**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**FORM
      10-Q**





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


OF
      THE
      SECURITIES EXCHANGE ACT OF 1934




**For
      the Quarterly Period Ended September 30, 2007**


or


 ̈
      TRANSITION REPORT
      PURSUANT TO SECTION 13 OR 15(d)


OF
      THE
      SECURITIES EXCHANGE ACT OF 1934





For
      the
      Transition Period from
 to










**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, or a non-accelerated filer. See definition of “accelerated
      filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.(Check
      one):





Large
                accelerated filer  ̈
            Accelerated
                filer þ
            Non-accelerated
                filer  ̈





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





As
      of
      November 6, 2007 there were 11,228,204 shares outstanding of the registrant’s
      common stock, no par value.





**CAPITAL
      BANK CORPORATION**


**Form
      10-Q for the Quarterly Period Ended September 30, 2007**








**INDEX**





**PART
                I – FINANCIAL INFORMATION**
            Page
                No.Item
                1.
            Financial
                StatementsCondensed
                Consolidated Balance Sheets as of September 30, 2007 (Unaudited)
                andDecember
                31, 2006
            3Condensed
                Consolidated Statements of Operations for the Three and Nine Months
                Ended
                September 30, 2007 and 2006 (Unaudited)
            4Condensed
                Consolidated Statements of Changes in Shareholders’ Equity for the Nine
                Months Ended September 30, 2007 and 2006 (Unaudited)
            5Condensed
                Consolidated Statements of Cash Flows for the Nine Months Ended September
                30, 2007 and 2006 (Unaudited)
            6Notes
                to Condensed Consolidated Financial Statements (Unaudited)
            8Item
                2.
            Management’s
                Discussion and Analysis of Financial Condition and Results of
                Operations
            12Item
                3.
            Quantitative
                and Qualitative Disclosures about Market Risk
            24Item
                4.
            Controls
                and Procedures
            24**PART
                II – OTHER INFORMATION**Item
                1.
            Legal
                Proceedings
            24Item
                1A.
            Risk
                Factors
            24Item
                2.
            Unregistered
                Sales of Equity Securities and Use of Proceeds
            28Item
                3.
            Defaults
                upon Senior Securities
            28Item
                4.
            Submission
                of Matters to a Vote of Security Holders
            28Item
                5.
            Other
                Information
            28Item
                6.
            Exhibits
            29Signatures


-
            2
            -
 Index


**PART
        I – FINANCIAL INFORMATION**





**Item
      1.  Financial Statements**





**CAPITAL
      BANK CORPORATION**


**CONDENSED
      CONSOLIDATED BALANCE SHEETS**


**September
      30, 2007 and December 31, 2006**





September
                30, 2007
            
            
            December
                31, 2006*(Dollars
                in thousands except share data)*
            
            *(Unaudited)***ASSETS**Cash
                and due from banks:Interest
                earning
            
            $
            3,749
            
            
            $
            12,348Noninterest
                earning
            
            
            32,627
            
            
            
            33,504Federal
                funds sold and short term investments
            
            
            11,946
            
            
            
            8,480Investment
                securities – available for sale, at fair value
            
            
            238,942
            
            
            
            228,214Investment
                securities – held to maturity, at amortized cost
            
            
            10,141
            
            
            
            10,833Loans
                – net of unearned income and deferred fees
            
            
            1,070,656
            
            
            
            1,008,052Allowance
                for loan losses
            
            
            (13,366
            )
            
            
            (13,347
            )Net
                loans
            
            
            1,057,290
            
            
            
            994,705Premises
                and equipment, net
            
            
            24,142
            
            
            
            23,125Bank-owned
                life insurance
            
            
            21,353
            
            
            
            20,662Deposit
                premium and goodwill, net
            
            
            63,643
            
            
            
            64,543Other
                assets
            
            
            26,411
            
            
            
            25,970**Total
                assets**
            
            $
            1,490,244
            
            
            $
            1,422,384**LIABILITIES**Deposits:Demand,
                noninterest bearing
            
            $
            123,831
            
            
            $
            120,945Savings
                and interest-bearing demand deposits
            
            
            392,796
            
            
            
            366,243Time
                deposits
            
            
            573,962
            
            
            
            568,021Total
                deposits
            
            
            1,090,589
            
            
            
            1,055,209Repurchase
                agreements and federal funds purchased
            
            
            34,778
            
            
            
            34,238Borrowings
            
            
            155,969
            
            
            
            125,924Subordinated
                debentures
            
            
            30,930
            
            
            
            30,930Other
                liabilities
            
            
            13,889
            
            
            
            14,402**Total
                liabilities**
            
            
            1,326,155
            
            
            
            1,260,703**SHAREHOLDERS’
                EQUITY**Common
                stock, no par value; 20,000,000 authorized; 11,252,334 and 11,393,990
                issued and outstanding as of September 30, 2007 and December 31,
                2006,
                respectively
            
            
            137,241
            
            
            
            139,484Retained
                earnings
            
            
            28,833
            
            
            
            23,754Accumulated
                other comprehensive loss
            
            
            (1,985
            )
            
            
            (1,557
            )**Total
                shareholders’ equity**
            
            
            164,089
            
            
            
            161,681**Total
                liabilities and shareholders’ equity**
            
            $
            1,490,244
            
            
            $
            1,422,384





*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 Nine Months Ended September 30, 2007 and 2006
      (Unaudited)**





Three
                Months Ended
              September
                30,
            
            
            Nine
                Months Ended
              September
                30,*(Dollars
                in thousands except share and per share data)*
            
            2007
            
            
            2006
            
            
            2007
            
            
            2006Interest
                income:Loans
                and loan fees
            
            $
            20,830
            
            
            $
            19,982
            
            
            $
            61,231
            
            
            $
            55,646Investment
                securities
            
            
            2,918
            
            
            
            2,223
            
            
            
            8,583
            
            
            
            6,488Federal
                funds and other interest income
            
            
            107
            
            
            
            463
            
            
            
            883
            
            
            
            1,313Total
                interest income
            
            
            23,855
            
            
            
            22,668
            
            
            
            70,697
            
            
            
            63,447Interest
                expense:Deposits
            
            
            9,847
            
            
            
            8,677
            
            
            
            29,771
            
            
            
            22,115Borrowings
                and repurchase agreements
            
            
            2,823
            
            
            
            2,398
            
            
            
            7,764
            
            
            
            6,741Total
                interest expense
            
            
            12,670
            
            
            
            11,075
            
            
            
            37,535
            
            
            
            28,856Net
                interest income
            
            
            11,185
            
            
            
            11,593
            
            
            
            33,162
            
            
            
            34,591Provision
                (credit)  for loan losses
            
            
            261
            
            
            
            (215
            )
            
            
            507
            
            
            
            446Net
                interest income after provision (credit) for loan
                losses
            
            
            10,924
            
            
            
            11,808
            
            
            
            32,655
            
            
            
            34,145Noninterest
                income:Service
                charges and other fees
            
            
            1,021
            
            
            
            895
            
            
            
            2,947
            
            
            
            2,921Mortgage
                fees and revenues
            
            
            561
            
            
            
            507
            
            
            
            1,682
            
            
            
            1,525Net
                gain on sale of securities
            
            
            –
            
            
            
            128
            
            
            
            –
            
            
            
            128Other
                noninterest income
            
            
            651
            
            
            
            728
            
            
            
            2,101
            
            
            
            2,311Total
                noninterest income
            
            
            2,233
            
            
            
            2,258
            
            
            
            6,730
            
            
            
            6,885Noninterest
                expense:Salaries
                and employee benefits
            
            
            4,890
            
            
            
            4,287
            
            
            
            15,298
            
            
            
            13,680Occupancy
            
            
            1,058
            
            
            
            1,044
            
            
            
            3,029
            
            
            
            2,760Furniture
                and equipment
            
            
            664
            
            
            
            675
            
            
            
            1,926
            
            
            
            1,729Director
                fees
            
            
            72
            
            
            
            369
            
            
            
            569
            
            
            
            1,028Data
                processing
            
            
            350
            
            
            
            214
            
            
            
            972
            
            
            
            814Advertising
            
            
            272
            
            
            
            234
            
            
            
            771
            
            
            
            813Amortization
                of deposit premiums
            
            
            300
            
            
            
            342
            
            
            
            900
            
            
            
            1,028Professional
                fees
            
            
            369
            
            
            
            290
            
            
            
            956
            
            
            
            856Other
                expenses
            
            
            1,324
            
            
            
            1,614
            
            
            
            3,902
            
            
            
            4,516Total
                noninterest expense
            
            
            9,299
            
            
            
            9,069
            
            
            
            28,323
            
            
            
            27,244Net
                income before tax expense
            
            
            3,858
            
            
            
            4,997
            
            
            
            11,062
            
            
            
            13,806Income
                tax expense
            
            
            1,105
            
            
            
            1,730
            
            
            
            3,249
            
            
            
            4,725Net
                income
            
            $
            2,753
            
            
            $
            3,267
            
            
            $
            7,813
            
            
            $
            9,081Earnings
                per share – basic
            
            $
            0.24
            
            
            $
            0.28
            
            
            $
            0.68
            
            
            $
            0.78Earnings
                per share – diluted
            
            $
            0.24
            
            
            $
            0.28
            
            
            $
            0.68
            
            
            $
            0.78Weighted
                average shares:Basic
            
            
            11,451,322
            
            
            
            11,611,476
            
            
            
            11,482,352
            
            
            
            11,622,442Fully
                diluted
            
            
            11,510,127
            
            
            
            11,694,498
            
            
            
            11,551,677
            
            
            
            11,708,446





*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 Nine Months Ended September 30, 2007 and 2006
      (Unaudited)**





Shares
                ofCommonStock
            
            Common
              Stock
            
            Other
                ComprehensiveIncome
            
            RetainedEarnings
            
            Total*(Dollars
                in thousands except share data)***Balance
                at January 1, 2006**
            
            
            6,852,156
            
            $
            70,985
            
            $
            (1,672
            )
            $
            14,179
            
            $
            83,492Repurchase
                of outstanding common stock
            
            
            (309,721
            )
            
            (5,038
            )
            
            –
            
            
            –
            
            
            (5,038
            )Issuance
                of common stock for acquisition of 1st State Bancorp, Inc.
            
