##### Table of Contents





UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549





FORM 10-Q





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

THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended
March 31, 2011

Commission File No.: 000-52195





BANK OF THE CAROLINAS CORPORATION

(Exact name of registrant as specified in its charter)







|                                                     |  |                                  
|---------------------------------------------------- |  | ---------------------------------
|NORTH CAROLINA                                       |  | 20-4989192                       
|(State or other jurisdiction of incorporation)       |  | (IRS Employer Identification No.)
|                                                     | 
|135 Boxwood Village Drive Mocksville, North Carolina |  | 27028                            
|(Address of principal executive offices)             |  | (Zip Code)                       

Registrants telephone number, including area code: (336) 751-5755





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  x    No   ̈

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every interactive Data File required to be submitted and posted pursuant to Rule
405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   ̈    No   ̈

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



|                        |  |   |  |                           |  |  
|----------------------- |  | - |  | ------------------------- |  | -
|Large accelerated filer |  |  ̈ |  | Accelerated filer         |  |  ̈
|                        |  |   | 
|Non-accelerated filer   |  |  ̈ |  | Smaller reporting company |  | x

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

On
May 12, 2011 there were 3,897,174 outstanding shares of the registrants common stock.









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##### Table of Contents

BANK OF THE CAROLINAS CORPORATION

FORM 10-Q

March 31, 2011

INDEX



|                              |  |          |    |                                                                                                               |  |  |    | 
|----------------------------- |  | -------- | -- | ------------------------------------------------------------------------------------------------------------- |  |  | -- | 
|Part I. FINANCIAL INFORMATION |  |          |    |                                                                                                              
|                              |  |          |   
|                              |  | Item 1.  |    | Financial Statements                                                                                          |  |  |    | 
|                              |  |          |   
|                              |  |          |    | Consolidated Balance Sheets at March 31, 2011 and December 31, 2010                                           |  |  | 3  | 
|                              |  |          |   
|                              |  |          |    | Consolidated Statements of Operations for the Three Months Ended March 31, 2011 and 2010                      |  |  | 4  | 
|                              |  |          |   
|                              |  |          |    | Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2011 and 2010                      |  |  | 5  | 
|                              |  |          |   
|                              |  |          |    | Consolidated Statements of Changes in Stockholders Equity for the Three Months Ended March 31, 2011 and 2010 |  |  | 6  | 
|                              |  |          |   
|                              |  |          |    | Notes to Consolidated Financial Statements                                                                    |  |  | 7  | 
|                              |  |          |   
|                              |  | Item 2.  |    | Managements Discussion and Analysis of Financial Condition and Results of Operations                         |  |  | 19 | 
|                              |  |          |   
|                              |  | Item 3.  |    | Quantitative and Qualitative Disclosures about Market Risk                                                    |  |  | 24 | 
|                              |  |          |   
|                              |  | Item 4.  |    | Controls and Procedures                                                                                       |  |  | 24 | 
|                              | 
|Part II. OTHER INFORMATION    |  |          |    |                                                                                                              
|                              |  |          |   
|                              |  | Item 1.  |    | Legal Proceedings                                                                                             |  |  | 24 | 
|                              |  |          |   
|                              |  | Item 1A. |    | Risk Factors                                                                                                  |  |  | 24 | 
|                              |  |          |   
|                              |  | Item 2.  |    | Unregistered Sales of Equity Securities and Use of Proceeds                                                   |  |  | 24 | 
|                              |  |          |   
|                              |  | Item 3.  |    | Defaults Upon Senior Securities                                                                               |  |  | 24 | 
|                              |  |          |   
|                              |  | Item 4.  |    | [Removed and Reserved]                                                                                        |  |  | 24 | 
|                              |  |          |   
|                              |  | Item 5.  |    | Other Information                                                                                             |  |  | 24 | 
|                              |  |          |   
|                              |  | Item 6.  |    | Exhibits                                                                                                      |  |  | 24 | 
|                              | 
|SIGNATURES                    |  |          | 25 |                                                                                                              
|                              | 
|EXHIBIT INDEX                 |  |          | 26 |                                                                                                              



2



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##### Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Bank of the Carolinas Corporation

Consolidated Balance Sheets

(amounts in thousands, except share and per share data)



|                                               |  |              |            |   |                  |   |            |  
|---------------------------------------------- |  | ------------ | ---------- | - | ---------------- | - | ---------- | -
|                                               |  | March 312011 |            |   | December 312010* |  
|                                               |  | (Unaudited)  |            |   |                  |  
|Assets:                                        |  |              |            |   |                  |   |            |  
|Cash and due from banks, noninterest-bearing   |  | $            | 4,174      |   |                  | $ | 4,303      |  
|Interest-bearing deposits in banks             |  |              | 4,208      |   |                  |   | 6,262      |  
|                                               |  |              |            |   |                  |   |            |  
|Cash and cash equivalents                      |  |              | 8,382      |   |                  |   | 10,565     |  
|                                               |  |             
|Federal funds sold                             |  |              | 14,985     |   |                  |   | 9,330      |  
|                                               |  |             
|Investment securities                          |  |              | 116,879    |   |                  |   | 110,373    |  
|                                               |  |             
|Loans receivable                               |  |              | 359,561    |   |                  |   | 366,153    |  
|Less: Allowance for loan losses                |  |              | (8,314     | ) |                  |   | (6,863     | )
|                                               |  |              |            |   |                  |   |            |  
|Total loans, net                               |  |              | 351,247    |   |                  |   | 359,290    |  
|Premises and equipment                         |  |              | 12,859     |   |                  |   | 13,106     |  
|Other real estate owned                        |  |              | 9,375      |   |                  |   | 8,314      |  
|Bank owned life insurance                      |  |              | 10,460     |   |                  |   | 10,371     |  
|Deferred tax assets                            |  |              | 4,409      |   |                  |   | 5,123      |  
|Prepaid FDIC insurance assessment              |  |              | 3,418      |   |                  |   | 3,670      |  
|Accrued interest receivable                    |  |              | 1,862      |   |                  |   | 1,814      |  
|Other assets                                   |  |              | 3,182      |   |                  |   | 3,014      |  
|                                               |  |              |            |   |                  |   |            |  
|Total assets                                   |  | $            | 537,058    |   |                  | $ | 534,970    |  
|                                               |  |              |            |   |                  |   |            |  
|                                               |  |             
|Liabilities and Stockholders Equity:          |  |              |            |   |                  |   |            |  
|Deposits:                                      |  |              |            |   |                  |   |            |  
|Noninterest-bearing demand deposits            |  | $            | 36,411     |   |                  | $ | 33,730     |  
|Interest-checking deposits                     |  |              | 35,221     |   |                  |   | 34,004     |  
|Savings and money market deposits              |  |              | 110,401    |   |                  |   | 114,923    |  
|Time deposits                                  |  |              | 241,706    |   |                  |   | 233,512    |  
|                                               |  |              |            |   |                  |   |            |  
|Total deposits                                 |  |              | 423,739    |   |                  |   | 416,169    |  
|Securities sold under agreements to repurchase |  |              | 45,458     |   |                  |   | 45,603     |  
|Federal Home Loan Bank advances                |  |              | 20,000     |   |                  |   | 22,000     |  
|Subordinated debt                              |  |              | 7,855      |   |                  |   | 7,855      |  
|Other liabilities                              |  |              | 1,819      |   |                  |   | 1,639      |  
|                                               |  |              |            |   |                  |   |            |  
|Total liabilities                              |  |              | 498,871    |   |                  |   | 493,266    |  
|                                               |  |              |            |   |                  |   |            |  
|                                               |  |             
|Commitments and contingencies (Note 5)         |  |              |           |   |                  |   |           |  
|                                               |  |             
|Stockholders Equity:                          |  |              |            |   |                  |   |            |  
|Preferred stock, no par value:                 |  |              | 13,179     |   |                  |   | 13,179     |  
|Discount on preferred stock                    |  |              | (923       | ) |                  |   | (991       | )
|Common stock, $5 per share par value           |  |              | 19,486     |   |                  |   | 19,486     |  
|Additional paid-in capital                     |  |              | 12,984     |   |                  |   | 12,988     |  
|Retained deficit                               |  |              | (6,715     | ) |                  |   | (3,268     | )
|Accumulated other comprehensive income         |  |              | 176        |   |                  |   | 310        |  
|                                               |  |              |            |   |                  |   |            |  
|Total Stockholders Equity                     |  |              | 38,187     |   |                  |   | 41,704     |  
|                                               |  |              |            |   |                  |   |            |  
|Total Liabilities and Stockholders Equity     |  | $            | 537,058    |   |                  | $ | 534,970    |  
|                                               |  |              |            |   |                  |   |            |  
|                                               |  |             
|Preferred shares authorized                    |  |              | 3,000,000  |   |                  |   | 3,000,000  |  
|Preferred shares issued and outstanding        |  |              | 13,179     |   |                  |   | 13,179     |  
|Common shares authorized                       |  |              | 15,000,000 |   |                  |   | 15,000,000 |  
|Common shares issued and outstanding           |  |              | 3,897,174  |   |                  |   | 3,897,174  |  



|* | Derived from audited consolidated financial statements.
|- | -------------------------------------------------------

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



3



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Bank of the Carolinas Corporation

Consolidated Statements of Operations

(Unaudited)

(dollars in thousands, except per share data)



|                                                                                    |  |                            |        |   |      |   |       |  
|----------------------------------------------------------------------------------- |  | -------------------------- | ------ | - | ---- | - | ----- | -
|                                                                                    |  | Three Months EndedMarch 31 |       
|                                                                                    |  | 2011                       |        |   | 2010 |  
|                                                                                    |  | (Unaudited)                |       
|Interest income                                                                     |  |                            |        |   |      |   |       |  
|Interest and fees on loans                                                          |  | $                          | 4,650  |   |      | $ | 5,383 |  
|Interest on securities                                                              |  |                            | 754    |   |      |   | 934   |  
|Other interest income                                                               |  |                            | 11     |   |      |   | 17    |  
|                                                                                    |  |                            |        |   |      |   |       |  
|Total interest income                                                               |  |                            | 5,415  |   |      |   | 6,334 |  
|                                                                                    |  |                            |        |   |      |   |       |  
|                                                                                    |  |                           
|Interest expense                                                                    |  |                            |        |   |      |   |       |  
|Interest on deposits                                                                |  |                            | 1,154  |   |      |   | 1,449 |  
|Interest on borrowed funds                                                          |  |                            | 613    |   |      |   | 672   |  
|                                                                                    |  |                            |        |   |      |   |       |  
|Total interest expense                                                              |  |                            | 1,767  |   |      |   | 2,121 |  
|                                                                                    |  |                            |        |   |      |   |       |  
|                                                                                    |  |                           
|Net Interest income                                                                 |  |                            | 3,648  |   |      |   | 4,213 |  
|Provision for loan losses                                                           |  |                            | 2,345  |   |      |   | 916   |  
|                                                                                    |  |                            |        |   |      |   |       |  
|Net interest income after provision for loan losses                                 |  |                            | 1,303  |   |      |   | 3,297 |  
|                                                                                    |  |                            |        |   |      |   |       |  
|                                                                                    |  |                           
|Noninterest income                                                                  |  |                            |        |   |      |   |       |  
|Customer service fees                                                               |  |                            | 305    |   |      |   | 315   |  
|Increase in value of bank owned life insurance                                      |  |                            | 89     |   |      |   | 89    |  
|Gains on investment securities                                                      |  |                            | 0      |   |      |   | 96    |  
|Other income                                                                        |  |                            | 8      |   |      |   | 3     |  
|                                                                                    |  |                            |        |   |      |   |       |  
|Total non-interest income                                                           |  |                            | 402    |   |      |   | 503   |  
|                                                                                    |  |                            |        |   |      |   |       |  
|                                                                                    |  |                           
|Noninterest expense                                                                 |  |                            |        |   |      |   |       |  
|Salaries and benefits                                                               |  |                            | 1,586  |   |      |   | 1,915 |  
|Occupancy and equipment                                                             |  |                            | 542    |   |      |   | 595   |  
|FDIC insurance assessments                                                          |  |                            | 270    |   |      |   | 299   |  
|Data processing services                                                            |  |                            | 212    |   |      |   | 206   |  
|Valuation provisions and net operating costs associated with foreclosed real estate |  |                            | 250    |   |      |   | 369   |  
|Other                                                                               |  |                            | 1,063  |   |      |   | 851   |  
|                                                                                    |  |                            |        |   |      |   |       |  
|Total noninterest expense                                                           |  |                            | 3,923  |   |      |   | 4,235 |  
|                                                                                    |  |                            |        |   |      |   |       |  
|Loss before income taxes                                                            |  |                            | (2,218 | ) |      |   | (435  | )
|Provision (benefit) for income taxes                                                |  |                            | 996    |   |      |   | (200  | )
|                                                                                    |  |                            |        |   |      |   |       |  
|Net loss                                                                            |  |                            | (3,214 | ) |      |   | (235  | )
|Dividends and accretion on preferred stock                                          |  |                            | (232   | ) |      |   | (227  | )
|                                                                                    |  |                            |        |   |      |   |       |  
|Net loss available to common stockholders                                           |  | $                          | (3,446 | ) |      | $ | (462  | )
|                                                                                    |  |                            |        |   |      |   |       |  
|                                                                                    |  |                           
|Income (loss) per common share:                                                     |  |                            |        |   |      |   |       |  
|Basic                                                                               |  | $                          | (0.88  | ) |      | $ | (0.12 | )
|                                                                                    |  |                            |        |   |      |   |       |  
|Diluted                                                                             |  | $                          | (0.88  | ) |      | $ | (0.12 | )
|                                                                                    |  |                            |        |   |      |   |       |  

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



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Bank of the Carolinas Corporation

Consolidated Statements of Cash Flows

(Unaudited)

