Bank of the Carolinas CORP - FORM 10-K

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EX-23.01 - CONSENT OF TURLINGTON AND COMPANY LLP - Bank of the Carolinas CORP	dex2301.htm
EX-99.02 - SECTION 111 CFO CERTIFICATION - Bank of the Carolinas CORP	dex9902.htm
EX-99.01 - SECTION 111 CEO CERTIFICATION - Bank of the Carolinas CORP	dex9901.htm
EX-23.02 - CONSENT OF DIXON HUGHES PLLC - Bank of the Carolinas CORP	dex2302.htm
EX-31.01 - SECTION 301 CEO CERTIFICATION - Bank of the Carolinas CORP	dex3101.htm
EX-31.02 - SECTION 302 CFO CERTIFICATION - Bank of the Carolinas CORP	dex3102.htm
EX-10.05 - CHANGE IN CONTROL AGREEMENT - Bank of the Carolinas CORP	dex1005.htm
EX-32.01 - SECTION 906 CEO AND CFO CERTIFICATION - Bank of the Carolinas CORP	dex3201.htm

U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT UNDER SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2010

Commission File No. 000-52195

BANK OF THE CAROLINAS CORPORATION

(Name of small business issuer in its charter)

North Carolina

20-4989192

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

135 Boxwood Village Drive

Mocksville, North Carolina 27028

(Address of principal executive offices, including Zip Code)

(336) 751-5755

Registrant’s telephone number, including area code


		Securities registered under Section 12(b) of the Act:		Common Stock, $5.00 par value per share
				(Title of class)
				NASDAQ Global Market
				(Name of exchange on which registered)
		Securities registered under Section 12(g) of the Act:		None

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ¨ No x

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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer,” “large 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

The aggregate market value of the voting and non-voting common equity held by nonaffiliates (computed by reference to the price at which the common equity was sold, or the average bid and asked price of such common equity), as of the last business day of the Registrant’s most recently completed second fiscal quarter was $13.5 million (based on the closing price of such stock as of June 30, 2010).

On March 30, 2011, the number of outstanding shares of Registrant’s common stock was 3,897,174.

Documents Incorporated by Reference

BANK OF THE CAROLINAS CORPORATION

FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2010

TABLE OF CONTENTS


PART I

		Page
Item 1.	Business		2
Item 1A.	Risk Factors		16
Item 1B.	Unresolved Staff Comments		24
Item 2.	Properties		24
Item 3.	Legal Proceedings		24
Item 4.	[Removed and Reserved]		24

PART II

Item 5.	Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities		25
Item 6.	Selected Financial Data		26
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		27
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk		44
Item 8.	Consolidated Financial Statements and Supplementary Data		44
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		76
Item 9A.	Controls and Procedures		76
Item 9B.	Other Information		76

PART III

Item 10.	Directors, Executive Officers and Corporate Governance		77
Item 11.	Executive Compensation		83
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		89
Item 13.	Certain Relationships and Related Transactions, and Director Independence		91
Item 14.	Principal Accountant Fees and Services		91

PART IV

Item 15.	Exhibits and Financial Statement Schedules		93

PART I

In this Report, the terms “we,” “us,” “our” and similar terms refer to Bank of the Carolinas Corporation separately and, as the context requires, on a consolidated basis with our banking subsidiary, Bank of the Carolinas. Bank of the Carolinas is sometimes referred to separately as the “Bank.”

ITEM 1. DESCRIPTION OF BUSINESS

General

Bank of the Carolinas Corporation (the “Company”) was formed in 2006 to serve as a holding company for Bank of the Carolinas (the “Bank”). The Company is registered with the Board of Governors of the Federal Reserve System (the “Federal Reserve”) under the Bank Holding Company Act of 1956, as amended (the “BHCA”), and the bank holding company laws of North Carolina. The Company’s office is located at 135 Boxwood Village Drive, Mocksville, North Carolina 27028. The Company’s primary business activity consists of directing the activities of the Bank.

The Bank is incorporated under the laws of North Carolina and began operations on December 7, 1998 as a North Carolina chartered commercial bank. The Bank operates under the banking laws of North Carolina and the rules and regulations of the Federal Deposit Insurance Corporation (the “FDIC”). As a state chartered non-Federal Reserve member bank, the Bank is subject to examination and regulation by the FDIC and the North Carolina Commissioner of Banks (the “Commissioner”). The Bank is further subject to certain regulations of the Federal Reserve. The business and regulation of the Bank are also subject to legislative changes from time to time. See Item 1. Business—Supervision and Regulation.

The Bank’s primary market area is in the Piedmont region of North Carolina where we are engaged in general commercial banking primarily in Davie, Randolph, Rowan, Cabarrus, Davidson, Forsyth and Stokes Counties. The Bank’s main office is located at 135 Boxwood Village Drive in Mocksville, North Carolina. Our main office in Mocksville and our Advance office are located in Davie County. Our other offices are located in Asheboro (Randolph County), Cleveland and Landis (Rowan County), Harrisburg and Concord (Cabarrus County), Lexington (Davidson County), King (Stokes County) and Winston-Salem (Forsyth County).

See Item 6. Selected Financial Data, for a summary of operations, selected year-end assets and liabilities, ratios and per share data for December 31, 2006 through 2010 and the years then ended.

Services

Our operations are primarily retail oriented and directed toward individuals and small- and medium-sized businesses located in our banking market. The majority of our deposits and loans are derived from customers in our banking market, but we also make loans and have deposit relationships in areas surrounding our immediate banking market. We also occasionally solicit and accept wholesale deposits. We offer a variety of commercial and consumer banking services, but our principal activities are the taking of demand and time deposits and the making of consumer and commercial loans. To a lesser extent, we also generate income from other fee-based products and services that we provide.

The Bank’s primary source of revenue is interest and fee income from its lending activities. These lending activities consist principally of originating commercial operating and working capital loans, residential mortgage loans, home equity lines of credit, other consumer loans and loans secured by commercial real estate. Interest and dividend income from investment activities generally provide the second largest source of income to the Bank.

Deposits are the primary source of the Bank’s funds for lending and other investment purposes. The Bank attracts both short-term and long-term deposits from the general public by offering a variety of accounts and rates. The Bank offers statement savings accounts, negotiable order of withdrawal accounts, money market demand accounts, non-interest-bearing accounts and fixed interest rate certificates with varying maturities. The Bank also utilizes alternative sources of funds such as brokered certificates of deposit and borrowings from the Federal Home Loan Bank (the “FHLB”) of Atlanta, Georgia and other commercial banks.

The Bank’s deposits are obtained primarily from its primary market area. The Bank uses traditional marketing methods to attract new customers and deposits including print media advertising and direct mailings. Deposit flows are greatly influenced by economic conditions, the general level of interest rates, competition and other factors.

Organization

The Bank is the sole banking subsidiary of the Company. A trust (Bank of the Carolinas Trust I) was formed as a subsidiary of the Company to facilitate the issuance of Trust Preferred Securities as a form of non-dilutive equity to supplement our capital.

The Bank formed an LLC (East Atlantic Properties, LLC) to manage our income producing assets transferred from our Other Real Estate Owned. The LLC is consolidated into the Bank and is a disregarded entity for tax purposes.

Lending Activities

General. We make a variety of types of consumer and commercial loans to individuals and small- and medium-sized businesses for various personal, business and agricultural purposes, including term and installment loans, commercial and equity lines of credit, and overdraft checking credit. For financial reporting purposes, our loan portfolio generally is divided into real estate loans (including home equity lines of credit), commercial loans, and consumer loans. We make credit card services available to our customers through a correspondent relationship. For an analysis of the components of our loan portfolio, see Table I. Analysis of Loan Portfolio in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Real Estate Secured Loans. Our real estate loan classifications include loans secured by real estate which are made to purchase, construct or improve residential or commercial real estate, for real estate development purposes, and for various other commercial and consumer purposes (whether or not those purposes are related to our real estate collateral).

Commercial real estate and construction loans typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. In the case of commercial real estate loans, loan repayment may be dependent on the successful operation of income producing properties, a business, or a real estate project and, thus, may, to a greater extent than in the case of other loans, be subject to the risk of adverse conditions in the economy generally or in the real estate market in particular.

Construction loans involve special risks due to the fact that loan funds are advanced upon the security of houses or other improvements that are under construction and that are of uncertain value prior to the completion of construction. For that reason, it is more difficult to evaluate accurately the total loan funds required to complete a project and the related loan-to-value ratios. To minimize these risks, generally we limit loan amounts to 80% of the projected appraised value of our collateral upon completion of construction.

Many of our real estate loans, while secured by real estate, were made for purposes unrelated to the real estate collateral. That generally is reflective of our efforts to minimize credit risk by taking real estate as primary or additional collateral, whenever possible, without regard to loan purpose. All our real estate loans are secured by first or junior liens on real property, the majority of which is located in or near our banking market. However, we have made loans, and have purchased participations in some loans from other entities, which are secured by real property located outside our banking market.

Our real estate loans may be made at fixed or variable interest rates and, generally, with the exception of our long-term residential mortgage loans discussed below, have maturities that do not exceed five years. However, we also make real estate loans that have maturities of more than five years, or which are based on amortization schedules of as much as 30 years, but that generally will include contractual provisions which allow us to call the loan in full, or provide for a “balloon” payment in full, at the end of no more than five to fifteen years.

In addition to residential real estate loans made for a variety of purposes, we offer long-term, residential mortgage loans that are funded by and closed in the name of third-party lenders. This arrangement permits us to offer this product

in our banking market and enhance our fee-based income, but, by closing the loans in the names of the ultimate owners of those loans, we avoid the credit and interest rate risk associated with these long-term loans. However, on a limited basis, we also make residential mortgage loans that we retain in our own loan portfolio. Those loans typically are secured by first liens on the related residential property, are made at fixed and variable interest rates, and have maturities that do not exceed 15 years, although we have a small number of residential mortgage loans in our portfolio with 30-year maturities.

Our home equity lines of credit include lines of credit that generally are used by borrowers for consumer purposes and are secured by first or junior liens on residential real property. Our commitment on each line is for a term of 15 years, and interest is charged at a variable rate. The terms of these lines of credit provide that borrowers either may pay accrued interest only, with the outstanding principal balances becoming due in full at the maturity of the lines, or they will make payments of principal and interest based on a 15-year amortization schedule.

Commercial Loans. Our commercial loan classification includes loans to individuals and small- and medium-sized businesses for working capital, equipment purchases, and various other business and agricultural purposes, but that classification excludes any such loan that is secured by real estate. These loans generally are secured by inventory, equipment or similar assets, but they also may be made on an unsecured basis. In addition to loans which are classified on our books as commercial loans, as described above, many of our loans included within the real estate loan classification were made for commercial purposes but are classified as real estate loans on our books because they are secured by first or junior liens on real estate. Commercial loans may be made at variable or fixed rates of interest. However, it is our policy that any loan which has a maturity or amortization schedule of longer than five years normally would be made at an interest rate that varies with our prime lending rate or would include contractual provisions which allow us to call the loan in full, or provide for a “balloon” payment in full, at the end of no more than five years.

Commercial loans typically are made on the basis of the borrower’s ability to make repayment from business cash flow, and those loans typically are secured by business assets, such as accounts receivable, equipment and inventory. As a result, the ability of borrowers to repay commercial loans may be substantially dependent on the success of their businesses, and the collateral for commercial loans may depreciate over time and their values may not be as determinable relative to the time the loans were originated.

Consumer Loans. Our consumer loans consist primarily of loans for various consumer purposes, as well as the outstanding balances on non-real estate secured consumer revolving credit accounts. A majority of these loans are secured by liens on various personal assets of the borrowers, but they also may be made on an unsecured basis. Additionally, our real estate loans include loans secured by first or junior liens on real estate which were made for consumer purposes unrelated to the real estate collateral. Consumer loans generally are made at fixed interest rates and with maturities or amortization schedules which generally do not exceed five years. However, consumer-purpose loans secured by real estate (and, thus, classified as real estate loans as described above) may be made for terms of up to 30 years, but under terms which allow us to call the loan in full, or provide for a “balloon” payment, at the end of no more than five to fifteen years.

Consumer loans generally are secured by personal property and other personal assets of borrowers which often depreciate rapidly or are vulnerable to damage or loss. In cases where damage or depreciation reduces the value of our collateral below the unpaid balance of a defaulted loan, repossession may not result in repayment of the entire outstanding loan balance. The resulting deficiency often does not warrant further substantial collection efforts against the borrower. In connection with consumer lending in general, the success of our loan collection efforts are highly dependent on the continuing financial stability of our borrowers. Our collection capacity on consumer loans may be more likely to be adversely affected by a borrower’s job loss, illness, personal bankruptcy or other change in personal circumstances than is the case with other types of loans.

Loan Administration and Underwriting. Like most community banks, we make loans based to a great extent, on our assessment of borrowers’ income, cash flow, net worth, character and ability to repay the loan. A principal risk associated with each loan category is the creditworthiness of our borrowers. Our loans may be viewed as involving a higher degree of credit risk than is typically the case with some other types of loans, such as long-term residential mortgage loans where greater emphasis is placed on assessed collateral values. To manage risk, we have adopted written loan policies and procedures. Our loan portfolio is administered under a defined process that includes guidelines for loan underwriting standards, risk assessment, procedures for loan approvals, loan risk grading, ongoing identification and management of credit deterioration, and portfolio reviews to assess loss exposure. These reviews also are used to test our compliance with our credit policies and procedures in an ongoing fashion.

The underwriting standards that we employ for loans include an evaluation of various factors, including but not limited to a loan applicant’s income, cash flow, payment history on other debts and an assessment of ability to meet existing obligations including payments on any proposed loan. Though creditworthiness of the applicant is a primary consideration within the loan approval process, we take collateral (particularly real estate) whenever it is available. This is done without regard to loan purpose. In the case of secured loans, the underwriting process includes an analysis of the value of the proposed collateral. The analysis is conducted in relation to the proposed loan amount. Consideration is given to the value of the collateral, the degree to which the value is ascertainable with any certainty, the marketability of the collateral in the event of default, and the likelihood of depreciation in the collateral value.

Our Board of Directors has approved levels of lending authority for lending personnel based on our aggregate credit exposures to borrowers, along with the secured or unsecured status and the risk grade of a proposed loan. A loan that satisfies our loan policies and is within a lending officer’s assigned authority may be approved by that officer. Anything above that amount must be approved before funding by our Credit Administration management, the Loan Committee of the Board of Directors or our Board of Directors.

At the time a loan is proposed, the account officer assigns a risk grade to the loan based on various underwriting and other criteria. The grades assigned to loans generally indicate the level of ongoing review and attention that we will give to those loans to protect our position.

After funding, all loans are reviewed by our Loan Administration personnel for adequacy of documentation and compliance with regulatory requirements. Most loans (including the largest exposure loans) are reviewed for compliance with our underwriting criteria and to reassess the grades assigned to them by the account officers.

During the life of each loan, its grade is reviewed and validated. Modifications can and are made to reflect changes in circumstances and risk. Loans generally are placed in a non-accrual status if they become 90 days past due (unless, based on relevant circumstances, we believe that collateral is sufficient to justify continued accrual and the loan is in process of collection). Non-accrual status is also applied whenever we believe that collection has become doubtful. Loans are charged off when the collection of principal and interest has become doubtful and the loans no longer can be considered a sound collectible asset (or, in the case of unsecured loans, when they become 90 days past due).

Allowance for Loan Losses. Our Board of Directors’ Loan Committee reviews all substandard loans at least monthly, and our management meets regularly to review asset quality trends and to discuss loan policy issues. Based on these reviews and our current judgments about the credit quality of our loan portfolio and other relevant internal and external factors as well as historical charge off rates, we have established an allowance for loan losses. The appropriateness of the allowance is assessed by our management, reviewed by the Loan Committee each month, and reviewed by the Board of Directors quarterly. We make provisions to the allowance based on those assessments which are charged against our earnings.

For additional information regarding loss experience, our allowance for loan losses and problem assets, see Table II. Summary of Loan Loss Experience, Table III. Allocation of Allowance for Loan Losses, and Table IV. Nonperforming Assets in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Deposit Activities

Our deposit products include business and individual checking accounts, savings accounts, NOW accounts, certificates of deposit and money market checking accounts. We monitor our competition in order to keep the rates paid on our deposits at a competitive level. The majority of our deposits are derived from within our banking market. However, we have historically solicited and accepted wholesale deposits as a way to supplement funding to support loan growth and provide added balance sheet liquidity. For additional analysis of deposit relationships, see Table VII. Deposit Mix in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Investment Portfolio

On December 31, 2010, our investment portfolio consisted of U.S. government agency securities, state and municipal obligations, mortgage-backed securities issued by FNMA, GNMA and FHLMC and corporate obligations. Our securities

are classified as both “held to maturity” and “available for sale.” We analyze their performance monthly and carry the available for sale securities on our books at their fair market values while carrying the held to maturity securities at their amortized cost. For additional analysis of investment security balances by type and maturities and average yields by security type, see Table V. Investment Securities and Table VI. Investment Securities in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. For additional information regarding appreciation and depreciation by security type, and information relating to Other Than Temporary Impairment, see Note 2. Investment Securities in our Consolidated Financial Statements under Item 8.

Competition

Commercial banking in North Carolina is highly competitive, due in large part to our state’s early adoption of statewide branching. Over the years, federal and state legislation (including the elimination of restrictions on interstate banking) has heightened the competitive environment in which all financial institutions conduct their business, and the potential for competition among financial institutions of all types has increased significantly. We compete with approximately 30 commercial banks and institutions with offices in our banking market.

Interest rates, both on loans and deposits, and prices of fee-based services are significant competitive factors among financial institutions in general. Other important competitive factors include office location, office hours, the quality of customer service, community reputation, continuity of personnel and services, and, in the case of larger commercial customers, relative lending limits and the ability to offer sophisticated cash management and other commercial banking services. Many of our competitors have greater resources, broader geographic markets, more extensive branch networks, and higher lending limits than we do. They also can offer more products and services and can better afford and make more effective use of media advertising, support services and electronic technology than we can. In terms of assets, we are one of the smaller commercial banks in North Carolina, and there is no assurance that we will be or continue to be an effective competitor in our banking market. However, we believe that community banks can compete successfully by providing personalized service and making timely, local decisions, and that further consolidation in the banking industry is likely to create additional opportunities for community banks to capture deposits from affected customers who may become dissatisfied as their financial institutions grow larger. Additionally, we believe that the continued growth of our banking market affords an opportunity to capture new deposits from new residents.

Substantially all of our customers are individuals and small- and medium-sized businesses. We try to differentiate ourselves from our larger competitors with our focus on relationship banking, personalized service, direct customer contact, and our ability to make credit and other business decisions locally. We also depend on our reputation as a community bank in our banking market, our involvement in the communities we serve, the experience of our senior management team, and the quality of our associates. We believe that our focus allows us to be more responsive to our customers’ needs and more flexible in approving loans based on our personal knowledge of our customers.

Employees

On December 31, 2010, we had approximately 108 full-time equivalent employees (including our executive officers). We are not party to any collective bargaining agreement with our employees, and we consider our relations with our employees to be good.

Supervision and Regulation

Our business and operations are subject to extensive federal and state governmental regulation and supervision. The following is a summary of some of the basic statutes and regulations that apply to us, but it is not a complete discussion of all the laws that affect our business.

Regulation of Bank Holding Companies. Bank of the Carolinas Corporation is a North Carolina business corporation that operates as a registered bank holding company under the Bank Holding Company Act of 1956, as amended (the “BHCA”). We are subject to supervision and examination by, and the regulations and reporting requirements of, the Federal Reserve Board (the “FRB”). Under the BHCA, a bank holding company’s activities are limited to banking, managing or controlling banks, or engaging in other activities the FRB determines are closely related and a proper incident to banking or managing or controlling banks.

Bank holding companies may elect to be regulated as “financial holding companies” if all their financial institution subsidiaries are and remain well capitalized and well managed as described in the FRB’s regulations and have a satisfactory record of compliance with the Community Reinvestment Act. In addition to the activities that are permissible for bank holding companies, financial holding companies are permitted to engage in additional activities that are determined by the FRB, in consultation with the Secretary of the Treasury, to be financial in nature or incidental to a financial activity, or that are complementary to a financial activity and do not pose a substantial risk to the safety and soundness of depository institutions, or the financial system generally, as determined by the FRB. We have not elected to become a financial holding company.

The BHCA prohibits a bank holding company or financial holding company from acquiring direct or indirect control of more than 5.0% of the outstanding voting stock, or substantially all of the assets, of any financial institution, or merging or consolidating with another bank holding company or savings bank holding company, without the prior approval of or, under specified circumstances, notice to, the FRB. Additionally, the BHCA generally prohibits banks or financial holding companies from acquiring ownership or control of more than 5.0% of the outstanding voting stock of any company that engages in an activity other than one that is permissible for the holding company. In approving an application to engage in a nonbanking activity, the FRB must consider whether that activity can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition, or gains in efficiency, that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices.

The law imposes a number of obligations and restrictions on a bank holding company and its insured bank subsidiaries designed to minimize potential losses to depositors and the FDIC insurance funds. For example, if a bank holding company’s insured bank subsidiary becomes “undercapitalized,” the bank holding company is required to guarantee the bank’s compliance (subject to certain limits) with the terms of any capital restoration plan filed with its federal banking agency. A bank holding company is required to serve as a source of financial strength to its bank subsidiaries and to commit resources to support those banks in circumstances in which, absent that policy, it might not do so. Under the BHCA, the FRB may require a bank holding company to terminate any activity or relinquish control of a nonbank subsidiary if the FRB determines that the activity or control constitutes a serious risk to the financial soundness and stability of a bank subsidiary of a bank holding company.

Regulation of the Bank. The Bank is a FDIC-insured, North Carolina-chartered bank. Its deposits are insured under the FDIC’s Deposit Insurance Fund (“DIF”), and it is subject to supervision and examination by, and the regulations and reporting requirements of, the FDIC and the North Carolina Commissioner of Banks (the “Commissioner”). The FDIC and the Commissioner are its primary federal and state banking regulators. The Bank is not a member bank of the Federal Reserve System.

As an insured bank, the Bank is prohibited from engaging as principal in any activity that is not permitted for national banks unless (1) the FDIC determines that the activity or investment would not pose a significant risk to the DIF, and (2) the Bank is, and continues to be, in compliance with the capital standards that apply to it. The Bank also is prohibited from directly acquiring or retaining any equity investment of a type or in an amount that is not permitted for national banks.

The FDIC and the Commissioner regulate all areas of the Bank’s business, including its reserves, mergers, payment of dividends and other aspects of its operations. They conduct regular examinations of the Bank, and the Bank must furnish periodic reports to the FDIC and the Commissioner containing detailed financial and other information about its affairs. The FDIC and the Commissioner have broad powers to enforce laws and regulations that apply to the Bank and to require the Bank to correct conditions that affect its safety and soundness. Among others, these powers include issuing cease and desist orders, imposing civil penalties, and removing officers and directors, and their ability otherwise to intervene in the Bank’s operation if their examinations of the Bank, or the reports it files, reflect a need for them to do so.

The Bank’s business also is influenced by prevailing economic conditions and governmental policies, both foreign and domestic, and, though it is not a member bank of the Federal Reserve System, by the monetary and fiscal policies of the FRB. The FRB’s actions and policy directives determine to a significant degree the cost and availability of funds the Bank obtains from money market sources for lending and investing, and they also influence, directly and indirectly, the rates of interest the Bank pays on time and savings deposits and the rates it charges on commercial bank loans.

Powers of the FDIC in Connection with the Insolvency of an Insured Depository Institution. Under the Federal Deposit Insurance Act (the “FDIA”), if any insured depository institution becomes insolvent and the FDIC is appointed as its conservator or receiver, the FDIC may disaffirm or repudiate any contract or lease to which the institution is a party which it determines to be burdensome, and the disaffirmance or repudiation of which is determined to promote the orderly administration of the institution’s affairs. The disaffirmance or repudiation of any of our obligations would result in a claim of the holder of that obligation against the conservatorship or receivership. The amount paid on that claim would depend upon, among other factors, the amount of conservatorship or receivership assets available for the payment of unsecured claims and the priority of the claim relative to the priority of other unsecured creditors and depositors.

In its resolution of the problems of an insured depository institution in default or in danger of default, the FDIC generally is required to satisfy its obligations to insured depositors at the least possible cost to the deposit insurance funds. In addition, the FDIC may not take any action that would have the effect of increasing the losses to the deposit insurance funds by protecting depositors for more than the insured portion of deposits or creditors other than depositors. The FDIA authorizes the FDIC to settle all uninsured and unsecured claims in the insolvency of an insured bank by making a final settlement payment after the declaration of insolvency as full payment and disposition of the FDIC’s obligations to claimants. The rate of the final settlement payments will be a percentage rate determined by the FDIC reflecting an average of the FDIC’s receivership recovery experience.

Dodd–Frank Wall Street Reform and Consumer Protection Act. On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) was signed into law. The Dodd-Frank Act represents a comprehensive overhaul of the financial services industry in the United States. The Dodd-Frank Act includes, among other things:

•

the creation of a Financial Stability Oversight Council to identify emerging systemic risks posed by financial firms, activities and practices, and to improve cooperation between federal agencies;

•

the creation of a Bureau of Consumer Financial Protection authorized to promulgate and enforce consumer protection regulations relating to financial products, which would affect both banks and non-bank financial companies;

•

the establishment of strengthened capital and prudential standards for banks and bank holding companies;

•

enhanced regulation of financial markets, including derivatives and securitization markets;

•

the elimination of certain trading activities by banks;

•

a permanent increase of the previously implemented temporary increase of FDIC deposit insurance to $250,000 per account, an extension of unlimited deposit insurance on qualifying noninterest-bearing transaction accounts, and an increase in the minimum deposit insurance fund reserve requirement from 1.15% to 1.35%, with assessments to be based on assets as opposed to deposits;

•

amendments to the Truth in Lending Act aimed at improving consumer protections with respect to mortgage originations, including originator compensation, minimum repayment standards, and prepayment considerations; and

•

new disclosure and other requirements relating to executive compensation and corporate governance.

Although the Dodd-Frank Act has been signed into law, a number of provisions remain to be implemented through the rulemaking process at various regulatory agencies. We are unable to predict the extent to which the Dodd-Frank Act or the forthcoming rules and regulations will impact our business. However, we believe that certain aspects of the new legislation, including, without limitation, the additional cost of higher deposit insurance coverage and the costs of compliance with disclosure and reporting requirements and examinations could have a significant impact on our business, financial condition, and results of operations. Additionally, we cannot predict whether there will be additional proposed laws or reforms that would affect the U.S. financial system or financial institutions, whether or when such changes may be adopted, how such changes may be interpreted and enforced, or how such changes may affect us.

Gramm-Leach-Bliley Act. The federal Gramm-Leach-Bliley Act enacted in 1999 (the “GLB Act”) dramatically changed various federal laws governing the banking, securities and insurance industries. The GLB Act permitted bank

holding companies to become “financial holding companies” and, in general (1) expanded opportunities to affiliate with securities firms and insurance companies; (2) overrode certain state laws that would prohibit certain banking and insurance affiliations; (3) expanded the activities in which banks and bank holding companies may participate; (4) required that banks and bank holding companies engage in some activities only through affiliates owned or managed in accordance with certain requirements; and (5) reorganized responsibility among various federal regulators for oversight of certain securities activities conducted by banks and bank holding companies. The GLB Act expanded opportunities for banks and bank holding companies to provide services and engage in other revenue-generating activities that previously were prohibited to them. However, while this expanded authority permits us to engage in additional activities, it also presents us with challenges as our larger competitors continue to expand their services and products into areas that are not feasible for smaller, community-oriented financial institutions. We have not elected to become a financial holding company.

Payment of Dividends. Under North Carolina law, we are authorized to pay dividends as declared by our Board of Directors, provided that no such distribution results in our insolvency on a going concern or balance sheet basis. However, although we are a legal entity separate and distinct from the Bank, our principal source of funds with which we can pay dividends to our shareholders and pay our own obligations is dividends we receive from the Bank. For that reason, our ability to pay dividends effectively is subject to the same limitations that apply to the Bank. There are statutory and regulatory limitations on the Bank’s payment of dividends to us.

Our and the Bank’s Board of Directors have entered into informal agreements with our respective banking regulators which are described in Note 10 to our audited financial statements included in Item 8 of this Report. Among other things, the agreements require that we and the Bank obtain the consent of our regulators before we may pay any cash dividends.

Our sale of Series A Preferred Stock to the U.S. Treasury during April 2009 under the TARP Capital Purchase Program resulted in additional restrictions on our ability to pay dividends on our common stock and to repurchase shares of our common stock. Unless all accrued dividends on the Series A Preferred Stock have been paid in full, (1) no dividends may be declared or paid on our common stock, and (2) we may not repurchase any of our outstanding common stock. Additionally, during the first three years following our sale of the Series A Preferred Stock, we are required to obtain the consent of the U.S. Treasury in order to increase the dividend per share paid on our common stock from the last quarterly cash dividend per share declared prior to our sale of the Series A Preferred Stock, or to purchase outstanding shares of our common stock, unless the Series A Preferred Stock has been redeemed in full or the U.S. Treasury has transferred all of the Series A Preferred Stock to third parties.

Under North Carolina law, the Bank may pay dividends only from its undivided profits. However, if the Bank’s surplus is less than 50% of its paid-in capital stock, then the Bank’s directors may not declare any cash dividend until it has transferred from undivided profits to surplus 25% of its undivided profits or any lesser percentage necessary to raise its surplus to an amount equal to 50% of its paid-in capital stock.

In addition to the restrictions described above, other state and federal statutory and regulatory restrictions apply to the Bank’s payment of cash dividends. As an insured depository institution, federal law prohibits the Bank from making any capital distributions, including the payment of a cash dividend if it is “undercapitalized” (as that term is defined in the FDIA) or after making the distribution, would become undercapitalized. If the FDIC believes that we are engaged in, or about to engage in, an unsafe or unsound practice, the FDIC may require, after notice and hearing, that we cease and desist from that practice. The FDIC has indicated that paying dividends that deplete a depository institution’s capital base to an inadequate level would be an unsafe and unsound banking practice. The FDIC has issued policy statements that provide that insured banks generally should pay dividends only from their current operating earnings, and, under the FDIA, no dividend may be paid by an insured bank while it is in default on any assessment due the FDIC. The Bank’s payment of dividends also could be affected or limited by other factors, such as events or circumstances which lead the FDIC to require (as further described below) that it maintain capital in excess of regulatory guidelines.

