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 June 30, 2014

Commission File No.: 000-52195

BANK OF THE CAROLINAS CORPORATION

(Exact name of registrant as specified in its charter)

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

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

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T 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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

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

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

On August 14, 2014 there were 462,028,831 outstanding shares of the registrant’s common stock.

BANK OF THE CAROLINAS CORPORATION

FORM 10-Q

June 30, 2014

INDEX

Part I. FINANCIAL INFORMATION		3
Item 1.	Financial Statements	3
	Consolidated Balance Sheets at June 30, 2014 and December 31, 2013	3
	Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2014 and 2013	4
	Consolidated Statements of Comprehensive Income (Loss) for the Three and Six Months Ended June 30, 2014 and 2013	5
	Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2014 and 2013	6
	Consolidated Statements of Changes in Stockholders’ Equity for the Six Months Ended June 30, 2014 and 2013	7
	Notes to Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	27
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	37
Item 4.	Controls and Procedures	37
Part II. OTHER INFORMATION		37
Item 1.	Legal Proceedings	37
Item 1A.	Risk Factors	37
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	37
Item 3.	Defaults Upon Senior Securities	37
Item 4.	Mine Safety Disclosures	37
Item 5.	Other Information	37
Item 6.	Exhibits	38
SIGNATURES		39
EXHIBIT INDEX		40

2

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Bank of the Carolinas Corporation

Consolidated Balance Sheets

(amounts in thousands, except share data)

	June 30 2014			December 31 2013*
	(Unaudited)
Assets:
Cash and due from banks, noninterest-bearing	$	18,342		$	12,778
Interest-bearing deposits in banks		20,209			2,064
Cash and cash equivalents		38,551			14,842
Federal funds sold		—			19,580
Investment securities		88,335			90,315
Loans receivable		279,437			278,510
Less: Allowance for loan losses		(5,153	)		(6,015	)
Total loans, net		274,284			272,495
Premises and equipment		11,097			11,274
Other real estate owned		1,951			1,233
Bank owned life insurance		11,059			10,888
Deferred tax assets		—			—
Accrued interest receivable		1,083			1,156
Other assets		1,467			1,867
Total Assets	$	427,827		$	423,650
Liabilities:
Deposits:
Noninterest-bearing demand deposits	$	34,657		$	35,243
Interest-checking deposits		42,466			40,939
Savings and money market deposits		111,385			109,419
Time deposits		178,504			180,549
Total deposits		367,012			366,150
Securities sold under agreements to repurchase		45,267			45,388
Subordinated debt		7,855			7,855
Other liabilities		2,914			2,509
Total Liabilities		423,048			421,902
Commitments and contingencies (Note 6)		—			—
Stockholders’ Equity:
Preferred stock, no par value		13,179			13,179
Discount on preferred stock		—			(100	)
Common stock, no par value at June 30, 2014, $5 per share par value at December 31, 2013		—			19,479
Additional paid-in capital		32,470			12,991
Retained deficit		(39,157	)		(38,422	)
Accumulated other comprehensive loss		(1,713	)		(5,379	)
Total Stockholders’ Equity		4,779			1,748
Total Liabilities and Stockholders’ Equity	$	427,827		$	423,650
Preferred shares authorized		3,000,000			3,000,000
Preferred shares issued and outstanding		13,179			13,179
Unaccrued preferred stock dividend	$	2,331		$	1,894
Common shares authorized		500,000,000			15,000,000
Common shares issued and outstanding		3,895,840			3,895,840

* Derived from audited consolidated financial statements.

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

3

Bank of the Carolinas Corporation

Consolidated Statements of Operations

(Unaudited)

(dollars in thousands, except per share data)

	Three Months Ended June 30						Six Months Ended June 30
	2014			2013			2014			2013
Interest income
Interest and fees on loans	$	3,235		$	3,224		$	6,428		$	6,440
Interest on securities		537			497			1,075			1,086
Other interest income		15			25			33			39
Total interest income		3,787			3,746			7,536			7,565
Interest expense
Interest on deposits		525			579			1,052			1,200
Interest on borrowed funds		564			563			1,121			1,120
Total interest expense		1,089			1,142			2,173			2,320
Net interest income		2,698			2,604			5,363			5,245
Provision for loan losses		(1,287	)		(12	)		(225	)		(1,158	)
Net interest income after provision for loan losses		3,985			2,616			5,588			6,403
Noninterest income
Customer service fees		293			291			584			572
Increase in value of bank owned life insurance		86			87			171			174
Gains on sales of investment securities		—			—			—			—
Other income		5			5			19			3
Total noninterest income		384			383			774			749
Noninterest expense
Salaries and benefits		1,547			1,595			3,137			3,193
Occupancy and equipment		456			426			928			878
FDIC insurance assessments		368			369			731			736
Data processing services		267			283			528			552
Valuation provisions and net operating costs associated with foreclosed real estate		(12	)		167			27			532
Other		856			881			1,646			1,549
Total noninterest expense		3,482			3,721			6,997			7,440
Income (loss) before income taxes		887			(722	)		(635	)		(288	)
Provision for income taxes		—			341			—			638
Net income (loss)		887			(1,063	)		(635	)		(926	)
Dividends and accretion on preferred stock		(288	)		(243	)		(537	)		(486	)
Net income (loss) available to common stockholders	$	599		$	(1,306	)	$	(1,172	)	$	(1,412	)
Earnings (Loss) per common share:
Basic	$	0.15		$	(0.33	)	$	(0.30	)	$	(0.36	)
Diluted	$	0.15		$	(0.33	)	$	(0.30	)	$	(0.36	)

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

4

Bank of the Carolinas Corporation

Consolidated Statements of Comprehensive Income (Loss)

(Unaudited)

(dollars in thousands)

	Three Months Ended June 30					Six Months Ended June 30
	2014		2013			2014			2013
Net income (loss)	$	887	$	(1,063	)	$	(635	)	$	(926	)
Other comprehensive income (loss):
Unrealized holding gains (losses) on securities available for sale		1,903		(3,757	)		3,666			(4,137	)
Reclassification adjustment for gains realized in net income (loss)		—		—			—			—
Income tax effect		—		189			—			335
Total other comprehensive income (loss), net of income tax effect		1,903		(3,568	)		3,666			(3,802	)
Total comprehensive income (loss)	$	2,790	$	(4,631	)	$	3,031		$	(4,728	)

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

5

Bank of the Carolinas Corporation

Consolidated Statements of Cash Flows

(Unaudited)

(dollars in thousands)

	Six Months Ended June 30
	2014			2013
Cash flows from operating activities:
Net loss	$	(635	)	$	(926	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Provision for loan losses		(225	)		(1,158	)
Deferred tax expense		—			638
Depreciation and amortization		340			341
Change in valuation allowance on other real estate owned		—			437
(Gain) loss on sale of other real estate owned		(17	)		6
Loss on disposal of premises and equipment		—			8
Increase in bank owned life insurance		(171	)		(174	)
Net amortization/accretion of premiums and discounts on investments		176			294
Net change in other assets		334			584
Net change in other liabilities		404			495
Net cash provided by operating activities		206			545
Cash flows from investing activities:
Net change in federal funds sold		19,580			(9,755	)
Purchases of premises and equipment		(163	)		(48	)
Purchases of securities		—			(14,037	)
Proceeds from sales, calls, maturities and principal repayments of securities available for sale		5,470			23,335
Redemption of FHLB stock		140			205
Proceeds from sales of other real estate owned		446			3,481
Net (increase) decrease in loans		(2,711	)		1,006
Net cash provided by investing activities		22,762			4,187
Cash flows from financing activities:
Net increase (decrease) in deposits		862			(6,664	)
Net increase (decrease) in repurchase agreements		(121	)		577
Cash dividends paid on preferred stock		—			—
Net cash provided (used) by financing activities		741			(6,087	)
Net increase (decrease) in cash and cash equivalents		23,709			(1,355	)
Cash and cash equivalents at beginning of period		14,842			7,786
Cash and cash equivalents at end of period	$	38,551		$	6,431
Supplemental disclosure of cash flow information:
Cash paid during the period for interest	$	2,035		$	2,219
Noncash investing and financing activities:
Change in fair value of securities available for sale	$	3,666		$	(3,802	)
Transfer from loans to other real estate owned	$	1,147		$	537

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

6

Bank of the Carolinas Corporation

Consolidated Statements of Changes in Stockholders’ Equity

(Unaudited)

(dollars in thousands)

	Preferred Stock				Discount on Preferred			Common Stock					Additional Paid-In		Retained			Accumulated Other Comprehensive			Total Stockholders’
	Shares		Amount		Stock			Shares		Amount			Capital		Deficit			Income (Loss)			Equity
Balance, December 31, 2012		13,179	$	13,179	$	(419	)		3,895,840	$	19,479		$	12,991	$	(36,748	)	$	583		$	9,065
Net income		—		—		—			—		—			—		(926	)		—			(926	)
Other comprehensive loss		—		—		—			—		—			—		—			(3,802	)		(3,802	)
Discount accretion on preferred stock		—		—		156			—		—			—		(156	)		—			—
Dividends accrued on preferred stock		—		—		—			—		—			—		—			—			—
Balance, June 30, 2013		13,179	$	13,179	$	(263	)		3,895,840	$	19,479		$	12,991	$	(37,830	)	$	(3,219	)	$	4,337
Balance, December 31, 2013		13,179	$	13,179	$	(100	)		3,895,840	$	19,479		$	12,991	$	(38,422	)	$	(5,379	)	$	1,748
Net loss		—		—		—			—		—			—		(635	)		—			(635	)
Other comprehensive income		—		—		—			—		—			—		—			3,666			3,666
Reclass due to no par value		—		—		—			—		(19,479	)		19,479		—			—			—
Discount accretion on preferred stock		—		—		100			—		—			—		(100	)		—			—
Dividends accrued on preferred stock		—		—		—			—		—			—		—			—			—
Balance, June 30, 2014		13,179	$	13,179	$	—			3,895,840	$	—		$	32,470	$	(39,157	)	$	(1,713	)	$	4,779

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

7

Bank of the Carolinas Corporation

Notes to Consolidated Financial Statements

(Unaudited)

NOTE 1. BASIS OF PRESENTATION

In the opinion of management, the financial information included in these unaudited financial statements reflects all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the financial information as of June 30, 2014 and December 31, 2013 and for the three- and six-month periods ended June 30, 2014 and 2013, in conformity with accounting principles generally accepted in the United States of America.

