News Column

FIRST BANCORP /NC/ - 10-Q - Management's Discussion and Analysis of Consolidated Results of Operations and Financial Condition

May 12, 2014

Critical Accounting Policies

The accounting principles we follow and our methods of applying these principles conform with accounting principles generally accepted in the United States of America and with general practices followed by the banking industry. Certain of these principles involve a significant amount of judgment and may involve the use of estimates based on our best assumptions at the time of the estimation. The allowance for loan losses, intangible assets, and the fair value and discount accretion of loans acquired in FDIC-assisted transactions are three policies we have identified as being more sensitive in terms of judgments and estimates, taking into account their overall potential impact to our consolidated financial statements. Allowance for Loan Losses

Due to the estimation process and the potential materiality of the amounts involved, we have identified the accounting for the allowance for loan losses and the related provision for loan losses as an accounting policy critical to our consolidated financial statements. The provision for loan losses charged to operations is an amount sufficient to bring the allowance for loan losses to an estimated balance considered adequate to absorb losses inherent in the portfolio. Our determination of the adequacy of the allowance is based primarily on a mathematical model that estimates the appropriate allowance for loan losses. This model has three components. The first component involves the estimation of losses on individually significant "impaired loans". A loan is considered to be impaired when, based on current information and events, it is probable we will be unable to collect all amounts due according to the contractual terms of the loan agreement. A loan is specifically evaluated for an appropriate valuation allowance if the loan balance is above a prescribed evaluation threshold (which varies based on credit quality, accruing status, and type of collateral) and the loan is determined to be impaired. The estimated valuation allowance is the difference, if any, between the loan balance outstanding and the value of the impaired loan as determined by either 1) an estimate of the cash flows that we expect to receive from the borrower discounted at the loan's effective rate, or 2) in the case of a collateral-dependent loan, the fair value of the collateral. The second component of the allowance model is the estimation of losses for impaired loans that have common risk characteristics and are aggregated to measure impairment. These impaired loans generally have loan balances below the thresholds that result in an individual review discussed above. For these impaired loans, we aggregate loans among similar loan types and apply loss rates that are derived from historical statistics. The third component of the allowance model is the estimation of losses for loans that are not considered to be impaired loans. Loans not considered to be impaired are segregated by loan type, and estimated loss percentages are assigned to each loan type, based on historical losses, current economic conditions, and operational conditions specific to each loan type. For loans with more than standard risk, loss percentages are based on a multiple of the estimated loss rate for loans of a similar loan type with normal risk. The multiples assigned vary by type of loan, depending on risk, and we have consulted with an external credit review firm in assigning those multiples. The reserves estimated for impaired loans (specifically reviewed and aggregate) are then added to the reserve estimated for all other loans. This becomes our "allocated allowance." In addition to the allocated allowance derived from the model, we also evaluate other data such as the ratio of the allowance for loan losses to total loans, net loan growth information, nonperforming asset levels and trends in such data. Based on this additional analysis, we may determine that an additional amount of allowance for loan losses is necessary to reserve for probable losses. This additional amount, if any, is our "unallocated allowance." The sum of the allocated allowance and the unallocated allowance is compared to the actual allowance for loan losses recorded on our books and any adjustment necessary for the recorded allowance to equal the computed allowance is recorded as a provision for loan losses. The provision for loan losses is a direct charge to earnings in the period recorded. Loans covered under loss share agreements (referred to as "covered loans") are recorded at fair value at acquisition date. Therefore, amounts deemed uncollectible at acquisition date become a part of the fair value calculation and are excluded from the allowance for loan losses. Subsequent decreases in the amount expected to be collected result in a provision for loan losses with a corresponding increase in the allowance for loan losses. Subsequent increases in the amount expected to be collected are accreted into income over the life of the loan. Proportional adjustments are also recorded to the FDIC indemnification asset. Page 39 Index

Although we use the best information available to make evaluations, future material adjustments may be necessary if economic, operational, or other conditions change. In addition, various regulatory agencies, as an integral part of their examination process, periodically review our allowance for loan losses. Such agencies may require us to recognize additions to the allowance based on the examiners' judgment about information available to them at the time of

their examinations.



For further discussion, see "Nonperforming Assets" and "Summary of Loan Loss Experience" below.

Intangible Assets



Due to the estimation process and the potential materiality of the amounts involved, we have also identified the accounting for intangible assets as an accounting policy critical to our consolidated financial statements.

When we complete an acquisition transaction, the excess of the purchase price over the amount by which the fair market value of assets acquired exceeds the fair market value of liabilities assumed represents an intangible asset. We must then determine the identifiable portions of the intangible asset, with any remaining amount classified as goodwill. Identifiable intangible assets associated with these acquisitions are generally amortized over the estimated life of the related asset, whereas goodwill is tested annually for impairment, but not systematically amortized. Assuming no goodwill impairment, it is beneficial to our future earnings to have a lower amount assigned to identifiable intangible assets and higher amount of goodwill as opposed to having a higher amount considered to be identifiable intangible assets and a lower amount classified as goodwill. The primary identifiable intangible asset we typically record in connection with a whole bank or bank branch acquisition is the value of the core deposit intangible, whereas when we acquire an insurance agency, the primary identifiable intangible asset is the value of the acquired customer list. Determining the amount of identifiable intangible assets and their average lives involves multiple assumptions and estimates and is typically determined by performing a discounted cash flow analysis, which involves a combination of any or all of the following assumptions: customer attrition/runoff, alternative funding costs, deposit servicing costs, and discount rates. We typically engage a third party consultant to assist in each analysis. For the whole bank and bank branch transactions recorded to date, the core deposit intangibles have generally been estimated to have a life ranging from seven to ten years, with an accelerated rate of amortization. For insurance agency acquisitions, the identifiable intangible assets related to the customer lists were determined to have a life of ten to fifteen years, with amortization occurring on a straight-line basis. Subsequent to the initial recording of the identifiable intangible assets and goodwill, we amortize the identifiable intangible assets over their estimated average lives, as discussed above. In addition, on at least an annual basis, goodwill is evaluated for impairment by comparing the fair value of our reporting units to their related carrying value, including goodwill (our community banking operation is our only material reporting unit). If the carrying value of a reporting unit were ever to exceed its fair value, we would determine whether the implied fair value of the goodwill, using a discounted cash flow analysis, exceeded the carrying value of the goodwill. If the carrying value of the goodwill exceeded the implied fair value of the goodwill, an impairment loss would be recorded in an amount equal to that excess. Performing such a discounted cash flow analysis would involve the significant use of estimates and assumptions. In our 2013 goodwill impairment evaluation, we engaged a consulting firm that used various valuation techniques to assist us in concluding that our goodwill was not impaired.

We review identifiable intangible assets for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Our policy is that an impairment loss is recognized, equal to the difference between the asset's carrying amount and its fair value, if the sum of the expected undiscounted future cash flows is less than the carrying amount of the asset. Estimating future cash flows involves the use of multiple estimates and assumptions, such as those listed above.



Fair Value and Discount Accretion of Loans Acquired in FDIC-Assisted Transactions

We consider the determination of the initial fair value of loans acquired in FDIC-assisted transactions, the initial fair value of the related FDIC indemnification asset, and the subsequent discount accretion of the purchased loans to involve a high degree of judgment and complexity. We determine fair value accounting estimates of newly assumed assets and liabilities in accordance with relevant accounting guidance. However, the amount that we realize on these assets could differ materially from the carrying value reflected in our financial statements, based upon the timing of collections on the acquired loans in future periods. To the extent the actual values realized for the acquired loans are different from the estimates, the FDIC indemnification asset will generally be impacted in an offsetting manner due to the loss-sharing support from the FDIC. Page 40 Index

Because of the inherent credit losses associated with the acquired loans in a failed bank acquisition, the amount that we record as the fair values for the loans is generally less than the contractual unpaid principal balance due from the borrowers, with the difference being referred to as the "discount" on the acquired loans. We have applied the cost recovery method of accounting to all purchased impaired loans due to the uncertainty as to the timing of expected cash flows. This will generally result in the recognition of interest income on these impaired loans only when the cash payments received from the borrower exceed the recorded net book value of the related loans.



