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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 March 31, 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  x    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   ̈    No  x

On May 17, 2010 there were 3,897,174 outstanding shares of the registrants common stock.









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##### Table of Contents

BANK OF THE CAROLINAS CORPORATION

FORM 10-Q

March 31, 2010

INDEX



|                                                                                                               |  |   
|-------------------------------------------------------------------------------------------------------------- |  | --
|Part I. FINANCIAL INFORMATION                                                                                  |  |   
|                                                                                                               | 
|Item 1. Financial Statements                                                                                   |  |   
|                                                                                                               | 
|Consolidated Balance Sheets at March 31, 2010 and December 31, 2009                                            |  | 3 
|                                                                                                               | 
|Consolidated Statements of Operations for the Three Months Ended March 31, 2010 and
2009                       |  | 4 
|                                                                                                               | 
|Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2010 and
2009                       |  | 5 
|                                                                                                               | 
|Consolidated Statements of Changes in Stockholders Equity for the Three Months Ended March 
31, 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                                              |  | 24
|                                                                                                               | 
|Item 4. Controls and Procedures                                                                                |  | 25
|                                                                                                               | 
|Part II. OTHER INFORMATION                                                                                     |  |   
|                                                                                                               | 
|Item 1. Legal Proceedings                                                                                      |  | 25
|                                                                                                               | 
|Item 1A. Risk Factors                                                                                          |  | 25
|                                                                                                               | 
|Item 2. Unregistered Sales of Equity Securities and Use of Proceeds                                            |  | 25
|                                                                                                               | 
|Item 3. Defaults Upon Senior Securities                                                                        |  | 25
|                                                                                                               | 
|Item 4. [Removed and Reserved]                                                                                 |  | 25
|                                                                                                               | 
|Item 5. Other Information                                                                                      |  | 25
|                                                                                                               | 
|Item 6. Exhibits                                                                                               |  | 25
|                                                                                                               | 
|SIGNATURES                                                                                                     |  | 26
|                                                                                                               | 
|EXHIBIT INDEX                                                                                                  |  | 27



2



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##### Table of Contents

PART I. FINANCIAL INFORMATION



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

Bank of the Carolinas Corporation

Consolidated Balance Sheets

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



|                                                          |  |               |            |   |                   |   |            |  
|--------------------------------------------------------- |  | ------------- | ---------- | - | ----------------- | - | ---------- | -
|                                                          |  | March 31,2010 |            |   | December 31,2009* |  
|                                                          |  | (Unaudited)   |            |   |                   |  
|Assets:                                                   |  |               |            |   |                   |   |            |  
|Cash and due from banks                                   |  | $             | 20,318     |   |                   | $ | 3,524      |  
|Federal funds sold and interest-bearing deposits in banks |  |               | 33,904     |   |                   |   | 33,835     |  
|Investment securities                                     |  |               | 95,674     |   |                   |   | 140,004    |  
|Loans                                                     |  |               | 380,890    |   |                   |   | 391,265    |  
|Less, allowance for loan losses                           |  |               | (7,050     | ) |                   |   | (8,167     | )
|                                                          |  |               |            |   |                   |   |            |  
|Loans, net                                                |  |               | 373,840    |   |                   |   | 383,098    |  
|Premises and equipment, net                               |  |               | 13,767     |   |                   |   | 14,010     |  
|Other real estate owned                                   |  |               | 9,023      |   |                   |   | 8,233      |  
|Bank owned life insurance                                 |  |               | 10,099     |   |                   |   | 10,010     |  
|Prepaid and deferred tax assets                           |  |               | 4,143      |   |                   |   | 5,470      |  
|Prepaid FDIC insurance assessment                         |  |               | 4,300      |   |                   |   | 4,569      |  
|Accrued interest receivable                               |  |               | 2,189      |   |                   |   | 2,397      |  
|Other assets                                              |  |               | 3,461      |   |                   |   | 5,237      |  
|                                                          |  |               |            |   |                   |   |            |  
|Total assets                                              |  | $             | 570,718    |   |                   | $ | 610,387    |  
|                                                          |  |               |            |   |                   |   |            |  
|                                                          |  |              
|Liabilities:                                              |  |               |            |   |                   |   |            |  
|Deposits:                                                 |  |               |            |   |                   |   |            |  
|Noninterest-bearing demand deposits                       |  | $             | 37,448     |   |                   | $ | 36,418     |  
|Interest-checking deposits                                |  |               | 34,697     |   |                   |   | 34,614     |  
|Savings and money market deposits                         |  |               | 180,554    |   |                   |   | 235,541    |  
|Time deposits                                             |  |               | 192,424    |   |                   |   | 187,344    |  
|                                                          |  |               |            |   |                   |   |            |  
|Total deposits                                            |  |               | 445,123    |   |                   |   | 493,917    |  
|Securities sold under agreements to repurchase            |  |               | 45,914     |   |                   |   | 46,682     |  
|Federal Home Loan Bank advances                           |  |               | 25,000     |   |                   |   | 15,000     |  
|Subordinated debt                                         |  |               | 7,855      |   |                   |   | 7,855      |  
|Other liabilities                                         |  |               | 1,921      |   |                   |   | 1,941      |  
|                                                          |  |               |            |   |                   |   |            |  
|Total liabilities                                         |  |               | 525,813    |   |                   |   | 565,395    |  
|                                                          |  |               |            |   |                   |   |            |  
|Commitments and Contingencies                             |  |               |           |   |                   |   |           |  
|Stockholders Equity:                                     |  |               |            |   |                   |   |            |  
|Preferred stock, no par value                             |  |               | 13,179     |   |                   |   | 13,179     |  
|Discount on preferred stock                               |  |               | (1,183     | ) |                   |   | (1,245     | )
|Common stock, $5 per share par value                      |  |               | 19,486     |   |                   |   | 19,486     |  
|Additional paid-in capital                                |  |               | 12,985     |   |                   |   | 12,978     |  
|Retained earnings (deficit)                               |  |               | (162       | ) |                   |   | 300        |  
|Accumulated other comprehensive income                    |  |               | 600        |   |                   |   | 294        |  
|                                                          |  |               |            |   |                   |   |            |  
|Total stockholders equity                                |  |               | 44,905     |   |                   |   | 44,992     |  
|                                                          |  |               |            |   |                   |   |            |  
|Total liabilities and stockholders equity                |  | $             | 570,718    |   |                   | $ | 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.



3



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Bank of the Carolinas Corporation

Consolidated Statements of Operations

(dollars in thousands, except per share data)



|                                                                                    |  |                              |       |   |      |   |       |  
|----------------------------------------------------------------------------------- |  | ---------------------------- | ----- | - | ---- | - | ----- | -
|                                                                                    |  | Three Months EndedMarch 
31, |      
|                                                                                    |  | 2010                         |       |   | 2009 |  
|                                                                                    |  | (Unaudited)                  |      
|Interest income                                                                     |  |                              |       |   |      |   |       |  
|Interest and fees on loans                                                          |  | $                            | 5,383 |   |      | $ | 6,052 |  
|Interest on securities                                                              |  |                              | 934   |   |      |   | 1,463 |  
|Other interest income                                                               |  |                              | 17    |   |      |   | 22    |  
|                                                                                    |  |                              |       |   |      |   |       |  
|Total interest income                                                               |  |                              | 6,334 |   |      |   | 7,537 |  
|                                                                                    |  |                              |       |   |      |   |       |  
|                                                                                    |  |                             
|Interest expense                                                                    |  |                              |       |   |      |   |       |  
|Interest on deposits                                                                |  |                              | 1,449 |   |      |   | 3,542 |  
|Interest on borrowed funds                                                          |  |                              | 672   |   |      |   | 811   |  
|                                                                                    |  |                              |       |   |      |   |       |  
|Total interest expense                                                              |  |                              | 2,121 |   |      |   | 4,353 |  
|                                                                                    |  |                              |       |   |      |   |       |  
|                                                                                    |  |                             
|Net interest income                                                                 |  |                              | 4,213 |   |      |   | 3,184 |  
|Provision for loan losses                                                           |  |                              | 916   |   |      |   | 700   |  
|                                                                                    |  |                              |       |   |      |   |       |  
|Net interest income after provision for loan losses                                 |  |                              | 3,297 |   |      |   | 2,484 |  
|                                                                                    |  |                              |       |   |      |   |       |  
|                                                                                    |  |                             
|Noninterest income                                                                  |  |                              |       |   |      |   |       |  
|Customer service fees                                                               |  |                              | 315   |   |      |   | 312   |  
|Increase in value of bank owned life insurance                                      |  |                              | 89    |   |      |   | 89    |  
|Gains on investment securities                                                      |  |                              | 96    |   |      |   |      |  
|Other income                                                                        |  |                              | 3     |   |      |   | 5     |  
|                                                                                    |  |                              |       |   |      |   |       |  
|Total noninterest income                                                            |  |                              | 503   |   |      |   | 406   |  
|                                                                                    |  |                              |       |   |      |   |       |  
|                                                                                    |  |                             
|Noninterest expense                                                                 |  |                              |       |   |      |   |       |  
|Salaries and benefits                                                               |  |                              | 1,915 |   |      |   | 1,671 |  
|Occupancy and equipment                                                             |  |                              | 595   |   |      |   | 562   |  
|FDIC insurance assessments                                                          |  |                              | 299   |   |      |   | 335   |  
|Data processing services                                                            |  |                              | 206   |   |      |   | 243   |  
|Valuation provisions and net operating costs associated with foreclosed real estate |  |                              | 369   |   |      |   | 136   |  
|Other                                                                               |  |                              | 851   |   |      |   | 913   |  
|                                                                                    |  |                              |       |   |      |   |       |  
|Total noninterest expense                                                           |  |                              | 4,235 |   |      |   | 3,860 |  
|                                                                                    |  |                              |       |   |      |   |       |  
|Loss before income taxes                                                            |  |                              | (435  | ) |      |   | (970  | )
|Provision for income taxes                                                          |  |                              | (200  | ) |      |   | (315  | )
|                                                                                    |  |                              |       |   |      |   |       |  
|Net loss                                                                            |  |                              | (235  | ) |      |   | (655  | )
|Dividends and accretion on preferred stock                                          |  |                              | (227  | ) |      |   |      |  
|                                                                                    |  |                              |       |   |      |   |       |  
|Net loss available to common stockholders                                           |  | $                            | (462  | ) |      | $ | (655  | )
|                                                                                    |  |                              |       |   |      |   |       |  
|Loss per common share:                                                              |  |                              |       |   |      |   |       |  
|Basic                                                                               |  | $                            | (0.12 | ) |      | $ | (0.17 | )
|                                                                                    |  |                              |       |   |      |   |       |  
|Diluted                                                                             |  | $                            | (0.12 | ) |      | $ | (0.17 | )
|                                                                                    |  |                              |       |   |      |   |       |  

