UNITED STATES


SECURITIES AND EXCHANGE
COMMISSION


Washington, D.C.
20549





FORM 10-Q





þQUARTERLY REPORT PURSUANT TO SECTION 13
OR 15(d)


OF THE SECURITIES EXCHANGE ACT OF
1934





For the Quarterly Period Ended March 31,
2009





or





 ̈TRANSITION REPORT PURSUANT TO SECTION
13 OR 15(d)


OF THE SECURITIES EXCHANGE ACT OF
1934





For the Transition Period fromto









CAPITAL BANK
CORPORATION


(Exact name of registrant as specified
in its charter)





North
    Carolina
            
            000-30062
            
            56-2101930(State or other jurisdiction of
      incorporation)
            
            (Commission
              File
Number)
            
            (IRS Employer
              Identification
      No.)





333 Fayetteville Street, Suite
700


Raleigh, North Carolina
27601


(Address of principal executive
offices)





(919) 645-6400


(Registrant’s telephone number,
including area code)





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





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





Large accelerated filer ̈
              Accelerated filerþNon-accelerated filer ̈ (Do not check if a smaller
      reporting company)
              Smaller reporting company ̈




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


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





As of May 7, 2009 therewere11,300,369shares outstanding of the registrant’s
common stock, no par value.





CAPITAL BANK
CORPORATION


Form 10-Q for the Quarterly Period Ended
March 31, 2009








INDEX





PART I – FINANCIAL
      INFORMATION
                Page
      No.Item 1.
                Financial
      StatementsCondensed Consolidated Balance
      Sheets as of March 31, 2009 (Unaudited) and December 31,
      2008
                3Condensed Consolidated Statements
      of Operations for the Three Months Ended March 31, 2009 and 2008
      (Unaudited)
                4Condensed Consolidated Statements
      of Changes in Shareholders’ Equity and Comprehensive Income for the Three
      Months Ended March 31, 2009 and 2008 (Unaudited)
                5Condensed Consolidated Statements
      of Cash Flows for the Three Months Ended March 31, 2009 and 2008
      (Unaudited)
                6Notes to Condensed Consolidated
      Financial Statements (Unaudited)
                7Item
      2.
                Management’s Discussion and
      Analysis of Financial Condition and Results of
      Operations
                15Item
      3.
                Quantitative and Qualitative
      Disclosures about Market Risk
                26Item 4.
                Controls and
      Procedures
                26PART II – OTHER
      INFORMATIONItem
      1.
                Legal
      Proceedings
                27Item
      1A.
                Risk
Factors
                27Item
      2.
                Unregistered Sales of Equity
      Securities and Use of Proceeds
                33Item 3.
                Defaults upon Senior
      Securities
                33Item
      4.
                Submission of Matters to a Vote of
      Security Holders
                33Item
      5.
                Other
      Information
                33Item
      6.
                Exhibits
                34Signatures





- 2
-
 Index


PART I – FINANCIAL
INFORMATION





Item 1.Financial
Statements





CAPITAL BANK
CORPORATION


CONDENSED CONSOLIDATED BALANCE
SHEETS


March 31, 2009 and December 31,
2008


March
      31, 2009
                  
                  December
      31, 2008(Dollars
      in thousands except share data)
                  
                  (Unaudited)AssetsCash and due from
      banks:Interest-earning
                  
                  $
                  378
                  
                  $
                  719Noninterest-earning
                  
                  
                  39,514
                  
                  
                  53,607Federal
      funds sold and short term investments
                  
                  
                  25
                  
                  
                  129Total
      cash and cash equivalents
                  
                  
                  39,917
                  
                  
                  54,455Investment
      securities – available for sale, at fair value
                  
                  
                  281,505
                  
                  
                  272,944Investment
      securities – held to maturity, at amortized cost
                  
                  
                  4,805
                  
                  
                  5,194Loans –
      net of unearned income and deferred fees
                  
                  
                  1,277,064
                  
                  
                  1,254,368Allowance
      for loan losses
                  
                  
                  (18,480
                  )
                  
                  (14,795
                  )Net
      loans
                  
                  
                  1,258,584
                  
                  
                  1,239,573Premises
      and equipment, net
                  
                  
                  24,810
                  
                  
                  24,640Bank-owned
      life insurance
                  
                  
                  22,646
                  
                  
                  22,368Deposit
      premium, net
                  
                  
                  3,569
                  
                  
                  3,857Deferred
      income tax
                  
                  
                  9,462
                  
                  
                  9,342Accrued
      interest receivable
                  
                  
                  6,114
                  
                  
                  6,225Other
      assets
                  
                  
                  14,199
                  
                  
                  15,634Total
      assets
                  
                  $
                  1,665,611
                  
                  $
                  1,654,232LiabilitiesDeposits:Demand,
      noninterest-bearing
                  
                  $
                  127,062
                  
                  $
                  125,281Savings
      and interest-bearing checking
                  
                  
                  205,402
                  
                  
                  173,711Money
      market deposit accounts
                  
                  
                  206,194
                  
                  
                  212,780Time
      deposits less than $100,000
                  
                  
                  499,063
                  
                  
                  509,231Time
      deposits $100,000 and greater
                  
                  
                  303,253
                  
                  
                  294,311Total
      deposits
                  
                  
                  1,340,974
                  
                  
                  1,315,314Repurchase
      agreements and federal funds purchased
                  
                  
                  11,650
                  
                  
                  15,010Borrowings
                  
                  
                  127,000
                  
                  
                  132,000Subordinated
      debentures
                  
                  
                  30,930
                  
                  
                  30,930Other
      liabilities
                  
                  
                  12,383
                  
                  
                  12,464Total
      liabilities
                  
                  
                  1,522,937
                  
                  
                  1,505,718Commitments
      and contingenciesShareholders’
      EquityPreferred
      stock, $1,000 par value; 100,000 shares authorized; 41,279 shares issued
      and outstanding (liquidation preference of $41,279)
                  
                  
                  39,910
                  
                  
                  39,839Common
      stock, no par value; 20,000,000 shares authorized; 11,300,369 and
      11,238,085 shares issued and outstanding
                  
                  
                  139,495
                  
                  
                  139,209Retained
      deficit
                  
                  
                  (37,373
                  )
                  
                  (31,420
                  )Accumulated
      other comprehensive income
                  
                  
                  642
                  
                  
                  886Total
      shareholders’ equity
                  
                  
                  142,674
                  
                  
                  148,514Total
      liabilities and shareholders’ equity
                  
                  $
                  1,665,611
                  
                  $
                  1,654,232
 
 The accompanying notes are an integral
part of these condensed consolidated financial statements.
  - 3
-
 Index
  CAPITAL BANK
CORPORATION
 CONDENSED CONSOLIDATED STATEMENTS OF
OPERATIONS
 For the ThreeMonthsEndedMarch 31, 2009 and 2008
(Unaudited)
 March 31,2009
                  
                  March 31,
    2008(Dollars in thousands except per
      share data)Interest
      income:Loans and loan
      fees
                  
                  $
                  16,092
                  
                  $
                  19,499Investment
      securities:Taxable interest
      income
                  
                  
                  2,799
                  
                  
                  2,218Tax-exempt interest
      income
                  
                  
                  764
                  
                  
                  829Dividends
                  
                  
                  –
                  
                  
                  117Federal funds and other interest
      income
                  
                  
                  13
                  
                  
                  55Total interest
      income
                  
                  
                  19,668
                  
                  
                  22,718Interest
      expense:Deposits
                  
                  
                  7,769
                  
                  
                  9,072Borrowings and repurchase
      agreements
                  
                  
                  1,718
                  
                  
                  2,737Total interest
      expense
                  
                  
                  9,487
                  
                  
                  11,809Net interest
      income
                  
                  
                  10,181
                  
                  
                  10,909Provision for loan
      losses
                  
                  
                  5,986
                  
                  
                  565Net interest income after
      provisionfor loan
    losses
                  
                  
                  4,195
                  
                  
                  10,344Noninterest
      income:Service charges and other
      fees
                  
                  
                  952
                  
                  
                  959Mortgage fees and
      revenues
                  
                  
                  233
                  
                  
                  272Other loan
    fees
                  
                  
                  294
                  
                  
                  113Brokerage
    fees
                  
                  
                  163
                  
                  
                  156Bank card
      services
                  
                  
                  339
                  
                  
                  299Bank-owned life
      insurance
                  
                  
                  258
                  
                  
                  302Net gain(loss)on investment
      securities
                  
                  
                  (320
                  )
                  
                  71Other
                  
                  
                  187
                  
                  
                  68Total noninterest
      income
                  
                  
                  2,106
                  
                  
                  2,240Noninterest
      expense:Salaries and employee
      benefits
                  
                  
                  6,013
                  
                  
                  5,036Occupancy
                  
                  
                  1,373
                  
                  
                  997Furniture and
      equipment
                  
                  
                  830
                  
                  
                  747Data processing and
      telecommunications
                  
                  
                  631
                  
                  
                  432Advertising
                  
                  
                  323
                  
                  
                  315Office
    expenses
                  
                  
                  335
                  
                  
                  365Professional
      fees
                  
                  
                  379
                  
                  
                  370Business development and
      travel
                  
                  
                  328
                  
                  
                  333Amortization of deposit
      premiums
                  
                  
                  288
                  
                  
                  257Miscellaneous loan handling
      costs
                  
                  
                  163
                  
                  
                  94Directors
    fees
                  
                  
                  307
                  
                  
                  267Insurance
                  
                  
                  104
                  
                  
                  95FDIC deposit
      insurance
                  
                  
                  229
                  
                  
                  47Other
                  
                  
                  261
                  
                  
                  263Total noninterest
      expense
                  
                  
                  11,564
                  
                  
                  9,618Net(loss)income before tax(benefit)expense
                  
                  
                  (5,263
                  )
                  
                  2,966Income tax (benefit)
      expense
                  
                  
                  (800
                  )
                  
                  799Net(loss)income
                  
                  $
                  (4,463
                  )
                  $
                  2,167Dividends
      and accretion on preferred stock
                  
                  
                  587
                  
                  
                  –Net
      (loss) income attributable to common shareholders
                  
                  $
                  (5,050
                  )
                  $
                  2,167Earnings (loss) per common share –
      basic
                  
                  $
                  (0.45
                  )
                  $
                  0.19Earnings (loss) per common share –
      diluted
                  
                  $
                  (0.45
                  )
                  $
                  0.19
 
 The accompanying notes are an integral
part of these condensed consolidated financial statements.
 - 4
-
 Index
  CAPITAL BANK
CORPORATION
 CONDENSED CONSOLIDATED STATEMENTS OF
CHANGES IN SHAREHOLDERS’ EQUITYAND COMPREHENSIVE
INCOME
 For theThreeMonths EndedMarch 31, 2009and 2008
(Unaudited)
 
 Shares
      of Common Stock
                  
                  Common
      Stock
                  
                  Preferred
      Stock
                  
                  Other
      Comprehensive Income
                  
                  Retained
      Earnings (Deficit)
                  
                  Total(Dollars in thousands exceptpershare data)Balance at January 1,
      2008
                  
                  
                  11,169,777
                  
                  $
                  136,154
                  
                  $
                  –
                  
                  $
                  161
                  
                  $
                  27,985
                  
                  $
                  164,300Repurchase of outstanding common
      stock
                  
                  
                  (166
                  )
                  
                  (2
                  )
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (2
                  )Issuance of common stock for
      options exercised
                  
                  
                  15,591
                  
                  
                  103
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  103Issuance of common stock for
      services
                  
                  
                  51,883
                  
                  
                  590
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  590Net income
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  2,167
                  
                  
                  2,167Net unrealizedgainonsecurities – available for sale,net of tax
      of$292
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  571
                  
                  
                  
                  
                  
                  571Net unrealized gain related tocash flow
      hedge,net
      of tax of $714
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  1,139
                  
                  
                  
                  
                  
                  1,139Comprehensive
      income
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  3,877Dividends on common stock
      ($0.08per
      share)
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (901
                  )
                  
                  (901
                  )Balance atMarch 31,
    2008
                  
                  
                  11,237,085
                  
                  $
                  136,845
                  
                  $
                  –
                  
                  $
                  1,871
                  
                  $
                  29,251
                  
                  $
                  167,967Balance atJanuary 1,
    2009
                  
                  
                  11,238,085
                  
                  $
                  139,209
                  
                  $
                  39,839
                  
                  $
                  886
                  
                  $
                  (31,420
                  )
                  $
                  148,514Issuance of common stock for
      services
                  
                  
                  62,284
                  
                  
                  120
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  120Stock option
    expense
                  
                  
                  
                  
                  
                  13
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  13Directors deferred compensation
      expense
                  
                  
                  
                  
                  
                  153
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  153Accretion
      of preferred stock discount
                  
                  
                  
                  
                  
                  
                  
                  
                  71
                  
                  
                  
                  
                  
                  (71
                  )
                  
                  –Net loss
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (4,463
                  )
                  
                  (4,463
                  )Net unrealizedgainonsecurities – available for sale,net of tax
      of$196
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  312
                  
                  
                  
                  
                  
                  312Net unrealized loss related tocash flow
      hedge,net
      of tax benefit of $315
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (502
                  )
                  
                  
                  
                  
                  (502
                  )Prior service cost recognized on
      SERP
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (54
                  )
                  
                  
                  
                  
                  (54
                  )Comprehensiveloss
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (4,707
                  )Dividends on preferred
      stock
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (516
                  )
                  
                  (516
                  )Dividends on common stock
      ($0.08per share)
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (903
                  )
                  
                  (903
                  )Balance atMarch 31,
    2009
                  
                  
                  11,300,369
                  
                  $
                  139,495
                  
                  $
                  39,910
                  
                  $
                  642
                  
                  $
                  (37,373
                  )
                  $
                  142,674
 
 The accompanying notes are an integral
part of these condensed consolidated financial
statements.
  - 5
-
 Index




CAPITAL BANK
CORPORATION


CONDENSED CONSOLIDATED STATEMENTS OF
CASH FLOWS


For the Three Months Ended March 31,
2009 and 2008 (Unaudited)
 
 2009
                  
                  2008(Dollars in
      thousands)Cash flows from operating
      activities:Net
      (loss) income
                  
                  $
                  (4,463
                  )
                  $
                  2,167Adjustments
      to reconcile net income to net cash provided by operating
      activities:Provision
      for loan losses
                  
                  
                  5,986
                  
                  
                  565Amortization
      of deposit premium
                  
                  
                  288
                  
                  
                  257Depreciation
                  
                  
                  759
                  
                  
                  668Stock-based
      compensation
                  
                  
                  196
                  
                  
                  172Net
      loss (gain) on investment securities
                  
                  
                  320
                  
                  
                  (71
                  )Net
      amortization of premium/discount on investment securities
                  
                  
                  20
                  
                  
                  26Loss
      (gain) on disposal of premises, equipment and real estate
      owned
                  
                  
                  8
                  
                  
                  (21
                  )Deferred
      income tax (benefit) expense
                  
                  
                  (18
                  )
                  
                  819Increase
      in cash surrender value of bank-owned life insurance
                  
                  
                  (278
                  )
                  
                  (113
                  )Net
      decrease (increase) in accrued interest receivable and other
      assets
                  
                  
                  3,105
                  
                  
                  (1,447
                  )Net
      (decrease) increase in accrued interest payable and other
      liabilities
                  
                  
                  (286
                  )
                  
                  679Net
      cash provided by operating activities
                  
                  
                  5,637
                  
                  
                  3,701Cash
      flows from investing activities:Loan
      originations, net of principal repayments
                  
                  
                  (27,321
                  )
                  