For nonimpaired purchased loans, we accrete the discount over the lives of the loans in a manner consistent with the guidance for accounting for loan origination fees and costs.

Page 41 Index



FDIC Indemnification Asset

The FDIC indemnification asset is the estimated amount that the Company will receive from the FDIC under loss share agreements associated with two FDIC-assisted failed bank acquisitions. See page 41 of the Company's 2013 Annual Report on Form 10-K for a detailed explanation of this asset.



The following table presents additional information regarding our covered loans, loan discounts, allowances for loan losses, foreclosed properties, and the corresponding FDIC indemnification asset:

($ in thousands) Cooperative Cooperative Bank of Single Family Non-Single Asheville Single Bank of Asheville Loss Share Family Loss Family Loss Non-Single Family At March 31, 2014 Loans Share Loans



Share Loans Loss Share Loans Total Expiration of loss share agreement

6/30/2019 6/30/2014 3/31/2021 3/31/2016



Nonaccrual covered loans

Unpaid principal balance $ 9,089 32,244 571 7,398 49,302 Carrying value prior to loan discount* 8,933 21,098 453 6,281 36,765 Loan discount 1,368 980 258 2,173 4,779 Net carrying value 7,565 20,118 195 4,108 31,986 Allowance for loan losses 439 937 1 85 1,462 Indemnification asset recorded 1,405 1,100 198 1,592 4,295 All other covered loans Unpaid principal balance 112,527 30,678 10,450 32,186 185,841 Carrying value prior to loan discount* 112,431 30,277 10,361 31,957 185,026 Loan discount 15,335 1,021 2,916 7,189 26,461 Net carrying value 97,096 29,256 7,445 24,768 158,565 Allowance for loan losses 168 1,508 11 272 1,959

Indemnification asset recorded 11,934

817 2,309 5,563 20,623 All covered loans Unpaid principal balance 121,616 62,922 11,021 39,584 235,143 Carrying value prior to loan discount* 121,364 51,375 10,814 38,238 221,791 Loan discount 16,703 2,001 3,174 9,362 31,240 Net carrying value 104,661 49,374 7,640 28,876 190,551 Allowance for loan losses 607 2,445 12 357 3,421 Indemnification asset recorded 13,339 1,917 2,507 7,155 24,918 ** Foreclosed Properties Net carrying value 3,391 10,670 170 5,273 19,504

Indemnification asset recorded 1,594

879 125 1,041 3,639



* Reflects partial charge-offs

** A present value adjustment of $154 reduces the carrying value of this asset to $24,764.

As noted in the table above, our loss share agreement related to Cooperative Bank's non-single family assets expires in June 2014 and our loss share agreement related to Bank of Asheville's non-single family assets expires in January 2016. We continue to make progress in winding down these portfolios, and we do not currently expect that the upcoming expiration of the Cooperative non-single family agreement will have a material impact on our company. As it relates to those portions of covered loans, we expect accelerated amounts of loan discount accretion and corresponding indemnification asset expense until the expiration dates and the loss share attributes of the loan portfolio are resolved. At June 30, 2014, the remaining balances associated with the Cooperative non-single family loans and foreclosed properties will be transferred from the covered portfolio to the non-covered portfolio. Therefore, after June 30, 2014, we will bear all future losses on that portfolio of loans and foreclosed properties. Page 42 Index Current Accounting Matters



See Note 2 to the Consolidated Financial Statements above for information about accounting standards that we have recently adopted.

RESULTS OF OPERATIONS Overview Net income available to common shareholders for the first quarter of 2014 amounted to $5.5 million, or $0.27 per diluted common share, compared to net income available to common shareholders of $2.9 million, or $0.14 per diluted common share, recorded in the first quarter of 2013. The higher earnings in 2014 were the result of a higher net interest margin, lower provision for loan losses and higher fee income.



Net Interest Income and Net Interest Margin

Net interest income for the first quarter of 2014 amounted to $35.5 million, an 11.3% increase from the $31.9 million recorded in the first quarter of 2013.

Our net interest margin (tax-equivalent net interest income divided by average earning assets) in the first quarter of 2014 was 5.13% compared to 4.69% for the first quarter of 2013. The 5.13% net interest margin realized in the first quarter of 2014 was a nine basis point increase from the 5.04% margin realized in the fourth quarter of 2013. The higher margins are primarily due to higher amounts of discount accretion on loans purchased in failed-bank acquisitions recognized during the respective periods. Loan discount accretion amounted to $6.4 million in the first quarter of 2014, $5.6 million in the fourth quarter of 2013, and $3.7 million in the first quarter of 2013. Our cost of funds has steadily declined from 0.45% in the first quarter of 2013 to 0.31% in the first quarter of 2014, which also had a positive impact on

our net interest margin.



Provision for Loan Losses and Asset Quality

We recorded total provisions for loan losses of $3.6 million in the first quarter of 2014 compared to $11.1 million for the first quarter of 2013, with the provisions related to both non-covered loans and covered loans being lower in 2014 compared to 2013 - see explanation of the terms "non-covered" and "covered" in the section entitled "Note Regarding Components of Earnings." Total non-covered nonperforming assets have remained relatively unchanged over the past year, amounting to $82.2 million at March 31, 2014 (2.65% of total non-covered assets), $82.0 million at December 31, 2013 and $83.4 million at March 31, 2013.

Total covered nonperforming assets have steadily declined in the past year, amounting to $58.9 million at March 31, 2014 compared to $70.6 million at December 31, 2013 and $92.0 million at March 31, 2013. We continue to resolve significant amounts of covered loans and to experience strong property sales along the North Carolina coast, which is where most of our covered assets are located. Noninterest Income



Total noninterest income for the three months ended March 31, 2014 was $0.3 million compared to $7.1 million for the comparable period of 2013.

Core noninterest income for the first quarter of 2014 was $7.5 million, an increase of 15.5% over the $6.5 million reported for the first quarter of 2013. Core noninterest income includes i) service charges on deposit accounts, ii) other service charges, commissions, and fees, iii) fees from presold mortgages, iv) commissions from financial product sales, and v) bank-owned life insurance income. The largest component of the increase in core noninterest income was in the amount of service charges on deposits that we recorded. In December 2013, we introduced a new deposit product line-up and altered the fee structure of many of our accounts. Page 43 Index Noncore components of noninterest income resulted in net losses of $7.2 million in the first quarter of 2014 compared to net gains of $0.6 million in the first quarter of 2013. The largest variance related to indemnification asset income (expense) - see discussion in the section entitled "Components of Earnings". Noninterest Expenses

Noninterest expenses amounted to $23.6 million in the first quarter of 2014 compared to $23.2 million recorded in the first quarter of 2013. Salaries expense increased in the first quarter of 2014 in comparison to the first quarter of 2013 due to hiring additional employees during 2013 in our credit administration and mortgage banking divisions. Partially offsetting the increase in salaries expense were lower collection and foreclosed property expenses in 2014, which reflects lower levels of problem assets. Balance Sheet and Capital Total assets at March 31, 2014 amounted to $3.3 billion, a 1.0% increase from a year earlier. Total loans at March 31, 2014 amounted to $2.4 billion, a 2.1% increase from a year earlier, and total deposits amounted to $2.8 billion at March 31, 2014, a 2.5% decrease from a year earlier. Total loans increased over the past year, as growth in non-covered loans has exceeded the steady decline in covered loans. Our non-covered loans increased by $124 million at March 31, 2014 compared to a year earlier, representing growth of 5.8%. We continue to see improved loan demand as the local economies in

our market areas improve. The lower amount of deposits at March 31, 2014 compared to March 31, 2013 was primarily due to declines in time deposits, with increases in checking accounts offsetting most of the decline. Time deposits are generally one of our most expensive funding sources, and thus the shift from this category benefited

our overall cost of funds.



We obtained new borrowings of $90 million in the first quarter of 2014 from a low cost funding source in order to enhance our cash position and in anticipation of future loan growth.

