form10-q.htm

6. Stock-Based Compensation

The Company uses the following forms of stock-based compensation as an incentive for certain employees and non-employee directors: stock options, restricted stock, and stock issued through a deferred compensation plan for non-employee directors.

Stock Options

Pursuant to the Capital Bank Corporation Equity Incentive Plan (“Equity Incentive Plan”), the Company has a stock option plan providing for the issuance of options for the purchase of up to 1,150,000 shares of the Company’s common stock to officers and directors. As of June 30, 2010, options for 293,600 shares of common stock were outstanding and options for 598,859 shares of common stock remained available for future issuance. In addition, options for 566,071 shares of common stock were assumed by the Company under various plans from previously acquired financial institutions, of which options for 19,820 shares remain outstanding. Grants of options are made by the Board of Directors or the Compensation/Human Resources Committee of the Board. All grants must be made with an exercise price at no less than fair market valu e on the date of grant, must be exercised no later than 10 years from the date of grant, and may be subject to certain vesting provisions.

A summary of the activity during the six months ended June 30, 2010 and 2009 of the Company’s stock option plans, including the weighted average exercise price (“WAEP”) is presented below:

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

	June 30, 2010					June 30, 2009
	Shares			WAEP		Shares		WAEP

Outstanding at beginning of period		366,583		$	11.76		377,083	$	11.71
Granted		19,250			4.38		–		–
Exercised		–			–		–		–
Forfeited and expired		(72,413	)		8.53		–		–
Outstanding at end of period		313,420		$	12.05		377,083	$	11.71

Options exercisable at end of period		220,470		$	13.70		275,883	$	12.43

The following table summarizes information about the Company’s stock options as of June 30, 2010:

Exercise Price	Number Outstanding		Weighted Average Remaining Contractual Life in Years		Number Exercisable		Intrinsic Value

$3.85 – $6.00		79,250		8.82		12,000	$	–
$6.01 – $9.00		10,040		0.50		10,040		–
$9.01 – $12.00		74,880		1.70		73,380		–
$12.01 – $15.00		20,000		6.13		10,400		–
$15.01 – $18.37		129,250		4.69		114,650		–
		313,420		4.98		220,470	$	–

The fair values of options granted are estimated on the date of the grants using the Black-Scholes option pricing model. Option pricing models require the use of highly subjective assumptions, including expected stock price volatility, which when changed can materially affect fair value estimates. The expected life of the options used in this calculation is the period the options are expected to be outstanding. Expected stock price volatility is based on the historical volatility of the Company’s common stock for a period approximating the expected life; the expected dividend yield is based on the Company’s historical annual dividend payout; and the risk-free rate is based on the implied yield available on U.S. Treasury issues. The weighted average fair value of options granted for the six months ended June 30, 2010 was $1.80. There were no options granted in the six months ended June 30, 2009.

As of June 30, 2010, the Company had unamortized compensation expense related to unvested stock options of $115,000, which is expected to be fully amortized over the next four years. For the six months ended June 30, 2010 and 2009, the Company recorded compensation expense of $24,000 and $25,000, respectively, related to stock options.

Restricted Stock

Pursuant to the Equity Incentive Plan, the Board of Directors may grant restricted stock to certain employees and Board members at its discretion. There have been no restricted stock grants since 2008. 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. As of June 30, 2010, the Company had 23,600 shares of unvested restricted stock grants, which represents unrecognized compensation expense of $133,000 to be recognized over the remaining vesting period of the respective grants. Total compensation expense related to these restricted stock awards for the six months ended June 30, 2010 and 2009 totaled $61,000 and $53,000, respectively.< /div>

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% 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. For the six months ended June 30, 2010 and 2009, the Company recognized compensation expense of $301,000 and $287,000, respectively, related to the Deferred Compensation Plan.

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

7. Derivative Instruments

The Company enters into interest rate lock commitments with customers and commitments to sell mortgages to investors. The period of time between the issuance of a mortgage loan commitment and the closing and sale of the mortgage loan is generally less than 60 days. Interest rate lock commitments and forward loan sale commitments represent derivative instruments which are carried at fair value. These derivative instruments do not qualify for hedge accounting. The fair values of the Company’s interest rate lock commitments and forward loan sales commitments are based on current secondary market pricing and are included on the Condensed Consolidated Balance Sheets in mortgage loans held for sale and on the Condensed Consolidated Statements of Operations in mortgage origination and other loan fees.

As of June 30, 2010, the Company had $16.9 million of commitments outstanding to originate mortgage loans held for sale at fixed rates and $18.8 million of forward commitments under best efforts contracts to sell mortgages to two different investors. The fair value adjustments of the interest rate lock commitments and forward loan sales commitments were not considered material as of June 30, 2010. Thus, there was no impact to the Condensed Consolidated Statements of operations for the three or six months ended June 30, 2010.

8. Commitments and Contingencies

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, 2010 and December 31, 2009 is as follows:

	June 30, 2010		December 31, 2009
(Dollars in thousands)

Unused lines of credit and overdraft lines	$	199,661	$	231,691
Standby letters of credit		9,878		9,144
Total commitments	$	209,539	$	240,835

The Company has limited partnership investments in two related private investment funds which totaled $1.8 million as of both June 30, 2010 and December 31, 2009. These investments are recorded on the cost basis and were included in other assets on the Condensed Consolidated Balance Sheets. Remaining capital commitments to these investment funds totaled $1.6 million as of June 30, 2010.

9. Fair Value Measurement

The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Investment securities, available for sale, 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.

Investment securities, available for sale, 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 and corporate entities as well as municipal bonds. Securities classif ied as Level 3 include corporate debt instruments that are not actively traded.

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

Mortgage loans held for sale are carried at the lower of cost or market value. The fair values of mortgage loans held for sale are based on commitments on hand from investors within the secondary market for loans with similar characteristics. As such, the fair value adjustment for mortgage loans held for sale is classified as nonrecurring Level 2.

Loans are not recorded at fair value on a recurring basis. However, from time to time, a loan is considered impaired, and a valuation allowance is established based on the estimated value of the loan. The fair value of impaired loans that are collateral dependent is based on collateral value. For impaired loans that are not collateral dependent, estimated value is based on either an observable market price, if available, or the present value of expected future cash flows. Those impaired loans not requiring an allowance represent loans for which the estimated fair value exceeds the recorded investments in such loans. When the fair value of an impaired loan 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 managemen t 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.

Other real estate, which includes foreclosed assets, is adjusted to fair value upon transfer of loans and premises to other real estate. Subsequently, other real estate is 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 other real estate 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 other real estate as nonrecurring Level 3.

Assets and liabilities measured at fair value on a recurring basis as of June 30, 2010 and December 31, 2009 are summarized below:

	Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
(Dollars in thousands)

June 30, 2010
Investment securities – available for sale:
U.S. agency obligations	$	–	$	47,229	$	–	$	47,229
Municipal bonds		–		36,179		–		36,179
Mortgage-backed securities issued by GSEs		–		124,044		–		124,044
Non-agency mortgage-backed securities		–		6,719		–		6,719
Other securities		1,772		–		1,300		3,072
Total	$	1,772	$	214,171	$	1,300	$	217,243

December 31, 2009
Investment securities – available for sale:
U.S. agency obligations	$	–	$	1,029	$	–	$	1,029
Municipal bonds		–		72,894		–		72,894
Mortgage-backed securities issued by GSEs		–		151,658		–		151,658
Non-agency mortgage-backed securities		–		7,797		–		7,797
Other securities		748		–		1,300		2,048
Total	$	748	$	233,378	$	1,300	$	235,426

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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, 2010:

		Level 3
(Dollars in thousands)

Balance at beginning of period	$	1,300
Total unrealized losses included in:
Net income		–
Other comprehensive income		–
Purchases, sales and issuances, net		–
Transfers in and (out) of Level 3		–
Balance at end of period	$	1,300

Assets and liabilities measured at fair value on a nonrecurring basis as of June 30, 2010 and December 31, 2009 are summarized below:

	Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
(Dollars in thousands)

June 30, 2010
Impaired loans	$	–	$	78,969	$	3,103	$	82,072
Other real estate		–		16,088		–		16,088

December 31, 2009
Impaired loans	$	–	$	36,972	$	34,181	$	71,153
Other real estate		–		10,732		–		10,732

10. Fair Value of Financial Instruments

Due to the nature of the Company’s business, a significant portion of its assets and liabilities consist of financial instruments. Accordingly, the estimated fair values of these financial instruments are disclosed. 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 est imates 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 liquid nature of the financial instruments. Estimated fair values of investment securities are based on quoted market prices, if available, or model-based values from pricing sources for mortgage-backed securities and municipal bonds. 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.

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, 2010 and December 31, 2009 are as follows:

	June 30, 2010				December 31, 2009
(Dollars in thousands)	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
Financial Assets:
Cash and cash equivalents	$	41,417	$	41,417	$	29,513	$	29,513
Investment securities		228,812		228,860		245,492		245,438
Mortgage loans held for sale		1,893		1,893		–		–
Loans		1,315,339		1,312,634		1,364,221		1,368,233
Accrued interest receivable		5,766		5,766		6,590		6,590

Financial Liabilities:
Non-maturity deposits	$	505,983	$	505,983	$	529,257	$	529,257
Time deposits		864,794		873,663		848,708		861,378
Repurchase agreements		–		–		6,543		6,543
Borrowings		153,000		159,588		167,000		171,278
Subordinated debentures		34,323		15,593		30,930		12,200
Accrued interest payable		1,838		1,838		1,824		1,824

There was no material difference between the carrying amount and estimated fair value of off-balance-sheet commitments totaling $209.5 million and $240.8 million as of June 30, 2010 and December 31, 2009, 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.

11. Private Placement Offering

On March 18, 2010, the Company sold 849 investment units (“Units”) for gross proceeds of $8.5 million. Each Unit was priced at $10,000 and consisted of a $3,996.90 subordinated promissory note and a number of shares of the Company’s common stock valued at $6,003.10. The offering and sale of the Units was limited to accredited investors. As a result of the sale of the Units, the Company sold $3.4 million in aggregate principal amount of subordinated promissory notes due March 18, 2020 (the “Notes”) and 1,468,770 shares of the Company’s common stock valued at $5.1 million. The Notes were recorded in subordinated debentures on the Condensed Consolidated Balance Sheets. The Company is obligated to pay interest on the Notes at 10% per annum payable in quarterly installments commencing on the third month anni versary of the date of issuance of the Notes. The Company may prepay the Notes at any time after March 18, 2015 subject to approval by the Federal Reserve and compliance with applicable law.

The Company’s obligation to repay the Notes is subordinate to all indebtedness owed by the Company to its current and future secured creditors and general creditors, including the Federal Reserve and the Federal Deposit Insurance Corporation, and certain other financial obligations of the Company.

12. Subsequent Events

On July 30, 2010, the Company announced its intention to commence a public offering of 34,500,000 shares of its common stock, which will be underwritten by FIG Partners, LLC as sole book-runner and lead manager on a best efforts basis. Proceeds from this public stock offering will be used for general corporate purposes, including to strengthen the capital of Capital Bank and to support the Company’s strategic growth opportunities in the future. The precise amounts and the timing of the Company’s use of the net proceeds will depend upon market conditions, Capital Bank’s funding requirements, the availability of other funds and other factors. The Company’s management will retain broad discretion in the allocation of net proceeds from the offering.

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, 2010 and 2009 for Capital Bank Corporation, or the Company, and its wholly owned subsidiary, Capital Bank, or 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.

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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, or 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, or SEC.

Overview

Capital Bank Corporation is a financial holding company incorporated under the laws of North Carolina on August 10, 1998. The Company’s primary wholly-owned subsidiary is Capital Bank, a state-chartered banking corporation. The Bank was incorporated under the laws of the State of North Carolina on May 30, 1997 and commenced operations on June 20, 1997. As of June 30, 2010, the Company conducted no business other than holding stock in the Bank and in three trusts, Capital Bank Statutory Trust I, II, and III.

Capital Bank is a community bank engaged in the general commercial banking business and operates through four North Carolina regions: Triangle, Sandhills, Triad and Western. As of June 30, 2010, the Bank had assets of approximately $1.7 billion, with gross loans and deposits outstanding of approximately $1.4 billion each. The Bank operates 32 branch offices in North Carolina: five in Raleigh, four in Asheville, four in Fayetteville; three in Burlington, three in Sanford, two in Cary, and one each in Clayton, Graham, Hickory, Holly Springs, Mebane, Morrisville, Oxford, Pittsboro, Siler City, Wake Forest and Zebulon.

The Bank offers a full range of banking services, including the following: checking accounts; savings accounts; NOW accounts; money market accounts; certificates of deposit; individual retirement accounts; loans for real estate, construction, businesses, agriculture, personal use, home improvement and automobiles; equity lines of credit; mortgage loans; credit loans; consumer loans; credit cards; safe deposit boxes; bank money orders; internet banking; electronic funds transfer services including wire transfers and remote deposit capture; traveler’s checks; and free notary services to all Bank customers. In addition, the Bank provides automated teller machine access to its customers for cash withdrawals through nationwide ATM networks. Through a partnership between the Bank’s financial services division and Capital Investment Companies, an unaffiliated Raleigh, North Carolina-based broker-dealer, the Bank also makes available a complete line of uninsured investment products and services. The securities involved in these services are not deposits or other obligations of the Bank and are not insured by the Federal Deposit Insurance Corporation, or the FDIC.

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, debit card transaction 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, or BOLI. Operating expenses primarily consist of employee compensation and benefits, occupancy related expenses, depreciation and maintenance expenses on furniture and equipment, data processing and telecommunications, advertising and public relations, professional fees, other real estate losses and loan-related costs, FDIC deposit insurance 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.

As a financial holding company, the Company is subject to the supervision of the Board of Governors of the Federal Reserve System, or Federal Reserve. The Company is required to file with the Federal Reserve reports and other information regarding its business operations and the business operations of its subsidiaries. As a North Carolina chartered bank, the Bank is subject to primary supervision, periodic examination and regulation by the North Carolina Commissioner of Banks, or NC Commissioner, and by the FDIC, as its primary federal regulator.

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Critical Accounting Policies and Estimates

The following discussion and analysis of the Company’s financial condition and results of operations are based on the Company’s condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States, or U.S. GAAP. The preparation of these financial statements requires the Company to make estimates and judgments regarding uncertainties that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. 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. However, because future events and their effects cannot be determined with certainty, actual results may differ from these estimates under different assumptions or conditions, and the Company may be exposed to gains or losses that could be material.