            
            4,882,630
            
            
            74,499
            
            
            –
            
            
            –
            
            
            74,499Issuance
                of common stock for options exercised
            
            
            82,102
            
            
            951
            
            
            –
            
            
            –
            
            
            951Noncash
                compensation
            
            
            –
            
            
            135
            
            
            –
            
            
            –
            
            
            135Net
                income
            
            
            –
            
            
            –
            
            
            –
            
            
            9,081
            
            
            9,081Other
                comprehensive loss
            
            
            –
            
            
            –
            
            
            (169
            )
            
            –
            
            
            (169
            )Comprehensive
                income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            8,912Dividends
                ($0.18 per share)
            
            
            –
            
            
            –
            
            
            –
            
            
            (2,080
            )
            
            (2,080
            )**Balance
                at September 30, 2006**
            
            
            11,507,167
            
            $
            141,532
            
            $
            (1,841
            )
            $
            21,180
            
            $
            160,871**Balance
                at January 1, 2007**
            
            
            11,393,990
            
            $
            139,484
            
            $
            (1,557
            )
            $
            23,754
            
            $
            161,681Repurchase
                of outstanding common stock
            
            
            (209,582
            )
            
            (3,181
            )
            
            –
            
            
            –
            
            
            (3,181
            )Issuance
                of common stock for options exercised
            
            
            35,597
            
            
            441
            
            
            –
            
            
            –
            
            
            441Noncash
                compensation
            
            
            32,329
            
            
            497
            
            
            –
            
            
            –
            
            
            497Net
                income
            
            
            –
            
            
            –
            
            
            –
            
            
            7,813
            
            
            7,813Other
                comprehensive loss
            
            
            –
            
            
            –
            
            
            (428
            )
            
            –
            
            
            (428
            )Comprehensive
                income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            7,385Dividends
                ($0.24 per share)
            
            
            –
            
            
            –
            
            
            –
            
            
            (2,734
            )
            
            (2,734
            )**Balance
                at September 30, 2007**
            
            
            11,252,334
            
            $
            137,241
            
            $
            (1,985
            )
            $
            28,833
            
            $
            164,089





*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 Nine Months Ended September 30, 2007 and 2006
      (Unaudited)**





September
                30, 2007
            
            
            September
                30, 2006*(Dollars
                in thousands)*Cash
                flows from operating activities:Net
                income
            
            $
            7,813
            
            
            $
            9,081Adjustments
                to reconcile net income to net cash usedin
                operating activities:Amortization
                of deposit premium
            
            
            900
            
            
            
            1,028Depreciation
            
            
            1,824
            
            
            
            1,624Net
                gains on sale of securities available for sale
            
            
            –
            
            
            
            (128
            )Loss
                (gain) on disposal of premises, equipment and real estate
                owned
            
            
            189
            
            
            
            (124
            )Change
                in held-for-sale loans, net
            
            
            562
            
            
            
            (3,890
            )Amortization
                of premiums on securities, net
            
            
            54
            
            
            
            104Deferred
                income tax (benefit) expense
            
            
            (128
            )
            
            
            4,705Issuance
                of stock for compensation
            
            
            497
            
            
            
            –Other
                non-cash compensation
            
            
            7
            
            
            
            –Provision
                for loan losses
            
            
            507
            
            
            
            446Changes
                in assets and liabilities:Accrued
                interest receivable and other assets
            
            
            (1752
            )
            
            
            3,024Accrued
                interest payable and other liabilities
            
            
            (520
            )
            
            
            11,220**Net
                cash provided by operating activities**
            
            
            9,953
            
            
            
            27,090Cash
                flows from investing activities:Loan
                originations, net of principal repayments
            
            
            (63,654
            )
            
            
            (97,506
            )Additions
                to premises and equipment
            
            
            (2,939
            )
            
            
            (4,094
            )Net (purchases)
                sales of Federal Home Loan Bank stock
            
            
            (419
            )
            
            
            543Purchase
                of securities available for sale
            
            
            (30,386
            )
            
            
            (69,690
            )Proceeds
                from calls/maturities of securities available for sale
            
            
            18,805
            
            
            
            12,542Proceeds
                from sales of securities available for sale
            
            
            –
            
            
            
            125,992Proceeds
                from calls/maturities of securities held to maturity
            
            
            689
            
            
            
            1,324Net
                cash paid in merger transaction
            
            
            –
            
            
            
            (37,541
            )Proceeds
                from sales of premises, equipment and real estate owned
            
            
            1,450
            
            
            
            1,231**Net
                cash used in investing activities**
            
            
            (76,454
            )
            
            
            (67,199
            )Cash
                flows from financing activities:Net
                increase in deposits
            
            
            35,380
            
            
            
            73,239Net
                increase in repurchase agreements
            
            
            540
            
            
            
            14,068Net
                increase (decrease) in borrowings
            
            
            30,045
            
            
            
            (16,290
            )Repayment
                of short term debt
            
            
            –
            
            
            
            (30,000
            )Distribution
                of cash held in escrow
            
            
            –
            
            
            
            33,185Dividends
                paid
            
            
            (2,734
            )
            
            
            (1,800
            )Issuance
                of common stock for options and other plans
            
            
            441
            
            
            
            951Repurchase
                of common stock
            
            
            (3,181
            )
            
            
            (5,038
            )**Net
                cash provided by financing activities**
            
            
            60,491
            
            
            
            68,315Net
                change in cash and cash equivalents
            
            
            (6,010
            )
            
            
            28,206Cash
                and cash equivalents at beginning of period
            
            
            54,332
            
            
            
            43,904Cash
                and cash equivalents at end of period
            
            $
            48,322
            
            
            $
            72,110*(continued
                on next page)*





*The
      accompanying notes are an integral part of these condensed consolidated
      financial statements.*





-
            6
            -
 Index


CAPITAL
        BANK CORPORATION
 CONDENSED
        CONSOLIDATED STATEMENTS OF CASH FLOWS
        (Continued)
 For
        the Nine Months Ended September 30, 2007 and 2006
        (Unaudited)
  September
                    30, 2007
                
                
                September
                    30, 2006*(Dollars
                    in thousands)***Supplemental
                    Disclosure of Cash Flow Information**Transfer
                    of loans and premises and equipment to other real estate
                    owned
                
                $
                1,280
                
                
                $
                2,866Dividends
                    payable
                
                $
                900
                
                
                $
                691Cash
                    paid for:Income
                    taxes
                
                $
                4,080
                
                
                $
                371Interest
                
                $
                7,765
                
                
                $
                28,230Acquisition
                    of 1st State Bancorp:Fair
                    value of assets acquired
                
                $
                –
                
                
                $
                430,131Issuance
                    of common stock
                
                $
                –
                
                
                $
                74,499Cash
                    paid, including transaction costs
                
                $
                –
                
                
                $
                46,639Liabilities
                    assumed
                
                $
                –
                
                
                $
                308,993
 The
        accompanying notes are an integral part of these condensed
        consolidated financial statements.
  -
            7
            -
 Index
  
  1.      Significant
        Accounting
        Policies and Interim Reporting
 
 Consolidation of Variable Interest Entities
 
  
  
  
  
 Accounting for Uncertainty in Income Taxes—an interpretation of FASB
          Statement No. 109, Accounting for
          Contingencies
 
 Fair Value
          Measurements
 
 “The Fair
        Value Option for Financial Assets and Financial Liabilities”  -
              8
              -
 Index
 
 **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 loss for the nine month periods ended
          September 30, 2007 and 2006 are as shown in the Company’s Condensed Consolidated
          Statements of Changes in Shareholders’ Equity (unaudited).
 
 The
          Company’s other comprehensive income (loss) and accumulated other comprehensive
          income (loss) are comprised of unrealized gains and losses on certain
          investments in debt securities and derivatives that qualify as cash flow
          hedges
          to the extent that the hedge is effective. Information concerning the Company’s
          other comprehensive income (loss) for the three and nine month periods
          ended
          September 30, 2007 and 2006 is as follows:
 
 **Three
                    Month Period Ended September 30, 2007 and 2006
                    (Unaudited)**2007
                
                
                2006*(Dollars
                    in thousands)*Unrealized
                    gains on available-for-sale securities
                
                $
                3,293
                
                
                $
                2,438Unrealized
                    gain on change in fair value of cash flow hedge
                
                
                1,549
                
                
                
                –Reclassification
                    of gains recognized in net income
                
                
                –
                
                
                
                (128
                )Income
                    tax (expense)
                
                
                (1,867
                )
                
                
                (891
                )Other
                    comprehensive income
                
                $
                2,975
                
                
                $
                1,419
   **Nine
                    Month Period Ended September 30, 2007 and 2006
                    (Unaudited)**2007
                
                
                2006*(Dollars
                    in thousands)*Unrealized
                    losses on available-for-sale securities
                
                $
                (1,222
                )
                
                $
                (147
                )Unrealized
                    gain on change in fair value of cash flow hedge
                
                
                607
                
                
                
                –Reclassification
                    of gains recognized in net income
                
                
                –
                
                
                
                (128
                )Income
                    tax benefit (expense)
                
                
                187
                
                
                
                106Other
                    comprehensive loss
                
                $
                (428
                )
                
                $
                (169
                )
 
 **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 tables provide a computation and
          reconciliation of basic and diluted EPS for the three and nine month periods
          ended September 30, 2007 and 2006, respectively.
 
