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 September 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 non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

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

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

On November 12, 2008 there were 3,891,174 outstanding shares of the registrant’s common stock.

BANK OF THE CAROLINAS CORPORATION

FORM 10-Q

September 30, 2008

INDEX

Part I. FINANCIAL INFORMATION
Item 1.   Consolidated Financial Statements
Consolidated Balance Sheets at September 30, 2008 and December 31, 2007	3
Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2008 and 2007	4
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2008 and 2007	5
Consolidated Statements of Changes in Shareholders’ Equity for the Nine Months Ended September 30, 2008 and 2007	6
Notes to Consolidated Financial Statements	6
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations	10
Item 3.   Quantitative and Qualitative Disclosure about Market Risk	16
Item 4.   Controls and Procedures	17
Part II. OTHER INFORMATION
Item 1.   Legal Proceedings	18
Item 1A.Risk Factors	18
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds	18
Item 3.   Defaults Upon Senior Securities	18
Item 4.   Submission of Matters to a Vote of Security Holders	19
Item 5.   Other Information	19
Item 6.   Exhibits	19
SIGNATURES	20
EXHIBIT INDEX	21

PART 1. FINANCIAL INFORMATION

Item 1. Financial Statements

Bank of the Carolinas Corporation

Consolidated Balance Sheets

(In thousands, except share and per share data)

	September 30 2008			December 31 2007*
	(Unaudited)
Assets
Cash and due from banks	$	12,734		$	8,192
Interest-bearing deposits in banks		10,407			12,756
Securities held to maturity		4,500			—
Securities available for sale		102,087			60,717
Loans		406,886			395,052
Less, Allowance for loan losses		(4,218	)		(4,245	)
Total Loans, net		402,668			390,807
Premises and equipment		15,245			13,888
Accrued interest receivable		3,057			3,239
Other real estate owned		5,155			2,528
Deferred tax assets		722			578
Goodwill		—			591
Bank owned life insurance		9,556			9,283
Other assets		4,739			3,419
Total assets	$	570,870		$	505,998
Liabilities and Shareholders’ Equity
Deposits:
Non-interest bearing demand deposits	$	33,303		$	29,835
Interest bearing demand deposits		198,203			62,883
Savings deposits		22,259			19,655
Large denomination time deposits		98,764			174,181
Other time deposits		100,067			135,374
Total deposits		452,596			421,928
Borrowings		25,000			34,000
Subordinated debt		7,855			—
Federal funds purchased and repurchase agreements		47,369			7,657
Other liabilities		1,750			2,173
Total liabilities		534,570			465,758
Commitments and contingencies (Note 3)
Shareholders’ Equity:
Preferred stock, No par value: authorized 3,000,000 shares: none issued	$	—		$	—
Common stock, par value $5 per share: 15,000,000 shares authorized; Issued and outstanding 3,891,174 shares in 2008 and 3,920,752 in 2007		19,456			19,604
Additional paid-in capital		11,593			11,716
Retained earnings		4,902			8,476
Accumulated other comprehensive income		349			444
Total shareholders’ equity		36,300			40,240
Total liabilities and shareholders’ equity	$	570,870		$	505,998

* Derived from audited consolidated financial statements.

See accompanying notes.

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Bank of the Carolinas Corporation

Consolidated Statements of Operations

(Unaudited)

(In thousands, except per share data)

	Three Months Ended September 30					Nine Months Ended September 30
	2008			2007		2008			2007
Interest Income
Interest and fees on loans	$	6,268		$	7,659	$	19,962		$	22,253
Interest on securities		1,202			757		2,638			2,070
Interest on federal funds sold		59			22		173			383
Interest on deposits in banks		2			4		8			9
Total interest income		7,531			8,442		22,781			24,715
Interest Expense
Interest on deposits		3,764			4,296		11,958			12,857
Interest on borrowed funds		757			333		1,418			921
Total interest expense		4,521			4,629		13,376			13,778
Net Interest Income		3,010			3,813		9,405			10,937
Provision for loan losses		3,150			546		4,245			1,020
Net interest income (loss) after provision for loan losses		(140	)		3,267		5,160			9,917
Non-interest income
Customer service fees		337			259		976			761
Mortgage loan broker fees		44			78		111			140
Investment services		3			99		18			198
Income from bank owned life insurance		93			89		273			257
Other income		(7	)		29		62			99
Total non-interest income		470			554		1,440			1,455
Noninterest Expense
Salaries and benefits		1,764			1,543		5,460			4,478
Occupancy and equipment		502			447		1,482			1,286
Goodwill impairment		591			—		591			—
Data processing expense		216			185		638			561
Other		1,067			794		2,641			2,210
Total non-interest expense		4,140			2,969		10,812			8,535
Income (Loss) before income taxes		(3,810	)		852		(4,212	)		2,837
Income taxes		(1,090	)		247		(1,228	)		860
Net Income (Loss)	$	(2,720	)	$	605	$	(2,984	)	$	1,977
Earnings (Loss) Per Share
Basic	$	(0.69	)	$	0.16	$	(0.76	)	$	0.52
Diluted	$	(0.69	)	$	0.15	$	(0.76	)	$	0.50
Dividends Declared	$	0.05		$	0.05	$	0.15		$	0.15

See accompanying notes.

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Bank of the Carolinas Corporation

Consolidated Statements of Cash Flows

(Unaudited)

(In thousands)

	Nine Months Ended September 30, 2008			Nine Months Ended September 30, 2007
Cash Flows from Operating Activities:
Net income (loss)	$	(2,984	)	$	1,977
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Provision for loan losses		4,245			1,020
Stock based compensation expense		17			16
Depreciation and amortization		675			538
Loss on sale of other real estate owned		151			7
Loss on disposal of premises and equipment		33			3
Income from bank owned life insurance		(273	)		(257	)
Net amortization/accretion of premiums and discounts on investments		23			50
Net change in other assets		(1,570	)		(1,301	)
Net change in other liabilities		(421	)		(12	)
Net cash provided (used) by operating activities		(104	)		2,041
Cash Flows from Investing Activities:
Decrease in federal funds sold		—			2,229
Purchases of premises and equipment		(1,396	)		(2,683	)
Purchases of securities		(64,980	)		(22,057	)
Proceeds from sales, calls, maturities and principal repayments of securities available for sale		18,939			14,070
Sale of FHLB stock		313			142
Improvement of other real estate owned		(12	)		(10	)
Proceeds from the sale of other real estate owned		1,542			602
Proceeds from sale of premises and equipment		8			—
Net Increase in loans		(20,474	)		(24,299	)
Net cash used in investing activities		(66,060	)		(32,006	)
Cash Flows from Financing Activities:
Net increase in deposits		30,668			27,718
Net originations (repayments) of other borrowings		(16,358	)		(4,000	)
Issuance of subordinated debt		7,700			—
Increase in repurchase agreements		47,225			—
Proceeds from exercise of stock options		424			269
Tax effect of stock options exercised		10			44
Common stock acquired		(722	)		—
Cash dividends paid		(590	)		(576	)
Net cash provided by financing activities		68,357			23,455
Net increase (decrease) in cash and cash equivalents		2,193			(6,510	)
Cash and cash equivalents at beginning of period		20,948			13,403
Cash and cash equivalents at end of period	$	23,141		$	6,893
Supplemental disclosure of cash flow information:
Cash paid during the period for interest	$	14,124		$	13,834
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	$	95		$	204
Dividends declared		199			193
Transfer from loans to other real estate owned		4,985			1,509
Transfer from OREO to premises and equipment		677			—

See accompanying notes.

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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	42,270			211			58									269
Current Income tax benefit on options exercised							44									44
Stock based compensation expense							16									16
Cash dividends declared ($.15 per share)										(578	)					(578	)
Comprehensive income:
Net income										1,977						1,977
Other comprehensive loss													204			204
Total comprehensive income																2,181
Balance, September 30, 2007	3,869,062		$	19,345		$	11,562		$	8,692		$	47		$	39,646
Balance, December 31, 2007	3,920,752		$	19,604		$	11,716		$	8,476		$	444		$	40,240
Stock options exercised	66,622			333			91									424
Repurchased shares	(96,200	)		(481	)		(241	)								(722	)
Current Income tax benefit on options exercised							10									10
Stock based compensation expense							17									17
Cash dividends declared ($.15 per share)										(590	)					(590	)
Comprehensive loss:
Net loss										(2,984	)					(2,984	)
Other comprehensive loss													(95	)		(95	)
Total comprehensive loss																(3,079	)
Balance, September 30, 2008	3,891,174		$	19,456		$	11,593		$	4,902		$	349		$	36,300

See accompanying notes

Notes to Consolidated Financial Statements

September 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 nine month periods ended September 30, 2008 and 2007, in conformity with accounting principles generally accepted in the United States of America.

