UNITED
STATES
 SECURITIES
AND EXCHANGE COMMISSION
 WASHINGTON,
D.C. 20549
 
 FORM
10-K
 
 x
              ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934
 
 For the
fiscal year ended December 31, 2009
 
 OR
 
  ̈
              TRANSITION
      REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934
 
 For the
transition period from _______ to _______.
 
 COMMISSION
FILE NUMBER 000-32951
 
 CRESCENT
FINANCIAL CORPORATION
 (Exact
name of registrant as specified in its charter)
 
 NORTH CAROLINA
                        
                        56-2259050(State
      or Other Jurisdiction of
                          Incorporation
      or Organization)
                        
                        (I.R.S.
      Employer
                          Identification
      No.)
 
 1005 High House Road, Cary,
North Carolina
 27513
 (Address
of Principal Executive Offices)
 (Zip
Code)
 
 Registrant’s
Telephone number, including area code:  (919) 460-7770
 
 Securities
registered pursuant to Section 12(b) of the Act
 
 NONE
 
 Securities
registered pursuant to Section 12(g) of the Act:
 
 COMMON STOCK, PAR VALUE
$1.00 PER SHARE
 
 Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.
  ̈
Yes    x  No
 
 Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.
  ̈
Yes   x  No
 
 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 if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of the registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K   ̈
 
 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 (Check one):
 
 Large
      accelerated filer
                 ̈
                Accelerated
      filer
                oNon-accelerated
      filer
                o (Do
      not check if a smaller reporting
                  company)
                Smaller
      reporting company
                þ
 
 Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
  ̈ Yes  x No
 
 State the
aggregate market value of the voting and non-voting common equity held by
non-affiliates computed by reference to the price at which the common equity was
last sold, or the average bid and asked price of such common equity, as of the
last business day of the registrant's most recently completed second fiscal
quarter: $31,414,494.
 
 Indicate
the number of shares outstanding of each of the registrant’s classes of Common
Stock as of the latest practicable date:  9,626,559 shares of Common
Stock outstanding as of March 31, 2010.
 
 Documents
Incorporated by Reference.
 Portions
of the registrant’s definitive proxy statement as filed with the Securities
Exchange Commission in connection with its 2010 annual meeting are incorporated
into Part III of this report.
  
 
 PART I
                    
                    FORM 10-K
                    
                    PROXY
                      STATEMENT
                    
                    ANNUAL
                      REPORTItem
      1 – Business
                    
                    3Item
      1A – Risk Factors
                    
                    20Item
      2 – Properties
                    
                    20Item
      3 – Legal Proceedings
                    
                    21Item
      4 – [Removed and Reserved]
                    
                    22PART
      IIItem
      5 – Market for Registrant’s
                      Common
      Equity, Related
                      Stockholder
      Matters and Issuer
                      Purchases
      of Equity Securities
                    
                    22Item
      6 – Selected Financial Data
                    
                    23Item
      7 – Management’s Discussion and
                      Analysis
      of Financial Condition
                      and
      Results of Operation
                    
                    25Item
      7A – Quantitative and Qualitative
                      Disclosures About Market
                      Risk
                    
                    44Item
      8 – Financial Statements and
                      Supplementary
      Data
                    
                    45Item
      9 – Changes in and Disagreements
                      with
      Accountants on
                      Accounting
      and Financial
                      Disclosure
                    
                    88Item
      9A(T) – Controls and Procedures
                    
                    88Item
      9B – Other Information
                    
                    89PART
      IIIItem
      10 – Directors and Executive
                      Officers and Corporate
                      Governance
                    
                    89
                    
                    XItem
      11 – Executive Compensation
                    
                    89
                    
                    XItem
      12 – Security Ownership of Certain
                      Beneficial Owners and
                      Management and Related
                      Stockholder Matters
                    
                    90
                    
                    XItem
      13 – Certain Relationships and
                      Related Transactions, and
                      Director Independence
                    
                    91
                    
                    XItem
      14 – Principal Accountant Fees and
                      Services
                    
                    91
                    
                    XPART
      IVItem
      15 – Exhibits and Financial
                      Statement
      Schedules
                    
                    91
  2
  PART
I
 
 ITEM
1 – BUSINESS
 
 General
 
 Crescent
Financial Corporation (referred to as the “Registrant,” the “Company” or by the
use of “we,” “our” or “us”) was incorporated under the laws of the State of
North Carolina on April 27, 2001, at the direction of the Board of Directors of
Crescent State Bank (“CSB” or the “Bank”), for the purpose of serving as the
bank holding company for CSB and became the holding company for CSB on June 29,
2001.  To become CSB’s holding company, Registrant received approval
of the Federal Reserve Board as well as CSB’s shareholders.  Upon
receiving such approval, each share of $5.00 par value common stock of CSB was
exchanged on a one-for-one basis for the $1.00 par value common stock of the
Registrant.  On August 31, 2006, the Registrant acquired Port City
Capital Bank (“PCCB”) for cash and stock valued at $40.2 million.  The
Company was a multi-bank holding company from August 31, 2006 through June 15,
2007.  Effective the close of business June 15, 2007, PCCB was merged
into CSB and the Company reverted to a one bank holding company.
 
