UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2009

or

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from  to 

CAPITAL BANK CORPORATION

(Exact name of registrant as specified in its charter)

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

333 Fayetteville Street, Suite 700

Raleigh, North Carolina 27601

(Address of principal executive offices)

(919) 645-6400

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant 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 ¨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 þ
Non-accelerated filer ¨ (Do not check if a smaller reporting company)	Smaller reporting company ¨

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

As of August 6, 2009 there were11,300,369 shares outstanding of the registrant’s common stock, no par value.

CAPITAL BANK CORPORATION

Form 10-Q for the Quarterly Period Ended June 30, 2009

INDEX

PART I – FINANCIAL INFORMATION		Page No.
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets as of June 30, 2009 (Unaudited) and December 31, 2008	3
	Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2009 and 2008 (Unaudited)	4
	Condensed Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income for the Six Months Ended June 30, 2009 and 2008 (Unaudited)	5
	Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2009 and 2008 (Unaudited)	6
	Notes to Condensed Consolidated Financial Statements (Unaudited)	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	34
Item 4.	Controls and Procedures	34
PART II – OTHER INFORMATION
Item 1.	Legal Proceedings	35
Item 1A.	Risk Factors	35
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	41
Item 3.	Defaults upon Senior Securities	41
Item 4.	Submission of Matters to a Vote of Security Holders	41
Item 5.	Other Information	42
Item 6.	Exhibits	42
Signatures

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PART I – FINANCIAL INFORMATION

Item 1.Financial Statements

CAPITAL BANK CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

June 30, 2009 and December 31, 2008

	June 30, 2009			December 31, 2008
(Dollars in thousands except share data)	(Unaudited)
Assets
Cash and due from banks:
Interest-earning	$	53,590		$	26,621
Noninterest-earning		19,094			27,705
Federal funds sold and short term investments		10			129
Total cash and cash equivalents		72,694			54,455
Investment securities – available for sale, at fair value		263,845			272,944
Investment securities – held to maturity, at amortized cost		4,379			5,194
Loans – net of unearned income and deferred fees		1,293,340			1,254,368
Allowance for loan losses		(18,602	)		(14,795	)
Net loans		1,274,738			1,239,573
Premises and equipment, net		24,170			24,640
Bank-owned life insurance		22,398			22,368
Deposit premium, net		3,282			3,857
Deferred income tax		9,116			9,342
Accrued interest receivable		6,191			6,225
Other assets		14,529			15,634
Total assets	$	1,695,342		$	1,654,232
Liabilities
Deposits:
Demand, noninterest-bearing	$	130,567		$	125,281
Savings and interest-bearing checking		209,622			173,711
Money market deposit accounts		206,259			212,780
Time deposits less than $100,000		503,476			509,231
Time deposits $100,000 and greater		330,918			294,311
Total deposits		1,380,842			1,315,314
Repurchase agreements and federal funds purchased		10,589			15,010
Borrowings		117,000			132,000
Subordinated debentures		30,930			30,930
Other liabilities		12,675			12,464
Total liabilities		1,552,036			1,505,718
Commitments and contingencies
Shareholders’ Equity
Preferred stock, $1,000 par value; 100,000 shares authorized; 41,279 shares issued and outstanding (liquidation preference of $41,279)		39,982			39,839
Common stock, no par value; 20,000,000 shares authorized; 11,300,369 and 11,238,085 shares issued and outstanding		139,641			139,209
Retained deficit		(37,515	)		(31,420	)
Accumulated other comprehensive income		1,198			886
Total shareholders’ equity		143,306			148,514
Total liabilities and shareholders’ equity	$	1,695,342		$	1,654,232

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

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CAPITAL BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

For the Three and SixMonths Ended June 30, 2009 and 2008 (Unaudited)

	Three Months Ended June 30,				Six Months Ended June 30,
	2009		2008		2009			2008
(Dollars in thousands except per share data)
Interest income:
Loans and loan fees	$	17,412	$	18,111	$	33,504		$	37,610
Investment securities:
Taxable interest income		2,561		2,216		5,360			4,434
Tax-exempt interest income		763		805		1,527			1,634
Dividends		13		118		13			235
Federal funds and other interest income		6		33		16			88
Total interest income		20,755		21,283		40,420			44,001
Interest expense:
Deposits		7,033		8,026		14,799			17,098
Borrowings and repurchase agreements		1,558		2,329		3,276			5,066
Total interest expense		8,591		10,355		18,075			22,164
Net interest income		12,164		10,928		22,345			21,837
Provision for loan losses		1,692		850		7,678			1,415
Net interest income after provision for loan losses		10,472		10,078		14,667			20,422
Noninterest income:
Service charges and other fees		959		1,266		1,911			2,225
Mortgage fees and revenues		385		354		618			626
Other loan fees		198		387		492			500
Brokerage fees		150		245		313			401
Bank card services		385		354		724			653
Bank-owned life insurance		1,165		260		1,423			562
Net gain on investment securities		336		69		16			140
Other		146		67		333			135
Total noninterest income		3,724		3,002		5,830			5,242
Noninterest expense:
Salaries and employee benefits		5,856		5,269		11,817			10,172
Occupancy		1,348		957		2,721			1,954
Furniture and equipment		739		793		1,569			1,540
Data processing and telecommunications		573		528		1,204			960
Advertising		223		205		546			520
Office expenses		322		315		657			680
Professional fees		434		281		813			651
Business development and travel		247		340		575			673
Amortization of deposit premiums		287		257		575			514
Miscellaneous loan handling costs		372		224		535			318
Directors fees		477		189		836			589
Insurance		140		103		244			198
FDIC deposit insurance		1,179		181		1,408			228
Other		268		354		529			617
Total noninterest expense		12,465		9,996		24,029			19,614
Net income (loss) before tax expense (benefit)		1,731		3,084		(3,532	)		6,050
Income tax expense (benefit)		382		869		(418	)		1,668
Net income (loss)	$	1,349	$	2,215	$	(3,114	)	$	4,382
Dividends and accretion on preferred stock		587		–		1,174			–
Net income (loss) attributable to common shareholders	$	762	$	2,215	$	(4,288	)	$	4,382
Earnings (loss) per common share – basic	$	0.07	$	0.20	$	(0.38	)	$	0.39
Earnings (loss) per common share – diluted	$	0.07	$	0.20	$	(0.38	)	$	0.39

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

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CAPITAL BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME

For the Six Months Ended June 30, 2009 and 2008 (Unaudited)

	Shares of Common Stock			Common Stock			Preferred Stock		Other Comprehensive Income (Loss)			Retained Earnings (Deficit)			Total
(Dollars in thousands except per share data)
Balance at January 1, 2008		11,169,777		$	136,154		$	–	$	161		$	27,985		$	164,300
Repurchase of outstanding common stock		(8,166	)		(74	)										(74	)
Issuance of common stock for options exercised		15,591			103											103
Issuance of common stock for services		51,883			582											582
Stock option expense					16											16
Net income													4,382			4,382
Net unrealized loss on securities – available for sale, net of tax benefit of$1,326										(2,113	)					(2,113	)
Net unrealized gain related to cash flow hedge, net of tax of $210										335						335
Comprehensive income																2,604
Dividends on common stock ($0.16 per share)													(1,800	)		(1,800	)
Balance at June 30, 2008		11,229,085		$	136,781		$	–	$	(1,617	)	$	30,567		$	165,731
Balance at January 1, 2009		11,238,085		$	139,209		$	39,839	$	886		$	(31,420	)	$	148,514
Issuance of common stock for services		62,284			120											120
Stock option expense					25											25
Directors deferred compensation expense					287											287
Accretion of preferred stock discount								143					(143	)		–
Net loss													(3,114	)		(3,114	)
Net unrealizedgain on securities – available for sale, net of tax of$865										1,379						1,379
Net unrealized loss related to cash flow hedge, net of tax benefit of $638										(1,018	)					(1,018	)
Prior service cost recognized on SERP, net of amortization of $5										(49	)					(49	)
Comprehensive loss																(2,802	)
Dividends on preferred stock													(1,031	)		(1,031	)
Dividends on common stock ($0.16 per share)													(1,807	)		(1,807	)
Balance at June 30, 2009		11,300,369		$	139,641		$	39,982	$	1,198		$	(37,515	)	$	143,306

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

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CAPITAL BANK CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Six Months Ended June 30, 2009 and 2008 (Unaudited)

	2009			2008
(Dollars in thousands)
Cash flows from operating activities:
Net (loss) income	$	(3,114	)	$	4,382
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
Provision for loan losses		7,678			1,415
Amortization of deposit premium		575			514
Depreciation		1,602			1,383
Stock-based compensation		365			214
Net gain on investment securities		(16	)		(140	)
Net amortization of premium/discount on investment securities		80			57
Loss on disposal of premises, equipment and real estate owned		34			70
Deferred income tax benefit		(18	)		(253	)
Increase in cash surrender value of bank-owned life insurance		(30	)		(363	)
Net decrease (increase) in accrued interest receivable and other assets		3,390			214
Net increase (decrease) in accrued interest payable and other liabilities		12			(1,923	)
Net cash provided by operating activities		10,558			5,570
Cash flows from investing activities:
Loan originations, net of principal repayments		(47,256	)		(85,006	)
Additions to premises and equipment		(1,164	)		(2,491	)
Proceeds from sales of premises, equipment and real estate owned		588			1,963
Net purchases of FHLB and Silverton Bank stock		(20	)		(483	)
Purchase of securities – available for sale		(21,872	)		(47,036	)
Proceeds from principal repayments/calls/maturities of securities – available for sale		33,179			52,320
Proceeds from principal repayments/calls/maturities of securities – held to maturity		807			4,491
Net cash used in investing activities		(35,738	)		(76,242	)
Cash flows from financing activities:
Net increase in deposits		65,528			83,917
Net decrease in repurchase agreements		(4,421	)		(9,603	)
Net repayments of federal funds borrowed		–			(5,395	)
Proceeds from borrowings		70,000			158,000
Principal repayments of borrowings		(85,000	)		(152,000	)
Repurchase of common stock		–			(74	)
Issuance of common stock for options exercised		–			103
Dividends paid		(2,688	)		(1,796	)
Net cash provided by financing activities		43,419			73,152
Net change in cash and cash equivalents		18,239			2,480
Cash and cash equivalents at beginning of period		54,455			40,172
Cash and cash equivalents at end of period	$	72,694		$	42,652
Supplemental Disclosure of Cash Flow Information
Transfer of loans and premises to other real estate owned	$	4,413		$	880
Dividends payable	$	1,161		$	898
Cash (received) paid for:
Income taxes	$	(4,297	)	$	1,971
Interest	$	18,905		$	22,498

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

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

1.Significant Accounting Policies and Interim Reporting

The accompanying unaudited condensed consolidated financial statements include the accounts of Capital Bank Corporation (the “Company”) and its wholly owned subsidiary, Capital Bank (the “Bank”). In addition, the Company has interests in three trusts, Capital Bank Statutory Trust I, II, and III (hereinafter collectively referred to as the “Trusts”). The Trusts have not been consolidated with the financial statements of the Company pursuant to the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 46R, Consolidation of Variable Interest Entities. The interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). They do not include all of the information and footnotes required by such accounting principles for complete financial statements, and therefore should be read in conjunction with the audited consolidated financial statements and accompanying footnotes in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.

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

In the opinion of management, all adjustments necessary for a fair presentation of the financial position and results of operations for the periods presented have been included, and all significant intercompany transactions have been eliminated in consolidation. Certain amounts reported in prior periods have been reclassified to conform to the current presentation. Such reclassifications have no effect on total assets, net income or shareholders’ equity as previously reported. The results of operations for the six months ended June 30, 2009 are not necessarily indicative of the results of operations that may be expected for the year ended December 31, 2009.

The condensed consolidated balance sheet at December 31, 2008 has been derived from the audited consolidated financial statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.

The accounting policies followed by the Company are as set forth in Note 1 of the Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.

In June 2009, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 168, The FASB Accounting Standards Codification™ and the Hierarchy of Generally Accepted Accounting Principles (“SFAS No. 168”). This statement replaces SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles, and establishes the FASB Accounting Standards Codification™ (“Codification”) as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with GAAP. Rules and interpretive releases of the Securities and Exchange Commission (“SEC”) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. SFAS No. 168 is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The adoption of this statement is not expected to have a material impact on the Company’s financial condition or results of operations.

In May 2009, the FASB issued SFAS No. 165, Subsequent Events (“SFAS No. 165”). This statement establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. In particular, this statement sets forth: (1) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, (2) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements, and (3) the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. The Company adopted this statement effective for the quarterly period ended June 30, 2009, and its adoption had no impact on the Company’s financial condition or results of operations. In connection with the adoption of SFAS No. 165, the Company evaluated all subsequent events through August 7, 2009 and determined that no material subsequent events have occurred that would require disclosure in the notes to these condensed consolidated financial statements.

In April 2009, the FASB issued three related Staff Positions to (1) clarify the application of SFAS No. 157, Fair Value Measurements (“SFAS No. 157”), to fair value measurements in the current economic environment, (2) modify the recognition of other-than-temporary impairments of debt securities, and (3) require companies to disclose the fair values of financial instruments in interim periods. The Company adopted these Staff Positions effective for the quarterly period ended June 30, 2009. The adoption of these Staff Positions did not have a significant impact on the Company’s financial condition or results of operations, but each is described in more detail below.

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

FASB Staff Position (“FSP”) FAS 157-4, Determining Fair Value of a Financial Asset When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly, provides additional guidance for estimating fair value in accordance with SFAS No. 157 when the volume and level of activity for the asset or liability have significantly decreased and also provides guidance on identifying circumstances that indicate a transaction is not orderly. The FSP emphasizes that even if there has been a significant decrease in the volume and level of activity for the asset or liability and regardless of the valuation technique used, the objective of a fair value measurement remains the same. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (that is, not a forced liquidation or distressed sale), between market participants at the measurement date under current market conditions.

FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments, amends the other-than-temporary impairment guidance in U.S. GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. The FSP does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities.

FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments,amends SFAS No. 107, Disclosures about Fair Value of Financial Instruments, to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. The FSP also amends Accounting Principles Bulletin Opinion No. 28, Interim Financial Reporting, to require those disclosures in summarized information in interim reporting periods. See Note 10 (Fair Value of Financial Instruments) for interim disclosure required by this FSP.

In October 2008, the FASB issued FSP FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active (“FSP FAS 157-3”). The FSP clarifies the application of SFAS No. 157in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. FSP FAS 157-3 was effective upon issuance, including prior periods for which financial statements had not been issued. The adoption of this FSP did not have a material impact on the Company’s financial condition or results of operations.

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133 (“SFAS No. 161”). The new statement is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial condition, financial performance, and cash flows. Effective January 1, 2009, the Company adopted SFAS No. 161. The adoption of this statement impacts disclosures only and had no impact on the Company’s financial condition or results of operations. See Note 6 (Derivative Instruments) for disclosures required by this statement.

