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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
September 30, 2010

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 to 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 definition 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   ̈    Nox

On November 15, 2010 there were 3,897,174 outstanding shares of the registrants common stock.









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BANK OF THE CAROLINAS CORPORATION

FORM 10-Q

September 30, 2010

INDEX



|                              |  |          |    |                                                                                                                   |  |  |    | 
|----------------------------- |  | -------- | -- | ----------------------------------------------------------------------------------------------------------------- |  |  | -- | 
|Part I. FINANCIAL INFORMATION |  |          |    |                                                                                                                  
|                              |  |          |   
|                              |  | Item 1.  |    | Financial Statements                                                                                              |  |  |    | 
|                              |  |          |   
|                              |  |          |    | Consolidated Balance Sheets at September 30, 2010 and December 31, 2009                                           |  |  | 3  | 
|                              |  |          |   
|                              |  |          |    | Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2010 and
2009             |  |  | 4  | 
|                              |  |          |   
|                              |  |          |    | Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2010 and
2009                       |  |  | 5  | 
|                              |  |          |   
|                              |  |          |    | Consolidated Statements of Changes in Stockholders Equity for the Nine Months Ended September 
30, 2010 and 2009 |  |  | 6  | 
|                              |  |          |   
|                              |  |          |    | Notes to Consolidated Financial Statements                                                                        |  |  | 7  | 
|                              |  |          |   
|                              |  | Item 2.  |    | Managements Discussion and Analysis of Financial Condition and Results of
Operations                             |  |  | 15 | 
|                              |  |          |   
|                              |  | Item 3.  |    | Quantitative and Qualitative Disclosure about Market Risk                                                         |  |  | 21 | 
|                              |  |          |   
|                              |  | Item 4.  |    | Controls and Procedures                                                                                           |  |  | 21 | 
|                              | 
|Part II. OTHER INFORMATION    |  |          |    |                                                                                                                  
|                              |  |          |   
|                              |  | Item 1.  |    | Legal Proceedings                                                                                                 |  |  | 21 | 
|                              |  |          |   
|                              |  | Item 1A. |    | Risk Factors                                                                                                      |  |  | 21 | 
|                              |  |          |   
|                              |  | Item 2.  |    | Unregistered Sales of Equity Securities and Use of Proceeds                                                       |  |  | 21 | 
|                              |  |          |   
|                              |  | Item 3.  |    | Defaults Upon Senior Securities                                                                                   |  |  | 21 | 
|                              |  |          |   
|                              |  | Item 4.  |    | [Removed and Reserved]                                                                                            |  |  | 21 | 
|                              |  |          |   
|                              |  | Item 5.  |    | Other Information                                                                                                 |  |  | 22 | 
|                              |  |          |   
|                              |  | Item 6.  |    | Exhibits                                                                                                          |  |  | 22 | 
|                              | 
|SIGNATURES                    |  |          | 23 |                                                                                                                  
|                              | 
|EXHIBIT INDEX                 |  |          | 24 |                                                                                                                  



2



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PART I.
FINANCIAL INFORMATION



|Item 1. | Financial Statements
|------- | --------------------

Bank of the Carolinas Corporation

Consolidated Balance Sheets

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



|                                                          |  |                   |            |   |                   |   |            |  
|--------------------------------------------------------- |  | ----------------- | ---------- | - | ----------------- | - | ---------- | -
|                                                          |  | September 30,2010 |            |   | December 31,2009* |  
|                                                          |  | (Unaudited)       |            |   |                   |  
|Assets:                                                   |  |                   |            |   |                   |   |            |  
|Cash and due from banks                                   |  | $                 | 11,690     |   |                   | $ | 3,524      |  
|Federal funds sold and interest-bearing deposits in banks |  |                   | 5,557      |   |                   |   | 33,835     |  
|Investment securities                                     |  |                   | 113,021    |   |                   |   | 140,004    |  
|Loans                                                     |  |                   | 367,021    |   |                   |   | 391,265    |  
|Less, allowance for loan losses                           |  |                   | (6,342     | ) |                   |   | (8,167     | )
|                                                          |  |                   |            |   |                   |   |            |  
|Loans, net                                                |  |                   | 360,679    |   |                   |   | 383,098    |  
|Premises and equipment, net                               |  |                   | 13,370     |   |                   |   | 14,010     |  
|Other real estate owned                                   |  |                   | 8,571      |   |                   |   | 8,233      |  
|Bank owned life insurance                                 |  |                   | 10,280     |   |                   |   | 10,010     |  
|Prepaids and deferred tax assets                          |  |                   | 3,099      |   |                   |   | 5,470      |  
|Prepaid FDIC insurance assessment                         |  |                   | 3,913      |   |                   |   | 4,569      |  
|Accrued interest receivable                               |  |                   | 2,080      |   |                   |   | 2,397      |  
|Other assets                                              |  |                   | 3,229      |   |                   |   | 5,237      |  
|                                                          |  |                   |            |   |                   |   |            |  
|Total Assets                                              |  | $                 | 535,489    |   |                   | $ | 610,387    |  
|                                                          |  |                   |            |   |                   |   |            |  
|                                                          |  |                  
|Liabilities:                                              |  |                   |            |   |                   |   |            |  
|Deposits:                                                 |  |                   |            |   |                   |   |            |  
|Noninterest-bearing demand deposits                       |  | $                 | 35,531     |   |                   | $ | 36,418     |  
|Interest-checking deposits                                |  |                   | 32,768     |   |                   |   | 34,614     |  
|Savings and money market deposits                         |  |                   | 126,782    |   |                   |   | 235,541    |  
|Time deposits                                             |  |                   | 219,877    |   |                   |   | 187,344    |  
|                                                          |  |                   |            |   |                   |   |            |  
|Total deposits                                            |  |                   | 414,958    |   |                   |   | 493,917    |  
|Securities sold under agreements to repurchase            |  |                   | 45,870     |   |                   |   | 46,682     |  
|Federal Home Loan Bank advances                           |  |                   | 20,000     |   |                   |   | 15,000     |  
|Subordinated debt                                         |  |                   | 7,855      |   |                   |   | 7,855      |  
|Other liabilities                                         |  |                   | 1,509      |   |                   |   | 1,941      |  
|                                                          |  |                   |            |   |                   |   |            |  
|Total Liabilities                                         |  |                   | 490,192    |   |                   |   | 565,395    |  
|                                                          |  |                   |            |   |                   |   |            |  
|Commitments and contingencies                             |  |                   |           |   |                   |   |           |  
|Stockholders Equity:                                     |  |                   |            |   |                   |   |            |  
|Preferred stock, no par value                             |  |                   | 13,179     |   |                   |   | 13,179     |  
|Discount on preferred stock                               |  |                   | (1,056     | ) |                   |   | (1,245     | )
|Common stock, $5 par value per share                      |  |                   | 19,486     |   |                   |   | 19,486     |  
|Additional paid-in capital                                |  |                   | 12,989     |   |                   |   | 12,978     |  
|Retained earnings (deficit)                               |  |                   | (724       | ) |                   |   | 300        |  
|Accumulated other comprehensive income                    |  |                   | 1,423      |   |                   |   | 294        |  
|                                                          |  |                   |            |   |                   |   |            |  
|Total Stockholders Equity                                |  |                   | 45,297     |   |                   |   | 44,992     |  
|                                                          |  |                   |            |   |                   |   |            |  
|Total Liabilities and Stockholders Equity                |  | $                 | 535,489    |   |                   | $ | 610,387    |  
|                                                          |  |                   |            |   |                   |   |            |  
|                                                          |  |                  
|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.
|- | -------------------------------------------------------