                  (56,054
                  )Additions
      to premises and equipment
                  
                  
                  (961
                  )
                  
                  (1,412
                  )Proceeds
      from sales of premises, equipment and real estate owned
                  
                  
                  79
                  
                  
                  84Net
      purchases of FHLB and Silverton Bank stock
                  
                  
                  (20
                  )
                  
                  (798
                  )Purchase
      of securities – available for sale
                  
                  
                  (16,958
                  )
                  
                  (32,045
                  )Proceeds
      from principal repayments/calls/maturities of securities – available for
      sale
                  
                  
                  8,590
                  
                  
                  30,605Proceeds
      from principal repayments/calls/maturities of securities – held to
      maturity
                  
                  
                  384
                  
                  
                  4,128Net
      cash used in investing activities
                  
                  
                  (36,207
                  )
                  
                  (55,492
                  )Cash
      flows from financing activities:Net
      increase in deposits
                  
                  
                  25,660
                  
                  
                  52,199Net
      decrease in repurchase agreements
                  
                  
                  (3,360
                  )
                  
                  (4,138
                  )Proceeds
      from borrowings
                  
                  
                  30,000
                  
                  
                  65,500Principal
      repayments of borrowings
                  
                  
                  (35,000
                  )
                  
                  (52,500
                  )Net
      repayments of federal funds borrowed
                  
                  
                  –
                  
                  
                  (5,395
                  )Dividends
      paid
                  
                  
                  (1,268
                  )
                  
                  (896
                  )Issuance
      of common stock for options exercised
                  
                  
                  –
                  
                  
                  103Repurchase
      of common stock
                  
                  
                  –
                  
                  
                  (2
                  )Net
      cash provided by financing activities
                  
                  
                  16,032
                  
                  
                  54,871Net
      change in cash and cash equivalents
                  
                  
                  (14,538
                  )
                  
                  3,080Cash
      and cash equivalents at beginning of period
                  
                  
                  54,455
                  
                  
                  40,172Cash
      and cash equivalents at end of period
                  
                  $
                  39,917
                  
                  $
                  43,252Supplemental
      Disclosure of Cash Flow InformationTransfer
      of loans and premises to other real estate owned
                  
                  $
                  2,324
                  
                  $
                  68Cash
      (received) paid for:Income
      taxes
                  
                  $
                  (4,297
                  )
                  $
                  –Interest
                  
                  $
                  9,375
                  
                  $
                  11,930


The accompanying notes are an integral
part of thesecondensedconsolidated financial
statements.


- 6
-
 Index


Capital
Bank Corporation – Notes to Condensed Consolidated Financial Statements
(Unaudited)




1.      Significant Accounting Policies and
Interim Reporting





The accompanying unaudited condensed
consolidated financial statements include the accounts of Capital Bank
Corporation (the “Company”) and its wholly owned subsidiary, Capital Bank (the
“Bank”). In addition, the Company has interests in three trusts, Capital Bank
Statutory Trust I, II, and III (hereinafter collectively referred to as the
“Trusts”). The Trusts have not been consolidated with the financial statements
of the Companypursuant to the provisions of Financial Accounting
Standards Board (“FASB”) Interpretation No. 46R, Consolidation of Variable Interest
Entities.The interim
financial statements have been prepared in accordance with accounting principles
generally accepted in the United States of America(“U.S. GAAP”). They do not include all of the
information and footnotes required by such accounting principles for complete
financial statements, and therefore should be read in conjunction with the
audited consolidated financial statements and accompanying footnotes in
the Company’s Annual Report on Form 10-K for the year ended December 31,
2008.





The preparation of financial statements
in conformity with U.S. GAAP requires management to make estimates and
assumptions that affect reported amounts of assets and liabilities and the
reported amounts of revenues and expenses during the reporting period.
The more significant estimates that are particularly susceptible to significant
change relate to the determination of the allowance for loan losses, valuation
of goodwill and intangible assets, valuation of investments, and tax assets,
liabilities and expense. Actual results could differ from those
estimates.





In the opinion of management, all
adjustments necessary for a fair presentation of the financial position and
results of operations for the periods presented have been included, and all
significant intercompany transactions have been eliminated in consolidation.Certain amounts reported in
prior periods have been reclassified to conform to the current presentation.
Such reclassifications have no effect ontotal assets,net income or shareholders’ equity as
previously reported.The
results of operations for the three months ended March 31, 2009 are not
necessarily indicative of the results of operations that may be expected for the
year ended December 31, 2009.





The condensed consolidated balance sheet
at December 31, 2008 has been derived from the audited consolidated financial
statements contained in the Company’s Annual Report on Form 10-K for the year
ended December 31, 2008.





The accounting policies followed by the
Company are as set forth in Note 1 of the Notes to Consolidated Financial
Statements in the Company’s Annual Report on Form 10-K for the year ended
December 31, 2008.





In April
2009, the FASB issued three related Staff Positions to (1) clarify the
application of Statement of Financial Accounting Standards No. 157 (“SFAS No.
157”) to fair value measurements in the current economic environment, (2) modify
the recognition of other-than-temporary impairments of debt securities, and (3)
require companies to disclose the fair values of financial instruments in
interim periods. The final Staff Positions are effective for interim and annual
periods ending after June 15, 2009, with early adoption permitted for
periods ending after March 15, 2009, if all three Staff Positions or both the
fair value measurements and other-than-temporary impairment Staff Positions are
adopted simultaneously. The Company will adopt these Staff Positions effective
for the quarterly period ending June 30, 2009. None of the Staff Positions are
expected to have a significant impact on financial condition or results of
operations, but each is described in more detail below.





FASB
Staff Position (“FSP”) FAS 157-4,Determining Fair Value When the
Volume and Level of Activity for the Asset or Liability Have Significantly
Decreased and Identifying Transactions That Are Not Orderly, provides
additional guidance for estimating fair value in accordance with SFAS No. 157
when the volume and level of activity for the asset or liability have
significantly decreased and also provides guidance on identifying circumstances
that indicate a transaction is not orderly. The FSP emphasizes that even if
there has been a significant decrease in the volume and level of activity for
the asset or liability and regardless of the valuation technique used, the
objective of a fair value measurement remains the same. Fair value is the price
that would be received to sell an asset or paid to transfer a liability in an
orderly transaction (that is, not a forced liquidation or distressed sale),
between market participants at the measurement date under current market
conditions.





FSP FAS
115-2 and FAS 124-2, Recognition and Presentation of
Other-Than-Temporary Impairments, amends the other-than-temporary
impairment guidance in U.S. GAAP for debt securities to make the guidance more
operational and to improve the presentation and disclosure of
other-than-temporary impairments on debt and equity securities in the financial
statements. The FSP does not amend existing recognition and measurement guidance
related to other-than-temporary impairments of equity
securities.


- 7
-
 Index


Capital
Bank Corporation – Notes to Condensed Consolidated Financial Statements
(Unaudited)




FSP FAS
107-1 and APB 28-1, Interim
Disclosures about Fair Value of Financial Instruments,amends SFAS No. 107,
Disclosures about Fair Value
of Financial Instruments, to require disclosures about fair value of
financial instruments for interim reporting periods of publicly traded companies
as well as in annual financial statements. The FSP also amends Accounting
Principles Bulletin Opinion No. 28, Interim Financial Reporting,
to require those disclosures in summarized information in interim reporting
periods.





In
October 2008, the FASB issued FSP FAS 157-3, Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active(“FSP FAS
157-3”). The FSP clarifies the application of SFAS No. 157in a market that is not
active and provides an example to illustrate key considerations in determining
the fair value of a financial asset when the market for that financial asset is
not active. FSP FAS 157-3 was effective upon issuance, including prior periods
for which financial statements had not been issued. The adoption of this FSP did
not have a material impact on the Company’s consolidated financial condition or
results of operations.





In March
2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities—an amendment of FASB Statement No.
133 (“SFAS No. 161”). The new statement is
intended to improve financial reporting about derivative instruments and hedging
activities by requiring enhanced disclosures to enable investors to better
understand their effects on an entity’s financial condition, financial
performance, and cash flows. Effective January 1, 2009, the Company adopted SFAS
No. 161. The adoption of this statement impacts disclosures only and had no
impact on the Company’s financial condition or results of operations. See Note
6, Derivative Instruments, for disclosures required upon adoption of this
statement.





In
December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (“SFAS
No. 141R”), which replaced SFAS No. 141, Business Combinations(“SFAS
No. 141”) issued in 2001. Whereas its predecessor
applied only to business combinations in which control was obtained by
transferring consideration, the revised standard applies to all transactions or
other events in which one entity obtains control over another. SFAS
No. 141R defines the acquirer as the entity that obtains control over one
or more other businesses and defines the acquisition date as the date the
acquirer achieves control. SFAS No. 141R requires the acquirer to recognize
assets acquired, liabilities assumed and any noncontrolling interest in the
acquiree at their respective fair values as of the acquisition date. The revised
standard changes the treatment of acquisition-related costs, restructuring costs
related to an acquisition that the acquirer expects but is not obligated to
incur, contingent consideration associated with the purchase price and
pre-acquisition contingencies associated with acquired assets and liabilities.
SFAS No. 141R retains the guidance in SFAS No. 141 for identifying and
recognizing intangible assets apart from goodwill. Effective January 1, 2009,
the Company adopted this statement and will apply its provisions to any business
combination which occurs on or after that date.





Also in
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements—an amendment of ARB No. 51(“SFAS No.
160”). This statement amends Accounting Research Bulletin No. 51, Consolidated Financial
Statements, to establish accounting and reporting standards for the
noncontrolling interests in a subsidiary and for the deconsolidation of a
subsidiary. It clarifies that a
noncontrolling interest in a subsidiary is an ownership interest in the
consolidated entity that should be reported as equity in the consolidated
financial statements. The Company adopted SFAS No. 160 effective January 1,
2009, and its adoption had no impact on the Company’s consolidated financial
condition or results of operations.





2.      Earnings Per Share





The Company follows SFAS No. 128,Earnings
per
Share. In accordance with
this statement, the Company has presented both basic and diluted earnings per
share (“EPS”) on the face of the Condensed Consolidated Statements of
Operations. Basic EPS excludes dilution and is computed by dividing income
available to common shareholders by the weighted average number of common shares
outstanding for the period. Diluted EPS assumes the conversion, exercise or
issuance of all potential common stock instruments, such as stock options and
warrants, unless the effect is to reduce a loss or increase earnings per share.
EPS is adjusted for outstanding stock options and warrants using the treasury
stock method in order to compute diluted EPS. The weighted average number of
shares outstanding for the three month periods ended March 31, 2009 and 2008
(unaudited) were as follows:


- 8
-
 Index


Capital
Bank Corporation – Notes to Condensed Consolidated Financial Statements
(Unaudited)




2009
                
                2008(Dollars in thousands)Earnings (loss) attributable to
      common shareholders – basic and diluted
                
                $
                (5,050
                )
                $
                2,167Shares used in the computation of
      earnings per share:Weighted average number of shares
      outstanding – basic
                
                
                11,293,480
                
                
                11,289,453Incremental shares from assumed
      exercise of stock options
                
                
                –
                
                
                16,643Weighted average number of shares
      outstanding – diluted
                
                
                11,293,480
                
                
                11,306,096





Due to
the net loss attributable to common shareholders for the three month period
ended March 31, 2009, the Company excluded potential shares in its EPS
calculations, as required by SFAS No. 128, since the effect of including those
potential shares would have been antidilutive to the per share amounts. For the
three month period ended March 31, 2008, options to purchase approximately
108,411 shares of common stock were used in the diluted calculation and options
to purchase 263,573 shares of common stock were not included in the diluted
calculation because the option price exceeded the average fair market value of
the associated shares of common stock.





3.      Comprehensive Income





The
Company follows SFAS No. 130, Reporting Comprehensive
Income, which establishes standards for reporting and displaying
comprehensive income and its components (revenues, expenses, gains, and losses)
in general-purpose financial statements. Comprehensive income is the change in
the Company’s equity during the period from transactions and other events and
circumstances from non-owner sources. Total comprehensive income consists of net
income and other comprehensive income. The Company’s other comprehensive income
and accumulated other comprehensive income are comprised of unrealized gains and
losses on certain investments in debt securities and derivatives that qualify as
cash flow hedges to the extent that the hedge is effective. Information
concerning the Company’s other comprehensive (loss) income for the three month
periods ended March 31, 2009 and 2008 (unaudited) is as follows:





2009
                
                2008(Dollars in
      thousands)Unrealized gain on
      available-for-sale investment securities
                
                $
                508
                
                $
                863Unrealized (loss) gain on change
      in fair value of cash flow hedge
                
                
                (817
                )
                
                1,853Prior service cost recognized on
      SERP
                
                
                (54
                )
                
                –Income tax benefit
      (expense)
                
                
                119
                
                
                (1,006
                )Other comprehensive (loss)
      income
                
                $
                (244
                )
                $
                1,710





4.      Investment
Securities





The following table shows the gross
unrealized losses and fair value of the Company’s marketable securities with
unrealized losses that are not deemed to be other-than-temporarily impaired,
aggregated by investment category and length of time that individual securities
have been in a continuous unrealized loss position, as of March31, 2009.





Less than 12
      Months
                
                12 Months or
      Greater
                
                Total(Dollars in
      thousands)
                
                Fair Value
                
                Unrealized
                  Losses
                
                Fair Value
                
                Unrealized
      Losses
                
                Fair Value
                
                Unrealized
      LossesAvailable for
      sale:Municipal
    bonds
                
                $
                42,155
                
                $
                2,840
                
                $
                19,235
                
                $
                2,295
                
                $
                61,390
                
                $
                5,135Mortgage-backed
      securities
                
                
                15,359
                
                
                1,238
                
                
                6,431
                
                
                575
                
                
                21,790
                
                
                1,813Other
      securities
                
                
                –
                
                
                –
                
                
                1,057
                
                
                193
                
                
                1,057
                
                
                19357,514
                
                
                4,078
                
                
                26,723
                
                
                3,063
                
                
                84,237
                
                
                7,141Held to
      maturity:Mortgage-backed
      securities
                
                
                –
                
                
                –
                
                
                1,930
                
                
                655
                
                
                1,930
                
                
                655Total at March 31,
      2009
                
                $
                57,514
                
                $
                4,078
                
                $
                28,653
                
                $
                3,718
                
                $
                86,167
                
                $
                7,796





- 9
-
 Index


Capital
Bank Corporation – Notes to Condensed Consolidated Financial Statements
(Unaudited)




Unrealized
losses on the Company’s investments in mortgage-backed securities are primarily
the result of interest rate changes. Mortgage-backed securities include
securities issued by government agencies and corporate entities. The
mortgage-backed securities issued by government agencies, such as Fannie Mae,
Freddie Mac and Ginnie Mae, are backed by the full faith and credit of the U.S.
government and do not receive credit ratings from rating agencies. The
mortgage-backed securities issued by corporate entities have all received the
highest possible credit rating by either Moody’s or S&P. Unrealized losses
on the Company’s investments in municipal bonds are partially related to
interest rate changes but are primarily related to concerns in the marketplace
regarding credit quality of issuers and the viability of certain bond insurers.
Municipal bonds in an unrealized loss position, however, are investment grade
securities without considering bond insurance backing the issuer.