In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (“SFAS No. 141R”), which replaced SFAS No. 141, Business Combinations (“SFAS No. 141”) issued in 2001. Whereas its predecessor applied only to business combinations in which control was obtained by transferring consideration, the revised standard applies to all transactions or other events in which one entity obtains control over another. SFAS No. 141R defines the acquirer as the entity that obtains control over one or more other businesses and defines the acquisition date as the date the acquirer achieves control. SFAS No. 141R requires the acquirer to recognize assets acquired, liabilities assumed and any noncontrolling interest in the acquiree at their respective fair values as of the acquisition date. The revised standard changes the treatment of acquisition-related costs, restructuring costs related to an acquisition that the acquirer expects but is not obligated to incur, contingent consideration associated with the purchase price and pre-acquisition contingencies associated with acquired assets and liabilities. SFAS No. 141R retains the guidance in SFAS No. 141 for identifying and recognizing intangible assets apart from goodwill. Effective January 1, 2009, the Company adopted this statement and will apply its provisions to any business combination which occurs on or after that date.

Also in December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51 (“SFAS No. 160”). This statement amends Accounting Research Bulletin No. 51, Consolidated Financial Statements, to establish accounting and reporting standards for the noncontrolling interests in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. The Company adopted SFAS No. 160 effective January 1, 2009, and its adoption had no impact on the Company’s financial condition or results of operations.

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

2.Earnings Per Share

The Company follows SFAS No. 128, Earnings per Share, which established standards for computing and presenting earnings per share (“EPS”). In accordance with this statement, the Company has presented both basic and diluted EPS on the face of the Condensed Consolidated Statements of Operations. Basic EPS excludes dilution and is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS assumes the conversion, exercise or issuance of all potential common stock instruments, such as stock options and warrants, unless the effect is to reduce a loss or increase EPS. EPS is adjusted for outstanding stock options and warrants using the treasury stock method in order to compute diluted EPS. The weighted average number of shares outstanding for the three and six month periods ended June 30, 2009 and 2008 were as follows:

Three Month Period Ended June 30, 2009 and 2008 (Unaudited)

	2009		2008
(Dollars in thousands)
Earnings attributable to common shareholders	$	762	$	2,215
Shares used in the computation of earnings per share:
Weighted average number of shares outstanding – basic		11,447,619		11,310,393
Incremental shares from assumed exercise of stock options		–		13,115
Weighted average number of shares outstanding – diluted		11,447,619		11,323,508

For the three month period ended June 30, 2009, all outstanding options to purchase 377,083 shares of common stock were excluded from the diluted calculation because the option price exceeded the average fair market value of the associated shares of common stock. For the three month period ended June 30, 2008, options to purchase 90,411 shares of common stock were used in the diluted calculation and options to purchase 281,573 shares of common stock were not included in the diluted calculation because the option price exceeded the average fair market value of the associated shares of common stock.

Six Month Period Ended June 30, 2009 and 2008 (Unaudited)

	2009			2008
(Dollars in thousands)
Earnings (loss) attributable to common shareholders	$	(4,288	)	$	4,382
Shares used in the computation of earnings per share:
Weighted average number of shares outstanding – basic		11,430,494			11,299,923
Incremental shares from assumed exercise of stock options		–			14,655
Weighted average number of shares outstanding – diluted		11,430,494			11,314,578

Due to the net loss attributable to common shareholders for the six month period ended June 30, 2009, the Company excluded potential shares in its EPS calculations, as required by SFAS No. 128, since the effect of including those potential shares, if any, would have been antidilutive to the per share amounts. For the six month period ended June 30, 2008, options to purchase 100,911 shares of common stock were used in the diluted calculation and options to purchase 271,073 shares of common stock were not included in the diluted calculation because the option price exceeded the average fair market value of the associated shares of common stock.

3.Comprehensive Income

The Company follows SFAS No. 130, Reporting Comprehensive Income, which established standards for reporting and displaying comprehensive income and its components (revenues, expenses, gains, and losses) in general-purpose financial statements. Comprehensive income is the change in the Company’s equity during the period from transactions and other events and circumstances from non-owner sources. Total comprehensive income consists of net income and other comprehensive income. The Company’s other comprehensive income and accumulated other comprehensive income are comprised of unrealized gains and losses on certain investments in debt securities and derivatives that qualify as cash flow hedges to the extent that the hedge is effective. Information concerning the Company’s other comprehensive income (loss) for the three and six month periods ended June 30, 2009 and 2008 is as follows:

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

Three Month Period Ended June 30, 2009 and 2008 (Unaudited)

	2009			2008
(Dollars in thousands)
Unrealized gain (loss) on securities – available for sale	$	1,736		$	(4,368	)
Unrealized loss in fair value of cash flow hedge		(839	)		(1,308	)
Amortization of prior service cost recognized on SERP		5			–
Income tax (expense) benefit		(346	)		2,188
Other comprehensive income (loss)	$	556		$	(3,488	)

Six Month Period Ended June 30, 2009 and 2008 (Unaudited)

	2009			2008
(Dollars in thousands)
Unrealized gain (loss) on securities – available for sale	$	2,244		$	(3,439	)
Unrealized (loss) gain in fair value of cash flow hedge		(1,656	)		545
Prior service cost recognized on SERP, net of amortization		(49	)		–
Income tax (expense) benefit		(227	)		1,116
Other comprehensive income (loss)	$	312		$	(1,778	)

4.  Investment Securities

The following table shows the gross unrealized losses and fair value of the Company’s marketable securities with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, as of June 30, 2009 (unaudited).

	Less than 12 Months				12 Months or Greater				Total
(Dollars in thousands)	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Available for sale:
Municipal bonds	$	31,949	$	969	$	24,783	$	2,202	$	56,732	$	3,171
Mortgage-backed securities		13,908		267		4,962		489		18,870		756
Other securities		–		–		1,105		145		1,105		145
		45,857		1,236		30,850		2,836		76,707		4,072
Held to maturity:
Mortgage-backed securities		–		–		1,948		282		1,948		282
Total at June 30, 2009	$	45,857	$	1,236	$	32,798	$	3,118	$	78,655	$	4,354

Unrealized losses on the Company’s investments in mortgage-backed securities are primarily the result of interest rate changes. Mortgage-backed securities include securities issued by government agencies and corporate entities. The contractual cash flows of mortgage-backed securities issued by government agencies are fully guaranteed by an agency of the U.S. government. The mortgage-backed securities issued by corporate entities have all received the highest possible credit rating by one of the major credit rating firms. Unrealized losses on the Company’s investments in municipal bonds are partially related to interest rate changes but are also largely related to concerns in the marketplace regarding credit quality of issuers and the viability of certain bond insurers. Municipal bonds in an unrealized loss position, however, are investment grade securities without considering bond insurance backing the issuer.

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

Each quarter, the Company makes an assessment to determine whether there have been any events or economic circumstances to indicate that a marketable security on which there is an unrealized loss is impaired on an other-than-temporary basis. The Company considers many factors, including the severity and duration of the impairment and recent events specific to the issuer or industry, including any changes in credit ratings. The marketable securities in an unrealized loss position as of June 30, 2009 are all still performing and are expected to perform through maturity, have not experienced recent credit rating downgrades, and the issuers have not experienced significant adverse events that would call into question their ability to repay these debt obligations according to contractual terms. Further, because the Company does not intend to sell these investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider any of its marketable securities to be other-than-temporarily impaired as of June 30, 2009.

During the six months ended June 30, 2009, the Company recorded an impairment charge of $320 thousand on an equity investment in Silverton Bank, a correspondent financial institution that was closed by the Federal Deposit Insurance Corporation (“FDIC”) in May 2009. The impairment charge represents the full amount of the Company’s investment in Silverton Bank and is recorded as a reduction to noninterest income on the Condensed Consolidated Statements of Operations. Because of restrictions on the ability to sell this investment, it did not have a readily determinable fair value and was recorded at cost when purchased.

5.Loans

The composition of the loan portfolio by loan classification as of June 30, 2009 and December 31, 2008 is as follows:

	June 30, 2009			December 31, 2008
(Dollars in thousands)	(Unaudited)
Commercial	$	772,567		$	726,522
Construction		357,116			366,376
Consumer		47,620			46,019
Home equity		93,618			92,722
Residential mortgage		22,794			22,652
		1,293,715			1,254,291
Deferred loan fees and origination costs, net		(375	)		77
	$	1,293,340		$	1,254,368

6.  Derivative Instruments

The Company maintains positions in derivative financial instruments as necessary to manage interest rate risk, to facilitate asset/liability management strategies, and to manage other risk exposures. While these risk mitigation strategies at times can involve multiple derivative positions, the only outstanding derivative position maintained by the Company at June 30, 2009 was an interest rate swap on a portion of its prime-based loan portfolio.

In October 2006, the Company entered into a $100.0 million (notional) three-year interest rate swap agreement to convert a portion of its prime-based loan portfolio to a fixed rate of 7.81%. The Company accounts for this swap as a cash flow hedge of the volatility in cash flows resulting from changes in interest rates. For cash flow hedges, changes in the fair value of the derivative are, to the extent that the hedging relationship is effective, recorded as other comprehensive income and are subsequently recognized in earnings at the same time that the hedged item is recognized in earnings. Any portion of the change in fair value of a cash flow hedge related to hedge ineffectiveness is recognized immediately as other noninterest income. The fair value of this cash flow hedge was $1.5 million and $3.2 million as of June 30, 2009 and December 31, 2008, respectively, and is recorded in other assets on the Condensed Consolidated Balance Sheets. No portion of the cash flow hedge was considered to be ineffective, and no portion of the change in fair value of the cash flow hedge was charged to other noninterest income during the six months ended June 30, 2009 and 2008.

7.  Stock-Based Compensation

The Company uses stock-based compensation as an incentive for certain employees and non-employee directors and accounts for stock-based compensation in accordance with SFAS No. 123R, Share-Based Payments. Stock-based grants currently take one of three forms: stock options, restricted stock, and stock issued through a deferred compensation plan for non-employee directors.

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

Stock Options. The Company has stock option plans providing for the issuance of up to 650,000 options to purchase shares of the Company’s stock to officers and directors. As of June 30, 2009, options for 315,850 shares of common stock were outstanding and options for 75,559 shares of common stock remained available for future issuance. In addition, there were 566,071 issued options that were assumed under various plans from previously acquired financial institutions, of which 61,233 remain outstanding. Grants of options are made by the Board of Directors or the Compensation/Human Resources Committee. All grants must be at no less than fair market value on the date of grant, must be exercised no later than 10 years from the date of grant, and may be subject to some vesting provisions.

The following is a summary of stock option information and the weighted average exercise price (“WAEP”) for the six months ended June 30, 2009 (unaudited).

	Number of Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term in Years		Aggregate Intrinsic Value
Outstanding at January 1, 2009		377,083	$	11.71
Granted		–		–
Exercised		–		–
Forfeited and expired		–		–
Outstanding at June 30, 2009		377,083	$	11.71		4.73	$	–
Options exercisable at June 30, 2009		275,883	$	12.43		3.18	$	–

The following table summarizes information about the Company’s stock options as of June 30, 2009 (unaudited).

Exercise Price	Number Outstanding	Weighted Average Remaining Contractual Life in Years	Number Exercisable
$6.00 – $9.00	129,631	4.85	69,631
$9.01 – $12.00	90,202	2.34	88,202
$12.01 – $15.00	20,000	7.13	7,200
$15.01 – $18.00	83,000	6.05	56,600
$18.01 – $18.37	54,250	5.49	54,250
	377,083	4.73	275,883

The fair values of the options were estimated on the date of grant using the Black-Scholes option-pricing model. Option pricing models require the use of highly subjective assumptions, including expected stock volatility, which, if changed, can materially affect fair value estimates. The expected life of the options used in this calculation was the period the options are expected to be outstanding. Expected stock price volatility was based on the historical volatility of the Company’s common stock for a period approximating the expected life; the expected dividend yield was based on the Company’s historical annual dividend payout; and the risk-free rate was based on the implied yield available on U.S. Treasury issues.

As of June 30, 2009, the Company had unamortized compensation expense related to unvested stock options of $165,000, which is expected to be amortized over 5 years. For the six months ended June 30, 2009 and 2008, the Company recorded compensation expense of $25,000 and $16,000, respectively, related to stock options.

Restricted Stock. Outstanding restricted stock represents 20,000 shares with a vesting period of five years granted by the Board of Directors to certain employees in December 2008, and 24,000 shares with a vesting period of three years granted by the Board of Directors to certain key executives in December 2007. Unvested shares are subject to forfeiture if employment terminates prior to the vesting dates. The Company expenses the cost of the stock awards, determined to be the fair value of the shares at the date of grant, ratably over the period of the vesting. Total compensation expense recognized in the six month periods ended June 30, 2009 and 2008 related to these restricted stock awards was $53,000and $50,000, respectively. As of June 30, 2009, the Company had 36,000 shares of unvested restricted stock grants representing unrecognized compensation expense of $262,000 to be recognized over the remaining vesting periods of the respective grants.

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

Deferred Compensation for Non-employee Directors. The Company administers the Capital Bank Corporation Deferred Compensation Plan for Outside Directors (“Deferred Compensation Plan”). Eligible directors may elect to participate in the Deferred Compensation Plan by deferring all or part of their directors’ fees for at least one calendar year, in exchange for common stock of the Company. If a director does not elect to defer all or part of his fees, then he is not considered a participant in the Deferred Compensation Plan. The amount deferred is equal to 125 percent of total director fees. Each participant is fully vested in his account balance. The Deferred Compensation Plan provides for payment of share units in shares of common stock of the Company after the participant ceases to serve as a director for any reason.

Prior to amendment and restatement in November 2008, the Deferred Compensation Plan was classified as a liability-based plan in accordance with SFAS No. 123R due to certain plan provisions which would have allowed payments to have been made in either cash or shares of common stock. The Deferred Compensation Plan was reclassified to an equity-based plan in accordance with SFAS No. 123R when amended and restated on November 20, 2008. Among other changes to the plan provisions, the Deferred Compensation Plan was modified to only allow payment in shares of common stock of the Company. As required for equity-based plans under SFAS No. 123R, the Company recognizes fixed expense and a corresponding increase to equity as the compensation is earned by eligible directors. For the six month periods ended June 30, 2009 and 2008, the Company recognized $287,000 and $148,000, respectively, of expense related to the Deferred Compensation Plan.

8.Financial Instruments with Off-Balance-Sheet Risk

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

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

The Company’s exposure to off-balance-sheet credit risk as of June 30, 2009 and December 31, 2008 is as follows:

	June 30, 2009		December 31, 2008
(Dollars in thousands)	(Unaudited)
Unused lines of credit and overdraft lines	$	242,706	$	263,663
Standby letters of credit		10,282		4,233
Total commitments	$	252,988	$	267,896

9.Fair Value Measurement

The Company follows SFAS No. 157, Fair Value Measurements, which defines fair value and establishes a framework for measuring fair value under U.S. GAAP, and enhances disclosures about fair value measurements. The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Available-for-sale investment securities and derivatives are recorded at fair value on a recurring basis. Additionally, the Company may be required to record at fair value other assets on a nonrecurring basis, such as loans held for sale, impaired loans and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets. The following is a description of valuation methodologies used for assets and liabilities recorded at fair value. The determination of where an asset or liability falls in the hierarchy requires significant judgment. The Company evaluates its hierarchy disclosures each quarter and based on various factors, it is possible that an asset or liability may be classified differently from quarter to quarter. However, the Company expects changes in classifications between levels will be rare.