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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 nine month periods ended September 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 (loss) 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:

	Nine months ended September 30,
	2008	2007
Weighted average number of common shares oustanding used to calculate basic earnings per share	3,941,582	3,841,070
Additional potential common shares due to stock options	—	104,172
Weighted average number of common shares outstanding used to calculate diluted earnings per share	3,941,582	3,945,242
	Three months ended September 30,
	2008	2007
Weighted average number of common shares oustanding used to calculate basic earnings per share	3,936,649	3,856,660
Additional potential common shares due to stock options	—	83,445
Weighted average number of common shares outstanding used to calculate diluted earnings per share	3,936,649	3,940,105

There were 30,063 shares for the three month and 40,455 shares for the nine month period ended September 30, 2008 that are anti-dilutive due to the net loss for the three and nine 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

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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 September 30, 2008, outstanding financial instruments whose contract amounts represent credit risk were approximately:

	(in thousands)
Loan commitments	$	60,624
Letters of credit	$	2,585

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 (loss). Accounting principles do not require per share amounts of comprehensive income (loss) to be disclosed. The information that follows reconciles net income (loss) to comprehensive income (loss).

	Three-months ended September 30,					Nine-months ended September 30,
	2008			2007		2008			2007
(In thousands)
Net Income (loss)	$	(2,720	)	$	605	$	(2,984	)	$	1,977
Net unrealized gain (loss) on AFS securities, net of taxes		166			405		(95	)		204
Comprehensive income (loss)	$	(2,554	)	$	1,010	$	(3,079	)	$	2,181

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 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 9/30/2008		Level 1		Level 2		Level 3
(In thousands)
Assets valued on a recurring basis
AFS securities	$	102,087	$	—	$	102,087		—
Assets valued on a non-recurring basis
Impaired loans		3,086		—		3,086		—
Total	$	105,173	$	—		105,173	$	—

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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).

The Company also has $2.7 dollars of private placement subordinated debt at a rate of Prime plus 75 basis points. The Company has the right to repay the debt at any time with no prepayment penalty. The debt was issued on August 13, 2008 and matures on August 13, 2018. The Company makes monthly interest payments on the outstanding debt to the holder of the note.

Note 8. IMPAIRED LOANS

We had impaired loans of $9.6 million at September 30, 2008. Of those loans $245 thousand had specific reserves of $103 thousand at September 30, 2008. Loans classified as impaired with no specific reserve totaled $9.3 million for the same period. Included in the $9.3 million impaired balance is $4.1 million in two impaired loans that are backed by a USDA guarantee. These loans have been charged down to the guaranteed amount and the Company expects no further losses on these loans. Without these two loans, our impaired loan balance would have been $5.2 million at September 30, 2008. The average recorded balance of impaired loans was $3.8 million for the period ending September 30, 2008. The interest accrued but not recognized on non-accrual loans was $809,000 for the nine months ended September 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.

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Recent Developments

On September 24, 2008, the Company declared a cash dividend of $ .05 per share on its common stock, payable October 23, 2008 to shareholders of record on October 09, 2008.

In an effort to stabilize the credit system the government has implemented a capital infusion program in which the nation’s nine largest financial institutions are required to participate. The Treasury has earmarked $250 billion of the $700 billion Economic Stabilization Act as a capital infusion for banks. Of that $250 billion, the largest banks will receive $125 billion with the rest being spread amongst the remainder of the nation’s institutions. This infusion is intended to stimulate the credit markets and restore confidence in the financial system. In order to preserve our options, the Corporation has applied for the Treasury’s TARP Capital Purchase program which would allow the Corporation to receive a capital infusion of between 1 and 3 percent of its risk weighted assets while we will continue to evaluate whether we can appropriately utilize these funds.

CHANGES IN FINANCIAL CONDITION

Total Assets

At September 30, 2008, total assets were $570.8 million compared to $506.0 million at December 31, 2007, and $480.2 million at September 30, 2007 representing a 18.9% percent year over year increase.

Investment Securities

Investment securities totaled $106.6 million at September 30, 2008, compared to $60.7 million at December 31, 2007 and $64.0 million at September 30, 2007. Total investments increased $45.9 million or 75.6 percent from December 31, 2007 and $42.6 million or 66.6 percent from September 30, 2007. The Company held $4.5 million of securities that were classified as held to maturity at September 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 September 30, 2008, the loan portfolio totaled $406.9 million and represented 71.3 percent of total assets compared to $395.0 million or 78.1 percent of total assets at December 31, 2007 and $376.6 million or 78.4 percent of total assets at September 30, 2007. Total loans increased $11.9 million or 3.0 percent from December 31, 2007 and $30.3 million or 8.0 percent from September 30, 2007. Real estate loans (including commercial real estate) constituted approximately 75.8 percent of the loan portfolio, and commercial loans comprised approximately 21.5 percent of the total loan portfolio at September 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.

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The provision for loan losses has increased substantially from September 30, 2007 primarily due to specific charge-offs related to several commercial credits. The majority of the impaired loan balance without a specific associated reserve is tied to two large credits of which the remaining balance is backed by a USDA guarantee. The Company has not made nor does it hold any subprime loans. However, we have been affected by the economic downturn in several of our markets. The significant write-offs in the third quarter are a reflection of this downturn and our intention to write troubled credits down to their current realizable value. We continue to work with our customers with troubled credit relationships to the extent that it is reasonably possible. The Company has historically been aggressive in identifying and recording losses as we believe they are necessary and these charges reflect that continued philosophy. Our allowance for loan loss as a percentage of loans is essentially unchanged from last year as a result of these aggressive charge offs rather than making specific reserves for problem loans.

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

	Nine-months ended September 30,
	2008			2007
	(dollars in thousands)
Balance at beginning of period	$	4,245		$	3,732
Provision for loan losses		4,245			1,020
Charge-offs		(4,450	)		(1,006	)
Recoveries of loans previously charged-off		178			32
Balance at end of period	$	4,218		$	3,778
Ratio of allowance for loan losses to total loans at end of period		1.04	%		1.00	%

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 September 30, 2008 and December 31, 2007. On those dates, we had no loans categorized as troubled debt restructuring within the meaning of SFAS 15.

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	September 30, 2008			December 31, 2007
	(dollars in thousands)
Loans accounted for on a nonaccrual basis:
Real estate loans:
Mortgage	$	—		$	—
Commercial		1,528			300
Construction		285			—
Home Equity		—			—
Commercial business and consumers		5,357			248
Total nonaccrual loans		7,170			548
Accruing loans, which are contractually past due 90 days or more		2,746			6,661
Total non-performing loans		9,916			7,209
Other real estate owned, net		5,155			2,528
Total non-performing assets	$	15,071		$	9,737
Non-performing loans as a percentage of net loans		2.28	%		1.82	%
Total non-performing assets as a percentage of total assets		2.64	%		1.92	%

The Company’s non-performing assets were $15.1 million at September 30, 2008, or 2.46% of net loans. As has been previously discussed, while the reported amount is at a historically high level it includes one credit relationship of approximately $4.1 million for which any remaining loss incurred by the Company is guaranteed by the US Department of Agriculture. It also includes a $2.2 million loan related to an A&D property in Chimney Rock, NC. The Company believes it can sell the property at the current book value but it may take some time to find a qualified interested buyer. The Company also has several rental property loans outstanding to one borrower, all of the properties are occupied and are not sub-prime loans, but due to borrower’s current delinquent status the Company has found it necessary to begin foreclosure proceedings. These loans total $794,000.

