Carolina Bank (CLBH) 10-Q 2010 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2010

or

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission File Number: 000-31877

Carolina Bank Holdings, Inc.

(Exact name of registrant as specified in its charter)

North Carolina	56-2215437
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
101 North Spring Street, Greensboro, North Carolina	27401
(Address of principal executive offices)	(Zip Code)

(336) 288-1898

(Registrant’s telephone number, including area code)

n/a

(Former name, former address and former fiscal year, if changed since last report)

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.    x  Yes    ¨  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 (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	¨	Accelerated filer	¨
Non-accelerated filer	¨  (Do not check if a smaller reporting company)	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    x  No

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

There were 3,387,045 shares of the Issuer’s common stock, $1.00 par value, outstanding as of August 11, 2010.

CAROLINA BANK HOLDINGS, INC.

INDEX

	Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements	2
Consolidated Balance Sheets as of June 30, 2010 and December 31, 2009	2
Consolidated Statements of Operations for the three and six months ended June 30, 2010 and 2009	3
Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2010 and 2009	4
Consolidated Statement of Stockholders’ Equity for the six months ended June 30, 2010	5
Consolidated Statements of Cash Flows for the six months ended June 30, 2010 and 2009	6
Notes to Consolidated Financial Statements	7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
Item 4T. Controls and Procedures	23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings	24
Item 4. (Reserved)	24
Item 6. Exhibits	24
Exhibit 31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act	26
Exhibit 31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act	28
Exhibit 32.1 Certification Pursuant to 18 U.S.C. Section 1350	30

1

PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements

Carolina Bank Holdings, Inc. and Subsidiary

Consolidated Balance Sheets

	June 30, 2010			December 31, 2009
	(unaudited)
	(in thousands)
Assets
Cash and due from banks	$	6,038		$	6,416
Interest-bearing deposits with banks		30,942			34,039
Securities available-for-sale, at fair value		48,572			52,924
Securities held-to-maturity		681			770
Loans held for sale		46,207			29,388
Loans		533,486			530,606
Less allowance for loan losses		(10,270	)		(10,081	)
Net loans		523,216			520,525
Premises and equipment, net		18,965			19,351
Other assets		29,719			33,639
Total assets	$	704,340		$	697,052
Liabilities and Stockholders’ Equity
Deposits
Non-interest bearing demand	$	42,132		$	39,261
NOW, money market and savings		298,092			314,265
Time		286,303			263,945
Total deposits		626,527			617,471
Advances from the Federal Home Loan Bank		2,744			7,783
Securities sold under agreements to repurchase		5,240			683
Subordinated debentures		19,377			19,360
Other liabilities and accrued expenses		4,093			3,807
Total liabilities		657,981			649,104
Commitments
Stockholders’ equity
Preferred stock, no par value, authorized 1,000,000 shares; issued and outstanding 16,000 shares in 2010 and 2009		14,639			14,473
Common stock, $1 par value; authorized 20,000,000 shares; issued and outstanding 3,387,045 in 2010 and 2009		3,387			3,387
Common stock warrants		1,841			1,841
Additional paid-in capital		15,817			15,799
Retained earnings		9,603			11,445
Stock in directors’ rabbi trust		(608	)		(874	)
Directors’ deferred fees obligation		608			874
Accumulated other comprehensive income		1,072			1,003
Total stockholders’ equity		46,359			47,948
Total liabilities and stockholders’ equity	$	704,340		$	697,052

See accompanying notes to consolidated financial statements.

2

Carolina Bank Holdings, Inc. and Subsidiary

Consolidated Statements of Operations (unaudited)

	Three Months Ended June 30,					Six Months Ended June 30,
	2010			2009		2010			2009
	(in thousands, except per share data)
Interest income
Loans	$	7,543		$	7,414	$	15,019		$	14,627
Investment securities, taxable		420			533		882			1,126
Investment securities, non taxable		164			135		326			258
Interest from federal funds sold and other		22			1		44			1
Total interest income		8,149			8,083		16,271			16,012
Interest expense
NOW, money market, savings		926			1,134		1,916			2,114
Time deposits		1,328			1,898		2,711			4,170
Other borrowed funds		225			311		454			676
Total interest expense		2,479			3,343		5,081			6,960
Net interest income		5,670			4,740		11,190			9,052
Provision for loan losses		4,700			2,036		6,688			3,231
Net interest income after provision for loan losses		970			2,704		4,502			5,821
Non-interest income
Service charges		235			248		451			498
Mortgage banking income		2,187			2,798		3,936			4,608
Gains on sale of investment securities		55			—		185			235
Repossessed asset (losses)		(140	)		51		(267	)		51
Other		165			139		330			246
Total non-interest income		2,502			3,236		4,635			5,638
Non-interest expense
Salaries and benefits		2,810			2,520		5,384			4,963
Occupancy and equipment		598			576		1,206			1,169
Professional fees		342			252		602			600
Outside data processing		216			201		457			406
FDIC insurance		262			623		519			720
Advertising and promotion		91			132		250			290
Stationery, printing and supplies		132			173		246			285
Impairment of investment security		—			514		—			765
Impairment of repossessed assets		962			—		1,469			—
Other		759			517		1,317			787
Total non-interest expense		6,172			5,508		11,450			9,985
Income (loss) before income taxes		(2,700	)		432		(2,313	)		1,474
Income tax expense (benefit)		(1,132	)		97		(1,044	)		474
Net income (loss)		(1,568	)		335		(1,269	)		1,000
Dividends and accretion on preferred stock		288			284		573			538
Net income (loss) available (allocable) to common stockholders	$	(1,856	)	$	51	$	(1,842	)	$	462
Net income (loss) per common share
Basic	$	(0.55	)	$	0.02	$	(0.54	)	$	0.14
Diluted	$	(0.55	)	$	0.02	$	(0.54	)	$	0.14

See accompanying notes to consolidated financial statements.

3

Carolina Bank Holdings, Inc. and Subsidiary

Consolidated Statements of Comprehensive Income (unaudited)

	Three Months Ended June 30,					Six Months Ended June 30,
	2010			2009		2010			2009
	(in thousands)
Net income (loss)	$	(1,568	)	$	335	$	(1,269	)	$	1,000
Other comprehensive income:
Unrealized holding gains (losses) arising during the period, net of income taxes		10			1,090		69			517
Comprehensive income (loss)	$	(1,558	)	$	1,425	$	(1,200	)	$	1,517

See accompanying notes to consolidated financial statements.

