UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-Q

              [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

                  For the Quarterly Period Ended March 31, 2006

                                       or

              [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

                  For the Transition Period From _____ to ____

                        Commission File Number 000-30062

                            CAPITAL BANK CORPORATION
             (Exact name of registrant as specified in its charter)

                 North Carolina                     56-2101930
                 --------------                     ----------
        State or other jurisdiction of           (IRS Employer
        incorporation or rganization)            Identification No.)

                              4901 Glenwood Avenue
                          Raleigh, North Carolina 27612
                          -----------------------------
               (Address of Principal executive offices) (Zip Code)

       Registrant's telephone number, including area code: (919) 645-6400

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. [X] Yes [ ] 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 [X]    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 [X] No

As of May 4, 2006 there were 11,623,629  shares  outstanding of the registrant's
common stock, no par value.


<PAGE>

                            Capital Bank Corporation
                                    Form 10-Q
                                    CONTENTS

<TABLE>
<CAPTION>

PART I - FINANCIAL INFORMATION                                                       Page No.
<S>                                                                                   <C>

       Item 1. Financial Statements

       Condensed consolidated statements of financial condition at March 31, 2006
            (Unaudited) and December 31, 2005                                              1
       Condensed consolidated statements of income for the three months
            ended March 31, 2006 and 2005 (Unaudited)                                      2
       Condensed consolidated statements of changes in shareholders' equity for
            the three months ended March 31, 2006 and 2005 (Unaudited)                     3
       Condensed consolidated statements of cash flows for the three months
            ended March 31, 2006 and 2005 (Unaudited)                                  4 - 5
       Notes to condensed consolidated financial statements                           6 - 11

       Item 2. Management's Discussion and Analysis of Financial Condition and
            Results of Operations                                                    12 - 23

       Item 3. Quantitative and Qualitative Disclosures About Market Risk                 23

       Item 4. Controls and Procedures                                                    24

PART II - OTHER INFORMATION

       Item 1. Legal Proceedings                                                          25

       Item 1A.  Risk Factors                                                             25

       Item 2. Unregistered Sales of Equity Securities and Use of Proceeds                29

       Item 3. Defaults Upon Senior Securities                                            29

       Item 4. Submission of Matters to a Vote of Security Holders                        29

       Item 5. Other Information                                                          29

       Item 6. Exhibits                                                                   29

       Signatures                                                                         31
</TABLE>

<PAGE>

Item 1      Financial Statements
            --------------------

CAPITAL BANK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
March 31, 2006 and December 31, 2005

<TABLE>
<CAPTION>
                                                               March 31,     December 31,
                                                                  2006           2005
----------------------------------------------------------------------------------------
<S>                                                               <C>            <C>
             (Dollars in thousands, except share data)        (Unaudited)
ASSETS
Cash and due from banks:
     Interest earning                                         $     6,938    $     4,603
     Noninterest earning                                           33,435         30,544
Cash held in escrow                                                    --         33,185
Federal funds sold and short term investments                      19,444          8,757
Investment securities - available for sale, at fair value         168,894        149,266
Investment securities - held to maturity, at amortized cost        12,138         12,334
Loans - net of unearned income and deferred fees                  944,325        668,982
Allowance for loan losses                                         (14,209)        (9,592)
                                                              -----------    -----------
         Net loans                                                930,116        659,390
                                                              -----------    -----------
Premises and equipment, net                                        21,594         14,868
Bank owned life insurance                                          20,088         19,857
Deposit premium and goodwill, net                                  67,149         12,853
Accrued interest receivable and other assets                       28,771         15,249
                                                              -----------    -----------
            Total assets                                      $ 1,308,567    $   960,906
                                                              ===========    ===========

LIABILITIES
Deposits:
     Demand, noninterest bearing                              $   107,425    $    77,847
     Savings and interest bearing demand deposits                 315,933        237,005
     Time deposits                                                548,874        383,628
                                                              -----------    -----------
         Total deposits                                           972,232        698,480
                                                              -----------    -----------
Repurchase agreements and federal funds purchased                  26,305         14,514
Short-term debt                                                        --         30,000
Federal Home Loan Bank advances                                   107,798         93,173
Subordinated debentures                                            30,930         30,930
Accrued interest payable and other liabilities                     13,207         10,317
                                                              -----------    -----------
            Total liabilities                                   1,150,472        877,414
                                                              -----------    -----------

SHAREHOLDERS' EQUITY
Common stock, no par value; 20,000,000 shares authorized;
     11,623,629 and 6,852,156 issued and outstanding as of
     March 31, 2006 and December 31, 2005, respectively           143,669         70,985
Retained earnings                                                  16,245         14,179
Accumulated other comprehensive loss                               (1,819)        (1,672)
                                                              -----------    -----------
            Total shareholders' equity                            158,095         83,492
                                                              -----------    -----------
            Total liabilities and shareholders' equity        $ 1,308,567    $   960,906
                                                              ===========    ===========
</TABLE>

See Notes to Condensed Consolidated Financial Statements


                                       1
<PAGE>
<TABLE>
<CAPTION>

CAPITAL BANK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended March 31, 2006 and 2005
(Unaudited)                                                                 2006           2005
--------------------------------------------------------------------------------------------------
<S>                                                                            <C>           <C>
               (Dollars in thousands, except share and per share data)
Interest income:
      Loans and loan fees                                                $    17,018   $     9,742
      Investment securities                                                    2,110         1,697
      Federal funds and other interest income                                    542            17
                                                                         -----------   -----------
          Total interest income                                               19,670        11,456
                                                                         -----------   -----------
Interest expense:
      Deposits                                                                 6,110         3,182
      Borrowings and repurchase agreements                                     2,170         1,368
                                                                         -----------   -----------
          Total interest expense                                               8,280         4,550
                                                                         -----------   -----------
          Net interest income                                                 11,390         6,906
Provision (credit) for loan losses                                               412          (250)
                                                                         -----------   -----------
          Net interest income after provision (credit) for loan losses        10,978         7,156
                                                                         -----------   -----------
Noninterest income:
      Service charges and other fees                                             965           657
      Mortgage fees and  revenues                                                364           272
      Net gain on sale of securities                                              --             6
      Bank owned life insurance                                                  231           123
      Other noninterest income                                                   455           282
                                                                         -----------   -----------
          Total noninterest income                                             2,015         1,340
                                                                         -----------   -----------
Noninterest expenses:
      Salaries and employee benefits                                           4,542         3,149
      Occupancy                                                                  778           614
      Furniture and equipment                                                    492           367
      Data processing                                                            489           311
      Director fees                                                              376           171
      Advertising                                                                255           216
      Amortization of deposit premium                                            343            54
      Professional fees                                                          212           322
      Telecommunications                                                         176           140
      Other expenses                                                           1,151           806
                                                                         -----------   -----------
          Total noninterest expenses                                           8,814         6,150
                                                                         -----------   -----------
              Income before income tax expense                                 4,179         2,346
Income tax expense                                                             1,416           791
                                                                         -----------   -----------
              Net income                                                 $     2,763   $     1,555
                                                                         ===========   ===========

Earnings per share - basic                                               $      0.24   $      0.23
                                                                         ===========   ===========
Earnings per share - diluted                                             $      0.24   $      0.22
                                                                         ===========   ===========

Weighted average shares
      Basic                                                               11,616,894     6,754,576
                                                                         ===========   ===========
      Fully diluted                                                       11,704,315     6,941,776
                                                                         ===========   ===========
</TABLE>

See Notes to Condensed Consolidated Financial Statements

                                       2
<PAGE>

Capital Bank Corporation
Consolidated Statements of Changes in Shareholders' Equity
For the Three Months Ended March 31, 2006 and 2005
(Unaudited)
                    (Dollars in thousands, except share data)

<TABLE>
<CAPTION>
                                               Shares of                      Other
                                                Common         Common      Comprehensive    Retained
                                                 Stock         Stock          Income        Earnings        Total
                                              -----------    -----------    -----------    -----------   -----------
<S>                                           <C>          <C>            <C>            <C>           <C>
Balance at January 1, 2005                      6,612,787    $    68,341    $       305    $     9,092   $    77,738
Repurchase of outstanding common stock            (50,000)          (892)                                       (892)
Issuance of common stock
     for options exercised                          2,255             19                                          19
Net income                                                                                       1,555         1,555
Other comprehensive loss                                                         (1,061)                      (1,061)
                                                                                                         -----------
     Comprehensive income                                                                                        494
                                                                                                         -----------
Dividends ($0.05 per share)                                                                       (394)         (394)
                                              -----------    -----------    -----------    -----------   -----------
Balance at March 31, 2005                       6,565,042    $    67,468    $      (756)   $    10,253   $    76,965
                                              ===========    ===========    ===========    ===========   ===========