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

Investment Securities. Available-for-sale investment securities are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets. Held-to-maturity investment securities are recorded at amortized cost, not at fair value.

As a member of the FHLB system, the Company is required to maintain an investment in capital stock of the FHLB. The carrying value of the Company’s investment in FHLB stock was $6.0 million as of June 30, 2009 and was classified as part of investment securities on the Condensed Consolidated Balance Sheets. Because of membership requirements to hold stock in this institution and restrictions on the Company’s ability to sell such stock, this investment does not have a readily determinable market value and is accounted for using the cost method. Thus, the Company’s investment in FHLB stock is not subject to SFAS No. 157 and has been excluded from the tables below.

Derivative Assets and Liabilities. Derivative instruments held or issued by the Company for risk management purposes are traded in over-the-counter markets where quoted market prices are not readily available. For those derivatives, the Company measures fair value using models that use primarily market observable inputs, such as yield curves and option volatilities, and include the value associated with counterparty credit risk. The Company classifies derivatives instruments held or issued for risk management purposes as Level 2. At June 30, 2009, the Company’s derivative instruments consisted solely of a cash flow interest rate swap on a portion of the Company’s variable-rate commercial loan portfolio.

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. Once a loan is identified as individually impaired, management measures impairment in accordance with SFAS No. 114, Accounting by Creditors for Impairment of a Loan. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. In accordance with SFAS No. 157, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company classifies the impaired loan as nonrecurring Level 3.

Foreclosed Assets. Foreclosed assets are adjusted to fair value upon transfer of the loans to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company classifies the foreclosed asset as nonrecurring Level 3.

Assets and liabilities measured at fair value on a recurring basis are summarized below:

	Fair Value Measurements at June 30, 2009 (Unaudited)
	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
(Dollars in thousands)
Investment securities – available for sale	$	1,105	$	254,752	$	2,000	$	257,857
Cash flow interest rate swap		–		1,495		–		1,495

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

The table below presents a reconciliation and income statement classification of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the six months ended June 30, 2009:

		Investment Securities
(Dollars in thousands)
Balance at January 1, 2009	$	2,000
Total unrealized gains (losses) included in:
Net income		–
Other comprehensive income		–
Purchases, sales and issuances, net		–
Transfers in and (out) of Level 3		–
Balance at June 30, 2009	$	2,000

Assets and liabilities measured at fair value on a nonrecurring basis are summarized below:

	Fair Value Measurements at June 30, 2009 (Unaudited)
	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
(Dollars in thousands)
Impaired loans	$	–	$	–	$	32,063	$	32,063
Foreclosed assets		–		–		5,170		5,170

10.  Fair Value of Financial Instruments

SFAS No. 107, Disclosures about Fair Value of Financial Instruments, requires the disclosure of estimated fair values for financial instruments. Quoted market prices, if available, are utilized as an estimate of the fair value of financial instruments. Because no quoted market prices exist for a significant part of the Company’s financial instruments, the fair value of such instruments has been derived based on management’s assumptions with respect to future economic conditions, the amount and timing of future cash flows and estimated discount rates. Different assumptions could significantly affect these estimates. Accordingly, the net amounts ultimately collected could be materially different from the estimates presented below. In addition, these estimates are only indicative of the values of individual financial instruments and should not be considered an indication of the fair value of the Company taken as a whole.

Fair values of cash and due from banks and federal funds sold are equal to the carrying value due to the nature of the financial instruments. Estimated fair values of investment securities are based on quoted market prices, except for FHLB stock where fair value equals cost. Fair value of the net loan portfolio has been estimated using the present value of future cash flows, discounted at an interest rate giving consideration to estimated prepayment risk. The credit risk component of the loan portfolio has been set at the recorded allowance for loan losses balance for purposes of estimating fair value. Thus, there is no difference between the carrying amount and estimated fair value attributed to credit risk in the portfolio. Carrying amounts for accrued interest approximate fair value given the short-term nature of interest receivable and payable. Derivative financial instruments are carried on the consolidated balance sheets at fair value based on external pricing sources.

Fair values of time deposits and borrowings are estimated by discounting the future cash flows using the current rates offered for similar deposits and borrowings with the same remaining maturities. Fair value of subordinated debt is estimated based on current market prices for similar trust preferred issues of financial institutions with equivalent credit risk. The estimated fair value for the Company’s subordinated debt is significantly lower than carrying value since credit spreads (i.e., spread to LIBOR) on similar trust preferred issues are currently much wider than when these securities were originally issued. Interest-bearing deposit liabilities and repurchase agreements with no stated maturities are predominately at variable rates and, accordingly, the fair values have been estimated to equal the carrying amounts (the amount payable on demand).

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

The carrying values and estimated fair values of the Company’s financial instruments as of June 30, 2009 and December 31, 2008 are as follows:

	June 30, 2009 (Unaudited)				December 31, 2008
(Dollars in thousands)	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
Financial Assets:
Cash and cash equivalents	$	72,694	$	72,694	$	54,455	$	54,455
Investment securities		268,224		267,995		278,138		277,629
Loans		1,274,738		1,273,244		1,239,573		1,235,216
Accrued interest receivable		6,191		6,191		6,225		6,225
Cash flow hedge		1,495		1,495		3,151		3,151
Financial Liabilities:
Non-maturity deposits	$	546,448		546,448	$	511,772	$	511,772
Time deposits		834,394		848,600		803,542		810,691
Repurchase agreements and federal funds purchased		10,589		10,589		15,010		15,010
Borrowings		117,000		120,866		132,000		136,220
Subordinated debt		30,930		10,700		30,930		10,700
Accrued interest payable		2,095		2,095		2,925		2,925

The carrying amount and estimated fair value of the fair value interest rate swaps on certain fixed-rate FHLB advances was $619,000 as of December 31, 2008. Since these swaps were considered to be effective hedges, there were offsetting adjustments to the fair value of the underlying FHLB advances for the same amount at that date. These interest rate swaps were either terminated or matured during the six months ended June 30, 2009 and were no longer outstanding at the balance sheet date. There is no material difference between the carrying amount and estimated fair value of off-balance-sheet commitments totaling $253.0 million and $267.9 million as of June 30, 2009 and December 31, 2008, respectively, which are primarily comprised of unfunded loan commitments and standby letters of credit. The Company’s remaining assets and liabilities are not considered financial instruments.

Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion presents an overview of the unaudited financial statements for the three and six months ended June 30, 2009 and 2008 for Capital Bank Corporation (the “Company”) and its wholly owned subsidiary, Capital Bank (the “Bank”). This discussion and analysis is intended to provide pertinent information concerning financial condition, results of operations, liquidity, and capital resources for the periods covered and should be read in conjunction with the unaudited financial statements and related footnotes contained in Part I, Item 1 of this report.

Information set forth below contains various forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which statements represent the Company’s judgment concerning the future and are subject to risks and uncertainties that could cause the Company’s actual operating results to differ materially. Such forward-looking statements can be identified by the use of forward-looking terminology, such as “may,” “will,” “expect,” “anticipate,” “estimate,” “believe,” or “continue,” or the negative thereof or other variations thereof or comparable terminology. The Company cautions that such forward-looking statements are further qualified by important factors that could cause the Company’s actual operating results to differ materially from those in the forward-looking statements, as well as the factors set forth in Part II, Item 1A of this report, and the Company’s periodic reports and other filings with the Securities and Exchange Commission (“SEC”).

Overview

Capital Bank is a full-service state chartered community bank conducting business throughout North Carolina. The Bank operates through four North Carolina regions: Triangle, Sandhills, Triad and Western. The Bank was incorporated on May 30, 1997 and opened its first branch in June of that same year in Raleigh. In 1999, the shareholders of the Bank approved the reorganization of the Bank into a bank holding company. In 2001, the Company received approval to become a financial holding company. As of June 30, 2009, the Company conducted no business other than holding stock in the Bank and its three trusts, Capital Bank Statutory Trust I, II, and III.

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The Bank’s business consists principally of attracting deposits from the general public and investing these funds in loans secured by commercial real estate, secured and unsecured commercial and consumer loans, single-family residential mortgage loans and home equity lines. As a community bank, the Bank’s profitability depends primarily upon its levels of net interest income, which is the difference between interest income from interest-earning assets and interest expense on interest-bearing liabilities. When interest-earning assets approximate or exceed interest-bearing liabilities, any positive interest rate spread will generate net interest income.

The Bank’s profitability is also affected by its provision for loan losses, noninterest income and other operating expenses. Noninterest income primarily consists of service charges and ATM fees, fees generated from originating mortgage loans, commission income generated from brokerage activity, and the increase in cash surrender value of bank-owned life insurance. Operating expenses primarily consist of compensation and benefits, occupancy related expenses, advertising, data processing, professional fees, telecommunication and other noninterest expenses.

The Bank’s operations are influenced significantly by local economic conditions and by policies of financial institution regulatory authorities. The Bank’s cost of funds is influenced by interest rates on competing investments and by rates offered on similar investments by competing financial institutions in our market area, as well as general market interest rates. Lending activities are affected by the demand for financing, which in turn is affected by the prevailing interest rates.

Impact of Recent Developments on the Banking Industry

The banking industry, including the Company, is operating in a challenging and volatile economic environment. The effects of the downturn in the housing market have adversely impacted credit markets, consumer confidence and the broader economy. Along with other financial institutions, the Company’s stock price has suffered as a result. Management cannot predict when these market difficulties will subside. The Company’s primary focus at this time is to manage the business safely during the economic downturn and be poised to take advantage of any market opportunities that may arise.

The current economic situation has led the U.S. government to attempt to stabilize the financial system. For example, the U.S. government enacted the Emergency Economic and Stabilization Act of 2008 (“EESA”), which, among other things, authorized the U.S. Treasury Department (“Treasury”) to establish the Troubled Asset Relief Program (“TARP”), of which the Capital Purchase Program (“CPP”) is a part. See the “Liquidity and Capital Resources” section below for a more detailed discussion of the Company’s participation in the CPP. Additionally, the American Recovery and Reinvestment Act of 2009 (“ARRA”) imposes certain new executive compensation and corporate governance obligations on all current and future TARP recipients, including the Company, until the institution has redeemed the preferred stock, which TARP recipients are now permitted to do under the ARRA without regard to the three year holding period and without the need to raise new capital, subject to approval of its primary federal regulator.It is not clear at this time what impact these measures will have on the Company or the financial markets as a whole. Management will continue to monitor the effects of these programs as they relate to the Company and its financial operations.

The Bank is subject to insurance assessments imposed by the Federal Deposit Insurance Commission (“FDIC”), which is actively seeking to replenish its insurance fund. The FDIC increased risk-based assessment rates uniformly by 7 basis points, on an annual basis, beginning with the first quarter of 2009.On May 22, 2009, the FDIC adopted a final rule imposing a 5 basis point special assessment on each insured depository institution’s assets less Tier 1 capital as of June 30, 2009, not to exceed 10 basis points multiplied by the institution’s assessment base for the second quarter of 2009. The Company accrued $750 thousand as of June 30, 2009 related to this special assessment with the related expense recorded in noninterest expense. The FDIC will collect the special assessment on September 30, 2009. An additional special assessment in 2009 of up to 5 basis points later in 2009 is expected, but the amount is uncertain at this time.

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Critical Accounting Policies and Estimates

The Company’s critical accounting policies are described in Note 1of the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2008. These policies are important in understanding management’s discussion and analysis. Some of the Company’s accounting policies require the Company to make estimates and judgments regarding uncertainties that may affect the reported amounts of assets, liabilities, revenues and expenses.

The Company has identified four accounting policies as being critical in terms of significant judgments and the extent to which estimates are used: allowance for loan losses, investment impairment, income tax valuation allowances and impairment of long-lived assets, including other intangible assets. In many cases, there are several alternative judgments that could be used in the estimation process. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. For more information on the Company’s critical accounting policies, refer to Part II, Item 7 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.

Executive Summary

As discussed in more detail below, the following is a summary of our significant results for the three and six month periods ended June 30, 2009.

• The Company reported net income of $1.3 million for the quarter ended June 30, 2009 compared to net income of $2.2 million for the quarter ended June 30, 2008. After dividends and accretion on preferred stock issued under the CPP of $0.6 million, net income available to common shareholders was $0.8 million, or $0.07 per diluted share, for the second quarter of 2009 compared with $2.2 million, or $0.20 per diluted share, for the second quarter of 2008.   The Company reported a net loss of $3.1 million for the six months ended June 30, 2009 compared to net income of $4.4 million for the six months ended June 30, 2008. After dividends and accretion on preferred stock issued under the CPP of $1.2 million, net loss attributable to common shareholders was $4.3 million, or $0.38 per diluted share, for the first half of 2009 compared with net income available to common shareholders of $4.4 million, or $0.39 per diluted share, for the first half of 2008.

• Net interest income increased $1.2 million, or 11.3%, from $10.9 million for the quarter ended June 30, 2008 to $12.2 million for the quarter ended June 30, 2009. This improvement was partially due to an increase in net interest margin from 3.14% for the second quarter of 2008 to 3.17% for the second quarter of 2009, coupled with a 10.8% growth in average earning assets over the same periods. Net interest margin benefited from a significant decline in the cost of interest-bearing liabilities from 3.24% for the second quarter of 2008 to 2.50% for the second quarter of 2009, which was largely due to disciplined pricing controls and a more rational competitive pricing landscape for customer deposits as liquidity concerns in the banking industry have somewhat subsided. Partially offsetting declining funding costs was a drop in loan yields largely due to steps taken by the Federal Reserve to revive an ailing national economy last year. One effect of the many policy actions implemented was a drop in the prime rate by 400 basis points during 2008, which negatively impacted yields on the Company’s prime-based loan portfolio. This rapid decline in rates decreased loan yields from 6.23% for the second quarter of 2008 to 5.43% for the second quarter of 2009.   Net interest income increased $508 thousand, or 2.3%, from $21.8 million for the six months ended June 30, 2008 to $22.3 million for the six months ended June 30, 2009. This improvement was primarily due to growth of 11.2% in average earning assets, partially offset by a decrease in net interest margin from 3.20% for the first half of 2008 to 2.95% for the first half of 2009. Net interest margin was negatively impacted by a drop in loan yields from 6.53% for the first half of 2008 to 5.30% for the first half of 2009, but the margin was benefited by a significant decline in the cost of interest-bearing liabilities from 3.50% for the first half of 2008 to 2.65% for the first half of 2009.