In the future, our ability to declare and pay cash dividends will be subject to our Board of Directors’ evaluation of our operating results, capital levels, financial condition, future growth plans, general business and economic conditions, and tax and other relevant considerations.

Capital Adequacy. We and the Bank are required to comply with the FRB’s and FDIC’s capital adequacy standards for bank holding companies and insured banks. The FRB and FDIC has issued risk-based capital and leverage capital guidelines for measuring capital adequacy, and all applicable capital standards must be satisfied for us or the Bank to be considered in compliance with regulatory capital requirements.

Under the FDIC’s risk-based capital measure, the minimum ratio (“Total Capital Ratio”) of the Bank’s total capital (“Total Capital”) to its risk-weighted assets (including various off-balance-sheet items, such as standby letters of credit) is 8.0%. At least half of Total Capital must be composed of “Tier 1 Capital.” Tier 1 Capital includes common equity, undivided profits, minority interests in the equity accounts of consolidated subsidiaries, qualifying noncumulative perpetual preferred stock, and a limited amount of cumulative perpetual preferred stock, less goodwill and various other intangible assets. The remainder of Total Capital may consist of “Tier 2 Capital” which includes certain subordinated debt, certain hybrid capital instruments and other qualifying preferred stock, and a limited amount of loan loss reserves. A bank or bank holding company that does not satisfy minimum capital requirements may be required to adopt and implement a plan acceptable to its federal banking regulator to achieve an adequate level of capital.

Under the leverage capital measure, the minimum ratio (“Leverage Capital Ratio”) of Tier 1 Capital to average assets, less goodwill and various other intangible assets, generally is 3.0% for entities that meet specified criteria, including having the highest regulatory rating. All other entities generally are required to maintain an additional cushion of 100 to 200 basis points above the stated minimum. The FDIC’s guidelines also provide that banks experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum levels without significant reliance on intangible assets, and a bank’s “Tangible Leverage Ratio” (determined by deducting all intangible assets) and other indicators of a bank’s capital strength also are taken into consideration by banking regulators in evaluating proposals for expansion or new activities.

Our and the Bank’s Board of Directors have entered into informal agreements with our respective banking regulators which are described in Note 10 to our audited financial statements included in Item 8 of this Report. Among other things, the agreements require that the Bank maintain capital levels in excess of normal statutory minimums, including a Leverage Capital Ratio of not less than 7.5%, and other ratios at least at “well capitalized” levels.

The FRB and FDIC also consider interest rate risk (arising when the interest rate sensitivity of the Bank’s assets does not match the sensitivity of its liabilities or its off-balance-sheet position) in the evaluation of the Bank’s capital adequacy. Banks with excessive interest rate risk exposure are required to hold additional amounts of capital against their exposure to losses resulting from that risk. The regulators also require banks to incorporate market risk components into their risk-based capital. Under these market risk requirements, capital is allocated to support the amount of market risk related to a bank’s trading activities.

Our capital categories are determined solely for the purpose of applying the “prompt corrective action” rules described below and they are not necessarily an accurate representation of our overall financial condition or prospects for other purposes. A failure to meet the capital guidelines could subject us to a variety of enforcement actions under those rules, including the issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on the taking of brokered deposits, and other restrictions on our business. As described below, the FDIC also can impose other substantial restrictions on banks that fail to meet applicable capital requirements.

Regulatory Guidance on “CRE” Lending Concentrations. During 2006, the FDIC and other federal banking regulators issued guidance for sound risk management for financial institutions whose loan portfolios are deemed to have significant concentrations in commercial real estate (“CRE”). In March 2008, the FDIC and other federal banking regulators issued further guidance on applying these principles in the current real estate lending environment, and they noted particular concern about construction and development loans. The banking regulators have indicated that this guidance does not set strict limitations on the amount or percentage of CRE within any given loan portfolio, and that they also will examine risk indicators in banks which have amounts or percentages of CRE below the thresholds. However, if a bank’s CRE exceeds these thresholds or if other risk indicators are present, the FDIC and other federal banking regulators may require additional reporting and analysis to document management’s evaluation of the potential additional risks of such concentration and the impact of any mitigating factors. The March 2008 supplementary guidance stated that banks with significant CRE concentrations should maintain or implement processes to: (1) increase and maintain strong capital levels; (2) ensure that their loan loss allowances are appropriately strong; (3) closely manage their CRE and construction and development loan portfolios; (4) maintain updated financial and analytical information about borrowers and guarantors; and (5) bolster their workout infrastructure for problem loans. It is possible that regulatory constraints associated with this guidance could adversely affect our ability to grow CRE assets, and they also could increase the costs of monitoring and managing this component of our loan portfolio.

Prompt Corrective Action. Federal law establishes a system of prompt corrective action to resolve the problems of undercapitalized banks. Under this system, the FDIC has established five capital categories (“well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized”) and is required to take various mandatory supervisory actions, and is authorized to take other discretionary actions, with respect to banks in the three undercapitalized categories. The severity of any such actions taken will depend upon the capital category in which a bank is placed. Generally, subject to a narrow exception, current federal law requires the FDIC to appoint a receiver or conservator for a bank that is critically undercapitalized.

Under the FDIC’s prompt corrective action rules, a bank that (1) has a Total Capital Ratio of 10.0% or greater, a Tier 1 Capital Ratio of 6.0% or greater, and a Leverage Ratio of 5.0% or greater, and (2) is not subject to any written agreement, order, capital directive, or prompt corrective action directive issued by the FDIC, is considered to be “well capitalized.” A bank with a Total Capital Ratio of 8.0% or greater, a Tier 1 Capital Ratio of 4.0% or greater, and a Leverage Ratio of 4.0% or greater, is considered to be “adequately capitalized.” A bank that has a Total Capital Ratio of less than 8.0%, a Tier 1 Capital Ratio of less than 4.0%, or a Leverage Ratio of less than 4.0%, is considered to be “undercapitalized.” A bank that has a Total Capital Ratio of less than 6.0%, a Tier 1 Capital Ratio of less than 3.0%, or a Leverage Ratio of less than 3.0%, is considered to be “significantly undercapitalized,” and a bank that has a tangible equity capital to assets ratio equal to or less than 2.0% is deemed to be “critically undercapitalized.” For purposes of these rules, the term “tangible equity” includes core capital elements counted as Tier 1 Capital for purposes of the risk-based capital standards, plus the amount of outstanding cumulative perpetual preferred stock (including related surplus), minus all intangible assets (with various exceptions). A bank may be considered to be in a capitalization category lower than indicated by its actual capital position if it receives an unsatisfactory examination rating.

A bank that becomes “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized,” is required to submit an acceptable capital restoration plan to the FDIC. An “undercapitalized” bank also is generally prohibited from increasing its average total assets, making acquisitions, establishing new branches, or engaging in any new line of business, except in accordance with an accepted capital restoration plan or with the approval of the FDIC. Also, the FDIC may treat an “undercapitalized” bank as being “significantly undercapitalized” if it determines that those actions are necessary to carry out the purpose of the law.

The following table lists our and the Bank’s capital ratios at December 31, 2010. We have entered into informal agreements with our banking regulators which are described in Note 10 to our audited financial statements included in Item 8 of this Report. The agreements require that the Bank maintain capital levels in excess of statutory minimums, including a leverage capital ratio of not less than 7.5% and other ratios at least at “well capitalized” levels.


	Minimum required ratios			Required ratios to be considered “Well capitalized”			The Company’s capital ratios			The Bank’s capital ratios
Leverage Capital Ratio (Tier 1 Capital to fourth quarter average assets)		4.0	%		5.0	%		7.79	%		8.17	%
Tier 1 Capital Ratio (Tier 1 Capital to risk- weighted assets)		4.0	%		6.0	%		9.63	%		10.09	%
Total Capital Ratio (Total Capital to risk- weighted assets)		8.0	%		10.0	%		11.51	%		11.35	%

U.S. Treasury’s Troubled Asset Relief Program (TARP) Capital Purchase Program. On April 17, 2009, we issued Series A Preferred Stock in the amount of $ 13.179 million and a warrant to purchase 475,024 shares of our common stock to the U.S. Treasury as a participant in the TARP Capital Purchase Program. The Series A Preferred Stock qualifies as Tier 1 capital for purposes of regulatory capital requirements and will pay cumulative dividends at a rate of 5% per annum for the first five years and 9% per annum thereafter. Unless all accrued dividends on the Series A Preferred Stock have been paid in full, (1) no dividends may be declared or paid on our common stock, and (2) we may not repurchase any of our outstanding common stock. Additionally, during the first three years following our sale of the Series A Preferred Stock, we are required to obtain the consent of the U.S. Treasury in order to increase the dividend per share paid on our common stock from the last quarterly cash dividend per share declared prior to our sale of the Series A Preferred Stock, or to purchase outstanding shares of our common stock, unless we have redeemed all of this preferred stock or the U.S. Treasury has transferred all of this preferred stock to a third party. In addition, until the U.S. Treasury

ceases to own our securities sold under the TARP Capital Purchase Program, the compensation arrangements for our senior executive officers must comply in all respects with the U.S. Emergency Economic Stabilization Act of 2008, as amended by the American Recovery and Reinvestment Act of 2009, and the rules and regulations there under.

Reserve Requirements. Under the FRB’s regulations, all FDIC-insured depository institutions must maintain average daily reserves against their transaction accounts. No reserves are required to be maintained on the first $10.7 million of transaction accounts, but reserves equal to 3.0% must be maintained on the aggregate balances of those accounts between $10.7 million and $48.1 million, and reserves equal to 10.0% must be maintained on aggregate balances in excess of $48.1 million. The FRB may adjust these percentages from time to time. Because the Bank’s reserves are required to be maintained in the form of vault cash or in an account at a Federal Reserve Bank or with a qualified correspondent bank, one effect of the reserve requirement is to reduce the amount of our assets that are available for lending and other investment activities.

Deposit Insurance. The Bank’s deposits are insured up to limits set by the Deposit Insurance Fund (the “DIF”) of the FDIC. The DIF was formed on March 31, 2006, upon the merger of the Bank Insurance Fund and the Savings Insurance Fund in accordance with the Federal Deposit Insurance Reform Act of 2005 (the “Reform Act”). The Reform Act established a range of 1.15% to 1.50% within which the FDIC may set the Designated Reserve Ratio (the “reserve ratio” or “DRR”). The Dodd-Frank Act gave the FDIC greater discretion to manage the DIF, raised the minimum DIF reserve ratio to 1.35%, and removed the upper limit of 1.50%. In October 2010, the FDIC adopted a restoration plan to ensure that the DIF reserve ratio reaches 1.35% by September 30, 2020, as required by the Dodd-Frank Act. The FDIC also proposed a comprehensive, long-range plan for management of the DIF. As part of this comprehensive plan, the FDIC has adopted a final rule to set the DRR at 2.0%.

On October 3, 2008, the Emergency Economic Stabilization Act of 2008 was enacted and temporarily raised the standard limit of FDIC insurance coverage from $100,000 to $250,000 per depositor. On May 20, 2009, the Helping Families Save Their Homes Act extended the temporary increase in the standard maximum deposit insurance amount (SMDIA) to per depositor through December 31, 2013. On July 21, 2010, the Dodd-Frank Act permanently increased FDIC insurance coverage to $250,000 per depositor.

The FDIC imposes a risk-based deposit insurance premium assessment on member institutions in order to maintain the DIF. This assessment system was amended by the Reform Act and further amended by the Dodd-Frank Act. Under this system, as amended, the assessment rates for an insured depository institution vary according to the level of risk incurred in its activities. To arrive at an assessment rate for a banking institution, the FDIC places it in one of four risk categories determined by reference to its capital levels and supervisory ratings. In addition, in the case of those institutions in the lowest risk category, the FDIC further determines its assessment rate based on certain specified financial ratios or, if applicable, its long-term debt ratings. The assessment rate schedule can change from time to time, at the discretion of the FDIC, subject to certain limits. The Dodd-Frank Act changed the methodology for calculating deposit insurance assessments from the amount of an insured institution’s domestic deposits to its total assets minus tangible capital. On February 7, 2011, the FDIC issued a new regulation implementing these revisions to the assessment system. The regulation will be effective April 1, 2011.

On October 14, 2008, the FDIC announced the Temporary Liquidity Guarantee Program (the “TLGP”) to strengthen confidence and encourage liquidity in the banking system. The TLGP consists of two components: a temporary guarantee of newly-issued senior unsecured debt named the Debt Guarantee Program, and a temporary unlimited guarantee of funds in noninterest-bearing transaction accounts at FDIC insured institutions named the Transaction Account Guarantee Program (“TAG”). All newly-issued senior unsecured debt will be charged an annual assessment of up to 100 basis points (depending on term) multiplied by the amount of debt issued and calculated through the date of that debt or June 30, 2012, whichever is earlier. The Bank elected to opt out of the Debt Guarantee Program and elected to participate in the TAG Program. On August 26, 2009, the FDIC adopted a final rule extending the TAG portion of the TLGP for six months through June 30, 2010 and it was extended again through December 31, 2010. The Bank elected to continue to participate in the TAG Program through December 31, 2010. On July 21, 2010, the Dodd-Frank Act extended unlimited FDIC insurance coverage to noninterest-bearing transaction deposit accounts. It does not apply to accounts earning any level of interest with the exception of Interest on Lawyers’ Trust Accounts (“IOLTA”) accounts. This unlimited FDIC insurance coverage is applicable to all applicable deposits at any FDIC-insured financial institution. Therefore, there is no additional FDIC insurance surcharge related to this coverage after December 31, 2010.

During 2009, the FDIC took several measures aimed at replenishing the DIF. On May 22, 2009, the FDIC imposed a 5 basis point special assessment on each insured institution’s assets minus Tier 1 capital as of June 30, 2009. On November 17, 2009, the FDIC voted to require insured institutions to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009, as well as all of 2010, 2011, and 2012. For purposes of determining the prepayment, the FDIC used an institution’s assessment rate in effect on September 30, 2009.

The FDIC has authority to increase insurance assessments. A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what insurance assessment rates will be in the future.

Insurance of deposits may be terminated by the FDIC upon a finding that an insured institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.

Community Reinvestment. Under the Community Reinvestment Act (the “CRA”), an insured institution has a continuing and affirmative obligation, consistent with its safe and sound operation, to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for banks, nor does it limit a bank’s discretion to develop, consistent with the CRA, the types of products and services that it believes are best suited to its particular community. The CRA requires the federal banking regulators, in connection with their examinations of insured banks, to assess the banks’ records of meeting the credit needs of their communities, using the ratings of “outstanding,” “satisfactory,” “needs to improve,” or “substantial noncompliance,” and to take that record into account in its evaluation of various applications by those banks. All banks are required to publicly disclose their CRA performance ratings. The Bank received a “Satisfactory” rating in its last CRA examination during July 2009.

Interstate Banking and Branching. The BHCA, as amended by the interstate banking provisions of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “Interstate Banking Law”), permits adequately capitalized and managed bank holding companies to acquire control of the assets of banks in any state. Acquisitions are subject to antitrust provisions that cap at 10.0% the portion of the total deposits of insured depository institutions in the United States that a single bank holding company may control, and generally cap at 30.0% the portion of the total deposits of insured depository institutions in a state that a single bank holding company may control. Under certain circumstances, states have the authority to increase or decrease the 30.0% cap, and states may set minimum age requirements of up to five years on target banks within their borders.

The Dodd-Frank Act allows national and state banks to establish branches in any state if that state would permit the establishment of the branch by a state bank chartered in that state.

Restrictions on Transactions with Affiliates. The Bank is subject to the provisions of Section 23A and 23B of the Federal Reserve Act which restrict a bank’s ability to enter into certain types of transactions with its “affiliates,” including its parent holding company or any subsidiaries of its parent company. Section 23A places limits on the amount of:

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a bank’s loans or extensions of credit to, or investment in, its affiliates;

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assets a bank may purchase from affiliates, except for real and personal property exempted by the FRB;

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the amount of loans or extensions of credit by a bank to third parties which are collateralized by the securities or obligations of the bank’s affiliates; and

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a bank’s guarantee, acceptance or letter of credit issued on behalf of one of its affiliates.

Transactions of the type described above are limited in amount, as to any one affiliate, to 10% of a bank’s capital and surplus and, as to all affiliates combined, to 20% of a bank’s capital and surplus. In addition to the limitation on the amount of these transactions, each of the above transactions must also meet specified collateral requirements. The Bank also must comply with other provisions designed to avoid the taking of low-quality assets from an affiliate.

Among other things, Section 23B prohibits a bank or its subsidiaries generally from engaging in transactions with its affiliates unless the transactions are on terms substantially the same, or at least as favorable to the bank or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.

Federal law also places restrictions on our ability to extend credit to our executive officers, directors, principal shareholders and their related interests. These extensions of credit (1) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated third parties, and (2) must not involve more than the normal risk of repayment or present other unfavorable features.

USA Patriot Act of 2001. The USA Patriot Act of 2001 is intended to strengthen the ability of U.S. law enforcement and the intelligence community to work cohesively to combat terrorism on a variety of fronts. The impact of the Act on financial institutions of all kinds is significant and wide ranging. The Act contains sweeping anti-money laundering and financial transparency laws and requires various regulations, including standards for verifying customer identification when accounts are opened, and rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering.

Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 is sweeping federal legislation that addressed accounting, corporate governance and disclosure issues. The Act applies to all public companies and imposed significant new requirements for public company governance and disclosure requirements. Some of the provisions of the Act became effective immediately while others are still in the process of being implemented.

In general, the Sarbanes-Oxley Act mandated important new corporate governance and financial reporting requirements intended to enhance the accuracy and transparency of public companies’ reported financial results. It established new responsibilities for corporate chief executive officers, chief financial officers and audit committees in the financial reporting process, and it created a new regulatory body to oversee auditors of public companies. It backed these requirements with new SEC enforcement tools, increased criminal penalties for federal mail, wire and securities fraud, and created new criminal penalties for document and record destruction in connection with federal investigations. It also increased the opportunity for more private litigation by lengthening the statute of limitations for securities fraud claims and providing new federal corporate whistleblower protection.

The Act also required that the various securities exchanges, including The Nasdaq Stock Market, prohibit the listing of the stock of an issuer unless that issuer complies with various requirements relating to their audit committees and the independence of their directors that serve on those committees. In response to the Act, the exchanges themselves have imposed additional corporate governance requirements as conditions to the continued listing of an issuer’s stock, including the requirement that various corporate matters (including executive compensation and board nominations) be approved, or recommended for approval by the issuer’s full board of directors, by directors of the issuer who are “independent” as defined by the exchanges’ rules or by committees made up of “independent” directors. We are subject to the requirements of the Act and, because our common stock is listed on The Nasdaq Global Market, we are subject to the corporate governance requirements of The Nasdaq Stock Market.

The economic and operational effects of the Sarbanes-Oxley Act on public companies, including us, have been and will continue to be significant in terms of the time, resources and costs associated with compliance. Because the Act, for the most part, applies equally to larger and smaller public companies, we have been and will continue to be presented with additional challenges as a smaller, community-oriented financial institution seeking to compete with larger financial institutions in our market.

Federal Banking Agency Guidance on Executive Compensation. In July 2010, the federal banking agencies issued guidance which applies to all banking organizations supervised by the agencies. Pursuant to the guidance, to be consistent with safety and soundness principles, a banking organization’s incentive compensation arrangements should: (1) provide employees with incentives that appropriately balance risk and reward; (2) be compatible with effective controls and risk management; and (3) be supported by strong corporate governance including active and effective oversight by the banking organization’s board of directors. Monitoring methods and processes used by a banking organization should be commensurate with the size and complexity of the organization and its use of incentive compensation.

Small Business Lending Fund. In September 2010, the Small Business Lending Fund Program (“SBLF”) was created by the Small Business Jobs Act of 2010. Under the SBLF, the U.S. Treasury may invest in preferred stock and other debt instruments issued by financial institutions. To be eligible, an institution must have total assets of $10 billion or less. An institution between $1 billion and $10 billion may apply for up to 3% of its total risk-weighted assets as long as it is

otherwise eligible. An institution with assets of $1 billion or less may apply for up to 5% of its total risk-weighted assets as long as it is otherwise eligible. The U.S. Treasury must consult with the institution’s regulators to determine if the institution should receive the investment. Institutions on the FDIC’s problem bank list as of, or within 90 days prior to, the date of the application, are ineligible to participate in the program.

Treasury’s investment must be repaid within 10 years. While the investment is outstanding, the rate at which dividends are payable varies between 1% and 7%, with an initial rate of 5%, and is wholly dependent upon the amount of increase in the bank’s quarterly small business lending following Treasury’s capital investment. If the amount of small business lending does not increase within 2 years, the dividend rate increases to 7%. If Treasury’s investment is not redeemed on or before 4¹/2 years following its investment, the dividend rate increases to 9%.

The application for participation in the SBLF along with a business plan for increasing small business lending must be submitted to the Treasury and the institution’s primary federal regulator prior to March 31, 2011. The Company has not yet determined whether it will submit an application for participation in the SBLF. If the Company chooses to submit an application and it is accepted, there is uncertainty as to whether the Bank will be able to increase the level of small business lending in order to qualify for a reduced level of dividend payments. There is also uncertainty as to the capital treatment of any funds received under the SBLF due to conflicts in capital treatment under the Dodd-Frank Act and the proposed Basel III rules. Further, Treasury could change the rules regarding participation in the SBLF at any time.

Available Information

Copies of reports we file electronically with the Securities and Exchange Commission, including copies of our Annual Reports on Form 10-K, Quarterly Reports on form 10-Q, Current Reports on Form 8-K, and amendments to those reports, are available free of charge through the Bank’s Internet website as soon as reasonably practicable after they are filed. The Bank’s website address is www.bankofthecarolinas.com.

Statistical Data

Certain statistical data regarding our loans, deposits, investment securities and business is included in the information provided in Part II of this Report under the caption Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Item 1A. Risk Factors.

The following paragraphs describe material risks that could affect our business. Other risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations. If any of the following risks actually occur, our business, results of operations and financial condition could suffer. The risks discussed below also include forward-looking statements, and our actual results may differ materially from those discussed in these forward-looking statements.

Risks Relating to our Business

The current economic environment poses significant challenges for our business and could adversely affect our financial condition and results of operations.

There has been significant disruption and volatility in the financial and capital markets since 2007. The financial services industry in particular has suffered unprecedented disruption, causing a number of institutions to fail or require government intervention to avoid failure. These conditions were largely the result of the erosion of the U.S. and global credit markets, including a significant and rapid deterioration in the mortgage lending and related real estate markets. Dramatic declines in the housing markets over the past three years, with falling home prices and increasing foreclosures and unemployment, have resulted in significant write-downs of asset values by financial institutions. Continued declines in real estate values, home sales volumes, and financial stress on borrowers as a result of the uncertain economic environment could have an adverse effect on our borrowers or their customers, which could adversely affect our financial condition and results of operations. A worsening of these conditions would likely exacerbate the adverse effects on us and others in the financial institutions industry. There can be no assurance that the economic conditions that have adversely affected the financial services industry, and the capital, credit and real estate markets generally, will improve significantly in the near term, in which case we could continue to experience losses, write-downs of assets, further impairment charges of investment securities and capital and liquidity constraints or other business challenges. A further deterioration in local economic conditions, particularly within our geographic regions and markets, could drive losses beyond that which is provided for in our allowance for loan losses. We may face the following risks in connection with these events:

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Economic conditions that negatively affect housing prices and the job market have resulted, and may continue to result, in deterioration in credit quality of our loan portfolios, and such deterioration in credit quality has had, and could continue to have, a negative impact on our business.

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Market developments may affect consumer confidence levels and may cause adverse changes in payment patterns, causing increases in delinquencies and default rates on loans and other credit facilities.

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The processes we use to estimate allowance for loan losses and reserves may no longer be reliable because they rely on our complex judgments, including forecasts of economic conditions, which may no longer be capable of accurate estimation.

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Our ability to assess the creditworthiness of our customers may be impaired if the models and approaches we use to select, manage, and underwrite our customers become less predictive of future charge-offs.

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We expect to face increased regulation of our industry, and compliance with such regulation may increase our costs, limit our ability to pursue business opportunities, and increase compliance challenges.

As the above conditions or similar ones continue to exist or worsen, we could experience continuing or increased adverse effects on our financial condition and results of operations.

We are subject to extensive regulation which could adversely affect our business and recent legislative and regulatory initiatives to address difficult market and economic conditions may not stabilize the U.S. banking system.

Our operations are subject to extensive regulation and supervision by federal and state governmental authorities and are subject to various laws and judicial and administrative decisions imposing requirements and restrictions on part or all of our operations. Banking regulations governing our operations are primarily intended to protect depositors’ funds, federal deposit insurance funds and the banking system as a whole, not security holders. Congress and federal regulatory

agencies continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect us in substantial and unpredictable ways. Such changes could subject us to additional costs, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Also, failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on our business, financial condition and results of operations. While we have policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur. These laws, rules and regulations, or any other laws, rules or regulations, that may be adopted in the future, could make compliance more difficult or expensive, restrict our ability to originate, broker or sell loans, further limit or restrict the amount of commissions, interest or other charges earned on loans originated or sold by the Bank and otherwise adversely affect our business, financial condition or prospects.

On October 3, 2008, the Emergency Economic Stabilization Act of 2008 (“EESA”) was signed into law. EESA authorized Treasury to purchase from financial institutions and their holding companies up to $700 billion in mortgage loans, mortgage-related securities and certain other financial instruments, including debt and equity securities issued by financial institutions and their holding companies, under a troubled asset relief program, or “TARP.” The purpose of TARP is to restore confidence and stability to the U.S. banking system and to encourage financial institutions to increase their lending to customers and to each other. The Treasury has allocated $250 billion towards the TARP Capital Purchase Program. Under that program, Treasury has purchased equity securities from participating institutions, including the Company.

In February 2009, the American Recovery and Reinvestment Act of 2009 (“ARRA”) was enacted containing additional provisions designed to support the national economy and aid in economic recovery. The provisions of EESA and ARRA are in addition to numerous other actions by the Federal Reserve, Treasury, the FDIC, the SEC and others to address the current decline in the national economy and liquidity and credit crisis that commenced in 2007. These measures include homeowner relief that encourages loan restructuring and modification; the establishment of significant liquidity and credit facilities for financial institutions and investment banks; the lowering of the federal funds rate; emergency action against short selling practices; a temporary guaranty program for money market funds; the establishment of a commercial paper funding facility to provide back-stop liquidity to commercial paper issuers; and coordinated international efforts to address illiquidity and other weaknesses in the banking sector.

The purpose of EESA, ARRA and other recent legislative and regulatory actions is to support the national economy, stabilize the U.S. banking system, and aid in economic recovery. However, there is no assurance that EESA, ARRA and the other regulatory initiatives described above will be fully effective or have their desired effects. If the volatility in the markets continues and economic conditions fail to improve or worsen, our business, financial condition and results of operations could be materially and adversely affected.

The Dodd-Frank Act may adversely impact the Company’s results of operations, financial condition, or liquidity.

On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) into law. The Dodd-Frank Act represents a comprehensive overhaul of the financial services industry in the United States. The Dodd-Frank Act includes, among other things:

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The creation of a Financial Stability Oversight Council to identify emerging systemic risks posed by financial firms, activities and practices, and to improve cooperation between federal agencies;

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The creation of a Bureau of Consumer Financial Protection authorized to promulgate and enforce consumer protection regulations relating to financial products, which would affect both banks and non-bank financial companies;

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The establishment of strengthened capital and prudential standards for banks and bank holding companies;

•

Enhanced regulation of financial markets, including derivatives and securitization markets;

•

The elimination of certain trading activities by banks;

•

A permanent increase of the previously implemented temporary increase of FDIC deposit insurance to $250,000 per account, an extension of unlimited deposit insurance on qualifying noninterest-bearing transaction accounts, and an increase in the minimum deposit insurance fund reserve requirement from 1.15% to 1.35%, with assessments to be based on assets as opposed to deposits;

•

Amendments to the Truth in Lending Act aimed at improving consumer protections with respect to mortgage originations, including originator compensation, minimum repayment standards, and prepayment considerations; and

•

New disclosure and other requirements relating to executive compensation and corporate governance

Although the Dodd-Frank Act has been signed into law, a number of provisions remain to be implemented through the rulemaking process at various regulatory agencies. We are unable to predict the extent to which the Dodd-Frank Act or the forthcoming rules and regulations will impact the business of the Company and the Bank. However, we believe that certain aspects of the new legislation, including, without limitation, the additional cost of higher deposit insurance coverage and the costs of compliance with disclosure and reporting requirements and examinations could have an impact on our business, financial condition, and results of operations. Additionally, we cannot predict whether there will be additional proposed laws or reforms that would affect the U.S. financial system or financial institutions, whether or when such changes may be adopted, how such changes may be interpreted and enforced, or how such changes may affect us.

Current levels of market volatility are unprecedented.

The capital and credit markets have experienced volatility and disruption for more than two years. As the volatility and disruption has continued, the markets have produced downward pressure on stock prices and credit availability for many issuers without regard to their underlying financial strength. This has been particularly the case with respect to financial institutions, and the market prices of the stock of financial services companies in general, including ours, are at their lowest levels in recent history. If current levels of market disruption and volatility continue or worsen, there can be no assurance that we will not experience an adverse effect, which may be material, on our ability to access capital and on our business, financial condition and results of operations.

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

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

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cash flow of the borrower and/or a business activity being financed;

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in the case of a collateralized loan, changes in and uncertainties regarding future values of collateral;

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the credit history of a particular borrower;

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changes in economic and industry conditions; and

•

the duration of the loan.

We use underwriting procedures and criteria that we believe minimize the risk of loan delinquencies and losses, but banks routinely incur losses in their loan portfolios. Regardless of the underwriting criteria we use, we will experience loan losses from time to time in the ordinary course of our business, and some of those losses will result from factors beyond our control.

Like all financial institutions, we maintain an allowance for loan losses to provide for probable losses. However, we cannot be certain that our allowance for loan losses will be adequate to cover actual loan losses we incur, and future provisions for loan losses could materially and adversely affect our operating results. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Our allowance for loan losses is determined by analyzing historical loan losses, current trends in delinquencies and charge-offs, plans for problem loan resolution, changes in the size and composition of the loan portfolio, and industry information. Also included in management’s estimates for loan losses are considerations with respect to the impact of economic events, the outcome of

which are uncertain. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates that may be beyond our control, and these losses may exceed current estimates. Federal and North Carolina regulatory agencies, as an integral part of their examination process, review our loans and allowance for loan losses. Although we believe that our allowance for loan losses is adequate to provide for probable losses, there are no assurances that future increases in the allowance for loan losses will not be needed or that regulators will not require us to increase its allowance. Either of these occurrences could materially and adversely affect our earnings and profitability.