Balance at January 1, 2006                      6,852,156    $    70,985    $    (1,672)   $    14,179   $    83,492
Repurchase of outstanding common stock           (116,000)        (1,847)                                     (1,847)
Issuance of common stock for
     acquisition of 1st State Bancorp, Inc.     4,882,630         74,499                                      74,499
Issuance of common stock
     for options exercised                          4,843             32                                          32
Net income                                                                                       2,763         2,763
Other comprehensive loss                                                           (147)                        (147)
                                                                                                         -----------
     Comprehensive income                                                                                      2,616
                                                                                                         -----------
Dividends ($0.06 per share)                                                                       (697)         (697)
                                              -----------    -----------    -----------    -----------   -----------
Balance at March 31, 2006                      11,623,629    $   143,669    $    (1,819)   $    16,245   $   158,095
                                              ===========    ===========    ===========    ===========   ===========
</TABLE>

See Notes to Condensed Consolidated Financial Statements

                                       3
<PAGE>
<TABLE>
<CAPTION>

CAPITAL BANK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended March 31, 2006 and 2005
(Unaudited)                                                           2006        2005
-----------------------------------------------------------------------------------------
<S>                                                                      <C>           <C>
                             (Dollars in thousands)
Cash Flows From Operating Activities:
      Net income                                                   $   2,763    $   1,555
      Adjustments to reconcile net income to net cash
         used in operating activities:
         Amortization of deposit premium                                 343           54
         Depreciation                                                    481          362
         Net gains on sale of securities available for sale               --           (6)
         Change in held for sale loans, net                           (2,458)      (1,550)
         Amortization of premiums on securities, net                      38           76
         Deferred income tax expense                                   1,548          135
         Provision (credit) for loan losses                              412         (250)
         Changes in assets and liabilities:
             Accrued interest receivable and other assets              4,688       (1,243)
             Accrued interest payable and other liabilities             (141)       2,457
         Other operating activities, net                                  --           --
                                                                   ---------    ---------
             Net cash provided by operating activities                 7,674        1,590
                                                                   ---------    ---------
Cash Flows From Investing Activities:
      Loan repayments (originations), net                            (38,375)       8,280
      Additions to premises and equipment                             (1,175)        (445)
      Net (purchase) sales of Federal Home Loan Bank stock               767          (47)
      Purchase of securities available for sale                      (15,489)      (7,491)
      Purchase of securities held to maturity                             --         (973)
      Proceeds from maturities of securities available for sale        2,427        4,637
      Proceeds from sales of securities available for sale           102,396        2,430
      Proceeds from maturities of securities held to maturity            199          261
      Net cash paid in merger transaction                            (37,470)          --
      Proceeds from sales of property and equipment                       12           --
                                                                   ---------    ---------
             Net cash provided by investing activities                13,292        6,652
                                                                   ---------    ---------
Cash Flows From Financing Activities:
      Net increase in deposits                                         1,716        7,202
      Net increase (decrease) in repurchase agreements                11,791       (2,409)
      Net decrease in borrowings                                     (19,519)      (1,456)
      Repayment of short-term debt                                   (30,000)          --
      Distribution of cash held in escrow                             33,185           --
      Dividends paid                                                    (411)        (397)
      Issuance of common stock for options and other plans                32           19
      Repurchase of common stock                                      (1,847)        (892)
      Other financing activities, net                                     --           --
                                                                   ---------    ---------
             Net cash (used in) provided by financing activities      (5,053)       2,067
                                                                   ---------    ---------
Net change in cash and cash equivalents                               15,913       10,309
Cash and cash equivalents at beginning of period                      43,904       23,011
                                                                   ---------    ---------
Cash and cash equivalents at end of period                         $  59,817    $  33,320
                                                                   =========    =========

                                                                  (continued on next page)
</TABLE>

See Notes to Condensed Consolidated Financial Statements

                                       4
<PAGE>

CAPITAL BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Three Months Ended March 31, 2006 and 2005
(Unaudited)                                            2006       2005
------------------------------------------------------------------------
                                                    (Dollars in thousands)

Supplemental Disclosure of Cash Flow Information
      Transfer of loans and premises and equipment
         to other real estate owned                  $  2,142   $    116
                                                     ========   ========

      Dividends payable                              $    697   $    394
                                                     ========   ========

      Cash paid for:
         Income taxes                                $     --   $    223
                                                     ========   ========

         Interest                                    $  7,992   $  4,414
                                                     ========   ========

      Acquisition of 1st State Bancorp
         Fair value of assets acquired               $429,981   $     --
         Issuance of common stock                    $ 74,499   $     --
         Cash paid                                   $ 46,570   $     --
         Liabilities assumed                         $308,912   $     --

See Notes to Condensed Consolidated Financial Statements


                                       5
<PAGE>

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.  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, 2005, as amended.

The preparation of financial statements in conformity with accounting principles
generally  accepted in the United States of America requires  management to make
estimates and assumptions that affect reported amounts of assets and liabilities
as well as the  amounts of income and  expenses  during  the  reporting  period.
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 month period ended March 31, 2006 are not  necessarily
indicative of the results of operations  that may be expected for the year ended
December 31, 2006.

The  balance  sheet at  December  31,  2005 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, 2005, as amended.

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, 2005, as amended.

In May 2005, the Financial  Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 154, Accounting Changes and Error
Corrections  ("SFAS 154"),  which replaces APB No. 20, Accounting  Changes ("APB
20"),  and SFAS  No.  3,  Reporting  Accounting  Changes  in  Interim  Financial
Statements.  SFAS 154 applies to all voluntary changes in accounting  principles
and requires  retrospective  application  of changes in accounting  principle to
prior  period  financial  statements,  unless it is  impracticable  to determine
either the period-specific effects or the cumulative effects of the change. SFAS
154  carries  forward  without  change  the  guidance  contained  in  APB 20 for
reporting the correction of an error and a change in accounting  estimate.  SFAS
154 is effective for accounting changes and corrections of errors made in fiscal
years  beginning after December 15, 2005. The Company

                                       6
<PAGE>

adopted  SFAS 154  effective  January 1, 2006.  The  adoption of SFAS 154 had no
impact on the Company's financial position or results of operations.

In March  2006,  the FASB  issued  SFAS No. 156,  Accounting  For  Servicing  of
Financial  Assets,  an  Amendment  of FASB  Statement  No. 140,  Accounting  for
Transfers and Servicing of Financial Assets and  Extinguishments of Liabilities,
("SFAS 156") which requires that all separately  recognized servicing assets and
liabilities be initially  measured at fair value, if  practicable,  and requires
entities  to elect  either  fair value  measurement  with  changes in fair value
reflected  in  earnings  or the  amortization  and  impairment  requirements  of
Statement  140 for  subsequent  measurement.  SFAS  156 is  effective  as of the
beginning of an entity's first fiscal year that begins after September 15, 2006.
The Company plans to adopt SFAS 156 on January 1, 2007. The adoption of SFAS 156
is not expected to have any material impact on the Company's financial condition
or results of operations.

2.       Acquisition of 1st State Bancorp

On January 3, 2006, the Company completed its acquisition of all the outstanding
capital stock of 1st State  Bancorp,  Inc.  ("1st State  Bancorp"),  the holding
company for 1st State Bank.  ("1st State Bank").  The total  purchase  price was
approximately $121.1 million,  including  transaction costs of $6.3 million. The
Company issued  approximately  4.9 million shares of common stock and paid $40.1
million in cash in exchange for 100% of 1st State Bancorp's  outstanding  common
stock and stock options.  The  transaction  was accounted for under the purchase
method of  accounting  and is intended  to qualify as a tax-free  reorganization
under Section 368(a) of the Internal Revenue Code.

