**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**FORM
      10-Q**





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


OF
      THE SECURITIES EXCHANGE ACT OF 1934




**For
      the Quarterly Period Ended March 31, 2007**


or


 ̈ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)


OF
      THE SECURITIES EXCHANGE ACT OF 1934





For
      the Transition Period from  to










**CAPITAL
      BANK CORPORATION**


*(Exact
      name of registrant as specified in its charter)*








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





**333
      Fayetteville Street, Suite 700**


**Raleigh,
      North Carolina 27601**


*(Address
      of principal executive offices)*





**(919)
      645-6400**


*(Registrant’s
      telephone number, including area code)*





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





Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer. See definition of “accelerated
      filer and large accelerated filer” in Rule 12b-2 of the Exchange
      Act.  (Check
      one):





Large
                accelerated filer ̈
            Accelerated
                filerþ
            Non-accelerated
                filer ̈





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


Yes  ̈ No þ





As
      of May 10, 2007 there were 11,441,030 shares outstanding of the registrant’s
      common stock, no par value.







**CAPITAL
      BANK CORPORATION**




**Form
      10-Q for the Quarterly Period Ended March 31, 2007**








**INDEX**





**PART
                I**–**FINANCIAL INFORMATION**
            Page
                No.Item
                1.
            Financial
                StatementsCondensed
                Consolidated Balance Sheets as of March 31, 2007 (Unaudited) and
                December
                31, 2006
            3Condensed
                Consolidated Statements of Operations for the Three Months Ended
                March 31,
                2007 and 2006 (Unaudited)
            4Condensed
                Consolidated Statements of Changes in Shareholders’ Equity for the Three
                Months Ended March 31, 2007 and 2006 (Unaudited)
            5Condensed
                Consolidated Statements of Cash Flows for the Three Months Ended
                March 31,
                2007 and 2006 (Unaudited)
            6Notes
                to Condensed Consolidated Financial Statements (Unaudited)
            8Item
                2.
            Management’s
                Discussion and Analysis of Financial Condition and Results of Operations
            12Item
                3.
            Quantitative
                and Qualitative Disclosures about Market Risk
            20Item
                4.
            Controls
                and Procedures
            20**PART
                II**–**OTHER INFORMATION**Item
                1.
            Legal
                Proceedings
            21Item
                1A.
            Risk
                Factors
            21Item
                2.
            Unregistered
                Sales of Equity Securities and Use of Proceeds
            24Item
                3.
            Defaults
                upon Senior Securities
            25Item
                4.
            Submission
                of Matters to a Vote of Security Holders
            25Item
                5.
            Other
                Information
            25Item
                6.
            Exhibits
            25Signatures


-
            2
            -
 **INDEX**




**PART
      I –
      FINANCIAL INFORMATION**





**Item
      1.****Financial
      Statements**





**CAPITAL
      BANK CORPORATION**


**CONDENSED
      CONSOLIDATED BALANCE SHEETS**


**March
      31, 2007 and December 31, 2006**


March
                31, 2007
            
            December
                31, 2006*(Dollars
                in thousands except share data)*
            
            *(Unaudited)***ASSETS**Cash
                and due from banks:Interest
                earning
            
            $
            20,485
            
            $
            12,348Noninterest
                earning
            
            
            32,249
            
            
            33,504Federal
                funds sold and short term investments
            
            
            35,117
            
            
            8,480Investment
                securities –
                available
                for sale, at fair value
            
            
            238,201
            
            
            228,214Investment
                securities – held to maturity, at amortized cost
            
            
            10,525
            
            
            10,833Loans
                - net of unearned income and deferred fees
            
            
            1,025,464
            
            
            1,008,052Allowance
                for loan losses
            
            
            (13,531
            )
            
            (13,347
            )Net
                loans
            
            
            1,011,933
            
            
            994,705Premises
                and equipment, net
            
            
            23,108
            
            
            23,125Bank-owned
                life insurance
            
            
            20,863
            
            
            20,662Deposit
                premium and goodwill, net
            
            
            64,242
            
            
            64,543Other
                assets
            
            
            24,418
            
            
            25,970**Total
                assets**
            
            $
            1,481,141
            
            $
            1,422,384**LIABILITIES**Deposits:Demand,
                noninterest bearing
            
            $
            124,899
            
            $
            120,945Savings
                and interest-bearing demand deposits
            
            
            396,938
            
            
            366,243Time
                deposits
            
            
            598,414
            
            
            568,021Total
                deposits
            
            
            1,120,251
            
            
            1,055,209Repurchase
                agreements and federal funds purchased
            
            
            34,228
            
            
            34,238Borrowings
            
            
            115,960
            
            
            125,924Subordinated
                debentures
            
            
            30,930
            
            
            30,930Other
                liabilities
            
            
            15,917
            
            
            14,402**Total
                liabilities**
            
            
            1,317,286
            
            
            1,260,703**SHAREHOLDERS’
                EQUITY**Common
                stock, no par value; 20,000,000 authorized; 11,443,030 and 11,393,990
                issued and outstanding as of March 31, 2007 and December 31, 2006,
                respectively
            
            
            140,126
            
            
            139,484Retained
                earnings
            
            
            25,221
            
            
            23,754Accumulated
                other comprehensive loss
            
            
            (1,492
            )
            
            (1,557
            )**Total
                shareholders’ equity**
            
            
            163,855
            
            
            161,681**Total
                liabilities and shareholders’ equity**
            
            $
            1,481,141
            
            $
            1,422,384





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


-
          3
          -
 **INDEX**




**CAPITAL
      BANK CORPORATION**


**CONDENSED
      CONSOLIDATED STATEMENTS OF OPERATIONS**


**For
      the Three Months Ended March 31, 2007 and 2006 (Unaudited)**


March
                31, 2007
            
            March
                31, 2006*(Dollars
                in thousands except share and per share data)*Interest
                income:Loans
                and loan fees
            
            $
            19,883
            
            $
            17,018Investment
                securities
            
            
            2,807
            
            
            2,110Federal
                funds and other interest income
            
            
            485
            
            
            542Total
                interest income
            
            
            23,175
            
            
            19,670Interest
                expense:Deposits
            
            
            10,006
            
            
            6,110Borrowings
                and repurchase agreements
            
            
            2,446
            
            
            2,170Total
                interest expense
            
            
            12,452
            
            
            8,280Net
                interest income
            
            
            10,723
            
            
            11,390Provision
                for loan losses
            
            
            337
            
            
            399Net
                interest income after provision for loan losses
            
            
            10,386
            
            
            10,991Noninterest
                income:Service
                charges and other fees
            
            
            928
            
            
            965Mortgage
                fees and revenues
            
            
            541
            
            
            364Net
                gain on sale of securities
            
            
            –
            
            
            –Other
                noninterest income
            
            
            721
            
            
            686Total
                noninterest income
            
            
            2,190
            
            
            2,015Noninterest
                expense:Salaries
                and employee benefits
            
            
            5,094
            
            
            4,542Occupancy
            
            
            998
            
            
            778Furniture
                and equipment
            
            
            615
            
            
            492Amortization
                of deposit premiums
            
            
            300
            
            
            343Data
                processing
            
            
            296
            
            
            489Directors
                fees
            
            
            268
            
            
            376Advertising
            
            
            249
            
            
            255Other
                expenses
            
            
            1,416
            
            
            1,552Total
                noninterest expense
            
            
            9,236
            
            
            8,827Net
                income before tax expense
            
            
            3,340
            
            
            4,179Income
                tax expense
            
            
            956
            
            
            1,416Net
                income
            
            $
            2,384
            
            $
            2,763Earnings
                per share – basic
            
            $
            0.21
            
            $
            0.24Earnings
                per share – diluted
            
            $
            0.21
            
            $
            0.24Weighted
                average shares:Basic
            
            
            11,492,749
            
            
            11,616,894Fully
                diluted
            
            
            11,573,094
            
            
            11,704,315





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


-
          4
          -
 **INDEX**




**CAPITAL
      BANK CORPORATION**


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


**For
      the Three Months Ended March 31, 2007 and 2006 (Unaudited)**





Shares
                ofCommonStock
            
            Common
              Stock
            
            Other
                ComprehensiveIncome
            
            RetainedEarnings
            
            Total*(Dollars
                in thousands except share data)***Balance
                at January 1, 2006**
            
            
            6,852,156
            
            $
            70,985
            
            $
            (1,672
            )
            $
            14,179
            
            $
            83,492Repurchase
                of outstanding common stock
            
            
            (116,000
            )
            
            (1,847
            )
            
            –
            
            
            –
            
            
            (1,847
            )Issuance
                of common stock for acquisition of 1st State Bancorp, Inc.
            
            
            4,882,630
            
            
            74,499
            
            
            –
            
            
            –
            
            
            74,499Issuance
                of common stock for options exercised
            
            
            4,843
            
            
            32
            
            
            –
            
            
            –
            
            
            32Net
                income
            
            
            –
            
            
            –
            
            
            –
            
            
            2,763
            
            
            2,763Other
                comprehensive loss
            
            
            –
            
            
            –
            
            
            (147
            )
            
            –
            
            
            (147
            )Comprehensive
                income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2,616Dividends
                ($0.06 per share)
            
            
            –
            
            
            –
            
            
            –
            
            
            (697
            )
            
            (697
            )**Balance
                at March 31, 2006**
            
            
            11,623,629
            
            $
            143,669
            
            $
            (1,819
            )
            $
            16,245
            
            $
            158,095**Balance
                at January 1, 2007**
            
            
            11,393,990
            
            $
            139,484
            
            $
            (1,557
            )
            $
            23,754
            
            $
            161,681Repurchase
                of outstanding common stock
            
            
            (82
            )
            
            (1
            )
            
            
            
            
            
            
            
            (1)Issuance
                of common stock for options exercised
            
            
            16,793
            
            
            146
            
            
            –
            
            
            –
            
            
            146Noncash
                compensation
            
            
            32,329
            
            
            497
            
            
            –
            
            
            –
            
            
            497Net
                income
            
            
            –
            
            
            –
            
            
            –
            
            
            2,384
            
            
            2,384Other
                comprehensive income
            
            
            –
            
            
            –
            
            
            65
            
            
            –
            
            
            65Comprehensive
                income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2,449Dividends
                ($0.08 per share)
            
            
            –
            
            
            –
            
            
            –
            
            
            (917
            )
            
            (917
            )**Balance
                at March 31, 2007**
            
            
            11,443,030
            
            $
            140,126
            
            $
            (1,492
            )
            $
            25,221
            
            $
            163,855





*The
      accompanying notes are an integral part of these condensed consolidated
      financial statements.*  -
            5
            -
 **INDEX**




**CAPITAL
      BANK CORPORATION**


**CONDENSED
      CONSOLIDATED STATEMENTS OF CASH FLOWS**


**For
      the Three Months Ended March 31, 2007 and 2006 (Unaudited)**





March
                31, 2007
            
            March
                31, 2006*(Dollars
                in thousands)*Cash
                flows from operating activities:Net
                income
            
            $
            2,384
            
            $
            2,763Adjustments
                to reconcile net income to net cash usedin
                operating activities:Amortization
                of deposit premium
            