We have experienced increases in the levels of non-performing assets and loan charge-offs in recent periods. For additional information regarding loss experience, our allowance for loan losses and problem assets, see Table II. Summary of Loss Experience, Table III. Allocation of Allowance for Loan Losses and Table IV. Nonperforming Assets in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. Additional increases in our non-performing assets or loan charge-offs may require it to increase its allowance for loan losses, which would have an adverse effect upon our future results of operations.

A large percentage of our loans are secured by real estate. Adverse conditions in the real estate market in our banking markets might adversely affect on our loan portfolio.

While we do not have a sub-prime lending program, a relatively large percentage of our loans are secured by real estate. Our management believes that, in the case of many of those loans, the real estate collateral is not being relied upon as the primary source of repayment, and the level of our real estate loans reflects, at least in part, our policy to take real estate whenever possible as primary or additional collateral rather than other types of collateral. However, adverse conditions in the real estate market and the economy in general have decreased real estate values in our banking markets. If the value of our collateral for a loan falls below the outstanding balance of that loan, our ability to collect the balance of the loan by selling the underlying real estate in the event of a default will be diminished, and we would be more likely to suffer a loss on the loan. An increase in our loan losses could have a material adverse effect on our operating results and financial condition.

The FDIC has adopted rules aimed at placing additional monitoring and management controls on financial institutions whose loan portfolios are deemed to have concentrations in commercial real estate (“CRE”). At December 31, 2010, our loan portfolio was less than the two thresholds established by the FDIC for CRE concentrations and for additional regulatory scrutiny. Indications from regulators are that strict limitations on the amount or percentage of CRE within any given portfolio are not expected, but, rather, that additional reporting and analysis will be required to document management’s evaluation of the potential additional risks of such concentrations and the impact of any mitigating factors. However, it is possible that regulatory constraints associated with these rules could adversely affect our ability to grow loan assets and thereby limit our overall growth. These rules also could increase the costs of monitoring and managing this component of our loan portfolio. Either of these eventualities could have an adverse impact on our operating results and financial condition.

Liquidity risk could impair our ability to fund operations and jeopardize our financial condition.

Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a substantial negative effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities, or on terms which are acceptable to us, could be impaired by factors that affect us specifically or the financial services industry or economy in general. Factors that could detrimentally affect our access to liquidity sources include a decrease in the level of our business activity as a result of a downturn in the markets in which our loans are concentrated or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry in light of the recent turmoil faced by banking organizations and the continued deterioration in credit markets.

Among other sources of funds, we rely heavily on deposits for funds to make loans and provide for our other liquidity needs. However, our loan demand has historically exceeded the rate at which we have been able to build core deposits, so we have relied heavily on interest-sensitive deposits, including wholesale deposits, as sources of funds. Those deposits may not be as stable as other types of deposits and, in the future, depositors may not renew those deposits when they mature,

or we may have to pay a higher rate of interest to attract or retain them or to replace them with other deposits or with funds from other sources. Not being able to attract those deposits, or to retain or replace them as they mature, would adversely affect our liquidity. Paying higher deposit rates to attract, retain or replace those deposits could have a negative effect on our interest margin and operating results.

We may need to raise additional capital in the future in order to continue to grow, but that capital may not be available when it is needed.

Federal and state banking regulators require us to maintain adequate levels of capital to support our operations. In addition, in the future we may need to raise additional capital to support our business or to finance acquisitions, if any, or we may otherwise elect or be required to raise additional capital. In that regard, a number of financial institutions recently have sought to raise considerable amounts of capital in response to deterioration in their results of operations and financial condition arising from the turmoil in the mortgage loan market, deteriorating economic conditions, declines in real estate values and other factors. On December 31, 2010, our three capital ratios were above “well capitalized” levels under bank regulatory guidelines. However, as described in Note 10 to our audited financial statements included in Item 8 of this Report, our and the Bank’s Boards of Directors have entered into informal agreements with our respective banking regulators which, among other things, require that the Bank maintain capital levels in excess of the normal statutory minimums, including a Leverage Capital Ratio of not less than 7.5%, and other ratios at least at “well capitalized” levels. If those agreed-upon minimums are not met at the end of any quarter, the Bank’s Board of Directors is required to submit a plan to its banking regulators within 30 days detailing how such minimums are to be met. At December 31, 2010, the Bank’s Leverage Capital Ratio was 8.17%, which was above the minimum required.

Future growth in our earning assets resulting from internal expansion and new branch offices, at rates in excess of the rate at which our capital is increased through retained earnings, will reduce our capital ratios unless we continue to increase our capital. Also, future unexpected losses, whether resulting from loan losses or other causes, would reduce our capital.

Should we need, or be required by regulatory authorities, to raise additional capital in the future to support our operations and growth, or if we seek to raise additional capital in order to redeem the preferred stock we have sold to the U.S. Treasury under the TARP Capital Purchase Program, we may seek to do so through the issuance of, among other things, our common stock or preferred stock. However, our ability to raise that additional capital will depend on conditions at that time in the capital markets, economic conditions, our financial performance and condition, and other factors, many of which are outside our control. There is no assurance that, if needed, we will be able to raise additional capital on terms favorable to us or at all. Our inability to raise additional capital, if needed, on terms acceptable to us, may have a material adverse effect on our ability to expand our operations, and on our financial condition, results of operations and future prospects.

If we are unable to redeem the preferred stock we sold to the U.S. Treasury under the TARP Capital Purchase Program after five years, the cost of this capital to us will increase substantially.

The dividend rate on the preferred stock we sold under the TARP Capital Purchase Program will increase from 5.0% per annum to 9.0% per annum beginning in 2014. Depending on our financial condition at the time, this increase in the annual dividend rate could have a material negative effect on our liquidity and on our net income available to holders of our common stock.

Increases in FDIC insurance premiums and changes to deposit insurance assessment methodologies may adversely affect the Company’s financial condition.

During 2008 and continuing in 2010, higher levels of bank failures have dramatically increased resolution costs of the FDIC and depleted the Deposit Insurance Fund. In addition, the FDIC instituted two temporary programs to further insure customer deposits at FDIC-insured banks: deposit accounts are now insured up to $250,000 per customer (up from $100,000) and noninterest-bearing transaction accounts are currently fully insured (unlimited coverage). These programs have placed additional stress on the Deposit Insurance Fund. In order to maintain a strong funding position and restore reserve ratios of the Deposit Insurance Fund, the FDIC has increased assessment rates of insured institutions. On November 12, 2009, the FDIC adopted a rule that required banks to prepay three years’ worth of estimated deposit

insurance premiums by December 31, 2009. We are unable to control the amount of premiums that the Company is required to pay for FDIC insurance. The Dodd-Frank Act also imposes additional assessments and costs with respect to deposits, requiring the FDIC to impose deposit insurance assessments based on total assets rather than total deposits, as well as making permanent the increase of deposit insurance to $250,000 and providing for full insurance of non-interest bearing transaction accounts beginning December 31, 2010, for two years. For additional information regarding changes with respect to deposit insurance assessments, see Item 1. Business—Supervision and Regulation—Deposit Insurance. These announced increases, legislative and regulatory changes and any future increases or required prepayments of FDIC insurance premiums may adversely impact the Company’s financial condition. If there are additional bank or financial institution failures, or the cost of resolving prior failures exceeds expectations, the Company may be required to pay even higher FDIC premiums than the recently increased levels.

Our profitability is subject to interest rate risk. Changes in interest rates could have an adverse effect on our operating results.

Our profitability depends, to a large extent, on our net interest income, which is the difference between our income on interest-earning assets and our expense on interest-bearing deposits and other liabilities. In other words, to be profitable, we have to earn more interest on our loans and investments than we pay on our deposits and borrowings. Like most financial institutions, we are affected by changes in general interest rate levels and by other economic factors beyond our control. Interest rate risk arises in part from the mismatch (i.e., the interest sensitivity “gap”) between the dollar amounts of repricing or maturing interest-earning assets and interest-bearing liabilities, and is measured in terms of the ratio of the interest rate sensitivity gap to total assets. When more interest-earning assets than interest-bearing liabilities will reprice or mature over a given time period, a bank is considered asset-sensitive and has a positive gap. When more liabilities than assets will reprice or mature over a given time period, a bank is considered liability-sensitive and has a negative gap. A liability-sensitive position (i.e., a negative gap) may generally enhance net interest income in a falling interest rate environment and reduce net interest income in a rising interest rate environment. An asset-sensitive position (i.e., a positive gap) may generally enhance net interest income in a rising interest rate environment and reduce net interest income in a falling interest rate environment. Our ability to manage our gap position determines to a great extent our ability to operate profitably. However, fluctuations in interest rates are not predictable or controllable, nor do specific asset and liability groups reprice at the same time or in the same magnitude as general changes in interest rates. Therefore, we cannot assure you we will be able to manage net interest income in a manner that will allow us to become or remain profitable.

On December 31, 2010, we had a negative one-year cumulative interest sensitivity gap, which means that, during a one-year period, our interest-bearing liabilities generally would be expected to reprice at a faster rate than our interest-earning assets.

Our business depends on the condition of the local and regional economies where we operate.

We currently have offices only in one region of North Carolina. Consistent with our community banking philosophy, a majority of our customers are located in and do business in that region, and we lend a substantial portion of our capital and deposits to commercial and consumer borrowers in our local banking markets. Therefore, our local and regional economy has a direct impact on our ability to generate deposits to support loan growth, the demand for loans, the ability of borrowers to repay loans, the value of collateral securing our loans (particularly loans secured by real estate), and our ability to collect, liquidate and restructure problem loans. If our local communities are adversely affected by current conditions in the national economy or by other specific events or trends, there could be a direct adverse effect on our operating results. Adverse economic conditions in our banking markets could reduce our growth rate, affect the ability of our customers to repay their loans to us, and generally affect our financial condition and operating results. We are less able than larger institutions to spread risks of unfavorable local economic conditions across a large number of diversified economies.

New or changes in existing tax, accounting, and regulatory rules and interpretations could have an adverse effect on our strategic initiatives, results of operations, cash flows, and financial condition.

We operate in a highly regulated industry and are subject to examination, supervision and comprehensive regulation by various federal and state agencies. Federal and state banking regulations are designed primarily to protect the deposit insurance funds and consumers, not to benefit a financial company’s shareholders. These regulations may sometimes

impose significant limitations on our operations, and our compliance with regulations is costly and restricts certain of our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits, and locations of offices.

The significant federal and state banking regulations that affect us are described under Item 1. Business—Supervision and Regulation. These regulations, along with the currently existing tax, accounting, securities, insurance, and monetary laws, regulations, rules, standards, policies, and interpretations, control the methods by which financial institutions conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures. The laws, regulations, rules, standards, policies, and interpretations are constantly evolving and may change significantly over time. As a result of recent turmoil in the financial services industry, it is likely that there will be an increase in the regulation of all financial institutions. We cannot predict the effects of future changes on our business and profitability.

Significant legal actions could subject us to substantial liabilities.

We are from time to time subject to claims related to our operations. These claims and legal actions, including supervisory actions by our regulators, could involve large monetary claims and significant defense costs. As a result, we may be exposed to substantial liabilities, which could adversely affect our results of operations and financial condition.

Among the laws that apply to us, the USA Patriot and Bank Secrecy Acts require financial institutions to develop programs to prevent financial institutions from being used for money laundering and terrorist activities. If such activities are detected, financial institutions are obligated to file suspicious activity reports with the Treasury’s Office of Financial Crimes Enforcement Network. These rules require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts. Failure to comply with these regulations could result in fines or sanctions. Several banking institutions have recently received large fines for non-compliance with these laws and regulations. Although we have developed policies and procedures designed to assist in compliance with these laws and regulations, no assurance can be given that these policies and procedures will be effective in preventing violations of these laws and regulations.

Competition from financial institutions and other financial service providers may adversely affect our profitability.

Our future growth and success will depend on, among other things, our ability to compete effectively with other financial services providers in our banking markets. To date, we have grown our business by focusing on our lines of business and emphasizing the high level of service and responsiveness desired by our customers. However, commercial banking in our banking markets and in North Carolina as a whole is extremely competitive. We compete against commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds and other mutual funds, as well as other local and community, super-regional, national and international financial institutions that operate offices in our market areas and elsewhere. We compete with these institutions in attracting deposits and in making loans, and we have to attract our customer base from other existing financial institutions and from new residents. Our larger competitors have greater resources, broader geographic markets and name recognition, and higher lending limits than we do, and they can offer more products and services and better afford and more effectively use media advertising, support services and electronic technology than we can. Also, larger competitors may be able to price loans and deposits more aggressively than we do. While we believe we compete effectively with other financial institutions, we may face a competitive disadvantage as a result of our size, lack of geographic diversification and inability to spread marketing costs across a broader market. Although we compete by concentrating our marketing efforts in our primary markets with local advertisements, personal contacts and greater flexibility and responsiveness in working with local customers, we cannot assure you that we will continue to be an effective competitor in our banking markets.

We rely on dividends from the Bank for substantially all of our revenue.

We receive substantially all of our revenue as dividends from the Bank. As described under the caption Item 1. Business—Supervision and Regulation, federal and state regulations limit the amount of dividends that the Bank may pay to us, and our and the Bank’s Boards of Directors have entered into informal agreements with our respective banking

regulators which require that we and the Bank obtain the consent of our regulators before we may pay any cash dividends. If the Bank becomes unable to pay dividends to us, then we may not be able to service our debt, pay our other obligations or pay dividends on our common stock and on the preferred stock we sold to the U.S. Treasury under the TARP Capital Purchase Program. Accordingly, our inability to receive dividends from the Bank could also have a material adverse effect on our business, financial condition and results of operations and the value of our common stock.

We depend on the services of our current management team.

Our operating results and ability to adequately manage our growth and minimize loan losses are highly dependent on the services, managerial abilities and performance of our executive officers. Smaller banks, like us, sometimes find it more difficult to attract and retain experienced management personnel than larger banks. We currently have an experienced management team that our Board of Directors believes is capable of managing and growing the Bank. However, changes in key personnel and their responsibilities may disrupt our business and could have a material adverse effect on our business, operating results and financial condition.

Risks Relating to Our Common Stock

The price of our common stock may fluctuate significantly, and this may make it difficult for you to resell our common stock when you want or at prices you find attractive.

We cannot predict how or at what prices our common stock will trade in the future. The market value of our common stock will likely continue to fluctuate in response to a number of factors including the following, most of which are beyond our control, as well as the other factors described in this “Risk Factors” section:

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actual or anticipated quarterly fluctuations in our operating and financial results;

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changes in financial estimates and recommendations by financial analysts;

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actions of our current shareholders, including sales of common stock by existing shareholders and our directors and executive officers;

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fluctuations in the stock price and operating results of our competitors;

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regulatory developments; and

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developments related to the financial services industry.

The market value of and trading in our common stock also is affected by conditions (including price and trading fluctuations) affecting the financial markets in general, and in the market for the stocks of financial services companies in particular. These conditions may result in volatility in the market prices of stocks generally and, in turn, our common stock. Also, market conditions may result in sales of substantial amounts of our common stock in the market. In each case, market conditions could affect the market price of our stock in a way that is unrelated or disproportionate to changes in our operating performance.

The trading volume in our common stock has been low, and the sale of a substantial number of shares in the public market could depress the price of our stock and make it difficult for you to sell your shares.

Our common stock is listed on the NASDAQ Global Market, but it has a relatively low average daily trading volume relative to many other stocks. Thinly traded stock can be more volatile than stock trading in an active public market, which can lead to significant price swings even when a relatively small number of shares are being traded and limit an investor’s ability to quickly sell blocks of stock. We cannot predict what effect future sales of our common stock in the market, or the availability of shares of our common stock for sale in the market, will have on the market price of our common stock.

Our management beneficially owns a substantial percentage of our common stock, so our directors and executive officers can significantly affect voting results on matters voted on by our shareholders.

Our current directors and executive officers, as a group, beneficially own a significant percentage of our outstanding common stock. Because of their voting rights, in matters put to a vote of our shareholders it could be difficult for any group of our other shareholders to defeat a proposal favored by our management (including the election of one or more of our directors) or to approve a proposal opposed by management.

We participate in the TARP Capital Purchase Program and there are restrictions on our ability to pay dividends on and repurchase our common stock.

The securities purchase agreement entered into with the U.S. Treasury generally provides that, for a period of three years, we may not, without the consent of Treasury:

•

increase the cash dividend on our common stock; or

•

subject to limited exceptions, redeem, repurchase or otherwise acquire shares of our common stock or preferred stock (other than the preferred stock we sell to Treasury) or trust preferred securities.

In addition, we are unable to pay any dividends on our common stock unless we are current in our dividend payments on the preferred stock we sold to the U.S. Treasury. 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. These restrictions, together with the potentially dilutive impact of the warrant described in the next risk factor, could have a negative effect on the value of our common stock. Moreover, holders of our common stock are entitled to receive dividends only when, as and if declared by our Board of Directors. We did not declare any dividends on our common stock in 2010 and we are not required to do so. Our Board of Directors likely will not restore our common stock dividend in the foreseeable future.

The preferred stock we sold to the U.S. Treasury affects net income available to our common shareholders and our earnings per common share, and the warrant we issued to Treasury is dilutive to holders of our common stock.

The dividends we pay on the preferred stock sold to the U.S. Treasury reduces the net income available to our common shareholders and our earnings per common share. The preferred stock also would receive preferential treatment in the event of liquidation, dissolution or winding up of our company. Additionally, the ownership interest of the existing holders of our common stock will be diluted to the extent the warrant we issued to Treasury in conjunction with the sale of preferred stock is exercised. Although Treasury has agreed not to vote any of the shares of our common stock it receives upon exercise of the warrant, a transferee of any portion of the warrant or of any shares of common stock acquired upon exercise of the warrant would not be bound by that restriction.

Item 1B. Unresolved Staff Comments.

Not applicable

Item 2. Properties.

We own the facilities housing six of our banking offices, and we lease the facilities housing our remaining four offices. In addition, we own an operations center which houses the deposit operations, information technology and loan administration departments of the Bank. Each of our banking offices is in good condition and fully equipped for our purposes. On December 31, 2010, our investment in premises and equipment (cost less accumulated depreciation) was approximately $13.1 million.

Item 3. Legal Proceedings.

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

Item 4. [Removed and Reserved]

PART II

Item 5. Market for Common Equity, Related Stockholder Matters and Purchases of Equity Securities

Market for Registrant’s Common Stock; Dividends. Our common stock is listed for trading on The Nasdaq Global Market under the trading symbol “BCAR”. The following table lists high and low published prices of our common stock, and cash dividends declared on our common stock, for each calendar quarter during 2009 and 2010.


	Sales price range				Cash Dividends Declared
Quarter	High		Low		Cash Dividends Declared
2010 Fourth	$	3.44	$	2.13	$	—
Third		3.97		3.04		—
Second		5.31		3.35		—
First		5.36		4.17		—

2009 Fourth		8.70		3.00		—
Third		5.00		3.25		—
Second		5.85		4.01		—
First		5.95		3.17		—

On December 31, 2010, there were approximately 1,815 total beneficial holders of our common stock, including 1,057 shareholders of record and approximately 758 holders whose shares were in street name.

Under North Carolina law, subject to certain restrictions, we are authorized to pay dividends as declared by our Board of Directors. However, although we are a legal entity separate and distinct from the Bank, our principal source of funds with which we can pay dividends to our shareholders and pay our own obligations is dividends we received from the Bank. For that reason, our ability to pay dividends effectively is subject to the same limitations that apply to the Bank. Information regarding restrictions on our and the Bank’s ability to pay dividends is contained in Item 1 of this Report under the caption “Payment of Dividends.”

In the future, any declaration and payment of cash dividends will be subject to the Board of Directors’ evaluation of our operating results, financial condition, future growth plans, general business and economic conditions, and tax and other relevant considerations. Also, the payment of cash dividends in the future will be subject to ongoing review by our banking regulators and to certain other legal and regulatory limitations including the requirement that our capital be maintained at certain minimum levels. In that regard, our and the Bank’s Boards of Directors have entered into informal agreements with our respective bank regulators (described in Note 10 to our audited financial statements included in Item 8 of this Report) which require that we and the Bank obtain the consent of our regulators before we may pay any cash dividends.

There is no assurance that, in the future, we will have funds available to pay cash dividends, or, even if funds are available, that we will pay or the Bank will be permitted to pay dividends in any particular amount or at any particular times, or that we will pay dividends at all.

Item 6. Selected Financial Data


	As of and for the years ended December 31,
	2010			2009			2008			2007			2006
	(In thousands, except per share data and financial ratios)
Summary of Operations
Net interest income	$	16,434		$	14,666		$	12,691		$	14,605		$	14,663
Provision for loan losses		6,441			5,547			6,291			1,470			1,157
Noninterest income		2,037			3,297			2,434			1,935			3,374
Noninterest expense		16,348			17,514			15,092			12,398			11,512

Income before income tax provision		(4,318	)		(5,098	)		(6,258	)		2,672			5,368
Income tax provision		(1,663	)		(1,968	)		(2,634	)		714			1,894

Net income (loss)		(2,655	)		(3,130	)		(3,624	)		1,958			3,474
Preferred dividends and accretion		(914	)		(637	)		—			—			—

Net income (loss) available to common shareholders	$	(3,569	)	$	(3,767	)	$	(3,624	)	$	1,958		$	3,474


Selected year-end assets and liabilities
Assets	$	534,970		$	610,387		$	562,007		$	505,998		$	454,578
Loans		366,153			391,265			405,402			395,052			354,555
Allowance for loan losses		6,863			8,167			6,308			4,245			3,732
Deposits		416,169			493,917			444,540			421,928			382,721
Borrowed funds		75,458			69,537			79,412			41,657			31,000
Preferred Shareholders’ Equity		13,179			13,179			—			—			—
Total Shareholders’ equity		41,704			44,992			36,591			40,240			37,714

Ratios
Return (loss) on average total assets		(0.48	)%		(0.50	)%		(0.68	)%		0.42	%		0.84	%
Return (loss) on average common equity		(11.00	)		(10.57	)		(9.59	)		5.10			9.57
Dividend Payout		n/a			n/a			n/a			39.22			21.98
Average equity to average assets		8.24			7.20			7.32			8.39			8.73

Per common share
Earnings (loss)
Basic	$	(0.92	)	$	(0.97	)	$	(0.92	)	$	0.51		$	0.91
Diluted		(0.92	)		(0.97	)		(0.92	)		0.50			0.88
Cash dividends declared		n/a			n/a			0.20			0.20			0.20
Tangible Book Value		7.32			8.16			9.40			10.11			9.70

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following presents management’s discussion and analysis of our financial condition and results of operations. The discussion is intended to assist in understanding our consolidated financial condition and results of operations, and it should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this annual report. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ significantly from those anticipated in these forward-looking statements as a result of various factors. All share and per share data have been adjusted to give retroactive effect to stock splits and stock dividends.

Bank of the Carolinas Corporation (the Company) is a North Carolina-chartered bank holding company that was incorporated on May 30, 2006, for the sole purpose of serving as the parent bank holding company for Bank of the Carolinas (the “Bank”). The Bank is a FDIC-insured, North Carolina-chartered bank that began operations on December 7, 1998.

Because the Company has no operations and conducts no business on its own other than owning the Bank, the discussion contained in these footnotes concerns primarily the business of the Bank. However, for ease of reading and because the financial statements are presented on a consolidated basis, the Company and its subsidiary are collectively referred to herein as the Company unless otherwise noted.

Critical Accounting Policies

Our financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The notes to our audited financial statements for the years ended December 31, 2010, 2009 and 2008 contain a summary of our significant accounting policies. We believe our policies with respect to methodology for the determination of our allowance for loan losses, and our asset impairment judgments, such as the recoverability of other real estate values, involve a higher degree of complexity and require us to make difficult and subjective judgments that often require assumptions or estimates about highly uncertain matters. Accordingly, we consider the policies related to those areas critical.

The allowance for loan losses represents our best estimate of probable losses that are inherent in the loan portfolio at the balance sheet date. The allowance is based on generally accepted accounting principles, which require that losses be accrued when they are probable of occurring and estimatable and require that losses be accrued based on the differences between the value of collateral, the present value of future cash flows or values that are observable in the secondary market, and the loan balance.

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 those loans, in our opinion, become uncollectible. Recoveries during the period are credited to the allowance. The factors that influence our judgment in determining the amount charged against operating income include analyzing historical loan and lease losses, current trends in delinquencies and charge-offs, current assessment of problem loan administration, the results of regulatory examinations, and changes in the size, composition and risk assessment of the loan and lease portfolio. Also included in our estimates for loan losses are considerations with respect to the impact of current economic events, the outcomes of which are uncertain. These events may include, but are not limited to, fluctuations in overall interest rates, political conditions, legislation that may directly or indirectly affect the banking industry and economic conditions affecting specific geographical areas and industries in which we conduct business.

The factors that are enumerated above form the basis for a model which we utilize in calculating the appropriate level of our allowance for loan losses at the balance sheet date. This model has three main components. First, losses are estimated on loans we have individually identified and determined to be “impaired”. A loan is considered to be impaired when, based on current information and events, it is probable we will be unable to collect all amounts due according to the contractual terms of the loan agreement. The loss allowance applicable to impaired loans is the difference, if any, between the loan balances outstanding and the value of the impaired loans as determined by either 1) an estimate of the cash flows that we expect to receive from those borrowers discounted at the loan’s effective rate, or 2) in the case of collateral-dependent loans, the fair value of the collateral securing those loans less estimated costs to sell.

Second, for all other loans, we divide the loan portfolio into groups or pools based on similarity of risk characteristics. Historical loss rates, which are weighted toward current experience, are then applied to determine an appropriate allowance for each pool or group.

Finally, an adjustment is applied, if appropriate, to give effect to qualitative or environmental factors that could cause estimated credit losses within the existing loan portfolio to differ from the historical loss experience.

We review our allowance on a quarterly basis and believe that it is adequate to cover inherent loan losses on the loans outstanding as of each reporting date. However, the appropriateness of the allowance using our procedures and methods is dependent upon the accuracy of various judgments and assumptions about economic conditions and other factors affecting loans. No assurance can be given that we will not, in any particular period, sustain loan losses that are significantly different from the amounts reserved for those loans, or that subsequent evaluations of the loan portfolio and our allowance, in light of conditions and factors then prevailing, will not require material changes in the allowance for loan losses or future charges to earnings. In addition, various regulatory agencies, as an integral part of their routine examination process, periodically review our allowance. Those agencies may require that we make additions to the allowance based on their judgments about information available to them at the time of their examinations.

Accounting for intangible assets is as prescribed by generally accepted accounting principles. We account for recognized intangible assets based on their estimated useful lives. Intangible assets with finite useful lives are amortized, while intangible assets with an indefinite useful life are not amortized. Goodwill is not amortized, but is subject to fair value impairment tests on at least an annual basis. If based upon our evaluation impairment has occurred, the impairment charge is recognized at that time. During the 2008 evaluation of our goodwill, the determination was made that our goodwill was impaired and the entire remaining balance of $591,000 was charged off our balance sheet.

Overview

The past two years have been difficult ones for the financial services industry in general. Bank failures have been numerous, particularly among community banks in some southeastern states, primarily brought about by the severe downturn in real estate markets. Our operating results over the past two years have been adversely affected by the weakness in the economy in general and real estate in particular. Our net loss available to common shareholders was $3.6 million for 2010 and $3.8 million for 2009. The losses in both years were driven by substantial increases in loan loss provisions due to deterioration in our loan portfolio, significant losses and net operating expenses associated with foreclosed real estate, as well as, lost interest revenue caused by elevated levels of nonperforming assets.

In addition to the effect on our operating results noted above, the economic environment of the past two years led to a decline of $25.1 million in our loan portfolio during 2010. Given the prominence of real estate loans in our lending activities, it has been and continues to be a challenge to generate quality credit in sufficient volume to outpace payments.

We strive to serve the financial needs of small to medium-sized businesses and individuals in our market area, offering an array of financial products emphasizing superior customer service.

Real estate secured loans, including construction loans and loans secured by existing commercial and residential properties, made up almost 84% of our loan portfolio at December 31, 2010, with the remainder of our loans consisting of commercial and industrial loans and loans to individuals. We also offer certain loan products through associations with various mortgage lending companies. Through these associations, we originate 1-4 family residential mortgages, at both fixed and variable rates. We earn fees for originating these loans and transferring the loan package to the mortgage lending companies.

The deposit services we offer include small business and personal checking accounts, savings accounts, money market checking accounts and certificates of deposit. The Company concentrates on providing customer service to build its customer deposit base and competes aggressively in the area of transaction accounts.

Additional funding includes certificates of deposit acquired through deposit brokers, advances from the Federal Home Loan Bank, term repurchase agreements from two money center financial institutions and federal funds lines of credit from correspondent banks.

Over 88% of our revenue (net interest income plus noninterest income) was comprised of net interest income, which is the difference between the interest earned on loans and securities and the interest paid on deposits and borrowings. Therefore, the levels of interest rates and our ability to effectively manage the effect that changes in interest rates have on

net interest income can have a significant impact on revenue and results of operations. Results of operations may also be materially affected by our provision for loan losses, which has been much higher during the past two years than our long-term trend. Service charges and fee income generated from customer services represented less than 11% of revenue in each of the past two years and represents an area of potential revenue growth. Noninterest expense is the third major driver of operating results along with net interest income and the provision for loan losses. Total noninterest expenses absorbed over 88% of our revenue in each of the past two years. Noninterest expenses include compensation and employee benefits, occupancy and equipment expenses, FDIC insurance premiums, expenses related to foreclosed real estate, professional services, expenditures for data processing services and various other costs of doing business.

Financial Condition at December 31, 2010 and December 31, 2009

Total assets at December 31, 2010, decreased by $75.4 million or 12.4% to $535.0 million compared to $610.4 million at December 31, 2009. We had earning assets of $492.2 million at December 31, 2010 consisting of $366.2 million in loans, $110.4 million in investment securities and $15.6 million in temporary investments. Stockholders’ equity was $41.7 million at December 31, 2010 compared to $45.0 million at December 31, 2009.

Loans. Total loans declined by $25.1 million or 6.4% during the twelve months of 2010, from $391.3 million on December 31, 2009 to $366.2 million at December 31, 2010. On December 31, 2010, real estate loans made up 83.9% of total loans while commercial non-real estate loans comprised another 14.1% of the portfolio. Total loans represented 68.4% and 64.1% of our total assets on December 31, 2010 and 2009, respectively.