See accompanying notes to 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 EndedSeptember 30 |       |   | Nine Months EndedSeptember 30 |  
|                                                                                    |  | 2010                           |       |   | 2009                          |   |       | 2010 |  |   | 2009   |  
|Interest income                                                                     |  |                                |       |   |                               |   |       |      |  |   |        |   |  |   |        |  
|Interest and fees on loans                                                          |  | $                              | 5,102 |   |                               | $ | 5,875 |      |  | $ | 15,809 |   |  | $ | 17,904 |  
|Interest on securities                                                              |  |                                | 822   |   |                               |   | 1,641 |      |  |   | 2,607  |   |  |   | 4,539  |  
|Other interest income                                                               |  |                                | 12    |   |                               |   | 13    |      |  |   | 45     |   |  |   | 56     |  
|                                                                                    |  |                                |       |   |                               |   |       |      |  |   |        |   |  |   |        |  
|Total interest income                                                               |  |                                | 5,936 |   |                               |   | 7,529 |      |  |   | 18,461 |   |  |   | 22,499 |  
|                                                                                    |  |                                |       |   |                               |   |       |      |  |   |        |   |  |   |        |  
|                                                                                    |  |                                |       |  
|Interest expense                                                                    |  |                                |       |   |                               |   |       |      |  |   |        |   |  |   |        |  
|Interest on deposits                                                                |  |                                | 1,181 |   |                               |   | 2,657 |      |  |   | 3,839  |   |  |   | 9,843  |  
|Interest on borrowed funds                                                          |  |                                | 641   |   |                               |   | 776   |      |  |   | 1,997  |   |  |   | 2,364  |  
|                                                                                    |  |                                |       |   |                               |   |       |      |  |   |        |   |  |   |        |  
|Total interest expense                                                              |  |                                | 1,822 |   |                               |   | 3,433 |      |  |   | 5,836  |   |  |   | 12,207 |  
|                                                                                    |  |                                |       |   |                               |   |       |      |  |   |        |   |  |   |        |  
|                                                                                    |  |                                |       |  
|Net interest income                                                                 |  |                                | 4,114 |   |                               |   | 4,096 |      |  |   | 12,625 |   |  |   | 10,292 |  
|Provision for loan losses                                                           |  |                                | 858   |   |                               |   | 1,046 |      |  |   | 2,860  |   |  |   | 2,466  |  
|                                                                                    |  |                                |       |   |                               |   |       |      |  |   |        |   |  |   |        |  
|Net interest income after provision for loan losses                                 |  |                                | 3,256 |   |                               |   | 3,050 |      |  |   | 9,765  |   |  |   | 7,826  |  
|                                                                                    |  |                                |       |   |                               |   |       |      |  |   |        |   |  |   |        |  
|                                                                                    |  |                                |       |  
|Noninterest income                                                                  |  |                                |       |   |                               |   |       |      |  |   |        |   |  |   |        |  
|Customer service fees                                                               |  |                                | 316   |   |                               |   | 369   |      |  |   | 961    |   |  |   | 1,019  |  
|Increase in value of bank owned life insurance                                      |  |                                | 91    |   |                               |   | 92    |      |  |   | 270    |   |  |   | 272    |  
|Gains on sale of investment securities                                              |  |                                | 178   |   |                               |   | 1,246 |      |  |   | 368    |   |  |   | 1,341  |  
|Other income                                                                        |  |                                | 4     |   |                               |   | 8     |      |  |   | 5      |   |  |   | 31     |  
|                                                                                    |  |                                |       |   |                               |   |       |      |  |   |        |   |  |   |        |  
|Total noninterest income                                                            |  |                                | 589   |   |                               |   | 1,715 |      |  |   | 1,604  |   |  |   | 2,663  |  
|                                                                                    |  |                                |       |   |                               |   |       |      |  |   |        |   |  |   |        |  
|                                                                                    |  |                                |       |  
|Noninterest expense                                                                 |  |                                |       |   |                               |   |       |      |  |   |        |   |  |   |        |  
|Salaries and benefits                                                               |  |                                | 1,686 |   |                               |   | 1,611 |      |  |   | 5,400  |   |  |   | 4,959  |  
|Occupancy and equipment                                                             |  |                                | 537   |   |                               |   | 553   |      |  |   | 1,665  |   |  |   | 1,647  |  
|FDIC insurance assessments                                                          |  |                                | 155   |   |                               |   | 217   |      |  |   | 717    |   |  |   | 932    |  
|Data processing                                                                     |  |                                | 210   |   |                               |   | 330   |      |  |   | 607    |   |  |   | 785    |  
|Valuation provisions and net operating costs associated with foreclosed real estate |  |                                | 349   |   |                               |   | 297   |      |  |   | 1,061  |   |  |   | 1,759  |  
|Other                                                                               |  |                                | 857   |   |                               |   | 838   |      |  |   | 2,660  |   |  |   | 2,735  |  
|                                                                                    |  |                                |       |   |                               |   |       |      |  |   |        |   |  |   |        |  
|Total noninterest expense                                                           |  |                                | 3,794 |   |                               |   | 3,846 |      |  |   | 12,110 |   |  |   | 12,817 |  
|                                                                                    |  |                                |       |   |                               |   |       |      |  |   |        |   |  |   |        |  
|Income (loss) before income taxes                                                   |  |                                | 51    |   |                               |   | 919   |      |  |   | (741   | ) |  |   | (2,328 | )
|Provision for income taxes                                                          |  |                                | (31   | ) |                               |   | 137   |      |  |   | (400   | ) |  |   | (976   | )
|                                                                                    |  |                                |       |   |                               |   |       |      |  |   |        |   |  |   |        |  
|Net income (loss)                                                                   |  |                                | 82    |   |                               |   | 782   |      |  |   | (341   | ) |  |   | (1,352 | )
|Dividends and accretion on preferred stock                                          |  |                                | (229  | ) |                               |   | (312  | )    |  |   | (683   | ) |  |   | (411   | )
|                                                                                    |  |                                |       |   |                               |   |       |      |  |   |        |   |  |   |        |  
|Net income (loss) available to common stockholders                                  |  | $                              | (147  | ) |                               | $ | 470   |      |  | $ | (1,024 | ) |  | $ | (1,763 | )
|                                                                                    |  |                                |       |   |                               |   |       |      |  |   |        |   |  |   |        |  
|                                                                                    |  |                                |       |  
|Income (loss) per common share                                                      |  |                                |       |   |                               |   |       |      |  |   |        |   |  |   |        |  
|Basic                                                                               |  | $                              | (0.04 | ) |                               | $ | 0.12  |      |  | $ | (0.26  | ) |  | $ | (0.45  | )
|                                                                                    |  |                                |       |   |                               |   |       |      |  |   |        |   |  |   |        |  
|Diluted                                                                             |  | $                              | (0.04 | ) |                               | $ | 0.12  |      |  | $ | (0.26  | ) |  | $ | (0.45  | )
|                                                                                    |  |                                |       |   |                               |   |       |      |  |   |        |   |  |   |        |  

See accompanying notes to financial statements.



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Bank of the Carolinas Corporation

Consolidated Statements of Cash Flows

(Unaudited)

(dollars in thousands)



