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, 2010

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 has submitted electronically and posted to its corporate web site, if any, every interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See 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 15, 2010 there were 3,897,174 outstanding shares of the registrant’s common stock.

BANK OF THE CAROLINAS CORPORATION

FORM 10-Q

September 30, 2010

INDEX

Part I. FINANCIAL INFORMATION
	Item 1.	Financial Statements
		Consolidated Balance Sheets at September 30, 2010 and December 31, 2009	3
		Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2010 and 2009	4
		Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2010 and 2009	5
		Consolidated Statements of Changes in Stockholders’ Equity for the Nine Months Ended September  30, 2010 and 2009	6
		Notes to Consolidated Financial Statements	7
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
	Item 3.	Quantitative and Qualitative Disclosure about Market Risk	21
	Item 4.	Controls and Procedures	21
Part II. OTHER INFORMATION
	Item 1.	Legal Proceedings	21
	Item 1A.	Risk Factors	21
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	21
	Item 3.	Defaults Upon Senior Securities	21
	Item 4.	[Removed and Reserved]	21
	Item 5.	Other Information	22
	Item 6.	Exhibits	22
SIGNATURES			23
EXHIBIT INDEX			24

2

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Bank of the Carolinas Corporation

Consolidated Balance Sheets

(dollars in thousands, except share and per share data)

	September 30, 2010			December 31, 2009*
	(Unaudited)
Assets:
Cash and due from banks	$	11,690		$	3,524
Federal funds sold and interest-bearing deposits in banks		5,557			33,835
Investment securities		113,021			140,004
Loans		367,021			391,265
Less, allowance for loan losses		(6,342	)		(8,167	)
Loans, net		360,679			383,098
Premises and equipment, net		13,370			14,010
Other real estate owned		8,571			8,233
Bank owned life insurance		10,280			10,010
Prepaids and deferred tax assets		3,099			5,470
Prepaid FDIC insurance assessment		3,913			4,569
Accrued interest receivable		2,080			2,397
Other assets		3,229			5,237
Total Assets	$	535,489		$	610,387
Liabilities:
Deposits:
Noninterest-bearing demand deposits	$	35,531		$	36,418
Interest-checking deposits		32,768			34,614
Savings and money market deposits		126,782			235,541
Time deposits		219,877			187,344
Total deposits		414,958			493,917
Securities sold under agreements to repurchase		45,870			46,682
Federal Home Loan Bank advances		20,000			15,000
Subordinated debt		7,855			7,855
Other liabilities		1,509			1,941
Total Liabilities		490,192			565,395
Commitments and contingencies		—			—
Stockholders’ Equity:
Preferred stock, no par value		13,179			13,179
Discount on preferred stock		(1,056	)		(1,245	)
Common stock, $5 par value per share		19,486			19,486
Additional paid-in capital		12,989			12,978
Retained earnings (deficit)		(724	)		300
Accumulated other comprehensive income		1,423			294
Total Stockholders’ Equity		45,297			44,992
Total Liabilities and Stockholders’ Equity	$	535,489		$	610,387
Preferred shares authorized		3,000,000			3,000,000
Preferred shares issued and outstanding		13,179			13,179
Common shares authorized		15,000,000			15,000,000
Common shares issued and outstanding		3,897,174			3,897,174

* Derived from audited consolidated financial statements.

See accompanying notes to consolidated financial statements.

3

Bank of the Carolinas Corporation

Consolidated Statements of Operations

(Unaudited)

(dollars in thousands, except per share data)

	Three Months Ended September 30						Nine Months Ended September 30
	2010			2009			2010			2009
Interest income
Interest and fees on loans	$	5,102		$	5,875		$	15,809		$	17,904
Interest on securities		822			1,641			2,607			4,539
Other interest income		12			13			45			56
Total interest income		5,936			7,529			18,461			22,499
Interest expense
Interest on deposits		1,181			2,657			3,839			9,843
Interest on borrowed funds		641			776			1,997			2,364
Total interest expense		1,822			3,433			5,836			12,207
Net interest income		4,114			4,096			12,625			10,292
Provision for loan losses		858			1,046			2,860			2,466
Net interest income after provision for loan losses		3,256			3,050			9,765			7,826
Noninterest income
Customer service fees		316			369			961			1,019
Increase in value of bank owned life insurance		91			92			270			272
Gains on sale of investment securities		178			1,246			368			1,341
Other income		4			8			5			31
Total noninterest income		589			1,715			1,604			2,663
Noninterest expense
Salaries and benefits		1,686			1,611			5,400			4,959
Occupancy and equipment		537			553			1,665			1,647
FDIC insurance assessments		155			217			717			932
Data processing		210			330			607			785
Valuation provisions and net operating costs associated with foreclosed real estate		349			297			1,061			1,759
Other		857			838			2,660			2,735
Total noninterest expense		3,794			3,846			12,110			12,817
Income (loss) before income taxes		51			919			(741	)		(2,328	)
Provision for income taxes		(31	)		137			(400	)		(976	)
Net income (loss)		82			782			(341	)		(1,352	)
Dividends and accretion on preferred stock		(229	)		(312	)		(683	)		(411	)
Net income (loss) available to common stockholders	$	(147	)	$	470		$	(1,024	)	$	(1,763	)
Income (loss) per common share
Basic	$	(0.04	)	$	0.12		$	(0.26	)	$	(0.45	)
Diluted	$	(0.04	)	$	0.12		$	(0.26	)	$	(0.45	)

See accompanying notes to financial statements.

4

Bank of the Carolinas Corporation

Consolidated Statements of Cash Flows

(Unaudited)

(dollars in thousands)

	Nine Months Ended September 30, 2010			Nine Months Ended September 30, 2009
Cash flows from operating activities:
Net loss	$	(341	)	$	(1,352	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Provision for loan losses		2,860			2,466
Stock based compensation expense		11			9
Loss (gain) on sale of premises and equipment		6			(11	)
Depreciation and amortization		804			805
Change in valuation allowance on other real estate owned		591			1,206
Loss on sale of other real estate owned		107			229
Gain on sale of securities		(368	)		(1,341	)
Increase in bank owned life insurance		(270	)		(272	)
Net amortization/accretion of premiums and discounts on investments		273			4
Net change in other assets		5,352			(2,015	)
Net change in other liabilities		(432	)		493
Net cash provided by operating activities		8,593			221
Cash flows from investing activities:
Net change in federal funds sold		23,480			(24,000	)
Purchase of premises and equipment		(171	)		(506	)
Purchases of securities		(99,832	)		(164,405	)
Proceeds from sales, calls, maturities, and principal repayments of securities available for sale		128,039			113,071
Purchase of FHLB stock		—			(58	)
Improvements made to other real estate owned		(19	)		—
Proceeds from sale of other real estate owned		2,581			414
Proceeds from sale of premises and equipment		1			68
Net decrease in loans		15,961			5,892
Net cash provided (used) by investing activities		70,040			(69,524	)
Cash flows from financing activities:
Net increase (decrease) in deposits		(78,959	)		100,704
Net additions (repayments) of other borrowings		5,000			(10,000	)
Decrease in repurchase agreements		(812	)		(199	)
Issuance of preferred stock		—			13,179
Cash dividends paid on preferred stock		(494	)		(217	)
Net cash provided (used) by financing activities		(75,265	)		103,467
Net increase in cash and cash equivalents		3,368			34,164
Cash and cash equivalents at beginning of period		12,544			10,491
Cash and cash equivalents at end of period	$	15,912		$	44,655
Supplemental disclosures of cash flow information:
Cash paid during the period for interest	$	2,139		$	12,350
Non-cash investing and financing activities:
Change in fair value of securities available for sale, net of tax	$	1,129		$	(85	)
Transfer of other real estate owned from loans receivable	$	3,598		$	5,220

See accompanying notes to financial statements.

