10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2008

Commission File No.: 000-52195

BANK OF THE CAROLINAS CORPORATION

(Exact name of registrant as specified in its charter)

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

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a nonaccelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

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

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

On August 13, 2008 there were 3,987,374 outstanding shares of the registrant’s common stock.

BANK OF THE CAROLINAS CORPORATION

FORM 10-Q

June 30, 2008

INDEX

Part I. FINANCIAL INFORMATION
Item 1.	Consolidated Financial Statements
	Consolidated Balance Sheets at June 30, 2008 and December 31, 2007	3
	Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2008 and 2007	4
	Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2008 and 2007	5
	Consolidated Statements of Changes in Shareholders’ Equity for the Six Months Ended June 30, 2008 and 2007	6
	Notes to Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	10
Item 3.	Quantitative and Qualitative Disclosure about Market Risk	N/A
Item 4.	Controls and Procedures	15
Part II. OTHER INFORMATION
Item 1.	Legal Proceedings	16
Item 1A.	Risk Factors	N/A
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	16
Item 3.	Defaults Upon Senior Securities	16
Item 4.	Submission of Matters to a Vote of Security Holders	16
Item 5.	Other Information	17
Item 6.	Exhibits	17
SIGNATURES		18
EXHIBIT INDEX		19

PART 1. FINANCIAL INFORMATION

Item 1. Financial Statements

Bank of the Carolinas Corporation

Consolidated Balance Sheets

(In thousands, except share and per share data)

	June 30 2008			December 31 2007*
	(Unaudited)
Assets
Cash and due from banks	$	8,047		$	8,192
Interest-bearing deposits in banks		7,834			12,756
Securities held to maturity		1,000			—
Securities available for sale		57,448			60,717
Loans		406,713			395,052
Less, Allowance for loan losses		(4,538	)		(4,245	)
Total Loans, net		402,175			390,807
Premises and equipment		15,181			13,888
Accrued interest receivable		2,873			3,239
Other real estate owned		2,432			2,528
Deferred tax assets		735			578
Goodwill		591			591
Bank owned life insurance		9,463			9,283
Other assets		4,134			3,419
Total assets	$	511,913		$	505,998
Liabilities and Shareholders’ Equity
Deposits:
Non-interest bearing demand deposits	$	32,683		$	29,835
Interest bearing demand deposits		59,408			62,883
Savings deposits		31,672			19,655
Large denomination time deposits		153,779			174,181
Other time deposits		136,803			135,374
Total deposits		414,345			421,928
Borrowings		41,000			34,000
Subordinated debt		5,155			—
Federal funds purchased and repurchase agreements		10,203			7,657
Other liabilities		1,446			2,173
Total liabilities		472,149			465,758
Commitments and contingencies (Note 3)
Shareholders’ Equity:
Common stock, par value $5 per share: 15,000,000 shares authorized; Issued and outstanding 3,987,374 shares in 2008 and 3,920,752 in 2007		19,937			19,604
Additional paid-in capital		11,828			11,716
Retained earnings		7,815			8,476
Accumulated other comprehensive income		184			444
Total shareholders’ equity		39,764			40,240
Total liabilities and shareholders’ equity	$	511,913		$	505,998

* Derived from audited consolidated financial statements.

See accompanying notes.

3

Bank of the Carolinas Corporation

Consolidated Statements of Operations

(Unaudited)

(In thousands, except per share data)

	Three Months Ended June 30					Six Months Ended June 30
	2008			2007		2008			2007
Interest Income
Interest and fees on loans	$	6,603		$	7,285	$	13,694		$	14,594
Interest on securities		710			699		1,436			1,313
Interest on federal funds sold		38			183		114			361
Interest on deposits in other banks		2			2		6			5
Total interest income		7,353			8,169		15,250			16,273
Interest Expense
Interest on deposits		3,808			4,311		8,194			8,561
Interest on borrowed funds		388			303		661			588
Total interest expense		4,196			4,614		8,855			9,149
Net Interest Income		3,157			3,555		6,395			7,124
Provision for loan losses		781			412		1,095			474
Net interest income after provision for loan losses		2,376			3,143		5,300			6,650
Non-interest income
Customer service fees		347			266		639			502
Mortgage loan broker fees		31			31		67			62
Investment services		6			56		15			99
Income from bank owned life insurance		92			86		180			168
Other income		42			33		69			70
Total non-interest income		518			472		970			901
Noninterest Expense
Salaries and benefits		1,802			1,418		3,696			2,935
Occupancy and equipment		481			421		980			839
Data processing expense		212			186		422			376
Other		796			754		1,574			1,416
Total non-interest expense		3,291			2,779		6,672			5,566
Income (Loss) before income taxes		(397	)		836		(402	)		1,985
Income taxes		(138	)		244		(138	)		613
Net Income (Loss)	$	(259	)	$	592	$	(264	)	$	1,372
Earnings (Loss) Per Share
Basic	$	(0.07	)	$	0.15	$	(0.07	)	$	0.36
Diluted	$	(0.07	)	$	0.15	$	(0.07	)	$	0.35
Dividends Declared	$	0.05		$	0.05	$	0.10		$	0.10

See accompanying notes.

4

Bank of the Carolinas Corporation

Consolidated Statements of Cash Flows

(Unaudited)

(In thousands)

	Six Months Ended June 30, 2008			Six Months Ended June 30, 2007
Cash Flows from Operating Activities:
Net income (loss)	$	(264	)	$	1,372
Adjustments to reconcile net income (loss) to netcash provided by operating activities:
Provision for loan losses		1,095			474
Deferred tax expense (benefit)		(80	)		52
Stock based compensation expense		11			11
Depreciation and amortization		445			348
(Gain) loss on sale of other real estate owned		(23	)		12
Loss on disposal of fixed assets		7			3
Income from bank owned life insurance		(180	)		(168	)
Net amortization/accretion of premiums and discounts on investments		16			39
Net change in other assets		58			(895	)
Net change in other liabilities		(727	)		(588	)
Net cash provided by operating activities		358			660
Cash Flows from Investing Activities:
Decrease in federal funds sold		—			5,480
Purchases of premises and equipment		(1,075	)		(1,512	)
Purchases of securities available-for-sale		(11,156	)		(19,979	)
Proceeds from sales, calls, maturities and principal repayments of securities available for sale		12,991			10,726
Sale (purchase) of FHLB stock		(408	)		165
Acquisition of other real estate owned		(12	)		—
Proceeds from the sale of other real estate owned		1,163			282
Proceeds from sale of premises and equipment		8
Net Increase in loans		(14,092	)		(2,124	)
Net cash used in investing activities		(12,581	)		(6,962	)
Cash Flows from Financing Activities:
Net increase (decrease) in deposits		(7,583	)		4,272
Net originations (repayments) of other borrowings		8,153			(4,500	)
Issuance of subordinated debt		5,000			—
Increase in repurchase agreements		1,547			2,111
Proceeds from exercise of stock options		424			167
Tax effect of stock options exercised		10			14
Cash dividends paid		(395	)		(383	)
Net cash provided by financing activities		7,156			1,681
Net decrease in cash and cash equivalents		(5,067	)		(4,621	)
Cash and cash equivalents at beginning of period		20,948			13,403
Cash and cash equivalents at end of period	$	15,881		$	8,782
Supplemental disclosure of cash flow information:
Cash paid during the period for interest	$	9,560		$	9,632
Cash paid during the period for income taxes	$	—		$	794
Noncash investing and financing activities:
Decrease in fair value of securities available for sale, net of tax	$	(260	)	$	(201	)
Dividends declared		199			193
Foreclosed real estate		1,709			287
Transfer from OREO to premises and equipment		677			—

See accompanying notes.