|                                                                                                  |  |                                     |         |   |                                     |   |          |  
|------------------------------------------------------------------------------------------------- |  | ----------------------------------- | ------- | - | ----------------------------------- | - | -------- | -
|                                                                                                  |  | Nine Months EndedSeptember 30, 2010 |         |   | Nine Months EndedSeptember 30, 2009 |  
|Cash flows from operating activities:                                                             |  |                                     |         |   |                                     |   |          |  
|Net loss                                                                                          |  | $                                   | (341    | ) |                                     | $ | (1,352   | )
|Adjustments to reconcile net loss to net cash provided by operating activities:                   |  |                                     |         |   |                                     |   |          |  
|Provision for loan losses                                                                         |  |                                     | 2,860   |   |                                     |   | 2,466    |  
|Stock based compensation expense                                                                  |  |                                     | 11      |   |                                     |   | 9        |  
|Loss (gain) on sale of premises and equipment                                                     |  |                                     | 6       |   |                                     |   | (11      | )
|Depreciation and amortization                                                                     |  |                                     | 804     |   |                                     |   | 805      |  
|Change in valuation allowance on other real estate owned                                          |  |                                     | 591     |   |                                     |   | 1,206    |  
|Loss on sale of other real estate owned                                                           |  |                                     | 107     |   |                                     |   | 229      |  
|Gain on sale of securities                                                                        |  |                                     | (368    | ) |                                     |   | (1,341   | )
|Increase in bank owned life insurance                                                             |  |                                     | (270    | ) |                                     |   | (272     | )
|Net amortization/accretion of premiums and discounts on investments                               |  |                                     | 273     |   |                                     |   | 4        |  
|Net change in other assets                                                                        |  |                                     | 5,352   |   |                                     |   | (2,015   | )
|Net change in other liabilities                                                                   |  |                                     | (432    | ) |                                     |   | 493      |  
|                                                                                                  |  |                                     |         |   |                                     |   |          |  
|Net cash provided by operating activities                                                         |  |                                     | 8,593   |   |                                     |   | 221      |  
|                                                                                                  |  |                                     |         |   |                                     |   |          |  
|                                                                                                  |  |                                    
|Cash flows from investing activities:                                                             |  |                                     |         |   |                                     |   |          |  
|Net change in federal funds sold                                                                  |  |                                     | 23,480  |   |                                     |   | (24,000  | )
|Purchase of premises and equipment                                                                |  |                                     | (171    | ) |                                     |   | (506     | )
|Purchases of securities                                                                           |  |                                     | (99,832 | ) |                                     |   | (164,405 | )
|Proceeds from sales, calls, maturities, and principal repayments of securities available for sale |  |                                     | 128,039 |   |                                     |   | 113,071  |  
|Purchase of FHLB stock                                                                            |  |                                     |        |   |                                     |   | (58      | )
|Improvements made to other real estate owned                                                      |  |                                     | (19     | ) |                                     |   |         |  
|Proceeds from sale of other real estate owned                                                     |  |                                     | 2,581   |   |                                     |   | 414      |  
|Proceeds from sale of premises and equipment                                                      |  |                                     | 1       |   |                                     |   | 68       |  
|Net decrease in loans                                                                             |  |                                     | 15,961  |   |                                     |   | 5,892    |  
|                                                                                                  |  |                                     |         |   |                                     |   |          |  
|Net cash provided (used) by investing activities                                                  |  |                                     | 70,040  |   |                                     |   | (69,524  | )
|                                                                                                  |  |                                     |         |   |                                     |   |          |  
|                                                                                                  |  |                                    
|Cash flows from financing activities:                                                             |  |                                     |         |   |                                     |   |          |  
|Net increase (decrease) in deposits                                                               |  |                                     | (78,959 | ) |                                     |   | 100,704  |  
|Net additions (repayments) of other borrowings                                                    |  |                                     | 5,000   |   |                                     |   | (10,000  | )
|Decrease in repurchase agreements                                                                 |  |                                     | (812    | ) |                                     |   | (199     | )
|Issuance of preferred stock                                                                       |  |                                     |        |   |                                     |   | 13,179   |  
|Cash dividends paid on preferred stock                                                            |  |                                     | (494    | ) |                                     |   | (217     | )
|                                                                                                  |  |                                     |         |   |                                     |   |          |  
|Net cash provided (used) by financing activities                                                  |  |                                     | (75,265 | ) |                                     |   | 103,467  |  
|                                                                                                  |  |                                     |         |   |                                     |   |          |  
|                                                                                                  |  |                                    
|Net increase in cash and cash equivalents                                                         |  |                                     | 3,368   |   |                                     |   | 34,164   |  
|Cash and cash equivalents at beginning of period                                                  |  |                                     | 12,544  |   |                                     |   | 10,491   |  
|                                                                                                  |  |                                     |         |   |                                     |   |          |  
|Cash and cash equivalents at end of period                                                        |  | $                                   | 15,912  |   |                                     | $ | 44,655   |  
|                                                                                                  |  |                                     |         |   |                                     |   |          |  
|                                                                                                  |  |                                    
|Supplemental disclosures of cash flow information:                                                |  |                                     |         |   |                                     |   |          |  
|Cash paid during the period for interest                                                          |  | $                                   | 2,139   |   |                                     | $ | 12,350   |  
|                                                                                                  |  |                                     |         |   |                                     |   |          |  
|                                                                                                  |  |                                    
|Non-cash investing and financing activities:                                                      |  |                                     |         |   |                                     |   |          |  
|Change in fair value of securities available for sale, net of tax                                 |  | $                                   | 1,129   |   |                                     | $ | (85      | )
|Transfer of other real estate owned from loans receivable                                         |  | $                                   | 3,598   |   |                                     | $ | 5,220    |  

See accompanying notes to
financial statements.



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Bank of the Carolinas Corporation

Consolidated Statements of Changes in Stockholders Equity

(Unaudited)

(dollars in thousands)



|                                                              |  |                 |            |  |                       |   |        |              |  |   |                   |   |  |                  |           |  |                               |   |        |                    |  |   |        |   |  |        |        |   |  |   |       |   |  |   |        |  
|------------------------------------------------------------- |  | --------------- | ---------- |  | --------------------- | - | ------ | ------------ |  | - | ----------------- | - |  | ---------------- | --------- |  | ----------------------------- | - | ------ | ------------------ |  | - | ------ | - |  | ------ | ------ | - |  | - | ----- | - |  | - | ------ | -
|                                                              |  | Preferred Stock |            |  | Discount on Preferred |   |        | Common Stock |  |   | AdditionalPaid-In |   |  | RetainedEarnings |           |  | AccumulatedOtherComprehensive |   |        | TotalStockholders | 
|                                                              |  | Shares          |            |  | Amount                |   |        | Stock        |  |   | Shares            |   |  | Amount           |           |  | Capital                       |   |        | (Deficit)          |  |   | Income |   |  | Equity |       
|Balance, December 31, 2008                                    |  |                 |           |  |                       | $ |       |              |  | $ |                  |   |  |                  | 3,891,174 |  |                               | $ | 19,456 |                    |  | $ | 11,625 |   |  | $      | 4,067  |   |  | $ | 1,443 |   |  | $ | 36,591 |  
|Net loss                                                      |  |                 |           |  |                       |   |       |              |  |   |                  |   |  |                  |          |  |                               |   |       |                    |  |   |       |   |  |        | (1,352 | ) |  |   |      |   |  |   | (1,352 | )
|Other comprehensive loss                                      |  |                 |           |  |                       |   |       |              |  |   |                  |   |  |                  |          |  |                               |   |       |                    |  |   |       |   |  |        |       |   |  |   | (85   | ) |  |   | (85    | )
|                                                              |  |                 |            |  |                       |   |        |              |  |   |                   |   |  |                  |           |  |                               |   |        |                    |  |   |        |   |  |        |        |   |  |   |       |   |  |   |        |  
|Total comprehensive loss                                      |  |                 |           |  |                       |   |       |              |  |   |                  |   |  |                  |          |  |                               |   |       |                    |  |   |       |   |  |        |       |   |  |   |      |   |  |   | (1,437 | )
|                                                              |  |                 |            |  |                       |   |        |              |  |   |                   |   |  |                  |           |  |                               |   |        |                    |  |   |        |   |  |        |        |   |  |   |       |   |  |   |        |  
|Stock based compensation expense                              |  |                 |           |  |                       |   |       |              |  |   |                  |   |  |                  |          |  |                               |   |       |                    |  |   | 9      |   |  |        |       |   |  |   |      |   |  |   | 9      |  
|Vesting of restricted stock grants                            |  |                 |           |  |                       |   |       |              |  |   |                  |   |  |                  | 6,000     |  |                               |   | 30     |                    |  |   | (30    | ) |  |        |       |   |  |   |      |   |  |   |       |  
|Issuance of preferred stock and related common stock warrants |  |                 | 13,179,000 |  |                       |   | 13,179 |              |  |   | (1,414            | ) |  |                  |          |  |                               |   |       |                    |  |   | 1,414  |   |  |        |       |   |  |   |      |   |  |   | 13,179 |  
|Expense of preferred stock issuance                           |  |                 |           |  |                       |   |       |              |  |   |                  |   |  |                  |          |  |                               |   |       |                    |  |   | (46    | ) |  |        |       |   |  |   |      |   |  |   | (46    | )
|Discount/accretion on preferred stock                         |  |                 |           |  |                       |   |       |              |  |   | 108               |   |  |                  |          |  |                               |   |       |                    |  |   |       |   |  |        | (108   | ) |  |   |      |   |  |   |       |  
|Dividends accrued on preferred stock                          |  |                 |           |  |                       |   |       |              |  |   |                  |   |  |                  |          |  |                               |   |       |                    |  |   |       |   |  |        | (303   | ) |  |   |      |   |  |   | (303   | )
|                                                              |  |                 |            |  |                       |   |        |              |  |   |                   |   |  |                  |           |  |                               |   |        |                    |  |   |        |   |  |        |        |   |  |   |       |   |  |   |        |  
|Balance, September 30, 2009                                   |  |                 | 13,179,000 |  |                       | $ | 13,179 |              |  | $ | (1,306            | ) |  |                  | 3,897,174 |  |                               | $ | 19,486 |                    |  | $ | 12,972 |   |  | $      | 2,304  |   |  | $ | 1,358 |   |  | $ | 47,993 |  
|                                                              |  |                 |            |  |                       |   |        |              |  |   |                   |   |  |                  |           |  |                               |   |        |                    |  |   |        |   |  |        |        |   |  |   |       |   |  |   |        |  
|                                                              |  |                 |            |  |                       |   |        |              | 
|Balance, December 31, 2009                                    |  |                 | 13,179,000 |  |                       | $ | 13,179 |              |  | $ | (1,245            | ) |  |                  | 3,897,174 |  |                               | $ | 19,486 |                    |  | $ | 12,978 |   |  | $      | 300    |   |  | $ | 294   |   |  | $ | 44,992 |  
|Net loss                                                      |  |                 |           |  |                       |   |       |              |  |   |                  |   |  |                  |          |  |                               |   |       |                    |  |   |       |   |  |        | (341   | ) |  |   |      |   |  |   | (341   | )
|Other comprehensive income                                    |  |                 |           |  |                       |   |       |              |  |   |                  |   |  |                  |          |  |                               |   |       |                    |  |   |       |   |  |        |       |   |  |   | 1,129 |   |  |   | 1,129  |  
|                                                              |  |                 |            |  |                       |   |        |              |  |   |                   |   |  |                  |           |  |                               |   |        |                    |  |   |        |   |  |        |        |   |  |   |       |   |  |   |        |  
|Total comprehensive income                                    |  |                 |           |  |                       |   |       |              |  |   |                  |   |  |                  |          |  |                               |   |       |                    |  |   |       |   |  |        |       |   |  |   |      |   |  |   | 788    |  
|                                                              |  |                 |            |  |                       |   |        |              |  |   |                   |   |  |                  |           |  |                               |   |        |                    |  |   |        |   |  |        |        |   |  |   |       |   |  |   |        |  
|Stock based compensation expense                              |  |                 |           |  |                       |   |       |              |  |   |                  |   |  |                  |          |  |                               |   |       |                    |  |   | 11     |   |  |        |       |   |  |   |      |   |  |   | 11     |  
|Discount/accretion on preferred stock                         |  |                 |           |  |                       |   |       |              |  |   | 189               |   |  |                  |          |  |                               |   |       |                    |  |   |       |   |  |        | (189   | ) |  |   |      |   |  |   |       |  
|Dividends accrued on preferred stock                          |  |                 |           |  |                       |   |       |              |  |   |                  |   |  |                  |          |  |                               |   |       |                    |  |   |       |   |  |        | (494   | ) |  |   |      |   |  |   | (494   | )
|                                                              |  |                 |            |  |                       |   |        |              |  |   |                   |   |  |                  |           |  |                               |   |        |                    |  |   |        |   |  |        |        |   |  |   |       |   |  |   |        |  
|Balance, September 30, 2010                                   |  |                 | 13,179,000 |  |                       | $ | 13,179 |              |  | $ | (1,056            | ) |  |                  | 3,897,174 |  |                               | $ | 19,486 |                    |  | $ | 12,989 |   |  | $      | (724   | ) |  | $ | 1,423 |   |  | $ | 45,297 |  
|                                                              |  |                 |            |  |                       |   |        |              |  |   |                   |   |  |                  |           |  |                               |   |        |                    |  |   |        |   |  |        |        |   |  |   |       |   |  |   |        |  