(dollars in thousands)



|                                                                                                 |  |                             |         |   |      |   |         |  
|------------------------------------------------------------------------------------------------ |  | --------------------------- | ------- | - | ---- | - | ------- | -
|                                                                                                 |  | Three Months Ended March 31 |        
|                                                                                                 |  | 2011                        |         |   | 2010 |  
|Cash flows from operating activities:                                                            |  |                             |         |   |      |   |         |  
|Net loss                                                                                         |  | $                           | (3,214  | ) |      | $ | (235    | )
|Adjustments to reconcile net loss to net cash provided by operating activities:                  |  |                             |         |   |      |   |         |  
|Provision for loan losses                                                                        |  |                             | 2,345   |   |      |   | 916     |  
|Stock based compensation expense (benefit)                                                       |  |                             | (4      | ) |      |   | 7       |  
|Depreciation and amortization                                                                    |  |                             | 253     |   |      |   | 272     |  
|Change in valuation allowance on other real estate owned                                         |  |                             | 123     |   |      |   | 114     |  
|Loss on sale of other real estate owned                                                          |  |                             | 14      |   |      |   | 156     |  
|Gain on sale of securities                                                                       |  |                             |        |   |      |   | (96     | )
|Increase in bank owned life insurance                                                            |  |                             | (89     | ) |      |   | (89     | )
|Net amortization/accretion of premiums and discounts on investments                              |  |                             | 229     |   |      |   | 93      |  
|Net change in other assets                                                                       |  |                             | 835     |   |      |   | 3,885   |  
|Net change in other liabilities                                                                  |  |                             | 180     |   |      |   | (19     | )
|                                                                                                 |  |                             |         |   |      |   |         |  
|Net cash provided by operating activities                                                        |  |                             | 672     |   |      |   | 5,004   |  
|                                                                                                 |  |                             |         |   |      |   |         |  
|                                                                                                 |  |                            
|Cash flows from investing activities:                                                            |  |                             |         |   |      |   |         |  
|Net change in federal funds sold                                                                 |  |                             | (5,655  | ) |      |   | (4,685  | )
|Purchases of premises and equipment                                                              |  |                             | (6      | ) |      |   | (29     | )
|Purchases of securities                                                                          |  |                             | (16,758 | ) |      |   | (9,000  | )
|Proceeds from sales, calls, maturities and principal repayments of securities available for sale |  |                             | 9,804   |   |      |   | 53,333  |  
|Improvements made to other real estate owned                                                     |  |                             |        |   |      |   | (19     | )
|Proceeds from sales of other real estate owned                                                   |  |                             | 44      |   |      |   | 617     |  
|Net decrease in loans                                                                            |  |                             | 4,456   |   |      |   | 6,684   |  
|                                                                                                 |  |                             |         |   |      |   |         |  
|Net cash provided (used) by investing activities                                                 |  |                             | (8,115  | ) |      |   | 46,901  |  
|                                                                                                 |  |                             |         |   |      |   |         |  
|                                                                                                 |  |                            
|Cash flows from financing activities:                                                            |  |                             |         |   |      |   |         |  
|Net increase (decrease) in deposits                                                              |  |                             | 7,570   |   |      |   | (48,794 | )
|Net additions (repayments) of other borrowings                                                   |  |                             | (2,000  | ) |      |   | 10,000  |  
|Decrease in repurchase agreements                                                                |  |                             | (145    | ) |      |   | (768    | )
|Cash dividends paid on preferred stock                                                           |  |                             | (165    | ) |      |   | (165    | )
|                                                                                                 |  |                             |         |   |      |   |         |  
|Net cash provided (used) by financing activities                                                 |  |                             | 5,260   |   |      |   | (39,727 | )
|                                                                                                 |  |                             |         |   |      |   |         |  
|                                                                                                 |  |                            
|Net increase (decrease) in cash and cash equivalents                                             |  |                             | (2,183  | ) |      |   | 12,178  |  
|Cash and cash equivalents at beginning of period                                                 |  |                             | 10,565  |   |      |   | 12,544  |  
|                                                                                                 |  |                             |         |   |      |   |         |  
|Cash and cash equivalents at end of period                                                       |  | $                           | 8,382   |   |      | $ | 24,722  |  
|                                                                                                 |  |                             |         |   |      |   |         |  
|                                                                                                 |  |                            
|Supplemental disclosure of cash flow information:                                                |  |                             |         |   |      |   |         |  
|Cash paid during the period for interest                                                         |  | $                           | 1,772   |   |      | $ | 2,329   |  
|                                                                                                 |  |                             |         |   |      |   |         |  
|                                                                                                 |  |                            
|Noncash investing and financing activities:                                                      |  |                             |         |   |      |   |         |  
|Change in fair value of securities available for sale, net of tax                                |  | $                           | (134    | ) |      | $ | 306     |  
|                                                                                                 |  |                             |         |   |      |   |         |  
|Transfer from loans to other real estate owned                                                   |  | $                           | 1,242   |   |      | $ | 1,658   |  
|                                                                                                 |  |                             |         |   |      |   |         |  

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



5



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##### Table of Contents

Bank of the Carolinas Corporation

Consolidated Statements of Changes in Stockholders Equity

(Unaudited)

(dollars in thousands)



|                                      |  |                 |        |  |                           |   |        |              |        |   |                   |        |  |                  |           |  |                               |           |        |                    |        |   |        |        |  |   |        |   |  |   |      |   |  |   |        |  
|------------------------------------- |  | --------------- | ------ |  | ------------------------- | - | ------ | ------------ | ------ | - | ----------------- | ------ |  | ---------------- | --------- |  | ----------------------------- | --------- | ------ | ------------------ | ------ | - | ------ | ------ |  | - | ------ | - |  | - | ---- | - |  | - | ------ | -
|                                      |  | Preferred Stock |        |  | Discounton PreferredStock |   |        | Common Stock |        |   | AdditionalPaid-In |        |  | RetainedEarnings |           |  | AccumulatedOtherComprehensive |           |        | TotalStockholders |       
|                                      |  | Shares          |        |  | Amount                    |   |        |              | Shares |   |                   | Amount |  |                  | Capital   |  |                               | (Deficit) |        |                    | Income |   |        | Equity | 
|                                      |  |                 |        |  |                           |   |        |              |       
|Balance, December 31, 2009            |  |                 | 13,179 |  |                           | $ | 13,179 |              |        | $ | (1,245            | )      |  |                  | 3,897,174 |  |                               | $         | 19,486 |                    |        | $ | 12,978 |        |  | $ | 300    |   |  | $ | 294  |   |  | $ | 44,992 |  
|Net loss                              |  |                 |       |  |                           |   |       |              |        |   |                  |        |  |                  |          |  |                               |           |       |                    |        |   |       |        |  |   | (235   | ) |  |   |     |   |  |   | (235   | )
|Other comprehensive income            |  |                 |       |  |                           |   |       |              |        |   |                  |        |  |                  |          |  |                               |           |       |                    |        |   |       |        |  |   |       |   |  |   | 306  |   |  |   | 306    |  
|                                      |  |                 |        |  |                           |   |        |              |        |   |                   |        |  |                  |           |  |                               |           |        |                    |        |   |        |        |  |   |        |   |  |   |      |   |  |   |        |  
|Total comprehensive income            |  |                 |       |  |                           |   |       |              |        |   |                  |        |  |                  |          |  |                               |           |       |                    |        |   |       |        |  |   |       |   |  |   |     |   |  |   | 71     |  
|                                      |  |                 |        |  |                           |   |        |              |        |   |                   |        |  |                  |           |  |                               |           |        |                    |        |   |        |        |  |   |        |   |  |   |      |   |  |   |        |  
|Stock based compensation expense      |  |                 |       |  |                           |   |       |              |        |   |                  |        |  |                  |          |  |                               |           |       |                    |        |   | 7      |        |  |   |       |   |  |   |     |   |  |   | 7      |  
|                                      |  |                 |        |  |                           |   |        |              |       
|Discount accretion on preferred stock |  |                 |       |  |                           |   |       |              |        |   | 62                |        |  |                  |          |  |                               |           |       |                    |        |   |       |        |  |   | (62    | ) |  |   |     |   |  |   |       |  
|                                      |  |                 |        |  |                           |   |        |              |       
|Dividends accrued on preferred stock  |  |                 |       |  |                           |   |       |              |        |   |                  |        |  |                  |          |  |                               |           |       |                    |        |   |       |        |  |   | (165   | ) |  |   |     |   |  |   | (165   | )
|                                      |  |                 |        |  |                           |   |        |              |        |   |                   |        |  |                  |           |  |                               |           |        |                    |        |   |        |        |  |   |        |   |  |   |      |   |  |   |        |  
|Balance, March 31, 2010               |  |                 | 13,179 |  |                           | $ | 13,179 |              |        | $ | (1,183            | )      |  |                  | 3,897,174 |  |                               | $         | 19,486 |                    |        | $ | 12,985 |        |  | $ | (162   | ) |  | $ | 600  |   |  | $ | 44,905 |  
|                                      |  |                 |        |  |                           |   |        |              |        |   |                   |        |  |                  |           |  |                               |           |        |                    |        |   |        |        |  |   |        |   |  |   |      |   |  |   |        |  
|                                      |  |                 |        |  |                           |   |        |              |       
|Balance, December 31, 2010            |  |                 | 13,179 |  |                           | $ | 13,179 |              |        | $ | (991              | )      |  |                  | 3,897,174 |  |                               | $         | 19,486 |                    |        | $ | 12,988 |        |  | $ | (3,268 | ) |  | $ | 310  |   |  | $ | 41,704 |  
|Net loss                              |  |                 |       |  |                           |   |       |              |        |   |                  |        |  |                  |          |  |                               |           |       |                    |        |   |       |        |  |   | (3,214 | ) |  |   |     |   |  |   | (3,214 | )
|Other comprehensive loss              |  |                 |       |  |                           |   |       |              |        |   |                  |        |  |                  |          |  |                               |           |       |                    |        |   |       |        |  |   |       |   |  |   | (134 | ) |  |   | (134   | )
|                                      |  |                 |        |  |                           |   |        |              |        |   |                   |        |  |                  |           |  |                               |           |        |                    |        |   |        |        |  |   |        |   |  |   |      |   |  |   |        |  
|Total comprehensive loss              |  |                 |       |  |                           |   |       |              |        |   |                  |        |  |                  |          |  |                               |           |       |                    |        |   |       |        |  |   |       |   |  |   |     |   |  |   | (3,348 | )
|                                      |  |                 |        |  |                           |   |        |              |        |   |                   |        |  |                  |           |  |                               |           |        |                    |        |   |        |        |  |   |        |   |  |   |      |   |  |   |        |  
|Stock based compensation benefit      |  |                 |       |  |                           |   |       |              |        |   |                  |        |  |                  |          |  |                               |           |       |                    |        |   | (4     | )      |  |   |       |   |  |   |     |   |  |   | (4     | )
|                                      |  |                 |        |  |                           |   |        |              |       
|Discount accretion on preferred stock |  |                 |       |  |                           |   |       |              |        |   | 68                |        |  |                  |          |  |                               |           |       |                    |        |   |       |        |  |   | (68    | ) |  |   |     |   |  |   |       |  
|                                      |  |                 |        |  |                           |   |        |              |       
|Dividends accrued on preferred stock  |  |                 |       |  |                           |   |       |              |        |   |                  |        |  |                  |          |  |                               |           |       |                    |        |   |       |        |  |   | (165   | ) |  |   |     |   |  |   | (165   | )
|                                      |  |                 |        |  |                           |   |        |              |        |   |                   |        |  |                  |           |  |                               |           |        |                    |        |   |        |        |  |   |        |   |  |   |      |   |  |   |        |  
|Balance, March 31, 2011               |  |                 | 13,179 |  |                           | $ | 13,179 |              |        | $ | (923              | )      |  |                  | 3,897,174 |  |                               | $         | 19,486 |                    |        | $ | 12,984 |        |  | $ | (6,715 | ) |  | $ | 176  |   |  | $ | 38,187 |  
|                                      |  |                 |        |  |                           |   |        |              |        |   |                   |        |  |                  |           |  |                               |           |        |                    |        |   |        |        |  |   |        |   |  |   |      |   |  |   |        |  

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



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Bank of the Carolinas Corporation

Notes to Consolidated Financial Statements

(Unaudited)

NOTE 1. BASIS OF PRESENTATION

In the opinion of management, the financial information included in these unaudited financial statements reflects all adjustments (consisting of normal
recurring adjustments) necessary for a fair presentation of the financial information as of March 31, 2011 and December 31, 2010 and for the three-month periods ended March 31, 2011 and 2010, in conformity with accounting principles
generally accepted in the United States of America.

The preparation of financial statements requires management to make estimates and
assumptions that affect reported amounts of assets and liabilities at the date of the financial statements, as well as the amounts of income and expense during the reporting period. Actual results could differ from those estimates. Operating results
for the three-month period ended March 31, 2011 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2011.

The results presented here are for Bank of the Carolinas Corporation (the Company), the parent company of Bank of the Carolinas (the Bank). The organization and business of the
Company, accounting policies followed by the Company and other relevant information are contained in the notes to the financial statements filed as part of the Companys annual report on Form 10-K for the year ended December 31, 2010. This
quarterly report should be read in conjunction with the annual report. Because the Company has no separate operations and conducts no business on its own other than owning the Bank, this discussion concerns primarily the business of the Bank.
However, because the financial statements are presented on a consolidated basis, the Company and the Bank are collectively referred to as the Company unless otherwise noted.

NOTE 2. EARNINGS PER SHARE

Basic earnings (loss) per share represents income (loss)
available to common stockholders divided by the weighted average number of common shares outstanding during the period. When applicable, the weighted average shares outstanding for the diluted earnings per share computations are adjusted to reflect
the assumed conversion of shares available under stock options using the treasury stock method.

Earnings (loss) per share have been computed
based on the following (dollars in thousands):



|                                                               |  |                             |           |   |      |   |           |  
|-------------------------------------------------------------- |  | --------------------------- | --------- | - | ---- | - | --------- | -
|                                                               |  | Three months endedMarch 31, |          
|                                                               |  | 2011                        |           |   | 2010 |  
|                                                               |  |                            
|Net income (loss) applicable to common stock                   |  | $                           | (3,446    | ) |      | $ | (462      | )
|                                                               |  |                             |           |   |      |   |           |  
|                                                               |  |                            
|Weighted average number of common shares outstanding           |  |                             | 3,897,174 |   |      |   | 3,897,174 |  
|                                                               |  |                             |           |   |      |   |           |  
|                                                               |  |                            
|Weighted average number of diluted common shares outstanding   |  |                             | 3,897,174 |   |      |   | 3,897,174 |  
|                                                               |  |                             |           |   |      |   |           |  
|                                                               |  |                            
|Common stock options and common stock warrants - anti-dilutive |  |                             | 508,605   |   |      |   | 36,431    |  
|                                                               |  |                             |           |   |      |   |           |  

The common stock warrants referred to above were issued to the United States Treasury in connection with the Companys
April 17, 2009 participation in the Capital Purchase Program, which was authorized as a part of the TARP legislation passed by Congress during 2008.