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 September 30, 2008, total deposits were $452.6 million compared to $421.9 million at December 31, 2007 and $410.4 million at September 30, 2007. These figures represent an increase of 7.2 percent over December 31, 2007 and an increase of 10.3 percent over September 30, 2007. While the Company’s overall deposits have increased over the period, the mix of deposits has also changed substantially. Our Company has increased its focus on developing long term relationships with our clients and as a result our core deposits have increased significantly over the period. At September 30, 2008, time deposits of $100,000 and over made up approximately 22.1 percent of total deposits versus 43.5 percent at December 31, 2007 and 39.1 percent at September 30, 2007. Our deposits are generated primarily within our banking market. However, the Company had $39.6 million in brokered deposits at September 30, 2008 compared to $97.1 million at December 31, 2007 and $89.2 million at September 30, 2007. The Company has chosen to intentionally roll off significant amounts of brokered deposits during the period in an effort to reduce our reliance on this funding source.

The Company has focused on developing long term relationships with its customers through establishing core deposit relationships, particularly through increased money market and savings accounts. This focus is evidenced through the substantial year over year increase in these deposits. The Company believes that this strategy will result in an increase in our net interest margin through the addition of long term profitable relationships with our expanded customer base.

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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 $60.2 million at September 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 85.6% percent of total assets at September 30, 2008. The Company has $20.5 million in borrowing lines available from various correspondent banks and $57.5 million at the Federal Home Loan Bank of Atlanta (FHLB) for short-term or long-term funding. At September 30, 2008, the Company had total borrowings of $25 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 September 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 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.

During the quarter the Company entered into two separate term repurchase agreements, totaling $45 million. The agreements were offset by purchases of mortgage backed securities which were pledged against these agreements. The Company primarily entered into these agreements in an effort to protect itself against customers’ possible inability to maintain their current loan structure in an increasing rate environment.

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 September 30, 2008, the Bank’s Total Capital Ratio and Tier 1 Capital Ratio were 10.44 percent and 9.44 percent, respectively, which were well above the minimum levels required by regulatory guidelines. At September 30, 2008, the Bank’s Leverage Capital Ratio was 8.04 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 September 30, 2008.

RESULTS OF OPERATIONS

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

The Company had a net loss of $2.7 million or $(.69) per diluted share for the three-month period ended September 30, 2008 while reporting income of $605,000 or $0.15 per diluted share for the three-month period ended September 30, 2007.

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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 September 30, 2008 and 2007 was $3.0 million and $3.8 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 $2.6 million in the third quarter of 2008 and was mainly due to specific charge-offs related to several troubled commercial credits. As previously discussed, the Company has no subprime loans and has taken aggressive measures to write down troubled credits to their net realizable values.

Interest expense for the three-month period ending September 30, 2008 was $4.5 million compared to $4.6 million during the same period in 2007. This decrease of $109,000 or 2.3% was primarily attributable to an increase in more cost effective savings deposits during the period as well as some benefit from the Fed’s rate reductions over the time period.

Non-interest income was $470,000 for the three-months compared to $554,000 for the three-month period ended September 30, 2007. The non-interest income total includes service charges on deposit accounts, bank owned life insurance, and mortgage broker fees. The $84,000 period over period decrease was largely the result of a $34,000 decrease in income from mortgage loan broker fees as well as a $96,000 decrease in revenue from our investment services division. The Company experienced a decline in non-interest income of 15.2% for the three month periods ended September 30, 2008 versus 2007.

Non-interest expense was $4.1 million for the three-months ended September 30, 2008, compared to $3.0 million for the same period in 2007, an increase of $1.2 million or 39.4 percent. Salaries and benefits increased $221,000, occupancy expense increased $55,000 and other non-interest expense increased $304,000 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 also took a $591,000 charge related to the impairment of our goodwill; reducing our intangible assets to zero. The write-down of goodwill is a non-cash charge that did not affect the Company’s liquidity or operations. Goodwill is deducted from regulatory capital therefore the charge had no effect on the regulatory capital ratios of the Company.

The Company accrued a tax benefit of $1.1 million for the three months ended September 30, 2008 based on the loss in the quarter. This compares to tax expense of $247,000 in the second quarter of 2007. The effective tax benefit for the period ending September 30, 2008 was 29.2% and the effective tax rate at September 30, 2007 was 30.3%. These changes are due to the Company’s loss during the quarter.

Nine-Month Period Ended September 30, 2008 and September 30, 2007

The Company had net loss of $3.0 million or ($.76) per diluted share for the nine-month period ended September 30, 2008 and net income of $2.0 million or $.50 per diluted share for the nine-month period ended September 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 nine-month period ended September 30, 2008 and 2007 was $9.4 million and $10.9 million, respectively.

Interest expense for the nine-month period ending September 30, 2008 was $13.4 million compared to $13.8 million during the same period in 2007. The $402,000 decrease resulted from lower market interest rates offset by increased deposits and borrowings.

Principal factors leading to the decrease in net income for the nine-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 nine-month period ended in 2008, the net interest margin declined to 2.62% from 3.40% in 2007. For the nine-month period ended September 30, 2008, approximately $809,000 or 28.2% 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 $3.2 million from the previous year primarily due to charge offs and the identification of impaired loans by Bank’s management.

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Non-interest income was $1,440,000 for the nine-months compared to $1,455,000 for the nine-month period ended September 30, 2007. The non-interest income total includes service charges on deposit accounts, bank owned life insurance, and mortgage broker fees. The $15,000 year over year difference was virtually unchanged from the same period in 2007. During the period there was a $215,000 increase in customer service fees while income from our investment services division decreased by $180,000.

Non-interest expense was $10.8 million for the nine-months ended September 30, 2008, compared to $8.5 million for the same period in 2007 an increase of $2.3 million or 26.7 percent. While non-interest expense has increased on an annualized basis it has decreased from 2.63% to 2.35% of assets during 2008; a result of the Company’s continuing focus on expense control. Salaries and benefits increased $982,000, occupancy expense increased $196,000 and other non-interest expense increased $508,000 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. As was previously stated in the three month discussion the Company charged off $591,000 related to goodwill impairment during the third quarter of 2008. The write-down was a non-cash charge and did not affect the Company’s liquidity or operations. It also had no effect on the Company’s regulatory ratios.

The Company accrued a tax benefit of $1,228,000 for the nine months ending September 30, 2008 compared to tax expense of $860,000 for the same time period in 2007. The effective tax benefit for the nine months ended September 30, 2008 was 29.9% as compared to a tax rate of 30.3% for the nine months ended September 30, 2007. The tax benefit was a result of the Company’s loss for the nine-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) pressures on the earnings, capital and liquidity of financial institutions resulting from current and future adverse conditions in the credit and equity markets and the banking industry in general, (b) our ability to manage and collect our non-performing loans and dispose of other real estate owned, (c) 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; (d) the financial success or changing strategies of the Company’s customers; (e) actions of government regulators, or changes in laws, regulations or accounting standards, that adversely affect the Company’s business; (f) 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; (g) changes in general economic or business conditions and real estate values in the Company’s banking markets (particularly changes that affect the Company’s loan portfolio, the abilities of its borrowers to repay their loans, and the values of loan collateral); and (h) 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

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Item 4. CONTROLS AND PROCEDURES

The Company’s management, under the supervision and with the participation of its Chief Executive Officer and 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.

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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

ISSUER REPURCHASES OF EQUITY SECURITIES

Period	(a) Total Number of Shares Purchased	(b) Average Price Paid Per Share (1)		(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (2)	(d) Maximum Number of Shares That May Yet Be Purchased Under the Plans or Programs (2)
Month #1 7/01/08 through 07/31/08	12,900	$	7.78	12,900	385,837
Month #2 08/01/08 through 08/31/08	65,800	$	7.48	65,800	320,037
Month #3 09/01/08 through 09/30/08	17,500	$	7.10	17,500	302,537
Total	96,200	$	7.45	96,200	302,537

(1) Reflects weighted average price paid per share.

(2) On June 27, 2008, the Company announced that its Board of Directors had authorized the repurchase of up to 398,737 shares of the Company’s outstanding common stock during the following year in the open market, in block purchases, or in solicited or unsolicited privately negotiated transactions, in accordance with the SEC’s rules and subject to factors such as market price, the Company’s operating results and available cash, general economic and market conditions, and other conditions. In conjunction with the Board’s authorization, the Company entered into a stock trading plan in accordance with guidelines specified under Rule 10b5-1 of the Securities and Exchange Act of 1934. The Board’s actions approving share repurchases did not obligate the Company to acquire any particular amount of shares, and purchases could be suspended or discontinued at any time at the Company’s discretion. Although the Board’s action authorizing the Company to repurchase shares remains in effect, during September 2008, the Company suspended the stock purchase plan.

