The following discussion presents an overview of the unaudited financial statements for the three and six months ended June 30, 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 June 30, 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 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. 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.

The current economic situation has led the U.S. government to attempt to stabilize the financial system. For example, the U.S. government enacted the Emergency Economic and Stabilization Act of 2008 ("EESA"), which, among other things, authorized the U.S. Treasury Department ("Treasury") to establish the Troubled Asset Relief Program ("TARP"), of which the Capital Purchase Program ("CPP") is a part. See the "Liquidity and Capital Resources" section below for a more detailed discussion of the Company's participation in the CPP. Additionally, the American Recovery and Reinvestment Act of 2009 ("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. It is not clear at this time what impact these measures will have on the Company or the financial markets as a whole. Management will continue to monitor the effects of these programs as they relate to the Company and its financial operations.

The Bank is subject to insurance assessments imposed by the Federal Deposit Insurance Commission ("FDIC"), which is actively seeking to replenish its insurance fund. The FDIC increased risk-based assessment rates uniformly by 7 basis points, on an annual basis, beginning with the first quarter of 2009. On May 22, 2009, the FDIC adopted a final rule imposing a 5 basis point special assessment on each insured depository institution's assets less Tier 1 capital as of June 30, 2009, not to exceed 10 basis points multiplied by the institution's assessment base for the second quarter of 2009. The Company accrued $750 thousand as of June 30, 2009 related to this special assessment with the related expense recorded in noninterest expense. The FDIC will collect the special assessment on September 30, 2009. An additional special assessment in 2009 of up to 5 basis points later in 2009 is expected, but the amount is uncertain at this time.

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 and six month periods ended June 30, 2009.

• The Company reported net income of $1.3 million for the quarter ended June 30, 2009 compared to net income of $2.2 million for the quarter ended June 30, 2008. After dividends and accretion on preferred stock issued under the CPP of $0.6 million, net income available to common shareholders was $0.8 million, or $0.07 per diluted share, for the second quarter of 2009 compared with $2.2 million, or $0.20 per diluted share, for the second quarter of 2008.

The Company reported a net loss of $3.1 million for the six months ended June 30, 2009 compared to net income of $4.4 million for the six months ended June 30, 2008. After dividends and accretion on preferred stock issued under the CPP of $1.2 million, net loss attributable to common shareholders was $4.3 million, or $0.38 per diluted share, for the first half of 2009 compared with net income available to common shareholders of $4.4 million, or $0.39 per diluted share, for the first half of 2008.

• Net interest income increased $1.2 million, or 11.3%, from $10.9 million for the quarter ended June 30, 2008 to $12.2 million for the quarter ended June 30, 2009. This improvement was partially due to an increase in net interest margin from 3.14% for the second quarter of 2008 to 3.17% for the second quarter of 2009, coupled with a 10.8% growth in average earning assets over the same periods. Net interest margin benefited from a significant decline in the cost of interest-bearing liabilities from 3.24% for the second quarter of 2008 to 2.50% for the second quarter of 2009, which was largely due to disciplined pricing controls and a more rational competitive pricing landscape for customer deposits as liquidity concerns in the banking industry have somewhat subsided. Partially offsetting declining funding costs was a drop in loan yields largely due to steps taken by the Federal Reserve to revive an ailing national economy last year. One effect of the many policy actions implemented was a drop in the prime rate by 400 basis points during 2008, which negatively impacted yields on the Company's prime-based loan portfolio. This rapid decline in rates decreased loan yields from 6.23% for the second quarter of 2008 to 5.43% for the second quarter of 2009.

Net interest income increased $508 thousand, or 2.3%, from $21.8 million for the six months ended June 30, 2008 to $22.3 million for the six months ended June 30, 2009. This improvement was primarily due to growth of 11.2% in average earning assets, partially offset by a decrease in net interest margin from 3.20% for the first half of 2008 to 2.95% for the first half of 2009. Net interest margin was negatively impacted by a drop in loan yields from 6.53% for the first half of 2008 to 5.30% for the first half of 2009, but the margin was benefited by a significant decline in the cost of interest-bearing liabilities from 3.50% for the first half of 2008 to 2.65% for the first half of 2009.

Provision for loan losses was $7.7 million for the six months ended June 30, 2009 compared to $1.4 million for the six months ended June 30, 2008. The significant increase in the provision was primarily driven by deteriorating economic conditions and weakness in the local real estate markets which resulted in downgrades to credit ratings of certain loans in the portfolio, but the provision increase was also partially due to loan growth of $115.2 million from June 30, 2008. Additionally, the decline in real estate values securing certain nonperforming loans required increased provision during the period. Net charge-offs for the six months ended June 30, 2009 were $3.9 million, or 0.30% of average loans (annualized), compared to net charge-offs of $1.1 million, or 0.19% of average loans (annualized), for the six months ended June 30, 2008.