Each
quarter, the Company makes an assessment to determine whether there have been
any events or economic circumstances to indicate that a marketable security on
which there is an unrealized loss is impaired on an other-than-temporary basis.
The Company considers many factors, including the severity and duration of the
impairment; the intent and ability of the Company to hold the security for a
period of time sufficient for a recovery in value, which may be maturity; and
recent events specific to the issuer or industry, including any changes in
credit ratings. The marketable securities in an unrealized loss position as of
March 31, 2009 are all still performing and are expected to perform through
maturity, have not experienced recent credit rating downgrades, and the issuers
have not experienced significant adverse events that would call into question
their ability to repay these debt obligations. Further, the Company has the
intent and ability to hold these securities for a period of time sufficient for
a recovery in value or until maturity. The Company’s ability to hold securities
for this period of time is based on an analysis of liquidity and capital levels.
Based on this detailed portfolio review, the Company does not consider any of
its marketable securities to be other-than-temporarily impaired as of March 31,
2009.





During
the three months ended March 31, 2009, the Company recorded an impairment charge
of $320 thousand on an equity investment in Silverton Bank, a correspondent
financial institution. The impairment charge represents the full amount of the
Company’s investment in Silverton Bank and is recorded as a reduction to
noninterest income on the Condensed Consolidated Statements of Operations.
Because of restrictions on the ability to sell this investment, it does not have
a readily determinable fair value and was recorded at cost when purchased.
Management believes that due to significant deterioration in Silverton Bank’s
capital ratios and overall financial strength as well as the departure of key
members of the management team in recent months, minimal value remains in this
equity investment, thus requiring the impairment charge.





5.      Loans





The composition of the loan portfolio by
loan classification as of March 31, 2009 and December 31, 2008 is as
follows:





March 31,
    2009
                
                December 31,
      2008(Dollars in
      thousands)
                
                (Unaudited)Commercial
                
                $
                740,553
                
                $
                726,522Construction
                
                
                372,977
                
                
                366,376Consumer
                
                
                47,106
                
                
                46,019Home equity
                
                
                94,862
                
                
                92,722Residential
      mortgage
                
                
                21,744
                
                
                22,6521,277,242
                
                
                1,254,291Deferred loan fees and origination
      costs, net
                
                
                (178
                )
                
                77$
                1,277,064
                
                $
                1,254,368





6.      Derivative
Instruments




The
Company maintains positions in derivative financial instruments to manage
interest rate risk, to facilitate asset/liability management strategies, and to
manage other risk exposures. Effective January 1, 2009, the Company adopted SFAS
No. 161, which is intended to improve financial reporting about derivative
instruments and hedging activities by requiring enhanced disclosures to enable
investors to better understand their effects on an entity’s financial condition,
financial performance, and cash flows. The disclosure requirements from the
adoption of this statement are reflected within this footnote.


- 10
-
 Index


Capital
Bank Corporation – Notes to Condensed Consolidated Financial Statements
(Unaudited)




In
October 2006, the Company entered into a $100.0 million (notional) three-year
interest rate swap agreement to convert a portion of its prime-based loan
portfolio to a fixed rate of 7.81%. The Company accounts for this swap as a cash
flow hedge of the volatility in cash flows resulting from changes in interest
rates. For cash flow hedges,
changes in the fair value of the derivative are, to the extent that the hedging
relationship is effective, recorded as other comprehensive income and are
subsequently recognized in earnings at the same time that the hedged item is
recognized in earnings. Any portion of the change in fair value of a cash flow
hedge related to hedge ineffectiveness is recognized immediately as other
noninterest income. The fair valueof this cash flow hedge was $2.3 million
and $3.2million as ofMarch 31, 2009 and December
31, 2008, respectively, and
was recorded in other
assets on the Condensed ConsolidatedBalanceSheets. No portion of the cash flow hedge
was considered to be ineffective, and no portion of the change in fair value of
the cash flow hedge was charged to other noninterest income duringthe three months ended March 31, 2009
and 2008.





In July
2003, the Company entered into $25.0 million (notional) interest rate swap
agreements to convert portions of its fixed-rate FHLB advances to variable
interest rates. In February 2009, $15.0 million (notional) of interest rate
swaps were unwound prior to maturity of the underlying FHLB advances for net
proceeds of $500 thousand. The
proceeds received from the swap counterparty will be amortized as a reduction to
interest expense over the remaining term of the underlying advances.The
Company continues to account for the remaining $10.0 million (notional) interest
rate swaps as a hedge of the fair value of the designated FHLB advances.For fair
value hedges, the change in the fair value of the derivative and the
corresponding change in fair value of the hedged risk in the underlying item
being hedged are accounted for in earnings. Because of the effectiveness of the
remaining swap agreements against the related debt instruments, the adjustments
needed to record the swaps at fair value were offset by the adjustments needed
to record the related debt instruments at fair value, and the net difference
between those amounts was not material for the three months ended March 31, 2009
and 2008.





7.      Stock-Based
Compensation





The Companyuses
stock-based compensation as an incentive for certain employees and non-employee
directors and accountsfor
stock-based compensation in accordance with SFAS No. 123R,Share-Based
Payments.Stock-based
grants currently take one of three forms: stock options, restricted stock, and
stock issued through a deferred compensation plan for non-employee
directors.





Stock Options. The Company
has stock option plans providing for the issuance of up to 650,000 options to
purchase shares of the Company’s stock to officers and directors. As of March
31, 2009, options for 315,850 shares of common stock were outstanding and
options for 75,559 shares of common stock remained available for future
issuance. In addition, there were 566,071 options that were assumed under
various plans from previously acquired financial institutions, of which 61,233
remain outstanding. Grants of options are made by the Board of Directors or the
Compensation/Human Resources Committee. All grants must be at no less than fair
market value on the date of grant, must be exercised no later than 10 years from
the date of grant, and may be subject to some vesting provisions.





The following is a summary of stock
option information and the weighted average exercise price (“WAEP”) for the
three months endedMarch
31, 2009.





Number
                  of Shares
                
                Weighted
                  Average
                  Exercise
    Price
                
                Weighted
      Average
                  Remaining
      Contractual
                  Term in
    Years
                
                Aggregate
                  Intrinsic
    ValueOutstanding at January 1,
      2009
                
                
                377,083
                
                $
                11.71Granted
                
                
                –
                
                
                –Exercised
                
                
                –
                
                
                –Forfeited and
      expired
                
                
                –
                
                
                –Outstanding at March 31,
      2009
                
                
                377,083
                
                $
                11.71
                
                
                4.98
                
                $
                –Options exercisable at March 31,
      2009
                
                
                274,283
                
                $
                12.40
                
                
                3.41
                
                $
                –


- 11
-
 Index
 Capital
Bank Corporation – Notes to Condensed Consolidated Financial Statements
(Unaudited)


The following table summarizes
information about the Company’s stock options as ofMarch 31, 2009.





Exercise
    Price
                Number
                  Outstanding
                
                Weighted
      Average
                  Remaining
      Contractual
                  Life in
    Years
                
                Number
                  Exercisable$6.00 –
    $9.00
                129,631
                
                5.10
                
                69,631$9.01 –
    $12.00
                90,202
                
                2.59
                
                88,202$12.01 –
    $15.00
                20,000
                
                7.38
                
                7,200$15.01 –
    $18.00
                83,000
                
                6.30
                
                55,000$18.01 –
    $18.37
                54,250
                
                5.74
                
                54,250377,083
                
                4.98
                
                274,283





The fair
values of the options were estimated on the date of grant using the
Black-Scholes option-pricing model. Option pricing models require the use of
highly subjective assumptions, including expected stock volatility, which, if
changed, can materially affect fair value estimates. The expected life of the
options used in this calculation was the period the options are expected to be
outstanding. Expected stock price volatility was based on the historical
volatility of the Company’s common stock for a period approximating the expected
life; the expected dividend yield was based on the Company’s historical annual
dividend payout; and the risk-free rate was based on the implied yield available
on U.S. Treasury issues.





As of
March 31, 2009, the Company had unamortized compensation expense related to
unvested stock options of $177,000, which is expected to be amortized over 5
years. For the three months ended March 31, 2009 and 2008, the Company recorded
compensation expense of $13,000 and $10,000, respectively, related to stock
options.





Restricted
Stock.Outstanding
restricted stock represents 20,000 shares with a vesting period of five yearsgrantedby the Board of Directors tocertain employeesin December 2008, and 24,000 shares with
a vesting period of three years granted by the Board of Directors to certain key
executives in December 2007.Unvested shares are subject to
forfeiture if employment terminates prior to the vesting dates. The Company
expenses the cost of the stock awards, determined to be the fair value of the
shares at the date of grant, ratably over the period of the vesting. Total
compensation expense recognized inthe three month periods ended March 31,
2009 and2008 related to
these restricted stock awards was$30,000and$24,000, respectively. As ofMarch31, 2009, the Company had36,000shares of unvested restricted stock
grants, which represents unrecognized compensation expense of$285,000to be recognizedover the remaining vesting periods of
the respective grants.





Deferred Compensation for
Non-employee Directors.The Company administers the Capital Bank
Corporation Deferred Compensation Plan for Outside Directors (“Deferred
Compensation Plan”). Eligible directors may elect to participate in the Deferred
Compensation Plan by deferring all or part of their directors’ fees for at least
one calendar year, in exchange for common stock of the Company. If a director
does not elect to defer all or part of his fees, then he is not considered a
participant in the Deferred Compensation Plan. The amount deferred is equal to
125 percent of total director fees. Each participant is fully vested in his
account balance. The Deferred Compensation Plan provides for payment of share
units in shares of common stock of the Company after the participant ceases to
serve as a director for any reason.





Prior to
amendment and restatement in November 2008, the Deferred Compensation Plan was
classified as a liability-based planin accordance withSFAS No. 123R due to certain plan
provisions which would have allowed payments to have been made in either cash or
shares of common stock. The Deferred Compensation Plan was reclassified to an
equity-based planin
accordance withSFAS No.
123R when amended and restated on November 20, 2008. Among other changes to the
plan provisions, the Deferred Compensation Plan was modified to only allow
payment in shares of common stock of the Company.As required forequity-based plansunderSFAS No. 123R,the Company recognizes fixedexpense and a
corresponding increase to
equityas the compensation
is earned by eligible
directors. For the
three month periods ended March 31, 2009 and 2008, the Company recognized
$153,000 and $138,000, respectively, of expense related to the Deferred
Compensation Plan.





8.      Financial Instruments with
Off-Balance-Sheet Risk





To meet the financial needs of its
customers, the Company is party to financial instruments with off-balance-sheet
risk in the normal course of business. These financial instruments are
comprised of unused lines of credit, overdraft lines and standby letters of
credit. These instruments involve, to varying degrees, elements of credit risk
in excess of the amount recognized in the balance sheet.


- 12
-
 Index


Capital
Bank Corporation – Notes to Condensed Consolidated Financial Statements
(Unaudited)




The Company’s exposure to credit loss in
the event of nonperformance by the other party is represented by the contractual
amount of those instruments. The Company uses the same credit policies in making
these commitments as it does for on-balance-sheet instruments. The amount of
collateral obtained, if deemed necessary by the Company, upon extension of
credit is based on management’s credit evaluation of the borrower. Collateral
held varies but may include trade accounts receivable, property, plant and
equipment, and income-producing commercial properties. Since many unused lines
of credit expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements.





The Company’s exposure to
off-balance-sheet credit risk as of March 31, 2009 and December 31, 2008 is as
follows:





March 31,
    2009
                
                December 31,
      2008(Dollars in
      thousands)
                
                (Unaudited)Unused lines of credit and
      overdraft lines
                
                $
                250,460
                
                $
                263,663Standby letters of
      credit
                
                
                9,047
                
                
                4,233Total
      commitments
                
                $
                259,507
                
                $
                267,896




9.      Fair Value
Measurement





The
Company follows SFAS No. 157, Fair Value Measurements,
which defines fair value and establishes a framework for measuring fair value
under U.S. GAAP, and enhances disclosures about fair value measurements. The
Company utilizes fair value measurements to record fair value adjustments to
certain assets and liabilities and to determine fair value disclosures.
Available-for-sale investment securities and derivatives are recorded at fair
value on a recurring basis. Additionally, the Company may be required to record
at fair value other assets on a nonrecurring basis, such as loans held for sale,
loans held for investment and certain other assets. These nonrecurring fair
value adjustments typically involve application of lower of cost or market
accounting or write-downs of individual assets. The following is a description
of valuation methodologies used for assets and liabilities recorded at fair
value. The determination of where an asset or liability falls in the hierarchy
requires significant judgment. The Company evaluates its hierarchy disclosures
each quarter and based on various factors, it is possible that an asset or
liability may be classified differently from quarter to quarter. However, the
Company expects changes in classifications between levels will be
rare.





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





As a
member of the FHLB system, the Company is required to maintain an investment in
capital stock of the FHLB. The carrying value of the Company’s investment in
FHLB stock was $6.0 million as of March 31, 2009 and was classified as part of
investment securities on the Condensed Consolidated Balance Sheets. Because of
membership requirements to hold stock in this institution and restrictions on
the Company’s ability to sell such stock, this investment does not have a
readily determinable market value and is accounted for using the cost method.
Thus, the Company’s investment in FHLB stock is not subject to SFAS No. 157 and
has been excluded from the tables below.





Derivative Assets and
Liabilities. Derivative instruments held or issued by the Company for
risk management purposes are traded in over-the-counter markets where quoted
market prices are not readily available. For those derivatives, the Company
measures fair value using models that use primarily market observable inputs,
such as yield curves and option volatilities, and include the value associated
with counterparty credit risk. The Company classifies derivatives instruments
held or issued for risk management purposes as Level 2. At March 31, 2009, the
Company’s derivative instruments consisted solely of a cash flow interest rate
swap on a portion of the Company’s variable-rate commercial loan portfolio and
fair value interest rate swaps on certain fixed-rate FHLB advances. For
effective fair value hedges, the change in the fair value of the derivative is
offset by a corresponding change in fair value of the hedged risk in the
underlying item being hedged. Thus, the adjusted value of the underlying FHLB
advances ($10.0 million notional) being hedged is also classified as Level
2.




- 13
-
 Index


Capital
Bank Corporation – Notes to Condensed Consolidated Financial Statements
(Unaudited)




Loans Held for Sale. Loans
held for sale are carried at the lower of cost or market value. The fair value
of loans held for sale is based on what secondary markets are currently offering
for portfolios with similar characteristics. As such, the Company classifies
loans subjected to nonrecurring fair value adjustments as Level 2. The Company
had no loans held for sale as of March 31, 2009.





Loans. The Company does not
record loans at fair value on a recurring basis. However, from time to time, a
loan is considered impaired, and an allowance for loan losses is established.
Loans for which it is probable that payment of interest and principal will not
be made in accordance with the contractual terms of the loan agreement are
considered impaired. Once a loan is identified as individually impaired,
management measures impairment in accordance with SFAS No. 114, Accounting by Creditors for
Impairment of a Loan. The fair value of impaired loans is estimated using
one of several methods, including collateral value, market value of similar
debt, enterprise value, liquidation value and discounted cash flows. Those
impaired loans not requiring an allowance represent loans for which the fair
value of the expected repayments or collateral exceed the recorded investments
in such loans. In accordance with SFAS No. 157, impaired loans where an
allowance is established based on the fair value of collateral require
classification in the fair value hierarchy. When the fair value of the
collateral is based on an observable market price or a current appraised value,
the Company records the impaired loan as nonrecurring Level 2. When an appraised
value is not available or management determines the fair value of the collateral
is further impaired below the appraised value and there is no observable market
price, the Company records the impaired loan as nonrecurring Level
3.





