UNITED STATES


SECURITIES AND EXCHANGE
COMMISSION


Washington, D.C.
20549





FORM 10-Q





þQUARTERLY REPORT PURSUANT TO
SECTION 13 OR 15(d)


OF THE SECURITIES EXCHANGE ACT OF
1934




For the Quarterly Period Ended June 30,
2008


or


 ̈TRANSITION REPORT PURSUANT TO SECTION
13 OR 15(d)


OF THE SECURITIES EXCHANGE ACT OF
1934





For the Transition Period fromto












CAPITAL BANK
CORPORATION


(Exact name of registrant as specified
in its charter)





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





333 Fayetteville Street, Suite
700


Raleigh, North Carolina
27601


(Address of principal executive
offices)





(919) 645-6400


(Registrant’s telephone number,
including area code)





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





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





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





Indicate by check mark whether the
registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act).


Yes   ̈  No  þ





As ofAugust8, 2008 therewere11,227,085shares outstanding of the registrant’s
common stock, no par value.





CAPITAL BANK
CORPORATION


Form 10-Q for the Quarterly Period Ended
June 30, 2008








INDEX





PART I – FINANCIAL
      INFORMATION
            Page
      No.Item 1.
            Financial
      StatementsCondensed Consolidated Balance
      Sheets as of June 30, 2008 (Unaudited) and December 31,2007
            3Condensed Consolidated Statements
      of Operations for the Three and Six Months Ended June 30, 2008 and 2007
      (Unaudited)
            4Condensed Consolidated Statements
      of Changes in Shareholders’ Equity for the Six Months Ended June 30, 2008
      and 2007 (Unaudited)
            5Condensed Consolidated Statements
      of Cash Flows for the Six Months Ended June 30, 2008 and 2007
      (Unaudited)
            6Notes to Condensed Consolidated
      Financial Statements (Unaudited)
            8Item
      2.
            Management’s Discussion and
      Analysis of Financial Condition and Results of
      Operations
            16Item
      3.
            Quantitative and Qualitative
      Disclosures about Market Risk
            28Item 4.
            Controls and
      Procedures
            28PART II – OTHER
      INFORMATIONItem
      1.
            Legal
      Proceedings
            29Item
      1A.
            Risk
Factors
            29Item
      2.
            Unregistered Sales of Equity
      Securities and Use of Proceeds
            34Item 3.
            Defaults upon Senior
      Securities
            34Item
      4.
            Submission of Matters to a Vote of
      Security Holders
            34Item
      5.
            Other
      Information
            34Item
      6.
            Exhibits
            35Signatures


- 2
-
 Index


PART I – FINANCIAL
INFORMATION





Item 1.Financial
Statements





CAPITAL BANK
CORPORATION


CONDENSED CONSOLIDATED BALANCE
SHEETS


June 30, 2008 and December 31,
2007




June
      30, 2008
                
                December
      31, 2007(Dollars
      in thousands)
                
                (Unaudited)AssetsCash
      and due from banks:Interest
      earning
                
                $
                10,377
                
                $
                7,815Noninterest
      earning
                
                
                32,257
                
                
                32,347Federal
      funds sold and short term investments
                
                
                18
                
                
                10Total
      cash and cash equivalents
                
                
                42,652
                
                
                40,172Investment
      securities – available for sale, at fair value
                
                
                240,940
                
                
                249,094Investment
      securities – held to maturity, at amortized cost
                
                
                5,528
                
                
                10,022Loans –
      net of unearned income and deferred fees
                
                
                1,178,157
                
                
                1,095,107Allowance
      for loan losses
                
                
                (13,910
                )
                
                (13,571
                )Net
      loans
                
                
                1,164,247
                
                
                1,081,536Premises
      and equipment, net
                
                
                24,726
                
                
                23,863Bank-owned
      life insurance
                
                
                21,952
                
                
                21,589Goodwill
      and deposit premium, net
                
                
                62,831
                
                
                63,345Deferred
      income tax
                
                
                7,198
                
                
                5,829Accrued
      interest receivable
                
                
                6,479
                
                
                7,789Other
      assets
                
                
                15,481
                
                
                14,364Total
      assets
                
                $
                1,592,034
                
                $
                1,517,603LiabilitiesDeposits:Demand,
      noninterest bearing
                
                $
                116,987
                
                $
                114,780Savings
      and interest bearing checking
                
                
                187,940
                
                
                151,698Money
      market deposit accounts
                
                
                199,839
                
                
                229,560Time
      deposits less than $100,000
                
                
                420,168
                
                
                370,416Time
      deposits $100,000 and greater
                
                
                257,681
                
                
                232,244Total
      deposits
                
                
                1,182,615
                
                
                1,098,698Repurchase
      agreements and federal funds purchased
                
                
                30,297
                
                
                45,295Borrowings
                
                
                171,000
                
                
                163,347Subordinated
      debentures
                
                
                30,930
                
                
                30,930Other
      liabilities
                
                
                11,461
                
                
                15,033Total
      liabilities
                
                
                1,426,303
                
                
                1,353,303Commitments
      and contingenciesShareholders’
      EquityCommon
      stock, no par value; 20,000,000 shares authorized; 11,229,085 and
      11,169,777 shares issued and outstanding as of June 30, 2008 and December
      31, 2007, respectively
                
                
                136,781
                
                
                136,154Retained
      earnings
                
                
                30,567
                
                
                27,985Accumulated
      other comprehensive (loss) income
                
                
                (1,617
                )
                
                161Total
      shareholders’ equity
                
                
                165,731
                
                
                164,300Total
      liabilities and shareholders’ equity
                
                $
                1,592,034
                
                $
                1,517,603
  The accompanying notes are an integral
part of these condensed consolidated financial statements.
 - 3
-
 Index
 CAPITAL BANK
CORPORATION
 CONDENSED CONSOLIDATED STATEMENTS OF
OPERATIONS
 For the Three and Six Months Ended June
30, 2008 and 2007 (Unaudited)




Three Months EndedJune 30,
              
              Six Months EndedJune 30,(Dollars in thousands except per
      share data)
              
              2008
              
              2007
              
              2008
              
              2007Interest
      income:Loans and loan
      fees
              
              $
              18,111
              
              $
              20,519
              
              $
              37,610
              
              $
              40,402Investment
      securities:Taxable interest
      income
              
              
              2,216
              
              
              1,842
              
              
              4,434
              
              
              3,768Tax-exempt interest
      income
              
              
              805
              
              
              810
              
              
              1,634
              
              
              1,584Dividends
              
              
              118
              
              
              106
              
              
              235
              
              
              213Federal funds and other interest
      income
              
              
              33
              
              
              290
              
              
              88
              
              
              775Total interest
      income
              
              
              21,283
              
              
              23,567
              
              
              44,001
              
              
              46,742Interest
      expense:Deposits
              
              
              8,026
              
              
              9,918
              
              
              17,098
              
              
              19,924Borrowings and repurchase
      agreements
              
              
              2,329
              
              
              2,403
              
              
              5,066
              
              
              4,849Total interest
      expense
              
              
              10,355
              
              
              12,321
              
              
              22,164
              
              
              24,773Net interest
      income
              
              
              10,928
              
              
              11,246
              
              
              21,837
              
              
              21,969Provision (credit) for loan
      losses
              
              
              850
              
              
              (91
              )
              
              1,415
              
              
              246Net interest income after
      provision (credit) for loan losses
              
              
              10,078
              
              
              11,337
              
              
              20,422
              
              
              21,723Noninterest
      income:Service charges and other
      fees
              
              
              1,237
              
              
              929
              
              
              2,196
              
              
              1,806Mortgage fees and
      revenues
              
              
              354
              
              
              568
              
              
              626
              
              
              1,096Brokerage
    fees
              
              
              245
              
              
              150
              
              
              401
              
              
              253Bank card
      services
              
              
              354
              
              
              254
              
              
              653
              
              
              470Net gain on sale of
      securities
              
              
              69
              
              
              –
              
              
              140
              
              
              –Bank-owned life
      insurance
              
              
              260
              
              
              208
              
              
              562
              
              
              405Other
              
              
              455
              
              
              275
              
              
              623
              
              
              544Total noninterest
      income
              
              
              2,974
              
              
              2,384
              
              
              5,201
              
              
              4,574Noninterest
      expense:Salaries and employee
      benefits
              
              
              5,326
              
              
              5,198
              
              
              10,362
              
              
              10,240Occupancy
              
              
              996
              
              
              1,035
              
              
              1,954
              
              
              1,991Furniture and
      equipment
              
              
              793
              
              
              647
              
              
              1,540
              
              
              1,262Data processing and
      telecommunications
              
              
              528
              
              
              397
              
              
              960
              
              
              785Advertising
              
              
              205
              
              
              300
              
              
              520
              
              
              598Office
    expenses
              
              
              315
              
              
              386
              
              
              680
              
              
              719Professional
      fees
              
              
              281
              
              
              422
              
              
              651
              
              
              605Business development and
      travel
              
              
              340
              
              
              344
              
              
              673
              
              
              657Amortization of deposit
      premiums
              
              
              257
              
              
              300
              
              
              514
              
              
              600Miscellaneous loan handling
      costs
              
              
              224
              
              
              112
              
              
              318
              
              
              298Directors
    fees
              
              
              132
              
              
              229
              
              
              399
              
              
              497Insurance
              
              
              103
              
              
              87
              
              
              198
              
              
              177FDIC deposit insurance
              
              
              181
              
              
              77
              
              
              228
              
              
              127Other
              
              
              287
              
              
              323
              
              
              576
              
              
              537Total noninterest
      expense
              
              
              9,968
              
              
              9,857
              
              
              19,573
              
              
              19,093Net income before tax
      expense
              
              
              3,084
              
              
              3,864
              
              
              6,050
              
              
              7,204Income tax
      expense
              
              
              869
              
              
              1,188
              
              
              1,668
              
              
              2,144Net income
              
              $
              2,215
              
              $
              2,676
              
              $
              4,382
              
              $
              5,060Earnings per share –
      basic
              
              $
              0.20
              
              $
              0.23
              
              $
              0.39
              
              $
              0.44Earnings per share –
      diluted
              
              $
              0.20
              
              $
              0.23
              
              $
              0.39
              
              $
              0.44
 
 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’ EQUITY
 For the Six Months Ended June 30, 2008
and 2007 (Unaudited)
 Shares ofCommonStock
                
                Common
                  Stock
                
                Other
      Comprehensive
                  Income(Loss)
                
                Retained
                  Earnings
                
                Total(Dollars in thousands exceptpershare data)Balance at January 1,
      2007
                
                
                11,393,990
                
                $
                139,484
                
                $
                (1,557
                )
                $
                23,754
                
                $
                161,681Repurchase of outstanding common
      stock
                
                
                (2,386
                )
                
                (41
                )
                
                –
                
                
                –
                
                
                (41
                )Issuance of common stock for
      options exercised
                
                
                35,597
                
                
                441
                
                
                –
                
                
                –
                
                
                441Noncash
      compensation
                
                
                32,329
                
                
                497
                
                
                –
                
                
                –
                
                
                497Net income
                
                
                –
                
                
                –
                
                
                –
                
                
                5,060
                
                
                5,060Other comprehensiveloss
                
                
                –
                
                
                –
                
                
                (3,403
                )
                
                –
                
                
                (3,403
                )Comprehensive
      income
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                1,657Dividends ($0.16 per
      share)
                
                
                –
                
                
                –
                
                
                –
                
                
                (1,833
                )
                
                (1,833
                )Balance at June 30,
      2007
                
                
                11,459,530
                
                $
                140,381
                
                $
                (4,960
                )
                $
                26,981
                
                $
                162,402Balance at January 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
                
                
                27,883
                
                
                295
                
                
                –
                
                
                –
                
                
                295Noncash
      compensation
                
                
                24,000
                
                
                295
                
                
                –
                
                
                –
                
                
                295Stock option
    expense
                
                
                –
                
                
                8
                
                
                –
                
                
                –
                
                
                8Net income
                
                
                –
                
                
                –
                
                
                –
                
                
                4,382
                
                
                4,382Unrealizedlosson securities, net of tax
      of$1,326
                
                
                –
                
                
                –
                
                
                (2,113
                )
                
