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, 2011

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 on its corporate web site, if any, every interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (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  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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	¨	Accelerated filer	¨
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 14, 2011 there were 3,897,174 outstanding shares of the registrant’s common stock.

BANK OF THE CAROLINAS CORPORATION

FORM 10-Q

September 30, 2011

INDEX

Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at September 30, 2011 and December 31, 2010	3
Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2011 and 2010	4
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2011 and 2010	5
Consolidated Statements of Changes in Stockholders’ Equity for the Nine Months Ended September 30, 2011 and 2010	6
Notes to Consolidated Financial Statements	7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	23
Item 3. Quantitative and Qualitative Disclosures about Market Risk	31
Item 4. Controls and Procedures	31
Part II. OTHER INFORMATION
Item 1. Legal Proceedings	32
Item 1A. Risk Factors	32
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	34
Item 3. Defaults Upon Senior Securities	34
Item 4. [Removed and Reserved]	34
Item 5. Other Information	34
Item 6. Exhibits	34
SIGNATURES	35
EXHIBIT INDEX	36

2

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Bank of the Carolinas Corporation

Consolidated Balance Sheets

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

	September 30, 2011			December 31 2010*
	(Unaudited)
Assets:
Cash and due from banks, noninterest-bearing	$	4,922		$	4,303
Interest-bearing deposits in banks		4,431			6,262
Cash and cash equivalents		9,353			10,565
Federal funds sold		22,630			9,330
Investment securities		113,768			110,373
Loans receivable		324,757			366,153
Less: Allowance for loan losses		(8,691	)		(6,863	)
Total loans, net		316,066			359,290
Premises and equipment		12,448			13,106
Other real estate owned		9,825			8,314
Bank owned life insurance		10,640			10,371
Deferred tax assets		3,509			5,123
Prepaid FDIC insurance assessment		2,759			3,670
Accrued interest receivable		1,700			1,814
Other assets		3,179			3,014
Total assets	$	505,877		$	534,970
Liabilities and Stockholders’ Equity:
Deposits:
Noninterest-bearing demand deposits	$	34,446		$	33,730
Interest-checking deposits		38,527			34,004
Savings and money market deposits		103,163			114,923
Time deposits		241,422			233,512
Total deposits		417,558			416,169
Securities sold under agreements to repurchase		45,412			45,603
Federal Home Loan Bank advances		10,000			22,000
Subordinated debt		7,855			7,855
Other liabilities		2,226			1,639
Total liabilities		483,051			493,266
Commitments and contingencies (Note 6)		—			—
Stockholders’ Equity:
Preferred stock, no par value		13,179			13,179
Discount on preferred stock		(787	)		(991	)
Common stock, $5 per share par value		19,486			19,486
Additional paid-in capital		12,984			12,988
Retained deficit		(23,650	)		(3,268	)
Accumulated other comprehensive income		1,614			310
Total Stockholders’ Equity		22,826			41,704
Total Liabilities and Stockholders’ Equity	$	505,877		$	534,970
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.

The accompanying notes are an integral part of these 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
	2011			2010			2011			2010
Interest income
Interest and fees on loans	$	4,276		$	5,102		$	13,415		$	15,809
Interest on securities		823			822			2,422			2,607
Other interest income		16			12			42			45
Total interest income		5,115			5,936			15,879			18,461
Interest expense
Interest on deposits		1,075			1,181			3,405			3,839
Interest on borrowed funds		571			641			2,075			1,997
Total interest expense		1,646			1,822			5,480			5,836
Net interest income		3,469			4,114			10,399			12,625
Provision for loan losses		5,650			858			14,567			2,860
Net interest income (loss) after provision for loan losses		(2,181	)		3,256			(4,168	)		9,765
Noninterest income
Customer service fees		318			316			951			961
Increase in value of bank owned life insurance		91			91			269			270
Gains on investment securities		—			178			6			368
Other income		6			4			16			5
Total non-interest income		415			589			1,242			1,604
Noninterest expense
Salaries and benefits		1,757			1,686			4,947			5,400
Occupancy and equipment		502			537			1,571			1,665
FDIC insurance assessments		345			155			949			717
Data processing services		218			210			654			607
Valuation provisions and net operating costs associated with foreclosed real estate		1,053			349			4,050			1,061
Other		1,205			857			3,591			2,660
Total noninterest expense		5,080			3,794			15,762			12,110
Income (loss) before income taxes		(6,846	)		51			(18,688	)		(741	)
Provision (benefit) for income taxes		—			(31	)		996			(400	)
Net income (loss)		(6,846	)		82			(19,684	)		(341	)
Dividends and accretion on preferred stock		(234	)		(229	)		(698	)		(683	)
Net loss available to common stockholders	$	(7,080	)	$	(147	)	$	(20,382	)	$	(1,024	)
Loss per common share:
Basic	$	(1.82	)	$	(0.04	)	$	(5.23	)	$	(0.26	)
Diluted	$	(1.82	)	$	(0.04	)	$	(5.23	)	$	(0.26	)

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

4

Bank of the Carolinas Corporation

Consolidated Statements of Cash Flows

(Unaudited)

(dollars in thousands)

	Nine Months Ended September 30
	2011			2010
Cash flows from operating activities:
Net loss	$	(19,684	)	$	(341	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Provision for loan losses		14,567			2,860
Stock based compensation expense (benefit)		(4	)		11
Loss on disposal of premises and equipment		3			6
Depreciation and amortization		751			804
Change in valuation allowance on other real estate owned		3,191			591
Loss on sale of other real estate owned		125			107
Gain on sale of securities		(6	)		(368	)
Increase in bank owned life insurance		(269	)		(270	)
Net amortization/accretion of premiums and discounts on investments		572			273
Net change in other assets		1,361			5,352
Net change in other liabilities		93			(432	)
Net cash provided by operating activities		700			8,593
Cash flows from investing activities:
Net change in federal funds sold		(13,300	)		23,480
Purchases of premises and equipment		(96	)		(171	)
Purchases of securities		(31,533	)		(99,832	)
Proceeds from sales, calls, maturities and principal repayments of securities available for sale		29,691			128,039
Redemption of FHLB stock		298			—
Improvements made to other real estate owned		—			(19	)
Proceeds from sales of other real estate owned		2,855			2,581
Proceeds from sales of premises and equipment		—			1
Net decrease in loans		20,975			15,961
Net cash provided by investing activities		8,890			70,040
Cash flows from financing activities:
Net increase (decrease) in deposits		1,389			(78,959	)
Net additions (repayments) of other borrowings		(12,000	)		5,000
Decrease in repurchase agreements		(191	)		(812	)
Cash dividends paid on preferred stock		—			(494	)
Net cash used by financing activities		(10,802	)		(75,265	)
Net increase (decrease) in cash and cash equivalents		(1,212	)		3,368
Cash and cash equivalents at beginning of period		10,565			12,544
Cash and cash equivalents at end of period	$	9,353		$	15,912
Supplemental disclosure of cash flow information:
Cash paid during the period for interest	$	4,900		$	2,139
Noncash investing and financing activities:
Change in fair value of securities available for sale, net of tax	$	1,304		$	1,129
Transfer from loans to other real estate owned	$	7,682		$	3,598

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

5

Bank of the Carolinas Corporation

Consolidated Statements of Changes in Stockholders’ Equity

(Unaudited)

(dollars in thousands)

																		Accumulated
					Discount							Additional			Retained			Other		Total
	Preferred Stock				on Preferred			Common Stock				Paid-In			Earnings			Comprehensive		Stockholders’
	Shares		Amount		Stock			Shares		Amount		Capital			(Deficit)			Income		Equity
Balance, December 31, 2009		13,179	$	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	$	13,179	$	(1,056	)		3,897,174	$	19,486	$	12,989		$	(724	)	$	1,423	$	45,297
Balance, December 31, 2010		13,179	$	13,179	$	(991	)		3,897,174	$	19,486	$	12,988		$	(3,268	)	$	310	$	41,704
Net loss		—		—		—			—		—		—			(19,684	)		—		(19,684	)
Other comprehensive income		—		—		—			—		—		—			—			1,304		1,304
Total comprehensive loss		—		—		—			—		—		—			—			—		(18,380	)
Stock based compensation benefit		—		—		—			—		—		(4	)		—			—		(4	)
Discount accretion on preferred stock		—		—		204			—		—		—			(204	)		—		—
Dividends accrued on preferred stock		—		—		—			—		—		—			(494	)		—		(494	)
Balance, September 30, 2011		13,179	$	13,179	$	(787	)		3,897,174	$	19,486	$	12,984		$	(23,650	)	$	1,614	$	22,826

The accompanying notes are an integral part of these consolidated 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 September 30, 2011 and December 31, 2010 and for the three- and nine-month periods ended September 30, 2011 and 2010, 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, 2011 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2011.

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, 2010. 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,
	2011			2010			2011			2010
Net income (loss) applicable to common stock	$	(7,080	)	$	(147	)	$	(20,382	)	$	(1,024	)
Weighted average number of common shares outstanding		3,897,174			3,897,174			3,897,174			3,897,174
Weighted average number of diluted common shares outstanding		3,897,174			3,897,174			3,897,174			3,897,174
Common stock options and common stock warrants - anti-dilutive		502,205			517,245			502,205			517,245

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, 2011
			Gross		Gross
	Amortized Cost		Unrealized Gains		Unrealized Losses		Estimated Fair Value		Carrying Value
Investment securities available for sale:
U.S. Government agencies securities	$	46,234	$	1,119	$	11	$	47,342	$	47,342
State and municipal bonds		3,436		173		—		3,609		3,609
Corporate securities		963		98		—		1,061		1,061
Mortgage-backed securities		58,184		1,248		33		59,399		59,399
Total investment securities available for sale		108,817		2,638		44		111,411		111,411
Investment securities held to maturity:
Corporate securities		2,357		68		239		2,186		2,357
Total investment securities	$	111,174	$	2,706	$	283	$	113,597	$	113,768

	December 31, 2010
			Gross		Gross
	Amortized Cost		Unrealized Gains		Unrealized Losses		Estimated Fair Value		Carrying Value
Investment securities available for sale:
U.S. Government agencies securities	$	53,141	$	746	$	369	$	53,518	$	53,518
State and municipal bonds		3,696		165		2		3,859		3,859
Corporate securities		962		—		22		940		940
Mortgage-backed securities		48,265		355		397		48,223		48,223
Total investment securities available for sale		106,064		1,266		790		106,540		106,540
Investment securities held to maturity:
Corporate securities		3,833		131		239		3,725		3,833
Total investment securities	$	109,897	$	1,397	$	1,029	$	110,265	$	110,373

Management of the Bank believes all unrealized losses on available-for-sale securities as of September 30, 2011 represent temporary impairments related to market fluctuations. The unrealized losses on our securities are a nominal portion of the total value of the portfolio. The Bank has no intention of selling these securities before their maturity and has the appropriate sources of liquidity to hold these securities until maturity so that no recognized losses will occur.

8

NOTE 4. LOANS

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

	September 30,			December 31,
	2011			2010
Real estate loans:
1-4 family residential	$	81,220		$	78,750
Commercial real estate		133,201			161,839
Construction and development		36,117			35,310
Home equity		30,116			31,465
Total real estate loans		280,654			307,364
Commercial business and other loans		37,226			51,581
Consumer loans:
Installment		3,738			4,300
Other		3,139			2,908
Total consumer loans		6,877			7,208
Gross loans receivable		324,757			366,153
Allowance for loan losses		(8,691	)		(6,863	)
Loans, net	$	316,066		$	359,290

9

Impaired loans, segregated by class of loans, are summarized as follows as of the dates indicated (dollars in thousands):

	September 30, 2011										December 31, 2010
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized		Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance:
Commercial - Non Real Estate	$	1,147	$	1,797	$	—	$	1,846	$	59	$	1,888	$	2,012	$	—	$	2,083	$	127
Commercial Real Estate
Owner occupied		4,491		8,681		—		9,480		244		6,805		7,755		—		7,778		412
Income producing		3,515		3,607		—		3,662		77		1,694		1,694		—		1,740		63
Multifamily		1,293		1,327		—		1,353		22		—		—		—		—		—
Construction & Development
1 - 4 Family		1,324		1,367		—		1,396		61		98		100		—		99		8
Other		1,077		1,243		—		1,255		54		1,141		1,192		—		1,247		56
Farmland		—		—		—		—		—		—		—		—		—		—
Residential
Equity Lines		65		65		—		66		2		37		80		—		80		6
1 - 4 Family		6,400		7,910		—		7,969		335		2,634		2,686		—		2,697		156
Junior Liens		—		—		—		—		—		18		20		—		20		2
Consumer - Non Real Estate
Credit Cards		—		—		—		—		—		—		—		—		—		—
Other		19		20		—		21		2		101		156		—		157		11
Total loans with no allowance	$	19,331	$	26,017	$	—	$	27,048	$	856	$	14,416	$	15,695	$	—	$	15,901	$	841
With an allowance recorded:
Commercial - Non Real Estate	$	2,478	$	3,503	$	1,002	$	3,568	$	149	$	2,633	$	3,103	$	513	$	3,138	$	149
Commercial Real Estate
Owner occupied		1,767		1,818		167		1,824		69		10,430		10,434		951		10,465		430
Income producing		3,992		3,992		126		4,023		153		2,899		2,899		72		2,924		123
Multifamily		—		—		—		—		—		—		—		—		—		—
Construction & Development
1 - 4 Family		380		380		10		401		16		1,138		1,138		44		1,138		69
Other		666		666		321		670		26		148		148		—		148		8
Farmland		—		—		—		—		—		—		—		—		—		—
Residential
Equity Lines		—		—		—		—		—		497		497		447		503		21
1 - 4 Family		6,709		6,714		223		6,740		193		3,117		3,134		516		3,141		142
Junior Liens		400		400		3		493		19		59		60		25		60		1
Consumer - Non Real Estate
Credit Cards		—		—		—		—		—		—		—		—		—		—
Other		—		—		—		—		—		—		—		—		—		—
Total loans with an allowance	$	16,392	$	17,473	$	1,852	$	17,719	$	625	$	20,921	$	21,413	$	2,568	$	21,517	$	943
Total:
Commercial - Non Real Estate	$	3,625	$	5,300	$	1,002	$	5,414	$	208	$	4,521	$	5,115	$	513	$	5,221	$	276
Commercial Real Estate	$	15,058	$	19,425	$	293	$	20,342	$	565	$	21,828	$	22,782	$	1,023	$	22,907	$	1,028
Construction & Development	$	3,447	$	3,656	$	331	$	3,722	$	157	$	2,525	$	2,578	$	44	$	2,632	$	141
Residential	$	13,574	$	15,089	$	226	$	15,268	$	549	$	6,362	$	6,477	$	988	$	6,501	$	328
Consumer - Non Real Estate	$	19	$	20	$	—	$	21	$	2	$	101	$	156	$	—	$	157	$	11
Totals	$	35,723	$	43,490	$	1,852	$	44,767	$	1,481	$	35,337	$	37,108	$	2,568	$	37,418	$	1,784

10

Impaired loans include loans whose contractual terms have been restructured in a manner that grants a concession to a borrower experiencing financial difficulties. Troubled debt restructurings (TDRs) are a subset of impaired loans and totaled $22.9 million at September 30, 2011 and $22.1 million at December 31, 2010.

