UNITED STATES


SECURITIES AND EXCHANGE
COMMISSION


Washington, D.C.
20549





FORM 10-Q





þ QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d)


OF THE SECURITIES EXCHANGE ACT OF
1934





For the Quarterly Period Ended June 30,
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 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 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 is a shell company (as defined in Rule 12b-2 of the Exchange
Act).Yes   ̈  No  þ





As of August 6, 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
June 30, 2009








INDEX







PART I – FINANCIAL
      INFORMATION
                  Page
      No.Item 1.
                  Financial
      StatementsCondensed Consolidated Balance
      Sheets as of June 30, 2009 (Unaudited) and December 31,
      2008
                  3Condensed Consolidated Statements
      of Operations for the Three and Six Months Ended June 30, 2009 and 2008
      (Unaudited)
                  4Condensed Consolidated Statements
      of Changes in Shareholders’ Equity and Comprehensive Income for the Six
      Months Ended June 30, 2009 and 2008 (Unaudited)
                  5Condensed Consolidated Statements
      of Cash Flows for the Six Months Ended June 30, 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
                  16Item
      3.
                  Quantitative and Qualitative
      Disclosures about Market Risk
                  34Item 4.
                  Controls and
      Procedures
                  34PART II – OTHER
      INFORMATIONItem
      1.
                  Legal
      Proceedings
                  35Item
      1A.
                  Risk
Factors
                  35Item
      2.
                  Unregistered Sales of Equity
      Securities and Use of Proceeds
                  41Item
      3.
                  Defaults upon Senior
      Securities
                  41Item
      4.
                  Submission of Matters to a Vote of
      Security Holders
                  41Item
      5.
                  Other
      Information
                  42Item
      6.
                  Exhibits
                  42Signatures




- 2 -
 Index


PART I – FINANCIAL
INFORMATION





Item 1.Financial
Statements





CAPITAL BANK
CORPORATION


CONDENSED CONSOLIDATED BALANCE
SHEETS


June 30, 2009 and December 31,
2008





June
      30, 2009
                
                December
      31, 2008(Dollars
      in thousands except share data)
                
                (Unaudited)AssetsCash and due from
      banks:Interest-earning
                
                $
                53,590
                
                $
                26,621Noninterest-earning
                
                
                19,094
                
                
                27,705Federal
      funds sold and short term investments
                
                
                10
                
                
                129Total
      cash and cash equivalents
                
                
                72,694
                
                
                54,455Investment
      securities – available for sale, at fair value
                
                
                263,845
                
                
                272,944Investment
      securities – held to maturity, at amortized cost
                
                
                4,379
                
                
                5,194Loans
      – net of unearned income and deferred fees
                
                
                1,293,340
                
                
                1,254,368Allowance
      for loan losses
                
                
                (18,602
                )
                
                (14,795
                )Net
      loans
                
                
                1,274,738
                
                
                1,239,573Premises
      and equipment, net
                
                
                24,170
                
                
                24,640Bank-owned
      life insurance
                
                
                22,398
                
                
                22,368Deposit
      premium, net
                
                
                3,282
                
                
                3,857Deferred
      income tax
                
                
                9,116
                
                
                9,342Accrued
      interest receivable
                
                
                6,191
                
                
                6,225Other
      assets
                
                
                14,529
                
                
                15,634Total
      assets
                
                $
                1,695,342
                
                $
                1,654,232LiabilitiesDeposits:Demand,
      noninterest-bearing
                
                $
                130,567
                
                $
                125,281Savings
      and interest-bearing checking
                
                
                209,622
                
                
                173,711Money
      market deposit accounts
                
                
                206,259
                
                
                212,780Time
      deposits less than $100,000
                
                
                503,476
                
                
                509,231Time
      deposits $100,000 and greater
                
                
                330,918
                
                
                294,311Total
      deposits
                
                
                1,380,842
                
                
                1,315,314Repurchase
      agreements and federal funds purchased
                
                
                10,589
                
                
                15,010Borrowings
                
                
                117,000
                
                
                132,000Subordinated
      debentures
                
                
                30,930
                
                
                30,930Other
      liabilities
                
                
                12,675
                
                
                12,464Total
      liabilities
                
                
                1,552,036
                
                
                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)
                
                
                39,982
                
                
                39,839Common
      stock, no par value; 20,000,000 shares authorized; 11,300,369 and
      11,238,085 shares issued and outstanding
                
                
                139,641
                
                
                139,209Retained
      deficit
                
                
                (37,515
                )
                
                (31,420
                )Accumulated
      other comprehensive income
                
                
                1,198
                
                
                886Total
      shareholders’ equity
                
                
                143,306
                
                
                148,514Total
      liabilities and shareholders’ equity
                
                $
                1,695,342
                
                $
                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 theThree and SixMonthsEndedJune 30, 2009 and 2008
(Unaudited)




Three Months Ended June
      30,
                      
                      Six Months Ended June
      30,2009
                      
                      2008
                      
                      2009
                      
                      2008(Dollars in thousands except per
      share data)Interest
      income:Loans and loan
      fees
                      
                      $
                      17,412
                      
                      $
                      18,111
                      
                      $
                      33,504
                      
                      $
                      37,610Investment
      securities:Taxable interest
      income
                      
                      
                      2,561
                      
                      
                      2,216
                      
                      
                      5,360
                      
                      
                      4,434Tax-exempt interest
      income
                      
                      
                      763
                      
                      
                      805
                      
                      
                      1,527
                      
                      
                      1,634Dividends
                      
                      
                      13
                      
                      
                      118
                      
                      
                      13
                      
                      
                      235Federal funds and other interest
      income
                      
                      
                      6
                      
                      
                      33
                      
                      
                      16
                      
                      
                      88Total interest
      income
                      
                      
                      20,755
                      
                      
                      21,283
                      
                      
                      40,420
                      
                      
                      44,001Interest
      expense:Deposits
                      
                      
                      7,033
                      
                      
                      8,026
                      
                      
                      14,799
                      
                      
                      17,098Borrowings and repurchase
      agreements
                      
                      
                      1,558
                      
                      
                      2,329
                      
                      
                      3,276
                      
                      
                      5,066Total interest
      expense
                      
                      
                      8,591
                      
                      
                      10,355
                      
                      
                      18,075
                      
                      
                      22,164Net interest
      income
                      
                      
                      12,164
                      
                      
                      10,928
                      
                      
                      22,345
                      
                      
                      21,837Provision for loan
      losses
                      
                      
                      1,692
                      
                      
                      850
                      
                      
                      7,678
                      
                      
                      1,415Net interest income after
      provision for loan losses
                      
                      
                      10,472
                      
                      
                      10,078
                      
                      
                      14,667
                      
                      
                      20,422Noninterest
      income:Service charges and other
      fees
                      
                      
                      959
                      
                      
                      1,266
                      
                      
                      1,911
                      
                      
                      2,225Mortgage fees and
      revenues
                      
                      
                      385
                      
                      
                      354
                      
                      
                      618
                      
                      
                      626Other loan
    fees
                      
                      
                      198
                      
                      
                      387
                      
                      
                      492
                      
                      
                      500Brokerage
    fees
                      
                      
                      150
                      
                      
                      245
                      
                      
                      313
                      
                      
                      401Bank card
      services
                      
                      
                      385
                      
                      
                      354
                      
                      
                      724
                      
                      
                      653Bank-owned life
      insurance
                      
                      
                      1,165
                      
                      
                      260
                      
                      
                      1,423
                      
                      
                      562Net gain on investment
      securities
                      
                      
                      336
                      
                      
                      69
                      
                      
                      16
                      
                      
                      140Other
                      
                      
                      146
                      
                      
                      67
                      
                      
                      333
                      
                      
                      135Total noninterest
      income
                      
                      
                      3,724
                      
                      
                      3,002
                      
                      
                      5,830
                      
                      
                      5,242Noninterest
      expense:Salaries and employee
      benefits
                      
                      
                      5,856
                      
                      
                      5,269
                      
                      
                      11,817
                      
                      
                      10,172Occupancy
                      
                      
                      1,348
                      
                      
                      957
                      
                      
                      2,721
                      
                      
                      1,954Furniture and
      equipment
                      
                      
                      739
                      
                      
                      793
                      
                      
                      1,569
                      
                      
                      1,540Data processing and
      telecommunications
                      
                      
                      573
                      
                      
                      528
                      
                      
                      1,204
                      
                      
                      960Advertising
                      
                      
                      223
                      
                      
                      205
                      
                      
                      546
                      
                      
                      520Office
    expenses
                      
                      
                      322
                      
                      
                      315
                      
                      
                      657
                      
                      
                      680Professional
      fees
                      
                      
                      434
                      
                      
                      281
                      
                      
                      813
                      
                      
                      651Business development and
      travel
                      
                      
                      247
                      
                      
                      340
                      
                      
                      575
                      
                      
                      673Amortization of deposit
      premiums
                      
                      
                      287
                      
                      
                      257
                      
                      
                      575
                      
                      
                      514Miscellaneous loan handling
      costs
                      
                      
                      372
                      
                      
                      224
                      
                      
                      535
                      
                      
                      318Directors
    fees
                      
                      
                      477
                      
                      
                      189
                      
                      
                      836
                      
                      
                      589Insurance
                      
                      
                      140
                      
                      
                      103
                      
                      
                      244
                      
                      
                      198FDIC deposit
      insurance
                      
                      
                      1,179
                      
                      
                      181
                      
                      
                      1,408
                      
                      
                      228Other
                      
                      
                      268
                      
                      
                      354
                      
                      
                      529
                      
                      
                      617Total noninterest
      expense
                      
                      
                      12,465
                      
                      
                      9,996
                      
                      
                      24,029
                      
                      
                      19,614Net income(loss)before tax expense(benefit)
                      
                      
                      1,731
                      
                      
                      3,084
                      
                      
                      (3,532
                      )
                      
                      6,050Income taxexpense(benefit)
                      
                      
                      382
                      
                      
                      869
                      
                      
                      (418
                      )
                      
                      1,668Netincome(loss)
                      
                      $
                      1,349
                      
                      $
                      2,215
                      
                      $
                      (3,114
                      )
                      $
                      4,382Dividends
      and accretion on preferred stock
                      
                      
                      587
                      
                      
                      –
                      
                      
                      1,174
                      
                      
                      –Net
      income (loss) attributable to common shareholders
                      
                      $
                      762
                      
                      $
                      2,215
                      
                      $
                      (4,288
                      )
                      $
                      4,382Earnings(loss)per common share –
      basic
                      
                      $
                      0.07
                      
                      $
                      0.20
                      
                      $
                      (0.38
                      )
                      $
                      0.39Earnings(loss)per common share –
      diluted
                      
                      $
                      0.07
                      
                      $
                      0.20
                      
                      $
                      (0.38
                      )
                      $
                      0.39





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 theSix Months Ended June 30, 2009 and
2008(Unaudited)





Shares
      of
                  Common
                  Stock
                
                Common
                  Stock
                
                Preferred
                  Stock
                
                Other
                  Comprehensive
                  Income
      (Loss)
                
                Retained
                  Earnings
                  (Deficit)
                
                Total(Dollars in thousands exceptpershare data)Balance atJanuary 1,
    2008
                
                
                11,169,777
                
                $
                136,154
                
                $
                –
                
                $
                161
                
                $
                27,985
                
                $
                164,300Repurchase of outstanding common
      stock
                
                
                (8,166
                )
                
                (74
                )
                
                
                
                
                
                
                
                
                
                
                (74
                )Issuance of common stock for
      options exercised
                
                
                15,591
                
                
                103
                
                
                
                
                
                
                
                
                
                
                
                103Issuance of common stock for
      services
                
                
                51,883
                
                
                582
                
                
                
                
                
                
                
                
                
                
                
                582Stock option
      expense
                
                
                
                
                
                16
                
                
                
                
                
                
                
                
                
                
                
                16Net income
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                4,382
                
                
                4,382Net unrealizedlossonsecurities – available for sale,net of taxbenefitof$1,326
                
                
                
                
                
                
                
                
                
                
                
                (2,113
                )
                
                
                
                
                (2,113
                )Net unrealized gain related tocash flow
      hedge,net
      of tax of $210
                
                
                
                
                
                
                
                
                
                
                
                335
                
                
                
                
                
                335Comprehensive
      income
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                2,604Dividends on common stock
      ($0.16per
      share)
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (1,800
                )
                