• Noninterest income increased $722 thousand, or 24.1%, in the second quarter of 2009 compared to the same period one year ago. Included in this increase was a nonrecurring gain recorded during the quarter of $913 thousand from the collection of bank-owned life insurance ("BOLI") policy proceeds. Additionally, the Company recorded a $336 thousand net gain from the sale of certain debt securities in the second quarter of 2009 compared to a $69 thousand net gain on the sale of debt securities in the same quarter one year ago. Partially offsetting these gains was a $307 thousand decrease in service charge income and a $189 thousand decrease in other loan fees. Service charge income, which includes overdraft and non-sufficient funds charges, dropped primarily from a decline in consumer spending during the current economic recession.

Noninterest income increased $588 thousand, or 11.2%, in the first half of 2009 compared to the same period one year ago. Included in this increase was a nonrecurring gain recorded during the period of $913 thousand from the collection of BOLI policy proceeds. Partially offsetting this gain was a $314 thousand decrease in service charge income primarily due to a decline in consumer spending during the current economic recession.

• Noninterest expense increased $2.5 million, from $10.0 million during the second quarter of 2008 to $12.5 million during the second quarter of 2009. This increase included higher FDIC deposit insurance expense of $998 thousand over the quarters under comparison, of which $750 thousand was related to an accrual of the FDIC's mandatory special assessment imposed on all insured financial institutions for the purpose of replenishing its insurance fund. The majority of the remaining $248 thousand increase in deposit insurance expense was due to increases in rates as the FDIC continues to increase insurance premiums to cover higher monitoring costs and claims. Further, salaries and employee benefits as well as occupancy costs increased a combined $978 thousand primarily due to additional costs incurred as new branches were opened during the past year in Asheville and Clayton in addition to the four branches purchased in the Fayetteville market in December 2008. Directors fees increased $288 thousand largely from an accelerated payout of deferred compensation benefits upon the death of a former director.

Noninterest expense increased $4.4 million, from $19.6 million during the first half of 2008 to $24.0 million during the first half of 2009. This increase included higher FDIC deposit insurance expense of $1.2 million over the periods under comparison, of which $750 thousand was related to an accrual of the FDIC's mandatory special assessment imposed on all insured financial institutions for the purpose of replenishing its insurance fund. The majority of the remaining $430 thousand increase in deposit insurance expense was due to increases in rates as the FDIC continues to increase insurance premiums to cover higher monitoring costs and claims. Further, salaries and employee benefits as well as occupancy costs increased a combined $2.4 million primarily due to additional costs incurred as new branches were opened during the past year in Asheville and Clayton in addition to the four branches purchased in the Fayetteville market in December 2008. Directors fees increased $247 thousand largely from an accelerated payout of deferred compensation benefits upon the death of a former director.

Quarter ended June 30, 2009 compared to quarter ended June 30, 2008

The Company reported net income of $1.3 million for the quarter ended June 30, 2009 compared to net income of $2.2 million for the quarter ended June 30, 2008. After dividends and accretion on preferred stock of $0.6 million, net income available to common shareholders was $0.8 million, or $0.07 per diluted share, for the second quarter of 2009 compared with $2.2 million, or $0.20 per diluted share, for the second quarter of 2008. Net interest income increased by $1.2 million over the quarters under comparison, reflecting a higher net interest margin and loan growth. Provision for loan losses increased by $842 thousand partially due to loan growth and partially from continued deteriorating economic conditions and weakness in the local real estate markets which resulted in downgrades to the credit ratings and chargeoffs of certain loans in the portfolio. Noninterest income increased by $722 thousand, which included nonrecurring gains from the collection of BOLI policy proceeds and the sale of certain debt securities in the second quarter of 2009. Partially offsetting these gains was a decrease in service charge income and other loan fees. Noninterest expense increased $2.5 million over the quarters under comparison partially from the FDIC's special assessment on all insured financial institutions and overall increase in base rates for deposit insurance but also partially 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 by $487 thousand, reflecting lower net income before taxes.