We remain well-capitalized by all regulatory standards, with a Total Risk-Based Capital Ratio at March 31, 2014 of 16.83% compared to the 10.00% minimum to be considered well-capitalized. Our tangible common equity to tangible assets ratio was 7.30% at March 31, 2014, an increase of 54 basis points from a year earlier.



Note Regarding Components of Earnings

Our results of operation are significantly affected by the on-going accounting for two FDIC-assisted failed bank acquisitions. In the discussion above and elsewhere in this document, the term "covered" is used to describe assets included as part of FDIC loss share agreements, which generally result in the FDIC reimbursing the Company for 80% of losses incurred on those assets. The term "non-covered" refers to the Company's legacy assets, which are not included in any type of loss share arrangement. For covered loans that deteriorate in terms of repayment expectations, we record immediate allowances through the provision for loan losses. For covered loans that experience favorable changes in credit quality compared to what was expected at the acquisition date, including loans that payoff, we record positive adjustments to interest income over the life of the respective loan - also referred to as loan discount accretion. For covered foreclosed properties that are sold at gains or losses or that are written down to lower values, we record the gains/losses within noninterest income. The adjustments discussed above are recorded within the income statement line items noted without consideration of the FDIC loss share agreements. Because favorable changes in covered assets result in lower expected FDIC claims, and unfavorable changes in covered assets result in higher expected FDIC claims, the FDIC indemnification asset is adjusted to reflect those expectations. The net increase or decrease in the indemnification asset is reflected within noninterest income. The adjustments noted above can result in volatility within individual income statement line items. Because of the FDIC loss share agreements and the associated indemnification asset, pretax income resulting from amounts recorded as provisions for loan losses on covered loans, discount accretion, and losses from covered foreclosed properties is generally only impacted by 20% of these amounts due to the corresponding adjustments made to the indemnification asset. Page 44 Index Components of Earnings

Net interest income is the largest component of earnings, representing the difference between interest and fees generated from earning assets and the interest costs of deposits and other funds needed to support those assets. Net interest income for the three month period ended March 31, 2014 amounted to $35.5 million, an increase of $3.6 million, or 11.3%, from the $31.9 million recorded in the first quarter of 2013. Net interest income on a tax-equivalent basis for the three month period ended March 31, 2014 amounted to $35.9 million, an increase of $3.6 million, or 11.2%, from the $32.3 million recorded in the first quarter of 2013. We believe that analysis of net interest income on a tax-equivalent basis is useful and appropriate because it allows a comparison of net interest income amounts in different periods without taking into account the different mix of taxable versus non-taxable investments that may have existed during those periods. Three Months Ended March 31, ($ in thousands) 2014 2013 Net interest income, as reported $ 35,535 31,921 Tax-equivalent adjustment 373 372 Net interest income, tax-equivalent $ 35,908 32,293 There are two primary factors that cause changes in the amount of net interest income we record - 1) changes in our loans and deposits balances, and 2) our net interest margin (tax-equivalent net interest income divided by average interest-earning assets).



For the three months ended March 31, 2014, the higher net interest income compared to the same period of 2013 was due to a higher net interest margin, increases in interest-earning assets (primarily average loan balances), and decreases in interest-bearing liabilities (see discussion below).

Page 45 Index The following table presents net interest income analysis on a tax-equivalent basis. For the Three Months Ended March 31, 2014 2013 Interest Interest Average Average Earned Average Average Earned ($ in thousands) Volume Rate or Paid Volume Rate or Paid Assets Loans (1) $ 2,459,368 5.95% $ 36,086$ 2,382,861 5.71% $ 33,551 Taxable securities 180,228 2.25% 1,001 164,284 2.23% 905 Non-taxable securities (2) 53,975 6.33% 843 55,948 6.17% 851

Short-term investments, principally federal funds 143,235 0.34% 119 187,652 0.33% 154 Total interest-earning assets 2,836,806

5.44% 38,049 2,790,745 5.15% 35,461 Cash and due from banks 83,243 81,081 Premises and equipment 77,440 75,255 Other assets 181,359 281,382 Total assets $ 3,178,848$ 3,228,463 Liabilities Interest bearing checking $ 529,110 0.06% $ 80$ 520,936 0.13% $ 162 Money market deposits 553,792 0.11% 151 560,203 0.22% 306 Savings deposits 173,228 0.05% 21 162,403 0.10% 42 Time deposits >$100,000 575,627 0.83% 1,183 653,930 1.00% 1,613 Other time deposits 414,987 0.45% 456 496,029 0.65% 789 Total interest-bearing deposits 2,246,744



0.34% 1,891 2,393,501 0.49% 2,912 Borrowings

47,394 2.14% 250 46,394 2.24% 256 Total interest-bearing liabilities 2,294,138 0.38% 2,141 2,439,895 0.53% 3,168 Noninterest bearing checking 492,450

409,744 Other liabilities 15,842 19,462 Shareholders' equity 376,418 359,362 Total liabilities and shareholders' equity $ 3,178,848$ 3,228,463

Net yield on interest-earning assets and net interest income

5.13% $ 35,908 4.69% $ 32,293 Interest rate spread 5.06% 4.62% Average prime rate 3.25% 3.25%



(1) Average loans include nonaccruing loans, the effect of which is to lower the

average rate shown.

(2) Includes tax-equivalent adjustments of $373,000 and $372,000 in 2014 and

2013, respectively, to reflect the tax benefit that we receive related to

tax-exempt securities, which carry interest rates lower than similar taxable

investments due to their tax exempt status. This amount has been computed

assuming a 39% tax rate and is reduced by the related nondeductible portion

of interest expense. Average loans outstanding for the first quarter of 2014 were $2.459 billion, which was 3.2% higher than the average loans outstanding for the first quarter of 2013 ($2.383 billion). The higher amount of average loans outstanding in 2014 is due to internal loan growth. Partially offsetting the internal loan growth was the resolution of covered loans within our "covered loan" portfolio through foreclosure, charge-off, or repayment. The mix of our loan portfolio remained substantially the same at March 31, 2014 compared to December 31, 2013, with approximately 90% of our loans being real estate loans, 7% being commercial, financial, and agricultural loans, and the remaining 3% being consumer installment loans. The majority of our real estate loans are personal and commercial loans where real estate provides additional security for the loan. Average total deposits outstanding for the first quarter of 2014 were $2.739 billion, which was 2.3% less than the average deposits outstanding for the first quarter of 2013 ($2.803 billion). Average transaction deposit accounts (noninterest bearing checking, interest bearing checking, money market and savings accounts) increased from $1.653 billion at March 31, 2013 to $1.749 billion at March 31, 2014, representing growth of $96 million, or 5.8%. With the growth of our transaction deposit accounts, we were able to lessen our reliance on higher cost sources of funding, specifically time deposits. Average time deposits declined from $1.150 billion at March 31, 2013 to $991 million at March 31, 2014, a decrease of $159 million, or 13.9%. The favorable change in the funding mix was largely responsible for our average cost of interest bearing liabilities decreasing from 0.53% in the first quarter of 2013 to 0.38% in the first quarter of 2014. Our total cost of funds, which includes noninterest bearing checking accounts at a zero percent cost, was 0.31% in the first quarter of 2014 compared to 0.45% in the first quarter of 2013. Page 46 Index



See additional information regarding changes in the Company's loans and deposits in the section below entitled "Financial Condition."

Our net interest margin (tax-equivalent net interest income divided by average earning assets) for the first quarter of 2014 was 5.13% compared to 4.69% for the first quarter of 2013. The higher margin was primarily a result of a higher amount of discount accretion on loans purchased in failed-bank acquisitions (see discussion below), as well as the lower overall funding costs just discussed. Our net interest margin benefitted from the net accretion of purchase accounting premiums/discounts associated with the Cooperative acquisition that occurred in June 2009 and, to a lesser degree, the acquisition of The Bank of Asheville in January 2011. For the three months ended March 31, 2014 and 2013, we recorded $6,362,000 and $3,551,000, respectively, in net accretion of purchase accounting premiums/discounts that increased net interest income. The following table presents the detail of the purchase accounting adjustments that impacted net interest income. For the Three Months Ended $ in thousands March 31, 2014 March 31, 2013



Interest income - reduced by premium amortization on loans $

(49 ) (116 ) Interest income - increased by accretion of loan discount 6,408 3,658 Interest expense - reduced by premium amortization of deposits 3 9 Impact on net interest income $ 6,362 3,551



See additional information regarding net interest income in the section entitled "Interest Rate Risk."