See accompanying notes to 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 and for the three- and nine-month periods ended September 30, 2010 and 2009, 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- and nine-month periods
ended September 30, 2010 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2010.

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, 2009. 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 EndedSeptember 30 |           |   | Nine Months EndedSeptember 30 |  
|                                                               |  | 2010                           |           |   | 2009                          |   |           | 2010 |  |   | 2009      |  
|Net income (loss) applicable to common stock                   |  | $                              | (147      | ) |                               | $ | 470       |      |  | $ | (1,024    | ) |  | $ | (1,763    | )
|                                                               |  |                                |           |   |                               |   |           |      |  |   |           |   |  |   |           |  
|                                                               |  |                                |           |  
|Weighted average number of common shares outstanding           |  |                                | 3,897,174 |   |                               |   | 3,897,174 |      |  |   | 3,897,174 |   |  |   | 3,893,350 |  
|                                                               |  |                                |           |   |                               |   |           |      |  |   |           |   |  |   |           |  
|Weighted average number of diluted common shares outstanding   |  |                                | 3,897,174 |   |                               |   | 3,901,735 |      |  |   | 3,897,174 |   |  |   | 3,893,350 |  
|                                                               |  |                                |           |   |                               |   |           |      |  |   |           |   |  |   |           |  
|                                                               |  |                                |           |  
|Common stock options and common stock warrants - anti-dilutive |  |                                | 517,245   |   |                               |   | 121,827   |      |  |   | 517,245   |   |  |   | 121,827   |  
|                                                               |  |                                |           |   |                               |   |           |      |  |   |           |   |  |   |           |  

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):



|                                               |  |                    |         |  |            |   |       |            |  |   |           |  |  |          |         |  |  |   |         | 
|---------------------------------------------- |  | ------------------ | ------- |  | ---------- | - | ----- | ---------- |  | - | --------- |  |  | -------- | ------- |  |  | - | ------- | 
|                                               |  | September 30, 2010 |        
|                                               |  |                    |         |  | Gross      |   |       | Gross      |  |   | Estimated |  |  |          |        
|                                               |  | Amortized          |         |  | Unrealized |   |       | Unrealized |  |   | Fair      |  |  | Carrying |        
|                                               |  | Cost               |         |  | Gains      |   |       | Losses     |  |   | Value     |  |  | Value    |        
|Investment securities available for sale:      |  |                    |         |  |            |   |       |            |  |   |           |  |  |          |         |  |  |   |         | 
|U.S. Government agency securities              |  | $                  | 58,802  |  |            | $ | 1,312 |            |  | $ | 5         |  |  | $        | 60,109  |  |  | $ | 60,109  | 
|State and municipal securities                 |  |                    | 3,700   |  |            |   | 229   |            |  |   |          |  |  |          | 3,929   |  |  |   | 3,929   | 
|Corporate securities                           |  |                    | 962     |  |            |   | 34    |            |  |   |          |  |  |          | 996     |  |  |   | 996     | 
|Mortgage-backed securities                     |  |                    | 43,335  |  |            |   | 816   |            |  |   | 91        |  |  |          | 44,060  |  |  |   | 44,060  | 
|                                               |  |                    |         |  |            |   |       |            |  |   |           |  |  |          |         |  |  |   |         | 
|                                               |  |                    |         |  |           
|Total investment securities available for sale |  |                    | 106,799 |  |            |   | 2,391 |            |  |   | 96        |  |  |          | 109,094 |  |  |   | 109,094 | 
|                                               |  |                    |         |  |           
|Investment securities held to maturity:        |  |                    |         |  |            |   |       |            |  |   |           |  |  |          |         |  |  |   |         | 
|Corporate securities                           |  |                    | 3,927   |  |            |   | 159   |            |  |   | 203       |  |  |          | 3,883   |  |  |   | 3,927   | 
|                                               |  |                    |         |  |            |   |       |            |  |   |           |  |  |          |         |  |  |   |         | 
|                                               |  |                    |         |  |           
|Total investment securities                    |  | $                  | 110,726 |  |            | $ | 2,550 |            |  | $ | 299       |  |  | $        | 112,977 |  |  | $ | 113,021 | 
|                                               |  |                    |         |  |            |   |       |            |  |   |           |  |  |          |         |  |  |   |         | 
|                                               | 
|                                               |  | December 31, 2009  |        
|                                               |  |                    |         |  | Gross      |   |       | Gross      |  |   | Estimated |  |  |          |        
|                                               |  | Amortized          |         |  | Unrealized |   |       | Unrealized |  |   | Fair      |  |  | Carrying |        
|                                               |  | Cost               |         |  | Gains      |   |       | Losses     |  |   | Value     |  |  | Value    |        
|Investment securities available for sale:      |  |                    |         |  |            |   |       |            |  |   |           |  |  |          |         |  |  |   |         | 
|U.S. Government agency securities              |  | $                  | 98,617  |  |            | $ | 272   |            |  | $ | 577       |  |  | $        | 98,312  |  |  | $ | 98,312  | 
|State and municipal securities                 |  |                    | 5,840   |  |            |   | 269   |            |  |   | 4         |  |  |          | 6,105   |  |  |   | 6,105   | 
|Corporate securities                           |  |                    | 1,958   |  |            |   | 5     |            |  |   | 103       |  |  |          | 1,860   |  |  |   | 1,860   | 
|Mortgage-backed securities                     |  |                    | 29,247  |  |            |   | 596   |            |  |   | 10        |  |  |          | 29,833  |  |  |   | 29,833  | 
|                                               |  |                    |         |  |            |   |       |            |  |   |           |  |  |          |         |  |  |   |         | 
|                                               |  |                    |         |  |           
|Total investment securities available for sale |  |                    | 135,662 |  |            |   | 1,142 |            |  |   | 694       |  |  |          | 136,110 |  |  |   | 136,110 | 
|                                               |  |                    |         |  |           
|Investment securities held to maturity:        |  |                    |         |  |            |   |       |            |  |   |           |  |  |          |         |  |  |   |         | 
|Corporate securities                           |  |                    | 3,894   |  |            |   | 131   |            |  |   | 202       |  |  |          | 3,823   |  |  |   | 3,894   | 
|                                               |  |                    |         |  |            |   |       |            |  |   |           |  |  |          |         |  |  |   |         | 
|                                               |  |                    |         |  |           
|Total investment securities                    |  | $                  | 139,556 |  |            | $ | 1,273 |            |  | $ | 896       |  |  | $        | 139,933 |  |  | $ | 140,004 | 
|                                               |  |                    |         |  |            |   |       |            |  |   |           |  |  |          |         |  |  |   |         | 



