**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**FORM
      10-Q**





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


OF
      THE
      SECURITIES EXCHANGE ACT OF 1934




**For
      the Quarterly Period Ended June 30, 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
      August 6, 2007 there were 11,439,030 shares outstanding of the registrant’s
      common stock, no par value.





**CAPITAL
      BANK CORPORATION**


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








**INDEX**





**PART
                I – FINANCIAL INFORMATION**
            Page
                No.Item
                1.
            Financial
                StatementsCondensed
                Consolidated Balance Sheets as of June 30, 2007 (Unaudited) and December
                31, 2006
            3Condensed
                Consolidated Statements of Operations for the Three and Six Months
                Ended
                June 30, 2007 and 2006 (Unaudited)
            4Condensed
                Consolidated Statements of Changes in Shareholders’ Equity for the Six
                Months Ended June 30, 2007 and 2006 (Unaudited)
            5Condensed
                Consolidated Statements of Cash Flows for the Six Months Ended June
                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
            29Item
                6.
            Exhibits
            29Signatures





-
          2
          -
 INDEX


**PART
        I – FINANCIAL INFORMATION**





**Item
      1.                      Financial
      Statements**





**CAPITAL
      BANK CORPORATION**


**CONDENSED
      CONSOLIDATED BALANCE SHEETS**


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





June
                30, 2007
            
            
            December
                31, 2006*(Dollars
                in thousands except share data)*
            
            *(Unaudited)***ASSETS**Cash
                and due from banks:Interest
                earning
            
            $
            3,794
            
            
            $
            12,348Noninterest
                earning
            
            
            32,294
            
            
            
            33,504Federal
                funds sold and short term investments
            
            
            18,108
            
            
            
            8,480Investment
                securities – available for sale, at fair value
            
            
            231,352
            
            
            
            228,214Investment
                securities – held to maturity, at amortized cost
            
            
            10,314
            
            
            
            10,833Loans
                – net of unearned income and deferred fees
            
            
            1,022,147
            
            
            
            1,008,052Allowance
                for loan losses
            
            
            (13,339
            )
            
            
            (13,347
            )Net
                loans
            
            
            1,008,808
            
            
            
            994,705Premises
                and equipment, net
            
            
            24,137
            
            
            
            23,125Bank-owned
                life insurance
            
            
            21,075
            
            
            
            20,662Deposit
                premium and goodwill, net
            
            
            63,943
            
            
            
            64,543Other
                assets
            
            
            26,415
            
            
            
            25,970**Total
                assets**
            
            $
            1,440,240
            
            
            $
            1,422,384**LIABILITIES**Deposits:Demand,
                noninterest bearing
            
            $
            123,628
            
            
            $
            120,945Savings
                and interest-bearing demand deposits
            
            
            416,898
            
            
            
            366,243Time
                deposits
            
            
            532,453
            
            
            
            568,021Total
                deposits
            
            
            1,072,979
            
            
            
            1,055,209Repurchase
                agreements and federal funds purchased
            
            
            34,243
            
            
            
            34,238Borrowings
            
            
            125,914
            
            
            
            125,924Subordinated
                debentures
            
            
            30,930
            
            
            
            30,930Other
                liabilities
            
            
            13,772
            
            
            
            14,402**Total
                liabilities**
            
            
            1,277,838
            
            
            
            1,260,703**SHAREHOLDERS’
                EQUITY**Common
                stock, no par value; 20,000,000 authorized; 11,459,530 and 11,393,990
                issued and outstanding as of June 30, 2007 and December 31, 2006,
                respectively
            
            
            140,381
            
            
            
            139,484Retained
                earnings
            
            
            26,981
            
            
            
            23,754Accumulated
                other comprehensive loss
            
            
            (4,960
            )
            
            
            (1,557
            )**Total
                shareholders’ equity**
            
            
            162,402
            
            
            
            161,681**Total
                liabilities and shareholders’ equity**
            
            $
            1,440,240
            
            
            $
            1,422,384





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




-
          3
          -
 INDEX




**CONDENSED
      CONSOLIDATED STATEMENTS OF OPERATIONS**


**For
      the Three and Six Months Ended June 30, 2007 and 2006
      (Unaudited)**




Three
                Months EndedJune
                30,
            
            
            Six
                Months EndedJune
                30,*(Dollars
              in thousands except share and per share data)*
            
            2007
            
            
            2006
            
            
            2007
            
            
            2006Interest
                income:Loans
                and loan fees
            
            $
            20,519
            
            
            $
            18,646
            
            
            $
            40,402
            
            
            $
            35,664Investment
                securities
            
            
            2,858
            
            
            
            2,155
            
            
            
            5,665
            
            
            
            4,265Federal
                funds and other interest income
            
            
            291
            
            
            
            308
            
            
            
            776
            
            
            
            850Total
                interest income
            
            
            23,668
            
            
            
            21,109
            
            
            
            46,843
            
            
            
            40,779Interest
                expense:Deposits
            
            
            9,918
            
            
            
            7,328
            
            
            
            19,924
            
            
            
            13,438Borrowings
                and repurchase agreements
            
            
            2,496
            
            
            
            2,173
            
            
            
            4,942
            
            
            
            4,343Total
                interest expense
            
            
            12,414
            
            
            
            9,501
            
            
            
            24,866
            
            
            
            17,781Net
                interest income
            
            
            11,254
            
            
            
            11,608
            
            
            
            21,977
            
            
            
            22,998(Credit)
                provision for loan losses
            
            
            (91
            )
            
            
            249
            
            
            
            246
            
            
            
            661Net
                interest income after (credit) provision for loan losses
            
            
            11,345
            
            
            
            11,359
            
            
            
            21,731
            
            
            
            22,337Noninterest
                income:Service
                charges and other fees
            
            
            998
            
            
            
            1,061
            
            
            
            1,926
            
            
            
            2,026Mortgage
                fees and revenues
            
            
            580
            
            
            
            654
            
            
            
            1,121
            
            
            
            1,018Other
                noninterest income
            
            
            729
            
            
            
            897
            
            
            
            1,450
            
            
            
            1,583Total
                noninterest income
            
            
            2,307
            
            
            
            2,612
            
            
            
            4,497
            
            
            
            4,627Noninterest
                expense:Salaries
                and employee benefits
            
            
            5,314
            
            
            
            4,851
            
            
            
            10,408
            
            
            
            9,393Occupancy
            
            
            973
            
            
            
            938
            
            
            
            1,971
            
            
            
            1,716Furniture
                and equipment
            
            
            647
            
            
            
            562
            
            
            
            1,262
            
            
            
            1,054Director
                fees
            
            
            229
            
            
            
            283
            
            
            
            497
            
            
            
            659Data
                processing
            
            
            326
            
            
            
            111
            
            
            
            622
            
            
            
            600Advertising
            
            
            250
            
            
            
            324
            
            
            
            499
            
            
            
            579Amortization
                of deposit premiums
            
            
            300
            
            
            
            343
            
            
            
            600
            
            
            
            686Professional
                fees
            
            
            378
            
            
            
            354
            
            
            
            587
            
            
            
            566Other
                expenses
            
            
            1,371
            
            
            
            1,575
            
            
            
            2,578
            
            
            
            2,902Total
                noninterest expense
            
            
            9,788
            
            
            
            9,341
            
            
            
            19,024
            
            
            
            18,155Net
                income before tax expense
            
            
            3,864
            
            
            
            4,630
            
            
            
            7,204
            
            
            
            8,809Income
                tax expense
            
            
            1,188
            
            
            
            1,579
            
            
            
            2,144
            
            
            
            2,995Net
                income
            
            $
            2,676
            
            
            $
            3,051
            
            
            $
            5,060
            
            
            $
            5,814Earnings
                per share – basic
            
            $
            0.23
            
            
            $
            0.26
            
            
            $
            0.44
            
            
            $
            0.50Earnings
                per share – diluted
            
            $
            0.23
            
            
            $
            0.26
            
            
            $
            0.44
            
            
            $
            0.50Weighted
                average shares:Basic
            
            
            11,503,441
            
            
            
            11,639,014
            
            
            
            11,498,125
            
            
            
            11,628,015Fully
                diluted
            
            
            11,574,110
            
            
            
            11,726,584
            
            
            
            11,573,632
            
            
            
            11,715,510





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




-
          4
          -
 INDEX




**CAPITAL
      BANK CORPORATION**


**CONDENSED
      CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY**


**For
      the Six Months Ended June 30, 2007 and 2006 (Unaudited)**





Shares
                ofCommonStock
            
            
            Common
              Stock
            
            
            OtherComprehensiveIncome
            
            
            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
            
            
            (217,782
            )
            
            
            (3,496
            )
            
            
            –
            
            
            
            –
            
            
            
            (3,496
            )Issuance
                of common stock for acquisition of 1st State Bancorp, Inc.
            