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• Provision for loan losses was $1.7 million for the quarter ended June 30, 2009 compared to $850 thousand for the quarter ended June 30, 2008. The increase in the provision was largely driven by deteriorating economic conditions and weakness in the local real estate markets which resulted in downgrades to credit ratings as well as chargeoffs of certain loans in the portfolio, but the provision increase was also partially due to loan growth of $115.2 million from June 30, 2008. Net charge-offs for the quarter ended June 30, 2009 were $1.6 million, or 0.49% of average loans (annualized), compared to net charge-offs of $503 thousand, or 0.17% of average loans (annualized), for the quarter ended June 30, 2008.   Provision for loan losses was $7.7 million for the six months ended June 30, 2009 compared to $1.4 million for the six months ended June 30, 2008. The significant increase in the provision was primarily driven by deteriorating economic conditions and weakness in the local real estate markets which resulted in downgrades to credit ratings of certain loans in the portfolio, but the provision increase was also partially due to loan growth of $115.2 million from June 30, 2008. Additionally, the decline in real estate values securing certain nonperforming loans required increased provision during the period. Net charge-offs for the six months ended June 30, 2009 were $3.9 million, or 0.30% of average loans (annualized), compared to net charge-offs of $1.1 million, or 0.19% of average loans (annualized), for the six months ended June 30, 2008.

• Noninterest income increased $722 thousand, or 24.1%, in the second quarter of 2009 compared to the same period one year ago. Included in this increase was a nonrecurring gain recorded during the quarter of $913 thousand from the collection of bank-owned life insurance (“BOLI”) policy proceeds. Additionally, the Company recorded a $336 thousand net gain from the sale of certain debt securities in the second quarter of 2009 compared to a $69 thousand net gain on the sale of debt securities in the same quarter one year ago. Partially offsetting these gains was a $307 thousand decrease in service charge income and a $189 thousand decrease in other loan fees. Service charge income, which includes overdraft and non-sufficient funds charges, dropped primarily from a decline in consumer spending during the current economic recession.   Noninterest income increased $588 thousand, or 11.2%, in the first half of 2009 compared to the same period one year ago. Included in this increase was a nonrecurring gain recorded during the period of $913 thousand from the collection of BOLI policy proceeds. Partially offsetting this gain was a $314 thousand decrease in service charge income primarily due to a decline in consumer spending during the current economic recession.

• Noninterest expense increased $2.5 million, from $10.0 million during the second quarter of 2008 to $12.5 million during the second quarter of 2009. This increase included higher FDIC deposit insurance expense of $998 thousand over the quarters under comparison, of which $750 thousand was related to an accrual of the FDIC’s mandatory special assessment imposed on all insured financial institutions for the purpose of replenishing its insurance fund. The majority of the remaining $248 thousand increase in deposit insurance expense was due to increases in rates as the FDIC continues to increase insurance premiums to cover higher monitoring costs and claims. Further, salaries and employee benefits as well as occupancy costs increased a combined $978 thousand primarily due to additional costs incurred as new branches were opened during the past year in Asheville and Clayton in addition to the four branches purchased in the Fayetteville market in December 2008. Directors fees increased $288 thousand largely from an accelerated payout of deferred compensation benefits upon the death of a former director.   Noninterest expense increased $4.4 million, from $19.6 million during the first half of 2008 to $24.0 million during the first half of 2009. This increase included higher FDIC deposit insurance expense of $1.2 million over the periods under comparison, of which $750 thousand was related to an accrual of the FDIC’s mandatory special assessment imposed on all insured financial institutions for the purpose of replenishing its insurance fund. The majority of the remaining $430 thousand increase in deposit insurance expense was due to increases in rates as the FDIC continues to increase insurance premiums to cover higher monitoring costs and claims. Further, salaries and employee benefits as well as occupancy costs increased a combined $2.4 million primarily due to additional costs incurred as new branches were opened during the past year in Asheville and Clayton in addition to the four branches purchased in the Fayetteville market in December 2008. Directors fees increased $247 thousand largely from an accelerated payout of deferred compensation benefits upon the death of a former director.

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Results of Operations

Quarter ended June 30, 2009 compared to quarter ended June 30, 2008

The Company reported net income of $1.3 million for the quarter ended June 30, 2009 compared to net income of $2.2 million for the quarter ended June 30, 2008. After dividends and accretion on preferred stock of $0.6 million, net income available to common shareholders was $0.8 million, or $0.07 per diluted share, for the second quarter of 2009 compared with $2.2 million, or $0.20 per diluted share, for the second quarter of 2008. Net interest income increased by $1.2 million over the quarters under comparison, reflecting a higher net interest margin and loan growth. Provision for loan losses increased by $842 thousand partially due to loan growth and partially from continued deteriorating economic conditions and weakness in the local real estate markets which resulted in downgrades to the credit ratings and chargeoffs of certain loans in the portfolio. Noninterest income increased by $722 thousand, which included nonrecurring gains from the collection of BOLI policy proceeds and the sale of certain debt securities in the second quarter of 2009. Partially offsetting these gains was a decrease in service charge income and other loan fees. Noninterest expense increased $2.5 million over the quarters under comparison partially from the FDIC’s special assessment on all insured financial institutions and overall increase in base rates for deposit insurance but also partially due to higher salaries and benefits as well as occupancy expenses from the purchase of four branches in Fayetteville and the opening of a Clayton branch in December 2008. Taxes declined by $487 thousand, reflecting lower net income before taxes.

Net Interest Income. Net interest income increased $1.2 million, or 11.3%, from $10.9 million for the quarter ended June 30, 2008 to $12.2 million for the quarter ended June 30, 2009. Average earning assets increased $155.4 million to $1.59 billion for the quarter ended June 30, 2009 from $1.43 billion for the quarter ended June 30, 2008. Average interest-bearing liabilities increased $94.6 million to $1.38 billion for the quarter ended June 30, 2009 from $1.28 billion for the quarter ended June 30, 2008. The net interest margin on a fully tax equivalent basis increased by 3 basis points to 3.17% for the quarter ended June 30, 2009 from 3.14% for the quarter ended June 30, 2008. The earned yield on average interest-earning assets was 5.34% and 6.07% for the quarters ended June 30, 2009 and 2008, respectively, while the interest rate on average interest-bearing liabilities for those periods was 2.50% and 3.24%, respectively. The increase in the margin was primarily due to the significant decline in the cost of customer deposits through disciplined pricing controls and a more rational competitive pricing landscape as liquidity concerns in the banking industry have somewhat subsided. Partially offsetting declining funding costs was a drop in loan yields largely due to steps taken by the Federal Reserve to revive an ailing national economy last year. One effect of the many policy actions implemented was a drop in the prime rate by 400 basis points during 2008, which negatively impacted yields on the Company’s prime-based loan portfolio.

The following table shows the Company’s effective yield on earning assets and cost of funds. Yields and costs are computed by dividing income or expense for the year by the respective daily average asset or liability balance.

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CAPITAL BANK CORPORATION

Average Balances, Interest Earned or Paid, and Interest Yields/Rates

For the Three Months Ended June 30, 2009, March 31, 2009and June 30, 2008 (Unaudited)

Tax Equivalent Basis (1)

	June 30, 2009								March 31, 2009								June 30, 2008
(Dollars in thousands)	Average Balance			Amount Earned		Average Rate			Average Balance			Amount Earned		Average Rate			Average Balance			Amount Earned		Average Rate
Assets
Loans receivable: (2)
Commercial	$	1,115,003		$	15,244		5.48	%	$	1,095,804		$	13,942		5.16	%	$	1,010,899		$	15,713		6.23	%
Consumer		54,552			902		6.63			52,873			910		6.98			46,344			869		7.52
Home equity		94,054			974		4.15			93,861			966		4.17			80,842			1,101		5.46
Residential mortgages		21,962			292		5.32			22,900			274		4.79			28,710			427		5.95
Total loans		1,285,571			17,412		5.43			1,265,438			16,092		5.16			1,166,795			18,111		6.23
Investment securities (3)		278,033			3,731		5.37			288,679			3,957		5.48			256,406			3,555		5.55
Federal funds sold and interest-earning cash (4)		24,898			6		0.10			19,900			10		0.20			9,898			33		1.34
Total interest-earning assets		1,588,502		$	21,149		5.34	%		1,574,017		$	20,059		5.17	%		1,433,099		$	21,699		6.07	%
Cash and due from banks		15,294								22,116								22,938
Other assets		80,296								78,814								135,976
Allowance for loan losses		(18,705	)							(15,180	)							(13,656	)
Total assets	$	1,665,387							$	1,659,767							$	1,578,357
Liabilities and Equity
Savings deposits	$	29,609		$	13		0.18	%	$	28,793		$	13		0.18	%	$	30,540		$	35		0.46	%
Interest-bearing demand deposits		368,132			1,152		1.26			353,262			1,202		1.38			335,851			1,635		1.95
Time deposits		796,306			5,868		2.96			800,879			6,551		3.32			668,690			6,356		3.81
Total interest-bearing deposits		1,194,047			7,033		2.36			1,182,934			7,766		2.66			1,035,081			8,026		3.11
Borrowed funds		140,682			1,273		3.63			146,233			1,389		3.85			181,841			1,820		4.01
Subordinated debt		30,930			278		3.61			30,930			322		4.22			30,930			403		5.23
Repurchase agreements and fed funds purchased		12,010			7		0.23			13,849			7		0.20			35,183			106		1.21
Total interest-bearing liabilities		1,377,669		$	8,591		2.50	%		1,373,946		$	9,484		2.80	%		1,283,035		$	10,355		3.24	%
Noninterest-bearing deposits		130,460								124,893								113,590
Other liabilities		12,042								11,643								10,787
Total liabilities		1,520,171								1,510,482								1,407,412
Shareholders’ equity		145,216								149,285								170,945
Total liabilities and shareholders’ equity	$	1,665,387							$	1,659,767							$	1,578,357
Net interest spread (5)							2.84	%							2.37	%							2.83	%
Tax equivalent adjustment				$	394							$	394							$	416
Net interest income and net interest margin (6)				$	12,558		3.17	%				$	10,575		2.72	%				$	11,344		3.14	%

(1)	The tax equivalent basis is computed using a tax rate of 34%.
(2)	Loans receivable include nonaccrual loans for which accrual of interest has not been recorded.
(3)	The average balance for investment securities excludes the effect of their mark-to-market adjustment, if any.
(4)	The Federal Reserve began paying interest on cash balances during the quarter ended December 31, 2008. For comparison purposes, average balances have been adjusted for all periods presented to include cash held at the Federal Reserve as interest earning.
(5)	Net interest spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.
(6)	Net interest margin represents net interest income divided by average interest-earning assets.

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Interest income on loans decreased from $18.1 million for the quarter ended June 30, 2008 to $17.4 million for the quarter ended June 30, 2009, a decline of $699 thousand, or 3.9%. This decrease was primarily due to declining loan yields, which decreased from 6.23% in the quarter ended June 30, 2008 to 5.43% in the quarter ended June 30, 2009, the effect of which was partially offset by higher average loan balances, which increased by $118.8 million. The declining loan yields were largely due to the drop in the prime rate from 5.00% at June 30, 2008 to 3.25% by June 30, 2009. In November 2006, the Company entered into a $100 million (notional) interest rate swap to help mitigate its exposure to interest rate volatility in the prime-based portion of the loan portfolio. This swap increased loan interest income by $1.1 million and $0.7 million for the quarters ended June 30, 2009 and 2008, respectively.

Interest income on investment securities increased from $3.1 million in for the quarter ended June 30, 2008 to $3.3 million for the quarter ended June 30, 2009, an increase of $198 thousand, or 6.3%. This increase was due to growth in the investment portfolio, partially offset by lower investment yields. Average investment balances increased from $256.4 million for the quarter ended June 30, 2008 to $278.0 million for the quarter ended June 30, 2009, and the tax equivalent yield on investment securities decreased from 5.55% to 5.37% over the same period. The increase in average investment balances partially reflects management’s efforts to efficiently deploy net cash received from the purchase of four Fayetteville branch offices from Omni National Bank in December 2008.

Interest expense on deposits decreased from $8.0 million for the quarter ended June 30, 2008 to $7.0 million for the quarter ended June 30, 2009. The decrease is primarily due to a decrease in average deposit rates from 3.11% for the quarter ended June 30, 2008 to 2.36% for the quarter ended June 30, 2009. For time deposits, which represented 66.7% and 64.6% of total average interest-bearing deposits for the quarters ended June 30, 2009 and 2008, respectively, the average rate decreased from 3.81% for the quarter ended June 30, 2008 to 2.96% for the quarter ended June 30, 2009, reflecting disciplined pricing controls and a more rational competitive pricing landscape as liquidity concerns in the marketplace have somewhat subsided.

Interest expense on borrowings decreased from $2.3 million for the quarter ended June 30, 2008 to $1.6 million for the quarter ended June 30, 2009, partially due to declines in interest rates as well as a $41.2 million decrease in average borrowings over the two periods. The rate on average borrowings, including subordinated debt and repurchase agreements, for the quarter ended June 30, 2008 was 3.77% compared to 3.40% for the quarter ended June 30, 2009. In July 2003, the Company entered into interest rate swap agreements on $25.0 million of its outstanding Federal Home Loan Bank advances to swap fixed rate borrowings to a variable rate. In February 2009, swaps on $15.0 million of advances were unwound, and the proceeds received from the swap counterparty will be amortized as a reduction to interest expense over the remaining term of the underlying advances. The remaining swaps on $10.0 million of advances expired during the second quarter of 2009. The net effect of the swaps, including amortization of swap terminations, was a decrease to interest expense of $75 thousand and $24 thousand for the quarters ended June 30, 2009 and 2008, respectively.

Provision for Loan Losses. Provision for loan losses was $1.7 million for the quarter ended June 30, 2009 compared to $850 thousand for the quarter ended June 30, 2008. The increase in the provision was largely driven by deteriorating economic conditions and weakness in the local real estate markets which resulted in downgrades to credit ratings as well as chargeoffs of certain loans in the portfolio, but the provision increase was also partially due to loan growth of $115.2 million from June 30, 2008. Net charge-offs for the quarter ended June 30, 2009 were $1.6 million, or 0.49% of average loans (annualized), compared to net charge-offs of $503 thousand, or 0.17% of average loans (annualized), for the quarter ended June 30, 2008. Nonperforming loans and past due loans increased from $5.2 million and $9.2 million, respectively, as of June 30, 2008 to $18.5 million and $15.2 million, respectively, as of June 30, 2009.

Noninterest Income. Noninterest income increased from $3.0 million for the quarter ended June 30, 2008 to $3.7 million for the quarter ended June 30, 2009, an increase of $722 thousand, or 24.1%. Management continues to focus on noninterest income improvement strategies, which are based on core deposit growth, expanded mortgage origination staff, fee collection efforts, restructured pricing and innovative product enhancements. The following table presents the detail of noninterest income and related changes for the quarters ended June 30, 2009 and 2008 (unaudited).

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		2009		2008		Variance
(Dollars in thousands)
Noninterest income:
Service charges and other fees	$	959	$	1,266	$	(307	)
Mortgage fees and revenues		385		354		31
Other loan fees		198		387		(189	)
Brokerage fees		150		245		(95	)
Bank card services		385		354		31
Bank-owned life insurance		1,165		260		905
Net gain on investment securities		336		69		267
Other		146		67		79
Total noninterest income	$	3,724	$	3,002	$	722

The primary reason for the increase in noninterest income was a nonrecurring gain recorded during the quarter of $913 thousand from the collection of BOLI policy proceeds upon the death of a former director. Additionally, the Company recorded a $336 thousand net gain from the sale of certain debt securities in the second quarter of 2009 compared to a $69 thousand net gain on the sale of debt securities in the same quarter one year ago.

