CRITICAL ACCOUNTING POLICIES

We follow and apply accounting principles that 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/or use of estimates based on our best assumptions at the time of the estimation. We have identified two policies as being more sensitive in terms of judgments and estimates, taking into account their overall potential impact to our consolidated financial statements - 1) the allowance for loan losses and 2) intangible assets.

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 two components. The first component involves the estimation of losses on loans defined as "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. 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 an estimate of losses for all loans not considered to be impaired loans. First, loans that we have risk graded as having more than "standard" risk but are not considered to be impaired are assigned estimated loss percentages generally accepted in the banking industry. Loans that we have classified as having normal credit risk are segregated by loan type, and estimated loss percentages are assigned to each loan type, based on the historical losses, current economic conditions, and operational conditions specific to each loan type.

The reserve estimated for impaired loans is 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.

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). At our last evaluation, the fair value of our community banking operation exceeded its carrying value, including goodwill. 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.

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.

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 for the third quarter of 2008 amounted to $6,197,000, or $0.37 per diluted share. This represents an increase in net income of 7.9% and a decrease in diluted earnings per share of 7.5% from the $5,743,000, or $0.40 per diluted share, reported in the third quarter of 2007. For the nine months ended September 30, 2008, net income amounted to $17,004,000, or $1.07 per diluted share. This represents an increase in net income of 6.0% and a decrease in diluted earnings per share of 3.6% from the net income of $16,048,000, or $1.11 per diluted share, reported for the first nine months of 2007. The 2008 earnings reflect the impact of the acquisition of Great Pee Dee Bancorp, which had $213 million in total assets as of the acquisition date of April 1, 2008, and resulted in the issuance of 2,059,091 shares of First Bancorp common stock.

Net Interest Income and Net Interest Margin

Net interest income for the third quarter of 2008 amounted to $22.8 million, a 12.9% increase over the $20.2 million recorded in the third quarter of 2007. Net interest income for the nine months ended September 30, 2008 amounted to $64.1 million, a 9.1% increase over the $58.7 million recorded in the same nine month period in 2007.

The impact of growth in loans and deposits on net interest income was partially offset by a decline in our net interest margin (tax-equivalent net interest income divided by average earning assets). Our net interest margin for the third quarter of 2008 was 3.79%, a 21 basis point decline from the 4.00% margin realized in the third quarter of 2007. Our net interest margin for the first nine months of 2008 was 3.76% compared to 4.00% for the same nine months of 2007. Our net interest margin has been negatively impacted by the Federal Reserve lowering interest rates by a total of 325 basis points from September 2007 to September 2008.

Our net interest margin of 3.79% realized for the third quarter of 2008 was an eight basis point increase from the margin realized in the second quarter of 2008. With no changes in the prime rate of interest during the third quarter of 2008, this margin increase was primarily due to our ability to reprice time deposits that matured during the quarter at lower interest rates.

Provision for Loan Losses

Our provision for loan losses amounted to $2,851,000 in the third quarter of 2008 compared to $1,299,000 in the third quarter of 2007. The provision for loan losses for the nine month period ended September 30, 2008 was $6,443,000 compared to $3,742,000 recorded in the first nine months of 2007. The higher provisions in 2008 are primarily related to negative trends in asset quality.

Noninterest Income

Noninterest income amounted to $5.4 million for the third quarter of 2008, a 27.1% increase from the $4.3 million recorded in the third quarter of 2007. Noninterest income for the nine months ended September 30, 2008 amounted to $16.1 million, an increase of 20.8% from the $13.4 million recorded in the first nine months of 2007. The increases in noninterest income in 2008 primarily relate to increases in service charges on deposit accounts. These higher service charges were primarily associated with our customer overdraft protection program
- we expanded the program in the fourth quarter of 2007 to include debit card purchases and ATM withdrawals. Previously the overdraft protection program, in which we charge a fee for honoring payments on overdrawn accounts, only applied to written checks.

Noninterest Expenses

Noninterest expenses amounted to $15.5 million in the third quarter of 2008, an 11.0% increase over 2007. Noninterest expenses for the nine months ended September 30, 2008 amounted to $46.6 million, a 9.4% increase from the $42.6 million recorded in the first nine months of 2007. These increases are primarily attributable to our growth, including the April 1, 2008 acquisition of Great Pee Dee. Additionally, we recorded FDIC insurance expense of $337,000 and $839,000 for the three and nine month periods ended September 30, 2008, respectively, compared to none for the same periods in 2007, as a result of the FDIC recently beginning to charge for FDIC insurance again in order to replenish its reserves.

Our effective tax rate was 37%-38% for each of the three and nine month periods ended September 30, 2008 and 2007.

Our annualized return on average assets for the third quarter of 2008 was 0.96% compared to 1.06% for the third quarter of 2007. Our annualized return on average assets for the nine months ended September 30, 2008 was 0.93% compared to 1.01% for the first nine months of 2007.

Our annualized return on average equity for the third quarter of 2008 was 11.09% compared to 13.25% for the third quarter of 2007. Our annualized return on average equity for the nine months ended September 30, 2008 was 11.02% compared to 12.68% for the first nine months of 2007.