Item 3. Defaults Upon Senior Securities.

None

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

None

Item 5. Other Information

None

Item 6. Exhibits

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

10.01	Employment Agreement between Bank of the Carolinas and Michael D. Larrowe (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)

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SIGNATURES

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

BANK OF THE CAROLINAS CORPORATION

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

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EXHIBIT INDEX

Exhibit Number	Description
10.01	Employment Agreement between Bank of the Carolinas and Michael D. Larrowe (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)

21

EX-10.01

Exhibit 10.01

STATE OF NORTH CAROLINA

COUNTY OF DAVIE

EMPLOYMENT AGREEMENT

THIS EMPLOYMENT AGREEMENT (the “Agreement”) is entered into as of 4th day of August, 2008 (the “Effective Date”), by and between BANK OF THE CAROLINAS (the “Bank”) and MICHAEL D. LARROWE (“Employee”).

WITNESSETH:

WHEREAS, Employee was employed as the Bank’s Executive Vice Chairman effective on May 12, 2008; and,

WHEREAS, Employee’s experience and knowledge of the Bank’s operations, customers, and affairs, and his knowledge of and standing and reputation in the Bank’s market area, will be of continuing benefit to the Bank in the future; and, for that reason, the Bank desires for Employee to continue as an employee of the Bank for the Term of Employment specified below and to restrict Employee’s ability to compete against the Bank in the Bank’s banking markets for a reasonable period following any termination of Employee’s employment; and,

WHEREAS, Employee desires to remain as an employee of the Bank and to accept the Bank’s offer of continued employment on the basis described herein; and,

WHEREAS, the Bank and Employee desire to set forth the terms and conditions of Employee’s continued employment with the Bank in a written agreement and, for that purpose, the Bank and Employee have agreed to enter into this Agreement.

NOW, THEREFORE, in consideration of the premises and mutual promises, covenants, and conditions hereinafter set forth, including without limitation the significant benefits described in Paragraphs 6 and 8 which Employee hereby acknowledges and agrees he would not be entitled to but for this Agreement, and for other good and valuable considerations, the receipt and sufficiency of which hereby are acknowledged, the Bank and Employee hereby agree as follows:

1. Employment. The Bank agrees to continue to employ Employee, and Employee accepts such continued employment with the Bank, upon the terms and conditions stated herein. As an employee of the Bank, Employee will (a) serve as Executive Vice Chairman of the Bank and/or in such other or additional executive position or positions as shall be specified from time to time by the Bank’s Board of Directors, (b) promote the Bank and its business and engage in business development activities on the Bank’s behalf, and (c) have such functional managerial duties and responsibilities as shall be assigned to him by the Bank from time to time.

2. Term. Unless sooner terminated as provided in this Agreement, and subject to the right of either Employee or the Bank to terminate Employee’s employment at any time as provided herein, the term of Employee’s employment with the Bank under this Agreement (the “Term of Employment”) shall begin on July 22, 2008 and be for a continually renewing period of three (3) years, with the effect that on July 22, 2009, and on July 22 of each year thereafter to and including July 22, 2020, and without any further action by the Bank or Employee, the Term of Employment automatically shall be extended by one additional year such that the then current unexpired Term of Employment under this Agreement will be extended to again be three (3) years; provided, however, that either party may prevent the Term of Employment from renewing or extending by giving written notice to the other at least 90 days prior to the renewal date indicating that party’s intention not to renew/extend this Agreement. In that event, the Term of Employment shall expire at the end of the then-current unexpired term. Upon the extension that occurs on July 22, 2020, if applicable, the Term of Employment shall become a fixed three (3) years, shall not be further extended, and shall expire at the close of the Bank’s business on July 22, 2023. If, following the date of expiration, Employee remains employed by the Bank, such employment shall be on an “at will” basis.

3. Cash Compensation. For all services rendered by Employee to the Bank under this Agreement, during the Term of Employment the Bank shall pay Employee a base salary at an annual rate of TWO HUNDRED FIFTY THOUSAND AND NO/100S DOLLARS ($250,000) (“Base Salary”).

As an executive officer of the Bank, Employee shall be eligible to participate in the Bank’s Management Incentive Program for any bonus opportunities. Employee’s Base Salary may be increased from time to time during the Term of Employment at the discretion of the Bank’s Board of Directors. Base Salary paid under this Agreement shall be payable not less frequently than monthly in accordance with the Bank’s payroll policies and procedures.

4. Employee Benefit Plans; Fringe Benefits; Income Taxes; Expenses.

(a) Benefit Plans. During the Term of Employment, Employee shall be eligible to participate in any and all employee benefit programs maintained by or for the Bank that are generally available to and which cover all the Bank’s officers at Employee’s job level or classification, subject to the rules applicable to such plans or programs prevailing from time to time. Except as otherwise specifically provided herein, Employee’s participation in such plans and programs shall be subject to and in accordance with the terms and conditions (including eligibility requirements) of such plans and programs, resolutions of the Bank’s Board of Directors establishing such programs and plans, and the Bank’s normal practices and established policies regarding such plans and programs.

Employee acknowledges that the terms and provisions of the Bank’s employee benefit plans and programs from time to time may be determined only by reading the actual plan documents under which the Bank or the plan administrator, as applicable, may make certain administrative determinations with discretion, and that the Bank reserves the right to modify or terminate each plan or program and any benefits provided thereunder.

(b) Annual Vacation Leave. During the Term of Employment, all matters pertaining to the entitlement to, and the accrual and scheduling of, vacation leave shall be determined under the Bank’s standard leave policies and procedures in effect from time to time; provided, however, that the minimum amount of annual vacation leave to which Employee shall be entitled shall be three weeks or, if longer, the number of weeks provided for in those policies and procedures for persons in Employee’s position or job classification.

(c) Income Taxes. All cash payments or other compensation payable or provided to Employee under this Agreement shall be subject to customary withholding of taxes and such other deductions or withholdings as are required by law or customary for the Bank’s employees. Employee shall be solely responsible for any income taxes owed on account of his receipt from the Bank of any such payments or any employee or fringe benefits under this Agreement and, to the extent that the Bank reasonably believes itself obligated to do so, the Bank may withhold any such taxes from cash compensation or other payments payable to Employee.

(d) Expense Reimbursement; Professional Dues. Subject to the conditions described below, during the Term of Employment the Bank shall reimburse Employee for (i) reasonable business expenses incurred by Employee in the performance of his duties under this Agreement, provided that those expenses are of a type that are reimbursable under employee expense reimbursement policies adopted by the Bank from time to time, and (ii) fees required to be paid to Virginia, North Carolina, West Virginia, South Carolina and Tennessee state licensing boards, and reasonable out-of-pocket expenses associated with mandatory continuing professional education, in each such case to the extent required in order to renew and maintain in effect his licenses to practice in those states as a certified public accountant, and dues paid to maintain his memberships in the American Institute of Certified Public Accountants and the corresponding state professional associations in each of the above states. As a condition of reimbursement for any of the above, Employee shall promptly submit verification of the nature and amount of such expenses in accordance with the Bank’s reimbursement policies and in sufficient detail to comply with rules and regulations promulgated by the Internal Revenue Service. Reimbursement for expenses shall be determined separately for each tax year, and without regard to the amount of reimbursement for any other tax year, and must be requested and paid no later than the end of the calendar year following the year during which the expenses were incurred.

5. Standards of Performance and Conduct. During the Term of Employment, Employee faithfully and diligently shall discharge his obligations under this Agreement, and he shall perform the duties associated with his positions with the Bank in a manner which is reasonably competent and satisfactory to the Bank, and Employee shall comply with and use his best efforts to implement the Bank’s policies and procedures currently in effect or as are established from time to time by the Bank.

In the execution of his employment duties under this Agreement, Employee shall, at all times and in all material respects, comply with any code of conduct or ethics policies applicable to Employee and/or the Bank’s employees in general in effect as of the Effective Date or as may be adopted, amended or supplemented from time to time subsequent thereto (the “Code of Conduct”), and with all federal and state statutes, and all rules, regulations, administrative orders, statements of policy, and other pronouncements or standards promulgated thereunder, which are applicable to the Bank and its employees, business, and operations.