The preparation of financial statements requires management to make estimates and assumptions that affect reported amounts of assets and liabilities at the date of the financial statements, as well as the amounts of income and expense during the reporting period. Actual results could differ from those estimates. Operating results for the three- and six-month periods ended June 30, 2014 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2014.

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, 2013, as amended. This quarterly report should be read in conjunction with the annual report. Because the Company has no separate operations and conducts no business on its own other than owning the Bank, this discussion concerns primarily the business of the Bank. However, because the financial statements are presented on a consolidated basis, the Company and the Bank are collectively referred to as “the Company” unless otherwise noted.

NOTE 2. EARNINGS PER SHARE

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

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

	Three months ended					Six months ended
	June 30,					June 30,
	2014		2013			2014			2013
Net loss applicable to common stockholders	$	599	$	(1,306	)	$	(1,172	)	$	(1,412	)
Weighted average number of common shares outstanding		3,895,840		3,895,840			3,895,840			3,895,840
Weighted average number of diluted common shares outstanding		3,895,840		3,895,840			3,895,840			3,895,840
Common stock options and common stock warrants - anti-dilutive		497,605		497,605			497,605			497,605

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.

8

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):

	June 30, 2014
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value		Carrying Value
Investment securities available for sale:
U.S. Government agencies securities	$	41,747	$	91	$	1,330	$	40,508	$	40,508
State and municipal bonds		11,128		34		355		10,807		10,807
Mortgage-backed securities		37,172		118		270		37,020		37,020
Total investment securities available for sale		90,047		243		1,955		88,335		88,335
Investment securities held to maturity:
Corporate securities		—		—		—		—		—
Total investment securities	$	90,047	$	243	$	1,955	$	88,335	$	88,335

	December 31, 2013
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value		Carrying Value
Investment securities available for sale:
U.S. Government agencies securities	$	44,077	$	87	$	3,234	$	40,930	$	40,930
State and municipal bonds		11,159		—		978		10,181		10,181
Mortgage-backed securities		39,458		34		1,288		38,204		38,204
Total investment securities available for sale		94,694		121		5,500		89,315		89,315
Investment securities held to maturity:
Corporate securities		1,000		—		180		820		1,000
Total investment securities	$	95,694	$	121	$	5,680	$	90,135	$	90,315

Management of the Bank believes all unrealized losses on available for sale securities as of June 30, 2014 represent temporary impairments related to market fluctuations. The unrealized losses on our securities are a nominal portion of the total value of the portfolio.

9

The fair values of securities with unrealized losses at June 30, 2014 and December 31, 2013 are as follows (dollars in thousands):

June 30, 2014:
	Less than 12 Months				12 Months or More				Total
Temporarily impaired securities:	Estimated Fair Value		Unrealized Losses		Estimated Fair Value		Unrealized Losses		Estimated Fair Value		Unrealized Losses
U.S. Government agency securities	$	—	$	—	$	37,005	$	1,330	$	37,005	$	1,330
State and municipal bonds		—		—		8,901		355		8,901		355
Mortgage-backed securities		6,747		12		18,064		258		24,811		270
Corporate securities		—		—		—		—		—		—
Total	$	6,747	$	12	$	63,970	$	1,943	$	70,717	$	1,955

December 31, 2013:
	Less than 12 Months				12 Months or More				Total
Temporarily impaired securities:	Estimated Fair Value		Unrealized Losses		Estimated Fair Value		Unrealized Losses		Estimated Fair Value		Unrealized Losses
U.S. Government agency securities	$	35,679	$	2,731	$	3,482	$	503	$	39,161	$	3,234
State and municipal bonds		7,835		723		2,346		255		10,181		978
Mortgage-backed securities		34,564		1,287		528		1		35,092		1,288
Corporate securities		—		—		820		180		820		180
Total	$	78,078	$	4,741	$	7,176	$	939	$	85,254	$	5,680

NOTE 4. LOANS

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

	June 30, 2014			December 31, 2013
Real estate loans:
Residential, 1-4 family	$	90,356		$	84,855
Commercial real estate		113,940			117,463
Construction and development		22,602			27,049
Home equity		27,747			28,217
Total real estate loans		254,645			257,584
Commercial business and other loans		20,153			17,428
Consumer loans:
Installment		3,146			2,554
Other		1,493			944
Total consumer loans		4,639			3,498
Gross loans receivable		279,437			278,510
Allowance for loan losses		(5,153	)		(6,015	)
Loans, net	$	274,284		$	272,495

10

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

	June 30, 2014										December 31, 2013
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized		Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance:
Commercial - Non Real Estate	$	975	$	1,170	$	—	$	1,193	$	34	$	1,099	$	1,305	$	—	$	1,384	$	79
Commercial Real Estate
Owner occupied		2,276		2,593		—		2,739		73		3,480		4,062		—		4,365		239
Income producing		3,505		3,679		—		3,701		85		3,734		3,887		—		3,938		183
Multifamily		—		—		—		—		—		—		—		—		—		—
Construction & Development
1 - 4 Family		—		—		—		—		—		—		—		—		—		—
Other		2,675		3,697		—		4,016		54		1,545		1,881		—		1,981		112
Farmland		136		156		—		175		7		252		273		—		340		26
Residential
Equity Lines		70		77		—		78		1		95		101		—		105		3
1 - 4 Family		4,658		5,079		—		5,400		126		5,632		6,198		—		6,281		322
Junior Liens		190		213		—		216		6		196		218		—		223		12
Consumer - Non Real Estate		66		67		—		67		2		68		68		—		70		4
Total loans with no allowance	$	14,551	$	16,731	$	—	$	17,585	$	388	$	16,101	$	17,993	$	—	$	18,687	$	980
With an allowance recorded:
Commercial - Non Real Estate	$	1,214	$	1,214	$	33	$	1,243	$	22	$	1,205	$	1,205	$	25	$	1,282	$	45
Commercial Real Estate
Owner occupied		4,205		4,206		117		4,230		90		3,666		3,666		77		3,727		166
Income producing		7,154		7,210		735		7,284		185		7,287		7,343		126		7,465		382
Multifamily		1,211		1,244		76		1,251		22		1,226		1,259		12		1,273		45
Construction & Development
1 - 4 Family		355		361		9		364		9		360		366		8		371		19
Other		741		746		11		754		17		3,176		3,181		107		3,224		118
Farmland		—		—		—		—		—		—		—		—		—		—
Residential
Equity Lines		—		—		—		—		—		—		—		—		—		—
1 - 4 Family		6,961		6,978		189		7,032		143		6,778		6,795		204		6,893		279
Junior Liens		335		337		4		338		9		339		341		4		345		19
Consumer - Non Real Estate		6		6		—		7		—		8		8		—		11		—
Total loans with an allowance	$	22,182	$	22,302	$	1,174	$	22,503	$	497	$	24,045	$	24,164	$	563	$	24,591	$	1,073
Total:
Commercial - Non Real Estate	$	2,189	$	2,384	$	33	$	2,436	$	56	$	2,304	$	2,510	$	25	$	2,666	$	124
Commercial Real Estate	$	18,351	$	18,932	$	928	$	19,205	$	455	$	19,393	$	20,217	$	215	$	20,768	$	1,015
Construction & Development	$	3,907	$	4,960	$	20	$	5,309	$	87	$	5,333	$	5,701	$	115	$	5,916	$	275
Residential	$	12,214	$	12,684	$	193	$	13,064	$	285	$	13,040	$	13,653	$	208	$	13,847	$	635
Consumer - Non Real Estate	$	72	$	73	$	—	$	74	$	2	$	76	$	76	$	—	$	81	$	4
Totals	$	36,733	$	39,033	$	1,174	$	40,088	$	885	$	40,146	$	42,157	$	563	$	43,278	$	2,053

Impaired loans include loans whose contractual terms have been restructured in a manner that grants a concession to a borrower experiencing financial difficulties. Troubled debt restructurings (TDRs) are a subset of impaired loans and totaled $35.1 million at June 30, 2014 and $37.5 million at December 31, 2013.

11

The following tables illustrate TDR information for the three- and six-months ended June 30, 2014 and 2013 (dollars in thousands):

	For the three months ended June 30, 2014						For the six months ended June 30, 2014
Troubled Debt Restructuring	Number of Contracts		Pre-Modification Recorded Investment		Post-Modification Recorded Investment		Number of Contracts		Pre-Modification Recorded Investment		Post-Modification Recorded Investment
Commercial - Non Real Estate		—	$	—	$	—		1	$	61	$	61
Commercial - Real Estate		1		436		436		2		458		458
Construction & Development		—		—		—		—		—		—
Residential		1		26		26		1		26		26
Consumer - Non Real Estate		—		—		—		—		—		—
Totals		2	$	462	$	462		4	$	545	$	545

	For the three months ended June 30, 2013						For the six months ended June 30, 2013
Troubled Debt Restructuring	Number of Contracts		Pre-Modification Recorded Investment		Post-Modification Recorded Investment		Number of Contracts		Pre-Modification Recorded Investment		Post-Modification Recorded Investment
Commercial - Non Real Estate		—	$	—	$	—		1	$	32	$	32
Commercial - Real Estate		—		—		—		1		238		238
Construction & Development		1		492		492		1		492		492
Residential		1		154		154		3		448		448
Consumer - Non Real Estate		—		—		—		—		—		—
Totals		2	$	646	$	646		6	$	1,210	$	1,210

For the purposes of this report, default is defined as being 90-days past due or on non-accrual status without performance. There were no loans restructured in the twelve months prior to June 30, 2014 and 2013 that went into default during the three-month periods ended June 30, 2014 and 2013.

Some loan modifications classified as TDRs may not ultimately result in the full collection of principal and interest, as modified, and may result in potential incremental losses. These potential incremental losses have been factored into our overall allowance for loan losses estimate. The level of any re-defaults will likely be affected by future economic conditions. Once a loan becomes a TDR, it will continue to be reported as a TDR until it is ultimately repaid in full, reclassified to loans held for sale, or foreclosed and sold. Included in the allowance for loan losses at June 30, 2014 and 2013 was an impairment reserve for TDRs in the amount of $1.2 million and $676,000, respectively.