The following tables illustrate TDR information for the three and nine months ended September 30, 2011:

	For the three months ended September 30, 2011						For the nine months ended September 30, 2011
Troubled Debt Restructuring	Number of Contracts		Pre-Modification Recorded Investment		Post-Modification Recorded Investment		Number of Contracts		Pre-Modification Recorded Investment		Post-Modification Recorded Investment
Commercial - Non Real Estate		5	$	315	$	315		18	$	2,195	$	2,195
Commercial - Real Estate		4		693		693		12		3,656		3,656
Construction & Development		1		902		902		6		2,311		2,311
Residential		8		3,891		3,891		25		6,270		6,270
Consumer - Non Real Estate		—		—		—		—		—		—
Totals		18	$	5,801	$	5,801		61	$	14,432	$	14,432

There were no loans restructured in the twelve months prior to September 30, 2011 that went into default during the three- or nine-month period ended September 30, 2011. For the purposes of this report, default is defined as being 90-days past due or on non-accrual status without performance.

Some loan modifications classified as TDRs may not ultimately result in the full collection of principal and interest, as modified, and result in potential incremental losses. These potential incremental losses have been factored into our overall allowance for loan losses estimate. The level of any re-defaults will likely be affected by future economic conditions. Once a loan becomes a TDR, it will continue to be reported as a TDR until it is ultimately repaid in full, reclassified to loans held for sale, or foreclosed and sold. Included in the allowance for loan losses at September 30, 2011 was an impairment reserve for TDRs in the amount of $564,000.

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Non-accrual loans and an age analysis of past due loans, segregated by class of loans, were as follows (dollars in thousands):

	30 - 59 Days Past Due		60 - 89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans		90 Days Past Due and Still Accruing		Non-accrual Loans
September 30, 2011:
Commercial - Non Real Estate	$	338	$	140	$	1,301	$	1,779	$	35,447	$	37,226	$	—	$	2,008
Commercial Real Estate
Owner occupied		992		—		2,769		3,761		77,472		81,233		—		5,045
Income producing		1,372		—		1,200		2,572		42,722		45,294		—		3,307
Multifamily		—		—		—		—		6,674		6,674		—		1,293
Construction & Development
1 - 4 Family		—		—		57		57		4,339		4,396		—		57
Other		518		514		478		1,510		28,869		30,379		—		1,378
Farmland		—		—		—		—		1,342		1,342		—		—
Residential
Equity Lines		65		—		—		65		30,051		30,116		—		65
1 - 4 Family		1,488		488		3,342		5,318		74,278		79,596		—		5,944
Junior Liens		19		—		—		19		1,605		1,624		—		—
Consumer - Non Real Estate
Credit Cards		—		—		—		—		—		—		—		—
Other		36		29		—		65		3,673		3,738		—		19
Other		—		—		—		—		3,139		3,139		—		—
Total	$	4,828	$	1,171	$	9,147	$	15,146	$	309,611	$	324,757	$	—	$	19,116

	30 - 59 Days Past Due		60 - 89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans		90 Days Past Due and Still Accruing		Non-accrual Loans
December 31, 2010:
Commercial - Non Real Estate	$	2,250	$	148	$	1,380	$	3,778	$	47,803	$	51,581	$	—	$	3,068
Commercial Real Estate
Owner occupied		4,321		—		3,785		8,106		96,100		104,206		—		13,827
Income producing		345		—		1,349		1,694		48,518		50,212		—		1,349
Multifamily		—		—		—		—		7,003		7,003		—		—
Construction & Development
1 - 4 Family		1,299		1,233		99		2,631		2,968		5,599		—		1,236
Other		286		—		251		537		29,174		29,711		—		1,038
Farmland		—		—		—		—		418		418		—		—
Residential
Equity Lines		503		87		—		590		30,875		31,465		—		432
1 - 4 Family		2,026		1,697		1,391		5,114		71,693		76,807		—		3,561
Junior Liens		—		—		—		—		1,943		1,943		—		78
Consumer - Non Real Estate
Credit Cards		—		—		—		—		—		—		—		—
Other		74		1		96		171		4,129		4,300		—		101
Other		—		—		—		—		2,908		2,908		—		—
Total	$	11,104	$	3,166	$	8,351	$	22,621	$	343,532	$	366,153	$	—	$	24,690

The Bank categorizes loans and leases into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. This categorization is made on all commercial, commercial real estate, and construction and development loans. The Bank uses the following definitions for risk ratings:

Special Mention - Loans and leases classified as special mention, while still adequately protected by the borrower’s capital adequacy and payment capability, exhibit distinct weakening trends and/or elevated levels of exposure to external conditions. If left unchecked or uncorrected, these potential weaknesses may result in deteriorated prospects of repayment. These exposures require management’s close attention so as to avoid becoming undue or unwarranted credit exposures.

Substandard - Loans and leases classified as substandard are inadequately protected by the borrower’s current financial condition and payment capability or of the collateral pledged, if any. Loans and leases so classified have a well-defined

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weakness or weaknesses that jeopardize the orderly repayment of debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

Doubtful - Loans and leases classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or orderly repayment in full, on the basis of current existing facts, conditions and values, highly questionable and improbable. Possibility of loss is extremely high, but because of certain important and reasonably specific factors that may work to the advantage and strengthening of the exposure, its classification as an estimated loss is deferred until its more exact status may be determined. The Company’s practice is to charge-off the portion of the loan amount determined to be doubtful in the quarter that the determination is made if the repayment of the loan is collateral dependent.

Loss - Loans and leases classified as loss are considered to be non-collectible and of such little value that their continuance as bankable assets is not warranted. This does not mean the loan has absolutely no recovery value, but rather it is neither practical nor desirable to defer writing off the loan, even though partial recovery may be obtained in the future. Losses are taken in the period in which they surface as uncollectible.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass-rated loans. As of September 30, 2011 and December 31, 2010, and based on the most recent analysis performed, the risk category of loans and leases is as follows (dollars in thousands):

	September 30, 2011
Internal Risk Rating Grades	Pass		Special Mention		Substandard		Doubtful		Loss
Commercial - Non Real Estate	$	29,578	$	3,195	$	3,092	$	1,361	$	—
Commercial Real Estate
Owner occupied		56,769		9,078		15,386		—		—
Income producing		29,154		7,449		8,691		—		—
Multifamily		3,753		801		2,120		—		—
Construction & Development
1 - 4 Family		2,105		1,489		802		—		—
Other		20,532		7,939		1,908		—		—
Farmland		980		362		—		—		—
Totals	$	142,871	$	30,313	$	31,999	$	1,361	$	—
Total:
Commercial - Non Real Estate	$	29,578	$	3,195	$	3,092	$	1,361	$	—
Commercial Real Estate	$	89,676	$	17,328	$	26,197	$	—	$	—
Construction & Development	$	23,617	$	9,790	$	2,710	$	—	$	—
Totals	$	142,871	$	30,313	$	31,999	$	1,361	$	—

	December 31, 2010
Internal Risk Rating Grades	Pass		Special Mention		Substandard		Doubtful		Loss
Commercial - Non Real Estate	$	36,269	$	9,381	$	5,625	$	306	$	—
Commercial Real Estate
Owner occupied		65,512		17,632		21,062		—		—
Income producing		36,450		9,169		4,593		—		—
Multifamily		4,646		1,524		833		—		—
Construction & Development
1 - 4 Family		2,996		1,125		1,478		—		—
Other		25,169		2,939		1,402		201		—
Farmland		418		—		—		—		—
Totals	$	171,460	$	41,770	$	34,993	$	507	$	—
Total:
Commercial - Non Real Estate	$	36,269	$	9,381	$	5,625	$	306	$	—
Commercial Real Estate	$	106,608	$	28,325	$	26,488	$	—	$	—
Construction & Development	$	28,583	$	4,064	$	2,880	$	201	$	—
Totals	$	171,460	$	41,770	$	34,993	$	507	$	—

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All consumer-related loans, including residential real estate and non-real estate, are evaluated and monitored based upon payment activity. Once a consumer-related loan becomes past due on a recurring basis, the Company will pull that loan out of the homogenized pool and evaluate it individually for impairment. At this time, the consumer-related loan may be placed on the Company’s internal watch list and risk rated either special mention or substandard, depending upon the individual circumstances. Consumer-related loans at September 30, 2011 and December 31, 2010, segregated by class of loans, were as follows (dollars in thousands):

	September 30, 2011				December 31, 2010
Risk Based on Payment Activity	Performing		Non- Performing		Performing		Non- Performing
Residential
Equity Lines	$	30,051	$	65	$	31,069	$	396
1 - 4 Family		78,084		1,512		73,682		3,125
Junior Liens		1,624		—		1,866		77
Consumer - Non Real Estate
Credit Cards		—		—		—		—
Other		3,719		19		4,294		6
Totals	$	113,478	$	1,596	$	110,911	$	3,604
Total:
Residential	$	109,759	$	1,577	$	106,617	$	3,598
Consumer - Non Real Estate	$	3,719	$	19	$	4,294	$	6
Totals	$	113,478	$	1,596	$	110,911	$	3,604

NOTE 5. ALLOWANCE FOR LOAN LOSSES

The allowance for possible loan losses is a reserve established through a provision for possible loan losses charged to expense, which represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The Company’s allowance for loan loss methodology includes allowance allocations calculated in accordance with ASC Topic 310, “Receivables” and allowance allocations calculated in accordance with ASC Topic 450, “Contingencies.” Accordingly, the methodology is based on historical loss experience by type of credit and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions. The Company’s process for determining the appropriate level of the allowance for loan losses is designed to account for credit deterioration as it occurs. The provision for loan losses reflects loan quality trends, including the levels of and trends related to non-accrual loans, past due loans, potential problem loans, criticized loans and net charge-offs or recoveries, among other factors. The provision for loan losses also reflects the totality of actions taken on all loans for a particular period. In other words, the amount of the provision reflects not only the necessary increases in the allowance for loan losses related to newly identified criticized loans, but it also reflects actions taken related to other loans including, among other things, any necessary increases or decreases in required allowances for specific loans.

The level of the allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Company’s control, including, among other things, the performance of the Company’s loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.

The Company’s allowance for loan losses consists of three elements: (i) specific valuation allowances determined in accordance with accounting principles regarding receivables based on probable losses on specific loans; (ii) historical valuation allowances determined in accordance with accounting principles regarding contingencies based on historical loan loss experience for similar loans with similar characteristics and trends, adjusted, as necessary, to reflect the impact of current

14

conditions; and (iii) general valuation allowances determined in accordance with accounting principles regarding contingencies based on general economic conditions and other qualitative risk factors both internal and external to the Company.

Historical valuation allowances are calculated based on the historical loss experience of specific types of loans at the time they were charged-off. The Company calculates historical loss ratios for pools of similar loans with similar characteristics based on the proportion of actual charge-offs experienced to the total population of loans in the pool. The historical loss ratios are periodically updated based on actual charge-off experience. A historical valuation allowance is established for each pool of similar loans based upon the product of the historical loss ratio and the total dollar amount of the loans in the pool. The Company’s pools of similar loans include commercial and industrial loans, commercial real estate loans, construction and development loans, residential real estate loans, and consumer and other loans. General valuation allowances are based on general economic conditions and other qualitative risk factors both internal and external to the Company. In general, such valuation allowances are determined by evaluating, among other things: (i) levels and trends in delinquencies and impaired loans; (ii) levels of and trends in chargeoffs and recoveries; (iii) levels of non-impaired substandard loans; (iv) trends in volume and terms of loans; (v) effects of changes in risk selection and underwriting practices; (vi) experience, ability, and depth of lending management and staff; (vii) national and local economic trends and conditions; (viii) industry conditions; and (ix) effect of changes in credit concentrations. Management evaluates the degree of risk that each one of these components has on the quality of the loan portfolio on a quarterly basis. Loans identified as losses by management, internal loan review and/or regulatory examiners are charged-off.

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Changes in the allowance for loan losses by segment are as follows (dollars in thousands):

	Beginning Balance		Chargeoffs			Recoveries		Provision		Ending Balance
September 30, 2011:
Commercial - Non Real Estate	$	2,252	$	(4,085	)	$	427	$	4,280	$	2,874
Commercial Real Estate
Owner occupied		1,055		(5,731	)		21		6,290		1,635
Income producing		99		(101	)		—		190		188
Multifamily		—		—			—		—		—
Construction & Development
1 - 4 Family		181		(212	)		4		168		141
Other		486		(492	)		99		785		878
Farmland		—		—			—		—		—
Residential
Equity Lines		459		(692	)		2		483		252
1 - 4 Family		1,078		(1,922	)		43		1,902		1,101
Consumer - Non Real Estate		161		(115	)		15		93		154
Unallocated		1,092		—			—		376		1,468
Total	$	6,863	$	(13,350	)	$	611	$	14,567	$	8,691

	Individually Evaluated for Impairment
	September 30, 2011				December 31, 2010
	Allowance		Total Loans		Allowance		Total Loans
Commercial - Non Real Estate	$	1,002	$	4,422	$	513	$	4,580
Commercial Real Estate
Owner occupied		167		5,541		951		17,235
Income producing		126		6,852		72		4,593
Multifamily		—		1,293		—		—
Construction & Development
1 - 4 Family		10		802		44		1,236
Other		321		3,054		25		1,288
Farmland		—		—		—		—
Residential
Equity Lines		—		65		447		534
1 - 4 Family		223		13,675		516		5,770
Consumer - Non Real Estate		3		19		—		101
Unallocated		—		—		—		—
Total	$	1,852	$	35,723	$	2,568	$	35,337

	Collectively Evaluated for Impairment
	September 30, 2011				December 31, 2010
	Allowance		Total Loans		Allowance		Total Loans
Commercial - Non Real Estate	$	1,872	$	32,804	$	1,739	$	47,001
Commercial Real Estate
Owner occupied		1,468		75,692		104		86,971
Income producing		62		38,442		27		45,619
Multifamily		—		5,381		—		7,003
Construction & Development
1 - 4 Family		131		3,595		137		4,363
Other		557		27,324		461		28,422
Farmland		—		1,342		—		418
Residential
Equity Lines		252		30,051		12		30,931
1 - 4 Family		878		67,545		562		72,981
Consumer - Non Real Estate		151		3,719		161		4,199
Unallocated		1,468		—		1,092		—
Total	$	6,839	$	285,895	$	4,295	$	327,908

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NOTE 6. 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, 2011 (dollars in thousands):

Unfunded loan commitments	$	30,538
Financial standby letters of credit		2,477
Total unused commitments	$	33,015

NOTE 7. OTHER COMPREHENSIVE INCOME

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

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Unrealized holding gains on securities available-for-sale	$	1,121		$	46		$	2,125		$	2,204
Reclassification adjustment for gains realized in net loss		—			(178	)		(6	)		(368	)
Net unrealized holding gains (losses) on securities available-for-sale		1,121			(132	)		2,119			1,836
Income tax effect		(431	)		51			(815	)		(707	)
Other comprehensive income (loss), net of income tax effect	$	690		$	(81	)	$	1,304		$	1,129

NOTE 8. RECENT ACCOUNTING PRONOUNCEMENTS

In January 2011, the Financial Accounting Standards Board issued Accounting Standards Update 2011-01, Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20. Under the existing effective date in Update 2010-20, public-entity creditors would have provided disclosures about troubled debt restructurings for periods beginning on or after December 15, 2010. The amendments in this Update temporarily defers the effective date for interim and annual periods ending after June 15, 2011, enabling public-entity creditors to provide those disclosures after the Board clarifies the guidance for determining what constitutes a troubled debt restructuring. The deferral in this Update will result in more consistent disclosures about troubled debt restructurings. This amendment does not defer the effective date of the other disclosure requirements in Update 2010-20. The deferral in this amendment is effective upon issuance and is not expected to have a significant impact on the Company.