4

Carolina Bank Holdings, Inc. and Subsidiary

Consolidated Statement of Stockholders’ Equity (unaudited)

	Preferred Stock		Discount on Preferred Stock			Common Stock		Common Stock Warrants		Additional Paid-In Capital		Retained Earnings			Stock in Directors’ Rabbi Trust			Directors’ Deferred Fees Obligation			Accumulated Other Comprehensive Income (Loss)		Total
	(in thousands)
Balance, December 31, 2009	$	16,000	$	(1,527	)	$	3,387	$	1,841	$	15,799	$	11,445		$	(874	)	$	874		$	1,003	$	47,948
Comprehensive income
Net income (loss)		—		—			—		—		—		(1,269	)		—			—			—		(1,269	)
Other comprehensive income—
Unrealized gain on securities available for sale, net of tax of $36		—		—			—		—		—		—			—			—			69		69
Comprehensive income																								(1,200	)
Directors’ deferred fees		—		—			—		—		—		—			(92	)		92			—		—
Directors’ deferred fees paid		—		—			—		—		—		—			358			(358	)		—		—
Stock options expensed		—		—			—		—		18		—			—			—			—		18
Amortization of preferred stock discount		—		166			—		—		—		(166	)		—			—			—		—
Preferred stock dividends		—		—			—		—		—		(407	)		—			—			—		(407	)
Balance, June 30, 2010	$	16,000	$	(1,361	)	$	3,387	$	1,841	$	15,817	$	9,603		$	(608	)	$	608		$	1,072	$	46,359

See accompanying notes to consolidated financial statements.

5

Carolina Bank Holdings, Inc. and Subsidiary

Consolidated Statements of Cash Flows (unaudited)

	Six Months Ended June 30,
	2010			2009
	(in thousands)
Cash flows from operating activities
Net income (loss)	$	(1,269	)	$	1,000
Adjustments to reconcile net income to net cash provided by operating activities
Provision for loan losses		6,688			3,231
Depreciation		476			457
Impairment of investment securities		—			765
Equity-based compensation		18			18
Deferred income tax (benefit)		(239	)		(807	)
Amortization (accretion), net		(37	)		(22	)
Amortization of subordinated debt discount		17			37
Loss (gain) on sale of repossessed assets		267			(51	)
Gain on sale of investments		(185	)		(235	)
Impairment of repossessed assets		1,469			—
Increase in loans held for sale, net of sales and gains		(16,819	)		(17,443	)
Decrease (increase) in other assets		(2,128	)		(278	)
Increase (decrease) in accrued expenses and other liabilities		279			(60	)
Other operating activities		—			22
Net cash (used for) operating activities		(11,463	)		(13,366	)
Cash flows from investing activities
Purchases of investment securities available-for-sale		(2,073	)		(4,434	)
Maturities and calls of securities available-for-sale		—			529
Repayments from mortgage-backed securities available-for-sale		3,357			3,090
Repayments from mortgage-backed securities held-to-maturity		52			179
Origination of loans, net of principal collected		(10,653	)		(38,255	)
Additions to premises and equipment		(90	)		(220	)
Proceeds from sales of assets		9,221			6,633
Net cash (used for) investing activities		(186	)		(32,478	)
Cash flows from financing activities
Net increase in deposits		9,056			60,726
Net decrease in Federal Home Loan Advances		(5,039	)		(15,035	)
Net decrease in Federal funds purchased		—			(3,166	)
Increase (decrease) in securities sold under agreements to repurchase		4,557			(1,287	)
Proceeds from issuance of preferred stock		—			16,000
Dividends paid		(400	)		(280	)
Proceeds from exercised stock options		—			215
Net cash provided by financing activities		8,174			57,173
Net increase (decrease) in cash and cash equivalents		(3,475	)		11,329
Cash and cash equivalents at beginning of period		40,455			5,948
Cash and cash equivalents at end of period	$	36,980		$	17,277
Supplemental disclosure of cash flow information
Cash paid during the period for interest	$	5,212		$	7,603
Cash paid during the period for income taxes	$	450		$	600
Supplemental disclosure of non-cash transactions
Transfer of loans to foreclosed assets	$	1,274		$	5,294
Accretion of preferred stock discount	$	166		$	154

See accompanying notes to consolidated financial statements.

6

Carolina Bank Holdings, Inc. and Subsidiary

Notes to Consolidated Financial Statements

Note A – Summary

Carolina Bank Holdings, Inc. (the “Holding Company” or the “Company”) is a North Carolina corporation organized in 2000. Effective October 31, 2000, pursuant to the plan of share exchange approved by the shareholders of Carolina Bank (the “Bank”), all of the outstanding shares of common stock of the Bank were exchanged for shares of common stock of the Holding Company. The Holding Company presently has no employees.

The Bank was incorporated in August 1996, and began banking operations in November 1996. It is engaged in lending and deposit gathering activities in Guilford, Alamance, Randolph and Forsyth Counties, North Carolina and operates under the laws of North Carolina, the rules and regulations of the Federal Deposit Insurance Corporation and the North Carolina Commissioner of Banks. The Bank has eight full-service banking locations, comprised of four in Greensboro and one in each of Asheboro, Burlington, High Point, and Winston-Salem. A mortgage loan production office was opened in Burlington in July 2010. All offices are in the Piedmont Triad region of North Carolina.

The Holding Company files periodic reports with the Securities and Exchange Commission and is also subject to regulation by the Federal Reserve Board.

Note B – Consolidation

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, the Bank. All significant inter-company transactions and balances have been eliminated.

Note C – Basis of presentation

In management’s opinion, the financial information, which is unaudited, reflects all adjustments (consisting solely of normal recurring adjustments) necessary for a fair presentation of the financial information as of and for the three and six months ended June 30, 2010 and 2009, in conformity with accounting principles generally accepted in the United States of America. Operating results for the three and six months ended June 30, 2010 and 2009, are not necessarily indicative of the results that may be expected for future periods.

The organization and business of the Company, accounting policies followed, and other information are contained in the notes to the financial statements of the Company as of and for the years ended December 31, 2009 and 2008, filed with the Securities and Exchange Commission as part of the Company’s annual report on Form 10-K. These financial statements should be read in conjunction with the annual financial statements.