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

	30 - 59 Days Past Due		60 - 89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans		90 Days Past Due and Still Accruing		Non-accrual Loans
June 30, 2014:
Commercial - Non Real Estate	$	—	$	174	$	105	$	279	$	19,874	$	20,153	$	—	$	286
Commercial Real Estate
Owner occupied		246		—		—		246		55,884		56,130		—		492
Income producing		—		—		—		—		50,256		50,256		—		318
Multifamily		—		—		—		—		7,554		7,554		—		—
Construction & Development
1 - 4 Family		—		—		—		—		2,417		2,417		—		—
Other		—		—		—		—		19,776		19,776		—		1,752
Farmland		—		—		136		136		273		409		—		136
Residential
Equity Lines		—		—		—		—		27,747		27,747		—		70
1 - 4 Family		356		152		132		640		88,679		89,319		—		754
Junior Liens		—		—		26		26		1,011		1,037		—		50
Consumer - Non Real Estate		1		—		—		1		3,145		3,146		—		7
Other		—		—		—		—		1,493		1,493		—		—
Total	$	603	$	326	$	399	$	1,328	$	278,109	$	279,437	$	—	$	3,865

	30 - 59 Days Past Due		60 - 89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans		90 Days Past Due and Still Accruing		Non-accrual Loans
December 31, 2013:
Commercial - Non Real Estate	$	46	$	—	$	154	$	200	$	17,228	$	17,428	$	—	$	463
Commercial Real Estate
Owner occupied		—		77		684		761		57,154		57,915		—		1,689
Income producing		—		—		503		503		51,297		51,800		—		503
Multifamily		—		—		—		—		7,748		7,748		—		—
Construction & Development
1 - 4 Family		—		—		—		—		1,745		1,745		—		—
Other		158		—		240		398		24,375		24,773		—		599
Farmland		—		—		252		252		279		531		—		252
Residential
Equity Lines		75		9		—		84		28,133		28,217		—		95
1 - 4 Family		157		242		355		754		82,995		83,749		—		1,128
Junior Liens		—		—		26		26		1,080		1,106		—		53
Consumer - Non Real Estate		1		2		—		3		2,551		2,554		—		6
Other		—		—		—		—		944		944		—		—
Total	$	437	$	330	$	2,214	$	2,981	$	275,529	$	278,510	$	—	$	4,788

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

Pass – Loans and leases classified as pass should be performing relatively close to expectations, with adequate evidence that the borrower is continuing to generate adequate cash flow to service debt. There should be no significant departure from the intended source and timing of repayment, and there should be no undue reliance on secondary sources of repayment. To the extent that some variance exists in one or more criteria being measured, it may be offset by the relative strength of other factors and/or collateral pledged to secure the transaction.

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

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

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

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

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Commercial loans that do not require individual analysis as part of the above described process are considered to be pass-rated loans. As of June 30, 2014 and December 31, 2013, and based on the most recent analysis performed, the loans and leases were categorized as follows (dollars in thousands):

	June 30, 2014
Internal Risk Rating Grades	Pass		Special Mention		Substandard		Doubtful		Loss
Commercial - Non Real Estate	$	16,348	$	2,964	$	841	$	—	$	—
Commercial Real Estate
Owner occupied		47,591		4,243		4,296		—		—
Income producing		32,733		14,421		3,102		—		—
Multifamily		5,762		1,792		—		—		—
Construction & Development
1 - 4 Family		1,823		239		355		—		—
Other		14,831		1,891		3,054		—		—
Farmland		273		136		—		—		—
Totals	$	119,361	$	25,686	$	11,648	$	—	$	—
Total:
Commercial - Non Real Estate	$	16,348	$	2,964	$	841	$	—	$	—
Commercial Real Estate	$	86,086	$	20,456	$	7,398	$	—	$	—
Construction & Development	$	16,927	$	2,266	$	3,409	$	—	$	—
Totals	$	119,361	$	25,686	$	11,648	$	—	$	—

	December 31, 2013
Internal Risk Rating Grades	Pass		Special Mention		Substandard		Doubtful		Loss
Commercial - Non Real Estate	$	13,289	$	3,157	$	982	$	—	$	—
Commercial Real Estate
Owner occupied		47,207		6,009		4,699		—		—
Income producing		33,875		10,501		7,424		—		—
Multifamily		5,925		1,823		—		—		—
Construction & Development
1 - 4 Family		1,133		252		360		—		—
Other		17,122		3,265		4,386		—		—
Farmland		279		—		252		—		—
Totals	$	118,830	$	25,007	$	18,103	$	—	$	—
Total:
Commercial - Non Real Estate	$	13,289	$	3,157	$	982	$	—	$	—
Commercial Real Estate	$	87,007	$	18,333	$	12,123	$	—	$	—
Construction & Development	$	18,534	$	3,517	$	4,998	$	—	$	—
Totals	$	118,830	$	25,007	$	18,103	$	—	$	—

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All consumer-related loans, including residential real estate and non-real estate, are evaluated and monitored based upon payment activity. Once a consumer-related loan becomes past due on a recurring basis, the Company will pull that loan out of the homogenized pool and evaluate it individually for impairment. At this time, the consumer-related loan may be placed on the Company’s internal watch list and risk rated either special mention or substandard, depending upon the individual circumstances. Consumer-related loans at June 30, 2014 and December 31, 2013, segregated by class of loans, were as follows (dollars in thousands):

	June 30, 2014				December 31, 2013
Risk Based on Payment Activity	Performing		Non- Performing		Performing		Non- Performing
Residential
Equity Lines	$	27,677	$	70	$	28,122	$	95
1 - 4 Family		88,866		453		83,092		657
Junior Liens		1,011		26		1,080		26
Consumer - Non Real Estate
Credit Cards		—		—		—		—
Other		3,140		6		2,548		6
Totals	$	120,694	$	555	$	114,842	$	784
Total:
Residential	$	117,554	$	549	$	112,294	$	778
Consumer - Non Real Estate	$	3,140	$	6	$	2,548	$	6
Totals	$	120,694	$	555	$	114,842	$	784

NOTE 5. ALLOWANCE FOR LOAN LOSSES

The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance is necessary to reserve for, in the judgment of management, estimated loan losses and risks inherent in the loan portfolio. The Company’s allowance for loan loss methodology includes allowance allocations calculated in accordance with ASC Topic 310, “Receivables” and allowance allocations calculated in accordance with ASC Topic 450, “Contingencies.” Accordingly, the methodology is based on historical loss experience by type of credit and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions. The Company’s process for determining the appropriate level of the allowance for loan losses is designed to account for credit deterioration as it occurs. The provision for loan losses reflects loan quality trends, including the levels of and trends related to non-accrual loans, past due loans, potential problem loans, criticized loans and net charge-offs or recoveries, among other factors. The provision for loan losses also reflects the totality of actions taken on all loans for a particular period. In other words, the amount of the provision reflects not only the necessary increases in the allowance for loan losses related to newly identified criticized loans, but it also reflects actions taken related to other loans including, among other things, any necessary increases or decreases in required allowances for specific loans.

The level of the allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Company’s control, including, among other things, the performance of the Company’s loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.

The Company’s allowance for loan losses consists of three elements: (i) specific valuation allowances determined in accordance with accounting principles regarding receivables based on probable losses on specific loans; (ii) historical valuation allowances determined in accordance with accounting principles regarding contingencies based on historical loan loss experience for similar loans with similar characteristics and trends, adjusted, as necessary, to reflect the impact of current conditions; and (iii) general valuation allowances determined in accordance with accounting principles regarding contingencies based on general economic conditions and other qualitative risk factors both internal and external to the Company.

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Historical valuation allowances are calculated based on the historical loss experience of specific types of loans at the time they were charged-off. The Company calculates historical loss ratios for pools of similar loans with similar characteristics based on the proportion of actual charge-offs experienced to the total population of loans in the pool. The historical loss ratios are periodically updated based on actual charge-off experience. A historical valuation allowance is established for each pool of similar loans based upon the product of the historical loss ratio and the total dollar amount of the loans in the pool. The Company’s pools of similar loans include commercial and industrial loans, commercial real estate loans, construction and development loans, residential real estate loans, and consumer and other loans. General valuation allowances are based on general economic conditions and other qualitative risk factors both internal and external to the Company. In general, such valuation allowances are determined by evaluating, among other things: (i) levels and trends in delinquencies and impaired loans; (ii) levels of and trends in charge-offs and recoveries; (iii) levels of non-impaired substandard loans; (iv) trends in volume and terms of loans; (v) effects of changes in risk selection and underwriting practices; (vi) experience, ability, and depth of lending management and staff; (vii) national and local economic trends and conditions; (viii) industry conditions; and (ix) effect of changes in credit concentrations. Management evaluates the degree of risk that each one of these components has on the quality of the loan portfolio on a quarterly basis. Loans identified as losses by management, internal loan review and/or regulatory examiners are charged-off.