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NOTE 3. INVESTMENT SECURITIES

The amortized cost, estimated fair values and carrying values of the investment securities portfolios at the indicated dates are summarized as follows (dollars in thousands):



|                                               |  |                   |         |  |                      |   |       |                       |  |   |                     |  |  |               |         |  |  |   |         | 
|---------------------------------------------- |  | ----------------- | ------- |  | -------------------- | - | ----- | --------------------- |  | - | ------------------- |  |  | ------------- | ------- |  |  | - | ------- | 
|                                               |  | March 31, 2011    |        
|                                               |  | AmortizedCost     |         |  | GrossUnrealizedGains |   |       | GrossUnrealizedLosses |  |   | EstimatedFair Value |  |  | CarryingValue |        
|Investment securities available for sale:      |  |                   |         |  |                      |   |       |                       |  |   |                     |  |  |               |         |  |  |   |         | 
|U.S. Government agencies securities            |  | $                 | 57,234  |  |                      | $ | 573   |                       |  | $ | 422                 |  |  | $             | 57,385  |  |  | $ | 57,385  | 
|State and municipal bonds                      |  |                   | 3,692   |  |                      |   | 172   |                       |  |   | 2                   |  |  |               | 3,862   |  |  |   | 3,862   | 
|Corporate securities                           |  |                   | 963     |  |                      |   | 24    |                       |  |   |                    |  |  |               | 987     |  |  |   | 987     | 
|Mortgage-backed securities                     |  |                   | 52,390  |  |                      |   | 327   |                       |  |   | 416                 |  |  |               | 52,301  |  |  |   | 52,301  | 
|                                               |  |                   |         |  |                      |   |       |                       |  |   |                     |  |  |               |         |  |  |   |         | 
|                                               |  |                   |         |  |                     
|Total investment securities available for sale |  |                   | 114,279 |  |                      |   | 1,096 |                       |  |   | 840                 |  |  |               | 114,535 |  |  |   | 114,535 | 
|                                               |  |                   |         |  |                     
|Investment securities held to maturity:        |  |                   |         |  |                      |   |       |                       |  |   |                     |  |  |               |         |  |  |   |         | 
|Corporate securities                           |  |                   | 2,344   |  |                      |   | 107   |                       |  |   | 239                 |  |  |               | 2,212   |  |  |   | 2,344   | 
|                                               |  |                   |         |  |                      |   |       |                       |  |   |                     |  |  |               |         |  |  |   |         | 
|                                               |  |                   |         |  |                     
|Total investment securities                    |  | $                 | 116,623 |  |                      | $ | 1,203 |                       |  | $ | 1,079               |  |  | $             | 116,747 |  |  | $ | 116,879 | 
|                                               |  |                   |         |  |                      |   |       |                       |  |   |                     |  |  |               |         |  |  |   |         | 
|                                               | 
|                                               |  | December 31, 2010 |        
|                                               |  | AmortizedCost     |         |  | GrossUnrealizedGains |   |       | GrossUnrealizedLosses |  |   | EstimatedFair Value |  |  | CarryingValue |        
|Investment securities available for sale:      |  |                   |         |  |                      |   |       |                       |  |   |                     |  |  |               |         |  |  |   |         | 
|U.S. Government agencies securities            |  | $                 | 53,141  |  |                      | $ | 746   |                       |  | $ | 369                 |  |  | $             | 53,518  |  |  | $ | 53,518  | 
|State and municipal bonds                      |  |                   | 3,696   |  |                      |   | 165   |                       |  |   | 2                   |  |  |               | 3,859   |  |  |   | 3,859   | 
|Corporate Securities                           |  |                   | 962     |  |                      |   |      |                       |  |   | 22                  |  |  |               | 940     |  |  |   | 940     | 
|Mortgage-backed securities                     |  |                   | 48,265  |  |                      |   | 355   |                       |  |   | 397                 |  |  |               | 48,223  |  |  |   | 48,223  | 
|                                               |  |                   |         |  |                      |   |       |                       |  |   |                     |  |  |               |         |  |  |   |         | 
|                                               |  |                   |         |  |                     
|Total investment securities available for sale |  |                   | 106,064 |  |                      |   | 1,266 |                       |  |   | 790                 |  |  |               | 106,540 |  |  |   | 106,540 | 
|                                               |  |                   |         |  |                     
|Investment securities held to maturity:        |  |                   |         |  |                      |   |       |                       |  |   |                     |  |  |               |         |  |  |   |         | 
|Corporate Securities                           |  |                   | 3,833   |  |                      |   | 131   |                       |  |   | 239                 |  |  |               | 3,725   |  |  |   | 3,833   | 
|                                               |  |                   |         |  |                      |   |       |                       |  |   |                     |  |  |               |         |  |  |   |         | 
|                                               |  |                   |         |  |                     
|Total investment securities                    |  | $                 | 109,897 |  |                      | $ | 1,397 |                       |  | $ | 1,029               |  |  | $             | 110,265 |  |  | $ | 110,373 | 
|                                               |  |                   |         |  |                      |   |       |                       |  |   |                     |  |  |               |         |  |  |   |         | 



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NOTE 4. LOANS

The loan portfolio as of the dates indicated is summarized below (dollars in thousands):



|                                    |  |               |         |   |                  |   |         |  
|----------------------------------- |  | ------------- | ------- | - | ---------------- | - | ------- | -
|                                    |  | March 31,2011 |         |   | December 31,2010 |  
|Real estate loans:                  |  |               |         |   |                  |   |         |  
|1-4 family residential              |  | $             | 80,267  |   |                  | $ | 78,750  |  
|Commercial real estate              |  |               | 160,797 |   |                  |   | 161,839 |  
|Construction and development        |  |               | 33,044  |   |                  |   | 35,310  |  
|Home equity                         |  |               | 30,364  |   |                  |   | 31,465  |  
|                                    |  |               |         |   |                  |   |         |  
|Total real estate loans             |  |               | 304,472 |   |                  |   | 307,364 |  
|                                    |  |               |         |   |                  |   |         |  
|                                    |  |              
|Commercial business and other loans |  |               | 48,401  |   |                  |   | 51,581  |  
|                                    |  |               |         |   |                  |   |         |  
|                                    |  |              
|Consumer loans:                     |  |               |         |   |                  |   |         |  
|Installment                         |  |               | 3,961   |   |                  |   | 4,300   |  
|Other                               |  |               | 2,727   |   |                  |   | 2,908   |  
|                                    |  |               |         |   |                  |   |         |  
|Total consumer loans                |  |               | 6,688   |   |                  |   | 7,208   |  
|                                    |  |               |         |   |                  |   |         |  
|Gross loans receivable              |  |               | 359,561 |   |                  |   | 366,153 |  
|Allowance for loan losses           |  |               | (8,314  | ) |                  |   | (6,863  | )
|                                    |  |               |         |   |                  |   |         |  
|Loans, net                          |  | $             | 351,247 |   |                  | $ | 359,290 |  
|                                    |  |               |         |   |                  |   |         |  

The changes in the allowance for loan losses for the three-month periods indicated are as follows (dollars in thousands):



|                                           |  |                              |       |   |      |   |        |  
|------------------------------------------ |  | ---------------------------- | ----- | - | ---- | - | ------ | -
|                                           |  | Three Months Ended March 31, |      
|                                           |  | 2011                         |       |   | 2010 |  
|Beginning balance                          |  | $                            | 6,863 |   |      | $ | 8,167  |  
|Provision for loan losses                  |  |                              | 2,345 |   |      |   | 916    |  
|Loans charged-off                          |  |                              | (953  | ) |      |   | (2,052 | )
|Recoveries of loans previously charged-off |  |                              | 59    |   |      |   | 19     |  
|                                           |  |                              |       |   |      |   |        |  
|Net chargeoffs                             |  |                              | (894  | ) |      |   | (2,033 | )
|                                           |  |                              |       |   |      |   |        |  
|Ending balance                             |  | $                            | 8,314 |   |      | $ | 7,050  |  
|                                           |  |                              |       |   |      |   |        |  



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Impaired loans, segregated by class of loans, are summarized as follows as of the dates indicated (dollars
in thousands):