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In April 2011, the Financial Accounting Standards Board issued Accounting Standards Update 2011-02, A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. This update provides additional guidance and amendments to Subtopic 310-40, Receivables – Troubled Debt Restructurings by Creditors. In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude that both of the following exist; the restructuring constitutes a concession, and the debtor is experiencing financial difficulties. The amendments clarify the guidance on a creditor’s evaluation of whether it has granted a concession, and on a creditor’s evaluation of whether a debtor is experiencing financial difficulties.

The amendments in this Update are effective for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. As a result of applying these amendments, an entity may identify receivables that are newly considered impaired. For purposes of measuring impairment of those receivables, an entity should apply the amendments prospectively for the first interim or annual period beginning on or after June 15, 2011. An entity should disclose the total amount of receivables and the allowance for credit losses as of the end of the period of adoption related to those receivables that are newly considered impaired under Section 310-10-35 for which impairment was previously measured under Subtopic 450-20, Contingencies—Loss Contingencies. An entity should disclose the information required by paragraphs 310-10-50-33 through 50-34, which was deferred by Accounting Standards Update No. 2011-01, Receivables (Topic 310): Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20, for interim and annual periods beginning on or after June 15, 2011. The amendments are not expected to have a significant impact on the Company.

In April 2011, the Financial Accounting Standards Board issued Accounting Standards Update 2011-3, Reconsideration of Effective Control for Repurchase Agreements. The amendments in this Update remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (2) the collateral maintenance implementation guidance related to that criterion. Other criteria applicable to the assessment of effective control are not changed by the amendments in this Update. Those criteria indicate that the transferor is deemed to have maintained effective control over the financial assets transferred (and thus must account for the transaction as a secured borrowing) for agreements that both entitle and obligate the transferor to repurchase or redeem the financial assets before their maturity when all of the listed conditions have been met. The amendments are not expected to have a significant impact on the Company.

In May 2011, the Financial Accounting Standards Board issued Accounting Standards Update 2011-4, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The amendments in this Update result in common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs. Consequently, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. For many of the requirements, the Board does not intend for the amendments in this Update to result in a change in the application of the requirements in Topic 820.

Some of the amendments clarify the Board’s intent about the application of existing fair value measurement requirements. Other amendments change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. The amendments are not expected to have a significant impact on the Company.

In June 2011, the Financial Accounting Standards Board issued Accounting Standards Update 2011-5, Presentation of Comprehensive Income. Under the amendments to Topic 220, Comprehensive Income, in this Update, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. In a single continuous statement, the entity is required to present the components of net income and total net income, the components of other comprehensive income and a total for other comprehensive income, along with the total of comprehensive income in that statement. In the two-statement approach, an entity is required to present components of net income and total net income in the statement of net income. The statement of other comprehensive income should immediately follow the statement of net income and include the components of other comprehensive income and a total for other comprehensive income, along with a total for comprehensive income.

Regardless of whether an entity chooses to present comprehensive income in a single continuous statement or in two separate but consecutive statements, the entity is required to present on the face of the financial statements reclassification adjustments

18

for items that are reclassified from other comprehensive income to net income in the statement(s) where the components of net income and the components of other comprehensive income are presented.

The amendments in this Update do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. The amendments do not change the option for an entity to present components of other comprehensive income either net of related tax effects or before related tax effects, with one amount shown for the aggregate income tax expense or benefit related to the total of other comprehensive income items. In both cases, the tax effect for each component must be disclosed in the notes to the financial statements or presented in the statement in which other comprehensive income is presented. The amendments do not affect how earnings per share is calculated or presented. The amendments are not expected to have a significant impact on the Company.

From time to time the FASB issues Proposed Accounting Standards Updates. Such proposed updates are subject to comment from the public, to revisions by the FASB and to final issuance by the FASB as Accounting Standards Updates. Management considers the effect of the proposed updates on the consolidated financial statements of the Company and monitors the status of changes to and proposed effective dates of proposed updates.

NOTE 9. FAIR VALUE

Accounting principles generally accepted in the United States of America 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.

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

	At September 30, 2011
	Total		Level 1		Level 2		Level 3
Assets valued on a recurring basis
Investment securities:
U.S. government and agency	$	47,342	$	—	$	47,342	$	—
State and municipals		3,609		—		3,609		—
Corporate		1,061		—		1,061		—
Mortgage-backed		59,399		—		59,399		—
Assets valued on a non-recurring basis
Impaired loans		35,723		—		35,723		—
Other real estate owned		9,825		—		9,825		—
Total	$	156,959	$	—	$	156,959	$	—

	At December 31, 2010
	Total		Level 1		Level 2		Level 3
Assets valued on a recurring basis
Investment securities:
U.S. government and agency	$	53,518	$	—	$	53,518	$	—
State and municipals		3,859		—		3,859		—
Corporate		940		—		940		—
Mortgage-backed		48,223		—		48,223		—
Assets valued on a non-recurring basis
Impaired loans		35,337		—		35,337		—
Other real estate owned		8,314		—		8,314		—
Total	$	150,191	$	—	$	150,191	$	—

NOTE 10. 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, 2011					December 31, 2010
	Outstanding Balance		Annual Interest Rate			Outstanding Balance		Annual Interest Rate
Securities sold under overnight repurchase agreements	$	412		0.10	%	$	603		0.13	%
Securities sold under term repurchase agreements		45,000		4.38			45,000		4.38
Federal Home Loan Bank advances		10,000		0.19			22,000		1.13
Trust preferred securities		5,155		3.29			5,155		3.25
Subordinated debt		2,700		4.00			2,700		4.00
Total borrowed funds	$	63,267		3.58	%	$	75,458		3.31	%

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.

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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, 2011 (dollars in thousands):

	Outstanding Principal Balance		Annual Effective Interest Rate			Final Maturity Date		Beginning Quarterly Call Dates		Collateral Requirement
Agreement dated 7/8/2008	$	25,000		4.85	%		7/8/2018		7/8/2013	$	8,790
Agreement dated 8/20/2008		20,000		3.78			8/20/2015		8/20/2011		3,363
Total	$	45,000		4.38	%					$	12,153

The Bank utilizes borrowings from the Federal Home Loan Bank (“FHLB”) as a source of liquidity. At September 30, 2011, the FHLB had advances totaling $10.0 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, 2011 (dollars in thousands):

	Outstanding Principal Balance		Annual Effective Interest Rate			Final Maturity Date
Advance dated 2/16/2010	$	10,000		0.19	%		02/16/12

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. In February 2011, the Company announced its election to defer its regularly scheduled interest payments on the junior subordinated debentures related to the trust preferred securities. Furthermore, the Company is now party to a written agreement with the Federal Reserve, which restricts the Company’s ability to make interest payments on subordinated debt, as described below.

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. This debt can be repaid in full at any time with no penalty.

Under the terms of a written agreement between the Company and the Federal Reserve Bank of Richmond, the Company and the Bank may not make any distributions of interest, principal, or other sums on subordinated debentures or trust preferred securities without the prior written approval of the Federal Reserve Bank of Richmond and the Director of the Division of Banking Supervision and Regulation of the Federal Reserve Board of Governors.

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NOTE 11. 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, 2011 and December 31, 2010. All of the shares were issued on April 17, 2009 in connection with the U.S. Treasury’s TARP Capital Purchase Program.

In February 2011, the Company notified the Treasury of its intent to defer the payment of its regular quarterly cash dividend on its Series A Preferred Stock sold to the Treasury. In addition, the Company has entered into a written agreement with the Federal Reserve Bank of Richmond, which prohibits the Company’s payment of any dividends without the prior approval of the Federal Reserve Bank of Richmond and the Director of the Division of Banking Supervision and Regulation of the Federal Reserve Board of Governors.

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, 2011 and December 31, 2010.

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.

NOTE 12. INCOME TAXES

The Company utilizes the liability method of computing income taxes. Under the liability method, deferred tax liabilities and assets are established for future tax return effects of the temporary differences between the stated value of assets and liabilities for financial reporting purposes and their tax bases. The focus is on accruing the appropriate balance sheet deferred tax amount, with the statement of income effect being the result of the changes in the balance sheet amounts from period to period. The current portion of income tax expense is provided based upon the actual tax liability incurred for tax return purposes.

An evaluation of the probability of being able to realize the future benefits of deferred tax assets is made. A valuation allowance is provided for the deferred tax asset when it is more likely than not that some portion or all of the deferred tax asset will not be realized. At September 30, 2011, a valuation allowance of $7.4 million was established against our deferred tax asset. This valuation along with a current year income tax benefit of $6.4 million resulted in a $996,000 income tax expense for the nine months ending September 30, 2011 compared to an income tax benefit of $400,000 for the first nine months of 2010.

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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.

Written Agreement with Federal Reserve

The Company entered into a written agreement (the “Agreement”) with the Federal Reserve Bank of Richmond on August 26, 2011. The description of the Agreement set forth below is qualified in its entirety by reference to the Agreement, a copy of which is included as Exhibit 10.01 to this Quarterly Report on Form 10-Q, and incorporated herein by reference.

Source of Strength. The Agreement requires that the Company take appropriate steps to fully utilize its financial and managerial resources to serve as a source of strength to the Bank and ensure that the Bank complies with the requirements of the consent order entered into between the North Carolina Commissioner of Banks, the FDIC, and the Bank.

Dividends, Distributions, and other Payments. The Agreement prohibits the Company’s payment of any dividends without the prior approval of the Federal Reserve Bank of Richmond and the Director of the Division of Banking Supervision and Regulation. It also prohibits the Company from directly or indirectly taking any dividends or any other form of payment representing a reduction in capital from the Bank without the prior written approval of the Federal Reserve Bank of Richmond.

Under the terms of the Agreement, the Company and the Bank may not make any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities without the prior written approval of the Federal Reserve Bank of Richmond and the Director of the Division of Banking Supervision and Regulation of the Federal Reserve Board of Governors.

Debt and Stock Redemption. The Agreement requires that the Company and any non-bank subsidiary of the Company not, directly or indirectly, incur, increase or guarantee any debt without the prior written approval of the Federal Reserve Bank. The Agreement also requires that the Company not, directly or indirectly, purchase or redeem any shares of its capital stock without the prior written approval of the Federal Reserve Bank of Richmond.

Capital Plan, Cash Flow Projections and Progress Reports. The Agreement requires that the Company file an acceptable capital plan and certain cash flow projections with the Federal Reserve Bank of Richmond. It also requires that the Company file a written progress report within 30 days after the end of each calendar quarter while the Agreement remains in effect.

Consent Order with Regulators

The Bank entered into a Stipulation to the Issuance of a Consent Order (the “Stipulation”) with the Federal Deposit Insurance Corporation (the “FDIC”) and the North Carolina Office of the Commissioner of Banks (the “Commissioner”) and the FDIC and the Commissioner issued the related Consent Order (the “Order”), effective April 27, 2011. The description of the Stipulation and the Order set forth below is qualified in its entirety by reference to the Stipulation and the Order, copies of which are included as exhibits 10.1 and 10.2, respectively, to the Company’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on May 3, 2011, and incorporated herein by reference.

Management. The Order requires that the Bank have and retain qualified management, including a chief executive officer, senior lending officer, and chief operating officer with qualifications and experience commensurate with their assigned duties

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and responsibilities within 60 days from the effective date of the Order. Within 30 days of the effective date of the Order, the board of directors must retain a bank consultant to develop a written analysis and assessment of the Bank’s management needs. Within 60 days from receipt of the consultant’s management report, the Bank must formulate a written management plan that incorporates the findings of the management report, a plan of action in response to each recommendation contained in the management report, and a time frame for completing each action.

Capital Requirements. While the Order is in effect, the Bank must maintain a leverage ratio (the ratio of Tier 1 capital to total assets) of at least 8% and a total risk-based capital ratio (the ratio of qualifying total capital to risk-weighted assets) of at least 10%. If the Bank’s capital ratios are below these levels as of the date of any call report or regulatory examination, the Bank must, within 30 days from receipt of a written notice of capital deficiency from its regulators, present a plan to increase capital to meet the requirements of the Order.

Allowance for Loan and Lease Losses and Call Report. Upon issuance of the Order, the Bank must make a provision to replenish the allowance for loan and lease losses (“ALLL”). Within 30 days of the effective date of the Order, the Bank must review its call reports filed with its regulators on or after December 31, 2010, and must amend those reports if necessary to accurately reflect the financial condition of the Bank. Within 60 days of the effective date of the Order, the Bank must submit a comprehensive policy for determining the adequacy of the ALLL.

Concentrations of Credit. Within 60 days of the issuance of the Order, the Bank must perform a risk segmentation analysis with respect to its concentrations of credit and must develop a written plan for systematically reducing and monitoring the Bank’s commercial real estate and acquisition, construction, and development loans to an amount commensurate with the Bank’s business strategy, management expertise, size, and location.

Charge-Offs, Credits. The Order requires that the Bank eliminate from its books, by charge-off or collection, all assets or portions of assets classified “loss” and 50% of those assets classified “doubtful.” If an asset is classified “doubtful,” the Bank may alternatively charge off the amount that is considered uncollectible in accordance with the Bank’s written analysis of loan or lease impairment. The Order also prevents the Bank from extending, directly or indirectly, any additional credit to, or for the benefit of, any borrower who has a loan or other extension of credit from the Bank that has been charged off or classified, on whole or in part, “loss” or “doubtful” and is uncollected. The Bank may not extend, directly or indirectly, any additional credit to any borrower who has a loan or other extension of credit from the Bank that has been classified “substandard.” These limitations do not apply if the Bank’s failure to extend further credit to a particular borrower would be detrimental to the best interests of the Bank.