The increase in discount accretion is primarily due to payoffs of loans with loan discounts and increased expectations regarding the collectability of other loans.



We recorded total provisions for loan losses of $3.6 million in the first quarter of 2014 compared to $11.1 million for the first quarter of 2013.

Our provision for loan losses on non-covered loans amounted to $3.4 million in the first quarter of 2014 compared to $5.8 million in the first quarter of 2013. The lower provision in 2014 was primarily the result of lower loan growth during the quarter, stable overall asset quality and low levels of net charge-offs. Our provision for loan losses on covered loans amounted to $0.2 million in the first quarter of 2014 compared to $5.4 million in the first quarter of 2013. The decrease was primarily due to lower levels of covered nonperforming loans during the period, stabilization in the underlying collateral values of nonperforming loans, and a $1.9 million recovery that we realized in the first quarter of 2014.



Total noninterest income was $0.3 million in the first quarter of 2014 compared to $7.1 million for the first quarter of 2013.

As presented in the table below, core noninterest income for the first quarter of 2014 was $7.5 million, an increase of 15.5% over the $6.5 million reported for the first quarter of 2013. Core noninterest income includes i) service charges on deposit accounts, ii) other service charges, commissions, and fees, iii) fees from presold mortgages, iv) commissions from financial product sales, and v) bank-owned life insurance income. Page 47 Index



The following table presents our core noninterest income for the three month periods ending March 31, 2014 and 2013, respectively.

For the Three Months Ended $ in thousands March 31, March 31, 2014 2013

Service charges on deposit accounts $ 3,573



2,935

Other service charges, commissions, and fees 2,367



2,175

Fees from presold mortgages 607 747 Commissions from sales of insurance and financial products 594 399 Bank-owned life insurance income 327

208 Core noninterest income $ 7,468 6,464



Most categories of core noninterest income increased during the first three months of 2014 compared to the same period in 2013.

As shown in the table above, service charges on deposit accounts increased from $2.9 million in the first quarter of 2013 to $3.6 million in the first quarter of 2014. In December 2013, we introduced a new deposit product line-up that simplified our product offering and also altered the fee structure of many accounts. Some customer charges were lowered or eliminated, while other fees were increased, with the most significant change being the elimination of free checking for customers maintaining low account balances, which is the primary cause of the higher service charges in 2014. Other service charges, commissions, and fees increased in 2014 compared to 2013 primarily as a result of higher debit card interchange fees. We earn a small fee each time a customer uses a debit card to make a purchase. Due to the growth in checking accounts and increased customer usage of debit cards, we have experienced increases in this line item. Fees from presold mortgages decreased from $0.7 million in the first quarter of 2013 to $0.6 million in the first quarter of 2014. Mortgage loan refinancing activity has slowed down since the second quarter of 2013. Commissions from sales of insurance and financial products have increased in 2014 compared to 2013 as a result of increased sales volume generated by additional personnel hired in our wealth management division over the past

three years. Bank-owned life insurance income was $0.3 million in the first quarter of 2014 compared to $0.2 million in the first quarter of 2013. The increase was due to the purchase of $15 million in bank-owned life insurance in June 2013. Within the noncore components of noninterest income, we recorded a net loss on non-covered foreclosed properties of $0.2 million during the first quarter of 2014 compared to a net gain of $0.8 million during the first quarter of 2013. For the first quarter of 2014, we recorded losses of $2.1 million on covered foreclosed properties compared to losses of $4.6 million for the comparable period of 2013. The lower level of losses on covered properties in 2014 has been primarily a result of lower levels of covered foreclosed properties. In addition, losses on covered assets have declined due to stabilization in real estate market values in the coastal region of North Carolina, where most of our covered foreclosed properties are located. Indemnification asset income (expense) is recorded to reflect additional (decreased) amounts expected to be received from the FDIC related to covered assets arising during the period. The three primary items that result in the recording of indemnification asset income (expense) are 1) loan discount accretion, 2) provisions for loan losses on covered loans and 3) foreclosed property gains (losses) on covered assets. Income and gains on covered assets generally result in the recording of indemnification asset expense, while losses result in indemnification asset income. In the first quarter of 2014, we recorded $4.9 million in indemnification asset expense compared to $4.9 million in indemnification asset income in the first quarter of 2013. The variance between the first quarter of 2014 and the first quarter of 2013 is primarily due to higher indemnification asset expense associated with higher loan discount accretion and fewer covered loan and foreclosed property losses that result in indemnification asset income, as shown in the following table: Page 48 Index ($ in millions)

For the Three Months Ended March 31, March 31, 2014 2013



Indemnification asset expense associated with loan discount accretion income $ (5.9 )

(2.9 )



Indemnification asset income (expense) associated with loan losses (recoveries),net (0.4 )

3.9 Indemnification asset income associated with foreclosed property losses 1.6 3.7 Other sources of indemnification asset income (expense) (0.2 ) 0.2 Total indemnification asset income (expense)

$ (4.9 ) 4.9 During the first quarter of 2013, we recorded "other losses" of $0.4 million related to the sale of a parcel of property that we had previously held for a future branch. We decided not to use the property for a branch and disposed

of the property.



Noninterest expenses amounted to $23.6 million in the first quarter of 2014, a 1.4% increase over the $23.2 million recorded in the same period of 2013.

Salaries expense was $11.6 million for the first quarter of 2014 compared to $10.7 million in the first quarter of 2013. The increase in salaries expense has been primarily associated with the hiring of additional employees in our credit administration and mortgage banking divisions. Employee benefits expense was $2.3 million in the first quarter of 2014 compared to $2.6 million in the first quarter of 2013. The decrease primarily relates to a $0.3 million decline in health care expense resulting from lower incurred medical claims. The combined amount of occupancy and equipment expense did not vary materially when comparing the first quarter of 2014 to the first quarter of 2013, amounting to approximately $2.8 million in each quarter. Other noninterest expenses amounted to $6.6 million for the first quarter of 2014 compared to $7.0 million in the first quarter of 2013. The biggest variance in this line item was lower repossession and collection expenses. Total collection expenses (net of FDIC reimbursement of covered assets) amounted to $0.3 million in the first quarter of 2014 compared to $1.2 million in the first quarter of 2013 and resulted from lower levels of collection activity and lower levels of foreclosed properties. For the first quarter of 2014, the provision for income taxes was $3.0 million, an effective tax rate of 34.8%. For the first quarter of 2013, the provision for income taxes was $1.6 million, an effective tax rate of 33.4%. We accrued total preferred stock dividends of $0.2 million in each of the three months ended March 31, 2014 and 2013. These amounts are deducted from net income in computing "net income available to common shareholders." The dividend rate can range from 1% to 5% per anum based upon changes in the level of our "Qualified Small Business Lending" ("QSBL"). We have been able to continually increase our levels of QSBL since 2011 and as such, our Series B Preferred Stock dividend rate has decreased to around 1.0% for both the first quarter of 2013 and 2014. We expect our Series B Preferred Stock dividend rate to remain at an annualized rate of 1.0% until 2016, unless that preferred stock is redeemed

at an earlier date. The Consolidated Statements of Comprehensive Income reflect other comprehensive income of $164,000 during the first quarter of 2014 compared to other comprehensive loss of $186,000 during the first quarter of 2013. The primary component of other comprehensive income (loss) for the periods presented was changes in unrealized holding gains (losses) of our available for sale securities. Our available for sale securities portfolio is predominantly comprised of fixed rate bonds that generally increase in value when market yields for fixed rate bonds decrease and decline in value when market yields for fixed rate bonds increase. Management has evaluated any unrealized losses on individual securities at each period end and determined that there is no other-than-temporary impairment. Page 49 Index FINANCIAL CONDITION Total assets at March 31, 2014 amounted to $3.31 billion, a 1.0% increase from a year earlier. Total loans at March 31, 2014 amounted to $2.45 billion, a 2.1% increase from a year earlier, and total deposits amounted to $2.79 billion, a 2.5 % decrease from a year earlier.