Note D – Use of estimates

The financial statements are prepared in accordance with accounting principles generally accepted in the United States of America which require management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

7

Note E – Stock compensation plans

The Company has four equity compensation plans, a nonqualified plan for directors (Director Plan), an Omnibus Stock Ownership and Long Term Incentive Plan (Omnibus Plan) and two incentive stock option plans for management and employees (Employee Plans). The plans provide for the issuance of options to purchase common shares of the Company, and the exercise price of each option is equal to the fair value of the common stock on the date of grant. The Omnibus Plan also provides for the issuance of restricted stock awards, stock appreciation rights and certain other forms of equity compensation.

There were no stock option grants in 2009 or the first six months of 2010. The fair value of employee plan options granted in December 2007 was $178,000, which is being expensed over a five year vesting period. Total expense related to the 2007 grants was $18,000 in the first six months of 2010 and 2009. At June 30, 2010, there was $86,000 of total unrecognized compensation cost related to unvested share-based compensation which is expected to be recognized over a weighted-average period of 2.4 years.

Note F – Earnings per share

Earnings per share has been determined on a basic basis and a diluted basis which considers potential stock issuances. For the quarters ended June 30, 2010 and 2009, basic earnings per share has been computed based upon the weighted average common shares outstanding of 3,387,045.

The only potential issuances of Company stock are stock options granted to various directors and officers of the Bank and a warrant to purchase common stock executed in conjunction with the issuance of preferred stock to the U.S. Treasury in 2009. The following is a summary of the diluted earnings per share calculation for the three and six months ended June 30, 2010 and 2009.

	Three Months Ended June 30,					Six Months Ended June 30,
	2010			2009		2010			2009
	(in thousands, except per share data)
Net income (loss) available (allocable) to common stockholders	$	(1,856	)	$	51	$	(1,842	)	$	462
Weighted average outstanding shares—basic		3,387			3,387		3,387			3,382
Dilutive effect of stock options		—			—		—			2
Weighted average shares—diluted		3,387			3,387		3,387			3,384
Diluted earnings (loss) per share	$	(0.55	)	$	0.02	$	(0.54	)	$	0.14

8

Note G – Preferred stock and common stock warrants

In December 2008, the shareholders of the Company approved an amendment to the Articles of Incorporation authorizing the issuance of up to 1,000,000 shares of preferred stock, no par value. In January 2009, the Company issued 16,000 shares of preferred stock to the U.S. Treasury and received $16 million under the Capital Purchase Program. The Company granted a warrant to purchase 357,675 shares of common stock at a price of $6.71 per share to the U.S. Treasury as part of the preferred stock transaction. In accordance with accounting principles, the preferred stock and common stock warrant were valued independently and their relative fair market values were allocated to the $16 million received. Under the relative value method, $14,159,000 was allocated to the preferred stock and $1,841,000 to the common stock warrant. The discount of $1,841,000 on the preferred stock is accreted over five years using the effective yield method, thereby increasing preferred stock dividends. The accretion of the discount for the first six months of 2010 and 2009 was $166,000 and $154,000, respectively. Dividends at 5% per annum are payable quarterly for the first five years; the dividend increases to 9% per annum after the fifth year.

Note H – Subordinated debentures

In December 2004, the Company issued $10,310,000 of unsecured junior subordinated debentures which accrue and pay interest quarterly at three month LIBOR plus 2% per annum. These debentures were issued to Carolina Capital Trust (“Carolina Trust”), a wholly owned subsidiary of the Company which is not consolidated in these consolidated financial statements pursuant to accounting principles governingConsolidated Variable Interest Entities. Carolina Trust acquired these debentures using the proceeds of its offerings of common securities to the Company and $10 million of Trust Preferred Securities to outside investors. The Trust Preferred Securities currently qualify as Tier 1 capital under Federal Reserve Board guidelines. The recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act eliminates trust preferred securities as an element of Tier 1 capital for certain institutions. However, bank holding companies with assets of less than $15 billion as of December 31, 2009, will be permitted to include trust preferred securities that were issued before May 19, 2010, as Tier 1 capital. The Company therefore believes the Trust Preferred Securities will continue to qualify as Tier 1 capital. The Company has entered into contractual arrangements which, in the aggregate, constitute a full, irrevocable and unconditional guarantee on a subordinated basis by the Company of the obligations of Carolina Trust under the Trust Preferred Securities. The Trust Preferred Securities are redeemable upon maturity of the debentures on January 7, 2035, or upon earlier redemption as provided in the indenture. The Company has the right to redeem the debentures purchased by Carolina Trust in whole or in part at any time.

In the third quarter of 2008, Carolina Bank issued $9,300,000 of unsecured junior subordinated notes to outside investors which accrue and pay interest quarterly at three month LIBOR plus 4% per annum. The notes, net of unamortized expenses associated with the offering, equal to $9,067,000 and $9,050,000 at June 30, 2010 and December 31, 2009, respectively and qualify as Tier 2 capital for the Bank. The notes are redeemable upon maturity on September 30, 2018, or earlier at the Bank’s option, in whole or part subject to regulatory approval, beginning September 30, 2013. The expenses of the offering of $373,000 were capitalized at issue and are being amortized over sixty months. The notes are subordinate to the rights of payment to depositors, bankers acceptances, letters of creditors and general creditors.

Note I – Operating segments

The Company is considered to have two principal business segments in 2010 and 2009, the Commercial/Retail Bank and the Wholesale Mortgage Division. The Wholesale Mortgage Division began originating home mortgage loans through third parties and selling these loans to investors in late 2007. Financial performance for the three and six months ending June 30, 2010 and 2009 and selected balance sheet information at June 30, 2010 and 2009 for each segment is as follows:

9

	Three months ending June 30, 2010								Three months ending June 30, 2009
	Commercial/Retail Bank			Wholesale Mortgage Division		Total			Commercial/Retail Bank			Wholesale Mortgage Division			Total
	(in thousands)								(in thousands)
Interest income	$	7,692		$	457	$	8,149		$	7,679		$	404		$	8,083
Interest expense		2,022			457		2,479			2,930			413			3,343
Net interest income		5,670			—		5,670			4,749			(9	)		4,740
Provision for loan losses		4,700			—		4,700			2,036			—			2,036
Net interest income after provision for loan losses		970			—		970			2,713			(9	)		2,704
Non-interest income		368			2,134		2,502			565			2,671			3,236
Non-interest expense		4,911			1,261		6,172			4,246			1,262			5,508
Income (loss) before income taxes		(3,573	)		873		(2,700	)		(968	)		1,400			432
Income tax (benefit) expense		(1,490	)		358		(1,132	)		(446	)		543			97
Net income (loss)	$	(2,083	)	$	515	$	(1,568	)	$	(522	)	$	857		$	335
Total Assets	$	657,149		$	47,191	$	704,340		$	638,292		$	36,900		$	675,192
Net loans		533,486			46,207		579,693			525,394			36,606			562,000
Equity		45,429			930		46,359			47,569			1,373			48,942
	Six months ending June 30, 2010								Six months ending June 30, 2009
	Commercial/Retail Bank			Wholesale Mortgage Division		Total			Commercial/Retail Bank			Wholesale Mortgage Division			Total
	(in thousands)								(in thousands)
Interest income	$	15,503		$	768	$	16,271		$	15,301		$	711		$	16,012
Interest expense		4,313			768		5,081			6,241			719			6,960
Net interest income		11,190			—		11,190			9,060			(8	)		9,052
Provision for loan losses		6,688			—		6,688			3,231			—			3,231
Net interest income after provision for loan losses		4,502			—		4,502			5,829			(8	)		5,821
Non-interest income		806			3,829		4,635			1,274			4,364			5,638
Non-interest expense		9,173			2,277		11,450			7,872			2,113			9,985
Income (loss) before income taxes		(3,865	)		1,552		(2,313	)		(769	)		2,243			1,474
Income tax (benefit) expense		(1,666	)		622		(1,044	)		(396	)		870			474
Net income (loss)	$	(2,199	)	$	930	$	(1,269	)	$	(373	)	$	1,373		$	1,000
Total Assets	$	657,149		$	47,191	$	704,340		$	638,292		$	36,900		$	675,192
Net loans		533,486			46,207		579,693			525,394			36,606			562,000
Equity		45,429			930		46,359			47,569			1,373			48,942

The Wholesale Mortgage Division experienced strong growth in originations and related fee income during 2009 and the first six months of 2010 due to low interest rates and due to expansion into new markets and new products such as FHA and VA loans. Risks have been minimized by obtaining optional loan sales commitments when loan origination commitments are made to borrowers and by primarily originating loans that conform to FNMA, FHLMC, or FHA standards. Borrower fraud is a risk that has been minimized by more robust underwriting standards and by obtaining indemnification from the originating banker or broker for the risks the Company assumes. Warranty expenses and related warranty liabilities were established, beginning in the third quarter of 2009, to provide for potential claims that might arise from borrower fraud or underwriting errors. Warranty expenses were $82,000 and $148,000 for the three and six months ending June 30, 2010. The warranty liability at June 30, 2010 was $364,000 and is available to fund future warranty claims. Several potential claims have been presented for possible payment, but no claims have been paid out of the warranty liability as of June 30, 2010.

10

Note J – Securities

A summary of the amortized cost, gross unrealized gains and losses and estimated fair values of securities available-for-sale and held-to-maturity follows:

	Amortized Cost		Gross Unrealized Gains			Gross Unrealized Losses		Estimated Fair Value
	(in thousands)
June 30, 2010
Available for sale
U.S. agency obligations	$	998	$	35		$	—	$	1,033
Municipal securities		16,683		409			20		17,072
FNMA, FHLMC, and GNMA mortgage-backed securities		19,518		1,320			—		20,838
Corporate securities		5,512		30			125		5,417
Restricted stock		3,702		—			—		3,702
Unrestricted stock		533		—			23		510
	$	46,946	$	1,794		$	168	$	48,572
Held to maturity
FNMA and GNMA mortgage-backed securities		681		40			—		721
	$	681	$	40		$	—	$	721
December 31, 2009
Available for sale
U.S. agency obligations	$	998	$	54		$	—	$	1,052
Municipal securities		15,102		397			40		15,459
FNMA, FHLMC, and GNMA mortgage-backed securities		25,580		1,383			—		26,963
Corporate securities		5,490		53			228		5,315
Restricted stock		3,702		—			—		3,702
Unrestricted stock		533		—	��		100		433
	$	51,405	$	1,887		$	368	$	52,924
Held to maturity
FNMA and GNMA mortgage-backed securities		770		27			—		797
	$	770	$	27		$	—	$	797

11

Investments are periodically evaluated for any impairment which would be deemed other than temporary. During 2009, our investment in a trust preferred debt security of $850,000 issued by Silverton Financial Services, Inc. (SFSI), formerly Community Financial Services, Inc., was estimated to be worthless. SFSI is the former parent company of Silverton Bank, NA which was closed by the Office of the Comptroller of the Currency in May 2009. SFSI is currently in bankruptcy. The decline in value was determined to be other than temporary and resulted in an impairment charge of $850,000 which was recorded over the first nine months of 2009. This is the only debt security which the Company has deemed impaired.

Information pertaining to securities with gross unrealized losses at June 30, 2010 and December 31, 2009, by category and length of time that individual securities have been in a continuous loss position follows:

	Less Than 12 Months				12 Months or Greater				Total
	Fair   Value		Gross Unrealized   Losses		Fair   Value		Gross Unrealized   Losses		Fair Value		Gross Unrealized Losses
	(in thousands)
June 30, 2010
Municipal securities	$	814	$	20	$	—	$	—	$	814	$	20
Corporate securities		2,006		35		1,910		90		3,916		125
Unrestricted stock		510		23		—		—		510		23
Total	$	3,330	$	78	$	1,910	$	90	$	5,240	$	168
December 31, 2009:
Municipal securities	$	4,069	$	40	$	—	$	—	$	4,069	$	40
Corporate securities		—		—		3,815		228		3,815		228
Unrestricted stock		—		—		433		100		433		100
Total	$	4,069	$	40	$	4,248	$	328	$	8,317	$	368

Note K – Fair value measurements

The Company has adopted the accounting standards within FASB Accounting Standards Codification (ASC) 820 “Fair Value Measurements and Disclosures”, which provides a framework for measuring fair value under GAAP and enhances disclosures about fair value measurements. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company utilizes fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. The Company has not elected the fair value option to value liabilities. Securities available-for-sale and loans held for sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

When measuring fair value, valuation techniques should be appropriate in the circumstances and consistently applied. A hierarchy is used to prioritize valuation inputs into the following three levels to determine fair value:

Level 1 – quoted prices (unadjusted) in active markets for identical assets or liabilities.

Level 2 – observable inputs other than the quoted prices included in Level 1.