Asset Growth. While the Order is in effect, the Bank must notify its regulators at least 60 days prior to undertaking asset growth that exceeds 10% or more per year or initiating material changes in asset or liability composition. The Bank’s asset growth cannot result in noncompliance with the capital maintenance provisions of the Order unless the Bank receives prior written approval from its regulators.

Restriction on Dividends and Other Payments. While the Order is in effect, the Bank cannot declare or pay dividends, pay bonuses, or pay any form of payment outside the ordinary course of business resulting in a reduction of capital without the prior written approval of its regulators. In addition, the Bank cannot make any distributions of interest, principal, or other sums on subordinated debentures without prior regulatory approval.

Brokered Deposits. The Order provides that the Bank may not accept, renew, or roll over any brokered deposits unless it is in compliance with the requirements of the FDIC regulations governing brokered deposits. These regulations prohibit undercapitalized institutions from accepting, renewing, or rolling over any brokered deposits and also prohibit undercapitalized institutions from soliciting deposits by offering an effective yield that exceeds by more than 75 basis points the prevailing effective yields on insured deposits of comparable maturity in the institution’s market area. An “adequately capitalized” institution may not accept, renew, or roll over brokered deposits unless it has applied for and been granted a waiver by the FDIC.

Written Plans and Other Material Terms. Under the terms of the Order, the Bank is required to prepare and submit the following written plans or reports to the FDIC and the Commissioner:

• Plan to improve liquidity, contingency funding, interest rate risk, and asset liability management

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• Plan to reduce assets of $500,000 or greater classified “doubtful” and “substandard”

• Revised lending and collection policy to provide effective guidance and control over the Bank’s lending and credit administration functions

• Effective internal loan review and grading system

• Policy for managing the Bank’s other real estate

• Business/strategic plan covering the overall operation of the Bank

• Plan and comprehensive budget for all categories of income and expense for the year 2011

• Policy and procedures for managing interest rate risk

• Assessment of the Bank’s information technology function

Under the Order, the Bank’s board of directors has agreed to increase its participation in the affairs of the Bank, including assuming full responsibility for the approval of policies and objectives for the supervision of all of the Bank’s activities. The Bank must also establish a board committee to monitor and coordinate compliance with the Order.

The Order will remain in effect until modified or terminated by the FDIC and the Commissioner.

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CHANGES IN FINANCIAL CONDITION

Total Assets

At September 30, 2011, total assets were $505.9 million, a decrease of 5.4% compared to $535.0 million at December 31, 2010. The asset decrease was primarily the result of reductions in the loan portfolio, including net chargeoffs of $12.7 million. The Bank continues to raise deposits, mainly customer time deposits, which has resulted in increased liquidity and offset reductions in long-term debt.

Investment Securities

Investment securities totaled $113.8 million at September 30, 2011, compared to $110.4 million at December 31, 2010. The increase was a result of the reduction in the loan portfolio referred to above. A summary of the Company’s investment securities holdings by major category at September 30, 2011 and December 31, 2010 is included in Note 3 of “Notes to Consolidated Financial Statements”.

Loans and Allowance for Loan Losses

At September 30, 2011, the loan portfolio totaled $324.8 million and represented 64.2% of total assets compared to $366.2 million or 68.4% of total assets at December 31, 2010. Total loans at September 30, 2011 decreased $41.4 million or 11.3% from December 31, 2010. The decrease in loans outstanding in the nine-month period is the result of net chargeoffs of $12.7 million and 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 85% of the loan portfolio, and commercial business and other loans comprised approximately 15% of the total loan portfolio at both September 30, 2011 and December 31, 2010.

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

The allowance for loan losses at September 30, 2011, amounted to $8.7 million, an increase of $1.8 million, or 26.6% from December 31, 2010. The allowance consists of specific reserves of $1.9 million and a general allowance $6.8 million. The Bank’s provisions for loan losses amounted to $14.6 million at September 30, 2011 compared to $2.9 million at September 30, 2010. 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

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due loans as of September 30, 2011 and December 31, 2010 (dollars in thousands):

	September 30, 2011			December 31, 2010
Loans accounted for on a nonaccrual basis:
Real estate loans:
1-4 family residential	$	6,009		$	4,071
Commercial real estate		9,645			15,176
Construction and development		1,435			2,274
Total real estate loans		17,089			21,521
Commercial business and other loans		2,008			3,068
Consumer loans		19			101
Total nonaccrual loans		19,116			24,690
Accruing loans which are contractually past due 90 days or more		0			0
Total nonperforming loans		19,116			24,690
Other real estate owned		9,825			8,314
Total nonperforming assets	$	28,941		$	33,004
Total nonperforming loans as a percentage of loans		5.89	%		6.74	%
Allowance for loan losses as a percentage of total nonperforming loans		45.46	%		27.80	%
Allowance for loan losses as a percentage of total loans		2.68	%		1.87	%
Total nonperforming assets as a percentage of loans and other real estate owned		8.65	%		8.81	%
Total nonperforming assets as a percentage of total assets		5.72	%		6.17	%

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, 2011, total deposits were $417.6 million compared to $416.2 million at December 31, 2010. The September 30, 2011 amount represents an increase of 0.3% from December 31, 2010, which is mainly recognized in customer time deposits. At September 30, 2011, the deposit mix was comparable to December 31, 2010.

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The following table presents a breakdown of our deposit base at September 30, 2011 and December 31, 2010 (dollars in thousands):

	September 30, 2011			December 31, 2010
Noninterest bearing demand deposits	$	34,446		$	33,730
Interest checking deposits		38,527			34,004
Savings deposits		11,603			11,787
Money market deposits		91,560			103,136
Customer time deposits		198,725			160,514
Brokered certificates of deposit		42,697			72,998
Total deposits	$	417,558		$	416,169
Time deposits $100,000 or more:
Brokered certificates of deposit	$	42,697		$	72,998
Customer time deposits issued in denominations of $100,000 or more		109,310			74,381
Total time deposits issued in denominations of $100,000 or more	$	152,007		$	147,379
As a percent of total deposits:
Noninterest bearing demand deposits		8.25	%		8.10	%
Interest checking deposits		9.23			8.17
Savings deposits		2.78			2.83
Money market deposits		21.93			24.78
Customer time deposits		47.59			38.57
Brokered certificates of deposit		10.23			17.54
Total time deposits issued in denominations of $100,000 or more		36.40			35.41

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, 2011 our balance sheet liquidity ratio (net liquid assets as a percent of unsecured liabilities) amounted to 18.9% and our total liquidity ratio (balance sheet plus off-balance sheet liquidity) was 21.5%.

In addition, we have the ability to borrow $10.0 million from the discount window of the Federal Reserve, as well as lines of credit from correspondent banks of $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 $10.0 million at September 30, 2011, 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, 2011 is adequate to meet its operating needs.

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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, 2011, we were cumulatively asset sensitive for the next twelve months, which means that our interest bearing assets would reprice more quickly than our interest bearing liabilities. Theoretically, our net interest margin will increase if market interest rates rise or decrease 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 described above, the Company and the Bank’s Boards of Directors entered into a regulatory consent order with their respective banking regulators during the second quarter which, among other things, requires that the Bank maintain capital levels in excess of normal regulatory minimums, including a Leverage Capital Ratio of at least 8.0% and a Total Risk-Based Capital Ratio of at least 10.0%, and that the Company and the Bank seek the approval of their respective regulators prior to the payment of any cash dividend. At September 30, 2011, the Bank was not in compliance with the minimum capital requirements. As a result, the Bank will be required to present its federal and state regulators with a plan to increase its capital ratios to the required percentages. The Bank has hired a consultant to help formulate this plan and assist in the exploration of other strategic alternatives.

At September 30, 2011, the Company’s leverage and Tier 1 risk-weighted Capital Ratios were 4.43% and 5.95%, respectively, which are above the minimum level required by regulatory guidelines. At September 30, 2011, the Company’s Total risk-weighted Capital Ratio was 7.92%, which is below the minimum level required by regulatory guidelines. At September 30, 2011, the Bank’s leverage and Tier 1 risk-weighted Capital Ratios were 4.97% and 6.68%, respectively, which are above the minimum levels required by regulatory guidelines. At September 30, 2011, the Bank’s Total risk-weighted Capital Ratio was 7.94%, which is below the minimum level required by regulatory guidelines. At September 30, 2011, the Bank’s leverage and Total risk-weighted Capital Ratios were both non-compliant with the levels specified in the above referenced consent order with bank regulators. 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 Bank was considered “under-capitalized” due to total capital ratio of less than 8.0% as of September 30, 2011.

RESULTS OF OPERATIONS

Three Months Ended September 30, 2011 and 2010

Overview. For the three months ended September 30, 2011, the Company incurred a net loss available to common shareholders of $7.1 million, or $1.82 per common share. This compares to a net loss of $147,000, or $0.04 per common share, for the three months ended September 30, 2010. The third quarter of 2011 has an increased level of provision for loan losses and costs related to foreclosed real estate that are still above the levels we experienced prior to 2008.

Net Interest Income. The Company’s net interest income for the three months ended September 30, 2011 totaled $3.5 million compared to $4.1 million at September 30, 2010. Net interest income decreased due to the loss of $25.1 million in interest earning assets and an increase of $8.7 million of non-performing assets compared to September 30, 2010. The net interest margin decreased 42 basis points from 3.35% in the third quarter of 2010 to 2.93% in the third quarter of 2011.

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Provision for Loan Losses. The loan loss provision amounted to $5.7 million for the quarter ended September 30, 2011, an increase of $4.8 million, or 558.5%, from the $858,000 provision recorded in the comparable quarter of 2010. Net charge-offs totaled $3.6 million in the third quarter of 2011 compared to $1.7 million in the third quarter of 2010.

Noninterest Income. Noninterest income totaled $415,000 for the three months ended September 30, 2011 compared to $589,000 for the comparable three-month period of 2010. 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 of $178,000 in 2010, noninterest income remained relatively flat for the three months ended September 30, 2011 and 2010.

Noninterest Expenses. Noninterest expenses totaled $5.1 million and $3.8 million for the three months ended September 30, 2011 and 2010, respectively. Excluding the increase of other real estate expenses of $704,000, noninterest expenses for the three months would have only increased by $582,000. The increase in other real estate expense is primarily due to valuations performed on foreclosed assets. Other noninterest expenses affecting overhead cost were: (1) FDIC insurance assessment, which increased $190,000 due to increased rates; (2) director and shareholder expenses, which has increased $114,000 due to increased premiums for director and officer liability insurance; and (3) consultant fees, which have increased $175,000 due to additional needs regarding the consent order.

Income Taxes. The Company performed an analysis of its tax position after three years of tax losses. From this analysis, a valuation allowance was established against our deferred tax asset and there was no income tax benefit or expense during the three months ending September 30, 2011 compared to an income tax benefit of $31,000 for the third quarter of 2010.

Nine Months Ended September 30, 2011 and 2010

Overview. For the nine months ended September 30, 2011, the Company incurred a net loss available to common shareholders of $20.4 million, or $5.23 per common share. This compares to a net loss of $1.0 million, or $0.26 per common share, for the nine months ended September 30, 2010. The first nine months of 2011 has an increased level of provision for loan losses that is still above the levels we experienced prior to 2008.

Net Interest Income. The Company’s net interest income for the nine months ended September 30, 2011 totaled $10.4 million compared to $12.6 million at September 30, 2010. Net interest income decreased due to the loss of $25.1 million in interest earning assets and an increase of $8.7 million of non-performing assets compared to September 30, 2010. Net interest margin decreased 42 basis points from 3.30% in the nine-month period of 2010 to 2.88% in the nine-month period of 2011. Also affecting the margin was a prepayment penalty of $273,000 paid to the FHLB on a $10.0 million note during the second quarter. The prepayment will assist the Bank with its capital ratios, earnings, and net interest margin on a prospective basis.

Provision for Loan Losses. The loan loss provision amounted to $14.6 million for the nine months ended September 30, 2011, an increase of $11.7 million, or 409.3%, from the $2.9 million provision recorded in the comparable period of 2010. Net charge-offs totaled $12.7 million in the nine-month period of 2011 compared to $4.7 million in the nine-month period of 2010.

Noninterest Income. Noninterest income totaled $1.2 million for the nine months ended September 30, 2011 compared to $1.6 million for the comparable nine-month period of 2010. 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 of $6,000 for 2011 and $368,000 in 2010, noninterest income remained relatively flat for the nine months ended September 30, 2011 and 2010.

Noninterest Expenses. Noninterest expenses totaled $15.8 million and $12.1 million for the nine months ended September 30, 2011 and 2010, respectively. Excluding the increase in other real estate expenses of $3.0 million, noninterest expenses for the nine months would have increased by only $663,000. The increase in other real estate expense is primarily due to valuations performed on foreclosed assets. Other noninterest expenses affecting overhead cost were: (1) FDIC insurance assessment, which increased $231,000 due to increased rates; (2) credit review expense, which has increased $153,000 due to capital raising efforts; (3) consulting expense, which increased $180,000 due to additional needs regarding the consent order; (4) director and shareholder expenses, which has increased $189,000 due to increased premiums for director and officer liability insurance; and (5) legal services, which have increased $172,000 due to ongoing litigation. An offset to the above-mentioned expenses has been a decrease of $453,000 in salaries and benefits as a result of management reorganization.

30

Income Taxes. The Company performed an analysis of its tax position after three years of tax losses. From this analysis, a valuation allowance of $7.4 million was established against our deferred tax asset. This valuation along with a current year income tax benefit of $6.4 million resulted in a $996,000 income tax expense for the nine months ending September 30, 2011 compared to an income tax benefit of $400,000 for the first nine months of 2010.

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.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Smaller reporting companies such as the Company are not required to provide the information required by this item.

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 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

As disclosed in the Company’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on September 7, 2011, the parties to the civil action Michael D. Larrowe v. Bank of the Carolinas, et al., (No. 1:10-CV-378), brought in the United States District Court for the Middle District of North Carolina, filed a stipulation of dismissal in which the parties agreed to dismiss their claims against one another. The dismissal is “with prejudice,” meaning that the parties may not file suit against each other again on the same claims. All parties agreed to bear their own costs and legal fees. No funds were exchanged in order to effect the dismissal.

Mr. Larrowe was formerly the chief financial officer and a director of the Company and the Bank. He also served as the Bank’s executive vice chairman and chief operating officer. On May 14, 2010, Mr. Larrowe instituted the above-referenced lawsuit against the Bank and certain of its directors and employees.

Item 1A. Risk Factors

In addition to the risk factors that were disclosed in response to Item 1A of Part I of Form 10-K for the year ended December 31, 2010, the following risk factors could impact our operations and financial results:

Risks Relating to Our Business

The Company has entered into a written agreement with the Federal Reserve Bank of Richmond, which will require us to dedicate a significant amount of resources to complying with the agreement and may have a material adverse effect on our operations and the value of our securities.