Although the Company grew core deposits over the past year, service charges and other fees, which also includes overdraft and non-sufficient funds charges decreased due to a significant decline in consumer spending during the current economic recession. Mortgage fees increased primarily as a result of higher staffing levels in this department as well as a favorable interest rate environment for residential mortgage refinancing activity. Other loan fees declined as commercial loan refinancing activity somewhat subsided during the second quarter of 2009 resulting in lower income from prepayment penalties and other related loan fees. Brokerage fees declined with increased concerns about the economic recession and volatility in the stock markets. Bank card services, which includes income received from debit card transactions, increased slightly from an increase in demand deposit accounts offset by a decline in overall consumer spending. Other noninterest income increased primarily due to a reclassification of certain sublease receipts.

Noninterest Expense. Noninterest expense represents the costs of operating the Company. Management regularly monitors all categories of noninterest expense in an effort to improve productivity and operating performance. Noninterest expense increased from $10.0 million for the quarter ended June 30, 2008 to $12.5 million for the quarter ended June 30, 2009, an increase of $2.5 million, or 24.7%. The following table presents the detail of noninterest expense and related changes for the quarters ended June 30, 2009 and 2008 (unaudited).

		2009		2008		Variance
(Dollars in thousands)
Noninterest expense:
Salaries and employee benefits	$	5,856	$	5,269	$	587
Occupancy		1,348		957		391
Furniture and equipment		739		793		(54	)
Data processing and telecommunications		573		528		45
Advertising		223		205		18
Office expenses		322		315		7
Professional fees		434		281		153
Business development and travel		247		340		(93	)
Amortization of deposit premiums		287		257		30
Miscellaneous loan handling costs		372		224		148
Directors fees		477		189		288
Insurance		140		103		37
FDIC deposit insurance		1,179		181		998
Other		268		354		(86	)
Total noninterest expense	$	12,465	$	9,996	$	2,469

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Included in the noninterest expense increase was significantly higher FDIC deposit insurance expense, of which $750 thousand was related to accrual of the FDIC’s mandatory special assessment imposed on all insured financial institutions for the purpose of replenishing its insurance fund. The remaining $248 thousand increase in deposit insurance expense was due to overall increases in rates as the FDIC continues to raise insurance premiums to cover higher monitoring costs and claims as well as growth in insured customer deposits. Salaries and employee benefits as well as occupancy costs increased a combined $978 thousand primarily due to additional costs incurred as new branches were opened during the past year in Asheville and Clayton in addition to the four branches purchased in the Fayetteville market in December 2008. Also partially contributing to this increase were nonrecurring costs incurred for the planned closing of two branches as part of a consolidation strategy in the Triad market as the Company continues to improve the efficiency of its branch network. The planned branch consolidation added $68 thousand and $127 thousand to employee benefits and occupancy expense, respectively, during the second quarter of 2009. Additionally, salaries and employee benefits increased from normal compensation increases while occupancy expenses increased from higher rent due to sale-leaseback agreements signed for three existing branch facilities in September 2008.

Furniture and equipment expense declined as certain computer equipment became fully depreciated in previous months. Management continues to monitor and update the Company’s technology infrastructure in an efficient and cost controlled manner. Data processing and telecommunications costs rose from increased transaction volume due to growth in the Company’s primary business lines since much of the data processing costs are volume based. Professional fees increased from higher legal fees related to professional consultation on various matters, including compliance with executive compensation and corporate governance requirements of CPP participants. Business development and travel costs declined as management continues to closely monitor and control discretionary spending and as a second partner was recruited to sublease the corporate airplane. Advertising and office expenses remained relatively flat, increasing only slightly over the quarters under comparison.

Amortization of deposit premiums increased from additional amortization required on the core deposit intangible recognized as part of the acquisition of four Fayetteville branches in December 2008. Miscellaneous loan handling costs increased partially due to loan growth but primarily due to higher levels of loan collection costs. Directors’ fees increased largely from an accelerated payout of deferred compensation benefits upon the death of a former director. Insurance costs rose as levels of foreclosed properties have increased. Other noninterest expense declined as the Company incurred lower losses on foreclosed property sales and successfully reduced operational losses throughout its branch network. Management continues to focus on maintaining a strong control environment and providing sufficient employee training to mitigate the risk of operational losses at its branches.

Income Taxes. Income taxes decreased from $869 thousand for the quarter ended June 30, 2008 to $382 thousand for the quarter ended June 30, 2009. The decrease in tax expense is due to the decline in pretax income over the same periods. The decline in the effective tax rate from 28.2% for the quarter ended June 30, 2008 to 22.1% for the quarter ended June 30, 2009 was primarily due a decrease in projected annual taxable income relative to pretax book income used in the intraperiod tax allocations for the quarters under comparison. Taxable income and book income can vary significantly due to nontaxable income such as municipal bond interest and bank-owned life insurance income.

Results of Operations

Six month period ended June 30, 2009 compared to six month period ended June 30, 2008

The Company reported a net loss of $3.1 million for the six months ended June 30, 2009 compared to net income of $4.4 million for the six months ended June 30, 2008. After dividends and accretion on preferred stock of $1.2 million, net loss attributable to common shareholders was $4.3 million, or $0.38 per diluted share, for the first half of 2009 compared with $4.4 million, or $0.39 per diluted share, for the first half of 2008. Net interest income increased by $508 thousand over the periods under comparison primarily due to loan growth, which was partially offset by a decline in net interest margin. Provision for loan losses increased by $6.3 million partially due to loan growth but largely from deteriorating economic conditions and weakness in the local real estate markets which resulted in downgrades to the credit ratings and chargeoffs of certain loans in the portfolio. Noninterest income increased by $588 thousand primarily due to a nonrecurring gain from the collection of bank-owned life insurance policy proceeds, which was partially offset by a decrease in service charge income. Noninterest expense increased $4.4 million over the periods under comparison partially from the FDIC’s special assessment on all insured financial institutions and overall increase in base rates for deposit insurance but also partially due to higher salaries and benefits as well as occupancy expenses from the purchase of four branches in Fayetteville and the opening of a Clayton branch in December 2008. Taxes declined from expense of $1.7 million for the six months ended June 30, 2008 to a benefit of $0.4 million for the six months ended June 30, 2009, reflecting the decline in net income before taxes.

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Net Interest Income. Net interest income increased $508 thousand, or 2.3%, from $21.8 million for the six months ended June 30, 2008 to $22.3 million for the six months ended June 30, 2009. Average earning assets increased $159.3 million to $1.58 billion for the six months ended June 30, 2009 from $1.42 billion for the six months ended June 30, 2008. Average interest-bearing liabilities increased $104.7 million to $1.38 billion for the six months ended June 30, 2009 from $1.27 billion for the six months ended June 30, 2008. The net interest margin on a fully tax equivalent basis decreased by 25 basis points to 2.95% for the six months ended June 30, 2009 from 3.20% for the six months ended June 30, 2008. The earned yield on average interest-earning assets was 5.26% and 6.32% for the six months ended June 30, 2009 and 2008, respectively, while the interest rate on average interest-bearing liabilities for those periods was 2.65% and 3.50%, respectively. The decrease in net interest margin was primarily due to a drop in loan yields largely due to steps taken by the Federal Reserve to revive an ailing national economy last year. One effect of the many policy actions implemented was a drop in the prime rate by 400 basis points during 2008, which negatively impacted yields on the Company’s prime-based loan portfolio. Partially offsetting falling loan yields was a significant decline in the cost of customer deposits through disciplined pricing controls and a more rational competitive pricing landscape as liquidity concerns in the marketplace have somewhat subsided.

The following table shows the Company’s effective yield on earning assets and cost of funds. Yields and costs are computed by dividing income or expense for the year by the respective daily average asset or liability balance.

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Average Balances, Interest Earned or Paid, and Interest Yields/Rates

For the Six Months Ended June 30, 2009 and 2008 (Unaudited)

Tax Equivalent Basis (1)

	June 30, 2009								June 30, 2008
(Dollars in thousands)	Average Balance			Amount Earned		Average Rate			Average Balance			Amount Earned		Average Rate
Assets
Loans receivable: (2)
Commercial	$	1,105,457		$	29,185		5.32	%	$	998,552		$	32,490		6.53	%
Consumer		53,717			1,812		6.80			46,522			1,779		7.67
Home equity		93,958			1,941		4.17			80,203			2,422		6.06
Residential mortgages		22,428			566		5.05			29,485			919		6.23
Total Loans		1,275,560			33,504		5.30			1,154,762			37,610		6.53
Investment securities (3)		283,327			7,688		5.43			256,472			7,144		5.57
Federal funds sold and interest earning cash (4)		22,413			16		0.14			10,721			88		1.65
Total interest-earnings assets		1,581,300		$	41,208		5.26	%		1,421,955		$	44,842		6.32	%
Cash and due from banks		18,686								22,854
Other assets		79,559								136,024
Allowance for loan losses		(16,952	)							(13,659	)
Total assets	$	1,662,593							$	1,567,174
Liabilities and Equity
Savings deposits	$	29,204		$	26		0.18	%	$	30,461		$	81		0.53	%
Interest-bearing demand deposits		360,738			2,355		1.32			334,480			3,489		2.09
Time deposits		798,580			12,418		3.14			663,150			13,528		4.09
Total interest-bearing deposits		1,188,522			14,799		2.51			1,028,091			17,098		3.34
Borrowed funds		143,442			2,663		3.74			176,743			3,843		4.36
Subordinated debt		30,930			599		3.91			30,930			929		6.02
Repurchase agreements and fed funds purchased		12,924			14		0.22			35,373			294		1.67
Total interest-bearing liabilities		1,375,818		$	18,075		2.65	%		1,271,137		$	22,164		3.50	%
Noninterest-bearing deposits		127,692								115,799
Other liabilities		11,844								10,960
Total liabilities		1,515,354								1,397,896
Shareholders’ equity		147,239								169,278
Total liabilities and shareholders’ equity	$	1,662,593							$	1,567,174
Net interest spread (5)							2.61	%							2.83	%
Tax equivalent adjustment				$	788							$	841
Net interest income and net interest margin (6)				$	23,133		2.95	%				$	22,678		3.20	%

(1)	The tax equivalent basis is computed using a blended federal and state tax rate of approximately 34%.
(2)	Loans receivable include nonaccrual loans for which accrual of interest has not been recorded.
(3)	The average balance for investment securities excludes the effect of their mark-to-market adjustment, if any.
(4)	The Federal Reserve began paying interest on cash balances during the quarter ended December 31, 2008. For comparison purposes, average balances have been adjusted for all periods presented to include cash held at the Federal Reserve as interest earning.
(5)	Net interest spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.
(6)	Net interest margin represents net interest income divided by average interest-earning assets.

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Interest income on loans decreased from $37.6 million for the six months ended June 30, 2008 to $33.5 million for the six months ended June 30, 2009, a decline of $4.1 million, or 10.9%. This decrease was primarily due to declining loan yields, which fell from 6.53% in the six months ended June 30, 2008 to 5.30% in the six months ended June 30, 2009, the effect of which was partially offset by higher average loan balances, which increased by $120.8 million. The declining loan yields were largely due to the drop in the prime rate from 5.00% at June 30, 2008 to 3.25% by June 30, 2009. In November 2006, the Company entered into a $100 million (notional) interest rate swap to help mitigate its exposure to interest rate volatility in the prime-based portion of the loan portfolio. This swap increased loan interest income by $2.3 million and $1.0 million for the six months ended June 30, 2009 and 2008, respectively.

Interest income on investment securities increased from $6.3 million in for the six months ended June 30, 2008 to $6.9 million for the six months ended June 30, 2009, an increase of $597 thousand, or 9.5%. This increase was due to growth in the investment portfolio, partially offset by lower investment yields. Average investment balances increased from $256.5 million for the six months ended June 30, 2008 to $283.3 million for the six months ended June 30, 2009, and the tax equivalent yield on investment securities decreased from 5.57% to 5.43% over the same period. The increase in average investment balances partially reflects management’s efforts to efficiently deploy net cash received from the purchase of four Fayetteville branch offices from Omni National Bank in December 2008.

Interest expense on deposits decreased from $17.1 million for the six months ended June 30, 2008 to $14.8 million for the six months ended June 30, 2009. The decrease is primarily due to a decrease in average deposit rates from 3.34% for the six months ended June 30, 2008 to 2.51% for the six months ended June 30, 2009. For time deposits, which represented 67.2% and 64.5% of total average interest-bearing deposits for the six months ended June 30, 2009 and 2008, respectively, the average rate decreased from 4.09% for the six months ended June 30, 2008 to 3.14% for the six months ended June 30, 2009, reflecting disciplined pricing controls and a more rational competitive pricing landscape as liquidity concerns in the marketplace have somewhat subsided.

Interest expense on borrowings decreased from $5.1 million for the six months ended June 30, 2008 to $3.3 million for the six months ended June 30, 2009, partially due to declines in interest rates as well as a $55.8 million decrease in average borrowings over the two periods. The rate on average borrowings, including subordinated debt and repurchase agreements, for the six months ended June 30, 2008 was 4.18% compared to 3.53% for the six months ended June 30, 2009. In July 2003, the Company entered into interest rate swap agreements on $25.0 million of its outstanding Federal Home Loan Bank advances to swap fixed rate borrowings to a variable rate. In February 2009, swaps on $15.0 million of advances were unwound, and the proceeds received from the swap counterparty will be amortized as a reduction to interest expense over the remaining term of the underlying advances. The remaining swaps on $10.0 million of advances expired during the second quarter of 2009. The net effect of the swaps, including amortization of swap terminations, was a decrease to interest expense of $162 thousand and an increase of $19 thousand for the six months ended June 30, 2009 and 2008, respectively.

Provision for Loan Losses. Provision for loan losses was $7.7 million for the six months ended June 30, 2009 compared to $1.4 million for the six months ended June 30, 2008. The significant increase in the provision was largely driven by deteriorating economic conditions and weakness in the local real estate markets which resulted in downgrades to credit ratings as well as chargeoffs of certain loans in the portfolio, but the provision increase was also partially due to loan growth of $115.2 million from June 30, 2008. Net charge-offs for the six months ended June 30, 2009 were $3.9 million, or 0.30% of average loans (annualized), compared to net charge-offs of $1.1 million, or 0.19% of average loans (annualized), for the six months ended June 30, 2008. Nonperforming loans and past due loans increased from $5.2 million and $9.2 million, respectively, as of June 30, 2008 to $18.5 million and $15.2 million, respectively, as of June 30, 2009.

Noninterest Income. Noninterest income increased from $5.2 million for the six months ended June 30, 2008 to $5.8 million for the six months ended June 30, 2009, an increase of $588 thousand, or 11.2%. Management continues to focus on noninterest income improvement strategies, which are based on core deposit growth, expanded mortgage origination staff, fee collection efforts, restructured pricing and innovative product enhancements. The following table presents the detail of noninterest income and related changes for the six months ended June 30, 2009 and 2008 (unaudited).