Level 3 – unobservable inputs.

12

Following is a description of valuation methodologies used for assets and liabilities recorded at fair value.

Investment Securities Available-for-Sale

Investment securities available-for-sale are recorded at fair value. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.

Loans Held for Sale

Loans held for sale are carried at fair value which is based on what secondary markets are currently offering for portfolios with similar characteristics. As such, the Company classifies loans subjected to recurring fair value adjustments as Level 2. Loans held for sale of $46.2 million and $29.4 million included positive fair value adjustments of $525,000 and $255,000 at June 30, 2010 and December 31, 2009, respectively.

Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, its fair value is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At June 30, 2010 and December 31, 2009, substantially all of the total impaired loans were evaluated based on the fair value of the collateral. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3. Impaired loans totaled $24.7 million and $14.2 million at June 30, 2010 and December 31, 2009, respectively. Of such loans, $13.8 million had specific loss allowances aggregating $3.5 million at June 30, 2010 and $14.2 million had specific loss allowances aggregating $4.4 million at December 31, 2009.

Assets measured at fair value on a recurring basis, including financial instruments for which the Company has elected the fair value option, are summarized below:

	June 30, 2010
	Fair Value Measurement Using						Assets at Fair Value
	Level 1		Level 2		Level 3
	(in thousands)
Assets
Loans held for sale	$	—	$	46,207	$	—	$	46,207
Securities available-for-sale		510		48,062		—		48,572
Total assets	$	510	$	94,269	$	—	$	94,779

13

The following represents the estimated fair values and carrying amounts of financial instruments at June 30, 2010 and December 31, 2009:

	June 30, 2010				December 31, 2009
	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
	(in thousands)
Financial Assets:
Cash and due from banks	$	6,038	$	6,038	$	6,416	$	6,416
Interest-bearing deposits with banks		30,942		30,942		34,039		34,039
Securities available for sale		48,572		48,572		52,924		52,924
Securities held to maturity		681		721		770		797
Net loans held for sale		46,207		46,207		29,388		29,388
Net loans held for investment		523,216		523,665		520,525		522,490
Accrued interest receivable		2,166		2,166		2,222		2,222
Financial Liabilities:
Demand and savings deposits		340,224		340,224		353,526		353,526
Time deposits		286,303		286,266		263,945		264,422
Federal Home Loan Bank advances		2,744		2,744		7,783		7,861
Securities sold under agreements to repurchase		5,240		5,240		683		683
Subordinated debt		9,067		9,067		9,050		9,050
Trust preferred debt		10,310		7,439		10,310		7,232
Accrued interest payable		698		698		1,019		1,019

Note L – Impact of recently adopted accounting standards

In July 2010, FASB issued new guidance under ASC 310 related to “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses”. This update amends ASC 310 to improve the disclosures that an entity provides about the credit quality of its financing receivables and the related allowance for credit losses. As a result of these amendments, an entity is required to disaggregate by portfolio segment or class certain existing disclosures and provide certain new disclosures about its financing receivables and related allowance for credit losses. For public entities, the disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. The adoption of the new accounting disclosures are not expected to have a material impact on the Company’s financial position or results of operations.

Several other new accounting standards became effective during the periods presented or will be effective subsequent to June 30, 2010. None of these new standards had or is expected to have a significant impact on the Company’s consolidated financial statements.

Note M – Reclassification

Certain amounts in the 2009 consolidated financial statements have been reclassified to conform to the 2010 presentation.

14

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion is intended to assist in understanding our financial condition and results of operations. Because we have no material operations and conduct no business on our own other than owning our subsidiaries, Carolina Bank and Carolina Capital Trust, and because Carolina Capital Trust has no operations other than the issuance of its trust preferred securities, the discussion contained in this Management’s Discussion and Analysis concerns primarily the business of Carolina Bank. However, for ease of reading and because the financial statements are presented on a consolidated basis, Carolina Bank Holdings, Inc. and Carolina Bank are collectively referred to herein as “we”, “our” or “us” unless otherwise noted.

This report contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 relating to, without limitation, our future economic performance, plans and objectives for future operations, and projections of revenues and other financial items that are based on our beliefs, as well as assumptions made by and information currently available to us. The words “may,” “will,” “anticipate,” “should,” “would,” “believe,” “contemplate,” “could”, “project”, “predict,” “expect,” “estimate,” “continue,” and “intend,” as well as other similar words and expressions of the future, are intended to identify forward-looking statements. Our actual results, performance, or achievements may differ materially from the results expressed or implied by our forward-looking statements.

Impact of Dodd-Frank Act.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:

• the creation of a Financial Stability Oversight Council to identify emerging systemic risks posed by financial firms, activities and practices, and 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.

The Company is unable to predict the extent to which the Dodd-Frank Act or the forthcoming rules and regulations will impact the Company’s business. However, the Company believes 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 the Company’s

15

business, financial condition, and results of operations. Additionally, the Company 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 the Company.

Comparison of Financial Condition

Assets. Our total assets increased by $7.3 million, or 1.0%, from $697.1 million at December 31, 2009, to $704.3 million at June 30, 2010. During the six months ended June 30, 2010, cash and due from banks and interest-bearing deposits with banks decreased by $3.5 million, while investment securities decreased by $4.4 million. Loans held for sale increased 57.2% during the first six months of 2010 to $46.2 million at June 30, 2010 due to continued strong originations by our wholesale loan division. Loans held for investment increased by $2.9 million or 0.5% during the first six months of 2010. We experienced slowing commercial and consumer loan demand in our primary lending markets, Guilford, Randolph, Alamance and Forsyth Counties, North Carolina in the first half of 2010 and second half of 2009.

Liabilities. Total deposits increased by $9.1 million, or 1.5%, from $617.5 million at December 31, 2009, to $626.5 million at June 30, 2010. Time deposits increased $22.4 million, noninterest demand accounts increased by $2.9 million, and interest-bearing transaction accounts declined $16.2 million during the first six months of 2010. We plan to continue our efforts to gain deposits through quality service, convenient locations, and competitive pricing. Our branching activities are designed to enhance customer convenience and related deposit gathering activities as well as provide new sources for loans. While deposit growth is an ongoing goal, wholesale sources of funding such as Federal Home Loan Bank advances and repurchase borrowings, may be utilized where cost beneficial and when necessary to meet liquidity requirements. Federal Home Loan Bank advances declined $5.0 million during the first six months to $2.7 million at June 30, 2010 due to maturing advances paid from deposit growth. We had approximately $18.6 million in out-of-market time deposits from other institutions and $53.4 million in brokered deposits at June 30, 2010, an increase of $17.5 million in these two types of accounts from December 31, 2009. Broker deposits and out-of-market time deposits increased because of more favorable pricing, no early withdrawal features, and ability to extend maturities.