Foreclosed Assets. Foreclosed
assets are adjusted to fair value upon transfer of the loans to foreclosed
assets. Subsequently, foreclosed assets are carried at the lower of carrying
value or fair value. Fair value is based upon independent market prices,
appraised values of the collateral or management’s estimation of the value of
the collateral. When the fair value of the collateral is based on an observable
market price or a current appraised value, the Company records the foreclosed
asset as nonrecurring Level 2. When an appraised value is not available or
management determines the fair value of the collateral is further impaired below
the appraised value and there is no observable market price, the Company records
the foreclosed asset as nonrecurring Level 3.





Assets
and liabilities measured at fair value on a recurring basis are summarized
below:





Fair Value Measurements atMarch31, 2009Quoted Prices inActive Markets
      forIdentical Assets
                  (Level 1)
                
                Significant Other
      Observable
                  Inputs
                  (Level 2)
                
                Significant
                  Unobservable
                  Inputs
                  (Level 3)
                
                Total(Dollars in thousands)Investment
      securities
                
                $
                993
                
                $
                272,524
                
                $
                2,000
                
                $
                275,517Cash flow interest rate
      swap
                
                
                –
                
                
                2,334
                
                
                –
                
                
                2,334Borrowings
                
                
                –
                
                
                (10,026
                )
                
                –
                
                
                (10,026
                )Fair value interest rate
      swaps
                
                
                –
                
                
                26
                
                
                –
                
                
                26





Assets
and liabilities measured at fair value on a nonrecurring basis are summarized
below:





Fair Value Measurements atMarch 31,
      2009Quoted Prices inActive Markets
      forIdentical Assets
                  (Level 1)
                
                Significant
      OtherObservableInputs
                  (Level 2)
                
                SignificantUnobservableInputs
                  (Level 3)
                
                Total(Dollars in thousands)Impaired
    loans
                
                $
                –
                
                $
                –
                
                $
                26,714
                
                $
                26,714Foreclosed
      assets
                
                
                –
                
                
                –
                
                
                3,616
                
                
                3,616





- 14
-
 Index


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





The following discussion presents an
overview of the unaudited financial statements for the three months ended March
31, 2009 and 2008 for Capital Bank Corporation (the “Company”) and its wholly
owned subsidiary, Capital Bank (the “Bank”). This discussion and analysis is
intended to provide pertinent information concerning financial condition,
results of operations, liquidity, and capital resources for the periods covered
and should be read in conjunction with the unaudited financial statements and
related footnotes contained in Part I, Item 1 of this
report.





Information set forth below contains
various forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended (the “Exchange Act”), which statements represent the
Company’s judgment concerning the future and are subject to risks and
uncertainties that could cause the Company’s actual operating results to differ
materially. Such forward-looking statements can be identified by the use of
forward-looking terminology, such as “may,” “will,” “expect,” “anticipate,”
“estimate,” “believe,” or “continue,” or the negative thereof or other
variations thereof or comparable terminology. The Company cautions that such
forward-looking statements are further qualified by important factors that could
cause the Company’s actual operating results to differ materially from those in
the forward-looking statements, as well as the factors set forth in Part II,
Item 1A of this report, and the Company’s periodic reports and other filings
with the Securities and
Exchange Commission (“SEC”).





Overview





Capital
Bank is a full-service state chartered community bank conducting business
throughout North Carolina. The Bank operates through four North Carolina
regions: Triangle, Sandhills, Triad and Western. The Bank was incorporated on
May 30, 1997 and opened its first branch in June of that same year in Raleigh.
In 1999, the shareholders of the Bank approved the reorganization of the Bank
into a bank holding company. In 2001, the Company received approval to become a
financial holding company. As of March 31, 2009, the Company conducted no
business other than holding stock in the Bank and its three trusts, Capital Bank
Statutory Trust I, II, and III.





The Bank’s business consists principally
of attracting deposits from the general public and investing these funds in
loans secured by commercial real estate, secured and unsecured commercial and
consumer loans, single-family residential mortgage loans and home equity lines.
As a community bank, the Bank’s profitability depends primarily upon its levels
of net interest income, which is the difference between interest income from
interest-earning assets and interest expense on interest-bearing liabilities.
When interest-earning assets approximate or exceed interest-bearing liabilities,
any positive interest rate spread will generate net interest
income.





The Bank’s profitability is also
affected by its provision for loan losses, noninterest income and other
operating expenses. Noninterest income primarily consists of service charges and
ATM fees, fees generated from originating mortgageloans, commission income generated from
brokerage activity, and the increase in cash surrender value of bank-owned life
insurance. Operating expenses primarily consist of compensation and benefits,
occupancy related expenses, advertising, data processing, professional fees,
telecommunication and othernoninterest expenses.





The
Bank’s operations are influenced significantly by local economic conditions and
by policies of financial institution regulatory authorities. The Bank’s cost of
funds is influenced by interest rates on competing investments and by rates
offered on similar investments by competing financial institutions in our market
area, as well as general market interest rates. Lending activities are affected
by the demand for financing, which in turn is affected by the prevailing
interest rates.





Impact
of Recent Developments on the Banking Industry





The
banking industry, including the Company, is operating in a challenging and
volatile economic environment. The effects of the downturn in the housing market
have adversely impacted credit markets, consumer confidence and the broader
economy. Along with other financial institutions, the Company’s stock price has
suffered as a result. Management cannot predict when these market difficulties
will subside. While the current economic downturn and the difficulties it
presents for the Company and others in the banking industry are unprecedented,
management believes that the business is cyclical and must be viewed and
measured over time. The Company’s primary focus at this time is to manage the
business safely during the economic downturn and be poised to take advantage of
any market opportunities that may arise.





- 15
-
 Index


Because
of the current economic situation, U.S. and foreign governments have acted in
attempt to stabilize the financial system. For example, the U.S. government
enacted the Emergency Economic and Stabilization Act of 2008 (“EESA”), which,
among other things, authorized the U.S. Treasury Department (“Treasury”) to
establish the Troubled Asset Relief Program (“TARP”), of which the Capital
Purchase Program (“CPP”) is a part. Under the CPP, certain U.S. financial
institutions may sell senior preferred stock and issue warrants to purchase an
institution’s common stock to the Treasury in exchange for a capital infusion.
See the “Liquidity and Capital Resources” section below for a more detailed
discussion of the Company’s participation in the CPP. It is not clear at this
time what impact these measures will have on the Company or the financial
markets as a whole. Management will continue to monitor the effects of these
programs as they relate to the Company and its financial
operations.





Additionally, the American Recovery and Reinvestment
Act of 2009 (“ARRA”) was enacted on February 17, 2009.
TheARRAincludes a wide variety of programs
intended to stimulate the economy and provide for extensive infrastructure,
energy, health, and education needs.The ARRAimposes certain new executive
compensation and corporate governance obligations on all current and future TARP
recipients, includingthe
Company, until the
institution has redeemed the preferred stock, which TARP recipients are now
permitted to do underthe
ARRAwithout regard to the
three year holding period and without the need to raise new capital, subject to
approval of its primary federal regulator.





The Bank
is subject to insurance assessments imposed by the FDIC. On December 16, 2008,
the FDIC adopted a final rule increasing risk-based assessment rates uniformly
by 7 basis points, on an annual basis, for the first quarter of 2009. On February 27, 2009, the FDIC adopted
an interim rule, with request for comment, which would institute a one-time
special assessment of 20 cents per $100 of domestic deposits on FDIC insured
institutions. If approved, the Bank estimates that theassessment would total approximately
$2.4 million. The assessment would be payable on September 30, 2009.On
March 5, 2009, the chairman of the FDIC indicated that the FDIC intended to
lower the special assessment to 10 cents per $100 of insured deposits contingent
upon Congress increasing the FDIC’s line of credit with the Treasury to $100
billion. On May 6, 2009, the U.S. Senate passed legislation that would increase
the FDIC’s line of credit with the Treasury to $100 billion. The U.S. House of
Representatives passed similar legislation in March 2009. The legislation has
not yet been reconciled and enacted into law. Even though both the U.S. Senate
and the U.S. House of Representatives have approved the increase in the FDIC’s
line of credit, the assessment rates, including the special assessment, are
subject to change at the discretion of the Board of Directors of the
FDIC.





Critical Accounting Policies and
Estimates





The Company’scriticalaccounting policies are described in
Note 1of the Company’s Annual Report on Form
10-Kfor the year endedDecember 31, 2008.These policies are important in
understanding management’s
discussion and analysis.Some of the Company’s accounting
policies require the Company to make estimates and judgments regarding
uncertainties that may affect the reported amounts of assets, liabilities,
revenues and expenses.





The Company has identifiedfouraccounting policies as being critical
in terms of significant judgments and the extent to which estimates are used:
allowance for loan losses,
investment impairment,income tax valuation
allowancesand
impairment of long-lived
assets, including other intangible assets.In many cases, there are several
alternative judgments that could be used in the estimation process.The Company bases its
estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily
apparent from other sources.Actual results may differ from these
estimates under different
assumptions or conditions.For more information on the Company’s critical accounting policies, refer to Part II, Item
7of the
Company’sAnnual Report on Form 10-K forthe year ended December 31,
2008.





Executive Summary





As discussed in more detail below, the
following is a summary of our significant results for the three months ended
March 31, 2009.





- 16
-
 Index


•
                The Company reported a net loss of
      $4.5 million, or $0.45 per diluted share, for the quarter ended March 31,
      2009 compared to net income of $2.2 million, or $0.19 per diluted share,
      for the quarter ended March 31, 2008. Net income decreased by $6.6
      million, primarily due to a $5.4 million increase in provision for loan
      losses. Additionally, net interest income decreased by $728 thousand over
      the quarters under comparison, reflecting a lower net interest margin.
      Noninterest income decreased by $134 thousand primarily due to an
      impairment charge taken on an equity investment in a financial institution
      while noninterest expense increased $1.9 million over the quarters under
      comparison primarily due to higher salaries and benefits as well as
      occupancy expenses from the purchase of four branches in Fayetteville and
      the opening of a Clayton branch in December 2008. Taxes declined from
      expense of $799 thousand for the quarter ended March 31, 2008 to a benefit
      of $800 thousand for the quarter ended March 31, 2009, reflecting the
      decline in net income before taxes over the same
      quarters.•
                Net interest income decreased $728
      thousand, or 6.7%, from $10.9 million for the quarter ended March 31, 2008
      to $10.2 million for the quarter ended March 31, 2009.This decrease was primarily due to
      a decline in the Company’s net interest margin from
      3.23%for the quarter ended March 31,
      2008 to 2.76% for the quarter ended March 31, 2009.The decline in the net
      interest margin was primarily a result of the 2.0% reduction in the prime
      rate over the last twelve months andcompetitive pressures in the
      Company’s primary marketsfor retail deposits. The majority
      of the Company’s loans are prime-based, while the Company’s
      interest-bearing deposits are impacted more by competitive rates in the
      marketplace offered for time deposits. The margin compression was partially offset by
      10.6% growth in
      average earning assets over the same period.•
                Provision for loan losses was $6.0
      million for the quarter ended March 31, 2009 compared to $565 thousand for
      the quarter ended March 31, 2008.Thesignificantincrease in the
      provisionwas primarily driven by
      deteriorating economic conditions and weaknesses in the local real estate
      markets which resulted in downgrades to the credit ratings of certain
      loans in the portfolioand a significant increase in the
      balances of nonperforming loans andwasalsopartially due to loan growthof$126.6 million from March 31,
      2008. Additionally, the decline in real estate values securing certain
      nonperforming loans required increased provision during the quarter.Net charge-offsfor the quarter ended
      March 31, 2009 were $2.3 million, or 0.73% of average loans (annualized),
      compared to net charge-offs of $573 thousand, or 0.20% of average loans
      (annualized), for the quarter ended March 31, 2008. Nonperformingloansandpast due loans increased from $4.3
      million and $9.4million, respectively,as of March 31, 2008 to $17.0
      million and $17.1million, respectively, as ofMarch 31,
    2009.•
                Noninterest income decreased from
      $2.2 million for the quarter ended March 31, 2008 to $2.1 million for the
      quarter ended March 31, 2009, a decline of $134 thousand, or 6.0%.
      The primary reason for the overall decline in noninterest income was an
      impairment charge of $320 thousand recorded on an equity investment in a
      correspondent financial institution during the quarter ended March 31,
      2009 compared to a gain of $71 thousand on the sale of certain debt
      securities during the quarter ended March 31, 2008. The impairment charge
      this quarter represents the full amount of the Company’s investment in
      that institution. Partially offsetting the impact of the impairment
      charge, mortgage and other loan fees increased a net of $142 thousand, or
      36.9%, compared to the same quarter last year primarily as a result of
      management’s emphasis on increasing loan-related fee income as well as
      favorable interest rates for the refinancing of residential and commercial
      loans.•
                Noninterest expense increased from
      $9.6 million for the quarter ended March 31, 2008 to $11.6 million for the
      quarter ended March 31, 2009, an increase of $1.9 million, or 20.2%.
      Salaries and employee benefits, occupancy, furniture and equipment, and
      data processing and telecommunicationsexpensesincreaseda combined $1.6
      million primarily due additional costs incurred as new branches were
      opened during the past year in Asheville (May 2008) and Clayton (December
      2008) in addition to four branches purchased in the Fayetteville market
      (December 2008). FDIC deposit insurance costs rose by $182 thousand as the
      regulatory agency continued to increase premiums to cover higher
      monitoring costs and claims.
 - 17
-
 Index
 Results of
Operations
 
 QuarterendedMarch 31, 2009compared toquarterendedMarch 31, 2008
 
 The Company reported a net loss of $4.5
million, or $0.45 per diluted share, for the quarter ended March 31, 2009
compared to net income of $2.2 million, or $0.19 per diluted share, for the
quarter ended March 31, 2008. Net income decreased by $6.6 million, primarily
due to a $5.4 million increase in provision for loan losses. Additionally, net
interest income decreased by $728 thousand over the quarters under comparison,
reflecting a lower net interest margin. Noninterest income decreased by $134
thousand primarily due to an impairment charge taken on an equity investment in
a financial institution while noninterest expense increased $1.9 million over
the quarters under comparison primarily due to higher salaries and benefits as
well as occupancy expenses from the purchase of four branches in Fayetteville
and the opening of a Clayton branch in December 2008. Taxes declined from
expense of $799 thousand for the quarter ended March 31, 2008 to a benefit of
$800 thousand for the quarter ended March 31, 2009, reflecting the decline in
net income before taxes over the same quarters.
 
 Net Interest Income.Net interest income
decreased $728 thousand, or 6.7%, from $10.9 million for the quarter ended March
31, 2008 to $10.2 million for the quarter ended March 31, 2008. Average earning
assets increased $148.9 million to $1.56 billion for the quarter ended March 31,
2009 from $1.41 billion for the quarter ended March 31, 2008. Average
interest-bearing liabilities increased $114.7 million to $1.37 billion for the
quarter ended March 31, 2009 from $1.26 billion for the quarter ended March 31,
2008. The net interest margin on a fully tax equivalent basis decreased by 47
basis points (“bps”) to 2.76% for the quarter ended March 31, 2009 from 3.23%
for the quarter ended March 31, 2008. The earned yield on average
interest-earning assets was 5.23% and 6.60% for the quarters ended March 31,
2009 and 2008, respectively, while the interest rate on average interest-bearing
liabilities for those periods was 2.80% and 3.76%, respectively.The
decline in the net interest margin was primarily a result of the 2.0% reduction
in the prime rate over the last twelve months andcompetitive pressures in the Company’s
primary marketsfor retail
deposits. The majority of the Company’s loans are prime-based, while the
Company’s interest-bearing deposits are impacted more by competitive rates in
the marketplace offered for time deposits.
 