See accompanying notes.



4



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Bank of the Carolinas Corporation

Consolidated Statements of Cash Flows

(dollars in thousands)



|                                                                                                 |  |                             |         |   |      |   |         |  
|------------------------------------------------------------------------------------------------ |  | --------------------------- | ------- | - | ---- | - | ------- | -
|                                                                                                 |  | Three Months EndedMarch 31, |        
|                                                                                                 |  | 2010                        |         |   | 2009 |  
|                                                                                                 |  | (Unaudited)                 |        
|Cash Flows from Operating Activities:                                                            |  |                             |         |   |      |   |         |  
|Net loss                                                                                         |  | $                           | (235    | ) |      | $ | (655    | )
|Adjustments to reconcile net loss to net cash provided by operating activities:                  |  |                             |         |   |      |   |         |  
|Provision for loan losses                                                                        |  |                             | 916     |   |      |   | 700     |  
|Stock based compensation expense                                                                 |  |                             | 7       |   |      |   | 5       |  
|Depreciation and amortization                                                                    |  |                             | 272     |   |      |   | 259     |  
|Change in valuation allowance on other real estate owned                                         |  |                             | 114     |   |      |   | (123    | )
|Loss on sale of other real estate owned                                                          |  |                             | 156     |   |      |   | 32      |  
|Gain on sale of securities                                                                       |  |                             | (96     | ) |      |   |        |  
|Increase in cash value of bank owned life insurance                                              |  |                             | (89     | ) |      |   | (89     | )
|Net amortization/accretion of premiums and discounts on investments                              |  |                             | 93      |   |      |   | 4       |  
|Net change in other assets                                                                       |  |                             | 3,885   |   |      |   | (39     | )
|Net change in other liabilities                                                                  |  |                             | (19     | ) |      |   | 385     |  
|                                                                                                 |  |                             |         |   |      |   |         |  
|Net cash provided by operating activities                                                        |  |                             | 5,004   |   |      |   | 479     |  
|                                                                                                 |  |                             |         |   |      |   |         |  
|                                                                                                 |  |                            
|Cash Flows from Investing Activities:                                                            |  |                             |         |   |      |   |         |  
|Increase in federal funds sold                                                                   |  |                             | (4,685  | ) |      |   | (9,000  | )
|Purchases of premises and equipment                                                              |  |                             | (29     | ) |      |   | (309    | )
|Purchases of securities                                                                          |  |                             | (9,000  | ) |      |   | (39,305 | )
|Proceeds from sales, calls, maturities and principal repayments of securities available for sale |  |                             | 53,333  |   |      |   | 11,537  |  
|Purchase of FHLB stock                                                                           |  |                             |        |   |      |   | (103    | )
|Improvements made to other real estate owned                                                     |  |                             | (19     | ) |      |   |        |  
|Proceeds from sales of other real estate owned                                                   |  |                             | 617     |   |      |   | 125     |  
|Net (increase) decrease in loans                                                                 |  |                             | 6,684   |   |      |   | (1,845  | )
|                                                                                                 |  |                             |         |   |      |   |         |  
|Net cash provided (used) by investing activities                                                 |  |                             | 46,901  |   |      |   | (38,900 | )
|                                                                                                 |  |                             |         |   |      |   |         |  
|                                                                                                 |  |                            
|Cash Flows from Financing Activities:                                                            |  |                             |         |   |      |   |         |  
|Net increase (decrease) in deposits                                                              |  |                             | (48,794 | ) |      |   | 40,732  |  
|Net additions (repayments) of other borrowings                                                   |  |                             | 10,000  |   |      |   | (2,000  | )
|Decrease in repurchase agreements                                                                |  |                             | (768    | ) |      |   | (24     | )
|Cash dividends paid on preferred stock                                                           |  |                             | (165    | ) |      |   |        |  
|                                                                                                 |  |                             |         |   |      |   |         |  
|Net cash provided (used) by financing activities                                                 |  |                             | (39,727 | ) |      |   | 38,708  |  
|                                                                                                 |  |                             |         |   |      |   |         |  
|Net increase in cash and cash equivalents                                                        |  |                             | 12,178  |   |      |   | 287     |  
|Cash and cash equivalents at beginning of period                                                 |  |                             | 12,544  |   |      |   | 10,491  |  
|                                                                                                 |  |                             |         |   |      |   |         |  
|Cash and cash equivalents at end of period                                                       |  | $                           | 24,722  |   |      | $ | 10,778  |  
|                                                                                                 |  |                             |         |   |      |   |         |  
|                                                                                                 |  |                            
|Supplemental disclosure of cash flow information:                                                |  |                             |         |   |      |   |         |  
|Cash paid during the period for interest                                                         |  | $                           | 2,329   |   |      | $ | 4,388   |  
|                                                                                                 |  |                             |         |   |      |   |         |  
|                                                                                                 |  |                            
|Noncash investing and financing activities:                                                      |  |                             |         |   |      |   |         |  
|Change in fair value of securities available for sale, net of tax                                |  | $                           | 306     |   |      | $ | 194     |  
|                                                                                                 |  |                             |         |   |      |   |         |  
|Transfer from loans to other real estate owned                                                   |  | $                           | 1,658   |   |      | $ | 895     |  
|                                                                                                 |  |                             |         |   |      |   |         |  

See accompanying notes.



