The following discussion presents an overview of the unaudited financial statements for the three months ended March 31, 2009 and 2008 for Capital Bank Corporation (the "Company") and its wholly owned subsidiary, Capital Bank (the "Bank"). This discussion and analysis is intended to provide pertinent information concerning financial condition, results of operations, liquidity, and capital resources for the periods covered and should be read in conjunction with the unaudited financial statements and related footnotes contained in Part I, Item 1 of this report.

Information set forth below contains various forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), which statements represent the Company's judgment concerning the future and are subject to risks and uncertainties that could cause the Company's actual operating results to differ materially. Such forward-looking statements can be identified by the use of forward-looking terminology, such as "may," "will," "expect," "anticipate," "estimate," "believe," or "continue," or the negative thereof or other variations thereof or comparable terminology. The Company cautions that such forward-looking statements are further qualified by important factors that could cause the Company's actual operating results to differ materially from those in the forward-looking statements, as well as the factors set forth in Part II, Item 1A of this report, and the Company's periodic reports and other filings with the Securities and Exchange Commission ("SEC").

Overview

Capital Bank is a full-service state chartered community bank conducting business throughout North Carolina. The Bank operates through four North Carolina regions: Triangle, Sandhills, Triad and Western. The Bank was incorporated on May 30, 1997 and opened its first branch in June of that same year in Raleigh. In 1999, the shareholders of the Bank approved the reorganization of the Bank into a bank holding company. In 2001, the Company received approval to become a financial holding company. As of March 31, 2009, the Company conducted no business other than holding stock in the Bank and its three trusts, Capital Bank Statutory Trust I, II, and III.

The Bank's business consists principally of attracting deposits from the general public and investing these funds in loans secured by commercial real estate, secured and unsecured commercial and consumer loans, single-family residential mortgage loans and home equity lines. As a community bank, the Bank's profitability depends primarily upon its levels of net interest income, which is the difference between interest income from interest-earning assets and interest expense on interest-bearing liabilities. When interest-earning assets approximate or exceed interest-bearing liabilities, any positive interest rate spread will generate net interest income.

The Bank's profitability is also affected by its provision for loan losses, noninterest income and other operating expenses. Noninterest income primarily consists of service charges and ATM fees, fees generated from originating mortgage loans, commission income generated from brokerage activity, and the increase in cash surrender value of bank-owned life insurance. Operating expenses primarily consist of compensation and benefits, occupancy related expenses, advertising, data processing, professional fees, telecommunication and other noninterest expenses.

The Bank's operations are influenced significantly by local economic conditions and by policies of financial institution regulatory authorities. The Bank's cost of funds is influenced by interest rates on competing investments and by rates offered on similar investments by competing financial institutions in our market area, as well as general market interest rates. Lending activities are affected by the demand for financing, which in turn is affected by the prevailing interest rates.

Impact of Recent Developments on the Banking Industry

The banking industry, including the Company, is operating in a challenging and volatile economic environment. The effects of the downturn in the housing market have adversely impacted credit markets, consumer confidence and the broader economy. Along with other financial institutions, the Company's stock price has suffered as a result. Management cannot predict when these market difficulties will subside. While the current economic downturn and the difficulties it presents for the Company and others in the banking industry are unprecedented, management believes that the business is cyclical and must be viewed and measured over time. The Company's primary focus at this time is to manage the business safely during the economic downturn and be poised to take advantage of any market opportunities that may arise.

Additionally, the American Recovery and Reinvestment Act of 2009 ("ARRA") was enacted on February 17, 2009. The ARRA includes a wide variety of programs intended to stimulate the economy and provide for extensive infrastructure, energy, health, and education needs. The ARRA imposes certain new executive compensation and corporate governance obligations on all current and future TARP recipients, including the Company, until the institution has redeemed the preferred stock, which TARP recipients are now permitted to do under the ARRA without regard to the three year holding period and without the need to raise new capital, subject to approval of its primary federal regulator.

The Bank is subject to insurance assessments imposed by the FDIC. On December 16, 2008, the FDIC adopted a final rule increasing risk-based assessment rates uniformly by 7 basis points, on an annual basis, for the first quarter of 2009. On February 27, 2009, the FDIC adopted an interim rule, with request for comment, which would institute a one-time special assessment of 20 cents per $100 of domestic deposits on FDIC insured institutions. If approved, the Bank estimates that the assessment would total approximately $2.4 million. The assessment would be payable on September 30, 2009. On March 5, 2009, the chairman of the FDIC indicated that the FDIC intended to lower the special assessment to 10 cents per $100 of insured deposits contingent upon Congress increasing the FDIC's line of credit with the Treasury to $100 billion. On May 6, 2009, the U.S. Senate passed legislation that would increase the FDIC's line of credit with the Treasury to $100 billion. The U.S. House of Representatives passed similar legislation in March 2009. The legislation has not yet been reconciled and enacted into law. Even though both the U.S. Senate and the U.S. House of Representatives have approved the increase in the FDIC's line of credit, the assessment rates, including the special assessment, are subject to change at the discretion of the Board of Directors of the FDIC.