|                              |  |                    |        |  |                        |   |        |                  |  |   |                           |  |  |                          |        |  |                    |   |     |                        |  |   |                  |  |  |                           |        |  |                          |   |       |  |  |   |        |  |  |   |       | 
|----------------------------- |  | ------------------ | ------ |  | ---------------------- | - | ------ | ---------------- |  | - | ------------------------- |  |  | ------------------------ | ------ |  | ------------------ | - | --- | ---------------------- |  | - | ---------------- |  |  | ------------------------- | ------ |  | ------------------------ | - | ----- |  |  | - | ------ |  |  | - | ----- | 
|                              |  | March 31, 2011     |        |  | December 31, 2010      |  
|                              |  | RecordedInvestment |        |  | UnpaidPrincipalBalance |   |        | RelatedAllowance |  |   | AverageRecordedInvestment |  |  | InterestIncomeRecognized |        |  | RecordedInvestment |   |     | UnpaidPrincipalBalance |  |   | RelatedAllowance |  |  | AverageRecordedInvestment |        |  | InterestIncomeRecognized |  
|With no related allowance:    |  |                    |        |  |                        |   |        |                  |  |   |                           |  |  |                          |        |  |                    |   |     |                        |  |   |                  |  |  |                           |        |  |                          |   |       |  |  |   |        |  |  |   |       | 
|Commercial - Non Real Estate  |  | $                  | 259    |  |                        | $ | 262    |                  |  | $ |                          |  |  | $                        | 262    |  |                    | $ | 4   |                        |  | $ | 1,888            |  |  | $                         | 2,012  |  |                          | $ |      |  |  | $ | 2,083  |  |  | $ | 127   | 
|Commercial Real Estate        |  |                    |        |  |                        |   |        |                  |  |   |                           |  |  |                          |        |  |                    |   |     |                        |  |   |                  |  |  |                           |        |  |                          |   |       |  |  |   |        |  |  |   |       | 
|Owner occupied                |  |                    | 7,177  |  |                        |   | 8,131  |                  |  |   |                          |  |  |                          | 8,134  |  |                    |   | 89  |                        |  |   | 6,805            |  |  |                           | 7,755  |  |                          |   |      |  |  |   | 7,778  |  |  |   | 412   | 
|Income producing              |  |                    | 2,426  |  |                        |   | 2,427  |                  |  |   |                          |  |  |                          | 2,427  |  |                    |   | 34  |                        |  |   | 1,694            |  |  |                           | 1,694  |  |                          |   |      |  |  |   | 1,740  |  |  |   | 63    | 
|Multifamily                   |  |                    | 1,375  |  |                        |   | 1,375  |                  |  |   |                          |  |  |                          | 1,375  |  |                    |   | 19  |                        |  |   |                 |  |  |                           |       |  |                          |   |      |  |  |   |       |  |  |   |      | 
|Construction & Development    |  |                    |        |  |                        |   |        |                  |  |   |                           |  |  |                          |        |  |                    |   |     |                        |  |   |                  |  |  |                           |        |  |                          |   |       |  |  |   |        |  |  |   |       | 
|1 - 4 Family                  |  |                    | 342    |  |                        |   | 345    |                  |  |   |                          |  |  |                          | 345    |  |                    |   | 4   |                        |  |   | 98               |  |  |                           | 100    |  |                          |   |      |  |  |   | 99     |  |  |   | 8     | 
|Other                         |  |                    | 770    |  |                        |   | 801    |                  |  |   |                          |  |  |                          | 802    |  |                    |   | 14  |                        |  |   | 1,141            |  |  |                           | 1,192  |  |                          |   |      |  |  |   | 1,247  |  |  |   | 56    | 
|Farmland                      |  |                    |       |  |                        |   |       |                  |  |   |                          |  |  |                          |       |  |                    |   |    |                        |  |   |                 |  |  |                           |       |  |                          |   |      |  |  |   |       |  |  |   |      | 
|Residential                   |  |                    |        |  |                        |   |        |                  |  |   |                           |  |  |                          |        |  |                    |   |     |                        |  |   |                  |  |  |                           |        |  |                          |   |       |  |  |   |        |  |  |   |       | 
|Equity Lines                  |  |                    | 57     |  |                        |   | 57     |                  |  |   |                          |  |  |                          | 57     |  |                    |   |    |                        |  |   | 37               |  |  |                           | 80     |  |                          |   |      |  |  |   | 80     |  |  |   | 6     | 
|1 - 4 Family                  |  |                    | 3,004  |  |                        |   | 3,148  |                  |  |   |                          |  |  |                          | 3,150  |  |                    |   | 48  |                        |  |   | 2,634            |  |  |                           | 2,686  |  |                          |   |      |  |  |   | 2,697  |  |  |   | 156   | 
|Junior Liens                  |  |                    |       |  |                        |   |       |                  |  |   |                          |  |  |                          |       |  |                    |   |    |                        |  |   | 18               |  |  |                           | 20     |  |                          |   |      |  |  |   | 20     |  |  |   | 2     | 
|Consumer - Non Real Estate    |  |                    |        |  |                        |   |        |                  |  |   |                           |  |  |                          |        |  |                    |   |     |                        |  |   |                  |  |  |                           |        |  |                          |   |       |  |  |   |        |  |  |   |       | 
|Credit Cards                  |  |                    |       |  |                        |   |       |                  |  |   |                          |  |  |                          |       |  |                    |   |    |                        |  |   |                 |  |  |                           |       |  |                          |   |      |  |  |   |       |  |  |   |      | 
|Other                         |  |                    | 1      |  |                        |   | 1      |                  |  |   |                          |  |  |                          | 1      |  |                    |   |    |                        |  |   | 101              |  |  |                           | 156    |  |                          |   |      |  |  |   | 157    |  |  |   | 11    | 
|                              |  |                    |        |  |                        |   |        |                  |  |   |                           |  |  |                          |        |  |                    |   |     |                        |  |   |                  |  |  |                           |        |  |                          |   |       |  |  |   |        |  |  |   |       | 
|Total loans with no allowance |  | $                  | 15,411 |  |                        | $ | 16,547 |                  |  | $ |                          |  |  | $                        | 16,553 |  |                    | $ | 212 |                        |  | $ | 14,416           |  |  | $                         | 15,695 |  |                          | $ |      |  |  | $ | 15,901 |  |  | $ | 841   | 
|                              |  |                    |        |  |                        |   |        |                  |  |   |                           |  |  |                          |        |  |                    |   |     |                        |  |   |                  |  |  |                           |        |  |                          |   |       |  |  |   |        |  |  |   |       | 
|                              |  |                    |        |  |                        |   |        |                  |  |  
|With an allowance recorded:   |  |                    |        |  |                        |   |        |                  |  |   |                           |  |  |                          |        |  |                    |   |     |                        |  |   |                  |  |  |                           |        |  |                          |   |       |  |  |   |        |  |  |   |       | 
|Commercial - Non Real Estate  |  | $                  | 2,995  |  |                        | $ | 3,576  |                  |  | $ | 1,428                     |  |  | $                        | 3,581  |  |                    | $ | 40  |                        |  | $ | 2,633            |  |  | $                         | 3,103  |  |                          | $ | 513   |  |  | $ | 3,138  |  |  | $ | 149   | 
|Commercial Real Estate        |  |                    |        |  |                        |   |        |                  |  |   |                           |  |  |                          |        |  |                    |   |     |                        |  |   |                  |  |  |                           |        |  |                          |   |       |  |  |   |        |  |  |   |       | 
|Owner occupied                |  |                    | 10,333 |  |                        |   | 10,717 |                  |  |   | 754                       |  |  |                          | 11,160 |  |                    |   | 101 |                        |  |   | 10,430           |  |  |                           | 10,434 |  |                          |   | 951   |  |  |   | 10,465 |  |  |   | 430   | 
|Income producing              |  |                    | 4,396  |  |                        |   | 4,396  |                  |  |   | 113                       |  |  |                          | 4,406  |  |                    |   | 48  |                        |  |   | 2,899            |  |  |                           | 2,899  |  |                          |   | 72    |  |  |   | 2,924  |  |  |   | 123   | 
|Multifamily                   |  |                    |       |  |                        |   |       |                  |  |   |                          |  |  |                          |       |  |                    |   |    |                        |  |   |                 |  |  |                           |       |  |                          |   |      |  |  |   |       |  |  |   |      | 
|Construction & Development    |  |                    |        |  |                        |   |        |                  |  |   |                           |  |  |                          |        |  |                    |   |     |                        |  |   |                  |  |  |                           |        |  |                          |   |       |  |  |   |        |  |  |   |       | 
|1 - 4 Family                  |  |                    |       |  |                        |   |       |                  |  |   |                          |  |  |                          |       |  |                    |   |    |                        |  |   | 1,138            |  |  |                           | 1,138  |  |                          |   | 44    |  |  |   | 1,138  |  |  |   | 69    | 
|Other                         |  |                    | 397    |  |                        |   | 398    |                  |  |   | 22                        |  |  |                          | 399    |  |                    |   | 4   |                        |  |   | 148              |  |  |                           | 148    |  |                          |   |      |  |  |   | 148    |  |  |   | 8     | 
|Farmland                      |  |                    |       |  |                        |   |       |                  |  |   |                          |  |  |                          |       |  |                    |   |    |                        |  |   |                 |  |  |                           |       |  |                          |   |      |  |  |   |       |  |  |   |      | 
|Residential                   |  |                    |        |  |                        |   |        |                  |  |   |                           |  |  |                          |        |  |                    |   |     |                        |  |   |                  |  |  |                           |        |  |                          |   |       |  |  |   |        |  |  |   |       | 
|Equity Lines                  |  |                    | 271    |  |                        |   | 271    |                  |  |   | 271                       |  |  |                          | 271    |  |                    |   | 2   |                        |  |   | 497              |  |  |                           | 497    |  |                          |   | 447   |  |  |   | 503    |  |  |   | 21    | 
|1 - 4 Family                  |  |                    | 3,586  |  |                        |   | 3,631  |                  |  |   | 656                       |  |  |                          | 3,635  |  |                    |   | 36  |                        |  |   | 3,117            |  |  |                           | 3,134  |  |                          |   | 516   |  |  |   | 3,141  |  |  |   | 142   | 
|Junior Liens                  |  |                    | 59     |  |                        |   | 60     |                  |  |   |                          |  |  |                          | 60     |  |                    |   |    |                        |  |   | 59               |  |  |                           | 60     |  |                          |   | 25    |  |  |   | 60     |  |  |   | 1     | 
|Consumer - Non Real Estate    |  |                    |        |  |                        |   |        |                  |  |   |                           |  |  |                          |        |  |                    |   |     |                        |  |   |                  |  |  |                           |        |  |                          |   |       |  |  |   |        |  |  |   |       | 
|Credit Cards                  |  |                    |       |  |                        |   |       |                  |  |   |                          |  |  |                          |       |  |                    |   |    |                        |  |   |                 |  |  |                           |       |  |                          |   |      |  |  |   |       |  |  |   |      | 
|Other                         |  |                    |       |  |                        |   |       |                  |  |   |                          |  |  |                          |       |  |                    |   |    |                        |  |   |                 |  |  |                           |       |  |                          |   |      |  |  |   |       |  |  |   |      | 
|                              |  |                    |        |  |                        |   |        |                  |  |   |                           |  |  |                          |        |  |                    |   |     |                        |  |   |                  |  |  |                           |        |  |                          |   |       |  |  |   |        |  |  |   |       | 
|Total loans with an allowance |  | $                  | 22,037 |  |                        | $ | 23,049 |                  |  | $ | 3,244                     |  |  | $                        | 23,512 |  |                    | $ | 231 |                        |  | $ | 20,921           |  |  | $                         | 21,413 |  |                          | $ | 2,568 |  |  | $ | 21,517 |  |  | $ | 943   | 
|                              |  |                    |        |  |                        |   |        |                  |  |   |                           |  |  |                          |        |  |                    |   |     |                        |  |   |                  |  |  |                           |        |  |                          |   |       |  |  |   |        |  |  |   |       | 
|                              |  |                    |        |  |                        |   |        |                  |  |  
|Total:                        |  |                    |        |  |                        |   |        |                  |  |   |                           |  |  |                          |        |  |                    |   |     |                        |  |   |                  |  |  |                           |        |  |                          |   |       |  |  |   |        |  |  |   |       | 
|Commercial - Non Real Estate  |  | $                  | 3,254  |  |                        | $ | 3,838  |                  |  | $ | 1,428                     |  |  | $                        | 3,843  |  |                    | $ | 44  |                        |  | $ | 4,521            |  |  | $                         | 5,115  |  |                          | $ | 513   |  |  | $ | 5,221  |  |  | $ | 276   | 
|Commercial Real Estate        |  | $                  | 25,707 |  |                        | $ | 27,046 |                  |  | $ | 867                       |  |  | $                        | 27,502 |  |                    | $ | 291 |                        |  | $ | 21,828           |  |  | $                         | 22,782 |  |                          | $ | 1,023 |  |  | $ | 22,907 |  |  | $ | 1,028 | 
|Construction & Development    |  | $                  | 1,509  |  |                        | $ | 1,544  |                  |  | $ | 22                        |  |  | $                        | 1,546  |  |                    | $ | 22  |                        |  | $ | 2,525            |  |  | $                         | 2,578  |  |                          | $ | 44    |  |  | $ | 2,632  |  |  | $ | 141   | 
|Residential                   |  | $                  | 6,977  |  |                        | $ | 7,167  |                  |  | $ | 927                       |  |  | $                        | 7,173  |  |                    | $ | 86  |                        |  | $ | 6,362            |  |  | $                         | 6,477  |  |                          | $ | 988   |  |  | $ | 6,501  |  |  | $ | 328   | 
|Consumer - Non Real Estate    |  | $                  | 1      |  |                        | $ | 1      |                  |  | $ |                          |  |  | $                        | 1      |  |                    | $ |    |                        |  | $ | 101              |  |  | $                         | 156    |  |                          | $ |      |  |  | $ | 157    |  |  | $ | 11    | 
|                              |  |                    |        |  |                        |   |        |                  |  |   |                           |  |  |                          |        |  |                    |   |     |                        |  |   |                  |  |  |                           |        |  |                          |   |       |  |  |   |        |  |  |   |       | 
|Totals                        |  | $                  | 37,448 |  |                        | $ | 39,596 |                  |  | $ | 3,244                     |  |  | $                        | 40,065 |  |                    | $ | 443 |                        |  | $ | 35,337           |  |  | $                         | 37,108 |  |                          | $ | 2,568 |  |  | $ | 37,418 |  |  | $ | 1,784 | 
|                              |  |                    |        |  |                        |   |        |                  |  |   |                           |  |  |                          |        |  |                    |   |     |                        |  |   |                  |  |  |                           |        |  |                          |   |       |  |  |   |        |  |  |   |       | 

Troubled debt restructurings (TDR) are a subset of impaired loans and totaled $21.7 million at March 31, 2011 and $22.1
million at December 31, 2010.



10



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##### Table of Contents

Non-accrual loans and an age analysis of past due loans, segregated by class of loans, were as follows
(dollars in thousands):



|                             |  |                     |        |  |                     |   |       |                        |  |   |               |  |  |         |        |  |            |   |         |                                  |  |   |                  |  |  |   |   |  |  |   |        | 
|---------------------------- |  | ------------------- | ------ |  | ------------------- | - | ----- | ---------------------- |  | - | ------------- |  |  | ------- | ------ |  | ---------- | - | ------- | -------------------------------- |  | - | ---------------- |  |  | - | - |  |  | - | ------ | 
|                             |  | 30 - 59DaysPast Due |        |  | 60 - 89DaysPast Due |   |       | 90 Daysor MorePast Due |  |   | TotalPast Due |  |  | Current |        |  | TotalLoans |   |         | 90 DaysPast Dueand StillAccruing |  |   | Non-accrualLoans | 
|March 31, 2011:              |  |                     |        |  |                     |   |       |                        |  |   |               |  |  |         |        |  |            |   |         |                                  |  |   |                  |  |  |   |   |  |  |   |        | 
|Commercial - Non Real Estate |  | $                   | 491    |  |                     | $ | 489   |                        |  | $ | 2,285         |  |  | $       | 3,265  |  |            | $ | 45,136  |                                  |  | $ | 48,401           |  |  | $ |  |  |  | $ | 2,934  | 
|Commercial Real Estate       |  |                     |        |  |                     |   |       |                        |  |   |               |  |  |         |        |  |            |   |         |                                  |  |   |                  |  |  |   |   |  |  |   |        | 
|Owner occupied               |  |                     | 710    |  |                     |   | 940   |                        |  |   | 7,782         |  |  |         | 9,432  |  |            |   | 94,639  |                                  |  |   | 104,071          |  |  |   |  |  |  |   | 13,845 | 
|Income producing             |  |                     | 409    |  |                     |   | 89    |                        |  |   | 3,510         |  |  |         | 4,008  |  |            |   | 45,770  |                                  |  |   | 49,778           |  |  |   |  |  |  |   | 3,599  | 
|Multifamily                  |  |                     | 890    |  |                     |   |      |                        |  |   | 1,376         |  |  |         | 2,266  |  |            |   | 4,682   |                                  |  |   | 6,948            |  |  |   |  |  |  |   | 1,375  | 
|Construction & Development   |  |                     |        |  |                     |   |       |                        |  |   |               |  |  |         |        |  |            |   |         |                                  |  |   |                  |  |  |   |   |  |  |   |        | 
|1 - 4 Family                 |  |                     |       |  |                     |   |      |                        |  |   | 245           |  |  |         | 245    |  |            |   | 3,990   |                                  |  |   | 4,235            |  |  |   |  |  |  |   | 342    | 
|Other                        |  |                     | 587    |  |                     |   |      |                        |  |   | 142           |  |  |         | 729    |  |            |   | 27,670  |                                  |  |   | 28,399           |  |  |   |  |  |  |   | 916    | 
|Farmland                     |  |                     |       |  |                     |   |      |                        |  |   |              |  |  |         |       |  |            |   | 410     |                                  |  |   | 410              |  |  |   |  |  |  |   |       | 
|Residential                  |  |                     |        |  |                     |   |       |                        |  |   |               |  |  |         |        |  |            |   |         |                                  |  |   |                  |  |  |   |   |  |  |   |        | 
|Equity Lines                 |  |                     | 28     |  |                     |   | 60    |                        |  |   | 328           |  |  |         | 416    |  |            |   | 29,948  |                                  |  |   | 30,364           |  |  |   |  |  |  |   | 327    | 
|1 - 4 Family                 |  |                     | 2,200  |  |                     |   | 232   |                        |  |   | 3,550         |  |  |         | 5,982  |  |            |   | 72,296  |                                  |  |   | 78,278           |  |  |   |  |  |  |   | 4,461  | 
|Junior Liens                 |  |                     | 49     |  |                     |   |      |                        |  |   | 59            |  |  |         | 108    |  |            |   | 1,881   |                                  |  |   | 1,989            |  |  |   |  |  |  |   | 59     | 
|Consumer - Non Real Estate   |  |                     |        |  |                     |   |       |                        |  |   |               |  |  |         |        |  |            |   |         |                                  |  |   |                  |  |  |   |   |  |  |   |        | 
|Credit Cards                 |  |                     |       |  |                     |   |      |                        |  |   |              |  |  |         |       |  |            |   |        |                                  |  |   |                 |  |  |   |  |  |  |   |       | 
|Other                        |  |                     | 29     |  |                     |   | 1     |                        |  |   |              |  |  |         | 30     |  |            |   | 3,931   |                                  |  |   | 3,961            |  |  |   |  |  |  |   | 1      | 
|Other                        |  |                     |       |  |                     |   |      |                        |  |   |              |  |  |         |       |  |            |   | 2,727   |                                  |  |   | 2,727            |  |  |   |  |  |  |   |       | 
|                             |  |                     |        |  |                     |   |       |                        |  |   |               |  |  |         |        |  |            |   |         |                                  |  |   |                  |  |  |   |   |  |  |   |        | 
|Total                        |  | $                   | 5,393  |  |                     | $ | 1,811 |                        |  | $ | 19,277        |  |  | $       | 26,481 |  |            | $ | 333,080 |                                  |  | $ | 359,561          |  |  | $ |  |  |  | $ | 27,859 | 
|                             |  |                     |        |  |                     |   |       |                        |  |   |               |  |  |         |        |  |            |   |         |                                  |  |   |                  |  |  |   |   |  |  |   |        | 
|                             |  |                     |        |  |                     |   |       |                       
|                             |  | 30 - 59DaysPast Due |        |  | 60 - 89DaysPast Due |   |       | 90 Daysor MorePast Due |  |   | TotalPast Due |  |  | Current |        |  | TotalLoans |   |         | 90 DaysPast Dueand StillAccruing |  |   | Non-accrualLoans | 
|December 31, 2010:           |  |                     |        |  |                     |   |       |                        |  |   |               |  |  |         |        |  |            |   |         |                                  |  |   |                  |  |  |   |   |  |  |   |        | 
|Commercial - Non Real Estate |  | $                   | 2,250  |  |                     | $ | 148   |                        |  | $ | 1,380         |  |  | $       | 3,778  |  |            | $ | 47,803  |                                  |  | $ | 51,581           |  |  | $ |  |  |  | $ | 3,068  | 
|Commercial Real Estate       |  |                     |        |  |                     |   |       |                        |  |   |               |  |  |         |        |  |            |   |         |                                  |  |   |                  |  |  |   |   |  |  |   |        | 
|Owner occupied               |  |                     | 4,321  |  |                     |   |      |                        |  |   | 3,785         |  |  |         | 8,106  |  |            |   | 96,100  |                                  |  |   | 104,206          |  |  |   |  |  |  |   | 13,827 | 
|Income producing             |  |                     | 345    |  |                     |   |      |                        |  |   | 1,349         |  |  |         | 1,694  |  |            |   | 48,518  |                                  |  |   | 50,212           |  |  |   |  |  |  |   | 1,349  | 
|Multifamily                  |  |                     |       |  |                     |   |      |                        |  |   |              |  |  |         |       |  |            |   | 7,003   |                                  |  |   | 7,003            |  |  |   |  |  |  |   |       | 
|Construction & Development   |  |                     |        |  |                     |   |       |                        |  |   |               |  |  |         |        |  |            |   |         |                                  |  |   |                  |  |  |   |   |  |  |   |        | 
|1 - 4 Family                 |  |                     | 1,299  |  |                     |   | 1,233 |                        |  |   | 99            |  |  |         | 2,631  |  |            |   | 2,968   |                                  |  |   | 5,599            |  |  |   |  |  |  |   | 1,236  | 
|Other                        |  |                     | 286    |  |                     |   |      |                        |  |   | 251           |  |  |         | 537    |  |            |   | 29,174  |                                  |  |   | 29,711           |  |  |   |  |  |  |   | 1,038  | 
|Farmland                     |  |                     |       |  |                     |   |      |                        |  |   |              |  |  |         |       |  |            |   | 418     |                                  |  |   | 418              |  |  |   |  |  |  |   |       | 
|Residential                  |  |                     |        |  |                     |   |       |                        |  |   |               |  |  |         |        |  |            |   |         |                                  |  |   |                  |  |  |   |   |  |  |   |        | 
|Equity Lines                 |  |                     | 503    |  |                     |   | 87    |                        |  |   |              |  |  |         | 590    |  |            |   | 30,875  |                                  |  |   | 31,465           |  |  |   |  |  |  |   | 432    | 
|1 - 4 Family                 |  |                     | 2,026  |  |                     |   | 1,697 |                        |  |   | 1,391         |  |  |         | 5,114  |  |            |   | 71,693  |                                  |  |   | 76,807           |  |  |   |  |  |  |   | 3,561  | 
|Junior Liens                 |  |                     |       |  |                     |   |      |                        |  |   |              |  |  |         |       |  |            |   | 1,943   |                                  |  |   | 1,943            |  |  |   |  |  |  |   | 78     | 
|Consumer - Non Real Estate   |  |                     |        |  |                     |   |       |                        |  |   |               |  |  |         |        |  |            |   |         |                                  |  |   |                  |  |  |   |   |  |  |   |        | 
|Credit Cards                 |  |                     |       |  |                     |   |      |                        |  |   |              |  |  |         |       |  |            |   |        |                                  |  |   |                 |  |  |   |  |  |  |   |       | 
|Other                        |  |                     | 74     |  |                     |   | 1     |                        |  |   | 96            |  |  |         | 171    |  |            |   | 4,129   |                                  |  |   | 4,300            |  |  |   |  |  |  |   | 101    | 
|Other                        |  |                     |       |  |                     |   |      |                        |  |   |              |  |  |         |       |  |            |   | 2,908   |                                  |  |   | 2,908            |  |  |   |  |  |  |   |       | 
|                             |  |                     |        |  |                     |   |       |                        |  |   |               |  |  |         |        |  |            |   |         |                                  |  |   |                  |  |  |   |   |  |  |   |        | 
|Total                        |  | $                   | 11,104 |  |                     | $ | 3,166 |                        |  | $ | 8,351         |  |  | $       | 22,621 |  |            | $ | 343,532 |                                  |  | $ | 366,153          |  |  | $ |  |  |  | $ | 24,690 | 
|                             |  |                     |        |  |                     |   |       |                        |  |   |               |  |  |         |        |  |            |   |         |                                  |  |   |                  |  |  |   |   |  |  |   |        | 