5

Bank of the Carolinas Corporation

Consolidated Statements of Changes in Shareholders’ Equity

(Unaudited) (In thousands, except share and per share data)

	Common Stock			Additional Paid-In Capital		Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total Shareholders’ Equity
	Shares	Amount
Balance, December 31, 2006	3,826,792	$	19,134	$	11,444	$	7,293		$	(157	)	$	37,714
Stock options exercised	26,200		131		36								167
Current Income tax benefit on options exercised					14								14
Stock based compensation expense					11								11
Cash dividends declared ($.10 per share)							(384	)					(384	)
Comprehensive income:
Net income							1,372						1,372
Other comprehensive loss										(201	)		(201	)
Total comprehensive income													1,171
Balance, June 30, 2007	3,852,992	$	19,265	$	11,505	$	8,281		$	(358	)	$	38,693
Balance, December 31, 2007	3,920,752	$	19,604	$	11,716	$	8,476		$	444		$	40,240
Stock options exercised	66,622		333		91								424
Current Income tax benefit on options exercised					10								10
Stock based compensation expense					11								11
Cash dividends declared ($.10 per share)							(397	)					(397	)
Comprehensive loss:
Net loss							(264	)					(264	)
Other comprehensive loss										(260	)		(260	)
Total comprehensive loss													(524	)
Balance, June 30, 2008	3,987,374	$	19,937	$	11,828	$	7,815		$	184		$	39,764

See accompanying notes

6

Notes to Consolidated Financial Statements

June 30, 2008 and 2007

(Unaudited)

NOTE 1. BASIS OF PRESENTATION

In the opinion of management, the financial information included in these unaudited financial statements reflect all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the financial information as of and for the three and six month periods ended June 30, 2008 and 2007, in conformity with accounting principles generally accepted in the United States of America.

The preparation of financial statements requires management to make estimates and assumptions that affect reported amounts of assets and liabilities at the date of the financial statements, as well as the amounts of income and expense during the reporting period. Actual results could differ from those estimates. Operating results for the three and six month periods ended June 30, 2008 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2008.

The results presented here are for Bank of the Carolinas Corporation (“BankCorp”), the parent company of Bank of the Carolinas (“the Bank”). The organization and business of BankCorp, accounting policies followed by BankCorp and other relevant information are contained in the notes to the financial statements filed as part of BankCorp’s annual report on Form 10-K for the year ended December 31, 2007. This quarterly report should be read in conjunction with the annual report. Because BankCorp has no separate operations and conducts no business on its own other than owning the Bank, this discussion concerns primarily the business of the Bank. However, because the financial statements are presented on a consolidated basis, BankCorp and the Bank are collectively referred to as the “Company” unless otherwise noted.

NOTE 2. EARNINGS PER SHARE

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

Earnings per share have been computed based on the following:

	Six months ended June 30,
	2008	2007
Weighted average number of common shares outstanding used to calculate basic earnings per share	3,944,205	3,833,146
Additional potential common shares due to stock options	—	114,237
Weighted average number of common shares outstanding used to calculate diluted earnings per share	3,944,205	3,947,383
	Three months ended June 30,
	2008	2007
Weighted average number of common shares outstanding used to calculate basic earnings per share	3,967,400	3,837,533
Additional potential common shares due to stock options	—	105,831
Weighted average number of common shares outstanding used to calculate diluted earnings per share	3,967,400	3,943,364

7

There were 32,581 shares for the three month and 46,274 shares for the six month period ended June 30, 2008 that are anti-dilutive due to the net loss for the three and six month periods then ended.

NOTE 3. COMMITMENTS AND CONTINGENCIES

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, lines of credit and standby letters of credit. These instruments involve elements of credit risk in excess of amounts recognized in the accompanying financial statements.

The Company’s risk of loss with the unfunded loans and lines of credit or standby letters of credit is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments under such instruments as it does for on-balance sheet instruments. The amount of collateral obtained, if any, is based on management’s credit evaluation of the borrower. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. At June 30, 2008, outstanding financial instruments whose contract amounts represent credit risk were approximately:

	(in thousands)
Loan commitments	$	59,870
Letters of credit	$	2,683

NOTE 4. COMPREHENSIVE INCOME (LOSS)

Accounting principles generally require that recognized revenue, expenses, gains, and losses be included in net income. Certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component in the equity section of the balance sheet. Such items, along with net income, are considered components of comprehensive income. Accounting principles do not require per share amounts of comprehensive income to be disclosed. The information that follows reconciles net income (loss) to comprehensive income (loss).

	Three-months ended June 30,						Six-months ended June 30,
	2008			2007			2008		2007
(In thousands)
Net Income (loss)	$	(259	)	$	592		(264	)	$	1,372
Net unrealized loss on AFS securities, net of taxes		(638	)		(290	)	(260	)		(201	)
Comprehensive income (loss)	$	(897	)	$	302		(524	)	$	1,171

NOTE 5. RECENT ACCOUNTING PRONOUNCEMENTS

In February 2007, the FASB issued FASB Statement No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities.” FASB 159 allows companies to measure financial instruments at fair value. The statement will be effective as of the beginning of each fiscal year that begins after November 15, 2007. The adoption had no effect on the Company’s financial statements as management has not elected the fair value option on any assets or liabilities.

In December 2007, the FASB issue SFAS NO. 141R “Business Combinations”, which replaces SFAS 141. SFAS 141R establishes principals and requirements for recognition and measurement of assets, liabilities, and any noncontrolling interest acquired due to a business combination. SFAS 141R requires that the acquirer record 100 percent of all assets and liabilities of the acquired business generally at fair value, including goodwill. The acquirer will not be able to recognize the allowance for loan losses of the acquiree. Under SFAS 141R, acquisition related and restructuring costs will be expensed as incurred rather than treated as part of the cost of the acquisition and included in the amount recorded for assets acquired. SFAS 141R is effective for fiscal years beginning after December 15, 2008. Accordingly, for acquisitions completed after December 31, 2008, the Company will apply the provisions of SFAS 141R.

8

In March 2008, the FASB issue SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133.” SFAS 161 applies to all derivatives and hedge agreements covered under FASB 133. SFAS 161 requires greater transparency regarding how and why they are using derivative instruments, how they are accounting for those instruments as well as how they affect a company’s financial position, results of operation and cash flow. SFAS 161 is effective for financial statements issued for fiscal years beginning after November 15, 2008. The Company does not expect the adoption of SFAS 161 to have a material effect on its financial condition or results of operations.