Changes in the allowance for loan losses by segment, since their respective year-end, are as follows (dollars in thousands):

	June 30, 2014												June 30, 2013
	Beginning Balance		Chargeoffs			Recoveries		Provision			Ending Balance		Beginning Balance		Chargeoffs			Recoveries		Provision			Ending Balance
Commercial - Non Real Estate	$	176	$	(49	)	$	97	$	(191	)	$	33	$	1,209	$	(107	)	$	1,364	$	(1,882	)	$	584
Commercial Real Estate
Owner occupied		1,224		—			7		(743	)		488		1,359		(290	)		12		487			1,568
Income producing		831		—			—		572			1,403		773		(21	)		20		(16	)		756
Multifamily		50		—			—		63			113		78		—			—		(11	)		67
Construction & Development
1 - 4 Family		52		(719	)		—		719			52		78		(5	)		—		12			85
Other		580		—			51		(106	)		525		728		—			6		(183	)		551
Farmland		3		—			—		—			3		—		(21	)		—		24			3
Residential
Equity Lines		332		(82	)		5		(106	)		149		314		(207	)		30		217			354
1 - 4 Family		1,218		(8	)		65		(466	)		809		1,267		(578	)		463		19			1,171
Consumer - Non Real Estate		44		(23	)		19		(4	)		36		98		(22	)		22		(8	)		90
Unallocated		1,505		—			—		37			1,542		986		—			—		183			1,169
Total	$	6,015	$	(881	)	$	244	$	(225	)	$	5,153	$	6,890	$	(1,251	)	$	1,917	$	(1,158	)	$	6,398

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As of June 30, 2014 and December 31, 2013, loans were evaluated for impairment as follows (dollars in thousands):

	Individually Evaluated for Impairment
	June 30, 2014				December 31, 2013
	Allowance		Total Loans		Allowance		Total Loans
Commercial - Non Real Estate	$	33	$	2,189	$	25	$	2,304
Commercial Real Estate
Owner occupied		117		6,481		77		7,146
Income producing		735		10,659		126		11,021
Multifamily		76		1,211		12		1,226
Construction & Development
1 - 4 Family		9		355		8		360
Other		11		3,416		107		4,721
Farmland		—		136		—		252
Residential
Equity Lines		—		70		—		95
1 - 4 Family		193		12,144		208		12,945
Consumer - Non Real Estate		—		72		—		76
Unallocated		—		—		—		—
Total	$	1,174	$	36,733	$	563	$	40,146

	Collectively Evaluated for Impairment
	June 30, 2014				December 31, 2013
	Allowance		Total Loans		Allowance		Total Loans
Commercial - Non Real Estate	$	—	$	17,964	$	151	$	15,124
Commercial Real Estate
Owner occupied		371		49,649		1,147		50,769
Income producing		668		39,597		705		40,779
Multifamily		37		6,343		38		6,522
Construction & Development
1 - 4 Family		43		2,062		44		1,385
Other		514		16,360		473		20,052
Farmland		3		273		3		279
Residential
Equity Lines		149		27,677		332		28,122
1 - 4 Family		616		78,212		1,010		71,910
Consumer - Non Real Estate		36		3,074		44		2,478
Unallocated		1,542		1,493		1,505		944
Total	$	3,979	$	242,704	$	5,452	$	238,364

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NOTE 6. 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 June 30, 2014 (dollars in thousands):

Unfunded loan commitments	$	32,444
Financial standby letters of credit		27
Total unused commitments	$	32,471

NOTE 7. RECENT ACCOUNTING PRONOUNCEMENTS

In January 2013, the FASB issued Accounting Standards Update 2013-01, Balance Sheet (Topic 210). The amendments in this Update affect entities that have derivatives accounted for in accordance with Topic 815, including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either offset in accordance with Section 210-20-45 or Section 815-10-45 or subject to an enforceable master netting arrangement or similar agreement. Entities with other types of financial assets and financial liabilities subject to a master netting arrangement or similar agreement also are affected because these amendments make them no longer subject to the disclosure requirements in Update 2011-11. The amendments clarify the intended scope of the disclosures required by Section 210-20-50. The FASB concluded that the clarified scope will reduce significantly the operability concerns expressed by preparers while still providing decision-useful information about certain transactions involving master netting arrangements. The amendments provide a user of financial statements with comparable information as it relates to certain reconciling differences between financial statements prepared in accordance with U.S. GAAP and those financial statements prepared in accordance with International Financial Reporting Standards (IFRS). An entity is required to apply the amendments for fiscal years beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the required disclosures retrospectively for all comparative periods presented. The effective date is the same as the effective date of Update 2011-11. The amendments have not had a significant impact on the Company.

In February 2013, the FASB issued Accounting Standards Update 2013-02, Comprehensive Income (Topic 220). The amendments do not change the current requirements for reporting net income or other comprehensive income in financial statements. However, the amendments require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under U.S. GAAP that provide additional detail about those amounts. Substantially all of the information that this Update requires already is required to be disclosed elsewhere in the financial statements under U.S. GAAP. However, the new requirement about presenting information about amounts reclassified out of accumulated other comprehensive income and their corresponding effect on net income will present, in one place, information about significant amounts reclassified and, in some cases, cross-references to related footnote disclosures. Currently, this information is presented in different places throughout the financial statements. For public entities, the amendments are effective prospectively for reporting periods beginning after December 15, 2012. For nonpublic entities, the amendments are effective prospectively for reporting periods beginning after December 15, 2013. Early adoption is permitted. The amendments have not had a significant impact on the Company.

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In February 2013, the FASB issued Accounting Standards Update 2013-03, Financial Instruments (Topic 825). The amendments clarify that the requirement to disclose “the level of the fair value hierarchy within which the fair value measurements are categorized in their entirety (Level 1, 2, or 3)” does not apply to nonpublic entities for items that are not measured at fair value in the statement of financial position but for which fair value is disclosed. The amendments have not had a significant impact on the Company.

In April 2013, the FASB issued Accounting Standards Update 2013-07, Presentation of Financial Statements (Topic 205). The amendments require an entity to prepare its financial statements using the liquidation basis of accounting when liquidation is imminent. Liquidation is imminent when the likelihood is remote that the entity will return from liquidation and either (a) a plan for liquidation is approved by the person or persons with the authority to make such a plan effective and the likelihood is remote that the execution of the plan will be blocked by other parties or (b) a plan for liquidation is being imposed by other forces (for example, involuntary bankruptcy). If a plan for liquidation was specified in the entity’s governing documents from the entity’s inception (for example, limited-life entities), the entity should apply the liquidation basis of accounting only if the approved plan for liquidation differs from the plan for liquidation that was specified at the entity’s inception.

The amendments require financial statements prepared using the liquidation basis of accounting to present relevant information about an entity’s expected resources in liquidation by measuring and presenting assets at the amount of the expected cash proceeds from liquidation. The entity should include in its presentation of assets any items it had not previously recognized under U.S. GAAP but that it expects to either sell in liquidation or use in settling liabilities (for example, trademarks).

An entity should recognize and measure its liabilities in accordance with U.S. GAAP that otherwise applies to those liabilities. The entity should not anticipate that it will be legally released from being the primary obligor under those liabilities, either judicially or by creditor(s). The entity also is required to accrue and separately present the costs that it expects to incur and the income that it expects to earn during the expected duration of the liquidation, including any costs associated with sale or settlement of those assets and liabilities.

Additionally, the amendments require disclosures about an entity’s plan for liquidation, the methods and significant assumptions used to measure assets and liabilities, the type and amount of costs and income accrued, and the expected duration of the liquidation process. The amendments are effective for entities that determine liquidation is imminent during annual reporting periods beginning after December 15, 2013, and interim reporting periods therein. Entities should apply the requirements prospectively from the day that liquidation becomes imminent. Early adoption is permitted. The amendments are not expected to have a significant impact on the Company.

In July 2013, the FASB issued Accounting Standards Update 2013-11, Income Taxes (Topic 740). An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The assessment of whether a deferred tax asset is available is based on the unrecognized tax benefit and deferred tax asset that exist at the reporting date and should be made presuming disallowance of the tax position at the reporting date. For example, an entity should not evaluate whether the deferred tax asset expires before the statute of limitations on the tax position or whether the deferred tax asset may be used prior to the unrecognized tax benefit being settled.

The amendments in this Update do not require new recurring disclosures. The amendments are not expected to have a significant impact on the Company.

In January 2014, the FASB issued Accounting Standards Update 2014-04, Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40). The amendments in this Update clarify that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require

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interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction.

The amendments in this Update are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. For entities other than public business entities, the amendments in this Update are effective for annual periods beginning after December 15, 2014, and interim periods within annual periods beginning after December 15, 2015. The amendments are not expected to have a significant impact on the Company.

In April 2014, the FASB issued ASU 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360. The amendments in this ASU change the criteria for reporting discontinued operations of all public and nonpublic entities. The amendments also require new disclosures about discontinued operations and disposals of components of an entity that do not qualify for discontinued operations reporting. This ASU is effective prospectively for annual periods beginning on or after December 15, 2014, and interim periods within annual periods beginning on or after December 15, 2015. The Company will evaluate the impact this ASU may have on its consolidated financial statements.

In June 2014, the FASB issued ASU 2014-11, Transfers and Servicing (Topic 860). The amendments in this ASU require that repurchase-to-maturity transactions be accounted for as secured borrowings consistent with the accounting for other repurchase agreements. In addition, the amendments require separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty (a repurchase financing), which will result in secured borrowing accounting for the repurchase agreement. The amendments require an entity to disclose information about transfers accounted for as sales in transactions that are economically similar to repurchase agreements, in which the transferor retains substantially all of the exposure to the economic return on the transferred financial asset throughout the term of the transaction. In addition the amendments require disclosure of the types of collateral pledged in repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions and the tenor of those transactions. This ASU is effective for first interim or annual periods beginning after December 15, 2014. The Company will evaluate the impact this ASU may have on its consolidated financial statements.

In June 2014, the FASB issued ASU 2014-12, Compensation – Stock Compensation (Topic 718). Some share-based payment awards that require a specific performance target to be achieved before the employee can benefit from the award, also require an employee to render service until the performance target is achieved. In some cases, the terms of an award may provide that the performance target could be achieved after an employee completes the requisite service period. That is, the employee would be entitled to benefit from the award regardless of whether the employee is rendering service on the date the performance target is achieved. Some entities account for those performance targets as performance conditions that affect the vesting of the award and, therefore, do not reflect the performance target in the estimate of the grant-date fair value. Others treat them as non-vesting conditions that affect the grant date fair value of the award. The amendments in this ASU apply to reporting entities that grant their employees share-based payments in which the terms of the award provide that a performance target can be achieved after the requisite service period. This ASU is effective for annual periods and interim periods within those annual periods, beginning after December 15, 2015. The Company will evaluate the impact this ASU may have on its consolidated financial statements.

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

NOTE 8. FAIR VALUE

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

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

• Level 1 – quoted prices (unadjusted) in active markets for identical assets or liabilities.

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• Level 2 – observable inputs other than the quoted prices included in Level 1.

• Level 3 – unobservable inputs.

Investment Securities – 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.

