shareholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate to outstanding stock options. Basic and diluted net income per common share have been computed based upon net income as presented in the accompanying consolidated statements of operations divided by the weighted average number of common shares outstanding or assumed to be outstanding as summarized below.

The Company effected a 3-for-2 stock split in 2006 and announced a 3-for-2 stock split on June 19, 2007 to be distributed on July 12, 2007 to shareholders of record as of June 28, 2007. All references in these financial statements to per share results and weighted average common and potential common shares outstanding have been adjusted for the effects of these stock splits.

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NOTE D—NET INCOME PER SHARE (Continued)

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

	Three Months Ended June 30,		Six Months Ended June 30,
	2007	2006	2007	2006
Weighted average number of common shares used in computing basic net income per share	6,889,775	6,512,074	6,867,118	6,500,243
Effect of dilutive stock options	448,861	578,655	468,195	587,246
Weighted average number of common shares and dilutive potential common shares used in computing diluted net income per share	7,338,636	7,090,729	7,335,313	7,087,489

For the three and six-month periods ended June 30, 2007 and 2006, there were no anti-dilutive stock options.

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

This report contains forward-looking statements intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. These forward-looking statements can generally be identified as such because the context of the statement will include words such as we “believe,” “anticipate,” “expect” or words of similar meaning. Similarly, statements that describe our future plans, objectives or goals are also forward-looking statements. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those currently anticipated, including: changes in interest rates, deposit flows, loan demand, real estate values and competition; our ability to manage growth; general and local economic conditions; changes in accounting principles, policies or guidelines; changes in legislation or regulation; and other competitive, technological, governmental and regulatory factors affecting our operations, pricing, products, and services.

Management’s discussion and analysis is intended to assist readers in the understanding and evaluation of our financial condition and results of operations. You should read this discussion in conjunction with our consolidated financial statements and notes thereto included in our Annual Report on Form 10-KSB for the year ended December 31, 2006.

Overview

We are a commercial bank holding company that was incorporated on June 5, 2002. Effective June 28, 2002, North State Bank became our wholly owned subsidiary. In March 2004, we formed North State Statutory Trust I, and in December 2005 we formed North State Statutory Trust II, both of which issued trust preferred securities to provide additional capital for general corporate purposes, including current and future expansion of North State Bank. Our primary business is the ownership and operation of North State Bank.

North State Bank is a commercial bank that was incorporated under the laws of the State of North Carolina on May 25, 2000 and began operations on June 1, 2000. The Bank is a full service community bank providing banking services through six locations: its main office in the North Hills section of Raleigh, North Carolina; one office in North Raleigh; one office in West Raleigh; one office in Garner, North Carolina; one office serving the Wake Forest area of North Carolina; and one loan production office in Wilmington, North Carolina. Construction is currently underway to open a full service office in Wilmington, North Carolina and an office in downtown Raleigh.

Comparison of Financial Condition at June 30, 2007 and December 31, 2006

Total assets at June 30, 2007 were $504.7 million compared to $455.5 million at December 31, 2006, an increase of $49.2 million or 10.8%.

Loan production was up a total of $41.2 million or 11.9% for the first six-month period of 2007, increasing $21.6 million in the second quarter of 2007. The growth was primarily in commercial real estate and construction loans, reflecting favorable market conditions particularly in our markets of Wilmington and the Wake Forest area. Investments decreased $1.6 million or 3.8% from $41.9 million at December 31, 2006 as maturing investments were redeployed into the loan portfolio. Federal funds sold were substantially unchanged from December 31, 2006 while cash and due from banks grew $7.1 million or 58.6% from December 31, 2006 due to increased real estate closings through our attorney trust accounts.

The growth in loans was funded by a $50.4 million or 12.5% increase in total deposits from December 31, 2006. A substantial portion of this deposit growth was in noninterest-bearing deposits, which accounted for $22.3 million of the overall increase in total deposits. Interest-bearing savings, money market and interest checking deposits grew $34.1 million or 22.1%, primarily in money market deposits,

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while higher costing time deposits declined $6.0 million or 4.2% to $136.4 million at June 30, 2007 from $142.5 million at December 31, 2006. The growth in non-interest bearing and money market deposits was the result of continuous efforts to emphasize relationship banking including relationships with attorneys and property management companies. Time deposit growth decreased as we concentrated on building deposit relationships rather than focus only on rate driven deposit products.

We also use borrowings to support balance sheet management and growth. Total borrowings were down $3.2 million or 29.6% to $18.7 million at June 30, 2007 from $21.9 million at December 31, 2006. This decrease was almost entirely in short-term customer repurchase agreements.