Critical Accounting Policies and Estimates

The Company's critical accounting policies are described in Note 1 of the Company's Annual Report on Form 10-K for the year ended December 31, 2008. These policies are important in understanding management's discussion and analysis. Some of the Company's accounting policies require the Company to make estimates and judgments regarding uncertainties that may affect the reported amounts of assets, liabilities, revenues and expenses.

The Company has identified four accounting policies as being critical in terms of significant judgments and the extent to which estimates are used: allowance for loan losses, investment impairment, income tax valuation allowances and impairment of long-lived assets, including other intangible assets. In many cases, there are several alternative judgments that could be used in the estimation process. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. For more information on the Company's critical accounting policies, refer to Part II, Item 7 of the Company's Annual Report on Form 10-K for the year ended December 31, 2008.

Executive Summary

As discussed in more detail below, the following is a summary of our significant results for the three months ended March 31, 2009.

• Net interest income decreased $728 thousand, or 6.7%, from $10.9 million for the quarter ended March 31, 2008 to $10.2 million for the quarter ended March 31, 2009. This decrease was primarily due to a decline in the Company's net interest margin from 3.23% for the quarter ended March 31, 2008 to 2.76% for the quarter ended March 31, 2009. The decline in the net interest margin was primarily a result of the 2.0% reduction in the prime rate over the last twelve months and competitive pressures in the Company's primary markets for retail deposits. The majority of the Company's loans are prime-based, while the Company's interest-bearing deposits are impacted more by competitive rates in the marketplace offered for time deposits. The margin compression was partially offset by 10.6% growth in average earning assets over the same period.

• Provision for loan losses was $6.0 million for the quarter ended March 31, 2009 compared to $565 thousand for the quarter ended March 31, 2008. The significant increase in the provision was primarily driven by deteriorating economic conditions and weaknesses in the local real estate markets which resulted in downgrades to the credit ratings of certain loans in the portfolio and a significant increase in the balances of nonperforming loans and was also partially due to loan growth of $126.6 million from March 31, 2008. Additionally, the decline in real estate values securing certain nonperforming loans required increased provision during the quarter. Net charge-offs for the quarter ended March 31, 2009 were $2.3 million, or 0.73% of average loans (annualized), compared to net charge-offs of $573 thousand, or 0.20% of average loans (annualized), for the quarter ended March 31, 2008. Nonperforming loans and past due loans increased from $4.3 million and $9.4 million, respectively, as of March 31, 2008 to $17.0 million and $17.1 million, respectively, as of March 31, 2009.

• Noninterest income decreased from $2.2 million for the quarter ended March 31, 2008 to $2.1 million for the quarter ended March 31, 2009, a decline of $134 thousand, or 6.0%. The primary reason for the overall decline in noninterest income was an impairment charge of $320 thousand recorded on an equity investment in a correspondent financial institution during the quarter ended March 31, 2009 compared to a gain of $71 thousand on the sale of certain debt securities during the quarter ended March 31, 2008. The impairment charge this quarter represents the full amount of the Company's investment in that institution. Partially offsetting the impact of the impairment charge, mortgage and other loan fees increased a net of $142 thousand, or 36.9%, compared to the same quarter last year primarily as a result of management's emphasis on increasing loan-related fee income as well as favorable interest rates for the refinancing of residential and commercial loans.

• Noninterest expense increased from $9.6 million for the quarter ended March 31, 2008 to $11.6 million for the quarter ended March 31, 2009, an increase of $1.9 million, or 20.2%. Salaries and employee benefits, occupancy, furniture and equipment, and data processing and telecommunications expenses increased a combined $1.6 million primarily due additional costs incurred as new branches were opened during the past year in Asheville (May 2008) and Clayton (December 2008) in addition to four branches purchased in the Fayetteville market (December 2008). FDIC deposit insurance costs rose by $182 thousand as the regulatory agency continued to increase premiums to cover higher monitoring costs and claims.