                (1,800
                )Balance atJune 30,
    2008
                
                
                11,229,085
                
                $
                136,781
                
                $
                –
                
                $
                (1,617
                )
                $
                30,567
                
                $
                165,731Balance 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
                
                
                
                
                
                25
                
                
                
                
                
                
                
                
                
                
                
                25Directors deferred compensation
      expense
                
                
                
                
                
                287
                
                
                
                
                
                
                
                
                
                
                
                287Accretion
      of preferred stock discount
                
                
                
                
                
                
                
                
                143
                
                
                
                
                
                (143
                )
                
                –Net loss
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (3,114
                )
                
                (3,114
                )Net unrealizedgainonsecurities – available for sale,net of tax
      of$865
                
                
                
                
                
                
                
                
                
                
                
                1,379
                
                
                
                
                
                1,379Net unrealized loss related tocash flow
      hedge,net
      of tax benefit of $638
                
                
                
                
                
                
                
                
                
                
                
                (1,018
                )
                
                
                
                
                (1,018
                )Prior service cost recognized on
      SERP, net of amortization of $5
                
                
                
                
                
                
                
                
                
                
                
                (49
                )
                
                
                
                
                (49
                )Comprehensiveloss
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (2,802
                )Dividends on preferred
      stock
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (1,031
                )
                
                (1,031
                )Dividends on common stock
      ($0.16per share)
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (1,807
                )
                
                (1,807
                )Balance atJune 30, 2009
                
                
                11,300,369
                
                $
                139,641
                
                $
                39,982
                
                $
                1,198
                
                $
                (37,515
                )
                $
                143,306





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 Six Months Ended June 30, 2009
and 2008 (Unaudited)


2009
                  
                  2008(Dollars in
      thousands)Cash flows from operating
      activities:Net
      (loss) income
                  
                  $
                  (3,114
                  )
                  $
                  4,382Adjustments
      to reconcile net (loss) income to net cash provided by operating
      activities:Provision
      for loan losses
                  
                  
                  7,678
                  
                  
                  1,415Amortization
      of deposit premium
                  
                  
                  575
                  
                  
                  514Depreciation
                  
                  
                  1,602
                  
                  
                  1,383Stock-based
      compensation
                  
                  
                  365
                  
                  
                  214Net
      gain on investment securities
                  
                  
                  (16
                  )
                  
                  (140
                  )Net
      amortization of premium/discount on investment securities
                  
                  
                  80
                  
                  
                  57Loss
      on disposal of premises, equipment and real estate owned
                  
                  
                  34
                  
                  
                  70Deferred
      income tax benefit
                  
                  
                  (18
                  )
                  
                  (253
                  )Increase
      in cash surrender value of bank-owned life insurance
                  
                  
                  (30
                  )
                  
                  (363
                  )Net
      decrease (increase) in accrued interest receivable and other
      assets
                  
                  
                  3,390
                  
                  
                  214Net
      increase (decrease) in accrued interest payable and other
      liabilities
                  
                  
                  12
                  
                  
                  (1,923
                  )Net
      cash provided by operating activities
                  
                  
                  10,558
                  
                  
                  5,570Cash
      flows from investing activities:Loan
      originations, net of principal repayments
                  
                  
                  (47,256
                  )
                  
                  (85,006
                  )Additions
      to premises and equipment
                  
                  
                  (1,164
                  )
                  
                  (2,491
                  )Proceeds
      from sales of premises, equipment and real estate owned
                  
                  
                  588
                  
                  
                  1,963Net
      purchases of FHLB and Silverton Bank stock
                  
                  
                  (20
                  )
                  
                  (483
                  )Purchase
      of securities – available for sale
                  
                  
                  (21,872
                  )
                  
                  (47,036
                  )Proceeds
      from principal repayments/calls/maturities of securities – available for
      sale
                  
                  
                  33,179
                  
                  
                  52,320Proceeds
      from principal repayments/calls/maturities of securities – held to
      maturity
                  
                  
                  807
                  
                  
                  4,491Net
      cash used in investing activities
                  
                  
                  (35,738
                  )
                  
                  (76,242
                  )Cash
      flows from financing activities:Net
      increase in deposits
                  
                  
                  65,528
                  
                  
                  83,917Net
      decrease in repurchase agreements
                  
                  
                  (4,421
                  )
                  
                  (9,603
                  )Net
      repayments of federal funds borrowed
                  
                  
                  –
                  
                  
                  (5,395
                  )Proceeds
      from borrowings
                  
                  
                  70,000
                  
                  
                  158,000Principal
      repayments of borrowings
                  
                  
                  (85,000
                  )
                  
                  (152,000
                  )Repurchase
      of common stock
                  
                  
                  –
                  
                  
                  (74
                  )Issuance
      of common stock for options exercised
                  
                  
                  –
                  
                  
                  103Dividends
      paid
                  
                  
                  (2,688
                  )
                  
                  (1,796
                  )Net
      cash provided by financing activities
                  
                  
                  43,419
                  
                  
                  73,152Net
      change in cash and cash equivalents
                  
                  
                  18,239
                  
                  
                  2,480Cash
      and cash equivalents at beginning of period
                  
                  
                  54,455
                  
                  
                  40,172Cash
      and cash equivalents at end of period
                  
                  $
                  72,694
                  
                  $
                  42,652Supplemental
      Disclosure of Cash Flow InformationTransfer
      of loans and premises to other real estate owned
                  
                  $
                  4,413
                  
                  $
                  880Dividends
      payable
                  
                  $
                  1,161
                  
                  $
                  898Cash
      (received) paid for:Income
      taxes
                  
                  $
                  (4,297
                  )
                  $
                  1,971Interest
                  
                  $
                  18,905
                  
                  $
                  22,498




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





- 6 -
 Index







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 six months ended June 30, 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 June
2009, the Financial Accounting Standards Board (“FASB”) issued Statement of
Financial Accounting Standards No. 168, TheFASB
Accounting Standards CodificationTMand
the Hierarchy of Generally Accepted Accounting Principles(“SFAS No. 168”).
This statement replaces SFAS No. 162, The Hierarchy of Generally Accepted
Accounting Principles, and establishes the FASB Accounting Standards
CodificationTM
(“Codification”) as the source of authoritative accounting principles recognized
by the FASB to be applied by nongovernmental entities in the preparation of
financial statements in conformity with GAAP. Rules and interpretive releases of
the Securities and Exchange Commission (“SEC”) under authority of federal
securities laws are also sources of authoritative GAAP for SEC registrants.SFAS No.
168 is effective for financial statements issued for interim and annual periods
ending after September 15, 2009. The adoption of this statement is not expected
to have a material impact on the Company’s financial condition or results of
operations.





In May
2009, the FASB issued SFAS No. 165, Subsequent Events(“SFAS No.
165”). This statement establishes general standards of accounting for and
disclosure of events that occur after the balance sheet date but before
financial statements are issued or are available to be issued. In particular,
this statement sets forth: (1) the period after the balance sheet date during
which management of a reporting entity should evaluate events or transactions
that may occur for potential recognition or disclosure in the financial
statements, (2) the circumstances under which an entity should recognize events
or transactions occurring after the balance sheet date in its financial
statements, and (3) the disclosures that an entity should make about events or
transactions that occurred after the balance sheet date. The Company adopted
this statement effective for the quarterly period ended June 30, 2009, and its
adoption had no impact on the Company’s financial condition or results of
operations. In connection with the adoption of SFAS No. 165, the Company
evaluated all subsequent events through August 7, 2009 and determined that no
material subsequent events have occurred that would require disclosure in the
notes to these condensed consolidated financial statements.





In April
2009, the FASB issued three related Staff Positions to (1) clarify the
application of SFAS No. 157, Fair Value Measurements
(“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 Company adopted these Staff
Positions effective for the quarterly period ended June 30, 2009. The adoption
of these Staff Positions did not have a significant impact on the Company’s
financial condition or results of operations, but each is described in more
detail below.





- 7 -
 Index







FASB
Staff Position (“FSP”) FAS 157-4,Determining Fair Value of a
Financial Asset 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.





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. See Note 10 (Fair Value of Financial Instruments) for interim
disclosure required by this FSP.





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 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 by 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 financial condition or
results of operations.





- 8 -
 Index








2.Earnings Per
Share





The Company follows SFAS No. 128,Earnings
per
Share, whichestablished standards for computing and presenting earnings per share
(“EPS”).Inaccordance with this statement, the
Company has presented both basic and diluted 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 EPS. 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 and six month periods ended June 30,
2009 and 2008 were as follows:





Three Month Period Ended June 30, 2009
and 2008 (Unaudited)





2009
                
                2008(Dollars in thousands)Earnings attributable to common
      shareholders
                
                $
                762
                
                $
                2,215Shares used in the computation of
      earnings per share:Weighted average number of shares
      outstanding – basic
                
                
                11,447,619
                
                
                11,310,393Incremental shares from assumed
      exercise of stock options
                
                
                –
                
                
                13,115Weighted average number of shares
      outstanding – diluted
                
                
                11,447,619
                
                
                11,323,508





For the
three month period ended June 30, 2009, all outstanding options to purchase
377,083 shares of common stock were excluded from the diluted calculation
because the option price exceeded the average fair market value of the
associated shares of common stock. For the three month period ended June 30,
2008, options to purchase 90,411 shares of common stock were used in the diluted
calculation and options to purchase 281,573 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.





Six Month Period Ended June 30, 2009 and
2008 (Unaudited)





2009
                
                2008(Dollars in
      thousands)Earnings (loss) attributable to
      common shareholders
                
                $
                (4,288
                )
                $
                4,382Shares used in the computation of
      earnings per share:Weighted average number of shares
      outstanding – basic
                
                
                11,430,494
                
                
                11,299,923Incremental shares from assumed
      exercise of stock options
                
                
                –
                
                
                14,655Weighted average number of shares
      outstanding – diluted
                
                
                11,430,494
                
                
                11,314,578





Due to
the net loss attributable to common shareholders for the six month period ended
June 30, 2009, the Company excluded potential shares in its EPS calculations, as
required by SFAS No. 128, since the effect of including those potential shares,
if any, would have been antidilutive to the per share amounts. For the six month
period ended June 30, 2008, options to purchase 100,911 shares of common stock
were used in the diluted calculation and options to purchase 271,073 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 established 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 income (loss) for the three and six
month periods ended June
30, 2009 and 2008 is as follows:


- 9 -
 Index


Three Month Period Ended June 30, 2009
and 2008 (Unaudited)





2009
                
                2008(Dollars in
      thousands)Unrealized gain (loss) on
      securities – available for sale
                
                $
                1,736
                
                $
                (4,368
                )Unrealized loss in fair value of
      cash flow hedge
                
                
                (839
                )
                
                (1,308
                )Amortization of prior service cost
      recognized on SERP
                
                
                5
                
                
                –Income tax (expense)
      benefit
                
                
                (346
                )
                
                2,188Other comprehensive income
      (loss)
                
                $
                556
                
                $
                (3,488
                )








Six Month Period Ended June 30, 2009 and
2008 (Unaudited)





2009
                
                2008(Dollars in
      thousands)Unrealized gain (loss) on
      securities – available for sale
                
                $
                2,244
                
                $
                (3,439
                )Unrealized (loss) gain in fair
      value of cash flow hedge
                
                
                (1,656
                )
                
                545Prior service cost recognized on
      SERP, net of amortization
                
                
                (49
                )
                
                –Income tax (expense)
      benefit
                
                
                (227
                )
                
                1,116Other comprehensive income
      (loss)
                
                $
                312
                
                $
                (1,778
                )





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 June 30, 2009(unaudited).





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
                
                $
                31,949
                
                $
                969
                
                $
                24,783
                
                $
                2,202
                
                $
                56,732
                
                $
                3,171Mortgage-backed
      securities
                
                
                13,908
                
                
                267
                
                
                4,962
                
                
                489
                
                
                18,870
                
                
                756Other
      securities
                
                
                –
                
                
                –
                
                
                1,105
                
                
                145
                
                
                1,105
                
                
                14545,857
                
                
                1,236
                
                
                30,850
                
                
                2,836
                
                
                76,707
                
                
                4,072Held to
      maturity:Mortgage-backed
      securities
                
                
                –
                
                
                –
                
                
                1,948
                
                
                282
                
                
                1,948
                
                
                282Total at June 30,
      2009
                
                $
                45,857
                
                $
                1,236
                
                $
                32,798
                
                $
                3,118
                
                $
                78,655
                
                $
                4,354





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 contractual
cash flows of mortgage-backed securities issued by government agencies are fully
guaranteed by an agency of the U.S. government. The mortgage-backed securities
issued by corporate entities have all received the highest possible credit
rating by one of the major credit rating firms. Unrealized losses on the
Company’s investments in municipal bonds are partially related to interest rate
changes but are also largely 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.