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		2009		2008		Variance
(Dollars in thousands)
Noninterest income:
Service charges and other fees	$	1,911	$	2,225	$	(314	)
Mortgage fees and revenues		618		626		(8	)
Other loan fees		492		500		(8	)
Brokerage fees		313		401		(88	)
Bank card services		724		653		71
Bank-owned life insurance		1,423		562		861
Net gain on investment securities		16		140		(124	)
Other		333		135		198
Total noninterest income	$	5,830	$	5,242	$	588

A major reason for the increase in noninterest income was a nonrecurring gain recorded during the period of $913 thousand from the collection of BOLI policy proceeds upon the death of a former director. Partially offsetting this BOLI gain was a decline in net investment gains. Part of this decline was related to the impairment charge of $320 thousand recorded on an equity investment in Silverton Bank, formerly a correspondent financial institution, during the first quarter of 2009. The impairment charge represented the full amount of the Company’s investment in Silverton Bank, which was closed by the FDIC in May 2009.

Although the Company grew core deposits over the past year, service charges and other fees, which also includes overdraft and non-sufficient funds charges decreased due to a significant decline in consumer spending during the current economic recession. Brokerage fees declined with increased concerns about the economic recession and volatility in the stock markets. Bank card services, which includes income received from debit card transactions, increased slightly from an increase in demand deposit accounts offset by a decline in overall consumer spending. Other noninterest income increased primarily due to a reclassification of certain sublease receipts. Mortgage and other loan fees remained relatively flat over the periods under comparison.

Noninterest Expense. Noninterest expense represents the costs of operating the Company. Management regularly monitors all categories of noninterest expense in an effort to improve productivity and operating performance. Noninterest expense increased from $19.6 million for the six months ended June 30, 2008 to $24.0 million for the six months ended June 30, 2009, an increase of $4.4 million, or 22.5%. The following table presents the detail of noninterest expense and related changes for the six months ended June 30, 2009 and 2008 (unaudited).

		2009		2008		Variance
(Dollars in thousands)
Noninterest expense:
Salaries and employee benefits	$	11,817	$	10,172	$	1,645
Occupancy		2,721		1,954		767
Furniture and equipment		1,569		1,540		29
Data processing and telecommunications		1,204		960		244
Advertising		546		520		26
Office expenses		657		680		(23	)
Professional fees		813		651		162
Business development and travel		575		673		(98	)
Amortization of deposit premiums		575		514		61
Miscellaneous loan handling costs		535		318		217
Directors fees		836		589		247
Insurance		244		198		46
FDIC deposit insurance		1,408		228		1,180
Other		529		617		(88	)
Total noninterest expense	$	24,029	$	19,614	$	4,415

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Included in the noninterest expense increase was significantly higher FDIC deposit insurance expense, of which $750 thousand was related to accrual of the FDIC’s mandatory special assessment imposed on all insured financial institutions for the purpose of replenishing its insurance fund. The remaining $430 thousand increase in deposit insurance expense was due to overall increases in rates as the FDIC continues to raise insurance premiums to cover higher monitoring costs and claims as well as growth in insured customer deposits. Salaries and employee benefits as well as occupancy costs increased a combined $2.4 million primarily due to additional costs incurred as new branches were opened during the past year in Asheville and Clayton in addition to the four branches purchased in the Fayetteville market in December 2008. Also partially contributing to this increase were nonrecurring costs incurred for the planned closing of two branches as part of a consolidation strategy in the Triad market as the Company continues to improve the efficiency of its branch network. The planned branch consolidation added $68 thousand and $127 thousand to employee benefits and occupancy expense, respectively, during the second quarter of 2009. Additionally, salaries and employee benefits increased from normal compensation increases while occupancy expenses increased from higher rent due to sale-leaseback agreements signed for three existing branch facilities in September 2008.

Data processing and telecommunications costs rose from increased transaction volume due to growth in the Company’s primary business lines since much of the data processing costs are volume based. Professional fees increased from higher legal fees related to professional consultation on various matters, including compliance with executive compensation and corporate governance requirements of CPP participants. Business development and travel costs declined as management continues to closely monitor and control discretionary spending and as a second partner was recruited to sublease the corporate airplane. Furniture and equipment, advertising and office expenses remained relatively flat over the quarters under comparison.

Amortization of deposit premiums increased from additional amortization required on the core deposit intangible recognized as part of the acquisition of four Fayetteville branches in December 2008. Miscellaneous loan handling costs increased partially due to loan growth but primarily due to higher levels of loan collection costs. Directors fees increased largely from an accelerated payout of deferred compensation benefits upon the death of a former director. Insurance costs rose as levels of foreclosed properties have increased. Other noninterest expense declined as the Company incurred lower losses on foreclosed property sales and successfully reduced operational losses throughout its branch network. Management continues to focus on maintaining a strong control environment and providing sufficient employee training to mitigate the risk of operational losses at its branches.

Income Taxes. Income taxes decreased from expense of $1.7 million for the six months ended June 30, 2008 to a benefit of $0.4 million for the six months ended June 30, 2009. The decrease in tax expense (benefit) is due to the decline in pretax income (loss) over the same periods. The decline in the effective tax rate from 27.6% for the six months ended June 30, 2008 to 11.8% for the six months ended June 30, 2009 was primarily due a decrease in projected annual taxable income relative to pretax book income used in the intraperiod tax allocations for the periods under comparison. Taxable income and book income can vary significantly due to nontaxable income such as municipal bond interest and bank-owned life insurance income.

Financial Condition

Total assets as of June 30, 2009 were $1.70 billion, an increase of $41.1 million, or 2.5%, from $1.65 billion as of December 31, 2008. The increase in total assets for the six months ended June 30, 2009 was primarily due to a $35.2 million increase in the Company’s loan portfolio, net of allowance for loan losses, since December 31, 2008. Total earning assets were $1.62 billion as of June 30, 2009 compared to $1.60 billion as of December 31, 2008. Earning assets represented 95.3% and 94.3% of total assets as of June 30, 2009 and December 31, 2008, respectively. As of June 30, 2009, investment securities were $268.2 million compared to $278.1 million as of December 31, 2008. Interest-earning cash, federal funds sold and short term investments were $53.6 million as of June 30, 2009 compared to $26.8 million as of December 31, 2008. Allowance for loan losses was $18.6 million as of June 30, 2009 compared to $14.8 million as of December 31, 2008, representing approximately 1.44% and 1.18%, respectively, of total loans as of both dates. Management believes that the allowance balance is adequate to absorb estimated losses inherent in the current loan portfolio. See “Asset Quality” section below for further discussion of the allowance for loan losses.

Total deposits as of June 30, 2009 were $1.38 billion, an increase of $65.5 million, or 5.0%, from $1.32 billion as of December 31, 2008. The increase was primarily due to a $41.2 million increase in demand deposit accounts and a $30.9 million increase in time deposits, partially offset by a $6.5 million decrease in money market deposits. Time deposits represented 60.4% of total deposits at June 30, 2009 compared to 61.1% at December 31, 2008.

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Total shareholders’ equity decreased from $148.5 million as of December 31, 2008 to $143.3 million as of June 30, 2009. Retained earnings declined by $6.1 million, reflecting a $3.1 million net loss for the six months ended June 30, 2009 in addition to $2.8 million of dividends declared during the period on common and preferred shares. Accumulated other comprehensive income, which represents the unrealized gains and losses on available-for-sale securities and derivatives accounted for as cash flow hedges, net of related tax benefits, increased from $886 thousand as of December 31, 2008 to $1.2 million as of June 30, 2009. The increase in accumulated other comprehensive income was primarily due to an increase in the fair value of available-for-sale securities, partially offset by a decline in fair value of the cash flow hedge. See the Condensed Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income for additional information regarding fluctuations in equity accounts during the six months ended June 30, 2009.

Asset Quality

Determining the allowance for loan losses is based on a number of factors, many of which are subject to judgments made by management. At the origination of each commercial loan, management assesses the relative risk of the loan and assigns a corresponding risk grade. To ascertain that the credit quality is maintained after the loan is booked, a loan review officer performs an annual review of all unsecured loans over a predetermined loan amount, a sampling of loans within a lender’s authority, and a sampling of the entire loan pool. Loans are reviewed for credit quality, sufficiency of credit and collateral documentation, proper loan approval, covenant, policy and procedure adherence, and continuing accuracy of the loan grade. The Loan Review Manager reports directly to the Chief Credit Officer and the Audit Committee of the Company’s Board of Directors.

The allowance for loan losses is an amount that management believes will be adequate to absorb losses estimated inherent in existing loans, based on evaluations of the collectability of loans and prior loan loss experience. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions and trends that may affect the borrowers’ ability to pay. The allowance calculation consists of two primary components: (1) a component for individual impairment as recognized and measured in accordance with SFAS No. 114, Accounting By Creditors for Impairment of a Loan, and (2) components for collective reserve as recognized in accordance with SFAS No. 5, Accounting for Contingencies, including a qualitative portion.

The Company maintains specific reserves for individually impaired loans pursuant to SFAS No. 114. A loan is considered impaired, based on current information and events, if it is probable that the Company will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. Uncollateralized loans are measured for impairment based on the present value of expected future cash flows discounted at the historical effective interest rate, while all collateral-dependent loans are measured for impairment based on the fair value of the collateral. The Company uses several factors in determining if a loan is impaired. The internal asset classification procedures include a thorough review of significant loans and lending relationships and include the accumulation of related data. This data includes loan payment status, borrowers’ financial data and borrowers’ operating factors such as cash flows, operating income or loss, etc.

For loans not considered impaired, the Company estimates the amount of allowance needed to cover losses inherent in the portfolio,in accordance with SFAS No. 5, by applying a loss allowance factor to each risk grade. Unless identified as an at-risk loan,consumer loans and mortgages are not risk graded, but a loss allocation factor is utilized for these loans based on historical losses. The loss allocation factors have been developed based on the Company’s historical losses and industry trends. Further, for commercial loans rated special mention and/or classified with outstanding relationship balances greater than $750 thousand, management determines the level of reserves based on the facts and circumstances of each borrower relationship, including among other factors, payment history, collateral values, guarantor liquidity, and net worth. In addition to this quantitative analysis, a qualitative assessment of the general economic trends, portfolio concentration, interest rate movements and the trend of delinquencies are taken into consideration. The loan loss allowance is adjusted to an amount that management believes is adequate to absorb losses inherent in the loan portfolio as of the balance sheet date presented.

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The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that the collectability of the principal is unlikely. Based on this allowance calculation, management recorded a provision of $7.7 million for the six months ended June 30, 2009 compared to $1.4 million for the six months ended June 30, 2008. The significant increase in the provision was largely driven by deteriorating economic conditions and weakness in the local real estate markets which resulted in downgrades to credit ratings as well as chargeoffs of certain loans in the portfolio, but the provision increase was also partially due to loan growth of $115.2 million from June 30, 2008. Net charge-offs for the six months ended June 30, 2009 were $3.9 million, or 0.30% of average loans (annualized), compared to net charge-offs of $1.1 million, or 0.19% of average loans (annualized), for the six months ended June 30, 2008.

The following table presents an analysis of changes in the allowance for loan losses for the three and six month periods ended June 30, 2098 and 2008 (unaudited), respectively.

	Three Months Ended June 30,						Six Months Ended June 30,
	2009			2008			2009			2008
(Dollars in thousands)
Allowance for loan losses, beginning of period	$	18,480		$	13,563		$	14,795		$	13,571
Net charge-offs:
Loans charged off:
Commercial		381			408			1,061			554
Construction		393			47			1,725			104
Consumer		720			137			793			730
Home equity		22			90			145			90
Residential mortgage		90			–			255			–
Total charge-offs		1,606			682			3,979			1,478
Recoveries of loans previously charged off:
Commercial		1			136			62			323
Construction		20			–			20			–
Consumer		14			42			24			76
Home equity		1			–			2			1
Residential mortgage		–			1			–			2
Total recoveries		36			179			108			402
Total net charge-offs		1,570			503			3,871			1,076
Loss provision charged to operations		1,692			850			7,678			1,415
Allowance for loan losses, end of period	$	18,602		$	13,910		$	18,602		$	13,910
Net charge-offs to average loans during the period (annualized)		0.49	%		0.17	%		0.30	%		0.19	%
Allowance as a percent of gross loans		1.44	%		1.18	%		1.44	%		1.18	%

The evaluation of the allowance for loan losses is inherently subjective, and management uses the best information available to establish this estimate. However, if factors such as economic conditions differ substantially from assumptions, or if amounts and timing of future cash flows expected to be received on impaired loans vary substantially from the estimates, future adjustments to the allowance for loan losses may be necessary. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance for loan losses based on their judgments about all relevant information available to them at the time of their examination. Any adjustments to original estimates are made in the period in which the factors and other considerations indicate that adjustments to the allowance for loan losses are necessary.

- 31 -

The following table presents an analysis of nonperforming assets as of June 30, 2009 and December 31, 2008.

	June 30, 2009			December 31, 2008
(Dollars in thousands)	(Unaudited)
Nonperforming loans:
Commercial	$	6,635		$	4,682
Construction		11,336			3,843
Consumer		32			92
Home equity		140			275
Residential mortgage		387			223
Total nonperforming loans		18,530			9,115
Foreclosed property held		5,170			1,347
Total nonperforming assets	$	23,700		$	10,462
Nonperforming loans to total loans		1.43	%		0.73	%
Nonperforming assets to total assets		1.40	%		0.63	%
Allowance coverage of nonperforming loans		100	%		162	%

Foreclosed property increased to $5.2 million at June 30, 2009 from $1.3 million at December 31, 2008. The increase was primarily due to the repossession during the quarter of certain commercial and residential real estate. The Company is actively marketing all of its foreclosed property. Foreclosed assets are adjusted to fair value upon transfer of the loans to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value. It is the Company’s practice to obtain updated appraisals and/or valuations for all foreclosed assets.

Impaired loans primarily consist of nonperforming loans and troubled debt restructurings (“TDRs”) but can include other loans identified by management as being impaired. Impaired loans totaled $34.5 million at June 30, 2009, compared to $13.7 million at December 31, 2008. The increase in impaired loans is generally consistent with the increase in nonperforming loans and is primarily due to weakness experienced in the local economy and real estate markets from the current recession. As of June 30, 2009 and December 31, 2008, impaired loans on relationships over $750 thousand totaled $26.7 million and $9.7 million, respectively, with specific reserves of $1.9 million and $0.2 million, respectively. These loans were evaluated individually based on the present value of expected future cash flows or the fair value of the collateral. As of June 30, 2009 and December 31, 2008, impaired loans on relationships less than $750 thousand, totaled $7.8 million and $4.0 million, respectively, with associated reserves of $0.6 million and $0.7 million, respectively. These loans were measured for impairment based on pools of loans stratified by common risk characteristics. For impaired loans where legal action has been taken to foreclose, the loan is charged down to estimated fair value, and a specific reserve is not established.

The following table summarizes TDRs, which are all classified as impaired loans, as of June 30, 2009 and December 31, 2008.