Interest rates charged on loans vary with the degree of risk, maturity and amount of the loan. Competitive pressures, money market rates, availability of funds, and government regulation also influence interest rates. On average, our loan portfolio yielded 5.6% for the year ending December 31, 2010 as compared to an average yield of 5.9% during 2009.

The following table contains selected data relating to the composition of our loan portfolio by type of loan on the dates indicated.

Table I.

Analysis of Loan Portfolio (dollars in thousands)


	At December 31,
	2010						2009						2008						2007						2006
	Amount			Percent			Amount			Percent			Amount			Percent			Amount			Percent			Amount			Percent
Real estate loans:
Residential 1-4 family	$	78,750			21.51	%	$	76,767			19.62	%	$	68,876			16.99	%	$	63,023			15.95	%	$	63,221			17.83	%
Commercial real estate		161,839			44.20			161,904			41.38			154,463			38.10			119,473			30.24			108,907			30.72
Construction and development		35,310			9.64			41,580			10.63			60,476			14.92			59,522			15.07			59,693			16.84
Home equity		31,465			8.59			30,775			7.87			29,656			7.32			26,575			6.73			21,640			6.10

Total real estate loans		307,364			83.94			311,026			79.50			313,471			77.33			268,593			67.99			253,461			71.49
Commercial business loans		51,581			14.09			75,762			19.36			84,282			20.79			116,105			29.39			92,479			26.08
Consumer loans:
Installment		4,300			1.17			3,303			0.84			5,989			1.48			6,933			1.75			6,614			1.87
Other		2,908			0.80			1,174			0.30			1,660			0.40			3,421			0.87			2,001			0.56

Total loans		366,153			100.00	%		391,265			100.00	%		405,402			100.00	%		395,052			100.00	%		354,555			100.00	%

Allowance for loan losses		(6,863	)					(8,167	)					(6,308	)					(4,245	)					(3,732	)

Total loans, net	$	359,290					$	383,098					$	399,094					$	390,807					$	350,823

The following table reflects the scheduled maturities of commercial real estate loans, construction and development loans, and commercial business loans (dollars in thousands):


	December 31, 2010
	1 year or less		After 1 year but within 5 years		After 5 years		Total
Commercial real estate loans	$	41,126	$	112,313	$	8,400	$	161,839
Constructions and development loans		15,513		18,922		875		35,310
Commercial business loans		31,550		16,846		3,185		51,581

Total	$	88,189	$	148,081	$	12,460	$	248,730

The following table reflects the scheduled maturities of all fixed and variable interest rate loans (dollars in thousands):


	December 31, 2010
	1 year or less		After 1 year but within 5 years		After 5 years		Total
Loans with fixed interest rates	$	52,731	$	144,596	$	39,910	$	237,237
Loans with variable interest rates		54,207		41,490		33,219		128,916

Total	$	106,938	$	186,086	$	73,129	$	366,153

Allowance for Loan Losses. On December 31, 2010, our allowance totaled approximately $6.9 million and amounted to 1.87% of total loans and 27.8% of our nonperforming loans. This compares to an allowance of $8.2 million, or 2.09% of loans and 88.5% of nonperforming loans at December 31, 2009 and $6.3 million, or 1.56% of loans and 93.9% of nonperforming loans as of December 31, 2008.

The following table contains an analysis of our allowance for loan losses for the time periods indicated.

Table II.

Summary of Loan Loss Experience (dollars in thousands)


	Year ended December 31,
	2010			2009			2008			2007			2006
Balance at beginning of period	$	8,167		$	6,308		$	4,245		$	3,732		$	3,315
Provision for loan losses		6,441			5,547			6,291			1,470			1,157
Charge-offs:
Residential mortgage		(1,041	)		(256	)		(645	)		(108	)		(358	)
Commercial real estate		(1,090	)		(141	)		(300	)		(738	)		(58	)
Construction and development		(1,006	)		(1,381	)		(640	)		(49	)		—
Commercial business		(4,561	)		(1,912	)		(2,919	)		(1	)		(210	)
Installment		(233	)		(218	)		(169	)		(143	)		(132	)

Total charge-offs		(7,931	)		(3,908	)		(4,673	)		(1,039	)		(758	)

Recoveries:
Residential mortgage		3			4			45			2			—
Commercial real estate		28			50			192			1			4
Construction and development		94			9			50			—			—
Commercial business		23			128			124			2			—
Installment		38			29			34			77			14

Total recoveries		186			220			445			82			18

Net charge-offs		(7,745	)		(3,688	)		(4,228	)		(957	)		(740	)

Balance at end of period	$	6,863		$	8,167		$	6,308		$	4,245		$	3,732

Ratio of net charge-offs during period to average loans outstanding		2.08	%		0.92	%		1.04	%		0.26	%		0.23	%

Ratio of allowance for loan losses to non-performing loans		27.8	%		88.5	%		93.9	%		58.9	%		80.1	%

Ratio of allowances for loan losses to total loans		1.87	%		2.09	%		1.56	%		1.07	%		1.05	%

During 2010, we incurred net loan charge-offs of $7.7 million, compared to $3.7 million in 2009 and $4.2 million in 2008. These levels of net charge-offs produced net loss ratios of 2.08% for 2010, 0.92% for 2009, and 1.04% for 2008. The loss ratios for 2010 and 2009 were substantially higher than our longer-term trend which contributed to increased loan loss provisions in both years. The deterioration in our loan portfolio, as evidenced by rising loss ratios and nonperforming loans, resulted in the increases in our allowance for loan losses in both 2010 and 2009.

An analysis of the allowance for loan losses for the years ended December 31, 2010, 2009, 2008, 2007, and 2006 is contained in the following table:

Table III.

Allocation of Allowance for Loan Losses (dollars in thousands)


	At December 31,
	2010					2009					2008					2007					2006
	Amount		Percent			Amount		Percent			Amount		Percent			Amount		Percent			Amount		Percent
Real estate loans:
Residential, 1-4 family	$	1,766		25.73	%	$	721		8.83	%	$	1,072		16.99	%	$	659		15.52	%	$	657		17.62	%
Commercial real estate		1,616		23.55			4,072		49.86			2,403		38.09			1,249		29.41			1,133		30.34
Construction and development		776		11.31			1,007		12.33			941		14.92			747		17.60			669		17.93
Home equity		114		1.66			93		1.14			462		7.32			278		6.54			225		6.03

Total real estate loans		4,272		62.25			5,893		72.16			4,878		77.32			2,933		69.07			2,684		71.92
Commercial business loans		2,407		35.07			2,165		26.51			1,311		20.78			1,213		28.59			962		25.77
Consumer loans:
Installment		175		2.55			104		1.27			93		1.47			72		1.71			69		1.84
Other		9		0.13			5		0.06			26		0.43			27		0.63			17		0.47

Total Loans	$	6,863		100.00	%	$	8,167		100.00	%	$	6,308		100.00	%	$	4,245		100.00	%	$	3,732		100.00	%

The allowance has been allocated on an approximate basis. The entire amount of the allowance is available to absorb losses occurring in any category.

The allocation is not necessarily indicative of future losses.

Asset Quality. Credit risks are inherent in making loans. We assess these risks and attempt to manage them effectively 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 non-accrual status when, in our judgment, the collection of interest appears doubtful. Nonperforming assets are defined as nonaccrual loans, loans contractually past due for more than 90 days but still accruing interest, and foreclosed or idled properties. At December 31, 2010, the Company’s non-performing assets totaled $33.0 million, or 8.81% of loan-related assets, compared to $17.4 million, or 4.37% of loan-related assets at December 31, 2009.

On December 31, 2010, we had no loans that were delinquent over 90 days and still accruing interest, and $24.7 million that were in non-accrual status. Interest accrued, but not recognized as income on non-accrual loans, was approximately $544,000 during 2010.

Other real estate owned at December 31, 2010 amounted to $8.3 million compared to $8.2 million as of December 31, 2009. Other real estate is carried at the lower of cost or estimated net realizable value.

The following table summarizes information regarding our nonperforming assets on December 31, 2010, 2009, 2008, 2007, and 2006.

Table IV.

Nonperforming Assets (dollars in thousands)


	At December 31,
	2010			2009			2008			2007			2006
Loans accounted for on a nonaccrual basis:
Real estate loans:
Mortgage	$	4,071		$	2,971		$	195		$	—		$	102
Commercial		15,176			1,606			5,466			300			2,596
Construction and development		2,274			1,488			285			—			—

Total real estate loans		21,521			6,065			5,946			300			2,698
Commercial business customers		3,068			3,151			771			248			82
Installment		101			8			—			—			—

Total nonaccrual loans		24,690			9,224			6,717			548			2,780
Accruing loans which are contractually past due 90 days or more		—			—			—			6,661			1,882

Total nonperforming loans		24,690			9,224			6,717			7,209			4,662
Other real estate owned		8,314			8,233			5,622			2,528			1,000

Total nonperforming assets	$	33,004		$	17,457		$	12,339		$	9,737		$	5,662

Total nonperforming loans as a percentage of loans		6.74	%		2.36	%		1.66	%		1.82	%		1.31	%
Total nonperforming assets as a percentage of loans and other real estate owned		8.81	%		4.37	%		3.00	%		2.45	%		1.59	%
Total nonperforming assets as a percentage of total assets		6.17	%		2.86	%		2.20	%		1.92	%		1.25	%

Investment Securities. Our investment securities totaled $110.4 million at December 31, 2010, and $140.0 million at December 31, 2009. Our investment portfolio includes U.S. Government Agency bonds, mortgage backed securities, state and municipal bonds and corporate subordinated debt of other financial institutions, all of which are classified as held to maturity or available-for-sale. Held to maturity securities are carried at amortized cost value and available for sale securities are carried at fair value.

We use our investment portfolio to employ liquid funds and as a tool in the management of interest rate risk, while at the same time providing interest income. Practically all of our securities are classified as available for sale and, as such, may be sold from time to time to increase liquidity or re-balance the interest rate sensitivity profile of our balance sheet. However, we do have the available liquidity to hold our securities to maturity should we have the need to. In fact, we have classified some of our more illiquid securities as held to maturity because we fully intend to hold them until their maturity date. All securities classified as held to maturity were purchased in 2008 and consist of subordinated debt and trust preferred securities issued or guaranteed by other financial institutions. In December 2010, we recorded an additional impairment charge of $105,000 for a total impairment of $603,000 on a $1 million investment in a trust preferred security as a result of the guarantor exercising its right to defer interest payments to the issuing trust in December 2009. In addition to the impairment charge, we have discontinued recognizing interest income on this investment until such time as the guarantor resumes interest payments to the trust.

The following table summarizes the carrying value of our investment securities on the dates indicated.

Table V.

Investment Securities (dollars in thousands)


	December 31,
	2010		2009		2008
U.S. Government agency bonds	$	53,518	$	98,312	$	32,479
State and municipal bonds		3,859		6,105		11,335
Mortgage-backed securities		48,223		29,833		61,889
Corporate securities		4,773		5,754		7,436

Total	$	110,373	$	140,004	$	113,139

The following tables summarize information regarding the scheduled maturities, amortized cost, and weighted average yields on a tax equivalent basis for our investment securities portfolio on December 31, 2010 and 2009.

Table VI.

Investment Securities (dollars in thousands)

At December 31, 2010:


	1 year or less					Over 1 to 5 years					Over 5 to 10 years					Over 10 years					Total Securities
	Amortized Cost		Average Yield			Amortized Cost		Average Yield			Amortized Cost		Average Yield			Amortized Cost		Average Yield			Amortized Cost		Average Yield
U.S. Government agency bonds	$	7,476		1.83	%	$	35,079		2.14	%	$	10,586		4.05	%	$	—		—	%	$	53,141		2.47	%
State and municipal bonds		251		3.42			3,249		3.57			196		3.88			—		—			3,696		3.58
Mortgage-backed securities		—		—			—		—			4,453		2.83			43,812		2.61			48,265		2.63
Corporate securities		1,496		8.48			940		7.79			1,000		4.03			1,359		7.25			4,795		7.07

Total investment securities	$	9,223		2.95	%	$	39,268		2.39	%	$	16,235		3.71	%	$	45,171		2.75	%	$	109,897		2.78	%

At December 31, 2009:


	1 year or less					Over 1 to 5 years					Over 5 to 10 years					Over 10 years					Total Securities
	Amortized Cost		Average Yield			Amortized Cost		Average Yield			Amortized Cost		Average Yield			Amortized Cost		Average Yield			Amortized Cost		Average Yield
U.S. Government agency bonds	$	26,997		1.56	%	$	55,391		2.30	%	$	13,179		3.34	%	$	3,050		4.35	%	$	98,617		2.30	%
State and municipal bonds		1,053		4.31			4,233		5.15			554		4.81			—		—			5,840		4.97
Mortgage-backed securities		133		2.51			525		3.72			3,587		3.99			25,002		4.25			29,247		4.20
Corporate securities		997		8.23			2,392		8.21			1,000		3.75			1,463		7.04			5,852		7.16

Total investment securities	$	29,180		1.89	%	$	62,541		2.73	%	$	18,320		3.53	%	$	29,515		4.40	%	$	139,556		3.01	%

Deposits. Our deposit service offerings include business and individual checking accounts, savings accounts, NOW accounts, certificates of deposit and money market checking accounts. On December 31, 2010, total deposits were $416.2 million compared with $493.9 million on December 31, 2009, a decrease of $77.7 million or 15.7%. This change was primarily the reduction of $121.4 million in our money market deposits during 2010 with an increase of $44.1 million in other customer time deposits.

The growth in money market deposits began in July 2008 when we offered a special money market rate that was guaranteed through June 30, 2009. Since the rate promotion expired we began to reduce the rates paid on money market deposits to levels more in-line with the markets we serve and at December 31, 2010 money market deposits totaled $103.1 million.

Brokered deposits have increased from $71.0 million at December 31, 2009 to $73.0 million at December 31, 2010, an increase of $2.0 million. On December 31, 2010, approximately 17.5% our total deposits were made up of brokered deposits as compared to 14.4% at December 31, 2009 and 7.3% as of December 31, 2008. On December 31, 2010, total time deposits issued in denominations of $100,000 or more made up approximately 35.4% of our total deposits as compared to 23.5% as of December 31, 2009 and 17.4% at December 31, 2008.

Retail deposits gathered through our branch network continue to be our principal source of funding. It is our intent to focus our efforts and marketing resources on the growth of our deposit base as we believe this to be the most effective long term strategy for profitable growth.

The following table summarizes our average deposits for the years ended December 31, 2010, 2009, and 2008.

Table VII.

Deposit Mix (dollars in thousands)


	For the Years ended December 31,
	2010					2009					2008
	Average Balance		Average Cost			Average Balance		Average Cost			Average Balance		Average Cost
Interest-bearing deposits:
Interest-checking deposits	$	34,157		0.61	%	$	32,172		1.13	%	$	25,801		1.11	%
Money market and savings deposits		153,820		0.66			266,108		2.62			113,220		3.26
Time deposits		205,979		1.85			169,825		2.67			267,649		4.35

Total interest-bearing deposits		393,956		1.28			468,105		2.54			406,670		3.84
Noninterest-bearing demand deposits		36,701					33,609					31,855

Total deposits	$	430,657		1.17	%	$	501,714		2.37	%	$	438,525		3.56	%

The following table contains an analysis of our time deposits of $100,000 or more December 31, 2010, 2009, and 2008.


	At December 31,
	2010		2009		2008
	(dollars in thousands)
Remaining maturity of three months or less	$	45,011	$	28,663	$	34,604
Remaining maturity of over three to twelve months		74,689		37,640		38,356
Remaining maturity of over twelve months		27,681		49,609		4,453

Total time deposits of $100,000 or more	$	147,381	$	115,912	$	77,413

Borrowed Funds. The following table summarizes our borrowings at December 31, 2010, 2009, and 2008.

Table VIII.

Borrowed Funds (dollars in thousands)


	At December 31,
	2010					2009					2008
	Outstanding Balance		Average Rate			Outstanding Balance		Average Rate			Outstanding Balance		Average Rate
Federal funds purchased and securities sold under overnight repurchase agreements	$	603		0.13	%	$	1,682		0.53	%	$	1,557		2.07	%
Securities sold under term repurchase agreements		45,000		4.38			45,000		4.38			45,000		4.38
Federal Home Loan Bank advances		22,000		1.92			15,000		3.15			25,000		3.80
Trust preferred securities		5,155		3.25			5,155		3.16			5,155		4.91
Subordinated debt		2,700		4.00			2,700		4.00			2,700		4.00

Total borrowed funds	$	75,458		3.78	%	$	69,537		3.92	%	$	79,412		4.17	%

The following table presents our average balances as well as the average cost associated with those balances for the specified periods.


	For the years ended December 31,
	2010					2009					2008
	Average Balance		Average Cost			Average Balance		Average Cost			Average Balance		Average Cost
Federal funds purchased and securities sold under overnight repurchase agreements	$	845		0.24	%	$	1,790		0.67	%	$	2,672		2.10	%
Securities sold under term repurchase agreements		45,000		4.38			45,000		4.40			19,413		4.39
Federal Home Loan Bank advances		22,373		1.68			21,433		3.65			28,223		3.83
Trust preferred securities		5,155		3.28			5,155		3.94			3,968		5.57
Subordinated debt		2,700		4.00			2,700		4.00			1,028		5.16

Total borrowed funds	$	76,073		3.45	%	$	76,078		4.06	%	$	55,304		4.10	%

During 2008, we entered into term repurchase agreements with two money center financial institutions. These two borrowing arrangements total $45.0 million in the aggregate and currently bear interest at an effective annual blended rate of 4.38%. These borrowings were secured by marketable securities totaling approximately $51.6 million at December 31, 2010. The agreements have final maturity dates in July 2018 and August 2015 but may be terminated by the lenders beginning July 2013 and August 2011, respectively.

On December 31, 2010, we had advances from the Federal Home Loan Bank (“FHLB”) totaling $22.0 million. These advances bear interest at the combined annual rate of 1.92% and are secured by eligible one-to-four family mortgages, commercial real estate loans and home equity loans with aggregate outstanding principal balances of approximately $43.0 million.

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 of which 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). The trust preferred securities bear interest at the annual rate of 90-day LIBOR plus 300 basis points adjusted quarterly. In February 2011, the Company announced its election to defer its regularly scheduled March 2011 interest payment on the junior subordinated debentures related to the trust preferred securities.

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

Capital Resources. Total stockholders’ equity decreased by $3.3 million to $41.7 million on December 31, 2010, compared to $45.0 million on December 31, 2009. The decrease was the substantially the net result of the current year’s net loss, net unrealized gains on securities available for sale, and the accrual of dividends on the preferred shares.

On April 17, 2009, the Company became a participant in the UST Capital Purchase Program by selling shares of Series A preferred stock to the UST having a liquidation value of $13.2 million. The preferred shares have a cumulative dividend rate of 5% per annum for the first five years and 9% per annum thereafter. As a part of the transaction, the Company also issued the UST warrants to purchase 475,204 shares of the Company’s common stock at $4.16 per share for a term of ten years.

Off-Balance Sheet Transactions. Certain financial transactions are entered into by the Company in the ordinary course of performing traditional banking services that result in off-balance sheet transactions. The off-balance sheet transactions as of December 31, 2010 and 2009 were commitments to extend credit and financial letters of credit. Except as disclosed in this report, the Company does not have any ownership interest in any off-balance sheet subsidiaries or special purpose entities.


	December 31,
	2010		2009
	(In thousands)
Loan commitments	$	34,328	$	24,176
Financial standby letters of credit		2,477		2,477

Total unused commitments	$	36,805	$	26,653

Commitments to extend credit to customers represent legally binding agreements with fixed expiration dates. Since many of these commitments expire without being funded, the commitment amounts do not necessarily represent liquidity requirements.

Contractual Obligations. The following disclosure shows the contractual obligations that the Company had outstanding at December 31, 2010.


	Total payments due by period
	Total		Less than 1 Year		1-3 Years		3-5 Years		More than 5 Years
	(in thousands)
Time deposits	$	233,512	$	177,102	$	54,340	$	2,070	$	—
Securities sold under term repurchase agreements (1)		45,000		—		—		—		45,000
Federal Home Loan Bank advances		22,000		2,000		20,000		—		—
Trust preferred securities		5,155		—		—		—		5,155
Subordinated debt		2,700		—		—		—		2,700
Leases		1,031		280		516		235		—

Total	$	309,398	$	179,382	$	74,856	$	1,579	$	52,855

(1)

Obligations in this category are classified as to maturity dates. One repurchase agreement, with a principal balance of $20 million, may be called by the holder on a quarterly basis beginning August 20, 2011. The other repurchase agreement included above, which has a principal balance of $25 million, may be called by the holder on a quarterly basis beginning July 8, 2013.

Comparison of Results of Operations for the Years Ended December 31, 2010, 2009, and 2008

Net Income (Loss). We had a net loss available to common shareholders of $3.6 million or $0.92 per share for the year ended December 31, 2010, compared to net loss of $3.8 million or $0.97 per share for the year ended December 31, 2009 and net loss for the year ended December 31, 2008 of $3.6 million, or $0.92 per diluted common share. As noted

earlier, the principal reason for the losses incurred during the past two years has been related to deterioration in our loan portfolio which has resulted in materially higher loan loss provisions and increased expenses related to the ownership and disposal of foreclosed real estate.

Net Interest Income. Our primary source of revenue is net interest income, which is the difference between interest income generated by our interest-earning assets (primarily loans and investment securities) and interest expense on interest-bearing liabilities (primarily deposits and borrowed funds). Net interest income increased $1.8 million to $16.4 million in 2010 from 2009 after increasing $2.0 million from 2008. Our net interest margin improved in 2010 to 3.26% compared to a margin in 2009 and 2008 of 2.56%. Our net interest spread improved to 3.15% in 2010 from 2.42% in 2009 and 2.29% in 2008. The volatility in our net interest margin and net interest spread and resulting net interest income over the past two years has been primarily due to the declines in short-term rates brought about by very aggressive Federal Reserve policies, slowing loan growth, and increased levels of nonperforming assets.

Table IX summarizes the average balances of our various categories of assets and liabilities and their associated yields or costs for the years ended on December 31, 2010, 2009, and 2008.

Table IX.

Summary of Net Interest Income and Average Balances (dollars in thousands)


	December 31, 2010							December 31, 2009							December 31, 2008
	Average Balance		Interest Income/ Expense		Yield/ Cost			Average Balance		Interest Income/ Expense		Yield/ Cost			Average Balance		Interest Income/ Expense		Yield/ Cost
Interest-earning assets:
Loans	$	373,156	$	20,723		5.55	%	$	401,512	$	23,685		5.90	%	$	405,951	$	26,276		6.47	%
Investment securities		118,826		3,318		2.79			149,061		5,860		3.93			80,916		4,091		5.06
Other interest-earning assets		12,600		53		0.42			22,445		76		0.34			9,441		208		2.20

Total interest-earning assets		504,582		24,094		4.78	%		573,018		29,621		5.17	%		496,308		30,575		6.16	%

Other assets, net		49,057							51,490							38,197

Total assets	$	553,639						$	624,508						$	534,505

Interest bearing liabilities:
Interest-checking deposits	$	34,157		210		0.61	%	$	32,172		365		1.13	%	$	25,801		287		1.11	%
Money Market and Savings deposits		153,821		1,015		0.66			266,108		6,973		2.62			113,220		3,687		3.26
Time deposits		205,979		3,811		1.85			169,825		4,530		2.67			267,649		11,645		4.35

Total interest-bearing deposits		393,957		5,036		1.28			468,105		11,868		2.54			406,670		15,619		3.84
Borrowed funds		76,073		2,624		3.45			76,078		3,087		4.06			55,304		2,265		4.10

Total Interest-bearing liabilities		470,030		7,660		1.63			544,183		14,955		2.75			461,974		17,884		3.87

Noninterest-bearing demand deposits		36,701							33,609							31,855
Other liabilities		1,294							1,739							1,535
Stockholders’ Equity		45,614							44,977							39,141

Total liabilities and stockholders’ equity	$	553,639						$	624,508						$	534,505

Net interest income & interest rate spread			$	16,434		3.15	%			$	14,666		2.42	%			$	12,691		2.29	%

Net yield on average interest-earning assets						3.26	%						2.56	%						2.56	%

Ratio of average interest-earning assets to average interest-bearing liabilities						107.35	%						105.30	%						107.43	%

Non accrual loans are included in the table for the years ended December 31, 2010, 2009, and 2008.

Loan fees and late charges of $208, $224, and $899 for 2010, 2009, and 2008, respectively, are included in interest income.

Table X summarizes the dollar amount of changes in interest income and interest expense for the major components of our interest-earning assets and interest-bearing liabilities during the twelve months ended December 31, 2010 and 2009. The table shows changes in interest income and expense attributable to volume changes and interest rate changes. The changes attributable to both rate and volume changes have been allocated between the two components on a relative basis. As the table indicates, the increase in net interest income realized during 2010 in comparison to 2009 was overwhelmingly the result of interest rate changes, as volume changes actually had a negative effect on the current year results. The table also indicates that rates reduced the cost of interest-bearing liabilities significantly more than they reduced the income from interest-earning assets, which is reflective of the effect of reducing the rates on our money market deposits.

Table X.

Volume / Rate Variance Analysis (dollars in thousands)


	Year Ended December 31, 2010 vs. 2009 Increase (Decrease) Due to									Year Ended December 31, 2009 vs. 2008 Increase (Decrease) Due to
	Volume			Rate			Total			Volume			Rate			Total
Interest-earning assets:
Loans	$	(1,680	)	$	(1,282	)	$	(2,962	)	$	(288	)	$	(2,303	)	$	(2,591	)
Investment securities		(1,258	)		(1,284	)		(2,542	)		2,800			(1,031	)		1,769
Other interest-earning assets		(30	)		7			(23	)		(47	)		(85	)		(132	)

Total interest income		(2,968	)		(2,559	)		(5,527	)		2,465			(3,419	)		(954	)

Interest-bearing liabilities:
Deposits		(2,028	)		(4,804	)		(6,832	)		2,238			(5,989	)		(3,751	)
Borrowed funds		(0	)		(463	)		(463	)		848			(26	)		822

Total interest expense		(2,028	)		(5,267	)		(7,295	)		3,086			(6,015	)		(2,929	)

Net interest income	$	(940	)	$	2,708		$	1,768		$	(621	)	$	2,596		$	1,975

Provision for Loan Losses. Provisions for loan losses are charged to income in order to maintain the allowance for loan losses at a level we deem appropriate under circumstances known to exist at the balance sheet date. In evaluating the allowance for loan losses, we consider factors that include portfolio size, composition and industry diversification of the portfolio, historical loan loss experience, current levels of impaired and delinquent loans, adverse situations that may affect a borrower’s ability to repay, estimated value of any underlying collateral, prevailing economic conditions and other relevant factors. The allowance for loan losses expressed as a percentage of total loans was 1.87%, 2.09%, and 1.56% at December 31, 2010, 2009, and 2008, respectively. The allowance includes $2.6 million at December 31, 2010 and $4.0 million at December 31, 2009 allocated to specific loans with principal balances totaling approximately $20.9 million and $11.3 million, respectively. See “Critical Accounting Policies”.

The provision for loan losses increased 16.1% to $6.4 million in 2010 from $5.5 million in 2009. The sizable provisions recorded in both 2010 and 2009 were the result of net charge-offs and nonperforming asset levels that were significantly above long-term historic trends on a relative basis.

Net loan charge-offs for 2010 totaled $7.7 million which equates to 2.08% of average loans for the year and a 110.0% increase from 2009 net charge-offs of $3.7 million which represented 0.92% of average loans outstanding for that year. For the five years prior to the current credit cycle (2004 – 2008), our net charge-offs averaged .37% of average loans on an annual basis.

Total nonperforming assets amounted to $33.0 at December 31, 2010, an increase of 89.2% from the year-end 2009 total of $17.4 million. Total nonperforming assets as a percent of loan-related assets (loans plus foreclosed real estate) amounted to 8.81% at December 31, 2010 compared to 4.37% as of year-end 2009. For the five year-ends preceding the current credit cycle, nonperforming assets averaged 1.83% of loan-related assets. Nonperforming assets as a percent of total assets was 6.17% of total assets at the end of 2010 compared to 2.86% at December 31, 2009. On a historic basis, nonperforming assets as a percent of total assets averaged 1.40% for the 2004 – 2008 year-ends.

Noninterest Income. In addition to net interest income, we derive revenues from providing a variety of financial services to our customers. Fees from providing these services totaled $1.3 million in 2010, $1.3 million in 2009 and $1.4 million in 2008. The largest component of customer service fees is revenues from deposit services which totaled $732,000 in 2010, $826,000 in 2009 and $889,000 in 2008. While this is a mature and very competitive part of our business, we believe this is an area of opportunity. The fastest growing area of fee revenue is from debit card services. While this is not a new service, it is still a relatively new part of the U.S. payment system. Our revenues in this area increased from $237,000 to $348,000 over the past two years. Fees from loan services, which primarily includes fees related to real estate loan production, declined 21.1% in 2010 as real estate lending slowed.

Other significant components of noninterest income are gains and losses on investment securities and increase in the cash value of life insurance policies we hold on our officer level employees. In 2010, we realized $344,000 in net gains on investment securities. This includes an other than temporary impairment charge of $105,000 on a $1 million investment in the trust preferred securities as a result of the guarantor exercising its right to defer interest payments to the issuing trust.

The following is a tabular presentation of our non-interest income for the years ended December 31, 2010, 2009, and 2008.

Table XI.

Noninterest Income (dollars in thousands)


	2010		2009		2008
Deposit services fees	$	732	$	826	$	889
Card services fees		348		290		237
Loan services fees		116		147		202
Investment services revenue		—		3		19
Other customer services fees		107		78		74

Total customer services fees		1,303		1,344		1,421
Net gain on investment securities		344		1,530		615
Increase in cash value of bank owned life insurance		361		364		362
All other income		29		59		36

Total noninterest income	$	2,037	$	3,297	$	2,434

Non-interest Expense. Non-interest expense totaled $16.3 million for the year ended December 31, 2010, a decrease of $1.2 million, or 6.7% below the $17.5 million reported for the year ended December 31, 2008, which was a $2.4 million increase, or 16.0%, from the 2008 amount. The major factors contributing to the decrease in noninterest expenses in 2010 compared to 2009 were (1) a decrease of $530,000, or 35.2%, in FDIC insurance cost, as the result decreased deposits, (2) a decrease of $221,000, or 21.2%, in data processing expense resulting from a systems conversion, (3) a decrease of $128,000, or 10.7%, in professional service expenditures, primarily the result of bringing in-house certain credit administration functions netted with increased legal fees, (4) a decrease of $81,000, or 1.2%, in salaries and benefits, and (5) a decrease of $88,000, or 27.8%, in advertising costs.