Impaired Loans – The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Impaired loans are recorded at fair value less estimated selling costs. Once a loan is identified as individually impaired, the Company measures impairment. Fair values of impaired loans are generally estimated using one of several methods, including collateral value, liquidation value, discounted cash flows and, in rare cases, the market value of the note. Those impaired loans not requiring an allowance represent loans for which the net present value of the expected cash flows or fair value of the collateral less costs to sell exceed the recorded investments in such loans. At June 30, 2014 and December 31, 2013, a majority of the total impaired loans were evaluated based on the fair value of the collateral. When the fair value of the collateral is based on an executed sales contract with an independent third party, the Company records the impaired loans as nonrecurring Level 1. If the collateral is based on another observable market price or a current appraised value, the Company records the impaired loans as nonrecurring Level 2. When an appraised value is not available or the Company determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3. Impaired loans can also be evaluated for impairment using the present value of expected future cash flows discounted at the loan’s effective interest rate. The measurement of impaired loans using future cash flows discounted at the loan’s effective interest rate rather than the market rate of interest is not a fair value measurement and is therefore excluded from fair value disclosure requirements. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly.

Other Real Estate Owned – Properties acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less costs to sell at the date of foreclosure. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying value or the new fair value less estimated selling costs. Fair value is generally based upon current appraisals, comparable sales, and other estimates of value obtained principally from independent sources, adjusted for selling costs. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the asset as nonrecurring Level 2. However, the Company also considers other factors or recent developments which could result in adjustments to the collateral value estimates indicated in the appraisals such as changes in absorption rates or market conditions from the time of valuation. In situations where an appraisal less estimated selling costs is used to determine fair value, management adjustments are significant to the fair value measurements, or other means are used to estimate fair value in the absence of an appraisal, the Company records the impaired loan as nonrecurring Level 3 within the valuation hierarchy.

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

	At June 30, 2014
	Total		Level 1		Level 2		Level 3
Assets valued on a recurring basis
Investment securities:
U.S. government agency	$	40,508	$	—	$	40,508	$	—
State and municipals		10,807		—		10,807		—
Mortgage-backed		37,020		—		37,020		—
Assets valued on a non-recurring basis
Impaired loans		35,559		—		—		35,559
Other real estate owned		1,951		—		—		1,951
Total	$	125,845	$	—	$	88,335	$	37,510
	At December 31, 2013
	Total		Level 1		Level 2		Level 3
Assets valued on a recurring basis
Investment securities:
U.S. government agency	$	40,930	$	—	$	40,930	$	—
State and municipals		10,181		—		10,181		—
Mortgage-backed		38,204		—		38,204		—
Assets valued on a non-recurring basis
Impaired loans		39,583		—		—		39,583
Other real estate owned		1,233		—		—		1,233
Total	$	130,131	$	—	$	89,315	$	40,816

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):

	June 30, 2014					December 31, 2013
	Outstanding Balance		Annual Interest Rate			Outstanding Balance		Annual Interest Rate
Securities sold under overnight repurchase agreements	$	267		0.10	%	$	388		0.14	%
Securities sold under term repurchase agreements		45,000		4.38			45,000		4.38
Trust preferred securities		5,155		3.23			5,155		3.19
Subordinated debt		2,700		4.00			2,700		4.00
Total borrowed funds	$	53,122		4.21	%	$	53,243		4.21	%

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

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The Bank had a total of $45.0 million of borrowings in the form of securities sold under term repurchase agreements that were entered into during 2008. These borrowings are secured by marketable investment securities equal to approximately 109.5% of the principal balances outstanding plus accrued interest and the value of an imbedded interest rate cap. The following table contains certain pertinent information with respect to these agreements at June 30, 2014 (dollars in thousands):

	Outstanding Principal Balance		Annual Effective Interest Rate			Final Maturity Date		Beginning Quarterly Call Dates		Collateral Requirement
Agreement dated 7/8/2008	$	25,000		4.85	%		7/8/2018		7/8/2013	$	6,688
Agreement dated 8/20/2008		20,000		3.78			8/20/2015		8/20/2011		3,314
Total	$	45,000		4.38	%					$	10,002

The Bank utilizes borrowings from the Federal Home Loan Bank (“FHLB”) as a source of liquidity. At June 30, 2014, the Bank had immediately available credit of $7.2 million. There were no advances from the FHLB at quarter-end.

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

In addition, the Trust may redeem the trust preferred securities in whole (but not in part) at any time within 90 days following the occurrence of a tax event, an investment company event, or a capital treatment event at a special redemption price (as defined in the debenture). Interest is payable quarterly on the trust preferred securities at the annual rate of 90-day LIBOR plus 300 basis points. In February 2011, the Company announced its election to defer its regularly scheduled interest payments on the junior subordinated debentures related to the trust preferred securities. Furthermore, the Company is party to a written agreement with the Federal Reserve, which restricts the Company’s ability to make interest payments on subordinated debt, as described below.

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. This debt can be repaid in full at any time with no penalty.

Under the terms of a written agreement between the Company and the Federal Reserve Bank of Richmond, the Company and the Trust may not make any distributions of interest, principal, or other sums on subordinated debentures or trust preferred securities without the prior written approval of the Federal Reserve Bank of Richmond and the Director of the Division of Banking Supervision and Regulation of the Federal Reserve Board of Governors.

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 June 30, 2014 and December 31, 2013. All of the shares were issued on April 17, 2009 in connection with the Company’s participation in the U.S. Treasury’s TARP Capital Purchase Program.

In February 2011, the Company notified the Treasury of its intent to defer the payment of its regular quarterly cash dividend on its Series A Preferred Stock sold to the Treasury. In addition, the Company has entered into a written agreement with the Federal Reserve Bank of Richmond, which prohibits the Company’s payment of any dividends without the prior approval of the Federal Reserve Bank of Richmond and the Director of the Division of Banking Supervision and Regulation of the Federal Reserve Board of Governors.

At June 30, 2014 and December 31, 2013, the cumulative amount of dividends in arrears not declared was $2.3 million and $1.9 million, respectively.

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Common Stock:

The Company has 500.0 million shares with no par value common stock authorized as of June 30, 2014. There were 3,895,840 shares of common stock issued and outstanding at June 30, 2014 and December 31, 2013, respectively.

Warrants:

In connection with the issuance of the preferred shares under the U.S. Treasury’s TARP Capital Purchase Program, 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.

NOTE 11. INCOME TAXES

The Company utilizes the liability method of computing income taxes. Under the liability method, deferred tax liabilities and assets are established for future tax return effects of the temporary differences between the stated value of assets and liabilities for financial reporting purposes and their tax bases. The focus is on accruing the appropriate balance sheet deferred tax amount, with the statement of income effect being the result of the changes in the balance sheet amounts from period to period. The current portion of income tax expense is provided based upon the actual tax liability incurred for tax return purposes.

An evaluation of the probability of being able to realize the future benefits of deferred tax assets is made. A valuation allowance is provided for the deferred tax asset when it is more likely than not that some portion or all of the deferred tax asset will not be realized. Management has established a deferred tax asset valuation allowance of $16.5 million and $17.7 as of June 30, 2014 and December 31, 2013, respectively. The valuation allowance has been established because management believes current overall credit trends, as well as actual and forecasted performance, raise significant concern over the ability of the Company to realize the components of its deferred tax assets relating to net operating losses and the allowances for losses on loans and OREO.

NOTE 12. GOING CONCERN

Going Concern Considerations

The consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the discharge of liabilities in the normal course of business for the foreseeable future. It is the responsibility of management to assess the Company’s ability to continue as a going concern. In making this assessment, the Company has taken into account all available information about the future, which is at least, but is not limited to, twelve months from the balance sheet date of June 30, 2014. The Company had a history of profitable operations prior to 2008 and sufficient sources of liquidity to meet its short-term and long-term funding needs.

The effects of the 2007 – 2009 recession were felt across many industries, with financial services and real estate being particularly hard-hit. The Bank, with a loan portfolio consisting of a concentration in commercial real estate loans, including residential construction and development loans, saw a decline in the value of the collateral securing its portfolio as well as rapid deterioration in its borrowers’ cash flow and ability to repay their outstanding loans to the Bank. As a result, the Bank’s level of nonperforming assets increased substantially during 2010 and 2011. During 2012, 2013, and continuing into 2014, the Bank saw significant improvement in levels of nonperforming assets. The significant losses from 2010 through the first six months of 2014, which were primarily related to credit losses and the valuation allowance on the Company’s deferred tax asset, reduced the Company’s capital levels. In order to again become well capitalized under federal banking agencies’ guidelines, at June 30, 2014 management believed that the Company would need to raise additional capital to recapitalize the Bank and to absorb the potential future credit losses associated with the disposition of its nonperforming assets.

At June 30, 2014, management believed that the Company’s financial condition and a depressed stock price were significant barriers to the success of any plan to issue additional equity in public or private offerings. An equity financing transaction would result in substantial dilution to the Company’s current stockholders and could adversely affect the market price of the Company’s common stock. As of June 30, 2014, there could be no assurance as to whether these efforts would be successful, either on a short-term or long-term basis. Should these efforts be unsuccessful, due to regulatory restrictions on cash payments and dividends between the Bank and the holding company, the Company would be unable to discharge its liabilities in the normal course of business. As of June 30, 2014, there could be no assurance that the Company would be successful in any efforts to raise additional capital during 2014.

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Both the Company and the Bank actively manage liquidity and cash flow needs. The Bank is prohibited from declaring or paying dividends without prior approval of the FDIC or the Commissioner and the Company is prohibited from declaring or paying dividends without the prior approval from the Federal Reserve. Even if these requirements were not in place, the Company does not intend to declare or pay dividends to shareholders at any time in the foreseeable future. At June 30, 2014, the Company had $38.6 million of cash and cash equivalents. The Company has no long-term debt maturing in 2014.

Based on capital levels and continued operating losses as of June 30, 2014, management believed the Company would require additional capital to be able to remain viable. Management implemented various strategies to provide this needed capital. In spite of management’s best efforts, there could be no guarantee management would be successful in raising the additional capital as of June 30, 2014. The accompanying consolidated financial statements for the Company have been prepared on a going concern basis, which contemplates the realization of assets and the discharge of liabilities in the normal course of business for the foreseeable future, and does not include any adjustments to reflect the possible future effects on the recoverability or classification of assets.