6. Termination and Termination Pay.

(a) By Employee without Good Reason. The Term of Employment and Employee’s employment under this Agreement may be terminated at any time by Employee upon 90 days’ written notice (the “Notice Period”) to the Bank. The Bank, in its sole discretion, may elect for Employee not to serve out part or all of the Notice Period. Upon such termination, Employee shall be entitled to receive compensation earned under this Agreement through the final day of Employee’s active employment and, thereafter, the Bank shall have no further obligations hereunder.

(b) By Employee for Good Reason. The Term of Employment and Employee’s employment under this Agreement may be terminated by Employee at any time for “Good Reason” (as defined below) upon delivery of written notice to the Bank, which notice shall specify the grounds constituting Good Reason. Subject to Paragraph 10 and the conditions set forth in Paragraph 7, if Employee’s employment is terminated under this Paragraph 6(b), the Bank shall be obligated to pay Base Salary to Employee at his then current Base Salary rate for the then current unexpired Term of Employment hereunder (which payments shall be made on the same schedule as Employee’s Base Salary was paid by the Bank during the Term of Employment), and, if Employee chooses to exercise his rights to purchase continued health insurance coverage under the Bank’s health insurance plan pursuant to the Consolidated Omnibus Budget Reconciliation Act (“COBRA”), the Bank shall reimburse Employee for the cost of such continued insurance coverage for the maximum period during which such coverage is available to Employee under COBRA, but not longer than the unexpired Term of Employment hereunder; and, thereafter, the Bank shall have no further obligations hereunder.

For purposes of this Paragraph 6(b), Employee shall have “Good Reason” to terminate his employment upon the occurrence of any of the following without Employee’s consent:

(i) Employee’s Base Salary is reduced below the annual rate set forth in this Agreement or below any higher annual rate in effect from time to time during the Term of Employment as a result of increases made following the date of this Agreement;

(ii) Employee’s employment is changed in any material respect such that Employee no longer serves as an executive officer or in a position with similar duties;

(iii) Employee is transferred to a job location which is more than 50 miles (by most direct highway route) from Mocksville, North Carolina;

(iv) the Bank gives Employee written notice as described in Paragraph 2 above of the Bank’s intent that this Agreement not be renewed or extended on its next renewal date; or

(v) the Bank materially breaches the terms of this Agreement;

provided, however, that the foregoing shall not constitute Good Reason unless Employee provides the Bank with written notice thereof within 90 days of the first occurrence of the condition being claimed to constitute Good Reason, and such condition continues uncorrected for thirty (30) or more days after such written notice.

(c) Death or Retirement. The Term of Employment and Employee’s employment under this Agreement automatically shall be terminated upon his death during the Term of Employment or upon the effective date of Employee’s “Retirement.” Upon any such termination, Employee (or, in the case of Employee’s death, his estate) shall be entitled to receive any compensation Employee shall have earned prior to the date of termination but which remains unpaid.

“Retirement” shall mean any termination of Employee’s employment with the Bank which is treated as a retirement (whether early, normal or delayed retirement) under the terms of any qualified retirement benefit plan generally applicable to the Bank’s salaried employees and in which Employee is a participant, or any other termination of employment that Employee and the Bank mutually agree in writing to treat as a Retirement.

(d) By the Bank with Cause. The Bank may terminate the Term of Employment and Employee’s employment under this Agreement at any time for “Cause” (as defined below). Upon any such termination with Cause, Employee shall be entitled to receive compensation earned under this Agreement through the final day of Employee’s active employment and, thereafter, the Bank shall have no further obligations under this Agreement.

For purposes of this Paragraph 6(d), the Bank shall have “Cause” to terminate Employee’s employment if:

(i) (A) Employee has breached in any material respect any of the terms or conditions of this Agreement, or has failed in any material respect to perform or discharge his duties or responsibilities of employment in the manner provided herein; provided however, that such a breach or failure shall not give the Bank “Cause” to terminate Employee’s employment if such breach or failure is corrected or cured by Employee to the Bank’s reasonable satisfaction (which shall not be unreasonably withheld by the Bank) within 30 days following written notice thereof to Employee, or (B) Employee has breached the Code of Conduct in any material respect, or (C) Employee is engaging or has engaged in willful misconduct or conduct which is detrimental in any material respect to the business or business prospects of the Bank or which has had, or is more likely than not to have, a material adverse effect on the Bank’s business or reputation;

(ii) The material violation by Employee of any applicable federal or state law, or any applicable rule, regulation, order, or statement of policy promulgated by any governmental agency or authority having jurisdiction over the Bank, including but not limited to the North Carolina Commissioner of Banks, the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other regulator (a “Regulatory Authority”), that results from Employee’s negligence, willful misconduct, or intentional disregard of such law, rule, regulation, order, or policy statement and results in any substantial damage, monetary or otherwise, to the Bank or to the Bank’s reputation;

(iii) The commission during the course of Employee’s employment with the Bank of an act of fraud, embezzlement, theft, or proven personal dishonesty (whether or not such act or charge results in criminal indictment, charges, prosecution, or conviction);

(iv) The conviction of Employee of any felony or any criminal offense involving dishonesty or breach of trust, or the occurrence of any event described in Section 19 of the Federal Deposit Insurance Act or any other event or circumstance which disqualifies Employee from serving as an employee or executive officer of, or a party affiliated with, the Bank; or, in the event Employee becomes unacceptable to, or is removed, suspended, or prohibited from participating in the conduct of the Bank’s affairs (or if proceedings for that purpose are commenced), by any Regulatory Authority; or

(v) The exclusion of Employee by the carrier or underwriter from coverage under the Bank’s then current “blanket bond” or other fidelity bond or insurance policy covering its or their directors, officers, or employees, or the occurrence of any event that the Bank believes, in good faith, will result in Employee being excluded from such coverage, or having coverage limited as to Employee as compared to other covered officers or employees, pursuant to the terms and conditions of such “blanket bond” or other fidelity bond or insurance policy.

(e) By the Bank without Cause. The Bank may terminate the Term of Employment and Employee’s employment under this Agreement at any time without Cause. Subject to Paragraph 10 and the conditions set forth in Paragraph 7, if Employee’s employment is terminated under this Paragraph 6(e), the Bank shall be obligated to pay Base Salary to Employee at his then current Base Salary rate for the then current unexpired Term of Employment hereunder (which payments shall be made on the same schedule as Employee’s Base Salary was paid by the Bank during the Term of Employment), and, if Employee chooses to exercise his rights to purchase continued health insurance coverage under the Bank’s health insurance plan pursuant to COBRA, the Bank shall reimburse Employee for the cost of such continued insurance coverage for the maximum period during which such coverage is available to Employee under COBRA, but not longer than the unexpired Term of Employment hereunder; and, thereafter, the Bank shall have no further obligations hereunder.

7. Noncompetition; Nonsolicitation; Confidentiality.

(a) Definitions. For purposes of this Paragraph 7, the following terms shall have the meanings set forth below:

Compete. The term “Compete” means:

(i) acting as an executive officer or in a position with similar duties, whether as a consultant, officer, director, advisory director, independent contractor, or employee, with any Financial Institution that has its main or principal office in the Relevant Market (as defined below), or, in acting in any such capacity with any other Financial Institution, to maintain an office or be employed at or assigned to or to have any direct involvement in the management, supervision, business, marketing activities, or solicitation of business for or operation of any office of such Financial Institution located in the Relevant Market; or

(ii) communicating to any Financial Institution the names or addresses or any financial information concerning any Person who was a Customer of the Bank on the date of termination of Employee’s employment with the Bank.

Customer. The term “Customer of the Bank” means any Person with whom the Bank has a depository or loan relationship, and/or to whom the Bank provides any other service or product.

Financial Institution. The term “Financial Institution” means (i) any federal or state chartered bank, savings bank, savings and loan association, or credit union (a “Depository Institution”), (ii) any holding company for, or corporation that owns or controls, any Depository Institution (a “Holding Company”), (iii) any subsidiary or service corporation of any Depository Institution or Holding Company, or any entity controlled in any way by any Depository Institution or Holding Company, or (iv) any other Person engaged in the business of making loans of any type, soliciting or taking deposits, or providing any other service or product that is provided by the Bank or one of its affiliated corporations.