 The following table shows the Company’s
effective yield on earning assets and cost of funds. Yields and costs are
computed by dividing income or expense for the year by the respective daily
average asset or liability balance.
 - 18
-
 Index


CAPITAL
BANK CORPORATION


Average Balances, Interest Earned or
Paid, and Interest Yields/Rates


For theThreeMonths EndedMarch 31, 2009, December 31,
2008and March 31, 2008
(Unaudited)


Tax Equivalent Basis(1)





March
      31, 2009
                
                December
      31, 2008
                
                March
      31, 2008(Dollars
      in thousands)
                
                Average
      Balance
                
                Amount
      Earned
                
                Average
      Rate
                
                Average
      Balance
                
                Amount
      Earned
                
                Average
      Rate
                
                Average
      Balance
                
                Amount
      Earned
                
                Average
      RateAssetsLoans
      receivable: (2)Commercial
                
                $
                1,095,804
                
                $
                13,942
                
                
                5.16
                %
                $
                1,052,172
                
                $
                14,719
                
                
                5.55
                %
                $
                986,205
                
                $
                16,777
                
                
                6.82
                %Consumer
                
                
                52,873
                
                
                910
                
                
                6.98
                
                
                47,537
                
                
                888
                
                
                7.41
                
                
                46,700
                
                
                910
                
                
                7.82Home
      equity
                
                
                93,861
                
                
                966
                
                
                4.17
                
                
                89,125
                
                
                1,047
                
                
                4.66
                
                
                79,564
                
                
                1,321
                
                
                6.66Residential
      mortgages
                
                
                22,900
                
                
                274
                
                
                4.79
                
                
                24,193
                
                
                355
                
                
                5.87
                
                
                30,259
                
                
                491
                
                
                6.49Total
      loans
                
                
                1,265,438
                
                
                16,092
                
                
                5.16
                
                
                1,213,027
                
                
                17,009
                
                
                5.56
                
                
                1,142,728
                
                
                19,499
                
                
                6.84Investment
      securities (3)
                
                
                289,368
                
                
                3,957
                
                
                5.47
                
                
                246,658
                
                
                3,430
                
                
                5.56
                
                
                256,538
                
                
                3,590
                
                
                5.60Federal
      funds sold and other interest on short-term investments
                
                
                1,437
                
                
                13
                
                
                3.67
                
                
                13,737
                
                
                25
                
                
                0.72
                
                
                8,079
                
                
                55
                
                
                2.73Total
      interest-earning assets
                
                
                1,556,243
                
                $
                20,062
                
                
                5.23
                %
                
                1,473,422
                
                $
                20,464
                
                
                5.51
                %
                
                1,407,345
                
                $
                23,144
                
                
                6.60
                %Cash
      and due from banks
                
                
                40,578
                
                
                
                
                
                
                
                
                25,018
                
                
                
                
                
                
                
                
                26,232Other
      assets
                
                
                78,126
                
                
                
                
                
                
                
                
                136,387
                
                
                
                
                
                
                
                
                136,071Allowance
      for loan losses
                
                
                (15,180
                )
                
                
                
                
                
                
                
                (14,010
                )
                
                
                
                
                
                
                
                (13,662
                )Total
      assets
                
                $
                1,659,767
                
                
                
                
                
                
                
                $
                1,620,817
                
                
                
                
                
                
                
                $
                1,555,986Liabilities
      and EquitySavings
      deposits
                
                $
                28,793
                
                $
                13
                
                
                0.18
                %
                $
                27,948
                
                $
                11
                
                
                0.16
                %
                $
                30,382
                
                $
                46
                
                
                0.61
                %Interest-bearing
      demand deposits
                
                
                353,262
                
                
                1,205
                
                
                1.38
                
                
                336,011
                
                
                1,363
                
                
                1.61
                
                
                333,108
                
                
                1,855
                
                
                2.23Time
      deposits
                
                
                800,879
                
                
                6,551
                
                
                3.32
                
                
                758,491
                
                
                6,733
                
                
                3.52
                
                
                657,609
                
                
                7,171
                
                
                4.37Total
      interest-bearing deposits
                
                
                1,182,934
                
                
                7,769
                
                
                2.66
                
                
                1,122,450
                
                
                8,107
                
                
                2.87
                
                
                1,021,099
                
                
                9,072
                
                
                3.56Borrowed
      funds
                
                
                146,233
                
                
                1,389
                
                
                3.85
                
                
                145,962
                
                
                1,605
                
                
                4.36
                
                
                171,645
                
                
                2,022
                
                
                4.72Subordinated
      debt
                
                
                30,930
                
                
                322
                
                
                4.22
                
                
                30,930
                
                
                424
                
                
                5.44
                
                
                30,930
                
                
                526
                
                
                6.82Repurchase
      agreements and fed funds purchased
                
                
                13,849
                
                
                7
                
                
                0.20
                
                
                22,050
                
                
                20
                
                
                0.36
                
                
                35,563
                
                
                189
                
                
                2.13Total
      interest-bearing liabilities
                
                
                1,373,946
                
                $
                9,487
                
                
                2.80
                %
                
                1,321,392
                
                $
                10,156
                
                
                3.05
                %
                
                1,259,237
                
                $
                11,809
                
                
                3.76
                %Noninterest-bearing
      deposits
                
                
                124,893
                
                
                
                
                
                
                
                
                115,893
                
                
                
                
                
                
                
                
                118,007Other
      liabilities
                
                
                11,643
                
                
                
                
                
                
                
                
                12,305
                
                
                
                
                
                
                
                
                11,132Total
      liabilities
                
                
                1,510,482
                
                
                
                
                
                
                
                
                1,449,590
                
                
                
                
                
                
                
                
                1,388,376Shareholders’
      equity
                
                
                149,285
                
                
                
                
                
                
                
                
                171,227
                
                
                
                
                
                
                
                
                167,610Total
      liabilities and shareholders’ equity
                
                $
                1,659,767
                
                
                
                
                
                
                
                $
                1,620,817
                
                
                
                
                
                
                
                $
                1,555,986Net
      interest spread(4)
                
                
                
                
                
                
                
                
                2.43
                %
                
                
                
                
                
                
                
                2.46
                %
                
                
                
                
                
                
                
                2.83
                %Tax
      equivalent adjustment
                
                
                
                
                $
                394
                
                
                
                
                
                
                
                $
                376
                
                
                
                
                
                
                
                $
                426Net
      interest income and net interest margin(5)
                
                
                
                
                $
                10,575
                
                
                2.76
                %
                
                
                
                $
                10,308
                
                
                2.78
                %
                
                
                
                $
                11,335
                
                
                3.23
                %





(1)
            The tax equivalent basis is
      computed using a blended federal and state tax rate of approximately
      34%.


(2)
            Loans receivable include
      nonaccrual loans for which accrual of interest has not been
      recorded.


(3)
            The average balance for investment
      securities excludes the effect of their mark-to-market adjustment, if
      any.


(4)
            Net interest spread represents the
      difference between the average yield on interest-earningassets and the average cost ofinterest-bearing
      liabilities.


(5)
            Net interest margin represents net
      interest income divided by average interest-earning
      assets.


- 19
-
 Index


Interest income on loans decreased from
$19.5 million for the quarter ended March 31, 2008 to $16.1 million for the
quarter ended March 31, 2009, a decline of $3.4 million, or 17.5%. This decrease
is primarily due to declining loan yields, which decreased from 6.84% in the
quarter ended March 31, 2008 to 5.16% in the quarter ended March 31, 2009, the
effect of which was partially offset by higher average loan balances, which
increased by $122.7 million. The declining loan yields are largely due to the
drop in the prime rate from 5.25% at March 31, 2008 to 3.25% by March 31, 2009.
In November 2006, the Company entered into a $100 million (notional) interest
rate swap to help mitigate its exposure to interest rate volatility in the
prime-based portion of the loan portfolio. This swap increased loan interest
income by $1.1 million and $0.4 million for the quarters ended March 31, 2009
and 2008, respectively.





Interest
income on investment securities increased from $3.2 million in for the quarter
ended March 31, 2008 to $3.6 million for the quarter ended March 31, 2009, an
increase of $399 thousand, or 12.6%. This increase is due to growth in the
investment portfolio, partially offset by slightly lower investment yields.
Average investment balances increased from $256.5 million for the quarter ended
March 31, 2008 to $289.4 million for the quarter ended March 31, 2009, and the
tax equivalent yield on investment securities decreased from 5.60% to 5.47% over
the same period. The increase in average investment balances largely reflects
management’s efforts to quickly deploy the $41.3 million of capital received
from the CPP in December 2008 and net cash received from the purchase of four
Fayetteville branch offices from Omni National Bank, also in December
2008.





Interest expense on deposits decreased
from $9.1 million for the quarter ended March 31, 2008 to $7.8 million for the
quarter ended March 31, 2009. The decrease is primarily due to a decrease in
average deposit rates from 3.56% for the quarter ended March 31, 2008 to 2.66%
for the quarter ended March 31, 2009. For time deposits, which represented 67.7%
and 64.4% of total average interest-bearing deposits for the quarters ended
March 31, 2009 and 2008, respectively, the average rate decreased from 4.37% for
the quarter ended March 31, 2008 to 3.32% for the quarter ended March 31, 2009,
reflecting the declining interest rate environment over the past year and some
recent easing in competitor pricing for time deposits in part from government
programs to ensure liquidity remains available in the financial
system.





Interest expense on borrowings decreased
from $2.7 million for the quarter ended March 31, 2008 to $1.7 million for the
quarter ended March 31, 2009, partially due to declines in interest rates as
well as a $47.1 million decrease in average borrowings over the two periods.The rate on average
borrowings, including
subordinated debt and repurchase agreements,for the quarter endedMarch 31, 2008was4.29%compared to3.65%for thequarter ended March 31, 2009. InJuly 2003, the Companyentered into interest rate swap
agreements on $25.0 million of its outstanding Federal Home Loan Bank advances
to swap fixed rate borrowings to a variable rate.In February 2009, swaps on $15.0 million
of advances were unwound, and the proceeds received from the swap counterparty
will be amortized as a reduction to interest expense over the remaining term of
the underlying advances.The net effect of the swaps, including amortization of swap
terminations,wasa decrease tointerest expense of $87 thousandandan increase to interest expense of$43 thousandfor the quarters endedMarch 31, 2009 and 2008, respectively.





Provision for Loan
Losses.Provision for loan
losses was $6.0 million for the quarter ended March 31, 2009 compared to $565
thousand for the quarter ended March 31, 2008.Thesignificantincrease in the provisionwas primarily driven by deteriorating
economic conditions and weaknesses in the local real estate markets which
resulted in downgrades to the credit ratings of certain loans in the
portfolioand a significant
increase in the balances of nonperforming loans andwasalsopartially due to loan growthof$126.6 million from March 31, 2008.
Additionally, the decline in real estate values securing certain nonperforming
loans required increased provision during the quarter.Net charge-offsfor the quarter ended March 31, 2009
were $2.3 million, or 0.73% of average loans (annualized), compared to net
charge-offs of $573 thousand, or 0.20% of average loans (annualized), for the
quarter ended March 31, 2008. Nonperformingloansandpast due loans increased from $4.3
million and $9.4million,
respectively,as of March
31, 2008 to $17.0 million and $17.1million, respectively, as ofMarch 31,
2009.





Noninterest Income.Noninterest income
decreased from $2.2 million for the quarter ended March 31, 2008 to $2.1 million
for the quarter ended March 31, 2009, a decline of $134 thousand, or 6.0%.Management continues to focus on noninterest income improvement
strategies, which are based on core deposit growth, expanded mortgage
origination staff, fee collection efforts, restructured pricing and innovative
product enhancements. The following table presents the detail of noninterest
income and related changes for the quarters ended March 31, 2009 and
2008.


- 20
-
 Index


2009
                  
                  
                  2008
                  
                  
                  Variance(Dollars
      in thousands)Noninterest
      income:Service
      charges and other fees
                  
                  $
                  952
                  
                  $
                  959
                  
                  $
                  (7
                  )Bank
      card services
                  
                  
                  339
                  
                  
                  299
                  
                  
                  40Mortgage
      fees and revenues
                  
                  
                  233
                  
                  
                  272
                  
                  
                  (39
                  )Other
      loan fees
                  
                  
                  294
                  
                  
                  113
                  
                  
                  181Brokerage
      fees
                  
                  
                  163
                  
                  
                  156
                  
                  
                  7Bank-owned
      life insurance
                  
                  
                  258
                  
                  
                  302
                  
                  
                  (44
                  )Net
      gain (loss) on investment securities
                  
                  
                  (320
                  )
                  
                  71
                  
                  
                  (391
                  )Other
                  
                  
                  187
                  
                  
                  68
                  
                  
                  119Total
      noninterest income
                  
                  $
                  2,106
                  
                  $
                  2,240
                  
                  $
                  (134
                  )





The
primary reason for the overall decline in noninterest income was an impairment
charge of $320 thousand recorded on an equity investment in Silverton Bank, a
correspondent financial institution during the quarter ended March 31, 2009
compared to a gain of $71 thousand on the sale of certain debt securities during
the quarter ended March 31, 2008. The impairment charge this quarter represents
the full amount of the Company’s investment in Silverton Bank. Management
believes that due to significant deterioration in Silverton Bank’s capital
ratios and overall financial strength as well as the departure of key members of
the management team in recent months, minimal value remains in this equity
investment.





Although
the Company grew core deposits over the past year, service charges and other
fees, which also includes overdraft and non-sufficient funds charges, remained
relatively flat due to a decline in consumer spending during the current
economic recession. Bank card services, which includes income received from
debit card transactions, increased slightly from an increase in demand deposit
accounts offset by a decline in overall consumer spending. Mortgage and other
loan fees increased a net of $142 thousand, or 36.9%, compared to the same
quarter last year primarily as a result of management’s emphasis on increasing
loan-related fee income as well as favorable interest rates for the refinancing
of residential and commercial loans. Brokerage fees remained relatively flat
over the periods under comparison. Bank-owned life insurance income declined as
the Company recorded a non-recurring gain during the quarter ended March 31,
2008 from the receipt of insurance proceeds upon the death of a former director.
Other noninterest income increased primarily due to a reclassification of
certain sublease receipts.





Noninterest Expense.Noninterest expense
represents the costs of operating the Company. Management regularly monitors all
categories of noninterest expense in an effort to improve productivity and
operating performance. Noninterest expense increased from $9.6 million for the
quarter ended March 31, 2008 to $11.6 million for the quarter ended March 31,
2009, an increase of $1.9 million, or 20.2%.The following table presents
the detail of noninterest expense and related changes for the quarters ended
March 31, 2009 and 2008.





2009
                
                
                2008
                
                
                Variance(Dollars
      in thousands)Noninterest
      expense:Salaries
      and employee benefits
                
                $
                6,013
                
                $
                5,036
                
                $
                977Occupancy
                
                
                1,373
                
                
                997
                
                
                376Furniture
      and equipment
                
                
                830
                
                
                747
                
                
                83Data
      processing and telecommunications
                
                
                631
                
                
                432
                
                
                199Advertising
                
                
                323
                
                
                315
                
                
                8Office
      expenses
                
                
                335
                
                
                365
                
                
                (30
                )Professional
      fees
                
                
                379
                
                
                370
                
                
                9Business
      development and travel
                
                
                328
                
                
                333
                
                
                (5
                )Amortization
      of deposit premiums
                
                
                288
                
                
                257
                
                
                31Miscellaneous
      loan handling costs
                
                
                163
                
                
                94
                
                
                69Directors
      fees
                
                
                307
                
                
                267
                
                
                40Insurance
                
                
                104
                
                
                95
                
                
                9FDIC
      deposit insurance
                
                
                229
                
                
                47
                
                
                182Other
                
                
                261
                
                
                263
                
                
                (2
                )Total
      noninterest expense
                
                $
                11,564
                
                $
                9,618
                
                $
                1,946


- 21
-
 Index


Salaries and employee benefits,
occupancy, furniture and equipment, and data processing and telecommunicationsexpensesincreaseda combined $1.6 million
primarily due to additional costs incurred as new branches were opened during
the past year in Asheville (May 2008) and Clayton (December 2008) in addition to
four branches purchased in the Fayetteville market (December 2008).
Additionally, salaries and employee benefits increased from normal compensation
increases as well as from lower levels of cost deferrals from loan originations.
Occupancy expenses increased from higher rent due to sale-leaseback agreements
signed for three existing branch facilities in September 2008. Data processing
and telecommunications costs rose from increased transaction volume due to
growth in the Company’s business lines since much of the data processing costs
are volume based.