The following table presents information regarding the nature of our growth for the twelve months ended March 31, 2014 and for the first quarter of 2014.

Balance at Internal Growth Balance at Total Internal April 1, 2013 to beginning Growth, from end of percentage percentage March 31, 2014 of period net (1) Acquisitions period growth growth (1) Loans - Non-covered $ 2,132,683 124,043 - 2,256,726 5.8% 5.8% Loans - Covered 263,468 (72,917 ) - 190,551 -27.7% -27.7% Total loans 2,396,151 51,126 - 2,447,277 2.1% 2.1% Deposits - Noninterest bearing checking 429,202 82,410 - 511,612 19.2% 19.2% Deposits - Interest bearing checking 539,270 11,432 - 550,702 2.1% 2.1% Deposits - Money market 568,092 (14,157 ) - 553,935 -2.5% -2.5% Deposits - Savings 166,510 11,234 - 177,744 6.7% 6.7% Deposits - Brokered 118,117 32,155 - 150,272 27.2% 27.2% Deposits - Internet time 7,689 (5,722 ) - 1,967 -74.4% -74.4% Deposits - Time>$100,000 532,747 (96,502 ) - 436,245 -18.1% -18.1% Deposits - Time$100,000 495,940 (91,693 ) - 404,247 -18.5% -18.5% Total deposits $ 2,857,567 (70,843 ) - 2,786,724 -2.5% -2.5% January 1, 2014 to March 31, 2014 Loans - Non-covered $ 2,252,885 3,841 - 2,256,726 0.2% 0.2% Loans - Covered 210,309 (19,758 ) -



190,551 -9.4% -9.4%

Total loans $ 2,463,194 (15,917 ) - 2,447,277 -0.6% -0.6% Deposits - Noninterest bearing checking $ 482,650 28,962 - 511,612 6.0% 6.0% Deposits - Interest bearing checking 557,413 (6,711 ) - 550,702 -1.2% -1.2% Deposits - Money market 547,556 6,379 - 553,935 1.2% 1.2% Deposits - Savings 169,023 8,721 - 177,744 5.2% 5.2% Deposits - Brokered 116,087 34,185 - 150,272 29.4% 29.4% Deposits - Internet time 1,319 648 - 1,967 49.1% 49.1% Deposits - Time>$100,000 451,741 (15,496 ) - 436,245 -3.4% -3.4% Deposits - Time$100,000 425,230 (20,983 ) - 404,247 -4.9% -4.9% Total deposits $ 2,751,019 35,705 -

2,786,724 1.3% 1.3%



(1) Excludes the impact of acquisitions in the year of acquisition, but includes

growth or declines in acquired operations after the date of acquisition.

As derived from the table above, for the twelve months preceding March 31, 2014, our total loans increased $51 million, or 2.1%. Over that period, we experienced internal growth in our non-covered loan portfolio of $124 million, or 5.8%. Partially offsetting the growth in non-covered loans were normal loan pay-downs, foreclosures, and loan charge-offs of our covered loans, which declined by $73 million at March 31, 2014 compared to a year earlier. We continue to pursue lending opportunities in order to improve our asset yields. For the first three months of 2014, we experienced internal growth in our non-covered loan portfolio of $4 million, or 0.2%. These increases were more than offset by a decline in our covered loans of $20 million. We expect to experience higher loan growth in our non-covered loans portfolio for the remainder of 2014, while we expect our current portfolio of covered loans to continue to steadily decline. As discussed previously, at June 30, 2014, one of our loss share agreements expires and we will transfer that portfolio of loans from the "covered" category to the "non-covered" category. The mix of our loan portfolio remains substantially the same at March 31, 2014 compared to December 31, 2013. The majority of our real estate loans are personal and commercial loans where real estate provides additional security for the loan. Page 50 Index Note 7 to the consolidated financial statements presents additional detailed information regarding our mix of loans, including a break-out between loans covered by FDIC loss share agreements and non-covered loans. Additionally, the section above titled "FDIC Indemnification Asset" contains detail of our covered loans and foreclosed properties segregated by each of the four loss-share agreements. For the twelve month periods ended March 31, 2014, we experienced a net decline in total deposits of $71 million, which was a result of growth in our transaction account deposits (checking, money market, and savings) that was more than offset by declines in our time deposit accounts. Over this period, growth of $91 million in our transaction account categories was more than offset by a $162 million decline in time deposits, including brokered deposits and internet time deposits.

For the first three months of 2014, we experienced a net increase in total deposits of $36 million. Transaction account deposits increased $37 million, while the net decline in time deposits was only $2 million. Within time deposits, we obtained $34 million in brokered deposits to help offset declines of $36 million in the retail time deposit categories ("Time>$100,000" and "Time$100,000" categories). As shown above, the retail time deposit categories experienced significant declines over the time periods shown. Due to the low interest rates we are currently offering as a result of the overall low interest rate environment in the marketplace, our analysis indicates that some customers are shifting their funds related to matured time deposits to their transaction accounts at our company, while other customers are withdrawing their funds from our company in search of higher yields from other companies. We expect this trend to continue.



We obtained new borrowings of $90 million in the first quarter of 2014 from a low cost funding source in order to enhance our cash position and in anticipation of future loan growth.

Nonperforming Assets Nonperforming assets include nonaccrual loans, troubled debt restructurings, loans past due 90 or more days and still accruing interest, nonperforming loans held for sale, and foreclosed real estate. As previously discussed, as a result of two FDIC-assisted transactions, we entered into loss share agreements that afford us significant protection from losses from all loans and foreclosed real estate acquired in those acquisitions. Because of the loss protection provided by the FDIC, the financial risk of the acquired loans and foreclosed real estate is significantly different from the risk associated with assets not covered under the loss share agreements. Accordingly, we present separately nonperforming assets subject to the loss share agreements as "covered" nonperforming assets, and nonperforming assets that are not subject to the loss share agreements as "non-covered." Page 51 Index



Nonperforming assets are summarized as follows:

As of/for the As of/for the As of/for the quarter



ended quarter ended quarter ended ASSET QUALITY DATA ($ in thousands)

March 31,



2014 December 31, 2013March 31, 2013

Non-covered nonperforming assets

Nonaccrual loans $ 44,129 41,938 38,917 Restructured loans - accruing 26,335 27,776 24,378 Accruing loans >90 days past due - - - Total non-covered nonperforming loans 70,464 69,714 63,295 Foreclosed real estate 11,740 12,251 20,115 Total non-covered nonperforming assets $ 82,204 81,965 83,410



Covered nonperforming assets (1)

Nonaccrual loans $ 31,986 37,217 51,221 Restructured loans - accruing 7,429 8,909 10,582 Accruing loans > 90 days past due - - - Total covered nonperforming loans 39,415 46,126 61,803 Foreclosed real estate 19,504 24,497 30,156 Total covered nonperforming assets $ 58,919 70,623 91,959 Total nonperforming assets $ 141,123 152,588 175,369 Asset Quality Ratios - All Assets Net charge-offs to average loans - annualized 0.65% 1.31% 1.32% Nonperforming loans to total loans 4.49% 4.70% 5.22% Nonperforming assets to total assets 4.26% 4.79% 5.35% Allowance for loan losses to total loans 1.97% 1.97% 2.08% Allowance for loan losses to nonperforming loans 43.80% 41.87% 39.80%



Asset Quality Ratios - Based on Non-covered Assets only Net charge-offs to average non-covered loans - annualized

0.52% 0.74% 0.51% Non-covered nonperforming loans to non-covered loans 3.12% 3.09% 2.97% Non-covered nonperforming assets to total non-covered assets 2.65% 2.78% 2.79% Allowance for loan losses to non-covered loans 1.98% 1.96% 2.10% Allowance for loan losses to non-covered nonperforming loans 63.45% 63.49% 70.72%



(1) Covered nonperforming assets consist of assets that are included in loss share agreements with the FDIC.