The Bank categorizes loans and leases into risk categories based on relevant information about the ability of borrowers to
service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. This categorization is made on all commercial, commercial real
estate, and construction and development loans. The Bank uses the following definitions for risk ratings:

Special Mention - Loans and leases
classified as special mention, while still adequately protected by the borrowers capital adequacy and payment capability, exhibit distinct weakening trends and/or elevated levels of exposure to external conditions. If left unchecked or
uncorrected, these potential weaknesses may result in deteriorated prospects of repayment. These exposures require managements close attention so as to avoid becoming undue or unwarranted credit exposures.



11



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##### Table of Contents

Substandard - Loans and leases classified as substandard are inadequately protected by the borrowers
current financial condition and payment capability or of the collateral pledged, if any. Loans and leases so classified have a well-defined weakness or weaknesses that jeopardize the orderly repayment of debt. They are characterized by the distinct
possibility that the Bank will sustain some loss if the deficiencies are not corrected.

Doubtful - Loans and leases classified as doubtful
have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or orderly repayment in full, on the basis of current existing facts, conditions and values, highly questionable
and improbable. Possibility of loss is extremely high, but because of certain important and reasonably specific factors that may work to the advantage and strengthening of the exposure, its classification as an estimated loss is deferred until its
more exact status may be determined. The Companys practice is to charge-off the portion of the loan amount determined to be doubtful in the quarter that the determination is made if the repayment of the loan is collateral dependent.

Loss - Loans and leases classified as loss are considered to be non-collectible and of such little value that their continuance as bankable
assets is not warranted. This does not mean the loan has absolutely no recovery value, but rather it is neither practical nor desirable to defer writing off the loan, even though partial recovery may be obtained in the future. Losses are taken in
the period in which they surface as uncollectible.

Loans not meeting the criteria above that are analyzed individually as part of the above
described process are considered to be pass-rated loans. As of March 31, 2011 and December 31, 2010, and based on the most recent analysis performed, the risk category of loans and leases is as follows (dollars in thousands):



|                             |  |                   |         |  |                |   |        |             |  |   |          |  |  |      |     |  |  |   |   | 
|---------------------------- |  | ----------------- | ------- |  | -------------- | - | ------ | ----------- |  | - | -------- |  |  | ---- | --- |  |  | - | - | 
|                             |  | March 31, 2011    |        
|                             |  | Pass              |         |  | SpecialMention |   |        | Substandard |  |   | Doubtful |  |  | Loss |    
|Internal Risk Rating Grades  |  |                   |         |  |                |   |        |             |  |   |          |  |  |      |     |  |  |   |   | 
|Commercial - Non Real Estate |  | $                 | 36,216  |  |                | $ | 3,425  |             |  | $ | 8,383    |  |  | $    | 377 |  |  | $ |  | 
|Commercial Real Estate       |  |                   |         |  |                |   |        |             |  |   |          |  |  |      |     |  |  |   |   | 
|Owner occupied               |  |                   | 63,903  |  |                |   | 12,497 |             |  |   | 27,671   |  |  |      |    |  |  |   |  | 
|Income producing             |  |                   | 37,058  |  |                |   | 5,898  |             |  |   | 6,822    |  |  |      |    |  |  |   |  | 
|Multifamily                  |  |                   | 4,516   |  |                |   | 225    |             |  |   | 2,207    |  |  |      |    |  |  |   |  | 
|Construction & Development   |  |                   |         |  |                |   |        |             |  |   |          |  |  |      |     |  |  |   |   | 
|1 - 4 Family                 |  |                   | 3,104   |  |                |   | 615    |             |  |   | 516      |  |  |      |    |  |  |   |  | 
|Other                        |  |                   | 24,021  |  |                |   | 2,345  |             |  |   | 2,033    |  |  |      |    |  |  |   |  | 
|Farmland                     |  |                   | 410     |  |                |   |       |             |  |   |         |  |  |      |    |  |  |   |  | 
|                             |  |                   |         |  |                |   |        |             |  |   |          |  |  |      |     |  |  |   |   | 
|Totals                       |  | $                 | 169,228 |  |                | $ | 25,005 |             |  | $ | 47,632   |  |  | $    | 377 |  |  | $ |  | 
|                             |  |                   |         |  |                |   |        |             |  |   |          |  |  |      |     |  |  |   |   | 
|                             |  |                   |         |  |               
|Total:                       |  |                   |         |  |                |   |        |             |  |   |          |  |  |      |     |  |  |   |   | 
|Commercial - Non Real Estate |  | $                 | 36,216  |  |                | $ | 3,425  |             |  | $ | 8,383    |  |  | $    | 377 |  |  | $ |  | 
|Commercial Real Estate       |  | $                 | 105,477 |  |                | $ | 18,620 |             |  | $ | 36,700   |  |  | $    |    |  |  | $ |  | 
|Construction & Development   |  | $                 | 27,535  |  |                | $ | 2,960  |             |  | $ | 2,549    |  |  | $    |    |  |  | $ |  | 
|                             |  |                   |         |  |                |   |        |             |  |   |          |  |  |      |     |  |  |   |   | 
|Totals                       |  | $                 | 169,228 |  |                | $ | 25,005 |             |  | $ | 47,632   |  |  | $    | 377 |  |  | $ |  | 
|                             |  |                   |         |  |                |   |        |             |  |   |          |  |  |      |     |  |  |   |   | 
|                             | 
|                             |  | December 31, 2010 |        
|                             |  | Pass              |         |  | SpecialMention |   |        | Substandard |  |   | Doubtful |  |  | Loss |    
|Internal Risk Rating Grades  |  |                   |         |  |                |   |        |             |  |   |          |  |  |      |     |  |  |   |   | 
|Commercial - Non Real Estate |  | $                 | 36,269  |  |                | $ | 9,381  |             |  | $ | 5,625    |  |  | $    | 306 |  |  | $ |  | 
|Commercial Real Estate       |  |                   |         |  |                |   |        |             |  |   |          |  |  |      |     |  |  |   |   | 
|Owner occupied               |  |                   | 65,512  |  |                |   | 17,632 |             |  |   | 21,062   |  |  |      |    |  |  |   |  | 
|Income producing             |  |                   | 36,450  |  |                |   | 9,169  |             |  |   | 4,593    |  |  |      |    |  |  |   |  | 
|Multifamily                  |  |                   | 4,646   |  |                |   | 1,524  |             |  |   | 833      |  |  |      |    |  |  |   |  | 
|Construction & Development   |  |                   |         |  |                |   |        |             |  |   |          |  |  |      |     |  |  |   |   | 
|1 - 4 Family                 |  |                   | 2,996   |  |                |   | 1,125  |             |  |   | 1,478    |  |  |      |    |  |  |   |  | 
|Other                        |  |                   | 25,169  |  |                |   | 2,939  |             |  |   | 1,402    |  |  |      | 201 |  |  |   |  | 
|Farmland                     |  |                   | 418     |  |                |   |       |             |  |   |         |  |  |      |    |  |  |   |  | 
|                             |  |                   |         |  |                |   |        |             |  |   |          |  |  |      |     |  |  |   |   | 
|Totals                       |  | $                 | 171,460 |  |                | $ | 41,770 |             |  | $ | 34,993   |  |  | $    | 507 |  |  | $ |  | 
|                             |  |                   |         |  |                |   |        |             |  |   |          |  |  |      |     |  |  |   |   | 
|                             |  |                   |         |  |               
|Total:                       |  |                   |         |  |                |   |        |             |  |   |          |  |  |      |     |  |  |   |   | 
|Commercial - Non Real Estate |  | $                 | 36,269  |  |                | $ | 9,381  |             |  | $ | 5,625    |  |  | $    | 306 |  |  | $ |  | 
|Commercial Real Estate       |  | $                 | 106,608 |  |                | $ | 28,325 |             |  | $ | 26,488   |  |  | $    |    |  |  | $ |  | 
|Construction & Development   |  | $                 | 28,583  |  |                | $ | 4,064  |             |  | $ | 2,880    |  |  | $    | 201 |  |  | $ |  | 
|                             |  |                   |         |  |                |   |        |             |  |   |          |  |  |      |     |  |  |   |   | 
|Totals                       |  | $                 | 171,460 |  |                | $ | 41,770 |             |  | $ | 34,993   |  |  | $    | 507 |  |  | $ |  | 
|                             |  |                   |         |  |                |   |        |             |  |   |          |  |  |      |     |  |  |   |   | 



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All consumer-related loans, including residential real estate and non-real estate, are evaluated and
monitored based upon payment activity. Once a consumer-related loan becomes past due on a recurring basis, the Company will pull that loan out of the homogenized pool and evaluate it individually for impairment. At this time, the
consumer-related loan may be placed on the Companys internal watch list and risk rated either special mention or substandard, depending upon the individual circumstances. Consumer-related loans at March 31, 2011 and December 31,
2010, segregated by class of loans, were as follows (dollars in thousands):



|                               |  |                |         |  |                   |   |       |            |  |   |                |  |  |   |       | 
|------------------------------ |  | -------------- | ------- |  | ----------------- | - | ----- | ---------- |  | - | -------------- |  |  | - | ----- | 
|                               |  | March 31, 2011 |         |  | December 31, 2010 |  
|                               |  | Performing     |         |  | Non-Performing    |   |       | Performing |  |   | Non-Performing | 
|Risk Based on Payment Activity |  |                |         |  |                   |   |       |            |  |   |                |  |  |   |       | 
|Residential                    |  |                |         |  |                   |   |       |            |  |   |                |  |  |   |       | 
|Equity Lines                   |  | $              | 30,037  |  |                   | $ | 327   |            |  | $ | 31,069         |  |  | $ | 396   | 
|1 - 4 Family                   |  |                | 73,850  |  |                   |   | 4,428 |            |  |   | 73,682         |  |  |   | 3,125 | 
|Junior Liens                   |  |                | 1,930   |  |                   |   | 59    |            |  |   | 1,866          |  |  |   | 77    | 
|Consumer - Non Real Estate     |  |                |         |  |                   |   |       |            |  |   |                |  |  |   |       | 
|Credit Cards                   |  |                |        |  |                   |   |      |            |  |   |               |  |  |   |      | 
|Other                          |  |                | 3,961   |  |                   |   |      |            |  |   | 4,294          |  |  |   | 6     | 
|                               |  |                |         |  |                   |   |       |            |  |   |                |  |  |   |       | 
|Totals                         |  | $              | 109,778 |  |                   | $ | 4,814 |            |  | $ | 110,911        |  |  | $ | 3,604 | 
|                               |  |                |         |  |                   |   |       |            |  |   |                |  |  |   |       | 
|                               |  |                |         | 
|Total:                         |  |                |         |  |                   |   |       |            |  |   |                |  |  |   |       | 
|Residential                    |  | $              | 105,817 |  |                   | $ | 4,814 |            |  | $ | 106,617        |  |  | $ | 3,598 | 
|Consumer - Non Real Estate     |  | $              | 3,961   |  |                   | $ |      |            |  | $ | 4,294          |  |  | $ | 6     | 
|                               |  |                |         |  |                   |   |       |            |  |   |                |  |  |   |       | 
|Totals                         |  | $              | 109,778 |  |                   | $ | 4,814 |            |  | $ | 110,911        |  |  | $ | 3,604 | 
|                               |  |                |         |  |                   |   |       |            |  |   |                |  |  |   |       | 

NOTE 5. COMMITMENTS AND CONTINGENCIES

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments
to extend credit, lines of credit and standby letters of credit. These instruments involve elements of credit risk in excess of amounts recognized in the accompanying financial statements.