The Company has identified the following accounting policies as being critical in terms of significant judgments and the extent to which estimates are used: allowance for loan losses, other-than-temporary impairment on investment securities, income taxes, and impairment of long-lived assets. These policies are important in understanding management’s discussion and analysis. 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, 2009.

Executive Summary

The following is a summary of the Company’s significant results of operations and changes in financial position for the three and six months ended June 30, 2010:

	•	The Company completed an $8.5 million private placement offering to qualified investors in the first half of 2010. The offering was structured in the form of investment units consisting of a subordinated promissory note and shares of the Company’s common stock. As a result of the offering, the Company sold subordinated promissory notes with an aggregate principal amount of $3.4 million and shares of the Company’s common stock valued at approximately $5.1 million.

	•	Net loss attributable to common shareholders was $14.2 million, or $1.09 per diluted share, in the second quarter of 2010 compared with net income available to common shareholders of $762 thousand, or $0.07 per share, in the second quarter of 2009. Year-to-date net loss attributable to common shareholders was $20.1 million, or $1.60 per share, in the first half of 2010 compared with net loss attributable to common shareholders of $4.3 million, or $0.38 per diluted share, in the first half of 2009. Results of operations primarily reflect a significant increase in provision for loan losses, partially offset by improved net interest income and a higher tax benefit (net of valuation allowance).

	•	Net interest income increased by $580 thousand, rising from $12.2 million in the second quarter of 2009 to $12.7 million in the second quarter of 2010. This improvement was due to an increase in net interest margin from 3.17% in the second quarter of 2009 to 3.25% in the second quarter of 2010, coupled with 2.2% growth in average earning assets over the same period. Year-to-date net interest income increased by $2.9 million, rising from $22.3 million in the first half of 2009 to $25.3 million in the first half of 2010. This improvement was due to an increase in net interest margin from 2.95% in the first half of 2009 to 3.23% in the first half of 2010, coupled with 3.2% growth in average earnings assets over the same period.

	•	Provision for loan losses for the quarter ended June 30, 2010 totaled $20.0 million, an increase from $1.7 million for the quarter ended June 30, 2009. Year-to-date provision for loan losses totaled $31.8 million for the first half of 2010, an increase from $7.7 million for the first half of 2009. The significant increase in the loan loss provision was primarily due to difficult economic conditions and troubled real estate markets which resulted in continued rising levels of nonperforming assets and impaired loans. Additionally, higher default and charge-off rates as well as downgrades to the credit ratings of certain loans in the portfolio increased general reserves applied to performing loan groupings. Further, declining real estate values contributed to higher levels of charge-offs on impaired loans.

	•	Noninterest income decreased by $1.2 million, or 33%, declining from $3.7 million in the second quarter of 2009 to $2.5 million in the second quarter of 2010. This decrease was primarily related to a nonrecurring BOLI gain of $913 thousand recorded in the quarter ended June 30, 2009. Additionally, the Company realized net gains from sales of certain debt securities totaling $69 thousand in the second quarter of 2010 compared with net gains of $336 thousand in the same quarter last year, which also contributed to the noninterest income decrease. Year-to-date noninterest income decreased $785 thousand, or 14%, declining from $5.8 million in the first half of 2009 to $5.0 million in the first half of 2010. This decrease was primarily related to the nonrecurring BOLI gain in 2009.

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	•	Noninterest expense decreased $85 thousand, or 1%, declining from $12.5 million in the second quarter of 2009 to $12.4 million in the second quarter of 2010. This decrease was due in part to a $537 thousand decline in salaries and employee benefits from the suspension of the Company’s 401(k) employer matching contributions in mid-2009 and higher deferred loan costs, which reduce expense. FDIC deposit insurance expense decreased by $528 thousand primarily due to the FDIC’s special assessment on all insured depository institutions in the second quarter of last year. Partially offsetting these decreases to noninterest expense was an increase in advertising and public relations expense as well as higher other real estate losses and loan-related costs. Year-to-date noninterest expense increased $941 thousand, or 4%, rising from $24 .0 million in the first half of 2009 to $25.0 million in the first half of 2010. This increase was primarily due to $1.5 million in higher other real estate losses and loan-related costs, of which $949 thousand was related to valuation adjustments to and losses on the sale of other real estate with the remaining increase representing higher loan workout, appraisal and foreclosure costs.

	•	Income tax benefits recorded in both the three and six months ended June 30, 2010 were primarily impacted by net losses before income taxes and were partially offset by a valuation allowance of $3.3 million recorded against deferred income taxes in the second quarter of 2010.

Results of Operations

Quarter ended June 30, 2010 compared to quarter ended June 30, 2009

Net loss attributable to common shareholders was $14.2 million, or $1.09 per share, in the second quarter of 2010 compared with net income available to common shareholders of $762 thousand, or $0.07 per diluted share, in the second quarter of 2009. Results of operations in the first quarter of 2010 compared with the same quarter last year primarily reflect a significant increase in provision for loan losses, partially offset by improved net interest income and a higher tax benefit (net of valuation allowance).

Net Interest Income. Net interest income increased from $12.2 million for the quarter ended June 30, 2009 to $12.7 million for the quarter ended June 30, 2010. Average interest-earning assets were $1.62 billion for the quarter ended June 30, 2010 compared to $1.59 billion for the quarter ended June 30, 2009, an increase of 2.2%. Average interest-bearing liabilities were $1.44 billion for the quarter ended June 30, 2010 compared to $1.38 billion for the quarter ended June 30, 2009, an increase of 4.4%. On a fully tax equivalent basis, net interest spread was 3.02% and 2.84% for the quarters ended June 30, 2010 and 2009, respectively. Net interest margin on a tax equivalent basis increased by 8 basis points to 3.25% for the quarter ended June 30, 2010 from 3.17% for the quarter ended June 30, 2009. The yield on average interest-earning assets was 4.99% and 5.34% for the quarters ended June 30, 2010 and 2009, respectively, while the interest rate paid on average interest-bearing liabilities for those periods was 1.97% and 2.50%, respectively.

The increase in the net interest margin was primarily due to the significant decline in funding costs through disciplined pricing controls and a declining interest rate environment. Partially offsetting declining funding costs was a significant increase in nonaccrual loans over the past year and the expiration of an interest rate swap on prime-indexed commercial loans.

The following two tables set forth certain information regarding the Company’s yield on interest-earning assets and cost of interest-bearing liabilities and the component changes in net interest income. The first table, Average Balances, Interest Earned or Paid, and Interest Yields/Rates, reflects 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. Changes in net interest income from year to year can be explained in terms of fluctuations in volume and rate. The second table, Rate and Volume Variance Analysis, presents further information on those changes. For each category of interest-earning asset and interest-bearing liability, we have provided information on changes attributable to:

	•	changes in volume, which are changes in average volume multiplied by the average rate for the previous period;

	•	changes in rates, which are changes in average rate multiplied by the average volume for the previous period;

	•	changes in rate/volume, which are changes in average rate multiplied by the changes in average volume; and

	•	total change, which is the sum of the previous columns.

Index

- 21 -

CAPITAL BANK CORPORATION

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

For the Three Months Ended June 30, 2010, March 31, 2010 and June 30, 2009

Tax Equivalent Basis 1

	June 30, 2010								March 31, 2010								June 30, 2009
(Dollars in thousands)	Average Balance			Amount Earned		Average Rate			Average Balance			Amount Earned		Average Rate			Average Balance			Amount Earned		Average Rate
Assets
Loans 2:
Commercial	$	1,158,238		$	14,825		5.13	%	$	1,187,760		$	15,089		5.15	%	$	1,115,003		$	15,244		5.48	%
Consumer		215,375			2,640		4.92			205,409			2,473		4.88			170,568			2,168		5.10
Total loans		1,373,613			17,465		5.10			1,393,169			17,562		5.11			1,285,571			17,412		5.43
Investment securities 3		224,366			2,722		4.85			225,819			2,956		5.24			278,033			3,731		5.37
Interest-bearing deposits		25,300			10		0.16			20,226			10		0.20			24,898			6		0.10
Total interest-earning assets		1,623,279		$	20,197		4.99	%		1,639,214		$	20,528		5.08	%		1,588,502		$	21,149		5.34	%
Cash and due from banks		17,819								19,450								15,294
Other assets		111,383								102,321								80,296
Allowance for loan losses		(33,241	)							(28,045	)							(18,705	)
Total assets	$	1,719,240							$	1,732,940							$	1,665,387

Liabilities and Equity
Savings accounts	$	30,721		$	10		0.13	%	$	28,992		$	10		0.14	%	$	29,609		$	13		0.18	%
Interest-bearing demand deposits		326,706			648		0.80			342,048			886		1.05			368,132			1,152		1.26
Time deposits		891,645			4,946		2.22			871,507			5,255		2.45			796,306			5,868		2.96
Total interest-bearing deposits		1,249,072			5,604		1.80			1,242,547			6,151		2.01			1,194,047			7,033		2.36
Borrowed funds		153,264			1,146		3.00			170,956			1,145		2.72			140,682			1,273		3.63
Subordinated debt		34,323			298		3.48			31,232			218		2.83			30,930			278		3.61
Repurchase agreements		1,590			2		0.50			4,667			2		0.17			12,010			7		0.23
Total interest-bearing liabilities		1,438,249		$	7,050		1.97	%		1,449,402		$	7,516		2.10	%		1,377,669		$	8,591		2.50	%
Noninterest-bearing deposits		133,455								131,973								130,460
Other liabilities		10,587								10,658								12,042
Total liabilities		1,582,291								1,592,033								1,520,171
Shareholders’ equity		136,949								140,907								145,216
Total liabilities and shareholders’ equity	$	1,719,240							$	1,732,940							$	1,665,387

Net interest spread 4							3.02	%							2.98	%							2.84	%
Tax equivalent adjustment				$	403							$	462							$	394
Net interest income and net interest margin 5				$	13,147		3.25	%				$	13,012		3.22	%				$	12,558		3.17	%

1	The tax equivalent basis is computed using a federal 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	Net interest spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.
5	Net interest margin represents net interest income divided by average interest-earning assets.

Index

- 22 -

Rate and Volume Variance Analysis

Tax Equivalent Basis 1

	Three Months Ended June 30, 2010 vs. 2009
(Dollars in thousands)	Rate Variance			Volume Variance			Total Variance
Interest income:
Loans	$	(1,049	)	$	1,102		$	53
Investment securities		(358	)		(651	)		(1,009	)
Federal funds sold		4			–			4
Total interest income		(1,403	)		451			(952	)
Interest expense:
Savings and interest-bearing demand deposits and other		(425	)		(82	)		(507	)
Time deposits		(1,451	)		529			(922	)
Borrowed funds		(221	)		94			(127	)
Subordinated debt		(9	)		29			20
Repurchase agreements and federal funds purchased		8			(13	)		(5	)
Total interest expense		(2,098	)		557			(1,541	)
Increase in net interest income	$	695		$	(106	)	$	589

1	The tax equivalent basis is computed using a federal tax rate of 34%.

Interest income on loans decreased from $17.4 million for the quarter ended June 30, 2009 to $17.3 million for the quarter ended June 30, 2010, a decrease of 0.6%. This decrease was primarily due to lower loan yields, partially offset by growth in the loan portfolio. Average loan balances, which yielded 5.10% and 5.43% for the quarters ended June 30, 2010 and 2009, respectively, increased from $1.29 billion in the second quarter of 2009 to $1.37 billion in the second quarter of 2010. The Company’s interest rate swap on prime-indexed commercial loans, which expired in October 2009, increased loan interest income by $1.1 million in the second quarter of 2009, representing a benefit to net interest margin of 28 basis points in that quarter. Since the swap expired in 2009, the Company received no benefit in the second quarter of 2010 . A significant increase in loans placed on nonaccrual status during the second quarter of 2010 also negatively affected loan interest income during the quarter when compared with the same quarter one year ago. When loans are placed on nonaccrual status, any accrued but unpaid interest is immediately reversed and has a direct impact on net interest income and net interest margin.

Interest income on investment securities decreased from $3.3 million for the quarter ended June 30, 2009 to $2.5 million for the quarter ended June 30, 2010, a decline of 25.9%. This decrease was due to a decline in the size of the investment portfolio coupled with lower fixed income investment yields. Average investment balances, at cost, decreased from $278.0 million for the quarter ended June 30, 2009 to $224.4 million for the quarter ended June 30, 2010, and the tax equivalent yield on investment securities decreased from 5.37% to 4.85% over the same period. The decrease in average investment balances reflects management’s efforts to reduce the duration of the portfolio to mitigate exposure to a future rising interest rate environment. Additionally, yields have fallen as prepayments on higher yielding mortgage-backed securities and sales of certain long-dated municipal bonds have been re-invested at lower rates in shorter-dated U.S. government agency debt.

Interest expense on deposits decreased from $7.0 million for the quarter ended June 30, 2009 to $5.6 million for the quarter ended June 30, 2010, a decline of 20.3%. The decline is primarily due to falling interest-bearing deposit rates from 2.36% for the quarter ended June 30, 2009 to 1.80% for the quarter ended June 30, 2010. For time deposits, which represented 71.4% and 66.7% of total average interest-bearing deposits for the quarters ended June 30, 2010 and 2009, respectively, the average rate decreased from 2.96 % for the quarter ended June 30, 2009 to 2.22% for the quarter ended June 30, 2010, reflecting disciplined pricing controls and re-pricing of maturing time deposits in a low interest rate environment. Interest expense on borrowings decreased from $1.6 million for the quarter ended June 30, 2009 to $1.4 million for the quarte r ended June 30, 2010, a decline of 7.2%. The average rate paid on average borrowings, including subordinated debt and repurchase agreements, decreased from 3.40% for the quarter ended June 30, 2009 to 3.07% for the quarter ended June 30, 2010.

Index

- 23 -

Provision for Loan Losses. Provision for loan losses for the quarter ended June 30, 2010 totaled $20.0 million, an increase from $1.7 million for the quarter ended June 30, 2009. The increase in the loan loss provision was primarily due to difficult economic conditions and troubled real estate markets which resulted in continued rising levels of nonperforming assets and impaired loans. Additionally, higher default and charge-off rates as well as downgrades to the credit ratings of certain loans in the portfolio increased general reserves applied to performing loan groupings. Further, declining real estate values contributed to higher levels of charge-offs on impaired loans.