5

Bank of the Carolinas Corporation

Consolidated Statements of Changes in Stockholders’ Equity

(Unaudited)

(dollars in thousands)

	Preferred Stock				Discount on Preferred			Common Stock				Additional Paid-In			Retained Earnings			Accumulated Other Comprehensive			Total Stockholders’
	Shares		Amount		Stock			Shares		Amount		Capital			(Deficit)			Income			Equity
Balance, December 31, 2008		—	$	—	$	—			3,891,174	$	19,456	$	11,625		$	4,067		$	1,443		$	36,591
Net loss		—		—		—			—		—		—			(1,352	)		—			(1,352	)
Other comprehensive loss		—		—		—			—		—		—			—			(85	)		(85	)
Total comprehensive loss		—		—		—			—		—		—			—			—			(1,437	)
Stock based compensation expense		—		—		—			—		—		9			—			—			9
Vesting of restricted stock grants		—		—		—			6,000		30		(30	)		—			—			—
Issuance of preferred stock and related common stock warrants		13,179,000		13,179		(1,414	)		—		—		1,414			—			—			13,179
Expense of preferred stock issuance		—		—		—			—		—		(46	)		—			—			(46	)
Discount/accretion on preferred stock		—		—		108			—		—		—			(108	)		—			—
Dividends accrued on preferred stock		—		—		—			—		—		—			(303	)		—			(303	)
Balance, September 30, 2009		13,179,000	$	13,179	$	(1,306	)		3,897,174	$	19,486	$	12,972		$	2,304		$	1,358		$	47,993
Balance, December 31, 2009		13,179,000	$	13,179	$	(1,245	)		3,897,174	$	19,486	$	12,978		$	300		$	294		$	44,992
Net loss		—		—		—			—		—		—			(341	)		—			(341	)
Other comprehensive income		—		—		—			—		—		—			—			1,129			1,129
Total comprehensive income		—		—		—			—		—		—			—			—			788
Stock based compensation expense		—		—		—			—		—		11			—			—			11
Discount/accretion on preferred stock		—		—		189			—		—		—			(189	)		—			—
Dividends accrued on preferred stock		—		—		—			—		—		—			(494	)		—			(494	)
Balance, September 30, 2010		13,179,000	$	13,179	$	(1,056	)		3,897,174	$	19,486	$	12,989		$	(724	)	$	1,423		$	45,297

See accompanying notes to financial statements.

6

Bank of the Carolinas Corporation

Notes to Consolidated Financial Statements

(Unaudited)

NOTE 1. BASIS OF PRESENTATION

In the opinion of management, the financial information included in these unaudited financial statements reflects all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the financial information as of and for the three- and nine-month periods ended September 30, 2010 and 2009, in conformity with accounting principles generally accepted in the United States of America.

The preparation of financial statements requires management to make estimates and assumptions that affect reported amounts of assets and liabilities at the date of the financial statements, as well as the amounts of income and expense during the reporting period. Actual results could differ from those estimates. Operating results for the three- and nine-month periods ended September 30, 2010 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2010.

The results presented here are for Bank of the Carolinas Corporation (“the Company”), the parent company of Bank of the Carolinas (“the Bank”). The organization and business of the Company, accounting policies followed by the Company and other relevant information are contained in the notes to the financial statements filed as part of the Company’s annual report on Form 10-K for the year ended December 31, 2009. This quarterly report should be read in conjunction with the annual report. Because the Company has no separate operations and conducts no business on its own other than owning the Bank, this discussion concerns primarily the business of the Bank. However, because the financial statements are presented on a consolidated basis, the Company and the Bank are collectively referred to as “the Company” unless otherwise noted.

NOTE 2. EARNINGS PER SHARE

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

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

	Three Months Ended September 30					Nine Months Ended September 30
	2010			2009		2010			2009
Net income (loss) applicable to common stock	$	(147	)	$	470	$	(1,024	)	$	(1,763	)
Weighted average number of common shares outstanding		3,897,174			3,897,174		3,897,174			3,893,350
Weighted average number of diluted common shares outstanding		3,897,174			3,901,735		3,897,174			3,893,350
Common stock options and common stock warrants - anti-dilutive		517,245			121,827		517,245			121,827

The common stock warrants referred to above were issued to the United States Treasury in connection with the Company’s April 17, 2009 participation in the Capital Purchase Program, which was authorized as a part of the TARP legislation passed by Congress during 2008.

7

NOTE 3. INVESTMENT SECURITIES

The amortized cost, estimated fair values and carrying values of the investment securities portfolios at the indicated dates are summarized as follows (dollars in thousands):

	September 30, 2010
			Gross		Gross		Estimated
	Amortized		Unrealized		Unrealized		Fair		Carrying
	Cost		Gains		Losses		Value		Value
Investment securities available for sale:
U.S. Government agency securities	$	58,802	$	1,312	$	5	$	60,109	$	60,109
State and municipal securities		3,700		229		—		3,929		3,929
Corporate securities		962		34		—		996		996
Mortgage-backed securities		43,335		816		91		44,060		44,060
Total investment securities available for sale		106,799		2,391		96		109,094		109,094
Investment securities held to maturity:
Corporate securities		3,927		159		203		3,883		3,927
Total investment securities	$	110,726	$	2,550	$	299	$	112,977	$	113,021
	December 31, 2009
			Gross		Gross		Estimated
	Amortized		Unrealized		Unrealized		Fair		Carrying
	Cost		Gains		Losses		Value		Value
Investment securities available for sale:
U.S. Government agency securities	$	98,617	$	272	$	577	$	98,312	$	98,312
State and municipal securities		5,840		269		4		6,105		6,105
Corporate securities		1,958		5		103		1,860		1,860
Mortgage-backed securities		29,247		596		10		29,833		29,833
Total investment securities available for sale		135,662		1,142		694		136,110		136,110
Investment securities held to maturity:
Corporate securities		3,894		131		202		3,823		3,894
Total investment securities	$	139,556	$	1,273	$	896	$	139,933	$	140,004

8

NOTE 4. LOANS

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

	September 30, 2010			December 31, 2009
Real estate loans:
1-4 family residential	$	76,782		$	76,767
Commercial real estate		155,279			161,904
Construction and development		40,433			41,580
Home equity		30,620			30,775
Total real estate loans		303,114			311,026
Commercial business and other loans		59,972			75,762
Consumer loans		3,935			4,477
Total loans		367,021			391,265
Allowance for loan losses		(6,342	)		(8,167	)
Total loans, net	$	360,679		$	383,098