The Companys risk of loss related to unfunded loan commitments and lines of credit or standby letters of credit is represented by the contractual amount of these instruments. The Company uses the
same credit policies in making commitments under such instruments as it does for on-balance sheet instruments. The amount of collateral obtained, if any, is based on managements credit evaluation of the borrower. Since many of the commitments
are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The following table presents a summary of outstanding financial instruments whose contract amounts represent credit
risk as of March 31, 2011 (dollars in thousands):



|                                    |  |   |        | 
|----------------------------------- |  | - | ------ | 
|Unfunded loan commitments:          |  | $ | 33,792 | 
|Financial standby letters of credit |  |   | 2,477  | 
|                                    |  |   |        | 
|Total unused commitments            |  | $ | 36,269 | 
|                                    |  |   |        | 

Following the termination of his employment on May 12, 2010, the Companys former Chief Financial Officer, who
also served as the Banks Executive Vice Chairman and Chief Operating Officer, and as a director of the Company and the Bank, instituted a lawsuit against the Bank and several individuals on May 14, 2010, as described under Part II,
Item 1 of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2010. Based on the advice of outside counsel, the Company believes that the claims against the Bank will not result in a material loss and the Bank is vigorously
defending the lawsuit.



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NOTE 6. OTHER COMPREHENSIVE INCOME (LOSS)

Accounting principles generally accepted in the United States of America require that recognized revenue, expenses, gains, and losses be included in net income. Certain changes in assets and liabilities,
such as unrealized gains and losses on available-for-sale securities, are reported as a separate component in the equity section of the balance sheet. Such items, along with net income, are considered components of comprehensive income (loss).
Accounting principles do not require per share amounts of comprehensive income (loss) to be disclosed. The components of other comprehensive income (loss) and related income tax effects are as follows (dollars in thousands):



|                                                                       |  |                             |      |   |      |   |      |  
|---------------------------------------------------------------------- |  | --------------------------- | ---- | - | ---- | - | ---- | -
|                                                                       |  | Three Months EndedMarch 31, |     
|                                                                       |  | 2011                        |      |   | 2010 |  
|Unrealized holding gains (losses) on securities available-for-sale     |  | $                           | (219 | ) |      | $ | 594  |  
|Reclassification adjustment for gains realized in net loss             |  |                             |     |   |      |   | (96  | )
|                                                                       |  |                             |      |   |      |   |      |  
|Net unrealized holding gains (losses) on securities available-for-sale |  |                             | (219 | ) |      |   | 498  |  
|Income tax effect                                                      |  |                             | 85   |   |      |   | (192 | )
|                                                                       |  |                             |      |   |      |   |      |  
|Other comprehensive income (loss), net of income tax effect            |  | $                           | (134 | ) |      | $ | 306  |  
|                                                                       |  |                             |      |   |      |   |      |  

NOTE 7. RECENT ACCOUNTING PRONOUNCEMENTS

In June 2009, the FASB issued SFAS No. 166,Accounting for Transfers of Financial Assets  an amendment of FASB Statement No. 140, which was subsequently codified by the FASB under
ASC Topic 860 (Topic 860). Topic 860 seeks to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets;
the effects of a transfer on its financial position, financial performance, and cash flows; and a transferors continuing involvement, if any, in transferred financial assets. Specifically, Topic 860 eliminates the concept of a qualifying
special-purpose entity, creates more stringent conditions for reporting a transfer of a portion of a financial asset as a sale, clarifies other sale-accounting criteria, and changes the initial measurement of a transferors interest in
transferred financial assets. SFAS No. 166 as codified under ASC Topic 860 is effective for financial asset transfers occurring after the beginning of fiscal years beginning after November 15, 2009. The Company adopted this statement with
no material impact on its consolidated financial statements.

In June 2009, the FASB issued SFAS No. 167,Amendments to FASB
Interpretation No. 46(R), which was subsequently codified by the FASB as ASC Topic 810 (Topic 810-10). Topic 810 amends FASB Interpretation No. 46(R),Variable Interest Entities, for determining whether an entity is
a variable interest entity (VIE) and requires an enterprise to perform an analysis to determine whether the enterprises variable interest or interests give it a controlling financial interest in a VIE. Under Topic 810, an
enterprise has a controlling financial interest when it has (a) the power to direct the activities of a VIE that most significantly impact the entitys economic performance, and (b) the obligation to absorb losses of the entity or the
right to receive benefits from the entity that could potentially be significant to the VIE. Topic 810 also requires an enterprise to assess whether it has an implicit financial responsibility to ensure that a VIE operates as designed when
determining whether it has power to direct the activities of the VIE that most significantly impact the entitys economic performance. Topic 810 also requires ongoing assessments of whether an enterprise is the primary beneficiary of a VIE,
requires enhanced disclosures and eliminates the scope exclusion for qualifying special-purpose entities. SFAS No. 167 as codified under ASC Topic 810 is effective as of the beginning of fiscal years beginning after November 15, 2009 and
is applied using a cumulative effect adjustment to retained earnings for any carrying amount adjustments. The Company adopted this statement with no material impact on its consolidated financial statements.

In January 2010, the FASB issued Accounting Standards Update No. 2010-06,Fair Value Measurements Disclosures, which amends Subtopic 820-10
of the FASB Accounting Standards Codification to require new disclosures for fair value measurements and provides clarification for existing disclosures requirements. More specifically, this update will require (a) an entity to disclose
separately the amounts of significant transfers in and out of Levels 1 and 2 fair value measurements and to describe the reasons for the transfers; and (b) information about purchases, sales, issuances and settlements to be presented separately
(i.e. present the activity on a gross basis rather than net) in the reconciliation for fair value measurements using



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significant unobservable inputs (Level 3 inputs). This update clarifies existing disclosure requirements for the level of disaggregation used for classes of assets and liabilities measured at
fair value and requires disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements using Level 2 and Level 3 inputs. The new disclosures and clarifications of existing
disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward activity in Level 3 fair value measurements.
Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The Company adopted this statement with no material impact on its consolidated financial statements.

In March 2010, the FASB issued new guidance impacting Receivables. The new guidance clarifies that a modification to a loan that is part of a
pool of loans that were acquired with deteriorated credit quality should not result in the removal of the loan from the pool. This guidance is effective for any modifications of loans accounted for within a pool in the first interim or annual
reporting period ending after July 15, 2010. The adoption of this guidance was not material to the Companys consolidated financial statements.

In July 2010, the FASB issued new guidance impacting Receivables. The new guidance requires additional disclosures that will allow users to understand the nature of credit risk inherent in a
companys loan portfolios, how that risk is analyzed and assessed in arriving at the allowance for loan and lease losses, and changes and reasons for those changes in the allowance for loan and lease losses. The new disclosures that relate to
information as of the end of the reporting period are required as of December 31, 2010. The disclosures related to activity that occurs during a reporting period are effective for reporting periods beginning on or after December 15, 2010,
except for the disclosure requirements relating to troubled debt restructurings, which have been indefinitely delayed pending the outcome of the FASBs deliberations related to the definition of a troubled debt restructuring.

From time to time the FASB issues Proposed Accounting Standards Updates. Such proposed updates are subject to comment from the public, to revisions by
the FASB and to final issuance by the FASB as Accounting Standards Updates. Management considers the effect of the proposed updates on the consolidated financial statements of the Company and monitors the status of changes to and proposed effective
dates of proposed updates.

NOTE 8. FAIR VALUE

Accounting principles generally accepted in the United States of America require that companies measure and record certain assets and liabilities at fair value and record any adjustments to the fair value
of those assets. Securities are recorded at fair value on a recurring basis while other assets, such as impaired loans, are recorded at fair value on a non-recurring basis.

The Company uses three levels of measurement to group those assets measured at fair value. These groupings are made based on the markets the assets are traded in and the reliability of the assumptions
used to determine fair value. The groupings include:



| |  |  | Level 1 pricing for an asset or liability is derived from the most likely actively traded markets and considered very reliable. Quoted prices on
actively traded equities, for example, fall into this category.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Level 2 pricing is derived from observable data including market spreads, current and projected rates, prepayment data and credit quality. Our bond
price adjustments fall into this category as well as impaired loans and other real estate owned that use appraisals or brokered price opinions to determine fair value.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Level 3 pricing is derived without observable data. In such cases, mark-to-market strategies are typically employed. These types of instruments often
have no active market, possess unique characteristics and are thinly traded.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The Companys investment securities are
measured on a recurring basis through a model used by our bond agent. All of our bond price adjustments meet Level 2 criteria. Prices are derived from a model which uses actively quoted rates, prepayment models and other underlying credit and
collateral data.



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The following table summarizes the Companys assets measured at fair value at the dates indicated
(dollars in thousands):



|                                       |  |                      |         |  |         |   |   |         |  |   |         |  |  |   |   | 
|-------------------------------------- |  | -------------------- | ------- |  | ------- | - | - | ------- |  | - | ------- |  |  | - | - | 
|                                       |  | At March 31, 2011    |        
|                                       |  | Total                |         |  | Level 1 |   |   | Level 2 |  |   | Level 3 | 
|                                       |  |                      |         | 
|Assets valued on a recurring basis     |  |                      |         |  |         |   |   |         |  |   |         |  |  |   |   | 
|Investment securities:                 |  |                      |         |  |         |   |   |         |  |   |         |  |  |   |   | 
|U.S. government and agency             |  | $                    | 57,385  |  |         | $ |  |         |  | $ | 57,385  |  |  | $ |  | 
|State and municipals                   |  |                      | 3,862   |  |         |   |  |         |  |   | 3,862   |  |  |   |  | 
|Corporate                              |  |                      | 987     |  |         |   |  |         |  |   | 987     |  |  |   |  | 
|Mortgage-backed                        |  |                      | 52,301  |  |         |   |  |         |  |   | 52,301  |  |  |   |  | 
|Assets valued on a non-recurring basis |  |                      |         |  |         |   |   |         |  |   |         |  |  |   |   | 
|Impaired loans                         |  |                      | 34,204  |  |         |   |  |         |  |   | 34,204  |  |  |   |  | 
|Other real estate owned                |  |                      | 9,375   |  |         |   |  |         |  |   | 9,375   |  |  |   |  | 
|                                       |  |                      |         |  |         |   |   |         |  |   |         |  |  |   |   | 
|Total                                  |  | $                    | 158,114 |  |         | $ |  |         |  | $ | 158,114 |  |  | $ |  | 
|                                       |  |                      |         |  |         |   |   |         |  |   |         |  |  |   |   | 
|                                       | 
|                                       |  | At December 31, 2010 |        
|                                       |  | Total                |         |  | Level 1 |   |   | Level 2 |  |   | Level 3 | 
|                                       |  |                      |         | 
|Assets valued on a recurring basis     |  |                      |         |  |         |   |   |         |  |   |         |  |  |   |   | 
|Investment securities:                 |  |                      |         |  |         |   |   |         |  |   |         |  |  |   |   | 
|U.S. government and agency             |  | $                    | 53,518  |  |         | $ |  |         |  | $ | 53,518  |  |  | $ |  | 
|State and municipals                   |  |                      | 3,859   |  |         |   |  |         |  |   | 3,859   |  |  |   |  | 
|Corporate                              |  |                      | 940     |  |         |   |  |         |  |   | 940     |  |  |   |  | 
|Mortgage-backed                        |  |                      | 48,223  |  |         |   |  |         |  |   | 48,223  |  |  |   |  | 
|Assets valued on a non-recurring basis |  |                      |         |  |         |   |   |         |  |   |         |  |  |   |   | 
|Impaired loans                         |  |                      | 32,769  |  |         |   |  |         |  |   | 32,769  |  |  |   |  | 
|Other real estate owned                |  |                      | 8,314   |  |         |   |  |         |  |   | 8,314   |  |  |   |  | 
|                                       |  |                      |         |  |         |   |   |         |  |   |         |  |  |   |   | 
|Total                                  |  | $                    | 147,623 |  |         | $ |  |         |  | $ | 147,623 |  |  | $ |  | 
|                                       |  |                      |         |  |         |   |   |         |  |   |         |  |  |   |   | 

NOTE 9. BORROWED FUNDS

A summary of the Companys outstanding borrowings and the annual rate of interest currently payable on each category is presented in the following table at the dates indicated (dollars in thousands):



|                                                      |  |                    |        |  |                     |  |      |                    |  |   |                     |  |  |  |      |  
|----------------------------------------------------- |  | ------------------ | ------ |  | ------------------- |  | ---- | ------------------ |  | - | ------------------- |  |  |  | ---- | -
|                                                      |  | March 31, 2011     |        |  | December 31, 2010   | 
|                                                      |  | OutstandingBalance |        |  | AnnualInterest Rate |  |      | OutstandingBalance |  |   | AnnualInterest Rate | 
|                                                      |  |                    |        | 
|Securities sold under overnight repurchase agreements |  | $                  | 458    |  |                     |  | 0.13 | %                  |  | $ | 603                 |  |  |  | 0.13 | %
|Securities sold under term repurchase agreements      |  |                    | 45,000 |  |                     |  | 4.38 |                    |  |   | 45,000              |  |  |  | 4.38 |  
|Federal Home Loan Bank advances                       |  |                    | 20,000 |  |                     |  | 1.21 |                    |  |   | 22,000              |  |  |  | 1.13 |  
|Trust preferred securities                            |  |                    | 5,155  |  |                     |  | 3.21 |                    |  |   | 5,155               |  |  |  | 3.25 |  
|Subordinated debt                                     |  |                    | 2,700  |  |                     |  | 4.00 |                    |  |   | 2,700               |  |  |  | 4.00 |  
|                                                      |  |                    |        |  |                     |  |      |                    |  |   |                     |  |  |  |      |  
|Total borrowed funds                                  |  | $                  | 73,313 |  |                     |  | 3.39 | %                  |  | $ | 75,458              |  |  |  | 3.31 | %
|                                                      |  |                    |        |  |                     |  |      |                    |  |   |                     |  |  |  |      |  

The Bank engages from time-to-time in federal funds purchases from upstream correspondent institutions to meet
temporary funding needs. There were none of these transactions outstanding at the close of either period presented in the above table.