 **Three
                    Month Period Ended September 30, 2007 and 2006
                    (Unaudited)**2007
                
                
                2006*(Dollars
                    in thousands except share data)*Income
                    available to shareholders – basic and diluted
                
                $
                2,753
                
                
                $
                3,267Shares
                    used in the computation of earnings per share:Weighted
                    average number of shares outstanding – basic
                
                
                11,451,322
                
                
                
                11,611,476Incremental
                    shares from assumed exercise of stock options
                
                
                58,805
                
                
                
                83,022Weighted
                    average number of shares outstanding – diluted
                
                
                11,510,127
                
                
                
                11,694,498
 -
              9
              -
 Index
  
  **Nine
                    Month Period Ended September 30, 2007 and 2006
                    (Unaudited)**2007
                
                
                2006*(Dollars
                    in thousands except share data)*Income
                    available to shareholders – basic and diluted
                
                $
                7,813
                
                
                $
                9,081Shares
                    used in the computation of earnings per share:Weighted
                    average number of shares outstanding – basic
                
                
                11,482,352
                
                
                
                11,622,442Incremental
                    shares from assumed exercise of stock options
                
                
                69,325
                
                
                
                86,004Weighted
                    average number of shares outstanding – diluted
                
                
                11,551,677
                
                
                
                11,708,446
 
 For
          the
          three and nine month periods ended September 30, 2007 and 2006, options
          to
          purchase approximately 237,000 shares and 345,000 shares, respectively,
          of
          common stock were used in the diluted calculation. For the three and nine
          month
          periods ended September 30, 2007 and 2006, options to purchase approximately
          161,000 shares and 65,000 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. As of September 30, 2007, optionsto purchase148,209shares of common stock
            remained available for future issuance.In addition, there were
            approximately 567,000 options, which were assumed under various plans
            from
            previously acquired financial institutions, of which 113,211 options remain
            outstanding.
 
 The
            Company also administers the Capital Bank Corporation Deferred Compensation
            Plan
            for Outside Directors (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 nine month periods ended September 30, 2007 and 2006, the Company
            recognized ($47,000) and $86,000, respectively, of share-based expense
            related
            to the Deferred Compensation Plan.
 
 The
            following is a summary of stock option information and the weighted average
            exercise price (“WAEP”) for the nine months ended September 30,
            2007.
 
 Number
                    of
                      Shares
                  
                  Weighted
                      Average Exercise Price
                  
                  Weighted
                      Average Remaining Contractual Term in Years
                  
                  Aggregate
                      Intrinsic Value*(Dollars
                      in thousands except share data)*Outstanding
                      at January 1, 2007
                  
                  
                  389,715
                  
                  $
                  11.75Granted
                  
                  
                  44,000
                  
                  
                  15.99Exercised
                  
                  
                  (35,597
                  )
                  
                  8.59Terminated
                  
                  
                  (1,000
                  )
                  
                  15.49Outstanding
                      at September 30, 2007
                  
                  
                  397,118
                  
                  $
                  12.49
                  
                  4.01
                  
                  $
                  1,040Options
                      exercisable at September 30, 2007
                  
                  
                  353,118
                  
                  $
                  12.05
                  
                  3.62
                  
                  $
                  997
  -
                10
                -
 Index
  
  The
            following table summarizes information about the Company’s stock options at
            September 30, 2007.
 
 Exercise
                      Price
                  NumberOutstanding
                  
                  Weighted
                      Average
                    Remaining
                      ContractualLife
                      in Years
                  
                  Number
                      Exercisable$6.62
                      – $9.00
                  107,165
                  
                  2.77
                  
                  107,165$9.01
                      – $12.00
                  87,702
                  
                  3.48
                  
                  87,702$12.01
                      – $15.00
                  41,750
                  
                  1.60
                  
                  33,750$15.01
                      – $18.00
                  102,751
                  
                  4.33
                  
                  66,751$18.01
                      – $18.37
                  57,750
                  
                  7.24
                  
                  57,750397,118
                  
                  4.01
                  
                  353,118
 
 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 September 30, 2007.
  Less
                    than 12 Months
                
                
                12
                    Months or Greater
                
                
                Total(*Dollars
                    in thousands)*
                
                Fair
                    Value
                
                
                UnrealizedLosses
                
                
                Fair
                    Value
                
                
                Unrealized
                    Losses
                
                
                Fair
                    Value
                
                
                Unrealized
                    Losses**Available
                    for Sale**U.S.
                    agency securities
                
                $
                23,799
                
                
                $
                124
                
                
                $
                35,768
                
                
                $
                577
                
                
                $
                59,567
                
                
                $
                701Municipal
                    bonds
                
                
                51,578
                
                
                
                1,447
                
                
                
                17,925
                
                
                
                384
                
                
                
                69,503
                
                
                
                1,831Mortgage-backed
                    securities
                
                
                6,114
                
                
                
                56
                
                
                
                53,202
                
                
                
                1,737
                
                
                
                59,316
                
                
                
                1,79381,491
                
                
                
                1,627
                
                
                
                106,895
                
                
                
                2,698
                
                
                
                188,386
                
                
                
                4,325**Held
                    to Maturity**U.S.
                    agency securities
                
                
                –
                
                
                
                –
                
                
                
                3,930
                
                
                
                68
                
                
                
                3,930
                
                
                
                68Municipal
                    bonds
                
                
                –
                
                
                
                –
                
                
                
                293
                
                
                
                7
                
                
                
                293
                
                
                
                7Mortgage-backed
                    securities
                
                
                –
                
                
                
                –
                
                
                
                5,650
                
                
                
                193
                
                
                
                5,650
                
                
                
                193–
                
                
                
                –
                
                
                
                9,873
                
                
                
                268
                
                
                
                9,873
                
                
                
                268Total
                    at September 30, 2007
                
                $
                81,491
                
                
                $
                1,627
                
                
                $
                116,768
                
                
                $
                2,966
                
                
                $
                198,259
                
                
                $
                4,593
 
 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 September 30, 2007.
 -
                11
                -
 Index
  
  **6.      Loans**
 
 The
          composition of the loan portfolio by loan classification at September 30,
          2007
          and December 31, 2006 is as follows:
 
 September
                    30, 2007
                
                
                December
                    31, 2006*(Dollars
                    in thousands)*
                
                *(Unaudited)*Commercial
                
                $
                634,360
                
                
                $
                593,410Construction
                
                
                279,868
                
                
                
                250,308Consumer
                
                
                36,952
                
                
                
                30,806Home
                    equity lines
                
                
                77,438
                
                
                
                83,231Mortgage
                
                
                41,650
                
                
                
                50,0991,070,268
                
                
                
                1,007,854Plus
                    deferred loan costs, net
                
                
                388
                
                
                
                198$
                1,070,656
                
                
                $
                1,008,052
 
 Loans
          held for sale as of September 30, 2007 and December 31, 2006 were $6.7
          million
          and $7.2 million, respectively, and were included in the mortgage
          category.
 
 **7.      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 September 30, 2007 and
          December 31, 2006 was as follows:
 
 September
                    30, 2007
                
                
                December
                    31, 2006*(Dollars
                    in thousands)*
                
                *(Unaudited)*Unused
                    lines of credit and overdraft lines
                
                $
                297,894
                
                
                $
                187,163Standby
                    letters of credit
                
                
                8,814
                
                
                
                12,698Total
                    commitments
                
                $
                306,708
                
                
                $
                199,861
 
 **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 and nine months ended September 30, 2007 and 2006 for Capital
          Bank
          Corporation (the “Company”) and it’s 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.
 
 -
                12
                -
 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 miscellaneous
            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’s critical accounting policies are described in Note 1 of the
            Company’s Annual Report on Form 10-K for the year ended December 31, 2006.
            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 7 of the
            Company’s Annual Report on Form 10-K for the year ended December 31,
            2006.
  -
                13
                -
 Index
 ***Executive
            Summary***
 
 As
            discussed in more detail below, the following is a summary of our significant
            results for the quarter ended September 30, 2007.
 
 •
                  The
                      Company reported net income for the quarter ended September
                      30, 2007 of
                      $2.8 million compared to $3.3 million for the quarter ended
                      September 30,
                      2006. Fully diluted earnings per share were $0.24 and $0.28
                      for the
                      quarters ended September 30, 2007 and 2006, respectively. The
                      decrease in
                      net income was primarily due to a $408,000 decrease in net
                      interest
                      income, which reflects a 34 basis point (“bp”) decrease in the net
                      interest margin as a result of the rising cost of funds, as
                      well as a
                      $230,000 increase in noninterest expense, primarily due to
                      higher
                      compensation costs, offset by a $625,000 decrease in income
                      tax expense
                      due to the lower pre-tax income along with an increase in tax-exempt
                      investment income.•
                  The
                      provision for loan losses for the quarter ended September 30,
                      2007 was
                      $261,000 compared to a credit of ($215,000) for the quarter
                      ended
                      September 30, 2006. The difference in the provision for loan
                      losses is
                      primarily due to net recoveries in the quarter ended September
                      30, 2006
                      versus net charge-offs in the same period in 2007 and the second
                      quarter
                      2007 revisions to the Company’s loan loss allowance estimation
                      methodology.•
                  Net
                      interest income for the quarter ended September 30, 2007 decreased
                      to
                      $11.2 million, a 3.5% decline from the $11.6 million earned
                      in the quarter
                      ended September 30, 2006. The decrease in net interest income
                      is primarily
                      due to a 30 bps increase in the cost of funds compared to an
                      11 bps
                      increase in the yield on earning assets.•
                  Noninterest
                      income for the quarter ended September 30, 2007 decreased $25,000
                      to $2.2
                      million compared to $2.3 million in the quarter ended September
                      30, 2006.
                      Fee income improved $180,000 in the quarter ended September
                      30, 2007 from
                      the same period in 2006.  In the quarter ended September 30,
                      2006, the Company recorded a net gain of $128,000 realized
                      on the sale of
                      securities, which, along with lower miscellaneous income, more
                      than offset
                      the improvements in fee income.•
                  Noninterest
                      expense was $9.3 million for the quarter ended September 30,
                      2007 compared
                      to $9.1 million for the quarter ended September 30, 2006. The
                      increase is
                      primarily due to higher salaries and employee benefits, which
                      increased by
                      $603,000 in the quarter ended September 30, 2007 compared to
                      the quarter
                      ended September 30, 2006. The increase in salaries and employee
                      benefits
                      was primarily due to the addition of sales associates during
                      2007, as well
                      as annual salary increases early in
                      2007.
 