The changes in the allowance for loan losses for the nine-month periods indicated are as follows (dollars in thousands):

	September 30,			September 30,
	2010			2009
Beginning balance	$	8,167		$	6,308
Provision for loan losses		2,860			2,466
Loans charged-off		(4,843	)		(2,777	)
Recoveries of loans previously charged-off		158			200
Net chargeoffs		(4,685	)		(2,577	)
Ending balance	$	6,342		$	6,197

Information with respect to non-homogeneous loans that were determined to be impaired as of the dates indicated is summarized as follows (dollars in thousands):

	September 30,		December 31,
	2010		2009
Impaired loans determined to not require specific allowances	$	13,659	$	6,313
Impaired loans on which specific allowances have been provided		13,025		11,278
Specific allowances provided on impaired loans		2,480		4,011

Troubled debt restructurings (TDR) are a subset of impaired loans and totaled $18.6 million at September 30, 2010. There were no loans categorized as TDRs at September 30, 2009.

9

NOTE 5. COMMITMENTS AND CONTINGENCIES

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

The Company’s risk of loss related to unfunded loan commitments and lines of credit or standby letters of credit is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments under such instruments as it does for on-balance sheet instruments. The amount of collateral obtained, if any, is based on management’s credit evaluation of the borrower. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The following table presents a summary of outstanding financial instruments whose contract amounts represent credit risk as of September 30, 2010 (dollars in thousands):

Unfunded loan commitments	$	38,471
Financial standby letters of credit		2,477
Total unused commitments	$	40,948

Following the termination of his employment on May 12, 2010, the Company’s former Chief Financial Officer, who also served as the Bank’s Executive Vice Chairman and Chief Operating Officer, and as a director of the Company and the Bank, instituted a lawsuit against the Bank and several individuals on May 14, 2010, as described under Part II, Item 1 of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2010. Based on the advice of outside counsel, the Company believes that the claims against the Bank will not result in a material loss and the Bank is vigorously defending the lawsuit.

NOTE 6. OTHER COMPREHENSIVE INCOME (LOSS)

Generally accepted accounting principles 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 components of other comprehensive income (loss) and related income tax effects are as follows (dollars in thousands):

	Three Months Ended September 30						Nine Months Ended September 30
	2010			2009			2010			2009
Unrealized holding gains on securities available for sale	$	46		$	1,742		$	2,204		$	1,029
Reclassification adjustment for gains realized in net income		(178	)		(1,246	)		(368	)		(1,341	)
Net unrealized holding gains (losses) on securities available for sale		(132	)		496			1,836			(312	)
Income tax effect		51			(84	)		(707	)		227
Other comprehensive income (loss), net of income tax effect	$	(81	)	$	412		$	1,129		$	(85	)

NOTE 7. RECENT ACCOUNTING PRONOUNCEMENTS

ASC 740 - Accounting for Uncertainty in Income Taxes - ASC 740 states that a company should evaluate the certainty that a tax position taken will be sustained upon examination. If the Company should determine upon evaluation that a position is likely to not be upheld then the institution is responsible for its recognition on the financial statements. The Company adopted this standard on January 1, 2008 with no material impact on the consolidated financial statements.

10

ASC 805 - Business Combinations - This statement changes the way that acquiring entities will account for business combinations. Some of the more significant changes are that the equity securities issued as consideration will be valued at the date that the acquirer takes control of assets and assumes liabilities of the acquired company (typically, the date of closing), and that direct costs of the acquisition will be expensed as incurred rather than capitalized. This statement is effective for transactions closing on or after January 1, 2009. The Company has not entered into any material business combination contracts so this statement has no anticipated impact on the consolidated financial statements.

ASC 820 - Fair Value Measurements - This pronouncement creates a framework for consistently measuring fair value of financial assets and liabilities. ASC 820 also requires increased interim and annual disclosure of the assumptions used to determine fair values. This pronouncement was adopted on January 1, 2008. FSP 157-3 deferred adoption of ASC 820 for nonfinancial assets and liabilities until years beginning after November 15, 2008. The Company has adopted ASC 820 with no material impact on financial statements.

ASC 320 - Recognition and Presentation of Other-than-Temporary Impairments - was issued in April 2009. These statements amend the other-than-temporary impairment guidance in U.S. GAAP for debt securities to make it more operational and to enhance the presentation and disclosure of other-than-temporary impairments in the financial statements. These statements clarify the factors that should be used to determine whether an other-than-temporary impairment has occurred and require a more detailed risk-oriented breakdown of major security types. These statements were effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The Company adopted these standards June 30, 2009 with no material impact on the consolidated financial statements.

NOTE 8. FAIR VALUE

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

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

• Level 1 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 and other real estate owned that use appraisals or brokered price opinions to determine fair value.

• Level 3 pricing is derived without observable data. In such cases, mark-to-market strategies are typically employed. These types of instruments often have no active market, possess unique characteristics and are thinly traded.

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

11

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

	At September 30, 2010
	Total		Level 1		Level 2		Level 3
Assets valued on a recurring basis
Investment securities:
U.S. government and agency	$	60,109	$	—	$	60,109	$	—
Mortgage-backed		44,060		—		44,060		—
State and municipals		3,929		—		3,929		—
Corporate		4,879		—		4,879		—
Assets valued on a non-recurring basis
Impaired loans		24,204		—		24,204		—
Other real estate owned		8,571		—		8,571		—
Total	$	145,752	$	—	$	145,752	$	—
	At December 31, 2009
	Total		Level 1		Level 2		Level 3
Assets valued on a recurring basis
Investment securities:
U.S. government and agency	$	98,312	$	—	$	98,312	$	—
Mortgage-backed		29,833		—		29,833		—
State and municipals		6,105		—		6,105		—
Corporate		5,683		—		5,683		—
Assets valued on a non-recurring basis
Impaired loans		13,509		—		13,509		—
Other real estate owned		8,233		—		8,233		—
Total	$	161,675	$	—	$	161,675	$	—

NOTE 9. BORROWED FUNDS

A summary of the Company’s outstanding borrowings and the annual rate of interest currently payable on each category is presented in the following table at the dates indicated (dollars in thousands):

	September 30, 2010					December 31, 2009
	Outstanding		Annual			Outstanding		Annual
	Balance		Interest Rate			Balance		Interest Rate
Securities sold under overnight repurchase agreements	$	870		0.15	%	$	1,682		0.53	%
Securities sold under term repurchase agreements		45,000		4.38			45,000		4.38
Federal Home Loan Bank advances		20,000		1.24			15,000		3.15
Trust preferred securities		5,155		3.20			5,155		3.20
Subordinated debt		2,700		4.00			2,700		4.00
Total borrowed funds	$	73,725		3.38	%	$	69,537		3.92	%

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

12

The Bank had a total of $45.0 million of borrowings in the form of securities sold under term repurchase agreements that were entered into during 2008. These borrowings are secured by marketable investment securities equal to approximately 109.5% of the principal balances outstanding plus accrued interest and the value of an imbedded interest rate cap. The following table contains certain pertinent information with respect to these agreements at September 30, 2010 (dollars in thousands):