Effective May 1, 2007, we extended the lease term on our operations center from September 2007 to April 2017 and also added square footage to expand the operations center. Beginning May 1, 2007, the space was increased by 1,421 square feet and beginning May 1, 2008 we will add another 1,765 square feet. The effect of the revised lease term and additional rental space increased our operating lease obligation to approximately $6.4 million from $3.7 million at December 31, 2006. Also, in May 2007 we purchased 1.73 acres of land for $2.2 million to build a new banking office at our 6200 Falls of Neuse Road location. Construction for the proposed multi-story full-service banking office is expected to begin in late 2008.

Total shareholders’ equity increased $1.7 million or 6.3% from $26.6 million at December 31, 2006 to $28.3 million at June 30, 2007. The increase was provided by net income of $1.6 million and the conversion of 57,749 stock options held by directors and employees into common stock. The exercise of these options contributed $303,000 to our total shareholders’ equity while stock based compensation added $43,000. Other comprehensive loss components decreased shareholders’ equity at June 30, 2007 by $236,000.

Comparison of Results of Operations for the Three-Month Periods Ended June 30, 2007 and 2006

Net Income. For the three-month period ended June 30, 2007, net income was $846,000 compared to $751,000 for the corresponding three-month period of 2006, representing a 12.6% increase. On a diluted share basis, earnings were $.12 and $.11 per share, respectively, for the three-month period ended June 30, 2007 and 2006.

The increase in earnings was provided by net interest income, which grew $602,000 in the three-month period ended June 30, 2007 compared to the prior year period, driven primarily by higher average loan volumes. This increase in net interest income as well as the $8,000 increase in noninterest income and the $12,000 decrease in loan loss provision partially offset increases of $410,000 and $117,000 in noninterest expense and tax expense, respectively.

Net Interest Income. Interest income for the three-month period ended June 30, 2007 increased $1.6 million or 24.6% over the prior year period. A significant portion (approximately 37%) of the Bank’s earning assets is based on short term rates. The average prime lending rate for the three-month period ended June 30, 2007 was 8.25% compared to an average of 7.90% for the prior year period. The increase in interest rates produced higher loan and other earning asset yields that provided an increase in interest income of approximately $350,000 over the prior year three-month period. Most of the increase in interest income, however, was provided by a higher average of earning assets. Average earning asset volumes increased $67.6 million providing additional interest income of approximately $1.2 million. Of this, $58.6 million and $1.1 million of average volume and interest income, respectively, was attributable to loans.

The increase in interest rates also increased our cost of funds. Repricing of our interest-bearing deposits to reflect market conditions and provide competitive rates increased our interest expense by approximately $343,000 while our increased volume of average interest-bearing deposits contributed

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additional interest expense of approximately $619,000. Our noninterest-bearing demand deposits grew an average of $5.7 million or 6.6% for the three-month period ended June 30, 2007 compared to the prior year period. Overall, net interest income for the first three-month period of 2007 increased $602,000 or 16.5%, with a net interest margin of 3.88% compared to a net interest margin of 3.94% for the prior year period.

The following table contains information relating to our average balance sheet and reflects the average yield on assets and cost of liabilities for the periods indicated. Such annualized yields and costs are derived by dividing annualized income or expense by the average balances of assets or liabilities, respectively, for the periods presented.

	Three Months Ended June 30, 2007						Three Months Ended June 30, 2006
	Average Balance		Interest		Average Rate		Average Balance		Interest		Average Rate
	(Amounts in thousands)						(Amounts in thousands)
Interest-earning assets:
Loans	$	371,078	$	7,055	7.63	%	$	312,492	$	5,701	7.32	%
Investments available for sale		38,162		423	4.45	%		44,434		447	4.04	%
Fed funds sold		28,322		383	5.42	%		11,753		146	4.98	%
Other interest-earning assets		2,291		56	9.80	%		3,560		59	6.65	%
Total interest-earning assets		439,853		7,917	7.22	%		372,239		6,353	6.85	%
Other assets		17,581						14,900
Total assets	$	457,434					$	387,139
Interest-bearing liabilities:
Deposits:
NOW & money market	$	173,736		1,668	3.85	%	$	135,356		1,219	3.61	%
Savings		1,165		2	0.69	%		1,052		2	0.76	%
Time deposits over $100		74,555		975	5.25	%		52,198		579	4.45	%
Other time deposits		62,657		769	4.92	%		59,757		594	3.99	%
Short-term borrowings		8,332		46	2.21	%		14,416		110	3.06	%
Long-term debt		11,189		203	7.28	%		11,207		197	7.05	%
Total interest-bearing liabilities		331,634		3,663	4.43	%		273,986		2,701	3.95	%
Demand deposits		93,082						87,362
Other liabilities		4,244						2,853
Shareholders’ equity		28,474						22,938
Total liabilities and shareholders’ equity	$	457,434					$	387,139
Net interest income and interest rate spread			$	4,254	2.79	%			$	3,652	2.90	%
Net yield on average interest-earning assets					3.88	%					3.94	%
Ratio of average interest-earning assets to average interest-bearing liabilities					132.63	%					135.86	%