 ***Financial
            Condition***
 
 Total
            consolidated assets of the Company at September 30, 2007 were $1.49 billion,
            a
            4.8% increase over the assets of $1.42 billion at December 31, 2006,
            an increase
            of $67.9 million. The increase in total consolidated assets for the nine
            months
            ended September 30, 2007 is primarily due to a $62.6 million increase
            in the
            Bank’s loan portfolio, net of the allowance for loan losses, since December
            31,
            2006. Total deposits as of September 30, 2007 were $1.09 billion, which
            represents growth of $35.4 million from December 31, 2006.
 
 Total
            earning assets were $1.34 billion at September 30, 2007 compared to $1.26
            billion at December 31, 2006. Earning assets represented 90.1% and 89.7%
            of
            total assets as of September 30, 2007 and December 31, 2006, respectively.
            At
            September 30, 2007, investment securities were $249.1 million, compared
            to
            $239.0 million at December 31, 2006. Interest-earning cash, federal funds
            sold
            and short term investments were $15.7 million at September 30, 2007 compared
            to
            $20.8 million at December 31, 2006.
 
 The
            allowance for loan losses as of September 30, 2007 and December 31, 2006
            was
            $13.4 million and $13.3 million, representing approximately 1.25% and
            1.32%,
            respectively, of total loans as of both dates. Management believes that
            the
            amount of the allowance is adequate to absorb the estimated losses inherent
            in
            the current loan portfolio. See *“Asset Quality”* below for further
            discussion of the allowance for loan
            losses***.***
 -
                  14
                  -
 Index
 Total
            deposits as of September 30, 2007 were $1.09 billion, an increase of
            $35.4
            million, or 3.4%, from December 31, 2006. The increase was primarily
            due to a
            $50.1 million increase in brokered CDs, a $20.4 million increase in money
            market
            deposits partially offset by a $44.9 million decrease in non-brokered
            time
            deposits. Total time deposits represented 52.6% of total deposits at
            September
            30, 2007 compared to 53.8% at December 31, 2006. The Company’s high yield
            checking account product, *Smart Checking*, which is designed to generate
            higher debit card interchange income to offset the higher yield offered,
            added
            almost 900 new accounts during the quarter ended September 30, 2007.
            As of
            September 30, 2007, there were approximately 6,800 *Smart Checking*
            accounts and $32.2 million of deposits associated with this
            product.
 
 Noninterest-bearing
            demand deposit accounts (“DDA”) were $123.8 million at September 30, 2007, an
            increase of $2.9 million from December 31, 2006. The average balance
            of
            non-interest bearing DDA accounts was $114.0 million during the quarter
            ended
            September 30, 2007 compared to $99.6 million during the quarter ended
            September
            30, 2006.
 
 Total
            consolidated shareholders’ equity was $164.1 million as of September 30, 2007,
            an increase of $2.4 million from December 31, 2006. Retained earnings
            increased
            by $5.1 million, reflecting $7.8 million of net income for the nine months
            ended
            September 30, 2007 less $2.7 million of dividends declared during the
            nine
            months ended September 30, 2007. Accumulated other comprehensive loss,
            which
            represents the unrealized loss on available-for-sale securities and derivatives
            accounted for as cash flow hedges, net of related tax benefits, was $2.0
            million
            and $1.6 million as of September 30, 2007 and December 31, 2006, respectively.
            The decrease is primarily due to the decline in the fair value of the
            Company’s
            available-for-sale security portfolio as a result of changing interest
            rate
            conditions in the bond market. See Item 1. Financial Statements – Condensed
            Consolidated Statements of Changes in Shareholders’ Equity for additional
            information.
 
 ***Results
            of Operations***
 
 **Quarter
            ended September 30, 2007 compared to quarter ended September 30,
            2006**
 
 For
            the
            quarter ended September 30, 2007, the Company reported net income of
            $2.8
            million, or $0.24 per diluted share, compared to net income of $3.3 million,
            or
            $0.28 per diluted share, for the quarter ended September 30, 2006. Net
            income
            decreased by $514,000, primarily due to margin compression as a result
            of the
            rising costs of funds, accompanied by a $476,000 difference between the
            provision for loan losses in the quarter ended September 30, 2007 compared
            to a
            credit provision in the quarter ended September 30, 2006. The Company’s net
            interest margin, on a fully taxable equivalent basis, for the quarter
            ended
            September 30, 2007 decreased by 34 bps compared to the net interest margin
            for
            the quarter ended September 30, 2006. The Company expects continued pressures
            on
            its net interest margin in the near term, primarily from increased competition
            for funds in the Company’s primary markets combined with the prime rate
            decreases by the Federal Reserve of 50 bps and 25 bps on September 18
            and
            October 31, 2007, respectively.
 
 Net
            interest income decreased $408,000, or 3.5%, from $11.6 million for the
            quarter
            ended September 30, 2006, to $11.2 million for the quarter ended September
            30,
            2007. Average earning assets increased $89.9 million to $1.30 billion
            for the
            quarter ended September 30, 2007 from $1.21 billion for the quarter ended
            September 30, 2006. Average interest-bearing liabilities increased $70.0
            million
            to $1.16 billion for the quarter ended September 30, 2007 from $1.09
            billion for
            the quarter ended September 30, 2006. The net interest margin on a fully
            taxable
            equivalent basis decreased by 34 bps to 3.57% for the quarter ended September
            30, 2007 from 3.91% for the quarter ended September 30, 2006. The earned
            yield
            on average interest-earning assets was 7.42% and 7.53% for the quarter
            ended
            September 30, 2007 and 2006, respectively, while the interest rate on
            average
            interest-bearing liabilities for those periods was 4.32% and 4.02%,
            respectively. The decrease in the net interest margin is primarily attributed
            to
            interest-bearing liabilities repricing at a faster rate than interest-earning
            assets as a result of the static interest rate environment throughout
            most of
            the quarter, and competitive pressures in the Company’s primary markets. The
            majority of the Company’s loans are linked to prime, which remained flat until
            the change on September 18, 2007, while the Company’s interest-bearing deposits
            are impacted more by rates paid by competitors on time deposits.  The
            Federal Reserve decreased the prime rate by 50 bps on September 18, 2007
            and 25
            bps on October 31, 2007, which the Company expects will put increased
            pressure
            on the net interest margin in the fourth quarter.
 
 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.
 -
                  15
                  -
 Index
 **Average
            Balances, Interest Earned or Paid, and Interest
            Yields/Rates**
 **Three
              Months Ended September 30, 2007 and 2006 (Unaudited)**
 Taxable
              Equivalent Basis 1
 
 2007
                    
                    
                    2006*(Dollars
                        in thousands)*
                    
                    Average
                        Balance
                    
                    Amount
                        Earned
                    
                    Average
                        Rate
                    
                    
                    Average
                        Balance
                    
                    Amount
                        Earned
                    
                    Average
                        Rate**Assets**Loans
                        receivable 2
                    
                    $
                    1,042,635
                    
                    $
                    20,830
                    
                    
                    7.93
                    %
                    
                    $
                    982,037
                    
                    $
                    19,980
                    
                    
                    8.07
                    %Investment
                        securities 3
                    
                    
                    252,090
                    
                    
                    3,443
                    
                    
                    5.42
                    %
                    
                    
                    195,323
                    
                    
                    2,586
                    
                    
                    5.25
                    %Federal
                        funds sold and other interest on short-term investments
                    
                    
                    8,134
                    
                    
                    107
                    
                    
                    5.22
                    %
                    
                    
                    35,642
                    
                    
                    463
                    
                    
                    5.15
                    %Total
                        interest earning assets
                    
                    
                    1,302,859
                    
                    $
                    24,380
                    
                    
                    7.42
                    %
                    
                    
                    1,213,002
                    
                    $
                    23,029
                    
                    
                    7.53
                    %Cash
                        and due from banks
                    
                    
                    28,261
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    32,094Other
                        assets
                    
                    
                    128,078
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    133,897Allowance
                        for loan losses
                    
                    
                    (13,283
                    )
                    
                    
                    
                    
                    
                    
                    
                    
                    (13,161
                    )Total
                        assets
                    
                    $
                    1,445,915
                    
                    
                    
                    
                    
                    
                    
                    
                    $
                    1,365,832**Liabilities
                        and Equity**Savings
                        deposits
                    
                    $
                    33,402
                    
                    $
                    51
                    
                    
                    0.61
                    %
                    
                    $
                    38,137
                    
                    $
                    48
                    
                    
                    0.50
                    %Interest-bearing
                        demand deposits
                    
                    
                    366,824
                    
                    
                    3,230
                    
                    
                    3.49
                    %
                    
                    
                    304,355
                    
                    
                    2,521
                    
                    
                    3.29
                    %Time
                        deposits
                    
                    
                    549,968
                    
                    
                    6,566
                    
                    
                    4.74
                    %
                    
                    
                    578,018
                    
                    
                    6,107
                    
                    
                    4.19
                    %Total
                        interest-bearing deposits
                    
                    
                    950,194
                    
                    
                    9,847
                    
                    
                    4.11
                    %
                    
                    
                    920,510
                    
                    
                    8,676
                    
                    
                    3.74
                    %Borrowed
                        funds
                    
                    
                    147,843
                    
                    
                    1,841
                    
                    
                    4.94
                    %
                    
                    
                    110,164
                    
                    
                    1,402
                    
                    
                    5.05
                    %Subordinated
                        debt
                    
                    
                    30,930
                    
                    
                    599
                    
                    
                    7.68
                    %
                    
                    
                    30,930
                    
                    
                    619
                    
                    
                    7.94
                    %Repurchase
                        agreements
                    
                    
                    34,233
                    
                    
                    383
                    
                    
                    4.44
                    %
                    
                    
                    31,562
                    
                    
                    378
                    
                    
                    4.75
                    %Total
                        interest-bearing liabilities
                    
                    
                    1,163,200
                    
                    $
                    12,670
                    
                    
                    4.32
                    %
                    
                    
                    1,093,166
                    
                    $
                    11,075
                    
                    
                    4.02
                    %Noninterest-bearing
                        deposits
                    
                    
                    113,980
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    99,633Other
                        liabilities
                    
                    
                    4,885
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    11,132Total
                        liabilities
                    
                    
                    1,282,065
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    1,203,931Shareholders’
                        equity
                    