	Outstanding		Annual			Final		Beginning
	Principal		Effective			Maturity		Quarterly		Collateral
	Balance		Interest Rate			Date		Call Dates		Requirement
Agreement dated 7/8/2008	$	25,000		4.85	%		7/8/2018		7/8/2013	$	33,669
Agreement dated 8/20/2008		20,000		3.78			8/20/2015		8/20/2011		23,380
Total	$	45,000		4.38	%					$	57,049

The Bank utilizes borrowings from the Federal Home Loan Bank (“FHLB”) as a source of liquidity. At September 30, 2010, the FHLB had advances totaling $20.0 million outstanding to the Bank. All of the FHLB advances are secured by the Bank’s qualifying real estate loans. The following table contains a summary of the more significant terms of these borrowings at September 30, 2010 (dollars in thousands):

	Outstanding		Annual			Final
	Principal		Effective			Maturity
	Balance		Interest Rate			Date
Advance dated 3/17/2008	$	10,000		2.21	%		03/18/13
Advance dated 2/16/2010		10,000		0.28			02/16/12
Total	$	20,000		1.24	%

During 2008, the Company issued $5.2 million of junior subordinated debentures to its wholly owned capital trust, Bank of the Carolinas Trust I (the “Trust”), which, in turn, issued $5.0 million in trust preferred securities having a like liquidation amount and $155,000 in common securities (all common securities are owned by the Company). The Company has fully and unconditionally guaranteed the Trust’s obligations related to the trust preferred securities. The Trust has the right to redeem the trust preferred securities in whole or in part, on or after March 26, 2013 at a redemption price equal to 100% of the principal amount plus accrued and unpaid interest.

In addition, the Trust may redeem the trust preferred securities in whole (but not in part) at any time within 90 days following the occurrence of a tax event, an investment company event, or a capital treatment event at a special redemption price (as defined in the debenture). Interest is payable quarterly on the trust preferred securities at the annual rate of 90-day LIBOR plus 300 basis points.

The Company also has issued $2.7 million of subordinated debt in a private transaction with another financial institution. This subordinated note has a floating interest rate equal to 75 basis points over the Prime Rate published by Wall Street Journal and a maturity date of August 13, 2018. The Company makes monthly interest payments on the outstanding debt to the holder of the note. This debt can be repaid in full at any time with no penalty.

13

NOTE 10. STOCKHOLDERS’ EQUITY

Preferred Stock:

The Company has 3.0 million shares of preferred stock authorized. There were 13,179 shares of preferred stock issued and outstanding with a $1,000 per share liquidation preference on September 30, 2010 and December 31, 2009. All of the shares were issued on April 17, 2009 in connection with the U.S. Treasury’s TARP Capital Purchase Program.

Common Stock:

The Company has 15.0 million shares of $5 par value common stock authorized. There were 3,897,174 shares of common stock issued and outstanding at September 30, 2010 and December 31, 2009.

Warrants:

In connection with the issuance of the preferred shares under the U.S. Treasury’s TARP Capital Purchase Plan, the Company issued the U.S. Treasury a warrant to purchase 475,204 shares of its common stock for $4.16 per share. The warrant expires April 17, 2019.

14

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

GENERAL

Introduction

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

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

CHANGES IN FINANCIAL CONDITION

Total Assets

At September 30, 2010, total assets were $535.5 million, a decrease of 12.3% compared to $610.4 million at December 31, 2009. The asset decline was primarily the result of reductions in rate sensitive deposits, mainly special rate money market deposits, which were funded by reductions in discretionary assets (investment securities, federal funds sold, and interest-bearing deposits in banks), as well as reductions in the loan portfolio.

Investment Securities

Investment securities totaled $113.0 million at September 30, 2010, compared to $140.0 million at December 31, 2009. The decline was a result of the planned reduction in discretionary assets referred to above. A summary of the Company’s investment securities holdings by major category at September 30, 2010 and December 31, 2009 is included in Note 3 of “Notes to Consolidated Financial Statements”.

Loans and Allowance for Loan Losses

At September 30, 2010, the loan portfolio totaled $367.0 million and represented 68.5% of total assets compared to $391.3 million or 64.1% of total assets at December 31, 2009. Total loans at September 30, 2010 decreased $24.3 million or 6.2% from December 31, 2009. The decrease in loans outstanding in the period is the result of principal repayments in excess of new loans originated due to slower loan demand under the current economic conditions. Real estate loans, including commercial real estate, constituted approximately 80% of the loan portfolio, and commercial business and other loans comprised approximately 20% of the total loan portfolio at both September 30, 2010 and December 31, 2009.

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

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

15

believes the allowance is appropriate based on management’s current analysis.

The allowance for loan losses at September 30, 2010, amounted to $6.3 million, a decrease of $1.9 million, or 22.3% from December 31, 2009. This is primarily the result of $4.6 million in net charge-offs against the total loss allowance related to loans for which specific allowances previously had been established and which were determined to be impaired during the nine-month period, while we recorded only $130,000 in net charge-offs against the general loss allowance in the nine-month period. As a result of decreasing loans, the general allowance also decreased $295,000 during the nine-month period since December 31, 2009. While the Company has not participated in “subprime” lending activities, we have been affected by the economic downturn in our markets. We continue to work with our customers with troubled credit relationships to the extent that it is reasonably possible.

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

The following table summarizes information regarding our nonaccrual loans, other real estate owned, and 90-day and over past due loans as of September 30, 2010 and December 31, 2009 (dollars in thousands):

	September 30, 2010			December 31, 2009
Loans accounted for on a nonaccrual basis:
Real estate loans:
1-4 family residential	$	1,848		$	2,971
Commercial real estate		5,111			1,606
Construction and development		1,321			1,488
Total real estate loans		8,280			6,065
Commercial business and other loans		3,197			3,151
Consumer loans		157			8
Total nonaccrual loans		11,634			9,224
Accruing loans which are contractually past due 90 days or more		—			—
Total nonperforming loans		11,634			9,224
Other real estate owned		8,571			8,233
Total nonperforming assets	$	20,205		$	17,457
Total nonperforming loans as a percentage of loans		3.17	%		2.36	%
Allowance for loan losses as a percentage of total nonperforming loans		54.51	%		88.54	%
Allowance for loan losses as a percentage of total loans		1.73	%		2.09	%
Total nonperforming assets as a percentage of loans and other real estate owned		5.38	%		4.37	%
Total nonperforming assets as a percentage of total assets		3.77	%		2.86	%

Deposits

The Company’s deposit services include business and individual checking accounts, interest bearing checking accounts, savings accounts, money market accounts, IRA deposits and certificates of deposit. At September 30, 2010, total deposits were $415.0 million compared to $493.9 million at December 31, 2009. The September 30, 2010 amount represents a decrease of 16.0% from December 31, 2009 and was the result of a reduction in interest-sensitive deposits, mainly money market accounts that were opened during a special promotion which began in July 2008 and offered a guaranteed rate through June 2009. While the Company’s overall deposits have decreased noticeably during the nine-month period of 2010, the mix of deposits has also changed toward a more cost effective source of funds. At September 30, 2010, money market deposits comprised 27.6% of total deposits compared to 45.5% at December 31, 2009 and, although brokered deposits decreased by $3.2 million, they were 16.3% of total deposits at September 30, 2010 compared to 14.4% at December 31, 2009.