Quarter ended March 31, 2009 compared to quarter ended March 31, 2008

The Company reported a net loss of $4.5 million, or $0.45 per diluted share, for the quarter ended March 31, 2009 compared to net income of $2.2 million, or $0.19 per diluted share, for the quarter ended March 31, 2008. Net income decreased by $6.6 million, primarily due to a $5.4 million increase in provision for loan losses. Additionally, net interest income decreased by $728 thousand over the quarters under comparison, reflecting a lower net interest margin. Noninterest income decreased by $134 thousand primarily due to an impairment charge taken on an equity investment in a financial institution while noninterest expense increased $1.9 million over the quarters under comparison primarily due to higher salaries and benefits as well as occupancy expenses from the purchase of four branches in Fayetteville and the opening of a Clayton branch in December 2008. Taxes declined from expense of $799 thousand for the quarter ended March 31, 2008 to a benefit of $800 thousand for the quarter ended March 31, 2009, reflecting the decline in net income before taxes over the same quarters.

Net Interest Income. Net interest income decreased $728 thousand, or 6.7%, from $10.9 million for the quarter ended March 31, 2008 to $10.2 million for the quarter ended March 31, 2008. Average earning assets increased $148.9 million to $1.56 billion for the quarter ended March 31, 2009 from $1.41 billion for the quarter ended March 31, 2008. Average interest-bearing liabilities increased $114.7 million to $1.37 billion for the quarter ended March 31, 2009 from $1.26 billion for the quarter ended March 31, 2008. The net interest margin on a fully tax equivalent basis decreased by 47 basis points ("bps") to 2.76% for the quarter ended March 31, 2009 from 3.23% for the quarter ended March 31, 2008. The earned yield on average interest-earning assets was 5.23% and 6.60% for the quarters ended March 31, 2009 and 2008, respectively, while the interest rate on average interest-bearing liabilities for those periods was 2.80% and 3.76%, respectively. The decline in the net interest margin was primarily a result of the 2.0% reduction in the prime rate over the last twelve months and competitive pressures in the Company's primary markets for retail deposits. The majority of the Company's loans are prime-based, while the Company's interest-bearing deposits are impacted more by competitive rates in the marketplace offered for time deposits.

The following table shows the Company's effective yield on earning assets and cost of funds. Yields and costs are computed by dividing income or expense for the year by the respective daily average asset or liability balance.

CAPITAL BANK CORPORATION
Average Balances, Interest Earned or Paid, and Interest Yields/Rates
For the Three Months Ended March 31, 2009, December 31, 2008 and March 31, 2008
(Unaudited)
Tax Equivalent Basis (1)

                                            March 31, 2009                                    December 31, 2008                                     March 31, 2008
(Dollars in thousands)                           Amount                                              Amount                                              Amount
                            Average Balance      Earned       Average Rate      Average Balance      Earned       Average Rate      Average Balance      Earned       Average Rate
Assets
Loans receivable: (2)
Commercial                 $       1,095,804    $  13,942              5.16 %  $       1,052,172    $  14,719              5.55 %  $         986,205    $  16,777              6.82 %
Consumer                              52,873          910              6.98               47,537          888              7.41               46,700          910              7.82
Home equity                           93,861          966              4.17               89,125        1,047              4.66               79,564        1,321              6.66
Residential mortgages                 22,900          274              4.79               24,193          355              5.87               30,259          491              6.49
Total loans                        1,265,438       16,092              5.16            1,213,027       17,009              5.56            1,142,728       19,499              6.84
Investment securities
(3)                                  289,368        3,957              5.47              246,658        3,430              5.56              256,538        3,590              5.60
Federal funds sold and
other interest on
short-term investments                 1,437           13              3.67               13,737           25              0.72                8,079           55              2.73
Total interest-earning
assets                             1,556,243    $  20,062              5.23 %          1,473,422    $  20,464              5.51 %          1,407,345    $  23,144              6.60 %
Cash and due from banks               40,578                                              25,018                                              26,232
Other assets                          78,126                                             136,387                                             136,071
Allowance for loan
losses                               (15,180 )                                           (14,010 )                                           (13,662 )
Total assets               $       1,659,767                                   $       1,620,817                                   $       1,555,986