	June 30, 2009		December 31, 2008
(Dollars in thousands)	(Unaudited)
Performing TDRs:
Commercial	$	4,352	$	219
Construction		10,065		5,624
Consumer		258		–
Home equity		40		–
		14,715		5,843
Nonperforming TDRs:
Commercial		1,877		–
Construction		9,921		–
Home equity		94		–
Residential mortgage		36		81
		11,928		81
Total TDRs	$	26,643	$	5,924

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Loans are classified as TDRs by the Company when certain modifications are made to the loan terms and concessions are granted to the borrowers due to financial difficulty experienced by those borrowers. Of the $26.6 million of TDRs at June 30, 2009, loans totaling $14.7 million were accruing interest and were not included in nonperforming loans at June 30, 2009. The largest of these is a loan relationship with a regional homebuilder located in the Triangle market with an outstanding balance of $5.6 million as of June 30, 2009. The loans were restructured to provide the borrower a period of time to complete construction on homes that were subsequently placed on the market for sale. The borrower is current on all principal and interest payments due according to the restructured note terms. The Company only restructures loans for borrowers in financial difficulty that have designed a viable business plan to fully pay off all obligations, including outstanding debt, interest, and fees, either by generating additional income from the business or through liquidation of assets. Generally, these loans are restructured to provide the borrower additional time to execute upon their plans.

These performing TDRs were not placed in nonaccrual status prior to the restructuring, and since the Company expects the borrowers to perform after the restructuring (based on modified note terms), the loans continue to accrue interest at the restructured rate. The Company will continue to closely monitor these loans and will cease accruing interest on them if management believes that the borrowers may not continue performing based on the restructured note terms. All TDRs are considered to be impaired and are evaluated for impairment in accordance with SFAS No. 114. As of June 30, 2009, loan loss reserves allocated to TDRs totaled $2.2 million.

Liquidity and Capital Resources

Liquidity. Liquidity management involves the ability to meet the cash flow requirements of depositors desiring to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. To ensure the Company is positioned to meet immediate and future cash demands, management relies on internal analysis of its liquidity, knowledge of current economic and market trends and forecasts of future conditions. Regulatory agencies set certain minimum liquidity standards, including the setting of a reserve requirement by the Federal Reserve. The Company must submit weekly reports to the Federal Reserve to ensure that it meets those requirements. As of June 30, 2009, the Company met all of its regulatory liquidity requirements.

The Company had $72.7 million in its most liquid assets, cash and cash equivalents, as of June 30, 2009. The Company’s principal sources of funds are loan repayments, deposits, short-term borrowings, capital and, to a lesser extent, investment repayments. Core deposits (total deposits less certificates of deposits in the amount of $100 thousand or more), one of the most stable sources of liquidity, together with equity capital funded$1.19 billion, or 70.4%, of total assets as of June 30, 2009 compared to $1.17 billion, or 70.7%, of total assets as of December 31, 2008.Additional sources of liquidity are available to the Company through the Federal Reserve and through membership in the FHLB system as well as access to funding through various brokered deposit programs, federal funds lines and security repurchase agreements.

Capital Resources. The management of equity is a critical aspect of capital management in any business. The determination of the appropriate amount of equity is affected by a wide number of factors. The primary factor for a regulated financial institution is the amount of capital needed to meet regulatory requirements, although other factors, such as the “risk equity” the business requires and balance sheet leverage, also affect the determination.

To be categorized as well capitalized, the Company and the Bank each must maintain minimum amounts and ratios. The Company’s and the Bank’s actual capital amounts and ratios as of June 30, 2009 (unaudited) and the minimum requirements are presented in the following table.

	Actual				Minimum Requirements To Be Well Capitalized
(Dollars in thousands)	Amount		Ratio		Amount		Ratio
Capital Bank Corporation:
Total capital (to risk-weighted assets)	$	184,241	12.77	%	$	144,287	10.00	%
Tier I capital (to risk-weighted assets)		166,186	11.52			86,572	6.00
Tier I capital (to average assets)		166,186	9.94			83,589	5.00
Capital Bank:
Total capital (to risk-weighted assets)	$	181,408	12.57	%	$	144,282	10.00	%
Tier I capital (to risk-weighted assets)		163,353	11.32			86,569	6.00
Tier I capital (to average assets)		163,353	9.86			82,874	5.00

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Total shareholders’ equity was $143.3 million as ofJune 30, 2009. Management believes this level of shareholders’ equity provides adequate capital to support the Company’s growth and to maintain a well capitalized position.

On October 3, 2008, the EESA was enacted, which authorized the Treasury to establish the TARP, of which the CPP is a part. Under the CPP, certain U.S. financial institutions sold senior preferred stock and issue warrants to purchase an institution’s common stock to the Treasury in exchange for a capital infusion. Eligible institutions applied to issue preferred stock to the Treasury in aggregate amounts between 1% and 3% of the institution’s risk-weighted assets, along with warrants covering shares of common stock. In order to participate in the CPP, the Company’s shareholders approved an amendment to the Company’s articles of incorporation to authorize 100,000 shares of preferred stock.

In December 2008, the Company entered into a Securities Purchase Agreement—Standard Terms with the Treasury (the “Stock Purchase Agreement”) pursuant to which, among other things, the Company sold to the Treasury for an aggregate purchase price of $41.3 million, 41,279 shares of Series A Fixed Rate Cumulative Perpetual Preferred Stock of the Company (“Series A Preferred Stock”) and warrants to purchase up to 749,619 shares of common stock (the “Warrants”) of the Company. As a condition under the CPP, the Company’s share repurchases are currently limited to purchases in connection with the administration of any employee benefit plan, consistent with past practices, including purchases to offset share dilution in connection with any such plans. This restriction is effective until December 2011 or until the Treasury no longer owns any of the Series A Preferred Stock.

The Series A Preferred Stock ranks senior to the Company’s common shares and pays a compounding cumulative dividend, in cash, at a rate of 5% per annum for the first five years, and 9% per annum thereafter on the liquidation preference of $1,000 per share. The Company is prohibited from paying any dividend with respect to shares of common stock or repurchasing or redeeming any shares of the Company’s common shares unless all accrued and unpaid dividends are paid on the Series A Preferred Stock for all past dividend periods (including the latest completed dividend period). The Series A Preferred Stock is non-voting, other than class voting rights on matters that could adversely affect the Series A Preferred Stock. The Series A Preferred Stock is callable at par after three years. Prior to the end of three years, the Series A Preferred Stock may be redeemed with the proceeds from one or more qualified equity offerings of any Tier 1 perpetual preferred or common stock of at least $10.3 million (each a “Qualified Equity Offering”). The Treasury may also transfer the Series A Preferred Stock to a third party at any time. Through June 30, 2009, the Company made dividend payments to the Treasury totaling approximately $877,000.

Item 3.Quantitative and Qualitative Disclosures about Market Risk

As described in more detail in Part II, Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2008, asset/liability management involves the evaluation, monitoring and management of interest rate risk, liquidity and funding. While the Board of Directors has overall responsibility for the Company’s asset/liability management policies, the Bank’s Asset and Liability Committee monitors loan, investment, and liability portfolios to ensure comprehensive management of interest rate risk and adherence to the Bank’s policies. The Company has not experienced any material change in the risk of its portfolios of interest-earning assets and interest-bearing liabilities from December 31, 2008 to June 30, 2009.

Item 4.Controls and Procedures

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports it files or submits under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), as appropriate, to allow timely decisions regarding disclosure. Management necessarily applies its judgment in assessing the costs and benefits of such controls and procedures, which, by their nature, can provide only reasonable assurance regarding management’s control objectives.

As required by paragraph (b) of Rule 13a-15 under the Exchange Act, an evaluation was carried out under the supervision and with the participation of the Company’s management, including the CEO and CFO, of the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report. During the course of their evaluation, management discovered that, as a result of human error, the Company failed to timely file a Form 8-K pursuant to Item 5.02 in connection with the award of certain discretionary bonuses under the Company’s Annual Incentive Plan. As a result, management has implemented further training of relevant Company personnel and Board members regarding Form 8-K triggers and the timing related thereto. Based upon that evaluation, the CEO and CFO concluded that, as of the period covered by the report, the Company’s disclosure controls and procedures are effective in that they provide reasonable assurances that

the information the Company is required to disclose in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods required by the SEC’s rules and forms.

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Changes in Internal Control over Financial Reporting

There were no changes in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that occurred during the period covered by this report that have materially affected or are reasonably likely to materially affect, the Company’s internal control over financial reporting. Management has implemented changes in internal control over financial reporting as a result of remediation of matters identified through its review of internal control over financial reporting as required under Section 404 of the Sarbanes-Oxley Act; however, it does not believe any of the changes implemented were material in nature.

PART II – OTHER INFORMATION

Item 1.Legal Proceedings

There are no material pending legal proceedings to which the Company or its subsidiaries is a party or to which any of the Company’s or its subsidiaries’ property is subject. In addition, the Company is not aware of any threatened litigation, unasserted claims or assessments that could have a material adverse effect on the Company’s business, operating results or condition.

Item 1A.Risk Factors

You should consider the following material risk factors carefully before deciding to invest in the Company’s securities. Additional risks and uncertainties not presently known to us, that we may currently deem to be immaterial or that are similar to those faced by other companies in our industry or business in general, such as competitive conditions, may also impact our business operations. If any of the events described below occur, the Company’s business, financial condition, or results of operations could be materially adversely affected. In that event, the trading price of the Company’s common stock may decline, in which case the value of your investment may decline as well. References herein to “we”, “us”, and “our” refer to Capital Bank Corporation, a North Carolina corporation, and its subsidiaries, unless the context otherwise requires.

Legislative and regulatory actions taken now or in the future to address the current liquidity and credit crisis in the financial industry may significantly affect our liquidity or financial condition.

The EESA, which established the TARP, was enacted on October 3, 2008. As part of the TARP, the Treasury created the CPP, under which the Treasury will invest up to $250 billion in senior preferred stock of U.S. banks and savings associations or their holding companies for the purpose of stabilizing and providing liquidity to the U.S. financial markets. On February 17, 2009, the ARRA was enacted as a sweeping economic recovery package intended to stimulate the economy and provide for extensive infrastructure, energy, health, and education needs. There can be no assurance as to the actual impact that EESA or its programs, including the CPP, and ARRA or its programs, will have on the national economy or financial markets. The failure of these significant legislative measures to help stabilize the financial markets and a continuation or worsening of current financial market conditions could materially and adversely affect the Company’s financial condition, results of operation, liquidity or stock price.

U.S. and international credit markets and economic conditions could adversely affect our liquidity and financial condition.

Global market and economic conditions continue to be disruptive and volatile and the disruption has particularly had a negative impact on the financial sector. The possible duration and severity of this adverse economic cycle is unknown. Although the Company remains well capitalized and has not suffered any liquidity issues as a result of these recent events, the cost and availability of funds may be adversely affected by illiquid credit markets. Continued turbulence in U.S. and international markets and economies may adversely affect our liquidity, financial condition and profitability.

In addition, federal and state governments could pass additional legislation responsive to current credit conditions. We could experience higher credit losses because of legislation or regulatory action that reduces the amounts borrowers are contractually required to pay under existing loan contracts or that limits our ability to foreclose on property or other collateral or makes foreclosure less economically feasible.

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Changes in local economic conditions could lead to higher loan charge-offs and reduce our net income and growth.

Our business is subject to periodic fluctuations based on local economic conditions in Central and Western North Carolina. These fluctuations are not predictable, cannot be controlled, and may have a material adverse impact on our operations and financial condition even if other favorable events occur. Our operations are locally oriented and community-based. Accordingly, we expect to continue to be dependent upon local business conditions as well as conditions in the local residential and commercial real estate markets we serve. For example, an increase in unemployment, a decrease in real estate values or increases in interest rates, as well as other factors, could weaken the economies of the communities we serve.

Weakness in our market areas could depress our earnings and consequently our financial condition because:

• customers may not want or need our products or services;

• borrowers may not be able to repay their loans;

• the value of the collateral securing loans to borrowers may decline; and

• the quality of our loan portfolio may decline.

Any of the latter three scenarios could require us to charge off a higher percentage of loans and/or increase provisions for credit losses, which would reduce our net income. For an analysis of our recent charge-off experience, please refer to the “Asset Quality” section in Part I, Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Because the majority of our borrowers are individuals and businesses located and doing business in Wake, Granville, Lee, Cumberland, Johnston, Chatham, Alamance, Buncombe and Catawba Counties, North Carolina, our success will depend significantly upon the economic conditions in those and the surrounding counties. Unfavorable economic conditions in those and the surrounding counties may result in, among other things, a deterioration in credit quality or a reduced demand for credit and may harm the financial stability of our customers. Due to our limited market areas, these negative conditions may have a more noticeable effect on us than would be experienced by a larger institution that is able to spread these risks of unfavorable local economic conditions across a large number of diversified economies.

Weakness in the markets for residential or commercial real estate could reduce our net income and profitability.

Recently, the financial markets have experienced volatility associated with subprime mortgages, including adverse impacts on credit quality and liquidity within the financial markets. The volatility has been exacerbated by a general decline in the real estate and housing market along with significant mortgage loan related losses reported by many other financial institutions. Our financial results may be adversely affected by changes in real estate values. Decreases in real estate values could adversely affect the value of property used as collateral for loans and investments. If poor economic conditions result in decreased demand for real estate loans, our net income and profits may decline.

The declines in home prices in the markets we serve, along with the reduced availability of mortgage credit, also may result in increases in delinquencies and losses in our portfolio of loans related to residential real estate construction and development. We significantly increased our provision for loan losses in the six months ended June 30, 2009 primarily due to deteriorating economic conditions and weakness in local real estate markets. Further declines in home prices coupled with a deepened economic recession and continued rises in unemployment levels could drive losses beyond that which is provided for in our allowance for loan losses. In that event, our earnings could be adversely affected.

Additionally, recent weakness in the secondary market for residential lending could have an adverse impact upon our profitability. Significant ongoing disruptions in the secondary market for residential mortgage loans have limited the market for and liquidity of most mortgage loans other than conforming Fannie Mae and Freddie Mac loans. The effects of ongoing mortgage market challenges, combined with the ongoing correction in residential real estate market prices and reduced levels of home sales, could result in further price reductions in single family home values, adversely affecting the value of collateral securing mortgage loans held, mortgage loan originations and gains on sale of mortgage loans. Continued declines in real estate values and home sales volumes, and financial stress on borrowers as a result of job losses, or other factors, could have further adverse effects on borrowers that result in higher delinquencies and greater charge-offs in future periods, which would adversely affect our financial condition or results of operations.

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Changes in interest rates may have an adverse effect on our profitability.

Our earnings and financial condition are dependent to a large degree upon net interest income, which is the difference between interest earned from loans and investments and interest paid on deposits and borrowings. The narrowing of interest rate spreads, meaning the difference between interest rates earned on loans and investments and the interest rates paid on deposits and borrowings, could adversely affect our earnings and financial condition. We cannot predict with certainty or control changes in interest rates. Regional and local economic conditions and the policies of regulatory authorities, including monetary policies of the Federal Reserve Board, affect interest income and interest expense. We have ongoing policies and procedures designed to manage the risks associated with changes in market interest rates. However, changes in interest rates still may have an adverse effect on our profitability.