We have reviewed the collateral for our nonperforming assets, including nonaccrual loans, and have included this review among the factors considered in the evaluation of the allowance for loan losses discussed below.

Consistent with the continuing weak economy in our market area, particularly in more rural areas, we have experienced high levels of loan losses, delinquencies and nonperforming assets compared to our historical averages. Page 52 Index The following is the composition, by loan type, of all of our nonaccrual loans (covered and non-covered) at each period end, as classified for regulatory purposes: ($ in thousands) At March 31, At December 31, At March 31, 2014 2013 2013

Commercial, financial, and agricultural $ 5,627 5,690 2,866 Real estate - construction, land development, and other land loans 20,692 22,688 26,657 Real estate - mortgage - residential (1-4 family) first mortgages 20,290 21,751 21,067 Real estate - mortgage - home equity loans/lines of credit 3,999 4,081 2,987 Real estate - mortgage - commercial and other 25,017 24,568 35,590 Installment loans to individuals 490

377 971 Total nonaccrual loans $ 76,115 79,155 90,138



The following segregates our nonaccrual loans at March 31, 2014 into covered and non-covered loans, as classified for regulatory purposes:

($ in thousands) Covered Non-covered Total Nonaccrual Nonaccrual Nonaccrual Loans Loans Loans

Commercial, financial, and agricultural $ 399 5,228 5,627



Real estate - construction, land development, and other land loans 10,836

9,856 20,692



Real estate - mortgage - residential (1-4 family) first mortgages 7,240

13,050 20,290 Real estate - mortgage - home equity loans/lines of credit 461 3,538 3,999 Real estate - mortgage - commercial and other 13,050 11,967 25,017 Installment loans to individuals

- 490 490 Total nonaccrual loans $ 31,986 44,129 76,115



The following segregates our nonaccrual loans at December 31, 2013 into covered and non-covered loans, as classified for regulatory purposes:

($ in thousands) Covered Non-covered Total Nonaccrual Nonaccrual Nonaccrual Loans Loans Loans

Commercial, financial, and agricultural $ 935 4,755 5,690



Real estate - construction, land development, and other land loans 13,274

9,414 22,688



Real estate - mortgage - residential (1-4 family) first mortgages 9,447

12,304 21,751 Real estate - mortgage - home equity loans/lines of credit 509 3,572 4,081 Real estate - mortgage - commercial and other 13,050 11,518 24,568 Installment loans to individuals

2 375 377 Total nonaccrual loans $ 37,217 41,938 79,155

Among non-covered loans, the tables above indicate small increases in most categories of non-covered nonaccrual loans. Residential first mortgage loans experienced the largest increase, which was caused by increased efforts to work with home borrowers on repayment plans, increased legal delays in the foreclosure process, and continued challenging economic conditions in some

of our more rural market areas. "Restructured loans - accruing", or troubled debt restructurings (TDRs), are accruing loans for which we have granted concessions to the borrower as a result of the borrower's financial difficulties. As seen in the previous table "Asset Quality Data", at March 31, 2014, total TDRs (covered and non-covered) amounted to $33.8 million, compared to $36.7 million at December 31, 2013, and $35.0 million at March 31, 2013. The decline from December 31, 2013 to March 31, 2014 is primarily a result of TDRs that re-defaulted during the quarter and were placed on nonaccrual status. Foreclosed real estate includes primarily foreclosed properties. Non-covered foreclosed real estate has decreased over the past year, amounting to $11.7 million at March 31, 2014, $12.3 million at December 31, 2013, and $20.1 million at March 31, 2013. The decreases were the result of strong sales activity during the periods, which was consistent with our strategy implemented in 2012 to accelerate the disposition of foreclosed properties. At March 31, 2014, we also held $19.5 million in foreclosed real estate that is subject to the loss share agreements with the FDIC, which is a decline from $24.5 million at December 31, 2013 and $30.2 million at March 31, 2013. The decreases are due to increased property sales activity, particularly along the North Carolina coast, which is where most of our covered foreclosed properties are located. Page 53 Index We believe that the fair values of the items of foreclosed real estate, less estimated costs to sell, equal or exceed their respective carrying values at the dates presented.



The following table presents the detail of all of our foreclosed real estate at each period end (covered and non-covered):

($ in thousands) At March 31, 2014 At December 31, 2013 At March 31, 2013 Vacant land $ 16,374 19,295 30,229 1-4 family residential properties 6,856 7,982 11,713 Commercial real estate 8,014 9,471 8,329 Total foreclosed real estate $ 31,244 36,748 50,271



The following segregates our foreclosed real estate at March 31, 2014 into covered and non-covered:

($ in thousands) Covered Foreclosed Non-covered Total Foreclosed Real Estate Foreclosed Real Estate Real Estate Vacant land $ 11,508 4,866 16,374

1-4 family residential properties 4,730 2,126 6,856 Commercial real estate 3,266

4,748 8,014 Total foreclosed real estate $ 19,504 11,740 31,244



The following segregates our foreclosed real estate at December 31, 2013 into covered and non-covered:

($ in thousands) Covered Foreclosed Non-covered Total Foreclosed Real Estate Foreclosed Real Estate Real Estate Vacant land $ 14,043 5,252 19,295

1-4 family residential properties 5,102 2,880 7,982 Commercial real estate 5,352

4,119 9,471 Total foreclosed real estate $ 24,497 12,251 36,748 Page 54 Index



The following table presents geographical information regarding our nonperforming assets at March 31, 2014.

As of March 31, 2014 ($ in thousands) Nonperforming Loans to Total Covered Non-covered Total Total Loans Loans Nonaccrual loans and Troubled Debt Restructurings (1) Eastern Region (NC) $ 30,769 11,728 42,497 $ 569,000 7.5% Triangle Region (NC) - 21,343 21,343 765,000 2.8% Triad Region (NC) - 17,606 17,606 372,000 4.7% Charlotte Region (NC) - 2,351 2,351 97,000 2.4% Southern Piedmont Region (NC) 1,861 6,541 8,402 237,000 3.5% Western Region (NC) 6,656 14 6,670 55,000 12.1% South Carolina Region 129 3,396 3,525 108,000 3.3% Virginia Region - 7,485 7,485 232,000 3.2% Other - - - 12,000 0.0%



Total nonaccrual loans and troubled debt restructurings $ 39,415

70,464 109,879 $ 2,447,000 4.5% Foreclosed Real Estate (1) Eastern Region (NC) $ 13,601 1,705 15,306 Triangle Region (NC) - 3,642 3,642 Triad Region (NC) - 2,976 2,976 Charlotte Region (NC) - 687 687 Southern Piedmont Region (NC) 411 842 1,253 Western Region (NC) 5,443 - 5,443 South Carolina Region 49 1,317 1,366 Virginia Region - 154 154 Other - 417 417 Total foreclosed real estate $ 19,504 11,740 31,244



(1) The counties comprising each region are as follows:

Eastern North Carolina Region - New Hanover, Brunswick, Duplin, Dare, Beaufort, Onslow, Carteret

Triangle North Carolina Region - Moore, Lee, Harnett, Chatham, Wake

Triad North Carolina Region - Montgomery, Randolph, Davidson, Rockingham, Guilford, Stanly

Charlotte North Carolina Region - Iredell, Cabarrus, Rowan, Mecklenburg

Southern Piedmont North Carolina Region - Anson, Richmond, Scotland, Robeson, Bladen, Columbus, Cumberland

Western North Carolina Region - Buncombe

South Carolina Region - Chesterfield, Dillon, Florence, Horry

Virginia Region - Wythe, Washington, Montgomery, Pulaski, Roanoke

Summary of Loan Loss Experience

The allowance for loan losses is created by direct charges to operations (known as a "provision for loan losses" for the period in which the charge is taken). Losses on loans are charged against the allowance in the period in which such loans, in management's opinion, become uncollectible. The recoveries realized during the period are credited to this allowance. We have no foreign loans, few agricultural loans and do not engage in significant lease financing or highly leveraged transactions. Commercial loans are diversified among a variety of industries. The majority of our real estate loans are primarily personal and commercial loans where real estate provides additional security for the loan. Collateral for virtually all of these loans is located within our principal market area. The weak economic environment since 2009 has resulted in elevated levels of classified and nonperforming assets, which has led to higher provisions for loan losses compared to historical averages. While we have begun to see signs of a recovering economy in most of our market areas, the recovery seems to be lagging and is less robust than that of the national economy. We continue to have an elevated level of past due and adversely classified assets compared to historic averages. In fact, over the past year we have experienced steady, but small, increases in our non-covered nonperforming and adversely classified assets - see Note 7 to the consolidated financial statements for detail. Despite the higher levels of these problem assets, based on our analysis, we believe the severity of the loss rate inherent in our classified loans is less than in recent years. In addition, we believe that our allowance for loan losses is sufficient to absorb the probable losses inherent in our portfolio at March 31, 2014. Page 55 Index

Our total provision for loan losses was $3.6 million for the first quarter of 2014 compared to $11.1 million in the first quarter of 2013. The total provision for loan losses is comprised of provisions for loan losses for non-covered loans and provisions for loan losses for covered loans, as discussed in the following paragraphs.