The following table summarizes the major components of our non-interest expense for the years ended December 31, 2010, 2009, and 2008.

Table XII.

Noninterest Expenses (dollars in thousands)


	2010		2009		2008
Salaries and benefits	$	6,959	$	7,040	$	7,054
Occupancy and equipment expenses		2,238		2,221		2,020
FDIC insurance assessments		975		1,505		328
Data processing		821		1,042		843
Professional services		1,066		1,194		465
Telephone and data communications		352		341		338
Advertising and promotional		228		316		443
Postage and courier		230		264		206
Printing and supplies		177		241		211
Valuation allowances and net operating costs associated with foreclosed real estate		1,829		1,899		1,117
Goodwill impairment		—		—		591
All other expenses		1,473		1,451		1,476

Total noninterest expenses	$	16,348	$	17,514	$	15,092

Income Taxes. We recorded income tax benefits of $1.7 million in 2010, $2.0 million in 2009, and $2.6 million in 2008. The 2010 income tax benefit amounted to 38.5% of our pretax loss as compared to 38.6% of pre-tax loss for 2009 and 42.1% of pre-tax income for 2008.

Capital Adequacy

We are required to comply with the capital adequacy standards established by the Federal Deposit Insurance Corporation (FDIC). The FDIC has issued risk-based capital and leverage capital guidelines for measuring the adequacy of a bank’s capital, and all applicable capital standards must be satisfied for us to be considered in compliance with the FDIC’s requirements. On December 31, 2010, our Total Capital Ratio and Tier 1 Capital Ratio were 11.51% and 9.63%, respectively, both well above the minimum levels required by the FDIC’s guidelines. On December 31, 2010 our Tier 1 Leverage Capital Ratio was 7.79%, which was also well above the minimum level required by the FDIC’s guidelines. However, the Company and the Bank’s Board of Directors have entered into informal agreements with our respective banking regulators which are described in Note 10 to our audited financial statements included in Item 8 of this Report.

Among other things, the agreements require that the Bank maintain capital levels in excess of normal statutory minimums, including a Tier 1 Leverage Capital Ratio of not less than 7.50%, and other ratios at least at “well capitalized” levels. At December 31, 2010, the Bank’s Tier1 Leverage Capital Ratio was 8.17%, above the agreed to minimum.

Liquidity and Interest Rate Sensitivity

Liquidity. Liquidity management is the process of managing assets and liabilities as well as their maturities to ensure adequate funding for loan and deposit activity 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 is the sum of cash and cash items, less required reserves on demand and NOW 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 is equal to total liabilities less required cash reserves on noninterest-bearing demand deposits and interest-checking deposits and 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 December 31, 2010 our balance sheet liquidity ratio (net liquid assets as a percent of unsecured liabilities) amounted to 16.2% and our total liquidity ratio (balance sheet plus off-balance sheet liquidity) was 18.4%.

In addition, we have the ability to borrow $10.0 million from the Discount Window of the Federal Reserve, as well as $14.0 million from correspondent banks, subject to our pledge of marketable securities, and an unsecured $5.0 million with another correspondent bank, 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 $22.0 million at December 31, 2010, are secured by various types of real estate-secured loans. The Company closely monitors and evaluates its overall liquidity position. The Company believes its liquidity position at December 31, 2010 is adequate to meet its operating needs.

Interest Rate Sensitivity. Our goal is to maintain a neutral interest rate sensitivity position whereby little or no change in interest income would occur as interest rates change. On December 31, 2010, we were cumulatively liability sensitive for the next twelve months, which means that our interest-bearing liabilities would reprice more quickly than our interest bearing assets. Theoretically, our net interest margin will decrease if market interest rates rise or increase if market interest rates fall. However, the repricing characteristic of assets is different from the repricing characteristics of funding sources. Therefore, net interest income can be impacted by changes in interest rates even if the repricing opportunities of assets and liabilities are perfectly matched.

The following table shows the interest rate sensitivity of our balance sheet on December 31, 2010, but is not necessarily indicative of our position on other dates. Each category of assets and liabilities is shown with projected repricing and maturity dates. Except as stated below, the amounts of assets and liabilities shown which reprice or mature within a particular period were determined in accordance with the contractual terms of the assets or liabilities. Loans with adjustable rates are shown as being due at the end of the next upcoming adjustment period. NOW accounts, savings accounts, and money market accounts are assumed to be subject to immediate repricing and depositor availability. Prepayment assumptions on mortgage loans and decay rates on deposit accounts have not been included in this analysis. Also, the table does not reflect scheduled principal repayments that will be received on loans. The interest rate sensitivity of our assets and liabilities may vary substantially if different assumptions are used or if our actual experience differs from that indicated by the assumptions.

Table XIII.

Interest Sensitivity (dollars in thousands)


	December 31, 2010
	1-3 months			Over 3 to 12 months			Over 12 to 60 months			Over 60 months			Total
Interest-earning assets:
Loans	$	197,122		$	31,510		$	99,556		$	37,965		$	366,153
Investment securities		11,468			19,139			63,093			16,673			110,373
Other interest-earning assets		11,549			4,043			—			—			15,592

Total interest-earning assets	$	220,139		$	54,692		$	162,649		$	54,638		$	492,118

Interest-bearing liabilities:
Interest-checking deposits	$	34,004		$	—		$	—		$	—		$	34,004
Money market and savings deposits		114,923			—			—			—			114,923
Time deposits		60,076			117,026			56,410			—			233,512
Borrowed funds		10,458			10,000			35,000			20,000			75,458

Total interest-bearing liabilities	$	219,461		$	127,026		$	91,410		$	20,000		$	457,897

Interest-sensitivity gap	$	678		$	(72,334	)	$	71,239		$	34,638		$	34,221

Cumulative sensitivity gap	$	678		$	(71,656	)	$	(417	)	$	34,221		$	34,221

Cumulative gap as a % of total interest-earning assets		0.14	%		(14.56	)%		(0.08	)%		6.95	%		6.95	%

Cumulative ratio of sensitive assets to sensitive liabilities		100.31	%		43.06	%		177.93	%		273.19	%		107.47	%

Quarterly financial data for 2010 and 2009 is summarized in the table below.

Table XIV.

Quarterly Financial Data (dollars in thousands except per share amounts)


	2010												2009
	4th Qtr			3rd Qtr.			2nd Qtr.			1st Qtr.			4th Qtr			3rd Qtr.			2nd Qtr.			1st Qtr.
Interest income	$	5,633		$	5,936		$	6,191		$	6,334		$	7,122		$	7,529		$	7,433		$	7,537
Interest expense		1,824			1,822			1,893			2,121			2,748			3,433			4,421			4,353

Net interest income		3,809			4,114			4,298			4,213			4,374			4,096			3,012			3,184
Provision for loan losses		3,581			858			1,086			916			3,081			1,046			720			700

Net interest income after provision for loan losses		228			3,256			3,212			3,297			1,293			3,050			2,292			2,484
Noninterest income		433			589			512			503			634			1,715			610			338
Noninterest expense		4,238			3,794			4,081			4,235			4,697			3,846			5,179			3,792

Income (loss) before income taxes		(3,577	)		51			(357	)		(435	)		(2,770	)		919			(2,277	)		(970	)
Income taxes (benefit)		(1,263	)		(31	)		(169	)		(200	)		(992	)		137			(798	)		(315	)

Net income (loss)		(2,314	)		82			(188	)		(235	)		(1,778	)		782			(1,479	)		(655	)
Dividends and accretion on preferred stock		(231	)		(229	)		(227	)		(227	)		(226	)		(312	)		(99	)		—

Net income (loss) available to common shareholders	$	(2,545	)	$	(147	)	$	(415	)	$	(462	)	$	(2,004	)	$	470		$	(1,578	)	$	(655	)

Earnings (loss) per common share:
Basic	$	(0.65	)	$	(0.04	)	$	(0.11	)	$	(0.12	)	$	(0.51	)	$	0.12		$	(0.41	)	$	(0.17	)
Diluted	$	(0.65	)	$	(0.04	)	$	(0.11	)	$	(0.12	)	$	(0.51	)	$	0.12		$	(0.41	)	$	(0.17	)

Effects of Inflation and Changing Prices

A commercial bank has an asset and liability structure that is distinctly different from that of a company with substantial investments in plant and inventory because the major portion of its assets is monetary in nature. As a result, a bank’s performance may be significantly influenced by changes in interest rates. Although the banking industry is more affected by changes in interest rates than by inflation in the price of goods and services, inflation also is a factor that may influence interest rates. Yet, the frequency and magnitude of interest rate fluctuations do not necessarily coincide with changes in the general inflation rate. Inflation does affect our operating expense in that personnel expense and the cost of supplies and outside services tend to increase more during periods of high inflation.

DISCLOSURES ABOUT FORWARD LOOKING STATEMENTS

This Report and its exhibits may contain statements relating to our financial condition, results of operations, plans, strategies, trends, projections of results of specific activities or investments, expectations or beliefs about future events or results, and other statements that are not descriptions of historical facts. Those statements may be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements may be identified by terms such as “may,” “will,” “should,” “could,” “expects,” “plans,” “intends,” “anticipates,” “believes,” “estimates,” “predicts,” “forecasts,” “potential” or “continue,” or similar terms or the negative of these terms, or other statements concerning opinions or judgments of the Company’s management about future events. Forward-looking information is inherently subject to risks and uncertainties, and actual results could differ materially from those currently anticipated due to a number of factors, which include, but are not limited to, risk factors discussed in the Company’s Annual Report on Form 10-K and in other documents the Company files with the Securities and Exchange Commission from time to time. Copies of those reports are available directly through the Commission’s website at www.sec.gov. Other factors that could influence the accuracy of forward-looking statements include, but are not limited to, (a) pressures on the earnings, capital and liquidity of financial institutions resulting from current and future adverse conditions in the credit and equity markets

and the banking industry in general; (b) changes in competitive pressures among depository and other financial institutions or in the Company’s ability to compete successfully against the larger financial institutions in its banking markets; (c) the financial success or changing strategies of the Company’s customers; (d) actions of government regulators, or changes in laws, regulations or accounting standards, that adversely affect the Company’s business; (e) changes in the interest rate environment and the level of market interest rates that reduce the Company’s net interest margins and/or the volumes and values of loans it makes and securities it holds; (f) changes in general economic or business conditions and real estate values in the Company’s banking markets (particularly changes that affect the Company’s loan portfolio, the abilities of its borrowers to repay their loans, and the values of loan collateral); and (g) other unexpected developments or changes in the Company’s business. Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, it cannot guarantee future results, levels of activity, performance or achievements. All forward-looking statements attributable to the Company are expressly qualified in their entirety by the cautionary statements in this paragraph. The Company has no obligation, and does not intend, to update these forward-looking statements.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

Not applicable

Item 8. Financial Statements and Supplementary Data.

Bank of the Carolinas

Report of Independent Registered Public Accounting Firm

To the Board of Directors and

Stockholders of Bank of the Carolinas Corporation

We have audited the accompanying consolidated balance sheets of Bank of the Carolinas Corporation and Subsidiary (hereinafter referred to as the “Company”) as of December 31, 2010 and 2009, and the related consolidated statements of operations, changes in stockholders’ equity and cash flows for the years ended December 31, 2010 and 2009. Bank of the Carolinas Corporation and Subsidiary’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. The consolidated financial statements of Bank of the Carolinas Corporation and Subsidiary for the year ended December 31, 2008 were audited by other auditors whose report dated April 15, 2009 expressed an unqualified opinion on those statements.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Bank of the Carolinas Corporation and Subsidiary as of December 31, 2010 and 2009, and the results of its operations and cash flows for the years ended December 31, 2010 and 2009 in conformity with accounting principles generally accepted in the United States of America.

/s/ Turlington and Company, LLP

Lexington, North Carolina

March 30, 2011

Bank of the Carolinas

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders

Bank of the Carolinas Corporation

Mocksville, North Carolina

We have audited the accompanying consolidated statements of operations, changes in stockholders’ equity and cash flows of Bank of the Carolinas Corporation and subsidiary (hereinafter referred to as the “Company”) for the year ended December 31, 2008. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations, changes in stockholders’ equity and cash flows of Bank of the Carolinas Corporation and subsidiary for the year ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America.

/s/ Dixon Hughes PLLC

Asheville, North Carolina

April 15, 2009

Bank of the Carolinas Corporation

Consolidated Balance Sheets

December 31, 2010 and 2009

(In thousands except share and per share data)


	2010			2009
Assets:
Cash and due from banks, noninterest-bearing	$	4,303		$	3,524
Interest-bearing deposits in banks		6,262			9,020

Cash and cash equivalents		10,565			12,544
Federal funds sold		9,330			24,815
Investment securities		110,373			140,004
Loans receivable		366,153			391,265
Less: Allowance for loan losses		(6,863	)		(8,167	)

Total loans, net		359,290			383,098
Premises and equipment, net		13,106			14,010
Other real estate owned		8,314			8,233
Bank owned life insurance		10,371			10,010
Deferred tax assets		5,123			3,429
Prepaid FDIC insurance assessment		3,670			4,569
Accrued interest receivable		1,814			2,397
Other assets		3,014			7,278

Total Assets	$	534,970		$	610,387

Liabilities:
Deposits:
Noninterest-bearing demand deposits	$	33,730		$	36,418
Interest-checking deposits		34,004			34,614
Money market and savings deposits		114,923			235,541
Time deposits		233,512			187,344

Total deposits		416,169			493,917
Securities sold under repurchase agreements		45,603			46,682
Federal Home Loan Bank advances		22,000			15,000
Subordinated debt		7,855			7,855
Other liabilities		1,639			1,941

Total Liabilities		493,266			565,395

Commitments and contingencies (Notes 4, 12, and 13)		—			—

Stockholders’ Equity:
Preferred stock, no par value		13,179			13,179
Discount on preferred stock		(991	)		(1,245	)
Common stock, $5 par value per share		19,486			19,486
Additional paid-in capital		12,988			12,978
Retained earnings (deficit)		(3,268	)		300
Accumulated other comprehensive income		310			294

Total Stockholders’ Equity		41,704			44,992

Total Liabilities and Stockholders’ Equity	$	534,970		$	610,387

Preferred shares authorized		3,000,000			3,000,000
Preferred shares issued and outstanding		13,179			13,179
Common shares authorized		15,000,000			15,000,000
Common shares issued and outstanding		3,897,174			3,897,174

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

Bank of the Carolinas Corporation

Consolidated Statements of Operations

For the Years Ended December 31, 2010, 2009, and 2008

(In thousands except per share data)


	2010			2009			2008
Interest and dividend income:
Loans, including fees	$	20,723		$	23,685		$	26,276
Investment securities		3,318			5,860			4,091
Other		53			76			208

Total interest income		24,094			29,621			30,575

Interest expense:
Deposits		5,036			11,868			15,619
Other borrowings		2,624			3,087			2,265

Total interest expense		7,660			14,955			17,884

Net interest income		16,434			14,666			12,691
Provision for loan losses		6,441			5,547			6,291

Net interest income after provision for loan losses		9,993			9,119			6,400

Non-interest income:
Customer service fees		1,303			1,344			1,421
Increase in bank owned life insurance		361			364			362
Gain on sale of securities (net)		344			1,530			615
Other		29			59			36

Total non-interest income		2,037			3,297			2,434

Noninterest expense:
Salaries and employee benefits		6,959			7,040			7,054
Net occupancy expense		2,238			2,221			2,020
FDIC insurance assessments		975			1,505			328
Data processing		821			1,042			843
Professional services		1,066			1,194			465
Advertising		228			316			443
Goodwill impairment		—			—			591
Valuation allowances and net operating costs associated with foreclosed real estate		1,829			1,899			1,117
Other		2,232			2,297			2,231

Total non-interest expense		16,348			17,514			15,092

Loss before income taxes		(4,318	)		(5,098	)		(6,258	)
Income tax benefit		(1,663	)		(1,968	)		(2,634	)

Net loss		(2,655	)		(3,130	)		(3,624	)
Preferred stock dividends and accretion		(914	)		(637	)		—

Net loss available to common stockholders	$	(3,569	)	$	(3,767	)	$	(3,624	)

Net loss per common share
Basic	$	(0.92	)	$	(0.97	)	$	(0.92	)

Diluted	$	(0.92	)	$	(0.97	)	$	(0.92	)

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

Bank of the Carolinas Corporation

Consolidated Statements of Changes in Stockholders’ Equity

For the Years Ended December 31, 2010, 2009, and 2008

(In thousands except share and per share data)


	Preferred Stock				Discount on Preferred			Common Stock						Additional Paid-In Capital			Retained Earnings (Deficit)			Accumulated Other Comprehensive Income			Total Stockholders’ Equity
	Shares		Amount		Discount on Preferred			Shares			Amount			Additional Paid-In Capital			Retained Earnings (Deficit)			Accumulated Other Comprehensive Income			Total Stockholders’ Equity
Balance, December 31, 2007		—	$	—	$	—			3,920,752		$	19,604		$	11,716		$	8,476		$	444		$	40,240
Stock options exercised		—		—		—			66,622			333			91			—			—			424
Stock repurchase		—		—		—			(96,200	)		(481	)		(241	)		—			—			(722	)
Current income tax benefit on options exercised		—		—		—			—			—			10			—			—			10
Stock based compensation expense		—		—		—			—			—			49			—			—			49
Cash dividends declared ($.20 per share)		—		—		—			—			—			—			(785	)		—			(785	)
Comprehensive loss:
Net loss		—		—		—			—			—			—			(3,624	)		—			(3,624	)
Other comprehensive income		—		—		—			—			—			—			—			999			999

Total comprehensive loss																								(2,625	)

Balance, December 31, 2008		—		—		—			3,891,174			19,456			11,625			4,067			1,443			36,591
Issuance of restricted stock		—		—		—			6,000			30			(30	)		—			—			—
Restricted stock expense		—		—		—			—			—			6			—			—			6
Issuance of preferred & warrants		13,179		13,179		(1,414	)		—			—			1,414			—			—			13,179
Cost of issuing preferred & warrants		—		—		—			—			—			(46	)		—			—			(46	)
Stock based compensation expense		—		—		—			—			—			9			—			—			9
Cash dividends on common		—		—		—			—			—			—			—			—			—
Cash dividends on preferred		—		—		—			—			—			—			(468	)		—			(468	)
Accretion of discount on preferred		—		—		169			—			—			—			(169	)		—			—
Comprehensive loss:
Net loss		—		—		—			—			—			—			(3,130	)		—			(3,130	)
Other comprehensive loss		—		—		—			—			—			—			—			(1,149	)		(1,149	)

Total comprehensive loss																								(4,279	)

Balance, December 31, 2009		13,179		13,179		(1,245	)		3,897,174			19,486			12,978			300			294			44,992
Restricted stock expense		—		—		—			—			—			8			—			—			8
Stock based compensation expense		—		—		—			—			—			2			—			—			2
Cash dividends on common		—		—		—			—			—			—			—			—			—
Cash dividends on preferred		—		—		—			—			—			—			(659	)		—			(659	)
Accretion of discount on preferred		—		—		254			—			—			—			(254	)		—			—
Comprehensive loss:
Net loss		—		—		—			—			—			—			(2,655	)		—			(2,655	)
Other comprehensive income		—		—		—			—			—			—			—			16			16

Total comprehensive loss																								(2,639	)

Balance, December 31, 2010		13,179	$	13,179	$	(991	)		3,897,174		$	19,486		$	12,988		$	(3,268	)	$	310		$	41,704

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

Bank of the Carolinas Corporation

Consolidated Statements of Cash Flows

For the Years Ended December 31, 2010, 2009, and 2008

(In thousands)


	2010			2009			2008
Cash flows from operating activities:
Net loss	$	(2,655	)	$	(3,130	)	$	(3,624	)
Adjustments to reconcile net loss to net cash provided (used) by operating activities:
Depreciation and amortization		1,063			1,081			962
Deferred tax benefit		(1,681	)		(1,346	)		(1,381	)
Provision for loan losses		6,441			5,547			6,291
Amortization of premiums on securities, net		537			214			28
Stock based compensation expense		2			9			49
Restricted stock expense		8			6			—
Increase in bank owned life insurance		(361	)		(364	)		(362	)
Loss on sale of other real estate owned		155			99			190
Impairment valuation of other real estate owned		1,294			1,483			821
Loss (gain) on sale of premises and equipment		(15	)		(24	)		38
Gain on sale of securities		(450	)		(2,028	)		(615	)
Impairment valuation of securities		105			498			—
Net changes in:
Accrued interest receivable		583			642			200
Other assets		5,263			(7,496	)		(511	)
Deferred loan costs, net		—			—			(96	)
Accrued expenses and other liabilities		(301	)		390			(573	)

Net cash provided (used) by operating activities		9,988			(4,419	)		1,417

Cash flows from investing activities:
Net change in federal funds sold		15,485			(24,815	)		—
Activity in available for sale securities:
Purchases		(116,494	)		(199,579	)		(100,960	)
Proceeds from sale		45,994			116,735			25,797
Maturities and calls of securities		99,967			57,293			24,959
Net loan originations and principal payments		13,187			4,027			(21,398	)
Redemption (purchase) of FHLB stock		(126	)		(58	)		222
Purchase of premises and equipment		(172	)		(600	)		(2,192	)
Proceeds from sale of premises and equipment		28			45			9
Additions to other real estate owned		—			(74	)		(60	)
Proceeds from sale of other real estate owned		2,650			1,244			2,455

Net cash provided (used) by investing activities		60,519			(45,782	)		(71,168	)

(continued)

Bank of the Carolinas Corporation

Consolidated Statements of Cash Flows, Continued

For the Years Ended December 31, 2010, 2009, and 2008

(In thousands)


	2010			2009			2008
Cash flows from financing activities:
Net increase (decrease) in deposits	$	(77,748	)	$	49,377		$	22,612
Net proceeds from (repayments of) FHLB advances		7,000			(10,000	)		(9,000	)
Issuance of subordinated debt		—			—			2,700
Issuance of preferred stock		—			13,133			—
Issuance of trust preferred securities		—			—			5,155
Net change in federal funds purchased		—			—			(7,513	)
Net change in retail repurchase agreements		(1,079	)		125			1,413
Net change in term repurchase agreements		—			—			45,000
Excess tax benefit from stock based compensation		—			—			10
Proceeds from issuance of common stock		—			—			424
Stock repurchase		—			—			(722	)
Cash dividends paid on preferred stock		(659	)		(381	)		—
Cash dividends paid on common stock		—			—			(785	)

Net cash provided (used) by financing activities		(72,486	)		52,254			59,294

Net increase (decrease) in cash and cash equivalents		(1,979	)		2,053			(10,457	)
Cash and cash equivalents at beginning of year		12,544			10,491			20,948

Cash and cash equivalents at end of year	$	10,565		$	12,544		$	10,491

Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest	$	7,718		$	15,076		$	18,527

Income taxes paid	$	—		$	—		$	—

Non-cash investing and financing activities:
Unrealized gains (losses) on securities available for sale, net of income tax effect	$	16		$	(1,149	)	$	999
Transfer of other real estate owned from loans receivable		4,180			4,674			7,178
Dividends declared, not paid		88			87			195

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

Bank of the Carolinas Corporation

Notes to Consolidated Financial Statements

December 31, 2010, 2009, and 2008

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

1. Summary of Significant Accounting Policies

Organization—Bank of the Carolinas Corporation (“the Company”) is a North Carolina-chartered bank holding company that was incorporated on May 30, 2006, for the sole purpose of serving as the parent bank holding company for Bank of the Carolinas (“the Bank”). The Bank is a FDIC-insured, North Carolina-chartered bank that began operations on December 7, 1998.

Because the Company has no significant operations and conducts no business on its own other than owning the Bank, the discussion contained in these footnotes concerns primarily the business of the Bank. However, for ease of reading and because the financial statements are presented on a consolidated basis, the Company and its subsidiary are collectively referred to herein as the Company unless otherwise noted.

The accounting and reporting policies of the Company follow accounting principles generally accepted in the United States of America and general practices within the banking industry. The following is a summary of the more significant accounting policies.

Business—The Company provides a variety of financial services to individuals and small businesses through its retail offices. Its primary deposit products are demand deposits and time certificate accounts and its primary lending products are consumer, commercial, and mortgage loans. The Company does not have significant concentrations to any one industry or customer.

Use of Estimates—The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses.

Cash and Cash Equivalents—The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Cash and cash equivalents are defined as those amounts included in the balance sheet captions “cash and due from banks” and “interest-bearing deposits in banks.”

Investment Securities—Securities available for sale are carried at fair value and held to maturity securities are carried at amortized cost. The unrealized holding gains or losses on securities available for sale are reported, net of related income tax effects, as accumulated other comprehensive income unless a valuation reserve has been established. Changes in unrealized holding gains or losses are included as a component of other comprehensive income until realized. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in income as realized losses. Gains or losses on sales of securities available for sale are based on the specific identification method.

Loans Receivable—The Company grants mortgage, commercial and consumer loans to customers. A substantial portion of the loan portfolio is invested within the central North Carolina region. The ability of the Company’s debtors to honor their contracts is dependent upon the real estate and general economic conditions in this area.

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for the allowance for loan losses, loans in process, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan using the interest method.

Bank of the Carolinas Corporation

Notes to Consolidated Financial Statements, Continued

The accrual of interest on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the loan is well secured and in process of collection. All interest accrued, but not collected, for loans that are placed on non-accrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Allowance for Loan Losses—The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to income. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.

A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures.

Premises and Equipment—Land is carried at cost. Buildings, leasehold improvements and equipment are stated at cost less accumulated depreciation. Depreciation is computed on the straight-line method over the lesser of estimated useful lives of the assets or lease terms ranging from 3 to 40 years. The cost of maintenance and repairs are charged to expense as incurred while expenditures that materially increase the useful lives of property are capitalized.

Federal Home Loan Bank Stock—Investment in stock of the Federal Home Loan Bank is required by law of every member. The investment is carried at cost since redemptions of this stock have historically been at par. No ready market exists for the stock, and it has no quoted market value. The stock is presented in other assets. Due to the redemption provisions of the FHLB, the Bank estimates carrying value equals fair value and that it was not impaired at December 31, 2010. The stock had a carrying value of $2.1 million and $2.2 million at December 31, 2010 and 2009, respectively.

Other Real Estate Owned—Assets acquired through, or in lieu of, loan foreclosure are held for sale and initially recorded at the lower of the loan balance or the fair value less costs to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management, and the assets are carried at the lower of carrying amount or fair value. Expenses associated with maintaining these properties, are included in other non-interest expense. The provision for real estate losses is included in non-interest expense. Realized gains and losses on disposal of real estate are included in non-interest expense. Foreclosed assets are presented in other real estate owned. As of December 31, 2010, the Company held a variety of properties in other real estate owned, including 1-4 family residential real estate, commercial and one A&D property. These properties are generally held within the Company’s market area.

Bank of the Carolinas Corporation

Notes to Consolidated Financial Statements, Continued

Goodwill—Goodwill is recognized in business combinations to the extent that the price paid exceeds the fair value of the net assets acquired, including any identifiable intangible assets. Goodwill is not amortized, but is subject to fair value impairment tests on at least an annual basis. As of December 31, 2010, the Company has no goodwill on its balance sheet.

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.

The Company’s policy is to report interest and penalties, if any, in tax expense in the Consolidated Statements of Operations. The Company and its subsidiary each reflect the tax expense or benefit associated with the results of their individual operating results. During 2010, the Internal Revenue Service performed an audit of the Company’s federal tax returns for the years end 2008 and 2009. Their audit was triggered by the amount of refund received when the Company filed NOL carrybacks to tax years 2006 and 2007 of the tax losses incurred for the years ended December 31, 2008 and 2009. These carrybacks resulted in federal refunds of $1,335,390 and $727,906, respectively. The IRS concluded their audit as of February 23, 2011 with the Company paying income tax of $209,922 for the tax year 2006 and $52,259 in alternative minimum tax for tax year 2007. Due to the audits of 2008 and 2009, only the Company’s 2010 federal and state income tax returns are open and subject to examination.

Earnings Per Share—Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options and warrants, and are determined using the treasury stock method.

Losses per share have been computed based on the following:


	Years Ended December 31,
	2010			2009			2008
	(in thousands except for share data)
Net loss applicable to common stock	$	(3,569	)	$	(3,767	)	$	(3,624	)

Average number of common shares outstanding used to calculate basic earnings per share		3,897,174			3,894,314			3,928,911
Additional potential common shares due to stock options and warrants		—			—			—

Average number of common shares outstanding used to calculate diluted earnings per share		3,897,174			3,894,314			3,928,911

The Company had 508,605, 38,538, and 11,577 shares that were considered anti-dilutive due to the net losses for the twelve month periods ended December 31, 2010, 2009, and 2008, respectively.

Stock Compensation Plans—The Company under generally accepted accounting principles accounts for stock option expense using the modified prospective method. The Company records expense as options are issued.

Bank of the Carolinas Corporation

Notes to Consolidated Financial Statements, Continued

Advertising Expense—The Company’s policy is to expense advertising cost as incurred.

Comprehensive Income (Loss)—Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section in the balance sheet, such items, along with net income, are components of comprehensive income.

The components of other comprehensive income (loss) and related tax effects are as follows:


	Years Ended December 31,
	2010			2009			2008
	(dollars in thousands)
Unrealized holding gains (losses) on available-for-sale securities	$	371		$	(377	)	$	2,243
Reclassification adjustment for gains realized in net income		(344	)		(1,530	)		(615	)

Net unrealized gains (losses)		27			(1,907	)		1,628
Tax effect		(11	)		758			(629	)

Other comprehensive income (loss) net of tax	$	16		$	(1,149	)	$	999

Reclassifications—In certain instances, amounts reported in prior years’ consolidated financial statements have been reclassified to conform to the current presentation. Such reclassifications had no effect on previously reported cash flows, stockholders’ equity or net loss.