An unaudited summary of the preliminary estimated fair values of assets acquired
and liabilities assumed is as follows:

               (Dollars in thousands)
Loans receivable, net of allowance for loan losses                  $ 230,600
Investment securities                                                 110,107
Premises and equipment                                                  7,925
Deposit premium                                                         5,331
Goodwill                                                               49,308
Other assets                                                           26,710
Deposits                                                             (272,037)
Borrowings                                                            (34,144)
Other liabilities                                                      (2,731)
                                                                    ---------
    Investment in subsidiary, net of dividends to shareholders
    and capitalized acquisition costs                               $ 121,069
                                                                    =========

3.       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 for the three month
periods ended March 31, 2006 and 2005 are as shown in the Company's Consolidated
Statements of Changes in  Shareholders'  Equity for the three months ended March
31,  2006  and  2005  (unaudited).   The  Company's  only  components  of  other
comprehensive  income  relate  to  unrealized  gains and  losses  on  securities
available for sale, net of the applicable income tax effect and are as follows:

                                       7
<PAGE>

                                                       As of March 31,
                                                       2006       2005
                                                     ------------------
(Dollars in thousands)                                   (Unaudited)
Unrealized losses on securities available for sale   $  (239)   $(1,721)

Reclassification of gains recognized in net income        --         (6)

Income tax benefit                                        92        666
                                                     -------    -------
Other comprehensive loss                             $  (147)   $(1,061)
                                                     =======    =======

4.       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 month
periods ended March 31, 2006 and 2005:

<TABLE>
<CAPTION>

                                                                     As of March 31,
                                                                    2006          2005
                                                                -----------   -----------
<S>                                                              <C>            <C>
(Dollars in thousands)                                                 (Unaudited)
      Income available to shareholders - basic and diluted      $     2,763   $     1,555
                                                                ===========   ===========
Shares used in the computation of earnings per share:
      Weighted average number of shares outstanding - basic      11,616,894     6,754,576
      Incremental shares from assumed exercise of stock
          options                                                    87,421       187,200
                                                                -----------   -----------
      Weighted average number of shares outstanding - diluted    11,704,315     6,941,776
                                                                ===========   ===========
</TABLE>

Options to purchase  approximately  374,000  shares of common stock were used in
the diluted  calculation.  An aggregate of 117,000  options were not included in
the diluted  calculation  because the option  price  exceeded  the average  fair
market value of the associated shares of common stock.

5.        Stock Based Compensation

Effective  January 1,  2006,  the  Company  adopted  the fair value  recognition
provisions  of SFAS No. 123R,  Share-Based  Payments  ("SFAS  123R"),  using the
modified-prospective transition    method.   Under   that   transition   method,
compensation  cost recognized in 2006 includes:  (a)  compensation  cost for all
share-based payments granted prior to, but not yet vested as of January 1, 2006,
based on the grant date fair value  estimated  in  accordance  with the original
provisions of SFAS No. 123, Accounting for Stock-Based Compensation ("SFAS 123")
and (b) compensation  cost for all share-based  payments  granted  subsequent to
December 31, 2005,  based on the grant date fair value  estimated in  accordance
with the provisions of SFAS 123R.

Beginning  January 1,  2006,  the  Company  will  recognize  the cost of all new
employee  share-based  awards on a  straight-line  basis over  their  respective
vesting periods, net of estimated

                                       8
<PAGE>

forfeitures.  The  Company  previously  accounted  for stock  options  using the
intrinsic  value method in accordance  with the provisions of APB Opinion No. 25
("APB 25"),  Accounting  for Stock Issued to Employees,  and SFAS 123. Under the
SFAS 123,  the Company was  required  to disclose  the pro forma  effects on net
income as if it had  recorded  compensation  based on the fair  value of options
granted.

On December 29, 2005, the Compensation/Human Resources Committee of the Board of
Directors  of the  Company  approved  the  acceleration  of  vesting of all then
outstanding  unvested stock options awarded under the Company's Equity Incentive
Plan. As a result,  options to purchase  67,200  shares of the Company's  common
stock,  which would  otherwise  have vested from time to time over the next five
years,  became immediately  exercisable on December 30, 2005. As a result of the
acceleration of vesting,  approximately  $331,000 of future compensation expense
that would have been  recognized  in operating  results under SFAS 123R over the
next five years was eliminated.  Accordingly,  the adoption of SFAS 123R did not
have  a  material  impact  on  the  Company's  operating  results  or  financial
condition.

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.  At March 31,  2006,  options  for  186,709  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  218,000  remain  outstanding.
Grants of options are made by the Board of Directors  or its  Compensation/Human
Resources Committee. All grants must be at no less than fair market value on the
date of grant,  must be exercised no later than 10 years from the date of grant,
and may be subject to certain vesting provisions. There were no new stock option
grants in the quarter  ended March 31,  2006 and all options  outstanding  as of
March 31, 2006 were fully vested.

The Company also administers the Capital Bank Corporation Deferred  Compensation
Plan for  Non-Employee  Directors  ("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 their total  director's  fees. Each participant is fully
vested in his account balance. The Deferred Compensation Plan generally provides
for  payment of share units  either in shares of common  stock of the Company or
cash (at the  Company's  option)  after  the  participant  ceases  to serve as a
director  for any reason.  The Deferred  Compensation  Plan is  classified  as a
liability-based plan under SFAS 123R.

The following is a summary of stock option  information and the weighted average
exercise price ("WAEP") for the quarter ended March 31, 2006:

                                         Shares       WAEP
                                        --------    --------

Outstanding at January 1, 2006           495,822    $  11.25
Granted                                       --          --
Exercised                                 (4,843)       6.92
Terminated                                    --          --
                                        --------    --------
Outstanding at March 31, 2006            490,979    $  11.70
                                        ========    ========

Options exercisable at March 31, 2006    490,979    $  11.70
                                        ========    ========

                                       9
<PAGE>

The following table summarizes  information about the Company's stock options at
March 31, 2006:

<TABLE>
<CAPTION>

                              Number            Contractual            Number
   Exercise Price          Outstanding         Life in Years        Exercisable
---------------------   -------------------  -------------------  -----------------
<S>                               <C>              <C>                    <C>
   $6.62 - $9.00                   167,925          4.00                   167,925
   $9.01 - $12.00                  105,201          5.31                   105,201
  $12.01 - $15.00                   74,692          2.32                    74,692
  $15.01 - $18.00                   82,911          7.29                    82,911
  $18.01 - $18.37                   60,250          8.99                    60,250
                        -------------------  -------------------  -----------------
                                   490,979          5.18                   490,979
                        ===================  ===================  =================
</TABLE>

The fair  values  of the  options  granted  prior to  January  1,  2006 had been
estimated  on the date of the  grants  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 US Treasury  issues.  The following
weighted-average assumptions were used in the determining fair value for options
granted in the quarter ended March 31, 2006 and 2005:

                                                     2006          2005
                                                  --------------------------

Dividend yield                                        --           1.21%
Expected volatility                                   --           27.7%
Risk-free interest rate                               --           4.02%
Expected life                                         --          7 years

6.       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 March 31, 2006:

                                       10
<PAGE>
<TABLE>
<CAPTION>

(Dollars in thousands)                             Less Than 12 Months         12 Months or Greater             Total
                                                ---------------------------------------------------------------------------------
                                                               Unrealized                 Unrealized                  Unrealized
Description of Security                         Fair Value       Losses      Fair Value     Losses       Fair Value     Losses
---------------------------------------------------------------------------------------------------------------------------------
<S>                                                   <C>              <C>        <C>             <C>         <C>             <C>
Available for sale
Direct obligations of U.S.
     government agencies                        $    23,003   $       126   $    34,558   $     1,075   $    57,561   $     1,201
Municipal bonds                                       4,686            18         3,925           126         8,611           144
Mortgage-backed securities                           24,380           481        39,552         1,573        63,932         2,054
                                                ---------------------------------------------------------------------------------
                                                     52,069           625        78,035         2,774       130,104         3,399
                                                ---------------------------------------------------------------------------------
Held to maturity
Direct obligations of U.S.
     government agencies                                594             3         3,888           108   $     4,482   $       111
Municipal bonds                                          --            --           290            10           290            10
Mortgage-backed securities                            2,239            58         4,780           168         7,019           226
                                                ---------------------------------------------------------------------------------
                                                      2,833            61         8,958           286        11,791           347
                                                ---------------------------------------------------------------------------------
Total at March 31, 2006                         $    54,902   $       686   $    86,993   $     3,060   $   141,895   $     3,746
                                                =================================================================================
</TABLE>

The unrealized losses on the Company's investments in direct obligations of U.S.
government agencies and mortgage-backed  securities were primarily the result of
interest rate changes.  Mortgage-backed  securities include securities issued by
government  agencies  and  corporate  entities.  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 March 31, 2006.