The provision for loan losses on non-covered loans amounted to $3.4 million in the first quarter of 2014 compared to $5.8 million in the first quarter of 2013. The lower provision in 2014 was primarily the result of lower loan growth during the quarter, less inherent risk in our portfolio resulting from stabilization of overall asset quality, and low levels of net charge-offs. The provision for loan losses on covered loans amounted to $0.2 million in the first quarter of 2014 compared to $5.4 million in the first quarter of 2013. The decrease was primarily due to lower levels of covered nonperforming loans during the period, stabilization in the underlying collateral values of nonperforming loans, and a $1.9 million recovery that we realized in the first quarter of 2014. For the first three months of 2014, we recorded $4.0 million in net charge-offs, compared to $7.8 million for the comparable period of 2013. The net charge-offs in 2014 included $1.0 million of covered loans and $2.9 million of non-covered loans, whereas in 2013 net charge-offs included $5.1 million of covered loans and $2.7 million of non-covered loans. The charge-offs in 2014 continue a trend that began in 2010, with charge-offs being concentrated in the construction and land development real estate categories. These types of loans have been impacted the most by the recession and decline in new housing. The allowance for loan losses amounted to $48.1 million at March 31, 2014, compared to $48.5 million at December 31, 2013 and $49.8 million at March 31, 2013. At March 31, 2014, December 31, 2013, and March 31, 2013, the allowance for loan losses attributable to covered loans was $3.4 million, $4.2 million, and $5.0 million, respectively. The allowance for loan losses for covered loans is attributable to covered loans that have exhibited credit quality deterioration due to lower collateral valuations. The allowance for loan losses for non-covered loans has remained stable and amounted to $44.7 million, $44.3 million, and $44.8 million at March 31, 2014, December 31, 2013, and March

31, 2013, respectively.

We believe our reserve levels are adequate to cover probable loan losses on the loans outstanding as of each reporting date. It must be emphasized, however, that the determination of the reserve using our procedures and methods rests upon various judgments and assumptions about economic conditions and other factors affecting loans. No assurance can be given that we will not in any particular period sustain loan losses that are sizable in relation to the amounts reserved or that subsequent evaluations of the loan portfolio, in light of conditions and factors then prevailing, will not require significant changes in the allowance for loan losses or future charges to earnings. See "Critical Accounting Policies - Allowance for Loan Losses" above. In addition, various regulatory agencies, as an integral part of their examination process, periodically review our allowance for loan losses and value of other real estate. Such agencies may require us to recognize adjustments to the allowance or the carrying value of other real estate based on their judgments about information available at the time of their examinations. Page 56 Index For the periods indicated, the following table summarizes our balances of loans outstanding, average loans outstanding, changes in the allowance for loan losses arising from charge-offs and recoveries, and additions to the allowance for loan losses that have been charged to expense. ($ in thousands) Three Months Twelve Months Three Months Ended Ended Ended March 31, December 31, March 31, 2014 2013 2013 Loans outstanding at end of period $ 2,447,277 2,463,194 2,396,151 Average amount of loans outstanding $ 2,459,368 2,419,679 2,382,861 Allowance for loan losses, at beginning of year $

48,505 46,402 46,402 Provision for loan losses 3,575 30,616 11,149 52,080 77,018 57,551 Loans charged off:

Commercial, financial, and agricultural (1,559 ) (4,667 ) (1,431 ) Real estate - construction, land development & other land loans (2,019 ) (10,582 ) (4,782 ) Real estate - mortgage - residential (1-4 family) first mortgages (1,078 ) (4,764 ) (653 ) Real estate - mortgage - home equity loans / lines of credit (285 ) (3,143 ) (746 ) Real estate - mortgage - commercial and other (934 ) (7,027 ) (1,763 ) Installment loans to individuals (541 ) (2,253 ) (529 ) Total charge-offs (6,416 ) (32,436 ) (9,904 ) Recoveries of loans previously charged-off: Commercial, financial, and agricultural 26 198 23 Real estate - construction, land development & other land loans 2,155 777 605 Real estate - mortgage - residential (1-4 family) first mortgages 30 595 526 Real estate - mortgage - home equity loans / lines of credit 21 199 66 Real estate - mortgage - commercial and other 112 1,531 787 Installment loans to individuals 119 623 135 Total recoveries 2,463 3,923 2,142 Net charge-offs (3,953 ) (28,513 ) (7,762 ) Allowance for loan losses, at end of period $ 48,127 48,505 49,789



Ratios:

Net charge-offs as a percent of average loans (annualized) 0.65% 1.18% 1.32% Allowance for loan losses as a percent of loans at end of period 1.97% 1.97% 2.08% Page 57 Index The following table discloses the activity in the allowance for loan losses for the three months ended March 31, 2014, segregated into covered and non-covered. As of March 31, 2014 ($ in thousands) Covered Non-covered Total Loans outstanding at end of period $ 190,551 2,256,726 2,447,277 Average amount of loans outstanding $ 200,430



2,258,938 2,459,368

Allowance for loan losses, at beginning of year $ 4,242 44,263 48,505 Provision for loan losses 210 3,365 3,575 4,452 47,628 52,080 Loans charged off: Commercial, financial, and agricultural (1,045 ) (514 ) (1,559 ) Real estate - construction, land development & other land loans (1,076 ) (943 ) (2,019 ) Real estate - mortgage - residential (1-4 family) first mortgages (480 ) (598 ) (1,078 ) Real estate - mortgage - home equity loans / lines of credit (23 ) (262 ) (285 ) Real estate - mortgage - commercial and other (322 ) (612 ) (934 ) Installment loans to individuals (2 )



(539 ) (541 )

Total charge-offs (2,948 )



(3,468 ) (6,416 )

Recoveries of loans previously charged-off: Commercial, financial, and agricultural - 26 26 Real estate - construction, land development & other land loans 1,917 238 2,155 Real estate - mortgage - residential (1-4 family) first mortgages - 30 30 Real estate - mortgage - home equity loans / lines of credit - 21 21 Real estate - mortgage - commercial and other - 112 112 Installment loans to individuals - 119 119 Total recoveries 1,917 546 2,463 Net charge-offs (1,031 )



(2,922 ) (3,953 ) Allowance for loan losses, at end of period $ 3,421 44,706 48,127

The following table discloses the activity in the allowance for loan losses for the three months ended March 31, 2013, segregated into covered and non-covered. As of March 31, 2013 ($ in thousands) Covered Non-covered Total Loans outstanding at end of period $ 263,468 2,132,683 2,396,151 Average amount of loans outstanding $



272,891 2,109,970 2,382,861

Allowance for loan losses, at beginning of year $ 4,759 41,643 46,402 Provision for loan losses 5,378 5,771 11,149 10,137 47,414 57,551 Loans charged off: Commercial, financial, and agricultural (608 ) (823 ) (1,431 )



Real estate - construction, land development & other land loans (2,999 ) (1,783 ) (4,782 ) Real estate - mortgage - residential (1-4 family) first mortgages (258 )