Net Interest Income. Net interest income increased $1.2 million, or 11.3%, from $10.9 million for the quarter ended June 30, 2008 to $12.2 million for the quarter ended June 30, 2009. Average earning assets increased $155.4 million to $1.59 billion for the quarter ended June 30, 2009 from $1.43 billion for the quarter ended June 30, 2008. Average interest-bearing liabilities increased $94.6 million to $1.38 billion for the quarter ended June 30, 2009 from $1.28 billion for the quarter ended June 30, 2008. The net interest margin on a fully tax equivalent basis increased by 3 basis points to 3.17% for the quarter ended June 30, 2009 from 3.14% for the quarter ended June 30, 2008. The earned yield on average interest-earning assets was 5.34% and 6.07% for the quarters ended June 30, 2009 and 2008, respectively, while the interest rate on average interest-bearing liabilities for those periods was 2.50% and 3.24%, respectively. The increase in the margin was primarily due to the significant decline in the cost of customer deposits through disciplined pricing controls and a more rational competitive pricing landscape as liquidity concerns in the banking industry have somewhat subsided. Partially offsetting declining funding costs was a drop in loan yields largely due to steps taken by the Federal Reserve to revive an ailing national economy last year. One effect of the many policy actions implemented was a drop in the prime rate by 400 basis points during 2008, which negatively impacted yields on the Company's prime-based loan portfolio.

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 June 30, 2009, March 31, 2009 and June 30, 2008
(Unaudited)
Tax Equivalent Basis (1)
                                            June 30, 2009                                       March 31, 2009                                      June 30, 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                 $       1,115,003    $  15,244              5.48 %  $       1,095,804    $  13,942              5.16 %  $       1,010,899    $  15,713              6.23 %
Consumer                              54,552          902              6.63               52,873          910              6.98               46,344          869              7.52
Home equity                           94,054          974              4.15               93,861          966              4.17               80,842        1,101              5.46
Residential mortgages                 21,962          292              5.32               22,900          274              4.79               28,710          427              5.95
Total loans                        1,285,571       17,412              5.43            1,265,438       16,092              5.16            1,166,795       18,111              6.23
Investment securities
(3)                                  278,033        3,731              5.37              288,679        3,957              5.48              256,406        3,555              5.55
Federal funds sold and
interest-earning cash
(4)                                   24,898            6              0.10               19,900           10              0.20                9,898           33              1.34
Total interest-earning
assets                             1,588,502    $  21,149              5.34 %          1,574,017    $  20,059              5.17 %          1,433,099    $  21,699              6.07 %
Cash and due from banks               15,294                                              22,116                                              22,938
Other assets                          80,296                                              78,814                                             135,976
Allowance for loan
losses                               (18,705 )                                           (15,180 )                                           (13,656 )
Total assets               $       1,665,387                                   $       1,659,767                                   $       1,578,357

Liabilities and Equity
Savings deposits           $          29,609    $      13              0.18 %  $          28,793    $      13              0.18 %  $          30,540    $      35              0.46 %
Interest-bearing demand
deposits                             368,132        1,152              1.26              353,262        1,202              1.38              335,851        1,635              1.95
Time deposits                        796,306        5,868              2.96              800,879        6,551              3.32              668,690        6,356              3.81
Total interest-bearing
deposits                           1,194,047        7,033              2.36            1,182,934        7,766              2.66            1,035,081        8,026              3.11
Borrowed funds                       140,682        1,273              3.63              146,233        1,389              3.85              181,841        1,820              4.01
Subordinated debt                     30,930          278              3.61               30,930          322              4.22               30,930          403              5.23
Repurchase agreements
and fed funds purchased               12,010            7              0.23               13,849            7              0.20               35,183          106              1.21
Total interest-bearing
liabilities                        1,377,669    $   8,591              2.50 %          1,373,946    $   9,484              2.80 %          1,283,035    $  10,355              3.24 %
Noninterest-bearing
deposits                             130,460                                             124,893                                             113,590
Other liabilities                     12,042                                              11,643                                              10,787
Total liabilities                  1,520,171                                           1,510,482                                           1,407,412
Shareholders' equity                 145,216                                             149,285                                             170,945
Total liabilities and
shareholders' equity       $       1,665,387                                   $       1,659,767                                   $       1,578,357

Net interest spread (5)                                                2.84 %                                              2.37 %                                              2.83 %
Tax equivalent
adjustment                                      $     394                                           $     394                                           $     416
Net interest income and
net interest margin (6)                         $  12,558              3.17 %                       $  10,575              2.72 %                       $  11,344              3.14 %

(1) The tax equivalent basis is computed using a tax rate of 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) The Federal Reserve began paying interest on cash balances during the quarter ended December 31, 2008. For comparison purposes, average balances have been adjusted for all periods presented to include cash held at the Federal Reserve as interest earning.
(5) Net interest spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.
(6) Net interest margin represents net interest income divided by average interest-earning assets.

Interest income on investment securities increased from $3.1 million in for the quarter ended June 30, 2008 to $3.3 million for the quarter ended June 30, 2009, an increase of $198 thousand, or 6.3%. This increase was due to growth in the . . .