16

The following table presents a breakdown of our deposit base at September 30, 2010 and December 31, 2009 (dollars in thousands):

	September 30, 2010			December 31, 2009
Noninterest bearing demand deposits	$	35,531		$	36,418
Interest checking deposits		32,768			34,614
Savings deposits		12,448			11,042
Money market deposits		114,334			224,499
Customer time deposits		152,110			116,370
Brokered certificates of deposit		67,767			70,974
Total deposits	$	414,958		$	493,917
Time deposits $100,000 or more:
Brokered certificates of deposit	$	67,767		$	70,974
Customer time deposits issued in denominations of $100,000 or more		70,233			44,939
Total time deposits issued in denominations of $100,000 or more	$	138,000		$	115,913
As a percent of total deposits:
Noninterest bearing demand deposits		8.56	%		7.37	%
Interest checking deposits		7.90			7.01
Savings deposits		3.00			2.24
Money market deposits		27.55			45.45
Customer time deposits		36.66			23.56
Brokered certificates of deposit		16.33			14.37
Total time deposits issued in denominations of $100,000 or more		33.26			23.47

Liquidity

Liquidity management is the process of managing assets and liabilities, as well as their maturities, to ensure adequate funding for loan and deposit activities, as well as continued growth of the Company. Sources of liquidity come from both balance sheet and off-balance sheet sources. We define balance sheet liquidity as the relationship that net liquid assets have to unsecured liabilities. Net liquid assets are the sum of cash and cash items, less required reserves on demand and interest checking deposits, plus demand deposits due from banks, plus temporary investments, including federal funds sold, plus the fair value of investment securities, less collateral requirements related to public funds on deposit and repurchase agreements. Unsecured liabilities are equal to total liabilities less required cash reserves on noninterest-bearing demand deposits and interest checking deposits less the outstanding balances of all secured liabilities, whether secured by liquid assets or not. We consider off-balance sheet liquidity to include unsecured federal funds lines from other banks and loan collateral which may be used for additional advances from the Federal Home Loan Bank. As of September 30, 2010 our balance sheet liquidity ratio (net liquid assets as a percent of unsecured liabilities) amounted to 15.1% and our total liquidity ratio (balance sheet plus off-balance sheet liquidity) was 17.4%.

In addition, we have the ability to borrow $10.0 million from the discount window of the Federal Reserve, as well as lines from correspondent banks of $5.0 million unsecured and $14.0 million subject to our pledge of marketable securities, which could be used for temporary funding needs. We also have the ability to borrow from the Federal Home Loan Bank on similar terms. While we consider these arrangements sources of back-up funding, we do not consider them as liquidity sources because they require our pledge of liquid assets as collateral. We regularly borrow from the Federal Home Loan Bank as a normal part of our business. These advances, which totaled $20.0 million at September 30, 2010, are secured by various types of real estate-secured loans. The Company closely monitors and evaluates its overall liquidity position. The Company believes its liquidity position at September 30, 2010 is adequate to meet its operating needs.

17

Interest Rate Sensitivity

Fluctuating interest rates, increased competition, and changes in the regulatory environment continue to significantly affect the importance of interest rate sensitivity management. Rate sensitivity arises when interest rates on assets change in a different period of time or in a different proportion to interest rates on liabilities. The primary objective of interest rate sensitivity management is to prudently structure the balance sheet so that movements of interest rates on assets and liabilities are highly correlated and produce a reasonable net interest margin even in periods of volatile interest rates. The Company uses an asset/liability simulation model to project potential changes to the Company’s net interest margin, net income, and economic value of equity based on simulated changes to market interest rates, namely the prime rate. Our goal is to maintain an interest rate sensitivity position as close to neutral as practicable whereby little or no change in interest income would occur as interest rates change. On September 30, 2010, we were cumulatively liability sensitive for the next twelve months, which means that our interest bearing liabilities would reprice more quickly than our interest bearing assets. Theoretically, our net interest margin will decrease if market interest rates rise or increase if market interest rates fall. However, the repricing characteristic of assets is different from the repricing characteristics of funding sources. Therefore, net interest income can be impacted by changes in interest rates even if the repricing opportunities of assets and liabilities are perfectly matched.

Capital Adequacy

Regulatory guidelines require banks to hold minimum levels of capital based upon the risk weighting of certain categories of assets as well as any off-balance sheet contingencies. Federal regulators have adopted risk-based capital and leverage capital guidelines for measuring the capital adequacy of banks and bank holding companies. All applicable capital standards must be satisfied for the Company and the Bank to be considered in compliance with regulatory requirements.

As previously disclosed, the Company and the Bank’s Boards of Directors have entered into informal agreements with their respective banking regulators which, among other things, require that the Bank maintain capital levels in excess of normal regulatory minimums, including a Leverage Capital Ratio of not less than 7.5% and risk-based capital ratios at least at “well capitalized” levels, and that the Company and the Bank seek the approval of their respective regulators prior to the payment of any cash dividend.

On September 30, 2010, the Company’s Tier 1 and Total risk-weighted Capital Ratios were 10.56% and 12.43%, respectively, which were well above the minimum levels required by regulatory guidelines. At September 30, 2010, the Company’s Leverage Capital Ratio was 8.57%, which was also well above the minimum level required by the regulatory guidelines. On September 30, 2010, the Bank’s Tier 1 and Total risk-weighted Capital Ratios were 10.96% and 12.22%, respectively, both well above the minimum levels required by regulatory guidelines. On September 30, 2010, the Bank’s leverage ratio was 8.90%, in compliance with the level specified in the above referenced informal agreement with bank regulators. Banks and bank holding companies 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 and the Bank are both considered “well-capitalized” as of September 30, 2010.

RESULTS OF OPERATIONS

Three Months Ended September 30, 2010 and 2009

Overview. For the three months ended September 30, 2010, the Company incurred a net loss available to common shareholders of $147,000, or $0.04 per common share. This compares to a net income of $470,000, or $0.12 per common share, for the three months ended September 30, 2009. When the gains on sale of investment securities are excluded in each of the third quarters, the third quarter of 2010 would have been an improvement in comparison to the third quarter of 2009. The third quarters in each of the past two years were affected by credit losses related to the extended economic downturn that were at levels well above those we experienced prior to 2008.

Net Interest Income. The Company’s net interest income for the three months ended September 30, 2010 totaled $4.1 million, which is almost identical to net interest income realized in the third quarter of 2009. Net interest income remained flat due to the net result of a $1.6 million decline in interest income brought about by lower volume and declining yields on earning assets, offset by a $1.6 million decline in interest expense primarily attributable to a decrease in interest expense on deposits resulting from a decline in interest rates and declines in the balances of money market accounts and brokered certificates of deposit. Net interest margin increased 62 basis points from 2.73% in the third quarter of 2009 to 3.35% in the third quarter of 2010.