- 10 -
 Index


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 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 June 30, 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 according to
contractual terms. Further, because the Company does not intend to sell these
investments and it is not more likely than not that the Company will be required
to sell the investments before recovery of their amortized cost bases, which may
be maturity, the Company does not consider any of its marketable securities to
be other-than-temporarily impaired as of June 30, 2009.





During
the six months ended June 30, 2009, the Company recorded an impairment charge of
$320 thousand on an equity investment in Silverton Bank, a correspondent
financial institution that was closed by the Federal Deposit Insurance
Corporation (“FDIC”) in May 2009. 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
did not have a readily determinable fair value and was recorded at cost when
purchased.





5.Loans





The composition of the loan portfolio by
loan classification as of June 30, 2009 and December 31, 2008 is as
follows:





June 30,
    2009
                
                December 31,
      2008(Dollars in
      thousands)
                
                (Unaudited)Commercial
                
                $
                772,567
                
                $
                726,522Construction
                
                
                357,116
                
                
                366,376Consumer
                
                
                47,620
                
                
                46,019Home equity
                
                
                93,618
                
                
                92,722Residential
      mortgage
                
                
                22,794
                
                
                22,6521,293,715
                
                
                1,254,291Deferred loan fees and origination
      costs, net
                
                
                (375
                )
                
                77$
                1,293,340
                
                $
                1,254,368





6.  Derivative
Instruments





The
Company maintains positions in derivative financial instruments as necessary to
manage interest rate risk, to facilitate asset/liability management strategies,
and to manage other risk exposures. While these risk mitigation strategies at
times can involve multiple derivative positions, the only outstanding derivative
position maintained by the Company at June 30, 2009 was an interest rate swap on
a portion of its prime-based loan portfolio.





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 $1.5 million
and $3.2million as ofJune 30, 2009 and December
31, 2008, respectively, andis 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 six months ended June 30, 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.





- 11 -
 Index








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 June 30,
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 issued 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 six
months ended June 30,
2009(unaudited).




Number
                    of Shares
                  
                  WeightedAverage
                    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 June 30,
      2009
                  
                  
                  377,083
                  
                  $
                  11.71
                  
                  
                  4.73
                  
                  $
                  –Options exercisable at June 30,
      2009
                  
                  
                  275,883
                  
                  $
                  12.43
                  
                  
                  3.18
                  
                  $
                  –
 
 
 The following table summarizes
information about the Company’s stock options as of June 30, 2009(unaudited).
 
 Exercise
    Price
                  Number
                    Outstanding
                  
                  Weighted
      Average
                    Remaining
      Contractual
                    Life in
    Years
                  
                  Number
                    Exercisable$6.00 –
    $9.00
                  129,631
                  
                  4.85
                  
                  69,631$9.01 –
    $12.00
                  90,202
                  
                  2.34
                  
                  88,202$12.01 –
    $15.00
                  20,000
                  
                  7.13
                  
                  7,200$15.01 –
    $18.00
                  83,000
                  
                  6.05
                  
                  56,600$18.01 –
    $18.37
                  54,250
                  
                  5.49
                  
                  54,250377,083
                  
                  4.73
                  
                  275,883


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
June 30, 2009, the Company had unamortized compensation expense related to
unvested stock options of $165,000, which is expected to be amortized over 5
years. For the six months ended June 30, 2009 and 2008, the Company recorded
compensation expense of $25,000 and $16,000, 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 six month periods ended June 30,
2009 and2008 related to
these restricted stock awards was$53,000and $50,000,respectively. As ofJune 30, 2009, the Company had36,000shares of unvested restricted stock
grantsrepresentingunrecognized compensation expense of$262,000to be recognizedover the remaining vesting periods of
the respective grants.




- 12 -
 Index







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
six month periods ended June 30, 2009 and 2008, the Company recognized $287,000
and $148,000, 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.





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 June 30, 2009 and December 31, 2008 is as
follows:





June 30,
    2009
                
                December 31,
      2008(Dollars in
      thousands)
                
                (Unaudited)Unused lines of credit and
      overdraft lines
                
                $
                242,706
                
                $
                263,663Standby letters of
      credit
                
                
                10,282
                
                
                4,233Total
      commitments
                
                $
                252,988
                
                $
                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,
impaired loans 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.


- 13 -
 Index


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 June 30, 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 June 30, 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.





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 classifies 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
classifies the foreclosed asset as nonrecurring Level 3.





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




Fair Value Measurements atJune 30, 2009
      (Unaudited)Quoted Prices
      in
                        Active Markets
      for
                        Identical
      Assets
                        (Level 1)
                      
                      Significant
      Other
                        Observable
                        Inputs
                        (Level 2)
                      
                      Significant
                        Unobservable
                        Inputs
                        (Level 3)
                      
                      Total(Dollars in
      thousands)Investment
      securities – available for sale
                      
                      $
                      1,105
                      
                      $
                      254,752
                      
                      $
                      2,000
                      
                      $
                      257,857Cash flow interest rate
      swap
                      
                      
                      –
                      
                      
                      1,495
                      
                      
                      –
                      
                      
                      1,495





- 14 -
 Index








The table
below presents a reconciliation and income statement classification of gains and
losses for all assets measured at fair value on a recurring basis using
significant unobservable inputs (Level 3) for the six months ended June 30,
2009:





Investment
                    Securities(Dollars
      in thousands)Balance
      at January 1, 2009
                  
                  $
                  2,000Total
      unrealized gains (losses) included in:Net
      income
                  
                  
                  –Other
      comprehensive income
                  
                  
                  –Purchases,
      sales and issuances, net
                  
                  
                  –Transfers
      in and (out) of Level 3
                  
                  
                  –Balance
      at June 30, 2009
                  
                  $
                  2,000





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




Fair Value Measurements atJune 30, 2009
      (Unaudited)Quoted Prices
      in
                        Active Markets
      for
                        Identical
      Assets
                        (Level 1)
                      
                      Significant
      Other
                        Observable
                        Inputs
                        (Level 2)
                      
                      Significant
                        Unobservable
                        Inputs
                        (Level 3)
                      
                      Total(Dollars in
      thousands)Impaired
    loans
                      
                      $
                      –
                      
                      $
                      –
                      
                      $
                      32,063
                      
                      $
                      32,063Foreclosed
      assets
                      
                      
                      –
                      
                      
                      –
                      
                      
                      5,170
                      
                      
                      5,170
 10.  Fair
Value of Financial Instruments





SFAS No.
107, Disclosures about Fair
Value of Financial Instruments, requires the disclosure of estimated fair
values for financial instruments. Quoted market prices, if available, are
utilized as an estimate of the fair value of financial instruments. Because no
quoted market prices exist for a significant part of the Company’s financial
instruments, the fair value of such instruments has been derived based on
management’s assumptions with respect to future economic conditions, the amount
and timing of future cash flows and estimated discount rates. Different
assumptions could significantly affect these estimates. Accordingly, the net
amounts ultimately collected could be materially different from the estimates
presented below. In addition, these estimates are only indicative of the values
of individual financial instruments and should not be considered an indication
of the fair value of the Company taken as a whole.





Fair
values of cash and due from banks and federal funds sold are equal to the
carrying value due to the nature of the financial instruments. Estimated fair
values of investment securities are based on quoted market prices, except for
FHLB stock where fair value equals cost. Fair value of the net loan portfolio
has been estimated using the present value of future cash flows, discounted at
an interest rate giving consideration to estimated prepayment risk. The credit
risk component of the loan portfolio has been set at the recorded allowance for
loan losses balance for purposes of estimating fair value. Thus, there is no
difference between the carrying amount and estimated fair value attributed to
credit risk in the portfolio. Carrying amounts for accrued interest approximate
fair value given the short-term nature of interest receivable and payable.
Derivative financial instruments are carried on the consolidated balance sheets
at fair value based on external pricing sources.





Fair
values of time deposits and borrowings are estimated by discounting the future
cash flows using the current rates offered for similar deposits and borrowings
with the same remaining maturities. Fair value of subordinated debt is estimated
based on current market prices for similar trust preferred issues of financial
institutions with equivalent credit risk. The estimated fair value for the
Company’s subordinated debt is significantly lower than carrying value since
credit spreads (i.e., spread to LIBOR) on similar trust preferred issues are
currently much wider than when these securities were originally issued.
Interest-bearing deposit liabilities and repurchase agreements with no stated
maturities are predominately at variable rates and, accordingly, the fair values
have been estimated to equal the carrying amounts (the amount payable on
demand).




- 15 -
 Index







The
carrying values and estimated fair values of the Company’s financial instruments
as of June 30, 2009 and December 31, 2008 are as follows:





June 30, 2009 (Unaudited)
                  
                  December 31,
      2008(Dollars in
      thousands)
                  
                  CarryingAmount
                  
                  EstimatedFair
      Value
                  
                  CarryingAmount
                  
                  EstimatedFair
      ValueFinancial
      Assets:Cash and cash
      equivalents
                  
                  $
                  72,694
                  
                  $
                  72,694
                  
                  $
                  54,455
                  
                  $
                  54,455Investment
      securities
                  
                  
                  268,224
                  
                  
                  267,995
                  
                  
                  278,138
                  
                  
                  277,629Loans
                  
                  
                  1,274,738
                  
                  
                  1,273,244
                  
                  
                  1,239,573
                  
                  
                  1,235,216Accrued interest
      receivable
                  
                  
                  6,191
                  
                  
                  6,191
                  
                  
                  6,225
                  
                  
                  6,225Cash flow
    hedge
                  
                  
                  1,495
                  
                  
                  1,495
                  
                  
                  3,151
                  
                  
                  3,151Financial
      Liabilities:Non-maturity
      deposits
                  
                  $
                  546,448
                  
                  
                  546,448
                  
                  $
                  511,772
                  
                  $
                  511,772Time
    deposits
                  
                  
                  834,394
                  
                  
                  848,600
                  
                  
                  803,542
                  
                  
                  810,691Repurchase agreements and federal
      funds purchased
                  
                  
                  10,589
                  
                  
                  10,589
                  
                  
                  15,010
                  
                  
                  15,010Borrowings
                  
                  
                  117,000
                  
                  
                  120,866
                  
                  
                  132,000
                  
                  
                  136,220Subordinated
      debt
                  
                  
                  30,930
                  
                  
                  10,700
                  
                  
                  30,930
                  
                  
                  10,700Accrued interest
      payable
                  
                  
                  2,095
                  
                  
                  2,095
                  
                  
                  2,925
                  
                  
                  2,925





The
carrying amount and estimated fair value of the fair value interest rate swaps
on certain fixed-rate FHLB advances was $619,000 as of December 31, 2008. Since
these swaps were considered to be effective hedges, there were offsetting
adjustments to the fair value of the underlying FHLB advances for the same
amount at that date. These interest rate swaps were either terminated or matured
during the six months ended June 30, 2009 and were no longer outstanding at the
balance sheet date. There is no material difference between the carrying amount
and estimated fair value of off-balance-sheet commitments totaling $253.0
million and $267.9 million as of June 30, 2009 and December 31, 2008,
respectively, which are primarily comprised of unfunded loan commitments and
standby letters of credit. The Company’s remaining assets and liabilities are
not considered financial instruments.




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





The following discussion presents an
overview of the unaudited financial statements for the three and six months
ended June 30, 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 June 30, 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.




- 16 -
 Index


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. 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.
 
 The
current economic situation has led the U.S. government to 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. See the “Liquidity and Capital Resources” section below for a more
detailed discussion of the Company’s participation in the CPP. Additionally, the American Recovery and Reinvestment
Act of 2009 (“ARRA”) imposes 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.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.
 
 The Bank
is subject to insurance assessments imposed by the Federal Deposit Insurance
Commission (“FDIC”), which is actively seeking to replenish its insurance fund.
The FDIC increased risk-based assessment rates uniformly by 7 basis points, on
an annual basis, beginning with the first quarter of 2009.On May 22,
2009, the FDIC adopted a final rule imposing a 5 basis point special assessment
on each insured depository institution’s assets less Tier 1 capital as of June
30, 2009, not to exceed 10 basis points multiplied by the institution’s
assessment base for the second quarter of 2009. The Company accrued $750
thousand as of June 30, 2009 related to this special assessment with the related
expense recorded in noninterest expense. The FDIC will collect the special
assessment on September 30, 2009. An additional special assessment in 2009 of up
to 5 basis points later in 2009 is expected, but the amount is uncertain at this
time.
 - 17 -
 Index
 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 and six month
periods ended June 30, 2009.
 