                    
                    163,850
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    161,901Total
                        liabilities and shareholders’ equity
                    
                    $
                    1,445,915
                    
                    
                    
                    
                    
                    
                    
                    
                    $
                    1,365,832Net
                        interest spread 4
                    
                    
                    
                    
                    
                    
                    
                    
                    3.10
                    %
                    
                    
                    
                    
                    
                    
                    
                    
                    3.51
                    %Tax
                        equivalent adjustment
                    
                    
                    
                    
                    $
                    525
                    
                    
                    
                    
                    
                    
                    
                    
                    $
                    363Net
                        interest income and net interest margin 5
                    
                    
                    
                    
                    $
                    11,710
                    
                    
                    3.57
                    %
                    
                    
                    
                    
                    $
                    11,954
                    
                    
                    3.91
                    %
 
 1
                    The
                        fully taxable equivalent basis is computed using a blended
                        federal and
                        state tax rate of approximately 36% and 38% in 2007 and 2006,
                        respectively.
 2
                    Loans
                        receivable include nonperforming loans for which accrual
                        of interest has
                        not been recorded and includes loans held for
                        sale.
 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-earning assets and the average cost of interest-bearing
                        liabilities.
 5
                    Net
                        interest margin represents net interest income divided by
                        average
                        interest-earning assets.
  -
                  16
                  -
 Index
 Interest
              income on loans increased from $20.0 million for the quarter ended
              September 30,
              2006 to $20.8 million for the quarter ended September 30, 2007. The
              increase is
              primarily due to higher average loan balances, which increased by $60.6
              million,
              due to net loan growth, partially offset by lower loan yields. The
              Company’s
              prime rate was 7.75% as of September 30, 2007 and 8.25% as of September
              30,
              2006, however, the decrease of 50 bps occurred after the Federal Reserve
              decreased prime on September 18, 2007.  Prior to that date, prime had
              remained flat. In November 2006, the Company entered into a $100 million
              (notional) interest rate swap to help mitigate its exposure to interest
              rate
              volatility. This swap reduced the overall yield on loans and the net
              interest
              margin by 5 bps and 4 bps, respectively, for the quarter ended September
              30,
              2007.
 
 Interest
              income on investment securities increased from $2.2 million for the
              quarter
              ended September 30, 2006 to $2.9 million for the quarter ended September
              30,
              2007. The increase is primarily due to a $57.0 million increase in
              average
              balances outstanding between the periods, with approximately $47.0
              million of
              the increase related to investments in tax-exempt municipal bonds as
              well as
              higher yielding investments acquired in the second half of 2006. The
              yield on
              investment securities increased from 5.25% for the quarter ended September
              30,
              2006 to 5.42% for the quarter ended September 30, 2007.
 
 Interest
              expense on deposits increased from $8.7 million for the quarter ended
              September
              30, 2006 to $9.8 million for the quarter ended September 30, 2007.
              The increase
              is primarily due to a $30.0 million increase in the average balance
              of
              interest-bearing deposits outstanding due to deposit growth and higher
              deposit
              rates. The average rate paid on total interest-bearing deposits increased
              from
              3.74% for the quarter ended September 30, 2006 to 4.11% for the quarter
              ended
              September 30, 2007, a 37 bps rise. The rate paid on time deposits,
              which
              represented 57.9% and 62.8% of total average interest-bearing deposits
              for the
              quarters ended September 30, 2007 and 2006, respectively, increased
              from 4.19%
              for the quarter ended September 30, 2006 to 4.74 % for the quarter
              ended
              September 30, 2007, primarily as a result of the rising interest rate
              environment and increased competition in the Company’s primary
              markets.
 
 Interest
              expense on borrowings increased from $2.4 million for the quarter ended
              September 30, 2006 to $2.8 million for the quarter ended September
              30, 2007,
              primarily due to a $40.0 million increase in average borrowing partially
              offset
              by lower borrowing rates in the quarter ended September 30, 2007. The
              rate on
              average borrowings and subordinated debentures for the quarter ended
              September
              30, 2007 was 4.94% and 7.68%, respectively, compared to 5.05% and 7.94%,
              respectively, for the quarter ended September 30, 2006. In July of
              2003, the
              Bank entered 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 was an increase in interest
              expense
              of $126,000 and $127,000 for the quarters ended September 30, 2007
              and 2006,
              respectively.
 
 For
              the
              quarter ended September 30, 2007, the provision for loan losses was
              $261,000
              compared to a credit of ($215,000) for the quarter ended September
              30, 2006. The
              increase in the provision for loan losses reflects the net recoveries
              in the
              quarter ended September 30, 2006 versus net chargeoffs during the same
              period in
              2007, and loan growth in the quarter ended September 30, 2007 partially
              offset
              by the effects of revisions made to the Company’s allowance for loan loss
              estimation methodology in the second quarter of 2007 as discussed more
              fully
              below under “*Asset**Qualit**y**.**”* Net charge-offs for
              the
              quarter ended September 30, 2007 were $234,000, or 0.02% of average
              loans,
              compared to net recoveries of ($102,000), or (0.01%) of average loans
              for the
              quarter ended September 30, 2006. Total nonperforming assets and past
              due loans
              increased from $8.5 million and $13.0 million, respectively, as of
              June 30, 2007
              to $10.5 million and $13.2 million, respectively, as of September 30,
              2007. Past
              due loans consists of all loans past due 30 days or more.
 
 Noninterest
              income for the quarter ended September 30, 2007 was $2.2 million compared
              to
              $2.3 million for the quarter ended September 30, 2006, a decrease of
              $25,000.
              Service charges and other fees increased $126,000, primarily due to
              an increase
              in interchange income from the***Smart Checking* product, as
              well as higher nonsufficient fund fees partially offset by lower service
              charges. Mortgage fees and revenues increased $54,000 while other noninterest
              income decreased $77,000 primarily due to losses on sales of collateral. In
              the quarter ended September 30, 2006 noninterest income includes a
              $128,000 gain
              on sale of securities.
 
 Noninterest
              expense for the quarter ended September 30, 2007 was $9.3 million compared
              to
              $9.1 million for the quarter ended September 30, 2006. Salaries and
              employee
              benefits, representing the largest noninterest expense category, increased
              to
              $4.9 million for the quarter ended September 30, 2007, from $4.3 million
              for the
              quarter ended September 30, 2006. The increase in salaries and employee
              benefits
              was primarily due to annual salary increases, changes in the composition
              of
              personnel, and higher benefit costs.
 -
                    17
                    -
 Index
 Occupancy
                costs, the second largest component of noninterest expense, increased
                $14,000 from $1.04 million for the quarter ended September 30, 2006 to
                $1.06 million for the quarter ended September 30, 2007. The increase
                is
                primarily due to the higher rent expenses related to the Company’s new
                headquarters and higher property taxes. Furniture and equipment expenses
                for the
                quarter ended September 30, 2007 decreased $11,000 from the same
                period in 2006,
                primarily due to lower depreciation expenses, lower non-capitalized
                expenses,
                and lower software expenses, partially offset by higher maintenance
                expenses.
                Data processing expenses for the quarter ended September 30, 2007
                increased
                $136,000 from the same period in 2006, primarily due to the Company’s
                implementation of an internet-based phone system, which increased
                network
                expenses but reduced telecommunication costs. Directors’ fees for the quarter
                ended September 30, 2007 decreased $297,000 from the same period
                in 2006,
                primarily due to lower share-based compensation expense associated
                with the
                Deferred Compensation Plan. Advertising expenses for the quarter
                ended September
                30, 2007 increased $38,000 from the same period in 2006 primarily
                due to the
                Company’s direct mail campaign in the quarter ended September 30, 2007.
                Professional fees for the quarter ended September 30, 2007 increased
                $79,000
                from the same period in 2006, primarily due to legal fees partially
                offset by a
                reduction in consulting fees. Other expenses for the quarter ended
                September 30,
                2007 decreased $290,000 from the same period in 2006, primarily due
                to lower
                costs associated with telecommunications, operational losses, and
                office
                supplies, partially offset by an increase in the provision for off-balance-sheet
                credit risk associated with unfunded commitments.
 
 Income
                tax expense for the quarters ended September 30, 2007 and 2006 was
                $1.1 million
                and $1.7 million, respectively. The Company’s effective tax rate for the quarter
                ended September 30, 2007 was 28.6 % compared to 34.6% for the quarter
                ended
                September 30, 2006. The decrease in the effective tax rate is primarily
                due to
                greater proportion of tax-exempt income to taxable income for the
                quarter ended
                September 30, 2007 compared to the same period in 2006 as a result
                of municipal
                bonds acquired during the quarter ended December 31, 2006. The Company
                forecasts
                its taxable and nontaxable income and calculates the effective tax
                rate for the
                entire year, which is then applied to the three month period.
 
 ***Results
                of Operations***
 
 **Nine
                month period ended September 30, 2007 compared to nine month period
                ended
                September 30, 2006**
 
 For
                the
                nine month period ended September 30, 2007, the Company reported
                net income of
                $7.8 million, or $0.68 per diluted share, compared to net income
                of $9.1
                million, or $0.78 per diluted share, for the nine month period ended
                September
                30, 2006. Net income decreased by $1.3 million, primarily due to
                higher interest
                expense partially offset by increased interest income, which resulted
                in a lower
                net interest margin.
 