Provision for Loan Losses. The provision for loan losses was $211,000 during the three-month period ended June 30, 2007 as compared with $223,000 for the same period in 2006. Provisions for loan losses are charged to income to bring the allowance for loan losses to a level considered appropriate by our management. One $3,000 loan was charged-off during the three-month period ended June 30, 2007, compared to recoveries of $50,000 and charge-offs of $5,000 recorded during the three-month period ended June 30, 2006. Nonaccrual loans were $98,000 and $14,000, representing ..03% and 0.0% of period end loans, respectively, as of June 30, 2007 and June 30, 2006. We had no restructured loans or other real estate owned at June 30, 2007 or June 30, 2006. The allowance for loan losses was $4.1 million at

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June 30, 2007, $4.0 million at December 31, 2006, and $4.2 million at June 30, 2006 representing 1.06%, 1.15% and 1.30%, respectively, of loans outstanding at each date. The allowance for loan losses was decreased to 1.06% at June 30, 2007 due to the elimination of the associated specific Statement of Financial Accounting Standards No. 114 allowance for impaired loans related to the 2007 charged off loans. The allowance for loan losses is maintained at a level management considers adequate to provide for probable loan losses based on our assessment of our loan portfolio at June 30, 2007.

Management determines the adequacy of our allowance for loan losses based on a number of factors including reviewing and evaluating our loan portfolio in order to identify potential problem loans, credit concentrations and other risk factors connected to the loan portfolio as well as current and projected economic conditions locally and nationally. As discussed in our Annual Report on Form 10-KSB for the year ended December 31, 2006, during the second half of 2006, management re-evaluated and implemented improvements to its methodology used to estimate the allowance for loan losses. In evaluating the allowance for loan losses, we prepare a statistically-based analysis of our current loan portfolio through the use of peer statistics utililizing key loan portfolio quality measures such as net losses to average loans, allowance for loan losses to nonaccrual loans and the percentage of loans over 30 days past due. Homogeneous loan groups are assigned risk factors based on estimated risk of inherent loss and on their respective risk ratings. We utilize a system of nine possible risk ratings. All loans risk rated “doubtful” and “loss” are removed from their homogeneous group and individually analyzed for impairment as detailed in Statement of Financial Accounting Standards No. 114. Other groups of loans based on loan size may be selected for impairment review. We have identified seven qualitative factors that are considered indicators of changes in the level of risk of loss inherent in our loan portfolio. These factors include and consider the risk of payment performance, overall portfolio quality (utilizing weighted average risk rating), general economic factors such as unemployment, inflation, delinquency and charge-off rates, regulatory examination results, interest rate environment, levels of highly leveraged transactions (as defined in Section 365.2 of the FDIC regulations) and levels of construction, development and non-owner occupied commercial real estate lending.

The following is a summary of nonperforming assets at the dates presented:

	June 30, 2007			December 31, 2006			June 30, 2006
	(Dollars in thousands)
Nonaccrual loans	$	98		$	397		$	14
Restructured loans		—			—			—
Total nonperforming loans		98			397			14
Other real estate owned		—			—			—
Total nonperforming assets	$	98		$	397		$	14
Total impaired loans	$	667		$	397		$	14
Accruing loans past due 90 days or more		569			—			—
Allowance for loan losses		4,103			3,983			4,162
Nonperforming loans to period end loans		0.03	%		0.11	%		0.00	%
Allowance for loan losses to period end loans		1.06	%		1.15	%		1.30	%
Nonperforming assets to loans and other real estate owned		0.03	%		0.11	%		0.00	%
Nonperforming assets to total assets		0.02	%		0.09	%		0.00	%
Ratio of allowance for loan losses to nonperforming loans		41.87	x		10.03	x		297.29	x

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Noninterest Income. For the three-month period ended June 30, 2007, non-interest income increased $8,000 to $303,000 from $295,000 for the same period in the prior year. Deposit fees and loan fees continued to trend downward, decreasing $3,000 and $24,000, respectively, for the three-month period ended June 30, 2007 compared to the prior year period. Fees from mortgage operations have fallen as overall mortgage loan production has declined due to fewer loan originators compared to the prior year period. Other non-interest income grew $35,000 to $53,000 primarily through annuity sales fees and other fees generated from wealth management services.