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NOTE 4. LOANS

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



|                                    |  |                   |         |   |                  |   |         |  
|----------------------------------- |  | ----------------- | ------- | - | ---------------- | - | ------- | -
|                                    |  | September 30,2010 |         |   | December 31,2009 |  
|Real estate loans:                  |  |                   |         |   |                  |   |         |  
|1-4 family residential              |  | $                 | 76,782  |   |                  | $ | 76,767  |  
|Commercial real estate              |  |                   | 155,279 |   |                  |   | 161,904 |  
|Construction and development        |  |                   | 40,433  |   |                  |   | 41,580  |  
|Home equity                         |  |                   | 30,620  |   |                  |   | 30,775  |  
|                                    |  |                   |         |   |                  |   |         |  
|Total real estate loans             |  |                   | 303,114 |   |                  |   | 311,026 |  
|Commercial business and other loans |  |                   | 59,972  |   |                  |   | 75,762  |  
|Consumer loans                      |  |                   | 3,935   |   |                  |   | 4,477   |  
|                                    |  |                   |         |   |                  |   |         |  
|Total loans                         |  |                   | 367,021 |   |                  |   | 391,265 |  
|Allowance for loan losses           |  |                   | (6,342  | ) |                  |   | (8,167  | )
|                                    |  |                   |         |   |                  |   |         |  
|Total loans, net                    |  | $                 | 360,679 |   |                  | $ | 383,098 |  
|                                    |  |                   |         |   |                  |   |         |  

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



|                                           |  |               |        |   |               |   |        |  
|------------------------------------------ |  | ------------- | ------ | - | ------------- | - | ------ | -
|                                           |  | September 30, |        |   | September 30, |  
|                                           |  | 2010          |        |   | 2009          |  
|Beginning balance                          |  | $             | 8,167  |   |               | $ | 6,308  |  
|Provision for loan losses                  |  |               | 2,860  |   |               |   | 2,466  |  
|Loans charged-off                          |  |               | (4,843 | ) |               |   | (2,777 | )
|Recoveries of loans previously charged-off |  |               | 158    |   |               |   | 200    |  
|                                           |  |               |        |   |               |   |        |  
|Net chargeoffs                             |  |               | (4,685 | ) |               |   | (2,577 | )
|                                           |  |               |        |   |               |   |        |  
|Ending balance                             |  | $             | 6,342  |   |               | $ | 6,197  |  
|                                           |  |               |        |   |               |   |        |  

Information with respect to non-homogeneous loans that were determined to be impaired as of the dates indicated is
summarized as follows (dollars in thousands):



|                                                               |  |               |        |  |              |   |        | 
|-------------------------------------------------------------- |  | ------------- | ------ |  | ------------ | - | ------ | 
|                                                               |  | September 30, |        |  | December 31, |  
|                                                               |  | 2010          |        |  | 2009         |  
|Impaired loans determined to not require specific allowances   |  | $             | 13,659 |  |              | $ | 6,313  | 
|Impaired loans on which specific allowances have been provided |  |               | 13,025 |  |              |   | 11,278 | 
|Specific allowances provided on impaired loans                 |  |               | 2,480  |  |              |   | 4,011  | 

Troubled debt restructurings (TDR)
are a subset of impaired loans and totaled $18.6 million at September 30, 2010. There were no loans categorized as TDRs at September 30, 2009.



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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 September 30, 2010 (dollars in thousands):



|                                    |  |   |        | 
|----------------------------------- |  | - | ------ | 
|Unfunded loan commitments           |  | $ | 38,471 | 
|Financial standby letters of credit |  |   | 2,477  | 
|                                    |  |   |        | 
|Total unused commitments            |  | $ | 40,948 | 
|                                    |  |   |        | 

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.

NOTE 6. OTHER COMPREHENSIVE INCOME (LOSS)

Generally accepted accounting principles 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 EndedSeptember 30 |      |   | Nine Months EndedSeptember 30 |  
|                                                                       |  | 2010                           |      |   | 2009                          |   |        | 2010 |  |   | 2009  |  
|                                                                       |  |                                |      |  
|Unrealized holding gains on securities available for sale              |  | $                              | 46   |   |                               | $ | 1,742  |      |  | $ | 2,204 |   |  | $ | 1,029  |  
|Reclassification adjustment for gains realized in net income           |  |                                | (178 | ) |                               |   | (1,246 | )    |  |   | (368  | ) |  |   | (1,341 | )
|                                                                       |  |                                |      |   |                               |   |        |      |  |   |       |   |  |   |        |  
|Net unrealized holding gains (losses) on securities available for sale |  |                                | (132 | ) |                               |   | 496    |      |  |   | 1,836 |   |  |   | (312   | )
|Income tax effect                                                      |  |                                | 51   |   |                               |   | (84    | )    |  |   | (707  | ) |  |   | 227    |  
|                                                                       |  |                                |      |   |                               |   |        |      |  |   |       |   |  |   |        |  
|Other comprehensive income (loss), net of income tax effect            |  | $                              | (81  | ) |                               | $ | 412    |      |  | $ | 1,129 |   |  | $ | (85    | )
|                                                                       |  |                                |      |   |                               |   |        |      |  |   |       |   |  |   |        |  

NOTE 7. RECENT ACCOUNTING PRONOUNCEMENTS

ASC 740 - Accounting for Uncertainty in Income Taxes - ASC 740 states that a company should evaluate the certainty that a tax position taken will be sustained upon examination. If the Company should
determine upon evaluation that a position is likely to not be upheld then the institution is responsible for its recognition on the financial statements. The Company adopted this standard on January 1, 2008 with no material impact on the
consolidated financial statements.



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ASC 805 - Business Combinations - This
statement changes the way that acquiring entities will account for business combinations. Some of the more significant changes are that the equity securities issued as consideration will be valued at the date that the acquirer takes control of
assets and assumes liabilities of the acquired company (typically, the date of closing), and that direct costs of the acquisition will be expensed as incurred rather than capitalized. This statement is effective for transactions closing on or after
January 1, 2009. The Company has not entered into any material business combination contracts so this statement has no anticipated impact on the consolidated financial statements.

ASC 820 - Fair Value Measurements - This pronouncement creates a framework for consistently measuring fair value of financial assets and liabilities. ASC 820 also requires increased interim and annual
disclosure of the assumptions used to determine fair values. This pronouncement was adopted on January 1, 2008. FSP 157-3 deferred adoption of ASC 820 for nonfinancial assets and liabilities until years beginning after November 15, 2008.
The Company has adopted ASC 820 with no material impact on financial statements.