Liabilities and Equity
Savings deposits           $          28,793    $      13              0.18 %  $          27,948    $      11              0.16 %  $          30,382    $      46              0.61 %
Interest-bearing demand
deposits                             353,262        1,205              1.38              336,011        1,363              1.61              333,108        1,855              2.23
Time deposits                        800,879        6,551              3.32              758,491        6,733              3.52              657,609        7,171              4.37
Total interest-bearing
deposits                           1,182,934        7,769              2.66            1,122,450        8,107              2.87            1,021,099        9,072              3.56
Borrowed funds                       146,233        1,389              3.85              145,962        1,605              4.36              171,645        2,022              4.72
Subordinated debt                     30,930          322              4.22               30,930          424              5.44               30,930          526              6.82
Repurchase agreements
and fed funds purchased               13,849            7              0.20               22,050           20              0.36               35,563          189              2.13
Total interest-bearing
liabilities                        1,373,946    $   9,487              2.80 %          1,321,392    $  10,156              3.05 %          1,259,237    $  11,809              3.76 %
Noninterest-bearing
deposits                             124,893                                             115,893                                             118,007
Other liabilities                     11,643                                              12,305                                              11,132
Total liabilities                  1,510,482                                           1,449,590                                           1,388,376
Shareholders' equity                 149,285                                             171,227                                             167,610
Total liabilities and
shareholders' equity       $       1,659,767                                   $       1,620,817                                   $       1,555,986

Net interest spread (4)                                                2.43 %                                              2.46 %                                              2.83 %
Tax equivalent
adjustment                                      $     394                                           $     376                                           $     426
Net interest income and
net interest margin (5)                         $  10,575              2.76 %                       $  10,308              2.78 %                       $  11,335              3.23 %

(1) The tax equivalent basis is computed using a blended federal and state tax rate of approximately 34%.

(2) Loans receivable include nonaccrual loans for which accrual of interest has not been recorded.

(3) The average balance for investment securities excludes the effect of their mark-to-market adjustment, if any.

(4) Net interest spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.

(5) Net interest margin represents net interest income divided by average interest-earning assets.

Interest income on investment securities increased from $3.2 million in for the quarter ended March 31, 2008 to $3.6 million for the quarter ended March 31, 2009, an increase of $399 thousand, or 12.6%. This increase is due to growth in the investment portfolio, partially offset by slightly lower investment yields. Average investment balances increased from $256.5 million for the quarter ended March 31, 2008 to $289.4 million for the quarter ended March 31, 2009, and the tax equivalent yield on investment securities decreased from 5.60% to 5.47% over the same period. The increase in average investment balances largely reflects management's efforts to quickly deploy the $41.3 million of capital received from the CPP in December 2008 and net cash received from the purchase of four Fayetteville branch offices from Omni National Bank, also in December 2008.

Interest expense on deposits decreased from $9.1 million for the quarter ended March 31, 2008 to $7.8 million for the quarter ended March 31, 2009. The decrease is primarily due to a decrease in average deposit rates from 3.56% for the quarter ended March 31, 2008 to 2.66% for the quarter ended March 31, 2009. For time deposits, which represented 67.7% and 64.4% of total average interest-bearing deposits for the quarters ended March 31, 2009 and 2008, respectively, the average rate decreased from 4.37% for the quarter ended March 31, 2008 to 3.32% for the quarter ended March 31, 2009, reflecting the declining interest rate environment over the past year and some recent easing in competitor pricing for time deposits in part from government programs to ensure liquidity remains available in the financial system.

Interest expense on borrowings decreased from $2.7 million for the quarter ended March 31, 2008 to $1.7 million for the quarter ended March 31, 2009, partially due to declines in interest rates as well as a $47.1 million decrease in average borrowings over the two periods. The rate on average borrowings, including subordinated debt and repurchase agreements, for the quarter ended March 31, 2008 was 4.29% compared to 3.65% for the quarter ended March 31, 2009. In July 2003, the Company entered into interest rate swap agreements on $25.0 million of its outstanding Federal Home Loan Bank advances to swap fixed rate borrowings to a variable rate. In February 2009, swaps on $15.0 million of advances were unwound, and the proceeds received from the swap counterparty will be amortized as a reduction to interest expense over the remaining term of the underlying advances. The net effect of the swaps, including amortization of swap terminations, was a decrease to interest expense of $87 thousand and an increase to interest expense of $43 thousand for the quarters ended March 31, 2009 and 2008, respectively.

Provision for Loan Losses. Provision for loan losses was $6.0 million for the quarter ended March 31, 2009 compared to $565 thousand for the quarter ended March 31, 2008. The significant increase in the provision was primarily driven by deteriorating economic conditions and weaknesses in the local real estate markets which resulted in downgrades to the credit ratings of certain loans in the portfolio and a significant increase in the balances of nonperforming loans and was also partially due to loan growth of $126.6 million from March 31, 2008. Additionally, the decline in real estate values securing certain nonperforming loans required increased provision during the quarter. Net charge-offs for the quarter ended March 31, 2009 were $2.3 million, or 0.73% of average loans . . .