7.       Loans

The composition of the loan portfolio by loan  classification  at March 31, 2006
and December 31, 2005 is as follows:

                                  March 31,    December 31,
(Dollars in thousands)              2006           2005
                                ------------   ------------

Commercial                      $    756,494   $    555,198
Consumer                              32,878         26,222
Home equity lines                     98,905         65,566
Residential mortgages                 55,953         21,863
                                ------------   ------------
                                     944,230        668,849
Plus deferred loan costs, net             95            133
                                ------------   ------------
                                $    944,325   $    668,982
                                ============   ============

Loans held for sale as of March 31, 2006 and December 31, 2005 were $6.6 million
and $4.2 million,  respectively,  and were included in the residential  mortgage
category.

                                       11
<PAGE>

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 month period ended March 31, 2006 and 2005 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 position, results of operations, liquidity, and
capital resources for the periods covered and should be read in conjunction with
the unaudited  financial  statements and related footnotes  contained in Part I,
Item 1 of this report.

Information set forth below contains various  forward-looking  statements within
the  meaning of Section  27A of the  Securities  Act of 1933,  as  amended,  and
Section 21E of the  Securities  Exchange Act of 1934, as amended (the  "Exchange
Act"), which statements  represent the Company's judgment  concerning the future
and are subject to risks and uncertainties that could cause the Company's actual
operating results to differ materially.  Such forward-looking  statements can be
identified by the use of  forward-looking  terminology,  such as "may",  "will",
"expect",  "anticipate",  "estimate",  "believe", or "continue", or the negative
thereof or other  variations  thereof or  comparable  terminology.  The  Company
cautions that such forward-looking statements are further qualified by important
factors  that  could  cause the  Company's  actual  operating  results to differ
materially from those in the forward-looking  statements, as well as the factors
set forth in Part II, Item 1A of this report, and the Company's periodic reports
and other filings with the Securities and Exchange Commission (the "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, other operating
income,  and other  operating  expenses.  Other  income  primarily  consists  of
miscellaneous  service  charges 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, telecommunication 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 our market
area, as well as general market interest rates.  Lending activities are affected
by the  demand  for  financing,  which  in turn is  affected  by the  prevailing
interest rates.

                                       12
<PAGE>

Executive Summary

As discussed in more detail  below,  the following is a brief summary of certain
of our significant results for the quarter ended March 31, 2006:

   o  The Company  reported  net income for the quarter  ended March 31, 2006 of
      $2.8  million  compared to $1.6  million  for the quarter  ended March 31,
      2005.  Fully  diluted  earnings  per  share  were  $0.24 and $0.22 for the
      quarter ended March 31, 2006 and 2005,  respectively.  The increase in net
      income was primarily  due to the effects of the 1st State  Bancorp  merger
      transaction  and a 53 basis point increase in the net interest  margin for
      the quarter  ended March 31, 2006  compared to the quarter ended March 31,
      2005.

   o  The  provision  for loan losses for the  quarter  ended March 31, 2006 was
      $412,000  compared  to a credit in the  quarter  ended  March 31,  2005 of
      $250,000.  The increase in the  provision for loan losses is primarily due
      to an increase in the specific  allocation for one loan  relationship  and
      the estimated  inherent losses  associated with the net growth in the loan
      portfolio during the quarter ended March 31, 2006. Net charge-offs for the
      quarter ended March 31, 2006 were $3.4 million, or 1.45% of average loans,
      compared to $99,000, or 0.06% of average loans for the quarter ended March
      31, 2005.  Charge-offs  for the quarter ended March 31, 2006 includes $3.2
      million related to one loan  relationship  that had been fully reserved by
      1st State  Bank as of  December  31,  2005 and had no impact on the Bank's
      loan loss provision for the quarter ended March 31, 2006

   o  Net  interest  income for the quarter  ended March 31, 2006 rose to record
      levels as the net  interest  margin  widened  to 4.06%,  a 33 basis  point
      increase  over the  fourth  quarter  of 2005 and an  increase  of 53 basis
      points over the net interest  margin for the quarter ended March 31, 2005.
      Net interest  income rose to $11.4 million for the quarter ended March 31,
      2006, a 65% increase  over the $6.9 million  reported in the quarter ended
      March 31,  2005,  primarily  due to the  infusion  of 1st State  Bancorp's
      interest-earning  assets, organic loan portfolio growth in the quarter and
      the continued increase in short term rates by the Federal Reserve.

   o  Non-interest  income  for the  quarter  ended  March  31,  2006  increased
      $675,000 to $2.0  million  compared to the quarter  ended March 31,  2005.
      This increase is primarily due to higher service charges and other fees as
      a result of a higher volume of transaction  accounts,  which were acquired
      in the 1st State Bancorp merger transaction.

   o  Non-interest  expenses  were $8.8 million for the quarter  ended March 31,
      2006  compared to $6.2 million for the quarter  ended March 31, 2005.  The
      increase is primarily due to higher salaries and employee benefits,  which
      increased by $1.4 million in the quarter  ended March 31, 2006 compared to
      the quarter  ended March 31,  2005.  The increase in salaries and employee
      benefits  was  primarily  due to an  increase  in the number of  personnel
      employed  by the  Company  as a result  of the 1st  State  Bancorp  merger
      transaction as well as higher costs associated with the Company's growth.

Financial Condition

Total consolidated assets of the Company at March 31, 2006 were $1,308.6 million
compared to $960.9 million at December 31, 2005, an increase of $347.7  million,
or approximately 36%. The

                                       13
<PAGE>

increase in total  consolidated  assets for the quarter  ended March 31, 2006 is
primarily due to a $271 million  increase in Capital Bank's loan portfolio,  net
of the allowance for loan losses,  from December 31, 2005,  which  includes $230
million of net loans acquired in the 1st State Bancorp merger transaction. Total
deposits as of March 31, 2006 were $972 million, which represents growth of $274
million  from  December 31, 2005 and  includes  $271  million of total  deposits
acquired in the 1st State Bancorp merger transaction.

Total earning assets were $1,151.7  million at March 31, 2006 compared to $843.9
million at December  31, 2005.  Earning  assets  represented  88.0% and 87.8% of
total assets as of March 31, 2006 and December 31, 2005, respectively.  At March
31, 2006, investment securities were $181.0 million, which includes $7.8 million
of investment  securities  acquired in the 1st State Bancorp merger transaction,
compared to $161.6 million at December 31, 2005. The Company sold  approximately
$102.3 million of investment securities acquired in the 1st State Bancorp merger
transaction  during January 2006, with proceeds  principally being used to repay
the $30 million of short-term  debt that was outstanding as of December 31, 2005
(used to fund the majority of the cash portion of the 1st State  Bancorp  merger
consideration),  fund new loan growth and  purchase new  investment  securities.
Interest-earning  cash, federal funds sold and short term investments were $26.4
million at March 31, 2006,  an increase of $13.0 million from December 31, 2005.
The Company  has  increased  its  holdings of  short-term  investment  assets to
maintain liquidity for loan fundings and future commitments.  As of December 31,
2005,  the Company had $33.1 million of cash held in escrow,  which  represented
funds the Company was required to deposit with its transfer agent for payment to
1st State Bancorp  shareholders as cash consideration in connection with the 1st
State  Bancorp  merger  transaction.  Earning  assets  exclude  bank  owned life
insurance,  which  increased  from $19.9  million at December  31, 2005 to $20.1
million at March 31, 2006 due to the increase in cash surrender values.

The  allowance  for loan  losses as of March  31,  2006 was  $14.2  million  and
represented  approximately 1.50% of total loans at March 31, 2006. The allowance
for loan losses  increased  $4.6  million  from the December 31, 2005 balance of
$9.6 million.  The increase is primarily due to the addition of 1st State Bank's
allowance  for loan  losses,  which was $7.6  million as of the  January 3, 2006
acquisition  date,  offset by net  charge-offs  of $3.4 million,  including $3.2
million  related  to one 1st State  Bank loan  relationship  that had been fully
reserved for prior to the closing date of the transaction.  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" for further
discussion of the allowance for loan losses.

Total deposits as of March 31, 2006 were $972.2  million,  an increase of $273.8
million, or 39.2%, from December 31, 2005. The increase was primarily the result
of  $271  million  of  deposits   acquired  in  the  1st  State  Bancorp  merger
transaction.  At March 31, 2006,  the Company  experienced an increase of $137.8
million,  or 39.8%, in certificates of deposit ("CDs")  compared to December 31,
2005,  which  includes  $139.8  million of CDs acquired in the 1st State Bancorp
merger  transaction.  Absent the CDs  acquired in the 1st State  Bancorp  merger
transaction,  CDs would have decreased  slightly  between  December 31, 2005 and
March 31, 2006 as a result of CD maturities exceeding new CD sales and renewals.
Total  time  deposits  represented  56.5% of total  deposits  at March 31,  2006
compared to 54.9% at December 31, 2005.