ASC 320 - Recognition and Presentation of
Other-than-Temporary Impairments - was issued in April 2009. These statements amend the other-than-temporary impairment guidance in U.S. GAAP for debt securities to make it more operational and to enhance the presentation and disclosure of
other-than-temporary impairments in the financial statements. These statements clarify the factors that should be used to determine whether an other-than-temporary impairment has occurred and require a more detailed risk-oriented breakdown of major
security types. These statements were effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The Company adopted these standards June 30,
2009 with no material impact on the consolidated financial statements.

NOTE 8. FAIR VALUE

Generally accepted accounting principles 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 September 30, 2010 |        
|                                       |  | Total                 |         |  | Level 1 |   |   | Level 2 |  |   | Level 3 | 
|                                       |  |                       |         | 
|Assets valued on a recurring basis     |  |                       |         |  |         |   |   |         |  |   |         |  |  |   |   | 
|Investment securities:                 |  |                       |         |  |         |   |   |         |  |   |         |  |  |   |   | 
|U.S. government and agency             |  | $                     | 60,109  |  |         | $ |  |         |  | $ | 60,109  |  |  | $ |  | 
|Mortgage-backed                        |  |                       | 44,060  |  |         |   |  |         |  |   | 44,060  |  |  |   |  | 
|State and municipals                   |  |                       | 3,929   |  |         |   |  |         |  |   | 3,929   |  |  |   |  | 
|Corporate                              |  |                       | 4,879   |  |         |   |  |         |  |   | 4,879   |  |  |   |  | 
|Assets valued on a non-recurring basis |  |                       |         |  |         |   |   |         |  |   |         |  |  |   |   | 
|Impaired loans                         |  |                       | 24,204  |  |         |   |  |         |  |   | 24,204  |  |  |   |  | 
|Other real estate owned                |  |                       | 8,571   |  |         |   |  |         |  |   | 8,571   |  |  |   |  | 
|                                       |  |                       |         |  |         |   |   |         |  |   |         |  |  |   |   | 
|Total                                  |  | $                     | 145,752 |  |         | $ |  |         |  | $ | 145,752 |  |  | $ |  | 
|                                       |  |                       |         |  |         |   |   |         |  |   |         |  |  |   |   | 
|                                       | 
|                                       |  | At December 31, 2009  |        
|                                       |  | Total                 |         |  | Level 1 |   |   | Level 2 |  |   | Level 3 | 
|                                       |  |                       |         | 
|Assets valued on a recurring basis     |  |                       |         |  |         |   |   |         |  |   |         |  |  |   |   | 
|Investment securities:                 |  |                       |         |  |         |   |   |         |  |   |         |  |  |   |   | 
|U.S. government and agency             |  | $                     | 98,312  |  |         | $ |  |         |  | $ | 98,312  |  |  | $ |  | 
|Mortgage-backed                        |  |                       | 29,833  |  |         |   |  |         |  |   | 29,833  |  |  |   |  | 
|State and municipals                   |  |                       | 6,105   |  |         |   |  |         |  |   | 6,105   |  |  |   |  | 
|Corporate                              |  |                       | 5,683   |  |         |   |  |         |  |   | 5,683   |  |  |   |  | 
|Assets valued on a non-recurring basis |  |                       |         |  |         |   |   |         |  |   |         |  |  |   |   | 
|Impaired loans                         |  |                       | 13,509  |  |         |   |  |         |  |   | 13,509  |  |  |   |  | 
|Other real estate owned                |  |                       | 8,233   |  |         |   |  |         |  |   | 8,233   |  |  |   |  | 
|                                       |  |                       |         |  |         |   |   |         |  |   |         |  |  |   |   | 
|Total                                  |  | $                     | 161,675 |  |         | $ |  |         |  | $ | 161,675 |  |  | $ |  | 
|                                       |  |                       |         |  |         |   |   |         |  |   |         |  |  |   |   | 

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):



|                                                      |  |                    |        |  |                   |  |      |             |  |   |               |  |  |  |      |  
|----------------------------------------------------- |  | ------------------ | ------ |  | ----------------- |  | ---- | ----------- |  | - | ------------- |  |  |  | ---- | -
|                                                      |  | September 30, 2010 |        |  | December 31, 2009 | 
|                                                      |  | Outstanding        |        |  | Annual            |  |      | Outstanding |  |   | Annual        | 
|                                                      |  | Balance            |        |  | Interest Rate     |  |      | Balance     |  |   | Interest Rate | 
|                                                      |  |                    |        | 
|Securities sold under overnight repurchase agreements |  | $                  | 870    |  |                   |  | 0.15 | %           |  | $ | 1,682         |  |  |  | 0.53 | %
|Securities sold under term repurchase agreements      |  |                    | 45,000 |  |                   |  | 4.38 |             |  |   | 45,000        |  |  |  | 4.38 |  
|Federal Home Loan Bank advances                       |  |                    | 20,000 |  |                   |  | 1.24 |             |  |   | 15,000        |  |  |  | 3.15 |  
|Trust preferred securities                            |  |                    | 5,155  |  |                   |  | 3.20 |             |  |   | 5,155         |  |  |  | 3.20 |  
|Subordinated debt                                     |  |                    | 2,700  |  |                   |  | 4.00 |             |  |   | 2,700         |  |  |  | 4.00 |  
|                                                      |  |                    |        |  |                   |  |      |             |  |   |               |  |  |  |      |  
|Total borrowed funds                                  |  | $                  | 73,725 |  |                   |  | 3.38 | %           |  | $ | 69,537        |  |  |  | 3.92 | %
|                                                      |  |                    |        |  |                   |  |      |             |  |   |               |  |  |  |      |  

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 September 30, 2010 (dollars in thousands):



|                          |  |             |        |  |               |  |      |          |  |  |            |  |  |             |           |  |  |   |        | 
|------------------------- |  | ----------- | ------ |  | ------------- |  | ---- | -------- |  |  | ---------- |  |  | ----------- | --------- |  |  | - | ------ | 
|                          |  | Outstanding |        |  | Annual        |  |      | Final    |  |  | Beginning  |  |  |             |          
|                          |  | Principal   |        |  | Effective     |  |      | Maturity |  |  | Quarterly  |  |  | Collateral  |          
|                          |  | Balance     |        |  | Interest Rate |  |      | Date     |  |  | Call Dates |  |  | Requirement |          
|Agreement dated 7/8/2008  |  | $           | 25,000 |  |               |  | 4.85 | %        |  |  | 7/8/2018   |  |  |             | 7/8/2013  |  |  | $ | 33,669 | 
|Agreement dated 8/20/2008 |  |             | 20,000 |  |               |  | 3.78 |          |  |  | 8/20/2015  |  |  |             | 8/20/2011 |  |  |   | 23,380 | 
|                          |  |             |        |  |               |  |      |          |  |  |            |  |  |             |           |  |  |   |        | 
|Total                     |  | $           | 45,000 |  |               |  | 4.38 | %        |  |  |            |  |  |             |           |  |  | $ | 57,049 | 
|                          |  |             |        |  |               |  |      |          |  |  |            |  |  |             |           |  |  |   |        | 

The Bank utilizes borrowings from the Federal Home Loan Bank (FHLB) as a source of liquidity. At
September 30, 2010, 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 September 30, 2010 (dollars in thousands):



|                        |  |             |        |  |               |  |      |          |  |  |          | 
|----------------------- |  | ----------- | ------ |  | ------------- |  | ---- | -------- |  |  | -------- | 
|                        |  | Outstanding |        |  | Annual        |  |      | Final    | 
|                        |  | Principal   |        |  | Effective     |  |      | Maturity | 
|                        |  | Balance     |        |  | Interest Rate |  |      | Date     | 
|Advance dated 3/17/2008 |  | $           | 10,000 |  |               |  | 2.21 | %        |  |  | 03/18/13 | 
|Advance dated 2/16/2010 |  |             | 10,000 |  |               |  | 0.28 |          |  |  | 02/16/12 | 
|                        |  |             |        |  |               |  |      |          |  |  |          | 
|Total                   |  | $           | 20,000 |  |               |  | 1.24 | %        |  |  |          | 
|                        |  |             |        |  |               |  |      |          |  |  |          | 

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.

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 September 30, 2010 and December 31, 2009. All of the
shares were issued on April 17, 2009 in connection with the U.S. Treasurys TARP Capital Purchase Program.

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 September 30, 2010 and December 31, 2009.

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 September 30, 2010, total assets were $535.5 million, a decrease of 12.3% compared to $610.4 million at December 31, 2009. The asset decline was primarily the result of reductions in rate
sensitive deposits, mainly special rate money market deposits, which were funded by reductions in discretionary assets (investment securities, federal funds sold, and interest-bearing deposits in banks), as well as reductions in the loan portfolio.