5



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Bank of the Carolinas Corporation

Consolidated Statements of Changes in Stockholders Equity

(dollars in thousands)

(unaudited)



|                                      |  |                 |  |                            |        |  |              |        |                          |  |                           |  |   |                                     |  |                          |        |  |   |       |   |  |   |       |  |   |        |  
|------------------------------------- |  | --------------- |  | -------------------------- | ------ |  | ------------ | ------ | ------------------------ |  | ------------------------- |  | - | ----------------------------------- |  | ------------------------ | ------ |  | - | ----- | - |  | - | ----- |  | - | ------ | -
|                                      |  | Preferred Stock |  | Discounton 
PreferredStock |        |  | Common Stock |        | AdditionalPaid-InCapital |  | RetainedEarnings(Deficit) |  |   | AccumulatedOtherComprehensiveIncome |  | TotalStockholdersEquity |       
|                                      |  | Shares          |  | Amount                     |        |  | Shares       |        | Amount                   |  |                           |  |  
|                                      |  |                 |  |                            |        |  |              |        |                         
|Balance, December 31, 2008            |  |                |  | $                          |       |  | $            |       |                          |  | 3,891,174                 |  | $ | 19,456                              |  | $                        | 11,625 |  | $ | 4,067 |   |  | $ | 1,443 |  | $ | 36,591 |  
|Net loss                              |  |                 |  |                            |        |  |              |        |                          |  |                           |  |   |                                     |  |                          |        |  |   | (655  | ) |  |   |       |  |   | (655   | )
|Other comprehensive income            |  |                 |  |                            |        |  |              |        |                          |  |                           |  |   |                                     |  |                          |        |  |   |       |   |  |   | 194   |  |   | 194    |  
|                                      |  |                 |  |                            |        |  |              |        |                          |  |                           |  |   |                                     |  |                          |        |  |   |       |   |  |   |       |  |   |        |  
|Total comprehensive loss              |  |                 |  |                            |        |  |              |        |                          |  |                           |  |   |                                     |  |                          |        |  |   |       |   |  |   |       |  |   | (461   | )
|Stock based compensation expense      |  |                 |  |                            |        |  |              |        |                          |  |                           |  |   |                                     |  |                          | 5      |  |   |       |   |  |   |       |  |   | 5      |  
|                                      |  |                 |  |                            |        |  |              |        |                          |  |                           |  |   |                                     |  |                          |        |  |   |       |   |  |   |       |  |   |        |  
|Balance, March 31, 2009               |  |                |  | $                          |       |  | $            |       |                          |  | 3,891,174                 |  | $ | 19,456                              |  | $                        | 11,630 |  | $ | 3,412 |   |  | $ | 1,637 |  | $ | 36,135 |  
|                                      |  |                 |  |                            |        |  |              |        |                          |  |                           |  |   |                                     |  |                          |        |  |   |       |   |  |   |       |  |   |        |  
|                                      |  |                 |  |                            |        |  |              |        |                         
|Balance, December 31, 2009            |  | 13,179          |  | $                          | 13,179 |  | $            | (1,245 | )                        |  | 3,897,174                 |  | $ | 19,486                              |  | $                        | 12,978 |  | $ | 300   |   |  | $ | 294   |  | $ | 44,992 |  
|Net loss                              |  |                 |  |                            |        |  |              |        |                          |  |                           |  |   |                                     |  |                          |        |  |   | (235  | ) |  |   |       |  |   | (235   | )
|Other comprehensive income            |  |                 |  |                            |        |  |              |        |                          |  |                           |  |   |                                     |  |                          |        |  |   |       |   |  |   | 306   |  |   | 306    |  
|                                      |  |                 |  |                            |        |  |              |        |                          |  |                           |  |   |                                     |  |                          |        |  |   |       |   |  |   |       |  |   |        |  
|Total comprehensive income            |  |                 |  |                            |        |  |              |        |                          |  |                           |  |   |                                     |  |                          |        |  |   |       |   |  |   |       |  |   | 71     |  
|Stock based compensation expense      |  |                 |  |                            |        |  |              |        |                          |  |                           |  |   |                                     |  |                          | 7      |  |   |       |   |  |   |       |  |   | 7      |  
|Discount/accretion on preferred stock |  |                 |  |                            |        |  |              | 62     |                          |  |                           |  |   |                                     |  |                          |        |  |   | (62   | ) |  |   |       |  |   |       |  
|Dividends accrued on preferred stock  |  |                 |  |                            |        |  |              |        |                          |  |                           |  |   |                                     |  |                          |        |  |   | (165  | ) |  |   |       |  |   | (165   | )
|                                      |  |                 |  |                            |        |  |              |        |                          |  |                           |  |   |                                     |  |                          |        |  |   |       |   |  |   |       |  |   |        |  
|Balance, March 31, 2010               |  | 13,179          |  | $                          | 13,179 |  | $            | (1,183 | )                        |  | 3,897,174                 |  | $ | 19,486                              |  | $                        | 12,985 |  | $ | (162  | ) |  | $ | 600   |  | $ | 44,905 |  
|                                      |  |                 |  |                            |        |  |              |        |                          |  |                           |  |   |                                     |  |                          |        |  |   |       |   |  |   |       |  |   |        |  

See accompanying notes



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Notes to Consolidated Financial Statements

March 31, 2010 and 2009

(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 month periods ended March 31, 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
month period ended March 31, 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 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 per share have been computed based on the following:



|                                                                                                                                                                                |  |                             |  |          
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------- |  | ---------
|                                                                                                                                                                                |  | Three months endedMarch 31,
|                                                                                                                                                                                |  | 2010                        |  | 2009     
|                                                                                                                                                                                |  |                            
|Weighted average number of common shares outstanding                                                                                                                            |  | 3,897,174                   |  | 3,891,174
|                                                                                                                                                                                |  |                             |  |          
|                                                                                                                                                                                |  |                            
|Weighted average number of diluted common shares outstanding                                                                                                                    |  | 3,897,174                   |  | 3,891,174
|                                                                                                                                                                                |  |                             |  |          
|Common stock options and common stock warrants that were anti-dilutive due to the exercise price exceeding the weighted average
market value of shares traded during the period |  | 30,540                      |  | 94,660   
|                                                                                                                                                                                |  |                             |  |          
|Common stock options and common stock warrants that were anti-dilutive due to the net loss incurred by the
Company                                                              |  | 36,431                      |  | 1,499    
|                                                                                                                                                                                |  |                             |  |          

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



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NOTE 3. INVESTMENT SECURITIES

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



|                                               |  |                   |         |                     |   |               |  |   |        
|---------------------------------------------- |  | ----------------- | ------- | ------------------- | - | ------------- |  | - | -------
|                                               |  | March 31, 2010   
|                                               |  | AmortizedCost     |         | EstimatedFair Value |   | CarryingValue
|Investment securities available for sale:      |  |                   |         |                     |   |               |  |   |        
|U.S. Government agency securities              |  | $                 | 65,921  |                     | $ | 66,004        |  | $ | 66,004 
|Mortgage-backed securities                     |  |                   | 19,183  |                     |   | 19,914        |  |   | 19,914 
|State and municipal bonds                      |  |                   | 4,758   |                     |   | 4,957         |  |   | 4,957  
|Corporate securities                           |  |                   | 961     |                     |   | 895           |  |   | 895    
|                                               |  |                   |         |                     |   |               |  |   |        
|Total investment securities available for sale |  |                   | 90,823  |                     |   | 91,770        |  |   | 91,770 
|                                               |  |                   |        
|Investment securities held to maturity:        |  |                   |         |                     |   |               |  |   |        
|Corporate securities                           |  |                   | 3,904   |                     |   | 3,852         |  |   | 3,904  
|                                               |  |                   |         |                     |   |               |  |   |        
|Total investment securities                    |  | $                 | 94,727  |                     | $ | 95,622        |  | $ | 95,674 
|                                               |  |                   |         |                     |   |               |  |   |        
|                                               | 
|                                               |  | December 31, 2009
|                                               |  | AmortizedCost     |         | EstimatedFair Value |   | CarryingValue
|Investment securities available for sale:      |  |                   |         |                     |   |               |  |   |        
|U.S. Government agency securities              |  | $                 | 98,617  |                     | $ | 98,312        |  | $ | 98,312 
|Mortgage-backed securities                     |  |                   | 29,247  |                     |   | 29,833        |  |   | 29,833 
|State and municipal bonds                      |  |                   | 5,840   |                     |   | 6,105         |  |   | 6,105  
|Corporate securities                           |  |                   | 1,958   |                     |   | 1,860         |  |   | 1,860  
|                                               |  |                   |         |                     |   |               |  |   |        
|Total investment securities available for sale |  |                   | 135,662 |                     |   | 136,110       |  |   | 136,110
|                                               |  |                   |        
|Investment securities held to maturity:        |  |                   |         |                     |   |               |  |   |        
|Corporate securities                           |  |                   | 3,894   |                     |   | 3,823         |  |   | 3,894  
|                                               |  |                   |         |                     |   |               |  |   |        
|Total investment securities                    |  | $                 | 139,556 |                     | $ | 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):



|                                    |  |               |         |   |                  |   |         |  
|----------------------------------- |  | ------------- | ------- | - | ---------------- | - | ------- | -
|                                    |  | March 31,2010 |         |   | December 31,2009 |  
|Real estate loans:                  |  |               |         |   |                  |   |         |  
|1-4 family residential              |  | $             | 75,390  |   |                  | $ | 76,767  |  
|Commercial real estate              |  |               | 159,009 |   |                  |   | 161,904 |  
|Construction and development        |  |               | 39,965  |   |                  |   | 41,580  |  
|Home equity                         |  |               | 30,662  |   |                  |   | 30,775  |  
|                                    |  |               |         |   |                  |   |         |  
|Total real estate loans             |  |               | 305,026 |   |                  |   | 311,026 |  
|Commercial business and other loans |  |               | 71,488  |   |                  |   | 75,762  |  
|Consumer loans                      |  |               | 4,376   |   |                  |   | 4,477   |  
|                                    |  |               |         |   |                  |   |         |  
|Total loans                         |  |               | 380,890 |   |                  |   | 391,265 |  
|Allowance for loan losses           |  |               | (7,050  | ) |                  |   | (8,167  | )
|                                    |  |               |         |   |                  |   |         |  
|Total loans, net                    |  | $             | 373,840 |   |                  | $ | 383,098 |  
|                                    |  |               |         |   |                  |   |         |  