Noninterest bearing demand deposit accounts ("DDA") were $107.4 million at March
31, 2006, an increase of $29.6  million,  or 38%, from December 31, 2005,  which
includes $19.8 million of noninterest bearing deposits acquired in the 1st State
Bancorp merger transaction.  The average

                                       14
<PAGE>

balance of noninterest  DDA accounts was $100.0 million during the quarter ended
March 31, 2006  compared  to $62.0  million  during the quarter  ended March 31,
2005.

Total consolidated shareholders' equity was $158.1 million as of March 31, 2006,
an increase of $74.6  million from  December 31,  2005.  The Company  issued 4.9
million  shares of common stock valued at $74.5 million in  connection  with the
1st State  Bancorp  merger  transaction.  Retained  earnings  increased  by $2.1
million  reflecting  $2.8 million of net income for the quarter  ended March 31,
2006 less $697,000 of dividends  paid during the quarter.  See Item 1. Financial
Statements -  Consolidated  Statements  of Changes in  Shareholders'  Equity for
additional information.

Results of Operations

Quarter ended March 31, 2006 compared to quarter ended March 31, 2005
---------------------------------------------------------------------

For the quarter  ended March 31, 2006,  the Company  reported net income of $2.8
million, or $0.24 per diluted share,  compared to net income of $1.6 million, or
$0.22 per diluted  share,  for the  quarter  ended  March 31,  2005.  Net income
increased by $1.2 million  primarily due to higher loan and deposit  balances on
which net interest  income and noninterest  income are generated.  The increased
balances were primarily the result of the 1st State Bancorp merger  transaction.
The  Company's  net interest  margin also widened in the quarter ended March 31,
2006 compared to the quarter ended March 31, 2005 as a result of the  increasing
interest rate environment.

Net interest income increased $4.5 million,  or approximately  64.9%,  from $6.9
million for the quarter  ended March 31,  2005,  to $11.4  million for the three
month period ended March 31,  2006.  Average  earning  assets  increased  $345.3
million to $1,158.3  million  for the  quarter  ended March 31, 2006 from $813.0
million  for  the  quarter  ended  March  31,  2005.  Average  interest  bearing
liabilities  increased  $299.4 million to $1,027.9 million for the quarter ended
March 31,  2006 from  $728.5  for the  quarter  ended  March 31,  2005.  The net
interest margin on a fully taxable equivalent basis increased 53 basis points to
4.06% for the quarter  ended  March 31,  2006 from 3.53% for the  quarter  ended
March 31, 2005. The earned yield on average  interest  earnings assets was 6.95%
and 5.80% for the quarter ended March 31, 2006 and 2005, respectively, while the
interest  rate on average  interest  bearing  liabilities  for those periods was
3.26% and  2.53%,  respectively.  The  increase  in the net  interest  margin is
primarily  attributed  to  increases  in the  benchmark  federal  funds rates as
determined by the Federal Reserve Open Market Committee ("FOMC").  The Company's
balance sheet remains  asset-sensitive  and, as a result,  its interest  earning
assets re-price faster than its interest bearing liabilities. The Company cannot
be certain of the direction of the  benchmark  federal funds rates as set by the
FOMC. Further increases by the FOMC will affect the level of the Company's prime
rate and likely  continue to increase  the  effective  cost of  interest-bearing
liabilities.

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
<PAGE>

      Average Balances, Interest Earned or Paid, and Interest Yields/Rates
                      Quarter Ended March 31, 2006 and 2005
              (Taxable Equivalent Basis - Dollars in Thousands) (1)
<TABLE>
<CAPTION>

                                                                 2006                                      2005
                                              ------------------------------------------------------------------------------------
                                                Average        Amount        Average        Average        Amount       Average
                                                Balance        Earned          Rate         Balance        Earned        Rate
                                              ------------------------------------------------------------------------------------
<S>                                                <C>               <C>          <C>          <C>               <C>          <C>
Assets
Loans receivable: (2)
  Commercial                                  $   738,162    $    13,677          7.51%   $   533,246    $     7,927          6.03%
  Consumer                                         31,570            640          8.23%        31,823            567          7.23%
  Home equity                                     100,319          1,822          7.37%        61,913            874          5.73%
  Residential mortgages (3)                        53,899            878          6.61%        25,447            374          5.96%
                                              ------------------------------------------------------------------------------------
Total loans                                       923,950         17,018          7.47%       652,429          9,742          6.06%
Investment securities (4)                         194,535          2,303          4.80%       157,963          1,861          4.78%
Federal funds sold and other
    interest on short term investments             39,839            542          5.52%         2,571             17          2.68%
                                              ------------------------------------------------------------------------------------
Total interest earning assets                   1,158,324    $    19,863          6.95%       812,963    $    11,620          5.80%
                                                             =========================                   =========================
Cash and due from banks                            31,374                                      22,466
Other assets                                      138,602                                      55,346
Allowance for loan losses                         (17,155)                                    (10,863)
                                              -----------                                 -----------
Total assets                                  $ 1,311,145                                 $   879,912
                                              ===========                                 ===========

Liabilities and Equity
Savings deposits                              $    43,815    $        60          0.56%   $    15,751    $        10          0.26%
Interest-bearing demand deposits                  265,685          1,549          2.36%       174,133            638          1.49%
Time deposits                                     548,217          4,501          3.33%       395,926          2,534          2.60%
                                              ------------------------------------------------------------------------------------
Total interest bearing deposits                   857,717          6,110          2.89%       585,810          3,182          2.20%
Borrowed funds                                    114,362          1,326          4.70%       106,541          1,019          3.88%
Subordinated debt                                  32,574            597          7.43%        20,620            276          5.43%
Repurchase agreements                              24,852            247          4.03%        15,480             73          1.91%
                                                             -------------------------                   -------------------------
  Total interest-bearing liabilities            1,029,505    $     8,280          3.26%       728,451    $     4,550          2.53%
                                                             =========================                   =========================
Non-interest bearing deposits                      99,976                                      61,977
Other liabilities                                  21,823                                      11,008
                                              -----------                                 -----------
Total liabilities                               1,151,304                                     801,436
Shareholders' equity                              159,841                                      78,476
                                              -----------                                 -----------
 Total liabilities and shareholders' equity   $ 1,311,145                                 $   879,912
                                              ===========                                 ===========

Net interest spread (5)                                                           3.69%                                       3.26%

Tax equivalent adjustment                                    $       193                                 $       164

Net interest income and net
  interest margin (6)                                        $    11,583          4.06%                  $     7,070          3.53%

</TABLE>

(1)  The taxable  equivalent basis is computed using a blended federal and state
     tax rate of approximately 38%.
(2)  Loans receivable include nonaccrual loans for which accrual of interest has
     not been recorded.
(3)  Includes loans held for sale.
(4)  The average balance for investment  securities  exclude the effect of their
     mark-to-market adjustment, if any.
(5)  Net interest spread represents the difference  between the average yield on
     interest-earning   assets  and  the   average   cost  of   interest-bearing
     liabilities.
(6)  Net interest  margin  represents the net interest income divided by average
     interest-earning assets.

                                       16
<PAGE>

Interest income on loans increased from $9.7 million for the quarter ended March
31, 2005 to $17.0 million for the quarter ended March 31, 2006.  The increase is
primarily due to higher average loan balances, which increased by $271.5 million
primarily  due to  loan  balances  acquired  in the  1st  State  Bancorp  merger
transaction, and increased loan yields. Yields on commercial, consumer, and home
equity  increased  148 basis  points,  100 basis  points  and 164 basis  points,
respectively,  in the quarter ended March 31, 2006 compared to the quarter ended
March 31,  2005.  Higher  yields in 2006  reflect the increase in the prime rate
charged  by the Bank  between  those two  periods.  Variable  rate loans made up
approximately  69.6% of the total loan  portfolio at March 31, 2006  compared to
69.3% at March 31, 2005.