            
            300
            
            
            343Depreciation
            
            
            612
            
            
            481Loss
                on disposal of premises, equipment and real estate owned
            
            
            7
            
            
            –Change
                in held-for-sale loans, net
            
            
            (1,931
            )
            
            (2,458
            )Amortization
                of premiums on securities, net
            
            
            13
            
            
            38Deferred
                income tax expense
            
            
            (252
            )
            
            1,548Issuance
                of stock for compensation
            
            
            497
            
            
            –Provision
                for loan losses
            
            
            337
            
            
            399Changes
                in assets and liabilities:Accrued
                interest receivable and other assets
            
            
            1,979
            
            
            4,688Accrued
                interest payable and other liabilities
            
            
            1,284
            
            
            (128
            )**Net
                cash provided by operating activities**
            
            
            5,230
            
            
            7,674Cash
                flows from investing activities:Loan
                (originations) repayments, net
            
            
            (16,195
            )
            
            (38,375
            )Additions
                to premises and equipment
            
            
            (653
            )
            
            (1,175
            )Net
                sale of Federal Home Loan Bank stock
            
            
            931
            
            
            767Purchase
                of securities available for sale
            
            
            (19,947
            )
            
            (15,489
            )Proceeds
                from maturities of securities available for sale
            
            
            9,269
            
            
            2,427Proceeds
                from sales of securities available for sale
            
            
            –
            
            
            102,396Proceeds
                from maturities of securities held to maturity
            
            
            306
            
            
            199Net
                cash paid in merger transaction
            
            
            –
            
            
            (37,470
            )Proceeds
                from sales of premises, equipment and real estate owned
            
            
            51
            
            
            12**Net
                cash (used in) provided by investing activities**
            
            
            (26,238
            )
            
            13,292Cash
                flows from financing activities:Net
                increase in deposits
            
            
            65,042
            
            
            1,716Net
                increase (decrease) in repurchase agreements
            
            
            (10
            )
            
            11,791Net
                decrease in borrowings
            
            
            (9,964
            )
            
            (19,519
            )Repayment
                of short term debt
            
            
            –
            
            
            (30,000
            )Distribution
                of cash held in escrow
            
            
            –
            
            
            33,185Dividends
                paid
            
            
            (686
            )
            
            (411
            )Issuance
                of common stock for options and other plans
            
            
            146
            
            
            32Repurchase
                of common stock
            
            
            (1
            )
            
            (1,847
            )**Net
                cash provided by (used in) financing activities**
            
            
            54,527
            
            
            (5,053
            )Net
                change in cash and cash equivalents
            
            
            33,519
            
            
            15,913Cash
                and cash equivalents at beginning of period
            
            
            54,332
            
            
            43,904Cash
                and cash equivalents at end of period
            
            $
            87,851
            
            $
            59,817*(continued
                on next page)*





*The
      accompanying notes are an integral part of these condensed consolidated
      financial statements.*  -
            6
            -
 **INDEX**




**CAPITAL
      BANK CORPORATION**


**CONDENSED
      CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)**


**For
      the Three Months Ended March 31, 2007 and 2006 (Unaudited)**





March
                31, 2007
            
            March
                31, 2006*(Dollars
                in thousands)***Supplemental
                Disclosure of Cash Flow Information**Transfer
                of loans and premises and equipment to other real estate
                owned
            
            $
            561
            
            $
            2,142Dividends
                payable
            
            $
            917
            
            $
            697Cash
                paid for:Income
                taxes
            
            $
            –
            
            $
            –Interest
            
            $
            12,299
            
            $
            7,992Acquisition
                of 1st State Bancorp:Fair
                value of assets acquired
            
            $
            –
            
            $
            429,981Issuance
                of common stock
            
            $
            –
            
            $
            74,499Cash
                paid, including transaction costs
            
            $
            –
            
            $
            46,570Liabilities
                assumed
            
            $
            –
            
            $
            308,912





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


-
          7
          -
 **INDEX**


**Capital
      Bank Corporation – Notes to Condensed Consolidated Financial Statements
      (Unaudited)**







**1.**  **Significant
      Accounting Policies and Interim Reporting**





The
      accompanying unaudited condensed consolidated financial statements include
      the
      accounts of Capital Bank Corporation (the “Company”) and its wholly owned
      subsidiary, Capital Bank (the “Bank”). In addition, the Company has interests in
      three trusts, Capital Bank Statutory Trust I, II, and III (hereinafter
      collectively referred to as the “Trusts”). The Trusts have not been consolidated
      with the financial statements of the Company. The interim financial statements
      have been prepared in accordance with accounting principles generally accepted
      in the United States of America. They do not include all of the information
      and
      footnotes required by such accounting principles for complete financial
      statements, and therefore should be read in conjunction with the audited
      consolidated financial statements and accompanying footnotes in the Company’s
      Annual Report on Form 10-K for the year ended December 31, 2006.





The
      preparation of financial statements in conformity with accounting principles
      generally accepted in the United States requires management to make estimates
      and assumptions that affect reported amounts of assets and liabilities and
      the
      reported amounts of revenues and expenses during the reporting
      period. The more
      significant estimates that are particularly susceptible to significant change
      relate to the determination of the allowance for loan losses, valuation of
      goodwill and intangible assets, valuation of investments, and tax assets,
      liabilities and expense. Actual
      results could differ from those estimates.





In
      the opinion of management, all adjustments necessary for a fair presentation
      of
      the financial position and results of operations for the periods presented
      have
      been included, and all significant intercompany transactions have been
      eliminated in consolidation. All such adjustments are of a normal and recurring
      nature. Certain amounts reported in prior periods have been reclassified to
      conform to the current presentation. Such reclassifications have no effect
      on
      net income or shareholders’ equity as previously reported. The results of
      operations for the three months ended March 31, 2007 are not necessarily
      indicative of the results of operations that may be expected for the year ended
      December 31, 2007.





The
      condensed consolidated balance sheet at December 31, 2006 has been derived
      from
      the audited consolidated financial statements contained in the Company’s Annual
      Report on Form 10-K for the year ended December 31, 2006.





The
      accounting policies followed are as set forth in Note 1 of the Notes to
      Consolidated Financial Statements in the Company’s Annual Report on Form 10-K
      for the year ended December 31, 2006.





The
      Company adopted the provisions of the Financial Accounting Standards Board
      (“FASB”) Interpretation No. 48, *“Accounting
      for Uncertainty in Income Taxes - an interpretation of FASB Statement
      No. 109,”* (“FIN
      48”) effective January 1, 2007. FIN 48 prescribes a recognition threshold
      and measurement attribute for the financial statement recognition and
      measurement of a tax position taken or expected to be taken in a tax return.
      FIN
      48 clarifies the accounting for uncertain tax positions and requires the Company
      to recognize management’s best estimate of the impact of a tax position only if
      it is considered “more likely than not,” as defined in Statement of Financial
      Accounting Standards (“SFAS”) No. 5, *Accounting
      for Contingencies* ,
      of
      being sustained on audit based solely on the technical merits of the tax
      position. FIN 48 also provides guidance on derecognition, classification,
      interest and penalties, accounting in interim periods, disclosure, and
      transition. The Company does not anticipate any changes in its current
      accounting policies associated with the adoption of FIN 48. The adoption of
      FIN
      48 did not have a material financial impact on the Company’s financial condition
      or results of operations for the quarter ended March 31, 2007.





In
      September 2006, the FASB issued SFAS No. 157, “ *Fair
      Value Measurements* ”
(“SFAS
      No. 157”), which defines fair value, establishes a framework for measuring fair
      value, and expands disclosures about fair value measurements. SFAS No. 157
      is
      effective for fiscal years beginning after November 15, 2007. The Company is
      currently in the process of evaluating the provisions of SFAS No. 157 and
      determining how this framework for measuring fair value will affect the
      Company’s current accounting policies and procedures and our financial
      statements, but does not expect the adoption of SFAS No. 157 to have a material
      impact on the Company’s financial condition or results of
      operations.





In
      February 2007, the FASB issued SFAS No. 159, *“The
      Fair Value Option for Financial Assets and Financial Liabilities”* (“SFAS
      No. 159”), which permits entities to choose to measure financial instruments and
      certain other financial assets and financial liabilities at fair value. SFAS
      No.
      159 is effective for fiscal years beginning after November 15, 2007. The Company
      is currently assessing the impact SFAS No. 159 will have on the Company’s
      financial position and results of operations, but does not expect the adoption
      of SFAS No. 159 to have a material impact on the Company’s financial condition
      or results of operations.


-
          8
          -
 **INDEX**


**Capital
      Bank Corporation – Notes to Condensed Consolidated Financial Statements
      (Unaudited)**







The
      Company elected not to adopt SFAS No. 157 and SFAS No. 159 in the quarter ended
      March 31, 2007 and will adopt both statements effective December 31,
      2007.





From
      time
      to time, the FASB issues exposure drafts for proposed statements of financial
      accounting standards. Such exposure drafts are subject to comment from the
      public, to revisions by the FASB and to final issuance by the FASB as statements
      of financial accounting standards. The Company considers the effect of the
      proposed statements on the financial statements of the Company and monitors
      the
      status of changes to, and proposed effective dates of, exposure
      drafts.





**2.**  **Comprehensive
      Income**





Comprehensive
      income includes net income and all other changes to the Company’s equity, with
      the exception of transactions with shareholders (“other comprehensive income”).
      The Company’s comprehensive income (loss) for the three months ended March 31,
      2007 and 2006 are as shown in the Company’s Condensed Consolidated Statements of
      Changes in Shareholders’ Equity (unaudited). The
      Company’s other comprehensive income (loss) and accumulated other comprehensive
      income (loss) are comprised of unrealized gains and losses on certain
      investments in debt securities and derivatives that qualify as cash flow hedges
      to the extent that the hedge is effective. Information concerning the Company’s
      other comprehensive income (loss) for the three months ended March 31, 2007
      and
      2006 is as follows:





**Three
                Months Ended March 31, 2007 and 2006 (Unaudited)**2007
            
            2006*(Dollars
                in thousands)*Unrealized
                gains (losses) on available-for-sale securities
            
            $
            252
            
            $
            (239
            )Unrealized
                gain (loss) on change in fair value of cash flow hedge
            
            
            (66
            )
            
            –Income
                tax benefit (expense)
            
            
            (121
            )
            
            92Other
                comprehensive income (loss)
            
            $
            65
            
            $
            (147
            )





**3.**  **Earnings
      Per Share**





The
      Company is required to report both basic and diluted earnings per share (“EPS”).
      Basic EPS excludes dilution and is computed by dividing income available to
      common shareholders by the weighted average number of common shares outstanding
      for the period. Diluted EPS assumes the conversion, exercise or issuance of
      all
      potential common stock instruments, such as stock options, unless the effect
      is
      to reduce a loss or increase earnings per share. For the Company, EPS is
      adjusted for outstanding stock options using the treasury stock method in order
      to compute diluted EPS. The following table provides a computation and
      reconciliation of basic and diluted EPS for the three months ended March 31,
      2007 and 2006, respectively:





**Three
                Months Ended March 31, 2007 and 2006 (Unaudited)**2007
            
            2006*(Dollars
                in thousands except share data)*Income
                available to shareholders –
                basic and
                diluted
            
            $
            2,384
            
            $
            2,763Shares
                used in the computation of earnings per share:Weighted
                average number of shares outstanding –
                basic
            
            
            11,492,749
            
            
            11,616,894Incremental
                shares from assumed exercise of stock options
            
            
            80,345
            
            
            87,421Weighted
                average number of shares outstanding –
                diluted
            
            
            11,573,094
            
            
            11,704,315





For
      the three months ended March 31, 2007 and 2006, options to purchase
      approximately 315,000 shares and 374,000 shares, respectively, of common stock
      were used in the diluted calculation. For the three months ended March 31,
      2007
      and 2006, options to purchase approximately 58,000 shares and 117,000 shares,
      respectively, of common stock were not included in the diluted calculation
      because the option price exceeded the average fair market value of the
      associated shares of common stock.