Management’s Plans and Intentions

On July 16, 2014, the Company completed a private placement of 458,132,991 shares of newly issued common stock at a price of 10 cents per share to institutional and other accredited investors. The Company plans to use approximately $34.8 million of the proceeds to inject new capital into its bank subsidiary.

NOTE 13. SUBSEQUENT EVENT

The Company completed a private placement of $45.8 million on July 16, 2014. In connection with the private placement, the Company repurchased all 13,179 shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A, issued under the Capital Purchase Program from the U.S. Treasury for a cash payment of $3.3 million. The Treasury also agreed to waive any unpaid dividends on the Series A Preferred Stock, and to cancel the warrant to purchase 475,204 shares of the Company’s common stock held by the Treasury. The Company also repurchased all of its floating rate trust preferred securities issued through its subsidiary, Bank of the Carolinas Trust I, from the holders of those securities for an aggregate cash payment of $1.75 million. The holders of the trust preferred securities agreed to forgive any unpaid interest on the securities. The Company also agreed to repurchase a subordinated note from the holder of the note for a cash payment of $1.35 million. The noteholder agreed to forgive any unpaid interest on the note. As of July 31, 2014, the Company and its subsidiaries have no debt obligations.

The Company injected $34.8 million from the private placement into the Company’s banking subsidiary. The following table lists the Company’s and the Bank’s capital ratios at July 31, 2014:

	Minimum required ratios			Required ratios to be considered “Well capitalized”			The Company’s capital ratios			The Bank’s capital ratios
Risk-based capital ratios:
Leverage Capital Ratio (Tier 1 Capital to July 2014’s average assets)		4.0	%		5.0	%		10.79	%		10.58	%
Tier 1 Capital Ratio (Tier 1 Capital to risk-weighted assets)		4.0	%		6.0	%		15.60	%		14.86	%
Total Capital Ratio (Total Capital to risk-weighted assets)		8.0	%		10.0	%		16.85	%		16.12	%

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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

GENERAL

Introduction

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

The Bank began operations in December 1998 as a state chartered bank and currently has eight 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.

Written Agreement with Federal Reserve

The Company entered into a written agreement (the “Agreement”) with the Federal Reserve Bank of Richmond on August 26, 2011. The description of the Agreement set forth below is qualified in its entirety by reference to the full text of the Agreement, a copy of which is included as Exhibit 10.01 to the Company’s Quarterly Report on Form 10-Q, filed with the Securities and Exchange Commission on November 14, 2011, and incorporated herein by reference.

Source of Strength. The Agreement requires that the Company take appropriate steps to fully utilize its financial and managerial resources to serve as a source of strength to the Bank and ensure that the Bank complies with the requirements of the consent order entered into between the North Carolina Commissioner of Banks, the FDIC, and the Bank.

Dividends, Distributions, and other Payments. The Agreement prohibits the Company’s payment of any dividends without the prior approval of the Federal Reserve Bank of Richmond and the Director of the Division of Banking Supervision and Regulation of the Federal Reserve Board of Governors. It also prohibits the Company from directly or indirectly taking any dividends or any other form of payment representing a reduction in capital from the Bank without the prior written approval of the Federal Reserve Bank of Richmond.

Under the terms of the Agreement, the Company and Bank of the Carolinas Trust I may not make any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities without the prior written approval of the Federal Reserve Bank of Richmond and the Director of the Division of Banking Supervision and Regulation.

Debt and Stock Redemption. The Agreement requires that the Company and any non-bank subsidiary of the Company not, directly or indirectly, incur, increase or guarantee any debt without the prior written approval of the Federal Reserve Bank. The Agreement also requires that the Company not, directly or indirectly, purchase or redeem any shares of its capital stock without the prior written approval of the Federal Reserve Bank of Richmond.

Capital Plan, Cash Flow Projections and Progress Reports. The Agreement requires that the Company file an acceptable capital plan and certain cash flow projections with the Federal Reserve Bank of Richmond. It also requires that the Company file a written progress report within 30 days after the end of each calendar quarter while the Agreement remains in effect.

The Agreement will remain in effect until modified or terminated by the Federal Reserve Bank of Richmond.

Consent Order with Regulators

The Bank entered into a Stipulation to the Issuance of a Consent Order (the “Stipulation”) with the Federal Deposit Insurance Corporation (the “FDIC”) and the North Carolina Office of the Commissioner of Banks (the “Commissioner”) and the FDIC and the Commissioner issued the related Consent Order (the “Order”), effective April 27, 2011. The description of the Stipulation and the Order set forth below is qualified in its entirety by reference to the Stipulation and the Order, copies of which are included as exhibits 10.1 and 10.2, respectively, to the Company’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on May 3, 2011, and incorporated herein by reference.

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Management. The Order required that the Bank have and retain qualified management, including a chief executive officer, senior lending officer, and chief operating officer with qualifications and experience commensurate with their assigned duties and responsibilities within 60 days from the effective date of the Order. Within 30 days of the effective date of the Order, the board of directors was required to retain a bank consultant to develop a written analysis and assessment of the Bank’s management needs. Within 60 days from receipt of the consultant’s management report, the Bank was required to formulate a written management plan that incorporated the findings of the management report, a plan of action in response to each recommendation contained in the management report, and a time frame for completing each action.

Capital Requirements. While the Order is in effect, the Bank must maintain a leverage ratio (the ratio of Tier 1 capital to total assets) of at least 8% and a total risk-based capital ratio (the ratio of qualifying total capital to risk-weighted assets) of at least 10%. If the Bank’s capital ratios are below these levels as of the date of any call report or regulatory examination, the Bank must, within 30 days from receipt of a written notice of capital deficiency from its regulators, present a plan to increase capital to meet the requirements of the Order. At June 30, 2014, the Bank was not in compliance with the capital requirements contained in the Order.

Allowance for Loan and Lease Losses and Call Report. Upon issuance of the Order, the Bank was required to make a provision to replenish the allowance for loan and lease losses (“ALLL”). Within 30 days of the effective date of the Order, the Bank was required to review its call reports filed with its regulators on or after December 31, 2010, and was required to amend those reports if necessary to accurately reflect the financial condition of the Bank. Within 60 days of the effective date of the Order, the Bank was required to submit a comprehensive policy for determining the adequacy of the ALLL.

Concentrations of Credit. Within 60 days of the issuance of the Order, the Bank was required to perform a risk segmentation analysis with respect to its concentrations of credit and develop a written plan for systematically reducing and monitoring the Bank’s commercial real estate and acquisition, construction, and development loans to an amount commensurate with the Bank’s business strategy, management expertise, size, and location.

Charge-Offs, Credits. The Order required that the Bank eliminate from its books, by charge-off or collection, all assets or portions of assets classified “loss” and 50% of those assets classified “doubtful.” If an asset is classified “doubtful,” the Bank may alternatively charge off the amount that is considered uncollectible in accordance with the Bank’s written analysis of loan or lease impairment. The Order also prevents the Bank from extending, directly or indirectly, any additional credit to, or for the benefit of, any borrower who has a loan or other extension of credit from the Bank that has been charged off or classified, in whole or in part, “loss” or “doubtful” and is uncollected. The Bank may not extend, directly or indirectly, any additional credit to any borrower who has a loan or other extension of credit from the Bank that has been classified “substandard.” These limitations do not apply if the Bank’s failure to extend further credit to a particular borrower would be detrimental to the best interests of the Bank.

Asset Growth. While the Order is in effect, the Bank must notify its regulators at least 60 days prior to undertaking asset growth that exceeds 10% or more per year or initiating material changes in asset or liability composition. The Bank’s asset growth cannot result in noncompliance with the capital maintenance provisions of the Order unless the Bank receives prior written approval from its regulators.

Restriction on Dividends and Other Payments. While the Order is in effect, the Bank cannot declare or pay dividends, pay bonuses, or pay any form of payment outside the ordinary course of business resulting in a reduction of capital without the prior written approval of its regulators. In addition, the Bank cannot make any distributions of interest, principal, or other sums on subordinated debentures without prior regulatory approval.

Brokered Deposits. The Order provides that the Bank may not accept, renew, or roll over any brokered deposits unless it is in compliance with the requirements of the FDIC regulations governing brokered deposits. These regulations prohibit undercapitalized institutions from accepting, renewing, or rolling over any brokered deposits and also prohibit undercapitalized institutions from soliciting deposits by offering an effective yield that exceeds by more than 75 basis points the prevailing effective yields on insured deposits of comparable maturity in the institution’s market area. An “adequately capitalized” institution may not accept, renew, or roll over brokered deposits unless it has applied for and been granted a waiver by the FDIC. As of June 30, 2014, the Bank was classified as “significantly undercapitalized.”

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Written Plans and Other Material Terms. Under the terms of the Order, the Bank was required to prepare and submit the following written plans or reports to the FDIC and the Commissioner:

• Plan to improve liquidity, contingency funding, interest rate risk, and asset liability management

• Plan to reduce assets of $500,000 or greater classified “doubtful” and “substandard”

• Revised lending and collection policy to provide effective guidance and control over the Bank’s lending and credit administration functions

• Effective internal loan review and grading system

• Policy for managing the Bank’s other real estate

• Business/strategic plan covering the overall operation of the Bank

• Plan and comprehensive budget for all categories of income and expense for the year 2011

• Policy and procedures for managing interest rate risk

• Assessment of the Bank’s information technology function

Under the Order, the Bank’s board of directors agreed to increase its participation in the affairs of the Bank, including assuming full responsibility for the approval of policies and objectives for the supervision of all of the Bank’s activities. The Bank was also required to establish a board committee to monitor and coordinate compliance with the Order.

The Order will remain in effect until modified or terminated by the FDIC and the Commissioner.

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CHANGES IN FINANCIAL CONDITION

Total Assets

At June 30, 2014, total assets were $427.8 million, an increase of 1.0% compared to $423.7 million at December 31, 2013. The asset increase was primarily the result of an increase in the amount of cash and cash equivalents held by the Company in response to liquidity needs. The Company had earning assets of $387.9 million at June 30, 2014 consisting of $279.4 million in loans, $88.3 million in investment securities, and $20.2 million in temporary investments. Stockholders’ equity was $4.8 million at June 30, 2014 compared to $1.7 million at December 31, 2013. The increase in stockholders’ equity was primarily the result of decreased unrealized losses included in other comprehensive income, which is offset by the Company’s net loss year-to-date.