            
            4,882,630
            
            
            
            74,499
            
            
            
            –
            
            
            
            –
            
            
            
            74,499Issuance
                of common stock for options exercised
            
            
            35,490
            
            
            
            380
            
            
            
            –
            
            
            
            –
            
            
            
            380Noncash
                compensation
            
            
            –
            
            
            
            58
            
            
            
            –
            
            
            
            –
            
            
            
            58Net
                income
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            5,814
            
            
            
            5,814Other
                comprehensive loss
            
            
            –
            
            
            
            –
            
            
            
            (1,589
            )
            
            
            –
            
            
            
            (1,589
            )Comprehensive
                income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            4,225Dividends
                ($0.12 per share)
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            (1,388
            )
            
            
            (1,388
            )**Balance
                at June 30, 2006**
            
            
            11,552,494
            
            
            $
            143,426
            
            
            $
            (3,261
            )
            
            $
            16,245
            
            
            $
            157,770**Balance
                at January 1, 2007**
            
            
            11,393,990
            
            
            $
            139,484
            
            
            $
            (1,557
            )
            
            $
            23,754
            
            
            $
            161,681Repurchase
                of outstanding common stock
            
            
            (2,386
            )
            
            
            (41
            )
            
            
            –
            
            
            
            –
            
            
            
            (41
            )Issuance
                of common stock for options exercised
            
            
            35,597
            
            
            
            441
            
            
            
            –
            
            
            
            –
            
            
            
            441Noncash
                compensation
            
            
            32,329
            
            
            
            497
            
            
            
            –
            
            
            
            –
            
            
            
            497Net
                income
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            5,060
            
            
            
            5,060Other
                comprehensive loss
            
            
            –
            
            
            
            –
            
            
            
            (3,403
            )
            
            
            –
            
            
            
            (3,403
            )Comprehensive
                income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,657Dividends
                ($0.16 per share)
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            (1,833
            )
            
            
            (1,833
            )**Balance
                at June 30, 2007**
            
            
            11,459,530
            
            
            $
            140,381
            
            
            $
            (4,960
            )
            
            $
            26,981
            
            
            $
            162,402





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


-
          5
          -
 INDEX




**CAPITAL
      BANK CORPORATION**


**CONDENSED
      CONSOLIDATED STATEMENTS OF CASH FLOWS**


**For
      the Six Months Ended June 30, 2007 and 2006 (Unaudited)**





June
                30, 2007
            
            
            June
                30, 2006*(Dollars
                in thousands)*Cash
                flows from operating activities:Net
                income
            
            $
            5,060
            
            
            $
            5,814Adjustments
                to reconcile net income to net cash usedin
                operating activities:Amortization
                of deposit premium
            
            
            600
            
            
            
            686Depreciation
            
            
            1,222
            
            
            
            1,019Loss
                (gain) on disposal of premises, equipment and real estate
                owned
            
            
            18
            
            
            
            (138
            )Change
                in held-for-sale loans, net
            
            
            (3,868
            )
            
            
            (3,958
            )Amortization
                of premiums on securities, net
            
            
            50
            
            
            
            73Deferred
                income tax (benefit) expense
            
            
            (163
            )
            
            
            3,258Issuance
                of stock for compensation
            
            
            497
            
            
            
            58Provision
                for loan losses
            
            
            246
            
            
            
            661Changes
                in assets and liabilities:Accrued
                interest receivable and other assets
            
            
            1,064
            
            
            
            3,101Accrued
                interest payable and other liabilities
            
            
            (863
            )
            
            
            550**Net
                cash provided by operating activities**
            
            
            3,863
            
            
            
            11,124Cash
                flows from investing activities:Loan
                originations, net of principal repayments
            
            
            (11,126
            )
            
            
            (58,670
            )Additions
                to premises and equipment
            
            
            (2,323
            )
            
            
            (3,124
            )Net
                sales of Federal Home Loan Bank stock
            
            
            931
            
            
            
            767Purchase
                of securities available for sale
            
            
            (24,020
            )
            
            
            (30,597
            )Proceeds
                from calls/maturities of securities available for sale
            
            
            15,388
            
            
            
            6,318Proceeds
                from sales of securities available for sale
            
            
            –
            
            
            
            102,396Proceeds
                from calls/maturities of securities held to maturity
            
            
            516
            
            
            
            397Net
                cash paid in merger transaction
            
            
            –
            
            
            
            (37,541
            )Proceeds
                from sales of premises, equipment and real estate owned
            
            
            71
            
            
            
            1,229**Net
                cash used in investing activities**
            
            
            (20,563
            )
            
            
            (18,825
            )Cash
                flows from financing activities:Net
                increase in deposits
            
            
            17,770
            
            
            
            55,433Net
                increase in repurchase agreements
            
            
            5
            
            
            
            13,490Net
                decrease in borrowings
            
            
            (10
            )
            
            
            (19,519
            )Repayment
                of short term debt
            
            
            –
            
            
            
            (30,000
            )Distribution
                of cash held in escrow
            
            
            –
            
            
            
            33,185Dividends
                paid
            
            
            (1,601
            )
            
            
            (1,106
            )Issuance
                of common stock for options and other plans
            
            
            441
            
            
            
            380Repurchase
                of common stock
            
            
            (41
            )
            
            
            (3,496
            )**Net
                cash provided by financing activities**
            
            
            16,564
            
            
            
            47,971Net
                change in cash and cash equivalents
            
            
            (136
            )
            
            
            40,270Cash
                and cash equivalents at beginning of period
            
            
            54,332
            
            
            
            43,904Cash
                and cash equivalents at end of period
            
            $
            54,196
            
            
            $
            84,174*(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 Six Months Ended June 30, 2007 and 2006 (Unaudited)**





June
                30, 2007
            
            
            June
                30, 2006*(Dollars
                in thousands)***Supplemental
                Disclosure of Cash Flow Information**Transfer
                of loans and premises and equipment to other real estate
                owned
            
            $
            645
            
            
            $
            2,327Dividends
                payable
            
            $
            916
            
            
            $
            693Cash
                paid for:Income
                taxes
            
            $
            2,720
            
            
            $
            371Interest
            
            $
            17,010
            
            
            $
            17,489Acquisition
                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


Capital
        Bank Corporation – Notes to Condensed Consolidated Financial Statements
        (Unaudited)
 
  **1.      Significant
          Accounting Policies and Interim Reporting**
 
 The
        accompanying unaudited condensed consolidated financial statements include
        the
        accounts of Capital Bank Corporation (the “Company”) and its wholly owned
        subsidiary, Capital Bank (the “Bank”). In addition, the Company has interests in
        three trusts, Capital Bank Statutory Trust I, II, and III (hereinafter
        collectively referred to as the “Trusts”). The Trusts have not been consolidated
        with the financial statements of the Company pursuant to the provisions of
        Financial Accounting Standards Board (“FASB”) Interpretation No. 46R,
*Consolidation of Variable Interest Entities*. The interim financial
        statements have been prepared in accordance with accounting principles generally
        accepted in the United States of America. They do not include all of the
        information and footnotes required by such accounting principles for complete
        financial statements, and therefore should be read in conjunction with the
        audited consolidated financial statements and accompanying footnotes in the
        Company’s Annual Report on Form 10-K for the year ended December 31,
        2006.


The
          preparation of financial statements in conformity with accounting principles
          generally accepted in the United States requires management to make estimates
          and assumptions that affect reported amounts of assets and liabilities
          and the
          reported amounts of revenues and expenses during the reporting period.
          The more
          significant estimates that are particularly susceptible to significant
          change
          relate to the determination of the allowance for loan losses, valuation
          of
          goodwill and intangible assets, valuation of investments, and tax assets,
          liabilities and expense. Actual results could differ from those
          estimates.
 
 In
          the
          opinion of management, all adjustments necessary for a fair presentation
          of the
          financial position and results of operations for the periods presented
          have been
          included, and all significant intercompany transactions have been eliminated
          in
          consolidation. All such adjustments are of a normal and recurring nature.
          Certain amounts reported in prior periods have been reclassified to conform
          to
          the current presentation. Such reclassifications have no effect on net
          income or
          shareholders’ equity as previously reported. The results of operations for the
          three and six months ended June 30, 2007 are not necessarily indicative
          of the
          results of operations that may be expected for the year ended December
          31,
          2007.
 
 The
          condensed consolidated balance sheet at December 31, 2006 has been derived
          from
          the audited consolidated financial statements contained in the Company’s Annual
          Report on Form 10-K for the year ended December 31, 2006.
 