-
            9
            -
 **INDEX**


**Capital
      Bank Corporation – Notes to Condensed Consolidated Financial Statements
      (Unaudited)**







**4.**  **Stock-Based
      Compensation**





The
      Company accounts for stock-based compensation in accordance with SFAS No. 123R, *Share-Based
      Payments* (“SFAS
      No. 123R”). The Company has stock option plans providing for the issuance of up
      to 650,000 options to purchase shares of the Company’s common stock to officers
      and directors. As of March 31, 2007, options for 192,209 shares of common stock
      remained available for future issuance. In addition, there were approximately
      567,000 options, which were assumed under various plans from previously acquired
      financial institutions, of which approximately 131,015 remain outstanding.
      There
      were no new stock option grants in the three months ended March 31, 2007 and
      all
      options outstanding as of March 31, 2007 were fully vested as of December 31,
      2005.





The
      Company also administers the Capital Bank Corporation Deferred Compensation
      Plan
      for Outside 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 the total director’s fees. Each participant is fully
      vested in his or her account balance. The Deferred Compensation Plan generally
      provides for payment of share units either in shares of Company common stock
      or
      cash (at the Company’s discretion). The Deferred Compensation Plan is classified
      as a liability-based plan under SFAS No. 123R. For the three months ended March
      31, 2007 and 2006, the Company recognized $0 and $86,000, respectively, of
      share-based expense related to the Deferred Compensation Plan.





The
      following is a summary of stock option information and the weighted average
      exercise price (“WAEP”) for the three months ended March 31, 2007:




Shares
            
            WAEPOutstanding
                at January 1, 2007
            
            
            389,715
            
            $
            11.75Granted
            
            
            –
            
            
            –Exercised
            
            
            (16,793
            )
            
            8.72Terminated
            
            
            –
            
            
            –Outstanding
                at March 31, 2007
            
            
            372,922
            
            $
            11.88Options
                exercisable at March 31, 2007
            
            
            372,922
            
            $
            11.88







The
      following table summarizes information about the Company’s stock options at
      March 31, 2007:





Exercise
                Price
            Number
                Outstanding
            
            Weighted
                Average
              Remaining
                Contractual Life in Years
            
            Number
                Exercisable$6.62 –
                $9.00
            117,969
            
            3.17
            
            117,969$9.01 –
                $12.00
            95,702
            
            4.07
            
            95,702$12.01 –
                $15.00
            33,750
            
            1.77
            
            33,750$15.01 –
                $18.00
            67,751
            
            6.05
            
            67,751$18.01 –
                $18.37
            57,750
            
            7.74
            
            57,750372,922
            
            4.51
            
            372,922





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 U.S. Treasury issues.


-
            10
            -
 **INDEX**


**Capital
      Bank Corporation – Notes to Condensed Consolidated Financial Statements
      (Unaudited)**





**5.**  **Investment
      Securities**





The
      following table shows the gross unrealized losses and fair value of the
      Company’s investments with unrealized losses that are not deemed to be
      other-than-temporarily impaired, aggregated by investment category and length
      of
      time that individual securities have been in a continuous unrealized loss
      position, at March 31, 2007:




Less
                  than 12 Months
              
              12
                  Months or Greater
              
              Total(*Dollars
                  in thousands)*
              
              Fair
                  Value
              
              Unrealized
                  Losses
              
              Fair
                  Value
              
              Unrealized
                  Losses
              
              Fair
                  Value
              
              Unrealized
                  Losses**Available
                  for Sale**U.S.
                  agency securities
              
              $
              11,481
              
              $
              19
              
              $
              38,135
              
              $
              683
              
              $
              49,616
              
              $
              702Municipal
                  bonds
              
              
              50,761
              
              
              664
              
              
              8,354
              
              
              117
              
              
              59,115
              
              
              781Mortgage-backed
                  securities
              
              
              7,958
              
              
              25
              
              
              54,345
              
              
              1,411
              
              
              62,303
              
              
              1,43670,200
              
              
              708
              
              
              100,834
              
              
              2,211
              
              
              171,034
              
              
              2,919**Held
                  to Maturity**U.S.
                  agency securities
              
              
              –
              
              
              –
              
              
              3,926
              
              
              71
              
              
              3,926
              
              
              71Municipal
                  bonds
              
              
              –
              
              
              –
              
              
              292
              
              
              8
              
              
              292
              
              
              8Mortgage-backed
                  securities
              
              
              –
              
              
              –
              
              
              6,063
              
              
              164
              
              
              6,063
              
              
              164–
              
              
              –
              
              
              10,281
              
              
              243
              
              
              10,281
              
              
              243Total
                  at March 31, 2007
              
              $
              70,200
              
              $
              708
              
              $
              111,115
              
              $
              2,454
              
              $
              181,315
              
              $
              3,162


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, 2007.





**6.**  **L** **oans**





The
      composition of the loan portfolio by loan classification at March 31, 2007
      and
      December 31, 2006 is as follows:





March
                31, 2007
            
            December
                31, 2006*(Dollars
                in thousands)*
            
            *(Unaudited)*Commercial
            
            $
            617,123
            
            $
            593,410Construction
            
            
            244,473
            
            
            250,308Consumer
            
            
            31,656
            
            
            30,806Home
                equity lines
            
            
            81,895
            
            
            83,231Mortgage
            
            
            50,160
            
            
            50,0991,025,307
            
            
            1,007,854Plus
                deferred loan costs, net
            
            
            157
            
            
            198$
            1,025,464
            
            $
            1,008,052





Loans
      held for sale as of March 31, 2007 and December 31, 2006 were $9.2 million
      and
      $7.2 million, respectively, and were included in the mortgage
      category.





**7.**  **Financial
      Instruments with Off-Balance-Sheet Risk**





To
      meet the financial needs of its customers, the Company is party to financial
      instruments with off-balance-sheet risk in the normal course of business. These
      financial instruments are comprised of unused lines of credit and standby
      letters of credit. These instruments involve, to varying degrees, elements
      of
      credit risk in excess of the amount recognized in the balance
      sheet.


-
            11
            -
 **INDEX**


**Capital
      Bank Corporation – Notes to Condensed Consolidated Financial Statements
      (Unaudited)**







The
      Company’s exposure to credit loss in the event of nonperformance by the other
      party is represented by the contractual amount of those instruments. The Company
      uses the same credit policies in making these commitments as it does for
      on-balance-sheet instruments. The amount of collateral obtained, if deemed
      necessary by the Company, upon extension of credit is based on management’s
      credit evaluation of the borrower. Collateral held varies but may include trade
      accounts receivable, property, plant and equipment, and income-producing
      commercial properties. Since many unused lines of credit expire without being
      drawn upon, the total commitment amounts do not necessarily represent future
      cash requirements.





The
      Company’s exposure to credit risk as of March 31, 2007 and December 31, 2006 was
      as follows:





March
                31, 2007
            
            December
                31, 2006*(Dollars
                in thousands)*
            
            *(Unaudited)*Unused
                lines of credit
            
            $
            171,423
            
            $
            187,163Standby
                letters of credit
            
            
            9,176
            
            
            12,698Total
                commitments
            
            $
            180,599
            
            $
            199,861




**Item
        2.****Management’s
        Discussion and Analysis of Financial Condition and Results of
        Operations**
 
 The
        following discussion presents an overview of the unaudited financial statements
        for the three months ended March 31, 2007 and 2006 for Capital Bank Corporation
        (the “Company”) and it’s wholly owned subsidiary, Capital Bank (the “Bank”).
        This discussion and analysis is intended to provide pertinent information
        concerning financial condition, results of operations, liquidity, and capital
        resources for the periods covered and should be read in conjunction with
        the
        unaudited financial statements and related footnotes contained in Part I,
        Item
        1. of this report.
 
 *Information
        set forth below contains various forward-looking statements within the meaning
        of Section 27A of the Securities Act of 1933, as amended, and Section 21E
        of the
        Securities Exchange Act of 1934, as amended (the “Exchange Act”), which
        statements represent the Company’s judgment concerning the future and are
        subject to risks and uncertainties that could cause the Company’s actual
        operating results to differ materially. Such forward-looking statements can
        be
        identified by the use of forward-looking terminology, such as “may,” “will,”
“expect,” “anticipate,” “estimate,” “believe,” or “continue,” or the negative
        thereof or other variations thereof or comparable terminology. The Company
        cautions that such forward-looking statements are further qualified by important
        factors that could cause the Company’s actual operating results to differ
        materially from those in the forward-looking statements, as well as the factors
        set forth in Part II, Item 1A of this report, and the Company’s periodic reports
        and other filings with the Securities and Exchange Commission
        (“SEC”).*
 
 ***Overview***
 
 The
        Bank is a full-service state chartered community bank conducting business
        throughout North Carolina. The Bank’s business consists principally of
        attracting deposits from the general public and investing these funds in
        loans
        secured by commercial real estate, secured and unsecured commercial and consumer
        loans, single-family residential mortgage loans, and home equity lines. As
        a
        community bank, the Bank’s profitability depends primarily upon its levels of
        net interest income, which is the difference between interest income from
        interest-earning assets and interest expense on interest-bearing liabilities.
        When interest-earning assets approximate or exceed interest-bearing liabilities,
        any positive interest rate spread will generate net interest income. The
        Bank’s
        profitability is also affected by its provision for loan losses, noninterest
        income, and other operating expenses. Noninterest income primarily consists
        of
        miscellaneous service charges, interchange income and ATM fees, fees generated
        from originating mortgage loans that are sold, and the increase in cash
        surrender value of bank-owned life insurance. Operating expenses primarily
        consist of compensation and benefits, occupancy related expenses, advertising,
        data processing, professional fees and other expenses.
 
 The
        Bank’s operations are influenced significantly by local economic conditions and
        by policies of financial institution regulatory authorities. The Bank’s cost of
        funds is influenced by interest rates on competing investments and by rates
        offered on similar investments by competing financial institutions in 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
            -
 **INDEX**
  ***Critical
        Accounting Policies and Estimates***
 
 The
        Company’s significant accounting policies are described in Note 1.of the
        Company’s Annual Report on Form 10-K for the year ended December 31, 2006 on
        pages 41–47.
        These policies are important in understanding management’s discussion and
        analysis. Some of the Company’s accounting policies require the Company to make
        estimates and judgments regarding uncertainties that may affect the reported
        amounts of assets, liabilities, revenues and expenses.
 