Net charge-offs increased from $1.6 million, or 0.49% (annualized) of average loans, in the second quarter of 2009 to $13.4 million, or 3.91% (annualized) of average loans, in the second quarter of 2010. Nonperforming assets, which include loans on nonaccrual and other real estate, increased to 5.37% of total assets as of June 30, 2010 compared to 2.90% as of December 31, 2009 and 1.40% as of June 30, 2009. Further, nonperforming loans increased to 5.54% of total loans as of June 30, 2010 compared to 2.84% as of December 31, 2009 and 1.43% as of June 30, 2009. The elevated provision for loan losses, net charge-offs and nonperforming loans reflect the economic climate in the Company’s primary markets and consistent application of the Company’s policy to recognize losses as they occur. Given significant volatility and rapid c hanges in current market conditions, management cannot predict its provision or nonperforming loan levels into the future but anticipates that credit losses and problem loans may remain elevated, or even increase, throughout 2010 as the Company continues working to resolve problem loans in these challenging market conditions.

Noninterest Income. Noninterest income decreased from $3.7 million for the quarter ended June 30, 2009 to $2.5 million for the quarter ended June 30, 2010, a decline of 32.5%. The following table presents the detail of noninterest income and related changes for the quarters ended June 30, 2010 and 2009:

		2010		2009		$ Change		% Change
(Dollars in thousands)

Noninterest income:
Service charges and other fees	$	854	$	959	$	(105	)	(10.9	)%
Bank card services		543		385		158		41.0
Mortgage origination and other loan fees		339		583		(244	)	(41.9	)
Brokerage fees		285		150		135		90.0
Bank-owned life insurance		255		1,165		(910	)	(78.1	)
Net gain on investment securities		69		336		(267	)	(79.5	)
Other		169		146		23		15.8
Total noninterest income	$	2,514	$	3,724	$	(1,210	)	(32.5	)%

The primary reason for the decrease in noninterest income was a nonrecurring BOLI gain recorded during the quarter ended June 30, 2009 of $913 thousand. Additionally, the Company realized net gains from sales of certain debt securities totaling $69 thousand in the second quarter of 2010 compared with net gains of $336 thousand in the same quarter last year. Mortgage origination and other loan fees declined primarily due to increased residential mortgage refinancing activity in the second quarter of 2009 and fewer prepayment penalties recognized on commercial loans.

Service charges and other fees, which includes overdraft and non-sufficient funds, or NSF, charges, decreased primarily from continued reduction in the frequency of overdrawn accounts and NSF checks as consumers have closely monitored their accounts during the recent economic recession. Bank card services, which includes income received from debit card transactions, increased primarily due to checking account growth and from a higher volume of debit card transactions. Brokerage fees increased as a result of improved sales efforts while other noninterest income remained relatively consistent over the period under comparison.

Noninterest Expense. Noninterest expense decreased from $12.5 million for the quarter ended June 30, 2009 to $12.4 million for the quarter ended June 30, 2010, a decrease of 0.7%. The following table presents the detail of noninterest expense and related changes for the quarters ended June 30, 2010 and 2009:

Index

- 24 -

		2010		2009		$ Change		% Change
(Dollars in thousands)

Noninterest expense:
Salaries and employee benefits	$	5,319	$	5,856	$	(537	)	(9.2	)%
Occupancy		1,456		1,348		108		8.0
Furniture and equipment		700		739		(39	)	(5.3	)
Data processing and telecommunications		525		573		(48	)	(8.4	)
Advertising and public relations		599		223		376		168.6
Office expenses		288		322		(34	)	(10.6	)
Professional fees		684		434		250		57.6
Business development and travel		307		247		60		24.3
Amortization of deposit premiums		235		287		(52	)	(18.1	)
Other real estate losses and other loan-related costs		708		398		310		77.9
Directors fees		294		477		(183	)	(38.4	)
FDIC deposit insurance		651		1,179		(528	)	(44.8	)
Other		614		382		232		60.7
Total noninterest expense	$	12,380	$	12,465	$	(85	)	(0.7	)%

Salaries and employee benefits expense decreased partially due to suspension of the Company’s 401(k) employer matching contributions in 2009 and partially due to higher levels of deferred loan costs, which reduce expense. In addition, FDIC deposit insurance expense decreased primarily due to the FDIC’s special assessment on all insured depository institutions in the second quarter of 2009. Directors’ fees decreased due to acceleration of benefit payments on a retirement plan upon the death of a former director in 2009 and in part due to the board reduction in late 2009.

Partially offsetting the decreases in noninterest expense, advertising and public relations expense increased due in part from radio and television ads promoting the Company’s special financing programs for home buyers. Other real estate losses and loan-related costs increased as higher loan workout, appraisal, and foreclosure costs were incurred. Professional fees increased due to higher legal costs. Other noninterest expense increased in part from a loss incurred upon the repurchase of a previously sold mortgage loan and from higher reserve levels for unfunded lending commitments.

Occupancy costs increased primarily due to additional overhead costs incurred as new branches were opened during the past year in the Triangle region. Furniture and equipment expense declined from lower depreciation charges. Data processing and telecommunications costs dropped as the Company realized cost savings through renegotiation of certain vendor contracts. Management continues to monitor and update the Company’s technology infrastructure in an efficient and cost controlled manner that provides for future growth opportunities. Amortization of deposit premiums decreased as intangible assets acquired in previous acquisitions are amortized on an accelerated method over the expected benefit of the core deposit premium. Business development and travel costs increased due to employee training and education expenses while office expe nses remained relatively constant over the period under comparison.

Income Taxes. Income tax benefit recorded in the three months ended June 30, 2010 was primarily impacted by net losses before income taxes and was partially offset by a valuation allowance of $3.3 million recorded against deferred income taxes in the second quarter of 2010.

Six months ended June 30, 2010 compared to six months ended June 30, 2009

Net loss attributable to common shareholders was $20.1 million, or $1.60 per diluted share, for the six months ended June 30, 2010 compared with net loss attributable to common shareholders of $4.3 million, or $0.38 per diluted share, for the six months ended June 30, 2009. Results of operations for the six months ended June 30, 2010 compared with the same period last year primarily reflect a significant increase in provision for loan losses, partially offset by improved net interest income and a higher tax benefit (net of valuation allowance).

Index

- 25 -

Net Interest Income. Net interest income increased from $22.3 million for the six months ended June 30, 2009 to $25.3 million for the six months ended June 30, 2010. Average interest-earning assets were $1.63 billion for the six months ended June 30, 2010 compared to $1.58 billion for the six months ended June 30, 2009, an increase of 3.2%. Average interest-bearing liabilities were $1.44 billion for the six months ended June 30, 2010 compared to $1.38 billion for the six months ended June 30, 2009, an increase of 4.9%. On a fully tax equivalent basis, net interest spread was 3.00% and 2.61% for the six months ended June 30, 2010 and 2009, respectively. Net interest margin on a tax equivalent basis increased by 28 basis points to 3.23% for the six months ended June 30, 2010 from 2.95% for the six months ended June 30, 2009. The yield on average interest-earning assets was 5.03% and 5.26% for the six months ended June 30, 2010 and 2009, respectively, while the interest rate paid on average interest-bearing liabilities for those periods was 2.03% and 2.65%, respectively.

The increase in the net interest margin was primarily due to the significant decline in funding costs through disciplined pricing controls and a more favorable competitive pricing landscape. Partially offsetting declining funding costs was a significant increase in nonaccrual loans over the past year and the expiration of an interest rate swap on prime-indexed commercial loans.

	•	changes in volume, which are changes in average volume multiplied by the average rate for the previous period;

	•	changes in rates, which are changes in average rate multiplied by the average volume for the previous period;

	•	changes in rate/volume, which are changes in average rate multiplied by the changes in average volume; and

	•	total change, which is the sum of the previous columns.

Index

- 26 -

CAPITAL BANK CORPORATION

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

For the Six Months Ended June 30, 2010 and 2009

Tax Equivalent Basis 1

	June 30, 2010								June 30, 2009
(Dollars in thousands)	Average Balance			Amount Earned		Average Rate			Average Balance			Amount Earned		Average Rate
Assets
Loans 2:
Commercial	$	1,172,917		$	29,914		5.14	%	$	1,105,457		$	29,185		5.32	%
Consumer		210,420			5,113		4.90			170,103			4,319		5.12
Total loans		1,383,337			35,027		5.11			1,275,560			33,504		5.30
Investment securities 3		225,088			5,678		5.05			283,327			7,688		5.43
Interest-bearing deposits		22,777			20		0.18			22,413			16		0.14
Total interest-earnings assets		1,631,202		$	40,725		5.03	%		1,581,300		$	41,208		5.26	%
Cash and due from banks		18,630								18,686
Other assets		106,877								79,559
Allowance for loan losses		(30,658	)							(16,952	)
Total assets	$	1,726,051							$	1,662,593

Liabilities and Equity
Savings accounts	$	29,861		$	20		0.14	%	$	29,204		$	26		0.18	%
Interest-bearing demand deposits		334,334			1,534		0.93			360,738			2,355		1.32
Time deposits		881,632			10,201		2.33			798,580			12,418		3.14
Total interest-bearing deposits		1,245,827			11,755		1.90			1,188,522			14,799		2.51
Borrowed funds		162,061			2,290		2.85			143,442			2,663		3.74
Subordinated debt		32,786			516		3.17			30,930			599		3.91
Repurchase agreements		3,120			5		0.32			12,924			14		0.22
Total interest-bearing liabilities		1,443,794		$	14,566		2.03	%		1,375,818		$	18,075		2.65	%
Noninterest-bearing deposits		132,718								127,692
Other liabilities		10,622								11,844
Total liabilities		1,587,134								1,515,354
Shareholders’ equity		138,917								147,239
Total liabilities and shareholders’ equity	$	1,726,051							$	1,662,593

Net interest spread 4							3.00	%							2.61	%
Tax equivalent adjustment				$	865							$	788
Net interest income and net interest margin 5				$	26,159		3.23	%				$	23,133		2.95	%

1	The tax equivalent basis is computed using a federal 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	Net interest spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.
5	Net interest margin represents net interest income divided by average interest-earning assets.

Index

- 27 -

Rate and Volume Variance Analysis

Tax Equivalent Basis 1

	Three Months Ended June 30, 2010 vs. 2009
(Dollars in thousands)	Rate Variance			Volume Variance			Total Variance
Interest income:
Loans	$	(1,177	)	$	2,700		$	1,523
Investment securities		(541	)		(1,469	)		(2,010	)
Federal funds sold		4			–			4
Total interest income		(1,714	)		1,231			(483	)
Interest expense:
Savings and interest-bearing demand deposits and other		(706	)		(121	)		(827	)
Time deposits		(3,178	)		961			(2,217	)
Borrowed funds		(636	)		263			(373	)
Subordinated debt		(112	)		29			(83	)
Repurchase agreements and federal funds purchased		7			(16	)		(9	)
Total interest expense		(4,625	)		1,116			(3,509	)
Increase in net interest income	$	2,911		$	115		$	3,026

1	The tax equivalent basis is computed using a federal tax rate of 34%.

Interest income on loans increased from $33.5 million for the six months ended June 30, 2009 to $34.7 million for the quarter ended June 30, 2010, an increase of 3.6%. This increase was primarily due to growth in the loan portfolio, partially offset by lower loan yields. Average loan balances, which yielded 5.11% and 5.30% in the six months ended June 30, 2010 and 2009, respectively, increased from $1.28 billion in the six months ended June 30, 2009 to $1.38 billion in the six months ended June 30, 2010. The Company’s interest rate swap on prime-indexed commercial loans, which expired in October 2009, increased loan interest income by $2.3 million in the six months ended June 30, 2009, representing a benefit to net interest margin of 29 basis points during the period. Since the swap expired in 2009, the Company received no benefi t in the six months ended June 30, 2010. A significant increase in loans placed on nonaccrual status during the six months ended June 30, 2010 also negatively affected loan interest income during the period when compared with the same period one year ago. When loans are placed on nonaccrual status, any accrued but unpaid interest is immediately reversed and has a direct impact on net interest income and net interest margin.

Interest income on investment securities decreased from $6.9 million for the six months ended June 30, 2009 to $5.1 million for the six months ended June 30, 2010, a decline of 25.8%. This decrease was due to a decline in the size of the investment portfolio coupled with lower fixed income investment yields. Average investment balances, at cost, decreased from $283.3 million for the six months ended June 30, 2009 to $225.1 million for the six months ended June 30, 2010, and the tax equivalent yield on investment securities decreased from 5.43% to 5.05% over the same period. The decrease in average investment balances reflects management’s efforts to reduce the duration of the portfolio to mitigate exposure to a future rising interest rate environment. Additionally, yields have fallen as prepayments on higher yielding mortgage-backed securities and sales of certain long-dated municipal bonds have been re-invested at lower rates in shorter-dated U.S. government agency debt.

Interest expense on deposits decreased from $14.8 million for the six months ended June 30, 2009 to $11.8 million for the six months ended June 30, 2010, a decline of 20.6%. The decline is primarily due to falling interest-bearing deposit rates from 2.51% for the six months ended June 30, 2009 to 1.90% for the six months ended June 30, 2010. For time deposits, which represented 70.8% and 67.2% of total average interest-bearing deposits for the six months ended June 30, 2010 and 2009, respectively, the average rate decreased from 3.14% for the six months ended June 30, 2009 to 2.33% for the six months ended June 30, 2010, reflecting disciplined pricing controls and re-pricing of maturing time deposits in a low interest rate environment. Interest expense on borrowings decreased from $3.3 million for the six months ended June 30, 2009 to $2. 8 million for the six months ended June 30, 2010, a decline of 14.2%. The average rate paid on average borrowings, including subordinated debt and repurchase agreements, decreased from 3.53% for the six months ended June 30, 2009 to 2.86% for the six months ended June 30, 2010.

Index

- 28 -

Provision for Loan Losses. Provision for loan losses for the six months ended June 30, 2010 totaled $31.8 million, an increase from $7.7 million for the six months ended June 30, 2009. The increase in the loan loss provision was primarily due to difficult economic conditions and troubled real estate markets which resulted in continued rising levels of nonperforming assets and impaired loans. Additionally, higher default and charge-off rates as well as downgrades to the credit ratings of certain loans in the portfolio increased general reserves applied to performing loan groupings. Further, declining real estate values contributed to higher levels of charge-offs on impaired loans.