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



|                                           |  |                              |        |   |      |   |       |  
|------------------------------------------ |  | ---------------------------- | ------ | - | ---- | - | ----- | -
|                                           |  | Three Months Ended March 31, |       
|                                           |  | 2010                         |        |   | 2009 |  
|Beginning balance                          |  | $                            | 8,167  |   |      | $ | 6,308 |  
|Provision for loan losses                  |  |                              | 916    |   |      |   | 700   |  
|Loans charged-off                          |  |                              | (2,052 | ) |      |   | (97   | )
|Recoveries of loans previously charged-off |  |                              | 19     |   |      |   | 58    |  
|                                           |  |                              |        |   |      |   |       |  
|Net chargeoffs                             |  |                              | (2,033 | ) |      |   | (39   | )
|                                           |  |                              |        |   |      |   |       |  
|Ending balance                             |  | $                            | 7,050  |   |      | $ | 6,969 |  
|                                           |  |                              |        |   |      |   |       |  

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):



|                                                               |  |               |        |                  |   |       
|-------------------------------------------------------------- |  | ------------- | ------ | ---------------- | - | ------
|                                                               |  | March 31,2010 |        | December 31,2009
|Impaired loans determined to not require specific allowances   |  | $             | 8,396  |                  | $ | 6,313 
|Impaired loans on which specific allowances have been provided |  |               | 10,052 |                  |   | 11,278
|Specific allowances provided on impaired loans                 |  |               | 2,760  |                  |   | 4,011 



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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 March 31, 2010 (dollars in thousands):



|                          |  |   |       
|------------------------- |  | - | ------
|Unfunded loan commitments |  | $ | 37,430
|Standby letters of credit |  |   | 2,477 
|                          |  |   |       
|Total                     |  | $ | 39,907
|                          |  |   |       

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 who is the Companys and the Banks director, instituted a lawsuit against the Bank and several
individuals on May 14, 2010, as described under Part II, Item 1 of this Quarterly Report on Form 10-Q (Legal Proceedings). Based on the advice of outside counsel, the Company believes that the claims against the Bank are without merit,
and the Bank intends to vigorously defend any action that may be commenced against it.

NOTE 6. OTHER COMPREHENSIVE INCOME

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. Accounting principles do not require per share amounts of comprehensive income to be disclosed. The components of other comprehensive income and related income tax effects are as follows (dollars in thousands):



|                                                              |  |                              |      |   |      |   |      |  
|------------------------------------------------------------- |  | ---------------------------- | ---- | - | ---- | - | ---- | -
|                                                              |  | Three Months EndedMarch 
31, |     
|                                                              |  | 2010                         |      |   | 2009 |  
|Unrealized holding gains on securities available for sale     |  | $                            | 594  |   |      | $ | 465  |  
|Reclassification adjustment for gains realized in net income  |  |                              | (96  | ) |      |   |     |  
|                                                              |  |                              |      |   |      |   |      |  
|Net unrealized holding gains on securities available for sale |  |                              | 498  |   |      |   | 465  |  
|Income tax effect                                             |  |                              | (192 | ) |      |   | (271 | )
|                                                              |  |                              |      |   |      |   |      |  
|Other comprehensive income, net of income tax effect          |  | $                            | 306  |   |      | $ | 194  |  
|                                                              |  |                              |      |   |      |   |      |  

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 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

Effective January 1, 2008, generally accepted accounting principles require that certain assets and liabilities be measured at fair value and to
record any adjustments to the fair value of those assets. Securities are recorded at fair value on a recurring basis while other assets are recorded at fair value on a non-recurring basis such as impaired loans.

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 summarized the Companys assets measured at fair value at the dates indicated
(dollars in thousands):



|                                       |  |                      |         |         |   |         |  |         |         |  |   |  
|-------------------------------------- |  | -------------------- | ------- | ------- | - | ------- |  | ------- | ------- |  | - | -
|                                       |  | At March 31, 2010   
|                                       |  | Total                |         | Level 1 |   | Level 2 |  | Level 3
|Assets valued on a recurring basis     |  |                      |         |         |   |         |  |         |         |  |   |  
|Investment securities:                 |  |                      |         |         |   |         |  |         |         |  |   |  
|U.S. government agencies securities    |  | $                    | 66,004  |         | $ |        |  | $       | 66,004  |  | $ | 
|Mortgage-backed securities             |  |                      | 19,914  |         |   |        |  |         | 19,914  |  |   | 
|State and municipal bonds              |  |                      | 4,957   |         |   |        |  |         | 4,957   |  |   | 
|Corporate securities                   |  |                      | 4,747   |         |   |        |  |         | 4,747   |  |   | 
|Assets valued on a non-recurring basis |  |                      |         |         |   |         |  |         |         |  |   |  
|Impaired loans                         |  |                      | 15,688  |         |   |        |  |         | 15,688  |  |   | 
|Other real estate owned                |  |                      | 9,023   |         |   |        |  |         | 9,023   |  |   | 
|                                       |  |                      |         |         |   |         |  |         |         |  |   |  
|Total                                  |  | $                    | 120,333 |         | $ |        |  | $       | 120,333 |  | $ | 
|                                       |  |                      |         |         |   |         |  |         |         |  |   |  
|                                       | 
|                                       |  | At December 31, 2009
|                                       |  | Total                |         | Level 1 |   | Level 2 |  | Level 3
|Assets valued on a recurring basis     |  |                      |         |         |   |         |  |         |         |  |   |  
|Investment securities:                 |  |                      |         |         |   |         |  |         |         |  |   |  
|U.S. government agencies securities    |  | $                    | 98,312  |         | $ |        |  | $       | 98,312  |  | $ | 
|Mortgage-backed securities             |  |                      | 29,833  |         |   |        |  |         | 29,833  |  |   | 
|State and municipal bonds              |  |                      | 6,105   |         |   |        |  |         | 6,105   |  |   | 
|Corporate securities                   |  |                      | 5,683   |         |   |        |  |         | 5,683   |  |   | 
|Assets valued on a non-recurring basis |  |                      |         |         |   |         |  |         |         |  |   |  
|Impaired loans                         |  |                      | 13,580  |         |   |        |  |         | 13,580  |  |   | 
|Other real estate owned                |  |                      | 8,233   |         |   |        |  |         | 8,233   |  |   | 
|                                       |  |                      |         |         |   |         |  |         |         |  |   |  
|Total                                  |  | $                    | 161,746 |         | $ |        |  | $       | 161,746 |  | $ | 
|                                       |  |                      |         |         |   |         |  |         |         |  |   |  

NOTE 9. BORROWED FUNDS

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



|                                                                                  |  |                    |        |                     |                   |   |                    |   |                     |  |      |  
|--------------------------------------------------------------------------------- |  | ------------------ | ------ | ------------------- | ----------------- | - | ------------------ | - | ------------------- |  | ---- | -
|                                                                                  |  | March 31, 2010     |        |                     | December 31, 2009 |  
|                                                                                  |  | OutstandingBalance |        | AnnualInterest Rate |                   |   | OutstandingBalance |   | AnnualInterest Rate | 
|Federal funds purchased and securities sold under overnight repurchase agreements |  | $                  | 914    |                     | 0.18              | % |                    | $ | 1,682               |  | 0.53 | %
|Securities sold under term repurchase agreements                                  |  |                    | 45,000 |                     | 4.38              |   |                    |   | 45,000              |  | 4.38 |  
|Federal Home Loan Bank advances                                                   |  |                    | 25,000 |                     | 1.95              |   |                    |   | 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                                                              |  | $                  | 78,769 |                     | 3.47              | % |                    | $ | 69,537              |  | 3.92 | %
|                                                                                  |  |                    |        |                     |                   |   |                    |   |                     |  |      |  



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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.