 The
        Company has identified five accounting policies as being critical in terms
        of
        significant judgments and the extent to which estimates are used: allowance
        for
        loan losses, investments, valuation allowances, goodwill and the impairment
        of
        long-lived assets. In many cases, there are several alternative judgments
        that
        could be used in the estimation process. The Company bases its estimates
        on
        historical experience and on various other assumptions that are believed
        to be
        reasonable under the circumstances, the results of which form the basis for
        making judgments about the carrying values of assets and liabilities that
        are
        not readily apparent from other sources. Actual results may differ from these
        estimates under different assumptions or conditions. For more information
        on the
        Company’s critical accounting policies, refer to page 19 of the Company’s Annual
        Report on Form 10-K for the year ended December 31, 2006.
 
 ***Executive
        Summary***
 
 As
        discussed in more detail below, the following is a summary of our significant
        results for the quarter ended March 31, 2007:
 
 •
              The
                  Company reported net income for the quarter ended March 31, 2007
                  of $2.4
                  million compared to $2.8 million for the quarter ended March 31,
                  2006.
                  Fully diluted earnings per share were $0.21 and $0.24 for the quarter
                  ended March 31, 2007 and 2006, respectively.•
              The
                  decrease in net income was primarily due to a $667,000 decrease
                  in net
                  interest income, which reflects a 54 basis points (“bps”) decrease in the
                  net interest margin as a result of the rising cost of funds and
                  a $409,000
                  increase in noninterest expense, primarily due to higher compensation
                  and
                  occupancy costs, offset by a $460,000 decrease in income tax expense
                  due
                  to an increase in tax-exempt investment income.•
              The
                  provision for loan losses for the quarter ended March 31, 2007
                  was
                  $337,000 compared to $399,000 in the quarter ended March 31, 2006.
                  The
                  decrease in the provision for loan losses reflects slower net loan
                  growth
                  in the quarter ended March 31, 2007 compared to the quarter ended
                  March
                  31, 2006.•
              Net
                  interest income for the quarter ended March 31, 2007 decreased
                  to $10.7
                  million, a 5.9% decline over the $11.4 million reported in the
                  quarter
                  ended March 31, 2006. The Company’s net interest margin declined to 3.52%,
                  a 54 bps decrease over the quarter ended March 31, 2006 and a 26
                  bps
                  decrease over the quarter ended December 31, 2006. The decrease
                  in net
                  interest income is primarily due to a 110 bps increase in the cost
                  of
                  funds compared to a 48 bps increase in the yield on earning
                  assets.•
              Noninterest
                  income for the quarter ended March 31, 2007 increased $175,000
                  to $2.2
                  million compared to $2.0 million in the quarter ended March 31,
                  2006. This
                  increase is primarily due to higher mortgage fees and revenues
                  as a result
                  of increased volume and more favorable pricing on mortgage loans
                  held for
                  sale.•
              Noninterest
                  expense was $9.2 million for the quarter ended March 31, 2007 compared
                  to
                  $8.8 million for the quarter ended March 31, 2006. The increase
                  is
                  primarily due to higher salaries and employee benefits and occupancy
                  costs, which increased by $552,000 and $220,000, respectively,
                  in the
                  quarter ended March 31, 2007 compared to the quarter ended March
                  31, 2006.
                  The increase in salaries and employee benefits was primarily due
                  to salary
                  increases and related payroll taxes. The increase in occupancy
                  costs was
                  primarily due to higher rental expenses associated the Company’s new
                  headquarters.
 
 ***Financial
        Condition***
 
 Total
        consolidated assets of the Company at March 31, 2007 were $1.48 billion compared
        to $1.42 billion at December 31, 2006, an increase of $58.8 million, or
        approximately 4%. The increase in total consolidated assets for the three
        months
        ended March 31, 2007 is primarily due to a $33.5 million increase in cash
        and
        cash equivalents and a $17.3 million increase in the Bank’s loan portfolio, net
        of the allowance for loan losses, since December 31, 2006. Total deposits
        as of
        March 31, 2007 were $1.12 billion, which represents growth of $65.0 million
        from
        December 31, 2006.
 -
              13
              -
 **INDEX**
  Total
        earning assets were $1.33 billion at March 31, 2007 compared to $1.27 billion
        at
        December 31, 2006. Earning assets represented 89.8% and 89.1% of total assets
        as
        of March 31, 2007 and December 31, 2006, respectively. At March 31, 2007,
        investment securities were $248.7 million, compared to $239.1 million at
        December 31, 2006, an increase of $9.6 million due to new investment security
        purchases. Interest-earning cash, federal funds sold and short term investments
        were $55.6 million at March 31, 2007, an increase of $34.8 million from December
        31, 2006. The Company increased its holdings of short term investment assets
        to
        maintain liquidity for anticipated loan growth and future
        commitments.
 
 The
        allowance for loan losses as of March 31, 2007 and December 31, 2006 was
        $13.5
        million and $13.3 million, respectively, and represented approximately 1.32%
        of
        total loans as of both dates. Management believes that the amount of the
        allowance is adequate to absorb the estimated probable losses inherent in
        the
        current loan portfolio. See *“Asset
        Quality”* below for further discussion of the allowance for loan losses ***.***
 
 Total
        deposits as of March 31, 2007 were $1.12 billion, an increase of $65.0 million,
        or 6.2%, from December 31, 2006. The increase was primarily due to the increase
        in money market and time deposits, which increased by $24.4 million and $30.4
        million, respectively. Total time deposits represented 53.4% of total deposits
        at March 31, 2007 compared to 53.8% at December 31, 2006. The Company’s high
        yield checking account product, *Smart
        Checking* ,
        which is designed to generate higher debit card interchange income to offset
        the
        higher yield offered, added over 900 new accounts during the quarter ended
        March
        31, 2007. As of March 31, 2007, there were over 4,500 *Smart
        Checking* accounts and $21.4 million of deposits associated with this
        product.
 
 Noninterest
        bearing demand deposit accounts (“DDA”) were $124.9 million at March 31, 2007,
        an increase of $4.0 million from December 31, 2006. The average balance of
        noninterest DDA accounts was $106.4 million during the quarter ended March
        31,
        2007 compared to $100.0 million during the quarter ended March 31,
        2006.
 
 Total
        consolidated shareholders’ equity was $163.9 million as of March 31, 2007, an
        increase of $2.2 million from December 31, 2006. Retained earnings increased
        by
        $1.5 million, reflecting $2.4 million of net income for the three months
        ended
        March 31, 2007 less $0.9 million of dividends paid during the three months
        ended
        March 31, 2007. Accumulated other comprehensive loss, which represents the
        unrealized loss on available-for-sale securities and derivatives accounted
        for
        as cash flow hedges, net of related tax benefits, was $1.5 million and $1.6
        million as of March 31, 2007 and December 31, 2006, respectively. See Item
        1.
        Financial Statements - Condensed Consolidated Statements of Changes in
        Shareholders’ Equity for additional information.
 
 ***Results
        of Operations***
 
 **Quarter
        ended March 31, 2007 compared to quarter ended March 31,
        2006**
 
 For
        the quarter ended March 31, 2007, the Company reported net income of $2.4
        million, or $0.21 per diluted share, compared to net income of $2.8 million,
        or
        $0.24 per diluted share, for the quarter ended March 31, 2006. Net income
        decreased by $379,000 primarily due to margin compression as a result of
        the
        rising costs of funds and a decline in the yield on earning assets. The
        Company’s net interest margin, on a fully taxable equivalent basis, for the
        quarter ended March 31, 2007 decreased by 54 bps and 26 bps compared to the
        net
        interest margin for the quarters ended March 31, 2006 and December 31, 2006,
        respectively. The Company expects competitive pressures will continue to
        affect
        its net interest margin in the near term. The majority of the Company’s time
        deposits have repriced at prevailing market rates, which rates the Company
        anticipates will begin to ease in the second half of 2007.
 
 Net
        interest income decreased $667,000, or 5.9%, from $11.4 million for the quarter
        ended March 31, 2006, to $10.7 million for the quarter ended March 31, 2007.
        Average earning assets increased $134.5 million to $1.29 billion for the
        quarter
        ended March 31, 2007 from $1.16 billion for the quarter ended March 31, 2006.
        Average interest-bearing liabilities increased $127.5 million to $1.16 billion
        for the quarter ended March 31, 2007 from $1.03 billion for the quarter ended
        March 31, 2006. The net interest margin on a taxable equivalent basis decreased
        by 54 bps to 3.52% for the quarter ended March 31, 2007 from 4.06% for the
        quarter ended March 31, 2006. The earned yield on average interest-earning
        assets was 7.43% and 6.95% for the quarter ended March 31, 2007 and 2006,
        respectively, while the interest rate on average interest- bearing liabilities
        for those periods was 4.36% and 3.26%, respectively. The decrease in the
        net
        interest margin is primarily attributed to interest-bearing liabilities
        repricing at a faster rate than interest-earning assets as a result of the
        current static interest rate environment and competitive pressures in the
        Company’s primary markets. The Company expects its effective cost of
        interest-bearing liabilities will increase slightly during the quarter ended
        June 30, 2007 as a result of increased competition for funds in the Company’s
        primary markets.
 -
              14
              -
 **INDEX**
  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.
 