We have entered into a written agreement with the Federal Reserve Bank of Richmond. The agreement was executed on August 26, 2011. Among other things, the agreement restricts the Company’s ability to pay dividends, make distributions of interest, principal, or other sums on subordinated debentures or trust preferred securities, incur debt, and redeem shares of its capital stock.

In addition, the agreement requires that the Company take appropriate steps to fully utilize its financial and managerial resources to serve as a source of strength to the Bank and ensure that the Bank complies with the requirements of the consent order entered into between the North Carolina Commissioner of Banks, the FDIC, and the Bank. While subject to the agreement, we expect that our management and board of directors will be required to focus considerable time and attention on taking corrective actions to comply with its terms.

There can be no assurance that we will be able to successfully address the Federal Reserve’s concerns in the written agreement or that we will be able to comply with the terms of the written agreement. If we do not comply with the written agreement, we could be subject to the assessment of civil money penalties, further regulatory sanctions, or other regulatory enforcement actions.

The Bank is subject to a consent order issued by the Federal Deposit Insurance Corporation and the North Carolina Office of the Commissioner of Banks. We will be required to devote significant resources to complying with the order. The order may have a material adverse effect on our operations and the value of our securities.

The Bank is subject to a consent order issued by the Federal Deposit Insurance Corporation and the North Carolina Office of the Commissioner of Banks. The order became effective on April 27, 2011. Among other things, the order restricts our ability to grow our assets and pay dividends.

In addition, the order requires us to improve our risk management, compliance systems, oversight functions, financial management, and capital. While subject to the order, we expect that our management and board of directors will be required to focus considerable time and attention on taking corrective actions to comply with its terms. We are also required to hire third-party consultants and advisers to assist us in complying with the order, which could increase our noninterest expense and reduce our earnings, which could affect the value of our securities.

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There can be no assurance that we will be able to successfully address our regulators’ concerns or that we will be able to comply with the terms of the order. If we do not comply with the order, we could be subject to the assessment of civil money penalties, further regulatory sanctions, or other regulatory enforcement actions. The order will remain in effect until modified or terminated by the Federal Deposit Insurance Corporation and the North Carolina Office of the Commissioner of Banks.

The Company relies on dividends from the Bank for substantially all of its revenue. The Bank is currently prohibited from paying dividends without prior regulatory approval.

The Company receives substantially all of its revenue as dividends from the Bank. Under the terms of the consent order with the Bank’s federal and state regulators, the Bank cannot declare or pay dividends without the prior written approval of its regulators. As a result of this dividend restriction, the Company may not be able to service its debt, pay its other obligations, or pay dividends on its common stock and on the preferred stock issued to the U.S. Department of the Treasury under the TARP Capital Purchase Program. Earlier this year, the Company notified the U.S. Department of the Treasury of its intent to defer the payment of its regular quarterly cash dividends on the preferred stock issued to the Treasury. The Company also elected to defer its regularly scheduled interest payment on its junior subordinated debentures related to the outstanding trust preferred securities of Bank of the Carolinas Trust I. These events could have a material adverse effect on the Company’s business, financial condition, results of operations, and the value of the Company’s securities.

The Company is currently prohibited from paying dividends and making distributions of interest, principal, or other sums on subordinated debentures or trust preferred securities without prior regulatory approval.

Under the terms of the written agreement with the Federal Reserve Bank of Richmond, the Company cannot declare or pay dividends or make distributions of interest, principal, or other sums on subordinated debentures or trust preferred securities without prior regulatory approval. As a result of these restrictions, the Company may not be able to service its debt, pay its other obligations, or pay dividends on its common stock or on the preferred stock issued to the U.S. Department of the Treasury under the TARP Capital Purchase Program. Earlier this year, the Company notified the U.S. Department of the Treasury of its intent to defer the payment of its regular quarterly cash dividends on the preferred stock issued to the Treasury. The Company also elected to defer its regularly scheduled interest payment on its junior subordinated debentures related to the outstanding trust preferred securities of Bank of the Carolinas Trust I. These events could have a material adverse effect on the Company’s business, financial condition, results of operations, and the value of the Company’s securities.

The recent downgrade of U.S. government securities by one of the credit ratings agencies could have a material adverse effect on the Company’s operations, earnings and financial condition.

The recent debate in Congress regarding the national debt ceiling, federal budget deficit concerns and overall weakness in the economy recently resulted in a downgrade of U.S. government securities by Standard & Poor’s, one of the three major credit ratings agencies. This downgrade, and the possible future downgrade of the federal government’s credit rating by one or both of the other two major ratings agencies, could create uncertainty in the U.S. and global financial markets and cause other events which, directly or indirectly, may adversely affect the Company’s operations, earnings and financial condition.

Risks Relating to Our Common Stock

The Company’s ability to pay dividends is limited by the Bank’s ability to pay future dividends. The Bank is currently prohibited from paying dividends without prior regulatory approval.

Virtually all of the Company’s operations are conducted through the Bank. As a result, the Company’s ability to pay dividends in the future is limited by the Bank’s ability to pay dividends to the Company. Under the terms of the consent order with the Bank’s federal and state regulators, the Bank cannot declare or pay dividends without the prior written approval of its regulators. If the Bank is not permitted to pay dividends, then the Company’s ability to pay dividends on its common stock will be adversely impacted. This could have a material adverse effect on the value of the Company’s common stock.

The Company is currently prohibited from paying dividends without prior regulatory approval.

Under the terms of the written agreement with the Federal Reserve Bank of Richmond, the Company cannot declare or pay dividends without prior regulatory approval. We can offer no assurance that any such regulatory approval could be obtained.

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This could have a material adverse effect on the value of the Company’s common stock.

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

None

Item 3. Defaults Upon Senior Securities.

As disclosed on its Current Report on Form 8-K, filed with the Securities and Exchange Commission on February 18, 2011, the Company has notified the United States Department of the Treasury of its intent to defer the payment of its regular quarterly cash dividends on its fixed rate cumulative perpetual preferred stock, series A, issued to the Treasury in connection with the Company’s participation in the Treasury’s TARP Capital Purchase Program. Therefore, the Company is currently in arrears with the dividend payments on the series A preferred stock. As of September 30, 2011, the amount of the arrearage on the dividend payments for the series A preferred stock was $582,072.50.

Item 4. [Removed and Reserved]

Item 5. Other Information

None

Item 6. Exhibits

The following exhibits are filed with this report.

10.01	Written Agreement by and between Bank of the Carolinas Corporation and the Federal Reserve Bank of Richmond, dated August 26, 2011
31.01	Certification of our Chief Executive Officer pursuant to Rule 13a-14(a)
31.02	Certification of our Chief Financial Officer pursuant to Rule 13a-14(a)
32.01	Certification of our Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350
101	Interactive data files providing financial information from the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2011, in XBRL (eXtensible Business Reporting Language)*

* Pursuant to Regulation 406T of Regulation S-T, these interactive data files are furnished and not filed or part of a registration statement or prospectus for purposes of section 11 or 12 of the Securities Act of 1933, as amended, or section 18 of the Securities Exchange Act of 1934, as amended, and are otherwise not subject to liability.

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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, 2011	By:	/s/ Stephen R. Talbert
	Stephen R. Talbert
	President and Chief Executive Officer
Date: November 14, 2011	By:	/s/ Eric E. Rhodes
	Eric E. Rhodes
	Executive Vice President and Chief Financial Officer

35

EXHIBIT INDEX

Exhibit Number	Description
10.01	Written Agreement by and between Bank of the Carolinas Corporation and the Federal Reserve Bank of Richmond, dated August 26, 2011
31.01	Certification of our Chief Executive Officer pursuant to Rule 13a-14(a)
31.02	Certification of our Chief Financial Officer pursuant to Rule 13a-14(a)
32.01	Certification of our Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350
101	Interactive data files providing financial information from the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2011, in XBRL (eXtensible Business Reporting Language)*

* Pursuant to Regulation 406T of Regulation S-T, these interactive data files are furnished and not filed or part of a registration statement or prospectus for purposes of section 11 or 12 of the Securities Act of 1933, as amended, or section 18 of the Securities Exchange Act of 1934, as amended, and are otherwise not subject to liability.

36

EX-10.01

Exhibit 10.01

UNITED STATES OF AMERICA

BEFORE THE

BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

WASHINGTON, D.C.

Written Agreement by and between
BANK OF THE CAROLINAS CORPORATION Mocksville, North Carolina	Docket No. 11-103-WA/RB-HC
and
FEDERAL RESERVE BANK OF RICHMOND Richmond, Virginia

WHEREAS, Bank of the Carolinas Corporation, Mocksville, North Carolina (“BCC”), a registered bank holding company, owns and controls Bank of the Carolinas, Mocksville, North Carolina (“Bank”), a state-chartered nonmember bank, and a nonbank subsidiary;

WHEREAS, it is the common goal of BCC and the Federal Reserve Bank of Richmond (the “Reserve Bank”) to maintain the financial soundness of BCC so that BCC may serve as a source of strength to the Bank;

WHEREAS, BCC and the Reserve Bank have mutually agreed to enter into this Written Agreement (the “Agreement”); and

WHEREAS, on August 24, 2011, the board of directors of BCC, at a duly constituted meeting, adopted a resolution authorizing and directing Dr. Francis W. Slate to enter into this Agreement on behalf of BCC, and consenting to compliance with each and every provision of this Agreement by BCC and its institution-affiliated parties, as defined in sections 3(u) and

8(b)(3) of the Federal Deposit Insurance Act, as amended (the “FDI Act”) (12 U.S.C. §§ 1813(u) and 1818(b)(3)).

NOW, THEREFORE, BCC and the Reserve Bank agree as follows:

Source of Strength

1. The board of directors of BCC shall take appropriate steps to fully utilize BCC’s financial and managerial resources, pursuant to section 38A of the FDI Act (12 U.S.C. § 1831o-1) and section 225.4 (a) of Regulation Y of the Board of Governors of the Federal Reserve System (the “Board of Governors”) (12 C.F.R. § 225.4(a)), to serve as a source of strength to the Bank, including, but not limited to, taking steps to ensure that the Bank complies with the Consent Order issued by the Federal Deposit Insurance Corporation on April 27, 2011, and any other supervisory action taken by the Bank’s federal or state regulator.

Dividends, Distributions, and Other Payments

2. (a) BCC shall not declare or pay any dividends without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation (the “Director”) of the Board of Governors.

(b) BCC shall not directly or indirectly take dividends or any other form of payment representing a reduction in capital from the Bank without the prior written approval of the Reserve Bank.

(c) BCC and its nonbank subsidiary shall not make any distributions of interest, principal, or other sums on subordinated debentures or trust preferred securities without the prior written approval of the Reserve Bank and the Director.

(d) All requests for prior approval shall be received by the Reserve Bank at least 30 days prior to the proposed dividend declaration date, proposed distribution on

subordinated debentures, and required notice of deferral on trust preferred securities. All requests shall contain, at a minimum, current and projected information on BCC’s capital, earnings, and cash flow; the Bank’s capital, asset quality, earnings, and allowance for loan and lease losses; and identification of the sources of funds for the proposed payment or distribution. For requests to declare or pay dividends, BCC must also demonstrate that the requested declaration or payment of dividends is consistent with the Board of Governors’ Policy Statement on the Payment of Cash Dividends by State Member Banks and Bank Holding Companies, dated November 14, 1985 (Federal Reserve Regulatory Service, 4-877 at page 4-323).

Debt and Stock Redemption

3. (a) BCC and its nonbank subsidiary shall not, directly or indirectly, incur, increase, or guarantee any debt without the prior written approval of the Reserve Bank. All requests for prior written approval shall contain, but not be limited to, a statement regarding the purpose of the debt, the terms of the debt, and the planned source(s) for debt repayment, and an analysis of the cash flow resources available to meet such debt repayment.

(b) BCC shall not, directly or indirectly, purchase or redeem any shares of its stock without the prior written approval of the Reserve Bank.

Capital Plan

4. Within 60 days of this Agreement, BCC shall submit to the Reserve Bank an acceptable written plan to maintain sufficient capital at BCC on a consolidated basis. The plan shall, at a minimum, address, consider, and include:

(a) The consolidated organization’s and the Bank’s current and future capital requirements, including compliance with the Capital Adequacy Guidelines for Bank Holding Companies: Risk-Based Measure and Tier 1 Leverage Measure, Appendices A and D of

Regulation Y of the Board of Governors (12 C.F.R. Part 225, App. A and D) and the applicable capital adequacy guidelines for the Bank issued by the Bank’s federal regulator;

(b) the adequacy of the Bank’s capital, taking into account the volume of classified credits, its risk profile, the adequacy of the allowance for loan and lease losses, current and projected asset growth, and projected earnings;

(c) the source and timing of additional funds necessary to fulfill the consolidated organization’s and the Bank’s future capital requirements;

(d) supervisory requests for additional capital at the Bank or the requirements of any supervisory action imposed on the Bank by its federal regulator; and

(e) the requirements of section 38A of the FDI Act and section 225.4(a) of Regulation Y of the Board of Governors that BCC serve as a source of strength to the Bank.

5. BCC shall notify the Reserve Bank, in writing, no more than 45 days after the end of any quarter in which any of BCC’s capital ratios fall below the approved plan’s minimum ratios. Together with the notification, BCC shall submit an acceptable written plan that details the steps that BCC will take to increase BCC’s capital ratios to or above the approved plan’s minimums.

Cash Flow Projections

6. Within 45 days of this Agreement, BCC shall submit to the Reserve Bank a written statement of its planned sources and uses of cash for debt service, operating expenses, and other purposes (“Cash Flow Projection”) for 2011. BCC shall submit to the Reserve Bank a Cash Flow Projection for each calendar year subsequent to 2011 at least one month prior to the beginning of that calendar year.

Compliance with Laws and Regulations

7. (a) In appointing any new director or senior executive officer, or changing the responsibilities of any senior executive officer so that the officer would assume a different senior executive officer position, BCC shall comply with the notice provisions of section 32 of the FDI Act (12 U.S.C. § 1831(i) and Subpart H of Regulation Y of the Board of Governors (12 C.F.R. §§ 225.71 et seq.).

(b) BCC shall comply with the restrictions on indemnification and severance payments of section 18(k) of the FDI Act (12 U.S.C. § 1828(k)) and Part 359 of the FDIC’s regulations (12 C.F.R. Part 359).

Progress Reports

8. Within 30 days after the end of each calendar quarter following the date of this Agreement, the board of directors shall submit to the Reserve Bank written progress reports detailing the form and manner of all actions taken to secure compliance with the provisions of this Agreement and the results thereof, and a parent company only balance sheet, income statement, and, as applicable, report of changes in stockholders’ equity.