Noninterest Expense. Total non-interest expense for the three-month period ended June 30, 2007 was $2.9 million, with salaries and benefits representing the largest expense category at $1.6 million. This compares to total non-interest expense for the three-month period ended June 30, 2006 of $2.5 million with salaries and benefits of $1.3 million. The $241,000 increase in salaries and benefits for the three-month period ended June 30, 2007 is attributable to an overall increase of 18 full time equivalent employees added to staff our new full service office in Wake Forest which opened in August 2006, a new loan production office in Wilmington which opened in April 2006 and other management and support staff added throughout the Bank, compared to the prior year period.

Occupancy and equipment costs increased $100,000 to $475,000 for the three-month period ended June 30, 2007 compared to the same period last year. These costs include the additional lease expense for our new loan production office in Wilmington, a new building lease for our planned downtown office as well as additional lease expense due to expansion in our operations area. Overall, lease expense increased approximately $41,400 over the prior year quarter. General operating costs were also higher due to the opening of the new offices. Additional costs were also incurred as we changed our credit processing to centralized document preparation and the purchase of credit software. Other non-interest expense increased $69,000 during the three-month period ended June 30, 2007 when compared to the prior year period in 2006. This increase is primarily attributable to higher costs associated with outsourced data processing fees, up $24,000, due to an increase in the volume of accounts. FDIC insurance increased $60,500 due to higher regulatory rates initiated in 2007.

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Provision for Income Taxes. The effective tax rate for three-month period ended June 30, 2007 was 39.9% compared to 37.3% for the same period ended June 30, 2006.

Comparison of Results of Operations for the Six-Month Periods Ended June 30, 2007 and 2006

Net Income. For the six-month period ended June 30, 2007, net income was $1.6 million compared to $1.4 million for the corresponding period in 2006, representing a 7.8% increase. On a diluted share basis, earnings were $.21 and $.20 per share, respectively, for the six-month period ended June 30, 2007 and 2006.

The increase in earnings was provided by net interest income, which grew $1.1 million in the six-month period ended June 30, 2007 compared to the prior year period, driven primarily by higher average loan volumes. The increase in net interest income absorbed increases in provision for loan losses of $46,000, noninterest expense of $792,000, income taxes of $142,000, as well as a decrease of $27,000 in noninterest income.

Net Interest Income. Interest income for the six-month period ended June 30, 2007 increased $3.2 million over the prior year period. The average prime lending rate for the six-month period ended June 30, 2007 was 59 basis points higher compared to an average of 7.66% for the prior year period. The increase in interest rates produced higher loan and other earning asset yields providing additional interest income of approximately $907,000 over the prior year six-month period. However, higher average loan volume attributed for most of the increase in interest income. Average loan volume increased $60.1 million providing additional interest income of approximately $2.2 million.

The increase in interest rates also increased our cost of funds. Repricing of our interest-bearing deposits to reflect market conditions and provide competitive rates increased our interest expense by approximately $978,000 while our increase in volume of average interest-bearing deposits contributed additional interest expense of approximately $1.2 million. Our noninterest-bearing demand deposits grew an average of $6.5 million for the six-month period ended June 30, 2007 compared to the prior year period. Overall, net interest income for the first six-month period of 2007 increased $1.1 million or 15.7% with a net interest margin of 3.86% compared to a net interest margin of 3.93% for the prior year period.

The following table contains information relating to our average balance sheet and reflects the average yield on assets and cost of liabilities for the periods indicated. Such annualized yields and costs are derived by dividing annualized income or expense by the average balances of assets or liabilities, respectively, for the periods presented.