 **Average
        Balances, Interest Earned or Paid, and Interest
        Yields/Rates**
 **Three
        Months Ended March 31, 2007 and 2006 (Unaudited)**
 Taxable
        Equivalent Basis 1
 March
                  31, 2007
              
              March
                  31, 2006*(Dollars
                  in thousands)*
              
              Average
                  Balance
              
              Amount
                  Earned
              
              Average
                  Rate
              
              Average
                  Balance
              
              Amount
                  Earned
              
              Average
                  Rate**Assets**Loans
                  receivable:2Commercial
              
              $
              589,892
              
              $
              11,261
              
              
              7.74%
              
              $
              582,676
              
              $
              10,678
              
              
              7.43%Construction
              
              
              262,236
              
              
              5,495
              
              
              8.50%
              
              
              166,615
              
              
              3,169
              
              
              7.71%Consumer
              
              
              30,822
              
              
              652
              
              
              8.58%
              
              
              20,441
              
              
              471
              
              
              9.34%Home
                  equity lines
              
              
              82,298
              
              
              1,727
              
              
              8.51%
              
              
              100,319
              
              
              1,822
              
              
              7.37%Mortgage3
              
              
              47,235
              
              
              748
              
              
              6.42%
              
              
              53,899
              
              
              878
              
              
              6.61%Total
                  loans
              
              
              1,012,483
              
              
              19,883
              
              
              7.96%
              
              
              923,950
              
              
              17,018
              
              
              7.47%Investment
                  securities4
              
              
              243,732
              
              
              3,303
              
              
              5.50%
              
              
              194,535
              
              
              2,303
              
              
              4.80%Federal
                  funds sold and other interest on short term investments
              
              
              36,596
              
              
              485
              
              
              5.37%
              
              
              39,839
              
              
              542
              
              
              5.52%Total
                  interest earning assets
              
              
              1,292,811
              
              $
              23,671
              
              
              7.43%
              
              
              1,158,324
              
              $
              19,863
              
              
              6.95%Cash
                  and due from banks
              
              
              27,593
              
              
              
              
              
              
              
              
              31,374Other
                  assets
              
              
              130,126
              
              
              
              
              
              
              
              
              138,602Allowance
                  for loan losses
              
              
              (13,296
              )
              
              
              
              
              
              
              
              (17,155
              )Total
                  assets
              
              $
              1,437,234
              
              
              
              
              
              
              
              $
              1,311,145**Liabilities
                  and Equity**Savings
                  deposits
              
              $
              34,370
              
              $
              42
              
              
              0.50%
              
              $
              43,815
              
              $
              60
              
              
              0.56%Interest-bearing
                  demand deposits
              
              
              342,814
              
              
              2,922
              
              
              3.46%
              
              
              265,685
              
              
              1,549
              
              
              2.36%Time
                  deposits
              
              
              600,865
              
              
              7,042
              
              
              4.75%
              
              
              548,217
              
              
              4,501
              
              
              3.33%Total
                  interest-bearing deposits
              
              
              978,049
              
              
              10,006
              
              
              4.15%
              
              
              857,717
              
              
              6,110
              
              
              2.89%Borrowed
                  funds
              
              
              113,686
              
              
              1,503
              
              
              5.36%
              
              
              114,362
              
              
              1,326
              
              
              4.70%Subordinated
                  debt
              
              
              30,930
              
              
              586
              
              
              7.68%
              
              
              32,574
              
              
              597
              
              
              7.43%Repurchase
                  agreements
              
              
              34,328
              
              
              357
              
              
              4.22%
              
              
              24,852
              
              
              247
              
              
              4.03%Total
                  interest-bearing liabilities
              
              
              1,156,993
              
              $
              12,452
              
              
              4.36%
              
              
              1,029,505
              
              $
              8,280
              
              
              3.26%Noninterest-bearing
                  deposits
              
              
              106,369
              
              
              
              
              
              
              
              
              99,976Other
                  liabilities
              
              
              10,581
              
              
              
              
              
              
              
              
              21,823Total
                  liabilities
              
              
              1,273,943
              
              
              
              
              
              
              
              
              1,151,304Shareholders’
                  equity
              
              
              163,291
              
              
              
              
              
              
              
              
              159,841Total
                  liabilities and shareholders’ equity
              
              $
              1,437,234
              
              
              
              
              
              
              
              $
              1,311,145Net
                  interest spread5
              
              
              
              
              
              
              
              
              3.07%
              
              
              
              
              
              
              
              
              3.69%Tax
                  equivalent adjustment
              
              
              
              
              $
              496
              
              
              
              
              
              
              
              $
              193Net
                  interest income and net interest margin6
              
              
              
              
              $
              11,219
              
              
              3.52%
              
              
              
              
              $
              11,583
              
              
              4.06%
 
 1 The fully taxable equivalent basis is computed using a blended federal and
        state
        tax rate of approximately 36% and 38% in 2007 and 2006,
        respectively.
 2 Loans receivable include nonaccrual loans for which accrual of interest has
        not
        been recorded.
 3 Mortgage includes loans held for sale.
 4 The average balance for investment securities excludes 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 net interest income divided by average
        interest-earning assets.
  -
            15
            -
 **INDEX**
  Interest
        income on loans increased from $17.1 million for the quarter ended March
        31,
        2006 to $19.9 million for the quarter ended March 31, 2007. The increase
        is
        primarily due to higher average loan balances, which increased by $88.5 million
        primarily due to organic net loan growth, and higher loan yields. Yields
        on
        commercial, construction, and home equity lines increased 31 bps, 79 bps,
        and
        114 bps, respectively, in the quarter ended March 31, 2007 compared to the
        quarter ended March 31, 2006 while yields on consumer loans decreased by
        76 bps
        during the same period. Higher yields in 2007 reflect the increase in the
        prime
        rate charged by the Bank between those two periods. The Company’s prime rate was
        8.25% as of March 31, 2007 compared to 7.75% as of March 31, 2006; however,
        the
        last change in the prime rate was in June 2006. In November 2006, the Company
        entered into a $100 million (notional) interest rate swap to help mitigate
        its
        exposure to interest rate volatility. This swap reduced the overall yield
        on
        loans and the net interest margin by 5 bps and 4 bps, respectively, for the
        quarter ended March 31, 2007.
 
 Interest
        income on investment securities increased from $2.1 million for the quarter
        ended March 31, 2006 to $2.8 million for the quarter ended March 31, 2007.
        The
        increase is primarily due to an increase in average balances outstanding
        between
        the periods, which increased by $95.6 million, with approximately $47.0 million
        of the increase related to investments in municipal bonds. The yield on
        investment securities on a fully taxable equivalent basis increased from
        4.80%
        for the quarter ended March 31, 2006 to 5.50% for the quarter ended March
        31,
        2007. The increase is primarily due to higher yields on new investment
        securities purchased in 2006.
 
 Interest
        expense on deposits increased from $6.1 million for the quarter ended March
        31,
        2006 to $10.0 million for the quarter ended March 31, 2007. The increase
        is
        primarily due to an increase in the average balance of interest-bearing deposits
        outstanding, which increased by $120.3 million due to organic deposit growth,
        and higher deposit rates. The average rate paid on total interest-bearing
        deposits increased from 2.89% for the quarter ended March 31, 2006 to 4.15%
        for
        the quarter ended March 31, 2007, a 126 bps rise. The rate paid on time
        deposits, which represented 61.4% and 63.9% of total average interest-bearing
        deposits for the quarters ended March 31, 2007 and 2006, respectively, increased
        from 3.33% and 4.51% for the quarters ended March 31, 2006 and December 31,
        2006, respectively, to 4.75% for the quarter ended March 31, 2007 as a result
        of
        the rising interest rate environment and increased competition in the Company’s
        primary markets. The Company anticipates that time deposit funding costs
        will
        increase slightly in the second quarter of 2007 based on prevailing rates
        being
        offered in the Company’s primary markets.
 
 Interest
        expense on borrowings increased from $2.2 million for the quarter ended March
        31, 2006 to $2.5 million for the quarter ended March 31, 2007, primarily
        due to
        an increase in borrowing rates. The rate on borrowings and subordinated
        debentures for the quarter ended March 31, 2007 increased to 5.36% and 7.68%,
        respectively, from 4.70% and 7.43%, respectively, for the quarter ended March
        31, 2006. In July of 2003, the Bank entered into interest rate swap agreements
        on $25.0 million of its outstanding Federal Home Loan Bank advances to swap
        fixed rate borrowings to a variable rate. The net effect of the swaps was
        an
        increase in interest expense of $125,000 and $72,000 for the quarters ended
        March 31, 2007 and 2006, respectively.
 
 For
        the quarter ended March 31, 2007, the provision for loan losses was $337,000
        compared to $399,000 for the quarter ended March 31, 2006, a decrease of
        $62,000. There was no significant deterioration in the overall credit quality
        of
        the loan portfolio between December 31, 2006 and March 31, 2007, and the
        decrease in the provision for loan losses reflects slower net loan growth
        in the
        quarter ended March 31, 2007 compared to the quarter ended March 31, 2006.
        Net
        charge-offs for the quarter ended March 31, 2007 were $153,000 or 0.06% of
        average loans, compared to $3.4 million or 1.49% of average loans for the
        quarter ended March 31, 2006. Net 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 prior to the acquisition date. Total nonperforming
        assets and past due loans increased from $6.0 million and $11.2 million,
        respectively, as of December 31, 2006 to $9.3 million and $16.2 million,
        respectively, as of March 31, 2007. Past due loans consists of all loans
        past
        due 30 days or more. Approximately $3.0 million and $4.7 million of the increase
        in nonperforming assets and past due loans, respectively, is related to three
        distinct loan relationships within each category, all of which have been
        adequately provided for in the allowance for loan losses as of March 31,
        2007.
        See “ *Asset
        Qualtiy”* below
        for additional information.
 
 Noninterest
        income for the quarter ended March 31, 2007 was $2.2 million compared to
        $2.0
        million for the quarter ended March 31, 2006, an increase of $175,000. This
        increase was primarily due to a $177,000 increase in mortgage fees and revenues
        as a result of increased volume and more favorable pricing on mortgage loans
        held for sale. Deposit service charges and other fees decreased $37,000
        primarily due to an increase in waived service charges and lower nonsufficient
        fund fees offset partially by an increase in interchange income from
        the *Smart Checking* product. The Company also recognized a gain of $74,000 from the sale of a
        closed
        branch in the quarter ended March 31, 2007.
 -
              16
              -
 **INDEX**
  Noninterest
        expense for the quarter ended March 31, 2007 was $9.2 million compared to
        $8.8
        million for the quarter ended March 31, 2006. Salaries and employee benefits,
        representing the largest noninterest expense category, increased to $5.1
        million
        for the quarter ended March 31, 2007, from $4.5 million for the quarter ended
        March 31, 2006. The increase in salaries and employee benefits was primarily
        due
        to salary increases and related payroll taxes and increased mortgage commission
        payouts due to increased loan volumes. As of March 31, 2007, the Company
        had 331
        full-time equivalent employees compared to 328 at March 31, 2006.
 
 Occupancy
        costs, the second largest component of noninterest expense, increased $220,000
        to $998,000 for the quarter ended March 31, 2007 from $778,000 for the quarter
        ended March 31, 2006. The increase is primarily due to the higher rent expenses
        related to the Company’s new headquarters. Furniture and equipment expenses for
        the quarter ended March 31, 2007 increased $123,000 from the same period
        in 2006
        primarily due to higher depreciation expenses associated with computer equipment
        acquired for the Company’s operations center. Data processing expenses for the
        quarter ended March 31, 2007 decreased $193,000 from the same period in 2006
        primarily due to a reduction in external account and item processing costs
        as a
        result of bringing operations in house during March 2006. Directors’ fees for
        the quarter ended March 31, 2007 decreased $108,000 from the same period
        in 2006
        primarily due to share-based compensation expense recorded as a result of
        the
        adoption of SFAS No.123R in the quarter ended March 31, 2006. Other expenses
        for
        the quarter ended March 31, 2007 decreased $136,000 from the same period
        in 2006
        primarily due to lower costs associated with telecommunications and postage,
        which decreased by $84,000, and $56,000, respectively.
 