Approval and Implementation of Plan

9. (a) BCC shall submit a written capital plan that is acceptable to the Reserve Bank within the applicable time period set forth in paragraph 4 of this Agreement.

(b) Within 10 days of approval by the Reserve Bank, BCC shall adopt the approved capital plan. Upon adoption, BCC shall promptly implement the approved plan, and thereafter fully comply with it.

(c) During the term of this Agreement, the approved capital plan shall not be amended or rescinded without the prior written approval of the Reserve Bank.

Communications

10. All communications regarding this Agreement shall be sent to:

(a)	Ms. Joan T. Garton
	Vice President
	Federal Reserve Bank of Richmond
	P.O. Box 27622
	Richmond, Virginia 23261-7622
(b)	Mr. Stephen Talbert
	President and Chief Executive Officer
	Bank of the Carolinas Corporation
	P.O. Box 129
	Mocksville, North Carolina 27028

Miscellaneous

11. Notwithstanding any provision of this Agreement, the Reserve Bank may, in its sole discretion, grant written extensions of time to BCC to comply with any provision of this Agreement.

12. The provisions of this Agreement shall be binding upon BCC and its institution- affiliated parties, in their capacities as such, and their successors and assigns.

13. Each provision of this Agreement shall remain effective and enforceable until stayed, modified, terminated, or suspended in writing by the Reserve Bank.

14. The provisions of this Agreement shall not bar, estop, or otherwise prevent the Board of Governors, the Reserve Bank, or any other federal or state agency from taking any other action affecting BCC, the Bank, the nonbank subsidiary of BCC, or any of their current or former institution-affiliated parties and their successors and assigns.

15. Pursuant to section 50 of the FDI Act (12 U.S.C. § 1831aa), this Agreement is enforceable by the Board of Governors under section 8 of the FDI Act (12 U.S.C. § 1818).

IN WITNESS WHEREOF, the parties have caused this Agreement to be executed as of the 26^th day of August, 2011.

BANK OF THE CAROLINAS CORPORATION		FEDERAL RESERVE BANK OF RICHMOND
By:	/s/ Dr. Francis W. Slate	By:	/s/ Joan T. Garton
	Dr. Francis W. Slate		Joan T. Garton
	Chairman of the Board of Directors		Vice President

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 14, 2011	/s/ Stephen R. Talbert
	Stephen R. Talbert
	President and Chief Executive Officer

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 14, 2011	/s/ Eric E. Rhodes
	Eric E. Rhodes
	Executive Vice President and Chief 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, 2011, 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, 2011	/s/ Stephen R. Talbert
	Stephen R. Talbert
	President and Chief Executive Officer
Date: November 14, 2011	/s/ Eric E. Rhodes
	Eric E. Rhodes
	Executive Vice President and Chief Financial Officer

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Consolidated Balance Sheets (Parenthetical) (USD $)	Sep. 30, 2011	Dec. 31, 2010
Consolidated Balance Sheets [Abstract]
Preferred stock, no par value
Common stock, par value	$ 5	$ 5

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Consolidated Statements Of Operations (USD $) In Thousands, except Per Share data	3 Months Ended		9 Months Ended
	Sep. 30, 2011	Sep. 30, 2010	Sep. 30, 2011	Sep. 30, 2010
Interest income
Interest and fees on loans	$ 4,276	$ 5,102	$ 13,415	$ 15,809
Interest on securities	823	822	2,422	2,607
Other interest income	16	12	42	45
Total interest income	5,115	5,936	15,879	18,461
Interest expense
Interest on deposits	1,075	1,181	3,405	3,839
Interest on borrowed funds	571	641	2,075	1,997
Total interest expense	1,646	1,822	5,480	5,836
Net interest income	3,469	4,114	10,399	12,625
Provision for loan losses	5,650	858	14,567	2,860
Net interest income (loss) after provision for loan losses	(2,181)	3,256	(4,168)	9,765
Noninterest income
Customer service fees	318	316	951	961
Increase in value of bank owned life insurance	91	91	269	270
Gains on investment securities		178	6	368
Other income	6	4	16	5
Total non-interest income	415	589	1,242	1,604
Noninterest expense
Salaries and benefits	1,757	1,686	4,947	5,400
Occupancy and equipment	502	537	1,571	1,665
FDIC insurance assessments	345	155	949	717
Data processing services	218	210	654	607
Valuation provisions and net operating costs associated with foreclosed real estate	1,053	349	4,050	1,061
Other	1,205	857	3,591	2,660
Total noninterest expense	5,080	3,794	15,762	12,110
Income (loss) before income taxes	(6,846)	51	(18,688)	(741)
Provision (benefit) for income taxes		(31)	996	(400)
Net income (loss)	(6,846)	82	(19,684)	(341)
Dividends and accretion on preferred stock	(234)	(229)	(698)	(683)
Net loss available to common stockholders	$ (7,080)	$ (147)	$ (20,382)	$ (1,024)
Loss per common share:
Basic	$ (1.82)	$ (0.04)	$ (5.23)	$ (0.26)
Diluted	$ (1.82)	$ (0.04)	$ (5.23)	$ (0.26)

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Document And Entity Information	9 Months Ended
	Sep. 30, 2011	Nov. 14, 2011
Document And Entity Information [Abstract]
Document Type	10-Q
Amendment Flag	false
Document Period End Date	Sep. 30, 2011
Document Fiscal Year Focus	2011
Document Fiscal Period Focus	Q3
Entity Registrant Name	Bank of the Carolinas CORP
Entity Central Index Key	0001365997
Entity Filer Category	Smaller Reporting Company
Current Fiscal Year End Date	--12-31
Entity Common Stock, Shares Outstanding		3,897,174

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Commitments And Contingencies

9 Months Ended

Sep. 30, 2011

Commitments And Contingencies [Abstract]

Commitments And Contingencies

NOTE 6. 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, 2011 (dollars in thousands):

Unfunded loan commitments	$	30,538
Financial standby letters of credit		2,477
Total unused commitments	$	33,015

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Stockholders' Equity

9 Months Ended

Sep. 30, 2011

Stockholders' Equity [Abstract]

Stockholders' Equity

NOTE 11. 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, 2011 and December 31, 2010. All of the shares were issued on April 17, 2009 in connection with the U.S. Treasury's TARP Capital Purchase Program.

In February 2011, the Company notified the Treasury of its intent to defer the payment of its regular quarterly cash dividend on its Series A Preferred Stock sold to the Treasury. In addition, the Company has entered into a written agreement with the Federal Reserve Bank of Richmond, which prohibits the Company's payment of any dividends without the prior approval of the Federal Reserve Bank of Richmond and the Director of the Division of Banking Supervision and Regulation of the Federal Reserve Board of Governors.

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, 2011 and December 31, 2010.

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.

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Earnings Per Share

9 Months Ended

Sep. 30, 2011

Earnings Per Share [Abstract]

Earnings Per Share

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,
	2011			2010			2011			2010
Net income (loss) applicable to common stock	$	(7,080	)	$	(147	)	$	(20,382	)	$	(1,024	)
Weighted average number of common shares outstanding		3,897,174			3,897,174			3,897,174			3,897,174
Weighted average number of diluted common shares outstanding		3,897,174			3,897,174			3,897,174			3,897,174
Common stock options and common stock warrants - anti-dilutive		502,205			517,245			502,205			517,245

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.

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Recent Accounting Pronouncements

9 Months Ended

Sep. 30, 2011

Recent Accounting Pronouncements [Abstract]

Recent Accounting Pronouncements

NOTE 8. RECENT ACCOUNTING PRONOUNCEMENTS

In January 2011, the Financial Accounting Standards Board issued Accounting Standards Update 2011-01, Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20. Under the existing effective date in Update 2010-20, public-entity creditors would have provided disclosures about troubled debt restructurings for periods beginning on or after December 15, 2010. The amendments in this Update temporarily defers the effective date for interim and annual periods ending after June 15, 2011, enabling public-entity creditors to provide those disclosures after the Board clarifies the guidance for determining what constitutes a troubled debt restructuring. The deferral in this Update will result in more consistent disclosures about troubled debt restructurings. This amendment does not defer the effective date of the other disclosure requirements in Update 2010-20. The deferral in this amendment is effective upon issuance and is not expected to have a significant impact on the Company.

In April 2011, the Financial Accounting Standards Board issued Accounting Standards Update 2011-02, A Creditor's Determination of Whether a Restructuring Is a Troubled Debt Restructuring. This update provides additional guidance and amendments to Subtopic 310-40, Receivables – Troubled Debt Restructurings by Creditors. In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude that both of the following exist; the restructuring constitutes a concession, and the debtor is experiencing financial difficulties. The amendments clarify the guidance on a creditor's evaluation of whether it has granted a concession, and on a creditor's evaluation of whether a debtor is experiencing financial difficulties.

The amendments in this Update are effective for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. As a result of applying these amendments, an entity may identify receivables that are newly considered impaired. For purposes of measuring impairment of those receivables, an entity should apply the amendments prospectively for the first interim or annual period beginning on or after June 15, 2011. An entity should disclose the total amount of receivables and the allowance for credit losses as of the end of the period of adoption related to those receivables that are newly considered impaired under Section 310-10-35 for which impairment was previously measured under Subtopic 450-20, Contingencies—Loss Contingencies. An entity should disclose the information required by paragraphs 310-10-50-33 through 50-34, which was deferred by Accounting Standards Update No. 2011-01, Receivables (Topic 310): Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20, for interim and annual periods beginning on or after June 15, 2011. The amendments are not expected to have a significant impact on the Company.

In April 2011, the Financial Accounting Standards Board issued Accounting Standards Update 2011-3, Reconsideration of Effective Control for Repurchase Agreements. The amendments in this Update remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (2) the collateral maintenance implementation guidance related to that criterion. Other criteria applicable to the assessment of effective control are not changed by the amendments in this Update. Those criteria indicate that the transferor is deemed to have maintained effective control over the financial assets transferred (and thus must account for the transaction as a secured borrowing) for agreements that both entitle and obligate the transferor to repurchase or redeem the financial assets before their maturity when all of the listed conditions have been met. The amendments are not expected to have a significant impact on the Company.

In May 2011, the Financial Accounting Standards Board issued Accounting Standards Update 2011-4, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The amendments in this Update result in common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs. Consequently, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. For many of the requirements, the Board does not intend for the amendments in this Update to result in a change in the application of the requirements in Topic 820.

Some of the amendments clarify the Board's intent about the application of existing fair value measurement requirements. Other amendments change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. The amendments are not expected to have a significant impact on the Company.

In June 2011, the Financial Accounting Standards Board issued Accounting Standards Update 2011-5, Presentation of Comprehensive Income. Under the amendments to Topic 220, Comprehensive Income, in this Update, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. In a single continuous statement, the entity is required to present the components of net income and total net income, the components of other comprehensive income and a total for other comprehensive income, along with the total of comprehensive income in that statement. In the two-statement approach, an entity is required to present components of net income and total net income in the statement of net income. The statement of other comprehensive income should immediately follow the statement of net income and include the components of other comprehensive income and a total for other comprehensive income, along with a total for comprehensive income.

Regardless of whether an entity chooses to present comprehensive income in a single continuous statement or in two separate but consecutive statements, the entity is required to present on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement(s) where the components of net income and the components of other comprehensive income are presented.

The amendments in this Update do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. The amendments do not change the option for an entity to present components of other comprehensive income either net of related tax effects or before related tax effects, with one amount shown for the aggregate income tax expense or benefit related to the total of other comprehensive income items. In both cases, the tax effect for each component must be disclosed in the notes to the financial statements or presented in the statement in which other comprehensive income is presented. The amendments do not affect how earnings per share is calculated or presented. The amendments are not expected to have a significant impact on the Company.

From time to time the FASB issues Proposed Accounting Standards Updates. Such proposed updates are subject to comment from the public, to revisions by the FASB and to final issuance by the FASB as Accounting Standards Updates. Management considers the effect of the proposed updates on the consolidated financial statements of the Company and monitors the status of changes to and proposed effective dates of proposed updates.

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Fair Value

9 Months Ended

Sep. 30, 2011

Fair Value [Abstract]

Fair Value

NOTE 9. FAIR VALUE

Accounting principles generally accepted in the United States of America 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.

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

	At September 30, 2011
	Total		Level 1		Level 2		Level 3
Assets valued on a recurring basis
Investment securities:
U.S. government and agency	$	47,342	$	—	$	47,342	$	—
State and municipals		3,609		—		3,609		—
Corporate		1,061		—		1,061		—
Mortgage-backed		59,399		—		59,399		—
Assets valued on a non-recurring basis
Impaired loans		35,723		—		35,723		—
Other real estate owned		9,825		—		9,825		—
Total	$	156,959	$	—	$	156,959	$	—

	At December 31, 2010
	Total		Level 1		Level 2		Level 3
Assets valued on a recurring basis
Investment securities:
U.S. government and agency	$	53,518	$	—	$	53,518	$	—
State and municipals		3,859		—		3,859		—
Corporate		940		—		940		—
Mortgage-backed		48,223		—		48,223		—
Assets valued on a non-recurring basis
Impaired loans		35,337		—		35,337		—
Other real estate owned		8,314		—		8,314		—
Total	$	150,191	$	—	$	150,191	$	—

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Other Comprehensive Income

9 Months Ended

Sep. 30, 2011

Other Comprehensive Income [Abstract]

Other Comprehensive Income

NOTE 7. OTHER COMPREHENSIVE INCOME

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

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Unrealized holding gains on securities available-for-sale	$	1,121		$	46		$	2,125		$	2,204
Reclassification adjustment for gains realized in net loss		—			(178	)		(6	)		(368	)
Net unrealized holding gains (losses) on securities available-for-sale		1,121			(132	)		2,119			1,836
Income tax effect		(431	)		51			(815	)		(707	)
Other comprehensive income (loss), net of income tax effect	$	690		$	(81	)	$	1,304		$	1,129

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Consolidated Statements Of Changes In Stockholders' Equity (USD $) In Thousands, except Share data	Preferred Stock [Member]	Discount On Preferred Stock [Member]	Common Stock [Member]	Additional Paid-In Capital [Member]	Retained Earnings (Deficit) [Member]	Accumulated Other Comprehensive Income [Member]	Total
Balance, value at Dec. 31, 2009	$ 13,179	$ (1,245)	$ 19,486	$ 12,978	$ 300	$ 294	$ 44,992
Balance, shares at Dec. 31, 2009	13,179		3,897,174
Net loss					(341)		(341)
Other comprehensive income						1,129	1,129
Total comprehensive income (loss)							788
Stock based compensation expense/benefit				11			11
Discount accretion on preferred stock		189			(189)
Dividends accrued on preferred stock					(494)		(494)
Balance, value at Sep. 30, 2010	13,179	(1,056)	19,486	12,989	(724)	1,423	45,297
Balance, shares at Sep. 30, 2010	13,179		3,897,174
Balance, value at Dec. 31, 2010	13,179	(991)	19,486	12,988	(3,268)	310	41,704	[1]
Balance, shares at Dec. 31, 2010	13,179		3,897,174
Net loss					(19,684)		(19,684)
Other comprehensive income						1,304	1,304
Total comprehensive income (loss)							(18,380)
Stock based compensation expense/benefit				(4)			(4)
Discount accretion on preferred stock		204			(204)
Dividends accrued on preferred stock					(494)		(494)
Balance, value at Sep. 30, 2011	$ 13,179	$ (787)	$ 19,486	$ 12,984	$ (23,650)	$ 1,614	$ 22,826
Balance, shares at Sep. 30, 2011	13,179		3,897,174

[1] Derived from audited consolidated financial statements.