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	Six Months Ended June 30, 2007						Six Months Ended June 30, 2006
	Average Balance		Interest		Average Rate		Average Balance		Interest		Average Rate
	(Amounts in thousands)						(Amounts in thousands)
Interest-earning assets:
Loans	$	364,921	$	13,817	7.64	%	$	304,796	$	10,907	7.22	%
Investments available for sale		39,355		869	4.45	%		43,645		851	3.93	%
Fed funds sold		24,966		670	5.41	%		13,372		319	4.81	%
Other interest-earning assets		2,370		109	9.27	%		4,394		141	6.47	%
Total interest-earning assets		431,612		15,465	7.23	%		366,207		12,218	6.73	%
Other assets		17,303						13,760
Total assets	$	448,915					$	379,967
Interest-bearing liabilities:
Deposits:
NOW & money market	$	166,548		3,194	3.87	%	$	135,131		2,252	3.36	%
Savings		1,164		3	0.52	%		1,122		4	0.72	%
Time deposits over $100		75,085		1,945	5.22	%		51,624		1,113	4.35	%
Other time deposits		64,176		1,561	4.91	%		60,985		1,172	3.88	%
Short-term borrowings		8,750		98	2.26	%		11,842		162	2.76	%
Long-term debt		11,191		405	7.30	%		11,210		375	6.75	%
Total interest-bearing liabilities		326,914		7,206	4.45	%		271,914		5,078	3.77	%
Demand deposits		89,378						82,847
Other liabilities		4,656						2,700
Shareholders’ equity		27,967						22,506
Total liabilities and shareholders’ equity	$	448,915					$	379,967
Net interest income and interest rate spread			$	8,259	2.78	%			$	7,140	2.96	%
Net yield on average interest-earning assets					3.86	%					3.93	%
Ratio of average interest-earning assets to average interest-bearing liabilities					132.03	%					134.68	%

Provision for Loan Losses. The provision for loan losses was $422,000 during the six-month period ended June 30, 2007 as compared with $376,000 for the same period in 2006. Provisions for loan losses are charged to income to bring the allowance for loan losses to a level considered appropriate by our management. One $299,000 loan and one $3,000 loan were charged-off during the six-month period ended June 30, 2007. Due to the level of the allowance specific to these loans of approximately $194,000, these charge-offs were the primary factor resulting in the decrease in the level of the allowance relative to gross loans of nine basis points to 1.06% as of June 30, 2007. By comparison, recoveries of $113,000 and charge-offs of $5,000 were recorded during the six-month period ended June 30, 2006.

Noninterest Income. For the six-month period ended June 30, 2007, non-interest income decreased $27,000 or 4.7% to $553,000 from $580,000 for the same period in the prior year. Deposit fees and loan fees continued to trend downward, decreasing $20,000 and $67,000, respectively, for the six-month period ended June 30, 2007 compared to the prior year period. Fees from mortgage operations have fallen as overall mortgage loan production has declined due to fewer loan originators compared to the prior year period. A restructuring of our mortgage loan performance standards during 2006 decreased the number of our loan originators. Other non-interest income grew $60,000 to $90,000 primarily through annuity sales fees and other fees generated from wealth management services.

Noninterest Expense. Total non-interest expense for the six-month period ended June 30, 2007 was $5.8 million, an increase of $792,000 or 15.7% over the prior year period. Salaries and benefits of $3.1 million, representing the largest expense category, were up $378,000 or 13.9% for the same time periods.

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Salaries and benefits for the six-month period ended June 30, 2007 were up due to an overall increase of 18 full time equivalent employees added to staff our new full service office in Wake Forest which opened in August 2006, a new loan production office in Wilmington which opened in April 2006 and other management and support staff added throughout the Bank, compared to the prior year period.

The opening of our Wake Forest full service office and Wilmington loan production office also contributed to the increase in occupancy and equipment and other general operating costs. In total, occupancy and equipment expense increased $184,000 or 24.5% to $936,000 for the six-month period ended June 30, 2007 compared to the same period last year. Building lease expense increased approximately $78,800 of which $42,000 was for our planned downtown office. We also incurred increased expenses as we changed our credit processing to centralized document preparation, which required the purchase of credit software. In total, other non-interest expense increased $230,000 during the six-month period ended June 30, 2007 when compared to the prior year period in 2006. In addition to overall higher operating costs due to the opening of new offices, higher costs associated with outsourced data processing fees were up $55,000, due to increase volume in accounts, and increased FDIC insurance and state regulatory assessments were up $138,000 due to higher regulatory rate requirements.

Provision for Income Taxes. The effective tax rate for three-month period ended June 30, 2007 was 39.0% compared to 37.2% for the same period ended June 30, 2006.