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The Bank had a total of $45.0 million of borrowings in the form of securities sold under term repurchase
agreements that were entered into during 2008. These borrowings are secured by marketable investment securities equal to approximately 109.5% of the principal balances outstanding plus accrued interest and the value of an imbedded interest rate cap.
The following table contains certain pertinent information with respect to these agreements at March 31, 2011 (dollars in thousands):



|                          |  |                             |        |  |                              |  |      |                   |  |  |                              |  |  |                       |           |  |  |   |        | 
|------------------------- |  | --------------------------- | ------ |  | ---------------------------- |  | ---- | ----------------- |  |  | ---------------------------- |  |  | --------------------- | --------- |  |  | - | ------ | 
|                          |  | OutstandingPrincipalBalance |        |  | AnnualEffectiveInterest Rate |  |      | FinalMaturityDate |  |  | BeginningQuarterlyCall Dates |  |  | CollateralRequirement |          
|Agreement dated 7/8/2008  |  | $                           | 25,000 |  |                              |  | 4.79 | %                 |  |  | 7/8/2018                     |  |  |                       | 7/8/2013  |  |  | $ | 29,095 | 
|Agreement dated 8/20/2008 |  |                             | 20,000 |  |                              |  | 3.78 |                   |  |  | 8/20/2015                    |  |  |                       | 8/20/2011 |  |  |   | 22,389 | 
|                          |  |                             |        |  |                              |  |      |                   |  |  |                              |  |  |                       |           |  |  |   |        | 
|Total                     |  | $                           | 45,000 |  |                              |  | 4.38 | %                 |  |  |                              |  |  |                       |           |  |  | $ | 51,484 | 
|                          |  |                             |        |  |                              |  |      |                   |  |  |                              |  |  |                       |           |  |  |   |        | 

The Bank utilizes borrowings from the Federal Home Loan Bank (FHLB) as a source of liquidity. At March 31,
2011, the FHLB had advances totaling $20.0 million outstanding to the Bank. All of the FHLB advances are secured by the Banks qualifying real estate loans. The following table contains a summary of the more significant terms of these
borrowings at March 31, 2011 (dollars in thousands):



|                        |  |                             |        |  |                              |  |      |                   |  |  |          | 
|----------------------- |  | --------------------------- | ------ |  | ---------------------------- |  | ---- | ----------------- |  |  | -------- | 
|                        |  | OutstandingPrincipalBalance |        |  | AnnualEffectiveInterest Rate |  |      | FinalMaturityDate | 
|Advance dated 3/17/2008 |  |                             | 10,000 |  |                              |  | 2.21 |                   |  |  | 03/18/13 | 
|Advance dated 2/16/2010 |  |                             | 10,000 |  |                              |  | 0.21 |                   |  |  | 02/16/12 | 
|                        |  |                             |        |  |                              |  |      |                   |  |  |          | 
|Total                   |  | $                           | 20,000 |  |                              |  | 1.21 | %                 |  |  |          | 
|                        |  |                             |        |  |                              |  |      |                   |  |  |          | 

During 2008, the Company issued $5.2 million of junior subordinated debentures to its wholly owned capital trust,
Bank of the Carolinas Trust I (the Trust), which, in turn, issued $5.0 million in trust preferred securities having a like liquidation amount and $155,000 in common securities (all common securities are owned by the Company). The Company
has fully and unconditionally guaranteed the Trusts obligations related to the trust preferred securities. The Trust has the right to redeem the trust preferred securities in whole or in part, on or after March 26, 2013 at a redemption
price equal to 100% of the principal amount plus accrued and unpaid interest.

In addition, the Trust may redeem the trust preferred
securities in whole (but not in part) at any time within 90 days following the occurrence of a tax event, an investment company event, or a capital treatment event at a special redemption price (as defined in the debenture). Interest is payable
quarterly on the trust preferred securities at the annual rate of 90-day LIBOR plus 300 basis points. In February 2011, the Company announced its election to defer its regularly scheduled March 2011 interest payment on the junior subordinated
debentures related to the trust preferred securities.

The Company also has issued $2.7 million of subordinated debt in a private transaction
with another financial institution. This subordinated note has a floating interest rate equal to 75 basis points over the Prime Rate published by Wall Street Journal and a maturity date of August 13, 2018. The Company makes monthly interest
payments on the outstanding debt to the holder of the note. This debt can be repaid in full at any time with no penalty.



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NOTE 10. STOCKHOLDERS EQUITY

Preferred Stock:

The Company has 3.0 million shares of preferred stock authorized.
There were 13,179 shares of preferred stock issued and outstanding with a $1,000 per share liquidation preference on March 31, 2011 and December 31, 2010. All of the shares were issued on April 17, 2009 in connection with the U.S.
Treasurys TARP Capital Purchase Program.

In February 2011, the Company notified the Treasury of its intent to defer the payment of its
regular quarterly cash dividend on its Series A Preferred Stock sold to the Treasury.

Common Stock:

The Company has 15.0 million shares of $5 par value common stock authorized. There were 3,897,174 shares of common stock issued and outstanding at
March 31, 2011 and December 31, 2010.

Warrants:

In connection with the issuance of the preferred shares under the U.S. Treasurys TARP Capital Purchase Plan, the Company issued the U.S. Treasury a warrant to purchase 475,204 shares of its common
stock for $4.16 per share. The warrant expires April 17, 2019.



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|Item 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------

GENERAL

Introduction

Bank of the Carolinas
Corporation (the Company) is the parent holding company of Bank of the Carolinas (the Bank). Because the Company has no separate operations and conducts no business on its own other than owning the Bank, the discussion
contained in this Managements Discussion and Analysis concerns primarily the business of the Bank. However, because the financial statements are presented on a consolidated basis, the Company and the Bank are collectively referred to herein as
the Company unless otherwise noted.

The Bank began operations in December 1998 as a state chartered bank and currently has ten offices in the
Piedmont region of North Carolina. The Bank competes for loans and deposits throughout the markets it serves. The Bank, like most community banks, derives most of its revenue from net interest income which is the difference between the income it
earns from loans and securities and the interest expense it incurs on deposits and borrowings.

CHANGES IN FINANCIAL
CONDITION

Total Assets

At March 31, 2011, total assets were $537.1 million, an increase of 0.4% compared to $535.0 million at December 31, 2010. The asset increase was primarily the result of increased deposits,
mainly customer time deposits, which has resulted in increased liquidity and offset reductions in the loan portfolio.

Investment
Securities

Investment securities totaled $116.9 million at March 31, 2011, compared to $110.4 million at December 31, 2010. The
increase was a result of increased customer time deposits referred to above. A summary of the Companys investment securities holdings by major category at March 31, 2011 and December 31, 2010 is included in Note 3 of Notes to
Consolidated Financial Statements.

Loans and Allowance for Loan Losses

At March 31, 2011, the loan portfolio totaled $359.6 million and represented 67.0% of total assets compared to $366.2 million or 68.4% of total assets at December 31, 2010. Total loans at
March 31, 2011 decreased $6.6 million or 1.8% from December 31, 2010. The decrease in loans outstanding in the period is the result of principal repayments in excess of new loans originated due to slower loan demand under the current
economic conditions. Real estate loans, including commercial real estate, constituted approximately 80% of the loan portfolio, and commercial business and other loans comprised approximately 20% of the total loan portfolio at both March 31,
2011 and December 31, 2010.

The allowance for loan losses is created by direct charges to income. Losses on loans are charged against
the allowance in the period in which such loans, in managements opinion, become uncollectible. Recoveries during the period are credited to this allowance. The factors that influence managements judgment in determining the amount charged
to operating expense include past loan experience, composition of the loan portfolio, current economic conditions and probable losses.

The
appropriateness of the allowance for loan losses is measured on a quarterly basis using an allocation model that assigns reserves to various components of the loan portfolio in order to provide for probable inherent losses. It must be emphasized,
however, that the determination of the reserve using the Companys procedures and methods rests upon various judgments and assumptions about current economic conditions and other factors affecting loans. No assurance can be given that the
Company will not in any particular period sustain loan losses that are sizable in relation to amounts reserved or that subsequent evaluations of the loan portfolio, in light of conditions and factors then prevailing, will not require significant
changes in the allowance for loan losses or future charges to earnings. In addition, bank regulatory agencies, as an integral part of their routine examination process, periodically review the Companys allowance. Those agencies may require the
Company to recognize adjustments to the allowance based on their judgments about information available to them at the time of their examinations. The Company believes the allowance is appropriate based on managements current analysis.



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##### Table of Contents

The allowance for loan losses at March 31, 2011, amounted to $8.3 million, an increase of $1.5 million,
or 21.1% from December 31, 2010. This additional allowance is the result of increased specific reserves of $676,000 and the general allowance also increased $774,000 during the three-month period since December 31, 2010, as a result of
updated chargeoff history. While the Company has not participated in subprime lending activities, we have been affected by the economic downturn in our markets. We continue to work with our customers with troubled credit relationships to
the extent that it is reasonably possible.

Certain credit risks are inherent in making loans, particularly commercial and consumer loans.
Management prudently assesses these risks and attempts to manage them effectively. The Company also attempts to reduce default risks by adhering to internal credit underwriting policies and procedures. These policies and procedures include officer
and customer limits, periodic loan documentation review and follow up on exceptions to credit policies. A loan is placed in nonaccrual status when, in managements judgment, the collection of interest appears doubtful.

The following table summarizes information regarding our nonaccrual loans, other real estate owned, and 90-day and over past due loans as of
March 31, 2011 and December 31, 2010 (dollars in thousands):



|                                                                                |  |               |        |   |                  |   |        |  
|------------------------------------------------------------------------------- |  | ------------- | ------ | - | ---------------- | - | ------ | -
|                                                                                |  | March 31,2010 |        |   | December 31,2010 |  
|Loans accounted for on a nonaccrual basis:                                      |  |               |        |   |                  |   |        |  
|Real estate loans:                                                              |  |               |        |   |                  |   |        |  
|1-4 family residential                                                          |  | $             | 4,847  |   |                  | $ | 4,071  |  
|Commercial real estate                                                          |  |               | 18,819 |   |                  |   | 15,176 |  
|Construction and development                                                    |  |               | 1,258  |   |                  |   | 2,274  |  
|                                                                                |  |               |        |   |                  |   |        |  
|Total real estate loans                                                         |  |               | 24,924 |   |                  |   | 21,521 |  
|Commercial business and other loans                                             |  |               | 2,934  |   |                  |   | 3,068  |  
|Consumer loans                                                                  |  |               | 1      |   |                  |   | 101    |  
|                                                                                |  |               |        |   |                  |   |        |  
|Total nonaccrual loans                                                          |  |               | 27,859 |   |                  |   | 24,690 |  
|Accruing loans which are contractually past due 90 days or more                 |  |               |       |   |                  |   |       |  
|                                                                                |  |               |        |   |                  |   |        |  
|Total nonperforming loans                                                       |  |               | 27,859 |   |                  |   | 24,690 |  
|Other real estate owned                                                         |  |               | 9,375  |   |                  |   | 8,314  |  
|                                                                                |  |               |        |   |                  |   |        |  
|Total nonperforming assets                                                      |  | $             | 37,234 |   |                  | $ | 33,004 |  
|                                                                                |  |               |        |   |                  |   |        |  
|                                                                                |  |              
|Total nonperforming loans as a percentage of loans                              |  |               | 7.75   | % |                  |   | 6.74   | %
|Allowance for loan losses as a percentage of total nonperforming loans          |  |               | 29.84  | % |                  |   | 27.80  | %
|Allowance for loan losses as a percentage of total loans                        |  |               | 2.31   | % |                  |   | 1.87   | %
|Total nonperforming assets as a percentage of loans and other real estate owned |  |               | 10.09  | % |                  |   | 8.81   | %
|Total nonperforming assets as a percentage of total assets                      |  |               | 6.93   | % |                  |   | 6.17   | %

Deposits

The Companys deposit services include business and individual checking accounts, interest bearing checking accounts, savings accounts, money market
accounts, IRA deposits and certificates of deposit. At March 31, 2011, total deposits were $423.7 million compared to $416.2 million at December 31, 2010. The March 31, 2011 amount represents an increase of 1.8% from December 31,
2010, which is mainly recognized in customer time deposits. At March 31, 2011, the deposit mix was comparable to December 31, 2010.