Stockholders’ Equity. Total stockholders’ equity was down $1.6 million at June 30, 2010 to $46.4 million from $48.0 million at December 31, 2009, primarily due to the net loss allocable to common stockholders for the first six months of 2010.

Comparison of Results of Operations for the Three Months Ended June 30, 2010 and 2009

General. Net income (loss) for the second quarter of 2010 was $(1,568,000) compared to $335,000 in the second quarter of 2009. Net loss allocable to common stockholders was $1,856,000, or $0.55 per diluted share, for the three months ended June 30, 2010 compared to net income available to common stockholders of $51,000, or $0.02 per diluted share, for the three months ended June 30, 2009. Net income (loss) available (allocable) to common stockholders represents net income (loss) less preferred stock dividends and related discount accretion. The decrease in net income available to common shareholders was primarily due to a higher provision for loan losses, lower mortgage banking income, higher asset impairments, and higher repossessed asset expenses during the second quarter of 2010. The seasonally adjusted unemployment rate in North Carolina decreased to 10.0% at June 30, 2010 from 11.2% at December 31, 2009 but remained higher than the 8.1% at December 31, 2008. Our primary lending market in the Piedmont Triad also experienced a similar unemployment rate change in the past eighteen months with deteriorating economic conditions which have negatively impacted our borrowers. The commercial/retail bank segment reported a net loss of $2,083,000 for the three months ending June 30, 2010 due to higher provisions for loan losses and higher repossessed asset losses and impairments. On the other hand, our wholesale mortgage division reported quarterly net income of $515,000 for the three months ending June 30, 2010 due to low mortgage rates and expanded operations.

Net interest income.Net interest income increased 19.6% to $5,670,000 for the three months ended June 30, 2010, from $4,740,000 for the three months ended June 30, 2009. Growth in interest earning assets and liabilities and a

16

35 basis point increase in the net yield on interest earning assets accounted for most of the higher net interest income in 2010. The net yield on interest earning assets, adjusted to a fully taxable basis, increased to 3.50% in the second quarter of 2010 from 3.15% in the second quarter of 2009. The table below provides an analysis of effective yields and rates on categories of interest-earning assets and interest-bearing liabilities for the three months ended June 30, 2010 and 2009.

17

Net Interest Income and Average Balance Analysis

	For the Three Months Ended June 30,
	2010						2009
	Average Balance (1.)		Interest Inc./Exp.		Average Yield/Cost		Average Balance (1.)		Interest Inc./Exp.		Average Yield/Cost
	(Dollars in thousands)
Interest-earning assets
Interest bearing deposits	$	32,792	$	22	0.27	%	$	2,101	$	1	0.19	%
Non-taxable investments (2.)		15,854		243	6.15	%		12,378		197	6.38	%
Taxable investments		33,362		420	5.05	%		42,968		533	4.98	%
Loan held for sale		36,929		456	4.95	%		33,500		404	4.84	%
Loans (3.)		539,554		7,087	5.27	%		521,406		7,010	5.39	%
Interest-earning assets		658,491		8,228				612,353		8,145
Interest-earning assets					5.01	%					5.34	%
Non interest-earning assets		42,107						42,547
Total assets	$	700,598					$	654,900
Interest-bearing liabilities
Interest checking	$	34,499	$	39	0.45	%	$	29,895	$	37	0.50	%
Money market and savings		267,844		887	1.33	%		209,365		1,182	2.26	%
Time certificates and IRAs		281,688		1,328	1.89	%		275,615		1,898	2.76	%
Other borrowings		26,848		225	3.36	%		55,327		226	1.64	%
Total interest-bearing liabilities		610,879		2,479				570,202		3,343
Cost on average
Interest-bearing liabilities					1.63	%					2.35	%
Non-interest-bearing liabilities
Demand deposits		40,527						30,276
Other liabilities		1,443						5,860
Total non-interest-bearing liabilities		41,970						36,136
Total liabilities		652,849						606,338
Stockholders’ equity		47,749						48,562
Total liabilities and equity	$	700,598					$	654,900
Net interest income			$	5,749					$	4,802
Net yield on average interest-earning assets					3.50	%					3.15	%
Interest rate spread					3.38	%					2.98	%

(1.) Average balances are computed on a daily basis.

(2.) Interest income and yields related to certain investment securities exempt from federal income tax are stated on a fully taxable basis using a 34% federal tax rate, reduced by the nondeductible portion of interest expense.

(3.) Nonaccrual loans are included in the average loan balance.

Provision for loan losses.The provision for loan losses amounted to $4,700,000 and $2,036,000 for the three months ended June 30, 2010 and 2009, respectively. The amount of the provision for loan losses increased primarily

18

because of higher allowances for loan losses required on performing loans at June 30, 2010 due to higher historical losses and due to higher loan charge-offs for the second quarter of 2010. We believe the allowance for loan losses is appropriate based on asset quality indicators and other factors.

Non-interest income.Total non-interest income amounted to $2,502,000 for the three months ended June 30, 2010, as compared to $3,236,000 for the three months ended June 30, 2009. The decrease in 2010 resulted from lower mortgage banking income and losses on repossessed asset sales compared to gains in the previous year.

Non-interest expense.Total non-interest expense amounted to $6,172,000 and $5,508,000 for the three months ended June 30, 2010 and 2009, respectively. FDIC insurance expense of $262,000 in the second quarter of 2010 declined $361,000 from the same quarter in 2009 due to the special assessment in 2009. Impairment charges of real estate owned of $962,000 in the second quarter of 2010 exceeded impairment charges of investment securities of $514,000 in 2009. Salaries and benefits increased 11.5% in 2010 due to an increase in employees and higher benefit costs.

Income taxes.Income tax benefit was $1,132,000, or 41.9% of net loss before income taxes, for the three month period ended June 30, 2010, as compared to income tax expense of $97,000, or 22.5% of income before income taxes, for the three month period ended June 30, 2009. Non-taxable income represented a larger percentage of net income before taxes in the second quarter of 2009 which resulted in the lower tax rate in the 2009 period.