New Accounting Pronouncements—In June 2009, the FASB issued SFAS No. 166, Accounting for Transfers of Financial Assets—an amendment of FASB Statement No. 140, which was subsequently codified by the FASB under ASC Topic 860 (“Topic 860”). Topic 860 seeks to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. Specifically, Topic 860 eliminates the concept of a qualifying special-purpose entity, creates more stringent conditions for reporting a transfer of a portion of a financial asset as a sale, clarifies other sale-accounting criteria, and changes the initial measurement of a transferor’s interest in transferred financial assets. SFAS No. 166 as codified under ASC Topic 860 is effective for financial asset transfers occurring after the beginning of fiscal years beginning after November 15, 2009. The Company adopted this statement with no material impact on its consolidated financial statements.

In June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R), which was subsequently codified by the FASB as ASC Topic 810 (“Topic 810-10”). Topic 810 amends FASB Interpretation No. 46(R), Variable Interest Entities, for determining whether an entity is a variable interest entity (“VIE”) and requires an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a VIE. Under Topic 810, an enterprise has a controlling financial interest when it has (a) the power to direct the activities of a VIE that most significantly impact the entity’s economic performance, and (b) the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the VIE. Topic 810 also requires an enterprise to assess whether it has an implicit financial responsibility to ensure that a VIE operates as designed when determining whether it has power to direct the activities of the VIE that most significantly impact the entity’s economic performance. Topic 810 also requires ongoing assessments of whether an enterprise is the primary beneficiary of a VIE, requires enhanced disclosures and eliminates the scope exclusion for qualifying special-purpose entities. SFAS No. 167 as codified under ASC Topic 810 is effective as of the beginning of fiscal years beginning after November 15, 2009 and is applied using a cumulative effect adjustment to retained earnings for any carrying amount adjustments. The Company adopted this statement with no material impact on its consolidated financial statements.

Bank of the Carolinas Corporation

Notes to Consolidated Financial Statements, Continued

In January 2010, the FASB issued Accounting Standards Update No. 2010-06, Fair Value Measurements Disclosures, which amends Subtopic 820-10 of the FASB Accounting Standards Codification to require new disclosures for fair value measurements and provides clarification for existing disclosures requirements. More specifically, this update will require (a) an entity to disclose separately the amounts of significant transfers in and out of Levels 1 and 2 fair value measurements and to describe the reasons for the transfers; and (b) information about purchases, sales, issuances and settlements to be presented separately (i.e. present the activity on a gross basis rather than net) in the reconciliation for fair value measurements using significant unobservable inputs (Level 3 inputs). This update clarifies existing disclosure requirements for the level of disaggregation used for classes of assets and liabilities measured at fair value and requires disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements using Level 2 and Level 3 inputs. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The Company does not anticipate that the adoption of this statement will materially expand its consolidated financial statement footnote disclosures.

In March 2010, the FASB issued new guidance impacting Receivables. The new guidance clarifies that a modification to a loan that is part of a pool of loans that were acquired with deteriorated credit quality should not result in the removal of the loan from the pool. This guidance is effective for any modifications of loans accounted for within a pool in the first interim or annual reporting period ending after July 15, 2010. The adoption of this guidance was not material to the Company’s consolidated financial statements.

In July 2010, the FASB issued new guidance impacting Receivables. The new guidance requires additional disclosures that will allow users to understand the nature of credit risk inherent in a company’s loan portfolios, how that risk is analyzed and assessed in arriving at the allowance for loan and lease losses, and changes and reasons for those changes in the allowance for loan and lease losses. The new disclosures that relate to information as of the end of the reporting period are required as of December 31, 2010. The disclosures related to activity that occurs during a reporting period are effective for reporting periods beginning on or after December 15, 2010, except for the disclosure requirements relating to troubled debt restructurings, which have been indefinitely delayed pending the outcome of the FASB’s deliberations related to the definition of a troubled debt restructuring.

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.

Bank of the Carolinas Corporation

Notes to Consolidated Financial Statements, Continued

2. Investment Securities

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


	December 31, 2010
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value		Carrying Value
Investment securities available for sale:
U.S. Government agency securities	$	53,141	$	746	$	369	$	53,518	$	53,518
State and municipal securities		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


	December 31, 2009
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value		Carrying Value
Investment securities available for sale:
U.S. Government agency securities	$	98,617	$	272	$	577	$	98,312	$	98,312
State and municipal securities		5,840		269		4		6,105		6,105
Corporate securities		1,958		5		103		1,860		1,860
Mortgage-backed securities		29,247		596		10		29,833		29,833

Total investment securities available for sale		135,662		1,142		694		136,110		136,110

Investment securities held to maturity:
Corporate securities		3,894		131		202		3,823		3,894

Total Investment Securities	$	139,556	$	1,273	$	896	$	139,933	$	140,004

The amortized cost and fair value of debt securities by contractual maturity at December 31, 2010 is as follows (dollars in thousands):


	Amortized Cost		Estimated Fair Value
Within 1 year	$	9,223	$	9,277
Over 1 year through 5 years		39,268		39,888
Over 5 years through 10 years		11,782		11,541
Over 10 years		1,359		1,336

		61,632		62,042
Mortgage backed securities		48,265		48,223

	$	109,897	$	110,265

Bank of the Carolinas Corporation

Notes to Consolidated Financial Statements, Continued

The fair values of securities with unrealized losses at December 31, 2010 and 2009 are as follows (dollars in thousands):


	Less than 12 Months				12 Months or More				Total
	Estimated Fair Value		Unrealized Losses		Estimated Fair Value		Unrealized Losses		Estimated Fair Value		Unrealized Losses
December 31, 2010:
Temporarily impaired securities:
U.S. Government agency securities	$	17,543	$	369	$	—	$	—	$	17,543	$	369
State and municipal securities		142		2		—		—		142		2
Mortgage backed securities		37,139		397		—		—		37,139		397
Corporate securities		939		22		1,000		239		1,939		261

Total	$	55,763	$	790	$	1,000	$	239	$	56,763	$	1,029


	Less than 12 Months				12 Months or More				Total
	Estimated Fair Value		Unrealized Losses		Estimated Fair Value		Unrealized Losses		Estimated Fair Value		Unrealized Losses
December 31, 2009:
Temporarily impaired securities:
U.S. Government agency securities	$	45,310	$	577	$	—	$	—	$	45,310	$	577
State and municipal securities		399		4		—		—		399		4
Mortgage backed securities		4,912		10		—		—		4,912		10
Corporate securities		1,000		202		858		103		1,858		305

Total	$	51,621	$	793	$	858	$	103	$	52,479	$	896

Management of the Bank believes all unrealized losses on available-for-sale securities as of December 31, 2010 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 had two corporate securities with unrealized loss positions at December 31, 2010 of less than 12 months in duration, which management believes were the result of market fluctuations. 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. The total carrying value of the two corporate securities with temporary unrealized losses was $939,000 at December 31, 2010. The Bank believes that the unrealized losses are primarily the result of the interest rate environment and general illiquidity currently in the marketplace for these types of securities. The corporate securities the Bank owns are subordinated debt and trust preferred securities issued by other banking organizations.

The Bank had one held-to-maturity corporate security at December 31, 2010 that had an unrealized loss position of longer than 12 months in duration. The Bank has no intention of selling this security before its maturity and has the appropriate sources of liquidity to hold the security until maturity so that no recognized loss will occur.

In December 2009, we received notice that the guarantor banking organization of a trust preferred security in which we had invested $1 million was exercising its right to defer interest payments to the issuing trust. As a result of this action, we performed a discounted cash flow analysis related to this security that assumed interest payments by the guarantor to the trust would be deferred for five years, which is the maximum deferral allowable under the terms of the security before an event of default occurs. We assumed that the dividend payments will be brought current after 5 years and would remain current over the remaining life of the security. As a result of this analysis, we recorded an impairment charge of $498,000 in December 2009 to reflect the effect of the deferral of dividends on our investment for five years and dividend payments resuming after five years at a discount rate representative of current market conditions. In December 2010, we updated this calculation and recorded an additional impairment of $105,000, for a total impairment of $603,000. In addition to the impairment charge, we have discontinued recognizing income from this investment until such time as the guarantor resumes interest payments to the issuing trust.

Bank of the Carolinas Corporation

Notes to Consolidated Financial Statements, Continued

The following shows the transactions recorded in the valuation allowance for other-than-temporary impairment of investment securities which is a component of investment securities (dollars in thousands):


Balance December 31, 2009	$	498
Additions		105
Deductions		—

Balance December 31, 2010	$	603

Investment securities with market values of $65.2 million and $82.4 million at December 31, 2010 and 2009, respectively, were pledged as collateral on public deposits and for other purposes as required or permitted by law. Gross realized gains and losses for the years ended December 31, 2010, 2009, and 2008 are as follows (dollars in thousands):


	December 31,
	2010			2009			2008
	(dollars in thousands)
Realized gains	$	457		$	2,028		$	615
Realized losses		(113	)		(498	)		—

	$	344		$	1,530		$	615

3. Loans Receivable

Loans receivable are summarized as follows (dollars in thousands):


	December 31,
	2010			2009
Real estate loans:
Residential, 1-4 family	$	78,750		$	76,767
Commercial real estate		161,839			161,904
Construction		35,310			41,580
Home equity		31,465			30,775

Total real estate loans		307,364			311,026

Commercial business loans		51,581			75,762
Consumer loans:
Installment		4,300			3,303
Other		2,908			1,174

Total consumer loans		7,208			4,477

Gross loans receivable		366,153			391,265
Allowance for loan losses		(6,863	)		(8,167	)

Loans, net	$	359,290		$	383,098

The changes in the allowance for loan losses are summarized as follows (dollars in thousands):


	For the Year Ended December 31,
	2010			2009			2008
Beginning balance	$	8,167		$	6,308		$	4,245
Provision for loan losses		6,441			5,547			6,291
Charge-offs		(7,931	)		(3,908	)		(4,673	)
Recoveries		186			220			445

Ending balance	$	6,863		$	8,167		$	6,308

Bank of the Carolinas Corporation

Notes to Consolidated Financial Statements, Continued

The following table details the 2010 ending balance in the allowance for possible loan losses by portfolio segment. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.


In thousands	Ending Balance		Individually Evaluated for Impairment		Collectively Evaluated for Impairment
Allowance for credit losses:
Commercial—Non Real Estate	$	2,845	$	513	$	2,332
Commercial Real Estate		1,199		1,023		176
Construction & Development		845		44		801
Residential		1,758		988		770
Consumer—Non Real Estate		216		—		216
Unallocated		—		—		—

Total	$	6,863	$	2,568	$	4,295

In accordance with generally accepted accounting principles, loans totaling approximately $35.3 million in non-homogenous groups were determined to be impaired as of December 31, 2010 while approximately $17.5 million were determined to be impaired as of December 31, 2009. Specific loan loss reserves of $2.6 million and $4.0 million, respectively, were related to these loans as of December 31, 2010 and 2009. These reserves were held against specific loan balances of $20.9 million and $11.3 million for 2010 and 2009, respectively. Income has been recognized on a cash basis on these loans since being placed in impaired status. The average balance invested in impaired loans during 2010 was approximately $23.7 and $12.2 million in 2009. All impaired loans as of December 31, 2010 and 2009 have been evaluated to determine whether a specific loan loss reserve is necessary.

Bank of the Carolinas Corporation

Notes to Consolidated Financial Statements, Continued

Impaired loans as of December 31, 2010, segregated by class of loans, were as follows (dollars in thousands):


	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance:
Commercial—Non Real Estate	$	1,888	$	2,012	$	—	$	2,083	$	127
Commercial Real Estate
Owner occupied		6,805		7,755		—		7,778		412
Income producing		1,694		1,694		—		1,740		63
Multifamily		—		—		—		—		—
Construction & Development
1-4 Family		98		100		—		99		8
Other		1,141		1,192		—		1,247		56
Farmland		—		—		—		—		—
Residential
Equity Lines		37		80		—		80		6
1-4 Family		2,634		2,686		—		2,697		156
Junior Liens		18		20		—		20		2
Consumer—Non Real Estate
Credit Cards		—		—		—		—		—
Other		101		156		—		157		11

Total loans with no allowance	$	14,416	$	15,695	$	—	$	15,901	$	841

With an allowance recorded:
Commercial—Non Real Estate	$	2,633	$	3,103	$	513	$	3,138	$	149
Commercial Real Estate
Owner occupied		10,430		10,434		951		10,465		430
Income producing		2,899		2,899		72		2,924		123
Multifamily		—		—		—		—		—
Construction & Development
1-4 Family		1,138		1,138		44		1,138		69
Other		148		148		—		148		8
Farmland		—		—		—		—		—
Residential
Equity Lines		497		497		447		503		21
1-4 Family		3,117		3,134		516		3,141		142
Junior Liens		59		60		25		60		1
Consumer—Non Real Estate
Credit Cards		—		—		—		—		—
Other		—		—		—		—		—

Total loans with an allowance	$	20,921	$	21,413	$	2,568	$	21,517	$	943

Total:
Commercial—Non Real Estate	$	4,521	$	5,115	$	513	$	5,221	$	276
Commercial Real Estate	$	21,828	$	22,782	$	1,023	$	22,907	$	1,028
Construction & Development	$	2,525	$	2,578	$	44	$	2,632	$	141
Residential	$	6,362	$	6,477	$	988	$	6,501	$	328
Consumer—Non Real Estate	$	101	$	156	$	—	$	157	$	11

Totals	$	35,337	$	37,108	$	2,568	$	37,418	$	1,784

Bank of the Carolinas Corporation

Notes to Consolidated Financial Statements, Continued

Loans in non-accrual status were approximately $24.7 million and $9.2 million at December 31, 2010 and 2009, respectively. Interest accrued, but not recognized as income on these loans, was approximately $544,000 and $254,000 for the years ended December 31, 2010 and 2009, respectively. 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
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

Bank of the Carolinas Corporation

Notes to Consolidated Financial Statements, Continued

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 December 31, 2010, and based on the most recent analysis performed, the risk category of loans and leases is as follows (dollars in thousands):


	Pass		Special Mention		Substandard		Doubtful		Loss
Internal Risk Rating Grades
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	$	—

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 December 31, 2010, segregated by class of loans, were as follows (dollars in thousands):


	Performing		Non- Performing
Risk Based on Payment Activity
Residential
Equity Lines	$	31,069	$	396
1-4 Family		73,682		3,125
Junior Liens		1,866		77
Consumer—Non Real Estate
Credit Cards		—		—
Other		4,294		6

Totals	$	110,911	$	3,604

Total:
Residential	$	106,617	$	3,598
Consumer—Non Real Estate	$	4,294	$	6

Totals	$	110,911	$	3,604

Bank of the Carolinas Corporation

Notes to Consolidated Financial Statements, Continued

Directors and officers of the Bank and companies with which they are affiliated are customers of the Bank in the ordinary course of business and are considered “insiders.” Outstanding balances for term loans and lines of credit to insiders as of December 31, 2010 and 2009 were approximately $8.5 and $10.0 million, respectively.

The following table summarizes the Bank’s loan transactions with insiders for the year ended December 31, 2010 (dollars in thousands):


Balance, December 31, 2009	$	9,954
Originations		2,024
Advances		271
Repayments and participations sold		(1,374	)
Insider turnover		(2,341	)

Balance, December 31, 2010	$	8,534

Available lines of credit that can be drawn upon by insiders totaled $462,000 as of December 31, 2010.

4. Premises and Equipment

Premises and equipment are summarized as follows (dollars in thousands):


	December 31,
	2010		2009
Land	$	1,826	$	1,826
Buildings		10,260		10,261
Leasehold improvements		776		776
Furniture, fixtures and equipment		5,691		5,835

		18,553		18,698
Less, accumulated depreciation		5,447		4,688

	$	13,106	$	14,010

The Bank has entered into non-cancelable lease agreements for certain branch facilities. The leases expire through December 2017 and contain various renewal options. For the years ended December 31, 2010, 2009, and 2008, rental expense was approximately $275,000, $275,000, and $272,000, respectively.

The approximate minimum future lease payments are as follows (dollars in thousands):


2011	$	280
2012		246
2013		135
2014		135
2015		135
Thereafter		100

	$	1,031

Bank of the Carolinas Corporation

Notes to Consolidated Financial Statements, Continued

5. Deposits

The aggregate amount of time deposits with a minimum denomination of $100,000 was approximately $147.4 million and $115.9 million at December 31, 2010 and 2009, respectively.

Contractual maturities of time deposits are summarized as follows (dollars in thousands):


	December 31,
	2010		2009
12 months or less	$	177,102	$	119,438
1-3 years		54,340		66,698
Thereafter		2,070		1,208

	$	233,512	$	187,344

At December 31, 2010 and 2009, the Company had $73.0 million and $71.0 million, respectively, in brokered CD’s.

6. Federal Home Loan Bank Advances

The Bank had total advances from the Federal Home Loan Bank (“FHLB”) of $22.0 and $15.0 million at December 31, 2010 and 2009, respectively. These advances were secured by certain of the Bank’s qualifying real estate loans. The weighted average interest rate on the advances was 1.92% and 3.15% at December 31, 2010 and 2009, respectively. The range of rates on the outstanding advances varied from 0.19% to 2.18%.

The contractual maturities of advances are as follows (dollars in thousands):


2011	$	2,000
2012		10,000
2013		10,000

	$	22,000

The Bank has total remaining credit availability through the FHLB of approximately $112.0 million; however, FHLB advances can only be obtained on a secured basis. As of December 31, 2010, the Bank had pledged its FHLB stock and certain qualifying real estate loans as collateral to secure currently outstanding advances plus approximately $6.0 million in additional advances.

7. Federal Funds Purchased and Repurchase Agreements

The Bank had no federal funds purchased outstanding at December 31, 2010 and 2009. The Bank had $45.6 million outstanding in securities sold under agreements to repurchase at December 31, 2010 and $46.7 million in outstanding balances at December 31, 2009. A total of $45.0 million of these borrowings relate to two term repurchase agreements entered into during 2008. The following table contains certain pertinent information with respect to these two agreements at December 31, 2010 (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		4.79	%		7/8/2018		7/8/2013	$	30,768
Agreement dated 8/20/2008		20,000		3.78			8/20/2015		8/20/2011		22,627

Total	$	45,000		4.38	%					$	53,395

Bank of the Carolinas Corporation

Notes to Consolidated Financial Statements, Continued

The remaining repurchase agreements were primarily overnight transactions offered as a cash management service to business customers. A summary of selected data related to federal funds purchased and securities sold under overnight agreements to repurchase follows (dollars in thousands):


	At or for the year ended December 31,
	2010			2009			2008
Maximum amount outstanding at any month-end during the year	$	1,593		$	2,558		$	13,311
Balance outstanding at end of year		603			1,682			1,557
Average outstanding balance during the year		844			1,790			2,672
Average interest rate during the year		0.16	%		0.68	%		2.11	%
Average interest rate at end of year (1)		0.13			0.53			2.07

(1)

Average rate for month of December

8. Subordinated Debt

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

Issuing Entity

Date of
Issuance

Interest
Rate

Maturity
Date

Principal
Amount

Bank of the Carolinas Trust I

3/26/2008

Libor + 3.00

3/26/2038

5,155,000

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

The Company also issued $2.7 million of subordinated debt in a private transaction with another banking institution. This subordinated debt has a rate of Prime plus 75 basis points and a maturity date of August 13, 2018. This debt can be repaid in full at any time with no penalty.

9. Income Taxes

The components of income tax benefit are as follows (dollars in thousands):


	For the Years Ended December 31,
	2010			2009			2008
Current tax expense (benefit)
Federal	$	—		$	(622	)	$	(1,253	)
State		18			—			—

		18			(622	)		(1,253	)

Deferred tax expense (benefit)
Federal		(1,663	)		(1,351	)		(1,078	)
State		(18	)		5			(303	)

		(1,681	)		(1,346	)		(1,381	)

Total income tax expense (benefit)	$	(1,663	)	$	(1,968	)	$	(2,634	)

Bank of the Carolinas Corporation

Notes to Consolidated Financial Statements, Continued

The Company and its subsidiary each reflect the tax expense or benefit associated with the results of their individual operating results. The differences between actual income tax expense and the amount computed by applying the federal statutory income tax rate of 34% are reconciled as follows (dollars in thousands):


	2010			2009			2008
Computed income tax expense (benefit)	$	(1,468	)	$	(1,733	)	$	(2,128	)
Changes resulting from:
State tax expense (benefit), net of federal benefit		(197	)		3			(237	)
Non-taxable income		(112	)		(266	)		(301	)
Other		114			28			32

Actual income tax expense (benefit)	$	(1,663	)	$	(1,968	)	$	(2,634	)

The components of deferred income taxes are as follows (dollars in thousands):


	December 31,
	2010		2009
Deferred tax assets:
Allowance for loan losses	$	2,535	$	3,011
Accrued expenses		177		162
Accrued income		210		18
Reserve for other real estate valuation		983		715
State net economic loss carryovers		164		164
Federal net operating loss carryovers		1,971		447

		6,040		4,517

Deferred tax liabilities:
Depreciation and amortization		430		514
Prepaid expenses		297		395
Securities		166		154
Other		24		25

		917		1,088

Net deferred tax asset	$	5,123	$	3,429

Management has not established a valuation allowance as of December 31, 2010 or 2009, as we believe it is more likely than not that deferred tax assets will be utilized. Income tax expense (benefit) contains no interest or penalty amounts for the years ended December 31, 2010, 2009, or 2008.

The 2010 state net economic loss of approximately $4.5 million must be carried forward to future years. The Company has approximately $8.4 million in total state net economic loss carryovers which will expire between 2013 and 2015 if not previously utilized. The Company’s 2010 federal net operating loss of approximately $4.5 million may be carried forward for up to 20 years, if not previously utilized. The Company has approximately $5.8 million in total federal net operating loss carryovers which will expire between 2029 and 2030 if not previously utilized.

10. Regulatory Matters

Dividends

The Company’s dividend payments, if any, will be made from dividends received from the Bank. The Bank, as a North Carolina banking corporation, may pay dividends only out of undivided profits (retained earnings) as determined pursuant to North Carolina General Statutes Section 53-87. However, regulatory authorities may limit payment of dividends by any bank when it is determined that such a limitation is in the public interest and is necessary to ensure financial soundness of the Bank. Also see Other Regulatory Restrictions below.

Bank of the Carolinas Corporation

Notes to Consolidated Financial Statements, Continued

Dividends paid on the Company’s preferred stock issued to the U.S. Treasury pursuant to the TARP Capital Purchase Program reduces the net income available to common stockholders and earnings per common share. The preferred stock also would receive preferential treatment in the event of liquidation, dissolution or winding up of the Company. Additionally, the ownership interest of existing common stockholders will be diluted to the extent the warrant issued to the U.S. Treasury in conjunction with the issuance of preferred stock is exercised.

Capital Requirements

The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory (and possibly additional discretionary) actions by regulators that, if undertaken, could have a direct material effect on the Company’s and the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital to risk-weighted assets, and of Tier I capital to average assets, as all those terms are defined in the regulations. Management believes, as of December 31, 2010 and 2009, that the Company and the Bank met all capital adequacy requirements to which they are subject. Also see Other Regulatory Restrictions below.

Intercompany transactions

Restrictions on loans by the Bank to the Company are imposed by Federal Reserve Act Sections 23A and 23B, and differ from legal lending limits on loans to external customers. Generally, a bank may lend up to 10% of its capital and surplus to its parent or other affiliate, if the loan is secured and so long as certain safety and soundness requirements and market terms requirements are met. If collateral is in the form of stocks, or other real or personal property, it must have a market value when the loan is made of at least 30% more than the amount of the loan; if the collateral is in the form of debt instruments, it must have a market value when the loan is made of at least 20% more than the amount of the loan; and if the collateral is in the form of obligations of a state or political subdivision or agency thereof, it must have a market value of at least 10% more than the amount of the loan. If such loans are secured by obligations of the United States or agencies thereof, or by notes, drafts, bills of exchange or bankers’ acceptances eligible for rediscount or purchase by a Federal Reserve Bank, requirements for collateral in excess of loan amount do not apply. Under this definition, the legal lending limit for the Bank on loans to the Company was approximately $4.8 million at December 31, 2010. No 23A transactions existed at December 31, 2010 or 2009.

Other Regulatory Restrictions

As noted above, Banking Regulators generally have the ability to require more stringent standards than those otherwise set forth in the regulations. As a result of challenging economic events and conditions associated with the Bank identified by its regulators, the Boards of Directors of the Company and the Bank have entered into informal agreements with their regulators to maintain the Bank’s capital levels in excess of normal statutory minimums (including a Bank leverage ratio of not less than 7.5%, and other ratios at least at “well capitalized” levels), and to take various other actions designed to improve the Bank’s lending procedures and various other conditions related to the Bank’s operations, and for the Company and the Bank to seek the approval of their respective regulators prior to payment of any cash dividend. The Company’s Board agreed to take steps necessary to ensure the Bank’s compliance with its above agreement and, without the approval of its regulator, to not incur additional debt or issue hybrid-capital instruments, or use cash assets other than for the benefit of the Bank, investment in short term, liquid assets or payment of normal expenses.

Bank of the Carolinas Corporation

Notes to Consolidated Financial Statements, Continued

As of December 31, 2010, the most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain the minimum capital ratios. The Bank’s actual capital amounts (in thousands) and ratios and minimum requirements are set forth in the table below:


	Actual Capital					Capital needed to meet Regulatory Guidelines
	Ratio			Amount		Minimum		Well- Capitalized
As of December 31, 2010:
Total Capital (to Risk Weighted Assets):
Bank of the Carolinas		11.35	%	$	48,716	$	34,341	$	42,926
Bank of the Carolinas Corporation Consolidated		11.51			49,420		34,347		42,934
Tier 1 Capital (to Risk Weighted Assets):
Bank of the Carolinas		10.09			43,331		17,170		25,756
Bank of the Carolinas Corporation Consolidated		9.63			41,335		17,174		25,760
Tier I Leverage Capital (to Fourth Quarter Average Assets):
Bank of the Carolinas*		8.17			43,331		21,228		21,230
Bank of the Carolinas Corporation Consolidated		7.79			41,335		26,534		26,538

As of December 31, 2009:
Total Capital (to Risk Weighted Assets):
Bank of the Carolinas		11.25	%	$	52,885	$	37,610	$	47,012
Bank of the Carolinas Corporation Consolidated		11.67			54,873		37,620		47,025
Tier 1 Capital (to Risk Weighted Assets):
Bank of the Carolinas		10.01			47,066		18,805		28,207
Bank of the Carolinas Corporation Consolidated		9.86			46,348		18,810		28,215
Tier I Leverage Capital (to Fourth Quarter Average Assets):
Bank of the Carolinas*		7.38			47,066		25,497		25,504
Bank of the Carolinas Corporation Consolidated		7.27			46,348		31,872		31,879

As previously described the Company’s Board of Directors agreed to maintain the Bank’s Leverage Capital Ratio of 7.5% which is above the minimum level required by regulatory capital guidelines. At December 31, 2009, the Bank was below the agreed upon level, but corrected by March 31, 2010.

11. Employee Benefit Plan

The Bank has a 401(k) Plan to benefit employees. Employees that meet certain age and service requirements may participate in the Plan. Employees may contribute up to 75 percent of their compensation subject to certain limits based on federal tax laws. The Bank may make contributions to the Plan as determined by the Bank’s Board of Directors. For the years ended December 31, 2010, 2009, and 2008, expense attributable to the Plan amounted to approximately $0, $33,000, and $95,000, respectively.

12. Commitments and Contingencies

To accommodate the financial needs of its customers, the Company makes commitments under various terms to lend funds. These commitments include revolving credit agreements, term loan commitments and short-term borrowing agreements. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. 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 Bank evaluates each customer’s creditworthiness. The amount of collateral obtained, if it is deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation of the counterparty. Collateral held includes first and second mortgages on one-to-four family dwellings, accounts receivable, inventory, and commercial real estate. Certain lines of credit are unsecured.

Bank of the Carolinas Corporation

Notes to Consolidated Financial Statements, Continued

The Bank had outstanding commitments to originate commercial and construction loans of approximately $34.3 million at December 31, 2010. These commitments were composed of variable rate loans, with interest rates based upon the prime rate. The commitments included various maturity terms with balloon payments due between one to five years.

The following summarizes the Bank’s approximate remaining available balance to customers under commitments to fund lines of credit at December 31, 2010 (in thousands):


	Unfunded Commitments
Unfunded loan commitments	$	34,328
Standby letter of credits		2,477

	$	36,805

13. Employment and Change of Control Agreements

The Company has entered into employment agreements with key employees. The employment agreements provide for three-year terms. In the majority of cases, commencing on the first anniversary date and continuing each anniversary date thereafter, the agreements automatically extend for an additional year so that the remaining terms shall remain three years. The agreements provide for severance payments and other benefits in the event of involuntary termination of employment in connection with any change in control of the Company. A severance payment will also generally be provided on a similar basis in connection with voluntary termination of employment where, subsequent to a change in control, the officer is assigned duties inconsistent with their position, duties, responsibilities and status immediately prior to such change in control. The severance payments are defined in each agreement, but in no case exceed 2.99 times the executive officer’s average annual compensation during the preceding five years. The employment agreements provide for termination by the Company for just cause at any time. The Company has not accrued any benefits under this post-employment agreement.

14. Stockholders’ Equity

Preferred Stock

The Company has 3 million shares of preferred stock authorized. At December 31, 2010, there were 13,179 shares of preferred stock issued and outstanding with a $1,000 per share liquidation preference. 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 U.S. Treasury of its intent to defer the payment of its regular quarterly cash dividend on its Series A Preferred Stock.

Common Stock

The Company has 15 million shares of $5 par value common stock authorized. There were 3,897,174 shares of common stock outstanding at both December 31, 2010 and 2009.

Warrants

In connection with the issuance of the preferred shares under the U.S. Treasury’s (“UST”) TARP Capital Purchase Program, the Company issued the UST an option to purchase 475,204 shares of its common stock for $4.16 per share. The Warrant expires April 17, 2019.

Equity-Based Plans

Under the Company’s 2007 Omnibus Equity Plan (which was approved by the Company stockholders during 2007 to replace the previous Employee Stock Option Plan and Directors Stock Option Plan which expired in 2008), the Company may grant incentive and non-qualified stock options, restricted stock awards and performance share awards to its officers

Bank of the Carolinas Corporation

Notes to Consolidated Financial Statements, Continued

and employees, and non-qualified stock options and restricted stock awards to its directors, for up to an aggregate of 300,000 shares of common stock. The exercise price of each option equals the market price of the Company’s stock on the date of grant and grants have a maximum term of ten years.

The Company granted 0, 8,000, and 16,500 options during the years ended December 31, 2010, 2009, and 2008, respectively. The options were granted with a weighted average fair market value of $5.25 per share. The fair value of each option grant is estimated on the date of the grant using the Black-Scholes option-pricing model.