 Net
                interest income decreased $1.4 million, or 4.1%, from $34.6 million
                for the nine
                month period ended September 30, 2006, to $33.2 million for the nine
                month
                period ended September 30, 2007. Average earning assets increased
                $114.9 million
                to $1.30 billion for the nine month period ended September 30, 2007
                from $1.18
                billion for the nine month period ended September 30, 2006, an increase
                of 9.7%.
                Average interest-bearing liabilities increased $98.7 million to $1.16
                billion
                for the nine month period ended September 30, 2007 from $1.06 billion
                for the
                nine month period ended September 30, 2006. The net interest margin
                on a fully
                taxable equivalent basis decreased 42 bps to 3.58% for the nine month
                period
                ended September 30, 2007 from 4.00% for the nine month period ended
                September
                30, 2006. The earned yield on average interest-earning assets was
                7.45% and
                7.27% for the nine month periods ended September 30, 2007 and 2006,
                respectively, while the interest rate on average interest-bearing
                liabilities
                for those same periods was 4.34% and 3.65%, respectively. The decrease
                in the
                net interest margin is primarily due to the cost of funds rising
                at a faster
                rate than the yield on earning assets as a result of the current
                interest rate
                environment. The average interest rate on interest-bearing deposits
                increased
                from 3.33% for the nine month period ended September 30, 2006 to
                4.13% for the
                nine month period ended September 30, 2007, an increase of 80 bps.
                However, the
                average yield on the loan portfolio increased from 7.80% for the
                nine month
                period ended September 30, 2006 to 7.98% for the nine month period
                ended
                September 30, 2007, an increase of 18 bps. The Company expects its
                net interest
                margin will continue to experience compression in the last quarter
                of 2007 based
                on the interest rate decreases by the Federal Reserve on September
                18, 2007 and
                October 31, 2007 of 50 bps and 25 bps, respectively.
 
 The
                following table shows the Company’s effective yield on earning assets and cost
                of funds. Yields and costs are computed by dividing income or expense
                for the
                year by the respective daily average asset or liability balance.
 -
                      18
                      -
 Index
 **Average
                Balances, Interest Earned or Paid, and Interest
                Yields/Rates**
 **Nine
                Months Ended September 30, 2007 and 2006**
 Taxable
                Equivalent Basis 1
 
 2007
                      
                      2006*(Dollars
                          in thousands)*
                      
                      Average
                          Balance
                      
                      Amount
                          Earned/Paid
                      
                      Average
                          Rate
                      
                      Average
                          Balance
                      
                      Amount
                          EarnedPaid
                      
                      Average
                          Rate**Assets**Loans
                          receivable 2
                      
                      $
                      1,025,545
                      
                      $
                      61,232
                      
                      
                      7.98
                      %
                      $
                      953,469
                      
                      $
                      55,646
                      
                      
                      7.80
                      %Investment
                          securities 3
                      
                      
                      248,224
                      
                      
                      10,128
                      
                      
                      5.46
                      %
                      
                      193,301
                      
                      
                      7,234
                      
                      
                      5.00
                      %Federal
                          funds sold and other interest on short term investments
                      
                      
                      22,338
                      
                      
                      883
                      
                      
                      5.29
                      %
                      
                      34,434
                      
                      
                      1,313
                      
                      
                      5.10
                      %Total
                          interest-earnings assets
                      
                      
                      1,296,107
                      
                      $
                      72,243
                      
                      
                      7.45
                      %
                      
                      1,181,204
                      
                      $
                      64,193
                      
                      
                      7.27
                      %Cash
                          and due from banks
                      
                      
                      27,781
                      
                      
                      
                      
                      
                      
                      
                      
                      31,890Other
                          assets
                      
                      
                      129,392
                      
                      
                      
                      
                      
                      
                      
                      
                      134,935Allowance
                          for loan losses
                      
                      
                      (13,369
                      )
                      
                      
                      
                      
                      
                      
                      
                      (14,869
                      )Total
                          assets
                      
                      $
                      1,439,911
                      
                      
                      
                      
                      
                      
                      
                      $
                      1,333,160**Liabilities
                          and Equity**Savings
                          deposits
                      
                      $
                      33,812
                      
                      $
                      138
                      
                      
                      0.55
                      %
                      $
                      41,143
                      
                      $
                      160
                      
                      
                      0.52
                      %Interest-bearing
                          demand deposits
                      
                      
                      362,304
                      
                      
                      9,415
                      
                      
                      3.47
                      %
                      
                      283,023
                      
                      
                      6,051
                      
                      
                      2.86
                      %Time
                          deposits
                      
                      
                      568,604
                      
                      
                      20,217
                      
                      
                      4.75
                      %
                      
                      563,420
                      
                      
                      15,904
                      
                      
                      3.77
                      %Total
                          interest-bearing deposits
                      
                      
                      964,720
                      
                      
                      29,770
                      
                      
                      4.13
                      %
                      
                      887,586
                      
                      
                      22,115
                      
                      
                      3.33
                      %Borrowed
                          funds
                      
                      
                      127,169
                      
                      
                      4,911
                      
                      
                      5.16
                      %
                      
                      110,750
                      
                      
                      4,015
                      
                      
                      4.85
                      %Subordinated
                          debt
                      
                      
                      30,930
                      
                      
                      1,777
                      
                      
                      7.68
                      %
                      
                      31,478
                      
                      
                      1,812
                      
                      
                      7.70
                      %Repurchase
                          agreements
                      
                      
                      33,419
                      
                      
                      1,077
                      
                      
                      4.31
                      %
                      
                      27,766
                      
                      
                      914
                      
                      
                      4.40
                      %Total
                          interest-bearing liabilities
                      
                      
                      1,156,238
                      
                      $
                      37,535
                      
                      
                      4.34
                      %
                      
                      1,057,580
                      
                      $
                      28,856
                      
                      
                      3.65
                      %Noninterest-bearing
                          deposits
                      
                      
                      110,954
                      
                      
                      
                      
                      
                      
                      
                      
                      101,705Other
                          liabilities
                      
                      
                      8,713
                      
                      
                      
                      
                      
                      
                      
                      
                      12,854Total
                          liabilities
                      
                      
                      1,275,905
                      
                      
                      
                      
                      
                      
                      
                      
                      1,172,139Shareholders’
                          equity
                      
                      
                      164,006
                      
                      
                      
                      
                      
                      
                      
                      
                      161,021Total
                          liabilities and shareholders’ equity
                      
                      $
                      1,439,911
                      
                      
                      
                      
                      
                      
                      
                      $
                      1,333,160Net
                          interest spread 4
                      
                      
                      
                      
                      
                      
                      
                      
                      3.11
                      %
                      
                      
                      
                      
                      
                      
                      
                      3.62
                      %Tax
                          equivalent adjustment
                      
                      
                      
                      
                      $
                      1,546
                      
                      
                      
                      
                      
                      
                      
                      $
                      746Net
                          interest income and net interest margin 5
                      
                      
                      
                      
                      $
                      34,708
                      
                      
                      3.58
                      %
                      
                      
                      
                      $
                      35,337
                      
                      
                      4.00
                      %
 
 1
                      The
                          taxable equivalent basis is computed using a blended federal
                          and state tax
                          rate of approximately 38% in 2007 and
                          2006.
 2
                      Loans
                          receivable include nonperforming loans for which accrual
                          of interest has
                          not been recorded and includes loans held for
                          sale.
 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-earning assets and the average cost of interest-bearing
                          liabilities.
 5
                      Net
                          interest margin represents net interest income divided
                          by average
                          interest-earning
                          assets.
 -
                19
                -
 Index
 For
          the
          nine month period ended September 30, 2007, the provision for loan losses
          was
          $507,000 compared to $446,000 for the nine month period ended September
          30,
          2006, an increase of $61,000. The increase in 2007 was primarily due to
          the net
          growth of the loan portfolio partially offset by revisions made to the
          Company’s
          allowance for loan loss estimation methodology. See *“Asset Quality”*
          below for further discussion of the allowance for loan losses and the revisions
          to estimation methodology.Net
          charge-offs for the nine month period ended September 30, 2007 were $488,000
          compared to $3.8 million for the nine month period ended September 30,
          2006. Net
          charge-offs for the nine month period ended September 30, 2006 includes
          $2.9
          million related to one 1st State Bank loan relationship that had been fully
          reserved by 1st State Bank as of December 31, 2005. See *“Asset Quality”*
          below for further discussion of the allowance for loan
          losses.





Noninterest
      income for the nine month period ended September 30, 2007, was $6.7 million
      compared to $6.9 million for the nine month period ended September 30, 2006,
      a
      decrease of $155,000. Service charges and other fees increased by $26,000 as
      a
      result of an increase in interchange fees for the Company’s debit card usage,
      partially offset by lower service charges and lower nonsufficient fund fees.
      Mortgage fees and revenues increased by $157,000, primarily due to higher loan
      volumes in 2007. Other noninterest income decreased by $210,000, primarily
      due
      to the gain of $138,000 in 2006 realized on the sale of a consolidated
      branch location.  In the nine months ended September 30, 2006, the
      Company also realized a gain on the sale of investments of
      $128,000.





Noninterest
      expense for the nine month period ended September 30, 2007 was $28.3 million
      compared to $27.2 million for the nine month period ended September 30, 2006.
      Salaries and employee benefits, representing the largest noninterest expense
      category, increased by $1.6 million to $15.3 million for the nine month period
      ended September 30, 2007, from $13.7 million for the nine month period ended
      September 30, 2006. This increase reflects an increase in the number of
      personnel employed by the Company during the nine months ended September 30,
      2007, as well as higher benefit and incentive compensation costs.





Occupancy
      costs and furniture and equipment expenses for the nine month period ended
      September 30, 2007 increased by $269,000 and $197,000, respectively, compared
      to
      the nine month period ended September 30, 2006, primarily due to higher expenses
      associated with the Company’s new headquarters and data processing equipment
      depreciation associated with the Company’s operations center. Directors’ fees
      decreased $459,000 for the nine month period ended September 30, 2007 compared
      to the same period in 2006, primarily due to a reduction in share-based
      compensation expense associated with the Deferred Compensation Plan as a result
      of a decrease in the Company’s share price. Data processing expenses increased
      $158,000 for the nine month period ended September 30, 2007 compared to the
      same
      period in 2006, primarily due to network costs associated with the
      implementation of an internet-based phone system, partially offset by a
      reduction in external item processing costs as a result of bringing operations
      in house during 2006.





Advertising
      expenses for the nine month period ended September 30, 2007 decreased by $42,000
      compared to the same period in 2006, primarily due to promotional campaign
      associated with the May 2006 introduction of *Smart Checking*.
      Professional fees for the nine month period ended September 30, 2007 increased
      by $100,000 compared to the same period in 2006, primarily due to higher legal
      and accounting fees, partially offset by reduced consulting expenses. Other
      expenses for the nine month period ended September 30, 2007 decreased $614,000
      from the same period in 2006, primarily due to lower costs associated with
      telecommunications, operational losses and office supplies partially offset
      by
      higher insurance costs.