NOTE 6. FAIR VALUE

Effective January 1, 2008, the Company adopted SFAS 157 which requires that certain assets and liabilities be measured at fair value and to record any adjustments to the fair value of those assets. Securities are recorded at fair value on a recurring basis while other assets are recorded at fair value on a non-recurring basis such as impaired loans.

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

• Level 1 pricing for an asset or liability is derived from the most likely actively traded markets and considered very reliable. Quoted prices on actively traded equities, for example, fall into this category.

• Level 2 pricing is derived from observable data including market spreads, current and projected rates, prepayment data and credit quality. Our bond price adjustments fall into this category as well as impaired loans that use appraisals or brokered price opinions to determine fair value.

• Level 3 pricing is used without the use of observable data. In such cases, market-to-market strategies are typically employed. Often, these types of instruments have no active market, possess unique characteristics and are thinly traded. Our impaired and other real estate loan balances fall into this category. We currently have no assets or liabilities that fall into this category.

The Company’s securities are measured on a recurring basis through a model used by our bond agent. All of our bond price adjustments meet level 2 criteria. Prices are derived from a model which uses actively quoted rates, prepayment models and other underlying credit and collateral data.

Our impaired loans and assets held in other real estate fall into the level 2 criteria. These assets are marked to market value, if lower than the current loan balance, from either their most recent appraisals or a broker’s price opinion, whichever is most recent.

	Total at 6/30/2008		Level 1		Level 2		Level 3
(In thousands)
Assets valued on a recurring basis
AFS securities	$	57,448	$		$	57,448
Assets valued on a non-recurring basis
Impaired loans		1,192				1,192
Total	$	58,640	$	0		58,640	$	0

9

Note 7. SUBORDINATED DEBT

The Company has issued $5.2 million of junior subordinated debentures to its wholly owned capital trust, (Bank of the Carolinas Trust I), to fully and unconditionally guarantee the preferred securities issued by the trust. This long term obligation constitutes a full and unconditional guarantee by the Company of the trust’s obligations.

A description of the junior subordinated debenture outstanding is as follows:

Issuing Entity	Date of Issuance	Interest Rate		Maturity Date	Principal Amount
Bank of the Carolinas Trust I	3/26/2008	Libor + 3.00	%	3/26/2038	$	5,155,000

The Company has the right to redeem the trust preferred securities in whole or in part, on or after March 26, 2013. If the trust preferred securities are redeemed on or after March 26, 2013, the redemption price will be 100% of the principal amount plus accrued and unpaid interest. In addition, the Company may redeem the trust preferred securities in whole (but not in part) at any time within 90 days following the occurrence of a tax event, an investment company event or a capital treatment event at a special redemption price (as defined in the indenture).

Note 8. IMPAIRED LOANS

We had impaired loans of $14.8 million at June 30, 2008. Of those loans $1.9 million had specific reserves of $745,000 at June 30, 2008. Loans classified as impaired with no specific reserve totaled $12.9 million for the same period. The average recorded balance of impaired loans was $3.9 million for the period ending June 30, 2008. The interest accrued but not recognized on non-accrual loans was $197,000 for the period ended June 30, 2008.

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

GENERAL

Introduction

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

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

Recent Developments

On June 25, 2008, the Company declared a cash dividend of $.05 per share on its common stock, payable July 23, 2008 to shareholders of record on July 09, 2008.

The Company also announced a stock repurchase plan on June 25, 2008. The plan grants the Company authority to repurchase up to 10% of the Company’s shares over the course of one year and can be rescinded at any time.

10

CHANGES IN FINANCIAL CONDITION

Total Assets

At June 30, 2008, total assets were $511.9 million compared to $506.0 million at December 31, 2007, and $456.9 million at June 30, 2007 representing a 12.0 percent year over year increase.

Investment Securities

Investment securities totaled $58.4 million at June 30, 2008, compared to $60.7 million at December 31, 2007 and $64.6 million at June 30, 2007. Total investments decreased $2.3 million or 3.8 percent from December 31, 2007 and $6.2 million or 9.6 percent from June 30, 2007. The Company held one security that was classified as held to maturity at June 30, 2008.

The investment portfolio includes U.S. Government Agency bonds, mortgage-backed securities, corporate bonds, municipal bonds, and treasuries and debt securities.

Loans and Allowance for Loan Losses

At June 30, 2008, the loan portfolio totaled $406.7 million and represented 79.4 percent of total assets compared to $395.0 million or 78.1 percent of total assets at December 31, 2007 and $355.8 million or 77.9 percent of total assets at June 30, 2007. Total loans increased $11.7 million from December 31, 2007 and $50.9 million or 14.3 percent from June 30, 2007. Real estate loans constituted approximately 69.1 percent of the loan portfolio, and commercial loans comprised approximately 27.2 percent of the total loan portfolio at June 30, 2008.

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

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

The allowance for loan loss has increased substantially from June 30, 2007 primarily due to management’s evaluation of necessary specific reserves for impaired loans.

The following table describes the activity in our allowance for loan losses for the six-month periods ended June 30, 2008 and 2007.

11

	Six-months ended June 30,
	2008			2007
	(dollars in thousands)
Balance at beginning of period	$	4,245		$	3,732
Provision for loan losses		1,095			474
Charge-offs		(876	)		(805	)
Recoveries of loans previously charged-off		74			24
Balance at end of period	$	4,538		$	3,425
Ratio of allowance for loan losses to total loans at end of period		1.12	%		0.96	%

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

The following table summarizes information regarding our nonaccrual loans, other real estate owned, and certain other repossessed assets and loans, as of June 30, 2008 and December 31, 2007. On those dates, we had no loans categorized as troubled debt restructuring within the meaning of SFAS 15.

	June 30, 2008			December 31, 2007
	(dollars in thousands)
Loans accounted for on a nonaccrual basis:
Real estate loans:
Mortgage	$	31		$	—
Commercial		3,318			300
Construction		850			—
Home Equity		—			—
Commercial business and consumers		6,164			248
Total nonaccrual loans		10,363			548
Accruing loans, which are contractually past due 90 days or more		1,644			6,661
Total non-performing loans		12,007			7,209
Other real estate owned, net		2,432			2,528
Total non-performing assets	$	14,439		$	9,737
Non-performing loans as a percentage of net loans		2.99	%		1.82	%
Total non-performing assets as a percentage of total assets		2.82	%		1.92	%

The Company’s non-performing assets were $14.4 million at June 30, 2008, or 3.0% of net loans. While the reported amount is at a historically high level, it includes one credit relationship of approximately $4.9 million for which 75% of any loss incurred by the Bank is guaranteed by the US Department of Agriculture. Presently the Bank expects no significant loss with regard to that particular credit. Excluding this credit, non-performing assets would amount to $9.5 million, or 2.3% of outstanding loans.