Liquidity and Capital Resources

To ensure that sufficient funds are available for loan growth and deposit withdrawals, as well as to provide for general needs, we must maintain an adequate level of liquidity. Both assets and liabilities provide sources of liquidity. Asset liquidity comes from our ability to convert short-term investments into cash and from the maturity and repayment of loans and investment securities. We had $105.4 million in liquid assets, consisting of cash and cash equivalents and investment securities, at June 30, 2007, compared with $99.4 million at December 31, 2006. Liability liquidity is provided by our ability to attract and retain deposits and from lines of credit with correspondent banks. The primary source of liquidity is our customer base, which provides our core deposits. Our deposits, together with our equity capital, represented 95.2% of total assets at June 30, 2007. We closely monitor and evaluate our overall liquidity position on a monthly basis and adjust our position as management deems appropriate. We believe our liquidity position at June 30, 2007 is adequate to meet our operating needs.

At June 30, 2007, our equity to assets ratio was 5.6%. The Bank’s leverage and risk based capital ratios and its total risk based capital ratio were 7.92%, 9.04% and 10.06%, respectively. At June 30, 2007, the Bank exceeded the minimum requirements of a “well capitalized” institution as defined by federal banking regulations and we also were considered to be well capitalized at the same date.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

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

The largest component of our earnings is net interest income which can fluctuate widely, directly impacting our overall earnings. Significant interest rate movements occur due to differing maturities or repricing intervals of our interest-earning assets and interest-bearing liabilities and the fact that rates on these financial instruments do not change uniformly. Management is responsible for minimizing our exposure to interest rate risk. This is accomplished by developing objectives, goals and strategies designed to enhance profitability and performance while minimizing our overall interest rate risk.

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We use several modeling techniques to measure interest rate risk. Our primary method is the simulation of net interest income under varying interest rate scenarios. We believe this methodology is preferable in that it takes into account the pricing strategies we would undertake in response to rate changes, whereas other methods such as interest rate shock or balance sheet gap analysis do not take these into consideration. Our balance sheet remains asset-sensitive, which means that more assets than liabilities are subject to immediate repricing as market rates change. During periods of rising rates, this should result in increased interest income. The opposite would be expected during periods of declining rates. Our market risk has not changed significantly since December 31, 2006.

Item 4T. Controls and Procedures

(a) As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e)) pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective.

(b) No change in our internal control over financial reporting occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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Part II. OTHER INFORMATION

Item 4. Submission of Matters to a Vote of Security Holders

Our Annual Meeting of Shareholders was held on May 3, 2007. The following matters were voted on at the meeting:

Proposal 1:To elect six Class I Directors for three-year terms until the Annual Meeting of Shareholders in 2010. Votes for each nominee were as follows:

Name	For	Withheld
Forrest H. Ball	2,825,412	8,271
C. Thomas Hendrickson	2,825,412	8,271
Honorable Burley B. Mitchell, Jr.	2,825,412	8,271
Barry W. Partlo	2,825,412	8,271
Nutan T. Shah	2,825,412	8,271
George C. Venters, M.D.	2,825,412	8,271

The following directors continued in office after the meeting: Larry D. Barbour, Charles T. Francis, Ambassador Jeanette W. Hyde, Brig. Gen. (Retired) Gary H. Pendleton, Fred J. Smith, Jr., James C. Branch, Glenn E. Futrell, J. Keith Keener, M.D., W. Harold (Hal) Perry and Jack M. Stancil.

Proposal 2: To amend our Articles of Incorporation to decrease the par value of our common stock from $1.00 per share to no par value per share.

For	Against	Abstain
2,786,912	21,797	30,487

Proposal 3:To amend the 2003 Stock Plan to increase the number of shares of common stock available thereunder by 350,000 shares.

For	Against	Abstain
2,766,346	49,761	17,576

Proposal 4: To ratify the appointment of Dixon Hughes PLLC, Raleigh, North Carolina, as our independent registered public accounting firm for the fiscal year ending December 31, 2007.

For	Against	Abstain
2,826,511	0	7,172

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Item 6. Exhibits

Exhibit #	Description
31.1	Certification of the Chief Executive Officer pursuant to Rule 13a-14(a)
31.2	Certification of the Chief Financial Officer pursuant to Rule 13a-14(a)
32.1	Certification by the Chief Executive Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2	Certification by the Chief Financial Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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SIGNATURES

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

	NORTH STATE BANCORP
Date: August 14, 2007	By:	/s/ Larry D. Barbour
		Larry D. Barbour
		President and Chief Executive Officer
Date: August 14, 2007	By:	/s/ Kirk A. Whorf
		Kirk A. Whorf
		Executive Vice President and Chief Financial Officer

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