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##### Table of Contents

The following table presents a breakdown of our deposit base at March 31, 2011 and December 31,
2010 (dollars in thousands):



|                                                                   |  |               |         |   |                  |   |         |  
|------------------------------------------------------------------ |  | ------------- | ------- | - | ---------------- | - | ------- | -
|                                                                   |  | March 31,2011 |         |   | December 31,2010 |  
|Noninterest bearing demand deposits                                |  | $             | 36,411  |   |                  | $ | 33,730  |  
|Interest checking deposits                                         |  |               | 35,221  |   |                  |   | 34,004  |  
|Savings deposits                                                   |  |               | 11,799  |   |                  |   | 11,787  |  
|Money market deposits                                              |  |               | 98,602  |   |                  |   | 103,136 |  
|Customer time deposits                                             |  |               | 168,943 |   |                  |   | 160,514 |  
|Brokered certificates of deposit                                   |  |               | 72,763  |   |                  |   | 72,998  |  
|                                                                   |  |               |         |   |                  |   |         |  
|Total deposits                                                     |  | $             | 423,739 |   |                  | $ | 416,169 |  
|                                                                   |  |               |         |   |                  |   |         |  
|                                                                   |  |              
|Time deposits $100,000 or more:                                    |  |               |         |   |                  |   |         |  
|Brokered certificates of deposit                                   |  | $             | 72,763  |   |                  | $ | 72,998  |  
|Customer time deposits issued in denominations of $100,000 or more |  |               | 79,095  |   |                  |   | 74,381  |  
|                                                                   |  |               |         |   |                  |   |         |  
|Total time deposits issued in denominations of $100,000 or more    |  | $             | 151,858 |   |                  | $ | 147,379 |  
|                                                                   |  |               |         |   |                  |   |         |  
|                                                                   |  |              
|As a percent of total deposits:                                    |  |               |         |   |                  |   |         |  
|Noninterest bearing demand deposits                                |  |               | 8.59    | % |                  |   | 8.10    | %
|Interest checking deposits                                         |  |               | 8.31    |   |                  |   | 8.17    |  
|Savings deposits                                                   |  |               | 2.78    |   |                  |   | 2.83    |  
|Money market deposits                                              |  |               | 23.27   |   |                  |   | 24.78   |  
|Customer time deposits                                             |  |               | 39.87   |   |                  |   | 38.57   |  
|Brokered certificates of deposit                                   |  |               | 17.17   |   |                  |   | 17.54   |  
|                                                                   |  |              
|Total time deposits issued in denominations of $100,000 or more    |  |               | 35.84   |   |                  |   | 35.41   |  

Liquidity

Liquidity management is the process of managing assets and liabilities, as well as their maturities, to ensure adequate funding for loan and deposit
activities, as well as continued growth of the Company. Sources of liquidity come from both balance sheet and off-balance sheet sources. We define balance sheet liquidity as the relationship that net liquid assets have to unsecured liabilities. Net
liquid assets are the sum of cash and cash items, less required reserves on demand and interest checking deposits, plus demand deposits due from banks, plus temporary investments, including federal funds sold, plus the fair value of investment
securities, less collateral requirements related to public funds on deposit and repurchase agreements. Unsecured liabilities are equal to total liabilities less required cash reserves on noninterest-bearing demand deposits and interest checking
deposits less the outstanding balances of all secured liabilities, whether secured by liquid assets or not. We consider off-balance sheet liquidity to include unsecured federal funds lines from other banks and loan collateral which may be used for
additional advances from the Federal Home Loan Bank. As of March 31, 2011 our balance sheet liquidity ratio (net liquid assets as a percent of unsecured liabilities) amounted to 19.6% and our total liquidity ratio (balance sheet plus
off-balance sheet liquidity) was 21.9%.

In addition, we have the ability to borrow $10.0 million from the discount window of the Federal
Reserve, as well as lines from correspondent banks of $19.0 million subject to our pledge of marketable securities, which could be used for temporary funding needs. We also have the ability to borrow from the Federal Home Loan Bank on similar terms.
While we consider these arrangements sources of back-up funding, we do not consider them as liquidity sources because they require our pledge of liquid assets as collateral. We regularly borrow from the Federal Home Loan Bank as a normal part of our
business. These advances, which totaled $20.0 million at March 31, 2011, are secured by various types of real estate-secured loans. The Company closely monitors and evaluates its overall liquidity position. The Company believes its liquidity
position at March 31, 2011 is adequate to meet its operating needs.



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Interest Rate Sensitivity

Fluctuating interest rates, increased competition, and changes in the regulatory environment continue to significantly affect the importance of interest rate sensitivity management. Rate sensitivity
arises when interest rates on assets change in a different period of time or in a different proportion to interest rates on liabilities. The primary objective of interest rate sensitivity management is to prudently structure the balance sheet so
that movements of interest rates on assets and liabilities are highly correlated and produce a reasonable net interest margin even in periods of volatile interest rates. The Company uses an asset/liability simulation model to project potential
changes to the Companys net interest margin, net income, and economic value of equity based on simulated changes to market interest rates, namely the prime rate. Our goal is to maintain an interest rate sensitivity position as close to neutral
as practicable whereby little or no change in interest income would occur as interest rates change. On March 31, 2011, we were cumulatively liability sensitive for the next twelve months, which means that our interest bearing liabilities would
reprice more quickly than our interest bearing assets. Theoretically, our net interest margin will decrease if market interest rates rise or increase if market interest rates fall. However, the repricing characteristic of assets is different from
the repricing characteristics of funding sources. Therefore, net interest income can be impacted by changes in interest rates even if the repricing opportunities of assets and liabilities are perfectly matched.

Capital Adequacy

Regulatory guidelines
require banks to hold minimum levels of capital based upon the risk weighting of certain categories of assets as well as any off-balance sheet contingencies. Federal regulators have adopted risk-based capital and leverage capital guidelines for
measuring the capital adequacy of banks and bank holding companies. All applicable capital standards must be satisfied for the Company and the Bank to be considered in compliance with regulatory requirements.

As previously disclosed, the Company and the Banks Boards of Directors have entered into informal agreements with their respective banking
regulators which, among other things, require that the Bank maintain capital levels in excess of normal regulatory minimums, including a Leverage Capital Ratio of not less than 7.5% and risk-based capital ratios at least at well
capitalized levels, and that the Company and the Bank seek the approval of their respective regulators prior to the payment of any cash dividend.

On March 31, 2011, the Companys Tier 1 and Total risk-weighted Capital Ratios were 9.16% and 11.06%, respectively, which were well above the minimum levels required by regulatory guidelines. At
March 31, 2011, the Companys Leverage Capital Ratio was 7.20%, which was also well above the minimum level required by the regulatory guidelines. On March 31, 2011, the Banks Tier 1 and Total risk-weighted Capital Ratios were
9.70% and 10.96%, respectively, both well above the minimum levels required by regulatory guidelines. On March 31, 2011, the Banks leverage ratio was 7.62%, in compliance with the level specified in the above referenced informal agreement
with bank regulators. Banks and bank holding companies are placed into one of four capital categories based on the above three separate capital ratios. The four categories are well-capitalized, adequately capitalized,
under-capitalized and critically under-capitalized. The Company and the Bank were both considered well-capitalized as of March 31, 2011.

RESULTS OF OPERATIONS

Three Months Ended March 31, 2011 and 2010

Overview. For the three months
ended March 31, 2011, the Company incurred a net loss available to common shareholders of $3.4 million, or $0.88 per common share. This compares to a net loss of $462,000, or $0.12 per common share, for the three months ended March 31,
2010. The first quarter of 2011 has an increased level of provision for loan losses that are still above the levels we experienced prior to 2008.

Net Interest Income. The Companys net interest income for the three months ended March 31, 2011 totaled $3.6 million compared to $4.2 million at March 31, 2010. Net interest income
decreased due to the loss of $34.9 million in interest earning assets compared to March 31, 2010. Net interest margin decreased 15 basis points from 3.17% in the first quarter of 2010 to 3.02% in the first quarter of 2011.

Provision for Loan Losses. The loan loss provision amounted to $2.3 million for the quarter ended March 31, 2011, an increase of $1.4
million, or 156.0%, from the $916,000 provision recorded in the comparable quarter of 2010. Net charge-offs totaled $894,000 in the first quarter of 2011 compared to $2.0 million in the first quarter of 2010.



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Noninterest Income. Noninterest income totaled $402,000 for the three months ended March 31,
2011 compared to $503,000 (including $96,000 in gains on sale of investment securities) for the comparable three-month period of 2010. Noninterest income includes customer service charges on deposit accounts, bank owned life insurance, and gains on
investment securities. Excluding gains on sale of investment securities, noninterest income remained relatively flat for the three months ended March 31, 2011 and 2010.

Noninterest Expenses. Noninterest expenses totaled $3.9 million and $4.2 million for the three months ended March 31, 2011 and 2010, respectfully. Noninterest expenses affecting overhead cost
were: (1) salaries and benefits, which have decreased $329,000 as a result of management reorganization; (2) FDIC insurance assessment, which decreased $29,000 due to the reduction in deposits; and (3) other real estate expense, which
decreased $119,000.

Income Taxes. The Company performed an analysis of its tax position after three years of tax losses. From this
analysis, a valuation allowance of $1,686,102 was established against our deferred tax asset. This valuation along with a current year income tax benefit of $690,000 resulted in a $996,000 income tax expense for the three months ending
March 31, 2011 compared to an income tax benefit of $200,000 for the first quarter of 2010.

DISCLOSURES ABOUT
FORWARD LOOKING STATEMENTS

Statements in this Report relating to plans, strategies, economic performance and trends, projections of
results of specific activities or investments, expectations or beliefs about future events or results, and other statements that are not descriptions of historical facts, may be forward-looking statements as defined in Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking information is inherently subject to risks and uncertainties, and actual results could differ materially from those currently anticipated due to a
number of factors which include, but are not limited to, factors discussed in our Annual Report on Form 10-K and in other documents we file with the Securities and Exchange Commission from time to time. Copies of those reports are available directly
through the SECs Internet website at www.sec.gov. Forward-looking statements may be identified by terms such as may, will, should, could, expects, plans,
intends, anticipates,  feels, believes, estimates, predicts, forecasts, potential or continue, or similar terms or the negative of these
terms, or other statements concerning opinions or judgments of our management about future events. Factors that could influence the accuracy of forward-looking statements include, but are not limited to (a) pressures on our earnings, capital
and liquidity resulting from current and future conditions in the credit and capital markets, (b) continued or unexpected increases in nonperforming loans and credit losses in our loan portfolio, (c) continued adverse conditions in the
economy and in the real estate market in our banking markets (particularly those conditions that affect our loan portfolio, the abilities of our borrowers to repay their loans, and the values of collateral that secures our loans), (d) the
financial success or changing strategies of our customers, (e) actions of government regulators, or change in laws, regulations or accounting standards, that adversely affect our business, (f) changes in the interest rate environment and
the level of market interest rates that reduce our net interest margins and/or the values of loans we make and securities we hold, and changes in general economic conditions and real estate values in our banking market (particularly changes that
affect our loan portfolio, the abilities of our borrowers to repay their loans, and the values of loan collateral), (g) changes in competitive pressures among depository and other financial institutions or in our ability to compete effectively
against other financial institutions in our banking markets, and (h) other developments or changes in our business that we do not expect. Although we believe that the expectations reflected in the forward-looking statements included in this
Report are reasonable, they represent our managements judgments only as of the date they are made, and we cannot guarantee future results, levels of activity, performance or achievements. As a result, readers are cautioned not to place undue
reliance on these forward-looking statements. All forward-looking statements attributable to us are expressly qualified in their entirety by the cautionary statements in this paragraph. We have no obligation, and do not intend to update these
forward-looking statements.



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##### Table of Contents

|Item 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|------- | ----------------------------------------------------------

Smaller reporting companies such as the Company are not required to provide the information required by this item.



|Item 4. | CONTROLS AND PROCEDURES
|------- | -----------------------

The
Companys management, under the supervision and with the participation of its Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of the Companys disclosure controls and
procedures in accordance with Rule 13a-15 of the Securities Exchange Act of 1934 (the Exchange Act). Based on their evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered
by this report, the Companys disclosure controls and procedures were effective to provide reasonable assurance that it is able to record, process, summarize and report in a timely manner the information required to be disclosed in reports it
files under the Exchange Act.

In connection with the above evaluation of the effectiveness of the Companys disclosure controls and
procedures, no change in the Companys internal control over financial reporting was identified that occurred during the most recent quarterly period and that has materially affected, or is reasonably likely to materially affect, the
Companys internal control over financial reporting.

PART II - OTHER INFORMATION



|Item 1. | Legal Proceedings
|------- | -----------------

Reference is made to
Part II, Item 1, of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2010, for a discussion of certain pending litigation.



|Item 1A. | Risk Factors
|-------- | ------------

There have been no material
changes in our risk factors from those disclosed in our annual report Form 10-K for the year ended December 31, 2010.



|Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds
|------- | -----------------------------------------------------------

None



|Item 3. | Defaults Upon Senior Securities.
|------- | --------------------------------

None



|Item 4. | [Removed and Reserved]
|------- | ----------------------



|Item 5. | Other Information
|------- | -----------------

None



|Item 6. | Exhibits
|------- | --------

The following
exhibits are filed with this report.



|      |  |                                                                                                            
|----- |  | -----------------------------------------------------------------------------------------------------------
|31.01 |  | Certification of our Chief Executive Officer pursuant to Rule 13a-14(a)                                    
|      | 
|31.02 |  | Certification of our Chief Financial Officer pursuant to Rule 13a-14(a)                                    
|      | 
|32.01 |  | Certification of our Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350



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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.

BANK OF THE CAROLINAS CORPORATION



|                   |  |                                                      |  |                       
|------------------ |  | ---------------------------------------------------- |  | ----------------------
|Date: May 12, 2011 |  | By:                                                  |  | /s/ Stephen R. Talbert
|                   |  | Stephen R. Talbert                                  
|                   |  | President and Chief Executive Officer               
|                   |  |                                                     
|Date: May 12, 2011 |  | By:                                                  |  | /s/ Eric E. Rhodes    
|                   |  | Eric E. Rhodes                                      
|                   |  | Executive Vice President and Chief Financial Officer



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EXHIBIT INDEX



|              |  |                                                                                                            
|------------- |  | -----------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                
|              | 
|31.01         |  | Certification of our Chief Executive Officer pursuant to Rule 13a-14(a)                                    
|              | 
|31.02         |  | Certification of our Chief Financial Officer pursuant to Rule 13a-14(a)                                    
|              | 
|32.01         |  | Certification of our Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350



26