Net charge-offs increased from $3.9 million, or 0.61% (annualized) of average loans, in the six months ended June 30, 2009 to $22.1 million, or 3.19% (annualized) of average loans, in the six months ended June 30, 2010. Nonperforming assets, which include loans on nonaccrual and other real estate, increased to 5.37% of total assets as of June 30, 2010 compared to 2.90% as of December 31, 2009 and 1.40% as of June 30, 2009. Further, nonperforming loans increased to 5.54% of total loans as of June 30, 2010 compared to 2.84% as of December 31, 2009 and 1.43% as of June 30, 2009. The elevated provision for loan losses, net charge-offs and nonperforming loans reflect the economic climate in the Company’s primary markets and consistent application of the Company’s policy to recognize losses as they occur. Given significant volati lity and rapid changes in current market conditions, management cannot predict its provision or nonperforming loan levels into the future but anticipates that credit losses and problem loans may remain elevated, or even increase, throughout 2010 as the Company continues working to resolve problem loans in these challenging market conditions.

Noninterest Income. Noninterest income decreased from $5.8 million for the six months ended June 30, 2009 to $5.0 million for the six months ended June 30, 2010, a decline of 13.5%. The following table presents the detail of noninterest income and related changes for the six months ended June 30, 2010 and 2009:

		2010		2009		$ Change		% Change
(Dollars in thousands)

Noninterest income:
Service charges and other fees	$	1,722	$	1,911	$	(189	)	(9.9	)%
Bank card services		958		724		234		32.3
Mortgage origination and other loan fees		666		1,110		(444	)	(40.0	)
Brokerage fees		472		313		159		50.8
Bank-owned life insurance		494		1,423		(929	)	(65.3	)
Net gain on investment securities		397		16		381		NM
Other		336		333		3		0.9
Total noninterest income	$	5,045	$	5,830	$	(785	)	(13.5	)%

The primary reason for the decrease in noninterest income was a nonrecurring BOLI gain recorded during the six months ended June 30, 2009 of $913 thousand. Additionally, mortgage origination and other loan fees declined primarily due to increased residential mortgage refinancing activity and fewer prepayment penalties recognized on commercial loans. Service charges and other fees, which includes overdraft and NSF charges, decreased primarily from continued reduction in the frequency of overdrawn accounts and NSF checks as consumers have closely monitored their accounts during the recent economic recession.

Partially offsetting the decreases in noninterest income, the Company realized net gains from sales of certain debt securities totaling $397 thousand in the first half of 2010 compared with net gains of $16 thousand in the same period last year. Bank card services, which includes income received from debit card transactions, increased primarily due to checking account growth and from a higher volume of debit card transactions. Brokerage fees increased as a result of improved sales efforts while other noninterest income remained relatively consistent over the period under comparison.

Noninterest Expense. Noninterest expense increased from $24.0 million for the six months ended June 30, 2009 to $25.0 million for the six months ended June 30, 2010, an increase of 3.9%. The following table presents the detail of noninterest expense and related changes for the six months ended June 30, 2010 and 2009:

Index

- 29 -

		2010		2009		$ Change		% Change
(Dollars in thousands)

Noninterest expense:
Salaries and employee benefits	$	10,719	$	11,817	$	(1,098	)	(9.3	)%
Occupancy		2,958		2,721		237		8.7
Furniture and equipment		1,445		1,569		(124	)	(7.9	)
Data processing and telecommunications		1,042		1,204		(162	)	(13.5	)
Advertising and public relations		1,029		546		483		88.5
Office expenses		620		657		(37	)	(5.6	)
Professional fees		1,159		813		346		42.6
Business development and travel		574		575		(1	)	(0.2	)
Amortization of deposit premiums		470		575		(105	)	(18.3	)
Other real estate losses and other loan-related costs		2,025		568		1,457		256.5
Directors fees		592		836		(244	)	(29.2	)
FDIC deposit insurance		1,316		1,408		(92	)	(6.5	)
Other		1,021		740		281		38.0
Total noninterest expense	$	24,970	$	24,029	$	941		3.9	%

Other real estate losses and loan-related costs increased primarily due to $949 thousand related to valuation adjustments to and losses on the sale of other real estate with the remaining increase representing higher loan workout, appraisal, and foreclosure costs. Management continues to proactively monitor the market values of its real estate owned by obtaining updated appraisals and recording any decline in valuations during the period to noninterest expense. Advertising and public relations expense increased due in part from radio and television ads promoting the Company’s special financing programs for home buyers. Professional fees increased due to higher legal costs. Other noninterest expense increased in part from a loss incurred upon the repurchase of a previously sold mortgage loan and from higher reserve levels for unfunde d lending commitments.

Salaries and employee benefits expense decreased partially due to suspension of the Company’s 401(k) employer matching contributions in 2009 and partially due to higher levels of deferred loan costs, which reduce expense. FDIC deposit insurance expense decreased primarily due to the FDIC’s special assessment on all insured depository institutions in the second quarter of 2009. Directors’ fees decreased due to acceleration of benefit payments on a retirement plan upon the death of a former director and in part due to the board reduction in late 2009.

Occupancy costs increased primarily due to additional overhead costs incurred as new branches were opened during the past year in the Triangle region. Furniture and equipment expense declined from lower depreciation charges. Data processing and telecommunications costs dropped as the Company realized cost savings through renegotiation of certain vendor contracts. Management continues to monitor and update the Company’s technology infrastructure in an efficient and cost controlled manner that provides for future growth opportunities. Amortization of deposit premiums decreased as intangible assets acquired in previous acquisitions are amortized on an accelerated method over the expected benefit of the core deposit premium. Business development and travel costs and office expenses remained relatively constant over the period under comp arison.

Income Taxes. Income tax benefit recorded in the six months ended June 30, 2010 was primarily impacted by net losses before income taxes and was partially offset by a valuation allowance of $3.3 million recorded against deferred income taxes in the first half of 2010.

Analysis of Financial Condition

Overview

The Company’s financial condition is measured in terms of its asset and liability composition as well as asset quality. The fluctuation and composition of the balance sheet during the six months ended June 30, 2010 reflects a decline in the loan portfolio as the Company focuses on resolving problem loans and capital preservation.

Total assets as of June 30, 2010 were $1.69 billion, a decrease of $40.3 million from $1.73 billion as of December 31, 2009. Earning assets, which represented 94.6% of total assets as of June 30, 2010 and December 31, 2009, decreased from $1.64 billion as of December 31, 2009 compared to $1.60 billion as of June 30, 2010. Loans declined from $1.39 billion as of December 31, 2009 to $1.35 billion as of June 30, 2010, a decrease of 2.82%. This decline primarily occurred in the commercial non-owner occupied and owner occupied real estate portfolios and to a lesser extent in the commercial and industrial portfolio.

Index

- 30 -

Allowance for loan losses was $35.8 million as of June 30, 2010 compared to $26.1 million as of December 31, 2009, representing approximately 2.65% and 1.88%, respectively, of total loans. As of June 30, 2010, investment securities totaled $228.8 million compared to $245.5 million as of December 31, 2009. The decrease in investments was primarily due to increased prepayments on mortgage-backed securities and sales of certain municipal bonds. These proceeds were partially re-invested in shorter duration U.S. agency debentures. Management is currently re-positioning its investment portfolio to provide for greater liquidity and to mitigate the risk of a rising interest rate environment and its impact on a fixed income portfolio.

Total deposits as of June 30, 2010 were $1.37 billion, a decrease of $7.2 million, or 0.52%, from $1.38 billion as of December 31, 2009. The decrease was primarily due to a $36.3 million decrease in money market accounts, partially offset by a $16.1 million increase in time deposit accounts and a $10.8 million increase in checking accounts. Time deposits represented 63.1% of total deposits at June 30, 2010 compared to 61.6% at December 31, 2009. Subordinated debt increased from $30.9 million as of December 31, 2009 to $34.3 million as of June 30, 2010 from the private placement offering in the first half of 2010.

Total shareholders’ equity decreased from $139.8 million as of December 31, 2009 to $125.5 million as of June 30, 2010. The Company’s accumulated deficit increased by $20.1 million in the first six months of 2010, reflecting an $18.9 million net loss and dividends and accretion on preferred stock of $1.2 million. Common stock increased primarily due to $5.1 million of proceeds from the issuance of shares of the Company’s common stock as part of the private placement offering. Accumulated other comprehensive income, which includes unrealized gains and losses on available-for-sale investment securities, net of tax, increased from $4.0 million as of December 31, 2009 to $4.2 million as of June 30, 2010.

Nonperforming Assets and Impaired Loans

Loans are generally classified as nonaccrual if they are past due as to maturity or payment of principal or interest for a period of more than 90 days, unless such loans are well secured and in the process of collection. If a loan or a portion of a loan is classified as doubtful or as partially charged off, the loan is generally classified as nonaccrual. Loans that are on a current payment status or past due less than 90 days may also be classified as nonaccrual if repayment in full of principal and/or interest is in doubt. Loans may be returned to accrual status when all principal and interest amounts contractually due (including arrearages) are reasonably assured of repayment within an acceptable period of time, and there is a sustained period of repayment performance of interest and principal by the borrower in accordance with the cont ractual terms.

The following table presents an analysis of nonperforming assets as of June 30, 2010 and December 31, 2009:

	June 30, 2010			December 31, 2009
(Dollars in thousands)

Nonperforming loans:
Commercial real estate	$	61,181		$	25,593
Consumer real estate		4,742			3,330
Commercial owner occupied		4,854			6,607
Commercial and industrial		3,311			3,974
Consumer		7			8
Other loans		781			–
Total nonperforming loans		74,876			39,512
Other real estate:
Construction, land development, and other land		6,789			2,863
1-4 family residential properties		1,338			2,060
1-4 family residential properties sold with 100% financing		4,309			3,314
Commercial properties		2,356			1,199
Closed branch office		1,296			1,296
Total other real estate		16,088			10,732
Total nonperforming assets		90,964			50,244
Performing restructured loans		6,570			34,177
Total nonperforming assets and restructured loans	$	97,534		$	84,421

Nonperforming ratios:
Nonperforming loans to total loans		5.54	%		2.84	%
Nonperforming assets to total assets		5.37	%		2.90	%
Nonperforming assets and restructured loans to total assets		5.76	%		4.87	%

Index

- 31 -

Other real estate, which includes foreclosed assets and other real property held for sale, increased to $16.1 million as of June 30, 2010 from $10.7 million as of December 31, 2009. As of June 30, 2010, other real estate included $1.3 million of real estate from a closed branch office held for sale and included $4.3 million of residential properties sold to individuals prior to June 30, 2010 where the Company financed 100% of the purchase price of the home at closing. These financed properties will remain in other real estate until regular payments are made by the borrowers that total at least 5% of the original purchase price, which is expected to occur late in 2010, at which time the property will be moved out of other real estate and into the performing mortgage loan portfolio.

The increase in other real estate was primarily due to the repossession of commercial and residential construction and land development properties in the first half of 2010. The Company is actively marketing all of its foreclosed properties. Such properties are adjusted to fair value upon transfer of the loans or premises to other real estate. Subsequently, these properties are carried at the lower of carrying value or updated fair value. The Company obtains updated appraisals and/or internal evaluations for all other real estate. The Company considers all other real estate to be classified as Level 2 fair value estimates since values are established based on recent independent appraisals.

Impaired loans primarily consist of nonperforming loans and troubled debt restructurings, or TDRs, but can include other loans identified by management as being impaired. Impaired loans totaled $85.0 million and $77.3 million as of June 30, 2010 and December 31, 2009, respectively. The increase in impaired loans is primarily due to weakness experienced in the local economy and real estate markets from the recent economic recession.

The following table summarizes the Company’s impaired loans and TDRs as of June 30, 2010 and December 31, 2009:

	June 30, 2010			December 31, 2009
(Dollars in thousands)

Impaired loans:
Impaired loans with related allowance for loan losses	$	19,067		$	60,490
Impaired loans for which the full loss has been charged off		65,895			16,775
Total impaired loans		84,962			77,265
Allowance for loan losses related to impaired loans		(2,890	)		(6,112	)
Net carrying value of impaired loans	$	82,072		$	71,153

Performing TDRs:
Commercial real estate	$	1,224		$	27,532
Consumer real estate		116			598
Commercial owner occupied		4,376			4,633
Commercial and industrial		664			1,288
Consumer		190			126
Total performing TDRs	$	6,570		$	34,177

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. 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. With respect to restructured loans, the Company grants concessions by (1) reduction of the stated interest rate for the remaining original life of the debt or (2) extension of the maturity date at a stated interest rate lower than the current market rate for new debt with similar risk. The Company does not generally grant concessions through forgiveness of principal or accrued interest. Restructured loans where a concession has been granted through extension of the maturity date generally include extension of payments in an interest only period, extension of payments with capitalized interest and extension of payments through a forbearance agreement. These extended payment terms are also combined with a reduction of the stated interest rate in certain cases. Success in restructuring loan terms has been mixed but it has proven to be a useful tool in certain situations to protect collateral values and allow certain borrowers additional time to execute upon defined business plans. In situations where a TDR is unsuccessful and the borrower is unable to follow through with terms of the restructured agreement, the loan is placed on nonaccrual status and continues to be written down to the underlying collateral value.

Index

- 32 -

The Company’s policy with respect to accrual of interest on loans restructured in a TDR follows relevant supervisory guidance. That is, if a borrower has demonstrated performance under the previous loan terms and shows capacity to perform under the restructured loan terms, continued accrual of interest at the restructured interest rate is likely. If a borrower was materially delinquent on payments prior to the restructuring but shows the capacity to meet the restructured loan terms, the loan will likely continue as nonaccrual going forward. Lastly, if the borrower does not perform under the restructured terms, the loan is placed on nonaccrual status. 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 rest ructured note terms. If a loan is restructured a second time, after previously being classified as a TDR, that loan is automatically placed on nonaccrual status. The Company’s policy with respect to nonperforming loans requires the borrower to make a minimum of six consecutive payments in accordance with the loan terms before that loan can be placed back on accrual status. Further, the borrower must show capacity to continue performing into the future prior to restoration of accrual status. To date, the Company has not restored any nonaccrual loan classified as a TDR to accrual status.

All TDRs are considered to be impaired and are evaluated as such in the quarterly allowance calculation. As of June 30, 2010, allowance for loan losses allocated to performing TDRs totaled $1.7 million. Outstanding nonperforming TDRs and their related allowance for loan losses totaled $20.7 million and $0.5 million, respectively, as of June 30, 2010.

Allowance for Loan Losses

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 Officer reports directly to the Chief Credit Officer and the Audit Committee of the Company ’s Board of Directors.