 Income
        tax expense for the quarters ended March 31, 2007 and 2006 was $1.0 million
        and
        $1.4 million, respectively. The Company’s effective tax rate for the quarter
        ended March 31, 2007 was 28.6% compared to 33.9% for the quarter ended March
        31,
        2006. The decrease in the effective tax rate is primarily due to greater
        proportion of tax exempt income to taxable income for the quarter ended March
        31, 2007 compared to the same period in 2006 as a result of municipal bonds
        acquired during the quarter ended December 31, 2006. The Company forecasts
        its
        taxable and nontaxable income and calculates the effective tax rate for the
        entire year, which is then applied to the three month period. The Company
        adopted FIN 48 effective January 1, 2007. There were no changes in uncertain
        tax
        positions for the quarter ended March 31, 2007. See Item 1. Note 1. Significant
        Accounting Policies and Interim Reporting for additional information regarding
        FIN 48.
 
 ***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 the Audit Committee of the
        Company’s Board of Directors. 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 inherent
        losses in the portfolio by applying a loss allowance factor to each risk
        grade.
        Consumer loans and mortgages are not risk graded, but a loss allocation factor
        is utilized for these loans based on historical losses. The loss allocation
        factors have been developed based on the Bank’s historical losses and industry
        trends. In addition to this quantitative analysis, a qualitative assessment
        of
        the general economic trends, portfolio concentration and the trend of
        delinquencies are taken into consideration. The loan loss allowance is adjusted
        to an amount that management believes is adequate to absorb probable losses
        inherent in the loan portfolio as of the balance sheet date
        presented.
 
 The
        Company provides a specific allowance for loan losses associated with certain
        commercial loans rated special mention and/or classified with outstanding
        balances greater than $750,000. Management determines the level of specific
        allowance based on the facts and circumstances of each loan, including among
        other factors, payment history, collateral values, guarantor liquidity, and
        net
        worth. Of the $13.5 million allowance for loan losses as of March 31, 2007,
        $2.2
        million has been allocated to specific loans.
 -
              17
              -
 **INDEX**
  The
        allowance for loan losses is established through a provision for loan losses
        charged to expense. Loans are charged against the allowance for loan losses
        when
        management believes that the collectibility of the principal is unlikely.
        Based
        on this allowance calculation, management recorded a provision of $337,000
        for
        the quarter ended March 31, 2007 compared to a provision of $399,000 for
        the
        quarter ended March 31, 2006. The Company experienced unfavorable developments
        in key risk metrics and trends associated with the credit quality of the
        loan
        portfolio during the quarter ended March 31, 2007. Past due loans as a
        percentage of average loans increased from 1.11% at December 31, 2006 to
        1.60%
        at March 31, 2007. Past dues greater than 90 days as a percentage of total
        loans
        increased from 0.37% at December 31, 2006 to 0.62% at March 31, 2007.
        Nonperforming assets as a percentage of total assets were 0.63% and 0.42%
        at
        March 31, 2007 and December 31, 2006, respectively. The increase in past
        due
        loans was primarily due to three loan relationships, which had an aggregate
        past
        due balance of $4.7 million as of March 31, 2007. The increase in nonperforming
        assets was primarily due to three other loan relationships, which had an
        aggregate nonperforming balance of $3.0 million as of March 31, 2007. Management
        believes these relationships are not indicative of the overall trend in the
        loan
        portfolio as these relationships account for the majority of the increases
        in
        past due loans and nonperforming assets as a percentage of total assets between
        December 31, 2006 and March 31, 2007. Management believes the allowance for
        loan
        losses as of March 31, 2007 is adequate to cover the
        probable loss exposures associated with the specific loans and inherent losses
        in the loan portfolio expected to be incurred.
 
 The
        following table presents an analysis of changes in the allowance for loan
        losses
        for the three months ended March 31, 2007 and 2006, respectively:
  March
                  31, 2007
              
              March
                  31, 2006*(Dollars
                  in thousands)*
              
              *(Unaudited)*Allowance
                  for loan losses, beginning of period
              
              $
              13,347
              
              $
              9,5921st
                  State Bank loan loss allowance acquired
              
              
              –
              
              
              7,650Net
                  charge-offs:Loans
                  charged off:Commercial
              
              
              72
              
              
              3,316Construction
              
              
              –
              
              
              –Consumer
              
              
              50
              
              
              106Home
                  equity lines
              
              
              25
              
              
              –Mortgage
              
              
              17
              
              
              31Total
                  charge-offs
              
              
              164
              
              
              3,453Recoveries
                  of loans previously charged off:Commercial
              
              
              –
              
              
              8Construction
              
              
              –
              
              
              –Consumer
              
              
              8
              
              
              4Home
                  equity lines
              
              
              3
              
              
              4Mortgage
              
              
              –
              
              
              5Total
                  recoveries
              
              
              11
              
              
              21Total
                  net charge-offs
              
              
              153
              
              
              3,432Loss
                  provisions charged to operations
              
              
              337
              
              
              399Allowance
                  for loan losses, end of period
              
              $
              13,531
              
              $
              14,209Net
                  charge-offs to average loans during the period
                  (annualized)
              
              
              0.06%
              
              
              1.49%Allowance
                  as a percent of gross loans
              
              
              1.32%
              
              
              1.50%
 
 Net
        charge-offs for the three months 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.
 
 The
        Company’s determination of the allowance for loan losses is subject to
        management’s judgment and analysis of many internal and external factors. While
        management is comfortable with the adequacy of the current allowance for
        loan
        losses, it is possible that these factors and management’s evaluation of the
        adequacy of the allowance for loan losses will change.
 -
              18
              -
 **INDEX**
  The
        following table presents an analysis of nonperforming assets as of March
        31,
        2007 and 2006 and December 31, 2006:
  March
                  31, 2007
              
              March
                  31, 2006
              
              December
                  31, 2006*(Dollars
                  in thousands)*
              
              *(Unaudited)*Nonaccrual
                  loans:Commercial
                  and commercial real estate
              
              $
              5,725
              
              $
              5,149
              
              $
              2,783Construction
              
              
              –
              
              
              807
              
              
              616Consumer
              
              
              241
              
              
              100
              
              
              50Home
                  equity lines
              
              
              443
              
              
              398
              
              
              410Mortgage
              
              
              433
              
              
              1,588
              
              
              1,043Total
                  nonaccrual loans
              
              
              7,356
              
              
              8,042
              
              
              4,902Foreclosed
                  property held
              
              
              1,961
              
              
              888
              
              
              1,111Total
                  nonperforming assets
              
              $
              9,317
              
              $
              8,930
              
              $
              6,013Nonperforming
                  assets to total loans
              
              
              0.91%
              
              
              0.95%
              
              
              0.60%Nonperforming
                  assets to total assets
              
              
              0.63%
              
              
              0.68%
              
              
              0.42%Allowance
                  coverage of nonperforming loans
              
              
              184%
              
              
              177%
              
              
              272%
 
 At
        March 31, 2007, nonperforming assets were $9.3 million, an increase of $3.3
        million from December 31, 2006. The majority of the Company’s nonperforming
        loans are secured by real estate, and to a lesser extent the Company relies
        on
        the support of guarantors. The Company monitors the value of the underlying
        collateral and the liquidity of the guarantors on a periodic basis. Based
        on
        this review and analysis, the Company does not currently anticipate any material
        losses associated with the nonperforming loans existing at March 31,
        2007.
 
 A
        loan is considered impaired, based on current information and events, if
        it is
        probable that the Bank will be unable to collect the scheduled payments of
        principal and interest when due according to the contractual terms of the
        loan
        agreement. The Bank uses several factors in determining if a loan is impaired.
        Internal asset classification procedures include a review of significant
        loans
        and lending relationships by both management and third-party credit review
        firms, and loan reviews include the accumulation of related data on loan
        payment
        status, borrowers’ financial data and borrowers’ operating factors such as cash
        flows, operating income or loss. Uncollateralized loans are measured for
        impairment based on the present value of expected future cash flows discounted
        at the historical effective interest rate, while all collateral-dependent
        loans
        are measured for impairment based on the fair value of the collateral. There
        were $5.1million and $6.2 million loans classified as impaired at March 31,
        2007
        and December 31, 2006, respectively. The related allowance for loan losses
        on
        these impaired loans was $1.1 million at both March 31, 2007 and at December
        31,
        2006. At March 31, 2007 and December 31, 2006, there were no impaired loans
        that
        did not have an allowance for loan losses. The average recorded investment
        in
        impaired loans for the quarter ended March 31, 2007 was $5.8
        million.
 
 Foreclosed
        property increased to $2.0 million at March 31, 2007 from $1.1 million at
        December 31, 2006. The increase is primarily due to the addition of certain
        foreclosed commercial and residential properties. Approximately $1.0 million
        of
        the foreclosed properties is expected to be sold or under contract before
        June
        30, 2007. The Company is actively marketing all of its foreclosed property.
        All
        foreclosed assets are recorded at the lower of cost or fair value.
 
 ***Liquidity
        and Capital Resources***
 
 The
        Company’s liquidity management involves planning to meet the Company’s
        anticipated funding needs at a reasonable cost. Liquidity management is guided
        by policies formulated by the Company’s senior management and the Asset and
        Liability Committee of the Bank’s Board of Directors. The Company had $87.9
        million in its most liquid assets, cash and cash equivalents, as of March
        31,
        2007. 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 $1.04 billion and
        $1.0
        billion at March 31, 2007 and December 31, 2006, respectively, funded 69.4%
        of
        total assets at March 31, 2007 compared to 70.1% at December 31, 2006. In
        addition, the Company has the ability to take advantage of various other
        funding
        programs available from the Federal Home Loan Bank of Atlanta, as well as
        access
        to funding through various brokered deposit programs, federal funds lines
        and
        security repurchase agreements.
 -
              19
              -
 **INDEX**
  The
        management of equity is a critical aspect of capital management in any business.
        The determination of the appropriate amount of equity is affected by a wide
        number of factors. The primary factor for a regulated financial institution
        is
        the amount of capital needed to meet regulatory requirements, although other
        factors, such as the “risk equity” the business requires and balance sheet
        leverage, also affect the determination.
 
 On
        February 27, 2006, the Company announced that its Board of Directors had
        authorized the Company to acquire in the open market or in any private
        transaction, from time-to-time and in accordance with applicable laws, rules
        and
        regulations, up to 1.0 million shares of the Company’s common stock. Management
        plans to utilize share repurchases to manage capital levels of the Company.
        The
        Company plans to effect the repurchase program through open-market purchases.
        During the first three months of 2007, the Company repurchased 82 shares
        at a
        weighted average price of $17.50 per share. See Part II - Other Information,
        Item 2. Unregistered Sales of Equity Securities and Use of Proceeds for more
        information on the Company’s share repurchases.
 