The Company also granted 6,000 shares of restricted stock grants during 2008. These grants were granted with a weighted average fair value of $5.25. The weighted average period over which awards are expected to be recognized is 1.41 years. The restricted stock grants were granted using the same fair value assumptions as the option grants during the year. The restricted stock grant agreements are based upon continued employment with the Company and carry no performance provisions in order to receive the shares at the end of the vesting schedule. The shares will vest equally over a three year period.

Stock based compensation expense was $2,000, $9,000, and $49,000 in 2010, 2009, and 2008, respectively. Total unrecognized compensation expense related to nonvested stock based awards at December 31, 2010 is approximately $10,000 and will be recognized over a weighted average period of 1.53 years.

Accounting principles generally accepted in the United States of America require the cash flows from the tax benefits resulting from tax deductions in excess of the compensation expense recognized for those options (“excess tax benefits”) to be classified as financing cash flows. Excess tax benefits totaling $0, $0 and $10,000 are classified as a financing cash inflow for the years ended December 31, 2010, 2009, and 2008, respectively. There were no options exercised in 2010.

A summary of the status of the Company’s stock options and stock awards as well as the warrants issued to the U.S. Treasury as of December 31, 2010 and changes during the year then ended is presented below:


For the Year ended December 31, 2010
Stock Options and Warrants						Restricted Stock Awards
	Shares			Weighted Average Exercise Price			Shares		Weighted Average Grant Date Fair Value
Options outstanding at beginning of year		55,025		$	7.06	Outstanding at beginning of year		6,000	$	5.25
Options granted		—			—	Granted		—		—
Options exercised		—			—	Forfeited		—		—

Options forfeited		(10,140	)		9.65	Outstanding at end of year		6,000	$	5.25

Options expired		(11,485	)		4.06

Options outstanding at end of year		33,400			7.31
Warrants issued and outstanding at end of year		475,204			4.16

Total Options and warrants outstanding at end of year		508,604		$	4.37

Bank of the Carolinas Corporation

Notes to Consolidated Financial Statements, Continued


At December 31, 2010
Stock Options and Warrants Outstanding									Stock Options and Warrants Exercisable
Range of Exercise Prices	Number Outstanding		Weighted Average Life		Weighted Average Exercise Price		Aggregate Intrinsic Value		Number Exercisable		Weighted Average Exercise Price		Aggregate Intrinsic Value
4.06-5.99		23,000		8.05 years		5.25		—		16,600		5.25		—
6.00-16.90		10,400		3.76 years		11.86		—		10,400		11.86		—

Total Options		33,400		6.76 years		7.31		—		27,000		7.79		—
Total Warrants		475,204		8.29 years		4.16		165		475,204		4.16		165

Total Options and warrants		508,604		8.19 years	$	4.37	$	165		502,204	$	4.46	$	165

15. Fair Value of Financial Instruments

The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Bank’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. Accounting principles generally accepted in the United States of America exclude certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Bank.

The following methods and assumptions were used by the Bank in estimating fair value disclosures for financial instruments:

Cash and Cash Equivalents—The carrying amounts of cash and short-term instruments approximate fair values.

Federal Funds Sold—The carrying amounts of federal funds sold approximate fair values.

Investment Securities—Fair values for securities are based on quoted market prices.

Loans Receivable—For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for other loans (e.g., commercial real estate and investment property mortgage loans, commercial and industrial loans) are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for non-performing loans, as applicable, are estimated using discounted cash flow analyses or underlying collateral values, where applicable.

Bank Owned Life Insurance—The carrying amount of bank owned life insurance is the current cash surrender value.

Other Assets—Other assets include interest receivable and Federal Home Loan Bank stock. The carrying amount of accrued interest receivable approximates fair value. The carrying value of Federal Home Loan Bank stock approximates fair value based on the redemption provisions of the Federal Home Loan Bank.

Deposit Liabilities—The fair values disclosed for demand deposits (e.g., interest and non-interest checking, statement savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts of variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.

Bank of the Carolinas Corporation

Notes to Consolidated Financial Statements, Continued

Federal Home Loan Bank Advances—The fair value of the Bank’s advances are estimated using discounted cash flow analyses based on the Bank’s current incremental borrowing rates for similar types of borrowing arrangements.

Repurchase Agreements—The Bank established two term repurchase agreements during 2008. These agreements are collateralized by securities held in our portfolio. The fair value amount for these agreements is based on the repurchase price and agreed upon terms.

Other Borrowings—Other borrowings includes federal funds purchased as well as repurchase agreements, trust preferred securities and subordinated debt. The carrying amounts approximate the fair value of these assets.

Other Liabilities—Other liabilities include accrued interest payable. The carrying amounts of accrued interest payable approximate fair value.

Off-Balance-Sheet Instruments—Fair values for off-balance-sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing.

The approximate carrying and estimated fair values of financial instruments are summarized below (in thousands):


	December 31, 2010				December 31, 2009
	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
Financial assets:
Cash and cash equivalents	$	10,565	$	10,565	$	12,544	$	12,544
Federal funds sold		9,330		9,330		24,815		24,815
Investment securities		110,373		110,265		140,004		139,933
Loans receivable, net		359,290		357,952		383,098		384,770
Bank owned life insurance		10,371		10,371		10,010		10,010
Other assets		8,498		8,498		14,244		14,244

Financial liabilities:
Deposits:
Demand, Savings, and Money Market		182,657		182,657		306,573		306,573
Time		233,512		234,236		187,344		188,146
Other borrowings		75,458		82,288		69,537		74,716
Other liabilities		1,639		1,639		1,941		1,941

Effective January 1, 2008, accounting principles generally accepted in the United States of America require that certain assets and liabilities be measured at fair value and to record any adjustments to the fair value of those assets. Securities are recorded at fair value on a recurring basis while other assets are recorded at fair value on a non-recurring basis such as impaired loans and other real estate owned.

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.

Bank of the Carolinas Corporation

Notes to Consolidated Financial Statements, Continued

•

Level 3 pricing is used without observable data. In such cases, mark-to-market strategies are typically employed. Often, these types of instruments 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.


(In thousands)	Total at 12/31/2010		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		4,665		—		4,665		—
Mortgage-backed		48,223		—		48,223		—
Assets valued on a non-recurring basis
Impaired loans		32,769		—		32,769		—
Other real estate owned		8,314		—		8,314		—

Total	$	151,348	$	—	$	151,348	$	—


(In thousands)	Total at 12/31/2009		Level 1		Level 2		Level 3
Assets valued on a recurring basis
Investment securities:
U.S. government and agency	$	98,312	$	—	$	98,312	$	—
State and municipals		6,105		—		6,105		—
Corporate		5,683		—		5,683		—
Mortgage-backed		29,833		—		29,833		—
Assets valued on a non-recurring basis
Impaired loans		13,509		—		13,509		—
Other real estate owned		8,233		—		8,233		—

Total	$	161,675	$	—	$	161,675	$	—

Bank of the Carolinas Corporation

Notes to Consolidated Financial Statements, Continued

16. Parent Company Financial Information

The condensed balance sheets for 2010 and 2009, and the statements of operations and cash flows for the parent company as of and for the periods ended December 31, 2010, 2009, and 2008 are presented below (in thousands):

Condensed Balance Sheets


	2010		2009
Assets
Cash	$	728	$	1,972
Investment in wholly owned subsidiary		48,319		50,455
Other assets		617		525

Total Assets	$	49,664	$	52,952

Liabilities and Stockholder’s equity:
Borrowings	$	7,855	$	7,855
Other liabilities		105		105
Stockholder’s Equity		41,704		44,992

Total Liabilities and Stockholder’s Equity	$	49,664	$	52,952

Condensed Statements of Operations


	2010			2009			2008
Dividends from subsidiary	$	—		$	—		$	—
Interest on deposits in other banks		10			79			2
Other income		1			—			—

Total operating income		11			79			2

Loss on sale of securities		—			—			—
Interest expense on borrowed funds		277			311			274
Other		113			102			74
Equity in undistributed loss of subsidiary		2,402			2,903			3,379

Total operating expense		2,792			3,316			3,727

Loss before taxes		(2,781	)		(3,237	)		(3,725	)
Income tax benefit		(126	)		(107	)		(101	)

Net loss		(2,655	)		(3,130	)		(3,624	)
Preferred stock dividends and accretion		(914	)		(637	)		—

Net loss available to common shareholders	$	(3,569	)	$	(3,767	)	$	(3,624	)

Bank of the Carolinas Corporation

Notes to Consolidated Financial Statements, Continued

Condensed Statements of Cash Flows


	2010			2009			2008
Cash Flows from Operating Activities:
Net loss	$	(2,655	)	$	(3,130	)	$	(3,624	)
Equity in undistributed net loss of subsidiary		2,402			2,903			3,379
Change in other assets		(91	)		9			(381	)
Change in other liabilities		9			15			19

Net cash used by operating activities		(335	)		(203	)		(607	)

Cash Flows from Investing Activities:
Investment in subsidiary		(250	)		(10,800	)		(5,979	)

Cash Flows from Financing Activities:
Proceeds from issuance of common stock		—			—			424
Stock repurchase		—			—			(722	)
Issuance of trust preferred securities		—			—			5,155
Issuance of subordinated debt		—			—			2,700
Issuance of preferred stock		—			13,179			—
Cash dividends paid on preferred stock		(659	)		(381	)		—
Cost of issuing preferred stock		—			(46	)		—
Excess tax benefit from stock based compensation		—			—			10
Cash dividends paid on common stock		—			(195	)		(784	)

Net cash provided (used) by financing activities		(659	)		12,557			6,783

Net increase (decrease) in cash and cash equivalents		(1,244	)		1,554			197
Cash and cash equivalents at beginning of year		1,972			418			221

Cash and cash equivalents at end of year	$	728		$	1,972		$	418

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

None.

ITEM 9A. CONTROLS AND PROCEDURES.

As of the end of the period covered by this report, the Company conducted an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures in accordance with Exchange Act Rule 13a-15(b). Based upon their evaluation, the Company’s 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 the Company is able to record, process, summarize, and report in a timely manner the information required to be disclosed in reports the Company files under the Exchange Act.

The Company’s Management’s Report on Internal Control Over Financial Reporting appears below.

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING.

Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. The Company’s internal control over financial reporting is a process designed under supervision of the Company’s Chief Executive Officer and Chief Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles. Management has made a comprehensive review, evaluation and assessment of the Company’s internal control over financial reporting as of December 31, 2010. In making its assessment of internal control over financial reporting, management used the criteria issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework. Based on this assessment, management believes that, as of December 31, 2010, the Company’s internal control over financial reporting is effective. In accordance with Section 404 of the Sarbanes-Oxley Act of 2002, management makes the following assertions:

•

Management has implemented a process to monitor and assess both design and operating effectiveness of internal control over financial reporting.

•

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

This Annual Report on Form 10-K does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to an exemption from that requirement available to smaller reporting companies.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

In connection with the above evaluation 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 quarter ended December 31, 2010 that has materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Item 9B. Other Information

None.

PART III

Item 10. Directors, Executive Officers and Corporate Governance

Directors

Our Bylaws provide that:

•

our Board of Directors consists of not less than five nor more than 18 members, and our Board is authorized to set and change the actual number of our directors from time to time within those limits; and

•

our directors are elected each year at our Annual Meeting for terms of one year, or until their successors have been duly elected and qualified.

The following table lists information about each of our current directors, including a description of his or her principal occupation and business experience. There are no family relationships among directors and executive officers of the Company.


Name and Age	Positions With Us and the Bank (1)	Year First Elected (2)	Principal Occupation and Business Experience
Jerry W. Anderson (71)	Director	1998	Partner, Anderson Aggregates, LLC (land clearing) since 1999; previously, President, Anderson Chip & Pulpwood, Inc., from 1986 until its merger with Anderson Aggregates in 1999

Alan M. Bailey (70)	Director	1998	Private investor; previously, owner and operator, 801 Shell Service (gasoline station)

William A. Burnette (70)	Director	1998	Managing Partner, The Hillsdale Group LLC (real estate development); Managing Partner, Burnfam Limited Partnership (golf courses and real estate development); Manager, Hillsdale West Business Park Associates LLC (real estate development); President, Davie Properties Inc. (real estate development); Managing Partner, East Davie Company, Ltd. (real estate development)

John A. Drye (47)	Director	2002	Partner, Central Carolina Insurance Agency (general insurance agency)

John W. Googe (85)	Director	2001	President and Chief Executive Officer, Flex-Pay Business Services, Inc. (payroll services); Director, Flight Op (aircraft charter) (2008-present); Manager, Coliseum Drive Association (real estate) (2005-present); Manager, Southeastern Pension Co. (pension record keeping) (2009-present)

Henry H. Land (68)	Director	2002	Retired; previously, Partner, McClary, Stocks, Smith, Land & Campbell, P.A., Certified Public Accountants (1988-2006)

Steven G. Laymon (49)	Director	1998	Optometrist; President and owner, Steven G. Laymon, O.D., P.A. (optometric practice)


Name and Age	Positions With Us and the Bank (1)	Year First Elected (2)	Principal Occupation and Business Experience

Robert E. Marziano (61)	Director	1998	President and Chief Executive Officer, Bank of the Carolinas, 1998–2010; President and Chief Executive Officer, Bank of the Carolinas Corporation, 2006–2010; Senior Vice President, First Bank, 1997–1998; President and Chief Executive Officer, Old North State Bank, 1989–1997

Grady L. McClamrock, Jr. (58)	Director	2001	Attorney; owner, Grady L. McClamrock, Jr., J.D., P.A. (law firm)

Lynne Scott Safrit (52)	Director	2002	President, North American Commercial Operations, Castle & Cooke, Inc. (property management and development)

Francis W. Slate (88)	Director; Chairman of the Board of Directors	1998	Mayor, Town of Mocksville; retired General Surgeon, Mocksville Surgical Associates, P.A.

Stephen R. Talbert (65)	Director; Vice Chairman of the Board of Directors; President and Chief Executive Officer	2002	Our executive officer (3)

(1)

Members of certain committees of our Board are as follows:


Audit Committee	Corporate Governance Committee	Risk Oversight Committee	Executive Committee
Henry H. Land - Chairman	John A. Drye - Chairman	John W. Googe - Chairman	Francis W. Slate - Chairman
Alan M. Bailey	Alan M. Bailey	Henry H. Land	William A. Burnette
Steven G. Laymon	William A. Burnette	Stephen R. Talbert	John W. Googe
Lynne Scott Safrit	John W. Googe	Lynne Scott Safrit	Steven G. Laymon
Francis W. Slate	Steven G. Laymon	John A. Drye	Grady L. McClamrock, Jr.
	Grady L. McClamrock, Jr.		Stephen R. Talbert

(2)

“Year first elected” refers to the year in which each individual first became a director of the Bank. Each nominee first became our director at the time we were incorporated during 2006 as the Bank’s holding company. Messrs. Drye, Land and Talbert and Ms. Safrit previously served as directors of BOC Financial Corp and were appointed as directors of the Bank following our merger with that company on December 31, 2001.

(3)

Information regarding Mr. Talbert’s business experience is included in his listing below under the heading “Executive Officers.”

Factors Bearing on Qualifications of Directors

The experience, qualifications, attributes, skills and other factors that leads our Board to conclude that each of our directors listed in the table above should serve, or continue to serve, as a director are described below.

Jerry W. Anderson

•

Understanding of our culture, values and goals from service as our director since 1998

•

Management and business experience through ownership and operation of Anderson Aggregates for over 40 years

•

Board experience for 25 years with Energy United

•

Active in civic clubs in Davie County

•

Understanding of the banking and financial needs of small business owners through personal experience operating a business for over 40 years

Alan M. Bailey

•

Understanding of our culture, values and goals from service as our director since 1998

•

Management and business experience through ownership and operation of 801 Shell Service and Bailey’s Auto Sales for over 30 years

•

Graduate of NC Bank Directors’ College

•

Respected in the Davie County business community as his family has been in business for over 100 years

•

Understanding of the banking and financial needs of small business owners through personal experience operating a business for over 30 years

William A. Burnette

•

Understanding of our culture, values and goals from service as our director since 1998

•

Over 50 years business experience in various industries from tobacco companies to the hospitality industry, and understanding of world markets and currencies through foreign business activities and travel

•

Prior bank board experience with Salem Trust Bank

•

Understanding of the banking and financial needs of commercial developers and small business owners through his current business ventures

John A. Drye

•

Understanding of our culture, values and goals from service as our director since 2002

•

Has previous banking experience through service as a director of BOC Financial Corp and the former Bank of the Carolinas from 1993 until their merger with the Bank in 2001

•

Management and business experience in the insurance industry as partner in a property and casualty insurance agency for 20 years

•

Received MBA degree from the University of Georgia, with a concentration in finance and risk management (1988)

•

Active involvement in church and civic clubs of Rowan County

•

Understanding of the banking and financial needs of small businesses through his experience providing insurance services to small businesses and his personal experience operating a business for over 30 years

John W. Googe

•

Understanding of our culture, values and goals from service as our director since 2001

•

Has previous public company experience, having served as President and Chief Operating Officer of one company and as a director of other companies

•

Management and business experience through organization and sale of 18 different companies

•

Understanding of the banking and financial needs of businesses in different industries through his prior business experience

Henry H. Land

•

Understanding of our culture, values and goals from service as our director since 2002

•

Has previous banking experience through service as a director of BOC Financial Corp and the former Bank of the Carolinas from 1986 until their merger with the Bank in 2001

•

Is a certified public accountant licensed in North Carolina with 40 years of accounting experience, including 18 years in public accounting and prior financial accounting and reporting experience with a large industrial corporation

•

Serves as Chairman of our Audit Committee and, based on his accounting training and experience, is an “audit committee financial expert”

•

Understanding of the banking and financial needs of small and mid-size businesses through his personal experience operating a business and providing accounting services to business clients

Steven G. Laymon

•

Understanding of our culture, values and goals from service as our director since 1998

•

Over 24 years of professional experience in the health care industry as an optometrist serving the residents of Davie County

•

Management and business experience through building and operating his optometric practice

•

Active involvement in the community through service on various boards within our market area

•

Understanding of the banking and financial needs of small business owners through personal experience operating a business for over 24 years

Robert E. Marziano

•

Understanding of our culture, values and goals from service as our director since 1998

•

Served as the Bank’s Chief Executive Officer from 1998 to 2010, and has over 40 years of banking experience, including 20 years of experience in executive management positions

•

Substantial personal financial interest in our long-term growth, stability, and success because of his significant personal ownership of our shares

•

Visible and active as a community leader in the Bank’s markets

Grady L. McClamrock, Jr.

•

Understanding of our culture, values and goals from service as our director since 2001.

•

Is a practicing attorney with business experience through owning and managing his law practice

•

Visible and active as a community leader serving on various boards within our marketing area

•

Understanding of the banking and financial needs of small and mid-size businesses in our market area through experience providing legal services

Lynne Scott Safrit

•

Understanding of our culture, values and goals from service as our director since 2002

•

Has previous banking experience through service as a director of BOC Financial Corp and the former Bank of the Carolinas from 1995 until their merger with the Bank in 2001

•

Management and business experience in commercial real estate industry through more than 15 years as president of a national real estate development company

•

Active in civic and professional organizations, including current service on the Board of Trustees at Catawba College and President of the Board of Directors for the Cabarrus County Economic Development Corp.

•

Member of the Catawba College Business Hall of Fame

•

Understanding of the banking and financial needs of small and mid-size businesses in our market area

Francis W. Slate

•

Understanding of our culture, values and goals from service as our director since 1998

•

Over 32 years experience in healthcare as a General Surgeon

•

Active in medical community and as a community leader, serving as Davie County Commissioner for 12 years, Mocksville Town Commissioner for 10 years, and Mayor of Mocksville for 12 years

•

Understanding of the banking and financial needs of small and mid-size businesses in our market area through experience in community and civic affairs

Stephen R. Talbert

•

Understanding of our culture, values and goals from service as an officer of the Bank and our Vice Chairman since 2002

•

Has a total of 38 years of banking experience, including his previous service as President and Chief Executive Officer of BOC Financial Corp and the former Bank of the Carolinas from 1986 until their merger with the Bank in 2001

•

Active in local community through service on various boards, including Rowan County Chamber of Commerce, NorthEast Medical Center Foundation and Trinity Lutheran Church

•

Understanding of the banking and financial needs of small and mid-size businesses in our market area through prior banking experience

Executive Officers

We consider our five officers listed below to be our executive officers.

Stephen R. Talbert, age 65, serves as our and the Bank’s Vice Chairman, President, and Chief Executive Officer. He joined the Bank on December 31, 2001, in connection with the Bank’s acquisition of BOC Financial Corp. Previously, he had served as Chairman, President and Chief Executive Officer of BOC Financial Corp since its organization during 1998, and in the same positions with that company’s bank subsidiary or its predecessor since 1971. He served as the Bank’s Chairman and Executive Vice President from 2002 to 2004 and has been Vice Chairman since 2004. Prior to being appointed President and Chief Executive Officer, Mr. Talbert served as our Interim Chief Executive Officer from August to September 2010.

Eric E. Rhodes, age 50, was elected to serve as our Vice President and Chief Financial Officer and the Bank’s Executive Vice President and Chief Financial Officer during October 2010. He was previously elected to serve as our Vice President and Chief Financial Officer and as Senior Vice President and Chief Financial Officer of the Bank on June 29, 2010. Mr. Rhodes formerly served as our Vice President and Chief Financial Officer and as the Bank’s Senior Vice President and Chief Financial Officer from 2005 until May 2008. Following his resignation in 2008, Mr. Rhodes served as a consultant to the Bank until August 2008. From September 2008 until he was reemployed by the Bank in May 2010, his principal occupation was as a private investor. Previously, he was employed by Rowan Bank in China Grove, North Carolina from 1990 to 2004, where he last served as Senior Vice President and Chief Financial Officer.

George E. (“Ed”) Jordan, age 52, was appointed to serve as Chief Operating Officer of the Bank on November 24, 2010. Mr. Jordan previously served as the Bank’s Executive Vice President since January 2008 and, in that position, supervised the Bank’s financial services, marketing and sales functions and served as regional executive for the Bank’s offices located in Stokes, Forsyth, Davidson and Randolph Counties. Prior to that, he served as the Bank’s President and Chief Operating Officer from May 2004 to January 2008. Prior to his employment with the Bank, Mr. Jordan was employed by Wachovia Bank for 24 years where his positions included supervisory responsibility over city executives for several of that bank’s Triad area offices and service as that bank’s Senior Vice President and Business Banking Sales Director with responsibilities for middle market lending.

Harry E. Hill, age 65, was elected as the Bank’s Executive Vice President during January 2001. He was employed by our organizing group during 1998 and became Senior Vice President of the Bank when it began operations during 1998, and he currently functions as the Bank’s business development officer in Davie County. Previously, he served as Vice President of Southern National Bank and its successor, Branch Banking & Trust Company, in Welcome, North Carolina, from 1994 to 1998, and as Business Development Officer of Davidson Savings Bank from 1992 to 1994.

Robert W. Johnson, age 60, was elected as our executive officer in June 2010. He was first elected as the Bank’s Chief Lending Officer in June 2009. Prior to joining the Bank, Mr. Johnson was a bank examiner with the North Carolina Office of the Commissioner of Banks from 2007 to 2009 and also from 2005 to 2007. During 2007, Mr. Johnson was a lending officer with Southern Community Bank.

Audit Committee

Our Board of Directors has a standing Audit Committee that operates under a written charter approved by our Board that sets out the Committee’s composition, authority, duties and responsibilities. A current copy of the charter of the Audit Committee is available on our website at www.bankofthecarolinas.com. We believe that each member of the Committee is an “independent director” as that term is defined by the listing standards of The Nasdaq Stock Market.

The current members of the Audit Committee are listed in the following table.

Audit Committee

Henry H. Land - Chairman

Alan M. Bailey

Steven G. Laymon

Lynne Scott Safrit

Francis W. Slate

The Audit Committee is a joint committee of our and the Bank’s Boards of Directors. Under its charter, the Committee is responsible for:

•

appointing our independent accountants and approving their compensation and the terms of their engagement;

•

approving services proposed to be provided by the independent accountants; and

•

monitoring and overseeing the quality and integrity of our accounting and financial reporting process and systems of internal controls.

The Committee reviews various reports from our independent accountants (including its annual audit report on our consolidated financial statements), financial reports we file under the Securities Exchange Act of 1934, and reports of examinations by our regulatory agencies, and it generally oversees our internal audit program. Also, as described in this Report under Item 13 (Certain Relationships and Related Transactions, and Director Independence), our Board has directed the Audit Committee to monitor and make annual reports regarding the independence of our directors. The Committee met ten times during 2010.

Audit Committee Financial Expert

Mr. Land, the Chairman of the Audit Committee, is a certified public accountant with 43 years of accounting experience, including approximately 20 years in public accounting. Our Board of Directors believes that Mr. Land is an “audit committee financial expert” as that term is defined by rules of the Securities and Exchange Commission.

Code of Ethics

Our Board of Directors has adopted a Code of Ethics which applies to our directors and executive officers, including our senior financial officers, and, among other things, is intended to promote:

•

honest and ethical conduct;

•

ethical handling of actual or apparent conflicts of interest between personal and professional relationships;

•

full, fair, accurate, timely and understandable disclosure in reports and documents that we file with the Securities and Exchange Commission and in other public communications we make;

•

compliance with governmental laws, rules and regulations;

•

prompt internal reporting of violations of the Code to the Board’s Audit Committee; and

•

accountability for adherence to the codes.

A copy of the Code is posted on the Bank’s Internet website at www.bankofthecarolinas.com. Illegal or unethical behavior, violations of the Code, or accounting or auditing concerns may be reported, anonymously or otherwise, to the Chairman of our Audit Committee addressed as follows:

Henry H. Land

Post Office Box 166

Kannapolis, NC 28082

Section 16(a) Beneficial Ownership Reporting Compliance

Our directors and executive officers are required by federal law to file reports with the Securities and Exchange Commission regarding the amounts of and changes in their beneficial ownership of our common stock. Based on our review of copies of those reports, we are required to disclose failures to report shares beneficially owned or changes in beneficial ownership, and failures to timely file required reports, during previous years. We currently are not aware of any of our directors or executive officers who, during 2010, failed to report shares beneficially owned or to timely file a required report.

Item 11. Executive Compensation

EXECUTIVE COMPENSATION

Summary

The following table shows the cash and certain other compensation paid or provided to or deferred by the named executive officers for 2010 and 2009. Our executive officers are compensated by the Bank for their services as its officers, and they receive no separate salaries or other cash compensation from us for their services as our officers

SUMMARY COMPENSATION TABLE


Name and Principal Position (1)	Year		Salary (4)		Bonus		Stock Awards		Option Awards		Non-Equity Incentive Plan Compensation		All Other Compensation (5)		Total
Stephen R. Talbert (2) Vice Chairman, President and Chief Executive Officer		2010	$	85,211		-0-		-0-		-0-		-0-	$	3,563	$	88,774
		2009		72,250		-0-		-0-		-0-		-0-		6,296		78,456


Robert E. Marziano (3) Former Chairman, President and Chief Executive Officer		2010	$	217,592		-0-		-0-		-0-		-0-	$	13,582	$	231,174
		2009		280,000		-0-		-0-		-0-		-0-		18,063		298,063


Harry E. Hill Executive Vice President		2010	$	149,073		-0-		-0-		-0-		-0-	$	7,682	$	156,755
Harry E. Hill Executive Vice President		2009		136,000		-0-		-0-		-0-		-0-		11,847		147,847

Robert W. Johnson Senior Vice President and Chief Lending Officer		2010	$	135,000		-0-		-0-		-0-		-0-	$	2,968	$	137,968
		2009		85,146		-0-		-0-		-0-		-0-		1,194		86,340

(1)

Messrs. Marziano and Talbert served as members of our Board of Directors during 2010 and 2009. Compensation paid to Mr. Marziano for his service on the board of directors is included under the heading “All Other Compensation.” Mr. Talbert received no additional compensation for his service as a director.

(2)

Mr. Talbert was appointed as our and the Bank’s Interim Chief Executive Officer on August 10, 2010, and was appointed as our and the Bank’s President and Chief Executive Officer on September 22, 2010. Amounts included for 2009 and a portion of 2010 reflect compensation paid to Mr. Talbert as Branch Manager of the Bank’s Landis office.

(3)

Mr. Marziano resigned from his positions as our and the Bank’s President and Chief Executive Officer on September 17, 2010.

(4)

Reflects total salary paid by the Bank each year, including the amount of salary deferred at each officer’s election under our Section 401(k) plan.

(5)

The following table describes each officer’s “Other Compensation” for 2010:


Description	Mr. Talbert		Mr. Marziano		Mr. Hill		Mr. Johnson
The Bank’s contributions for the officers’ accounts under our Section 401(k) plan		-0-		-0-		-0-		-0-
Portion of total premium paid by the Bank on a key-man life insurance policy that is attributable to death benefits payable to the officer’s beneficiary		-0-	$	3,864		-0-		-0-
Our estimated aggregate incremental cost related to personal benefits received during 2010 (a)	$	3,563		7,168	$	7,682	$	2,968
Director fees		-0-		2,550		-0-		-0-

Total	$	3,563	$	13,582	$	7,682	$	2,968

(a)

Our executive officers receive, or we may treat them as receiving, various non-cash personal benefits. During 2010, the personal benefits received by the named officers included:

•

for Mr. Talbert, personal use of a Bank-owned vehicle and the Bank’s payment of club dues;

•

for Mr. Marziano, the Bank’s payment of club dues, premiums paid by the Bank for family coverage under our group insurance plans over and above amounts paid for other employees, and compensation for service on the board of directors;

•

for Mr. Hill, personal use of a Bank-owned vehicle and the Bank’s payment of club dues; and

•

For Mr. Johnson, personal use of a Bank-owned vehicle.

We also provide our officers with group life, health, medical and other insurance coverages that are generally available on the same basis to all salaried employees. The cost of that insurance is not included in the table.

Employment Agreements

Mr. Marziano was employed by the Bank under an employment agreement. The original terms of the agreement provided for a “rolling” term of employment of three years that, at the end of each year, would be extended by one additional year. The agreement also provided for:

•

annual base salary (which was subject to review and periodic increase by the Bank’s Board) of at least $250,000; and

•

the right to participate in bonus or incentive plans and other benefits made available by the Bank to its executive officers; and

Mr. Marziano’s agreement was terminated effective September 17, 2010. Subject to certain limitations, the terms of the agreement provided for payments and benefits to be provided to Mr. Marziano, and for his ability to compete against the Bank to be limited, after a termination of his employment under various circumstances (including a termination following a change in control of our company or the Bank). Those provisions, and the limitations on their operation, are described below under the caption “Potential Payments Upon Termination of Employment or a Change of Control.”