The allowance for loan losses represents management’s best estimate of probable credit losses that are inherent in the loan portfolio at the balance sheet date and is determined by management through quarterly evaluations of the loan portfolio. The allowance calculation consists of specific and general reserves. Specific reserves are applied to individually impaired loans. 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. Specific reserves on impaired loans that are collateral dependent are based on the fair value of the underlying collateral while specific reserves on loans that are not collateral dependent are based on either an observ able market price, if available, or the present value of expected future cash flows discounted at the historical effective interest rate. Management evaluates loans that are classified as doubtful, substandard or special mention to determine whether or not they are impaired. This evaluation includes several factors, including review of the loan payment status and the borrower’s financial condition and operating results such as cash flows, operating income or loss, etc. General reserves are determined by applying loss percentages to pools of loans that are grouped according to loan type and internal risk ratings. Loss percentages are based on the Company’s historical default and charge-off experience in each pool and management’s consideration of environmental factors such as changes in economic conditions, credit quality trends, collateral values, concentrations of credit risk, and loan review as well as regulatory exam findings.

Impaired loans on borrower relationships over $750 thousand totaled $74.5 million and $69.4 million as of June 30, 2010 and December 31, 2009, respectively, with specific reserves of $1.7 million and $5.7 million, respectively. Specific reserves represented 2.3% and 8.2% of impaired loan balances as of June 30, 2010 and December 31, 2009, respectively. Specific reserves represented 12.5% and 10.6% of impaired loan balances, net of impaired loans charged down to estimated market value, as of June 30, 2010 and December 31, 2009, respectively. These loans were evaluated for impairment and valued individually. Given the Company’s concentration in real estate lending, the vast majority of impaired loans are collateral dependent and are therefore valued based on underlying collateral values. In the case of unsecured loans that become impa ired, principal balances are fully charged off. 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.

For impaired loans on borrower relationships less than $750 thousand where legal action has been taken to foreclose, impairment is evaluated on an individual basis and the loan is charged down to estimated fair value. Impaired loans on relationships less than $750 thousand charged down to estimated fair value totaled $5.1 million and $3.1 million as of June 30, 2010 and December 31, 2009, respectively. For impaired loans on borrower relationships less than $750 thousand classified as TDRs, management began evaluating for impairment on an individual basis as of June 30, 2010 and began establishing a specific reserve for each relationship. Impaired loans less than $750 thousand classified as a TDR totaled $3.0 million as of June 30, 2010, with associated reserves of $0.8 million.

Index

- 33 -

For most impaired loans evaluated individually, the fair value of underlying collateral is generally estimated based on a current independent appraised value, adjusted for estimated holding and selling costs. These are considered Level 2 fair value estimates. For certain impaired loans where appraisals are aged or where market conditions have significantly changed since the appraisal date, a further reduction is made to appraised value to arrive at the fair value of collateral. These are considered Level 3 fair value estimates. In other situations, management will use broker price opinions, internal valuations or other valuation sources. These are also considered Level 3 fair value estimates. Of the $80.1 million in estimated fair value of impaired loans evaluated and valued on an individual basis as of June 30, 2010, $79.0 million were v alued based on current independent appraisals and $1.1 million were valued based on a combination of internal valuations and other valuation sources. Internal valuations are used primarily for equipment valuations or for certain real estate valuations where recent home sales data was used to estimate value for similar fully or partially built houses. For any impaired loan where a specific reserve has previously been established, or where a partial charge-off has been recorded, an updated appraisal that reflects a further decline in value will result in an additional reserve or partial charge-off during the current period.

Impaired loans on borrower relationships less than $750 thousand not evaluated individually for impairment totaled $2.3 million and $4.8 million as of June 30, 2010 and December 31, 2009, respectively, with associated reserves of $0.4 million each. Reserves on these loans were based on loss percentages applied to pools of loans stratified by common risk rating and loan type.

General reserves are determined by applying loss percentages to pools of loans that are grouped according to loan type and internal risk ratings. Loss percentages are based on the Company’s historical default and charge-off experience in each pool and management’s consideration of environmental factors. As of June 30, 2010, the Company used two years of charge-off history for purposes of calculating general reserve rates. Nonperforming loans and net charge-offs have significantly increased over recent quarters, particularly in the commercial real estate portfolio. Such increases have directly impacted loss percentages and the resulting allowance for loan losses for each loan pool.

The allowance 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. The following table presents an analysis of changes in the allowance for loan losses for the three and six month periods ended June 30, 2010 and 2009:

	Three Months Ended June 30,				Six Months Ended June 30,
	2010		2009		2010		2009
(Dollars in thousands)

Allowance for loan losses, beginning of period	$	29,160	$	18,480	$	26,081	$	14,795
Net charge-offs:
Loans charged off:
Commercial real estate		8,421		646		15,301		2,239
Consumer real estate		1,571		823		2,286		1,208
Commercial owner occupied		1,249		–		1,886		173
Commercial and industrial		1,875		99		2,342		282
Consumer		146		38		194		77
Other loans		221		–		232		–
Total charge-offs		13,483		1,606		22,241		3,979
Recoveries of loans previously charged off:
Commercial real estate		30		10		87		10
Consumer real estate		4		13		28		14
Commercial and industrial		1		–		17		61
Consumer		5		13		11		23
Other loans		8		–		8		–
Total recoveries		48		36		151		108
Total net charge-offs		13,435		1,570		22,090		3,871
Provision for loan losses		20,037		1,692		31,771		7,678
Allowance for loan losses, end of period	$	35,762	$	18,602	$	35,762	$	18,602

Net charge-offs to average loans (annualized)

3.91

0.49

3.19

0.61

Index

- 34 -

	June 30, 2010			December 31, 2009

Allowance-related ratios:
Allowance for loan losses to total loans		2.65	%		1.88	%
Allowance to nonperforming loans		48	%		66	%
Allowance to nonperforming loans, net of loans charged down to fair value		295	%		115	%

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 th e period in which the factors and other considerations indicate that adjustments to the allowance for loan losses are necessary.

Supplemental Commercial Real Estate Analysis

Residential Acquisition, Development and Construction Loan Analysis by Type:

	Residential Land / Development			Residential Construction			Total
(Dollars in thousands)

June 30, 2010
Loans outstanding	$	134,298		$	91,676		$	225,974
Nonaccrual loans		40,565			3,700			44,265
Allowance for loan losses		4,825			3,247			8,072
YTD net charge-offs		10,557			2,983			13,540

Loans outstanding to total loans		9.94	%		6.79	%		16.73	%
Nonaccrual loans to loans in category		30.21			4.04			19.59
Allowance to loans in category		3.59			3.54			3.57
YTD net charge-offs to average loans in category (annualized)		14.22			6.20			11.07

December 31, 2009
Loans outstanding	$	162,733		$	100,724		$	263,457
Nonaccrual loans		16,935			7,102			24,037
Allowance for loan losses		7,569			1,707			9,276

Loans outstanding to total loans		11.70	%		7.24	%		18.95	%
Nonaccrual loans to loans in category		10.41			7.05			9.12
Allowance to loans in category		4.65			1.69			3.52

Index

- 35 -

Residential Acquisition, Development and Construction Loan Analysis by Region:

	Loans Outstanding		Percent of Total Loans Outstanding			Nonaccrual Loans		Nonaccrual Loans to Loans Outstanding			Allowance for Loan Losses		Allowance to Loans Outstanding
(Dollars in thousands)

June 30, 2010
Triangle	$	162,417		71.88	%	$	35,738		22.00	%	$	5,529		3.40	%
Sandhills		28,430		12.58			1,110		3.90			1,029		3.62
Triad		5,201		2.30			–		–			277		5.33
Western		29,926		13.24			7,417		24.78			1,237		4.13
Total	$	225,974		100.00	%	$	44,265		19.59	%	$	8,072		3.57	%

December 31, 2009
Triangle	$	185,319		70.34	%	$	14,349		7.74	%	$	7,325		3.95	%
Sandhills		31,257		11.86			–		–			412		1.32
Triad		5,509		2.09			106		1.92			86		1.56
Western		41,372		15.71			9,582		23.16			1,453		3.51
Total	$	263,457		100.00	%	$	24,037		9.12	%	$	9,276		3.52	%

Other Commercial Real Estate Loan Analysis by Type:

	Commercial Land / Development			Commercial Construction			Multifamily			Other Non- Residential CRE			Total
(Dollars in thousands)

June 30, 2010
Loans outstanding	$	150,995		$	94,328		$	40,808		$	170,426		$	456,557
Nonaccrual loans		11,981			–			–			4,935			16,916
Allowance for loan losses		3,725			1,999			564			3,140			9,428
YTD net charge-offs		1,426			–			15			248			1,689

Loans outstanding to total loans		11.18	%		6.98	%		3.02	%		12.61	%		33.79	%
Nonaccrual loans to loans in category		7.93			–			–			2.90			3.71
Allowance to loans in category		2.47			2.12			1.38			1.84			2.07
YTD net charge-offs to average loans in category (annualized)		2.04			–			0.07			0.27			0.76

December 31, 2009
Loans outstanding	$	128,745		$	59,918		$	43,379		$	202,295		$	434,337
Nonaccrual loans		529			–			325			702			1,556
Allowance for loan losses		1,732			462			474			3,043			5,711

Loans outstanding to total loans		9.26	%		4.31	%		3.12	%		14.55	%		31.24	%
Nonaccrual loans to loans in category		0.41			–			0.75			0.35			0.36
Allowance to loans in category		1.35			0.77			1.09			1.50			1.31

Index

- 36 -

Other Commercial Real Estate Loan Analysis by Region:

	Loans Outstanding		Percent of Total Loans Outstanding			Nonaccrual Loans		Nonaccrual Loans to Loans Outstanding			Allowance for Loan Losses		Allowance to Loans Outstanding
(Dollars in thousands)

June 30, 2010
Triangle	$	294,328		64.47	%	$	15,821		5.38	%	$	5,877		2.00	%
Sandhills		68,321		14.97			610		0.89			1,917		2.81
Triad		38,553		8.44			280		0.73			757		1.96
Western		55,355		12.12			205		0.37			877		1.58
Total	$	456,557		100.00	%	$	16,916		3.71	%	$	9,428		2.07	%

December 31, 2009
Triangle	$	281,664		64.85	%	$	361		0.13	%	$	3,653		1.30	%
Sandhills		60,593		13.95			605		1.00			937		1.55
Triad		35,987		8.29			41		0.11			576		1.60
Western		56,093		12.91			549		0.98			545		0.97
Total	$	434,337		100.00	%	$	1,556		0.36	%	$	5,711		1.31	%

The Company utilizes interest reserves on certain commercial real estate loans to fund the interest payments which are funded from loan proceeds. The decision to establish a loan-funded interest reserve upon origination of a loan is based on the feasibility of the project, the creditworthiness of the borrower and guarantors and the protection provided by the real estate and other collateral. For the lender, an interest reserve may provide an effective means for addressing the cash flow characteristics of a properly underwritten acquisition, development and construction loan. Similarly, for the borrower, interest reserves may provide the funds to service the debt until the property is developed, and cash flow is generated from the sale or lease of the developed property.

Although potentially beneficial to the lender and the borrower, the use of interest reserves carries certain risks. Of particular concern is the possibility that an interest reserve may not accurately reflect problems with a borrower’s willingness or ability to repay the debt consistent with the terms and conditions of the loan obligation. For example, a project that is not completed in a timely manner or falters once completed may appear to perform if the interest reserve keeps the loan current. In some cases, a lender may extend, renew or restructure the term of certain loans, providing additional interest reserves to keep the loan current. As a result, the financial condition of the project may not be apparent and developing problems may not be addressed in a timely manner. Consequently, a lender may end up with a matured loan wh ere the interest reserve has been fully advanced, and the borrower’s financial condition has deteriorated. In addition, the project may not be complete, its sale or lease-up may not be sufficient to ensure timely repayment of the debt or the value of the collateral may have declined, exposing the lender to increasing credit losses.

To mitigate risks related to the use of interest reserves, the Company follows an interest reserve policy approved by its Board of Directors which sets underwriting standards for loans with interest reserves. These policies include loan-to-value, or LTV, limits as well as guarantor strength and equity requirements. Additionally, strict monitoring requirements are followed. LTV limits have been established based on regulatory guidelines for each loan type, and any loan with an LTV (using an updated independent appraisal) exceeding those limits are immediately placed on nonaccrual status.

As of June 30, 2010, the Company had a total of 35 loans funded by an interest reserve with total outstanding balances of $71.3 million, representing approximately 5% of total outstanding loans. Total commitments on these loans equaled $93.1 million with total remaining interest reserves of $2.4 million, representing a weighted average term of approximately eight months of remaining interest coverage. The following table summarizes the Company’s residential and commercial acquisition, development and construction, or ADC, loans with active interest reserves 1 as of June 30, 2010 and December 31, 2009:

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	Outstanding Balance		Committed Balance		Number of Loans		Remaining Reserves
(Dollars in thousands)

June 30, 2010
Residential	$	39,666	$	42,726		18	$	858
Commercial		31,666		50,338		17		1,508
Total	$	71,332	$	93,064		35	$	2,366

December 31, 2009
Residential	$	69,698	$	75,068		31	$	1,449
Commercial		72,565		103,734		19		3,547
Total	$	142,263	$	178,802		50	$	4,996

1	Excludes loans where interest reserves have previously been depleted and the borrower is paying from other sources.

Capital Resources

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 capital amounts and ratios. The Company’s and the Bank’s actual capital amounts and ratios as of June 30, 2010 and the minimum requirements to be well capitalized 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)	$	152,795	10.60	%	$	144,177	10.00	%
Tier I capital (to risk-weighted assets)		131,145	9.10			86,506	6.00
Tier I capital (to average assets)		131,145	7.75			84,588	5.00

Capital Bank:
Total capital (to risk-weighted assets)	$	151,876	10.55	%	$	144,010	10.00	%
Tier I capital (to risk-weighted assets)		130,247	9.04			86,406	6.00
Tier I capital (to average assets)		130,247	7.67			84,867	5.00

As of June 30, 2010, the Company had a leverage ratio of 7.75%, a Tier 1 capital ratio of 9.10%, and a total risk-based capital ratio of 10.60%. These ratios exceed the federal regulatory minimum requirements for a “well capitalized” bank. The Company’s tangible equity to tangible assets ratio decreased from 7.91% as of December 31, 2009 to 7.28% as of June 30, 2010, and its tangible common equity to tangible assets ratio declined from 5.53% as of December 31, 2009 to 4.84% as of June 30, 2010.