Person. The term “Person” means any natural person or any corporation, partnership, proprietorship, joint venture, limited liability company, trust, estate, governmental agency or instrumentality, fiduciary, unincorporated association, or other entity.

Relevant Market. The term “Relevant Market” means any county in North Carolina or any other state in which the Bank maintains a business office on the date of any termination of Employee’s employment with the Bank.

Restriction Period. The term “Restriction Period” means the one (1) year period commencing on the effective date of any termination of Employee’s employment with the Bank, whether by Employee or by the Bank, for any reason; provided, however, that in the case of a termination of Employee’s employment pursuant to Paragraph 6(b) or 6(e) above, the Restriction Period shall be the length of the then current unexpired Term of Employment during which the Bank is obligated to continue to pay Base Salary to Employee, but, in such case, the Restriction Period shall immediately expire upon a default by the Bank in making the payments for which it is obligated. Notwithstanding anything contained herein to the contrary, in the event any payment required under Paragraph 6(b) or 6(e) is not made by the Bank by the due date for that payment, the Bank shall not be considered to be in default with respect to that payment for purposes of this Paragraph 7 unless it shall fail to make that payment within ten days after its receipt of written notice from Employee that the payment has not been made.

(b) General. Employee hereby acknowledges and agrees that (i) the Bank has and will continue to make a significant investment in the development of its business in the geographic area identified as the Relevant Market and, as a result, has and will continue to have a valuable economic interest in its business in the Relevant Market which it is entitled to protect; (ii) in the course of his service as an employee of the Bank, Employee will gain substantial knowledge of and familiarity with the Bank’s customers and its dealings with them, and other information concerning the Bank’s businesses, all of which will constitute valuable assets and privileged information belonging to the Bank; and (iii) in order

to protect the Bank’s interest in its business, it is reasonable and necessary to place certain restrictions on Employee’s ability to compete against the Bank and on his disclosure of information about the Bank’s business and customers. For that purpose, and in consideration of the mutual promises, covenants, and conditions set forth in this Agreement, including without limitation the significant benefits described in Paragraphs 6 and 8 which Employee acknowledges and agrees he would not be entitled to but for his agreements contained here, Employee expressly covenants and agrees that Employee shall not do any of the following without the Bank’s prior written consent (which may be withheld in the Bank’s sole discretion).

(c) Covenant Not to Compete. During the Restriction Period, Employee shall not Compete, directly or indirectly, with the Bank.

(d) Covenant of Nonsolicitation. During the Restriction Period, Employee shall not, either directly, indirectly, or through any Person:

(i) solicit any Person who was a Customer of the Bank on the date of termination of Employee’s employment with the Bank and with whom Employee had “Material Contact” (as defined below) on behalf of the Bank within the one-year period immediately preceding the termination of Employee’s employment with the Bank, to become a depositor in or a borrower from any other Financial Institution, to obtain any other service or product from any other Financial Institution, or to change any depository, loan, and/or other banking relationship of the Customer from the Bank to another Financial Institution; or

(ii) employ or seek to employ, or advise or recommend to any other person or business entity that such person/entity employ or seek to employ, any employee of the Bank, or solicit, induce, recruit, or encourage any such employee to leave the Bank’s employment.

For purposes of this Paragraph 7(d), Employee will be deemed to have had “Material Contact” with a Person if, in the course of Employee’s employment with the Bank, Employee obtained Confidential Information (as defined below) concerning the Person, or Employee had personal dealings with the Person regarding matters related to the Bank’s business.

(e) Confidentiality Covenant. Employee covenants and agrees that any and all data, figures, projections, estimates, lists, files, records, documents, manuals, or other such materials or information (whether financial or otherwise, and including any files, data, or information maintained electronically, on microfiche, or otherwise) relating to the Bank and its lending and deposit operations and related business, regulatory examinations, financing sources, financial results and condition, Customers (including lists of Customers and former customers and information regarding their accounts and business dealings with the Bank), prospective customers, contemplated acquisitions (whether of business or assets), ideas, methods, marketing investigations, surveys, research, policies and procedures, computer systems and software, shareholders, employees, officers, and directors (herein referred to as “Confidential Information”) are confidential and proprietary to the Bank and are valuable, special, and unique assets of the Bank’s business which are not directly reproducible from any other source and to which Employee will have access during his employment with the Bank.

Employee agrees that (i) all such Confidential Information shall be considered and kept as the confidential, private, and privileged records and information of the Bank, and (ii) during the Term of Employment and at all times following the termination of this Agreement or his employment for any reason, and except as shall be required in the course of the performance by Employee of his duties on behalf of the Bank or otherwise pursuant to the direct, written authorization of the Bank, Employee will not: divulge any such Confidential Information to any other Person; remove any such Confidential Information in written or other recorded form from the Bank’s premises; or make any use of any Confidential Information for his own purposes or for the benefit of any Person other than the Bank. However, this Paragraph 7(e) shall not apply to any Confidential Information which then is in the public domain (provided that Employee was not responsible, directly or indirectly, for permitting such Confidential Information to enter the public domain without the Bank’s consent), or which is obtained by Employee from a third party which or who is not obligated under an agreement of confidentiality with respect to such information and who did not acquire such Confidential Information in a manner which constituted a violation of the covenants contained in this Paragraph 7(e) or which otherwise breached any duty of confidentiality. Further, the above obligations of confidentiality shall not prohibit the disclosure of any such Confidential Information by Employee to the extent such disclosure is required by subpoena or order of a court or regulatory authority of

competent jurisdiction or to the extent that, in the reasonable opinion of legal counsel to Employee, disclosure otherwise is required by law; provided Employee gives the Bank prior written notice of any such disclosure so that the Bank may seek to contest such disclosure or seek a protective order.

(f) Reasonableness of Restrictions. If any of the restrictions set forth in this Paragraph 7 shall be declared invalid for any reason whatsoever by a court of competent jurisdiction, the validity and enforceability of the remainder of such restrictions shall not thereby be adversely affected. Employee acknowledges that the Bank will have a substantial economic interest in its business in the Relevant Market which this Paragraph 7 specifically is intended to protect, and that the Relevant Market and Restriction Period are limited in scope to the geographic territory and period of time reasonably necessary to protect the Bank’s economic interest and otherwise are reasonable and proper. In the event the Restriction Period or any other such time limitation is deemed to be unreasonable by a court of competent jurisdiction, Employee hereby agrees to submit to such reduction of the Restriction Period as the court shall deem reasonable. In the event the Relevant Market is deemed by a court of competent jurisdiction to be unreasonable, Employee hereby agrees that the Relevant Market shall be reduced by excluding any separately identifiable and geographically severable area necessary to make the remaining geographic restriction reasonable, but this Paragraph 7 shall be enforced as to all other areas included in the Relevant Market which are not so excluded.

(g) Remedies for Breach. Employee understands and acknowledges that a breach or violation by him of any of the covenants contained in this Paragraph 7 shall be deemed a material breach of this Agreement and will cause substantial, immediate, and irreparable injury to the Bank, and that the Bank will have no adequate remedy at law for such breach or violation. In the event of Employee’s actual or threatened breach or violation of the covenants contained in this Paragraph, the Bank shall be entitled to bring a civil action seeking, and shall be entitled to, an injunction restraining Employee from violating or continuing to violate such covenant or from any threatened violation thereof, or for any other legal or equitable relief relating to the breach or violation of such covenant. Employee agrees that, if the Bank institutes any action or proceeding against Employee seeking to enforce any of such covenants or to recover other relief relating to an actual or threatened breach or violation of any of such covenants, Employee shall be deemed to have waived the claim or defense that the Bank has an adequate remedy at law and shall not urge in any such action or proceeding the claim or defense that such a remedy at law exists. However, the exercise by the Bank of any such right, remedy, power, or privilege shall not preclude the Bank or its successors or assigns from pursuing any other remedy or exercising any other right, power, or privilege available to it for any such breach or violation, whether at law or in equity, including the recovery of damages, all of which shall be cumulative and in addition to all other rights, remedies, powers, or privileges of the Bank.