                –
                
                
                (2,113
                )Unrealized gain related to cash
      flow hedge,net of tax of
      $210
                
                
                –
                
                
                –
                
                
                335
                
                
                –
                
                
                335Comprehensive
      income
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                2,604Dividends ($0.16 per
      share)
                
                
                –
                
                
                –
                
                
                –
                
                
                (1,800
                )
                
                (1,800
                )Balance at June 30,
      2008
                
                
                11,229,085
                
                $
                136,781
                
                $
                (1,617
                )
                $
                30,567
                
                $
                165,731
 
 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, 2008
and 2007 (Unaudited)
 
 2008
                
                2007(Dollars in
      thousands)Cash flows from operating
      activities:Net
      income
                
                $
                4,382
                
                $
                5,060Adjustments
      to reconcile net income to net cash provided by operating
      activities:Amortization
      of deposit premium
                
                
                514
                
                
                600Depreciation
                
                
                1,383
                
                
                1,222Net
      gains on sale of securities available for sale
                
                
                (140
                )
                
                –Increase
      in cash surrender value of BOLI
                
                
                (363
                )
                
                (413
                )Loss
      on disposal of premises, equipment and real estate owned
                
                
                70
                
                
                18Net
      funding of held-for-sale loans
                
                
                –
                
                
                (3,868
                )Amortization
      of premium/discount on securities, net
                
                
                57
                
                
                50Deferred
      income tax benefit
                
                
                (253
                )
                
                (163
                )Issuance
      of stock for compensation
                
                
                295
                
                
                497Stock
      option expense
                
                
                8
                
                
                –Provision
      for loan losses
                
                
                1,415
                
                
                246Changes
      in assets and liabilities:Accrued
      interest receivable and other assets
                
                
                (170
                )
                
                1,477Accrued
      interest payable and other liabilities
                
                
                (1,923
                )
                
                (863
                )Net
      cash provided by operating activities
                
                
                5,275
                
                
                3,863Cash
      flows from investing activities:Loan
      originations, net of principal repayments
                
                
                (85,006
                )
                
                (11,126
                )Additions
      to premises and equipment
                
                
                (2,491
                )
                
                (2,323
                )Proceeds
      from sales of premises, equipment and real estate owned
                
                
                1,963
                
                
                71Net
      (purchases) sales of FHLB and Silverton Bank stock
                
                
                (483
                )
                
                931Purchase
      of securities available for sale
                
                
                (47,036
                )
                
                (24,020
                )Proceeds
      from principal repayments/calls/maturities of available for
      sale
                
                
                52,320
                
                
                15,388Proceeds
      from principal repayments/calls/maturities of securities held to
      maturity
                
                
                4,491
                
                
                516Net
      cash used in investing activities
                
                
                (76,242
                )
                
                (20,563
                )(continued
      on next page)
 
 The accompanying notes are an integral
part of these condensed consolidated financial statements.
 
 - 6
-
 Index
 CAPITAL BANK
CORPORATION
 CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
 For theSixMonths EndedJune 30, 2008 and 2007(Unaudited)
 
 2008
                
                2007(Dollars in
      thousands)Cash
      flows from financing activities:Net
      increase in deposits
                
                $
                83,917
                
                $
                17,770Net
      (decrease) increase in repurchase agreements
                
                
                (9,603
                )
                
                5Proceeds
      from borrowings
                
                
                158,000
                
                
                56,000Principal
      repayments of borrowings
                
                
                (152,000
                )
                
                (56,010
                )Net
      repayments of federal funds borrowed
                
                
                (5,395
                )
                
                –Dividends
      paid
                
                
                (1,796
                )
                
                (1,601
                )Issuance
      of common stock for options and other plans
                
                
                398
                
                
                441Repurchase
      of common stock
                
                
                (74
                )
                
                (41
                )Net
      cash provided by financing activities
                
                
                73,447
                
                
                16,564Net
      change in cash and cash equivalents
                
                
                2,480
                
                
                (136
                )Cash
      and cash equivalents at beginning of period
                
                
                40,172
                
                
                54,332Cash
      and cash equivalents at end of period
                
                $
                42,652
                
                $
                54,196Supplemental
      Disclosure of Cash Flow InformationTransfer
      of loans and premises to other real estate owned
                
                $
                880
                
                $
                645Dividends
      payable
                
                $
                898
                
                $
                916Cash
      paid for:Income
      taxes
                
                $
                1,971
                
                $
                2,720Interest
                
                $
                22,498
                
                $
                17,010
 
 The accompanying notes are an integral
part of thesecondensedconsolidated financial
statements.
 
 - 7
-
 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,
2007.
 
 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, 2008 are not necessarily
indicative of the results of operations that may be expected for the year ended
December 31, 2008.
 
 The condensed consolidated balance sheet
at December 31, 2007 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, 2007.
 
 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, 2007.
 
 In May
2008, the FASB issued Statement of Financial Accounting Standards No. 162, The Hierarchy of Generally Accepted
Accounting Principles(“SFAS No. 162”). The new standard identifies the sources
of accounting principles and the framework for selecting the principles to be
used in the preparation of financial statements of nongovernmental entities that
are presented in conformity with U.S. GAAP. It is effective60 days following the
SEC’s approval of the Public Company Accounting Oversight Board amendments to AU
Section 411,The
Meaning ofPresent
Fairly in Conformity With Generally Accepted Accounting Principles. The Company is
currently evaluating the effect of SFAS No. 162, but does not expect its
adoption to have a material impact on the Company’s financial condition or
results of operations.
 
 In March
2008, the FASB issued Statement of Financial Accounting Standards No. 161,
Disclosures about Derivative
Instruments and Hedging Activities—an amendment of FASB Statement No.
133 (“SFAS No. 161”). The new standard 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. SFAS No. 161 is effective for financial statements
issued for fiscal years and interim periods beginning after November 15,
2008. SFAS No. 161 will impact disclosures only and will not have an impact
on the Company’s consolidated financial condition, results of operations or cash
flows.
 
 - 8
-
 Index
 Capital
Bank Corporation – Notes to Condensed Consolidated Financial Statements
(Unaudited)
  In
December 2007, the FASB issued Statement of Financial Accounting Standards
No. 141 (revised 2007), Business Combinations (“SFAS
No. 141R”), which replaces Statement of Financial Accounting Standards
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. The revised standard applies prospectively to business
combinations for which the acquisition date is on or after the beginning of the
first annual reporting period beginning on or after December 15, 2008. The
Company will apply the provisions of SFAS No. 141R to any business
acquisition which occurs on or after the date the standard becomes
effective.
 
 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. SFAS No. 160 is effective for fiscal years, and
interim periods within those fiscal years, beginning on or after
December 15, 2008. Early adoption is prohibited. The Company is currently
evaluating the provisions of SFAS No. 160 and assessing the impact it
may have on the Company.
 
 In February 2007, the FASB issued FASB
Statement No. 159,The Fair Value
Options for Financial Assets and Financial Liabilities—Including an
amendment of FASB Statement No. 115(“SFAS No. 159”), effective for fiscal
years beginning after November 15, 2007. SFAS No. 159 permits entities to
choose, at specified election dates, to measure eligible items at fair value and
requires unrealized gains and losses on items for which the fair value option
has been elected to be reported in earnings. At this time, the Company does not
expect to elect the fair value option as outlined in the provisions of SFAS No.
159.
 
 In September 2006, the FASB issued SFAS
No. 157,Fair Value
Measurements(“SFAS No.
157”), which defines fair value, establishes a framework for measuring fair
value, and expands disclosures about fair value measurements. SFAS No. 157waseffective for the Company beginning
January 1, 2008.Certain
requirements of SFAS No. 157 are effective for fiscal years beginning after
November 15, 2007, and interim periods within those fiscal years. The effective
date for other requirements of SFAS No. 157 has been deferred for one year by
the FASB. On January 1, 2008, the Company adopted SFAS No. 157, which has not
had a material impact on the Company’s financial condition or results of
operations.See Part I – Financial Information,
Item 1. Financial Statements, Notes to Condensed Consolidated Financial
Statements – Note 9. Fair Value Measurement for additional
information.
 
 In
September 2006, the FASB issued SFAS No. 158, Employers’ Accounting for Defined
Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements
No. 87, 88, 106, and 132(R) (“SFAS No. 158”). SFAS No. 158 requires
employers to recognize a net liability or asset and an offsetting adjustment to
accumulated other comprehensive income to report the funded status of defined
benefit pension and other post-retirement benefit plans. SFAS No. 158 requires
prospective application; thus, the recognition and disclosure requirements are
effective for fiscal years ending after December 31, 2006. Additionally, SFAS
No. 158 requires companies to measure plan assets and obligations at their
year-end balance sheet date. This requirement is effective for the Company’s
fiscal year ending after December 31, 2008. The Company is currently evaluating
the effect of the additional provisions of SFAS No. 158, but does not expect
adoption of the additional provisions to have a material impact on the Company’s
financial condition or results of operations.
 
 2.      Comprehensive Income
 
 Comprehensive income includes net income
and all other changes to the Company’s equity, with the exception of
transactions with shareholders (“other comprehensive income”). The Company’s
other comprehensive income for the six month periods ended June 30, 2008 and
2007 are as shown in the Company’s Condensed Consolidated Statements of Changes
in Shareholders’ Equity (unaudited).
 
 - 9
-
 Index
  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 for the three and six months ended June 30, 2008 and 2007 is as
follows:
 
 Three Month Period Ended June 30, 2008
and 2007 (Unaudited)
  2008
                    
                    2007(Dollars in
      thousands)Unrealized losses on
      available-for-sale securities
                    
                    $
                    (4,368
                    )
                    $
                    (4,766
                    )Unrealized loss on change in fair
      value of cash flow hedge
                    
                    
                    (1,308
                    )
                    
                    (877
                    )Income tax
      benefit
                    
                    
                    2,188
                    
                    
                    2,176Other comprehensive
      loss
                    
                    $
                    (3,488
                    )
                    $
                    (3,467
                    )
 
 
 Six Month Period Ended June 30, 2008 and
2007 (Unaudited)
 
 2008
                    
                    2007(Dollars in
      thousands)Unrealized losses on
      available-for-sale securities
                    
                    $
                    (3,439
                    )
                    $
                    (4,516
                    )Unrealized gain (loss) on change
      in fair value of cash flow hedge
                    
                    
                    545
                    
                    
                    (942
                    )Income tax
      benefit
                    
                    
                    1,116
                    
                    
                    2,055Other comprehensive
      loss
                    
                    $
                    (1,778
                    )
                    $
                    (3,403
                    )
 
 3.      Earnings Per Share
 
 The Company is required to report both
basic and diluted earnings per share (“EPS”). 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, unless the effect is to reduce a loss or increase
earnings per share. For the Company, EPS is adjusted for outstanding stock
options using the treasury stock method in order to compute diluted EPS. The
following table provides a computation and reconciliation of basic and diluted
EPS for the three and six month periods ended June 30, 2008 and 2007,
respectively.
 
 Three Month Period Ended June 30, 2008
and 2007 (Unaudited)
 
 2008
                    
                    2007(Dollars in thousands)Income available to shareholders –
      basic and diluted
                    
                    $
                    2,215
                    
                    $
                    2,676Shares used in the computation of
      earnings per share:Weighted average number of shares
      outstanding – basic
                    
                    
                    11,310,393
                    
                    
                    11,503,441Incremental shares from assumed
      exercise of stock options
                    
                    
                    13,115
                    
                    
                    70,669Weighted average number of shares
      outstanding – diluted
                    
                    
                    11,323,508
                    
                    
                    11,574,110
 
 For the
three month periods ended June 30, 2008 and 2007, options to purchase
approximately 90,411 shares and 299,368 shares, respectively, of common stock
were used in the diluted calculation. For the three month periods ended June 30,
2008 and 2007, options to purchase 281,573 shares and 63,750 shares,
respectively, 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.
 