The Bank had a total of $45.0 million of borrowings in the form of securities sold under term repurchase agreements that were entered into during 2008.
These borrowings are secured by marketable investment securities equal to approximately 109.5% of the principal balances outstanding plus accrued interest and the value of an imbedded interest rate cap. The following table contains certain pertinent
information with respect to these agreements at March 31, 2010 (dollars in thousands):



|                          |  |                             |        |                              |      |   |                   |           |                              |           |                       |   |       
|------------------------- |  | --------------------------- | ------ | ---------------------------- | ---- | - | ----------------- | --------- | ---------------------------- | --------- | --------------------- | - | ------
|                          |  | OutstandingPrincipalBalance |        | AnnualEffectiveInterest Rate |      |   | FinalMaturityDate |           | BeginningQuarterlyCall Dates |           | CollateralRequirement
|Agreement dated 7/8/2008  |  | $                           | 25,000 |                              | 4.85 | % |                   | 7/8/2018  |                              | 7/8/2013  |                       | $ | 31,353
|Agreement dated 8/20/2008 |  |                             | 20,000 |                              | 3.78 |   |                   | 8/20/2015 |                              | 8/20/2011 |                       |   | 22,089
|                          |  |                             |        |                              |      |   |                   |           |                              |           |                       |   |       
|Total                     |  | $                           | 45,000 |                              | 4.38 | % |                   |           |                              |           |                       | $ | 53,442
|                          |  |                             |        |                              |      |   |                   |           |                              |           |                       |   |       

The Bank utilizes borrowings from the Federal Home Loan Bank
(FHLB) as a source of liquidity. At March 31, 2010, the FHLB had advances totaling $25.0 million outstanding to the Company. All of the FHLB advances are secured by the Banks qualifying real estate loans. The following table
contains a summary of the more significant terms of these borrowings at March 31, 2010 (dollars in thousands):



|                        |  |                             |        |                              |      |   |                   |         
|----------------------- |  | --------------------------- | ------ | ---------------------------- | ---- | - | ----------------- | --------
|                        |  | OutstandingPrincipalBalance |        | AnnualEffectiveInterest Rate |      |   | FinalMaturityDate
|Advance dated 7/06/2007 |  | $                           | 5,000  |                              | 5.02 | % |                   | 07/06/10
|Advance dated 3/17/2008 |  |                             | 10,000 |                              | 2.21 |   |                   | 03/18/13
|Advance dated 2/16/2010 |  |                             | 10,000 |                              | 0.15 |   |                   | 02/16/12
|                        |  |                             |        |                              |      |   |                   |         
|Total                   |  | $                           | 25,000 |                              | 1.95 | % |                   |         
|                        |  |                             |        |                              |      |   |                   |         

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 of which is 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 March 31, 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
March 31, 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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##### Table of Contents

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

GENERAL

Introduction

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

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

CHANGES IN FINANCIAL
CONDITION

Total Assets

At March 31, 2010, total assets were $570.7 million, a decrease of 6.5% compared to $610.4 million at December 31, 2009. The asset decline was
primarily the result of planned 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.

Investment Securities

Investment securities totaled $95.7 million at March 31, 2010, compared to $140.0 million at December 31, 2009. The decline was as 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 March 31, 2010 and December 31, 2009 is included in Note 3 of Notes to Consolidated
Financial Statements.

Loans and Allowance for Loan Losses

At March 31, 2010, the loan portfolio totaled $380.9 million and represented 66.7% of total assets compared to $391.3 million or 64.1% of total
assets at December 31, 2009. Total loans at March 31, 2010 decreased $10.4 million or 2.7% from December 31, 2009. Real estate loans, including commercial real estate, constituted approximately 80% of the loan portfolio, and
commercial business and other loans comprised approximately 20% of the total loan portfolio at both March 31, 2010 and December 31, 2009. A break-down of the Companys loan portfolio by major category at the indicated dates follows
(dollars in thousands).



15



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##### Table of Contents

|                                    |  |                |         |         |                   |   |        |   |         |  |        |  
|----------------------------------- |  | -------------- | ------- | ------- | ----------------- | - | ------ | - | ------- |  | ------ | -
|                                    |  | March 31, 2010 |         |         | December 31, 2009 |  
|                                    |  | Amount         |         | Percent |                   |   | Amount |   | Percent | 
|Real estate loans:                  |  |                |         |         |                   |   |        |   |         |  |        |  
|1-4 family residential              |  | $              | 75,390  |         | 19.79             | % |        | $ | 76,767  |  | 19.62  | %
|Commercial real estate              |  |                | 159,009 |         | 41.75             |   |        |   | 161,904 |  | 41.38  |  
|Construction and development        |  |                | 39,965  |         | 10.49             |   |        |   | 41,580  |  | 10.63  |  
|Home equity                         |  |                | 30,662  |         | 8.05              |   |        |   | 30,775  |  | 7.87   |  
|                                    |  |                |         |         |                   |   |        |   |         |  |        |  
|Total real estate loans             |  |                | 305,026 |         | 80.08             |   |        |   | 311,026 |  | 79.50  |  
|Commercial business and other loans |  |                | 71,488  |         | 18.77             |   |        |   | 75,762  |  | 19.36  |  
|Consumer loans                      |  |                | 4,376   |         | 1.15              |   |        |   | 4,477   |  | 1.14   |  
|                                    |  |                |         |         |                   |   |        |   |         |  |        |  
|Total loans                         |  | $              | 380,890 |         | 100.00            | % |        | $ | 391,265 |  | 100.00 | %
|                                    |  |                |         |         |                   |   |        |   |         |  |        |  



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##### Table of Contents

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, various regulatory agencies, as an integral part of their routine examination process, periodically review the Companys allowance. Those agencies may require
the Company to recognize adjustments to the allowance based on their judgments about information available to them at the time of their examinations. The Company believes the allowance is appropriate based on managements current analysis.

The allowance for loan losses at March 31, 2010, amounted to $7.1 million, a decrease of $1.1 million, or 13.8% from December 31,
2009. This is primarily the result of $1.8 million in first quarter net charge-offs charged against the total loss allowance to loans for which specific allowances previously had been established and which were determined to be impaired during the
quarter, while we recorded only $215,000 in net charge-offs against the general loss allowance. As a result, while the total allowance declined by $1.1 million since year-end 2009, the general allowance actually increased by $134,000 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.

The following table sets forth the activity in our allowance for loan losses for the periods
indicated (dollars in thousands):



|                                                                             |  |                              |        |   |      |   |       |  
|---------------------------------------------------------------------------- |  | ---------------------------- | ------ | - | ---- | - | ----- | -
|                                                                             |  | Three Months Ended March 31, |       
|                                                                             |  | 2010                         |        |   | 2009 |  
|                                                                             |  |                             
|Balance at beginning of period                                               |  | $                            | 8,167  |   |      | $ | 6,308 |  
|Provision for loan losses                                                    |  |                              | 916    |   |      |   | 700   |  
|Charge-offs:                                                                 |  |                              |        |   |      |   |       |  
|1-4 family residential                                                       |  |                              | (647   | ) |      |   | (79   | )
|Commercial real estate                                                       |  |                              |       |   |      |   |      |  
|Construction and development                                                 |  |                              | (76    | ) |      |   |      |  
|Commercial business and other loans                                          |  |                              | (1,322 | ) |      |   | (5    | )
|Consumer loans                                                               |  |                              | (7     | ) |      |   | (13   | )
|                                                                             |  |                              |        |   |      |   |       |  
|Total loans charged-off                                                      |  |                              | (2,052 | ) |      |   | (97   | )
|                                                                             |  |                              |        |   |      |   |       |  
|Recoveries of loans previously charged-off:                                  |  |                              |        |   |      |   |       |  
|1-4 family residential                                                       |  |                              | 1      |   |      |   |      |  
|Commercial real estate                                                       |  |                              |       |   |      |   | 50    |  
|Construction and development                                                 |  |                              | 1      |   |      |   |      |  
|Commercial business and other loans                                          |  |                              | 3      |   |      |   |      |  
|Consumer loans                                                               |  |                              | 14     |   |      |   | 8     |  
|                                                                             |  |                              |        |   |      |   |       |  
|Total recoveries of loans previously charged-off                             |  |                              | 19     |   |      |   | 58    |  
|                                                                             |  |                              |        |   |      |   |       |  
|Loans charged-off, net of recoveries                                         |  |                              | (2,033 | ) |      |   | (39   | )
|                                                                             |  |                              |        |   |      |   |       |  
|Balance at end of period                                                     |  | $                            | 7,050  |   |      | $ | 6,969 |  
|                                                                             |  |                              |        |   |      |   |       |  
|                                                                             |  |                             
|Annualized net loan charge-offs as a percentage of average loans outstanding |  |                              | 2.14   | % |      |   | 0.04  | %



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##### Table of Contents

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.