Employee further understands and acknowledges that the Bank’s obligation, if any, for continued payments of Base Salary under Paragraph 6(b) or 6(e) above is conditioned upon Employee’s compliance with covenants contained in this Paragraph 7. In the event of Employee’s actual or threatened breach or violation of the covenants contained in either such Paragraphs, the Bank’s obligation under Paragraph 6(b) or 6(e), if any, shall immediately cease.

Notwithstanding anything contained herein to the contrary, Employee agrees that the provisions of this Paragraph 7 and the remedies provided in this Paragraph 7(g) for a breach by Employee shall be in addition to, and shall not be deemed to supersede or to otherwise restrict, limit, or impair the rights of the Bank under any state or federal law or regulation dealing with or providing a remedy for the wrongful disclosure, misuse, or misappropriation of trade secrets or other proprietary or confidential information.

8. Change in Control of the Bank.

(a) If :

(i) at the effective time of, or any time within 36 months following, a “Change in Control” (as defined below), the Bank terminates Employee’s employment other than for Cause (as defined in Paragraph 6(d) above), or

(ii) at the effective time of, or any time within 365 days following, a “Change in Control” (as defined below), Employee voluntarily terminates his own employment with the Bank, then (subject to the limitations set forth herein, and except as provided below) Employee shall be entitled to receive from the Bank, and the Bank shall be obligated to pay or cause to be paid to Employee, an amount equal to 2.99 multiplied by Employee’s annual Base Salary in effect at the time the Change in Control became effective or in effect at the time the termination of Employee’s employment becomes effective, whichever is greater (and which amount shall be subject to adjustment as provided in Paragraph 8(g) below).

Notwithstanding anything contained in this Paragraph 8(a) to the contrary, in the case of a voluntary termination of Employee’s employment pursuant to Paragraph 8(a)(ii) above, the Bank shall not be obligated to make the above payment to Employee if, at the time of such termination, events have occurred, or circumstances exist, that constitute “Cause” to terminate Employee’s employment as described in Paragraph 6(d) above, other than the circumstances described in Paragraph 6(d)(i)(A).

(b) For purposes of this Agreement, a “Change in Control” shall be deemed to have occurred if:

(i) after the Effective Date, any “Person” (as such term is defined in Sections 3(a)(9) and 13(d)(3) of the Securities Exchange Act of 1934, as amended), directly or indirectly, acquires beneficial ownership of voting stock, or acquires irrevocable proxies or any combination of voting stock and irrevocable proxies, representing more than 50% of any class of voting securities of the Bank or its parent bank holding company, Bank of the Carolinas Corporation (“BankCorp”), or in any manner acquires control of the election of a majority of the directors of the Bank or BankCorp; or

(ii) the Bank or BankCorp consolidates or merges with or into another corporation, or otherwise is reorganized, where the Bank or BankCorp is not the resulting or surviving corporation in such transaction; or

(iii) all or substantially all the Bank’s or BankCorp’s assets are sold or otherwise transferred to or acquired by any other corporation, association or other person, entity, or group.

However, notwithstanding anything contained herein to the contrary, for purposes of this Agreement the term “Change in Control” shall not include a transaction approved by the Bank’s or BankCorp’s Board of Directors that results in the Bank or BankCorp merging with, transferring its assets to, or becoming the subsidiary of, a corporation or entity newly formed at the direction of the Bank’s or BankCorp’s Board of Directors for the purpose of such transaction (including a corporation or entity so formed for the purpose of a corporate reorganization of the Bank or BankCorp, serving as the Bank’s parent bank holding company, or effecting a reincorporation of BankCorp in a different state), and in connection with which transaction BankCorp’s shareholders (other than those who exercise statutory rights of dissent and appraisal) continue to hold substantially all of BankCorp’s voting stock or become the holders of substantially all of the voting stock of any such newly formed corporation. Further, notwithstanding the other provisions of this Paragraph 8, a transaction or event shall not be considered a Change in Control if, prior to the consummation or occurrence of such transaction or event, the Bank and Employee agree in writing that the same shall not be treated as a Change in Control for purposes of this Agreement.

(c) For purposes of this Paragraph 8, all references to the Bank shall include any “Successor” (as defined below) to the Bank which shall have assumed and become liable for the Bank’s obligations hereunder (whether such assumption is by agreement, operation of law, or otherwise). “Successor” refers to any Person or entity (corporate or otherwise) into which the Bank (or any such Successor) shall be merged or consolidated or to which all or substantially all the Bank’s (or any such Successor’s) assets shall be transferred in any manner.

(d) If Employee’s employment is terminated by the Bank without Cause prior to the effective time of a Change in Control, but following, or within 365 days before, the date on which the Bank’s or BankCorp’s Board of Directors takes action to approve an agreement (including any definitive agreement or an agreement in principle) relating to the Change in Control, and if that Change in Control becomes effective, then, for purposes of Paragraph 8(a)(i) of this Agreement, such termination of employment shall be deemed to have occurred at the effective time of the Change in Control.

(e) Subject to Paragraph 10 below, amounts payable pursuant to Paragraph 8(a) shall be paid not later than the 45th day following the “Termination Date” (which, for purposes of this Agreement, will be the effective date of the termination of Employee’s employment which gives rise to the Bank’s payment obligation under this Paragraph 8) or, in the case of a termination described in Paragraph 8(d) above, not later than the 45th day following the effective date of the Change in Control. Such payment shall be in lieu of any other payments provided for in this Agreement (including,

without limitation, the payments provided for in Paragraph 6 above); provided, that in the case of a termination of Employee’s employment described in Paragraph 8(a)(i) above, the Bank shall remain obligated to reimburse Employee for the cost of health insurance coverage to the extent described in Paragraph 6(e). Notwithstanding anything contained in this Agreement to the contrary, in the case of a termination described in Paragraph 8(d) above, the amount payable to Employee under Paragraph 8(a) shall be reduced by the aggregate of any payments previously paid to Employee pursuant to Paragraph 6(e).

(f) In order to become entitled to any payments under Paragraph 8(a)(ii) above, Employee must effectively terminate his employment with the Bank within 365 days from the date of occurrence of the Change in Control which gives rise to his right to terminate. If Employee does not so terminate his employment with the Bank within such 365-day period following the occurrence of a Change in Control, then he thereafter shall have no rights hereunder with respect to that Change in Control but shall retain rights, if any, hereunder with respect to any subsequent Change in Control.

(g) It is the intent of the parties hereto that all payments made pursuant to this Agreement be deductible by the Bank for federal income tax purposes and not result in the imposition of an excise tax on Employee. Notwithstanding anything contained in this Agreement to the contrary, if the Bank reasonably believes, based on the advice of its independent certified public accountants or legal counsel, that the aggregate of the amount of any payments to be made to or for the benefit of Employee under this Agreement, plus the amounts of any other payments or benefits which Employee receives or is deemed to have received as a result of a Change in Control, would be treated as a “parachute payment” as that term is defined in Section 280G of the Internal Revenue Code of 1986, as amended (the “Code”), then the payments provided for under this Agreement may be modified or reduced by the Bank to the extent (but only to the extent) which, based on the advice of the Bank’s independent certified public accountants or legal counsel, the Bank’s Board of Directors in good faith deems to be necessary to avoid the imposition of excise taxes on Employee under Section 4999 of the Code and the disallowance of a deduction to the Bank under Section 280G(a) of the Code.

9. Reimbursement of Employee’s Legal Expenses in Enforcing Agreement. In the event that the Bank fails or refuses to pay to Employee when due all or any portion of the cash compensation or payments for which the Bank is or becomes obligated under Paragraph 3, 6(b), 6(e) or 8(a) above, then the Bank shall be obligated to reimburse Employee for up to an aggregate of $100,000 in out-of-pocket legal expenses, including reasonable fees of Employee’s legal counsel, actually paid by Employee in collecting amounts owed to him hereunder (whether pursuant to a legal proceeding or otherwise); provided, however, that in the case of a disagreement between the Bank and Employee in which the Bank believes the amount it is obligated to pay to Employee hereunder is less than the amount being demanded by Employee, if the Bank pays to Employee the amount it believes is owed, or offers in writing to pay that amount in full settlement of the dispute, then the Bank shall not be obligated to pay or reimburse Employee for any such legal expenses or fees incurred by Employee following the date of such payment or written offer of payment in connection with efforts to enforce payment of the higher amount demanded by Employee unless a Court of competent jurisdiction later determines that the Bank is obligated to pay the higher amount demanded by Employee.