 - 10
-
 Index
  Six Month Period Ended June 30, 2008 and
2007 (Unaudited)
 
 2008
                    
                    2007(Dollars in thousands)Income available to shareholders –
      basic and diluted
                    
                    $
                    4,382
                    
                    $
                    5,060Shares used in the computation of
      earnings per share:Weighted average number of shares
      outstanding – basic
                    
                    
                    11,299,923
                    
                    
                    11,498,125Incremental shares from assumed
      exercise of stock options
                    
                    
                    14,655
                    
                    
                    75,507Weighted average number of shares
      outstanding – diluted
                    
                    
                    11,314,578
                    
                    
                    11,573,632
 
 For the
six month periods ended June 30, 2008 and 2007, options to purchase
approximately 100,911 shares and 299,368 shares, respectively, of common stock
were used in the diluted calculation. For the six month periods ended June 30,
2008 and 2007, options to purchase 271,073 shares and 63,750 shares,
respectively, 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.
 4.      Stock-Based
Compensation
 
 The Company
accounts for stock-based compensation in accordance with SFAS No. 123R,Share-Based
Payments(“SFAS No.
123R”). The Company has stock option plans providing for the issuance of up to
650,000 options to purchase shares of the Company’s common stock to officers and
directors, of which
608,700 have been granted, with 287,600 remaining outstanding as of June 30,
2008.In addition, there were566,071options, which were assumed under
various plans from previously acquired financial institutions, of which84,384remain outstanding.
 
 The Company also administers the Capital
Bank Corporation Deferred Compensation Plan forOutsideDirectors (the “Deferred Compensation
Plan”). Under the Deferred Compensation Plan, eligible directors may elect to
defer all or part of their directors’ fees for a calendar year, in exchange for
common stock of the Company, based on the year-end share price. The amount
deferred, if elected, is equal to 125 percent of the total director’s fees. Each
participant is fully vested in his or her account balance. The Deferred
Compensation Plan generally provides for payment of share units either in shares
of Company common stock or cash (at the Company’s discretion). The Deferred
Compensation Plan is classified as a liability-based plan under SFAS No. 123R.
Accordingly, changes in the Company’s stock price affect the amount of expense
recognized during the period. For the six month periods ended June 30, 2008 and
2007, the Company recognized a reduction to noninterest expense for $151
thousand and $47 thousand,respectively, related to the Deferred
Compensation Plan.
 
 The following is a summary of stock
option information and the weighted average exercise price (“WAEP”) for the six
months ended June 30, 2008.
 
 Number
                        of Shares
                      
                      WeightedAverage
                        Exercise
    Price
                      
                      Weighted
      Average
                        Remaining
      Contractual
                        Term in
    Years
                      
                      Aggregate
                        Intrinsic
    Value(Dollars in thousands)Outstanding at January 1,
      2008
                      
                      
                      384,075
                      
                      $
                      12.09Granted
                      
                      
                      3,500
                      
                      
                      10.42Exercised
                      
                      
                      (15,591
                      )
                      
                      6.62Terminated
                      
                      
                      –Outstanding at June 30,
      2008
                      
                      
                      371,984
                      
                      $
                      12.79
                      
                      
                      4.25
                      
                      $
                      121Options exercisable at June 30,
      2008
                      
                      
                      318,284
                      
                      $
                      12.38
                      
                      
                      3.42
                      
                      $
                      121
 
 - 11
-
 Index
  The following table summarizes
information about the Company’s stock options at June 30,
2008.
  Exercise
    Price
                        Number
                          Outstanding
                        
                        Weighted
      Average
                          Remaining
      Contractual
                          Life in
    Years
                        
                        Number
                          Exercisable$6.62 –
    $9.00
                        80,631
                        
                        1.88
                        
                        80,631$9.01 –
    $12.00
                        91,202
                        
                        3.41
                        
                        87,702$12.01 –
    $15.00
                        49,750
                        
                        3.33
                        
                        33,750$15.01 –
    $18.00
                        96,151
                        
                        6.24
                        
                        61,951$18.01 –
    $18.37
                        54,250
                        
                        6.49
                        
                        54,250371,984
                        
                        4.25
                        
                        318,284
  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.
 
 5.      Investment
Securities
 
 The following table shows the gross
unrealized losses and fair value of the Company’s investments 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, at June 30, 2008.
 
 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 SaleMunicipal bonds and
      other
                      
                      $
                      63,153
                      
                      $
                      2,201
                      
                      $
                      5,987
                      
                      $
                      402
                      
                      $
                      69,140
                      
                      $
                      2,603Mortgage-backed
      securities
                      
                      
                      112,960
                      
                      
                      2,466
                      
                      
                      8,585
                      
                      
                      460
                      
                      
                      121,545
                      
                      
                      2,926176,113
                      
                      
                      4,667
                      
                      
                      14,572
                      
                      
                      862
                      
                      
                      190,685
                      
                      
                      5,529Held to MaturityMunicipal bonds and
      other
                      
                      $
                      298
                      
                      $
                      2
                      
                      $
                      –
                      
                      $
                      –
                      
                      $
                      298
                      
                      $
                      2Mortgage-backed
      securities
                      
                      
                      2,425
                      
                      
                      74
                      
                      
                      2,592
                      
                      
                      136
                      
                      
                      5,017
                      
                      
                      2102,723
                      
                      
                      76
                      
                      
                      2,592
                      
                      
                      136
                      
                      
                      5,315
                      
                      
                      212Total at June 30,
      2008
                      
                      $
                      178,836
                      
                      $
                      4,743
                      
                      $
                      17,164
                      
                      $
                      998
                      
                      $
                      196,000
                      
                      $
                      5,741
 
 
 The unrealized losses on the Company’s
investments were primarily the result of interest rate changes. The Company has
the ability and intent to hold these investments until a recovery of fair value,
which may be at maturity. Accordingly, the Company does not consider these
investments to be other-than-temporarily impaired at June 30,
2008.
 
 - 12
-
 Index
  6.      Loans
 
 The composition of the loan portfolio by
loan classification at June 30, 2008 and December 31, 2007 is as
follows:
 June 30,
    2008
                        
                        December 31,
      2007(Dollars in
      thousands)
                        
                        (Unaudited)Commercial
                        
                        $
                        688,869
                        
                        $
                        640,355Construction
                        
                        
                        339,121
                        
                        
                        301,799Consumer
                        
                        
                        11,560
                        
                        
                        12,788Home equity
                        
                        
                        81,557
                        
                        
                        79,361Residential
      mortgages
                        
                        
                        56,708
                        
                        
                        60,5961,177,815
                        
                        
                        1,094,899Plus deferred loan costs,
      net
                        
                        
                        342
                        
                        
                        208$
                        1,178,157
                        
                        $
                        1,095,107
 
 There were no loans held for sale at
June 30, 2008 or December 31, 2007.
 
 7.      Assets Held for Sale
 
 On
May 21, 2008, the Company entered into an agreement with NewBridge Bank, a
wholly-owned subsidiary of NewBridge Bancorp, pursuant to which NewBridge Bank
will purchase the Company’s branch located in Greensboro, North Carolina. The
divestiture, which is subject to customary closing conditions, including
regulatory approvals, is expected to be completed in the third quarter of
2008.
 
 The
Company classifies assets, and related liabilities, as held for sale when it has
committed to a plan to sell the assets, the assets are available for immediate
sale, and it is probable that the assets will be sold within one year based on
the current condition and sales price of the assets. Upon classifying the assets
as held for sale, the assets are recorded at the lower of historical cost or
fair value less selling costs, and depreciation is discontinued. Assets and
liabilities held for sale related to the pending branch divestiture are $5.1
million and $12.8 million, respectively, as of June 30, 2008.
 
 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, 2008 and December 31, 2007 was as
follows:
 
 June 30,
    2008
                        
                        December 31,
      2007(Dollars in
      thousands)
                        
                        (Unaudited)Unused lines of credit and
      overdraft lines
                        
                        $
                        291,552
                        
                        $
                        301,089Standby letters of
      credit
                        
                        
                        8,834
                        
                        
                        7,697Total
      commitments
                        
                        $
                        300,386
                        
                        $
                        308,786
 
 - 13
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 Index
  9.      Fair Value
Measurement
 
 On
January 1, 2008, the Company adopted SFAS No. 157, which defines fair
value, establishes a framework for measuring fair value under U.S. GAAP, and
enhances disclosures about fair value measurements. The Company elected to delay
the application of SFAS No. 157 to nonfinancial assets and nonfinancial
liabilities, as allowed by FASB Staff Position SFAS No. 157-2. SFAS No. 157
applies whenever other standards require (or permit) assets or liabilities to be
measured at fair value and, therefore, does not expand the use of fair value in
any new circumstances. Fair value is defined as the exchange price that would be
received to sell an asset or paid to transfer a liability in the principal or
most advantageous market for the asset or liability in an orderly transaction
between market participants on the measurement date. SFAS No. 157 clarifies that
fair value should be based on the assumptions market participants would use when
pricing an asset or liability and establishes a fair value hierarchy that
prioritizes the information used to develop those assumptions. The fair value
hierarchy gives the highest priority to quoted prices in active markets
(observable inputs) and the lowest priority to the Company’s assumptions
(unobservable inputs). SFAS No. 157 requires fair value measurements to be
separately disclosed by level within the fair value hierarchy. For assets and
liabilities recorded at fair value, it is the Company’s policy to maximize the
use of observable inputs and minimize the use of unobservable inputs when
developing fair value measurements, in accordance with the fair value hierarchy
in SFAS No. 157.
 
 Fair
value measurements for assets and liabilities where there exists limited or no
observable market data and, therefore, are based primarily upon estimates, are
often calculated based on the economic and competitive environment, the
characteristics of the asset or liability and other factors. Therefore, the
results cannot be determined with precision and may not be realized in an actual
sale or immediate settlement of the asset or liability. Additionally, there may
be inherent weaknesses in any calculation technique, and changes in the
underlying assumptions used, including discount rates and estimates of future
cash flows, could significantly affect the results of current or future
values.
 
 The
Company utilizes fair value measurements to record fair value adjustments to
certain assets and liabilities and to determine fair value disclosures.
Securities available for sale and derivatives are recorded at fair value on a
recurring basis. Additionally, from time to time, the Company may be required to
record at fair value other assets on a nonrecurring basis, such as loans held
for sale, loans held for investment and certain other assets. These nonrecurring
fair value adjustments typically involve application of lower of cost or market
accounting or write-downs of individual assets.
 
 Under
SFAS No. 157, the Company groups assets and liabilities at fair value in three
levels, based on the markets in which the assets and liabilities are traded and
the reliability of the assumptions used to determine fair value. An adjustment
to the pricing method used within either Level 1 or Level 2 inputs could
generate a fair value measurement that effectively falls in a lower level in the
hierarchy. These levels are:
 
 Level 1 –
Valuations for assets and liabilities traded in active exchange markets, such as
the New York Stock Exchange.
 
 Level 2 –
Valuations for assets and liabilities that can be obtained from readily
available pricing sources via independent providers for market transactions
involving similar assets or liabilities. The Company’s principal market for
these securities is the secondary institutional markets, and valuations are
based on observable market data in those markets.
 
 Level 3 –
Valuations for assets and liabilities that are derived from other valuation
methodologies, including option pricing models, discounted cash flow models and
similar techniques, and not based on market exchange, dealer, or broker traded
transactions. Level 3 valuations incorporate certain assumptions and projections
in determining the fair value assigned to such assets or
liabilities.
 
 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.
 
 - 14
-
 Index
  Investment Securities,
Available for Sale
 Investment
securities, available for sale, 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. Investment securities,
held to maturity, are recorded at amortized cost, not at fair
value.
 
 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. As of June 30, 2008 the Company’s derivative
instruments consist solely of interest rate swaps.
 
 Loans Held for
Sale
 Loans
held for sale are carried at the lower of cost or market value. The fair value
of loans held for sale is based on what secondary markets are currently offering
for portfolios with similar characteristics. As such, the Company classifies
loans subjected to nonrecurring fair value adjustments as Level 2. The Company
has no loans held for sale as of June 30, 2008.
 
 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. At June 30, 2008, substantially all of the total impaired loans
were evaluated based on the fair value of the collateral. In accordance with
SFAS No. 157, impaired loans where an allowance is established based on the fair
value of collateral require classification in the fair value hierarchy. When the
fair value of the collateral is based on an observable market price or a current
appraised value, the Company records the impaired loan as nonrecurring Level 2.
When an appraised value is not available or management determines the fair value
of the collateral is further impaired below the appraised value and there is no
observable market price, the Company records the impaired loan as nonrecurring
Level 3. Impaired loans totaled $4.4 million at June 30, 2008 with specific loss
allowances aggregating $1.7 million at that date.
 