 The
          accounting policies followed are as set forth in Note 1 of the Notes to
          Consolidated Financial Statements in the Company’s Annual Report on Form 10-K
          for the year ended December 31, 2006.
 
 The
            Company adopted the provisions of FASB Interpretation No. 48, “*Accounting
            for Uncertainty in Income Taxes—an interpretation of FASB Statement No.
            109,*” (“FIN 48”) effective January 1, 2007. FIN 48 prescribes a recognition
            threshold and measurement attribute for the financial statement recognition
            and
            measurement of a tax position taken or expected to be taken in a tax
            return. FIN
            48 clarifies the accounting for uncertain tax positions and requires
            the Company
            to recognize management’s best estimate of the impact of a tax position only if
            it is considered “more likely than not,” as defined in Statement of Financial
            Accounting Standards (“SFAS”) No. 5, *Accounting for Contingencies*, of
            being sustained on audit based solely on the technical merits of the
            tax
            position. FIN 48 also provides guidance on derecognition, classification,
            interest and penalties, accounting in interim periods, disclosure, and
            transition. The Company does not anticipate any changes in its current
            accounting policies associated with the adoption of FIN 48. The adoption
            of FIN
            48 has not had a material financial impact on the Company’s financial condition
            or results of operations.
 
 In
            September 2006, the FASB issued SFAS No. 157, “*Fair Value Measurements*”
(“SFAS No. 157”), which defines fair value, establishes a framework for
            measuring fair value, and expands disclosures about fair value measurements.
            SFAS No. 157 is effective for fiscal years beginning after November 15,
            2007.
            The Company is currently in the process of evaluating the provisions
            of SFAS No.
            157 and determining how this framework for measuring fair value will
            affect the
            Company’s current accounting policies and procedures and our financial
            statements, but does not expect the adoption of SFAS No. 157 to have
            a material
            impact on the Company’s financial condition or results of
            operations.
 
 In
          February 2007, the FASB issued SFAS No. 159,*“The Fair Value Option for
          Financial Assets and Financial Liabilities”*(“SFAS No. 159”), which permits
          entities to choose to measure financial instruments and certain other financial
          assets and financial liabilities at fair value. SFAS No. 159 is effective
          for
          fiscal years beginning after November 15, 2007. The Company is currently
          assessing the impact SFAS No. 159 will have on the Company’s financial position
          and results of operations, but does not expect the adoption of SFAS No.
          159 to
          have a material impact on the Company’s financial condition or results of
          operations.
  -
              8
              -
 INDEX
 Capital
        Bank Corporation – Notes to Condensed Consolidated Financial Statements
        (Unaudited)
 
  From
          time
          to time, the FASB issues exposure drafts for proposed statements of financial
          accounting standards. Such exposure drafts are subject to comment from
          the
          public, to revisions by the FASB and to final issuance by the FASB as statements
          of financial accounting standards. The Company considers the effect of
          the
          proposed statements on the financial statements of the Company and monitors
          the
          status of changes to, and proposed effective dates of, exposure
          drafts.
 
 **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 comprehensive income (loss) for the six month periods ended June
          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 six month periods ended
          June
          30, 2007 and 2006 is as follows:
 **Three
                  Month Period Ended June 30, 2007 and 2006
                  (Unaudited)**2007
              
              
              2006*(Dollars
                  in thousands)*Unrealized
                  losses on available-for-sale securities
              
              $
              (4,766
              )
              
              $
              (2,346
              )Unrealized
                  loss on change in fair value of cash flow hedge
              
              
              (877
              )
              
              
              –Income
                  tax benefit
              
              
              2,176
              
              
              
              94Other
                  comprehensive loss
              
              $
              (3,467
              )
              
              $
              (1,442
              )
 
 **Six
                  Month Period Ended June 30, 2007 and 2006
                  (Unaudited)**2007
              
              
              2006*(Dollars
                  in thousands)*Unrealized
                  losses on available-for-sale securities
              
              $
              (4,516
              )
              
              $
              (2,585
              )Unrealized
                  loss on change in fair value of cash flow hedge
              
              
              (942
              )
              
              
              –Income
                  tax benefit
              
              
              2,055
              
              
              
              996Other
                  comprehensive loss
              
              $
              (3,403
              )
              
              $
              (1,589
              )
 
 **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 six month periods
          ended June 30, 2007 and 2006, respectively.
 **Three
                  Month Period Ended June 30, 2007 and 2006
                  (Unaudited)**2007
              
              
              2006*(Dollars
                  in thousands except share data)*Income
                  available to shareholders – basic and diluted
              
              $
              2,676
              
              
              $
              3,051Shares
                  used in the computation of earnings per share:Weighted
                  average number of shares outstanding – basic
              
              
              11,503,441
              
              
              
              11,639,014Incremental
                  shares from assumed exercise of stock options
              
              
              70,669
              
              
              
              87,570Weighted
                  average number of shares outstanding – diluted
              
              
              11,574,110
              
              
              
              11,726,584
  -
              9
              -
 INDEX
 Capital
        Bank Corporation – Notes to Condensed Consolidated Financial Statements
        (Unaudited)
 
  **Six
                    Month Period Ended June 30, 2007 and 2006
                    (Unaudited)**2007
                
                
                2006*(Dollars
                    in thousands except share data)*Income
                    available to shareholders – basic and diluted
                
                $
                5,060
                
                
                $
                5,814Shares
                    used in the computation of earnings per share:Weighted
                    average number of shares outstanding – basic
                
                
                11,498,125
                
                
                
                11,628,015Incremental
                    shares from assumed exercise of stock options
                
                
                75,507
                
                
                
                87,495Weighted
                    average number of shares outstanding – diluted
                
                
                11,573,632
                
                
                
                11,715,510
  For
              the
              three and six month periods ended June 30, 2007 and 2006, options to
              purchase
              approximately 299,000 shares and 383,000 shares, respectively, of common
              stock
              were used in the diluted calculation. For
              the
              three and six month periods ended June 30, 2007 and 2006, options to
              purchase
              approximately 64,000 shares and 74,000 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 June 30, 2007,
          options for 183,209 shares 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 approximately 131,015 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. For the six month periods
          ended
          June 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 six months ended June 30, 2007.
 Number
                    of
                      Shares
                  
                  
                  WeightedAverageExercise
                      Price
                  
                  
                  Weighted
                      AverageRemaining ContractualTerm in Years
                  
                  
                  AggregateIntrinsic
                      Value*(Dollars
                      in thousands except share data)*Outstanding
                      at January 1, 2007
                  
                  
                  389,715
                  
                  
                  $
                  11.75Granted
                  
                  
                  9,000
                  
                  
                  
                  16.89Exercised
                  
                  
                  (35,597
                  )
                  
                  
                  8.59Outstanding
                      at June 30, 2007
                  
                  
                  363,118
                  
                  
                  $
                  12.18
                  
                  
                  
                  4.53
                  
                  
                  $
                  1,766Options
                      exercisable at June 30, 2007
                  
                  
                  354,118
                  
                  
                  $
                  12.06
                  
                  
                  
                  4.39
                  
                  
                  $
                  1,766
 -
            10
            -
 INDEX
 Capital
        Bank Corporation – Notes to Condensed Consolidated Financial Statements
        (Unaudited)
 
  The
          following table summarizes information about the Company’s stock options at June
          30, 2007.
 