 •
                  The Company reportednet
      income of $1.3 million for the quarter ended June 30, 2009 compared to net
      income of $2.2 million for the quarter ended June 30, 2008. After
      dividends and accretion on preferred stock issued under the CPP of $0.6
      million, net income available to common shareholders was $0.8 million, or
      $0.07 per diluted share, for the second quarter of 2009 compared with $2.2
      million, or $0.20 per diluted share, for the second quarter of
      2008.
                    
                    The
      Company reported a net loss of $3.1 million for the six months ended June
      30, 2009 compared to net income of $4.4 million for the six months ended
      June 30, 2008. After dividends and accretion on preferred stock issued
      under the CPP of $1.2 million, net loss attributable to common
      shareholders was $4.3 million, or $0.38 per diluted share, for the first
      half of 2009 compared with net income available to common shareholders of
      $4.4 million, or $0.39 per diluted share, for the first half of
      2008.•
                  Net interest income increased $1.2
      million, or 11.3%, from $10.9 million for the quarter ended June 30, 2008
      to $12.2 million for the quarter ended June 30, 2009.This
      improvement was partially due to an increase in net interest margin from
      3.14% for the second quarter of 2008 to 3.17% for the second quarter of
      2009, coupled with a 10.8% growth in average earning assets over the same
      periods. Net interest margin benefited from a significant decline in the
      cost of interest-bearing liabilities from 3.24% for the second quarter of
      2008 to 2.50% for the second quarter of 2009, which was largely due to
      disciplined pricing controls
      and a more rational competitive pricing landscape for customer deposits as
      liquidity concerns in the banking industry have somewhat subsided.Partially offsetting declining funding costs was a drop in loan
      yields largely due to steps taken by the Federal Reserve to revive an
      ailing national economy last year. One effect of the many policy actions
      implemented was a drop in the prime rate by 400 basis points during 2008,
      which negatively impacted yields on the Company’s prime-based loan
      portfolio. This rapid decline in rates decreased loan yields from 6.23%
      for the second quarter of 2008 to 5.43% for the second quarter of
      2009.
                    
                    Net
      interest income increased $508 thousand, or 2.3%, from $21.8 million for
      the six months ended June 30, 2008 to $22.3 million for the six months
      ended June 30, 2009. This improvement was primarily due to growth of 11.2%
      in average earning assets, partially offset by a decrease in net interest
      margin from 3.20% for the first half of 2008 to 2.95% for the first half
      of 2009. Net interest margin was negatively impacted by a drop in loan
      yields from 6.53% for the first half of 2008 to 5.30% for the first half
      of 2009, but the margin was benefited by a significant decline in the cost
      of interest-bearing liabilities from 3.50% for the first half of 2008 to
      2.65% for the first half of
2009.
 - 18 -
 Index
 •
                  Provision for loan losses was $1.7
      million for the quarter ended June 30, 2009 compared to $850 thousand for
      the quarter ended June 30, 2008. The increase in the
      provisionwas largelydriven by
      deteriorating economic conditions and
      weaknessin the local
      real estate markets which resulted in downgrades to credit ratingsas well as chargeoffsof certain loans in
      the portfolio, but
      the provision increase was also partially due to loan growth of $115.2
      million from June 30, 2008.Net charge-offsfor the quarter ended June 30,
      2009 were $1.6 million, or 0.49% of average loans (annualized), compared
      to net charge-offs of $503 thousand, or 0.17% of average loans
      (annualized), for the quarter ended June 30, 2008.
                    
                    Provision for loan losses was $7.7
      million for the six months ended June 30, 2009 compared to $1.4 million
      for the six months ended June 30, 2008. Thesignificantincrease in the
      provisionwas
      primarilydriven by
      deteriorating economic conditions and
      weaknessin the local
      real estate markets which resulted in downgrades to credit ratingsof certain loans in
      the portfolio, but the provision increase was also partially due to loan
      growth of $115.2 million from June 30, 2008.Additionally, the decline in real
      estate values securing certain nonperforming loans required increased
      provision during the period.Net charge-offsfor the six months ended June 30,
      2009 were $3.9 million, or 0.30% of average loans (annualized), compared
      to net charge-offs of $1.1 million, or 0.19% of average loans
      (annualized), for the six months ended June 30,
    2008.•
                  Noninterest
      income increased $722 thousand, or 24.1%, in the second quarter of 2009
      compared to the same period one year ago. Included in this increase was a
      nonrecurring gain recorded during the quarter of $913 thousand from the
      collection of bank-owned life insurance (“BOLI”) policy proceeds.
      Additionally, the Company recorded a $336 thousand net gain from the sale
      of certain debt securities in the second quarter of 2009 compared to a $69
      thousand net gain on the sale of debt securities in the same quarter one
      year ago. Partially offsetting these gains was a $307 thousand decrease in
      service charge income and a $189 thousand decrease in other loan fees.
      Service charge income, which includes overdraft and non-sufficient funds
      charges, dropped primarily from a decline in consumer spending during the
      current economic recession.
                    
                    Noninterest
      income increased $588 thousand, or 11.2%, in the first half of 2009
      compared to the same period one year ago. Included in this increase was a
      nonrecurring gain recorded during the period of $913 thousand from the
      collection of BOLI policy proceeds. Partially offsetting this gain was a
      $314 thousand decrease in service charge income primarily due to a decline
      in consumer spending during the current economic
  recession.•
                  Noninterest
      expense increased $2.5 million, from $10.0 million during the second
      quarter of 2008 to $12.5 million during the second quarter of 2009. This
      increase included higher FDIC deposit insurance expense of $998 thousand
      over the quarters under comparison, of which $750 thousand was related to
      an accrual of the FDIC’s mandatory special assessment imposed on all
      insured financial institutions for the purpose of replenishing its
      insurance fund. The majority of the remaining $248 thousand increase in
      deposit insurance expense was due to increases in rates as the FDIC
      continues to increase insurance premiums to cover higher monitoring costs
      and claims. Further, salaries and employee benefits as well as occupancy
      costs increased a combined $978 thousand primarily due to additional costs
      incurred as new branches were opened during the past year in Asheville and
      Clayton in addition to the four branches purchased in the Fayetteville
      market in December 2008. Directors fees increased $288 thousand largely
      from an accelerated payout of deferred compensation benefits upon the
      death of a former director.
                    
                    Noninterest
      expense increased $4.4 million, from $19.6 million during the first half
      of 2008 to $24.0 million during the first half of 2009. This increase
      included higher FDIC deposit insurance expense of $1.2 million over the
      periods under comparison, of which $750 thousand was related to an accrual
      of the FDIC’s mandatory special assessment imposed on all insured
      financial institutions for the purpose of replenishing its insurance fund.
      The majority of the remaining $430 thousand increase in deposit insurance
      expense was due to increases in rates as the FDIC continues to increase
      insurance premiums to cover higher monitoring costs and claims. Further,
      salaries and employee benefits as well as occupancy costs increased a
      combined $2.4 million primarily due to additional costs incurred as new
      branches were opened during the past year in Asheville and Clayton in
      addition to the four branches purchased in the Fayetteville market in
      December 2008. Directors fees increased $247 thousand largely from an
      accelerated payout of deferred compensation benefits upon the death of a
      former director.
 - 19 -
 Index
 Results of
Operations
 
 QuarterendedJune 30, 2009compared toquarterendedJune 30, 2008
 
 The Company reportednet income
of $1.3 million for the quarter ended June 30, 2009 compared to net income of
$2.2 million for the quarter ended June 30, 2008. After dividends and accretion
on preferred stock of $0.6 million, net income available to common shareholders
was $0.8 million, or $0.07 per diluted share, for the second quarter of 2009
compared with $2.2 million, or $0.20 per diluted share, for the second quarter
of 2008. Net interest income
increased by $1.2 million over the quarters under comparison, reflecting a
higher net interest margin and loan growth. Provision for loan losses increased
by $842 thousand partially due to loan growth and partially fromcontinued deteriorating economic
conditions and weakness in the local real estate markets which resulted in
downgrades to the credit ratingsand chargeoffsof certain loans in the
portfolio. Noninterest
income increased by $722 thousand, which included nonrecurring gains from
the collection of BOLI policy proceeds and the sale of certain debt securities
in the second quarter of 2009. Partially offsetting these gains was a decrease
in service charge income and other loan fees. Noninterest expense increased $2.5
million over the quarters under comparison partially from the FDIC’s special
assessment on all insured financial institutions and overall increase in base
rates for deposit insurance but also partially 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 by $487 thousand, reflecting lower net income before
taxes.
 
 Net Interest Income.Net interest income
increased $1.2 million, or 11.3%, from $10.9 million for the quarter ended June
30, 2008 to $12.2 million for the quarter ended June 30, 2009. Average earning
assets increased $155.4 million to $1.59 billion for the quarter ended June 30,
2009 from $1.43 billion for the quarter ended June 30, 2008. Average
interest-bearing liabilities increased $94.6 million to $1.38 billion for the
quarter ended June 30, 2009 from $1.28 billion for the quarter ended June 30,
2008. The net interest margin on a fully tax equivalent basis increased by 3
basis points to 3.17% for the quarter ended June 30, 2009 from 3.14% for the
quarter ended June 30, 2008. The earned yield on average interest-earning assets
was 5.34% and 6.07% for the quarters ended June 30, 2009 and 2008, respectively,
while the interest rate on average interest-bearing liabilities for those
periods was 2.50% and 3.24%, respectively. The increase in the margin was
primarily due to the significant decline in the cost of customer deposits
through disciplined pricing controls and a more rational competitive pricing
landscape as liquidity concerns in the banking industry have somewhat subsided.Partially offsetting declining funding costs was a drop in loan yields
largely due to steps taken by the Federal Reserve to revive an ailing national
economy last year. One effect of the many policy actions implemented was a drop
in the prime rate by 400 basis points during 2008, which negatively impacted
yields on the Company’s prime-based loan portfolio.
 
 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.
 - 20 -
 Index
 CAPITAL
BANK CORPORATION
 Average Balances, Interest Earned or
Paid, and Interest Yields/Rates
 For theThreeMonths EndedJune 30, 2009, March 31,
2009and June 30, 2008
(Unaudited)
 Tax Equivalent Basis(1)
 June
      30, 2009
                          
                          March
      31, 2009
                          
                          June
      30, 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
                          
                          $
                          1,115,003
                          
                          $
                          15,244
                          
                          
                          5.48
                          %
                          $
                          1,095,804
                          
                          $
                          13,942
                          
                          
                          5.16
                          %
                          $
                          1,010,899
                          
                          $
                          15,713
                          
                          
                          6.23
                          %Consumer
                          
                          
                          54,552
                          
                          
                          902
                          
                          
                          6.63
                          
                          
                          52,873
                          
                          
                          910
                          
                          
                          6.98
                          
                          
                          46,344
                          
                          
                          869
                          
                          
                          7.52Home
      equity
                          
                          
                          94,054
                          
                          
                          974
                          
                          
                          4.15
                          
                          
                          93,861
                          
                          
                          966
                          
                          
                          4.17
                          
                          
                          80,842
                          
                          
                          1,101
                          
                          
                          5.46Residential
      mortgages
                          
                          
                          21,962
                          
                          
                          292
                          
                          
                          5.32
                          
                          
                          22,900
                          
                          
                          274
                          
                          
                          4.79
                          
                          
                          28,710
                          
                          
                          427
                          
                          
                          5.95Total
      loans
                          
                          
                          1,285,571
                          
                          
                          17,412
                          
                          
                          5.43
                          
                          
                          1,265,438
                          
                          
                          16,092
                          
                          
                          5.16
                          
                          
                          1,166,795
                          
                          
                          18,111
                          
                          
                          6.23Investment
      securities (3)
                          
                          
                          278,033
                          
                          
                          3,731
                          
                          
                          5.37
                          
                          
                          288,679
                          
                          
                          3,957
                          
                          
                          5.48
                          
                          
                          256,406
                          
                          
                          3,555
                          
                          
                          5.55Federal
      funds sold and interest-earning cash (4)
                          