Interest  income on investment  securities  increased  from $1.7 million for the
quarter  ended  March 31, 2005 to $2.1  million for the quarter  ended March 31,
2006.  The  increase  is  primarily  due  to an  increase  in  average  balances
outstanding between the periods,  which increased by $36.6 million. The yield on
investment  securities on a  tax-equivalent  basis  increased  from 4.78% in the
quarter ended March 31, 2005 to 4.80% in the quarter  ended March 31, 2006.  The
slight increase is due to higher yields on new investment  securities  purchases
offset by the overall  lower yield on the acquired  1st State Bank's  investment
security  portfolio.  The  Company  sold  $102.3  million  of 1st  State  Bank's
investment security portfolio after the completion of the merger.  Proceeds were
principally  used  to  repay  the  $30  million  of  short-term  debt  that  was
outstanding  at December 31, 2005 (used to fund the majority of the cash portion
of  the1st  State  Bancorp  merger  consideration),  fund loan  commitments  and
purchase new investment securities.

Interest  expense on deposits  increased from $3.2 million for the quarter ended
March 31,  2005 to $6.1  million  for the  quarter  ended  March 31,  2006.  The
increase is primarily due an increase in the average balance of interest bearing
deposits  outstanding,  which increased $271.9 million  primarily due to deposit
balances  acquired  in the 1st State  Bancorp  merger  transaction,  and  higher
deposit rates.  The average rate paid on time deposits  increased from 2.60% for
the quarter  ended March 31, 2005 to 3.33% for the quarter ended March 31, 2006,
a 73 basis point rise,  as new  certificates  were opened at higher rates due to
the  rising  interest  rate  environment.  Rates on  shorter  maturity  CDs have
increased  significantly  with the FOMC interest rate  increases and  management
anticipates the Bank's CD funding costs will increase on a quarterly basis going
forward for the remainder of 2006.

Interest expense on borrowings increased from $1.4 million for the quarter ended
March 31,  2005 to $2.2  million  for the  quarter  ended  March 31,  2006.  The
increase is primarily due to higher outstanding  borrowing and subordinated debt
balances  and an  increase  in  interest  rates.  The  rate  on  borrowings  and
subordinated  debentures for the quarter ended March 31, 2006 increased to 4.70%
and 7.43%,  respectively,  from 3.88% and 5.43%,  respectively,  for the quarter
ended March 31, 2005. 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. In the first quarter of 2005,
the net effect of the swaps was a reduction of interest expense,  however,  as a
result of the significant  increase in short-term interest rates, the net effect
of the swaps was an increase in interest  expense for the first quarter of 2006.
As short-term  interest rates have increased  following the FOMC rate increases,
the  overall  effective  rate on  both  borrowings  and  subordinated  debt  has
increased.

                                       17
<PAGE>

For the quarter ended March 31, 2006, the provision for loan losses was $412,000
compared  to a credit of  $250,000  for the quarter  ended  March 31,  2005,  an
increase  of  $662,000.  The  increase  in the  provision  for loan  losses  was
primarily  due  to  an  increase  in  the  specific   allocation  for  one  loan
relationship and the estimated inherent losses associated with the net growth in
the loan portfolio  during the quarter ended March 31, 2006 and other factors as
discussed  more fully below  under  "Asset  Quality".  Net  charge-offs  for the
quarter  ended  March 31,  2006 were $3.4  million,  or 1.45% of average  loans,
compared to $99,000,  or 0.06% of average  loans for the quarter ended March 31,
2005.  Charge-offs  for the quarter  ended March 31, 2006  includes $3.2 million
related to one loan  relationship that had been fully reserved by 1st State Bank
as of December 31, 2005 and had no impact on the Bank's loan loss  provision for
the quarter ended March 31, 2006.

Noninterest  income  for the  quarter  ended  March  31,  2006 was $2.0  million
compared to $1.3 million for the quarter  ended March 31,  2005,  an increase of
$0.7 million.  This increase was  primarily  due to higher  service  charges and
other fees,  which  increased  by  $308,000,  as a result of a higher  volume of
transaction  accounts,  which  were  acquired  in the 1st State  Bancorp  merger
transaction.  Income on bank owned life insurance  increased  $108,000 primarily
due to additional insurance purchased in the second quarter of 2005.

Noninterest  expenses  for the quarter  ended  March 31, 2006 were $8.8  million
compared to $6.2  million for the quarter  ended March 31,  2005.  Salaries  and
employee  benefits,  representing  the  largest  noninterest  expense  category,
increased  to $4.5  million for the  quarter  ended  March 31,  2006,  from $3.1
million for the quarter ended March 31, 2005.  The increase was primarily due to
an  increase in the number of  personnel  employed by the Company as a result of
the  1st  State  Bancorp   merger   transaction   and  the   Company's   overall
period-over-period  growth.  As of March 31, 2006, the Company had 328 full-time
equivalent  employees  compared  to 241 for  the  same  date in 2005  and 256 at
December 31, 2005.

Occupancy costs, the second largest component of noninterest expenses, increased
$164,000 to $778,000 for the quarter  ended March 31, 2006 from $614,000 for the
same period in 2005. The increase is primarily due to expenses  associated  with
branches  acquired in the 1st State Bancorp  merger  transaction.  Furniture and
equipment  expenses for the quarter ended March 31, 2006 increased $125,000 from
the same period in 2005 primarily due to higher equipment repair and maintenance
costs associated with the increase in branch locations. Data processing expenses
for the quarter ended March 31, 2006 increased  $178,000 from the same period in
2005  primarily  due to higher  fees  from  third-party  providers  prior to the
start-up  of  the  Company's   operations  center.  The  Company  completed  the
consolidation of its state-wide  operations during the first quarter of 2006 and
now processes  data and banking items  in-house.  The Company  anticipates  data
processing  costs will decrease in future  periods as a result of  consolidating
the  transaction  processing  at its  operations  center  in  Burlington,  North
Carolina.  Director fees for the quarter ended March 31, 2006 increased $205,000
from the same period in 2005 primarily due to higher expense accruals associated
with the  directors  supplemental  retirement  plan and the  directors  deferred
compensation  plan as a result of the  adoption  of SFAS 123R.  Deposit  premium
amortization  for the quarter ended March 31, 2006  increased  $289,000 from the
same  period in 2005  primarily  as a result of the deposit  premium  intangible
associated  with the 1st State Bancorp merger  transaction,  which was valued at
$5.3  million as of the  closing  date and is being  amortized  over eight years
Other expenses for the quarter ended March 31, 2006 increased  $345,000 from the
same  period  in 2005  primarily  due to higher  postage,  printing  and  travel
expenses associated with the 1st State Bancorp merger transaction.

                                       18
<PAGE>

The  Company's  effective  tax  rate for the  first  quarter  of 2006 was  33.9%
compared to 33.7% for the comparable  period of 2005. Income tax expense for the
quarter  ended  March  31,  2006  and 2005 was  $1.4  million  and $0.8  million
respectively.  The Company  forecasts  its taxable  and  non-taxable  income and
calculates the effective tax rate for the entire year,  which is then applied to
the three month period.

Asset Quality

Determining the allowance for loan losses is based on a number of factors,  many
of which are subject to judgments made by management. At the origination of each
commercial loan, management assesses the relative risk of the loan and assigns a
corresponding  risk grade.  To ascertain  that the credit  quality is maintained
after the loan is booked, the Bank has a procedure whereby 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 Audit  Committee.  On an as
needed  basis,  the Bank will hire an  outside  third  party  firm to review the
Bank's loan portfolio to ensure  quality  standards and  reasonableness  of risk
assessment.

The Company estimates the amount of allowance needed to cover probable 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.

Beginning in the second quarter of 2005, the Company began estimating a specific
allowance for loan losses associated with certain  commercial loans 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 $14.2
million  allowance  for loan losses as of March 31, 2006,  $3.1 million has been
allocated to specific loans.