 Exercise
                  Price
              Number
                  Outstanding
              
              Weighted
                  Average
                Remaining
                  Contractual Life in Years
              
              Number
                  Exercisable$6.62
                  – $9.00
              107,165
              
              2.91
              
              107,165$9.01
                  – $12.00
              87,702
              
              4.17
              
              87,702$12.01
                  – $15.00
              33,750
              
              1.53
              
              33,750$15.01
                  – $18.00
              67,751
              
              6.28
              
              67,751$18.01
                  – $18.37
              57,750
              
              7.49
              
              57,750354,118
              
              4.53
              
              354,118
  The
          fair
          values of the options granted prior to January 1, 2006 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 when changed can materially affect fair value estimates.
          The expected life of the options used in this calculation was the period
          the
          options are expected to be outstanding. Expected stock price volatility
          was
          based on the historical volatility of the Company’s common stock for a period
          approximating the expected life; the expected dividend yield was based
          on the
          Company’s historical annual dividend payout; and the risk-free rate was based on
          the implied yield available on U.S. Treasury issues.
  **5.      Investment
        Securities**
 
 The
        following table shows the gross unrealized losses and fair value of the
        Company’s investments with unrealized losses that are not deemed to be
        other-than-temporarily impaired, aggregated by investment category and length
        of
        time that individual securities have been in a continuous unrealized loss
        position, at June 30, 2007.
  Less
                  than 12 Months
              
              
              12
                  Months or Greater
              
              
              Total(*Dollars
                  in thousands)*
              
              FairValue
              
              
              UnrealizedLosses
              
              
              FairValue
              
              
              UnrealizedLosses
              
              
              FairValue
              
              
              UnrealizedLosses**Available
                  for Sale**U.S.
                  agency securities
              
              $
              37,439
              
              
              $
              408
              
              
              $
              36,441
              
              
              $
              890
              
              
              $
              73,880
              
              
              $
              1,298Municipal
                  bonds
              
              
              63,277
              
              
              
              3,038
              
              
              
              8,060
              
              
              
              244
              
              
              
              71,337
              
              
              
              3,282Mortgage-backed
                  securities
              
              
              14,628
              
              
              
              192
              
              
              
              51,199
              
              
              
              2,543
              
              
              
              65,827
              
              
              
              2,735115,344
              
              
              
              3,638
              
              
              
              95,700
              
              
              
              3,677
              
              
              
              211,044
              
              
              
              7,315**Held
                  to Maturity**U.S.
                  agency securities
              
              
              –
              
              
              
              –
              
              
              
              3,909
              
              
              
              90
              
              
              
              3,909
              
              
              
              90Municipal
                  bonds
              
              
              –
              
              
              
              –
              
              
              
              288
              
              
              
              12
              
              
              
              288
              
              
              
              12Mortgage-backed
                  securities
              
              
              –
              
              
              
              –
              
              
              
              5,769
              
              
              
              248
              
              
              
              5,769
              
              
              
              248–
              
              
              
              –
              
              
              
              9,966
              
              
              
              350
              
              
              
              9,966
              
              
              
              350Total
                  at June 30, 2007
              
              $
              115,344
              
              
              $
              3,638
              
              
              $
              105,666
              
              
              $
              4,027
              
              
              $
              221,010
              
              
              $
              7,665
 
 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 maturity. Accordingly,
        the Company does not consider these investments to be other-than-temporarily
        impaired at June 30, 2007.
  -
            11
            -
 INDEX
 Capital
        Bank Corporation – Notes to Condensed Consolidated Financial Statements
        (Unaudited)
 
  **6.      Loans**
 
 The
        composition of the loan portfolio by loan classification at June 30, 2007
        and
        December 31, 2006 was as follows:
 
 June
                  30, 2007
              
              
              December
                  31, 2006*(Dollars
                  in thousands)*
              
              *(Unaudited)*Commercial
              
              $
              608,813
              
              
              $
              593,410Construction
              
              
              249,443
              
              
              
              250,308Consumer
              
              
              34,188
              
              
              
              30,806Home
                  equity lines
              
              
              80,580
              
              
              
              83,231Mortgage
              
              
              48,896
              
              
              
              50,0991,021,920
              
              
              
              1,007,854Plus
                  deferred loan costs, net
              
              
              227
              
              
              
              198$
              1,022,147
              
              
              $
              1,008,052
 
 Loans
        held for sale as of June 30, 2007 and December 31, 2006 were $11.1 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 credit risk as of June 30, 2007 and December 31, 2006 was
            as follows:
 
 June
                    30, 2007
                
                
                December
                    31, 2006*(Dollars
                    in thousands)*
                
                *(Unaudited)*Unused
                    lines of credit and overdraft lines
                
                $
                208,303
                
                
                $
                187,163Standby
                    letters of credit
                
                
                2,394
                
                
                
                12,698Total
                    commitments
                
                $
                210,697
                
                
                $
                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 six months ended June 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 June 30, 2007.
 
 •
                The
                    Company reported net income for the quarter ended June 30, 2007
                    of $2.7
                    million compared to $3.1 million for the quarter ended June 30,
                    2006.
                    Fully diluted earnings per share were $0.23 and $0.26 for the
                    quarter
                    ended June 30, 2007 and 2006, respectively. The
                    decrease in net income was primarily due to a $354,000 decrease
                    in net
                    interest income, which reflects a 39 basis point (“bp”) decrease in the
                    net interest margin as a result of the rising cost of funds and
                    a $447,000
                    increase in noninterest expense, primarily due to higher compensation
                    costs, offset by a $391,000 decrease in income tax expense due
                    to an
                    increase in tax-exempt investment income.•
                The
                    provision for loan losses for the quarter ended June 30, 2007
                    was a credit
                    of ($91,000) compared to $249,000 for the quarter ended June
                    30, 2006. The
                    decrease in the provision for loan losses is primarily due to
                    revisions to
                    the Company’s loan loss allowance estimation
                    methodology.•
                Net
                    interest income for the quarter ended June 30, 2007 decreased
                    to $11.3
                    million, a 3.1% decline from the $11.6 million earned in the
                    quarter ended June 30, 2006. The decrease in net interest income
                    is
                    primarily due to a 71 bps increase in the cost of funds compared
                    to a 22
                    bps increase in the yield on earning assets.•
                Noninterest
                    income for the quarter ended June 30, 2007 decreased $305,000
                    to $2.3
                    million compared to $2.6 million in the quarter ended June 30,
                    2006. This
                    decrease is primarily due to lower mortgage fees and revenues
                    as a result
                    of decreased volume and a $138,000 gain realized on the sale
                    of a closed
                    branch location in the quarter ended June 30, 2006.•
                Noninterest
                    expense was $9.8 million for the quarter ended June 30, 2007
                    compared to
                    $9.3 million for the quarter ended June 30, 2006. The increase
                    is
                    primarily due to higher salaries and employee benefits, which
                    increased by
                    $463,000 in the quarter ended June 30, 2007 compared to the quarter
                    ended
                    June 30, 2006. The increase in salaries and employee benefits
                    was
                    primarily due to the addition of sales associates during
                    2007.
 
 ***Financial
          Condition***
 
 Total
            consolidated assets of the Company at June 30, 2007 were $1.44 billion
            compared
            to $1.42 billion at December 31, 2006, an increase of $17.9 million.
            The
            increase in total consolidated assets for the six months ended June 30,
            2007 is
            primarily due to a $14.1 million increase in the Bank’s loan portfolio, net of
            the allowance for loan losses, since December 31, 2006. Total deposits
            as of
            June 30, 2007 were $1.07 billion, which represents growth of $17.8 million
            from
            December 31, 2006.
 
 Total
            earning assets were $1.29 billion at June 30, 2007 compared to $1.27
            billion at
            December 31, 2006. Earning assets represented 89.2% and 89.1% of total
            assets as
            of June 30, 2007 and December 31, 2006, respectively. At June 30, 2007,
            investment securities were $241.7 million, compared to $239.1 million
            at
            December 31, 2006. Interest-earning cash, federal funds sold and short
            term
            investments were $21.9 million at June 30, 2007 compared to $20.8 million
            at
            December 31, 2006.
 
 The
            allowance for loan losses as of June 30, 2007 and December 31, 2006 was
            $13.3
            million and represented approximately 1.31% 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 probable losses inherent in the current
            loan
            portfolio. See *“Asset Quality”* below for further discussion of the
            allowance for loan losses***.***
 
 Total
            deposits as of June 30, 2007 were $1.07 billion, an increase of $17.8
            million,
            or 1.9%, from December 31, 2006. The increase was primarily due to a
            $42.9
            million increase in money market deposits offset by a $35.0 million decrease
            in
            time deposits. Total time deposits represented 49.6% of total deposits
            at June
            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
            over 1,300 new accounts during the quarter ended June 30, 2007. As of
            June 30,
            2007, there were over 5,800 *Smart Checking* accounts and $28.1 million
            of deposits associated with this product.
  -
              14
              -
 INDEX
 Noninterest-bearing
            demand deposit accounts (“DDA”) were $123.6 million at June 30, 2007, an
            increase of $2.7 million from December 31, 2006. The average balance
            of
            noninterest DDA accounts was $112.5 million during the quarter ended
            June 30,
            2007 compared to $105.5 million during the quarter ended June 30,
            2006.
 
 Total
            consolidated shareholders’ equity was $162.4 million as of June 30, 2007, an
            increase of $721,000 from December 31, 2006. Retained earnings increased
            by $3.2
            million, reflecting $5.1 million of net income for the six months ended
            June 30,
            2007 less $1.9 million of dividends paid during the six months ended
            June 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 $5.0 million and $1.6 million
            as of
            June 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 June 30, 2007 compared to quarter ended June 30,
          2006**
 
 For
            the
            quarter ended June 30, 2007, the Company reported net income of $2.7
            million, or
            $0.23 per diluted share, compared to net income of $3.1 million, or $0.26
            per
            diluted share, for the quarter ended June 30, 2006. Net income decreased
            by
            $375,000, primarily due to margin compression as a result of the rising
            costs of
            funds. The Company’s net interest margin, on a fully taxable equivalent basis,
            for the quarter ended June 30, 2007 decreased by 39 bps compared to the
            net
            interest margin for the quarter ended June 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.
 