12

Deposits

The Company’s deposit services include business and individual checking accounts, savings accounts, NOW accounts, certificates of deposit and money market checking accounts. At June 30, 2008, total deposits were $414.3 million compared to $421.9 million at December 31, 2007 and $387.0 million at June 30, 2007. These figures represent a decrease of 1.8 percent over December 31, 2007 and an increase of 7.1 percent over June 30, 2007. At June 30, 2008, time deposits of $100,000 and over made up approximately 37.0 percent of total deposits versus 43.5 percent at December 31, 2007 and 36.8 percent at June 30, 2007. Our deposits are generated primarily within our banking market. However, the Company had $67.1 million in brokered deposits at June 30, 2008 compared to $97.1 million at December 31, 2007 and $68.0 million at June 31, 2007.

Liquidity

Liquidity management is the process of managing assets and liabilities as well as their maturities to insure adequate funding for loan and deposit activity as well as continued growth of the Company. Sources of funding come from both the asset and liability side of the balance sheet. Asset side sources include cash and cash equivalents, federal funds sold and unpledged available for sale securities. These totaled $62.1 million at June 30, 2008 and $67.0 million at December 31, 2007. Liquidity sources from liabilities include deposits and lines of credit with other institutions. These sources are largely affected by our ability to attract and maintain deposits. Our deposits, together with equity capital, funded 88.7 percent of total assets at June 30, 2008. The Company has borrowing lines available from various correspondent banks and the Federal Home Loan Bank of Atlanta (FHLB) for short-term or long-term funding. At June 30, 2008, the Company had total borrowings of $41.0 million from the FHLB, with maturity dates on these borrowings extending through 2013. A blanket lien on loans secured by residential 1-4 family dwellings, qualifying non-residential loans and home equity lines of credit is in place with the FHLB to secure these advances. The Company closely monitors and evaluates its overall liquidity position. The Company believes its liquidity position at June 30, 2008 is adequate to meet its operating needs.

Interest Rate Sensitivity

Fluctuating interest rates, increased competition and changes in the regulatory environment continue to significantly affect the importance of interest-rate sensitivity management. Rate sensitivity arises when interest rates on assets change in a different period of time or in a different proportion to interest rates on liabilities. The primary objective of interest-rate sensitivity management is to prudently structure the balance sheet so that movements of interest rates on assets and liabilities are highly correlated and produce a reasonable net interest margin even in periods of volatile interest rates. The Company uses an asset/liability simulation model to project potential changes to the Company’s net interest margin, net income, and economic value of equity based on simulated changes to market interest rates, namely the prime rate. The Company is slightly liability sensitive over the next twelve months, which means that interest-earning liabilities could re-price more quickly than interest bearing assets. Theoretically, the Company’s net interest margin will decline if market interest rates rise or improve if market interest rates fall.

Capital Adequacy

Regulatory guidelines require banks to hold minimum levels of capital based upon the risk weighting of certain categories of assets as well as any off-balance sheet contingencies. Federal regulators have adopted risk-based capital and leverage capital guidelines for measuring the adequacy of a bank’s capital, and all applicable capital standards must be satisfied for us to be considered in compliance with regulatory requirements. On June 30, 2008, the Bank’s Total Capital Ratio and Tier 1 Capital Ratio were 10.97 percent and 9.92 percent, respectively, which were well above the minimum levels required by regulatory guidelines. At June 30, 2008, the Bank’s Leverage Capital Ratio was 8.41 percent, which was also well above the minimum level required by the regulatory guidelines. Banks are placed into one of four capital categories based on the above three separate capital ratios. The four categories are “well-capitalized”, “adequately capitalized”, “under-capitalized”, and “critically under-capitalized.” The Company is considered “well-capitalized” as of June 30, 2008.

RESULTS OF OPERATIONS

Three-Month Period Ended June 30, 2008 and June 30, 2007

The Company had a net loss of $259,000 or $(0.07) per diluted share for the three-month period ended June 30, 2008 while reporting income of $592,000 or $.15 per diluted share for the three-month period ended June 30, 2007.

13

Net interest income, or the difference between income generated by earning assets (primarily loans, investment securities, and interest-bearing balances) and the expense incurred on interest bearing liabilities (primarily deposits and borrowed funds used to fund earning assets), is the Company’s primary source of earnings. The Company’s net interest income for the three-month period ended June 30, 2008 and 2007 was $3.2 million and $3.6 million, respectively. The decrease was primarily attributable to a decrease in interest income on loans, which was in large part due to several loans that were placed in non-accrual status during the quarter as well as the continued effects of the Federal Reserve’s rate cuts of 325 basis points since September 2007.

The loan loss provision increased $369,000 in the second quarter of 2008 and was mainly due to an increase in non-performing assets as well as the identification of specific impairment on loans identified by management as has been previously discussed.

Interest expense for the three-month period ending June 30, 2008 was $4.2 million compared to $4.6 million during the same period in 2007. This decrease of $418,000 or 9.1% was primarily attributable to an increase in more cost effective savings deposits during the period.

Non-interest income was $518,000 for the three-months compared to $472,000 for the three-month period ended June 30, 2007. The non-interest income total includes service charges on deposit accounts, bank owned life insurance, and mortgage broker fees. The $46,000 period over period increase was largely the result of an $81,000 increase in income from customer service fees in conjunction with a $50,000 decrease in investment services income. The Company experienced growth in non-interest income of 9.7% for the three month periods ended June 30, 2008 versus 2007.

Non-interest expense was $3.3 million for the three-months ended June 30, 2008, compared to $2.8 million for the same period in 2007 an increase of $512,000 or 18.4 percent. Salaries and benefits increased $384,000, occupancy expense increased $60,000 and other non-interest expense increased $68,000 for the current year period. The increased salary and benefit and occupancy expense levels are comprised of normal salary adjustments plus increased staffing and occupancy costs associated with two banking offices opened in mid-2007.

The Company accrued a tax benefit of $138,000 for the three months ended June 30, 2008 based on the loss in the quarter. This compares to tax expense of $244,000 in the second quarter of 2007.

Six-Month Period Ended June 30, 2008 and June 30, 2007

The Company had net loss of $264,000 or $.07 per diluted share for the six-month period ended June 30, 2008 and net income $1,372,000 or $.35 per diluted share for the six-month period ended June 30, 2007.

Net interest income, or the difference between income generated by earning assets (primarily loans, investment securities, and interest-bearing balances) and the expense incurred on interest bearing liabilities (primarily deposits and borrowed funds used to fund earning assets), is the Company’s primary source of earnings. The Company’s net interest income for the six-month period ended June 30, 2008 and 2007 was $6.4 million and $7.1 million, respectively.

Interest expense for the six-month period ending June 30, 2008 was $8.9 million compared to $9.1 million during the same period in 2007. The $294,000 decrease left the Company relatively flat year over year.

Principal factors leading to the decrease in net income for the six-month period ended in 2008, relative to 2007, was a decline in the Company’s net interest income, an increase in the provision for loan losses and increased non-interest expense. For the six-month period ended in 2008, the net interest margin declined to 2.75% from 3.35% in 2007. For the six-month period ended June 30, 2008, approximately $197,000 or 15.0% of the decline in our net interest margin was attributable to the loss of income associated with non-accrual loans. The provision for loan losses increased $621,000 from the previous year primarily due to charge offs and the identification of impaired loans by Bank’s management.