As of March 31, 2010, we identified one loan with a balance of $3.0 million as a troubled debt restructuring that was not previously
included in our nonperforming assets. The following table summarizes information regarding our nonaccrual loans, other real estate owned, and 90-day and over past due loans, as of March 31, 2010 and December 31, 2009 (dollars in
thousands):



|                                                                                |  |               |        |   |                  |   |        |  
|------------------------------------------------------------------------------- |  | ------------- | ------ | - | ---------------- | - | ------ | -
|                                                                                |  | March 31,2010 |        |   | December 31,2009 |  
|Loans accounted for on a nonaccrual basis:                                      |  |               |        |   |                  |   |        |  
|Real estate loans:                                                              |  |               |        |   |                  |   |        |  
|1-4 family residential                                                          |  | $             | 567    |   |                  | $ | 2,971  |  
|Commercial real estate                                                          |  |               | 3,986  |   |                  |   | 1,606  |  
|Construction and development                                                    |  |               | 3,727  |   |                  |   | 1,488  |  
|                                                                                |  |               |        |   |                  |   |        |  
|Total real estate loans                                                         |  |               | 8,280  |   |                  |   | 6,065  |  
|Commercial business and other loans                                             |  |               | 3,185  |   |                  |   | 3,151  |  
|Consumer loans                                                                  |  |               | 267    |   |                  |   | 8      |  
|                                                                                |  |               |        |   |                  |   |        |  
|Total nonaccrual loans                                                          |  |               | 11,732 |   |                  |   | 9,224  |  
|Accruing loans which are contractually past due 90 days or more                 |  |               |       |   |                  |   |       |  
|                                                                                |  |               |        |   |                  |   |        |  
|Total nonperforming loans                                                       |  |               | 11,732 |   |                  |   | 9,224  |  
|Other real estate owned                                                         |  |               | 9,023  |   |                  |   | 8,233  |  
|                                                                                |  |               |        |   |                  |   |        |  
|Total nonperforming assets                                                      |  | $             | 20,755 |   |                  | $ | 17,457 |  
|                                                                                |  |               |        |   |                  |   |        |  
|                                                                                |  |              
|Total nonperforming loans as a percentage of loans                              |  |               | 3.08   | % |                  |   | 2.36   | %
|Allowance for loan losses as a percentage of total nonperforming loans          |  |               | 60.09  | % |                  |   | 88.54  | %
|Allowance for loan losses as a percentage of total loans                        |  |               | 1.85   | % |                  |   | 2.09   | %
|Total nonperforming assets as a percentage of loans and other real estate owned |  |               | 5.32   | % |                  |   | 4.37   | %
|Total nonperforming assets as a percentage of total assets                      |  |               | 3.64   | % |                  |   | 2.86   | %



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##### Table of Contents

Deposits

The Companys deposit services include business and individual checking accounts, interest bearing checking accounts, savings accounts, money market
accounts, IRA deposits and certificates of deposit. At March 31, 2010, total deposits were $445.1 million compared to $493.9 million at December 31, 2009. The March 31, 2010 amount represents a decrease of 9.9% from December 31,
2009 and was the result of a planned 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 first quarter of 2010, the mix of deposits has also changed toward a more cost effective source of funds. At March 31, 2010, money market deposits comprised 37.8% of total
deposits compared to 45.5% at December 31, 2009 and brokered deposits have declined to 12.0% of total deposits at March 31, 2010 from 14.4% at December 31, 2009. The following table presents a breakdown of our deposit base at
March 31, 2010 and December 31, 2009 (dollars in thousands):



|                                                                   |  |               |         |   |                  |   |         |  
|------------------------------------------------------------------ |  | ------------- | ------- | - | ---------------- | - | ------- | -
|                                                                   |  | March 31,2010 |         |   | December 31,2009 |  
|Noninterest bearing demand deposits                                |  | $             | 37,448  |   |                  | $ | 36,418  |  
|Interest checking deposits                                         |  |               | 34,697  |   |                  |   | 34,614  |  
|Savings deposits                                                   |  |               | 12,217  |   |                  |   | 11,042  |  
|Money market deposits                                              |  |               | 168,337 |   |                  |   | 224,499 |  
|Customer time deposits                                             |  |               | 139,161 |   |                  |   | 116,370 |  
|Brokered certificates of deposit                                   |  |               | 53,263  |   |                  |   | 70,974  |  
|                                                                   |  |               |         |   |                  |   |         |  
|Total deposits                                                     |  | $             | 445,123 |   |                  | $ | 493,917 |  
|                                                                   |  |               |         |   |                  |   |         |  
|                                                                   |  |              
|Brokered certificates of deposit                                   |  | $             | 53,263  |   |                  | $ | 70,974  |  
|Customer time deposits issued in denominations of $100,000 or more |  |               | 59,760  |   |                  |   | 44,939  |  
|                                                                   |  |               |         |   |                  |   |         |  
|Total time deposits issued in denominations of $100,000 or more    |  | $             | 113,023 |   |                  | $ | 115,913 |  
|                                                                   |  |               |         |   |                  |   |         |  
|                                                                   |  |              
|As a percent of total deposits:                                    |  |               |         |   |                  |   |         |  
|Noninterest bearing demand deposits                                |  |               | 8.41    | % |                  |   | 7.37    | %
|Interest checking deposits                                         |  |               | 7.80    |   |                  |   | 7.01    |  
|Savings deposits                                                   |  |               | 2.74    |   |                  |   | 2.24    |  
|Money market deposits                                              |  |               | 37.82   |   |                  |   | 45.45   |  
|Customer time deposits                                             |  |               | 31.26   |   |                  |   | 23.56   |  
|Brokered certificates of deposit                                   |  |               | 11.97   |   |                  |   | 14.37   |  
|                                                                   |  |              
|Total time deposits issued in denominations of $100,000 or more    |  |               | 25.39   |   |                  |   | 23.47   |  



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##### Table of Contents

Liquidity

Liquidity management is the process of managing assets and liabilities as well as their maturities to ensure adequate funding for loan and deposit
activity as well as continued growth of the Company. Sources of liquidity come from both balance sheet and off-balance sheet sources. We define balance sheet liquidity as the relationship that net liquid assets have to unsecured liabilities. Net
liquid assets are the sum of cash and cash items, less required reserves on demand and interest checking deposits, plus demand deposits due from banks, plus temporary investments, including federal funds sold, plus the fair value of investment
securities, less collateral requirements related to public funds on deposit and repurchase agreements. Unsecured liabilities are equal to total liabilities less required cash reserves on noninterest-bearing demand deposits and interest checking
deposits less the outstanding balances of all secured liabilities, whether secured by liquid assets or not. We consider off-balance sheet liquidity to include unsecured federal funds lines from other banks and loan collateral which may be used for
additional advances from the Federal Home Loan Bank. As of March 31, 2010 our balance sheet liquidity ratio (net liquid assets as a percent of unsecured liabilities) amounted to 19.8% and our total liquidity ratio (balance sheet plus
off-balance sheet liquidity) was 21.7%.

In addition, we have the ability to borrow $10.0 million from the discount window of the Federal
Reserve, as well as $10.0 million from a correspondent bank, 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 $25.0 million at March 31, 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 March 31, 2010 is adequate to meet its operating needs.

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 a neutral interest
rate sensitivity position whereby little or no change in interest income would occur as interest rates change. On March 31, 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 in our 2008 and 2009 Annual Reports on Form 10-K, the Company and the Banks Board of Directors 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%, 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.



20



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##### Table of Contents

On March 31, 2010, the Companys Tier 1 and Total risk-weighted Capital Ratios were 10.07% and
11.92%, respectively, which were well above the minimum levels required by regulatory guidelines. At March 31, 2010, the Companys Leverage Capital Ratio was 7.87%, which was also well above the minimum level required by the regulatory
guidelines. On March 31, 2010, the Banks Tier 1 and Total risk-weighted Capital Ratios were 10.34% and 11.59%, respectively, both well above the minimum levels required by regulatory guidelines. On March 31, 2010, the Banks
leverage ratio was 8.09%, 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 March 31, 2010. The following table summarized the Companys and the Banks regulatory capital ratios at March 31, 2010:



|                                                                         |  |                        |   |  |                                                   |   |  |                             |   |  |                          |  
|------------------------------------------------------------------------ |  | ---------------------- | - |  | ------------------------------------------------- | - |  | --------------------------- | - |  | ------------------------ | -
|                                                                         |  | Minimumrequired ratios |   |  | Required ratiosto be consideredWell capitalized |   |  | The Companyscapital ratios |   |  | The Bankscapital ratios |  
|Risk-based capital ratios:                                               |  |                        |   |  |                                                   |   |  |                             |   |  |                          |  
|Leverage Capital Ratio (Tier 1 Capital to fourth quarter average assets) |  | 4.0                    | % |  | 5.0                                               | % |  | 7.87                        | % |  | 8.09                     | %
|Tier 1 Capital Ratio (Tier 1 Capital to risk-weighted assets)            |  | 4.0                    | % |  | 6.0                                               | % |  | 10.07                       | % |  | 10.34                    | %
|Total Capital Ratio (Total Capital to risk-weighted assets)              |  | 8.0                    | % |  | 10.0                                              | % |  | 11.92                       | % |  | 11.59                    | %

RESULTS
OF OPERATIONS

Three-Month Period Ended March 31, 2010 and March 31, 2009

For the three-month period ended March 31, 2010, the Company incurred a net loss available to common shareholders of $462,000, or $.12 per common
share. This compares to a net loss of $655,000, or $.17 per common share for the three months ended March 31, 2009. The losses realized in the first quarters 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.