 Net
            interest income decreased $354,000, or 3.1%, from $11.6 million for the
            quarter
            ended June 30, 2006, to $11.3 million for the quarter ended June 30,
            2007.
            Average earning assets increased $121.0 million to $1.29 billion for
            the quarter
            ended June 30, 2007 from $1.17 billion for the quarter ended June 30,
            2006.
            Average interest-bearing liabilities increased $98.5 million to $1.15
            billion
            for the quarter ended June 30, 2007 from $1.05 billion for the quarter
            ended
            June 30, 2006. The net interest margin on a fully taxable equivalent
            basis
            decreased by 39 bps to 3.65% for the quarter ended June 30, 2007 from
            4.04% for
            the quarter ended June 30, 2006. The earned yield on average interest-earning
            assets was 7.51% and 7.29% for the quarter ended June 30, 2007 and 2006,
            respectively, while the interest rate on average interest-bearing liabilities
            for those periods was 4.34% and 3.63%, 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
            current static interest rate environment and competitive pressures in
            the
            Company’s primary markets. The majority of the Company’s loans are prime based,
            which has remained flat while the interest-bearing deposits are impacted
            more by
            rates paid by competitors.
  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 June 30, 2007 and 2006 (Unaudited)**
 Taxable
            Equivalent Basis 1
 June
                      30, 2007
                  
                  
                  June
                      30, 2006*(Dollars
                      in thousands)*
                  
                  Average
                      Balance
                  
                  
                  AmountEarned/Paid
                  
                  
                  Average
                      Rate
                  
                  
                  Average
                      Balance
                  
                  
                  AmountEarned/Paid
                  
                  
                  Average
                      Rate**Assets**Loans
                      receivable 2
                  
                  $
                  1,021,517
                  
                  
                  $
                  20,519
                  
                  
                  
                  8.06
                  %
                  
                  $
                  954,420
                  
                  
                  $
                  18,648
                  
                  
                  
                  7.84
                  %Investment
                      securities 3
                  
                  
                  248,850
                  
                  
                  
                  3,382
                  
                  
                  
                  5.45
                  %
                  
                  
                  190,045
                  
                  
                  
                  2,345
                  
                  
                  
                  4.95
                  %Federal
                      funds sold and other interest on short term investments
                  
                  
                  22,284
                  
                  
                  
                  291
                  
                  
                  
                  5.24
                  %
                  
                  
                  27,183
                  
                  
                  
                  308
                  
                  
                  
                  4.94
                  %Total
                      interest earning assets
                  
                  
                  1,292,651
                  
                  
                  $
                  24,192
                  
                  
                  
                  7.51
                  %
                  
                  
                  1,171,648
                  
                  
                  $
                  21,301
                  
                  
                  
                  7.29
                  %Cash
                      and due from banks
                  
                  
                  27,489
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  32,202Other
                      assets
                  
                  
                  129,972
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  133,222Allowance
                      for loan losses
                  
                  
                  (13,528
                  )
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (14,291
                  )Total
                      assets
                  
                  $
                  1,436,584
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  1,322,781**Liabilities
                      and Equity**Savings
                      deposits
                  
                  $
                  33,664
                  
                  
                  $
                  44
                  
                  
                  
                  0.52
                  %
                  
                  $
                  41,477
                  
                  
                  $
                  52
                  
                  
                  
                  0.50
                  %Interest-bearing
                      demand deposits
                  
                  
                  377,274
                  
                  
                  
                  3,264
                  
                  
                  
                  3.47
                  %
                  
                  
                  279,029
                  
                  
                  
                  1,981
                  
                  
                  
                  2.85
                  %Time
                      deposits
                  
                  
                  554,979
                  
                  
                  
                  6,610
                  
                  
                  
                  4.78
                  %
                  
                  
                  564,025
                  
                  
                  
                  5,296
                  
                  
                  
                  3.77
                  %Total
                      interest-bearing deposits
                  
                  
                  965,917
                  
                  
                  
                  9,918
                  
                  
                  
                  4.12
                  %
                  
                  
                  884,531
                  
                  
                  
                  7,329
                  
                  
                  
                  3.32
                  %Borrowed
                      funds
                  
                  
                  119,978
                  
                  
                  
                  1,567
                  
                  
                  
                  5.24
                  %
                  
                  
                  107,724
                  
                  
                  
                  1,287
                  
                  
                  
                  4.79
                  %Subordinated
                      debt
                  
                  
                  30,930
                  
                  
                  
                  592
                  
                  
                  
                  7.68
                  %
                  
                  
                  30,930
                  
                  
                  
                  596
                  
                  
                  
                  7.73
                  %Repurchase
                      agreements
                  
                  
                  31,696
                  
                  
                  
                  337
                  
                  
                  
                  4.26
                  %
                  
                  
                  26,884
                  
                  
                  
                  289
                  
                  
                  
                  4.31
                  %Total
                      interest-bearing liabilities
                  
                  
                  1,148,521
                  
                  
                  $
                  12,414
                  
                  
                  
                  4.34
                  %
                  
                  
                  1,050,069
                  
                  
                  $
                  9,501
                  
                  
                  
                  3.63
                  %Noninterest-bearing
                      deposits
                  
                  
                  112,513
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  105,506Other
                      liabilities
                  
                  
                  10,673
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  5,885Total
                      liabilities
                  
                  
                  1,271,707
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  1,161,460Shareholders’
                      equity
                  
                  
                  164,877
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  161,321Total
                      liabilities and shareholders’ equity
                  
                  $
                  1,436,584
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  1,322,781Net
                      interest spread 4
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  3.17
                  %
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  3.66
                  %Tax
                      equivalent adjustment
                  
                  
                  
                  
                  
                  $
                  524
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  192Net
                      interest income and net interest margin 5
                  
                  
                  
                  
                  
                  $
                  11,778
                  
                  
                  
                  3.65
                  %
                  
                  
                  
                  
                  
                  $
                  11,800
                  
                  
                  
                  4.04
                  %
 
 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 nonaccrual loans for which accrual of interest
                      has not
                      been recorded and mortgage 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 $18.6 million for the quarter ended
              June 30, 2006
              to $20.5 million for the quarter ended June 30, 2007. The increase
              is primarily
              due to higher average loan balances, which increased by $67.1 million,
              primarily
              due to organic net loan growth, and higher loan yields. Higher yields
              in 2007
              reflect the increase in the prime rate charged by the Bank between
              the quarters
              ended June 30, 2007 and 2006. The Company’s prime rate was 8.25% as of June 30,
              2007 and as of June 30, 2006, however the last change in the prime
              rate was in
              late June 2006. 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 June
              30,
              2007.
 
 Interest
              income on investment securities increased from $2.2 million for the
              quarter
              ended June 30, 2006 to $2.9 million for the quarter ended June 30,
              2007. The
              increase is primarily due to a $58 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 acquired
              in the
              second half of 2006. The yield on investment securities on a fully
              taxable
              equivalent basis increased from 4.95% for the quarter ended June 30,
              2006 to
              5.45% for the quarter ended June 30, 2007.
 
 Interest
              expense on deposits increased from $7.3 million for the quarter ended
              June 30,
              2006 to $9.9 million for the quarter ended June 30, 2007. The increase
              is
              primarily due to a $81.4 million increase in the average balance of
              interest-bearing deposits outstanding, due to organic deposit growth
              and higher
              deposit rates. The average rate paid on total interest-bearing deposits
              increased from 3.32% for the quarter ended June 30, 2006 to 4.12% for
              the
              quarter ended June 30, 2007, a 80 bps rise. The rate paid on time deposits,
              which represented 57.5% and 63.8% of total average interest-bearing
              deposits for
              the quarters ended June 30, 2007 and 2006, respectively, increased
              from 3.77%
              for the quarter ended June 30, 2006 to 4.78 % for the quarter ended
              June 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 $2.2 million for the quarter ended
              June 30,
              2006 to $2.5 million for the quarter ended June 30, 2007, primarily
              due to an
              increase in overall borrowing rates. The rate on borrowings and subordinated
              debentures for the quarter ended June 30, 2007 was 5.24% and 7.68%,
              respectively, compared to 4.79% and 7.73%, respectively, for the quarter
              ended
              June 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 $100,000 for the
              quarters
              ended June 30, 2007 and 2006, respectively.
 