The allowance for loan losses is established through a provision for loan losses
charged to expense. Loans are charged against the allowance for loan losses when
management believes that the collectibility of the principal is unlikely.  Based
on this allowance  calculation,  management recorded a provision of $412,000 for
the quarter  ended  March 31,  2006,  compared  to a credit of $250,000  for the
quarter ended March 31, 2005.  The Company added 1st State Bank's  allowance for
loan losses,  which was $7.6 million as of December 31, 2005,  to the  Company's
allowance  for loan  losses.  The Company  continued  to  experience  an overall
improvement in the risk ratings of the loan  portfolio  during the quarter ended
March 31, 2006,  however past due loans as a  percentage  of the loan  portfolio
increased from 1.07% at December 31, 2005 to 1.26% at March 31, 2006.  Past dues
greater  than 90 days as a  percentage  of total loans  decreased  from 0.66% at
December 31, 2005 to 0.46% at March 31, 2006. The following

                                       19
<PAGE>

table  presents an analysis of changes in the  allowance for loan losses for the
three month periods ended March 31, 2006 and 2005, respectively:

                                                             Three Months
                                                            Ended March 31,
                                                          2006        2005
                                                        --------    --------
(Dollars in thousands)
Allowance for loan losses, beginning of period          $  9,592    $ 10,721
  1st State Bank loan loss allowance acquired              7,637          --
Net charge-offs:
      Loans charged off:
      Commercial                                           3,316          96
      Consumer                                               106         159
      Home equity lines                                       --          --
      Mortgage                                                31          51
                                                        --------    --------
           Total charge-offs                               3,453         306
                                                        --------    --------
      Recoveries of loans previously charged off:
      Commercial                                               8         201
      Consumer                                                 4           6
      Home equity lines                                        4          --
      Mortgage                                                 5          --
                                                        --------    --------
           Total recoveries                                   21         207
                                                        --------    --------
           Total net charge-offs                           3,432          99
                                                        --------    --------
      Loss provisions (credits) charged to operations        412        (250)
                                                        --------    --------
Allowance for loan losses, end of period                $ 14,209    $ 10,372
                                                        ========    ========

Net charge-offs to average loans during the
period (annualized)                                         1.49%       0.06%
Allowance as a percent of gross loans                       1.50%       1.60%

Net  charge-offs  for the quarter  ended March 31, 2006  includes  $3.2  million
related to one 1st State Bank loan  relationship  that was fully reserved by 1st
State Bank as of December  31, 2005.  Excluding  this  transaction,  charge-offs
declined, which reflects the resources management has allocated to improving the
overall credit quality of the loan portfolio.

The following table presents an analysis of nonperforming assets as of March 31,
2006 and 2005 and December 31, 2005:

                                       20
<PAGE>

                                                   March 31,      December 31,
                                               2006        2005       2005
                                              -------    -------    -------
(Dollars in thousands)
Nonaccrual loans:
      Commercial and commercial real estate   $ 5,149    $ 5,797    $ 5,040
      Mortgage                                  1,588      1,880      1,628
      Construction                                807      2,374        737
      Equity lines                                398        323        497
      Comsumer                                    100        195        176
                                              -------    -------    -------
           Total nonaccrual loans               8,042     10,569      8,078
      Foreclosed property held                    888        431        771
                                              -------    -------    -------
           Total nonperforming assets         $ 8,930    $11,000    $ 8,849
                                              =======    =======    =======

Nonperforming assets to total loans              0.95%      1.63%      1.32%
Nonperforming assets to total assets             0.68%      1.24%      0.92%
Allowance coverage of nonperforming loans         177%        98%       119%

At March 31, 2006,  nonperforming  assets were $8.9 million, an increase of $0.1
million  from  December 31, 2005.  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 existing at March 31, 2006.

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.  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.  There were no  impaired
loans at March 31, 2006 and December 31, 2005.

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 and
includes  the  accumulation  of  related  data  such  as  loan  payment  status,
borrowers'  financial data and borrowers'  operating factors such as cash flows,
operating income or loss. 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,  changes in factors and management's future evaluation of the
adequacy of the allowance for loan losses will change.

Foreclosed  property  increased  to $888,000 at March 31, 2006 from  $771,000 at
December 31, 2005. The increase is largely  attributable  to the  foreclosure of
certain  nonaccrual loans during the quarter.  The Company is actively marketing
all of its foreclosed property.  All foreclosed assets are recorded at the lower
of cost or fair value. Foreclosed property excludes $1.8 million related to four
branch  locations  that are held for sale and are  reported as other real estate
owned pursuant to bank regulations and are also recorded at the lower of cost or
fair value.

                                       21
<PAGE>

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/Liability  Management  Committee of the Company's Board of Directors.  The
Company had $59.8 million in its most liquid assets,  cash and cash equivalents,
as of March  31,  2006.  The  Company's  principal  sources  of  funds  are loan
repayments,  deposits,  Federal Home Loan Bank  borrowings and 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 $ 948.6
million  and  $652.1   million  at  March  31,  2006  and   December  31,  2005,
respectively,  funded 72.2% of total assets at March 31, 2006  compared to 67.7%
at December 31, 2005. 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 the Company's 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 first quarter of 2006,  the Company  repurchased  116,000 shares at a
weighted average price of $15.92 per share.

To be  categorized as well  capitalized,  the Company and the Bank must maintain
minimum amounts and ratios.  The Company's  actual capital amounts and ratios as
of March 31, 2006 and the minimum  requirements  are  presented in the following
table:

<TABLE>
<CAPTION>

                                                                                     Minimum
                                                                               Requirements To Be
                                                       Actual                  Well Capitalized
                                            -----------------------------  ----------------------------
(Dollars in thousands)                         Amount          Ratio          Amount         Ratio
                                            -------------  --------------  -------------  -------------
<S>                                              <C>              <C>            <C>             <C>
        Capital Bank Corporation
        ------------------------
Total Capital (to Risk Weighted Assets)        $ 131,036          11.42%      $ 114,713         10.00%
Tier I Capital (to Risk Weighted Assets)         115,602          10.08%         68,829          6.00%
Tier I Capital (to Average Assets)               115,602           9.34%         61,898          5.00%

            Capital Bank
            ------------
Total Capital (to Risk Weighted Assets)        $ 127,832          11.15%      $ 114,638         10.00%
Tier I Capital (to Risk Weighted Assets)         113,500           9.90%         68,783          6.00%
Tier I Capital (to Average Assets)               113,500           9.68%         58,645          5.00%

</TABLE>

                                       22
<PAGE>

Consolidated capital ratios decreased from December 31, 2005 due to the increase
in risk-weighted and total assets  associated with the Company's  acquisition of
1st State Bancorp exceeding the tangible capital acquired. 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, 2005 were  13.71%,
11.73% and 10.64%, respectively.

Shareholders' equity was $158.1 million, or $13.60 per share, at March 31, 2006.
Management believes this level of shareholders' equity provides adequate capital
to support the Company's growth and to maintain a well capitalized position.

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,  2005,  as  amended,   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 Asset and Liability Committee
monitors  loan,  investment,  and liability  portfolios to ensure  comprehensive
management of interest rate risk and adherence to the policies.

The Company utilizes an outside asset liability management advisory firm to help
management  evaluate interest rate risk and develop  asset/liability  management
strategies.  One tool used is a computer  simulation  model which  projects  the
Company's  performance  under different  interest rate  scenarios.  Analyses are
prepared  quarterly  which evaluate the Company's  performance  under  different
interest rate  scenarios  (flat,  rising and  declining).  The following  tables
illustrate the output from the Company's  simulation  model based on the balance
sheets  as of  March  31,  2006  and  December  31,  2005.  The  tables  reflect
rate-sensitive  positions at March 31, 2006 and  December 31, 2005,  and are not
necessarily  indicative of positions on other dates. The projected results as of
March 31, 2006 include the impact of the 1st State Bancorp  merger  transaction,
which was completed on January 3, 2006.

The following table  illustrates the Company's  interest rate  sensitivity as of
March 31, 2006 and  December 31, 2005.  The  carrying  amounts of interest  rate
sensitive  assets and  liabilities  are  presented in periods in which they next
reprice to market rates or mature and are  aggregated  to show the interest rate
sensitivity gap. To reflect anticipated prepayments, certain asset and liability
amounts were based on estimated cash flows rather than  contractual  cash flows.
The Company  continues to be "asset  sensitive"  at March 31, 2006 as its assets
reprice faster than its liabilities.

<TABLE>
<CAPTION>
                                               Within One     One to Two     Two to Five   After Five
Interest Rate Sensitivity                         Year           Years          Years         Years        Total
-------------------------                         ----           -----          -----         -----        -----
<S>                                             <C>            <C>            <C>           <C>         <C>
(Dollars in thousands)
As of March 31, 2006
  Total assets                                  $ 845,796      $  92,466      $ 161,215     $ 209,090   $1,308,567
  Total liabilities and equity                  $ 654,266      $ 217,885      $ 198,395     $ 238,021   $1,308,567
                                                ---------      ---------      ---------     ---------   ----------
   Interest-rate sensitivity gap                $ 191,530     ($ 125,419)    ($  37,180)   ($  28,931)  $       --
  Cumulative interest-rate sensitivity gap      $ 191,530      $  66,111       $ 28,931     $      --
</TABLE>

                                       23
<PAGE>
<TABLE>
<CAPTION>

                                               Within One     One to Two     Two to Five   After Five
                                                  Year           Years          Years        Years         Total
                                                  ----           -----          -----         -----        -----
<S>                                             <C>            <C>             <C>          <C>           <C>
As of December 31, 2005
  Total assets                                  $ 569,081      $  60,830       $182,755     $ 148,240     $960,906
  Total liabilities and equity                  $ 387,158      $ 250,575       $115,821     $ 207,352     $960,906
                                                ---------      ---------       --------     ---------     --------
   Interest-rate sensitivity gap                $ 181,923     ($ 189,745)      $ 66,934    ($ 59,112)     $     --
  Cumulative interest-rate sensitivity gap      $ 181,923     ($   7,822)      $ 59,112     $     --
</TABLE>

As of March 31, 2006 and December 31, 2005,  under the flat rate  scenario,  the
Company was projected to earn $50.4 million and $34.9 million, respectively. The
table below  measures  the impact on net  interest  income of both a gradual and
immediate  200 basis  point  change in  interest  rates over the  twelve  months
following  the interest  rate  change.  Actual  results  could differ from these
estimates.