Balance Sheet Growth

During the third quarter of 2008, loans outstanding increased by $45 million, or 8.3% annualized, while deposits increased by $6 million, or 1.3% annualized. Our growth in deposits during the quarter was concentrated in brokered CD's, which had interest rates meaningfully lower than the interest rates being offered by several local competitors in our marketplace. Our brokered CD's amounted to $47 million at September 30, 2008 compared to $22 million at June 30, 2008. The $47 million in brokered CD's at September 30, 2008 represented just 2.3% of our total deposits.

Total assets at September 30, 2008 amounted to $2.7 billion, 18.2% higher than a year earlier. Total loans at September 30, 2008 amounted to $2.2 billion, a 20.3% increase from a year earlier, and total deposits amounted to $2.0 billion at September 30, 2008, an 11.2% increase from a year earlier. We completed the acquisition of Great Pee Dee Bancorp on April 1, 2008, which had $187 million in loans, $148 million in deposits, and $213 million in assets.

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 September 30, 2008 amounted to $22,785,000, an increase of $2,608,000, or 12.9%, from the $20,177,000 recorded in the third quarter of 2007. Net interest income on a taxable equivalent basis for the three months ended September 30, 2008 amounted to $22,950,000, an increase of $2,637,000, or 13.0%, from the $20,313,000 recorded in the third quarter of 2007. 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 September 30,
     ($ in thousands)                           2008                  2007
     Net interest income, as reported      $        22,785                20,177
     Tax-equivalent adjustment                         165                   136
     Net interest income, tax-equivalent   $        22,950                20,313

Net interest income for the nine months ended September 30, 2008 amounted to $64,050,000, an increase of $5,329,000, or 9.1%, from the $58,721,000 recorded in the first nine months of 2007. Net interest income on a taxable equivalent basis for the nine months ended September 30, 2008 amounted to $64,543,000, an increase of $5,423,000, or 9.2%, from the $59,120,000 recorded in the first nine months of 2007.

                                              Nine Months Ended September 30,
     ($ in thousands)                           2008                  2007
     Net interest income, as reported      $        64,050                58,721
     Tax-equivalent adjustment                         493                   399
     Net interest income, tax-equivalent   $        64,543                59,120

There are two primary factors that cause changes in the amount of net interest income that we record - 1) growth in loans and deposits, and 2) our net interest margin (tax-equivalent net interest income divided by average earning assets). For the three and nine months ended September 30, 2008, the increases in net interest income over the comparable periods in 2007 were due to growth in loans and deposits, as our net interest margins in 2008 have been lower than in the comparable periods of 2007. Our net interest margin of 3.79% in the third quarter of 2008 was lower than the 4.00% recorded in the third quarter of 2007. For the nine months ended September 30, 2008 and 2007, our net interest margin was 3.76% and 4.00%, respectively. Our net interest margin has been negatively impacted by the Federal Reserve lowering interest rates by a total of 325 basis points from September 2007 to September 2008. When interest rates are lowered, our net interest margin declines, at least temporarily, as most of our adjustable rate loans reprice downward immediately by the amount of the Federal Reserve cut, while rates on our customers' time deposits are fixed, and thus do not adjust downward until they mature. Also, for many of our deposit products, including time deposits that have recently matured, we have been unable to lower the interest rates we pay our customers by the full 325 basis point interest rate decrease due to competitive pressures. Additionally, some of our deposit accounts had rates lower than 3.25% prior to the rate cuts, and thus could not be reduced by 325 basis points.

The following tables present net interest income analysis on a taxable-equivalent basis for the three and nine month periods ended September 30, 2008 and 2007.

                                                   For the Three Months Ended September 30,
                                             2008                                           2007
                                                           Interest                                       Interest
                             Average         Average        Earned          Average         Average        Earned
($ in thousands)             Volume           Rate          or Paid         Volume           Rate          or Paid
Assets
Loans (1)                  $ 2,195,971           6.44 %    $  35,556      $ 1,819,253           7.79 %    $  35,717
Taxable securities             161,589           4.60 %        1,867          133,644           4.76 %        1,605
Non-taxable securities
(2)                             15,983           7.96 %          320           13,506           8.05 %          274
Short-term investments          38,494           2.18 %          211           50,077           5.66 %          715
Total interest-earning
assets                       2,412,037           6.26 %       37,954        2,016,480           7.54 %       38,311

Cash and due from banks         39,076                                         39,055
Premises and equipment          51,053                                         45,779
Other assets                    67,901                                         55,841
  Total assets             $ 2,570,067                                    $ 2,157,155