While overall results were disappointing, there were some areas of
improvement. Net interest income, or the difference between interest income generated by earning assets (primarily loans and investment securities) and the interest expense related to funding earning assets (primarily deposits and borrowed funds),
is the Companys primary source of earnings. As shown in the table below, net interest income represented approximately 89% of the Companys total revenue (net interest income plus noninterest income) for the first quarter of 2010 and
2009.



|                                                  |  |                              |       |   |      |   |       |  
|------------------------------------------------- |  | ---------------------------- | ----- | - | ---- | - | ----- | -
|                                                  |  | Three Months Ended March 31, |      
|                                                  |  | 2010                         |       |   | 2009 |  
|                                                  |  | (dollars in thousands)       |      
|Net interest income                               |  | $                            | 4,213 |   |      | $ | 3,184 |  
|Noninterest income                                |  |                              | 503   |   |      |   | 406   |  
|                                                  |  |                              |       |   |      |   |       |  
|Total revenue                                     |  | $                            | 4,716 |   |      | $ | 3,590 |  
|                                                  |  |                              |       |   |      |   |       |  
|                                                  |  |                             
|Net interest income as a percent of total revenue |  |                              | 89.33 | % |      |   | 88.69 | %
|                                                  |  |                              |       |   |      |   |       |  



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##### Table of Contents

The Companys net interest income for the three-month period ended March 31, 2010 totaled $4.2
million, an increase of $1.0 million, or 32.3% over the $3.2 million in net interest income realized in the first quarter of 2009. The increase was the net result of a $1.2 million decline in interest income brought about by declining yields on
earning assets being more than offset by a $2.2 million decline in interest expense primarily attributable to a decrease in interest expense on deposits brought about by a decline in interest rates. The following table presents the average balances
of earning assets and interest-bearing liabilities along with related interest income or expense and average annual rates earned or paid for the three-month periods ended March 31, 2010 and 2009:



|                                                                                 |  |                              |         |                        |      |                      |  |        |                |  |                        |         |                      |   |       |  |        |  
|-------------------------------------------------------------------------------- |  | ---------------------------- | ------- | ---------------------- | ---- | -------------------- |  | ------ | -------------- |  | ---------------------- | ------- | -------------------- | - | ----- |  | ------ | -
|                                                                                 |  | Three Months Ended March 31. |        
|                                                                                 |  | 2010                         |         |                        | 2009 |                     
|                                                                                 |  | AverageBalance               |         | InterestIncome/Expense |      | AnnualizedYield/Cost |  |        | AverageBalance |  | InterestIncome/Expense |         | AnnualizedYield/Cost |  
|                                                                                 |  | (dollars in thousands)       |        
|Interest-earning assets:                                                         |  |                              |         |                        |      |                      |  |        |                |  |                        |         |                      |   |       |  |        |  
|Loans                                                                            |  | $                            | 385,847 |                        | $    | 5,383                |  | 5.66   | %              |  | $                      | 408,543 |                      | $ | 6,052 |  | 6.01   | %
|Investment securities                                                            |  |                              | 134,503 |                        |      | 934                  |  | 2.82   |                |  |                        | 117,778 |                      |   | 1,463 |  | 5.04   |  
|Other interest-earning assets                                                    |  |                              | 18,743  |                        |      | 17                   |  | 0.37   |                |  |                        | 15,301  |                      |   | 22    |  | 0.58   |  
|                                                                                 |  |                              |         |                        |      |                      |  |        |                |  |                        |         |                      |   |       |  |        |  
|Total interest-earning assets                                                    |  |                              | 539,093 |                        |      | 6,334                |  | 4.77   | %              |  |                        | 541,622 |                      |   | 7,537 |  | 5.64   | %
|                                                                                 |  |                              |         |                        |      |                      |  |        |                |  |                        |         |                      |   |       |  |        |  
|Other assets, net                                                                |  |                              | 47,208  |                        |      |                      |  |        |                |  |                        | 41,349  |                      |   |       |  |        |  
|                                                                                 |  |                              |         |                        |      |                      |  |        |                |  |                        |         |                      |   |       |  |        |  
|Total assets                                                                     |  | $                            | 586,301 |                        |      |                      |  |        |                |  | $                      | 582,971 |                      |   |       |  |        |  
|                                                                                 |  |                              |         |                        |      |                      |  |        |                |  |                        |         |                      |   |       |  |        |  
|                                                                                 |  |                              |         |                        |      |                     
|Interest-bearing liabilities:                                                    |  |                              |         |                        |      |                      |  |        |                |  |                        |         |                      |   |       |  |        |  
|Interest-checking deposits                                                       |  | $                            | 34,450  |                        |      | 96                   |  | 1.13   | %              |  | $                      | 31,207  |                      |   | 83    |  | 1.08   | %
|Money market and savings deposits                                                |  |                              | 201,795 |                        |      | 424                  |  | 0.85   |                |  |                        | 248,141 |                      |   | 2,215 |  | 3.62   |  
|Time deposits                                                                    |  |                              | 191,735 |                        |      | 929                  |  | 1.97   |                |  |                        | 154,350 |                      |   | 1,244 |  | 3.27   |  
|                                                                                 |  |                              |         |                        |      |                      |  |        |                |  |                        |         |                      |   |       |  |        |  
|Total interest-bearing deposits                                                  |  |                              | 427,980 |                        |      | 1,449                |  | 1.37   |                |  |                        | 433,698 |                      |   | 3,542 |  | 3.31   |  
|Borrowed funds                                                                   |  |                              | 74,094  |                        |      | 672                  |  | 3.68   |                |  |                        | 79,440  |                      |   | 811   |  | 4.14   |  
|                                                                                 |  |                              |         |                        |      |                      |  |        |                |  |                        |         |                      |   |       |  |        |  
|Total interest-bearing liabilities                                               |  |                              | 502,074 |                        |      | 2,121                |  | 1.71   |                |  |                        | 513,138 |                      |   | 4,353 |  | 3.44   |  
|                                                                                 |  |                              |         |                        |      |                      |  |        |                |  |                        |         |                      |   |       |  |        |  
|Noninterest-bearing demand deposits                                              |  |                              | 37,083  |                        |      |                      |  |        |                |  |                        | 30,095  |                      |   |       |  |        |  
|Other liabilities                                                                |  |                              | 1,567   |                        |      |                      |  |        |                |  |                        | 1,749   |                      |   |       |  |        |  
|                                                                                 |  |                              |         |                        |      |                      |  |        |                |  |                        |         |                      |   |       |  |        |  
|Total liabilities                                                                |  |                              | 540,724 |                        |      |                      |  |        |                |  |                        | 544,982 |                      |   |       |  |        |  
|                                                                                 |  |                              |         |                        |      |                      |  |        |                |  |                        |         |                      |   |       |  |        |  
|Preferred stockholders equity                                                   |  |                              | 13,179  |                        |      |                      |  |        |                |  |                        |        |                      |   |       |  |        |  
|Common stockholders equity                                                      |  |                              | 32,398  |                        |      |                      |  |        |                |  |                        | 37,989  |                      |   |       |  |        |  
|                                                                                 |  |                              |         |                        |      |                      |  |        |                |  |                        |         |                      |   |       |  |        |  
|Total stockholders equity                                                       |  |                              | 45,577  |                        |      |                      |  |        |                |  |                        | 37,989  |                      |   |       |  |        |  
|                                                                                 |  |                              |         |                        |      |                      |  |        |                |  |                        |         |                      |   |       |  |        |  
|Total liabilities and stockholders equity                                       |  | $                            | 586,301 |                        |      |                      |  |        |                |  | $                      | 582,971 |                      |   |       |  |        |  
|                                                                                 |  |                              |         |                        |      |                      |  |        |                |  |                        |         |                      |   |       |  |        |  
|                                                                                 |  |                              |         |                        |      |                     
|Net interest income & interest rate spread                                       |  |                              |         |                        | $    | 4,213                |  | 3.06   | %              |  |                        |         |                      | $ | 3,184 |  | 2.20   | %
|                                                                                 |  |                              |         |                        |      |                      |  |        |                |  |                        |         |                      |   |       |  |        |  
|                                                                                 |  |                              |         |                        |      |                     
|Net yield on average interest-earning assets                                     |  |                              |         |                        |      |                      |  | 3.17   | %              |  |                        |         |                      |   |       |  | 2.38   | %
|                                                                                 |  |                              |         |                        |      |                      |  |        |                |  |                        |         |                      |   |       |  |        |  
|                                                                                 |  |                              |         |                        |      |                     
|Ratio of average interest-earning assets to average interest-bearing liabilities |  |                              |         |                        |      |                      |  | 107.37 | %              |  |                        |         |                      |   |       |  | 105.55 | %
|                                                                                 |  |                              |         |                        |      |                      |  |        |                |  |                        |         |                      |   |       |  |        |  

Non-accrual loans are included in the above table.