(395 ) (653 ) Real estate - mortgage - home equity loans / lines of credit (21 ) (725 ) (746 ) Real estate - mortgage - commercial and other (1,223 ) (540 ) (1,763 ) Installment loans to individuals 0 (529 ) (529 ) Total charge-offs



(5,109 ) (4,795 ) (9,904 )

Recoveries of loans previously charged-off: Commercial, financial, and agricultural - 23 23 Real estate - construction, land development & other land loans - 605 605



Real estate - mortgage - residential (1-4 family) first mortgages -

526 526 Real estate - mortgage - home equity loans / lines of credit - 66 66 Real estate - mortgage - commercial and other - 787 787 Installment loans to individuals

- 135 135 Total recoveries - 2,142 2,142 Net charge-offs (5,109 ) (2,653 ) (7,762 ) Allowance for loan losses, at end of period $ 5,028 44,761 49,789 Based on the results of our loan analysis and grading program and our evaluation of the allowance for loan losses at March 31, 2014, there have been no material changes to the allocation of the allowance for loan losses among the various categories of loans since December 31, 2013. Page 58 Index



Liquidity, Commitments, and Contingencies

Our liquidity is determined by our ability to convert assets to cash or acquire alternative sources of funds to meet the needs of our customers who are withdrawing or borrowing funds, and to maintain required reserve levels, pay expenses and operate the Company on an ongoing basis. Our primary liquidity sources are net income from operations, cash and due from banks, federal funds sold and other short-term investments. Our securities portfolio is comprised almost entirely of readily marketable securities, which could also be sold

to provide cash.

In addition to internally generated liquidity sources, we have the ability to obtain borrowings from the following three sources - 1) an approximately $438 million line of credit with the Federal Home Loan Bank (of which $70 million was outstanding at March 31, 2014), 2) a $50 million overnight federal funds line of credit with a correspondent bank (of which $10 million was outstanding at March 31, 2014), and 3) an approximately $83 million line of credit through the Federal Reserve Bank of Richmond's discount window (of which $10 million was outstanding at March 31, 2014). In addition to the outstanding borrowings from the FHLB that reduce the available borrowing capacity of that line of credit, our borrowing capacity was reduced by $193 million and $143 million at March 31, 2014 and 2013, respectively, as a result of our pledging letters of credit for public deposits at each of those dates. Unused and available lines of credit amounted to $288 million at March 31, 2014 compared to $254 million at December 31, 2013. Our overall liquidity has increased since March 31, 2013, primarily as a result of our increased borrowings. Our liquid assets (cash and securities) as a percentage of our total deposits and borrowings increased from 18.7% at March 31, 2013 to 21.1% at March 31, 2014. We believe our liquidity sources, including unused lines of credit, are at an acceptable level and remain adequate to meet our operating needs in the foreseeable future. We will continue to monitor our liquidity position carefully and will explore and implement strategies to increase liquidity if deemed appropriate. The amount and timing of our contractual obligations and commercial commitments has not changed materially since December 31, 2013, detail of which is presented in Table 18 on page 87 of our 2013 Annual Report on Form 10-K.



We are not involved in any legal proceedings that, in our opinion, could have a material effect on our consolidated financial position.

Off-Balance Sheet Arrangements and Derivative Financial Instruments

Off-balance sheet arrangements include transactions, agreements, or other contractual arrangements pursuant to which we have obligations or provide guarantees on behalf of an unconsolidated entity. We have no off-balance sheet arrangements of this kind other than letters of credit and repayment guarantees associated with our trust preferred securities. Derivative financial instruments include futures, forwards, interest rate swaps, options contracts, and other financial instruments with similar characteristics. We have not engaged in significant derivative activities through March 31, 2014, and have no current plans to do so. Capital Resources We are regulated by the Board of Governors of the Federal Reserve Board (FED) and are subject to the securities registration and public reporting regulations of the Securities and Exchange Commission. Our banking subsidiary is regulated by the Federal Deposit Insurance Corporation (FDIC) and the North Carolina Office of the Commissioner of Banks. We are not aware of any recommendations of regulatory authorities or otherwise which, if they were to be implemented, would have a material effect on our liquidity, capital resources, or operations. We must comply with regulatory capital requirements established by the FED and FDIC. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. Our capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. These capital standards require us to maintain minimum ratios of "Tier 1" capital to total risk-weighted assets and total capital to risk-weighted assets of 4.00% and 8.00%, respectively. Tier 1 capital is comprised of total shareholders' equity calculated in accordance with generally accepted accounting principles, excluding accumulated other comprehensive income (loss), less intangible assets, and total capital is comprised of Tier 1 capital plus certain adjustments, the largest of which is our allowance for loan losses. Risk-weighted assets refer to our on- and off-balance sheet exposures, adjusted for their related risk levels using formulas set forth in FED and FDIC regulations. Page 59 Index

In addition to the risk-based capital requirements described above, we are subject to a leverage capital requirement, which calls for a minimum ratio of Tier 1 capital (as defined above) to quarterly average total assets of 3.00% to 5.00%, depending upon the institution's composite ratings as determined by its regulators. The FED has not advised us of any requirement specifically applicable to us.



At March 31, 2014, our capital ratios exceeded the regulatory minimum ratios discussed above. The following table presents our capital ratios and the regulatory minimums discussed above for the periods indicated.

March 31, December 31, March 31, 2014 2013 2013



Risk-based capital ratios:

Tier I capital to Tier I risk adjusted assets 15.57% 15.53% 15.56% Minimum required Tier I capital 4.00% 4.00% 4.00%

Total risk-based capital to Tier II risk-adjusted assets 16.83% 16.79% 16.82% Minimum required total risk-based capital 8.00% 8.00% 8.00% Leverage capital ratios: Tier I leverage capital to adjusted most recent quarter average assets

11.27% 11.18% 10.55% Minimum required Tier I leverage capital 4.00% 4.00% 4.00% Our bank subsidiary is also subject to capital requirements similar to those discussed above. The bank subsidiary's capital ratios do not vary materially from our capital ratios presented above. At March 31, 2014, our bank subsidiary exceeded the minimum ratios established by the FED and FDIC. In addition to regulatory capital ratios, we also closely monitor our ratio of tangible common equity to tangible assets ("TCE Ratio"). Our TCE ratio was 7.30% at March 31, 2014 compared to 7.46% at December 31, 2013 and 6.76% at March

31, 2013. Page 60 Index



BUSINESS DEVELOPMENT MATTERS

The following is a list of business development and other miscellaneous matters affecting First Bancorp and First Bank, our bank subsidiary.

On January 15, 2014, the First Bank branch located in Wallace, North Carolina

relocated to a new location at 517 North Norwood Street. A grand opening

celebration was held on January 24, 2014 with the staff welcoming customers to

its new and improved facility.



On January 16, 2014, the Company unveiled its new website,

www.LocalFirstBank.com, which has a new look and many new features that make

banking with First Bank better than ever.



On March 14, 2014, the Company announced a quarterly cash dividend of $0.08

cents per share payable on April 25, 2014 to shareholders of record on March

31, 2014. This is the same dividend rate as the Company declared in the first

quarter of 2013.



On March 21, 2014, the First Bank branch located in West Innes Street in

Salisbury, North Carolina was closed. The accounts at that branch were

reassigned to First Bank's branch located at 1525 Jake Alexander Boulevard.

The Company expects to open a full-service branch in Fuquay-Varina, North

Carolina, in the second quarter of 2014. The new branch will be located at 125

North Main Street.



The Company is planning to construct a new branch facility at 4110 Bradham

Drive, Jacksonville, North Carolina. Upon completion, the First Bank branch

located on Western Boulevard will be closed and the accounts at that branch

will be reassigned to the new and improved branch. This is expected to occur in

the first quarter of 2015 and is subject to regulatory approval. SHARE REPURCHASES We did not repurchase any shares of our common stock during the first three months of 2014. At March 31, 2014, we had approximately 214,000 shares available for repurchase under existing authority from our board of directors. We may repurchase these shares in open market and privately negotiated transactions, as market conditions and our liquidity warrants, subject to compliance with applicable regulations. See also Part II, Item 2 "Unregistered Sales of Equity Securities and Use of Proceeds."


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