Comparison of Results of Operations for the Six Months Ended June 30, 2010 and 2009

General. Net income (loss) for the six months ended June 30, 2010 and 2009, amounted to $(1,269,000) and $1,000,000, respectively. Net income (loss) available (allocable) to common stockholders for the six months ended June 30, 2010 and 2009, amounted to $(1,842,000), or $(0.54) per diluted share and $462,000, or $0.14 per diluted share, respectively. The decrease in net income available to common shareholders in 2010 was primarily due to a sharply higher provision for loan losses, lower mortgage banking income, higher repossessed asset losses, and higher asset impairment charges. The provision for loan losses in 2010 was negatively impacted by an increase in charge-offs which in turn led to a higher loan loss experience used for calculating the allowance for loan losses at June 30, 2010. Higher non-performing assets in 2010 have resulted from continued challenging credit conditions in our markets, especially in construction and development projects.

Net interest income.Net interest income increased 23.6% to $11,190,000 for the six months ended June 30, 2010, from $9,052,000 for the six months ended June 30, 2009. Growth in interest earning assets and liabilities and an increase in the net yield on interest earning assets accounted for most of the higher net interest income in 2010. The net yield on average interest earning assets increased in 2010 due to progress in pricing loans and interest-bearing deposits.

Provision for loan losses.The provision for loan losses amounted to $6,688,000 for the six months ended June 30, 2010 compared to $3,231,000 for the six months ended June 30, 2009, an increase of 107.0%. The amount of the provision for loan losses increased because of higher loan charge-offs during 2010 and the related impact on historical loan losses. We believe the allowance for loan losses is adequate based on asset quality indicators and other factors. The economic conditions in our markets have declined during 2009 and 2010, resulting in high unemployment and higher loan defaults. Our non-performing loans have increased 74.5% to $24,721,000 at June 30, 2010 from $14,163,000 at December 31, 2009.

Non-interest income.Total non-interest income amounted to $4,635,000 for the six months ended June 30, 2010, as compared to $5,638,000 for the six months ended June 30, 2009. The decrease in 2010 was primarily attributable to lower mortgage banking income which was still quite strong at $3.9 million. Repossessed asset losses of $267,000 in 2010 compared to repossessed asset gains of $51,000 in 2009.

19

Non-interest expense.Total non-interest expense amounted to $11,450,000 for the six months ended June 30, 2010, as compared to $9,985,000 for the six months ended June 30, 2009, an increase of 14.7%. Salaries and employee benefits increased $421,000, or 8.5%, in 2010 to $5,384,000 due to higher benefit costs and an increase in the number of full-time equivalent employees by 8.1% in one year to 147. Impairment of repossessed assets increased to $1,469,000 for the six months ended June 30, 2010 compared to an impairment of an investment security of $765,000 for the six months ended June 30, 2009. Other expenses increased $530,000 in 2010 from higher expenses related to repossessed assets and from the accrual of $148,000 in warranty expenses related to the sale of mortgage loans.

Income taxes.Income tax benefit of $1,044,000, or 45.1% of loss before income taxes, for the six months ended June 30, 2010, as compared to income tax expense of $474,000, or 32.2% of income before income taxes, for the six months ended June 30, 2009. The tax rates are less than the combined federal and state incremental rate of 38.7% due to non-taxable income such as increase in cash value of life insurance and non-taxable municipal securities interest income.

Asset Quality

Non-performing assets, composed of foreclosed real estate, repossessions, non-accrual loans and restructured loans, totaled $32,513,000 at June 30, 2010, compared to $28,127,000 at December 31, 2009. Non-performing assets, as a percentage of total assets, was 4.62% at June 30, 2010, compared to 4.04% at December 31, 2009. There were no loans 90 days or more past due and still accruing interest at June 30, 2010 or at December 31, 2009. Loans past due 30 to 89 days increased to $6,264,000 at June 30, 2010 from $3,675,000 at December 31, 2009. Foreclosed real estate and other repossessed assets were $7,792,000 at June 30, 2010 and $13,964,000 at December 31, 2009. The elevated level of non-performing assets at June 30, 2010 is related to the declining economic conditions in our lending markets. The unemployment rate in North Carolina decreased to 10.0% in June 2010 from 11.2% in December 2009 but remained higher than the 8.1% at December 2008. A large portion of our loans are made to businesses and real estate developers and are secured by real estate. Due to slowing economic conditions, it has been difficult for borrowers to sell businesses or real estate properties as needed to pay off their loans.

Our allowance for loan losses is composed of two parts, a specific portion related to non-performing and problem loans and a general section related to performing loans. We adopted a more conservative loan loss methodology suggested by the FDIC in the second quarter of 2010 which resulted in acceleration of loan charge-offs and in a higher provision for loan losses than would have been experienced under our former loan loss methodology. The specific portion of our allowance for loan losses, which relates to non-performing loans, decreased to $3,512,000 at June 30, 2010 from $5,285,000 at March 31, 2010 and $4,431,000 at December 31, 2009 due to the change in methodology to generally recording loan charge-offs at the time appraisals are received on non-performing real estate loans rather than setting up specific loan loss reserves for these loans until deemed uncollectible. Net loan charge-offs amounted to $5,127,000 and $6,499,000 for the three and six months ending June 30, 2010, respectively, compared to $6,199,000 for all of 2009. The general section of our allowance for loan losses increased to $6,758,000 at June 30, 2010 from $5,412,000 at March 31, 2010 and $5,650,000 at December 31, 2009. The general section of our allowance applies to performing loans and was determined by applying estimated loss ratios inherent in the loan portfolio, ranging from 0.20% on loans secured by stocks and deposits to 11.3% on unsecured consumer revolving loans, to categories of performing loans at each period end. The loss ratios in the general section of the allowance were increased for most of our loan categories due to an increase in historical loss trends resulting from higher loan charge-offs in the current quarter and from shortening the loss trend period to an average of the eight most recent quarters from a modified three year period plus qualitative factors. The change of using a shorter period to calculate historical losses in the current quarter was recommended by the FDIC. The general section also includes higher allowances for substandard loans which are still performing but carry a higher degree of risk because of declining credit factors. Substandard loans totaled $39,806,000 and related allowances for loan losses were $1,068,000 at June 30, 2010.