 Foreclosed
Assets
 Foreclosed
assets are adjusted to fair value upon transfer of the loans to foreclosed
assets. Subsequently, foreclosed assets are carried at the lower of carrying
value or fair value. Fair value is based upon independent market prices,
appraised values of the collateral or management’s estimation of the value of
the collateral. When the fair value of the collateral is based on an observable
market price or a current appraised value, the Company records the foreclosed
asset as nonrecurring Level 2. When an appraised value is not available or
management determines the fair value of the collateral is further impaired below
the appraised value and there is no observable market price, the Company records
the foreclosed asset as nonrecurring Level 3. There were no fair value
adjustments related to foreclosed real estate of $0.7 million at June 30,
2008.
 
 - 15
-
 Index
  Below is
a table that presents information about certain assets and liabilities measured
at fair value on a recurring basis:
 
 Fair Value Measurements at June
      30, 2008Quoted Prices inActive Markets
      forIdentical Assets
                          (Level 1)
                        
                        Significant Other ObservableInputs
                          (Level 2)
                        
                        Significant
                          UnobservableInputs
                          (Level 3)
                        
                        Total(Dollars in
      Thousands)Investment
      securities
                        
                        $
                        1,103
                        
                        $
                        239,837
                        
                        $
                        –
                        
                        $
                        240,940Fair value interest rate
      swaps
                        
                        
                        –
                        
                        
                        1,015
                        
                        
                        –
                        
                        
                        1,015Cash flow interest rate
      swaps
                        
                        
                        –
                        
                        
                        2,495
                        
                        
                        –
                        
                        
                        2,495
  Below is
a table that presents information about certain assets and liabilities measured
at fair value on a nonrecurring basis:
  Fair Value Measurements at June
      30, 2008Quoted Prices inActive Markets
      forIdentical Assets
                            (Level 1)
                          
                          Significant Other ObservableInputs
                            (Level 2)
                          
                          Significant
                            UnobservableInputs
                            (Level 3)
                          
                          Total(Dollars in
      Thousands)Loans held for
      sale
                          
                          $
                          –
                          
                          $
                          –
                          
                          $
                          –
                          
                          $
                          –Loans
                          
                          
                          –
                          
                          
                          –
                          
                          
                          1,164,247
                          
                          
                          1,164,247Foreclosed
      assets
                          
                          
                          –
                          
                          
                          –
                          
                          
                          663
                          
                          
                          663
 10.           Redeemable Common
Stock
 
 The
Company maintains the Capital Bank 401(k) Retirement Plan (the “Plan”) for the
benefit of its employees, through which participants can elect to purchase
Company common stock at market prices. In prior years, the Company had
registered 50,000 shares of its common stock with the Securities and Exchange
Commission (“SEC”) to be available for issuance under the Plan. The Company
recently determined that it may have inadvertently failed to register with the
SEC the issuance of shares under the Plan in excess of the number previously
registered. The Company common stock held in the Plan is not purchased from the
Company; rather, the plan trustee accumulates plan contributions that are then
used to purchase Company common stock in open market transactions. Nevertheless,
because the Company sponsors the Plan, the Company may have
been required to register with the SEC all transactions in the Plan related
to shares of its common stock.
 
 As a
result, certain purchasers of common stock pursuant to the Plan may have the
right to rescind their purchases for an amount equal to the purchase
price paid for the shares, plus interest from the date of purchase. As of June
30, 2008 and December 31, 2007, the Company had common shares subject to
potential rescission rights that are considered redeemable common stock, because
the redemption features are not within the control of the Company. The balance
of redeemable common stock at June 30, 2008 and December 31, 2007, however, is
not considered material for separate classification on the condensed
consolidated balance sheets. These shares have always been treated as
outstanding for financial reporting purposes.
 
 Item 2.Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
 
 The following discussion presents an
overview of the unaudited financial statements for the three months ended June
30, 2008 and 2007 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.
 - 16
-
 Index
 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
 
 The Bank is a full-service state
chartered community bank conducting business throughout North Carolina. 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,
interchange income and ATM fees, fees generated from originating mortgage loans
that are sold, 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 and
other 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 its 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.
 
 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, 2007.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 identified five
accounting policies as being critical in terms of significant judgments and the
extent to which estimates are used: allowance for loan losses, investments,
valuation allowances, goodwill and the impairment of long-lived 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,
2007.
 
 Executive Summary
 
 As discussed in more detail below, the
following is a summary of our significant results for the quarter ended June 30,
2008.
 
 •
                          The Companyreported net
      income for the quarter ended June 30, 2008 of $2.2 million compared to
      $2.7 million for the quarter ended June 30, 2007. Earnings per share on a
      fully diluted basis were $0.20 for the second quarter of 2008 compared to
      $0.23 for the second quarter of 2007. The Company reported net income for
      the six months ended June 30, 2008 of $4.4 million compared to $5.1
      million for the six months ended June 30, 2007. Earnings per share on a
      fully diluted basis were $0.39 for the first half of 2008 compared to
      $0.44 for the first half of 2007.
 - 17
-
 Index
 •
                          Nonperforming
      assets, which includes loans on nonaccrual and other real estate owned,
      decreased to 0.37% of total assets at the end of June 2008 compared to
      0.50% at the end of December 2007 and 0.59% at the end of June 2007. In
      addition, past due loans declined to 0.78% of total loans at the end of
      June 2008 compared to 0.98% at the end of December 2007 and 1.27% at the
      end of June 2007. Allowance for loan losses totaled 1.18% of total loans
      at the end of June 2008 compared to 1.24% at the end of December 2007 and
      1.31% at the end of June 2007. The allowance for loan losses as a percent
      of nonperforming loans increased to 267% at end of the second quarter 2008
      compared to 227% at the end of the fourth quarter 2007 and 175% at the end
      of the second quarter 2007.•
                          The provision for loan losses for
      the quarter ended June 30, 2008 was $850 thousand compared to a credit of
      $91 thousand for the quarter ended June 30, 2007. The provision for loan
      losses for the six months ended June 30, 2008 was $1.4 million compared to
      $246 thousand for the six months ended June 30, 2007. The increase in the
      provision was primarily due to enhancements in the methodology for
      calculating the allowance for loan losses, which reduced the allowance and
      related provision during the second quarter of 2007. The enhancements to
      the allowance methodology were implemented during 2007 based on updated
      guidance issued through an interagency policy statement by the FDIC,
      Federal Reserve, and other regulatory agencies.•
                          Net
      interest income for the second quarter of 2008 decreased $318 thousand
      compared to the second quarter of 2007. This decrease was primarily due to
      the decline in net interest margin from 3.65% in the quarter ended June
      30, 2007 to 3.18% in the quarter ended June 30, 2008. Net interest income
      for the first half of 2008 decreased $132 thousand compared to the first
      half of 2007. This decrease was primarily due to the decline in net
      interest margin from 3.59% in the six months ended June 30, 2007 to 3.21%
      in the six months ended June 30, 2008. The decline in the net interest
      margin is a result of the 3.25% reduction in the prime rate over the last
      twelve months.•
                          In
      the quarter ended June 30, 2008, noninterest income increased $590
      thousand compared to the same period one year ago. Service charges,
      brokerage fees, and bank card services increased a combined $503 thousand
      primarily as a result of management’s continued emphasis on increasing
      income from these sources. For the six month period ended June 30, 2008,
      noninterest income increased $627 thousand compared to the same period one
      year ago. Service charges, brokerage fees, and bank card services
      increased a combined $721 thousand primarily as a result of management’s
      continued emphasis cited above.•
                          Noninterest
      expense increased $111 thousand in the quarter ended June 30, 2008 from
      the same quarter one year ago. This increase was partially due to higher
      FDIC deposit insurance costs of $104 thousand as the regulatory agency
      increased premiums to cover higher monitoring costs and claims.
      Noninterest expense increased $480 thousand in the first half of 2008 from
      the same period one year ago. This increase was partially due to higher
      FDIC deposit insurance costs of $101 thousand and higher furniture and
      equipment expense of $278 thousand. The increase in furniture and
      equipment expense was due to equipment and building upgrades as well as
      higher maintenance costs.
 
 Financial Condition
 
 Total assets of the Company as of June
30, 2008 were $1.59 billion, an increase of $74.4 million, or 4.9%, over total
assets of $1.52 billion as of December 31, 2007. The increase in total assets
for the six months ended June 30, 2008 is primarily due to an $82.7 million
increase in the Bank’s loan portfolio, net of allowance for loan losses, since
December 31, 2007. Total deposits at June 30, 2008 were $1.18 billion, which
represents growth of $83.9 million from December 31, 2007.
 
 Total earning assetswere $1.44 billion as of June 30, 2008
compared to $1.36 billion as of December 31, 2007. Earning assets represented
90.1% and89.8% of total
assets as of June 30, 2008 and December 31, 2007, respectively. At June 30,
2008, investment securities were $246.5 million compared to $259.1million as of December 31, 2007.
Interest-earning cash, federal funds sold and short term investments were $10.4
million as of June 30, 2008 compared to $7.8 million as of December 31,
2007.
 
 Allowance for loan losses was $13.9
million as of June 30, 2008 compared to $13.6 million as of December 31, 2007,
representing approximately 1.18% and 1.24%, 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”below for further
discussion of the allowance for loan losses.
 - 18
-
 Index
 Total deposits as of March 31, 2008 were
$1.18 billion, an increase of $83.9 million, or 7.6%, from December 31, 2007.
The increase was primarily due to a $38.4 million increase in demand deposit
accounts, and a $75.2 million increase in time deposits, partially offset by a
$29.7 million decrease in money market deposits. Time deposits represented 57.3%
of total deposits at June 30, 2008 compared to 54.9% at December 31,
2007.
 
 Total shareholders’ equity was $165.7
million as of June 30, 2008, an increase of $1.4 million from December 31, 2007.
Retained earnings increased by $2.6 million, reflecting $4.4 million of net
income for the six months ended June 30, 2008 less $1.8 million of dividends
declared during the six months ended June 30, 2008. Accumulated other
comprehensive income (loss), 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, was $(1.6) million and $0.2 million as of June 30,
2008 and December 31, 2007, respectively. The decrease in accumulated other
comprehensive income to a loss position for the six months ended June 30, 2008
was due to a decline in fair value of available-for-sale investment securities,
partially offset by an increase in fair value of the cash flow hedge. See Item
1. Financial Statements – Condensed Consolidated Statements of Changes in
Shareholders’ Equity for additional information.
 
 Results of
Operations
 
 Quarter endedJune 30, 2008compared to quarter endedJune 30, 2007
 
 For the quarter ended June 30, 2008, the
Company reported net income of $2.2 million, or $0.20 per diluted share,
compared to net income of $2.7 million, or $0.23 per diluted share, for the
quarter ended June 30, 2007. Net income decreased by $461 thousand, primarily
due to the $941 thousand increase in the provision for loan losses, partially
offset by a $590 thousand increase in noninterest income.
 
 Net interest income decreased $318
thousand, or 2.8%, from $11.2 million for the quarter ended June 30, 2007 to
$10.9 million for the quarter ended June 30, 2008. Average earning assets
increased $136.7 million to $1.4 billion for the quarter ended June 30, 2008
from $1.3 billion for the quarter ended June 30, 2007. Average interest-bearing
liabilities increased $134.5 million to $1.3 billion for the quarter ended June
30, 2008 from $1.1 billion for the quarter ended June 30, 2007. The net interest
margin on a fully tax equivalent basis decreased by 47 basis points (“bps”) to
3.18% for the quarter ended June 30, 2008 from 3.65% for the quarter ended June
30, 2007. The earned yield on average interest-earning assets was 6.09% and
7.48% for the quarters ended June 30, 2008 and 2007, respectively, while the
interest rate on average interest-bearing liabilities for those periods was
3.24% and 4.30%, respectively.The decline in the net interest margin was
primarily a result of the 3.25% reduction in the prime rate over the last twelve
months andcompetitive pressures
in the Company’s primary marketsfor retail deposits. The majority of
the Company’s loans are prime-based, while the Company’s interest-bearing
deposits are impacted more by competitive rates in the marketplace offered for
time deposits.
 