 For
              the
              quarter ended June 30, 2007, the provision for loan losses was a credit
              of
              ($91,000) compared to $249,000 for the quarter ended June 30, 2006,
              a decrease
              of $340,000. The decrease in the provision for loan losses reflects
              slower net
              loan growth in the quarter and the effects of revisions made to the
              Company’s
              allowance for loan loss estimation methodology as discussed more fully
              below
              under “*Asset**Qualit**y**.**”* Net
              charge-offs for the quarter ended June 30, 2007 were $101,000, or 0.04%
              of
              average loans, compared to $523,000, or 0.22% of average loans for
              the quarter
              ended June 30, 2006. Total nonperforming assets and past due loans
              decreased
              from $9.3 million and $16.2 million, respectively, as of March 31,
              2007 to $8.5
              million and $13.0 million, respectively, as of June 30, 2007. Past
              due loans
              consists of all loans past due 30 days or more.
 
 Noninterest
              income for the quarter ended June 30, 2007 was $2.3 million compared
              to $2.6
              million for the quarter ended June 30, 2006, a decrease of $305,000.
              This
              decrease was primarily due to a $74,000 decrease in mortgage fees and
              revenues
              as a result of a lower volume of mortgage originations. Service charges
              and
              other fees decreased $63,000, primarily due to lower service charges and
              nonsufficient fund fees, offset partially by an increase in interchange
              income
              from the***Smart Checking* product. The Company also
              recognized a $138,000 gain from the sale of a consolidated branch location
              in
              the quarter ended June 30, 2006.
 
 Noninterest
              expense for the quarter ended June 30, 2007 was $9.8 million compared
              to $9.3
              million for the quarter ended June 30, 2006. Salaries and employee
              benefits,
              representing the largest noninterest expense category, increased to
              $5.3 million
              for the quarter ended June 30, 2007, from $4.9 million for the quarter
              ended
              June 30, 2006. The increase in salaries and employee benefits was primarily
              due
              to salary increases and staff additions. As of June 30, 2007, the Company
              had
              340 full-time equivalent employees compared to 326 at June 30,
              2006.
  -
                  17
                  -
 INDEX
  Occupancy
            costs, the second largest component of noninterest expense, increased
            $35,000 from $938,000 for the quarter ended June 30, 2006 to $973,000 for
            the quarter ended June 30, 2007. The increase is primarily due to the
            higher
            rent expenses related to the Company’s new headquarters. Furniture and equipment
            expenses for the quarter ended June 30, 2007 increased $85,000 from the
            same
            period in 2006, primarily due to higher depreciation expenses associated
            with
            computer equipment acquired for the Company’s operations center. Data processing
            expenses for the quarter ended June 30, 2007 increased $215,000 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 June 30, 2007
            decreased $54,000 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 June 30, 2007 decreased $74,000
            from
            the same period in 2006, primarily due to the state wide marketing campaign
            associated with the introduction of *Smart Checking* in 2006. Other
            expenses for the quarter ended June 30, 2007 decreased $204,000 from
            the same
            period in 2006, primarily due to lower costs associated with telecommunications,
            operational losses and office supplies, which decreased by $138,000,
            $77,000 and
            $68,000, respectively, partially offset by an increase of $51,000 in
            the
            provision for off-balance-sheet credit risk associated with unfunded
            commitments.
 Income
              tax expense for the quarters ended June 30, 2007 and 2006 was $1.2
              million and
              $1.6 million, respectively. The Company’s effective tax rate for the quarter
              ended June 30, 2007 was 30.7 % compared to 34.1% for the quarter ended
              June 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
              June 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***
 
 **Six
            month period ended June 30, 2007 compared to six month period ended June
            30,
            2006**
 
 For
              the
              six month period ended June 30, 2007, the Company reported net income
              of $5.1
              million, or $0.44 per diluted share, compared to net income of $5.8
              million, or
              $0.50 per diluted share, for the six month period ended June 30, 2006.
              Net
              income decreased by $754,000, primarily due to lower net interest income,
              which
              decreased due to a lower net interest margin and higher noninterest
              expense.
 
 Net
              interest income decreased $1.0 million, or 4.4%, from $23.0 million
              for the six
              month period ended June 30, 2006, to $22.0 million for the six month
              period
              ended June 30, 2007. Average earning assets increased $127.4 million
              to $1.29
              billion for the six month period ended June 30, 2007 from $1.17 billion
              for the
              six month period ended June 30, 2006. Average interest-bearing liabilities
              increased $113.0 million to $1.15 billion for the six month period
              ended June
              30, 2007 from $1.04 billion for the six month period ended June 30,
              2006. The
              net interest margin on a fully taxable equivalent basis decreased 46
              bps to
              3.59% for the six month period ended June 30, 2007 from 4.05% for the
              six month
              period ended June 30, 2006. The earned yield on average interest-earning
              assets
              was 7.47% and 7.12% for the six month periods ended June 30, 2007 and
              2006,
              respectively, while the interest rate on average interest-bearing liabilities
              for those same periods was 4.35% and 3.44%, 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 3.11% for the six month period ended June 30, 2006 to 4.13% for
              the six
              month period ended June 30, 2007, an increase of 102 bps. However,
              the average
              yield on the loan portfolio increased from 7.66% for the six month
              period ended
              June 30, 2006 to 8.01% for the six month period ended June 30, 2007,
              an increase
              of 35 bps. The Company expects its net interest margin will continue
              to
              experience compression in the second half of 2007 based on Fed Funds
              rate
              projections for the remainder of 2007.
  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**
 **Six
            Months Ended June 30, 2007 and 2006**
 Taxable
            Equivalent Basis 1
  2007
                    
                    
                    2006*(Dollars
                        in thousands)*
                    
                    Average
                        Balance
                    
                    
                    AmountEarned/Paid
                    
                    
                    Average
                        Rate
                    
                    
                    Average
                        Balance
                    
                    
                    AmountEarned/Paid
                    
                    
                    Average
                        Rate**Assets**Loans
                        receivable 2
                    
                    $
                    1,017,000
                    
                    
                    $
                    40,402
                    
                    
                    
                    8.01
                    %
                    
                    $
                    939,185
                    
                    
                    $
                    35,666
                    
                    
                    
                    7.66
                    %Investment
                        securities 3
                    
                    
                    246,291
                    
                    
                    
                    6,685
                    
                    
                    
                    5.47
                    %
                    
                    
                    192,290
                    
                    
                    
                    4,648
                    
                    
                    
                    4.87
                    %Federal
                        funds sold and other interest on short term investments
                    
                    
                    29,440
                    
                    
                    
                    776
                    
                    
                    
                    5.32
                    %
                    
                    
                    33,830
                    
                    
                    
                    850
                    
                    
                    
                    5.07
                    %Total
                        interest-earnings assets
                    
                    
                    1,292,731
                    
                    
                    $
                    47,863
                    
                    
                    
                    7.47
                    %
                    
                    
                    1,165,305
                    
                    
                    $
                    41,164
                    
                    
                    
                    7.12
                    %Cash
                        and due from banks
                    
                    
                    27,541
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    31,788Other
                        assets
                    
                    
                    130,049
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    135,454Allowance
                        for loan losses
                    
                    
                    (13,412
                    )
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (15,723
                    )Total
                        assets
                    
                    $
                    1,436,909
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    $
                    1,316,824**Liabilities
                        and Equity**Savings
                        deposits
                    
                    $
                    34,017
                    
                    
                    $
                    86
                    
                    
                    
                    0.51
                    %
                    
                    $
                    42,646
                    
                    
                    
                    112
                    
                    
                    
                    0.53
                    %Interest-bearing
                        demand deposits
                    
                    
                    360,044
                    
                    
                    
                    6,186
                    
                    
                    
                    3.46
                    %
                    
                    
                    272,357
                    
                    
                    
                    3,530
                    
                    
                    
                    2.61
                    %Time
                        deposits
                    
                    
                    577,922
                    
                    
                    
                    13,652
                    
                    
                    
                    4.76
                    %
                    
                    
                    556,121
                    
                    
                    
                    9,797
                    
                    
                    
                    3.55
                    %Total
                        interest-bearing deposits
                    
                    
                    971,983
                    
                    
                    
                    19,924
                    
                    
                    
                    4.13
                    %
                    
                    
                    871,124
                    
                    
                    
                    13,439
                    
                    
                    
                    3.11
                    %Borrowed
                        funds
                    
                    
                    116,832
                    
                    
                    
                    3,070
                    
                    
                    
                    5.30
                    %
                    
                    
                    111,043
                    
                    
                    