18

Provision for Loan Losses. The loan loss provision amounted to $858,000 for the quarter ended September 30, 2010, a decrease of $188,000, or 18.0%, from the $1,046,000 provision recorded in the comparable quarter of 2009. Net charge-offs totaled $1.7 million in the third quarter of 2010 compared to $1.6 million in the third quarter of 2009.

Noninterest Income. Noninterest income totaled $589,000 (including $178,000 in gains on sale of investment securities) for the three months ended September 30, 2010 compared to $1,715,000 (including $1,246,000 in gains on sale of investment securities) for the comparable three-month period of 2009. Noninterest income includes customer service charges on deposit accounts, bank owned life insurance, and gains on investment securities. Excluding gains on sale of investment securities, noninterest income remained relatively flat for the three months ended September 30, 2010 and 2009.

Noninterest Expenses. Noninterest expenses totaled $3.8 million for the three months ended September 30, 2010 and 2009. Noninterest expenses affecting overhead cost were: (1) salaries and benefits, which increased $75,000 as a result of transferring an administrative function from an external provider to in-house employees; (2) FDIC insurance assessment, which decreased $62,000 due to the reduction in deposits; and (3) data processing expense, which decreased $120,000 due to a core system conversion in the third quarter of 2009.

Income Taxes. The Company accrued an income tax benefit of $31,000 for the three months ending September 30, 2010 compared to an income tax expense of $137,000 for the third quarter of 2009. The tax benefit was a result of the Company’s loss for the three months ended September 30, 2010 and the tax expense was a result of the Company’s taxable income for the three months ended September 30, 2009.

Nine Months Ended September 30, 2010 and 2009

Overview. For the nine months ended September 30, 2010, the Company incurred a net loss available to common shareholders of $1.0 million, or $0.26 per common share. This compares to a net loss of $1.8 million, or $0.45 per common share for the nine months ended September 30, 2009. The losses realized in the first nine months in each of the past two years stem from the extended economic downturn which has led to credit losses well above the levels we experienced prior to 2008.

Net Interest Income. The Company’s net interest income for the nine months ended September 30, 2010 totaled $12.6 million, an increase of $2.3 million, or 22.3%, over the $10.3 million in net interest income realized in the comparable period of 2009. The increase was the net result of a $4.0 million decline in interest income brought about by lower volume and declining yields on earning assets being more than offset by a $6.3 million decline in interest expense primarily attributable to a decrease in interest expense on deposits resulting from a decline in interest rates and declines in the balances in money market accounts and brokered certificates of deposit. Net interest margin increased 87 basis points from 2.43% for the nine-month period of 2009 to 3.30% in the nine-month period of 2010.

Provision for Loan Losses. The loan loss provision amounted to $2.9 million for the nine months ended September 30, 2010, an increase of $394,000, or 16.0%, from the $2.5 million provision recorded in the comparable period of 2009. Net charge-offs totaled $4.7 million in the first nine months of 2010 compared to $2.7 million in the first nine months of 2009.

Noninterest Income. Noninterest income totaled $1.6 million for the nine months ended September 30, 2010 compared to $2.7 million for the comparable period of 2009. The decrease was substantially the result of higher levels of gains realized on the sale of investment securities available-for-sale during the previous year’s nine-month period.

Noninterest Expenses. Noninterest expenses totaled $12.1 million for the nine months ended September 30, 2010 compared to $12.8 million for the same period in 2009, a decrease of $707,000 or 5.5%. The primary source of this decrease was reduction in other real estate owned expenses and valuation provisions of $698,000 compared to the same nine-month period of 2009. Other noninterest expenses affecting overhead cost were: (1) salaries and benefits, which increased $441,000 as a result of funding our employees’ Health Savings Accounts for all of 2010 in the first quarter, benefit payments to terminated employees, and transferring an administrative function from an external provider to in-house employees; (2) FDIC insurance assessment, which decreased $215,000 due to the reduction in deposits; and (3) data processing expense, which decreased $178,000 due to a core system conversion in the third quarter of 2009.

19

Income Taxes. The Company accrued an income tax benefit of $400,000 for the nine months ending September 30, 2010 compared to an income tax benefit of $976,000 for the comparable period of 2009. The tax benefit was a result of the Company’s loss for the nine months ended September 30, 2010 and 2009.

DISCLOSURES ABOUT FORWARD LOOKING STATEMENTS

Statements in this Report relating to plans, strategies, economic performance and trends, projections of results of specific activities or investments, expectations or beliefs about future events or results, and other statements that are not descriptions of historical facts, may be forward-looking statements as defined in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking information is inherently subject to risks and uncertainties, and actual results could differ materially from those currently anticipated due to a number of factors which include, but are not limited to, factors discussed in our Annual Report on Form 10-K and in other documents we file with the Securities and Exchange Commission from time to time. Copies of those reports are available directly through the SEC’s Internet website at www.sec.gov. Forward-looking statements may be identified by terms such as “may,” “will,” “should,” “could,” “expects,” “plans,” “intends,” “anticipates,” “ feels,” “believes,” “estimates,” “predicts,” “forecasts,” “potential” or “continue,” or similar terms or the negative of these terms, or other statements concerning opinions or judgments of our management about future events. Factors that could influence the accuracy of forward-looking statements include, but are not limited to (a) pressures on our earnings, capital and liquidity resulting from current and future conditions in the credit and capital markets, (b) continued or unexpected increases in nonperforming loans and credit losses in our loan portfolio, (c) continued adverse conditions in the economy and in the real estate market in our banking markets (particularly those conditions that affect our loan portfolio, the abilities of our borrowers to repay their loans, and the values of collateral that secures our loans), (d) the financial success or changing strategies of our customers, (e) actions of government regulators, or change in laws, regulations or accounting standards, that adversely affect our business, (f) changes in the interest rate environment and the level of market interest rates that reduce our net interest margins and/or the values of loans we make and securities we hold, and changes in general economic conditions and real estate values in our banking market (particularly changes that affect our loan portfolio, the abilities of our borrowers to repay their loans, and the values of loan collateral), (g) changes in competitive pressures among depository and other financial institutions or in our ability to compete effectively against other financial institutions in our banking markets, and (h) other developments or changes in our business that we do not expect. Although we believe that the expectations reflected in the forward-looking statements included in this Report are reasonable, they represent our management’s judgments only as of the date they are made, and we cannot guarantee future results, levels of activity, performance or achievements. As a result, readers are cautioned not to place undue reliance on these forward-looking statements. All forward-looking statements attributable to us are expressly qualified in their entirety by the cautionary statements in this paragraph. We have no obligation, and do not intend, to update these forward-looking statements.

20

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable

Item 4. CONTROLS AND PROCEDURES

The Company’s management, under the supervision and with the participation of its Chief Executive Officer and Chief 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 Chief Financial Officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective to provide reasonable assurance that it is able to record, process, summarize and report in a timely manner the information required to be disclosed in reports it files under the Exchange Act.

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

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

Reference is made to Part II, Item 1, of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2010, for a discussion of certain pending litigation.