Investment Securities

Investment securities totaled $113.0 million at September 30, 2010, compared to $140.0 million at December 31, 2009. The decline was a result of
the planned reduction in discretionary assets referred to above. A summary of the Companys investment securities holdings by major category at September 30, 2010 and December 31, 2009 is included in Note 3 of Notes to
Consolidated Financial Statements.

Loans and Allowance for Loan Losses

At September 30, 2010, the loan portfolio totaled $367.0 million and represented 68.5% of total assets compared to $391.3 million or 64.1% of total assets at December 31, 2009. Total loans at
September 30, 2010 decreased $24.3 million or 6.2% from December 31, 2009. 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 September 30,
2010 and December 31, 2009.

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



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believes the allowance is appropriate based on managements current analysis.

The
allowance for loan losses at September 30, 2010, amounted to $6.3 million, a decrease of $1.9 million, or 22.3% from December 31, 2009. This is primarily the result of $4.6 million in net charge-offs against the total loss allowance
related to loans for which specific allowances previously had been established and which were determined to be impaired during the nine-month period, while we recorded only $130,000 in net charge-offs against the general loss allowance in the
nine-month period. As a result of decreasing loans, the general allowance also decreased $295,000 during the nine-month period since December 31, 2009. 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 September 30, 2010 and December 31, 2009 (dollars in thousands):



|                                                                                |  |                   |        |   |                  |   |        |  
|------------------------------------------------------------------------------- |  | ----------------- | ------ | - | ---------------- | - | ------ | -
|                                                                                |  | September 30,2010 |        |   | December 31,2009 |  
|Loans accounted for on a nonaccrual basis:                                      |  |                   |        |   |                  |   |        |  
|Real estate loans:                                                              |  |                   |        |   |                  |   |        |  
|1-4 family residential                                                          |  | $                 | 1,848  |   |                  | $ | 2,971  |  
|Commercial real estate                                                          |  |                   | 5,111  |   |                  |   | 1,606  |  
|Construction and development                                                    |  |                   | 1,321  |   |                  |   | 1,488  |  
|                                                                                |  |                   |        |   |                  |   |        |  
|Total real estate loans                                                         |  |                   | 8,280  |   |                  |   | 6,065  |  
|Commercial business and other loans                                             |  |                   | 3,197  |   |                  |   | 3,151  |  
|Consumer loans                                                                  |  |                   | 157    |   |                  |   | 8      |  
|                                                                                |  |                   |        |   |                  |   |        |  
|Total nonaccrual loans                                                          |  |                   | 11,634 |   |                  |   | 9,224  |  
|Accruing loans which are contractually past due 90 days or more                 |  |                   |       |   |                  |   |       |  
|                                                                                |  |                   |        |   |                  |   |        |  
|Total nonperforming loans                                                       |  |                   | 11,634 |   |                  |   | 9,224  |  
|Other real estate owned                                                         |  |                   | 8,571  |   |                  |   | 8,233  |  
|                                                                                |  |                   |        |   |                  |   |        |  
|Total nonperforming assets                                                      |  | $                 | 20,205 |   |                  | $ | 17,457 |  
|                                                                                |  |                   |        |   |                  |   |        |  
|                                                                                |  |                  
|Total nonperforming loans as a percentage of loans                              |  |                   | 3.17   | % |                  |   | 2.36   | %
|Allowance for loan losses as a percentage of total nonperforming loans          |  |                   | 54.51  | % |                  |   | 88.54  | %
|Allowance for loan losses as a percentage of total loans                        |  |                   | 1.73   | % |                  |   | 2.09   | %
|Total nonperforming assets as a percentage of loans and other real estate owned |  |                   | 5.38   | % |                  |   | 4.37   | %
|Total nonperforming assets as a percentage of total assets                      |  |                   | 3.77   | % |                  |   | 2.86   | %

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 September 30, 2010, total deposits were $415.0 million compared to $493.9 million at December 31, 2009. The September 30, 2010 amount represents a decrease of 16.0% from
December 31, 2009 and was the result of a reduction in interest-sensitive deposits, mainly money market accounts that were opened during a special promotion which began in July 2008 and offered a guaranteed rate through June 2009. While the
Companys overall deposits have decreased noticeably during the nine-month period of 2010, the mix of deposits has also changed toward a more cost effective source of funds. At September 30, 2010, money market deposits comprised 27.6% of
total deposits compared to 45.5% at December 31, 2009 and, although brokered deposits decreased by $3.2 million, they were 16.3% of total deposits at September 30, 2010 compared to 14.4% at December 31, 2009.



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The following table presents a
breakdown of our deposit base at September 30, 2010 and December 31, 2009 (dollars in thousands):



|                                                                   |  |                   |         |   |                  |   |         |  
|------------------------------------------------------------------ |  | ----------------- | ------- | - | ---------------- | - | ------- | -
|                                                                   |  | September 30,2010 |         |   | December 31,2009 |  
|Noninterest bearing demand deposits                                |  | $                 | 35,531  |   |                  | $ | 36,418  |  
|Interest checking deposits                                         |  |                   | 32,768  |   |                  |   | 34,614  |  
|Savings deposits                                                   |  |                   | 12,448  |   |                  |   | 11,042  |  
|Money market deposits                                              |  |                   | 114,334 |   |                  |   | 224,499 |  
|Customer time deposits                                             |  |                   | 152,110 |   |                  |   | 116,370 |  
|Brokered certificates of deposit                                   |  |                   | 67,767  |   |                  |   | 70,974  |  
|                                                                   |  |                   |         |   |                  |   |         |  
|Total deposits                                                     |  | $                 | 414,958 |   |                  | $ | 493,917 |  
|                                                                   |  |                   |         |   |                  |   |         |  
|                                                                   |  |                  
|Time deposits $100,000 or more:                                    |  |                   |         |   |                  |   |         |  
|Brokered certificates of deposit                                   |  | $                 | 67,767  |   |                  | $ | 70,974  |  
|Customer time deposits issued in denominations of $100,000 or more |  |                   | 70,233  |   |                  |   | 44,939  |  
|                                                                   |  |                   |         |   |                  |   |         |  
|Total time deposits issued in denominations of $100,000 or more    |  | $                 | 138,000 |   |                  | $ | 115,913 |  
|                                                                   |  |                   |         |   |                  |   |         |  
|                                                                   |  |                  
|As a percent of total deposits:                                    |  |                   |         |   |                  |   |         |  
|Noninterest bearing demand deposits                                |  |                   | 8.56    | % |                  |   | 7.37    | %
|Interest checking deposits                                         |  |                   | 7.90    |   |                  |   | 7.01    |  
|Savings deposits                                                   |  |                   | 3.00    |   |                  |   | 2.24    |  
|Money market deposits                                              |  |                   | 27.55   |   |                  |   | 45.45   |  
|Customer time deposits                                             |  |                   | 36.66   |   |                  |   | 23.56   |  
|Brokered certificates of deposit                                   |  |                   | 16.33   |   |                  |   | 14.37   |  
|                                                                   |  |                  
|Total time deposits issued in denominations of $100,000 or more    |  |                   | 33.26   |   |                  |   | 23.47   |  

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 September 30, 2010 our balance sheet liquidity ratio (net liquid assets as a percent of unsecured liabilities) amounted to 15.1% and our total liquidity ratio (balance sheet plus
off-balance sheet liquidity) was 17.4%.

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 $5.0 million unsecured and $14.0 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 September 30, 2010, 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 September 30, 2010 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 September 30, 2010, 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 September 30, 2010, the Companys Tier 1 and Total risk-weighted Capital Ratios were 10.56% and 12.43%, respectively, which were well above the minimum levels required by regulatory
guidelines. At September 30, 2010, the Companys Leverage Capital Ratio was 8.57%, which was also well above the minimum level required by the regulatory guidelines. On September 30, 2010, the Banks Tier 1 and Total
risk-weighted Capital Ratios were 10.96% and 12.22%, respectively, both well above the minimum levels required by regulatory guidelines. On September 30, 2010, the Banks leverage ratio was 8.90%, 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 are both considered well-capitalized as of September 30, 2010.