                    2,613
                    
                    
                    
                    4.75
                    %Subordinated
                        debt
                    
                    
                    30,930
                    
                    
                    
                    1,178
                    
                    
                    
                    7.68
                    %
                    
                    
                    31,752
                    
                    
                    
                    1,193
                    
                    
                    
                    7.58
                    %Repurchase
                        agreements
                    
                    
                    33,012
                    
                    
                    
                    694
                    
                    
                    
                    4.24
                    %
                    
                    
                    25,868
                    
                    
                    
                    536
                    
                    
                    
                    4.18
                    %Total
                        interest-bearing liabilities
                    
                    
                    1,152,757
                    
                    
                    $
                    24,866
                    
                    
                    
                    4.35
                    %
                    
                    
                    1,039,787
                    
                    
                    
                    17,781
                    
                    
                    
                    3.44
                    %Noninterest-bearing
                        deposits
                    
                    
                    109,441
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    102,741Other
                        liabilities
                    
                    
                    10,627
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    13,715Total
                        liabilities
                    
                    
                    1,272,825
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    1,156,243Shareholders’
                        equity
                    
                    
                    164,084
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    160,581Total
                        liabilities and shareholders’ equity
                    
                    $
                    1,436,909
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    $
                    1,316,824Net
                        interest spread 4
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    3.12
                    %
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    3.68
                    %Tax
                        equivalent adjustment
                    
                    
                    
                    
                    
                    $
                    1,020
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    $
                    385Net
                        interest income and net interest margin 5
                    
                    
                    
                    
                    
                    $
                    22,997
                    
                    
                    
                    3.59
                    %
                    
                    
                    
                    
                    
                    $
                    23,383
                    
                    
                    
                    4.05
                    %
  1
                  The
                      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 nonaccrual loans for which accrual of interest
                      has not
                      been recorded and mortgage 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
              six month period ended June 30, 2007, the provision for loan losses
              was $246,000
              compared to $661,000 for the six month period ended June 30, 2006,
              a decrease of
              $415,000. The decrease in 2007 was primarily due to the slower net
              growth of the
              loan portfolio and 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 six month period ended June 30, 2007 were $254,000
              compared
              to $3.9 million for the six month period ended June 30, 2006. Net charge-offs
              for the six month period ended June 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 six month period ended June 30, 2007, was $4.5 million
              compared
              to $4.7 million for the six month period ended June 30, 2006, a decrease
              of
              $130,000. Service charges and other fees decreased by $100,000 as a
              result of an
              increase in waived service charges and lower nonsufficient fund fees.
              Mortgage
              fees and revenues increased by $103,000, primarily due to higher loan
              volumes in
              the first quarter of 2007. Other noninterest income decreased by $133,000,
              primarily due to a gain of $138,000 realized on the sale of a consolidated
              branch location in 2006.
 
 Noninterest
              expense for the six month period ended June 30, 2007 was $19.0 million
              compared
              to $18.2 million for the six month period ended June 30, 2006. Salaries
              and
              employee benefits, representing the largest noninterest expense category,
              increased by $1.0 million to $10.4 million for the six month period
              ended June
              30, 2007, from $9.4 million for the six month period ended June 30,
              2006. This
              increase reflects an increase in the number of personnel employed by
              the Company
              as well as higher benefit and incentive compensation costs.
 
 Occupancy
              costs and furniture and equipment expenses for the six month period
              ended June
              30, 2007 increased by $255,000 and $208,000, respectively, compared
              to the six
              month period ended June 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
              $162,000 for the six month period ended June 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 $22,000 for the six
              month period ended June 30, 2007 compared to the same period in 2006,
              primarily
              due to network costs associated with implementing 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 six month period ended June 30, 2007 decreased by
              $80,000
              compared to the same period in 2006, primarily due to the promotional
              campaign
              associated with the May 2006 introduction of *Smart Checking*.
              Professional fees for the six month period ended June 30, 2007 increased
              by
              $21,000 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 six month period ended June 30, 2007 decreased $324,000 from
              the same
              period in 2006, primarily due to lower costs associated with telecommunications,
              operational losses and office supplies, which decreased by $222,000,
              $87,000 and
              $86,000, respectively, partially offset by higher insurance costs,
              which
              increased by $57,000.
 
 The
              Company’s effective tax rate for the six month periods ended June 30, 2007
              and
              2006 was 29.8% and 34.0%, 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. On an as needed basis,
                the Bank hires an outside third party firm to review the Bank’s loan portfolio
                to ensure quality standards and reasonableness of risk
                assessment.
 -
                    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.
                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 probable 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. 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 $13.3 million allowance for loan losses as of June
                30, 2007, $3.0
                million has been allocated to specific loans, including loans considered
                to be
                impaired. As of June 30, 2007 and December 31, 2006, there were $8.1
                million and
                $6.2 million, respectively, of impaired loans. As of June 30, 2007
                and December
                31, 2006, $2.5 million and $1.1 million, respectively, was included
                in the
                allowance for loan losses for impaired loans. At June 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 both management and third-party credit review firms.
                The loan
                reviews include the accumulation of related data on loan payment
                status,
                borrowers’ financial data and borrowers’ operating factors such as cash flows,
                operating income or loss. Uncollateralized loans are measured for
                impairment
                based on the present value of expected future cash flows discounted
                at the
                historical effective interest rate, while all collateral-dependent
                loans are
                measured for impairment based on the fair value of the collateral.
                Impaired
                loans at June 30, 2007 includes $1.9 million related to a developer
                who has been
                accused of engaging in fraudulent marketing and financing practices
                in Western
                North Carolina by the North Carolina Attorney General. The Company
                has
                established an $800,000 specific loan loss allocation 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 credit provision
                of
                ($91,000) for the quarter ended June 30, 2007 compared to a provision
                of
                $249,000 for the quarter ended June 30, 2006. The decrease in the
                provision was
                primarily due to 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, as well as several other factors, 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 and,
                in the quarter ended June 30, 2007, resulted in a provision for loan
                losses that
                was $2.5 million lower than would have occurred under the Company’s previous
                methodology.
 
 The
                Company also experienced favorable developments in key risk metrics
                and trends
                associated with the credit quality of the loan portfolio during the
                quarter
                ended June 30, 2007. Past due loans as a percentage of average loans
                decreased
                from 1.60% at March 31, 2007 to 1.27% at June 30, 2007. Past dues
                greater than
                90 days as a percentage of total loans decreased from 0.63% at March
                31, 2007 to
                0.61% at June 30, 2007. Nonperforming assets as a percentage of total
                assets
                were 0.59% and 0.63% at June 30, 2007 and March 31, 2007, respectively.
                Management believes the allowance for loan losses as of June 30,
                2007 is
                adequate to absorb the probable losses on existing loans that may
                become
                uncollectible, based on evaluations of the collectibility of loans
                and prior
                loan loss experience.
  The
                following table presents an analysis of changes in the allowance
                for loan losses
                for the three and six month periods ended June 30, 2007 and 2006,
                respectively.
  -
                  21
                  -
 INDEX
  Three
                        Months Ended June 30,
                    
                    
                    Six
                        Months Ended June 30,*(Dollars
                          in thousands)*
                    
                    2007
                    
                    
                    2006
                    
                    
                    2007
                    
                    
                    2006Allowance
                        for loan losses, beginning of period
                    
                    $
                    13,531
                    
                    
                    $
                    14,209
                    
                    
                    $
                    13,347
                    
                    
                    $
                    9,5921st
                        State Bank loan loss allowance acquired
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    7,637Net
                        charge-offs:Loans
                        charged off:Commercial
                    
                    
                    94
                    
                    
                    
                    531
                    
                    
                    
                    165
                    
                    
                    
                    3,847
                    1Construction
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –Consumer
                    
                    
                    59
                    
                    
                    
                    30
                    
                    
                    
                    109
                    
                    
                    
                    136Home
                        equity lines
                    
                    
                    –
                    
                    
                    
                    26
                    
                    
                    
                    25
                    
                    
                    
                    26Mortgage
                    
                    
                    36
                    
                    
                    
                    3
                    
                    
                    
                    53
                    
                    
                    
                    34Total
                        charge-offs
                    
                    
                    189
                    
                    
                    
                    590
                    
                    
                    
                    352
                    
                    
                    
                    4,043Recoveries
                        of loans previously charged off:Commercial
                    
                    
                    35
                    
                    
                    
                    117
                    
                    
                    
                    35
                    
                    
                    
                    125Construction
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –Consumer
                    
                    
                    51
                    
                    
                    
                    22
                    
                    
                    
                    59
                    
                    
                    