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Recent Items Impacting Capital Resources

On December 12, 2008, the Company entered into a Securities Purchase Agreement with the U.S. Treasury Department 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, or Series A Preferred Stock, and warrants to purchase up to 749,619 shares of common stock of the Company. 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 co mmon 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. The Treasury may also transfer the Series A Preferred Stock to a third party at any time.

On February 1, 2010, the Company announced that its Board of Directors voted to suspend payment of the Company’s quarterly cash dividend to its common shareholders.

On March 18, 2010, the Company sold 849 investment units, or the Units, for gross proceeds of $8.5 million. Each Unit was priced at $10,000 and consisted of a $3,996.90 subordinated promissory note and a number of shares of the Company’s common stock valued at $6,003.10. The offering and sale of the Units was limited to accredited investors. As a result of the sale of the Units, the Company sold $3.4 million in aggregate principal amount of subordinated promissory notes due March 18, 2020, or the Notes, and 1,468,770 shares of the Company’s common stock valued at $5.1 million. The Company is obligated to pay interest on the Notes at 10% per annum payable in quarterly installments commencing on the third month anniversary of the date of issuance of the Notes. The Company may prepay the Notes at any time after March 18, 2015 sub ject to approval by the Federal Reserve and compliance with applicable law.

Liquidity Management

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 compliance with those requirements. As of June 30, 2010, the Company met all of its regulatory liquidity requirements.

The Company had $41.4 million in its most liquid assets, cash and cash equivalents, as of June 30, 2010. 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 $1.18 billion, or 69.5%, of total assets as of June 30, 2010 compared to $1.18 billion, or 67.8%, of total assets as of December 31, 2009.

Additional sources of liquidity are available to the Company through the Federal Reserve Bank, or FRB, and through membership in the Federal Home Loan Bank, or FHLB, system. As of June 30, 2010, the Company had a maximum and available borrowing capacity of $108.8 million and $5.8 million, respectively, through the FHLB. These funds can be made available with various maturities and interest rate structures. Borrowings with the FHLB are collateralized by a blanket lien on certain qualifying assets. The Company also maintains a credit line at the FRB’s discount window that is used for short-term funding needs and as an additional source of available liquidity. As of June 30, 2010, the Company had a maximum and available borrowing capacity of $69.9 million at the discount window. Available credit at the discount window is collateralized by eligible commercial construction and commercial and industrial loans. The Company also maintains off-balance sheet liquidity from other sources such as federal funds lines, repurchase agreement lines and through brokered deposit sources.

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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, 2009, 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, 2009 to June 30, 2010.

Item 4. Controls and Procedures

Not applicable.

Item 4T. 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 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, or CEO, and Chief Financial Officer, or 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. Based upon that evaluation, the CEO and CFO concluded that, as of the end 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.

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.

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

The following discussion addresses some of the risks and uncertainties that could cause, or contribute to causing, actual results to differ materially from expectations. In evaluating our business, you should pay particular attention to the descriptions of risks and uncertainties described below. 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.

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Risks Related to Our Business

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

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 we remain well capitalized and have not suffered any significant liquidity problems 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 also adversely affect our liquidity, financial condition and profitability.

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 Federal Reserve, U.S. Congress, the Treasury, the FDIC and others have taken numerous actions to address the current liquidity and credit situation in the financial markets. These measures include actions to encourage loan restructuring and modification for homeowners; the establishment of significant liquidity and credit facilities for financial institutions and investment banks; and coordinated efforts to address liquidity and other weaknesses in the banking sector. The Emergency Economic Stabilization Act of 2008, or EESA, which established the Troubled Asset Relief Program, or TARP, was enacted on October 3, 2008. As part of the TARP, the Treasury created the Capital Purchase Program, or CPP, which authorizes the Treasury to 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 American Recovery and Reinvestment Act, or ARRA, was enacted as a sweeping economic recovery package intended to stimulate the economy and provide for extensive infrastructure, energy, health and education needs. We participated in the CPP and sold $41.3 million of our Series A Preferred Stock, and a warrant to purchase 749,619 shares of our common stock to the Treasury. Future participation in this or similar programs may subject us to additional restrictions and regulation. 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 our financial condition, results of operations, liquidity or stock price.

On July 21, 2010, President Obama signed into law the Dodd-Frank Act, which was intended primarily to overhaul the financial regulatory framework following the global financial crisis and will impact all financial institutions including our holding company and Capital Bank. The Dodd-Frank Act contains provisions that will, among other things, establish a Bureau of Consumer Financial Protection, establish a systemic risk regulator, consolidate certain federal bank regulators and impose increased corporate governance and executive compensation requirements. While many of the provisions in the Dodd-Frank Act are aimed at financial institutions significantly larger than us, it will likely increase our regulatory compliance burden and may have a material adverse effect on us, including by increasing the costs associated with our regulatory exa minations and compliance measures. However, it is too early for us to fully assess the impact of the Dodd-Frank Act and subsequent regulatory rulemaking processes on our business, financial condition or results of operations.

Further, the U.S. Congress and state legislatures and federal and state regulatory authorities continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including interpretation and implementation of statutes, regulation or policies, including EESA, ARRA, TARP and the Dodd-Frank Act and recently proposed executive compensation guidance by the Federal Reserve and FDIC, could affect us in substantial and unpredictable ways, including limiting the types of financial services and products we may offer or increasing the ability of non-banks to offer competing financial services and products. While we cannot predict the regulatory changes that may be borne out of the current economic crisis, and we cannot predict whether we will become subject to increased regulatory scrutiny by any of these regulatory agencies, any regulatory changes or scrutiny could increase or decrease the cost of doing business, limit or expand our permissible activities, or affect the competitive balance among banks, credit unions, savings and loan associations and other institutions. We cannot predict whether additional legislation will be enacted and, if enacted, the effect that it, or any regulations, would have on our business, financial condition or results of operations.

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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.

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 or a continued increase in unemployment rates 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 ec onomies.

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 and may require the establishment of or an increase in loan loss reserves. Furthermore, the decrease in interest income resulting from a loan defau lt 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.

A significant portion of our loan portfolio is secured by real estate, and events that negatively impact the real estate market could hurt our business.

A significant portion of our loan portfolio is secured by real estate. As of June 30, 2010, approximately 83% of our loans had real estate as a primary or secondary component of collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. A continued weakening of the real estate market in our primary market areas could continue to result in an increase in the number of borrowers who default on their loans and a reduction in the value of the collateral securing their loans, which in turn could have an adverse effect on our profitability and asset quality. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and shareholders’ equity could be adversely affected. 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. 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.

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Additionally, recent weakness in the secondary market for residential lending could have an adverse impact on 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 could adversely affect our financial condition or results of operations.

Our real estate and land acquisition and development loans are based upon estimates of costs and the value of the complete project.

We extend real estate land loans, construction loans, and acquisition and development loans to builders and developers, primarily for the construction/development of properties. We originate these loans on a presold and speculative basis and they include loans for both residential and commercial purposes. As of June 30, 2010, these loans totaled $471.3 million, or 35% of our total loan portfolio. Approximately $91.7 million of this amount was for construction of residential properties and $94.3 million was for construction of commercial properties. Additionally, approximately $202.1 million was for acquisition and development loans for both residential and commercial properties. Land loans, which are loans made with raw land as security, totaled $83.2 million, or 6% of our portfolio, as of June 30, 2010.

In general, construction and land lending involves additional risks because of the inherent difficulty in estimating a property’s value both before and at completion of the project. Construction costs may exceed original estimates as a result of increased materials, labor or other costs. In addition, because of current uncertainties in the residential and commercial real estate markets, property values have become more difficult to determine than they have been historically. Construction and land acquisition and development loans often involve the repayment dependent, in part, on the ability of the borrower to sell or lease the property. These loans also require ongoing monitoring. In addition, speculative construction loans to a residential builder are often associated with homes that are not presold, and thus pose a greater potent ial risk than construction loans to individuals on their personal residences. As of June 30, 2010, $75.4 million of our residential construction loans were for speculative construction loans. Slowing housing sales have been a contributing factor to an increase in nonperforming loans as well as an increase in delinquencies.

Our non-owner occupied commercial real estate loans may be dependent on factors outside the control of our borrowers.

We originate non-owner occupied commercial real estate loans for individuals and businesses for various purposes, which are secured by commercial properties. These loans typically involve repayment dependent upon income generated, or expected to be generated, by the property securing the loan in amounts sufficient to cover operating expenses and debt service. This may be adversely affected by changes in the economy or local market conditions. Non-owner occupied commercial real estate loans expose a lender to greater credit risk than loans secured by residential real estate because the collateral securing these loans typically cannot be liquidated as easily as residential real estate. If we foreclose on a non-owner occupied commercial real estate loan, our holding period for the collateral typically is longer than a 1-4 family residential property because there are fewer potential purchasers of the collateral. Additionally, non-owner occupied commercial real estate loans generally have relatively large balances to single borrowers or related groups of borrowers. Accordingly, charge-offs on non-owner occupied commercial real estate loans may be larger on a per loan basis than those incurred with our residential or consumer loan portfolios.

As of June 30, 2010, our non-owner occupied commercial real estate loans totaled $211.2 million, or 16% of our total loan portfolio.

Repayment of our commercial business loans is dependent on the cash flows of the borrower, which may be unpredictable, and the collateral securing these loans may fluctuate in value.

We offer different types of commercial loans to a variety of small to medium-sized businesses. The types of commercial loans offered are owner-occupied term real estate loans, business lines of credit and term equipment financing. Commercial business lending involves risks that are different from those associated with non-owner occupied commercial real estate lending. Our commercial business loans are primarily underwritten based on the cash flow of the borrower and secondarily on the underlying collateral, including real estate. The borrowers’ cash flow may be unpredictable, and collateral securing these loans may fluctuate in value. Some of our commercial business loans are collateralized by equipment, inventory, accounts receivable or other business assets, and the liquidation of collateral in the event of default is often an ins ufficient source of repayment because accounts receivable may be uncollectible and inventories may be obsolete or of limited use.

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As of June 30, 2010, our commercial business loans totaled $356.2 million, or 26% of our total loan portfolio. Of this amount, $180.9 million was secured by owner-occupied real estate and $175.3 million was secured by business assets.

A portion of our commercial real estate loan portfolio utilizes interest reserves which may not accurately portray the financial condition of the project and the borrower’s ability to repay the loan.

Some of our commercial real estate loans utilize interest reserves to fund the interest payments and are funded from loan proceeds. Our decision to establish a loan-funded interest reserve upon origination of a loan is based on the feasibility of the project, the creditworthiness of the borrower and guarantors and the protection provided by the real estate and other collateral. When applied appropriately, an interest reserve can benefit both the lender and the borrower. For the lender, an interest reserve provides an effective means for addressing the cash flow characteristics of a properly underwritten acquisition, development and construction loan. Similarly, for the borrower, interest reserves provide the funds to service the debt until the property is developed, and cash flow is generated from the sale or lease of the developed proper ty.

Although potentially beneficial to the lender and the borrower, our use of interest reserves carries certain risks. Of particular concern is the possibility that an interest reserve may not accurately reflect problems with a borrower’s willingness or ability to repay the debt consistent with the terms and conditions of the loan obligation. For example, a project that is not completed in a timely manner or falters once completed may appear to perform if the interest reserve keeps the loan current. In some cases, we may extend, renew or restructure the term of certain loans, providing additional interest reserves to keep the loan current. As a result, the financial condition of the project may not be apparent and developing problems may not be addressed in a timely manner. Consequently, we may end up with a matured loan where the inte rest reserve has been fully advanced, and the borrower’s financial condition has deteriorated. In addition, the project may not be complete, its sale or lease-up may not be sufficient to ensure timely repayment of the debt or the value of the collateral may have declined, exposing us to increasing credit losses.

As of June 30, 2010, we had a total of 35 active residential and commercial acquisition, development and construction loans funded by an interest reserve with a total outstanding balance of $71.3 million, representing approximately 5% of our total outstanding loans. Total commitments on these loans equaled $93.1 million with total remaining interest reserves of $2.4 million, representing a weighted average term of approximately eight months of remaining interest coverage.

Our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio.

Lending money is a substantial part of our business, and each loan carries a certain risk that it will not be repaid in accordance with its terms or that any underlying collateral will not be sufficient to assure repayment. This risk is affected by, among other things:

	•	cash flow of the borrower and/or the project being financed;

	•	the changes and uncertainties as to the future value of the collateral, in the case of a collateralized loan;

	•	the duration of the loan;

	•	the credit history of a particular borrower; and

	•	changes in economic and industry conditions.

We maintain an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, which we believe is appropriate to provide for probable losses in our loan portfolio. The amount of this allowance is determined by our management through periodic reviews and consideration of several factors, including, but not limited to:

	•	our general reserve, based on our historical default and loss experience and certain macroeconomic factors based on management’s expectations of future events; and

	•	our specific reserve, based on our evaluation of impaired loans and their underlying collateral.

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The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Continuing deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses. In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for probable loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance for loan losses, we will need additional provisions to increase the allowance for loan lo sses. Any increases in the allowance for loan losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on our financial condition and results of operations.

If our allowance for loan losses is not adequate, we may be required to make further increases in our provisions for loan losses and to charge off additional loans, which could adversely affect our results of operations.

For the six months ended June 30, 2010, we recorded a provision for loan losses of $31.8 million compared to $7.7 million for the six months ended June 30, 2009, an increase of $24.1 million. We also recorded net loan charge-offs of $22.1 million for the six months ended June 30, 2010 compared to $3.9 million for the six months ended June 30, 2009. Generally, our nonperforming loans and assets reflect operating difficulties of individual borrowers resulting from weakness in the local economy; however, more recently the deterioration in the general economy has become a significant contributing factor to the increased levels of delinquencies and nonperforming loans.

Slower sales and excess inventory in the housing market has been the primary cause of the increase in delinquencies and foreclosures for residential construction loans, which represented 5% of our nonperforming loans as of June 30, 2010. In addition, slowing housing sales have been a contributing factor to the increase in nonperforming loans as well as the increase in delinquencies. As of June 30, 2010, our total nonperforming loans increased to $74.9 million, or 5.54% of total loans, compared to $18.5 million, or 1.43% of total loans, as of June 30, 2009. If current trends in the housing and real estate markets continue, we expect that we will continue to experience higher than normal delinquencies and credit losses. Moreover, until general economic conditions improve, we may continue to experience increased delinquencies and credit loss es. As a result, we may be required to make additional provisions for loan losses and to charge off additional loans in the future, which could materially adversely affect our financial condition and results of operations.