Non-interest income was $970,000 for the six-months compared to $901,000 for the six-month period ended June 30, 2007. The non-interest income total includes service charges on deposit accounts, bank owned life insurance, and mortgage broker fees. The $70,000 year over year increase was largely a result of $137,000 increase in customer service fees in conjunction with an $84,000 decrease in income from our investment services division.

14

Non-interest expense was $6.7 million for the six-months ended June 30, 2008, compared to $5.6 million for the same period in 2007 an increase of $1,106,000 or 19.9 percent. Salaries and benefits increased $761,000, occupancy expense increased $141,000 and other non-interest expense increased $204,000 for the current year period. The increased salary and benefit and occupancy expense levels are comprised of normal salary adjustments plus increased staffing and occupancy costs associated with two banking offices opened in mid-2007.

The bank accrued a tax benefit of $138,000 for the six months ending June 30, 2008 compared to tax expense of $613,000 for the same time period in 2007. The tax benefit was a result of the Company’s loss for the six month period.

DISCLOSURES ABOUT FORWARD LOOKING STATEMENTS

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

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable

Item 4. CONTROLS AND PROCEDURES

The Company’s management, under the supervision and with the participation of its Chief Executive Officer and Principal Financial Officer, has evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures in accordance with Rule 13a-15 of the Securities Exchange Act of 1934 (the “Exchange Act”). Based on their evaluation, the Chief Executive Officer and Principal Financial Officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective to provide reasonable assurance that it is able to record, process, summarize and report in a timely manner the information required to be disclosed in reports it filed under the Exchange Act.

In connection with the above evaluation of the effectiveness of the Company’s disclosure controls and procedures, no change in the Company’s internal control over financial reporting was identified that occurred during the most recent quarterly period and that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

15

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

None

Item 1A. Risk Factors

Not applicable

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

None

Item 3. Defaults Upon Senior Securities.

None

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

The Company’s annual meeting of shareholders was held on May 28, 2008. At the meeting, the shareholders:

• elected 14 directors for terms of one year each; and

• voted on a proposal to amend our articles of Incorporation to authorize the issuance of preferred stock.

Name of Nominee or Description of Other Matter Voted On	Shares Voted “For”	Shares “Withheld” or Voted “Against”	Shares Abstained	Broker “NonVotes”
Election of Directors
Jerry W. Anderson	3,003,513	90,466	N/A	N/A
Alan M. Bailey	3,003,513	90,466	N/A	N/A
William A. Burnette	3,001,785	92,194	N/A	N/A
John A. Drye	3,002,113	91,866	N/A	N/A
Thomas G. Fleming	3,017,103	76,876	N/A	N/A
John W. Googe	3,003,129	90,850	N/A	N/A
Henry H. Land	3,002,113	91,866	N/A	N/A
Michel D. Larrowe	3,002,113	91,866	N/A	N/A
Steven G. Laymon	3,015,375	78,604	N/A	N/A
Robert E. Marziano	3,019,044	74,935	N/A	N/A
Grady L. McClamrock, Jr.	3,003,513	90,466	N/A	N/A
Lynne S. Safrit	3,003,513	90,466	N/A	N/A
Francis W. Slate	3,003,129	90,850	N/A	N/A
Stephen R. Talbert	2,977,162	116,817	N/A	N/A
Proposal to Approve an Amendment to the Company’s Articles of Incorporation to Authorize the Issuance of Preferred Stock	1,680,088	543,989	24,683	845,219

16

Item 5. Other Information

None

Item 6. Exhibits

The following exhibits are being furnished or filed with this report.

3.01	The Company’s Articles of Incorporation, as amended (filed herewith)
10.01	Resignation and Consultation Agreement and Release between the Bank and Eric E. Rhodes (filed herewith)
31.01	Certification of Chief Executive Officer pursuant to Rule 13a-14(a) (furnished herewith)
31.02	Certification of Principal Financial Officer pursuant to Rule 13a-14(a) (furnished herewith)
32.01	Certification of our Chief Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350 (furnished herewith)

17

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	BANK OF THE CAROLINAS CORPORATION
Date: August 14, 2008	By:	/s/ Robert E. Marziano
		Robert E. Marziano
		President and Chief Executive Officer
Date: August 14, 2008	By:	/s/ Michelle L. Clodfelter
		Michelle L. Clodfelter
		Vice President and Principal Financial Officer

18

EXHIBIT INDEX

Exhibit Number	Description
3.01	The Company’s Articles of Incorporation, as amended (filed herewith)
10.01	Resignation and Consultation Agreement and Release between the Bank and Eric E. Rhodes (filed herewith)
31.01	Certification of our Chief Executive Officer pursuant to Rule 13a-14(a) (furnished herewith)
31.02	Certification of our Principal Financial Officer pursuant to Rule 13a-14(a) (furnished herewith)
32.01	Certifications of our Chief Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350 (furnished herewith)

19

EX-3.01

Exhibit 3.01

SOSID: 848466

Date Filed: 5/30/2006 8:17:00 AM

Elaine F. Marshall

North Carolina Secretary of State

C200614600523

ARTICLES OF INCORPORATION

OF

BANK OF THE CAROLINAS CORPORATION

The undersigned entity hereby makes and acknowledges these Articles of Incorporation for the purpose of forming a business corporation under and by virtue of the laws of the State of North Carolina as contained in Chapter 55 of the General Statutes of North Carolina and the several amendments thereto, and to that end hereby does set forth that:

1. The name of the corporation is BANK OF THE CAROLINAS CORPORATION.

2. The corporation shall have authority to issue 15,000,000 shares of common stock, all of one class and having a par value of $5.00 per share.

3. The street address and mailing address of the corporation’s initial registered office in Davie County, North Carolina, is 135 Boxwood Village Drive, Mocksville, North Carolina 27028, and the name of the corporation’s initial registered agent at that address is Robert E. Marziano.

4. To the fullest extent permitted by the North Carolina Business Corporation Act as it exists or may hereafter be amended, no person who is serving or who has served as a director of the corporation shall be personally liable to the corporation or any of its shareholders or otherwise for monetary damages for breach of any duty as a director. No amendment or repeal of this article, nor the adoption of any provision to these Articles of Incorporation inconsistent with this Article 4, shall eliminate or reduce the protection granted herein with respect to any matter that occurred prior to such amendment, repeal, or adoption. This provision shall not affect any charter or by-law provision or contract or resolution of the Corporation indemnifying or agreeing to indemnify a director against personal liability.

5. The name and address of the incorporator is Bank of the Carolinas, 135 Boxwood Village Drive, Mocksville, North Carolina 27028.

IN TESTIMONY WHEREOF, the undersigned has caused this instrument properly to be executed in its name, this the 25th day of May, 2006.

BANK OF THE CAROLINAS
By:	/S/ Robert E. Marziano
	Robert E. Marziano
	Chairman and Chief Executive Officer

SOSID: 0848466

Date Filed: 8/17/2006 2:48:00 PM

Elaine F. Marshall

North Carolina Secretary of State

C200622900370

ARTICLES OF SHARE EXCHANGE

BETWEEN

BANK OF THE CAROLINAS CORPORATION

AND

BANK OF THE CAROLINAS

Pursuant to § 55-11-05 of the General Statutues of North Carolina, the undersigned corporation hereby submits the following Articles of Share Exchange as the acquiring corporation in a share exchange between a North Carolina business corporation and a North Carolina banking corporation.