                          
                          24,898
                          
                          
                          6
                          
                          
                          0.10
                          
                          
                          19,900
                          
                          
                          10
                          
                          
                          0.20
                          
                          
                          9,898
                          
                          
                          33
                          
                          
                          1.34Total
      interest-earning assets
                          
                          
                          1,588,502
                          
                          $
                          21,149
                          
                          
                          5.34
                          %
                          
                          1,574,017
                          
                          $
                          20,059
                          
                          
                          5.17
                          %
                          
                          1,433,099
                          
                          $
                          21,699
                          
                          
                          6.07
                          %Cash
      and due from banks
                          
                          
                          15,294
                          
                          
                          
                          
                          
                          
                          
                          
                          22,116
                          
                          
                          
                          
                          
                          
                          
                          
                          22,938Other
      assets
                          
                          
                          80,296
                          
                          
                          
                          
                          
                          
                          
                          
                          78,814
                          
                          
                          
                          
                          
                          
                          
                          
                          135,976Allowance
      for loan losses
                          
                          
                          (18,705
                          )
                          
                          
                          
                          
                          
                          
                          
                          (15,180
                          )
                          
                          
                          
                          
                          
                          
                          
                          (13,656
                          )Total
      assets
                          
                          $
                          1,665,387
                          
                          
                          
                          
                          
                          
                          
                          $
                          1,659,767
                          
                          
                          
                          
                          
                          
                          
                          $
                          1,578,357Liabilities
      and EquitySavings
      deposits
                          
                          $
                          29,609
                          
                          $
                          13
                          
                          
                          0.18
                          %
                          $
                          28,793
                          
                          $
                          13
                          
                          
                          0.18
                          %
                          $
                          30,540
                          
                          $
                          35
                          
                          
                          0.46
                          %Interest-bearing
      demand deposits
                          
                          
                          368,132
                          
                          
                          1,152
                          
                          
                          1.26
                          
                          
                          353,262
                          
                          
                          1,202
                          
                          
                          1.38
                          
                          
                          335,851
                          
                          
                          1,635
                          
                          
                          1.95Time
      deposits
                          
                          
                          796,306
                          
                          
                          5,868
                          
                          
                          2.96
                          
                          
                          800,879
                          
                          
                          6,551
                          
                          
                          3.32
                          
                          
                          668,690
                          
                          
                          6,356
                          
                          
                          3.81Total
      interest-bearing deposits
                          
                          
                          1,194,047
                          
                          
                          7,033
                          
                          
                          2.36
                          
                          
                          1,182,934
                          
                          
                          7,766
                          
                          
                          2.66
                          
                          
                          1,035,081
                          
                          
                          8,026
                          
                          
                          3.11Borrowed
      funds
                          
                          
                          140,682
                          
                          
                          1,273
                          
                          
                          3.63
                          
                          
                          146,233
                          
                          
                          1,389
                          
                          
                          3.85
                          
                          
                          181,841
                          
                          
                          1,820
                          
                          
                          4.01Subordinated
      debt
                          
                          
                          30,930
                          
                          
                          278
                          
                          
                          3.61
                          
                          
                          30,930
                          
                          
                          322
                          
                          
                          4.22
                          
                          
                          30,930
                          
                          
                          403
                          
                          
                          5.23Repurchase
      agreements and fed funds purchased
                          
                          
                          12,010
                          
                          
                          7
                          
                          
                          0.23
                          
                          
                          13,849
                          
                          
                          7
                          
                          
                          0.20
                          
                          
                          35,183
                          
                          
                          106
                          
                          
                          1.21Total
      interest-bearing liabilities
                          
                          
                          1,377,669
                          
                          $
                          8,591
                          
                          
                          2.50
                          %
                          
                          1,373,946
                          
                          $
                          9,484
                          
                          
                          2.80
                          %
                          
                          1,283,035
                          
                          $
                          10,355
                          
                          
                          3.24
                          %Noninterest-bearing
      deposits
                          
                          
                          130,460
                          
                          
                          
                          
                          
                          
                          
                          
                          124,893
                          
                          
                          
                          
                          
                          
                          
                          
                          113,590Other
      liabilities
                          
                          
                          12,042
                          
                          
                          
                          
                          
                          
                          
                          
                          11,643
                          
                          
                          
                          
                          
                          
                          
                          
                          10,787Total
      liabilities
                          
                          
                          1,520,171
                          
                          
                          
                          
                          
                          
                          
                          
                          1,510,482
                          
                          
                          
                          
                          
                          
                          
                          
                          1,407,412Shareholders’
      equity
                          
                          
                          145,216
                          
                          
                          
                          
                          
                          
                          
                          
                          149,285
                          
                          
                          
                          
                          
                          
                          
                          
                          170,945Total
      liabilities and shareholders’ equity
                          
                          $
                          1,665,387
                          
                          
                          
                          
                          
                          
                          
                          $
                          1,659,767
                          
                          
                          
                          
                          
                          
                          
                          $
                          1,578,357Net
      interest spread (5)
                          
                          
                          
                          
                          
                          
                          
                          
                          2.84
                          %
                          
                          
                          
                          
                          
                          
                          
                          2.37
                          %
                          
                          
                          
                          
                          
                          
                          
                          2.83
                          %Tax
      equivalent adjustment
                          
                          
                          
                          
                          $
                          394
                          
                          
                          
                          
                          
                          
                          
                          $
                          394
                          
                          
                          
                          
                          
                          
                          
                          $
                          416Net
      interest income and net interest margin (6)
                          
                          
                          
                          
                          $
                          12,558
                          
                          
                          3.17
                          %
                          
                          
                          
                          $
                          10,575
                          
                          
                          2.72
                          %
                          
                          
                          
                          $
                          11,344
                          
                          
                          3.14
                          %
 
 (1)
                  The tax equivalent basis is
      computed using a tax rate of34%.(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)
                  The Federal Reserve began paying
      interest on cash balances during the quarter ended December 31, 2008. For
      comparison purposes, average balances have been adjusted for all periods
      presented to include cash held at the Federal Reserve as interest
      earning.(5)
                  Net interest spread represents the
      difference between the average yield on interest-earning assets and the
      average cost of interest-bearing liabilities.(6)
                  Net interest margin represents net
      interest income divided by average interest-earning
      assets.
 - 21 -
 Index
 Interest income on loans decreased from
$18.1 million for the quarter ended June 30, 2008 to $17.4 million for the
quarter ended June 30, 2009, a decline of $699 thousand, or 3.9%. This decrease
was primarily due to declining loan yields, which decreased from 6.23% in the
quarter ended June 30, 2008 to 5.43% in the quarter ended June 30, 2009, the
effect of which was partially offset by higher average loan balances, which
increased by $118.8 million. The declining loan yields were largely due to the
drop in the prime rate from 5.00% at June 30, 2008 to 3.25% by June 30, 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 $0.7 million for the quarters ended June 30, 2009 and
2008, respectively.
 
 Interest
income on investment securities increased from $3.1 million in for the quarter
ended June 30, 2008 to $3.3 million for the quarter ended June 30, 2009, an
increase of $198 thousand, or 6.3%. This increase was due to growth in the
investment portfolio, partially offset by lower investment yields. Average
investment balances increased from $256.4 million for the quarter ended June 30,
2008 to $278.0 million for the quarter ended June 30, 2009, and the tax
equivalent yield on investment securities decreased from 5.55% to 5.37% over the
same period. The increase in average investment balances partially reflects
management’s efforts to efficiently deploy net cash received from the purchase
of four Fayetteville branch offices from Omni National Bank in December
2008.
 
 Interest expense on deposits decreased
from $8.0 million for the quarter ended June 30, 2008 to $7.0 million for the
quarter ended June 30, 2009. The decrease is primarily due to a decrease in
average deposit rates from 3.11% for the quarter ended June 30, 2008 to 2.36%
for the quarter ended June 30, 2009. For time deposits, which represented 66.7%
and 64.6% of total average interest-bearing deposits for the quarters ended June
30, 2009 and 2008, respectively, the average rate decreased from 3.81% for the
quarter ended June 30, 2008 to 2.96% for the quarter ended June 30, 2009,
reflecting disciplined pricing controls and a more rational competitive pricing
landscape as liquidity concerns in the marketplace have somewhat
subsided.
 
 Interest expense on borrowings decreased
from $2.3 million for the quarter ended June 30, 2008 to $1.6 million for the
quarter ended June 30, 2009, partially due to declines in interest rates as well
as a $41.2 million decrease in average borrowings over the two periods.The rate on average
borrowings, including
subordinated debt and repurchase agreements,for the quarter endedJune 30, 2008was3.77%compared to3.40%for thequarter ended June 30, 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 remaining swaps on $10.0 million of advances
expired during the second quarter of 2009.The net effect of the swaps, including amortization of swap
terminations,wasa decrease tointerest expense of $75 thousand and$24 thousandfor the quarters endedJune 30, 2009 and 2008, respectively.
 
 Provision for Loan
Losses.Provision for loan
losses was $1.7 million for the quarter ended June 30, 2009 compared to $850
thousand for the quarter ended June 30, 2008. The increase in the provisionwas largelydriven by deteriorating economic conditions and
weaknessin the local real
estate markets which resulted in downgrades to credit ratingsas well as chargeoffsof certain loans in the
portfolio, but the
provision increase was also partially due to loan growth of $115.2 million from
June 30, 2008.Net charge-offsfor the quarter ended June 30, 2009 were
$1.6 million, or 0.49% of average loans (annualized), compared to net
charge-offs of $503 thousand, or 0.17% of average loans (annualized), for the
quarter ended June 30, 2008. Nonperformingloansandpast due loans increased from $5.2
million and $9.2million,
respectively,as of June
30, 2008 to $18.5 million and $15.2million, respectively, as ofJune 30,
2009.
 
 Noninterest Income.Noninterest income
increased from $3.0 million for the quarter ended June 30, 2008 to $3.7 million
for the quarter ended June 30, 2009, an increase of $722 thousand, or 24.1%.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 June 30, 2009 and 2008
(unaudited).
 - 22 -
 Index
 2009
                        
                        
                        2008
                        
                        
                        Variance(Dollars in
      thousands)Noninterest
      income:Service
      charges and other fees
                        
                        $
                        959
                        
                        $
                        1,266
                        
                        $
                        (307
                        )Mortgage
      fees and revenues
                        
                        
                        385
                        
                        
                        354
                        
                        
                        31Other
      loan fees
                        
                        
                        198
                        
                        
                        387
                        
                        
                        (189
                        )Brokerage
      fees
                        
                        
                        150
                        
                        
                        245
                        
                        
                        (95
                        )Bank
      card services
                        
                        
                        385
                        
                        
                        354
                        
                        
                        31Bank-owned
      life insurance
                        
                        
                        1,165
                        
                        
                        260
                        
                        
                        905Net
      gain on investment securities
                        
                        
                        336
                        
                        
                        69
                        
                        
                        267Other
                        
                        
                        146
                        
                        
                        67
                        
                        
                        79Total
      noninterest income
                        
                        $
                        3,724
                        
                        $
                        3,002
                        
                        $
                        722
 
 The
primary reason for the increase in noninterest income was a nonrecurring gain
recorded during the quarter of $913 thousand from the collection of BOLI policy
proceeds upon the death of a former director. Additionally, the Company recorded
a $336 thousand net gain from the sale of certain debt securities in the second
quarter of 2009 compared to a $69 thousand net gain on the sale of debt
securities in the same quarter one year ago.
 
 Although
the Company grew core deposits over the past year, service charges and other
fees, which also includes overdraft and non-sufficient funds charges decreased
due to a significant decline in consumer spending during the current economic
recession. Mortgage fees increased primarily as a result of higher staffing
levels in this department as well as a favorable interest rate environment for
residential mortgage refinancing activity. Other loan fees declined as
commercial loan refinancing activity somewhat subsided during the second quarter
of 2009 resulting in lower income from prepayment penalties and other related
loan fees. Brokerage fees declined with increased concerns about the economic
recession and volatility in the stock markets. 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. 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 $10.0 million for the
quarter ended June 30, 2008 to $12.5 million for the quarter ended June 30,
2009, an increase of $2.5 million, or 24.7%.The following table presents
the detail of noninterest expense and related changes for the quarters ended
June 30, 2009 and 2008 (unaudited).
 