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Investment Securities

9 Months Ended

Sep. 30, 2011

Investment Securities [Abstract]

Investment Securities

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, 2011
			Gross		Gross
	Amortized Cost		Unrealized Gains		Unrealized Losses		Estimated Fair Value		Carrying Value
Investment securities available for sale:
U.S. Government agencies securities	$	46,234	$	1,119	$	11	$	47,342	$	47,342
State and municipal bonds		3,436		173		—		3,609		3,609
Corporate securities		963		98		—		1,061		1,061
Mortgage-backed securities		58,184		1,248		33		59,399		59,399
Total investment securities available for sale		108,817		2,638		44		111,411		111,411
Investment securities held to maturity:
Corporate securities		2,357		68		239		2,186		2,357
Total investment securities	$	111,174	$	2,706	$	283	$	113,597	$	113,768

	December 31, 2010
			Gross		Gross
	Amortized Cost		Unrealized Gains		Unrealized Losses		Estimated Fair Value		Carrying Value
Investment securities available for sale:
U.S. Government agencies securities	$	53,141	$	746	$	369	$	53,518	$	53,518
State and municipal bonds		3,696		165		2		3,859		3,859
Corporate securities		962		—		22		940		940
Mortgage-backed securities		48,265		355		397		48,223		48,223
Total investment securities available for sale		106,064		1,266		790		106,540		106,540
Investment securities held to maturity:
Corporate securities		3,833		131		239		3,725		3,833
Total investment securities	$	109,897	$	1,397	$	1,029	$	110,265	$	110,373

Management of the Bank believes all unrealized losses on available-for-sale securities as of September 30, 2011 represent temporary impairments related to market fluctuations. The unrealized losses on our securities are a nominal portion of the total value of the portfolio. The Bank has no intention of selling these securities before their maturity and has the appropriate sources of liquidity to hold these securities until maturity so that no recognized losses will occur.

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Loans

9 Months Ended

Sep. 30, 2011

Loans [Abstract]

Loans

NOTE 4. LOANS

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

	September 30,			December 31,
	2011			2010
Real estate loans:
1-4 family residential	$	81,220		$	78,750
Commercial real estate		133,201			161,839
Construction and development		36,117			35,310
Home equity		30,116			31,465
Total real estate loans		280,654			307,364
Commercial business and other loans		37,226			51,581
Consumer loans:
Installment		3,738			4,300
Other		3,139			2,908
Total consumer loans		6,877			7,208
Gross loans receivable		324,757			366,153
Allowance for loan losses		(8,691	)		(6,863	)
Loans, net	$	316,066		$	359,290

Impaired loans, segregated by class of loans, are summarized as follows as of the dates indicated (dollars in thousands):

	September 30, 2011										December 31, 2010
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized		Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance:
Commercial - Non Real Estate	$	1,147	$	1,797	$	—	$	1,846	$	59	$	1,888	$	2,012	$	—	$	2,083	$	127
Commercial Real Estate
Owner occupied		4,491		8,681		—		9,480		244		6,805		7,755		—		7,778		412
Income producing		3,515		3,607		—		3,662		77		1,694		1,694		—		1,740		63
Multifamily		1,293		1,327		—		1,353		22		—		—		—		—		—
Construction & Development
1 - 4 Family		1,324		1,367		—		1,396		61		98		100		—		99		8
Other		1,077		1,243		—		1,255		54		1,141		1,192		—		1,247		56
Farmland		—		—		—		—		—		—		—		—		—		—
Residential
Equity Lines		65		65		—		66		2		37		80		—		80		6
1 - 4 Family		6,400		7,910		—		7,969		335		2,634		2,686		—		2,697		156
Junior Liens		—		—		—		—		—		18		20		—		20		2
Consumer - Non Real Estate
Credit Cards		—		—		—		—		—		—		—		—		—		—
Other		19		20		—		21		2		101		156		—		157		11
Total loans with no allowance	$	19,331	$	26,017	$	—	$	27,048	$	856	$	14,416	$	15,695	$	—	$	15,901	$	841
With an allowance recorded:
Commercial - Non Real Estate	$	2,478	$	3,503	$	1,002	$	3,568	$	149	$	2,633	$	3,103	$	513	$	3,138	$	149
Commercial Real Estate
Owner occupied		1,767		1,818		167		1,824		69		10,430		10,434		951		10,465		430
Income producing		3,992		3,992		126		4,023		153		2,899		2,899		72		2,924		123
Multifamily		—		—		—		—		—		—		—		—		—		—
Construction & Development
1 - 4 Family		380		380		10		401		16		1,138		1,138		44		1,138		69
Other		666		666		321		670		26		148		148		—		148		8
Farmland		—		—		—		—		—		—		—		—		—		—
Residential
Equity Lines		—		—		—		—		—		497		497		447		503		21
1 - 4 Family		6,709		6,714		223		6,740		193		3,117		3,134		516		3,141		142
Junior Liens		400		400		3		493		19		59		60		25		60		1
Consumer - Non Real Estate
Credit Cards		—		—		—		—		—		—		—		—		—		—
Other		—		—		—		—		—		—		—		—		—		—
Total loans with an allowance	$	16,392	$	17,473	$	1,852	$	17,719	$	625	$	20,921	$	21,413	$	2,568	$	21,517	$	943
Total:
Commercial - Non Real Estate	$	3,625	$	5,300	$	1,002	$	5,414	$	208	$	4,521	$	5,115	$	513	$	5,221	$	276
Commercial Real Estate	$	15,058	$	19,425	$	293	$	20,342	$	565	$	21,828	$	22,782	$	1,023	$	22,907	$	1,028
Construction & Development	$	3,447	$	3,656	$	331	$	3,722	$	157	$	2,525	$	2,578	$	44	$	2,632	$	141
Residential	$	13,574	$	15,089	$	226	$	15,268	$	549	$	6,362	$	6,477	$	988	$	6,501	$	328
Consumer - Non Real Estate	$	19	$	20	$	—	$	21	$	2	$	101	$	156	$	—	$	157	$	11
Totals	$	35,723	$	43,490	$	1,852	$	44,767	$	1,481	$	35,337	$	37,108	$	2,568	$	37,418	$	1,784

Impaired loans include loans whose contractual terms have been restructured in a manner that grants a concession to a borrower experiencing financial difficulties. Troubled debt restructurings (TDRs) are a subset of impaired loans and totaled $22.9 million at September 30, 2011 and $22.1 million at December 31, 2010.

The following tables illustrate TDR information for the three and nine months ended September 30, 2011:

	For the three months ended September 30, 2011						For the nine months ended September 30, 2011
Troubled Debt Restructuring	Number of Contracts		Pre-Modification Recorded Investment		Post-Modification Recorded Investment		Number of Contracts		Pre-Modification Recorded Investment		Post-Modification Recorded Investment
Commercial - Non Real Estate		5	$	315	$	315		18	$	2,195	$	2,195
Commercial - Real Estate		4		693		693		12		3,656		3,656
Construction & Development		1		902		902		6		2,311		2,311
Residential		8		3,891		3,891		25		6,270		6,270
Consumer - Non Real Estate		—		—		—		—		—		—
Totals		18	$	5,801	$	5,801		61	$	14,432	$	14,432

There were no loans restructured in the twelve months prior to September 30, 2011 that went into default during the three- or nine-month period ended September 30, 2011. For the purposes of this report, default is defined as being 90-days past due or on non-accrual status without performance.

Some loan modifications classified as TDRs may not ultimately result in the full collection of principal and interest, as modified, and result in potential incremental losses. These potential incremental losses have been factored into our overall allowance for loan losses estimate. The level of any re-defaults will likely be affected by future economic conditions. Once a loan becomes a TDR, it will continue to be reported as a TDR until it is ultimately repaid in full, reclassified to loans held for sale, or foreclosed and sold. Included in the allowance for loan losses at September 30, 2011 was an impairment reserve for TDRs in the amount of $564,000.

Non-accrual loans and an age analysis of past due loans, segregated by class of loans, were as follows (dollars in thousands):

	30 - 59 Days Past Due		60 - 89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans		90 Days Past Due and Still Accruing		Non-accrual Loans
September 30, 2011:
Commercial - Non Real Estate	$	338	$	140	$	1,301	$	1,779	$	35,447	$	37,226	$	—	$	2,008
Commercial Real Estate
Owner occupied		992		—		2,769		3,761		77,472		81,233		—		5,045
Income producing		1,372		—		1,200		2,572		42,722		45,294		—		3,307
Multifamily		—		—		—		—		6,674		6,674		—		1,293
Construction & Development
1 - 4 Family		—		—		57		57		4,339		4,396		—		57
Other		518		514		478		1,510		28,869		30,379		—		1,378
Farmland		—		—		—		—		1,342		1,342		—		—
Residential
Equity Lines		65		—		—		65		30,051		30,116		—		65
1 - 4 Family		1,488		488		3,342		5,318		74,278		79,596		—		5,944
Junior Liens		19		—		—		19		1,605		1,624		—		—
Consumer - Non Real Estate
Credit Cards		—		—		—		—		—		—		—		—
Other		36		29		—		65		3,673		3,738		—		19
Other		—		—		—		—		3,139		3,139		—		—
Total	$	4,828	$	1,171	$	9,147	$	15,146	$	309,611	$	324,757	$	—	$	19,116

	30 - 59 Days Past Due		60 - 89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans		90 Days Past Due and Still Accruing		Non-accrual Loans
December 31, 2010:
Commercial - Non Real Estate	$	2,250	$	148	$	1,380	$	3,778	$	47,803	$	51,581	$	—	$	3,068
Commercial Real Estate
Owner occupied		4,321		—		3,785		8,106		96,100		104,206		—		13,827
Income producing		345		—		1,349		1,694		48,518		50,212		—		1,349
Multifamily		—		—		—		—		7,003		7,003		—		—
Construction & Development
1 - 4 Family		1,299		1,233		99		2,631		2,968		5,599		—		1,236
Other		286		—		251		537		29,174		29,711		—		1,038
Farmland		—		—		—		—		418		418		—		—
Residential
Equity Lines		503		87		—		590		30,875		31,465		—		432
1 - 4 Family		2,026		1,697		1,391		5,114		71,693		76,807		—		3,561
Junior Liens		—		—		—		—		1,943		1,943		—		78
Consumer - Non Real Estate
Credit Cards		—		—		—		—		—		—		—		—
Other		74		1		96		171		4,129		4,300		—		101
Other		—		—		—		—		2,908		2,908		—		—
Total	$	11,104	$	3,166	$	8,351	$	22,621	$	343,532	$	366,153	$	—	$	24,690

The Bank categorizes loans and leases into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. This categorization is made on all commercial, commercial real estate, and construction and development loans. The Bank uses the following definitions for risk ratings:

Special Mention - Loans and leases classified as special mention, while still adequately protected by the borrower's capital adequacy and payment capability, exhibit distinct weakening trends and/or elevated levels of exposure to external conditions. If left unchecked or uncorrected, these potential weaknesses may result in deteriorated prospects of repayment. These exposures require management's close attention so as to avoid becoming undue or unwarranted credit exposures.

Substandard - Loans and leases classified as substandard are inadequately protected by the borrower's current financial condition and payment capability or of the collateral pledged, if any. Loans and leases so classified have a well-defined weakness or weaknesses that jeopardize the orderly repayment of debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

Doubtful - Loans and leases classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or orderly repayment in full, on the basis of current existing facts, conditions and values, highly questionable and improbable. Possibility of loss is extremely high, but because of certain important and reasonably specific factors that may work to the advantage and strengthening of the exposure, its classification as an estimated loss is deferred until its more exact status may be determined. The Company's practice is to charge-off the portion of the loan amount determined to be doubtful in the quarter that the determination is made if the repayment of the loan is collateral dependent.

Loss - Loans and leases classified as loss are considered to be non-collectible and of such little value that their continuance as bankable assets is not warranted. This does not mean the loan has absolutely no recovery value, but rather it is neither practical nor desirable to defer writing off the loan, even though partial recovery may be obtained in the future. Losses are taken in the period in which they surface as uncollectible.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass-rated loans. As of September 30, 2011 and December 31, 2010, and based on the most recent analysis performed, the risk category of loans and leases is as follows (dollars in thousands):

	September 30, 2011
Internal Risk Rating Grades	Pass		Special Mention		Substandard		Doubtful		Loss
Commercial - Non Real Estate	$	29,578	$	3,195	$	3,092	$	1,361	$	—
Commercial Real Estate
Owner occupied		56,769		9,078		15,386		—		—
Income producing		29,154		7,449		8,691		—		—
Multifamily		3,753		801		2,120		—		—
Construction & Development
1 - 4 Family		2,105		1,489		802		—		—
Other		20,532		7,939		1,908		—		—
Farmland		980		362		—		—		—
Totals	$	142,871	$	30,313	$	31,999	$	1,361	$	—
Total:
Commercial - Non Real Estate	$	29,578	$	3,195	$	3,092	$	1,361	$	—
Commercial Real Estate	$	89,676	$	17,328	$	26,197	$	—	$	—
Construction & Development	$	23,617	$	9,790	$	2,710	$	—	$	—
Totals	$	142,871	$	30,313	$	31,999	$	1,361	$	—

	December 31, 2010
Internal Risk Rating Grades	Pass		Special Mention		Substandard		Doubtful		Loss
Commercial - Non Real Estate	$	36,269	$	9,381	$	5,625	$	306	$	—
Commercial Real Estate
Owner occupied		65,512		17,632		21,062		—		—
Income producing		36,450		9,169		4,593		—		—
Multifamily		4,646		1,524		833		—		—
Construction & Development
1 - 4 Family		2,996		1,125		1,478		—		—
Other		25,169		2,939		1,402		201		—
Farmland		418		—		—		—		—
Totals	$	171,460	$	41,770	$	34,993	$	507	$	—
Total:
Commercial - Non Real Estate	$	36,269	$	9,381	$	5,625	$	306	$	—
Commercial Real Estate	$	106,608	$	28,325	$	26,488	$	—	$	—
Construction & Development	$	28,583	$	4,064	$	2,880	$	201	$	—
Totals	$	171,460	$	41,770	$	34,993	$	507	$	—

All consumer-related loans, including residential real estate and non-real estate, are evaluated and monitored based upon payment activity. Once a consumer-related loan becomes past due on a recurring basis, the Company will pull that loan out of the homogenized pool and evaluate it individually for impairment. At this time, the consumer-related loan may be placed on the Company's internal watch list and risk rated either special mention or substandard, depending upon the individual circumstances. Consumer-related loans at September 30, 2011 and December 31, 2010, segregated by class of loans, were as follows (dollars in thousands):

	September 30, 2011				December 31, 2010
Risk Based on Payment Activity	Performing		Non- Performing		Performing		Non- Performing
Residential
Equity Lines	$	30,051	$	65	$	31,069	$	396
1 - 4 Family		78,084		1,512		73,682		3,125
Junior Liens		1,624		—		1,866		77
Consumer - Non Real Estate
Credit Cards		—		—		—		—
Other		3,719		19		4,294		6
Totals	$	113,478	$	1,596	$	110,911	$	3,604
Total:
Residential	$	109,759	$	1,577	$	106,617	$	3,598
Consumer - Non Real Estate	$	3,719	$	19	$	4,294	$	6
Totals	$	113,478	$	1,596	$	110,911	$	3,604

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Income Taxes

9 Months Ended

Sep. 30, 2011

Income Taxes [Abstract]

Income Taxes

NOTE 12. INCOME TAXES

The Company utilizes the liability method of computing income taxes. Under the liability method, deferred tax liabilities and assets are established for future tax return effects of the temporary differences between the stated value of assets and liabilities for financial reporting purposes and their tax bases. The focus is on accruing the appropriate balance sheet deferred tax amount, with the statement of income effect being the result of the changes in the balance sheet amounts from period to period. The current portion of income tax expense is provided based upon the actual tax liability incurred for tax return purposes.