1. The name of the acquiring corporation is BANK OF THE CAROLINAS CORPORATION, a business corporation organized under the laws of North Carolina.

2. The name of the corporation whose shares are being acquired is BANK OF THE CAROLINAS, a banking corporation organized under the laws of North Carolina.

3. The Plan of Share Exchange has been duly approved by the corporation whose shares are being acquired and by the acquiring corporation in the manner required by law.

4. These Articles of Share Exchange will become effective at 5:01 o’clock P.M. on August 18, 2006.

This the 15th day of August, 2006.

BANK OF THE CAROLINAS CORPORATION
By:	/s/ Robert E. Marziano
	Robert E. Marziano
	Chairman, President and Chief Executive Officer

SOSID: 0848466

Date Filed: 7/7/2008 5:59:00 PM

Elaine F. Marshall

North Carolina Secretary of State

C200818500321

ARTICLES OF AMENDMENT

TO

ARTICLES OF INCORPORATION

OF

BANK OF THE CAROLINAS CORPORATION

The undersigned corporation hereby submits these Articles of Amendment for the purpose of amending its Articles of Incorporation:

1. The name of the corporation is BANK OF THE CAROLINAS CORPORATION.

2. The text of the amendment to the Articles of Incorporation adopted as of the 28th day of May, 2008, and approved by the shareholders of the corporation, as required by Chapter 55 of the North Carolina General Statutes, is as follows:

The Articles of Incorporation of the corporation are hereby amended by deleting Section 2 in its entirety and inserting in lieu thereof the following new Section 2:

“2. The aggregate number of shares which the corporation shall have the authority to issue is 18,000,000 shares divided into two classes. The designation, par value and number of shares of each class are as follows:

Class	Par Value	Number of Shares
Common Stock	$5.00	15,000,000
Preferred Stock	No Par	3,000,000
Total Shares		18,000,000

The corporation’s Board of Directors shall be authorized to issue shares of Preferred Stock from time to time, to create series thereof, and to determine the designations, terms, relative rights, preferences, and limitations of the Preferred Stock, or of shares within each series of Preferred Stock, at the time of issuance, all by its resolution. Without limiting the generality of the foregoing authority, the Board of Directors shall be authorized to fix and determine:

(a) the designation of each series and the number of shares to constitute each series (which number may be increased or decreased from time to time unless otherwise provided by the Board of Directors);

(b) the dividend rate (or method of determining such rate), if any; any conditions on which and times at which dividends are payable; any preference or relation which such dividends shall bear to the dividends payable on any other class or classes or any other series of capital stock, including Preferred Stock; whether such dividends shall be cumulative or non-cumulative; and whether the Preferred Stock will be participating or nonparticipating with other shares with respect to dividends;

(c) whether shares within a series will be redeemable (at the option of the corporation or the holders of such shares or both, or upon the happening of a specified event) and, if so, the redemption prices and the conditions and times upon which redemption may take place and whether for cash, property, or rights, including securities of the corporation or of another corporation;

(d) the terms and amount of any sinking, retirement, or purchase fund;

(e) with respect to each series, the conversion or exchange rights (at the option of the corporation or the holders of such shares or both, or upon the happening of a specified event), if any, including the conversion or exchange times, prices, rates, adjustments, and other terms of conversion or exchange;

(f) the voting rights, if any (other than any voting rights that the Preferred Stock may have as a matter of law);

(g) any restrictions on the issuance or reissuance of additional Preferred Stock;

(h) with respect to each series, the rights of the holders upon voluntary or involuntary liquidation, dissolution or winding up of the affairs of the corporation, including any preferences over the common stock or any other class or classes or any other series of capital stock, including Preferred Stock, and whether the Preferred Stock will be participating or nonparticipating with other shares with respect to distributions of the corporation’s assets;

(i) any limitations or restrictions on transfer; and

(j) with respect to each series, such other special rights and privileges, if any, for the benefit of the holders of, or other terms or limitations with respect to, the shares within that series as shall not be inconsistent with the provisions of the corporation’s Articles of Incorporation, as amended, or applicable law.

All shares of Preferred Stock of the same series shall be identical in all respects, except that shares of any one series issued at different times may differ as to dates, if any, from which dividends thereon may accumulate. The number, designations, terms, relative rights, preferences, and limitations of shares within any one series may differ from those of shares within any other series. All shares of Preferred Stock redeemed, purchased or otherwise acquired by the corporation (including shares surrendered for conversion) shall be canceled and thereupon restored to the status of authorized but unissued shares of Preferred Stock undesignated as to series.

3. This document shall be effective upon filing.”

This the 24th day of June, 2008.

BANK OF THE CAROLINAS CORPORATION
By:	/s/ Robert E. Marziano
	Robert E. Marziano
	Chairman and Chief Executive Officer

EX-10.01

Exhibit 10.01

STATE OF NORTH CAROLINA

COUNTY OF DAVIE

RESIGNATION AND

CONSULTATION AGREEMENT

AND RELEASE

THIS RESIGNATION AND CONSULTATION AGREEMENT AND RELEASE (the “Agreement”) is made and entered into by and between BANK OF THE CAROLINAS (the “Bank”); and ERIC E. RHODES (“Rhodes”);

W I T N E S S E T H:

WHEREAS, Rhodes is employed by the Bank as Senior Vice President and Chief Financial Officer, and serves as Vice President and Chief Financial Officer of the Bank’s parent company, Bank of the Carolinas Corporation (“BCC”); and

WHEREAS, Rhodes has notified the Bank and BCC that he wishes to resign from these positions, effective May 30, 2008 (the “Resignation Date”), and the parties have reached an arrangement as to such resignation, as evidenced in this Agreement; and

WHEREAS, the Bank desires to assure itself of Rhodes’ availability during the period following his resignation to assist in the transition of his duties to a new or interim chief financial officer and, for that purpose, the Bank and Rhodes have negotiated an agreement pursuant to which Rhodes shall, after the Resignation Date, perform certain services and provide support, advice, and counsel from time-to-time to the Bank’s and BCC’s management on an as needed basis; and

WHEREAS, an agreement has been reached between Rhodes and the Bank concerning certain other matters as contained herein, and the Bank and Rhodes hereby desire to set forth the terms and conditions thereof in writing.

NOW, THEREFORE, for and in consideration of the mutual covenants and agreements contained in this Agreement, and for other good and valuable considerations, the receipt and sufficiency of which hereby are acknowledged, the Bank and Rhodes agree as follows:

1. RESIGNATION. Rhodes hereby resigns from his positions with the Bank and BCC. Rhodes’ employment shall terminate on the Resignation Date, and Rhodes shall have no further authority as an employee or agent of the Bank or BCC. Rhodes specifically recognizes and agrees that this Agreement is a full and complete resolution, settlement, and termination of any rights or claims that Rhodes may have had, or alleges to have had, to any further employment with the Bank, its subsidiaries, or affiliates following the Resignation Date, including but not limited to BCC.