 The following table shows the Company’s
effective yield on earning assets and cost of funds. Yields and costs are
computed by dividing income or expense for the year by the respective daily
average asset or liability balance.
 - 19
-
 Index
 CAPITAL
BANK CORPORATION
 Average Balances, Interest Earned or
Paid, and Interest Yields/Rates
 For theThreeMonths EndedJune 30, 2008, June 30, 2007and March 31, 2008
 Tax Equivalent Basis(1)
 June
      30, 2008
                              
                              June
      30, 2007
                              
                              March
      31, 2008(Dollars
      in thousands)
                              
                              Average
      Balance
                              
                              Amount
      Earned
                              
                              Average
      Rate
                              
                              Average
      Balance
                              
                              Amount
      Earned
                              
                              Average
      Rate
                              
                              Average
      Balance
                              
                              Amount
      Earned
                              
                              Average
      RateAssetsLoans
      receivable: (2)Commercial
                              
                              $
                              1,010,809
                              
                              $
                              15,713
                              
                              
                              6.23
                              %
                              $
                              861,872
                              
                              $
                              17,359
                              
                              
                              8.08
                              %
                              $
                              986,205
                              
                              $
                              16,777
                              
                              
                              6.82
                              %Consumer
                              
                              
                              46,344
                              
                              
                              869
                              
                              
                              7.53
                              
                              
                              31,300
                              
                              
                              677
                              
                              
                              8.68
                              
                              
                              46,700
                              
                              
                              910
                              
                              
                              7.81Home
      equity
                              
                              
                              80,842
                              
                              
                              1,101
                              
                              
                              5.46
                              
                              
                              81,736
                              
                              
                              1,727
                              
                              
                              8.47
                              
                              
                              79,564
                              
                              
                              1,321
                              
                              
                              6.66Residential
      mortgages
                              
                              
                              28,710
                              
                              
                              427
                              
                              
                              5.95
                              
                              
                              46,609
                              
                              
                              756
                              
                              
                              6.51
                              
                              
                              30,259
                              
                              
                              491
                              
                              
                              6.51Total
      loans
                              
                              
                              1,166,795
                              
                              
                              18,111
                              
                              
                              6.23
                              
                              
                              1,021,517
                              
                              
                              20,519
                              
                              
                              8.06
                              
                              
                              1,142,728
                              
                              
                              19,499
                              
                              
                              6.84Investment
      securities (3)
                              
                              
                              256,406
                              
                              
                              3,555
                              
                              
                              5.55
                              
                              
                              248,850
                              
                              
                              3,282
                              
                              
                              5.29
                              
                              
                              256,538
                              
                              
                              3,590
                              
                              
                              5.61Federal
      funds sold and other interest on short-term investments
                              
                              
                              6,100
                              
                              
                              33
                              
                              
                              2.18
                              
                              
                              22,284
                              
                              
                              290
                              
                              
                              5.22
                              
                              
                              8,079
                              
                              
                              55
                              
                              
                              2.72Total
      interest-earning assets
                              
                              
                              1,429,301
                              
                              $
                              21,699
                              
                              
                              6.09
                              %
                              
                              1,292,651
                              
                              $
                              24,091
                              
                              
                              7.48
                              %
                              
                              1,407,345
                              
                              $
                              23,144
                              
                              
                              6.60
                              %Cash
      and due from banks
                              
                              
                              26,736
                              
                              
                              
                              
                              
                              
                              
                              
                              27,489
                              
                              
                              
                              
                              
                              
                              
                              
                              26,232Other
      assets
                              
                              
                              135,976
                              
                              
                              
                              
                              
                              
                              
                              
                              129,972
                              
                              
                              
                              
                              
                              
                              
                              
                              136,071Allowance
      for loan losses
                              
                              
                              (13,656
                              )
                              
                              
                              
                              
                              
                              
                              
                              (13,528
                              )
                              
                              
                              
                              
                              
                              
                              
                              (13,662
                              )Total
      assets
                              
                              $
                              1,578,357
                              
                              
                              
                              
                              
                              
                              
                              $
                              1,436,584
                              
                              
                              
                              
                              
                              
                              
                              $
                              1,555,986Liabilities
      and EquitySavings
      deposits
                              
                              $
                              30,540
                              
                              $
                              35
                              
                              
                              0.46
                              %
                              $
                              33,664
                              
                              $
                              44
                              
                              
                              0.52
                              %
                              $
                              30,382
                              
                              $
                              46
                              
                              
                              0.61
                              %Interest-bearing
      demand deposits
                              
                              
                              335,851
                              
                              
                              1,635
                              
                              
                              1.95
                              
                              
                              377,274
                              
                              
                              3,264
                              
                              
                              3.47
                              
                              
                              333,108
                              
                              
                              1,855
                              
                              
                              2.23Time
      deposits
                              
                              
                              668,690
                              
                              
                              6,356
                              
                              
                              3.81
                              
                              
                              554,979
                              
                              
                              6,610
                              
                              
                              4.78
                              
                              
                              657,609
                              
                              
                              7,171
                              
                              
                              4.37Total
      interest-bearing deposits
                              
                              
                              1,035,081
                              
                              
                              8,025
                              
                              
                              3.11
                              
                              
                              965,917
                              
                              
                              9,918
                              
                              
                              4.12
                              
                              
                              1,021,099
                              
                              
                              9,072
                              
                              
                              3.56Borrowed
      funds
                              
                              
                              181,841
                              
                              
                              1,820
                              
                              
                              4.01
                              
                              
                              119,978
                              
                              
                              1,570
                              
                              
                              5.25
                              
                              
                              171,645
                              
                              
                              2,022
                              
                              
                              4.73Subordinated
      debt
                              
                              
                              30,930
                              
                              
                              403
                              
                              
                              5.23
                              
                              
                              30,930
                              
                              
                              496
                              
                              
                              6.43
                              
                              
                              30,930
                              
                              
                              526
                              
                              
                              6.82Repurchase
      agreements and fed funds purchased
                              
                              
                              35,183
                              
                              
                              106
                              
                              
                              1.21
                              
                              
                              31,696
                              
                              
                              337
                              
                              
                              4.26
                              
                              
                              35,563
                              
                              
                              189
                              
                              
                              2.13Total
      interest-bearing liabilities
                              
                              
                              1,283,035
                              
                              $
                              10,355
                              
                              
                              3.24
                              %
                              
                              1,148,521
                              
                              $
                              12,321
                              
                              
                              4.30
                              %
                              
                              1,259,237
                              
                              $
                              11,809
                              
                              
                              3.76
                              %Noninterest-bearing
      deposits
                              
                              
                              113,590
                              
                              
                              
                              
                              
                              
                              
                              
                              112,513
                              
                              
                              
                              
                              
                              
                              
                              
                              118,007Other
      liabilities
                              
                              
                              10,787
                              
                              
                              
                              
                              
                              
                              
                              
                              10,673
                              
                              
                              
                              
                              
                              
                              
                              
                              11,132Total
      liabilities
                              
                              
                              1,407,412
                              
                              
                              
                              
                              
                              
                              
                              
                              1,271,707
                              
                              
                              
                              
                              
                              
                              
                              
                              1,388,376Shareholders’
      equity
                              
                              
                              170,945
                              
                              
                              
                              
                              
                              
                              
                              
                              164,877
                              
                              
                              
                              
                              
                              
                              
                              
                              167,610Total
      liabilities and shareholders’ equity
                              
                              $
                              1,578,357
                              
                              
                              
                              
                              
                              
                              
                              $
                              1,436,584
                              
                              
                              
                              
                              
                              
                              
                              $
                              1,555,986Net
      interest spread(4)
                              
                              
                              
                              
                              
                              
                              
                              
                              2.85
                              %
                              
                              
                              
                              
                              
                              
                              
                              3.17
                              %
                              
                              
                              
                              
                              
                              
                              
                              2.83
                              %Tax
      equivalent adjustment
                              
                              
                              
                              
                              $
                              416
                              
                              
                              
                              
                              
                              
                              
                              $
                              524
                              
                              
                              
                              
                              
                              
                              
                              $
                              426Net
      interest income and net interest margin(5)
                              
                              
                              
                              
                              $
                              11,344
                              
                              
                              3.18
                              %
                              
                              
                              
                              $
                              11,778
                              
                              
                              3.65
                              %
                              
                              
                              
                              $
                              11,335
                              
                              
                              3.23
                              %
 (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)
                            Net interest spread represents the
      difference between the average yield on interest-earningassets and the average cost ofinterest-bearing
      liabilities.
 (5)
                            Net interest margin represents net
      interest income divided by average interest-earning
      assets.
  - 20
-
 Index
 Interest income on loans decreased from
$20.5 million for the quarter ended June 30, 2007 to $18.1 million for the
quarter ended June 30, 2008. The decrease is primarily due to lower loan yields,
which decreased from 8.06% in the quarter ended June 30, 2007 to 6.23% in the
quarter ended June 30, 2008, the effect of which was partially offset by higher
average loan balances, which increased by $145.3 million. The declining loan
yields are largely due to the decline in the prime rate from 8.25% as of June
30, 2007 to 5.00% as of June 30, 2008. 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 loan portfolio. This swap increased loan
interest income by 4 bps, or $0.7 million, in the quarter ended June 30, 2008,
whereas for the quarter ended June 30, 2007, the swap decreased loan interest
income by 0.5 bps or $0.1 million.
 
 Interest income on investment securities
increased from $2.8 million for the quarter ended June 30, 2007 to $3.1 million
for the quarter ended June 30, 2008. The increase was primarily due to a $7.6
million increase in average balances outstanding between the periods.Also contributing to the increase in
interest income, theyield
on investment securitieson
a fully tax equivalent basisincreased from5.29% for thequarter ended June 30, 2007to 5.55% for the quarter endedJune 30, 2008.
 
 Interest expense on deposits decreased
from $9.9 million for the quarter ended June 30, 2007 to $8.0 million for the
quarter ended June 30, 2008. The decrease is primarily due to a decrease in
average deposit rates from 4.12% for the quarter ended June 30, 2007 to 3.11%
for the quarter ended June 30, 2008. For time deposits, which represented 64.6%
and 57.5% of total average interest-bearing deposits for the quarters ended June
30, 2008 and 2007, respectively, the average rate decreased from 4.78% for the
quarter ended June 30, 2007 to 3.81% for the quarter ended June 30, 2008,
reflective of the decreasing interest rate environment.
 
 Interest expense on borrowings decreased
from $2.4 million for the quarter ended June 30, 2007 to $2.3 million for the
quarter ended June 30, 2008, primarily due to declines in interest rates, which
were partially offset by a $65.4 million increase in average borrowings.The rate on average
borrowings,includingsubordinateddebt,for the quarter endedJune 30, 2008was3.77%, compared to5.28%for thequarter ended June 30, 2007. 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. The net effect of the swaps
wasa decrease
tointerest expense of
$24 thousandandan increase to interest expense of$125 thousandfor the quarters endedJune 30, 2008and 2007, respectively.
 
 Provision for loan losses was $850
thousand for the quarter ended June 30, 2008 compared to a credit of $91
thousand for the quarter ended June 30, 2007. The increase in the provision was
partially due to loan growth but was also partially due to enhancements in the
methodology for calculating the allowance for loan losses, which reduced the
allowance and related provision during the second quarter of 2007. The
enhancements to the allowance methodology were implemented during 2007 based on
updated guidance issued through an interagency policy statement by the FDIC,
Federal Reserve, and other regulatory agencies.Net charge-offsfor the quarter ended June 30, 2008 were
$503 thousand, or 0.17% of average loans, compared to net charge-offs of $101
thousand, or 0.04% of average loans, for the quarter ended June 30, 2007. In
spite of the increased net charge-offs, loan quality improved by several
metrics. For example, total
nonperforming assets andpast due loans declined from $8.5
million and $13.0million,
respectively,as of June
30, 2007 to $5.9 million and $9.2million, respectively, as ofJune 30,
2008.
 