Item 1A. Risk Factors

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 was enacted on July 21, 2010. The Dodd-Frank Act creates a new Consumer Financial Protection Bureau with power to promulgate and enforce consumer protection laws. Smaller depository institutions (those with $10 billion or less in assets) will be subject to the Consumer Financial Protection Bureau’s rule-writing authority, and existing depository institution regulatory agencies will retain examination and enforcement authority for such institutions. The Dodd-Frank Act also establishes a Financial Stability Oversight Council chaired by the Secretary of the Treasury with authority to identify institutions and practices that might pose a systemic risk and, among other things, includes provisions affecting (1) corporate governance and executive compensation of all companies whose securities are registered with the SEC, (2) FDIC insurance assessments, (3) interchange fees for debit cards, which would be set by the Federal Reserve under a restrictive “reasonable and proportional cost” per transaction standard, (4) minimum capital levels for bank holding companies, subject to a grandfather clause for financial institutions with less than $15 billion in assets, (5) derivative and proprietary trading by financial institutions, and (6) the resolution of large financial institutions.

At this time, it is difficult to predict the extent to which the Dodd-Frank Act or the resulting regulations may adversely impact the Company. However, compliance with these new laws and regulations will likely increase the Company’s costs and may limit its ability to pursue attractive business opportunities, cause the Company to modify its strategies and business operations and increase its capital requirements and constraints, any of which may have a material adverse impact on its business, financial condition, liquidity or results of operations.

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

None

Item 3. Defaults Upon Senior Securities.

None

Item 4. [Removed and Reserved]

21

Item 5. Other Information

None

Item 6. Exhibits

The following exhibits are provided with this report.

10.01	Landis Savings Bank, SSB Directors’ Retirement Plan (filed herewith)
31.01	Certification of our Chief Executive Officer pursuant to Rule 13a-14(a) (furnished herewith)
31.02	Certification of our Chief Financial Officer pursuant to Rule 13a-14(a) (furnished herewith)
32.01	Certification of our Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 (furnished herewith)

22

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 15, 2010	By:	/s/ Stephen R. Talbert
	Stephen R. Talbert
	President and Chief Executive Officer
Date: November 15, 2010	By:	/s/ Eric E. Rhodes
	Eric E. Rhodes
	Senior Vice President and Chief Financial Officer

23

EXHIBIT INDEX

Exhibit Number	Description
10.01	Landis Savings Bank, SSB Directors’ Retirement Plan (filed herewith)
31.01	Certification of our Chief Executive Officer pursuant to Rule 13a-14(a) (furnished herewith)
31.02	Certification of our Chief Financial Officer pursuant to Rule 13a-14(a) (furnished herewith)
32.01	Certification of our Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 (furnished herewith)

24

EX-10.01

Exhibit 10.01

LANDIS SAVINGS BANK, SSB

DIRECTORS’ RETIREMENT PLAN

(As Amended and Restated Effective December 29, 2008)

1. Purpose. The purpose of the Landis Savings Bank, SSB Directors’ Retirement Plan (the “Plan”) was adopted effective on June 1, 1997 is to provide retirement benefits to members of the Board of Directors of Landis Savings Bank, SSB (the “Savings Bank,” which changed its name to “Bank of the Carolinas” effective on April 27, 1998) who provided and will provide expertise in enabling the Savings Bank to experience successful growth and development and to ensure that the Savings Bank will have their continued services and assistance in the conduct of its business in the future. Effective on December 27, 2001, the Savings Bank was merged into Bank of Davie (the “Merger”), which changed its name to Bank of the Carolinas (“BOC”). In connection with the merger, the Savings Bank’s directors became directors of BOC, BOC assumed the Savings Bank’s obligations under the Plan with respect to directors who had served as directors of the Savings Bank for at least ten years and whose benefits under the Plan had begun to vest, and BOC was released from any further obligations under the Plan with respect to all other former directors of the Savings Bank. Participants in the Plan following the Merger include only those directors of the Savings Bank who had served as such for at least ten years at the time of the Merger, and no other former directors of the Savings Bank, or current or former directors of BOC, shall be eligible or have any right to receive benefits under the Plan. Benefits under the Plan shall be in addition to any other benefits that the Participant may be eligible to receive.

2. Definitions. “Administrator” means the Administrator of the Plan., North Carolina Savings Institutions Division.

(a) “Board of Directors” means those persons serving, from time to time, on the Board of Directors of the Savings Bank.

(b) “Commissioner” means the North Carolina Commissioner of Banks.

(c) “Committee” means the Corporate Governance Committee comprised of three or more persons appointed by the BOC’s Board of Directors of the Savings Bank.

(d) “Disability” means absence from normal employment duties on a full-time basis and certified by a physician that such illness or injury has caused the disabled party to be incapable of performing normal employment duties.

(e) “Participant” means a former member of the Board of Directors of the Savings Bank who is eligible to receive benefits under the Plan as provided herein. Persons hereafter elected or appointed to fill vacancies on the Board of Directors shall become Participants on the date of election or appointment

(f) “Retirement Benefit” for a particular Participant means an amount equal to the Retirement Fee multiplied by ten (10), subject to the appropriate vesting schedule.

(g) “Retirement Fee” means an amount equal to Twelve Thousand Dollar ($12,000).

“Savings Bank” means Landis Savings Bank, SSB, a North Carolina chartered mutual savings bank, or any successor financial institution.

3. Eligibility. Any person who, is serving or hereinafter serves at the effective time of the Merger, had served on the Board of Directors of the Savings Bank for at least ten years and whose benefits under the Plan had begun vesting shall be a Participant in the Plan. Retirement Benefits, to the extent vested, shall be payable to a Participant upon (i) such person attaining the age of 70, and (ii) such Participant’s retirement from service on the BOC’s Board of Directors, and shall be paid in 120 equal monthly installments commencing within 30 days from the date of the Participant’s retirement.

25

4. Vesting of Benefits.

(a) For Participants who have had attained the age of 65 on the effective date of this Plan, the Retirement Benefit shall vest over a five year period beginning on the first anniversary of the Plan at a rate of 20% per year.

(b) For all other Participants, the Retirement Benefit shall vest 10% per year commencing on the first anniversary following such Participant’s tenth year of service as a member of the Savings Bank’s or BOC’s Board of Directors.

(c) Notwithstanding the foregoing, (i) no Retirement Benefit shall be paid until a Participant attains the age of 70, and (ii) no Retirement Benefit shall be paid after the AdministratorCommissioner, the Federal Deposit Insurance Corporation or any other appropriate regulatory body directs the Savings BankBOC to cease such payments.

5. Designation of Beneficiary. The Participant may file with the Committee a written designation of one or more persons as the beneficiary who shall be entitled to receive benefits under this Plan upon the Participant’s death. The Participant may, from time to time, revoke or change this designation without the consent of any prior beneficiary, if any, by filing a new designation with the Committee. The last such designation received by the Committee shall be controlling; provided, however, that no designation, or change or revocation thereof, shall be effective unless received by the Committee prior to the Participant’s death, and in no event shall it be effective as of a day prior to such receipt.