An evaluation of the probability of being able to realize the future benefits of deferred tax assets is made. A valuation allowance is provided for the deferred tax asset when it is more likely than not that some portion or all of the deferred tax asset will not be realized. At September 30, 2011, a valuation allowance of $7.4 million was established against our deferred tax asset. This valuation along with a current year income tax benefit of $6.4 million resulted in a $996,000 income tax expense for the nine months ending September 30, 2011 compared to an income tax benefit of $400,000 for the first nine months of 2010.

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Allowance For Loan Losses

9 Months Ended

Sep. 30, 2011

Allowance For Loan Losses [Abstract]

Allowance For Loan Losses

NOTE 5. ALLOWANCE FOR LOAN LOSSES

The allowance for possible loan losses is a reserve established through a provision for possible loan losses charged to expense, which represents management's best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The Company's allowance for loan loss methodology includes allowance allocations calculated in accordance with ASC Topic 310, "Receivables" and allowance allocations calculated in accordance with ASC Topic 450, "Contingencies." Accordingly, the methodology is based on historical loss experience by type of credit and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions. The Company's process for determining the appropriate level of the allowance for loan losses is designed to account for credit deterioration as it occurs. The provision for loan losses reflects loan quality trends, including the levels of and trends related to non-accrual loans, past due loans, potential problem loans, criticized loans and net charge-offs or recoveries, among other factors. The provision for loan losses also reflects the totality of actions taken on all loans for a particular period. In other words, the amount of the provision reflects not only the necessary increases in the allowance for loan losses related to newly identified criticized loans, but it also reflects actions taken related to other loans including, among other things, any necessary increases or decreases in required allowances for specific loans.

The level of the allowance reflects management's continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management's judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Company's control, including, among other things, the performance of the Company's loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.

The Company's allowance for loan losses consists of three elements: (i) specific valuation allowances determined in accordance with accounting principles regarding receivables based on probable losses on specific loans; (ii) historical valuation allowances determined in accordance with accounting principles regarding contingencies based on historical loan loss experience for similar loans with similar characteristics and trends, adjusted, as necessary, to reflect the impact of current conditions; and (iii) general valuation allowances determined in accordance with accounting principles regarding contingencies based on general economic conditions and other qualitative risk factors both internal and external to the Company.

Historical valuation allowances are calculated based on the historical loss experience of specific types of loans at the time they were charged-off. The Company calculates historical loss ratios for pools of similar loans with similar characteristics based on the proportion of actual charge-offs experienced to the total population of loans in the pool. The historical loss ratios are periodically updated based on actual charge-off experience. A historical valuation allowance is established for each pool of similar loans based upon the product of the historical loss ratio and the total dollar amount of the loans in the pool. The Company's pools of similar loans include commercial and industrial loans, commercial real estate loans, construction and development loans, residential real estate loans, and consumer and other loans. General valuation allowances are based on general economic conditions and other qualitative risk factors both internal and external to the Company. In general, such valuation allowances are determined by evaluating, among other things: (i) levels and trends in delinquencies and impaired loans; (ii) levels of and trends in chargeoffs and recoveries; (iii) levels of non-impaired substandard loans; (iv) trends in volume and terms of loans; (v) effects of changes in risk selection and underwriting practices; (vi) experience, ability, and depth of lending management and staff; (vii) national and local economic trends and conditions; (viii) industry conditions; and (ix) effect of changes in credit concentrations. Management evaluates the degree of risk that each one of these components has on the quality of the loan portfolio on a quarterly basis. Loans identified as losses by management, internal loan review and/or regulatory examiners are charged-off.

Changes in the allowance for loan losses by segment are as follows (dollars in thousands):

	Beginning Balance		Chargeoffs			Recoveries		Provision		Ending Balance
September 30, 2011:
Commercial - Non Real Estate	$	2,252	$	(4,085	)	$	427	$	4,280	$	2,874
Commercial Real Estate
Owner occupied		1,055		(5,731	)		21		6,290		1,635
Income producing		99		(101	)		—		190		188
Multifamily		—		—			—		—		—
Construction & Development
1 - 4 Family		181		(212	)		4		168		141
Other		486		(492	)		99		785		878
Farmland		—		—			—		—		—
Residential
Equity Lines		459		(692	)		2		483		252
1 - 4 Family		1,078		(1,922	)		43		1,902		1,101
Consumer - Non Real Estate		161		(115	)		15		93		154
Unallocated		1,092		—			—		376		1,468
Total	$	6,863	$	(13,350	)	$	611	$	14,567	$	8,691

	Individually Evaluated for Impairment
	September 30, 2011				December 31, 2010
	Allowance		Total Loans		Allowance		Total Loans
Commercial - Non Real Estate	$	1,002	$	4,422	$	513	$	4,580
Commercial Real Estate
Owner occupied		167		5,541		951		17,235
Income producing		126		6,852		72		4,593
Multifamily		—		1,293		—		—
Construction & Development
1 - 4 Family		10		802		44		1,236
Other		321		3,054		25		1,288
Farmland		—		—		—		—
Residential
Equity Lines		—		65		447		534
1 - 4 Family		223		13,675		516		5,770
Consumer - Non Real Estate		3		19		—		101
Unallocated		—		—		—		—
Total	$	1,852	$	35,723	$	2,568	$	35,337

	Collectively Evaluated for Impairment
	September 30, 2011				December 31, 2010
	Allowance		Total Loans		Allowance		Total Loans
Commercial - Non Real Estate	$	1,872	$	32,804	$	1,739	$	47,001
Commercial Real Estate
Owner occupied		1,468		75,692		104		86,971
Income producing		62		38,442		27		45,619
Multifamily		—		5,381		—		7,003
Construction & Development
1 - 4 Family		131		3,595		137		4,363
Other		557		27,324		461		28,422
Farmland		—		1,342		—		418
Residential
Equity Lines		252		30,051		12		30,931
1 - 4 Family		878		67,545		562		72,981
Consumer - Non Real Estate		151		3,719		161		4,199
Unallocated		1,468		—		1,092		—
Total	$	6,839	$	285,895	$	4,295	$	327,908

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Consolidated Statements Of Cash Flows (USD $) In Thousands	9 Months Ended
	Sep. 30, 2011		Sep. 30, 2010
Cash flows from operating activities:
Net loss	$ (19,684)		$ (341)
Adjustments to reconcile net loss to net cash provided by operating activities:
Provision for loan losses	14,567		2,860
Stock based compensation expense (benefit)	(4)		11
Loss on disposal of premises and equipment	3		6
Depreciation and amortization	751		804
Change in valuation allowance on other real estate owned	3,191		591
Loss on sale of other real estate owned	125		107
Gain on sale of securities	(6)		(368)
Increase in bank owned life insurance	(269)		(270)
Net amortization/accretion of premiums and discounts on investments	572		273
Net change in other assets	1,361		5,352
Net change in other liabilities	93		(432)
Net cash provided by operating activities	700		8,593
Cash flows from investing activities:
Net change in federal funds sold	(13,300)		23,480
Purchases of premises and equipment	(96)		(171)
Purchases of securities	(31,533)		(99,832)
Proceeds from sales, calls, maturities and principal repayments of securities available for sale	29,691		128,039
Redemption of FHLB stock	298
Improvements made to other real estate owned			(19)
Proceeds from sales of other real estate owned	2,855		2,581
Proceeds from sales of premises and equipment			1
Net decrease in loans	20,975		15,961
Net cash provided by investing activities	8,890		70,040
Cash flows from financing activities:
Net increase (decrease) in deposits	1,389		(78,959)
Net additions (repayments) of other borrowings	(12,000)		5,000
Decrease in repurchase agreements	(191)		(812)
Cash dividends paid on preferred stock			(494)
Net cash used by financing activities	(10,802)		(75,265)
Net increase (decrease) in cash and cash equivalents	(1,212)		3,368
Cash and cash equivalents at beginning of period	10,565	[1]	12,544
Cash and cash equivalents at end of period	9,353		15,912
Supplemental disclosure of cash flow information:
Cash paid during the period for interest	4,900		2,139
Noncash investing and financing activities:
Change in fair value of securities available for sale, net of tax	1,304		1,129
Transfer from loans to other real estate owned	$ 7,682		$ 3,598

[1] Derived from audited consolidated financial statements.

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Basis Of Presentation

9 Months Ended

Sep. 30, 2011

Basis Of Presentation [Abstract]

Basis Of Presentation

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 September 30, 2011 and December 31, 2010 and for the three- and nine-month periods ended September 30, 2011 and 2010, 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, 2011 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2011.

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, 2010. 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.

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Borrowed Funds

9 Months Ended

Sep. 30, 2011

Borrowed Funds [Abstract]

Borrowed Funds

NOTE 10. 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, 2011					December 31, 2010
	Outstanding Balance		Annual Interest Rate			Outstanding Balance		Annual Interest Rate
Securities sold under overnight repurchase agreements	$	412		0.10	%	$	603		0.13	%
Securities sold under term repurchase agreements		45,000		4.38			45,000		4.38
Federal Home Loan Bank advances		10,000		0.19			22,000		1.13
Trust preferred securities		5,155		3.29			5,155		3.25
Subordinated debt		2,700		4.00			2,700		4.00
Total borrowed funds	$	63,267		3.58	%	$	75,458		3.31	%

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.

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, 2011 (dollars in thousands):

	Outstanding Principal Balance		Annual Effective Interest Rate			Final Maturity Date		Beginning Quarterly Call Dates		Collateral Requirement
Agreement dated 7/8/2008	$	25,000		4.85	%		7/8/2018		7/8/2013	$	8,790
Agreement dated 8/20/2008		20,000		3.78			8/20/2015		8/20/2011		3,363
Total	$	45,000		4.38	%					$	12,153

The Bank utilizes borrowings from the Federal Home Loan Bank ("FHLB") as a source of liquidity. At September 30, 2011, the FHLB had advances totaling $10.0 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, 2011 (dollars in thousands):

	Outstanding Principal Balance		Annual Effective Interest Rate			Final Maturity Date
Advance dated 2/16/2010	$	10,000		0.19	%		02/16/12

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. In February 2011, the Company announced its election to defer its regularly scheduled interest payments on the junior subordinated debentures related to the trust preferred securities. Furthermore, the Company is now party to a written agreement with the Federal Reserve, which restricts the Company's ability to make interest payments on subordinated debt, as described below.

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. This debt can be repaid in full at any time with no penalty.

Under the terms of a written agreement between the Company and the Federal Reserve Bank of Richmond, the Company and the Bank may not make any distributions of interest, principal, or other sums on subordinated debentures or trust preferred securities without the prior written approval of the Federal Reserve Bank of Richmond and the Director of the Division of Banking Supervision and Regulation of the Federal Reserve Board of Governors.

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Consolidated Balance Sheets (USD $) In Thousands, except Share data	Sep. 30, 2011	Dec. 31, 2010
Assets:
Cash and due from banks, noninterest-bearing	$ 4,922	$ 4,303	[1]
Interest-bearing deposits in banks	4,431	6,262	[1]
Cash and cash equivalents	9,353	10,565	[1]
Federal funds sold	22,630	9,330	[1]
Investment securities	113,768	110,373	[1]
Loans receivable	324,757	366,153	[1]
Less: Allowance for loan losses	(8,691)	(6,863)	[1]
Total loans, net	316,066	359,290	[1]
Premises and equipment	12,448	13,106	[1]
Other real estate owned	9,825	8,314	[1]
Bank owned life insurance	10,640	10,371	[1]
Deferred tax assets	3,509	5,123	[1]
Prepaid FDIC insurance assessment	2,759	3,670	[1]
Accrued interest receivable	1,700	1,814	[1]
Other assets	3,179	3,014	[1]
Total assets	505,877	534,970	[1]
Liabilities and Stockholders' Equity:
Noninterest-bearing demand deposits	34,446	33,730	[1]
Interest-checking deposits	38,527	34,004	[1]
Savings and money market deposits	103,163	114,923	[1]
Time deposits	241,422	233,512	[1]
Total deposits	417,558	416,169	[1]
Securities sold under agreements to repurchase	45,412	45,603	[1]
Federal Home Loan Bank advances	10,000	22,000	[1]
Subordinated debt	7,855	7,855	[1]
Other liabilities	2,226	1,639	[1]
Total liabilities	483,051	493,266	[1]
Commitments and contingencies (Note 6)			[1]
Stockholders' Equity:
Preferred stock, no par value:	13,179	13,179	[1]
Discount on preferred stock	(787)	(991)	[1]
Common stock, $5 per share par value	19,486	19,486	[1]
Additional paid-in capital	12,984	12,988	[1]
Retained deficit	(23,650)	(3,268)	[1]
Accumulated other comprehensive income	1,614	310	[1]
Total Stockholders' Equity	22,826	41,704	[1]
Total Liabilities and Stockholders' Equity	$ 505,877	$ 534,970	[1]
Preferred shares authorized	3,000,000	3,000,000	[1]
Preferred shares issued and outstanding	13,179	13,179	[1]
Common shares authorized	15,000,000	15,000,000	[1]
Common shares issued and outstanding	3,897,174	3,897,174	[1]

[1] Derived from audited consolidated financial statements.