Loan fees and late charges of $28 and $63 for 2010 and 2009, respectively, are included in interest income.

The loan loss provision amounted to $916,000 for the quarter ended March 31, 2010, an increase of $216,000, or 30.9%, from the $700,000 provision
recorded in the comparable quarter of 2009. The increase in the provision for the first quarter of 2010 was in recognition of a rise in nonperforming assets and past due loans since December 31, 2009.



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Noninterest income totaled $503,000 for the three-months ended March 31, 2010 compared to $406,000 for
the comparable three-month period of 2009. The increase was substantially all the result of gains realized on the sale of investment securities available for sale during the current years quarter. The following table presents an analysis of
noninterest income for the three month periods ended March 31, 2010 and 2009 (dollars in thousands):



|                                                    |  |                              |     |      |   |    
|--------------------------------------------------- |  | ---------------------------- | --- | ---- | - | ---
|                                                    |  | Three Months Ended March 31,
|                                                    |  | 2010                         |     | 2009
|Noninterest income:                                 |  |                              |     |      |   |    
|Deposit services fees                               |  | $                            | 191 |      | $ | 191
|Card services fees                                  |  |                              | 76  |      |   | 63 
|Loan services fees                                  |  |                              | 19  |      |   | 38 
|Other customer services fees                        |  |                              | 29  |      |   | 20 
|                                                    |  |                              |     |      |   |    
|Total customer services fees                        |  |                              | 315 |      |   | 312
|Net gain on investment securities                   |  |                              | 96  |      |   |   
|Increase in cash value of bank owned life insurance |  |                              | 89  |      |   | 89 
|All other income                                    |  |                              | 3   |      |   | 5  
|                                                    |  |                              |     |      |   |    
|Total noninterest income                            |  | $                            | 503 |      | $ | 406
|                                                    |  |                              |     |      |   |    

Noninterest expenses totaled $4.2 million for the three-months ended
March 31, 2010, compared to $3.9 million for the same period in 2009, an increase of $375,000 or 9.7%. The primary sources of the increase in overhead costs were: (1) salaries and benefits, which increased $244,000 as a result of funding
our employees Health Savings Accounts for all of 2010 in the first quarter, benefit payments to 6 terminated employees and transferring an administrative function from an external provider to in-house employees; and (2) expenses
associated with foreclosed real estate which increased $233,000 over the first quarter of 2009 due to increased activity. An analysis of noninterest expenses for the first quarters of 2010 and 2009 is presented in the following table (dollars in
thousands):



|                                                                                    |  |                              |       |      |   |      
|----------------------------------------------------------------------------------- |  | ---------------------------- | ----- | ---- | - | -----
|                                                                                    |  | Three Months Ended March 31,
|                                                                                    |  | 2010                         |       | 2009
|Salaries and benefits                                                               |  | $                            | 1,915 |      | $ | 1,671
|Occupancy                                                                           |  |                              | 306   |      |   | 303  
|Furniture and equipment                                                             |  |                              | 289   |      |   | 259  
|FDIC insurance assessments                                                          |  |                              | 299   |      |   | 335  
|Data processing services                                                            |  |                              | 206   |      |   | 243  
|Professional services                                                               |  |                              | 210   |      |   | 233  
|Advertising and promotional                                                         |  |                              | 92    |      |   | 117  
|Telephone and data communications                                                   |  |                              | 93    |      |   | 92   
|Postage and courier                                                                 |  |                              | 60    |      |   | 57   
|Printing and supplies                                                               |  |                              | 55    |      |   | 51   
|Valuation provisions and net operating costs associated with foreclosed real estate |  |                              | 369   |      |   | 136  
|Other noninterest expenses                                                          |  |                              | 341   |      |   | 363  
|                                                                                    |  |                              |       |      |   |      
|Total noninterest expenses                                                          |  | $                            | 4,235 |      | $ | 3,860
|                                                                                    |  |                              |       |      |   |      

The Company accrued an income tax benefit of $200,000 for the
three-months ending March 31, 2010 compared to an income tax benefit of $315,000 for the first quarter of 2009. The tax benefit was a result of the Companys loss for the three month periods ended March 31, 2010 and 2009.



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DISCLOSURES ABOUT FORWARD LOOKING STATEMENTS

This Report and its exhibits may contain statements relating to our financial condition, results of operations, plans, strategies, 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. Those statements may be forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements may be identified by terms such as may,
will, should, could, expects, plans, intends, anticipates, believes, estimates, predicts, forecasts,
potential or continue, or similar terms or the negative of these terms, or other statements concerning opinions or judgments of the Companys management about future events. 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, risk factors discussed in the Companys Annual Report on
Form 10-K and in other documents the Company files with the Securities and Exchange Commission from time to time. Copies of those reports are available directly through the Commissions website at www.sec.gov. Other factors that
could influence the accuracy of forward-looking statements include, but are not limited to, (a) pressures on the earnings, capital and liquidity of financial institutions resulting from current and future adverse conditions in the credit and
equity markets and the banking industry in general; (b) changes in competitive pressures among depository and other financial institutions or in the Companys ability to compete successfully against the larger financial institutions in its
banking markets; (c) the financial success or changing strategies of the Companys customers; (d) actions of government regulators, or changes in laws, regulations or accounting standards, that adversely affect the Companys
business; (e) changes in the interest rate environment and the level of market interest rates that reduce the Companys net interest margins and/or the volumes and values of loans it makes and securities it holds; (f) changes in
general economic or business conditions and real estate values in the Companys banking markets (particularly changes that affect the Companys loan portfolio, the abilities of its borrowers to repay their loans, and the values of loan
collateral); and (g) other unexpected developments or changes in the Companys business. Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, it cannot guarantee future results,
levels of activity, performance or achievements. All forward-looking statements attributable to the Company are expressly qualified in their entirety by the cautionary statements in this paragraph. The Company has no obligation, and does not intend
to update these forward-looking statements.



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

Not applicable



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

The
Companys management, under the supervision and with the participation of its Chief Executive Officer and Acting 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 his evaluation, the Chief Executive Officer and Acting 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
|------- | -----------------

On May 14, 2010,
Michael D. Larrowe, who was formerly the Companys and the Banks Chief Financial Officer and the Banks Executive Vice Chairman and Chief Operating Officer, and who is the Companys and the Banks director, instituted a
lawsuit against the Bank, two directors of the Company and the Bank (Thomas G. Fleming and William A. Burnette), the Banks Chief Lending Officer (Robert W. Johnson), two former employees of the Bank (Michelle Clodfelter and Denise Barnhardt)
and another individual (James Timothy Merritt) in the U.S. District Court for the Middle District of North Carolina. His Complaint makes claims against the Bank for negligent retention/supervision of the Banks Chief Lending Officer and the
directors named above in connection with his allegations that those individuals made false statements regarding him which he claims damaged his reputation and interfered with his contractual relationship with the Bank, causing him financial harm; he
also contends that the Bank is responsible for the alleged actions of those individuals. He seeks compensatory damages in excess of $3,000,000 and his legal fees from the Bank. Based on the advice of outside counsel, the Bank believes that the
allegations are without merit and the Bank intends to vigorously defend the lawsuit.



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

None



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

None



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

None



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



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

None



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

The following exhibits are
provided with this report.



|      |  |                                                                                                                                        
|----- |  | ---------------------------------------------------------------------------------------------------------------------------------------
|31.01 |  | Certification of our Chief Executive Officer and Acting Chief Financial Officer pursuant to Rule 13a-14(a) (furnished herewith)        
|      | 
|32.01 |  | Certification of our Chief Executive Officer and Acting 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: May 17, 2010 |  |  |  | By:                               |  | /s/ Robert E. Marziano            
|                   |  |  |  |                                   |  | Robert E. Marziano                
|                   |  |  |  |                                   |  | President, Chief Executive Officer
|                   |  |  |  |                                   |  | & Acting Chief Financial Officer  



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EXHIBIT INDEX



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



27