The
      Company’s effective tax rate for the nine month periods ended September 30, 2007
      and 2006 was 29.3% and 34.2%, respectively. The change in the effective tax
      rate
      was due to changes in forecasted levels of taxable and tax-exempt income and
      the
      decrease for these comparable periods primarily reflects a higher mix of
      tax-exempt income as a result of municipal bonds acquired during the quarter
      ended December 31, 2006.





***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.


-
          20
          -
 Index


The
      Company estimates the amount of allowance needed to cover inherent losses 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
      Bank’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 $750,000 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 $13.4
      million allowance for loan losses as of September 30, 2007, $3.0 million has
      been allocated to specific loans, including loans considered to be impaired.
      As
      of September 30, 2007 and December 31, 2006, there were $4.1 million and $6.2
      million, respectively, of impaired loans. As of September 30, 2007 and December
      31, 2006, $1.2 million and $1.1 million, respectively, are included in the
      allowance for loan losses for impaired loans. At September 30, 2007 and December
      31, 2006, 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 Bank will be unable to collect the scheduled payments of principal
      and
      interest when due according to the contractual terms of the loan agreement.
      The
      Bank 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 September 30, 2007 include $1.9 million
      related to 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
      $950,000 for this exposure, which management believes is adequate.





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 $261,000
      for
      the quarter ended September 30, 2007 compared to a credit provision for the
      quarter ended September 30, 2006 of ($215,000) which in part resulted from
      recoveries of $431,000 during the period. The increase in the provision was
      primarily due to the loan growth during the quarter ended September 30, 2007,
      partially offset by revisions made to the allowance for loan loss estimation
      methodology as a result of recent regulatory guidance, which emphasized that
      institutions should incorporate historical loss experience into the allowance
      for loan loss estimation methodology. The Company’s former estimation
      methodology was based primarily on a standard loss percentage for loan
      categories. The revised estimation methodology takes into consideration the
      Company’s historical loss experience and utilizes a greater dispersion of risk
      rating classifications based on the collateral backing of the loans. The revised
      estimation methodology shifts a portion of the unallocated loan loss allowance
      to specific allocation loans.





Past
      due
      loans as a percentage of average loans decreased from 1.27% June 30, 2007 to
      1.26% at September 30, 2007. Nonperforming loans, which includes all loans
      past
      due greater than 90 days or in nonaccrual status, as a percentage of total
      loans
      increased from 0.83% at June 30, 2007 to 0.98% at September 30, 2007.
      Nonperforming assets as a percentage of total assets were 0.71% and 0.59% at
      September 30, 2007 and June 30, 2007, respectively. Management believes the
      allowance for loan losses as of September 30, 2007 is adequate to absorb the
      losses on existing loans that may become uncollectible, based on evaluations
      of
      the collectibility of loans and prior loan loss experience.





At
      September 30, 2007, nonperforming loans were $10.2 million, an increase of
      $5.3
      million from December 31, 2006. 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 associated with the nonperforming loans at September 30,
      2007.





The
      following table presents an analysis of changes in the allowance for loan losses
      for the three and nine month periods ended September 30, 2007 and 2006,
      respectively.


-
            21
            -
 Index
 Three
                    Months Ended September 30,
                
                
                Nine
                    Months Ended September 30,*(Dollars
                    in thousands)*
                
                2007
                
                
                2006
                
                
                2007
                
                
                2006Allowance
                    for loan losses, beginning of period
                
                $
                13,339
                
                
                $
                14,007
                
                
                $
                13,347
                
                
                $
                9,5921st
                    State Bank loan loss allowance acquired
                
                
                –
                
                
                
                –
                
                
                
                –
                
                
                
                7,637Net
                    charge-offs:Loans
                    charged off:Commercial
                
                
                100
                
                
                
                114
                
                
                
                265
                
                
                
                3,961
                1Consumer
                
                
                226
                
                
                
                118
                
                
                
                335
                
                
                
                254Home
                    equity lines
                
                
                54
                
                
                
                29
                
                
                
                79
                
                
                
                55Mortgage
                
                
                –
                
                
                
                68
                
                
                
                53
                
                
                
                102Total
                    charge-offs
                
                
                380
                
                
                
                329
                
                
                
                732
                
                
                
                4,372Recoveries
                    of loans previously charged off:Commercial
                
                
                64
                
                
                
                376
                
                
                
                102
                
                
                
                501Consumer
                
                
                28
                
                
                
                10
                
                
                
                88
                
                
                
                36Home
                    equity lines
                
                
                54
                
                
                
                27
                
                
                
                54
                
                
                
                31Mortgage
                
                
                –
                
                
                
                18
                
                
                
                –
                
                
                
                23Total
                    recoveries
                
                
                146
                
                
                
                431
                
                
                
                244
                
                
                
                591Total
                    net charge-offs (recoveries)
                
                
                234
                
                
                
                (102
                )
                
                
                488
                
                
                
                3,781Loss
                    (credit) provision charged to operations
                
                
                261
                
                
                
                (215
                )
                
                
                507
                
                
                
                446Allowance
                    for loan losses, end of period
                
                $
                13,366
                
                
                $
                13,894
                
                
                $
                13,366
                
                
                $
                13,894Net
                    charge-offs to average loans during the period
                    (annualized)
                
                
                0.09%
                
                
                
                (0.04)%
                
                
                
                0.06%
                
                
                
                0.53%
                1Allowance
                    as a percent of gross loans
                
                
                1.25%
                
                
                
                1.38%
 1
              Net
                  charge-offs for the nine month period ended September 30, 2006
                  includes
                  $3.2 million related to one 1st State Bank loan relationship that
                  was
                  fully reserved by 1st State Bank as of December 31,
                  2005.
 
 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 September
        30,
        2007, September 30, 2006 and December 31, 2006.
  September
                  30, 2007
              
              
              September
                  30, 2006
              
              
              December
                  31,2006*(Dollars
                  in thousands)*
              
              *(Unaudited)*Nonperforming
                  loans:Commercial
              
              $
              7,304
              
              
              $
              3,885
              
              
              $
              2,783Construction
              
              
              –
              
              
              
              71
              
              
              
              616Consumer
              
              
              23
              
              
              
              259
              
              
              
              50Home
                  equity lines
              
              
              491
              
              
              
              440
              
              
              
              410Mortgage
              
              
              2,414
              
              
              
              1,453
              
              
              
              1,043Total
                  nonperforming loans
              
              
              10,232
              
              
              
              6,108
              
              
              
              4,902Foreclosed
                  property held
              
              
              309
              
              
              
              637
              
              
              
              1,111Total
                  nonperforming assets
              
              $
              10,541
              
              
              $
              6,745
              
              
              $
              6,013Nonperforming
                  loans to total loans
              
              
              0.96
              %
              
              
              0.61
              %
              
              
              0.49
              %Nonperforming
                  assets to total assets
              
              
              0.71
              %
              
              
              0.48
              %
              
              
              0.42
              %Allowance
                  coverage of nonperforming loans
              
              
              131
              %
              
              
              227
              %
              
              
              272
              %
 
 -
              22
              -
 Index
 Foreclosed
        property decreased to $309,000 at September 30, 2007 from $1.1 million at
        December 31, 2006. The decrease was primarily due to the net 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 $48.3
        million in its most liquid assets, cash and cash equivalents as of September
        30,
        2007. 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 $100,000 or more), one of the most stable sources of liquidity,
        together with equity capital, which totaled $1.0 billion at both September
        30,
        2007 and December 31, 2006, funded 67% of total assets at September 30, 2007
        compared to 70.1% at December 31, 2006. In addition, the Company has the
        ability
        to take advantage of various other funding 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
        February 27, 2006, the Company announced a program to acquire in the open
        market
        or in any private transaction, from time-to-time and in accordance with
        applicable laws, rules and regulations, up to 1.0 million shares of the
        Company’s common stock. Management plans to utilize share repurchases to manage
        capital levels of the Company. The Company plans to effect the repurchase
        program through open-market purchases. During the quarter ended September
        30,
        2007, the Company repurchased 207,196 shares at a weighted average price
        of
        $15.15 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.
 
 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 September 30, 2007 and the minimum requirements are presented
        in the following table.
 
 Actual
              
              
              Minimum
                  Requirements
                To
                  Be Well Capitalized*(Dollars
                  in thousands)*
              
              Amount
              
              
              Ratio
              
              
              Amount
              
              
              Ratio**Capital
                  Bank Corporation**Total
                  capital (to risk weighted assets)
              
              $
              144,330
              
              
              
              11.64
              %
              
              $
              124,022
              
              
              
              10.00
              %Tier
                  I capital (to risk weighted assets)
              
              
              130,657
              
              
              
              10.54
              %
              
              
              74,413
              
              
              
              6.00
              %Tier
                  1 capital (to average assets)
              
              
              130,657
              
              
              
              9.49
              %
              
              
              68,851
              
              
              
              5.00
              %**Capital
                  Bank**Total
                  capital (to risk weighted assets)
              
              $
              140,841
              
              
              
              11.36
              %
              
              $
              123,960
              
              
              
              10.00
              %Tier
                  I capital (to risk weighted assets)
              
              
              127,168
              
              
              
              10.26
              %
              
              
              74,376
              
              
              
              6.00
              %Tier
                  1 capital (to average assets)
              
              
              127,168
              
              
              
              9.24
              %
              
              
              68,805
              
              
              
              5.00
              %
 
 The
        Company’s total capital to risk weighted assets, Tier I capital to risk weighted
        assets and Tier I capital to average assets on a consolidated basis as of
        December 31, 2006 were 11.92%, 10.76% and 9.42%, respectively.
 
 Shareholders’
        equity was $164.1 million, or $14.58 per share, at September 30, 2007.
        Management believes this level of shareholders’ equity provides adequate capital
        to support the Company’s growth and to maintain a well capitalized
        position.
 
 -
              23
              -
 Index
 **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, 2006, 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,
        2006
        to September 30, 2007.
 