Plan-Based Awards

We maintain two arrangements under which awards may be granted from time to time to our officers and employees. They are our:

•

Omnibus Equity Plan, under which stock options, restricted stock awards, and performance share awards may be granted; and

•

Annual Management Incentive Compensation Plan, under which additional cash compensation may be paid each year based on the extent to which corporate and individual goals or other performance criteria are met or satisfied for the year.

Stock-Based Awards. Our shareholders approved the Omnibus Equity Plan at our 2007 Annual Meeting to replace both our Employee Stock Option Plan and Director Stock Option Plan which had been in effect since 1998 and under which we had granted options from time to time to our officers, employees and directors to purchase shares of our common stock. Those old plans have expired.

Under the new plan, awards may be granted to officers and employees consisting of either:

•

Incentive stock options;

•

Non-qualified stock options;

•

Restricted stock awards; or

•

Performance share awards.

As described under the caption “Director Compensation,” the Omnibus Equity Plan also authorizes the grant of non-qualified stock options and restricted stock awards to our non-employee directors.

A stock option gives the officer or employee to whom it is granted the right to buy shares of our common stock during a stated period of time (ordinarily ten years) at a fixed price per share equal to the fair market value of our stock on the date the option is granted. Options generally are granted to officers and employees on terms that provide for them to “vest,” or become exercisable, at intervals as to portions of the shares they cover based on a vesting schedule, and they do not include any performance-based conditions. They generally terminate immediately on the date of, or after a stated number of days following, the termination of an officer’s employment. Options granted to officers and employees may be “incentive stock options” that qualify for special tax treatment under the Internal Revenue Code, or they may be “non-qualified stock options” that do not qualify for that special tax treatment. We expect that options granted in the future to officers and employees under the Omnibus Equity Plan will be incentive stock options.

Restricted stock awards are conditional grants of shares of our common stock that are subject to forfeiture if specified conditions (usually the officer’s or employee’s continued performance) are not satisfied by the end of a specified restriction period. When an award is granted, the shares are issued and, if we pay dividends on our common stock during the restriction period, the officer or director would receive those dividends on the shares covered by his award at the same rate and on the same basis as they are paid to our other shareholders. However, the shares may not be sold or transferred until the restriction period ends. In most cases the restrictions lapse over time as to portions of the shares according to a “vesting” schedule. If the officer’s employment terminates for any reason prior to the end of the restriction period, he forfeits all unvested shares. As the restrictions expire, the shares become “vested” and are released to the officer.

Performance share awards are awards of shares of our common stock that may be earned based on performance objectives or criteria specified at the time the awards are granted. Like restricted stock awards, performance shares would be granted subject to conditions that must be satisfied before the officer or employee will own the shares outright. However, performance shares would be earned only to the extent that performance criteria are met by the end of a measurement period, while restricted stock awards usually are granted subject only to the condition of continued employment. Also, performance shares would not actually be issued until the end of the measurement period during which the performance criteria must be met, while restricted shares generally are issued at the time awards are granted and become unrestricted at the end of the restriction period.

The exercise price of stock options, and the other terms of options and stock awards, are determined by our Board, based on the recommendation of the Corporate Governance Committee, at the time they are granted.

Options covering a total of 8,000 shares have been granted to Mr. Johnson. Of these 8,000 shares, 1,600 were exercisable on December 31, 2010.

Cash Incentive Awards. Our Board first adopted our Management Incentive Compensation Plan during 2007. Under the plan, our executive officers and other employees chosen to participate each year may earn additional cash compensation based on the extent to which:

•

Our pre-tax profits set by the Board (before any deduction for the expense of payments under the plan) exceed a threshold amount; and

•

Other individual goals (which vary for different participants or groups of participants) set by the Board are achieved.

The plan contemplates that each year our Board will set the maximum award each participant may receive for that year (stated as a percentage of his or her base salary). No cash awards are paid unless our pre-tax, pre-incentive profits for that year exceed a minimum amount set by the Board. Subject to the extent to which individual goals set by the Board for each participant are met, the maximum incentive awards may be paid if our pretax, pre-incentive profits reach a higher target level set by the Board.

During April 2009, we became a participant in the U.S. Department of the Treasury’s TARP Capital Purchase Program. Under rules adopted by Treasury under the Emergency Economic Stabilization Act of 2008 that apply to participants in that program, and with limited exceptions, we are prohibited from paying or accruing any bonus, retention award or incentive compensation to our most highly compensated employee. Also, in connection with any bonuses or incentive compensation, we are required to implement provisions to “clawback” payments to our senior executive officers and our next 20 highest paid employees if any of the criteria on which those payments are based is later found to have been inaccurate.

Like most financial institutions, our recent financial performance has been negatively affected by the decline in the economy and in real estate values in our banking markets, and increased levels of non-performing loans, loan charge-offs and provisions to our allowance for loan losses. As a result, for 2007, we did not achieve the minimum performance targets and no awards were paid under the Plan, and our Board chose not to implement the Plan at all for 2008, 2009, and 2010. As a result, none of our officers and employees were eligible to receive any cash awards under the plan, and no such awards were paid, for either of those years.

Potential Payments Upon Termination of Employment or a Change of Control

Agreements with Robert E. Marziano. The terms of various agreements or arrangements between the Bank Mr. Marziano provided for him to receive payments and benefits if his employment terminated under various circumstances or following a change in control of our company or the Bank. However, during April 2009, we became a participant in the U.S. Department of the Treasury’s (“Treasury”) TARP Capital Purchase Program (the “CPP”). Under rules adopted by Treasury under the Emergency Economic Stabilization Act of 2008, as amended by the American Recovery and Reinvestment Act of 2009, that apply to CPP participants (the “CPP Rules”), we believe we are prohibited from paying severance, “golden parachute,” or other such payments to any of our senior executive officers, or to certain of our other employees, in connection with any termination of their employment for any reason while we remain a CPP participant, other than payments relating to services already performed or benefits already accrued.

In order to comply with the CPP Rules, each of our executive officers have agreed that our Board of Directors or Corporate Governance Committee may unilaterally, and without the officer’s consent, modify any of their compensation agreements or arrangements (including by reducing or eliminating severance benefits) to the extent the Board, in its judgment, considers necessary to comply with the CPP Rules and guidance governing compensation paid by CPP participants. As a result, notwithstanding the terms of the above agreements and arrangements with Mr. Marziano, no severance or golden parachute payments has been made to him.

Change in Control Agreement with Robert W. Johnson. The Bank entered into a change in control agreement with Robert W. Johnson, the Bank’s Senior Vice President and Chief Lending Officer, on September 16, 2009. This agreement provides Mr. Johnson with cash payments in the event of a termination of his employment with the Bank under certain circumstances in connection with a change in control of the Bank. At December 31, 2010, Mr. Johnson was not included in the category of employees to whom we were prohibited from paying such benefits under the CPP Rules. Under the agreement, a “change in control” will be deemed to have occurred if:

any “Person” (as such term is defined in the Securities Exchange Act of 1934) directly or indirectly, in any manner, acquires beneficial ownership of more than 50% of the shares entitled to vote in the election of directors of the Bank or the Company, or in any manner acquires control of the election of a majority of the directors of the Bank or the Company; or

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

all or substantially all of the assets of the Bank or the Company are sold or otherwise transferred to or acquired by any other corporation, association, person, entity or group.

If the Bank terminates Mr. Johnson’s employment other than for “cause” at the effective time of, or any time within two years following a change in control, then Mr. Johnson will be entitled to receive an amount equal to his base salary for 36 months at his annual rate of salary in effect at the time of termination. At December 31, 2010, Mr. Johnson’s base salary was $135,000.

The Bank has “cause” to terminate Mr. Johnson upon:

a good faith determination by the Bank that (a) Mr. Johnson has materially breached any code of conduct or ethics policy that applies to him or the Bank’s employees generally; (b) following reasonable notice and opportunity to correct deficiencies, Mr. Johnson fails to perform or discharge his duties or responsibilities in a reasonably competent and satisfactory manner; (c) Mr. Johnson has engaged in willful misconduct or conduct which is materially detrimental to the general business prospects of the Bank or the Company or which has had or likely will have a material adverse effect on the Bank’s or the Company’s business or reputation.

Mr. Johnson’s violation of any federal or state law or regulation applicable to the Bank or the Company which results from Mr. Johnson’s negligence, willful misconduct, or intentional disregard of such law or regulation and which results in any substantial damage to the Bank or the Company or their reputation

the commission in the course of employment of an act of fraud, embezzlement, theft, or proven person dishonesty by Mr. Johnson;

the conviction of Mr. Johnson of any felony or any criminal offense involving dishonesty or breach of trust or any other event which disqualifies Mr. Johnson from serving as an employee of the Bank

the exclusion of Mr. Johnson by the carrier or underwriter from coverage under the Bank’s then-current “blanket bond” or other fidelity bond or insurance policy, or the occurrence of an event which the Bank believes will result in such exclusion;

If, at the effective time of or within two years of a change in control, a “termination event” occurs, and Mr. Johnson voluntarily terminates his employment, then Mr. Johnson will be entitled to receive an amount equal to his base salary for 36 months at his annual rate of salary in effect at the time of termination. At December 31, 2010, Mr. Johnson’s base salary was $135,000.

A “termination event” will be deemed to have occurred if Mr. Johnson’s base salary is materially reduced or Mr. Johnson is transferred to a job location more than 25 miles from his job location at the time of the change in control;

Life Insurance Benefits. During 2010, the Bank maintained a key-man term life insurance policy covering Mr. Marziano. The total death benefit under the policy was $800,000, of which $500,000 was to be paid to the Bank upon his death. The remaining $300,000 of the death benefit was to be paid to Mr. Marziano’s beneficiary.

We also provide life insurance benefits to each of the named executive officers under our group life insurance plan in which all employees participate on the same terms. Under the group plan, death benefits are payable to a participant’s beneficiaries equal to two times the participant’s annual salary rate at the time of his or her death.

Accelerated Vesting of Stock Options. Under our Omnibus Equity Plan, in the event of a change in control of our company, our Corporate Governance Committee may provide for outstanding stock options and other equity awards under the plan to be assumed by or converted into awards covering shares of the acquiring or surviving company. Alternatively, the Committee may accelerate the vesting of outstanding awards so that they become exercisable in full immediately before the change in control becomes effective. On December 31, 2010, Mr. Johnson had 6,400 unvested stock options that could have been subject to accelerated vested if a change in control had occurred on that date.

DIRECTOR COMPENSATION

General

Directors’ Fees. Our non-employee directors serve and are compensated as directors of the Bank. Our and the Bank’s Boards usually meet jointly, and directors do not receive any additional cash compensation for their services as our directors unless our Board meets separately. The following table describes our standard schedule of fees paid to our non-employee directors for their service during 2010.


Description	Amount
Monthly retainer	$	450

Additional monthly retainer paid to Lead Independent Director		100
Per diem fee for attendance in person at meetings of our and the Bank’s Boards (1)		425
Per diem fee paid to all committee members for attendance at committee meetings:
Audit Committee		300
Corporate Governance Committee		250
Executive, Loan and Risk Oversight Committees		225

Additional per diem fee paid to committee chairmen for attendance at committee meetings:
Audit Committee		450
Corporate Governance Committee		350
Executive, Loan and Risk Oversight Committees		325

(1)

This fee is not paid for attendance at meetings by telephone.

Mr. Talbert is compensated as an officer of the Bank, and he receives no additional compensation for his service as a director.

Stock Options. From time to time we have granted options to our non-employee directors to purchase shares of our common stock. As described above under the caption “Plan Based Awards,” during 2007 our shareholders approved our Omnibus Equity Plan which replaced our 1998 Director Stock Option Plan and which authorizes the grant of nonqualified stock options and restricted stock awards to our directors in a manner similar to that described for officers. Each stock option gives the director who holds it the right to buy shares of our common stock during a stated period of time (ordinarily ten years) at a fixed price per share that is equal to the market value of our stock on the date the option was granted. We have not yet granted any restricted stock awards to directors under the plan.

No stock options or other equity awards of any type were granted under the Omnibus Equity Plan to any of our directors during 2010.

Director Compensation for 2010

The following table summarizes the compensation paid or provided to our non-employee directors for their services during 2010. Although they served as directors during 2010, Michael D. Larrowe, Robert E. Marziano, and Stephen R. Talbert are not listed in the table. Messrs. Larrowe and Talbert were compensated as officers and employees of the Bank and they received no separate or additional compensation for their services as directors. Mr. Marziano was compensated as an officer and employee of the Bank until his resignation, after which he began to receive compensation for his service as a director. Amounts paid to Mr. Marziano for his service as a director are included in the Summary Compensation Table.

2010 DIRECTOR COMPENSATION


Name	Fees Earned or Paid in Cash		Option Awards (1)		Total
Jerry W. Anderson	$	15,575	$	-0-	$	15,575
Alan M. Bailey		20,475		-0-		20,475
William A. Burnette		16,700		-0-		16,700
John A. Drye		20,575		-0-		20,575
Thomas G. Fleming (2)		7,275		-0-		7,275
John W. Googe		20,300		-0-		20,300
Henry H. Land		20,400		-0-		20,400
Steven G. Laymon		18,025		-0-		18,025
Grady L. McClamrock, Jr.		19,000		-0-		19,000
Lynne Scott Safrit		14,750		-0-		14,750
Francis W. Slate		21,775		-0-		21,775

(1)

No stock options or other equity awards of any type were granted to any of our non-employee directors during 2010. On December 31, 2010, our non-employee directors held stock options covering the following aggregate numbers of shares: Messrs. Anderson, Fleming, Burnette, Bailey, Googe, Slate, McClamrock, and Laymon—1,500 shares each; Messrs. Land and Drye—4,245 shares each (of which options for 2,745 shares have since expired without being exercised); and Ms. Safrit—4,244 shares (of which options for 2,744 shares have since expired without being exercised).

(2)

Mr. Fleming resigned from the Board of Directors of the Bank as of May 26, 2010, and resigned from the Board of Directors of the Company as of June 29, 2010.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

Beneficial Ownership of Securities

Principal Shareholders. The following table lists the only person who we believe owned, beneficially or of record, 5% or more of our outstanding common stock on December 31, 2010.

Name and address of beneficial owner

Amount and nature of
beneficial ownership

Percent of
class

Wellington Management Company, LLP

75 State Street

Boston, MA 02109

225,240

(1)

5.78

(1)

The beneficial owner’s Schedule 13G filed with the Securities and Exchange Commission on February 14, 2007, indicates that, in its capacity as an investment adviser, it has shared voting power and shared investment power with respect to all of the listed shares, which are held of record by its clients.

Directors and Executive Officers. The following table describes the beneficial ownership of our common stock on December 31, 2010, by our current directors and named executive officers, individually, and by all our directors and named executive officers as a group.


Name of beneficial owner	Amount and nature of beneficial ownership (1)		Percent of class (2)
Jerry W. Anderson		40,349		1.03	%
Alan M. Bailey		58,665		1.50	%
William A. Burnette		115,157		2.95	%
John A. Drye		23,982		0.62	%
John W. Googe		35,500		0.91	%
Harry E. Hill		53,546		1.37	%
Robert W. Johnson		3,600		0.09	%
Henry H. Land		18,589		0.48	%
Steven G. Laymon		69,606		1.79	%
Robert E. Marziano		136,561		3.50	%
Grady L. McClamrock, Jr.		56,419		1.45	%
Lynne Scott Safrit		15,384		0.39	%
Francis W. Slate		43,014		1.10	%
Stephen R. Talbert		40,275		1.03	%
All current directors and executive officers as a group (14 people)		710,647		18.16	%

(1)

Individuals named and included in the group have shared voting and investment power with respect to certain of the listed shares as follows: Mr. Anderson—12,066 shares; Mr. Bailey—175 shares; Mr. Burnette—6,000 shares; Mr. Drye—1,936 shares; Mr. Hill—9,746 shares; Mr. Marziano—20,639 shares; Mr. McClamrock—3,286 shares; Ms. Safrit—7,948 shares; Mr. Slate—9,264 shares; Mr. Talbert—20,114 shares; and all persons included in the group—91,174 shares. The listed shares also include the following numbers of shares that could be purchased by individuals named and included in the group pursuant to stock options that could be exercised within 60 days of December 31, 2010 and with respect to which shares they may be deemed to have sole investment power: Mr. Anderson—1,500 shares; Mr. Bailey—1,500 shares; Mr. Burnette—1,500 shares; Mr. Drye—1,500 shares; Mr. Googe—1,500 shares; Mr. Land—1,500 shares; Mr. Laymon—1,500 shares; Mr. Johnson—1,600 shares; Mr. McClamrock – 1,500 shares; Ms. Safrit—1,500 shares; Mr. Slate—1,500 shares; and all persons included in the group—15,100 shares. Except as otherwise noted above, and to the best of our knowledge, the individuals named and included in the group exercise sole voting and investment power with respect to all remaining listed shares. Shares listed for certain of the named individuals have been pledged as security for loans to other banks as follows: Mr. Marziano—89,472 shares.

(2)

Percentages are calculated based on 3,897,174 total outstanding shares plus, in the case of each named individual and the group, the number of additional shares that could be purchased by that individual or by persons included in the group under stock options that could be exercised within 60 days of December 31, 2010.

Securities Authorized for Issuance Under Equity Compensation Plans

The following table summarizes all compensation plans and individual compensation arrangements which were in effect on December 31, 2010, and under which shares of our common stock have been authorized for issuance.

EQUITY COMPENSATION PLAN INFORMATION


	(a) Number of shares to be issued upon exercise of outstanding options (1)		(b) Weighted-average exercise price of outstanding options		(c) Number of shares remaining available for future issuance under equity compensation plans (excluding shares reflected in column (a)) (2)
Equity compensation plans approved by our security holders		33,400	$	4.37		267,500
Equity compensation plans not approved by our security holders		N/A		N/A		N/A
Total		33,400	$	4.37		267,500

(1)

Includes outstanding options to purchase an aggregate of 10,400 shares previously granted under our Employee Stock Option Plan and Director Stock Option Plan and options for 23,000 shares granted under the 2007 Omnibus Equity Plan which has replaced those plans.

(2)

Reflects the aggregate number of shares for which options and other equity-based awards could be granted in the future under the 2007 Omnibus Equity Plan. No additional options may be granted under our Employee Stock Option Plan and Director Stock Option Plan.

Item 13. Certain Relationships and Related Transactions, and Director Independence

Related Person Transactions

The Bank has had, and expects to have in the future, banking transactions in the ordinary course of its business with certain of our current directors, nominees for director, executive officers, and our other related persons. Except as described below, all loans included in those transactions were made in the ordinary course of the Bank’s business on substantially the same terms, including interest rates, repayment terms and collateral, as those prevailing at the time the loans were made for comparable transactions with other persons, and those loans did not involve more than the normal risk of collectability or present other unfavorable features.

Director Independence

Each year our Board of Directors reviews transactions, relationships and other arrangements involving our directors and determines which of the directors the Board considers to be “independent.” In making those determinations, the Board applies the independence criteria contained in the listing requirements of The Nasdaq Stock Market. The Board has directed our Audit Committee to assess each outside director’s independence and report its findings to the Board in connection with the Board’s annual determinations, and to monitor the status of each director on an ongoing basis and inform the Board of changes in factors or circumstances that may affect a director’s ability to exercise independent judgment. The following table lists our current directors who our Board believes are “independent” directors under Nasdaq’s criteria.


Jerry W. Anderson	John W. Googe	Lynne Scott Safrit
Alan M. Bailey	Henry H. Land	Francis W. Slate
William A. Burnette	Steven G. Laymon
John A. Drye	Grady L. McClamrock, Jr.

In addition to the specific Nasdaq criteria, in determining the independence of each director the Board considers whether it believes transactions that are disclosable in our proxy statements as “related person transactions,” or any other transactions, relationships, arrangements or factors, could impair a director’s ability to exercise independent judgment. In its determination that the directors named above are independent, those other factors considered by the Committee and the Board included (1) the Bank’s lending relationships with directors who are loan customers; (2) services provided to the Bank by Mr. Googe’s firm in connection with payroll processing and administration services relating to the Bank’s 125 Plan (for which we paid $7,756 during 2010), and (3) legal services that Mr. McClamrock provides from time to time in connection with matters involving such things as loan closings or collections (none of which were provided during 2010). In the case of Mr. McClamrock, the Board concluded that he is independent under Nasdaq’s criteria, but that he may not serve on our Audit Committee.

Item 14. Principal Accounting Fees and Services

Turlington and Company LLP was appointed by our Audit Committee on April 17, 2009, to serve as our independent accountants and audit our consolidated financial statements. Except as described below, under its current procedures our Audit Committee specifically preapproves all audit services and other services provided by our independent accountants. Since it is difficult to determine in advance the exact nature and extent of the tax services or advice we will need during the year, the Committee authorizes our management to obtain tax services from our accountants from time to time during the year up to preapproved aggregate amounts of fees set by the Committee. Requests for services with costs in addition to those amounts would require further Committee approval. The entire Audit Committee generally participates in the preapproval of services. However, in the case of proposals that arise during the year to obtain certain types of non-audit services from our accountants beyond what has been preapproved by the Committee, the Committee delegates authority to its Chairman to preapprove those additional services on behalf of the Committee. Any such action by the Chairman is to be reported to the full Committee at its next regularly scheduled meeting.

As our independent accountants for 2010 and 2009, Turlington and Company LLP provided us with various audit and other professional services for which we were billed, or expect to be billed, for fees as further described below. Our

Audit Committee considers whether the provision of non-audit services by our independent accounting firm is compatible with maintaining its independence. The Committee believes that the provision of non-audit services by Turlington and Company LLP during 2010 and 2009 did not affect its independence.

The following table lists the aggregate amounts of fees paid to Turlington and Company LLP for audit services for 2010 and 2009 and for other services they provided during 2010 and 2009.


Type of Fees and Description of Services	2010			2009
*Audit Fees,* including audits of our consolidated financial statements, reviews of our condensed interim consolidated financial statements, and other audit services	$	105,000		$	85,154

*Audit-Related Fees*		56,250	(1)		-0-

*Tax Fees,* including reviews of our federal and related state income tax returns, non-routine tax consultations		20,100			16,000

*All Other Fees*		-0-			-0-

(1)

Audit-Related Fees for 2010 include amounts paid in connection with audits of the Bank’s 401(k) plan.

Item 15. Exhibits and Financial Statement Schedules

(a)

Financial Statements. The following financial statements are included in Item 8 of this Report:


Reports of Independent Registered Public Accounting Firms			44
Consolidated Balance Sheets—December 31, 2010 and 2009			46
Consolidated Statements of Operations for the years ended December 31, 2010, 2009, and 2008			47
Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2010, 2009, and 2008			48
Consolidated Statements of Cash Flows for the years ended December 31, 2010, 2009, and 2008			49
Notes to Consolidated Financial Statements—December 31, 2010, 2009, and 2008			51

(b)

Exhibits. An Exhibit Index listing exhibits that are being filed or furnished with, or incorporated by reference into, this Report appears immediately following the signature page and is incorporated herein by reference.

(c)

Financial Statement Schedules. No separate financial statement schedules are being filed as all required schedules either are not applicable or are contained in the financial statements listed above or in Item 8 of this Report.

SIGNATURES

In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, we have caused this Report to be signed on our behalf by the undersigned, thereunto duly authorized.


	BANK OF THE CAROLINAS CORPORATION

Date: March 30, 2011	By:	/s/ STEPHEN R. TALBERT
		Stephen R. Talbert
		President and Chief Executive Officer

In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on our behalf and in the capacities and on the dates indicated.


Signature	Title	Date

/s/ STEPHEN R. TALBERT Stephen R. Talbert	President, Vice-Chairman and Chief Executive Officer (principal executive officer)	March 30, 2011

/s/ ERIC E. RHODES Eric E. Rhodes	Vice-President and Chief Financial Officer (principal financial officer and principal accounting officer)	March 30, 2011

/s/ FRANCIS W. SLATE Francis W. Slate	Chairman	March 30, 2011

/s/ JERRY W. ANDERSON Jerry W. Anderson	Director	March 30, 2011

/s/ ALAN M. BAILEY Alan M. Bailey	Director	March 30, 2011

/s/ WILLIAM A. BURNETTE William A. Burnette	Director	March 30, 2011

/s/ JOHN A. DRYE John A. Drye	Director	March 30, 2011

/s/ JOHN W. GOOGE John W. Googe	Director	March 30, 2011

/s/ HENRY H. LAND Henry H. Land	Director	March 30, 2011

/s/ STEVEN G. LAYMON Steven G. Laymon	Director	March 30, 2011

/s/ ROBERT E. MARZIANO Robert E. Marziano	Director	March 30, 2011

/s/ GRADY L. MCCLAMROCK, JR. Grady L. McClamrock, Jr.	Director	March 30, 2011

/s/ LYNNE SCOTT SAFRIT Lynne Scott Safrit	Director	March 30, 2011

EXHIBIT INDEX


Exhibit Number			Description
	3.01		Our Articles of Incorporation, as amended (incorporated by reference from exhibits to our Current Report on Form 8-K dated April 13, 2009)

	3.02		Our By-laws, as amended (incorporated by reference from exhibits to our Current Report on Form 8-K dated August 18, 2006)

	4.01		Indenture between us and Wells Fargo Bank, N.A. (incorporated by reference from exhibits to our Current Report on Form 8-K dated March 26, 2008)

	4.02		Guarantee Agreement between us and Wells Fargo Bank, N.A. (incorporated by reference from exhibits to our Current Report on Form 8-K dated March 26, 2008)

	4.03		Amended and Restated Trust Agreement among us, Wells Fargo Bank N.A. and the Administrators (incorporated by reference from exhibits to our Current Report on Form 8-K dated March 26, 2008)

	4.04		Warrant dated April 17, 2009, between us and the United States Department of the Treasury (incorporated by reference from Exhibits to our Registration Statement on Form S-3 (Reg. No. 333-159934) filed on June 12, 2009)

	10.01		Letter Agreement dated April 17, 2009, between us and the United States Department of the Treasury (incorporated by reference from Exhibits to our Registration Statement on Form S-3 (Reg. No. 333-159934) filed on June 12, 2009)

	10.02	*	Amended and Restated Employment Agreement between us and Robert E. Marziano (incorporated by reference from exhibits to our Current Report on Form 8-K dated December 23, 2008)

	10.03	*	Amended and Restated Employment Agreement between us and Michael D. Larrowe (incorporated by reference from exhibits to our Current Report on Form 8-K dated December 23, 2008)

	10.04	*	Amended and Restated Employment Agreement between us and George E. Jordan (incorporated by reference from exhibits to our Current Report on Form 8-K dated December 23, 2008)

	10.05	*	Change in Control Agreement between us and Robert W. Johnson (filed herewith)

	10.06	*	Employee Stock Option Plan (incorporated by reference from exhibits to our Current Report on Form 8-K dated August 18, 2006)

	10.07	*	Form of Employee Stock Option Agreement (incorporated by reference from exhibits to our Current Report on Form 8-K dated August 18, 2006)

	10.08	*	Director Stock Option Plan, as amended (incorporated by reference from exhibits to our Current Report on Form 8-K dated August 18, 2006)

	10.09	*	Form of Director Stock Option Agreement (incorporated by reference from exhibits to our Current Report on Form 8-K dated August 18, 2006)

	10.10	*	Sections 1.2(g) and 2.5 of Agreement and Plan of Reorganization and Share Exchange dated June 1, 2006, between us and the Bank pertaining to our assumption of the Bank’s Employee Stock Option Plan, Director Stock Option Plan and outstanding stock options (incorporated by reference from exhibits to our Current Report on Form 8-K dated August 18, 2006)

	10.11	*	BOC Financial Corp 1999 Nonstatutory Stock Option Plan (incorporated by reference from exhibits to our Current Report on Form 8-K dated August 18, 2006)

	10.12	*	BOC Financial Corp 1999 Incentive Stock Option Plan (incorporated by reference from exhibits to our Current Report on Form 8-K dated August 18, 2006)

	10.13	*	Section 6.07 of Agreement and Plan of Reorganization and Merger dated July 20, 2001, between the Bank and BOC Financial Corp pertaining to the Bank’s assumption of outstanding BOC Financial Corp (incorporated by reference from exhibits to our Current Report on Form 8-K dated August 18, 2006)

	10.14	*	Option Conversion Agreements relating to stock options previously granted by BOC Financial Corp and held by former directors of BOC Financial Corp as assumed by us from the Bank (incorporated by reference from exhibits to our Current Report on Form 8-K dated August 18, 2006)


Exhibit Number			Description

	10.15	*	2007 Omnibus Equity Plan (incorporated by reference from Exhibits to our Current Report on Form 8-K dated May 24, 2007)

	10.16	*	Management Incentive Compensation Plan (incorporated by reference from Exhibits to our Current Report on Form 8-K dated May 24, 2007)

	23.01		Consent of Turlington and Company LLP (filed herewith)

	23.02		Consent of Dixon Hughes PLLC (filed herewith)

	31.01		Certification of our Chief Executive Officer pursuant to Rule 13a-14(a) (filed herewith)

	31.02		Certification of our Chief Financial Officer pursuant to Rule 13a-14(a) (filed herewith)

	32.01		Certifications of our Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 (filed herewith)

	99.01		Certification of our Chief Executive Officer pursuant to Section 111(b)(4) of EESA

	99.02		Certification of our Chief Financial Officer pursuant to Section 111(b) (4) of EESA

An asterisk denotes a management contract or compensatory plan or arrangement.

COPIES OF EXHIBITS ARE AVAILABLE UPON REQUEST TO:

ERIC E. RHODES

CHIEF FINANCIAL OFFICER

BANK OF THE CAROLINAS

P.O. BOX 129

MOCKSVILLE, N.C. 27028

This Annual Report on Form 10-K also serves as the annual disclosure statement

of Bank of the Carolinas pursuant to Part 350 of the

Federal Deposit Insurance Corporation’s Rules and Regulations.

THIS STATEMENT HAS NOT BEEN REVIEWED OR CONFIRMED FOR ACCURACY OR

RELEVANCE BY THE FEDERAL DEPOSIT INSURANCE CORPORATION.

Bank of the Carolinas CORP - FORM 10-K - March 30, 2011

Attached files

Bank of the Carolinas CORP Reports