Investment Securities

Investment securities totaled $88.3 million at June 30, 2014, compared to $90.3 million at December 31, 2013. The decrease was primarily a result of $3.0 million in maturities and calls netted with a decrease unrealized losses. A summary of the Company’s investment securities holdings by major category at June 30, 2014 and December 31, 2013 is included in Note 3 of “Notes to Consolidated Financial Statements”.

Loans and Allowance for Loan Losses

At June 30, 2014, the loan portfolio totaled $279.4 million and represented 65.3% of total assets compared to $278.5 million or 65.7% of total assets at December 31, 2013. Total loans at June 30, 2014 increased $927,000 or 0.3% from December 31, 2013. The increase in loans outstanding in the six-month period is the result of new loans originated in excess of net chargeoffs and principal repayments. Loan demand has increased over the last year. Real estate loans, including commercial real estate, constituted approximately 91% of the loan portfolio, and commercial business and other loans comprised approximately 9% of the total loan portfolio at both June 30, 2014 and December 31, 2013.

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

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

The allowance for loan losses at June 30, 2014, amounted to $5.2 million, a decrease of $862,000, or 14.3% from December 31, 2013. The allowance consists of specific reserves of $1.2 million and a general allowance $4.0 million. The Bank’s provisions for loan losses amounted to a recovery of $225,000 during the six months ended June 30, 2014 compared to a $1.2 million recovery during the six months ended June 30, 2013. The loan loss provision for 2014 reflects a specific impairment of $1.1 million to one of the Bank’s top ten largest loan relationships. While the Company has not participated in “subprime” lending activities, we were affected by the economic downturn in our markets. We continue to work with our customers with troubled credit relationships to the extent that it is reasonably possible.

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

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The following table summarizes information regarding our nonaccrual loans, other real estate owned, and 90-day and over past due loans as of June 30, 2014 and December 31, 2013 (dollars in thousands):

	June 30, 2014			December 31, 2013
Loans accounted for on a nonaccrual basis:
Real estate loans:
1-4 family residential	$	874		$	1,276
Commercial real estate		810			2,192
Construction and development		1,888			851
Total real estate loans		3,572			4,319
Commercial business and other loans		286			463
Consumer loans		7			6
Total nonaccrual loans		3,865			4,788
Accruing loans which are contractually past due 90 days or more		—			—
Total nonperforming loans		3,865			4,788
Other real estate owned		1,951			1,233
Total nonperforming assets	$	5,816		$	6,021
Total nonperforming loans as a percentage of loans		1.38	%		1.72	%
Allowance for loan losses as a percentage of total nonperforming loans		133.32	%		125.63	%
Allowance for loan losses as a percentage of total loans		1.84	%		2.16	%
Total nonperforming assets as a percentage of loans and other real estate owned		2.07	%		2.15	%
Total nonperforming assets as a percentage of total assets		1.36	%		1.42	%

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 June 30, 2014, total deposits were $367.0 million compared to $366.2 million at December 31, 2013. The June 30, 2014 amount represents an increase of 0.2% from December 31, 2013, which is mainly recognized in savings and money market accounts, as well as, interest bearing checking accounts. At June 30, 2014, the deposit mix was comparable to December 31, 2013.

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The following table presents a breakdown of our deposit base at June 30, 2014 and December 31, 2013 (dollars in thousands):

	June 30, 2014			December 31, 2013
Noninterest bearing demand deposits	$	34,657		$	35,243
Interest checking deposits		42,466			40,939
Savings deposits		16,320			15,637
Money market deposits		95,065			93,782
Customer time deposits		178,504			180,549
Brokered certificates of deposit		—			—
Total deposits	$	367,012		$	366,150
Time deposits $100,000 or more:
Brokered certificates of deposit	$	—		$	—
Customer time deposits issued in denominations of $100,000 or more		115,699			115,926
Total time deposits issued in denominations of $100,000 or more	$	115,699		$	115,926
As a percent of total deposits:
Noninterest bearing demand deposits		9.44	%		9.63	%
Interest checking deposits		11.57			11.18
Savings deposits		4.45			4.27
Money market deposits		25.90			25.61
Customer time deposits		48.64			49.31
Brokered certificates of deposit		—			—
Total time deposits issued in denominations of $100,000 or more		31.52			31.66

Liquidity

Liquidity management is the process of managing assets and liabilities, as well as their maturities, to ensure adequate funding for loan and deposit activities. 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 June 30, 2014 our balance sheet liquidity ratio (net liquid assets as a percent of unsecured liabilities) amounted to 17.18% and our total liquidity ratio (balance sheet plus off-balance sheet liquidity) was 18.78%. As of December 31, 2014, our balance sheet liquidity ratio was 17.04% and our total liquidity ratio was 18.78%.

In addition, we have the ability to borrow up to $10.0 million from the discount window of the Federal Reserve 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, of which there were none at June 30, 2014, 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 June 30, 2014 is adequate to meet its operating needs.

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Interest Rate Sensitivity

Fluctuating interest rates, increased competition, and changes in the regulatory environment continue to significantly affect the importance of interest rate sensitivity management. Rate sensitivity arises when interest rates on assets change in a different period of time or in a different proportion to interest rates on liabilities. The primary objective of interest rate sensitivity management is to prudently structure the balance sheet so that movements of interest rates on assets and liabilities are highly correlated and produce a reasonable net interest margin even in periods of volatile interest rates. The Company uses an asset/liability simulation model to project potential changes to the Company’s net interest margin, net income, and economic value of equity based on simulated changes to market interest rates, namely the prime rate. Our goal is to maintain an interest rate sensitivity position as close to neutral as practicable whereby little or no change in interest income would occur as interest rates change. On June 30, 2014, 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 described above, the Bank is subject to a consent order issued by the FDIC and the North Carolina Office of the Commissioner of Banks and the Company is party to a written agreement with the Federal Reserve Bank of Richmond. These regulatory agreements require that the Bank maintain capital levels in excess of normal regulatory minimums, including a Leverage Capital Ratio of at least 8.0% and a Total Risk-Based Capital Ratio of at least 10.0%, and that the Company and the Bank seek the approval of their respective regulators prior to the payment of any cash dividend. At June 30, 2014, the Bank was not in compliance with the minimum capital requirements set forth in the consent order. As a result, the Bank was required to present its federal and state regulators with a plan to increase its capital ratios to the required percentages. The Bank hired a consultant to help formulate this plan and assist in the exploration of other strategic alternatives.

At June 30, 2014, the Company’s leverage and Tier 1 risk-weighted Capital Ratios were 1.88% and 2.57%, respectively, which are below the minimum level required by regulatory guidelines. At June 30, 2014, the Company’s Total risk-weighted Capital Ratio was 5.77%, which is below the minimum level required by regulatory guidelines. At June 30, 2014 the Bank’s leverage and Tier 1 risk-weighted Capital Ratios were 3.43% and 4.70%, respectively, which are below the minimum levels required by regulatory guidelines. At June 30, 2014, the Bank’s Total risk-weighted Capital Ratio was 5.96%, which is below the minimum level required by regulatory guidelines. At June 30, 2014, the Bank’s leverage and Total risk-weighted Capital Ratios were both non-compliant with the levels specified in the above referenced consent order with bank regulators. Banks are placed into one of five capital categories based on the above three separate capital ratios. The five categories are “well-capitalized,” “adequately capitalized,” “under-capitalized,” “significantly under-capitalized,” and “critically under-capitalized.” The Bank was considered “significantly under-capitalized” as of June 30, 2014.

Revised Capital Requirements. On July 2, 2013, the Federal Reserve and the Office of the Comptroller of the Currency adopted a final rule that will revise the current risk-based and leverage capital requirements for banking organizations. The final rule is a continuation of joint notices of proposed rulemaking originally published in the Federal Register during August 2012.

The final rule implements a revised definition of regulatory capital, a new common equity Tier 1 minimum capital requirement, and a higher overall minimum Tier 1 capital requirement, incorporating these new requirements into the existing prompt corrective action (PCA) framework. It also establishes limits on a banking organization’s capital distributions and certain discretionary bonus payments if the organization does not hold a specified amount of common equity Tier 1 capital in addition to the amount necessary to meet its minimum risk-based capital requirements. This additional capital is referred to as the “capital conservation buffer.” The “countercyclical capital buffer” provisions from the proposed rule have also been adopted, however, they apply only to large financial institutions (banks and bank holding companies with total consolidated assets of $250 billion or more) implementing the “advanced approaches” framework and are not applicable to the Bank.

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The final rule permanently grandfathers the Tier 1 capital treatment for certain non-qualifying capital instruments, including trust preferred securities, outstanding as of May 19, 2010.

Under the proposed rules released in August 2012, banking organizations would have been required to recognize in regulatory capital all components of accumulated other comprehensive income (excluding accumulated net gains and losses on cash-flow hedges that relate to the hedging of items that are not recognized at fair value on the balance sheet). The final rule carries this requirement forward, with an exception for smaller banking organizations, such as the Bank, which are not subject to the “advanced approaches” rule. Such organizations may make a one-time election not to include most elements of accumulated other comprehensive income (including unrealized gains and losses on securities designated as available-for-sale) in regulatory capital under the final rule. Organizations making this election will be permitted to use the currently existing treatment under the general risk-based capital rules that exclude most accumulated other comprehensive income elements from regulatory capital. The election must be made with the first call report or FR Y-9 report filed after the banking organization becomes subject to the final rule (January 2015 in the Bank’s case).

The new rule also amends the existing methodologies for determining risk-weighted assets for all banking organizations. Specifically, the final rule assigns a 50% or 100% risk weight to mortgage loans secured by one-to-four family residential properties. Generally, residential mortgage loans secured by a first lien on a one- to-four family residential property that are prudently underwritten and that are performing according to their original terms receive a 50% risk weight. All other one-to-four family residential mortgage loans, including loans secured by a junior lien on residential property, are assigned a 100% risk weight.