                    26Home
                        equity lines
                    
                    
                    2
                    
                    
                    
                    –
                    
                    
                    
                    4
                    
                    
                    
                    4Mortgage
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    5Total
                        recoveries
                    
                    
                    88
                    
                    
                    
                    139
                    
                    
                    
                    98
                    
                    
                    
                    160Total
                        net charge-offs
                    
                    
                    101
                    
                    
                    
                    451
                    
                    
                    
                    254
                    
                    
                    
                    3,883(Credit)
                        loss provisions charged to operations
                    
                    
                    (91
                    )
                    
                    
                    249
                    
                    
                    
                    246
                    
                    
                    
                    661Allowance
                        for loan losses, end of period
                    
                    $
                    13,339
                    
                    
                    $
                    14,007
                    
                    
                    $
                    13,339
                    
                    
                    $
                    14,007Net
                        charge-offs to average loans during the period
                        (annualized)
                    
                    
                    0.04
                    %
                    
                    
                    0.22
                    %
                    
                    
                    0.05
                    %
                    
                    
                    0.83
                    %1Allowance
                        as a percent of gross loans
                    
                    
                    1.31
                    %
                    
                    
                    1.45
                    %
 
 1
                    Net
                        charge-offs for the six month period ended June 30, 2006
                        includes $3.3
                        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
              June 30,
              2007, June 30, 2006 and December 31, 2006.
  June
                        30, 2007
                    
                    
                    June
                        30, 2006
                    
                    
                    December
                        31, 2006*(Dollars
                        in thousands)*
                    
                    *(Unaudited)*Nonaccrual
                        loans:Commercial
                    
                    $
                    6,089
                    
                    
                    $
                    3,728
                    
                    
                    $
                    2,783Construction
                    
                    
                    –
                    
                    
                    
                    193
                    
                    
                    
                    616Consumer
                    
                    
                    67
                    
                    
                    
                    106
                    
                    
                    
                    50Home
                        equity lines
                    
                    
                    471
                    
                    
                    
                    418
                    
                    
                    
                    410Mortgage
                    
                    
                    975
                    
                    
                    
                    1,695
                    
                    
                    
                    1,043Total
                        nonaccrual loans
                    
                    
                    7,602
                    
                    
                    
                    6,140
                    
                    
                    
                    4,902Foreclosed
                        property held
                    
                    
                    866
                    
                    
                    
                    879
                    
                    
                    
                    1,111Total
                        nonperforming assets
                    
                    $
                    8,468
                    
                    
                    $
                    7,019
                    
                    
                    $
                    6,013Nonperforming
                        assets to total loans
                    
                    
                    0.83
                    %
                    
                    
                    0.73
                    %
                    
                    
                    0.60
                    %Nonperforming
                        assets to total assets
                    
                    
                    0.59
                    %
                    
                    
                    0.51
                    %
                    
                    
                    0.42
                    %Allowance
                        coverage of nonperforming loans
                    
                    
                    175
                    %
                    
                    
                    228
                    %
                    
                    
                    272
                    %
 -
                    22
                    -
 INDEX
  At
                June
                30, 2007, nonperforming assets were $8.5 million, an increase of
                $2.5 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 June 30, 2007.
 
 Foreclosed
                property decreased to $866,000 at June 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 $54.2
                million in its most liquid assets, cash and cash equivalents as of
                June 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 $1.03 billion and $1.0
                billion at
                June 30, 2007 and December 31, 2006, respectively, funded 71.4% of
                total assets
                at June 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 that its Board of Directors
                had
                authorized the Company 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 June 30, 2007, the Company repurchased 2,304
                shares at
                a weighted average price of $17.04 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 must maintain
              minimum
              amounts and ratios. The Company’s and the Bank’s actual capital amounts and
              ratios as of June 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)
                      
                      $
                      143,255
                      
                      
                      
                      11.77
                      %
                      
                      $
                      121,702
                      
                      
                      
                      10.00
                      %Tier
                          I capital (to risk weighted assets)
                      
                      
                      129,632
                      
                      
                      
                      10.65
                      %
                      
                      
                      73,021
                      
                      
                      
                      6.00
                      %Tier
                          1 capital (to average assets)
                      
                      
                      129,632
                      
                      
                      
                      9.08
                      %
                      
                      
                      73,395
                      
                      
                      
                      5.00
                      %**Capital
                          Bank**Total
                          capital (to risk weighted assets)
                      
                      $
                      138,331
                      
                      
                      
                      11.70
                      %
                      
                      $
                      118,217
                      
                      
                      
                      10.00
                      %Tier
                          I capital (to risk weighted assets)
                      
                      
                      124,708
                      
                      
                      
                      10.55
                      %
                      
                      
                      70,930
                      
                      
                      
                      6.00
                      %Tier
                          1 capital (to average assets)
                      
                      
                      124,708
                      
                      
                      
                      9.13
                      %
                      
                      
                      68,287
                      
                      
                      
                      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 $164.2 million, or $14.17 per share, at June 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 June 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.
 -
                      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.
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                      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 June 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
                          NumberofShares
                          Purchased
                      
                      Average
                          Price Paidper Share
                      
                      Total
                          Number of SharesPurchased as Part of Publicly Announced Plans or
                          Programs 1
                      
                      Maximum
                          Number of Shares thatMay Yet Be Purchased under thePlans or
                          ProgramsApril
                          2007
                      
                      
                      304
                      
                      $
                      16.96
                      
                      
                      304
                      
                      
                      568,043May
                          2007
                      
                      
                      2,000
                      
                      $
                      17.05
                      
                      
                      2,000
                      
                      
                      566,043June
                          2007
                      
                      
                      –
                      
                      $
                      –
                      
                      
                      –
                      
                      
                      566,043
  1
                    On
                        February 27, 2006, the Company
                        announced that its Board of Directors authorized 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 andsupersedes
                        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 June 30,
                        2007, there were an aggregate of 566,043 shares remaining
                        authorized for
                        future repurchases.
 
 **Item
              3.                      Defaults
              upon Senior Securities**
  None
  **Item
              4.                      Submission
              of Matters to a Vote of Security Holders**
 
 On
                May
                24, 2007, the Company held its annual shareholders’ meeting to consider and
                vote on three issues: (i) election of six nominees to serve as Class
                I directors
                with terms continuing until the Annual Meeting of Shareholders in
                2010; (ii)
                ratification of the appointment of Grant Thornton LLP as the Company’s
                independent registered public accounting firm for the fiscal year
                ending
                December 31, 2007; and (iii) approval of the reservation of 125,000
                additional shares of Capital Bank Corporation common stock for issuance
                under
                the Deferred Compensation Plan. Each item considered was approved
                by the
                Company’s shareholders. Of the 11,444,449 shares eligible to vote, 10,357,440
                shares were voted as shown on the following table.
  -
                    28
                    -
 INDEX
 
 For
                    
                    
                    Against/Withheld
                    
                    
                    Abstain**Class
                        I Directors:**Charles
                        F. Atkins
                    
                    
                    8,642,871
                    
                    
                    
                    1,714,569
                    
                    
                    
                    –Oscar
                        A. Keller, Jr.
                    
                    
                    8,635,784
                    
                    
                    
                    1,721,656
                    
                    
                    
                    –James
                        G. McClure, Jr.
                    
                    
                    8,643,781
                    
                    
                    
                    1,713,659
                    
                    
                    
                    –James
                        D. Moser, Jr.
                    
                    
                    8,640,271
                    
                    
                    
                    1,717,169
                    
                    
                    
                    –Don
                        W. Perry
                    
                    
                    8,642,868
                    
                    
                    
                    1,714,572
                    
                    
                    
                    –B.
                        Grant Yarber
                    
                    
                    8,388,552
                    
                    
                    
                    1,968,888
                    
                    
                    
                    –**Ratification
                        of Auditors**
                    
                    
                    10,225,074
                    
                    
                    
                    109,773
                    
                    
                    
                    22,593**Approval
                        of Shares**
                    
                    
                    5,089,795
                    
                    
                    
                    2,315,528
                    
                    
                    
                    48,138
 
 The
              term
              of office of James A. Barnwell, Jr., John F. Grimes, III, Robert L.
              Jones,
              Richard H. Shirley, J. Rex Thomas and Samuel J. Wornom, III continue
              after the
              annual shareholders’ meeting until 2008. In addition, the term of office of
              Leopold I. Cohen, O. A. Keller, III, Ernest A. Koury, Jr., George R.
              Perkins,
              III and Carl H. Ricker, Jr. continue after the annual shareholders’ meeting
              until 2009.
 
 **Item
              5.                      Other
              Information**
 
 None
 
 **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 August
              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