 2009
                        
                        
                        2008
                        
                        
                        Variance(Dollars in
      thousands)Noninterest
      expense:Salaries
      and employee benefits
                        
                        $
                        5,856
                        
                        $
                        5,269
                        
                        $
                        587Occupancy
                        
                        
                        1,348
                        
                        
                        957
                        
                        
                        391Furniture
      and equipment
                        
                        
                        739
                        
                        
                        793
                        
                        
                        (54
                        )Data
      processing and telecommunications
                        
                        
                        573
                        
                        
                        528
                        
                        
                        45Advertising
                        
                        
                        223
                        
                        
                        205
                        
                        
                        18Office
      expenses
                        
                        
                        322
                        
                        
                        315
                        
                        
                        7Professional
      fees
                        
                        
                        434
                        
                        
                        281
                        
                        
                        153Business
      development and travel
                        
                        
                        247
                        
                        
                        340
                        
                        
                        (93
                        )Amortization
      of deposit premiums
                        
                        
                        287
                        
                        
                        257
                        
                        
                        30Miscellaneous
      loan handling costs
                        
                        
                        372
                        
                        
                        224
                        
                        
                        148Directors
      fees
                        
                        
                        477
                        
                        
                        189
                        
                        
                        288Insurance
                        
                        
                        140
                        
                        
                        103
                        
                        
                        37FDIC
      deposit insurance
                        
                        
                        1,179
                        
                        
                        181
                        
                        
                        998Other
                        
                        
                        268
                        
                        
                        354
                        
                        
                        (86
                        )Total
      noninterest expense
                        
                        $
                        12,465
                        
                        $
                        9,996
                        
                        $
                        2,469
 - 23 -
 Index
 Included
in the noninterest expense increase was significantly higher FDIC deposit
insurance expense, of which $750 thousand was related to accrual of the FDIC’s
mandatory special assessment imposed on all insured financial institutions for
the purpose of replenishing its insurance fund. The remaining $248 thousand
increase in deposit insurance expense was due to overall increases in rates as
the FDIC continues to raise insurance premiums to cover higher monitoring costs
and claims as well as growth in insured customer deposits. Salaries and employee
benefits as well as occupancy costs increased a combined $978 thousand primarily
due to additional costs incurred as new branches were opened during the past
year in Asheville and Clayton in addition to the four branches purchased in the
Fayetteville market in December 2008. Also partially contributing to this
increase were nonrecurring costs incurred for the planned closing of two
branches as part of a consolidation strategy in the Triad market as the Company
continues to improve the efficiency of its branch network. The planned branch
consolidation added $68 thousand and $127 thousand to employee benefits and
occupancy expense, respectively, during the second quarter of 2009.
Additionally, salaries and employee benefits increased from normal compensation
increases while occupancy expenses increased from higher rent due to
sale-leaseback agreements signed for three existing branch facilities in
September 2008.
 
 Furniture
and equipment expense declined as certain computer equipment became fully
depreciated in previous months. Management continues to monitor and update the
Company’s technology infrastructure in an efficient and cost controlled manner.
Data processing and telecommunications costs rose from increased transaction
volume due to growth in the Company’s primary business lines since much of the
data processing costs are volume based. Professional fees increased from higher
legal fees related to professional consultation on various matters, including
compliance with executive compensation and corporate governance requirements of
CPP participants. Business development and travel costs declined as management
continues to closely monitor and control discretionary spending and as a second
partner was recruited to sublease the corporate airplane. Advertising and office
expenses remained relatively flat, increasing only slightly over the quarters
under comparison.
 
 Amortization
of deposit premiums increased from additional amortization required on the core
deposit intangible recognized as part of the acquisition of four Fayetteville
branches 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 largely from an accelerated payout of deferred
compensation benefits upon the death of a former director. Insurance costs rose
as levels of foreclosed properties have increased. Other noninterest expense
declined as the Company incurred lower losses on foreclosed property sales and
successfully reduced operational losses throughout its branch network.
Management continues to focus on maintaining a strong control environment and
providing sufficient employee training to mitigate the risk of operational
losses at its branches.
 
 Income Taxes.Income taxes decreased from
$869 thousand for the quarter ended June 30, 2008 to $382 thousand for the
quarter ended June 30, 2009. The decrease in tax expense is due to the decline
in pretax income over the same periods. The decline in the effective tax rate
from 28.2% for the quarter ended June 30, 2008 to 22.1% for the quarter ended
June 30, 2009 was primarily due a decrease in projected annual taxable income
relative to pretax book income used in the intraperiod tax allocations for the
quarters under comparison. Taxable income and book income can vary significantly
due to nontaxable income such as municipal bond interest and bank-owned life
insurance income.
 
 Results of
Operations
 
 Six month periodendedJune 30, 2009compared tosix month periodendedJune 30, 2008
 
 The Company reporteda net loss
of $3.1 million for the six months ended June 30, 2009 compared to net income of
$4.4 million for the six months ended June 30, 2008. After dividends and
accretion on preferred stock of $1.2 million, net loss attributable to common
shareholders was $4.3 million, or $0.38 per diluted share, for the first half of
2009 compared with $4.4 million, or $0.39 per diluted share, for the first half
of 2008. Net interest income
increased by $508 thousand over the periods under comparison primarily due to
loan growth, which was partially offset by a decline in net interest margin.
Provision for loan losses increased by $6.3 million partially due to loan growth
but largely fromdeteriorating economic conditions and
weakness in the local real estate markets which resulted in downgrades to the
credit ratingsand
chargeoffsof certain loans
in the portfolio.
Noninterest income increased by $588 thousand primarily due toa
nonrecurring gain from the collection of bank-owned life insurance policy
proceeds, which was partially offset by a decrease in service charge income.
Noninterest expense increased $4.4
million over the periods under comparison partially from the FDIC’s special
assessment on all insured financial institutions and overall increase in base
rates for deposit insurance but also partially 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 $1.7 million for the six months ended June 30, 2008 to
a benefit of $0.4 million for the six months ended June 30, 2009, reflecting the
decline in net income before taxes.
 - 24 -
 Index
 Net Interest Income.Net interest income
increased $508 thousand, or 2.3%, from $21.8 million for the six months ended
June 30, 2008 to $22.3 million for the six months ended June 30, 2009. Average
earning assets increased $159.3 million to $1.58 billion for the six months
ended June 30, 2009 from $1.42 billion for the six months ended June 30, 2008.
Average interest-bearing liabilities increased $104.7 million to $1.38 billion
for the six months ended June 30, 2009 from $1.27 billion for the six months
ended June 30, 2008. The net interest margin on a fully tax equivalent basis
decreased by 25 basis points to 2.95% for the six months ended June 30, 2009
from 3.20% for the six months ended June 30, 2008. The earned yield on average
interest-earning assets was 5.26% and 6.32% for the six months ended June 30,
2009 and 2008, respectively, while the interest rate on average interest-bearing
liabilities for those periods was 2.65% and 3.50%, respectively. The decrease in
net interest margin was primarily due toa drop in loan yields largely
due to steps taken by the Federal Reserve to revive an ailing national economy
last year. One effect of the many policy actions implemented was a drop in the
prime rate by 400 basis points during 2008, which negatively impacted yields on
the Company’s prime-based loan portfolio. Partially offsetting falling loan
yields was asignificant decline
in the cost of customer deposits through disciplined pricing controls and a more
rational competitive pricing landscape as liquidity concerns in the marketplace
have somewhat subsided.
 
 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.
 - 25 -
 Index
 Average Balances, Interest Earned or
Paid, and Interest Yields/Rates
 For the Six Months Ended June 30, 2009
and 2008 (Unaudited)
 Tax Equivalent Basis(1)
 June 30,
    2009
                        
                        June 30,
    2008(Dollars in thousands)
                        
                        Average
    Balance
                        
                        Amount
    Earned
                        
                        AverageRate
                        
                        Average
    Balance
                        
                        Amount
    Earned
                        
                        AverageRateAssetsLoans receivable:(2)Commercial
                        
                        $
                        1,105,457
                        
                        $
                        29,185
                        
                        
                        5.32
                        %
                        $
                        998,552
                        
                        $
                        32,490
                        
                        
                        6.53
                        %Consumer
                        
                        
                        53,717
                        
                        
                        1,812
                        
                        
                        6.80
                        
                        
                        46,522
                        
                        
                        1,779
                        
                        
                        7.67Home equity
                        
                        
                        93,958
                        
                        
                        1,941
                        
                        
                        4.17
                        
                        
                        80,203
                        
                        
                        2,422
                        
                        
                        6.06Residential
      mortgages
                        
                        
                        22,428
                        
                        
                        566
                        
                        
                        5.05
                        
                        
                        29,485
                        
                        
                        919
                        
                        
                        6.23Total Loans
                        
                        
                        1,275,560
                        
                        
                        33,504
                        
                        
                        5.30
                        
                        
                        1,154,762
                        
                        
                        37,610
                        
                        
                        6.53Investment securities(3)
                        
                        
                        283,327
                        
                        
                        7,688
                        
                        
                        5.43
                        
                        
                        256,472
                        
                        
                        7,144
                        
                        
                        5.57Federal funds sold andinterest earning cash
      (4)
                        
                        
                        22,413
                        
                        
                        16
                        
                        
                        0.14
                        
                        
                        10,721
                        
                        
                        88
                        
                        
                        1.65Total interest-earnings
      assets
                        
                        
                        1,581,300
                        
                        $
                        41,208
                        
                        
                        5.26
                        %
                        
                        1,421,955
                        
                        $
                        44,842
                        
                        
                        6.32
                        %Cash and due from
      banks
                        
                        
                        18,686
                        
                        
                        
                        
                        
                        
                        
                        
                        22,854Other
assets
                        
                        
                        79,559
                        
                        
                        
                        
                        
                        
                        
                        
                        136,024Allowance for loan
      losses
                        
                        
                        (16,952
                        )
                        
                        
                        
                        
                        
                        
                        
                        (13,659
                        )Total
assets
                        
                        $
                        1,662,593
                        
                        
                        
                        
                        
                        
                        
                        $
                        1,567,174Liabilities and
      EquitySavings
      deposits
                        
                        $
                        29,204
                        
                        $
                        26
                        
                        
                        0.18
                        %
                        $
                        30,461
                        
                        $
                        81
                        
                        
                        0.53
                        %Interest-bearing demand
      deposits
                        
                        
                        360,738
                        
                        
                        2,355
                        
                        
                        1.32
                        
                        
                        334,480
                        
                        
                        3,489
                        
                        
                        2.09Time
    deposits
                        
                        
                        798,580
                        
                        
                        12,418
                        
                        
                        3.14
                        
                        
                        663,150
                        
                        
                        13,528
                        
                        
                        4.09Total interest-bearing
      deposits
                        
                        
                        1,188,522
                        
                        
                        14,799
                        
                        
                        2.51
                        
                        
                        1,028,091
                        
                        
                        17,098
                        
                        
                        3.34Borrowed
    funds
                        
                        
                        143,442
                        
                        
                        2,663
                        
                        
                        3.74
                        
                        
                        176,743
                        
                        
                        3,843
                        
                        
                        4.36Subordinated
      debt
                        
                        
                        30,930
                        
                        
                        599
                        
                        
                        3.91
                        
                        
                        30,930
                        
                        
                        929
                        
                        
                        6.02Repurchase agreements and fed
      funds purchased
                        
                        
                        12,924
                        
                        
                        14
                        
                        
                        0.22
                        
                        
                        35,373
                        
                        
                        294
                        
                        
                        1.67Total interest-bearing
      liabilities
                        
                        
                        1,375,818
                        
                        $
                        18,075
                        
                        
                        2.65
                        %
                        
                        1,271,137
                        
                        $
                        22,164
                        
                        
                        3.50
                        %Noninterest-bearing
      deposits
                        
                        
                        127,692
                        
                        
                        
                        
                        
                        
                        
                        
                        115,799Other
      liabilities
                        
                        
                        11,844
                        
                        
                        
                        
                        
                        
                        
                        
                        10,960Total
      liabilities
                        
                        
                        1,515,354
                        
                        
                        
                        
                        
                        
                        
                        
                        1,397,896Shareholders’
      equity
                        
                        
                        147,239
                        
                        
                        
                        
                        
                        
                        
                        
                        169,278Total liabilities and
      shareholders’ equity
                        
                        $
                        1,662,593
                        
                        
                        
                        
                        
                        
                        
                        $
                        1,567,174Net interest spread(5)
                        
                        
                        
                        
                        
                        
                        
                        
                        2.61
                        %
                        
                        
                        
                        
                        
                        
                        
                        2.83
                        %Tax equivalent
      adjustment
                        
                        
                        
                        
                        $
                        788
                        
                        
                        
                        
                        
                        
                        
                        $
                        841Net interest income and net
      interest margin(6)
                        
                        
                        
                        
                        $
                        23,133
                        
                        
                        2.95
                        %
                        
                        
                        
                        $
                        22,678
                        
                        
                        3.20
                        %
 
 (1)
                      The tax equivalent basis is
      computed using a blended federal and state tax rate ofapproximately
      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)
                      The Federal Reserve began paying
      interest on cash balances during the quarter ended December 31, 2008. For
      comparison purposes, average balances have been adjusted for all periods
      presented to include cash held at the Federal Reserve as interest
      earning.(5)
                      Net interest spread represents the
      difference between the average yield on interest-earning assets and the
      average cost of interest-bearing liabilities.(6)
                      Net interest margin represents net
      interest income divided by average interest-earning
      assets.
 - 26 -
 Index


Interest income on loans decreased from
$37.6 million for the six months ended June 30, 2008 to $33.5 million for the
six months ended June 30, 2009, a decline of $4.1 million, or 10.9%. This
decrease was primarily due to declining loan yields, which fell from 6.53% in
the six months ended June 30, 2008 to 5.30% in the six months ended June 30,
2009, the effect of which was partially offset by higher average loan balances,
which increased by $120.8 million. The declining loan yields were largely due to
the drop in the prime rate from 5.00% at June 30, 2008 to 3.25% by June 30,
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 $2.3 million and $1.0 million for the six months ended June 30, 2009
and 2008, respectively.