Office
expenses declined due to lower printing costs. Amortization of deposit premiums
increased from additional amortization required on the core deposit intangible
recognized as part of the acquisition of four Fayetteville branches from Omni
National Bank in December 2008. Miscellaneous loan handling costs increased
partially due to loan growth but primarily due to higher levels of loan
collection costs. Directors fees increased as expense was reduced during the
quarter ended March 31, 2008 to reflect a slight decline in the Company’s stock
price during the quarter. The Deferred Compensation Plan for Outside Directors,
which is a stock-based plan, was modified in November 2008, and since the
modified terms of the Deferred Compensation Plan required a change from variable
to fixed accounting in accordance with SFAS No. 123R, no market value adjustment
was recorded during the quarter ended March 31, 2009. FDIC deposit insurance
costs rose as the regulatory agency continued to increase premiums to cover
higher monitoring costs and claims. Advertising, professional fees, business
development and travel, insurance, and other noninterest expenses remained
relatively flat over the periods under comparison.





Income Taxes.Income taxes represented a
benefit of $800 thousand for the quarter ended March 31, 2009 compared to tax
expense of $799 thousand for the quarter ended March 31, 2008. The significant
decrease in tax expense (benefit) is due to the change in pretax income (loss)
recorded for both periods. The decline in the effective tax rate from 26.9% for
the quarter ended March 31, 2008 to 15.2% for the quarter ended March 31, 2009
is primarily due a change in projected annual taxable income used in the
intraperiod tax allocation. Taxable income and book income can vary
significantly due to nontaxable income such as municipal bond interest and
bank-owned life insurance income.





Financial Condition





Total assets as of March 31, 2009 were
$1.67 billion, an increase of $11.4 million, or 0.7%, from $1.65 billion as of
December 31, 2008. The increase in total assets for the three months ended March
31, 2009 is primarily due to a $19.0 million increase in the Company’s loan
portfolio, net of allowance for loan losses, since December 31, 2008.Total earning
assetswere $1.56 billion
as of March 31, 2009 compared to $1.53 billion as of December 31, 2008. Earning
assets represented 93.9% and92.7% of total assets as of March 31, 2009
and December 31, 2008, respectively. As of March 31, 2009, investment securities
were $286.3 million compared to $278.1million as of December 31, 2008.
Interest-earning cash, federal funds sold and short term investments were $403
thousand as of March 31, 2009 compared to $848 thousand as of December 31, 2008.
Allowance for loan losses was $18.5 million as of March 31, 2009 compared to
$14.8 million as of December 31, 2008, representing approximately 1.45% and
1.18%, respectively, of total loans as of both dates. Management believes that
the allowance balance is adequate to absorb estimated losses inherent in the
current loan portfolio. See“Asset
Quality”section below for
further discussion of the allowance for loan losses.





Total deposits as of March 31, 2009 were
$1.34 billion, an increase of $25.7 million, or 2.0%, from $1.32 billion as of
December 31, 2008. The increase was primarily due to a $33.5 million increase in
demand deposit accounts, partially offset by a $1.2 million decrease in time
deposits and a $6.6 million decrease in money market deposits. Time deposits
represented 59.8% of total deposits at March 31, 2009 compared to 61.1% at
December 31, 2008.





Total shareholders’ equity decreased
from $148.5 million as of December 31, 2008 to $142.7 million as of March 31,
2009. Retained earnings declined by $5.9 million, reflecting a $4.5 million net
loss for the quarter ended March 31, 2009 in addition to $1.4 million of
dividends declared during the quarter on common and preferred shares.
Accumulated other comprehensive income, which represents the unrealized gains
and losses on available-for-sale securities and derivatives accounted for as
cash flow hedges, net of related tax benefits, declined from $886 thousand as of
December 31, 2008 to $642 thousand as of March 31, 2009. The decrease in
accumulated other comprehensive income was primarily due to a decline in fair
value of the cash flow hedge, partially offset by an increase in the fair value
of available-for-sale securities. See the Condensed Consolidated Statements of
Changes in Shareholders’ Equity and Comprehensive Income for additional
information regarding fluctuations in equity accounts during the quarter ended
March 31, 2009.


- 22
-
 Index


Asset Quality





Determining the allowance for loan
losses is based on a number of factors, many of which are subject to judgments
made by management. At the origination of each commercial loan, management
assesses the relative risk of the loan and assigns a corresponding risk grade.
To ascertain that the credit quality is maintained after the loan is booked, a
loan review officer performs an annual review of all unsecured loans over a
predetermined loan amount, a sampling of loans within a lender’s authority, and
a sampling of the entire loan pool. Loans are reviewed for credit quality,
sufficiency of credit and collateral documentation, proper loan approval,
covenant, policy and procedure adherence, and continuing accuracy of the loan
grade. The Loan Review Manager reports directly to the Chief Credit Officer and
the Audit Committee of the Company’s Board of Directors.





The
allowance for loan losses is an amount that management believes will be adequate
to absorb losses estimated inherent in existing loans, based on evaluations of
the collectability of loans and prior loan loss experience. The evaluations take
into consideration such factors as changes in the nature and volume of the loan
portfolio, overall portfolio quality, review of specific problem loans, and
current economic conditions and trends that may affect the borrowers’ ability to
pay. The allowance calculation consists of two primary components: (1) a
component for individual impairment as recognized and measured in accordance
with SFAS No. 114, Accounting
By Creditors for Impairment of a Loan, and (2) components for collective
reserve as recognized in accordance with SFAS No. 5, Accounting for Contingencies,
including a qualitative portion.





The
Company maintains specific reserves for individually impaired loans pursuant to
SFAS No. 114. A loan is considered impaired, based on current information and
events, if it is probable that the Company will be unable to collect the
scheduled payments of principal and interest when due according to the
contractual terms of the loan agreement. Uncollateralized loans are measured for
impairment based on the present value of expected future cash flows discounted
at the historical effective interest rate, while all collateral-dependent loans
are measured for impairment based on the fair value of the collateral. The
Company uses several factors in determining if a loan is impaired. The internal
asset classification procedures include a thorough review of significant loans
and lending relationships and include the accumulation of related data. This
data includes loan payment status, borrowers’ financial data and borrowers’
operating factors such as cash flows, operating income or loss, etc. As of March
31, 2009 and December 31, 2008 impaired loans on relationships over $750
thousand totaled $22.4 million and $9.7 million, respectively, with specific
reserves of $1.5 million and $0.3 million, respectively. These loans were
evaluated individually based on the present value of expected future cash flows
or the fair value of the collateral. As of March 31, 2009 and December 31, 2008,
impaired loans on relationships less than $750 thousand, totaled $6.9 million
and $6.0 million, respectively, with associated reserves of $1.1 million and
$0.6 million, respectively. These loans were evaluated on the pooled method as
allowed by SFAS No. 114 and were assigned reserves based on each loan’s risk
grading.





For loans not considered impaired,
the Company estimates the
amount of allowance needed to cover losses inherent in the portfolio,in accordance with SFAS No. 5,by applying a loss
allowance factor to each risk grade.Unless identified as an at-risk
loan,consumer loans and mortgages are not
risk graded, but a loss allocation factor is utilized for these loans based on
historical losses. The loss allocation factors have been developed based on the
Company’s historical losses and industry trends.Further, for commercial loans rated
special mention and/or classified with outstanding relationship balances greater
than $750 thousand, management determines the level of reserves based on the
facts and circumstances of each borrower relationship, including among other
factors, payment history, collateral values, guarantor liquidity, and net worth.In addition to this
quantitative analysis, a qualitative assessment of the general economic trends,
portfolio concentration, interest rate movements and the trend of delinquencies
are taken into consideration. The loan loss allowance is adjusted to an amount
that management believes is adequate to absorb losses inherent in the loan
portfolio as of the balance sheet date presented.





The allowance for loan losses is
established through a provision for loan losses charged to expense. Loans are
charged against the allowance for loan losses when management believes that the
collectability of the principal is unlikely. Based on this allowance
calculation, management recorded a provision of $6.0 million for the quarter
ended March 31, 2009 compared to $565 thousand for the quarter ended March 31,
2008.Thesignificantincrease in the provision was partially
due to loan growthof$126.6 million from March
31, 2008, but the increase was primarily driven by deteriorating economic
conditions and weaknesses in the local real estate markets which resulted in
downgrades to the credit ratings of certain loans in the portfolioand a significant increase in the
balances of nonperforming loans. Additionally, the decline in real
estate values securing certain nonperforming loans required increased provision
during the quarter.Net
charge-offsfor the quarter
ended March 31, 2009 were $2.3 million, or 0.73% of average loans (annualized),
compared to net charge-offs of $573 thousand, or 0.20% of average loans
(annualized), for the quarter ended March 31, 2008.


- 23
-
 Index


The following table presents an analysis
of changes in the allowance for loan losses for the three months ended March
31, 2009 and 2008,
respectively.





Three Months Ended March
      31,2009
                
                2008(Dollars in
      thousands)Allowance for loan losses,
      beginning of period
                
                $
                14,795
                
                $
                13,571Net
      charge-offs:Loans charged
      off:Commercial
                
                
                680
                
                
                346Construction
                
                
                1,332
                
                
                332Consumer
                
                
                73
                
                
                593Home equity
                
                
                123
                
                
                –Residential
      mortgages
                
                
                165
                
                
                –Total
      charge-offs
                
                
                2,373
                
                
                1,271Recoveries of loans previously
      charged off:Commercial
                
                
                61
                
                
                386Construction
                
                
                –
                
                
                275Consumer
                
                
                10
                
                
                35Home equity
                
                
                1
                
                
                1Residential
      mortgages
                
                
                –
                
                
                1Total
      recoveries
                
                
                72
                
                
                698Total net
      charge-offs
                
                
                2,301
                
                
                573Loss provision charged to
      operations
                
                
                5,986
                
                
                565Allowance for loan losses, end of
      period
                
                $
                18,480
                
                $
                13,563Net charge-offs to average loans
      during the period (annualized)
                
                
                0.73
                %
                
                0.20
                %Allowance as a percent of gross
      loans
                
                
                1.45
                %
                
                1.18
                %





The
evaluation of the allowance for loan losses is inherently subjective, and
management uses the best information available to establish this estimate.
However, if factors such as economic conditions differ substantially from
assumptions, or if amounts and timing of future cash flows expected to be
received on impaired loans vary substantially from the estimates, future
adjustments to the allowance for loan losses may be necessary. In addition,
various regulatory agencies, as an integral part of their examination process,
periodically review the Company’s allowance for loan losses. Such agencies may
require the Company to recognize additions to the allowance for loan losses
based on their judgments about all relevant information available to them at the
time of their examination. Any adjustments to original estimates are made in the
period in which the factors and other considerations indicate that adjustments
to the allowance for loan losses are necessary.





The following table presents an analysis
of nonperforming assets as of March 31, 2009 and December 31,
2008.





March 31,
    2009
                
                December 31,
      2008(Dollars in
      thousands)
                
                (Unaudited)Nonperforming
      loans:Commercial
                
                $
                6,231
                
                $
                4,682Construction
                
                
                10,259
                
                
                3,843Consumer
                
                
                33
                
                
                92Home equity
                
                
                96
                
                
                275Residential
      mortgages
                
                
                389
                
                
                223Total nonperforming
      loans
                
                
                17,008
                
                
                9,115Foreclosed property
      held
                
                
                3,616
                
                
                1,347Total nonperforming
      assets
                
                $
                20,624
                
                $
                10,462Nonperforming loans to total
      loans
                
                
                1.33
                %
                
                0.73
                %Nonperforming assets to total
      assets
                
                
                1.24
                %
                
                0.63
                %Allowance coverage of
      nonperforming loans
                
                
                109
                %
                
                162
                %


- 24
-
 Index
 Of the
$29.3 million of loans considered impaired in accordance with SFAS No. 114, loan
relationships totaling $8.5 million are still accruing interest and are not
included in nonperforming loans as of March 31, 2009. The largest of these is a
builder/developer relationship located in Central North Carolina and an
automobile dealership/real estate relationship located in Central North
Carolina, with outstanding loan balances of $5.6 million and $1.6 million,
respectively, as of March 31, 2009. Such loans are classified as troubled debt
restructurings by the Company when certain modifications are made to the loan
terms due to financial difficulty experienced by the debtors. These loans were
not placed in nonaccrual status prior to the restructuring, and since the
Company expects the borrowers to perform after the restructuring (based on
modified note terms), the loans continue to accrue interest at the restructured
rate. The Company will continue to closely monitor these loans and will cease
accruing interest on them if management believes that the borrowers may not
continue performing based on the restructured note terms. Since these loans were
classified as troubled debt restructurings, they were considered to be impaired
and were evaluated for impairment in accordance with SFAS No. 114. As of March
31, 2009, specific reserves recorded on impaired loans still accruing interest
totaled $1.0 million.
 
 Foreclosed propertyincreasedto $3.6 millionatMarch 31, 2009 from $1.3 million at
December 31, 2008. Theincreasewas primarily due to the repossession during the quarter
of certaincommercial and
residentialreal
estate. The Company is
actively marketing all of its foreclosed property.Foreclosed assets are adjusted to fair
value upon transfer of the loans to foreclosed assets. Subsequently, foreclosed
assets are carried at the lower of carrying value or fair
value.
 
 Liquidity and Capital
Resources
 
 Liquidity.Liquidity management involves the ability to meet the cash flow
requirements of depositors desiring to withdraw funds or borrowers needing
assurance that sufficient funds will be available to meet their credit needs. To
ensure the Company is positioned to meet immediate and future cash demands,
management relies on internal analysis of its liquidity, knowledge of current
economic and market trends and forecasts of future conditions. Regulatory
agencies set certain minimum liquidity standards, including the setting of a
reserve requirement by the Federal Reserve. The Company must submit weekly
reports to the Federal Reserve to ensure that it meets those requirements. As of
March 31, 2009, the Company met all of its regulatory liquidity
requirements.
 
 The Company had $39.9million in its most liquid assets, cash
and cash equivalents,as ofMarch 31, 2009. The Company’s principal sources of
funds are loan repayments, deposits,short-termborrowings, capital and, to a lesser
extent, investment repayments. Core deposits (total deposits less certificates
of deposits in the amount of $100 thousand or more), one of the most stable sources of
liquidity,together with
equity capitalfunded$1.18billion, or 70.9%, of total assets as of March
31, 2009 compared to $1.17 billion, or 70.7%, of total assets as of December 31,
2008.Additional sources of liquidity are
available to the Company through the Federal Reserve and through membership in
the FHLB system as well as access to funding through various brokered deposit
programs, federal funds lines and security repurchase
agreements.
 