 **Item
        4.  Controls and Procedures**
 
 The
        Company maintains disclosure controls and procedures that are designed to
        ensure
        that information required to be disclosed in the reports it files or submits
        under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded,
        processed, summarized and reported within the time periods specified in the
        rules and forms of the SEC, and that such information is accumulated and
        communicated to the Company’s management, including its Chief Executive Officer
        (“CEO”) and Chief Financial Officer (“CFO”), as appropriate, to allow timely
        decisions regarding disclosure. Management necessarily applies its judgment
        in
        assessing the costs and benefits of such controls and procedures, which,
        by
        their nature, can provide only reasonable assurance regarding management’s
        control objectives.
 
 As
        required by paragraph (b) of Rule 13a-15 under the Exchange Act, an evaluation
        was carried out under the supervision and with the participation of the
        Company’s management, including the CEO and CFO, of the effectiveness of the
        Company’s disclosure controls and procedures as of the end of the period covered
        by this report. 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 is a party or
        to
        which any of its 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.
  -
              24
              -
 Index
 **Our
        results are impacted by the economic conditions of our principal operating
        regions.**
 
 Our
        operations are concentrated throughout Central and Western North Carolina.
        As a
        result of this geographic concentration, our results may correlate to the
        economic conditions in these areas. Deterioration in economic conditions
        in any
        of these market areas, particularly in the industries on which these geographic
        areas depend, may adversely affect the quality of our loan portfolio and
        the
        demand for our products and services, and accordingly, our results of
        operations.
 
 **We
        are exposed to risks in connection with the loans we make.**
 
 A
        significant source of risk for us arises from the possibility that losses
        will
        be sustained because borrowers, guarantors and related parties may fail to
        perform in accordance with the terms of their loans. We have underwriting
        and
        credit monitoring procedures and credit policies, including the establishment
        and review of the allowance for loan losses, that we believe are appropriate
        to
        minimize this risk by assessing the likelihood of nonperformance, tracking
        loan
        performance and diversifying our loan portfolio. Such policies and procedures,
        however, may not prevent unexpected losses that could adversely affect our
        results of operations.
 
 **We
        compete with larger companies for business.**
 
 The
        banking and financial services business in our market areas continues to
        be a
        competitive field and is becoming more competitive as a result of:
 
 •
              changes
                  in regulations;•
              changes
                  in technology and product delivery systems; and•
              the
                  accelerating pace of consolidation among financial services
                  providers.
 
 We
        may
        not be able to compete effectively in our markets, and our results of operations
        could be adversely affected by the nature or pace of change in competition.
        We
        compete for loans, deposits and customers with various bank and nonbank
        financial services providers, many of which have substantially greater
        resources, including higher total assets and capitalization, greater access
        to
        capital markets and a broader offering of financial services.
 
 **Our
        trading volume has been low compared with larger banks.**
 
 The
        trading volume in the Company’s common stock on the NASDAQ Global Select Market
        has been comparable to other similarly-sized banks. Nevertheless, this trading
        is relatively low when compared with more seasoned companies listed on the
        NASDAQ Global Select Market or other consolidated reporting systems or stock
        exchanges. Thus, the market in the Company’s common stock may be limited in
        scope relative to other companies.
 
 **We
        depend heavily on our key management personnel.**
 
 The
        Company’s success depends in part on its ability to retain key executives and to
        attract and retain additional qualified management personnel who have experience
        both in sophisticated banking matters and in operating a small- to mid-size
        bank. Competition for such personnel is strong in the banking industry, and
        we
        may not be successful in attracting or retaining the personnel we require.
        We
        expect to effectively compete in this area by offering financial packages
        that
        include incentive-based compensation and the opportunity to join in the
        rewarding work of building a growing bank.
 
 **Technological
        advances impact our business.**
 
 The
        banking industry is undergoing technological changes with frequent introductions
        of new technology-driven products and services. In addition to improving
        customer services, the effective use of technology increases efficiency and
        enables financial institutions to reduce costs. Our future success will depend,
        in part, on our ability to address the needs of our customers by using
        technology to provide products and services that will satisfy customer demands
        for convenience as well as to create additional efficiencies in our operations.
        Many of our competitors have substantially greater resources than we do to
        invest in technological improvements. We may not be able to effectively
        implement new technology-driven products and services or successfully market
        such products and services to our customers.
 -
              25
              -
 Index
 **Government
        regulations may prevent or impact our ability to pay dividends, engage in
        acquisitions or operate in other ways.**
 
 Current
        and future legislation and the policies established by federal and state
        regulatory authorities will affect our operations. We are subject to supervision
        and periodic examination by the Federal Deposit Insurance Corporation and
        the
        North Carolina State Banking Commission. Banking regulations, designed primarily
        for the protection of depositors, may limit our growth and the return to
        you,
        our investors, by restricting certain of our activities, such as:
 
 •
              the
                  payment of dividends to our shareholders;•
              possible
                  mergers with, or acquisitions of or by, other
                  institutions;•
              our
                  desired investments;•
              loans
                  and interest rates on loans;•
              interest
                  rates paid on our deposits;•
              the
                  possible expansion of our branch offices; and/or•
              our
                  ability to provide securities or trust
                  services.
 
 We
        also
        are subject to capitalization guidelines set forth in federal legislation,
        and
        could be subject to enforcement actions to the extent that we are found by
        regulatory examiners to be undercapitalized. We cannot predict what changes,
        if
        any, will be made to existing federal and state legislation and regulations
        or
        the effect that such changes may have on our future business and earnings
        prospects. The cost of compliance with regulatory requirements including
        those
        imposed by the SEC may adversely affect our ability to operate
        profitably.
 
 **There
        are potential risks associated with future acquisitions and
        expansions.**
 
 We
        intend
        to continue to explore expanding our branch system through selective
        acquisitions of existing banks or bank branches in the Research Triangle
        area
        and other North Carolina markets. We cannot say with any certainty that we
        will
        be able to consummate, or if consummated, successfully integrate, future
        acquisitions, or that we will not incur disruptions or unexpected expenses
        in
        integrating such acquisitions. In the ordinary course of business, we evaluate
        potential acquisitions that would bolster our ability to cater to the small
        business, individual and residential lending markets in North Carolina. In
        attempting to make such acquisitions, we anticipate competing with other
        financial institutions, many of which have greater financial and operational
        resources. In addition, since the consideration for an acquired bank or branch
        may involve cash, notes or the issuance of shares of common stock, existing
        shareholders could experience dilution in the value of their shares of our
        common stock in connection with such acquisitions. Any given acquisition,
        if and
        when consummated, may adversely affect our results of operations or overall
        financial condition. In addition, we may expand our branch network through
        de
        novo branches in existing or new markets. These de novo branches will have
        expenses in excess of revenues for varying periods after opening, which could
        decrease our reported earnings.
 
 **Compliance
        with changing regulation of corporate governance and public disclosure may
        result in additional risks and expenses.**
 
 Changing
        laws, regulations and standards relating to corporate governance and public
        disclosure, including the Sarbanes-Oxley Act of 2002 and new SEC regulations,
        are creating uncertainty for companies such as ours. These laws, regulations
        and
        standards are subject to varying interpretations in many cases, and as a
        result,
        their application in practice may evolve over time as new guidance is provided
        by regulatory and governing bodies, which could result in continuing uncertainty
        regarding compliance matters and higher costs necessitated by ongoing revisions
        to disclosure and governance practices. We are committed to maintaining high
        standards of corporate governance and public disclosure. As a result, our
        efforts to comply with evolving laws, regulations and standards have resulted
        in, and are likely to continue to result in, increased expenses and a diversion
        of management time and attention. In particular, our efforts to comply with
        Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations
        regarding management’s required assessment of our internal control over
        financial reporting and our external auditors’ audit of that assessment has
        required the commitment of significant financial and managerial
        resources.
 
 -
              26
              -
 Index
 We
        expect
        these efforts to require the continued commitment of significant resources.
        Further, the members of our Board of Directors, members of the Audit or
        Compensation/Human Resources Committees, our chief executive officer, our
        chief
        financial officer and certain other of our executive officers could face
        an
        increased risk of personal liability in connection with the performance of
        their
        duties. As a result, our ability to attract and retain executive officers
        and
        qualified Board and committee members could be more difficult. In addition,
        it
        may become more difficult and more expensive to obtain director and officer
        liability insurance.
 
 **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.
 
 **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.
 
 -
              27
              -
 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 that would have historically been held as
        bank
        deposits in brokerage accounts or mutual funds. 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 September 30, 2007 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 Announced Plans
                  or Programs
                  1
              
              Maximum
                  Number of Shares that May Yet Be Purchased under the Plans or
                  ProgramsJuly
                  2007
              
              
              –
              
              $
              –
              
              
              –
              
              
              566,043August
                  2007
              
              
              89,032
              
              $
              15.28
              
              
              89,032
              
              
              477,011September
                  2007
              
              
              118,164
              
              $
              15.06
              
              
              118,164
              
              
              358,847
 
 1
              On
                  February 27, 2006, the Company announced a program to repurchase
                  (in the
                  open market or in any private transaction), up to 1.0 million shares
                  of
                  the Company’s outstanding common stock. The repurchase program is for a
                  period of up to two years and supersedes the share repurchase program
                  authorized by the Company’s Board of Directors on December 22, 2004, which
                  authorized the repurchase of up to 100,000 shares. The Company
                  did not
                  acquire any shares under this former repurchase program. As of
                  September
                  30, 2007, there were an aggregate of 358,847 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
  -
              28
              -
 Index
 **Item
        6.  Exhibits**
  **Exhibit
                  No.**
              
              **Description**Exhibit
                  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 A. Christine Baker 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 A. Christine Baker 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.]
  -
              29
              -
 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 November
        2007.
  **CAPITAL
                  BANK CORPORATION**By:  /s/ 
                  *A. Christine Baker*A.
                  Christine
                  BakerChief
                  Financial Officer(Authorized
                  Officer and Principal Financial
                  Officer)
  -
              30
              -
 Index
 **EXHIBIT
        INDEX**
  **Exhibit
                  No.**
              
              **Description**Exhibit
                  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 A. Christine Baker 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 A. Christine Baker 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.]
  -
              31
              -
 Index