The following table shows the composition of the loan portfolio, non-performing or impaired loans, specific loan loss allowances on impaired loans, and year to date net loan charge-offs, all by loan type, at June 30, 2010:

20

	At June 30, 2010
					Impaired Loans					Year to Date Net Loan Charge-offs
	Loans Outstanding				Outstanding			Specific Loan Loss Allowances
	Outstanding		Percent
	(Dollars in thousands)
Loans secured by real estate:
Construction & land development	$	124,058	23.25	%	$	12,633		$	419	$	2,608
Revolving residential lines		61,793	11.58	%		799			37		352
Closed-end residential		56,571	10.60	%		1,678			166		634
Multifamily		15,186	2.85	%		—			—		—
Non farm nonresidential		187,690	35.18	%		8,404			2,295		414
Total loans secured by real estate		445,298	83.47	%		23,514	��		2,917		4,008
Commercial and industrial		79,877	14.97	%		1,153			431		2,270
Consumer		6,351	1.19	%		54			164		28
All other loans		1,960	0.37	%		—			—		193
Total loans held for investment	$	533,486	100.00	%	$	24,721		$	3,512	$	6,499

The allowance for loan losses is increased by direct charges to operating expense, the provision for loan losses. Losses on loans or charge-offs are deducted from the allowance in the period that loans are deemed to become uncollectible or in the period that updated appraisals indicate a loss in value of non-performing real estate loans. Recoveries of previously charged-off loans are added back to the allowance. Net loan charge-offs (charge-offs minus recoveries) totaled $5,127,000 for the three months ended June 30, 2010 compared to $1,225,000 for the same period in 2009. Due to the higher loan charge-offs in 2010, the provision for loan losses, or amount charged to operating expense, increased to $4,700,000 for the three months ended June 30, 2010 from $2,036,000 for the three months ended June 30, 2009.

Liquidity and Capital Resources

The objective of our liquidity management is to ensure the availability of sufficient cash flows to meet all financial commitments and to capitalize on opportunities for expansion. Liquidity management addresses our ability to meet deposit withdrawals on demand or at contractual maturity, to repay borrowings as they mature, and to fund new loans and investments as opportunities arise.

Our primary sources of internally generated funds are principal and interest payments on loans receivable and cash flows generated from operations. External sources of funds include increases in deposits, repurchase agreements, federal funds purchased from banks and advances from the Federal Home Loan Bank of Atlanta (“FHLB”).

Carolina Bank is required under applicable federal regulations to maintain specified levels of liquid investments in qualifying types of investments. Cash and due from banks, interest-bearing deposits in banks, federal funds sold, and investment securities available-for-sale are the primary liquid assets of Carolina Bank. We regularly monitor Carolina Bank’s liquidity position to ensure its liquidity is sufficient to meet its needs. During 2009 and 2010, we increased our levels of short-term liquidity due to our strong deposit growth and moderate loan growth. Short-term liquidity in the forms of cash and due from banks and interest-bearing deposits in banks increased to $37.0 million at June 30, 2010 from $17.3 million at June 30, 2009. We also reduced borrowings from FHLB by $39.1 million over the same one year period to $2.7 million at June 30, 2010. We further increased our secondary sources of liquidity in 2010 by obtaining a secured line of credit of over $100 million from the Federal Reserve. The Federal Reserve line has never been used and is secured by loans.

21

We are subject to various regulatory capital requirements administered by the banking regulatory agencies. Failure to meet minimum capital requirements can initiate mandatory and possibly discretionary actions by the regulators that, if undertaken, could have a direct material effect on our financial condition. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. Our capital amounts and classifications are subject to qualitative judgments by the regulators about components, risk-weightings, and other factors. As of June 30, 2010 and December 31, 2009, our levels of capital exceeded all applicable published regulatory requirements; however, capital requirements could increase for Carolina Bank or Carolina Bank Holdings, Inc. as regulators are increasingly requiring financial institutions to maintain higher levels of capital commensurate with higher non-performing assets or greater risk.

Due to our strong growth in recent years and our anticipation of continued growth, we increased our capital in January 2009 by issuing $16 million in preferred stock to the United States Treasury under the Capital Purchase program. Carolina Bank also issued approximately $9 million in subordinated debt through a private placement in the third quarter of 2008 to increase capital at the bank level.

Commitments

In the normal course of business there are outstanding commitments for the extension of credit which are not reflected in the financial statements. At June 30, 2010 and December 31, 2009, pre-approved but unused lines of credit for loans totaled approximately $111,965,000 and $129,192,000, respectively. In addition, we had $7,855,000 and $10,217,000 in standby letters of credit at June 30, 2010 and December 31, 2009, respectively. These commitments represent no more than the normal lending risk that we commit to borrowers. If these commitments are drawn, we will obtain collateral if it is deemed necessary based on our credit evaluation of the counter-party. We believe these commitments can be funded through normal operations.

We are committed for future lease payments on our Friendly Center office, the land for our Greensboro headquarters, our office in Winston-Salem and an ATM out-parcel in Asheboro. Aggregate minimum lease payments over the next five years are $1,821,000 and $3,312,000 thereafter. Subsequent to June 30, 2010, we assumed a lease for our new mortgage loan production office in Burlington at $3,200 per month through September 2012.

22

ITEM 4T. Controls and Procedures

Our Chief Executive Officer and Chief Financial Officer have conducted an evaluation of our disclosure controls and procedures as of June 30, 2010. Based on their evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time period specified in the applicable Securities and Exchange Commission Rules and Forms. There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the most recent evaluation of these controls by our Chief Executive Officer and Chief Financial Officer.

Management of the Company has evaluated, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, changes in the Company’s internal controls over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) of the Exchange Act) during the second quarter of 2010. In connection with such evaluation, the Company has determined that there have been no changes in internal control over financial reporting during the second quarter that have materially affected or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

23

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

There are various claims and lawsuits in which the Company is periodically involved incidental to the Company’s business. In the opinion of management, no material loss is expected from any of such pending claims or lawsuits.

Item 4. (Reserved)

Item 6. Exhibits

Exhibit No.	Description of Exhibit
31.1	Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.
31.2	Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.
32.1	Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed by the undersigned thereunto duly authorized.

	Carolina Bank Holdings, Inc.
Date: August 11, 2010	By:	/s/ Robert T. Braswell
		Robert T. Braswell President and Chief Executive Officer
Date: August 11, 2010	By:	/s/ T. Allen Liles
		T. Allen Liles Chief Financial and Principal Accounting Officer

24

Exhibit Index

Exhibit No.	Description of Exhibit
31.1	Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.
31.2	Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.
32.1	Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act.

25