 Capital Resources.The management of equity is
a critical aspect of capital management in any business. The determination of
the appropriate amount of equity is affected by a wide number of factors. The
primary factor for a regulated financial institution is the amount of capital
needed to meet regulatory requirements, although other factors, such as the
“risk equity” the business requires and balance sheet leverage, also affect the
determination.
 
 To be categorized as well capitalized,
the Company and the Bank each must maintain minimum amounts and ratios. The
Company’s and the Bank’s actual capital amounts and ratios as of March 31, 2009
and the minimum requirements are presented in the following
table.
 
 Actual
                  
                  Minimum
      Requirements
                    To Be Well
      Capitalized(Dollars
      in thousands)
                  
                  Amount
                  
                  
                  Ratio
                  
                  Amount
                  
                  
                  RatioCapital
      Bank Corporation:Total
      capital (to risk-weighted assets)
                  
                  $
                  183,990
                  
                  
                  13.07
                  %
                  $
                  140,779
                  
                  
                  10.00
                  %Tier
      I capital (to risk-weighted assets)
                  
                  
                  166,386
                  
                  
                  11.82
                  
                  
                  84,467
                  
                  
                  6.00Tier
      I capital (to average assets)
                  
                  
                  166,386
                  
                  
                  10.01
                  
                  
                  83,100
                  
                  
                  5.00Capital
      Bank:Total
      capital (to risk-weighted assets)
                  
                  $
                  181,557
                  
                  
                  12.90
                  %
                  $
                  140,718
                  
                  
                  10.00
                  %Tier
      I capital (to risk-weighted assets)
                  
                  
                  163,953
                  
                  
                  11.65
                  
                  
                  84,431
                  
                  
                  6.00Tier
      I capital (to average assets)
                  
                  
                  163,953
                  
                  
                  9.93
                  
                  
                  82,584
                  
                  
                  5.00
  - 25
-
 Index
 Total shareholders’ equity was $142.7millionas ofMarch 31, 2009. Management believes this level
ofshareholders’ equity
provides adequate capital to support the Company’s growth and to maintain a well
capitalized position.
 
 On
October 3, 2008, the EESA was enacted, which authorized the Treasury to
establish the TARP, of which the CPP is a part. Under the CPP, certain U.S.
financial institutions sold senior preferred stock and issue warrants to
purchase an institution’s common stock to the Treasury in exchange for a capital
infusion. Eligible institutions applied to issue preferred stock to the Treasury
in aggregate amounts between 1% and 3% of the institution’s risk-weighted
assets, along with warrants covering shares of common stock. In order to
participate in the CPP, the Company’s shareholders approved an amendment to the
Company’s articles of incorporation to authorize 100,000 shares of preferred
stock.
  In
December 2008, the Company entered into a Securities Purchase Agreement—Standard
Terms with the Treasury (the “Stock Purchase Agreement”) pursuant to which,
among other things, the Company sold to the Treasury for an aggregate purchase
price of $41.3 million, 41,279 shares of Series A Fixed Rate Cumulative
Perpetual Preferred Stock of the Company (“Series A Preferred Stock”) and
warrants to purchase up to 749,619 shares of common stock (the “Warrants”) of
the Company. As a condition under the CPP, the Company’s share repurchases are
currently limited to purchases in connection with the administration of any
employee benefit plan, consistent with past practices, including purchases to
offset share dilution in connection with any such plans. This restriction is
effective until December 2011 or until the Treasury no longer owns any of the
Series A Preferred Stock.
 
 The
Series A Preferred Stock ranks senior to the Company’s common shares and pays a
compounding cumulative dividend, in cash, at a rate of 5% per annum for the
first five years, and 9% per annum thereafter on the liquidation preference of
$1,000 per share. The Company is prohibited from paying any dividend with
respect to shares of common stock or repurchasing or redeeming any shares of the
Company’s common shares unless all accrued and unpaid dividends are paid on the
Series A Preferred Stock for all past dividend periods (including the latest
completed dividend period). The Series A Preferred Stock is non-voting, other
than class voting rights on matters that could adversely affect the Series A
Preferred Stock. The Series A Preferred Stock is callable at par after
three years. Prior to the end of three years, the Series A Preferred Stock may
be redeemed with the proceeds from one or more qualified equity offerings of any
Tier 1 perpetual preferred or common stock of at least $10.3 million (each a
“Qualified Equity Offering”). The Treasury may also transfer the Series A
Preferred Stock to a third party at any time. The Company made its first
scheduled dividend payment to the Treasury for approximately $361,000 during the
quarter ended March 31, 2009.
 
 Item 3.Quantitative and Qualitative Disclosures about Market
Risk
 
 As described in more detail in Part II,
Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2008,
asset/liability management involves the evaluation, monitoring and management of
interest rate risk, liquidity and funding. While the Board of Directors has
overall responsibility for the Company’s asset/liability management policies,
the Bank’s Asset and Liability Committee monitors loan, investment, and
liability portfolios to ensure comprehensive management of interest rate risk
and adherence to the Bank’s policies.The Company has not experienced any
material change in the risk of its portfolios of interest-earning assets and
interest-bearing liabilities from December 31, 2008 to March 31,
2009.
 
 Item 4.Controls and
Procedures
 
 The Company maintains disclosure
controls and procedures that are designed to ensure that information required to
be disclosed in the reports it files or submits under the Securities Exchange
Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported
within the time periods specified in the rules and forms of the SEC, and that
such information is accumulated and communicated to the Company’s management,
including its Chief Executive Officer (“CEO”) and Chief Financial Officer
(“CFO”), as appropriate, to allow timely decisions regarding disclosure.
Management necessarily applies its judgment in assessing the costs and benefits
of such controls and procedures, which, by their nature, can provide only
reasonable assurance regarding management’s control
objectives.
 
 As required by paragraph (b) of Rule
13a-15 under the Exchange Act, an evaluation was carried out under the
supervision and with the participation of the Company’s management, including
the CEO and CFO, of the effectiveness of the Company’s disclosure controls and
procedures as of the end of the period covered by this report.During the
course of their evaluation, management discovered that, as a result of human
error, the Company failed to file a Form 8-K pursuant to Item 5.02 in connection
with the award of certain discretionary bonuses under the Company’s Annual
Incentive Plan. As a result, management has implemented further training of
relevant Company personnel and Board members regarding Form 8-K triggers and the
timing related thereto. Based upon
that evaluation, the CEO and CFO concluded that, as of the period covered by the
report, the Company’s disclosure controls and procedures are effective in that
they provide reasonable assurances that the information the Company is required
to disclose in the reports it files or submits under the Exchange Act is
recorded, processed, summarized and reported within the time periods required by
the SEC’s rules and forms.
  - 26
-
 Index
 Changes in Internal Control over
Financial Reporting
 
 There were no changes in the Company’s
internal control over financial reporting (as defined in Rules 13a-15(f) and
15d-15(f) of the Exchange Act) that occurred during the period covered by this
report that have materially affected or are reasonably likely to materially
affect, the Company’s internal control over financial reporting. Management has
implemented changes in internal control over financial reporting as a result of
remediation of matters identified through its review of internal control over
financial reporting as required under Section 404 of the Sarbanes-Oxley Act;
however, it does not believe any of the changes implemented were material in
nature.
 
 
 PART II – OTHER
INFORMATION
 
 Item 1.Legal
Proceedings
 
 There are no material pending legal
proceedings to which the Company or its subsidiaries is a party or to which any
of the Company’s or its subsidiaries’ property is subject. In addition, the
Company is not aware of any threatened litigation, unasserted claims or
assessments that could have a material adverse effect on the Company’s business,
operating results or condition.
 
 Item 1A.Risk
Factors
 
 You should consider the following
material risk factors carefully before deciding to invest in the Company’s
securities. Additional risks and uncertainties not presently known to us, that
we may currently deem to be immaterial or that are similar to those faced by
other companies in our industry or business in general, such as competitive
conditions, may also impact our business operations. If any of the events
described below occur, the Company’s business, financial condition, or results
of operations could be materially adversely affected. In that event, the trading
price of the Company’s common stock may decline, in which case the value of your
investment may decline as well. References herein to “we”, “us”, and “our” refer
to Capital Bank Corporation, a North Carolina corporation, and its subsidiaries,
unless the context otherwise requires.
 
 Legislative and regulatory actions taken
now or in the future to address the current liquidity and credit crisis in the
financial industry may significantly affect our liquidity or financial
condition.
 
 The EESA,
which established the TARP, was enacted on October 3, 2008. As part of the TARP,
the Treasury created the CPP, under which the Treasury will invest up to $250
billion in senior preferred stock of U.S. banks and savings associations or
their holding companies for the purpose of stabilizing and providing liquidity
to the U.S. financial markets. On February 17, 2009, the ARRA was enacted as a
sweeping economic recovery package intended to stimulate the economy and provide
for extensive infrastructure, energy, health, and education needs. There can be
no assurance as to the actual impact that EESA or its programs, including the
CPP, and ARRA or its programs, will have on the national economy or financial
markets. The failure of these significant legislative measures to help stabilize
the financial markets and a continuation or worsening of current financial
market conditions could materially and adversely affect the Company’s financial
condition, results of operation, liquidity or stock price.
 
 U.S.
and international credit markets and economic conditions could adversely affect
our liquidity and financial condition.
 
 Global
market and economic conditions continue to be disruptive and volatile and the
disruption has particularly had a negative impact on the financial sector. The
possible duration and severity of this adverse economic cycle is unknown.
Although the Company remains well capitalized and has not suffered any liquidity
issues as a result of these recent events, the cost and availability of funds
may be adversely affected by illiquid credit markets. Continued turbulence in
U.S. and international markets and economies may adversely affect our liquidity,
financial condition and profitability.
 
 In
addition, federal and state governments could pass additional legislation
responsive to current credit conditions. We could experience higher credit
losses because of legislation or regulatory action that reduces the amounts
borrowers are contractually required to pay under existing loan contracts or
that limits our ability to foreclose on property or other collateral or makes
foreclosure less economically feasible.
  - 27
-
 Index


Changes in local economic conditions
could lead to higher loan charge-offs and reduce our net income and
growth.





Our business is subject to periodic
fluctuations based on local economic conditions in Central and Western North
Carolina. These fluctuations are not predictable, cannot be controlled, and may
have a material adverse impact on our operations and financial condition even if
other favorable events occur. Our operations are locally oriented and
community-based.Accordingly, we expect to continue to be
dependent upon local business conditions as well as conditions in the local
residential and commercial real estate markets we serve. For example, an
increase in unemployment, a decrease in real estate values or increases in
interest rates, as well as other factors, could weaken the economies of the communities we
serve.





Weakness in our market areas could
depress our earnings and consequently our financial condition
because:





•
              customers may not want or need our
      products or services;•
              borrowers may not be able to repay
      their loans;•
              the value of the collateral
      securing loans to borrowers may decline; and•
              the quality of our loan portfolio
      may decline.





Any of the latter three
scenarios could require us
to chargeoff a higher
percentage of loans and/or increase provisions for credit losses, which would
reduce our net income. For an analysis of our recent charge-off experience,
please refer to the “Asset
Quality” section in Part I, Item 2. Management’s Discussion and Analysis
of Financial Condition and Results of Operations.





Because the majority of our borrowers
are individuals and businesses located and doing business in Wake, Granville,
Lee, Cumberland, Johnston, Chatham, Alamance, Buncombe and Catawba Counties,
North Carolina, our success will depend significantly upon the economic
conditions in those and the surrounding counties. Unfavorable economic
conditions in those and the surrounding counties may result in, among other
things, a deterioration in credit quality or a reduced demand for credit and may
harm the financial stability of our customers. Due to our limited market areas,
these negative conditions may have a more noticeable effect on us than would be
experienced by a larger institution that is able to spread these risks of
unfavorable local economic conditions across a large number of diversified
economies.





Weakness in the markets for residential
or commercial real estate could reduce our net income and
profitability.





Recently, the financial markets have
experienced volatility associated with subprime mortgages, including adverse
impacts on credit quality and liquidity within the financial markets. The
volatility has been exacerbated by a general decline in the real estate and
housing market along with significant mortgage loan related losses reported by
many other financial institutions. Our financial results may be adversely
affected by changes in real estate values. Decreases in real estate values could
adversely affect the value of property used as collateral for loans and
investments. If poor economic conditions result in decreased demand for real
estate loans, our net income and profits may decline.





The declines in home prices in the
markets we serve, along with the reduced availability of mortgage credit, also
may result in increases in delinquencies and losses in our portfolio of loans
related to residential real estate construction and development.We significantly increased our provision
for loan losses in the quarter ended March 31, 2009 primarily due to
deteriorating economic conditions and weakness in local real estate markets.Further declines in home
prices coupled with a deepened economic recession and continued rises in
unemployment levels could drive losses beyond that which is provided for in our
allowance for loan losses. In that event, our earnings could be adversely
affected.





Additionally, recent weakness in the
secondary market for residential lending could have an adverse impact upon our
profitability. Significant ongoing disruptions in the secondary market for
residential mortgage loans have limited the market for and liquidity of most
mortgage loans other than conforming Fannie Mae and Freddie Mac loans. The
effects of ongoing mortgage market challenges, combined with the ongoing
correction in residential real estate market prices and reduced levels of home
sales, could result in further price reductions in single family home values,
adversely affecting the value of collateral securing mortgage loans held,
mortgage loan originations and gains on sale of mortgage loans. Continued
declines in real estate values and home sales volumes, and financial stress on
borrowers as a result of job losses, or other factors, could have further
adverse effects on borrowers that result in higher delinquencies and greater
charge-offs in future periods, which would adversely affect our financial
condition or results of
operations.


- 28
-
 Index


Changes in interest rates may have an
adverse effect on our profitability.





Our earnings and financial condition are
dependent to a large degree upon net interest income, which is the difference
between interest earned from loans and investments and interest paid on deposits
and borrowings. The narrowing of interest rate spreads, meaning the difference
between interest rates earned on loans and investments and the interest rates
paid on deposits and borrowings, could adversely affect our earnings and
financial condition. We cannot predict with certainty or control changes in
interest rates. Regional and local economic conditions and the policies of
regulatory authorities, including monetary policies of the Federal Reserve
Board, affect interest income and interest expense. We have ongoing policies and
procedures designed to manage the risks associated with changes in market
interest rates. However, changes in interest rates still may have an adverse
effect on our profitability.





We are exposed to risks in connection
with the loans we make.





A significant source of risk for us
arises from the possibility that losses will be sustained because borrowers,
guarantors and related parties may fail to perform in accordance with the terms
of their loans. We have underwriting and credit monitoring procedures and credit
policies, including the establishment and review of the allowance for loan
losses, that we believe are appropriate to minimize this risk by assessing the
likelihood of nonperformance, tracking loan performance and diversifying our
loan portfolio. Such policies and procedures, however, may not prevent
unexpected losses that could adversely affect our results of operations. Loan
defaults result in a decrease in interest income resulting from a loan default
or defaults may be for a prolonged period of time as we seek to recover,
primarily through legal proceedings, the outstanding principal balance, accrued
interest and default interest due on a defaulted loan plus the legal costs
incurred in pursuing our legal remedies. No assurance can be given that recent
market conditions will not result in our need to increase loan loss reserves or
charge off a higher percentage of loans, thereby reducing net
income.





We compete with larger companies for
business.





The banking and financial services
business in our market areas continues to be a competitive field and is becoming
more competitive as a result of:





•
              changes in
      regulations;•
              changes in technology and product
      delivery systems; and•
              the accelerating pace of
      consolidation among financial services
  providers.