 Noninterest income increased from $2.4
million for the quarter ended June 30, 2007 to $3.0 million for the quarter
ended June 30, 2008. Service charges and other fees increased $308 thousand,
partially due to an increase in overdraft and non-sufficient fund fees. Mortgage
fees and revenues decreased $214 thousand, which reflects the Company’s decision
to de-emphasize this business line. Brokerage fees and bank card services
increased $95 thousand and $100 thousand, respectively. Bank-owned life
insurance increased $52 thousand, primarily due to higher yields on existing
policies. In the quarter ended June 30, 2008, noninterest income includes a $69
thousand gain on sale of securities. Other noninterest income increased from
$275 thousand for the quarter ended June 30, 2007 to $455 thousand for the
quarter ended June 30, 2008, primarily due to an increased focus on charging
prepayment penalties.
 - 21
-
 Index
 Noninterest expense for the quarter
ended June 30, 2008 was $10.0 million compared to $9.9 million for the quarter
ended June 30, 2007. Salaries and employee benefits, representing the largest
noninterest expense category, increased $128 thousand, primarily due to normal
compensation adjustments. Occupancy, the second largest component of noninterest
expense, remained flat at $1.0 million for the two quarters under comparison.
Furniture and equipment increased $146 thousand, primarily due toequipment and building upgrades as well as higher maintenance costs.Data processing and telecommunications
increased $131 thousand, primarily due to the Company’s implementation of
an internet-based phone system which increased network expenses but reduced
telecommunication costs. Advertising and office expenses
decreased $95 thousand and $71 thousand, respectively, largely due to higher
advertising and promotional costs in 2007 related to new checking products.
Professional fees decreased $141 thousand due to lower legal fees. Business
development and travel
 remained flat at $340 thousand for the
two quarters under comparison. Amortization of deposit premiums acquired during
prior acquisitions continued to decrease as deposit premiums from earlier
acquisitions became fully amortized. Miscellaneous loan handling costs increased
$112 thousand. Directors fees decreased $97 thousand, reflecting a decline in
the market value of stock underlying units allocated to participants in the
Deferred Compensation Plan. Insurance remained relatively flat, increasing $16
thousand, for the two quarters under comparison, but FDIC deposit insurance rose
$104 thousand as the regulatory agency increased premiums to cover higher
monitoring costs and claims. Other
declined $36 thousand over the quarters under comparison.
 
 Income tax expense for the quarters
ended June 30, 2008 and 2007 was $0.9 million and $1.2 million, respectively.
The Company’s effective tax rate declined from 30.7% for the quarter ended June
30, 2007 to 28.2% for the quarter ended June 30, 2008, due primarily to an
increase in the mixture of tax-exempt income compared to net income before tax
expense over the same period.
 Results of
Operations
 
 Six month period ended June 30, 2008
compared to six month periodendedJune 30, 2007
 
 For the six months ended June 30, 2008,
the Company reported net income of $4.4 million, or $0.39 per diluted share,
compared to net income of $5.1 million, or $0.44 per diluted share, for the six
months ended June 30, 2007. Net income decreased by $678 thousand, primarily due
to the $1.2 million increase in the provision for loan losses, partially offset
by a $627 thousand increase in noninterest income.
 
 Net interest income decreased $132
thousand, or 0.6%, from $22.0 million for the six months ended June 30, 2007 to
$21.8 million for the six months ended June 30, 2008. Average earning assets
increased $125.6 million to $1.4 billion for the six months ended June 30, 2008
from $1.3 billion for the six months ended June 30, 2007. Average
interest-bearing liabilities increased $118.4 million to $1.3 billion for the
six months ended June 30, 2008 from $1.2 billion for the six months ended June
30, 2007. The net interest margin on a fully tax equivalent basis decreased by
38 bps to 3.21% for the six months ended June 30, 2008 from 3.59% for the six
months ended June 30, 2007. The earned yield on average interest-earning assets
was 6.34% and 7.45% for the six months ended June 30, 2008 and 2007,
respectively, while the interest rate on average interest-bearing liabilities
for those periods was 3.50% and 4.33%, respectively.The decline in the
net interest margin was primarily a result of the 3.25% reduction in the prime
rate over the last twelve months andcompetitive pressures in the Company’s
primary marketsfor retail
deposits. The majority of the Company’s loans are prime-based, while the
Company’s interest-bearing deposits are impacted more by competitive rates in
the marketplace offered for time deposits.
 
 The following table shows the Company’s
effective yield on earning assets and cost of funds. Yields and costs are
computed by dividing income or expense for the year by the respective daily
average asset or liability balance.
 - 22
-
 Index
 Average Balances, Interest Earned or
Paid, and Interest Yields/Rates
 Six Months Ended June 30, 2008 and
2007
 Tax Equivalent Basis(1)
 
 June 30,
    2008
                              
                              June 30,
    2007(Dollars in thousands)
                              
                              Average
    Balance
                              
                              Amount
    Earned
                              
                              Average
Rate
                              
                              Average
    Balance
                              
                              Amount
    Earned
                              
                              Average
RateAssetsLoans receivable:(2)Commercial
                              
                              $
                              998,552
                              
                              $
                              32,490
                              
                              
                              6.53
                              %
                              $
                              857,000
                              
                              $
                              34,115
                              
                              
                              8.03
                              %Consumer
                              
                              
                              46,522
                              
                              
                              1,779
                              
                              
                              7.67
                              
                              
                              31,061
                              
                              
                              1,329
                              
                              
                              8.63Home equity
                              
                              
                              80,203
                              
                              
                              2,422
                              
                              
                              6.06
                              
                              
                              82,017
                              
                              
                              3,454
                              
                              
                              8.49Residential
      mortgages
                              
                              
                              29,485
                              
                              
                              919
                              
                              
                              6.23
                              
                              
                              46,922
                              
                              
                              1,504
                              
                              
                              6.46Total Loans
                              
                              
                              1,154,762
                              
                              
                              37,610
                              
                              
                              6.53
                              
                              
                              1,017,000
                              
                              
                              40,402
                              
                              
                              8.01Investment securities(3)
                              
                              
                              256,472
                              
                              
                              7,145
                              
                              
                              5.57
                              
                              
                              246,291
                              
                              
                              6,585
                              
                              
                              5.39Federal funds sold and other
      interest on short-term investments
                              
                              
                              7,090
                              
                              
                              88
                              
                              
                              2.49
                              
                              
                              29,440
                              
                              
                              775
                              
                              
                              5.31Total interest-earnings
      assets
                              
                              
                              1,418,323
                              
                              $
                              44,842
                              
                              
                              6.34
                              %
                              
                              1,292,731
                              
                              $
                              47,762
                              
                              
                              7.45
                              %Cash and due from
      banks
                              
                              
                              26,484
                              
                              
                              
                              
                              
                              
                              
                              
                              27,541Other
assets
                              
                              
                              136,024
                              
                              
                              
                              
                              
                              
                              
                              
                              130,049Allowance for loan
      losses
                              
                              
                              (13,659
                              )
                              
                              
                              
                              
                              
                              
                              
                              (13,412
                              )Total
assets
                              
                              $
                              1,567,172
                              
                              
                              
                              
                              
                              
                              
                              $
                              1,436,909Liabilities and
      EquitySavings
      deposits
                              
                              $
                              30,461
                              
                              $
                              81
                              
                              
                              0.53
                              %
                              $
                              34,017
                              
                              $
                              86
                              
                              
                              0.51
                              %Interest-bearing demand
      deposits
                              
                              
                              334,480
                              
                              
                              3,489
                              
                              
                              2.09
                              
                              
                              360,044
                              
                              
                              6,186
                              
                              
                              3.46Time
    deposits
                              
                              
                              663,150
                              
                              
                              13,528
                              
                              
                              4.09
                              
                              
                              577,922
                              
                              
                              13,652
                              
                              
                              4.76Total interest-bearing
      deposits
                              
                              
                              1,028,090
                              
                              
                              17,098
                              
                              
                              3.34
                              
                              
                              971,983
                              
                              
                              19,924
                              
                              
                              4.13Borrowed
    funds
                              
                              
                              176,743
                              
                              
                              3,843
                              
                              
                              4.36
                              
                              
                              116,832
                              
                              
                              3,070
                              
                              
                              5.30Subordinated
      debt
                              
                              
                              30,930
                              
                              
                              929
                              
                              
                              6.02
                              
                              
                              30,930
                              
                              
                              1,085
                              
                              
                              7.07Repurchase agreements and fed
      funds purchased
                              
                              
                              35,373
                              
                              
                              294
                              
                              
                              1.67
                              
                              
                              33,012
                              
                              
                              694
                              
                              
                              4.24Total interest-bearing
      liabilities
                              
                              
                              1,271,136
                              
                              $
                              22,164
                              
                              
                              3.50
                              %
                              
                              1,152,757
                              
                              $
                              24,773
                              
                              
                              4.33
                              %Noninterest-bearing
      deposits
                              
                              
                              115,799
                              
                              
                              
                              
                              
                              
                              
                              
                              109,441Other
      liabilities
                              
                              
                              10,960
                              
                              
                              
                              
                              
                              
                              
                              
                              10,627Total
      liabilities
                              
                              
                              1,397,894
                              
                              
                              
                              
                              
                              
                              
                              
                              1,272,825Shareholders’
      equity
                              
                              
                              169,278
                              
                              
                              
                              
                              
                              
                              
                              
                              164,084Total liabilities and
      shareholders’ equity
                              
                              $
                              1,567,172
                              
                              
                              
                              
                              
                              
                              
                              $
                              1,436,909Net interest spread(4)
                              
                              
                              
                              
                              
                              
                              
                              
                              2.84
                              %
                              
                              
                              
                              
                              
                              
                              
                              3.12
                              %Tax equivalent
      adjustment
                              
                              
                              
                              
                              $
                              841
                              
                              
                              
                              
                              
                              
                              
                              $
                              1,020Net interest income and net
      interest margin(5)
                              
                              
                              
                              
                              $
                              22,679
                              
                              
                              3.21
                              %
                              
                              
                              
                              $
                              22,989
                              
                              
                              3.59
                              %
 
 (1)
                              The tax equivalent basis is
      computed using a blended federal and state tax rate of approximately34%.
 (2)
                              Loans receivable include
      nonaccrual loans for which accrual of interest has not been
      recorded.
 (3)
                              The average balance for investment
      securities excludes the effect of their mark-to-market adjustment, if
      any.
 (4)
                              Net interest spread represents the
      difference between the average yield on interest-earningassets and the average cost ofinterest-bearing
      liabilities.
 (5)
                              Net interest margin represents net
      interest income divided by average interest-earning
      assets.
 - 23
-
 Index
 Interest income on loans decreased from
$40.4 million for the six months ended June 30, 2007 to $37.6 million for the
six months ended June 30, 2008. The decrease is primarily due to lower loan
yields, which decreased from 8.01% in the six months ended June 30, 2007 to
6.53% in the six months ended June 30, 2008, the effect of which was partially
offset by higher average loan balances, which increased by $137.8 million. The
declining loan yields are largely due to the decline in the prime rate from
8.25% as of June 30, 2007 to 5.00% as of June 30, 2008. 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 loan portfolio. This
swap increased loan interest income by 3 bps, or $1.0 million, in the six months
ended June 30, 2008, whereas for the six months ended June 30, 2007, the swap
decreased loan interest income by 0.6 bps, or $250 thousand.
 
 Interest income on investment securities
increased from $5.6 million for the six months ended June 30, 2007 to $6.3
million for the six months ended June 30, 2008. The increase was primarily due
to a $10.2 million increase in average balances outstanding between the
periods.Also contributing to the increase in
interest income, theyield
on investment securitieson
a fully tax equivalent basisincreased from5.39% for thesix months ended June 30,
2007to 5.57% for thesix monthsendedJune 30, 2008.
 
 Interest expense on deposits decreased
from $19.9 million for the six months ended June 30, 2007 to $17.1 million for
the six months ended June 30, 2008. The decrease is primarily due to decrease in
average deposit rates from 4.13% for the six months ended June 30, 2007 to 3.34%
for the six months ended June 30, 2008. For time deposits, which represented
64.5% and 59.5% of total average interest-bearing deposits for the six months
ended June 30, 2008 and 2007, respectively, the average rate decreased from
4.76% for the six months ended June 30, 2007 to 4.09% for the six months ended
June 30, 2008, reflecting the declining interest rate
environment.
 