2. SALARY AND VACATION PAY. The Bank shall pay to Rhodes his normal salary, plus the amount of his accrued but unused vacation leave, less normal deductions and withholdings, through and as of the Resignation Date, and agrees to provide further special payments and consideration to Rhodes as set forth below.

3. CONSULTING SERVICES AND PAYMENTS.

(a) Effective as of the Resignation Date and continuing until August 31, 2008 (the “Consulting Period”), Rhodes shall become an independent contractor and consultant to the Bank and BCC and provide support, advice, and counsel to the Bank’s and BCC’s management on an as-needed basis on matters related to his former responsibilities as an officer and employee of the Bank and an officer of BCC and to the transition of his duties to a new or interim chief financial officer; provided, however, that the Consulting Period shall terminate immediately in the event Rhodes revokes the release provisions of this Agreement pursuant to Paragraph 7. Rhodes shall not be obligated to provide consulting services for more than ten hours per calendar week during the Consulting Period, and, at his option, he may provide those services at such location, including his home, as he shall determine from time to time. To the extent that all or any portion of the consulting services are provided on the Bank’s premises, the Bank will provide Rhodes with office space, computer access and such other support services as shall reasonably be needed in order to provide the services requested by the Bank.

(b) As consideration for the consulting services to be provided by Rhodes, and for the other terms and conditions of this Agreement, including but not limited to the provisions of Paragraph 6 (Covenant of Nondisclosure) and Paragraph 7 (Release), during the Consulting Period the Bank shall pay to Rhodes the amount of $9,660.00 per full calendar month, beginning June 1, 2008, for each of the three full calendar months during the Consulting Period (the “Consulting Payments”); provided, however, that Rhodes shall be entitled to only a pro rata portion of such Consulting Payments in the event the Consulting Period is terminated early pursuant to Paragraph 3(a). The Consulting Payments will be due and payable monthly, in arrears, on the last business day of each calendar month, as applicable.

Rhodes acknowledges that no withholdings shall be made from the Consulting Payments, and Rhodes hereby agrees that he shall be solely responsible for all taxes, insurance, penalties, and other charges, if any, which may be owed to or assessed by governmental agencies as a result of the payments paid to him pursuant to this Paragraph 3. Rhodes further agrees to indemnify and hold harmless the Bank and its attorneys from any claims, demands, deficiencies, levies, assessments, judgments, or recoveries by any governmental authority asserted against the Bank because of Rhodes’ failure to pay applicable taxes.

4. INSURANCE CONTINUATION. Rhodes acknowledges and agrees that, upon the Resignation Date, he shall no longer be eligible for any benefits, including but not limited to insurance, which are available to employees of the Bank. Rhodes may elect to continue his group insurance coverage in accordance with provisions of the Consolidated Omnibus Budget Reconciliation Act (“COBRA”); provided, however, that Rhodes shall be solely responsible for the payment of the premiums of such coverage.

5. TERMINATION/CONTINUATION OF CERTAIN RIGHTS AND BENEFITS. Rhodes recognizes and agrees that payment of his salary, payment for accrued but unused vacation leave, and payment of the Consulting Payments, as described in Paragraphs 2 and 3 of this Agreement, are in full settlement of any wages and benefits owing to Rhodes through the Resignation Date. Except for Rhodes’ rights and benefits under this Agreement and his vested rights under the Bank’s Section 401(k) plan, all of Rhodes’ employment rights, wages, and benefits with the Bank, and all subsidiaries and affiliates of the Bank, including but not limited to BCC, shall, to the extent permitted by law, terminate and be forfeited as of the Resignation Date, including, without limitation, his eligibility for further payment of any salary, vacation, personal leave, sick leave, severance pay, bonuses, or any other amounts. Rhodes further recognizes and agrees that payment of his salary, payment for accrued but unused vacation leave, and payment of the Consulting Payments by the Bank, are not to be construed as an admission of any liability on the part of the Bank or its subsidiaries or affiliates, and that the Bank has denied and denies any violation of any law and any liability, and intends by such payments simply to recognize Rhodes’ service prior to the Resignation Date, his consulting services to be rendered, and his agreements contained herein.

6. COVENANT OF NONDISCLOSURE. During the course of Rhodes’ employment with the Bank, Rhodes has been given and has obtained various confidential and material non-public information concerning the Bank, BCC, their subsidiaries and affiliates, the shareholders, directors, officers, associates, employees, and agents of said entities, and their customers, prospective customers, services, trade secrets, proprietary information, personnel information, and other information concerning their operations, business and financial condition and results (collectively, the “Information”), all of which constitute valuable assets and privileged information of the Bank and BCC, and which Information is particularly sensitive due to the fiduciary responsibilities and public trust inherent in the Bank’s business and the public trading market for BCC’s common stock. The Bank and Rhodes acknowledge that the Bank has invested, and shall continue to invest, considerable amounts of time, effort, and resources in developing such valuable assets and Information, that BCC and its officers and directors are subject to various federal laws and regulations regarding the orderly disclosure of material information, and that disclosure by Rhodes of such assets and Information to the public or to any other person or entity, regardless of how insignificant such assets or Information may seem, would cause irreparable harm, damage, and loss to the Bank and BCC.

To protect the Bank and BCC from Rhodes’ use, disclosure, or exploitation of customer contacts and the Information, Rhodes agrees that Rhodes shall not, directly or indirectly, at any time after the Resignation Date, for any reason, reveal, divulge, disclose, or communicate to any person, corporation, firm, or other entity or to any shareholder, director, officer, partner, member, manager, employee, agent, or associate of any such person, corporation, firm, or other entity, any confidential, sensitive, or personal information, proprietary information, trade secret, or other information whatsoever, including but not limited to the Information, about or received by Rhodes from the Bank, BCC, or their subsidiaries or affiliates, developed or received by Rhodes during employment with the Bank, BCC, or their subsidiaries or affiliates, or developed or received by Rhodes during the course of Rhodes’ association with the Bank, BCC, or their subsidiaries or affiliates, relating to the operations, business or financial condition or results of the Bank, BCC, or their subsidiaries or affiliates, or the business or personal affairs of the shareholders, directors, officers, associates, employees, agents, or attorneys of said entities, including, without limitation,

information concerning customer and prospective customer records, personnel information, ideas, proprietary information, methods, marketing investigations, surveys, research, accounting information, regulatory examinations, and other like or similar information, unless required to do so by law or by a court of competent jurisdiction. Further, Rhodes shall not use the Information to the detriment of the Bank, BCC, their subsidiaries or affiliates, or the principals, shareholders, directors, officers, associates, or employees of said entities, particularly in any manner competitive with the Bank or BCC, in any unlawful manner, or to interfere with or attempt to terminate or otherwise adversely affect any business relationship of the Bank or BCC with a customer.