Liabilities
NOW accounts               $   197,710           0.19 %    $      94      $   191,389           0.39 %    $     187
Money market accounts          326,995           2.28 %        1,876          249,104           3.47 %        2,176
Savings accounts               133,672           1.71 %          576          107,312           1.73 %          468
Time deposits >$100,000        539,657           3.72 %        5,047          463,525           5.06 %        5,908
Other time deposits            584,137           3.49 %        5,131          570,958           4.72 %        6,789
   Total
interest-bearing
deposits                     1,782,171           2.84 %       12,724        1,582,288           3.89 %       15,528
Securities sold under
agreements to
repurchase                      39,293           1.96 %          194           34,410           3.78 %          328
Borrowings                     270,865           3.06 %        2,086          124,797           6.81 %        2,142
Total interest-bearing
liabilities                  2,092,329           2.85 %       15,004        1,741,495           4.10 %       17,998

Non-interest-bearing
deposits                       236,142                                        226,180
Other liabilities               19,359                                         17,533
Shareholders' equity           222,237                                        171,947
  Total liabilities and
shareholders' equity       $ 2,570,067                                    $ 2,157,155

Net yield on
interest-earning
 assets and net
interest income                                  3.79 %    $  22,950                            4.00 %    $  20,313
Interest rate spread                             3.41 %                                         3.44 %

Average prime rate                               5.00 %                                         8.18 %

(1) Average loans include nonaccruing loans, the effect of which is to lower the average rate shown.

(2) Includes tax-equivalent adjustments of $165,000 and $136,000 in 2008 and 2007, respectively, to reflect the tax benefit that the Company receives related to its 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.

                                                   For the Nine Months Ended September 30,
                                             2008                                           2007
                                                           Interest                                       Interest
                             Average         Average        Earned          Average         Average        Earned
($ in thousands)             Volume           Rate          or Paid         Volume           Rate          or Paid
Assets
Loans (1)                  $ 2,085,331           6.68 %    $ 104,309      $ 1,786,631           7.74 %    $ 103,420
Taxable securities             146,791           5.01 %        5,506          129,306           4.91 %        4,750
Non-taxable securities
(2)                             16,327           7.98 %          977           13,308           8.11 %          806
Short-term investments          43,406           2.86 %          930           47,335           5.79 %        2,051
Total interest-earning
assets                       2,291,855           6.51 %      111,722        1,976,580           7.51 %      111,027

Cash and due from banks         39,730                                         39,173
Premises and equipment          49,067                                         45,139
Other assets                    64,341                                         57,127
  Total assets             $ 2,444,993                                    $ 2,118,019

Liabilities
NOW accounts               $   196,956           0.20 %    $     300      $   192,321           0.40 %    $     574
Money market accounts          303,831           2.40 %        5,456          231,690           3.35 %        5,806
Savings accounts               124,058           1.66 %        1,540          106,662           1.60 %        1,275
Time deposits >$100,000        523,711           4.17 %       16,345          443,539           5.05 %       16,768
Other time deposits            585,511           3.95 %       17,293          566,076           4.68 %       19,822
   Total
interest-bearing
deposits                     1,734,067           3.15 %       40,934        1,540,288           3.84 %       44,245
Securities sold under
agreements to
repurchase                      39,403           2.22 %          656           40,198           3.82 %        1,148
Other, principally
borrowings                     210,193           3.55 %        5,589          128,687           6.77 %        6,514
Total interest-bearing
liabilities                  1,983,663           3.18 %       47,179        1,709,173           4.06 %       51,907

Non-interest-bearing
deposits                       235,750                                        221,184
Other liabilities               19,401                                         18,411
Shareholders' equity           206,179                                        169,251
  Total liabilities and
shareholders' equity       $ 2,444,993                                    $ 2,118,019

Net yield on
interest-earning
 assets and net
interest income                                  3.76 %    $  64,543                            4.00 %    $  59,120
Interest rate spread                             3.33 %                                         3.45 %

Average prime rate                               5.43 %                                         8.23 %

(1) Average loans include nonaccruing loans, the effect of which is to lower the average rate shown.

(2) Includes tax-equivalent adjustments of $493,000 and $399,000 in 2008 and 2007, respectively, to reflect the tax benefit that the Company receives related to its 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 third quarter of 2008 were $2.196 billion, which was 20.7% higher than the average loans outstanding for the third quarter of 2007 ($1.819 billion). Average loans outstanding for the nine months ended September 30, 2008 were $2.085 billion, which was 16.7% higher than the average loans outstanding for the nine months ended September 30, 2007 ($1.787 billion).

Average total deposits outstanding for the third quarter of 2008 were $2.018 billion, which was 11.6% higher than the average deposits outstanding for the third quarter of 2007 ($1.808 billion). Average deposits outstanding for the nine months ended September 30, 2008 were $1.970 billion, which was 11.9% higher than the average deposits outstanding for the nine months ended September 30, 2007 ($1.761 billion). Generally, we can reinvest funds from deposits at higher yields than the interest rate being paid on those deposits, and therefore increases in deposits typically result in higher amounts of net interest income.

A majority of the increases in loans and deposits came as a result of the acquisition of Great Pee Dee. As of the April 1, 2008 acquisition, Great Pee Dee had $187 million in loans and $148 million in deposits. See additional discussion regarding the nature of the growth in loans and deposits in the section entitled "Financial Condition" below. The effect of the higher amounts . . .