 Interest expense on borrowings increased
from $4.8 million for the six months ended June 30, 2007 to $5.1 million for the
six months ended June 30, 2008, primarily due to a $62.3 million increase in
average borrowings, which was partially offset by a decline in the rate on
average borrowings over the same period.The rate on average
borrowings,includingsubordinateddebt,for thesix monthsendedJune 30, 2008was4.18%compared to5.41%for thesix months ended June 30,
2007. 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. The net effect of the swaps
wasan increase
tointerest expense of
$19 thousandand $250 thousandfor thesix monthsendedJune 30, 2008and 2007, respectively.
 
 Provision for loan losses was $1.4
million for the six months ended June 30, 2008 compared to $246 thousand for the
six months ended June 30, 2007. The increase in the provision was partially due
to loan growth but was also partially due to enhancements in the methodology for
calculating the allowance for loan losses, which reduced the allowance and
related provision during the second quarter of 2007. The enhancements to the
allowance methodology were implemented during 2007 based on updated guidance
issued through an interagency policy statement by the FDIC, Federal Reserve, and
other regulatory agencies.Net charge-offsfor the six months ended June 30, 2008
were $1.1 million, or 0.19% of average loans, compared to net charge-offs of
$254 thousand, or 0.05% of average loans, for the six months ended June 30,
2007. In spite of increased net charge-offs, loan quality improved by several
metrics. For example, total
nonperforming assets andpast due loans declined from $8.5
million and $13.0million,
respectively,as of June
30, 2007 to $5.9 million and $9.2million, respectively, as ofJune 30,
2008.
 
 Noninterest income increased from $4.6
million for the six months ended June 30, 2007 to $5.2 million for the six
months ended June 30, 2008. Service charges and other fees increased $390
thousand, partially due to an increase in overdraft and non-sufficient fund
fees. Mortgage fees and revenues decreased $470 thousand, which reflects the
Company’s decision to de-emphasize this business line. Brokerage fees and bank
card services increased $148 thousand and $183 thousand, respectively.
Bank-owned life insurance increased $157 thousand, primarily due to higher
yields on existing policies. In the quarter ended June 30, 2008, noninterest
income includes a $140 thousand gain on sale of securities. Other noninterest
income increased $79 thousand, primarily due to an increased focus on charging
prepayment penalties.
 
 Noninterest expense increased from $19.1
million for the six months ended June 30, 2007 to $19.6 million for the six
months ended June 30, 2008. Salaries and employee benefits, representing the
largest noninterest expense category, increased $122 thousand, primarily due to
normal compensation adjustments. Occupancy, the second largest component of
noninterest expense, remained flat at $2.0 million for the two periods under
comparison. Furniture and equipment increased $278 thousand, primarily due toequipment and building upgrades as well as higher maintenance costs.Data processing and telecommunications
increased $175 thousand, primarily due to the Company’s implementation of
an internet-based phone system which increased network expenses but reduced
telecommunication costs. Advertising and office expenses
decreased $78 thousand and $39 thousand, respectively, largely due to higher
advertising and promotional costs in 2007 related to new checking products.
Professional fees increased $46 thousand due to higher recruitment fees.
Business development and travel
  - 24
-
 Index
 remained relatively flat, increasing $16
thousand. Amortization of deposit premiums acquired during prior acquisitions
continued to decrease as deposit premiums from earlier acquisitions became fully
amortized. Miscellaneous loan handling costs increased $20 thousand. Directors
fees decreased $98 thousand, reflecting a decline in the market value of stock
underlying units allocated to participants in the Deferred Compensation Plan.
Insurance remained relatively flat, increasing $21 thousand, but FDIC deposit
insurance rose $101 thousandas the regulatory agency increased premiums
to cover higher monitoring costs and claims. Other increased $39 thousand over the
periods under comparison.
 
 Income tax expense for the six months
ended June 30, 2008 and 2007 was $1.7 million and $2.1 million, respectively.
The Company’s effective tax rate declined from 29.8% for the six months ended
June 30, 2007 to 27.6% for the six months ended June 30, 2008, due primarily to
an increase in the mixture of tax-exempt income compared to net income before
tax expense over the same period.
 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. This officer reports directly to the Chief Credit Officer and the Audit
Committee of the Company’s Board of Directors.
 
 The Company estimates the amount of
allowance needed to cover losses inherent in the portfolio 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. In addition to this
quantitative analysis, a qualitative assessment of the general economic trends,
portfolio concentration and the trend of delinquencies are taken into
consideration. The loan loss allowance is adjusted to an amount that management
believes is adequate to absorb losses inherent in the loan portfolio as of the
balance sheet date presented.
 
 The Company provides a specific
allowance for loan losses associated with certain commercial loans rated special
mention and/or classified with outstanding balances greater than $750 thousand,
including all related loans, as well as all loans management has identified as
impaired. Management determines the level of specific allowance based on the
facts and circumstances of each loan, including among other factors, payment
history, collateral values, guarantor liquidity, and net worth. Of the $13.9
million allowance for loan losses as of June 30, 2008, $3.5 million has been
allocated to specific loans, including loans considered to be impaired. As of
June 30, 2008 and December 31, 2007, there were $2.2 million and $2.7 million,
respectively, of specific impaired loans with balances greater than $750
thousand. As of June 30, 2008 and December 31, 2007, there were $2.2 million and
$1.7 million, respectively, of impaired loans with balances less than $750
thousand. As of June 30, 2008 and December 31, 2007, $0.4 million and $0.2
million, respectively, are included in the allowance for loan losses for
impaired loans less than $750 thousand. At June 30, 2008 and December 31, 2007,
there were no impaired loans that did not have an allowance for loan
losses.
 
 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. The Company uses
several factors in determining if a loan is impaired. Internal asset
classification procedures include a review of significant loans and lending
relationships by management. The loan reviews include the accumulation of
related data on loan payment status, borrowers’ financial data and borrowers’
operating factors such as cash flows, operating income or loss. 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. Impaired loans at June 30, 2008 include $1.2 million relatedto a developer who has been accused by the North Carolina Attorney
General of engaging in fraudulent marketing and financing practices in Western
North Carolina. The Company has established a specific loan loss allocation of
$1.0 million for this exposure, which management believes is
adequate.
 - 25
-
 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
collectibility of the principal is unlikely. Based on this allowance
calculation, management recorded a provision of $850 thousand for the quarter
ended June 30, 2008 compared to a credit for the quarter ended June 30, 2007 of
$91 thousand, and management recorded a provision of $1.4 million for the six
months ended June 30, 2008 compared to $246 thousand for the six months ended
June 30, 2007. The increase in the provision was partially due to loan
growth but was also partially due to enhancements in the methodology for
calculating the allowance for loan losses, which reduced the allowance and
related provision during the second quarter of 2007. The enhancements to the
allowance methodology were implemented during 2007 based on updated guidance
issued through an interagency policy statement by the FDIC, Federal Reserve, and
other regulatory agencies. Among other refinements, the enhanced methodologyutilizes a greater dispersion of risk rating classifications based on the
collateral backing of the loans.
 
 Past due loans as a percentage oftotalloans decreased from 0.98% at December 31, 2007 to
0.78% at June 30, 2008.Nonperforming loans, which
includes all loans past due
greater than 90 daysor in
nonaccrual status,as a
percentage of total loans
declined from 0.55% at December 31, 2007 to 0.44%atJune 30, 2008. Nonperforming assets as a percentage
of total assetsdeclined
from 0.50% at December 31, 2007 to 0.37% at June 30, 2008.Management believes the allowance for
loan losses as ofJune 30,
2008is adequate toabsorb the inherent losses on existing loans that may become
uncollectible, based on evaluations of the collectibility of loans and prior
loan loss experience.
 
 At June 30, 2008, nonperforming loans
were $5.2 million, a decrease of $0.8 million from December 31, 2007. The
majority of the Company’s nonperforming loans are secured by real estate, and to
a lesser extent, the Company relies on the support of guarantors. The Company
monitors the value of the underlying collateral and the liquidity of the
guarantors on a periodic basis.Based on this review and analysis, the
Company does not currently anticipate any material losses associatedwith the nonperforming loans as
ofJune 30, 2008.Nonperforming loans as of June 30, 2008
do not include outstanding loans and loan commitments extended to a residential
builder in Central North Carolina due to a deferred payment plan. Outstanding
principal and unused commitment related to this lending relationship were $650
thousand and $64 thousand, respectively, as of June 30,
2008.
 
 The following table presents an analysis
of changes in the allowance for loan losses for the three and six month periods
endedJune 30, 2008 and
2007, respectively.
 Three Months Ended June
      30,
                                  
                                  Six Months Ended June
      30,(Dollars in
      thousands)
                                  
                                  2008
                                  
                                  2007
                                  
                                  2008
                                  
                                  2007Allowance for loan losses,
      beginning of period
                                  
                                  $
                                  13,563
                                  
                                  $
                                  13,531
                                  
                                  $
                                  13,571
                                  
                                  $
                                  13,347Net
      charge-offs:Loans charged
      off:Commercial
                                  
                                  
                                  408
                                  
                                  
                                  94
                                  
                                  
                                  554
                                  
                                  
                                  165Construction
                                  
                                  
                                  47
                                  
                                  
                                  –
                                  
                                  
                                  104
                                  
                                  
                                  –Consumer
                                  
                                  
                                  137
                                  
                                  
                                  59
                                  
                                  
                                  730
                                  
                                  
                                  109Home equity
                                  
                                  
                                  90
                                  
                                  
                                  –
                                  
                                  
                                  90
                                  
                                  
                                  25Residential
      mortgages
                                  
                                  
                                  –
                                  
                                  
                                  36
                                  
                                  
                                  –
                                  
                                  
                                  53Total
      charge-offs
                                  
                                  
                                  682
                                  
                                  
                                  189
                                  
                                  
                                  1,478
                                  
                                  
                                  352Recoveries of loans previously
      charged off:Commercial
                                  
                                  
                                  136
                                  
                                  
                                  35
                                  
                                  
                                  323
                                  
                                  
                                  35Construction
                                  
                                  
                                  –
                                  
                                  
                                  –
                                  
                                  
                                  –
                                  
                                  
                                  –Consumer
                                  
                                  
                                  42
                                  
                                  
                                  51
                                  
                                  
                                  76
                                  
                                  
                                  59Home equity
                                  
                                  
                                  –
                                  
                                  
                                  2
                                  
                                  
                                  1
                                  
                                  
                                  4Residential
      mortgages
                                  
                                  
                                  1
                                  
                                  
                                  –
                                  
                                  
                                  2
                                  
                                  
                                  –Total
      recoveries
                                  
                                  
                                  179
                                  
                                  
                                  88
                                  
                                  
                                  402
                                  
                                  
                                  98Total net
      charge-offs
                                  
                                  
                                  503
                                  
                                  
                                  101
                                  
                                  
                                  1,076
                                  
                                  
                                  254Loss (credit) provision charged to
      operations
                                  
                                  
                                  850
                                  
                                  
                                  (91
                                  )
                                  
                                  1,415
                                  
                                  
                                  246Allowance for loan losses, end of
      period
                                  
                                  $
                                  13,910
                                  
                                  $
                                  13,339
                                  
                                  $
                                  13,910
                                  
                                  $
                                  13,339Net charge-offs to average loans
      during the period (annualized)
                                  
                                  
                                  0.17
                                  %
                                  
                                  0.04
                                  %
                                  
                                  0.19
                                  %
                                  
                                  0.05
                                  %Allowance as a percent of gross
      loans
                                  
                                  
                                  1.18
                                  %
                                  
                                  1.31
                                  %
                                  
                                  1.18
                                  %
                                  
                                  1.31
                                  %
 - 26
-
 Index
 The Company’s determination of the
allowance for loan losses is subject to management’s judgment and analysis of
many internal and external factors. While management is comfortable with the
adequacy of the current allowance for loan losses, it is possible that these
factors and management’s evaluation of the adequacy of the allowance for loan
losses will change.
 
 The following table presents an analysis
of nonperforming assets as of June 30, 2008 and December 31,
2007.
 