Future losses may result in an increase to the valuation allowance on our deferred tax assets.

As of June 30, 2010, we had deferred tax assets of $18.7 million, net of a $3.3 million valuation allowance. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax asset will not be realized. In management’s opinion, as of June 30, 2010, it was more likely than not that the results of future operations will generate sufficient taxable income to recognize the deferred tax assets not covered by the valuation allowance. This opinion was based on the availability of several realistic tax planning strategies and forecasted levels of pre-tax book income. However, we reached a cumulative three-year pre-tax loss position (excluding a goodwill impairment charge in 2008) during the quarter ended March 31, 2010. A cumulative loss position makes it more difficult for management to rely on future earnings as a reliable source of future taxable income to realize deferred tax assets. Future losses and a continuing cumulative loss period may result in an increase to the partial valuation allowance or even a full valuation allowance on our deferred tax assets in future periods, which will negatively impact results of operations.

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 to address unknown liabilities 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 p erform 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.

Index

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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. Approximately 60% of our loans were variable rate loans as of June 30, 2010, which means that our interest income will generally decrease in lower interest rate environments and rise in higher interest rate environments. Our net interest income will be adversely affected if market interest rates change such that the interest we earn on loans and investments decreases faster than the interest we pay on deposits and borrowings. 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 Board of Govern ors of the Federal Reserve, 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 earnings and financial condition.

The fair value of our investments could decline.

The majority of our investment portfolio as of June 30, 2010 has been designated as available-for-sale. Unrealized gains and losses in the estimated value of the available-for-sale portfolio must be “marked to market” and reflected as a separate item in shareholders’ equity (net of tax) as accumulated other comprehensive income. As of June 30, 2010, we maintained $217.2 million, or 95%, of our total investment securities as available-for-sale. Shareholders’ equity will continue to reflect the unrealized gains and losses (net of tax) of these investments. The fair value of our investment portfolio may decline, causing a corresponding decline in shareholders’ equity.

Management believes that several factors affect the fair values of our investment portfolio. These include, but are not limited to, changes in interest rates or expectations of changes, changes to the credit ratings and financial condition of security issuers, the degree of volatility in the securities markets, inflation rates or expectations of inflation, and the slope of the interest rate yield curve. The yield curve refers to the differences between shorter-term and longer-term interest rates; a positively sloped yield curve means shorter-term rates are lower than longer-term rates. These and other factors may impact specific categories of the portfolio differently, and we cannot predict the effect these factors may have on any specific category.

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. Banking regulations, designed primarily for the protection of depositors, may limit our growth and the return to our current and/or potential investors by restricting certain of our activities, such as:

	•	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.

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. Many of these regulations are intended to protect depositors, the public and the FDIC, not shareholders. The cost of compliance with regulatory requirements including those imposed by the SEC may adversely affect our ability to operate profitably.

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Specifically, federal and state governments could pass additional legislation responsive to current credit conditions, such as the Dodd-Frank Act and the regulations expected to be promulgated under the Dodd-Frank Act in the near future. 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.

We are subject to examination and scrutiny by a number of regulatory authorities, and, depending upon the findings and determinations of our regulatory authorities, we may be required to make adjustments to our business, operations or financial position and could become subject to formal or informal regulatory orders.

We are subject to examination by federal and state banking regulators. Federal and state regulators have the ability to impose substantial sanctions, restrictions and requirements on us and our banking subsidiaries if they determine, upon conclusion of their examination or otherwise, violations of laws with which we or our subsidiaries must comply or weaknesses or failures with respect to general standards of safety and soundness, including, for example, in respect of any financial concerns that the regulators may identify and desire for us to address. Such enforcement may be formal or informal and can include directors’ resolutions, memoranda of understanding, cease and desist orders, civil money penalties and termination of deposit insurance and bank closures. Enforcement actions may be taken regardless of the capital levels of th e institutions, and regardless of prior examination findings. In particular, institutions that are not sufficiently capitalized in accordance with regulatory standards may also face capital directives or prompt corrective actions. Enforcement actions may require certain corrective steps (including staff additions or changes), impose limits on activities (such as lending, deposit taking, acquisitions or branching), prescribe lending parameters (such as loan types, volumes and terms) and require additional capital to be raised, any of which could adversely affect our financial condition and results of operations. The imposition of regulatory sanctions, including monetary penalties, may have a material impact on our financial condition and results of operations, damage our reputation and/or cause us to lose our financial holding company status. In addition, compliance with any such action could distract management’s attention from our operations, cause us to incur significant expenses, restrict us from en gaging in potentially profitable activities and limit our ability to raise capital.

The terms governing the issuance of the Series A Preferred Stock to the Treasury may be changed, the effect of which may have an adverse effect on our operations.

The terms of the Securities Purchase Agreement, which we entered into with the Treasury, provide that the Treasury may unilaterally amend any provision of the Securities Purchase Agreement to the extent required to comply with any changes in applicable federal law that may occur in the future. We have no control over such changes in the terms of the Securities Purchase Agreement that may occur in the future. Such changes may place restrictions on our business or results of operations, which may adversely affect the market price of our common stock.

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 markets in North Carolina, South Carolina and Virginia, at this time particularly through FDIC-assisted transactions. 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 our target markets. In attempting to make such acquisitions, we anticipate competing with other financial institutions, many of which have greater financial and operational resources. The process of identifying acquisition opportunities, negotiating potential acquisitions, obtaining the required regulatory approvals, and integrating new operations and personnel requires a significant amount of time and expense and may divert management’s attention from our existing business. 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.

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Our ability to raise additional capital could be limited, could affect our liquidity and could be dilutive to existing shareholders.

We may be required or choose to raise additional capital, including for strategic, regulatory or other reasons. Current conditions in the capital markets are such that traditional sources of capital may not be available to us on reasonable terms if we need to raise additional capital, and the inability to access the capital markets could impair our liquidity, which is important to our business. In such case, there is no guarantee that we will be able to successfully raise additional capital at all or on terms that are favorable or otherwise not dilutive to existing shareholders.

We are dependent on our key personnel, including our senior management and directors, and our inability to hire and retain key personnel may adversely affect our operations and financial performance.

We are, and for the foreseeable future will be, dependent on the services of our senior management and directors. Members of our senior management have extensive and long-standing ties within our market area and substantial experience with our operations, which have contributed significantly to our growth. Should the services of a member of our senior management team become unavailable, our operations and growth may be disrupted, and there can be no assurance that a suitable successor could be retained upon the terms and conditions that we would offer. In December 2008, we entered into the Securities Purchase Agreement in connection with the CPP pursuant to which we sold the Treasury 41,279 shares of our Series A Preferred Stock and a warrant to purchase up to 749,619 shares of our common stock for an aggregate purchase price of $41.3 mil lion. Our participation in the CPP restricts our ability to provide certain types of compensation to certain senior executive officers and employees. The inability to make certain types of compensation available to certain senior executive officers and employees may reduce our ability to retain key personnel.

Further, as we continue to grow our operations both in our current markets and other markets that we may target, we expect to continue to be dependent on our senior management and their relationships in such markets. Our inability to attract or retain additional personnel could materially adversely affect our business or growth prospects in one or more markets.

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.

The failure of other financial institutions could adversely affect us.

Our ability to engage in routine transactions, including, for example, funding transactions, could be adversely affected by the actions and potential failures of other financial institutions. We have exposure to many different industries and counterparties, and we routinely execute transactions with a variety of counterparties in the financial services industry. As a result, defaults by, or even rumors or concerns about, one or more financial institutions with which we do business, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by others. In addition, our credit risk may be exacerbated when the collateral we hold cannot be sold at prices that are sufficient for us to recover the full amount of our exposure. Any such losses could materially and adversel y affect our financial condition and results of operations.

Index

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Consumers may decide not to use banks to complete their financial transactions, which could limit our revenue.

Technology and other changes are allowing parties to complete financial transactions through alternative methods that historically have involved banks. 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 through the use of various electronic payment systems. 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.

Technological advances impact our business.

The banking industry is undergoing rapid 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.

Our information systems, or those of our third party contractors, may experience an interruption or breach in security.

We rely heavily on our communications and information systems, and those of third party contractors, 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 of our information systems, or those of our third party contractors, or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of such 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.

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.

Risks Related to Ownership of Our Common Stock

The trading volume in our common stock has been low, which could make it difficult to sell shares of our common stock.

Our common stock is currently traded on the NASDAQ Global Select Market. Our common stock is thinly traded and has substantially less liquidity than the average trading market for many other publicly traded companies. Thinly traded stocks can be more volatile than stock trading in an active public market. Our stock price has been volatile in the past and several factors could cause the price to fluctuate substantially in the future. These factors include but are not limited to changes in analysts’ recommendations or projections, our announcement of developments related to our business, operations and stock performance of other companies deemed to be peers, news reports of trends, concerns, irrational exuberance on the part of investors and other issues related to the financial services industry. Recently, the stock market has experi enced a high level of price and volume volatility, and market prices for the stock of many companies, including those in the financial services sector, have experienced wide price fluctuations that have not necessarily been related to operating performance. Our stock price may fluctuate significantly in the future, and these fluctuations may be unrelated to our performance. General market declines or market volatility in the future, especially in the financial institutions sector of the economy, could adversely affect the price of our common stock, and the current market price may not be indicative of future market prices. Therefore, our shareholders may not be able to sell their shares at the volume, prices or times that they desire.

Index

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We may issue additional shares of common stock or convertible securities that will dilute the percentage ownership interest of existing shareholders and may dilute the book value per share of our common stock and adversely affect the terms on which we may obtain additional capital.

Our authorized capital includes 50,000,000 shares of common stock. As of June 30, 2010, we had 12,880,954 shares of common stock outstanding and had reserved for issuance 313,420 shares underlying options that are or may become exercisable at an average price of $12.05 per share. In addition, as of June 30, 2010, we had the ability to issue 598,859 shares of common stock pursuant to options and restricted stock that may be granted in the future under our existing equity compensation plans. Subject to applicable NASDAQ Listing Rules, our Board of Directors generally has the authority, without action by or vote of the shareholders, to issue all or part of any authorized but unissued shares of common stock for any corporate purpose, including issuance of equity-based incentives under or outside of our equity compensation plans. We may seek a dditional equity capital in the future as we develop our business and expand our operations. Any issuance of additional shares of common stock or convertible securities will dilute the percentage ownership interest of our shareholders and may dilute the book value per share of our common stock.

The Bank’s ability to pay dividends is subject to regulatory limitations, which may affect our ability to pay our obligations and dividends.

We are a separate legal entity from the Bank and our other subsidiaries, and we do not have significant operations of our own. We have historically depended on the Bank’s cash and liquidity as well as dividends to pay our operating expenses. Various federal and state statutory provisions limit the amount of dividends that subsidiary banks can pay to their holding companies without regulatory approval. The Bank is also subject to limitations under state law regarding the payment of dividends, including the requirement that dividends may be paid only out of undivided profits and only if the Bank has surplus of a specified level. In addition to these explicit limitations, it is possible, depending upon the financial condition of the Bank and other factors, that the federal and state regulatory agencies could take the position that paym ent of dividends by the Bank would constitute an unsafe or unsound banking practice. In the event the Bank is unable to pay dividends sufficient to satisfy our obligations or is otherwise unable to pay dividends to us, we may not be able to service our obligations as they become due or to pay dividends on our common stock or Series A Preferred Stock. Consequently, the inability to receive dividends from the Bank could adversely affect our financial condition, results of operations, cash flows and prospects.

In addition, holders of our common stock are only entitled to receive such dividends as our Board of Directors may declare out of funds legally available for such payments. Although we have historically paid cash dividends on our common stock, we are not required to do so and our Board of Directors voted in the first quarter of 2010 to suspend the payment of our quarterly cash dividend. This may continue to adversely affect the market price of our common stock. Also, we are a financial holding company and our ability to declare and pay dividends depends on certain federal regulatory considerations, including the guidelines of the Federal Reserve regarding capital adequacy and dividends.

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

Under the Securities Purchase Agreement and the rights of the Series A Preferred Stock set forth in our Articles of Incorporation, our ability to declare or pay dividends on any of our shares is restricted. Specifically, we may not declare dividend payments on common, junior preferred or pari passu preferred shares if we are in arrears on the dividends on the Series A Preferred Stock. Furthermore, prior to December 12, 2011, unless we have redeemed all of the Series A Preferred Stock, or the Treasury has transferred all of the Series A Preferred Stock to a third party, the consent of the Treasury will be required for us to, among other things, increase common stock dividends or effect repurchases of common stock (with certain exceptions, including the repurchase of our common stock to offset share dilution from equity-based employee compensation awards).

Holders of Series A Preferred Stock have certain voting rights that may adversely affect our common shareholders, and the holders of Series A Preferred Stock may have different interests from, and vote their shares in a manner deemed adverse to, our common shareholders.

In the event that we fail to pay dividends on shares of Series A Preferred Stock for an aggregate of at least six quarterly dividend periods (whether or not consecutive), the Treasury will have the right to appoint two directors to our Board of Directors until all accrued but unpaid dividends have been paid; otherwise, except as required by law, holders of Series A Preferred Stock have limited voting rights. So long as shares of Series A Preferred Stock are outstanding, in addition to any other vote or consent of shareholders required by law or our Articles of Incorporation, the vote or consent of holders owning at least 66 2/3% of the shares of Series A Preferred Stock outstanding is required for:

Index

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	•	any amendment or alteration of our Articles of Incorporation to authorize or create or increase the authorized amount of, or any issuance of, any shares of, or any securities convertible into or exchangeable or exercisable for shares of, any class or series of capital stock ranking senior to the Series A Preferred Stock with respect to payment of dividends and/or distribution of assets on our liquidation, dissolution or winding up;

	•	any amendment, alteration or repeal of any provision of our Articles of Incorporation so as to adversely affect the rights, preferences, privileges or voting powers of the Series A Preferred Stock; or

	•	any consummation of a binding share exchange or reclassification involving the Series A Preferred Stock or of a merger or consolidation of us with another entity, unless (i) the shares of Series A Preferred Stock remain outstanding following any such transaction or, if we are not the surviving or resulting entity, such shares are converted into or exchanged for preference securities of the surviving or resulting entity or its ultimate parent, and (ii) such remaining outstanding shares of Series A Preferred Stock or preference securities, as the case may be, have rights, preferences, privileges and voting powers, and limitations and restrictions thereof, that are not materially less favorable than the rights, preferences, privileges and voting powers, and limitations and restrictions thereof, of the Series A Preferred Stock prior to such c onsummation, taken as a whole. Holders of Series A Preferred Stock could block such a transaction, even where considered desirable by, or in the best interests of, holders of our common stock.