We may not be able to compete
effectively in our markets, and our results of operations could be adversely
affected by the nature or pace of change in competition. We compete for loans,
deposits and customers with various bank and nonbank financial services
providers, many of which have substantially greater resources, including higher
total assets and capitalization, greater access to capital markets and a broader
offering of financial services.





Our trading volume has been low compared
with larger banks.





The trading volume in the Company’s
common stock on the NASDAQ Global Select Market has been comparable to other
similarly-sized banks. Nevertheless, this trading is relatively low when
compared with more seasoned companies listed on the NASDAQ Global Select Market
or other consolidated reporting systems or stock exchanges. Thus, the market in
the Company’s common stock may be limited in scope relative to other
companies.





We depend heavily on our key management
personnel.





The Company’s success depends in part on
its ability to retain key executives and to attract and retain additional
qualified management personnel who have experience both in sophisticated banking
matters and in operating a small- to mid-size bank. Competition for such
personnel is strong in the banking industry, and we may not be successful in
attracting or retaining the personnel we require. We expect to effectively
compete in this area by offering financial packages that include incentive-based
compensation and the opportunity to join in the rewarding work of building a
growing bank.


- 29
-
 Index
 Participation
in the TARP imposes several restrictions on compensation paid to our
executives.





Pursuant
to the terms of the Stock Purchase Agreement, we adopted certain standards for
executive compensation and corporate governance for the period during which the
Treasury holds the equity issued pursuant to the Stock Purchase Agreement,
including the common stock which may be issued pursuant to the Warrants. These
standards generally apply to our Chief Executive Officer, Chief Financial
Officer and our senior executive officers (“SEOs”). The standards include (1)
ensuring that bonus incentive compensation arrangements for SEOs do not
encourage unnecessary and excessive risks that threaten the value of the
financial institution; (2) requiring clawback of any bonus or incentive
compensation paid to a SEOs based on statements of earnings, gains or other
criteria that are later proven to be materially inaccurate; (3) prohibiting
certain parachute payments to SEOs; and (4) agreeing not to deduct for tax
purposes executive compensation in excess of $500,000 for each SEO. In
particular, the change to the deductibility limit on executive compensation will
likely increase the overall cost of our compensation programs in future periods.
Since the Warrants have a ten year term, we could potentially be subject to the
executive compensation and corporate governance restrictions for a ten year time
period.





Additionally,
the ARRA amends Section 111 of the EESA to require the Treasury to adopt
additional standards with respect to executive compensation and corporate
governance for TARP recipients (including the Company). The standards required
to be established by the Treasury include, in part, (1) prohibitions on making
golden parachute payments to SEOs and the next 5 most highly-compensated
employees during such time as any obligation arising from financial assistance
provided under the TARP remains outstanding (the “Restricted Period”), (2)
prohibitions on paying or accruing bonuses or other incentive awards for certain
SEOs and employees, except for awards of long-term restricted stock with a value
equal to no greater than 1/3 of an individual’s annual compensation that do not
fully vest during the Restricted Period or unless such compensation is pursuant
to a valid written employment contract prior to February 11, 2009, (3)
requirements that CPP participants provide for the recovery of any bonus or
incentive compensation paid to SEOs and the next 20 most highly-compensated
employees based on statements of earnings, revenues, gains or other criteria
later found to be materially inaccurate, with the Treasury having authority to
negotiate for reimbursement, and (4) a review by the Treasury of all bonuses and
other compensation paid by TARP participants to senior executive employees and
the next 20 most highly-compensated employees before the date of enactment of
the ARRA to determine whether such payments were inconsistent with the purposes
of the EESA.





Technological advances impact our
business.





The banking industry is undergoing
technological changes with frequent introductions of new technology-driven
products and services. In addition to improving customer services, the effective
use of technology increases efficiency and enables financial institutions to
reduce costs. Our future success will depend, in part, on our ability to address
the needs of our customers by using technology to provide products and services
that will satisfy customer demands for convenience as well as to create
additional efficiencies in our operations. Many of our competitors have
substantially greater resources than we do to invest in technological
improvements. We may not be able to effectively implement new technology-driven
products and services or successfully market such products and services to our
customers.





Government regulations may prevent or
impact our ability to pay dividends, engage in acquisitions or operate in other
ways.





Current and future legislation and the
policies established by federal and state regulatory authorities will affect our
operations. We are subject to supervision and periodic examination by the
Federal Deposit Insurance Corporation and the North Carolina State Banking
Commission. Banking regulations, designed primarily for the protection of
depositors, may limit our growth and the return to you, our investors, by
restricting certain of our activities, such as:





•
                the payment of dividends to our
      shareholders;•
                possible mergers with, or
      acquisitions of or by, other institutions;•
                our desired
      investments;•
                loans and interest rates on
      loans;•
                interest rates paid on our
      deposits;•
                the possible expansion of our
      branch offices; and/or•
                our ability to provide securities
      or trust
services.


- 30
-
 Index
 We also are subject to capitalization
guidelines set forth in federal legislation, and could be subject to enforcement
actions to the extent that we are found by regulatory examiners to be
undercapitalized. We cannot predict what changes, if any, will be made to
existing federal and state legislation and regulations or the effect that such
changes may have on our future business and earnings prospects. The cost of
compliance with regulatory requirements including those imposed by the SEC may
adversely affect our ability to operate profitably.





The
Treasury’s investment in us imposes restrictions and obligations limiting our
ability to increase dividends and repurchase common stock.





In
December 2008, the Company issued preferred stock and Warrants to the Treasury.
Prior to December 12, 2011, unless the Company has redeemed all of the preferred
stock, or the Treasury has transferred all of the preferred stock to a third
party, the consent of the Treasury will be required for the Company to, among
other things, increase common stock dividends or effect repurchases of common
stock (with certain exceptions, including the repurchase of the Company’s common
stock to offset share dilution from equity-based employee compensation
awards).





There are potential risks associated
with future acquisitions and expansions.





We intend to continue to explore
expanding our branch system through selective acquisitions of existing banks or
bank branches in the Research Triangle area and other North Carolina markets. We
cannot say with any certainty that we will be able to consummate, or if
consummated, successfully integrate, future acquisitions, or that we will not
incur disruptions or unexpected expenses in integrating such acquisitions. In
the ordinary course of business, we evaluate potential acquisitions that would
bolster our ability to cater to the small business, individual and residential
lending markets in North Carolina. In attempting to make such acquisitions, we
anticipate competing with other financial institutions, many of which have
greater financial and operational resources. In addition, since the
consideration for an acquired bank or branch may involve cash, notes or the
issuance of shares of common stock, existing shareholders could experience
dilution in the value of their shares of our common stock in connection with
such acquisitions. Any given acquisition, if and when consummated, may adversely
affect our results of operations or overall financial condition. In addition, we
may expand our branch network through de novo branches in existing or new
markets. These de novo branches will have expenses in excess of revenues for
varying periods after opening, which could decrease our reported
earnings.





Compliance with changing regulation of
corporate governance and public disclosure may result in additional risks and
expenses.





Changing laws, regulations and standards
relating to corporate governance and public disclosure, including the
Sarbanes-Oxley Act of 2002 and new SEC regulations, are creating uncertainty for
companies such as ours. These laws, regulations and standards are subject to
varying interpretations in many cases, and as a result, their application in
practice may evolve over time as new guidance is provided by regulatory and
governing bodies, which could result in continuing uncertainty regarding
compliance matters and higher costs necessitated by ongoing revisions to
disclosure and governance practices. We are committed to maintaining high
standards of corporate governance and public disclosure. As a result, our
efforts to comply with evolving laws, regulations and standards have resulted
in, and are likely to continue to result in, increased expenses and a diversion
of management time and attention. In particular, our efforts to comply with
Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations
regarding management’s required assessment of our internal control over
financial reporting and our external auditors’ audit of that assessment has
required the commitment of significant financial and managerial
resources.





We expect these efforts to require the
continued commitment of significant resources. Further, the members of our Board
of Directors, members of the Audit or Compensation/Human Resources Committees,
our CEO, our CFO and certain other of our executive officers could face an
increased risk of personal liability in connection with the performance of their
duties. As a result, our ability to attract and retain executive officers and
qualified Board and committee members could be more difficult. In addition, it
may become more difficult and more expensive to obtain director and officer
liability insurance.


- 31
-
 Index
 We
are subject to environmental liability risk associated with lending
activities.





A
significant portion of our loan portfolio is secured by real property. During
the ordinary course of business, we may foreclose on and take title to
properties securing certain loans. In doing so, there is a risk that hazardous
or toxic substances could be found on these properties. If hazardous or toxic
substances are found, we may be liable for remediation costs, as well as for
personal injury and property damage. Environmental laws may require us to incur
substantial expenses and may materially reduce the affected property’s value or
limit our ability to use or sell the affected property. In addition, future laws
or more stringent interpretations or enforcement policies with respect to
existing laws may increase our exposure to environmental liability. Although we
have policies and procedures to perform an environmental review before
initiating any foreclosure action on nonresidential real property, these reviews
may not be sufficient to detect all potential environmental hazards. The
remediation costs and any other financial liabilities associated with an
environmental hazard could have a material adverse effect on our financial
condition and results of operations.Loan defaults result in a decrease in
interest income and may require the establishment of or an increase in loan loss
reserves. Furthermore, the decrease in interest income resulting from a loan
default or defaults may be for a prolonged period of time as we seek to recover,
primarily through legal proceedings, the outstanding principal balance, accrued
interest and default interest due on a defaulted loan plus the legal costs
incurred in pursuing our legal remedies. No assurance can be given that recent
market conditions will not result in our need to increase loan loss reserves or
charge-off a higher percentage of loans, thereby reducing net income.





Our
controls and procedures may fail or be circumvented.





Management
regularly reviews and updates our internal controls, disclosure controls and
procedures, and corporate governance policies and procedures. Any system of
controls, however well designed and operated, is based in part on certain
assumptions and can provide only reasonable, not absolute, assurances that the
objectives of the system are met. Any failure or circumvention of our controls
and procedures or failure to comply with regulations related to controls and
procedures could have a material adverse effect on our business, results of
operations and financial condition.





The
holders of our subordinated debentures have rights that are senior to those of
our shareholders.





We have
issued $30.9 million of subordinated debentures in connection with three trust
preferred securities issuances by our subsidiaries, Trust I, II and III. We
conditionally guarantee payments of the principal and interest on the trust
preferred securities. Our subordinated debentures are senior to our shares of
common stock. As a result, we must make payments on the subordinated debentures
(and the related trust preferred securities) before any dividends can be paid on
our common stock and, in the event of bankruptcy, dissolution or liquidation,
the holders of the debentures must be satisfied before any distributions can be
made to the holders of common stock.





Our information systems may
experience an interruption or breach in security.





We rely
heavily on communications and information systems to conduct our business. Any
failure, interruption or breach in security of these systems could result in
failures or disruptions in our customer relationship management, general ledger,
deposit, loan and other systems. While we have policies and procedures designed
to prevent or limit the effect of the failure, interruption or security breach
of our information systems, there can be no assurance that we can prevent any
such failures, interruptions or security breaches or, if they do occur, that
they will be adequately addressed. The occurrence of any failures, interruptions
or security breaches of our information systems could damage our reputation,
result in a loss of customer business, subject us to additional regulatory
scrutiny, or expose us to civil litigation and possible financial liability, any
of which could have a material adverse effect on our financial condition and
results of operations.





An
investment in our common stock is not an insured deposit.





Our
common stock is not a bank deposit and, therefore, is not insured against loss
by the FDIC, any other deposit insurance fund or by any other public or private
entity. Investment in our common stock is inherently risky for the reasons
described in this “Risk Factors” section and elsewhere in this report and is
subject to the same market forces that affect the price of common stock in any
company. As a result, if you acquire our common stock, you may lose some or all
of your investment.


- 32
-
 Index
 Consumers
may decide not to use banks to complete their financial
transactions.





Technology
and other changes are allowing parties to complete financial transactions that
historically have involved banks through alternative methods. For example,
consumers can now maintain funds in brokerage accounts or mutual funds that
would have historically been held as bank deposits. Consumers can also complete
transactions such as paying bills and/or transferring funds directly without the
assistance of banks. The process of eliminating banks as intermediaries could
result in the loss of fee income, as well as the loss of customer deposits and
the related income generated from those deposits. The loss of these revenue
streams and the lower cost deposits as a source of funds could have a material
adverse effect on our financial condition and results of
operations.





Item 2.Unregistered Sales of Equity Securities and Use of
Proceeds





There were no repurchases (both open
market and private transactions) during the three months ended March 31, 2009 of
any of the Company’s securities registered under Section 12 of the Exchange
Act, by or on behalf of the Company, or any affiliated purchaser of the
Company.





Item 3.Defaults upon Senior
Securities





None





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





None





Item 5.Other
Information





None




- 33
-
 Index


Item 6.Exhibits




Exhibit No.
              
              DescriptionExhibit 4.1
              
              In accordance with Item
      601(b)(4)(iii)(A) of Regulation S-K, certain instruments respecting
      long-term debt of the registrant have been omitted but will be furnished
      to the Commission upon request.Exhibit
31.1
              
              Certification of B. Grant Yarber
      pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section
      302 of the Sarbanes-Oxley Act of 2002Exhibit
31.2
              
              Certification of Michael R. Moore
      pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section
      302 of the Sarbanes-Oxley Act of 2002Exhibit
32.1
              
              Certification of B. Grant Yarber
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002 [This exhibit is being furnished pursuant
      to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to
      the extent required by that Act, be deemed to be incorporated by reference
      into any document or filed herewith for purposes of liability under the
      Securities Exchange Act of 1934, as amended, or the Securities Act of
      1933, as amended, as the case may be.]Exhibit
32.2
              
              Certification of Michael R. Moore
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002 [This exhibit is being furnished pursuant
      to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to
      the extent required by that Act, be deemed to be incorporated by reference
      into any document or filed herewith for purposes of liability under the
      Securities Exchange Act of 1934, as amended, or the Securities Act of
      1933, as amended, as the case may
be.]


- 34
-
 Index
 Signatures





Pursuant to the requirements of the
Securities Exchange Act of 1934, the registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized, in
Raleigh, North Carolina, on the 8th day of May 2009.





CAPITAL BANK
      CORPORATIONBy:  /s/Michael R.
      MooreMichael R.
      MooreChief Financial
      Officer(Authorized Officer and Principal
      Financial Officer)





- 35
-
 Index


Exhibit Index





Exhibit No.
              
              DescriptionExhibit 4.1
              
              In accordance with Item
      601(b)(4)(iii)(A) of Regulation S-K, certain instruments respecting
      long-term debt of the registrant have been omitted but will be furnished
      to the Commission upon request.Exhibit
31.1
              
              Certification of B. Grant Yarber
      pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section
      302 of the Sarbanes-Oxley Act of 2002Exhibit
31.2
              
              Certification of Michael R. Moore
      pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section
      302 of the Sarbanes-Oxley Act of 2002Exhibit
32.1
              
              Certification of B. Grant Yarber
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002 [This exhibit is being furnished pursuant
      to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to
      the extent required by that Act, be deemed to be incorporated by reference
      into any document or filed herewith for purposes of liability under the
      Securities Exchange Act of 1934, as amended, or the Securities Act of
      1933, as amended, as the case may be.]Exhibit
32.2
              
              Certification of Michael R. Moore
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002 [This exhibit is being furnished pursuant
      to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to
      the extent required by that Act, be deemed to be incorporated by reference
      into any document or filed herewith for purposes of liability under the
      Securities Exchange Act of 1934, as amended, or the Securities Act of
      1933, as amended, as the case may
be.]


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