We are exposed to risks in connection with the loans we make.

A significant source of risk for us arises from the possibility that losses will be sustained because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loans. We have underwriting and credit monitoring procedures and credit policies, including the establishment and review of the allowance for loan losses, that we believe are appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance and diversifying our loan portfolio. Such policies and procedures, however, may not prevent unexpected losses that could adversely affect our results of operations. Loan defaults result in a decrease in interest income resulting from a loan default or defaults may be for a prolonged period of time as we seek to recover, primarily through legal proceedings, the outstanding principal balance, accrued interest and default interest due on a defaulted loan plus the legal costs incurred in pursuing our legal remedies. No assurance can be given that recent market conditions will not result in our need to increase loan loss reserves or charge off a higher percentage of loans, thereby reducing net income.

We compete with larger companies for business.

The banking and financial services business in our market areas continues to be a competitive field and is becoming more competitive as a result of:

• changes in regulations;

• changes in technology and product delivery systems; and

• the accelerating pace of consolidation among financial services providers.

We may not be able to compete effectively in our markets, and our results of operations could be adversely affected by the nature or pace of change in competition. We compete for loans, deposits and customers with various bank and nonbank financial services providers, many of which have substantially greater resources, including higher total assets and capitalization, greater access to capital markets and a broader offering of financial services.

Our trading volume has been low compared with larger banks.

The trading volume in the Company’s common stock on the NASDAQ Global Select Market has been comparable to other similarly-sized banks. Nevertheless, this trading is relatively low when compared with more seasoned companies listed on the NASDAQ Global Select Market or other consolidated reporting systems or stock exchanges. Thus, the market in the Company’s common stock may be limited in scope relative to other companies.

We depend heavily on our key management personnel.

The Company’s success depends in part on its ability to retain key executives and to attract and retain additional qualified management personnel who have experience both in sophisticated banking matters and in operating a small- to mid-size bank. Competition for such personnel is strong in the banking industry, and we may not be successful in attracting or retaining the personnel we require. We expect to effectively compete in this area by offering financial packages that include incentive-based compensation and the opportunity to join in the rewarding work of building a growing bank.

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Participation in the TARP imposes several restrictions on compensation paid to our executives.

Pursuant to the terms of the Stock Purchase Agreement, we adopted certain standards for executive compensation and corporate governance for the period during which the Treasury holds the equity issued pursuant to the Stock Purchase Agreement, including the common stock which may be issued pursuant to the Warrants. These standards generally apply to our Chief Executive Officer, Chief Financial Officer and our senior executive officers (“SEOs”). The standards include (1) ensuring that bonus incentive compensation arrangements for SEOs do not encourage unnecessary and excessive risks that threaten the value of the financial institution; (2) requiring clawback of any bonus or incentive compensation paid to a SEOs based on statements of earnings, gains or other criteria that are later proven to be materially inaccurate; (3) prohibiting certain parachute payments to SEOs; and (4) agreeing not to deduct for tax purposes executive compensation in excess of $500,000 for each SEO. In particular, the change to the deductibility limit on executive compensation will likely increase the overall cost of our compensation programs in future periods. Since the Warrants have a ten year term, we could potentially be subject to the executive compensation and corporate governance restrictions for a ten year time period.

Additionally, the ARRA amends Section 111 of the EESA to require the Treasury to adopt additional standards with respect to executive compensation and corporate governance for TARP recipients (including the Company). The standards required to be established by the Treasury include, in part, (1) prohibitions on making golden parachute payments to SEOs and the next 5 most highly-compensated employees during such time as any obligation arising from financial assistance provided under the TARP remains outstanding (the “Restricted Period”), (2) prohibitions on paying or accruing bonuses or other incentive awards for certain SEOs and employees, except for awards of long-term restricted stock with a value equal to no greater than 1/3 of an individual’s annual compensation that do not fully vest during the Restricted Period or unless such compensation is pursuant to a valid written employment contract prior to February 11, 2009, (3) requirements that CPP participants provide for the recovery of any bonus or incentive compensation paid to SEOs and the next 20 most highly-compensated employees based on statements of earnings, revenues, gains or other criteria later found to be materially inaccurate, with the Treasury having authority to negotiate for reimbursement, and (4) a review by the Treasury of all bonuses and other compensation paid by TARP participants to senior executive employees and the next 20 most highly-compensated employees before the date of enactment of the ARRA to determine whether such payments were inconsistent with the purposes of the EESA.

Technological advances impact our business.

The banking industry is undergoing technological changes with frequent introductions of new technology-driven products and services. In addition to improving customer services, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend, in part, on our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources than we do to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or successfully market such products and services to our customers.

Government regulations may prevent or impact our ability to pay dividends, engage in acquisitions or operate in other ways.

Current and future legislation and the policies established by federal and state regulatory authorities will affect our operations. We are subject to supervision and periodic examination by the Federal Deposit Insurance Corporation and the North Carolina State Banking Commission. Banking regulations, designed primarily for the protection of depositors, may limit our growth and the return to you, our investors, by restricting certain of our activities, such as:

• the payment of dividends to our shareholders;

• possible mergers with, or acquisitions of or by, other institutions;

• our desired investments;

• loans and interest rates on loans;

• interest rates paid on our deposits;

• the possible expansion of our branch offices; and/or

• our ability to provide securities or trust services.

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We also are subject to capitalization guidelines set forth in federal legislation, and could be subject to enforcement actions to the extent that we are found by regulatory examiners to be undercapitalized. We cannot predict what changes, if any, will be made to existing federal and state legislation and regulations or the effect that such changes may have on our future business and earnings prospects. The cost of compliance with regulatory requirements including those imposed by the SEC may adversely affect our ability to operate profitably.

The Treasury’s investment in us imposes restrictions and obligations limiting our ability to increase dividends and repurchase common stock.

In December 2008, the Company issued preferred stock and Warrants to the Treasury. Prior to December 12, 2011, unless the Company has redeemed all of the preferred stock, or the Treasury has transferred all of the preferred stock to a third party, the consent of the Treasury will be required for the Company to, among other things, increase common stock dividends or effect repurchases of common stock (with certain exceptions, including the repurchase of the Company’s common stock to offset share dilution from equity-based employee compensation awards).

There are potential risks associated with future acquisitions and expansions.

We intend to continue to explore expanding our branch system through selective acquisitions of existing banks or bank branches in the Research Triangle area and other North Carolina markets. We cannot say with any certainty that we will be able to consummate, or if consummated, successfully integrate, future acquisitions, or that we will not incur disruptions or unexpected expenses in integrating such acquisitions. In the ordinary course of business, we evaluate potential acquisitions that would bolster our ability to cater to the small business, individual and residential lending markets in North Carolina. In attempting to make such acquisitions, we anticipate competing with other financial institutions, many of which have greater financial and operational resources. In addition, since the consideration for an acquired bank or branch may involve cash, notes or the issuance of shares of common stock, existing shareholders could experience dilution in the value of their shares of our common stock in connection with such acquisitions. Any given acquisition, if and when consummated, may adversely affect our results of operations or overall financial condition. In addition, we may expand our branch network through de novo branches in existing or new markets. These de novo branches will have expenses in excess of revenues for varying periods after opening, which could decrease our reported earnings.

Compliance with changing regulation of corporate governance and public disclosure may result in additional risks and expenses.

Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002 and new SEC regulations, are creating uncertainty for companies such as ours. These laws, regulations and standards are subject to varying interpretations in many cases, and as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies, which could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We are committed to maintaining high standards of corporate governance and public disclosure. As a result, our efforts to comply with evolving laws, regulations and standards have resulted in, and are likely to continue to result in, increased expenses and a diversion of management time and attention. In particular, our efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations regarding management’s required assessment of our internal control over financial reporting and our external auditors’ audit of that assessment has required the commitment of significant financial and managerial resources.

We expect these efforts to require the continued commitment of significant resources. Further, the members of our Board of Directors, members of the Audit or Compensation/Human Resources Committees, our CEO, our CFO and certain other of our executive officers could face an increased risk of personal liability in connection with the performance of their duties. As a result, our ability to attract and retain executive officers and qualified Board and committee members could be more difficult. In addition, it may become more difficult and more expensive to obtain director and officer liability insurance.

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We are subject to environmental liability risk associated with lending activities.

A significant portion of our loan portfolio is secured by real property. During the ordinary course of business, we may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require us to incur substantial expenses and may materially reduce the affected property’s value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. Although we have policies and procedures to perform an environmental review before initiating any foreclosure action on nonresidential real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on our financial condition and results of operations. Loan defaults result in a decrease in interest income and may require the establishment of or an increase in loan loss reserves. Furthermore, the decrease in interest income resulting from a loan default or defaults may be for a prolonged period of time as we seek to recover, primarily through legal proceedings, the outstanding principal balance, accrued interest and default interest due on a defaulted loan plus the legal costs incurred in pursuing our legal remedies. No assurance can be given that recent market conditions will not result in our need to increase loan loss reserves or charge-off a higher percentage of loans, thereby reducing net income.

Our controls and procedures may fail or be circumvented.

Management regularly reviews and updates our internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations and financial condition.

The holders of our subordinated debentures have rights that are senior to those of our shareholders.

We have issued $30.9 million of subordinated debentures in connection with three trust preferred securities issuances by our subsidiaries, Trust I, II and III. We conditionally guarantee payments of the principal and interest on the trust preferred securities. Our subordinated debentures are senior to our shares of common stock. As a result, we must make payments on the subordinated debentures (and the related trust preferred securities) before any dividends can be paid on our common stock and, in the event of bankruptcy, dissolution or liquidation, the holders of the debentures must be satisfied before any distributions can be made to the holders of common stock.

Our information systems may experience an interruption or breach in security.

We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that we can prevent any such failures, interruptions or security breaches or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.

An investment in our common stock is not an insured deposit.

Our common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, any other deposit insurance fund or by any other public or private entity. Investment in our common stock is inherently risky for the reasons described in this “Risk Factors” section and elsewhere in this report and is subject to the same market forces that affect the price of common stock in any company. As a result, if you acquire our common stock, you may lose some or all of your investment.

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Consumers may decide not to use banks to complete their financial transactions.

Technology and other changes are allowing parties to complete financial transactions that historically have involved banks through alternative methods. For example, consumers can now maintain funds in brokerage accounts or mutual funds that would have historically been held as bank deposits. Consumers can also complete transactions such as paying bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.

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

There were no equity securities sold during the quarter ended June 30, 2009 that were not registered under the Securities Act. There were no repurchases (both open market and private transactions) during the six months ended June 30, 2009 of any of the Company’s securities registered under Section 12 of the Exchange Act, by or on behalf of the Company, or any affiliated purchaser of the Company.

Item 3.Defaults upon Senior Securities

None

Item 4.Submission of Matters to a Vote of Security Holders

During our annual meeting of shareholders on May 28, 2009, the following matters were submitted to a vote of the shareholders with the results shown below:

(1) Elected five nominees to serve as Class III directors with terms continuing until the Annual Meeting of Shareholders in 2012. The votes were cast as follows:
Name	Votes For	Votes Withheld
Leopold I. Cohen	8,270,579	442,341
O. A. Keller, III	7,884,192	828,728
Ernest A. Koury, Jr.	7,905,535	807,385
George R. Perkins, III	8,286,764	426,156
Carl H. Ricker, Jr.	7,866,146	846,774

(2) Ratified the appointment of Grant Thornton LLP as our independent registered public accounting firm for the fiscal year ending December 31, 2009. The votes were cast as follows:
Votes For	Votes Against	Abstained
8,505,043	181,510	26,366

(3)  Approval of a nonbinding advisory proposal regarding Capital Bank Corporation’s overall pay-for-performance executive compensation program. The votes were cast as follows:
Votes For	Votes Against	Abstained
7,656,729	994,345	61,847

(4) Approval of the reservation of 500,000 additional shares of Capital Bank Corporation common stock for issuance under the Capital Bank Corporation Deferred Compensation Plan for Outside Directors. The votes were cast as follows:
Votes For	Votes Against	Abstained
5,608,375	871,953	138,827

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(5)  Approval of the reservation of 500,000 additional shares of Capital Bank Corporation common stock for issuance under the Capital Bank Corporation Equity Incentive Plan. The votes were cast as follows:
Votes For	Votes Against	Abstained
5,555,339	924,900	138,917

The matters listed above are described in detail in our definitive proxy statement dated April 17, 2009 for the Annual Meeting of Shareholders held on May 28, 2009.

Item 5.Other Information

None

Item 6.Exhibits

Exhibit No.	Description
Exhibit 4.1	In accordance with Item 601(b)(4)(iii)(A) of Regulation S-K, certain instruments respecting long-term debt of the registrant have been omitted but will be furnished to the Commission upon request.
Exhibit 10.1	Form of Incentive Stock Option Agreement under the Capital Bank Corporation Equity Incentive Plan (incorporated by reference to Exhibit 99.3 to the Company’s Form S-8 filed with the SEC on July 20, 2009)
Exhibit 31.1	Certification of B. Grant Yarber pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 31.2	Certification of Michael R. Moore pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 32.1	Certification of B. Grant Yarber pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 [This exhibit is being furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by that Act, be deemed to be incorporated by reference into any document or filed herewith for purposes of liability under the Securities Exchange Act of 1934, as amended, or the Securities Act of 1933, as amended, as the case may be.]
Exhibit 32.2	Certification of Michael R. Moore pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 [This exhibit is being furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by that Act, be deemed to be incorporated by reference into any document or filed herewith for purposes of liability under the Securities Exchange Act of 1934, as amended, or the Securities Act of 1933, as amended, as the case may be.]

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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, in Raleigh, North Carolina, on the 7th day of August 2009.

CAPITAL BANK CORPORATION

By:  /s/  Michael R. Moore

Michael R. Moore

Chief Financial Officer

(Authorized Officer and Principal Financial Officer)

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Exhibit Index

Exhibit No.	Description
Exhibit 4.1	In accordance with Item 601(b)(4)(iii)(A) of Regulation S-K, certain instruments respecting long-term debt of the registrant have been omitted but will be furnished to the Commission upon request.
Exhibit 10.1	Form of Incentive Stock Option Agreement under the Capital Bank Corporation Equity Incentive Plan (incorporated by reference to Exhibit 99.3 to the Company’s Form S-8 filed with the SEC on July 20, 2009)
Exhibit 31.1	Certification of B. Grant Yarber pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 31.2	Certification of Michael R. Moore pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 32.1	Certification of B. Grant Yarber pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 [This exhibit is being furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by that Act, be deemed to be incorporated by reference into any document or filed herewith for purposes of liability under the Securities Exchange Act of 1934, as amended, or the Securities Act of 1933, as amended, as the case may be.]
Exhibit 32.2	Certification of Michael R. Moore pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 [This exhibit is being furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by that Act, be deemed to be incorporated by reference into any document or filed herewith for purposes of liability under the Securities Exchange Act of 1934, as amended, or the Securities Act of 1933, as amended, as the case may be.]

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