RESULTS OF OPERATIONS

Three Months Ended September 30, 2010 and 2009

Overview. For the three months
ended September 30, 2010, the Company incurred a net loss available to common shareholders of $147,000, or $0.04 per common share. This compares to a net income of $470,000, or $0.12 per common share, for the three months ended
September 30, 2009. When the gains on sale of investment securities are excluded in each of the third quarters, the third quarter of 2010 would have been an improvement in comparison to the third quarter of 2009. The third quarters in each of
the past two years were affected by credit losses related to the extended economic downturn that were at levels well above those we experienced prior to 2008.

Net Interest Income. The Companys net interest income for the three months ended September 30, 2010 totaled $4.1 million, which is almost identical to net interest income realized in the
third quarter of 2009. Net interest income remained flat due to the net result of a $1.6 million decline in interest income brought about by lower volume and declining yields on earning assets, offset by a $1.6 million decline in interest expense
primarily attributable to a decrease in interest expense on deposits resulting from a decline in interest rates and declines in the balances of money market accounts and brokered certificates of deposit. Net interest margin increased 62 basis points
from 2.73% in the third quarter of 2009 to 3.35% in the third quarter of 2010.



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Provision for Loan Losses. The
loan loss provision amounted to $858,000 for the quarter ended September 30, 2010, a decrease of $188,000, or 18.0%, from the $1,046,000 provision recorded in the comparable quarter of 2009. Net charge-offs totaled $1.7 million in the third
quarter of 2010 compared to $1.6 million in the third quarter of 2009.

Noninterest Income. Noninterest income totaled $589,000
(including $178,000 in gains on sale of investment securities) for the three months ended September 30, 2010 compared to $1,715,000 (including $1,246,000 in gains on sale of investment securities) for the comparable three-month period of 2009.
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 September 30, 2010 and 2009.

Noninterest Expenses. Noninterest expenses totaled $3.8 million for the three months
ended September 30, 2010 and 2009. Noninterest expenses affecting overhead cost were: (1) salaries and benefits, which increased $75,000 as a result of transferring an administrative function from an external provider to in-house
employees; (2) FDIC insurance assessment, which decreased $62,000 due to the reduction in deposits; and (3) data processing expense, which decreased $120,000 due to a core system conversion in the third quarter of 2009.

Income Taxes. The Company accrued an income tax benefit of $31,000 for the three months ending September 30, 2010 compared to an income tax
expense of $137,000 for the third quarter of 2009. The tax benefit was a result of the Companys loss for the three months ended September 30, 2010 and the tax expense was a result of the Companys taxable income for the three months
ended September 30, 2009.

Nine Months Ended September 30, 2010 and 2009

Overview. For the nine months ended September 30, 2010, the Company incurred a net loss available to common shareholders of $1.0 million, or
$0.26 per common share. This compares to a net loss of $1.8 million, or $0.45 per common share for the nine months ended September 30, 2009. The losses realized in the first nine months in each of the past two years stem from the extended
economic downturn which has led to credit losses well above the levels we experienced prior to 2008.

Net Interest Income. The
Companys net interest income for the nine months ended September 30, 2010 totaled $12.6 million, an increase of $2.3 million, or 22.3%, over the $10.3 million in net interest income realized in the comparable period of 2009. The increase
was the net result of a $4.0 million decline in interest income brought about by lower volume and declining yields on earning assets being more than offset by a $6.3 million decline in interest expense primarily attributable to a decrease in
interest expense on deposits resulting from a decline in interest rates and declines in the balances in money market accounts and brokered certificates of deposit. Net interest margin increased 87 basis points from 2.43% for the nine-month period of
2009 to 3.30% in the nine-month period of 2010.

Provision for Loan Losses. The loan loss provision amounted to $2.9 million for the
nine months ended September 30, 2010, an increase of $394,000, or 16.0%, from the $2.5 million provision recorded in the comparable period of 2009. Net charge-offs totaled $4.7 million in the first nine months of 2010 compared to $2.7 million
in the first nine months of 2009.

Noninterest Income. Noninterest income totaled $1.6 million for the nine months ended
September 30, 2010 compared to $2.7 million for the comparable period of 2009. The decrease was substantially the result of higher levels of gains realized on the sale of investment securities available-for-sale during the previous years
nine-month period.

Noninterest Expenses. Noninterest expenses totaled $12.1 million for the nine months ended September 30, 2010
compared to $12.8 million for the same period in 2009, a decrease of $707,000 or 5.5%. The primary source of this decrease was reduction in other real estate owned expenses and valuation provisions of $698,000 compared to the same nine-month period
of 2009. Other noninterest expenses affecting overhead cost were: (1) salaries and benefits, which increased $441,000 as a result of funding our employees Health Savings Accounts for all of 2010 in the first quarter, benefit payments to
terminated employees, and transferring an administrative function from an external provider to in-house employees; (2) FDIC insurance assessment, which decreased $215,000 due to the reduction in deposits; and (3) data processing expense,
which decreased $178,000 due to a core system conversion in the third quarter of 2009.



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Income Taxes. The Company
accrued an income tax benefit of $400,000 for the nine months ending September 30, 2010 compared to an income tax benefit of $976,000 for the comparable period of 2009. The tax benefit was a result of the Companys loss for the nine months
ended September 30, 2010 and 2009.

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

Not applicable



|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
|-------- | ------------

The Dodd-Frank Wall Street
Reform and Consumer Protection Act of 2010 was enacted on July 21, 2010. The Dodd-Frank Act creates a new Consumer Financial Protection Bureau with power to promulgate and enforce consumer protection laws. Smaller depository institutions (those
with $10 billion or less in assets) will be subject to the Consumer Financial Protection Bureaus rule-writing authority, and existing depository institution regulatory agencies will retain examination and enforcement authority for such
institutions. The Dodd-Frank Act also establishes a Financial Stability Oversight Council chaired by the Secretary of the Treasury with authority to identify institutions and practices that might pose a systemic risk and, among other things,
includes provisions affecting (1) corporate governance and executive compensation of all companies whose securities are registered with the SEC, (2) FDIC insurance assessments, (3) interchange fees for debit cards, which would be set
by the Federal Reserve under a restrictive reasonable and proportional cost per transaction standard, (4) minimum capital levels for bank holding companies, subject to a grandfather clause for financial institutions with less than
$15 billion in assets, (5) derivative and proprietary trading by financial institutions, and (6) the resolution of large financial institutions.

At this time, it is difficult to predict the extent to which the Dodd-Frank Act or the resulting regulations may adversely impact the Company. However, compliance with these new laws and regulations will
likely increase the Companys costs and may limit its ability to pursue attractive business opportunities, cause the Company to modify its strategies and business operations and increase its capital requirements and constraints, any of which
may have a material adverse impact on its business, financial condition, liquidity or results of operations.



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

None



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

None



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



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

None



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

The following
exhibits are provided with this report.



|      |  |                                                                                                                                 
|----- |  | --------------------------------------------------------------------------------------------------------------------------------
|10.01 |  | Landis Savings Bank, SSB Directors Retirement Plan (filed herewith)                                                            
|      | 
|31.01 |  | Certification of our Chief Executive Officer pursuant to Rule 13a-14(a) (furnished herewith)                                    
|      | 
|31.02 |  | Certification of our Chief Financial Officer pursuant to Rule 13a-14(a) (furnished herewith)                                    
|      | 
|32.01 |  | Certification of our Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 (furnished herewith)



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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: November 15, 2010 |  |  |  | By:                                               |  | /s/ Stephen R. Talbert
|                        |  |  |  | Stephen R. Talbert                               
|                        |  |  |  | President and Chief Executive Officer            
|                        |  |  | 
|Date: November 15, 2010 |  |  |  | By:                                               |  | /s/ Eric E. Rhodes    
|                        |  |  |  | Eric E. Rhodes                                   
|                        |  |  |  | Senior Vice President and Chief Financial Officer



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EXHIBIT INDEX



|              |  |                                                                                                                                 
|------------- |  | --------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                     
|              | 
|10.01         |  | Landis Savings Bank, SSB Directors Retirement Plan (filed herewith)                                                            
|              | 
|31.01         |  | Certification of our Chief Executive Officer pursuant to Rule 13a-14(a) (furnished herewith)                                    
|              | 
|31.02         |  | Certification of our Chief Financial Officer pursuant to Rule 13a-14(a) (furnished herewith)                                    
|              | 
|32.01         |  | Certification of our Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 (furnished herewith)



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