 To
        be categorized as well capitalized, the Company and the Bank must maintain
        minimum amounts and ratios. The Company’s and the Bank’s actual capital amounts
        and ratios as of March 31, 2007 and the minimum requirements are presented
        in
        the following table:
 Actual
              
              Minimum
                  Requirements
                To
                  Be Well Capitalized*(Dollars
                    in thousands)*
              
              Amount
              
              Ratio
              
              Amount
              
              Ratio**Capital
                  Bank Corporation**Total
                  capital (to risk weighted assets)
              
              $
              141,821
              
              
              11.77%
              
              $
              120,492
              
              
              10.00%Tier
                  I capital (to risk weighted assets)
              
              
              128,108
              
              
              10.63%
              
              
              72,295
              
              
              6.00%Tier
                  1 capital (to average assets)
              
              
              128,108
              
              
              9.35%
              
              
              68,503
              
              
              5.00%**Capital
                  Bank**Total
                  capital (to risk weighted assets)
              
              $
              136,781
              
              
              11.35%
              
              $
              120,462
              
              
              10.00%Tier
                  I capital (to risk weighted assets)
              
              
              123,068
              
              
              10.22%
              
              
              72,277
              
              
              6.00%Tier
                  1 capital (to average assets)
              
              
              123,068
              
              
              9.00%
              
              
              68,357
              
              
              5.00%
 
 The
        Company’s total capital to risk weighted assets, Tier I capital to risk weighted
        assets and Tier I capital to average assets on a consolidated basis as of
        December 31, 2006 were 11.92%, 10.76% and 9.42%, respectively.
 
 Shareholders’
        equity was $163.3 million, or $14.32 per share, at March 31, 2007. 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, 2006, asset/liability management involves the evaluation,
        monitoring and management of interest rate risk, liquidity and funding. While
        the Board of Directors has overall responsibility for the Company’s
        asset/liability management policies, the Bank’s Asset and Liability Committee
        monitors loan, investment, and liability portfolios to ensure comprehensive
        management of interest rate risk and adherence to the Bank’s policies. The
        Company has not experienced any material change in the risk of its portfolios
        of
        interest-earning assets and interest-bearing liabilities from December 31,
        2006
        to March 31, 2007.
 
 **Item
        4.****Controls
        and Procedures**
 
 The
        Company maintains disclosure controls and procedures that are designed to
        ensure
        that information required to be disclosed in the reports it files or submits
        under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded,
        processed, summarized and reported within the time periods specified in the
        rules and forms of the SEC, and that such information is accumulated and
        communicated to the Company’s management, including its Chief Executive Officer
        (“CEO”) and Chief Financial Officer (“CFO”), as appropriate, to allow timely
        decisions regarding disclosure. Management necessarily applies its judgment
        in
        assessing the costs and benefits of such controls and procedures, which,
        by
        their nature, can provide only reasonable assurance regarding management’s
        control objectives.
 -
              20
              -
 **INDEX**
  As
        required by paragraph (b) of Rule 13a-15 under the Exchange Act, an evaluation
        was carried out under the supervision and with the participation of the
        Company’s management, including the CEO and CFO, of the effectiveness of the
        Company’s disclosure controls and procedures as of the end of the period covered
        by this report. Based upon that evaluation, the CEO and CFO concluded that,
        as
        of the period covered by the report, the Company’s disclosure controls and
        procedures are effective in that they provide reasonable assurances that
        the
        information the Company is required to disclose in the reports it files or
        submits under the Exchange Act is recorded, processed, summarized and reported
        within the time periods required by the SEC’s rules and forms. ******
 
 ***Changes
        in Internal Control over Financial Reporting***
 
 There
        were no changes in the Company’s internal control over financial reporting (as
        defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that occurred
        during the period covered by this report that have materially affected or
        are
        reasonably likely to materially affect, the Company’s internal control over
        financial reporting. Management has implemented changes in internal control
        over
        financial reporting as a result of remediation of matters identified through
        its
        review of internal control over financial reporting as required under Section
        404 of the Sarbanes-Oxley Act; however, it does not believe any of the changes
        implemented were material in nature.
 
 
 **PART
        II –
        OTHER INFORMATION**
 
 **Item
        1.****Legal
        Proceedings**
 
 There
        are no material pending legal proceedings to which the Company is a party
        or to
        which any of its property is subject. In addition, the Company is not aware
        of
        any threatened litigation, unasserted claims or assessments that could have
        a
        material adverse effect on the Company’s business, operating results or
        condition.
 
 **Item
        1A.****Risk
        Factors**
 
 You
        should consider the following material risk factors carefully before deciding
        to
        invest in the Company’s securities. Additional risks and uncertainties not
        presently known to us, that we may currently deem to be immaterial or that
        are
        similar to those faced by other companies in our industry or business in
        general, such as competitive conditions, may also impact our business
        operations. If any of the events described below occur, the Company’s business,
        financial condition, or results of operations could be materially adversely
        affected. In that event, the trading price of the Company’s common stock may
        decline, in which case the value of your investment may decline as well.
 
 **Our
        results are impacted by the economic conditions of our principal operating
        regions.**
 
 Our
        operations are concentrated throughout Central and Western North Carolina.
        As a
        result of this geographic concentration, our results may correlate to the
        economic conditions in these areas. Deterioration in economic conditions
        in any
        of these market areas, particularly in the industries on which these geographic
        areas depend, may adversely affect the quality of our loan portfolio and
        the
        demand for our products and services, and accordingly, our results of
        operations.
 
 **We
        are exposed to risks in connection with the loans we make.**
 
 A
        significant source of risk for us arises from the possibility that losses
        will
        be sustained because borrowers, guarantors and related parties may fail to
        perform in accordance with the terms of their loans. We have underwriting
        and
        credit monitoring procedures and credit policies, including the establishment
        and review of the allowance for loan losses, that we believe are appropriate
        to
        minimize this risk by assessing the likelihood of nonperformance, tracking
        loan
        performance and diversifying our loan portfolio. Such policies and procedures,
        however, may not prevent unexpected losses that could adversely affect our
        results of operations.
 
 **We
        compete with larger companies for business.**
 
 The
        banking and financial services business in our market areas continues to
        be a
        competitive field and is becoming more competitive as a result
        of:
  -
            21
            -
 **INDEX**
  •
              changes
                  in regulations;•
              changes
                  in technology and product delivery systems; and•
              the
                  accelerating pace of consolidation among financial services
                  providers.
 
 We
        may not be able to compete effectively in our markets, and our results of
        operations could be adversely affected by the nature or pace of change in
        competition. We compete for loans, deposits and customers with various bank
        and
        nonbank financial services providers, many of which have substantially greater
        resources, including higher total assets and capitalization, greater access
        to
        capital markets and a broader offering of financial services.
 
 **Our
        trading volume has been low compared with larger banks.**
 
 The
        trading volume in the Company’s common stock on the NASDAQ Global Select Market
        has been comparable to other similarly-sized banks. Nevertheless, this trading
        is relatively low when compared with more seasoned companies listed on the
        NASDAQ Global Select Market or other consolidated reporting systems or stock
        exchanges. Thus, the market in the Company’s common stock may be limited in
        scope relative to other companies.
 
 **We
        depend heavily on our key management personnel.**
 
 The
        Company’s success depends in part on its ability to retain key executives and to
        attract and retain additional qualified management personnel who have experience
        both in sophisticated banking matters and in operating a small- to mid-size
        bank. Competition for such personnel is strong in the banking industry, and
        we
        may not be successful in attracting or retaining the personnel we require.
        We
        expect to effectively compete in this area by offering financial packages
        that
        include incentive-based compensation and the opportunity to join in the
        rewarding work of building a growing bank.
 
 **Technological
        advances impact our business.**
 
 The
        banking industry is undergoing technological changes with frequent introductions
        of new technology-driven products and services. In addition to improving
        customer services, the effective use of technology increases efficiency and
        enables financial institutions to reduce costs. Our future success will depend,
        in part, on our ability to address the needs of our customers by using
        technology to provide products and services that will satisfy customer demands
        for convenience as well as to create additional efficiencies in our operations.
        Many of our competitors have substantially greater resources than we do to
        invest in technological improvements. We may not be able to effectively
        implement new technology-driven products and services or successfully market
        such products and services to our customers.
 
 **Government
        regulations may prevent or impact our ability to pay dividends, engage in
        acquisitions or operate in other ways.**
 
 Current
        and future legislation and the policies established by federal and state
        regulatory authorities will affect our operations. We are subject to supervision
        and periodic examination by the Federal Deposit Insurance Corporation and
        the
 North
        Carolina State Banking Commission. Banking regulations, designed primarily
        for
        the protection of depositors, may limit our growth and the return to you,
        our
        investors, by restricting certain of our activities, such as:
 
 •
              the
                  payment of dividends to our shareholders;•
              possible
                  mergers with, or acquisitions of or by, other
                  institutions;•
              our
                  desired investments;•
              loans
                  and interest rates on loans;•
              interest
                  rates paid on our deposits;•
              the
                  possible expansion of our branch offices; and/or•
              our
                  ability to provide securities or trust
                  services.
 -
              22
              -
 **INDEX**
  We
        also are subject to capitalization guidelines set forth in federal legislation,
        and could be subject to enforcement actions to the extent that we are found
        by
        regulatory examiners to be undercapitalized. We cannot predict what changes,
        if
        any, will be made to existing federal and state legislation and regulations
        or
        the effect that such changes may have on our future business and earnings
        prospects. The cost of compliance with regulatory requirements including
        those
        imposed by the SEC may adversely affect our ability to operate
        profitably.
 
 **There
        are potential risks associated with future acquisitions and
        expansions.**
 
 We
        intend to continue to explore expanding our branch system through selective
        acquisitions of existing banks or bank branches in the Research Triangle
        area
        and other North Carolina markets. We cannot say with any certainty that we
        will
        be able to consummate, or if consummated, successfully integrate, future
        acquisitions, or that we will not incur disruptions or unexpected expenses
        in
        integrating such acquisitions. In the ordinary course of business, we evaluate
        potential acquisitions that would bolster our ability to cater to the small
        business, individual and residential lending markets in North Carolina. In
        attempting to make such acquisitions, we anticipate competing with other
        financial institutions, many of which have greater financial and operational
        resources. In addition, since the consideration for an acquired bank or branch
        may involve cash, notes or the issuance of shares of common stock, existing
        shareholders could experience dilution in the value of their shares of our
        common stock in connection with such acquisitions. Any given acquisition,
        if and
        when consummated, may adversely affect our results of operations or overall
        financial condition. In addition, we may expand our branch network through
        de
        novo branches in existing or new markets. These de novo branches will have
        expenses in excess of revenues for varying periods after opening, which could
        decrease our reported earnings.
 
 **Compliance
        with changing regulation of corporate governance and public disclosure may
        result in additional risks and expenses.**
 
 Changing
        laws, regulations and standards relating to corporate governance and public
        disclosure, including the Sarbanes-Oxley Act of 2002 and new SEC regulations,
        are creating uncertainty for companies such as ours. These laws, regulations
        and
        standards are subject to varying interpretations in many cases, and as a
        result,
        their application in practice may evolve over time as new guidance is provided
        by regulatory and governing bodies, which could result in continuing uncertainty
        regarding compliance matters and higher costs necessitated by ongoing revisions
        to disclosure and governance practices. We are committed to maintaining high
        standards of corporate governance and public disclosure. As a result, our
        efforts to comply with evolving laws, regulations and standards have resulted
        in, and are likely to continue to result in, increased expenses and a diversion
        of management time and attention. In particular, our efforts to comply with
        Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations
        regarding management’s required assessment of our internal control over
        financial reporting and our external auditors’ audit of that assessment has
        required the commitment of significant financial and managerial resources.
        We
        expect these efforts to require the continued commitment of significant
        resources. Further, the members of our Board of Directors, members of the
        Audit
        or Compensation/Human Resources Committees, our chief executive officer,
        our
        chief financial officer and certain other of our executive officers could
        face
        an increased risk of personal liability in connection with the performance
        of
        their duties. As a result, our ability to attract and retain executive officers
        and qualified Board and committee members could be more difficult. In addition,
        it may become more difficult and more expensive to obtain director and officer
        liability insurance.
 