 June 30,
    2008
                                  
                                  December 31,
      2007(Dollars in
      thousands)
                                  
                                  (Unaudited)Nonperforming
      loans:Commercial
                                  
                                  $
                                  3,650
                                  
                                  $
                                  4,489Construction
                                  
                                  
                                  418
                                  
                                  
                                  562Consumer
                                  
                                  
                                  42
                                  
                                  
                                  28Home equity
                                  
                                  
                                  515
                                  
                                  
                                  397Residential
      mortgages
                                  
                                  
                                  582
                                  
                                  
                                  506Total nonperforming
      loans
                                  
                                  
                                  5,207
                                  
                                  
                                  5,982Foreclosed property
      held
                                  
                                  
                                  663
                                  
                                  
                                  1,571Total nonperforming
      assets
                                  
                                  $
                                  5,870
                                  
                                  $
                                  7,553Nonperforming loans to total
      loans
                                  
                                  
                                  0.44
                                  %
                                  
                                  0.55
                                  %Nonperforming assets to total
      assets
                                  
                                  
                                  0.37
                                  %
                                  
                                  0.50
                                  %Allowance coverage of
      nonperforming loans
                                  
                                  
                                  267
                                  %
                                  
                                  227
                                  %
 
 Foreclosed property decreased to
$663thousand at June 30, 2008 from $1.6
million at December 31, 2007. The decrease was primarily due to the disposition
of certain foreclosed commercial and residential properties. The Company is
actively marketing all of its foreclosed property. All foreclosed assets are
recorded at the lower of cost or net realizable fair value.
 
 Liquidity and Capital
Resources
 
 The Company’s liquidity management
involves planning to meet the Company’s anticipated funding needs at a
reasonable cost. Liquidity management is guided by policies formulated by the
Company’s senior management and the Asset and Liability Committee of the Bank’s
Board of Directors. The Company had $42.7million in its most liquid assets, cash
and cash equivalents as of June 30, 2008. The Company’s principal sources of
funds are loan repayments, deposits, Federal Home Loan Bank borrowings, 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 capital, which
totaled$1.1billionand $1.0 billionat June 30, 2008 and December 31,
2007,respectively,funded68.5% of total assets at June 30, 2008
compared to 67.9% at December 31, 2007. In addition, the Company has the ability
to take advantage of various otherfunding programs available from the
Federal Home Loan Bank of Atlanta, as well as access to funding through various
brokered deposit programs, federal funds lines and security repurchase
agreements.
 
 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.
 
 On
January 24, 2008, the Company’s Board of Directors authorized the repurchase of
up to 1.0 million shares of the Company’s currently outstanding shares of common
stock, and all previous authorizations for the repurchase of the Company’s
currently outstanding shares of common stock were superseded and revoked. During the quarter ended June 30, 2008,
the Company repurchased 8,000 shares at a weighted average price of $9.00 per
share. See Part II – Other Information, Item 2. Unregistered Sales of Equity
Securities and Use of Proceeds for more information on the Company’s share
repurchases.
  - 27
-
 Index
 To be categorized as well capitalized,
the Company and the Bank each must maintain minimum amounts and ratios. The
Company’s and the Bank’s actual capital amounts and ratios as of June 30, 2008
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 CorporationTotal
      capital (to risk-weighted assets)
                                  
                                  $
                                  148,549
                                  
                                  
                                  10.88
                                  %
                                  $
                                  136,930
                                  
                                  
                                  10.00
                                  %Tier
      I capital (to risk-weighted assets)
                                  
                                  
                                  134,345
                                  
                                  
                                  9.85
                                  
                                  
                                  82,158
                                  
                                  
                                  6.00Tier
      I capital (to average assets)
                                  
                                  
                                  134,345
                                  
                                  
                                  8.91
                                  
                                  
                                  75,619
                                  
                                  
                                  5.00Capital
      BankTotal
      capital (to risk-weighted assets)
                                  
                                  $
                                  144,695
                                  
                                  
                                  10.59
                                  %
                                  $
                                  136,601
                                  
                                  
                                  10.00
                                  %Tier
      I capital (to risk-weighted assets)
                                  
                                  
                                  130,492
                                  
                                  
                                  9.55
                                  
                                  
                                  81,961
                                  
                                  
                                  6.00Tier
      I capital (to average assets)
                                  
                                  
                                  130,492
                                  
                                  
                                  8.63
                                  
                                  
                                  71,292
                                  
                                  
                                  5.00
 
 Shareholders’ equity was $165.7million, or $14.76per share, at June 30, 2008. Management
believes this level ofshareholders’ equity provides adequate capital to support the Company’s growth
and to maintain a well capitalized position.
 
 The
Company maintains the Capital Bank 401(k) Retirement Plan for the benefit of its
employees, through which participants can elect to purchase Company common stock
at market prices. In prior years, the Company had registered 50,000 shares of
its common stock with the SEC to be available for issuance under the Plan. The
Company recently determined that it may have inadvertently failed to register
with the SEC the issuance of shares under the Plan in excess of the number
previously registered. As a result, certain purchasers of common stock pursuant
to the Plan may have the right to rescind their purchases for an amount equal to the purchase
price paid for the shares, plus interest from the date of purchase. As of June
30, 2008 and December 31, 2007, the Company had common shares subject to
potential rescission rights that are considered redeemable common stock, because
the redemption features are not within the control of the Company. These shares
have always been treated as outstanding for financial reporting
purposes.
 
 Item 3.Quantitative and
Qualitative Disclosures about Market Risk
 
 As described in more detail in our
Annual Report on Form 10-K for the year ended December 31, 2007, 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, 2007 to June 30,
2008.
 
 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.
 - 28
-
 Index
 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. 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.
 
 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.
 
 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.
 - 29
-
 Index
 Any of the latter three scenarios could
require us to charge-off 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 “Assets” section in Item 7. Management’s
Discussion and Analysis of Financial Condition and Results of Operationsabove.
 
 Because the majority of our borrowers
are individuals and businesses located and doing business in Wake, Granville,
Lee, Chatham, Alamance, Guilford, 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
experiencedvolatilityassociated 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 manyother 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 netincome 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.Further declines in home prices coupled
with an economic recession and associated 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.As of December 31, 2007, approximately
13.4% of our total loans were secured by real estate.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.
 
 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.
 
 Weare 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 accordancewith 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
 
 - 30
-
 Index
 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 paceof 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.
 
 Ourtrading volume has been low compared
with larger banks.
 
 The trading volume in the
Company’s common stock on the NASDAQGlobal SelectMarket has been comparable
to other similarly-sized
banks.Nevertheless, this
trading is relatively low when compared with more seasoned companies listed on
the NASDAQGlobal
SelectMarket 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.
 
 Wedepend 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.
 
 Technologicaladvances 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 financialinstitutions 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 investin 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.
 
 Governmentregulations 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:
 
 - 31
-
 Index
 •
                                  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.
 
 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
SECmay adversely affect our ability to
operate profitably.
 
 Thereare 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 andother 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 inintegrating 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
suchacquisitions.Any given acquisition, if
and when consummated, may adversely affect our results of operationsor 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.
 
 Compliancewith 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 ofmanagement 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, ourCEO, ourCFOand 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.
 - 32
-
 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.
 - 33
-
 Index
 Consumers
may decide not to use banks to complete their financial
transactions.
 
 Technology
and other changes are allowing parties to complete financial transactions that
historically have involved banks through alternative methods. For example,
consumers can now maintain funds in brokerage accounts or mutual funds that
would have historically been held as bank deposits. Consumers can also complete
transactions such as paying bills and/or transferring funds directly without the
assistance of banks. The process of eliminating banks as intermediaries could
result in the loss of fee income, as well as the loss of customer deposits and
the related income generated from those deposits. The loss of these revenue
streams and the lower cost deposits as a source of funds could have a material
adverse effect on our financial condition and results of
operations.
 
 Item 2.Unregistered Sales of
Equity Securities and Use of Proceeds
 
 The following table lists all
repurchases (both open market and private transactions) during the three months
ended June 30, 2008 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.
 
 Issuer Purchases of Equity
Securities
 
 Month
                                  
                                  Total
      Number
                                    of
      Shares Purchased
                                  
                                  Average
      Price
                                    Paid
      per Share
                                  
                                  Total
      Number of Shares Purchased as Part of Publicly AnnouncedPlans or
      Programs (1)
                                  
                                  Maximum
      Number of Shares that May Yet Be Purchased under the Plans or
      ProgramsApril
      1, 2008 – April 30, 2008
                                  
                                  
                                  –
                                  
                                  $
                                  –
                                  
                                  
                                  –
                                  
                                  
                                  999,900May
      1, 2008 – May 31, 2008
                                  
                                  
                                  –
                                  
                                  
                                  –
                                  
                                  
                                  –
                                  
                                  
                                  999,900June
      1, 2008 – June 30, 2008
                                  
                                  
                                  8,000
                                  
                                  
                                  9.00
                                  
                                  
                                  8,000
                                  
                                  
                                  991,900
 
 (1)
                                  On January 24, 2008, the Company’s
      Board of Directors authorized the repurchase of up to 1.0 million shares
      of the Company’s currently outstanding shares of common stock (in the open
      market or in any private transaction). There is no expiration date for the
      repurchase program. As of June 30, 2008, there were an aggregate of
      991,900 shares remaining authorized for future
      repurchases.
 
 Item 3.Defaults upon Senior
Securities
 
 None
 
 Item 4.Submission of Matters
to a Vote of Security Holders
 
 None
 
 Item 5.Other
Information
 
 None
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 Index
 Item 6.Exhibits
 Exhibit No.
                                    
                                    DescriptionExhibit 4.1
                                    
                                    In accordance with Item
      601(b)(4)(iii)(A) of Regulation S-K, certain instruments respecting
      long-term debt of the registrant have been omitted but will be furnished
      to the Commission upon request.Exhibit
31.1
                                    
                                    Certification of B. Grant Yarber
      pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section
      302 of the Sarbanes-Oxley Act of 2002Exhibit
31.2
                                    
                                    Certification of Michael R. Moore
      pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section
      302 of the Sarbanes-Oxley Act of 2002Exhibit
32.1
                                    
                                    Certification of B. Grant Yarber
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002 [This exhibit is being furnished pursuant
      to Section 906 of the Sarbanes- Oxley Act of 2002 and shall not, except to
      the extent required by that Act, be deemed to be incorporated by reference
      into any document or filed herewith for purposes of liability under the
      Securities Exchange Act of 1934, as amended, or the Securities Act of
      1933, as amended, as the case may be.]Exhibit
32.2
                                    
                                    Certification of Michael R. Moore
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002 [This exhibit is being furnished pursuant
      to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to
      the extent required by that Act, be deemed to be incorporated by reference
      into any document or filed herewith for purposes of liability under the
      Securities Exchange Act of 1934, as amended, or the Securities Act of
      1933, as amended, as the case may
be.]
  - 35
-
 Index
 Signatures
 
 Pursuant to the requirements of the
Securities Exchange Act of 1934, the registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized, in
Raleigh, North Carolina, on the 8th day of August 2008.
  CAPITAL BANK
      CORPORATIONBy:  /s/Michael R.
      MooreMichael R.
      MooreChief Financial
      Officer(Authorized Officer and Principal
      Financial Officer)
 
  - 36
-
 Index
 EXHIBIT INDEX
 
 Exhibit No.
                                    
                                    DescriptionExhibit 4.1
                                    
                                    In accordance with Item
      601(b)(4)(iii)(A) of Regulation S-K, certain instruments respecting
      long-term debt of the registrant have been omitted but will be furnished
      to the Commission upon request.Exhibit
31.1
                                    
                                    Certification of B. Grant Yarber
      pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section
      302 of the Sarbanes-Oxley Act of 2002Exhibit
31.2
                                    
                                    Certification of Michael R. Moore
      pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section
      302 of the Sarbanes-Oxley Act of 2002Exhibit
32.1
                                    
                                    Certification of B. Grant Yarber
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002 [This exhibit is being furnished pursuant
      to Section 906 of the Sarbanes- Oxley Act of 2002 and shall not, except to
      the extent required by that Act, be deemed to be incorporated by reference
      into any document or filed herewith for purposes of liability under the
      Securities Exchange Act of 1934, as amended, or the Securities Act of
      1933, as amended, as the case may be.]Exhibit
32.2
                                    
                                    Certification of Michael R. Moore
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002 [This exhibit is being furnished pursuant
      to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to
      the extent required by that Act, be deemed to be incorporated by reference
      into any document or filed herewith for purposes of liability under the
      Securities Exchange Act of 1934, as amended, or the Securities Act of
      1933, as amended, as the case may
be.]


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