7. RELEASE. Except for Rhodes’ specific contractual rights and benefits under this Agreement and except as prohibited by law, Rhodes hereby releases, acquits, quitclaims, and discharges the Bank, any subsidiaries or affiliates of the Bank, and their respective successors and assigns, and the shareholders, directors, officers, associates, employees, agents, attorneys, benefit plans, and plan administrators of all of said entities, and their respective successors and assigns (collectively, the “Releasees”), of and from any and all actions, causes of action, claims, demands, damages, costs (including reasonable attorneys’ fees), loss of services, expenses, and compensation, and for all consequential, compensatory, actual, punitive, or liquidated damages, known or unknown, including those under the Age Discrimination in Employment Act, 29 U.S.C. § 621 et seq., on account of, or in any way arising from the employment or any other relationship between Rhodes and the Bank, and any and all collateral matters pertaining thereto, whether directly, indirectly, or in any way connected with any Releasee. As part of the consideration for this Agreement, Rhodes agrees that, to the extent permitted by law and except as otherwise required by law, neither Rhodes nor any of his heirs, legal representatives, or assigns will make or file any claim, charge, or lawsuit, or cooperate voluntarily in any investigation, lawsuit, or legal or administrative proceeding by any individual, entity, or agency, against or involving any Releasee, for or on account of any claim Rhodes may have or may have had against any Releasee in connection with Rhodes’ employment or any other relationship with the Bank, the matters referenced above, and/or the cessation of Rhodes’ employment with the Bank. Rhodes further agrees that, except as prohibited by law, Rhodes will waive and release any and all personal damages (including but not limited to damages relating to pain and suffering, back pay, and compensatory and/or punitive damages) resulting from any charge filed with or investigation conducted by the Equal Employment Opportunity Commission or any other administrative agency in connection with Rhodes’ employment or any other relationship with the Bank.

Rhodes understands and agrees that with respect to any rights or claims of Rhodes under the Age Discrimination in Employment Act, 29 U.S.C. § 621 et seq. (the “Act”): (a) no rights or claims are waived by Rhodes that may arise from an event or transaction that occurs after the date this Agreement is executed by Rhodes; (b) Rhodes has been advised in writing to consult with an attorney prior to executing this Agreement; (c) Rhodes has been advised that he has twenty-one (21) days from his receipt of this Agreement, unless extended in writing by the Bank, to consider the release provisions of this Agreement; (d) Rhodes has been advised that he has seven (7) days following his execution of this Agreement to revoke the release provisions of this Agreement pertaining to any right or claim under the Act; and (e) the release provisions of this Agreement pertaining to any right or claim under the Act shall not become effective or enforceable until the revocation period of seven (7) days following Rhodes’ execution hereof has expired (the “Effective Date”).

8. FORFEITURE OF STOCK OPTIONS. Rhodes hereby acknowledges and agrees that his resignation is voluntary and that, pursuant to the terms of the Bank’s Employee Stock Option Plan, such voluntary resignation shall result in the immediate forfeiture of all outstanding stock options currently held by Rhodes, whether vested or unvested.

9. ENTIRE UNDERSTANDING/AMENDMENTS. This Agreement contains the entire understanding between the Bank and Rhodes as to the matters contained herein, and no conditions precedent or subsequent exist which are not contained herein. This Agreement may not be altered, amended, or revoked except by a written agreement signed by the Bank and Rhodes.

10. BINDING EFFECT. The Bank and Rhodes recognize and agree that this Agreement is binding upon the Bank and Rhodes and its/Rhodes’ respective heirs, representatives, successors, and assigns, as applicable. Rhodes further acknowledges that Rhodes has carefully read this Agreement, which contains a release, and knows and understands the contents hereof and voluntarily executes the same as Rhodes’ free act and deed, and that the provisions contained herein constitute the entire agreement between the parties hereto, and that the terms of this Agreement are contractual and not a mere recital.

11. GOVERNING LAW AND VENUE. The Bank and Rhodes agree that without regard to principles of conflicts of laws, the internal laws of the State of North Carolina shall govern and control the validity, interpretation, performance, and enforcement of this Agreement. The Bank and Rhodes agree that any action relating to this Agreement shall be instituted and prosecuted only in the courts of Davie County, North Carolina or the federal courts of the Middle District of North Carolina, and the Bank and Rhodes hereby consent to the jurisdiction of such courts and waive any right or defense relating to venue and jurisdiction over the person.

12. SEVERABILITY. The invalidity or unenforceability of any particular provision of this Agreement shall not affect the other provisions hereof, and this Agreement shall be construed in all respects as if such invalid or unenforceable provision were not contained herein.

13. ASSIGNMENT. The Bank may assign this Agreement to any other corporation or entity acquiring all or substantially all of the assets of the Bank, or to any other corporation or entity into which or with which the Bank may be merged or consolidated. Upon such assignment, merger, or consolidation, the rights of the Bank under this Agreement, as well as the obligations and liabilities of the Bank herein, shall inure to the benefit of and be binding upon any and all successors-in-interest or transferees of all or substantially all of the assets of the Bank. This Agreement is not assignable in any respect by Rhodes.

14. HEADINGS. The headings appearing in this Agreement are for convenience only and are not to be considered in interpreting this Agreement.

IN TESTIMONY WHEREOF, the Bank has caused this instrument to be executed under seal by its duly authorized officer in pursuance of authority duly given by its Board of Directors, and Rhodes has hereunto set his hand and adopted as his seal the typewritten word “SEAL” appearing beside his name, all effective as of the Effective Date.

BANK OF THE CAROLINAS
By:	/S/ Robert E. Marziano
	Robert E. Marziano, Chief Executive Officer
ERIC E. RHODES:
/S/ Eric E. Rhodes		(SEAL)
Eric E. Rhodes
5-19-08
Date of Execution by Rhodes

EX-31.01

Exhibit 31.01

CERTIFICATION

(Pursuant to Rule 13a-14(a))

I, Robert E. Marziano, certify that:

1. I have reviewed this Quarterly Report on Form 10-Q of Bank of the Carolinas 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 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 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 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 14, 2008	/s/ Robert E. Marziano
	Robert E. Marziano
	President and Chief Executive Officer

EX-31.02

Exhibit 31.02

CERTIFICATION

(Pursuant to Rule 13a-14(a))

I, Michelle L. Clodfelter, certify that:

1. I have reviewed this Quarterly Report on Form 10-Q of Bank of the Carolinas 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 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 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 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 14, 2008	/s/ Michelle L. Clodfelter
	Michelle L. Clodfelter
	Vice President and Principal Financial Officer

EX-32.01

Exhibit 32.01

CERTIFICATIONS

(Pursuant to 18 U.S.C. Section 1350)

The undersigned hereby certifies that (i) the foregoing Quarterly Report on Form 10-Q filed by Bank of the Carolinas Corporation (the “Registrant”) for the quarter ended June 30, 2007, fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and (ii) the information contained in that Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant.

Date: August 14, 2008	/s/ Robert E. Marziano
	Robert E. Marziano
	President and Chief Executive Officer
Date: August 14, 2008	/s/ Michelle L. Clodfelter
	Michelle L. Clodfelter
	Vice President and Principal Financial Officer