 **We
        are subject to environmental liability risk associated with lending
        activities.**
 
 A
        significant portion of our loan portfolio is secured by real property. During
        the ordinary course of business, we may foreclose on and take title to
        properties securing certain loans. In doing so, there is a risk that hazardous
        or toxic substances could be found on these properties. If hazardous or toxic
        substances are found, we may be liable for remediation costs, as well as
        for
        personal injury and property damage. Environmental laws may require us to
        incur
        substantial expenses and may materially reduce the affected property’s value or
        limit our ability to use or sell the affected property. In addition, future
        laws
        or more stringent interpretations or enforcement policies with respect to
        existing laws may increase our exposure to environmental liability. Although
        we
        have policies and procedures to perform an environmental review before
        initiating any foreclosure action on nonresidential real property, these
        reviews
        may not be sufficient to detect all potential environmental hazards. The
        remediation costs and any other financial liabilities associated with an
        environmental hazard could have a material adverse effect on our financial
        condition and results of operations.
 -
              23
              -
 **INDEX**
  **Our
        controls and procedures may fail or be circumvented.**
 
 Management
        regularly reviews and updates our internal controls, disclosure controls
        and
        procedures, and corporate governance policies and procedures. Any system
        of
        controls, however well designed and operated, is based in part on certain
        assumptions and can provide only reasonable, not absolute, assurances that
        the
        objectives of the system are met. Any failure or circumvention of our controls
        and procedures or failure to comply with regulations related to controls
        and
        procedures could have a material adverse effect on our business, results
        of
        operations and financial condition.
 
 **The
        holders of our subordinated debentures have rights that are senior to those
        of
        our shareholders.**
 
 We
        have
        issued $30.9 million of subordinated debentures in connection with three
        trust
        preferred securities issuances by our subsidiaries, Trust I, II and III.
        We
        conditionally guarantee payments of the principal and interest on the trust
        preferred securities. Our subordinated debentures are senior to our shares
        of
        common stock. As a result, we must make payments on the subordinated debentures
        (and the related trust preferred securities) before any dividends can be
        paid on
        our common stock and, in the event of bankruptcy, dissolution or liquidation,
        the holders of the debentures must be satisfied before any distributions
        can be
        made to the holders of common stock.
 
 **Our
        information systems may experience an interruption or breach in
        security** *.*
 
 We
        rely
        heavily on communications and information systems to conduct our business.
        Any
        failure, interruption or breach in security of these systems could result
        in
        failures or disruptions in our customer relationship management, general
        ledger,
        deposit, loan and other systems. While we have policies and procedures designed
        to prevent or limit the effect of the failure, interruption or security breach
        of our information systems, there can be no assurance that we can prevent
        any
        such failures, interruptions or security breaches or, if they do occur, that
        they will be adequately addressed. The occurrence of any failures, interruptions
        or security breaches of our information systems could damage our reputation,
        result in a loss of customer business, subject us to additional regulatory
        scrutiny, or expose us to civil litigation and possible financial liability,
        any
        of which could have a material adverse effect on our financial condition
        and
        results of operations.
 
 **An
        investment in our common stock is not an insured deposit.**
 
 Our
        common stock is not a bank deposit and, therefore, is not insured against
        loss
        by the FDIC, any other deposit insurance fund or by any other public or private
        entity. Investment in our common stock is inherently risky for the reasons
        described in this “Risk Factors” section and elsewhere in this report and is
        subject to the same market forces that affect the price of common stock in
        any
        company. As a result, if you acquire our common stock, you may lose some
        or all
        of your investment.
 
 **Consumers
        may decide not to use banks to complete their financial
        transactions.**
 
 Technology
        and other changes are allowing parties to complete financial transactions
        that
        historically have involved banks through alternative methods. For example,
        consumers can now maintain funds that would have historically been held as
        bank
        deposits in brokerage accounts or mutual funds. Consumers can also complete
        transactions such as paying bills and/or transferring funds directly without
        the
        assistance of banks. The process of eliminating banks as intermediaries could
        result in the loss of fee income, as well as the loss of customer deposits
        and
        the related income generated from those deposits. The loss of these revenue
        streams and the lower cost deposits as a source of funds could have a material
        adverse effect on our financial condition and results of
        operations.
 
 **Item
        2.****Unregistered
        Sales of Equity Securities and Use of Proceeds**
 
 The
        following table lists all repurchases (both open market and private
        transactions) during the three months ended March 31, 2007 of any of the
        Company’s securities registered under Section 12 of the Exchange Act, by or on
        behalf of the Company, or any affiliated purchaser of the Company:
 -
              24
              -
 **INDEX**
  **Issuer
        Purchases of Equity Securities**
  Month
                
                Total
                    Number of Shares Purchased
                
                Average
                    Price Paid per Share
                
                Total
                    Number of Shares Purchased as Part of Publicly Announced Plans
                    or Programs
                    1
                
                Maximum
                    Number of Shares that May Yet Be Purchased under the Plans or
                    ProgramsJanuary
                    2007
                
                
                –
                
                $
                –
                
                
                –
                
                
                568,429February
                    2007
                
                
                82
                
                $
                17.50
                
                
                82
                
                
                568,347March
                    2007
                
                
                –
                
                $
                –
                
                
                –
                
                
                568,347
 1  On
          February 27, 2006, the Company announced that its Board of Directors authorized
          a program to repurchase (in the open market or in any private transaction),
          up
          to 1.0 million shares of the Company’s outstanding common stock. The repurchase
          program is for a period of up to two years 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,
          2007,
          there were an aggregate of 690,197 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
                  No.**
              
              **Description**Exhibit
                  4.1
              
              In
                  accordance with Item 601(b)(4)(iii)(A) of Regulation S-K, certain
                  instruments respecting long term debt of the registrant have been
                  omitted
                  but will be furnished to the Commission upon request.Exhibit
                  10.1
              
              Amendment
                  to Employment Agreement, dated January 25, 2007, between Capital
                  Bank and
                  B. Grant Yarber (incorporated by reference to Exhibit 10.1 to Capital
                  Bank
                  Corporation’s current report on Form 8-K filed with the Securities and
                  Exchange Commission on January 29, 2007)Exhibit
                  31.1
              
              Certification
                  of B. Grant Yarber pursuant to Rule 13a-14(a) and 15d-14(a), as
                  adopted
                  pursuant to Section 302 of the Sarbanes-Oxley Act of
                  2002Exhibit
                  31.2
              
              Certification
                  of A. Christine Baker pursuant to Rule 13a-14(a) and 15d-14(a),
                  as adopted
                  pursuant to Section 302 of the Sarbanes-Oxley Act of
                  2002Exhibit
                  32.1
              
              Certification
                  of B. Grant Yarber pursuant to 18 U.S.C. Section 1350, as Adopted
                  Pursuant
                  to Section 906 of the Sarbanes-Oxley Act of 2002 [This exhibit
                  is being
                  furnished pursuant to Section 906 of the Sarbanes- Oxley Act of
                  2002 and
                  shall not, except to the extent required by that act, be deemed
                  to be
                  incorporated by reference into any document or filed herewith for
                  purposes
                  of liability under the Securities Exchange Act of 1934, as amended,
                  or the
                  Securities Act of 1933, as amended, as the case may
                  be.]Exhibit
                  32.2
              
              Certification
                  of A. Christine Baker pursuant to 18 U.S.C. Section 1350, as Adopted
                  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 [This
                  exhibit is
                  being furnished pursuant to Section 906 of the Sarbanes-Oxley Act
                  of 2002
                  and shall not, except to the extent required by that act, be deemed
                  to be
                  incorporated by reference into any document or filed herewith for
                  purposes
                  of liability under the Securities Exchange Act of 1934, as amended,
                  or the
                  Securities Act of 1933, as amended, as the case may
                  be.]  -
              25
              -
 **INDEX**
  **Signatures**
 
 Pursuant
        to the requirements of the Securities Exchange Act of 1934, the registrant
        has
        duly caused this report to be signed on its behalf by the undersigned, thereunto
        duly authorized, in Raleigh, North Carolina, on the 10th day of May
        2007.
  **CAPITAL
                  BANK CORPORATION**By:  /s/*A.
                  Christine Baker*A.
                  Christine BakerChief
                  Financial Officer(Authorized
                  Officer and Principal Financial
                  Officer)
  -
              26
              -
 **INDEX**
  **EXHIBIT
        INDEX**
  **Exhibit
                  No.**
              
              **Description**Exhibit
                  4.1
              
              In
                  accordance with Item 601(b)(4)(iii)(A) of Regulation S-K, certain
                  instruments respecting long term debt of the registrant have been
                  omitted
                  but will be furnished to the Commission upon request.Exhibit
                  10.1
              
              Amendment
                  to Employment Agreement, dated January 25, 2007, between Capital
                  Bank and
                  B. Grant Yarber (incorporated by reference to Exhibit 10.1 to Capital
                  Bank
                  Corporation’s current report on Form 8-K filed with the Securities and
                  Exchange Commission on January 29, 2007)Exhibit
                  31.1
              
              Certification
                  of B. Grant Yarber pursuant to Rule 13a-14(a) and 15d-14(a), as
                  adopted
                  pursuant to Section 302 of the Sarbanes-Oxley Act of
                  2002Exhibit
                  31.2
              
              Certification
                  of A. Christine Baker pursuant to Rule 13a-14(a) and 15d-14(a),
                  as adopted
                  pursuant to Section 302 of the Sarbanes-Oxley Act of
                  2002Exhibit
                  32.1
              
              Certification
                  of B. Grant Yarber pursuant to 18 U.S.C. Section 1350, as Adopted
                  Pursuant
                  to Section 906 of the Sarbanes-Oxley Act of 2002 [This exhibit
                  is being
                  furnished pursuant to Section 906 of the Sarbanes- Oxley Act of
                  2002 and
                  shall not, except to the extent required by that act, be deemed
                  to be
                  incorporated by reference into any document or filed herewith for
                  purposes
                  of liability under the Securities Exchange Act of 1934, as amended,
                  or the
                  Securities Act of 1933, as amended, as the case may
                  be.]Exhibit
                  32.2
              
              Certification
                  of A. Christine Baker pursuant to 18 U.S.C. Section 1350, as Adopted
                  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 [This
                  exhibit is
                  being furnished pursuant to Section 906 of the Sarbanes-Oxley Act
                  of 2002
                  and shall not, except to the extent required by that act, be deemed
                  to be
                  incorporated by reference into any document or filed herewith for
                  purposes
                  of liability under the Securities Exchange Act of 1934, as amended,
                  or the
                  Securities Act of 1933, as amended, as the case may
                  be.]
 
 -
            27
            -