Interest
income on investment securities increased from $6.3 million in for the six
months ended June 30, 2008 to $6.9 million for the six months ended June 30,
2009, an increase of $597 thousand, or 9.5%. This increase was due to growth in
the investment portfolio, partially offset by lower investment yields. Average
investment balances increased from $256.5 million for the six months ended June
30, 2008 to $283.3 million for the six months ended June 30, 2009, and the tax
equivalent yield on investment securities decreased from 5.57% to 5.43% over the
same period. The increase in average investment balances partially reflects
management’s efforts to efficiently deploy net cash received from the purchase
of four Fayetteville branch offices from Omni National Bank in December
2008.





Interest expense on deposits decreased
from $17.1 million for the six months ended June 30, 2008 to $14.8 million for
the six months ended June 30, 2009. The decrease is primarily due to a decrease
in average deposit rates from 3.34% for the six months ended June 30, 2008 to
2.51% for the six months ended June 30, 2009. For time deposits, which
represented 67.2% and 64.5% of total average interest-bearing deposits for the
six months ended June 30, 2009 and 2008, respectively, the average rate
decreased from 4.09% for the six months ended June 30, 2008 to 3.14% for the six
months ended June 30, 2009, reflecting disciplined pricing controls and a more
rational competitive pricing landscape as liquidity concerns in the marketplace
have somewhat subsided.





Interest expense on borrowings decreased
from $5.1 million for the six months ended June 30, 2008 to $3.3 million for the
six months ended June 30, 2009, partially due to declines in interest rates as
well as a $55.8 million decrease in average borrowings over the two periods.The rate on average
borrowings, including
subordinated debt and repurchase agreements,for thesix monthsendedJune 30, 2008was4.18%compared to3.53%for thesix months ended June 30,
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 remaining swaps on $10.0 million of advances
expired during the second quarter of 2009.The net effect of the swaps, including amortization of swap
terminations,wasa decrease tointerest expense of $162 thousand and an increase of$19 thousandfor thesix monthsendedJune 30, 2009 and 2008, respectively.





Provision for Loan
Losses.Provision for loan
losses was $7.7 million for the six months ended June 30, 2009 compared to $1.4
million for the six months ended June 30, 2008. Thesignificantincrease in the provisionwas largelydriven by deteriorating economic conditions and
weaknessin the local real
estate markets which resulted in downgrades to credit ratingsas well as chargeoffsof certain loans in the
portfolio, but the
provision increase was also partially due to loan growth of $115.2 million from
June 30, 2008.Net charge-offsfor the six months ended June 30, 2009
were $3.9 million, or 0.30% of average loans (annualized), compared to net
charge-offs of $1.1 million, or 0.19% of average loans (annualized), for the six
months ended June 30, 2008. Nonperformingloansandpast due loans increased from $5.2
million and $9.2million,
respectively,as of June
30, 2008 to $18.5 million and $15.2million, respectively, as ofJune 30,
2009.





Noninterest Income.Noninterest income
increased from $5.2 million for the six months ended June 30, 2008 to $5.8
million for the six months ended June 30, 2009, an increase of $588 thousand, or
11.2%.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 six months ended June 30, 2009 and 2008
(unaudited).


- 27 -
 Index


2009
                  
                  
                  2008
                  
                  
                  Variance(Dollars in
      thousands)Noninterest
      income:Service
      charges and other fees
                  
                  $
                  1,911
                  
                  $
                  2,225
                  
                  $
                  (314
                  )Mortgage
      fees and revenues
                  
                  
                  618
                  
                  
                  626
                  
                  
                  (8
                  )Other
      loan fees
                  
                  
                  492
                  
                  
                  500
                  
                  
                  (8
                  )Brokerage
      fees
                  
                  
                  313
                  
                  
                  401
                  
                  
                  (88
                  )Bank
      card services
                  
                  
                  724
                  
                  
                  653
                  
                  
                  71Bank-owned
      life insurance
                  
                  
                  1,423
                  
                  
                  562
                  
                  
                  861Net
      gain on investment securities
                  
                  
                  16
                  
                  
                  140
                  
                  
                  (124
                  )Other
                  
                  
                  333
                  
                  
                  135
                  
                  
                  198Total
      noninterest income
                  
                  $
                  5,830
                  
                  $
                  5,242
                  
                  $
                  588





A major
reason for the increase in noninterest income was a nonrecurring gain recorded
during the period of $913 thousand from the collection of BOLI policy proceeds
upon the death of a former director. Partially offsetting this BOLI gain was a
decline in net investment gains. Part of this decline was related to the
impairment charge of $320 thousand recorded on an equity investment in Silverton
Bank, formerly a correspondent financial institution, during the first quarter
of 2009. The impairment charge represented the full amount of the Company’s
investment in Silverton Bank, which was closed by the FDIC in May
2009.





Although
the Company grew core deposits over the past year, service charges and other
fees, which also includes overdraft and non-sufficient funds charges decreased
due to a significant decline in consumer spending during the current economic
recession. Brokerage fees declined with increased concerns about the economic
recession and volatility in the stock markets. 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. Other noninterest income increased primarily due to a reclassification
of certain sublease receipts. Mortgage and other loan fees remained relatively
flat over the periods under comparison.





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 $19.6 million for the
six months ended June 30, 2008 to $24.0 million for the six months ended June
30, 2009, an increase of $4.4 million, or 22.5%.The following table
presents the detail of noninterest expense and related changes for the six
months ended June 30, 2009 and 2008 (unaudited).





2009
                  
                  
                  2008
                  
                  
                  Variance(Dollars in
      thousands)Noninterest
      expense:Salaries
      and employee benefits
                  
                  $
                  11,817
                  
                  $
                  10,172
                  
                  $
                  1,645Occupancy
                  
                  
                  2,721
                  
                  
                  1,954
                  
                  
                  767Furniture
      and equipment
                  
                  
                  1,569
                  
                  
                  1,540
                  
                  
                  29Data
      processing and telecommunications
                  
                  
                  1,204
                  
                  
                  960
                  
                  
                  244Advertising
                  
                  
                  546
                  
                  
                  520
                  
                  
                  26Office
      expenses
                  
                  
                  657
                  
                  
                  680
                  
                  
                  (23
                  )Professional
      fees
                  
                  
                  813
                  
                  
                  651
                  
                  
                  162Business
      development and travel
                  
                  
                  575
                  
                  
                  673
                  
                  
                  (98
                  )Amortization
      of deposit premiums
                  
                  
                  575
                  
                  
                  514
                  
                  
                  61Miscellaneous
      loan handling costs
                  
                  
                  535
                  
                  
                  318
                  
                  
                  217Directors
      fees
                  
                  
                  836
                  
                  
                  589
                  
                  
                  247Insurance
                  
                  
                  244
                  
                  
                  198
                  
                  
                  46FDIC
      deposit insurance
                  
                  
                  1,408
                  
                  
                  228
                  
                  
                  1,180Other
                  
                  
                  529
                  
                  
                  617
                  
                  
                  (88
                  )Total
      noninterest expense
                  
                  $
                  24,029
                  
                  $
                  19,614
                  
                  $
                  4,415


- 28 -
 Index
 Included
in the noninterest expense increase was significantly higher FDIC deposit
insurance expense, of which $750 thousand was related to accrual of the FDIC’s
mandatory special assessment imposed on all insured financial institutions for
the purpose of replenishing its insurance fund. The remaining $430 thousand
increase in deposit insurance expense was due to overall increases in rates as
the FDIC continues to raise insurance premiums to cover higher monitoring costs
and claims as well as growth in insured customer deposits. Salaries and employee
benefits as well as occupancy costs increased a combined $2.4 million primarily
due to additional costs incurred as new branches were opened during the past
year in Asheville and Clayton in addition to the four branches purchased in the
Fayetteville market in December 2008. Also partially contributing to this
increase were nonrecurring costs incurred for the planned closing of two
branches as part of a consolidation strategy in the Triad market as the Company
continues to improve the efficiency of its branch network. The planned branch
consolidation added $68 thousand and $127 thousand to employee benefits and
occupancy expense, respectively, during the second quarter of 2009.
Additionally, salaries and employee benefits increased from normal compensation
increases while 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 primary business lines since much of the data
processing costs are volume based. Professional fees increased from higher legal
fees related to professional consultation on various matters, including
compliance with executive compensation and corporate governance requirements of
CPP participants. Business development and travel costs declined as management
continues to closely monitor and control discretionary spending and as a second
partner was recruited to sublease the corporate airplane. Furniture and
equipment, advertising and office expenses remained relatively flat over the
quarters under comparison.





Amortization
of deposit premiums increased from additional amortization required on the core
deposit intangible recognized as part of the acquisition of four Fayetteville
branches 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 largely from an accelerated payout of deferred
compensation benefits upon the death of a former director. Insurance costs rose
as levels of foreclosed properties have increased. Other noninterest expense
declined as the Company incurred lower losses on foreclosed property sales and
successfully reduced operational losses throughout its branch network.
Management continues to focus on maintaining a strong control environment and
providing sufficient employee training to mitigate the risk of operational
losses at its branches.





Income Taxes.Income taxes decreased from
expense of $1.7 million for the six months ended June 30, 2008 to a benefit of
$0.4 million for the six months ended June 30, 2009. The decrease in tax expense
(benefit) is due to the decline in pretax income (loss) over the same periods.
The decline in the effective tax rate from 27.6% for the six months ended June
30, 2008 to 11.8% for the six months ended June 30, 2009 was primarily due a
decrease in projected annual taxable income relative to pretax book income used
in the intraperiod tax allocations for the periods under comparison. 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 June 30, 2009 were
$1.70 billion, an increase of $41.1 million, or 2.5%, from $1.65 billion as of
December 31, 2008. The increase in total assets for the six months ended June
30, 2009 was primarily due to a $35.2 million increase in the Company’s loan
portfolio, net of allowance for loan losses, since December 31, 2008.Total earning
assetswere $1.62 billion
as of June 30, 2009 compared to $1.60 billion as of December 31, 2008. Earning
assets represented 95.3% and94.3% of total assets as of June 30, 2009
and December 31, 2008, respectively. As of June 30, 2009, investment securities
were $268.2 million compared to $278.1million as of December 31, 2008.
Interest-earning cash, federal funds sold and short term investments were $53.6
million as of June 30, 2009 compared to $26.8 million as of December 31, 2008.
Allowance for loan losses was $18.6 million as of June 30, 2009 compared to
$14.8 million as of December 31, 2008, representing approximately 1.44% 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 June 30, 2009 were
$1.38 billion, an increase of $65.5 million, or 5.0%, from $1.32 billion as of
December 31, 2008. The increase was primarily due to a $41.2 million increase in
demand deposit accounts and a $30.9 million increase in time deposits, partially
offset by a $6.5 million decrease in money market deposits. Time deposits
represented 60.4% of total deposits at June 30, 2009 compared to 61.1% at
December 31, 2008.