In addition, the shares of common stock that are issuable upon the exercise of the warrant held by the Treasury will enjoy voting rights identical to those of our other outstanding shares of common stock. Although the Treasury has agreed not to vote the shares of common stock it would receive upon any exercise of the warrant, a transferee of any portion of the warrant or any of the shares of common stock it acquires upon exercise of the warrant is not bound by this limitation.

There can be no assurance when the Series A Preferred Stock may be redeemed and the warrant held by the Treasury may be repurchased.

There can be no assurance when the Series A Preferred Stock may be redeemed and the warrant may be repurchased. In addition, the Series A Preferred Stock may only be redeemed upon the express approval of the Federal Reserve. Until such time as the Series A Preferred Stock is redeemed and the warrant is repurchased, we will remain subject to the terms and conditions set forth in the Securities Purchase Agreement, the warrant and the rights of the Series A Preferred Stock as set forth in the Articles of Incorporation.

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

We have issued $34.3 million of subordinated debentures, which are senior to our shares of common stock. As a result, we must make payments on the subordinated debentures (and the trust preferred securities related to a portion of the subordinated debentures) 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.

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, our shareholders may lose some or all of their investment in our common stock.

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

There were no repurchases (both open market and private transactions) during the three months ended June 30, 2010 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.

The Company has not completed any unregistered sales of equity securities during the three months ended June 30, 2010.

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Item 3. Defaults upon Senior Securities

None

Item 4. (Removed and Reserved)

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 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

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

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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 6th day of August 2010.

	CAPITAL BANK CORPORATION


	By:	/s/ Michael R. Moore
		Michael R. Moore
		Chief Financial Officer
		(Authorized Officer and Principal Financial Officer)

Index

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 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

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

Index

EX-31.1 2 ex31_1.htm EXHIBIT 31.1 ex31_1.htm

Exhibit 31.1

Certification by Chief Executive Officer

pursuant to Rule 13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act of 1934,

as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, B. Grant Yarber, certify that:

1. I have reviewed this Quarterly Report on Form 10-Q of Capital Bank Corporation;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

	(a)	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

	(b)	Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

	(c)	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

	(d)	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

	(a)	All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

	(b)	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 6, 2010	CAPITAL BANK CORPORATION


	By:	/s/ B. Grant Yarber
		B. Grant Yarber
		President and Chief Executive Officer

EX-31.2 3 ex31_2.htm EXHIBIT 31.2 ex31_2.htm

Exhibit 31.2

Certification by Chief Financial Officer

pursuant to Rule 13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act of 1934,

as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, Michael R. Moore, certify that:

1. I have reviewed this Quarterly Report on Form 10-Q of Capital Bank Corporation;

	(a)	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

	(b)	Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

	(c)	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

	(d)	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

	(a)	All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

	(b)	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 6, 2010	CAPITAL BANK CORPORATION


	By:	/s/ Michael R. Moore
		Michael R. Moore
		Chief Financial Officer

EX-32.1 4 ex32_1.htm EXHIBIT 32.1 ex32_1.htm

Exhibit 32.1

Certification by Chief Executive Officer

pursuant to 18 U.S.C. Section 1350,

as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

In connection with the Quarterly Report on Form 10-Q of Capital Bank Corporation (the “Company”) for the period ended June 30, 2010 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, B. Grant Yarber, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, to my knowledge that:

The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ B. Grant Yarber

B. Grant Yarber

President and Chief Executive Officer

August 6, 2010

This Certification is being furnished solely to accompany the Report pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not be deemed “filed” by the Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and shall not be incorporated by reference into any filing of the Company under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Report, irrespective of any general incorporation language contained in such filing.

A signed original of this written statement required by Section 906 of the Sarbanes-Oxley Act of 2002 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.

EX-32.2 5 ex32_2.htm EXHIBIT 32.2 ex32_2.htm

Exhibit 32.2

Certification by Chief Financial Officer

pursuant to 18 U.S.C. Section 1350,

as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

In connection with the Quarterly Report on Form 10-Q of Capital Bank Corporation (the “Company”) for the period ended June 30, 2010 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Michael R. Moore, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, to my knowledge that:

The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Michael R. Moore

Michael R. Moore

Chief Financial Officer

August 6, 2010

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

Large accelerated filer ¨	Accelerated filer ¨	Non-accelerated filer ¨	(Do not check here if a smaller reporting company)
Smaller reporting company þ

	June 30, 2010			December 31, 2009
(Dollars in thousands except share data)	(Unaudited)

Assets
Cash and cash equivalents:
Cash and due from banks	$	20,332		$	25,002
Interest-bearing deposits with banks		21,085			4,511
Total cash and cash equivalents		41,417			29,513
Investment securities:
Investment securities – available for sale, at fair value		217,243			235,426
Investment securities – held to maturity, at amortized cost		3,082			3,676
Other investments		8,487			6,390
Total investment securities		228,812			245,492
Mortgage loans held for sale		1,893			–
Loans:
Loans – net of unearned income and deferred fees		1,351,101			1,390,302
Allowance for loan losses		(35,762	)		(26,081	)
Net loans		1,315,339			1,364,221
Premises and equipment, net		24,128			23,756
Bank-owned life insurance		23,264			22,746
Core deposit intangible, net		2,241			2,711
Deferred income tax		18,702			12,096
Accrued interest receivable		5,766			6,590
Other assets		32,774			27,543
Total assets	$	1,694,336		$	1,734,668

Liabilities
Deposits:
Demand, noninterest checking	$	130,768		$	141,069
NOW accounts		196,171			175,084
Money market deposit accounts		147,815			184,146
Savings accounts		31,229			28,958
Time deposits		864,794			848,708
Total deposits		1,370,777			1,377,965
Repurchase agreements		–			6,543
Borrowings		153,000			167,000
Subordinated debentures		34,323			30,930
Other liabilities		10,757			12,445
Total liabilities		1,568,857			1,594,883

Shareholders’ Equity
Preferred stock, $1,000 par value; 100,000 shares authorized; 41,279 shares issued and outstanding (liquidation preference of $41,279)		40,273			40,127
Common stock, no par value; 50,000,000 shares authorized; 12,880,954 and 11,348,117 shares issued and outstanding		145,297			139,909
Accumulated deficit		(64,301	)		(44,206	)
Accumulated other comprehensive income		4,210			3,955
Total shareholders’ equity		125,479			139,785
Total liabilities and shareholders’ equity	$	1,694,336		$	1,734,668

	Preferred Stock			Common Stock						Other Comprehensive			Accumulated
	Shares	Amount		Shares			Amount			Income			Deficit			Total
(Dollars in thousands except share data)

Balance at January 1, 2009	41,279	$	39,839		11,238,085		$	139,209		$	886		$	(31,420	)	$	148,514
Comprehensive loss:
Net loss														(3,114	)		(3,114	)
Net unrealized gain on securities, net of tax of $865											1,379						1,379
Net unrealized loss on 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	)
Total comprehensive loss																	(2,802	)
Accretion of preferred stock discount			143											(143	)		–
Restricted stock awards					20,000			120									120
Stock option expense								25									25
Directors’ deferred compensation					42,284			287									287
Dividends on preferred stock														(1,031	)		(1,031	)
Dividends on common stock ($0.08 per share)														(1,807	)		(1,807	)
Balance at June 30, 2009	41,279	$	39,982		11,300,369		$	139,641		$	1,198		$	(37,515	)	$	143,306


Balance at January 1, 2010	41,279	$	40,127		11,348,117		$	139,909		$	3,955		$	(44,206	)	$	139,785
Comprehensive loss:
Net loss														(18,917	)		(18,917	)
Net unrealized gain on securities, net of tax of $157											251						251
Amortization of prior service cost on SERP											4						4
Total comprehensive loss																	(18,662	)
Accretion of preferred stock discount			146											(146	)		–
Issuance of common stock					1,468,770			5,065									5,065
Restricted stock forfeiture					(400	)		(2	)								(2)
Stock option expense								24									24
Directors’ deferred compensation					64,467			301									301
Dividends on preferred stock														(1,032	)		(1,032	)
Balance at June 30, 2010	41,279	$	40,273		12,880,954		$	145,297		$	4,210		$	(64,301	)	$	125,479

	June 30, 2010			June 30, 2009
(Dollars in thousands)

Cash flows from operating activities:
Net loss	$	(18,917	)	$	(3,114	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Provision for loan losses		31,771			7,678
Amortization of deposit premium		470			575
Depreciation		1,271			1,602
Stock-based compensation		386			365
Net gain on investment securities		(397	)		(16	)
Net amortization of premium/discount on investment securities		49			80
Net change in mortgage loans held for sale		(1,893	)		–
Loss on disposal of premises, equipment and other real estate		334			34
Loss on write-down of other real estate		646			–
Deferred income tax benefit		(6,763	)		(18	)
Increase in cash surrender value of bank-owned life insurance		(518	)		(30	)
Net decrease in accrued interest receivable and other assets		886			3,390
Net (decrease) increase in accrued interest payable and other liabilities		(776	)		12
Net cash provided by operating activities		6,549			10,558

Cash flows from investing activities:
Loan originations, net of principal repayments		4,057			(47,256	)
Additions to premises and equipment		(1,655	)		(1,164	)
Proceeds from sales of premises, equipment and real estate owned		6,730			588
Net purchases of FHLB stock		(2,025	)		(20	)
Purchase of securities – available for sale		(57,013	)		(21,872	)
Proceeds from principal repayments/calls/maturities of securities – available for sale		75,881			33,179
Proceeds from principal repayments/calls/maturities of securities – held to maturity		593			807
Net cash provided by (used in) investing activities		26,568			(35,738	)

Cash flows from financing activities:
Net (decrease) increase in deposits		(7,188	)		65,528
Net decrease in repurchase agreements		(6,543	)		(4,421	)
Proceeds from borrowings		151,000			70,000
Principal repayments of borrowings		(165,000	)		(85,000	)
Proceeds from issuance of subordinated debentures		3,393			–
Proceeds from issuance of common stock		5,065			–
Dividends paid		(1,940	)		(2,688	)
Net cash (used in) provided by financing activities		(21,213	)		43,419

Net change in cash and cash equivalents		11,904			18,239
Cash and cash equivalents at beginning of period		29,513			54,455
Cash and cash equivalents at end of period	$	41,417		$	72,694

Supplemental Disclosure of Cash Flow Information

Transfer of loans and premises to other real estate owned	$	13,054		$	4,413
Cash paid (received) for:
Income taxes	$	–		$	(4,297	)
Interest	$	14,516		$	18,905

PART I – FINANCIAL INFORMATION		Page No.

Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets as of June 30, 2010 (Unaudited) and December 31, 2009	3
	Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2010 and 2009 (Unaudited)	4
	Condensed Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income (Loss) for the Six Months Ended June 30, 2010 and 2009 (Unaudited)	5
	Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2010 and 2009 (Unaudited)	6
	Notes to Condensed Consolidated Financial Statements (Unaudited)	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	18

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	40

Item 4.	Controls and Procedures	40

Item 4T.	Controls and Procedures	40

PART II – OTHER INFORMATION

Item 1.	Legal Proceedings	40

Item 1A.	Risk Factors	40

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	51

Item 3.	Defaults upon Senior Securities	52

Item 4.	(Removed and Reserved)	52

Item 5.	Other Information	52

Item 6.	Exhibits	52

Signatures

	Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value
(Dollars in thousands)

June 30, 2010
Available for sale:
U.S. agency obligations	$	47,012	$	217	$	–	$	47,229
Municipal bonds		36,745		197		763		36,179
Mortgage-backed securities issued by GSEs		116,185		7,859		–		124,044
Non-agency mortgage-backed securities		7,132		33		446		6,719
Other securities		3,252		22		202		3,072
		210,326		8,328		1,411		217,243
Held to maturity:
Municipal bonds		300		4		–		304
Mortgage-backed securities issued by GSEs		1,299		91		–		1,390
Non-agency mortgage-backed securities		1,483		3		50		1,436
		3,082		98		50		3,130
Other investments		8,487		–		–		8,487
Total	$	221,895	$	8,426	$	1,461	$	228,860

December 31, 2009
Available for sale:
U.S. agency obligations	$	1,000	$	29	$	–	$	1,029
Municipal bonds		72,556		1,006		668		72,894
Mortgage-backed securities issued by GSEs		144,762		6,896		–		151,658
Non-agency mortgage-backed securities		8,345		19		567		7,797
Other securities		2,252		–		204		2,048
		228,915		7,950		1,439		235,426
Held to maturity:
Municipal bonds		300		7		–		307
Mortgage-backed securities issued by GSEs		1,576		84		–		1,660
Non-agency mortgage-backed securities		1,800		–		145		1,655
		3,676		91		145		3,622
Other investments		6,390		–		–		6,390
Total	$	238,981	$	8,041	$	1,584	$	245,438

	Less than 12 Months				12 Months or Greater				Total
(Dollars in thousands)	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
June 30, 2010
Available for sale:
Municipal bonds	$	19,877	$	522	$	2,360	$	241	$	22,237	$	763
Non-agency mortgage-backed securities		–		–		4,741		446		4,741		446
Other securities		–		–		798		202		798		202
		19,877		522		7,899		889		27,776		1,411
Held to maturity:
Non-agency mortgage-backed securities		–		–		829		50		829		50
Total	$	19,877	$	522	$	8,728	$	939	$	28,605	$	1,461

December 31, 2009
Available for sale:
Municipal bonds	$	21,194	$	448	$	2,382	$	220	$	23,576	$	668
Non-agency mortgage-backed securities		3,711		93		2,791		474		6,502		567
Other securities		–		–		1,546		204		1,546		204
		24,905		541		6,719		898		31,624		1,439
Held to maturity:
Non-agency mortgage-backed securities		–		–		1,655		145		1,655		145
Total	$	24,905	$	541	$	8,374	$	1,043	$	33,279	$	1,584

	Available for Sale				Held to Maturity
(Dollars in thousands)	Amortized Cost		Fair Value		Amortized Cost		Fair Value

Debt securities:
Due within one year	$	–	$	–	$	300	$	304
Due after one year through five years		38,924		39,111		–		–
Due after five years through ten years		17,267		17,405		890		955
Due after ten years		152,385		158,955		1,892		1,871
Total debt securities		208,576		215,471		3,082		3,130
Total equity securities		1,750		1,772		–		–
Total investment securities	$	210,326	$	217,243	$	3,082	$	3,130