The mandatory compliance date for the Bank will be January 1, 2015, with a transition period for the capital conservation buffer until January 1, 2016, and additional transition periods for certain other measures under the new rule.

Management will continue to evaluate the potential effect of the new final rule over the coming quarters.

RESULTS OF OPERATIONS

Three Months Ended June 30, 2014 and 2013

Overview. For the three months ended June 30, 2014, the Company had net income available to common shareholders of $599,000, or $0.15 per common share. This compares to a net loss of $1.3 million, or $0.33 per common share, for the three months ended June 30, 2013. The increase in net income was primarily due to an increased recovery in the provision for loan losses, an increase in net interest income, and a decrease in noninterest expenses.

Net Interest Income. The Company’s net interest income for the three months ended June 30, 2014 totaled $2.7 million compared to $2.6 million at June 30, 2013. Net interest income increased due to the increase in loan balances and reductions in non-performing loans compared to June 30, 2013. The net interest margin was 2.74% for the second quarter of 2014 compared to 2.67% for the second quarter of 2013.

Provision for Loan Losses. The loan loss provision amounted to a recovery of $1.3 million for the quarter ended June 30, 2014, an increase of $1.3 million, from the $12,000 recovery recorded in the comparable quarter of 2013. Net chargeoffs totaled $671,000 in the second quarter of 2014 compared to net chargeoffs of $88,000 in the second quarter of 2013. The recovery for the quarter was based on the Company’s historical loss ratios, which were updated to include the most recent 12 quarters.

Noninterest Income. Noninterest income totaled $384,000 for the three months ended June 30, 2014 compared to $383,000 for the comparable three-month period of 2013. Noninterest income includes customer service charges on deposit accounts, bank owned life insurance, and gains on investment securities. Noninterest income increased 0.2% for the three months ended June 30, 2014 as compared to the same three months of 2013, primarily as a result of increases in the Company’s fee schedule.

Noninterest Expenses. Noninterest expenses totaled $3.5 million and $3.7 million for the three months ended June 30, 2014 and 2013, respectively. Excluding the decrease in other real estate expenses of $179,000, noninterest expenses for the three months ended June 30, 2014 decreased by $60,000. The Company is performing due diligence in all cost categories to minimize expense.

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Income Taxes. There was no provision for income taxes made for the second quarter of 2014 as compared to an income tax expense of $341,000 for the second quarter of 2013. Our deferred tax asset had no value at June 30, 2014 and at December 31, 2013.

Six Months Ended June 30, 2014 and 2013

Overview. For the six months ended June 30, 2014, the Company had a net loss available to common shareholders of $1.2 million, or $0.30 per common share. This compares to a net loss of $1.4 million, or $0.36 per common share, for the six months ended June 30, 2013. The decreased net loss was primarily due to an increase in net interest income and a decrease in noninterest expenses. There was no provision for income taxes for the first six months of 2014 as compared to an income tax expense of $638,000 the first six months of 2013.

Net Interest Income. The Company’s net interest income for the six months ended June 30, 2014 totaled $5.4 million compared to $5.2 million at June 30, 2013. Net interest income increased due to the increase in loan balances and reductions in non-performing loans compared to June 30, 2013. The net interest margin has increased to 2.74% for the first six months of 2014 compared to 2.70% for the first six months of 2013.

Provision for Loan Losses. The loan loss provision amounted to a recovery of $225,000 for the six months ended June 30, 2014, compared to the $1.2 million recovery recorded in the comparable six months of 2013. Net chargeoffs totaled $637,000 in the first six months of 2014 compared to net recoveries of $666,000 in the first six months of 2013.

Noninterest Income. Noninterest income totaled $774,000 for the six months ended June 30, 2014 compared to $749,000 for the comparable six-month period of 2013. Noninterest income includes customer service charges on deposit accounts, bank owned life insurance, and gains on investment securities. Noninterest income increased 3.3% for the six months ended June 30, 2014 as compared to the same six months of 2013, primarily as a result of increases in the Company’s fee schedule.

Noninterest Expenses. Noninterest expenses totaled $7.0 million and $7.4 million for the six months ended June 30, 2014 and 2013, respectively. Excluding the decrease in other real estate expenses of $505,000 and reimbursement of out-of-pocket expenses related to a loan for which $245,000 of life insurance premiums were paid to ensure final collection, noninterest expenses for the six months ended June 30, 2014 decreased by $183,000. The Company is performing due diligence in all cost categories to minimize expense.

Income Taxes. There was no provision for income taxes made for the first six months of 2014 as compared to an income tax expense of $638,000 for the first six months of 2013. Our deferred tax asset had no value at June 30, 2014 and at December 31, 2013.

DISCLOSURES ABOUT FORWARD LOOKING STATEMENTS

Statements in this Report relating to plans, strategies, economic performance and trends, projections of results of specific activities or investments, expectations or beliefs about future events or results, and other statements that are not descriptions of historical facts, may be forward-looking statements as defined in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking information is inherently subject to risks and uncertainties, and actual results could differ materially from those currently anticipated due to a number of factors. Forward-looking statements may be identified by terms such as “may,” “will,” “should,” “could,” “expects,” “plans,” “intends,” “anticipates,” “ feels,” “believes,” “estimates,” “predicts,” “forecasts,” “potential” or “continue,” or similar terms or the negative of these terms, or other statements concerning opinions or judgments of our management about future events. Factors that could influence the accuracy of forward-looking statements include, but are not limited to (a) pressures on our earnings, capital and liquidity resulting from current and future conditions in the credit and capital markets, (b) continued or unexpected increases in nonperforming loans and credit losses in our loan portfolio, (c) adverse conditions in the economy and in the real estate market in our banking markets (particularly those conditions that affect our loan portfolio, the abilities of our borrowers to repay their loans, and the values of collateral that secures our loans), (d) the financial success or changing strategies of our customers, (e) actions of government regulators, or changes in laws, regulations or accounting standards, that adversely affect our business, (f) changes in the interest rate environment and the level of market interest rates that reduce our net interest margins and/or the values of loans we make and securities we hold, and changes in general economic conditions and real estate values in our banking market (particularly changes that affect our loan portfolio, the abilities of our borrowers to repay their loans, and the

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values of loan collateral), (g) changes in competitive pressures among depository and other financial institutions or in our ability to compete effectively against other financial institutions in our banking markets, and (h) other developments or changes in our business that we do not expect. Although we believe that the expectations reflected in the forward-looking statements included in this Report are reasonable, they represent our management’s judgments only as of the date they are made, and we cannot guarantee future results, levels of activity, performance or achievements. As a result, readers are cautioned not to place undue reliance on these forward-looking statements. All forward-looking statements attributable to us are expressly qualified in their entirety by the cautionary statements in this paragraph. We have no obligation, and do not intend to update these forward-looking statements.

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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

Item 4. CONTROLS AND PROCEDURES

The Company’s management, under the supervision and with the participation of its principal executive officer and principal financial officer, has evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures in accordance with Rule 13a-15 of the Securities Exchange Act of 1934 (the “Exchange Act”). Based on their evaluation, the principal executive officer and principal 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 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

There are no material pending legal proceedings to which the Company or the Bank is a party, or of which any of their property is the subject other than routine litigation that is incidental to their business.

Item 1A. Risk Factors

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

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

None during the period covered by this report.

Item 3. Defaults Upon Senior Securities.

As disclosed on its Current Report on Form 8-K, filed with the Securities and Exchange Commission on February 18, 2011, the Company notified the United States Department of the Treasury of its intent to defer the payment of its regular quarterly cash dividends on its fixed rate cumulative perpetual preferred stock, series A, issued to the Treasury in connection with the Company’s participation in the Treasury’s TARP Capital Purchase Program. As of June 30, 2014, the Company was in arrears with the dividend payments on the series A preferred stock. As of June 30, 2014, the amount of the arrearage on the dividend payments for the series A preferred stock was $2,495,590.08.

Item 4. Mine Safety Disclosures

Not applicable

Item 5. Other Information

None

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Item 6. Exhibits

The following exhibits are filed with this report.

3.01	Articles of Incorporation
10.01	Securities Purchase Agreement with the United States Department of the Treasury, dated April 18, 2014
31.01	Certification of our principal executive officer pursuant to Rule 13a-14(a)
31.02	Certification of our principal financial officer pursuant to Rule 13a-14(a)
32.01	Certification of our principal executive officer and principal financial officer pursuant to 18 U.S.C. Section 1350
101	Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets as of June 30, 2014 and December 31, 2013; (ii) Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2014 and 2013; (iii) Consolidated Statements of Comprehensive Income (Loss) for the Three and Six Months Ended June 30, 2014 and 2013; (iv) Consolidated Statements of Changes in Stockholders’ Equity for the Six Months Ended June 30, 2014 and 2013; (v) Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2014 and 2013; and (vi) Notes to Consolidated Financial Statements as of June 30, 2014 and December 31, 2013 and for the Six Months Ended June 30, 2014 and 2013

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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: August 14, 2014	By:	/s/ Stephen R. Talbert
	Stephen R. Talbert
	President and Chief Executive Officer
	(principal executive officer)
Date: August 14, 2014	By:	/s/ Megan W. Patton
	Megan W. Patton
	Senior Vice President and Chief Financial Officer
	(principal financial officer)

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EXHIBIT INDEX

Exhibit Number	Description
3.01	Articles of Incorporation
10.01	Securities Purchase Agreement with the United States Department of the Treasury, dated April 18, 2014
31.01	Certification of our principal executive officer pursuant to Rule 13a-14(a)
31.02	Certification of our principal financial officer pursuant to Rule 13a-14(a)
32.01	Certification of our principal executive officer and principal financial officer pursuant to 18 U.S.C. Section 1350
101	Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets as of June 30, 2014 and December 31, 2013; (ii) Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2014 and 2013; (iii) Consolidated Statements of Comprehensive Income (Loss) for the Three and Six Months Ended June 30, 2014 and 2013; (iv) Consolidated Statements of Changes in Stockholders’ Equity for the Six Months Ended June 30, 2014 and 2013; (v) Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2014 and 2013; and (vi) Notes to Consolidated Financial Statements as of June 30, 2014 and December 31, 2013 and for the Six Months Ended June 30, 2014 and 2013

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