<TABLE>
<CAPTION>
                                     Change in 12 month Projected Net Interest Income Versus
                                       Projected Net Interest Income Under No Rate Change
                                       --------------------------------------------------
                                     March 31, 2006                        December 31, 2005
                                     --------------                        -----------------
(Dollars in millions)     Dollar Change    Percentage Change     Dollar Change    Percentage Change
                          -------------    -----------------     -------------    -----------------
<S>                             <C>                   <C>              <C>                    <C>
Basis Point Change
+200 gradual                     $ 4.8                  9.5%            $ 2.9                   8.3%
+200 immediate                   $ 8.4                 16.6%            $ 5.2                  14.9%
No rate change                      --                   --                --                    --
-200 gradual                    ($2.5)                (5.0%)           ($1.7)                 (4.9%)
-200 immediate                  ($5.2)               (10.3%)           ($3.3)                 (9.5%)
</TABLE>

The table does not reflect  the impact of hedging  strategies  discussed  in the
Company's  Annual  Report on Form 10-K for the year ended  December 31, 2005, as
amended.

Item 4   Controls and Procedures
         -----------------------

The Company  maintains  disclosure  controls and procedures that are designed to
ensure that information  required to be disclosed in its Exchange Act reports is
recorded, processed, summarized and reported within the time periods required by
the SEC's  rules  and  forms,  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 applied 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
design and operation 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 the Company's  disclosure controls and procedures are
effective  in timely  alerting  them to  material  information  relating  to the
Company that is required to be included in its Exchange Act filings.

                                       24
<PAGE>

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 Capital Bank Corporation 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.

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

                                       25
<PAGE>

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:

   o  Changes in regulations;
   o  Changes in technology and product delivery systems; and
   o  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  National 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  National  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.

                                       26
<PAGE>

Government  Regulations  May  Prevent  or Impair 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:

      o  The payment of dividends to our shareholders;
      o  Possible mergers with or acquisitions of or by other institutions;
      o  Our desired investments;
      o  Loans and interest rates on loans;
      o  Interest rates paid on our deposits;
      o  The possible expansion of our branch offices; and/or
      o  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 Securities and Exchange  Commission 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.

                                       27
<PAGE>

Compliance  with  Changing   Regulation  of  Corporate   Governance  and  Public
Disclosure May Result in Additional Risks and Expenses

Changing laws,  regulations and standards  relating to corporate  governance and
public  disclosure,  including  the  Sarbanes-Oxley  Act of  2002  and  new  SEC
regulations,  are creating  uncertainty for companies such as ours.  These laws,
regulations and standards are subject to varying  interpretations in many cases,
and as a result,  their  application  in  practice  may evolve  over time as new
guidance is provided by regulatory and governing  bodies,  which could result in
continuing   uncertainty   regarding   compliance   matters  and  higher   costs
necessitated by ongoing revisions to disclosure and governance practices. We are
committed to  maintaining  high  standards of  corporate  governance  and public
disclosure.  As a result, our efforts to comply with evolving laws,  regulations
and  standards  have  resulted  in,  and are  likely to  continue  to result in,
increased  expenses  and a  diversion  of  management  time  and  attention.  In
particular,  our efforts to comply with Section 404 of the Sarbanes-Oxley Act of
2002 and the related regulations  regarding  management's required assessment of
our internal control over financial  reporting and our external  auditors' audit
of that  assessment  has required the  commitment of  significant  financial and
managerial  resources.   We  expect  these  efforts  to  require  the  continued
commitment  of  significant  resources.  Further,  the  members  of our Board of
Directors,  members of the Audit or Compensation/Human Resources committees, our
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 May Not Be Able to Successfully Integrate 1st State Bancorp or to Realize the
Anticipated Benefits of our Recently Completed Merger

Our recently completed merger with 1st State Bancorp involves the combination of
two bank holding  companies  that  previously  have  operated  independently.  A
successful  combination  of the  operations  of the  two  entities  will  depend
substantially on our ability to consolidate  operations,  systems and procedures
and to  eliminate  redundancies  and costs.  We may not be able to  combine  the
operations  of 1st  State  Bancorp  with  our  operations  without  encountering
difficulties, such as:

      o  The loss of key employees and customers;
      o  The disruption of operations and business;
      o  Inability to maintain and increase competitive presence;
      o  Deposit attrition, customer loss and revenue loss;
      o  Possible inconsistencies in standards, control procedures and policies;
      o  Unexpected problems with costs, operations,  personnel,  technology and
         credit; and/or
      o  Problems with the  assimilation of new operations,  sites or personnel,
         which could divert resources from regular banking operations.

Further,  although  meaningful  cost savings are  anticipated as a result of the
merger,  such  expected  cost  savings may not be  realized.  Finally,  any cost
savings that are  realized may be offset by losses in revenues or other  charges
to earnings.

                                       28
<PAGE>


Item 2   Unregistered Sale of Equity Securities and Use of Proceeds
         ----------------------------------------------------------

The  following  table  lists all  repurchases  (both  open  market  and  private
transactions)  during the  quarter  ended  March 31,  2006 of any 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:

<TABLE>
<CAPTION>
                                 Issuer Purchase of Equity Securities
                                 ------------------------------------

                                                               Total Number
                                                                of Shares        Maximum Number
                                                               Purchased as      of Shares That
                                                             Part of Publicly      May Yet Be
                              Total Number    Average Price      Announced       Purchased Under
                               of Shares        Paid per          Plans or           Plans or
Month of                       Purchased          Share         Programs (1)         Programs
---------------------------  -------------------------------------------------------------------
<S>                          <C>                 <C>         <C>                      <C>
January 2006                             --      $    --                 --         1,000,000
February 2006                            --           --                 --         1,000,000
March 2006                          116,000        15.92            116,000           884,000
                             ----------------------------------------------
                                    116,000      $ 15.92            116,000
                             ==============                  ==============

</TABLE>

(1)  On February 27, 2006,  the Company  announced that on February 23, 2006 the
     Company's Board of Directors had 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 and supercedes 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 March 31, 2006, there
     was  an  aggregate  of  884,000  shares  remaining  authorized  for  future
     repurchases.

Item 3   Defaults Upon Senior Securities
         -------------------------------
None

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

None

Item 5   Other Information
         -----------------

None

Item 6   Exhibits
         --------

   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.

                                       29
<PAGE>

   Exhibit 10.1   Employment  Agreement,  dated January 3, 2006, between Capital
                  Bank and A.  Christine  Baker  (incorporated  by  reference to
                  Exhibit 10.1 to the Company's Current Report on Form 8-K filed
                  with the SEC on January 9, 2006).

   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 2002

   Exhibit 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 2002

   Exhibit 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.]

   Exhibi 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.]


                                       30
<PAGE>

                                   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 10th
day of May 2006.

                                                      CAPITAL BANK CORPORATION


                                                    By:  /s/ A. Christine Baker
                                                        -----------------------
                                                        A. Christine Baker
                                                      Chief Financial Officer

                                       31
<PAGE>


                                  Exhibit Index

--------------------------------------------------------------------------------
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 10.1      Employment  Agreement,  dated January 3, 2006, between Capital
                  Bank and A.  Christine  Baker  (incorporated  by  reference to
                  Exhibit 10.1 to the Company's Current Report on Form 8-K filed
                  with the SEC on January 9, 2006).
--------------------------------------------------------------------------------
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 2002
--------------------------------------------------------------------------------
Exhibit 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 2002
--------------------------------------------------------------------------------
Exhibit 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.]
--------------------------------------------------------------------------------
Exhibi 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.]
--------------------------------------------------------------------------------


                                       32