10. Effect of Internal Revenue Code Section 409A. Notwithstanding anything contained in this Agreement to the contrary, in the case of a termination of Employee’s employment that constitutes a “separation from service” under Section 409A of the Internal Revenue Code of 1986, as amended, and the regulations thereunder (“Section 409A”), if the Bank determines that Employee is a “specified employee” within the meaning of Section 409A on the date of such termination (the “Separation from Service Date”), then (a) any payments which the Bank is obligated pay to Employee under Paragraph 6 that would result in a tax, interest, and/or penalties under Section 409A if paid during the first six months after the Separation from Service Date shall be delayed and accumulated by the Bank and the accumulated amount shall be payable to Employee in a lump sum on the date that is six months and one week after the Separation from Service Date, with any additional payments for which the Bank is obligated after that six-month period being payable on the same schedule as Employee’s Base Salary was paid by the Bank during the Term of Employment, and (b) any lump-sum payment which the Bank is obligated to pay to Employee under Paragraph 8 that would result in a tax, interest, and/or penalties under Section 409A if paid during the first six months after the Separation from Service Date shall be delayed and be payable to Employee in a lump sum on the date that is six months and one week after the Separation from Service Date. The purpose of this paragraph is to comply with Section 409A.

11. Indemnification.

(a) If Employee is or was a party, or is threatened to be made a party, to any threatened, pending or completed action, suit or proceeding (including any appeal therein), whether civil, criminal, administrative, arbitrative or investigative, and whether or not brought by or on behalf of the Bank, by reason of the fact that Employee is or was a director, officer, employee or agent of the Bank, or is or was serving at the Bank’s request as a director, officer, partner, trustee, employee or agent of another corporation, partnership, joint venture, trust or other enterprise or as a trustee or administrator under an employee benefit plan, or which arises out of Employee’s activities in any of the foregoing capacities, then the Bank shall be obligated to indemnify Employee, to the fullest extent permitted or required by, and in the manner provided in, the Bank’s Articles of Incorporation, Bylaws and applicable law (in each case, as in effect on the date of this Agreement and as they may be modified or amended in the future), against liability and litigation expense, including reasonable attorneys’ fees, arising or incurred in connection with such action, suit or proceeding, together with reasonable costs and expenses (including attorneys’ fees) incurred by him in connection with the enforcement of his right to indemnification hereunder. In any such case, the Bank’s Board of Directors shall, as promptly as practicable, take all such actions as are required by applicable law, or otherwise are necessary or appropriate, to determine whether the Bank is permitted or required to indemnify Employee and to authorize any such permissible or required indemnification.

The Bank shall pay all expenses incurred by Employee in defending any such civil or criminal action, suit or proceeding in advance of the final disposition of such action, suit or proceeding upon receipt of an undertaking by or on behalf of Employee to repay such amount unless it ultimately shall be determined that Employee is entitled to be indemnified by the Bank against such expenses.

If the Bank’s Articles of Incorporation, Bylaws or applicable law hereafter are modified or amended to provide officers and directors with broader or greater rights of indemnification than is provided under this Paragraph 11(a), Employee shall be entitled to indemnification to the fullest extent provided under the Bank’s Articles of Incorporation, Bylaws or applicable law, as so modified or amended. In no event shall Employee be entitled to any lesser rights of indemnification than would be available to Employee under the Bank’s Articles of Incorporation, Bylaws and applicable law.

(b) The Bank shall carry directors and officers liability insurance in such amounts as the Bank’s Board of Directors, in its discretion, deems appropriate, and any payments made under such policy to Employee or on Employee’s behalf shall be offset against the Bank’s indemnification obligation under Paragraph 11(a) above.

(c) The Bank’s obligation under Paragraph 11(a) to indemnify Employee shall be subject to the prohibitions and limitations established by applicable law and as set forth in applicable regulations adopted by any federal or state bank regulatory agency having jurisdiction over the Bank or any affiliate of the Bank.

12. Effect of Termination; Survival of Certain Agreements. Except as otherwise provided below, upon the earlier of the expiration date of this Agreement or the effective date of any actual termination of Employee’s employment with the Bank under this Agreement for any reason, the provisions of this Agreement shall terminate and be of no further force or effect. The Bank’s obligations for any payments and reimbursement for the cost of health insurance coverage to which Employee becomes entitled as provided in Paragraph 6(b), 6(e), and 8(a) above as a result of a termination of his employment, and Employee’s and the Bank’s respective covenants, rights and obligations under Paragraphs 7, 9, 10 and 11, shall survive and remain in effect in accordance with their terms following termination or expiration of this Agreement or any actual termination of Employee’s employment.

13. Additional Regulatory Requirements. Notwithstanding anything contained in this Agreement to the contrary, it is understood and agreed that the Bank (or any of its successors in interest) shall not be required to make any payment or take any action under this Agreement if the Bank’s Board of Directors believes in good faith, based on the opinion of the Bank’s legal counsel, that such payment or action (a) would be prohibited by or would violate any provision of state or federal law applicable to the Bank, including without limitation the Federal Deposit Insurance Act, as now in effect or hereafter amended, (b) would be prohibited by or would violate any applicable rules, regulations, orders or statements of policy, whether now existing or hereafter promulgated, of any Regulatory Authority, or (c) otherwise would be prohibited by any Regulatory Authority.

14. Successors and Assigns.

(a) This Agreement shall inure to the benefit of and be binding upon any corporate or other successor of the Bank which shall acquire, directly or indirectly, by conversion, merger, consolidation, purchase, or otherwise, all or substantially all of the assets of the Bank.

(b) The Bank is contracting for the unique and personal skills of Employee. Therefore, Employee shall be precluded from assigning or delegating his rights or duties hereunder without first obtaining the written consent of the Bank.

15. Modification; Waiver; Amendments. No provision of this Agreement may be modified, waived, or discharged unless such waiver, modification, or discharge is agreed to in writing and signed by the parties hereto. No waiver by either party hereto, at any time, of any breach by the other party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party, shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. No amendments or additions to this Agreement shall be binding unless in writing and signed by both parties, except as herein otherwise provided.

16. Applicable Law. The parties hereto 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.

17. Severability. The provisions of this Agreement shall be deemed severable and the invalidity or unenforceability of any provision shall not affect the validity or enforceability of the other provisions hereof.

18. Headings. The section and paragraph headings contained in this Agreement are for reference purposes only and shall not affect in any way the meaning or interpretation of this Agreement.

19. Notices. Except as otherwise may be provided herein, all notices, claims, certificates, requests, demands, and other communications hereunder shall be in writing and shall be deemed to have been duly given when hand delivered or sent by facsimile transmission by one party to the other, or when deposited by one party with the United States Postal Service, postage prepaid, and addressed to the other party as follows:

If to the Bank:		If to Employee:
	Bank of the Carolinas	Michael D. Larrowe
	135 Boxwood Drive	416 Country Club Lane
	Mocksville, NC 27028	Galax, Virginia 24333
	Attention: Robert E. Marziano

20. Counterparts. This Agreement may be executed in any number of counterparts, and each such counterpart hereof shall be deemed an original instrument, but all such counterparts together shall constitute but one agreement.

21. Entire Agreement. This Agreement contains the entire understanding and agreement of the parties, and there are no agreements, promises, warranties, covenants, or undertakings other than those expressly set forth or referred to herein.

IN WITNESS WHEREOF, the Bank has caused this Agreement to be executed under seal by its duly authorized officer in pursuance of authority duly given by its Board of Directors, and Employee has set hereunto his hand and adopted as his seal the typewritten word “SEAL” appearing beside his name, all as of the day and year first above written.

	BANK OF THE CAROLINAS
[Corporate Seal]
	By:	/s/ Robert E. Marziano
Attested:		Robert E. Marziano
	Its:	Chairman and Chief Executive Officer
/s/ Joy L. Chaffin
Secretary
		/s/ Michael D. Larrowe	(SEAL)
		Michael D. Larrowe

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: November 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: November 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 September 30, 2008, 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: November 14, 2008	/s/ Robert E. Marziano
	Robert E. Marziano
	President and Chief Executive Officer
Date: November 14, 2008	/s/ Michelle L. Clodfelter
	Michelle L. Clodfelter
	Vice President and Principal Financial Officer