6. Death of a Participant.

(a) Should a Participant designated in Section 4(a) die while serving on the BOC’s Board of Directors, if there is a designated beneficiary, the Retirement Benefit immediately shall become 100% vested and its then current present value as of the Participant’s date of death, discounted based on prevailing interest rates, shall be paid in 120 equal monthly installments one lump sum payment to such the Participant’s designated beneficiary within sixty (60) days following the Participant’s death. Should a Participant designated in Section 4(b) die while serving on the BOC’s Board of Directors, if there is a designated beneficiary, the then current present value as of the Participant’s date of death of the Retirement Benefit that heretofore has vested prior to the date of such director’s death, discounted based on prevailing interest rates, shall become immediately payable over the following 120 month period in equal monthly installments be paid in one lump sum payment to the Participant’s designated beneficiary within sixty (60) days following the Participant’s death.

(b) If no such beneficiary designation is in effect at the time of the Participant’s death, or if no designated beneficiary survives the Participant, or if such designation conflicts with law, the balance then current present value as of the Participant’s date of death of the Retirement Benefit, discounted as described above, shall be paid to the executor or administrator of the Participant’s estate in one lump sum payment, discounted for current value based upon the prevailing interest rates at the time of the Participant’s death. Such lump sum payment shall be made within sixty (60) days of following the participant’s death.

(c) If the Committee is in doubt as to the right of any person to receive the Retirement Benefit, the Committee may retain the Retirement Benefit without liability for any interest in respect thereof, until the rights thereto are determined, or the Committee may direct the transfer of the Retirement Benefit into any court of appropriate jurisdiction and such transfer shall be deemed a complete discharge of the BOC’s obligations of the Savings Bank hereunder.

26

7. Disability. Should the service of a Participant designated in Section 4(a) become disabled, as a member of BOC’s Board of Directors terminate as a result of his Disability, the Participant’s Retirement Benefit immediately shall become 100% vested and shall be paid in 120 equal monthly installments commencing within 30 days from the date of the Participant’s termination of service. Should the service of a Participant designated in Section 4(b) become disabled, as a member of BOC’s Board of Directors terminate as a result of his Disability, the Participant’s Retirement Benefit, to the extent vested on the date of Disability, shall be immediately payable over the following 120 month period in equal monthly installments paid in 120 equal monthly installments commencing within 30 days from the date of the Participant’s termination of service.

8. Administration. The Plan shall be administered by the Committee. All questions of interpretation of the Plan or of any opinions issued under it shall be final and binding upon all persons having an interest in the Plan. Any or all powers and discretion vested in the Committee under this Plan may be exercised by any subcommittee of three or more persons so authorized by the Committee.

9. Amendment. The Committee may amend, modify, suspend, or terminate this Plan at any time, provided, however, that any amendment, modification, suspension, or termination shall not affect the rights of Participants who are receiving payments to which they are entitled pursuant to Paragraph 4. Notwithstanding the foregoing, this Plan may be terminated at any time and benefits may be affected in whole or in part if the Plan is deemed by the AdministratorCommissioner or the Federal Deposit Insurance Corporation to constitute an unsafe or unsound banking practice.

10. State Law. Notwithstanding the principals of conflicts of laws, this Plan shall be governed and construed in accordance with the laws of the State of North Carolina. Any suit or action relating to this Plan shall be instituted and prosecuted in the Courts of the County of RowanDavie, State of North Carolina.

11. Effective Date. This Plan shall become operative and in effect on June 1, 1997, provided it has been adopted by the Board of Directors prior or simultaneously thereto and is amended and restated effective on December 29, 2008.

12. Funding. This Plan at all times shall be entirely unfunded and no provision at any time shall be made with respect to segregating any asset of the Savings BankBOC for payment of benefits hereunder. No Participant, beneficiary or other person shall have any interest in any particular assets of the Savings BankBOC by reason of the right to receive the Retirement Benefit under the Plan, and any such Participant, beneficiary or other person shall have only the rights of a general unsecured creditor of the Savings BankBOC with respect to any rights under this Plan.

13. Section 409A. Notwithstanding anything contained in this Plan to the contrary:

(a) the terms used in this Plan shall be defined and interpreted in a manner that is consistent with Section 409A of the Internal Revenue Code of 1986, as amended, and regulations promulgated thereunder, as applicable (“Section 409A), and in the event of any ambiguity in any of the terms or provisions of this Plan, those terms or provisions shall be interpreted in a manner so as to comply with the applicable requirements of Section 409A;

(b) to the extent the Participant is entitled to a series of installment payments under the provisions of this Plan, such series of installment payments shall be treated as a series of separate payments for purposes of Section 409A, as applicable;

27

(c) in the case of a payment upon the termination of the Participant’s services as a member of BOC’s Board of Directors, payment shall not be made under this Plan unless the termination of service constitutes a “separation from service” under Section 409A and, if BOC determines that the Participant is a “specified employee” within the meaning of Section 409A on the date of any such separation from service (the “Separation from Service Date”), then (i) any installment payments which the Participant is entitled to under this Plan 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 Administrator and the accumulated amount shall be payable to the Participant in a lump sum on the date that is six months and one week after the Separation from Service Date, with any additional installment payments for which the Participant is entitled to after that six-month period being payable on the same schedule as otherwise provided under this Plan, and (ii) any lump-sum payment which the Participant is entitled to under this Plan 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 the Participant in a lump sum on the date that is six months and one week after the Separation from Service Date.

(d) in the event that the terms of this Plan shall be deemed not to comply with Section 409A, BOC shall not be liable to the Participant for any income or excise taxes or any other amounts payable by the Participant with respect to any payments made hereunder or for any actions, decisions or determinations made by BOC in good faith.

The purpose of this Paragraph 13 is to comply with Section 409A

28

DESIGNATION OF BENEFICIARY

To: Compensation Corporate Governance Committee

Landis Savings Bank, SSB Bank of the Carolinas

Gentlemen:

The undersigned hereby designates                                                               whose address is                                                                                   as beneficiary of any and all payments which may be made under the Landis Savings Bank, SSB Directors’ Retirement Plan (as amended and restated effective December 29, 2008) after my death. In the event that said beneficiary does not survive me, I direct that such payments be made to                                         , whose address is                                                              . This designation supersedes any and all prior designations and shall be effective until such time as it should be succeeded by a subsequent designation.

Dated:

Signature:

29

EX-31.01

Exhibit 31.01

CERTIFICATION

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

I, Stephen R. Talbert, 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 15, 2010	/s/ Stephen R. Talbert
	Stephen R. Talbert
	President and Chief Executive Officer

30

EX-31.02

Exhibit 31.02

CERTIFICATION

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

I, Eric E. Rhodes, 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 15, 2010	/s/ Eric E. Rhodes
	Eric E. Rhodes
	Senior Vice President and Chief Financial Officer

31

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, 2010, 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 15, 2010	/s/ Stephen R. Talbert
	Stephen R. Talbert
	President and Chief Executive Officer
Date: November 15, 2010	/s/ Eric E. Rhodes
	Eric E. Rhodes
	Senior Vice President and Chief Financial Officer

32