- 29 -
 Index
 Total shareholders’ equity decreased
from $148.5 million as of December 31, 2008 to $143.3 million as of June 30,
2009. Retained earnings declined by $6.1 million, reflecting a $3.1 million net
loss for the six months ended June 30, 2009 in addition to $2.8 million of
dividends declared during the period 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, increased from $886 thousand as of December 31,
2008 to $1.2 million as of June 30, 2009. The increase in accumulated other
comprehensive income was primarily due to an increase in the fair value of
available-for-sale securities, partially offset by a decline in fair value of
the cash flow hedge. See the Condensed Consolidated Statements of Changes in
Shareholders’ Equity and Comprehensive Income for additional information
regarding fluctuations in equity accounts during the six months ended June 30,
2009.





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.





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.


- 30 -
 Index
 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 $7.7 million for the six months
ended June 30, 2009 compared to $1.4 million for the six months ended June 30,
2008. Thesignificantincrease in the provisionwas largelydriven by deteriorating economic conditions and
weaknessin the local real
estate markets which resulted in downgrades to credit ratingsas well as chargeoffsof certain loans in the
portfolio, but the
provision increase was also partially due to loan growth of $115.2 million from
June 30, 2008.Net charge-offsfor the six months ended June 30, 2009
were $3.9 million, or 0.30% of average loans (annualized), compared to net
charge-offs of $1.1 million, or 0.19% of average loans (annualized), for the six
months ended June 30, 2008.





The following table presents an analysis
of changes in the allowance for loan losses for the three and six month periods
ended June 30, 2098 and 2008 (unaudited), respectively.





Three Months Ended June
      30,
                
                Six Months Ended June
      30,2009
                
                2008
                
                2009
                
                2008(Dollars in
      thousands)Allowance for loan losses,
      beginning of period
                
                $
                18,480
                
                $
                13,563
                
                $
                14,795
                
                $
                13,571Net
      charge-offs:Loans charged
      off:Commercial
                
                
                381
                
                
                408
                
                
                1,061
                
                
                554Construction
                
                
                393
                
                
                47
                
                
                1,725
                
                
                104Consumer
                
                
                720
                
                
                137
                
                
                793
                
                
                730Home equity
                
                
                22
                
                
                90
                
                
                145
                
                
                90Residential
      mortgage
                
                
                90
                
                
                –
                
                
                255
                
                
                –Total
      charge-offs
                
                
                1,606
                
                
                682
                
                
                3,979
                
                
                1,478Recoveries of loans previously
      charged off:Commercial
                
                
                1
                
                
                136
                
                
                62
                
                
                323Construction
                
                
                20
                
                
                –
                
                
                20
                
                
                –Consumer
                
                
                14
                
                
                42
                
                
                24
                
                
                76Home equity
                
                
                1
                
                
                –
                
                
                2
                
                
                1Residential
      mortgage
                
                
                –
                
                
                1
                
                
                –
                
                
                2Total
      recoveries
                
                
                36
                
                
                179
                
                
                108
                
                
                402Total net
      charge-offs
                
                
                1,570
                
                
                503
                
                
                3,871
                
                
                1,076Loss provision charged to
      operations
                
                
                1,692
                
                
                850
                
                
                7,678
                
                
                1,415Allowance for loan losses, end of
      period
                
                $
                18,602
                
                $
                13,910
                
                $
                18,602
                
                $
                13,910Net charge-offs to average loans
      during the period (annualized)
                
                
                0.49
                %
                
                0.17
                %
                
                0.30
                %
                
                0.19
                %Allowance as a percent of gross
      loans
                
                
                1.44
                %
                
                1.18
                %
                
                1.44
                %
                
                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.


- 31 -
 Index
 The following table presents an analysis
of nonperforming assets as ofJune 30, 2009 and December 31,
2008.





June
      30,
    2009
                
                December 31,
      2008(Dollars in
      thousands)
                
                (Unaudited)Nonperforming
      loans:Commercial
                
                $
                6,635
                
                $
                4,682Construction
                
                
                11,336
                
                
                3,843Consumer
                
                
                32
                
                
                92Home equity
                
                
                140
                
                
                275Residential
      mortgage
                
                
                387
                
                
                223Total nonperforming
      loans
                
                
                18,530
                
                
                9,115Foreclosed property
      held
                
                
                5,170
                
                
                1,347Total nonperforming
      assets
                
                $
                23,700
                
                $
                10,462Nonperforming loans to total
      loans
                
                
                1.43
                %
                
                0.73
                %Nonperforming assets to total
      assets
                
                
                1.40
                %
                
                0.63
                %Allowance coverage of
      nonperforming loans
                
                
                100
                %
                
                162
                %





Foreclosed propertyincreasedto $5.2 millionatJune 30, 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. It is the
Company’s practice to obtain updated appraisals and/or valuations for all
foreclosed assets.





Impaired
loans primarily consist of nonperforming loans and troubled debt restructurings
(“TDRs”) but can include other loans identified by management as being impaired.
Impaired loans totaled $34.5 million at June 30, 2009, compared to $13.7 million
at December 31, 2008. The increase in impaired loans is generally consistent
with the increase in nonperforming loans and is primarily due to weakness
experienced in the local economy and real estate markets from the current
recession. As of June 30, 2009 and December 31, 2008, impaired loans on
relationships over $750 thousand totaled $26.7 million and $9.7 million,
respectively, with specific reserves of $1.9 million and $0.2 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 June
30, 2009 and December 31, 2008, impaired loans on relationships less than $750
thousand, totaled $7.8 million and $4.0 million, respectively, with associated
reserves of $0.6 million and $0.7 million, respectively. These loans were
measured for impairment based on pools of loans stratified by common risk
characteristics. For impaired loans where legal action has been taken to
foreclose, the loan is charged down to estimated fair value, and a specific
reserve is not established.





The
following table summarizes TDRs, which are all classified as impaired loans, as
of June 30, 2009 and December 31, 2008.





June
      30,
    2009
                
                December 31,
      2008(Dollars in
      thousands)
                
                (Unaudited)Performing
      TDRs:Commercial
                
                $
                4,352
                
                $
                219Construction
                
                
                10,065
                
                
                5,624Consumer
                
                
                258
                
                
                –Home equity
                
                
                40
                
                
                –14,715
                
                
                5,843Nonperforming
      TDRs:Commercial
                
                
                1,877
                
                
                –Construction
                
                
                9,921
                
                
                –Home equity
                
                
                94
                
                
                –Residential
      mortgage
                
                
                36
                
                
                8111,928
                
                
                81Total TDRs
                
                $
                26,643
                
                $
                5,924


- 32 -
 Index
 Loans are
classified as TDRs by the Company when certain modifications are made to the
loan terms and concessions are granted to the borrowers due to financial
difficulty experienced by those borrowers. Of the $26.6 million of TDRs at June
30, 2009, loans totaling $14.7 million were accruing interest and were not
included in nonperforming loans at June 30, 2009. The largest of these is a loan
relationship with a regional homebuilder located in the Triangle market with an
outstanding balance of $5.6 million as of June 30, 2009. The loans were
restructured to provide the borrower a period of time to complete construction
on homes that were subsequently placed on the market for sale. The borrower is
current on all principal and interest payments due according to the restructured
note terms. The Company only restructures loans for borrowers in financial
difficulty that have designed a viable business plan to fully pay off all
obligations, including outstanding debt, interest, and fees, either by
generating additional income from the business or through liquidation of assets.
Generally, these loans are restructured to provide the borrower additional time
to execute upon their plans.





These
performing TDRs 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. All TDRs are
considered to be impaired and are evaluated for impairment in accordance with
SFAS No. 114. As of June 30, 2009, loan loss reserves allocated to TDRs totaled
$2.2 million.




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
June 30, 2009, the Company met all of its regulatory liquidity
requirements.
 
 The Company had $72.7million in its most liquid assets, cash
and cash equivalents,as ofJune 30, 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$1.19billion, or 70.4%, of total assets as of June
30, 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 ofJune
30, 2009 (unaudited) 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)
                  
                  $
                  184,241
                  
                  
                  12.77
                  %
                  $
                  144,287
                  
                  
                  10.00
                  %Tier
      I capital (to risk-weighted assets)
                  
                  
                  166,186
                  
                  
                  11.52
                  
                  
                  86,572
                  
                  
                  6.00Tier
      I capital (to average assets)
                  
                  
                  166,186
                  
                  
                  9.94
                  
                  
                  83,589
                  
                  
                  5.00Capital
      Bank:Total
      capital (to risk-weighted assets)
                  
                  $
                  181,408
                  
                  
                  12.57
                  %
                  $
                  144,282
                  
                  
                  10.00
                  %Tier
      I capital (to risk-weighted assets)
                  
                  
                  163,353
                  
                  
                  11.32
                  
                  
                  86,569
                  
                  
                  6.00Tier
      I capital (to average assets)
                  
                  
                  163,353
                  
                  
                  9.86
                  
                  
                  82,874
                  
                  
                  5.00
 - 33 -
 Index
 Total shareholders’ equity was $143.3millionas ofJune 30, 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. Through June 30, 2009, the Company
made dividend payments to the Treasury totaling approximately
$877,000.
 
 Item 3.Quantitative and QualitativeDisclosures 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 June 30,
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 timely 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.
 - 34 -
 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.
  - 35 -
 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 six months ended June 30, 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.
 - 36 -
 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.
 - 37 -
 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.
 - 38 -
 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.
 - 39 -
 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.
 - 40 -
 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 EquitySecurities and Use of
Proceeds
 
 There were no equity securities sold
during the quarter ended June 30, 2009 that were not registered under the
Securities Act. There were no repurchases (both open market and private
transactions) during the six months ended June 30, 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.Defaultsupon Senior Securities
 
 None
  Item 4.Submission of Mattersto a Vote of Security
Holders
 
 During
our annual meeting of shareholders on May 28, 2009, the following matters were
submitted to a vote of the shareholders with the results shown
below:
 
 (1)
      Elected five nominees to serve as Class III directors with terms
      continuing until the Annual Meeting of Shareholders in 2012. The votes
      were cast as follows:Name
                Votes
      For
                Votes
      WithheldLeopold
      I. Cohen
                8,270,579
                442,341O.
      A. Keller, III
                7,884,192
                828,728Ernest
      A. Koury, Jr.
                7,905,535
                807,385George
      R. Perkins, III
                8,286,764
                426,156Carl
      H. Ricker, Jr.
                7,866,146
                846,774
 
 (2)
      Ratified the appointment of Grant Thornton LLP as our independent
      registered public accounting firm for the fiscal year ending December 31,
      2009. The votes were cast as follows:Votes
      For
                Votes
      Against
                Abstained8,505,043
                181,510
                26,366
 
 (3)  Approval
      of a nonbinding advisory proposal regarding Capital Bank Corporation’s
      overall pay-for-performance executive compensation program. The votes were
      cast as follows:Votes
      For
                Votes
      Against
                Abstained7,656,729
                994,345
                61,847
 
 (4)
      Approval of the reservation of 500,000 additional shares of Capital Bank
      Corporation common stock for issuance under the Capital Bank Corporation
      Deferred Compensation Plan for Outside Directors. The votes were cast as
      follows:Votes
      For
                Votes
      Against
                Abstained5,608,375
                871,953
                138,827
 - 41 -
 Index
 (5)  Approval
      of the reservation of 500,000 additional shares of Capital Bank
      Corporation common stock for issuance under the Capital Bank Corporation
      Equity Incentive Plan. The votes were cast as follows:Votes
      For
                Votes
      Against
                Abstained5,555,339
                924,900
                138,917
 
 The
matters listed above are described in detail in our definitive proxy statement
dated April 17, 2009 for the Annual Meeting of Shareholders held on May 28,
2009.
 
 Item 5.Other
Information
 
 None
 
 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
10.1
                
                Form of Incentive Stock Option
      Agreement under the Capital Bank Corporation Equity Incentive Plan
      (incorporated by reference to Exhibit 99.3 to the Company’s Form S-8 filed
      with the SEC on July 20, 2009)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.]
 - 42 -
 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 7th day of August 2009.
  CAPITAL BANK
      CORPORATIONBy:  /s/Michael R.
      MooreMichael R.
      MooreChief Financial
      Officer(Authorized Officer and Principal
      Financial Officer)
 - 43 -
 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
10.1
                
                Form of Incentive Stock Option
      Agreement under the Capital Bank Corporation Equity Incentive Plan
      (incorporated by reference to Exhibit 99.3 to the Company’s Form S-8 filed
      with the SEC on July 20, 2009)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.]
 - 44 -
 Index