 CSB was
incorporated on December 22, 1998 as a North Carolina-chartered commercial bank
and opened for business on December 31, 1998.  Including its main
office, CSB operates fifteen (15) full service branch offices in Cary (2), Apex,
Clayton, Holly Springs, Pinehurst, Raleigh (3), Southern Pines, Sanford, Garner,
Wilmington (2) and Knightdale, North Carolina.  The Southern Pines and
Pinehurst offices were acquired through a merger with Centennial Bank of
Southern Pines in August, 2003.
 
 The
Registrant operates for the primary purpose of serving as the holding company
for CSB. The Registrant’s headquarters are located at 1005 High House Road,
Cary, North Carolina 27513.
 
 CSB
operates for the primary purpose of serving the banking needs of individuals,
and small- to medium-sized businesses in its market area. The Bank offers a
range of banking services including checking and savings accounts, commercial,
consumer and personal loans, on-line banking, mortgage services and other
associated financial services.
 
 Lending
Activities
 
 General.  We
provide a wide range of short- to medium-term commercial and personal loans,
both secured and unsecured.  We also make real estate mortgage and
construction loans and Small Business Administration guaranteed loans. Many of
our commercial loans are collateralized with real estate in our market but such
collateral is mainly a secondary, not primary, source of
repayment.  We have maintained a balance between variable and fixed
rate loans within our portfolio.  Variable rate loans accounted for
43% of the loan balances outstanding at December 31, 2009 while fixed rate loans
accounted for 57% of the balances.
 
 Our loan
policies and procedures establish the basic guidelines governing our lending
operations.  Generally, the guidelines address the types of loans that
we seek, target markets, underwriting and collateral requirements, terms,
interest rate and yield considerations and compliance with laws and
regulations.  All loans or credit lines are subject to approval
procedures and amount limitations.  These limitations apply to the
borrower’s total outstanding indebtedness to us, including the indebtedness of
any guarantor.  The policies are reviewed and approved annually by the
board of directors of the Bank.  We supplement our own supervision of
the loan underwriting and approval process with annual loan audits by internal
loan examiners and quarterly credit reviews performed by outside third party
professionals experienced in loan review work.
 
 Commercial Mortgage
Loans.Historically we have originated and maintained a
significant amount of commercial real estate loans.  This lending
involves loans secured principally by commercial office buildings, both
investment and owner occupied.  We require the personal guaranty of
principals where prudent and a demonstrated cash flow capability sufficient to
service the debt.  The real estate collateral is a secondary source of
repayment.  Loans secured by commercial real estate may be in greater
amount and involve a greater degree of risk than one to four family residential
mortgage loans.  Payments on such loans are often dependent on
successful operation or management of the properties.  We also make
loans secured by commercial/investment properties provided the subject property
is typically either pre-leased or pre-sold before the Bank commits to finance
its construction.
  3
  Construction
Loans.Another of our lending focuses has been
construction/development lending.  We originate one to four family
residential construction loans for custom homes (where the home buyer is the
borrower and general contractor) and provide financing to builders who construct
homes for re-sale.  We finance “starter” homes as well as “high-end”
homes.  We generally receive a pre-arranged permanent financing
commitment from an outside banking entity prior to financing the construction of
pre-sold homes.  The Bank is active in the construction market and
makes construction loans to builders of homes that are not pre-sold, but limits
the number of such loans to any one builder.  This type of lending is
only done with local, well-established builders and not with large or national
tract builders.  We lend to builders in our market who have
demonstrated a favorable record of performance and profitable
operations.  We limit the number of unsold homes for each builder but
there is no limit for pre-sold homes.  We will also finance small
tract developments and sub-divisions; however, we seek to be only one of a
number of financial institutions making construction loans in any one tract or
sub-division.  We endeavor to further limit our construction lending
risk through adherence to established underwriting procedures and the
requirement of documentation for all draw requests.  We require
personal guarantees of the principals, when appropriate, and demonstrated
secondary sources of repayment on construction loans.  Construction
loan repayments are sensitive to general economic conditions, the housing market
and population migration patterns.
 
 Over the
past year we have reduced our concentration in construction and land development
lending.  The economic conditions and their impact on the one-to-four
family residential market has reduced both demand and increased the credit risk
for this type of lending.  While we continue to evaluate credit
opportunities presented in this line of business, we are actively trying to
diversify our loan portfolio by being selective and trying to create
opportunities in other loan types.
 
 Commercial Loans. Commercial
business lending is another focus of our lending activities. Commercial loans
include secured loans for working capital, expansion and other business
purposes. Short-term working capital loans generally are secured by accounts
receivable, inventory and/or equipment. Lending decisions are based on an
evaluation of the financial strength, cash flow, management and credit history
of the borrower, and the quality of the collateral securing the loan. With few
exceptions, we require personal guarantees of the principals and secondary
sources of repayment, primarily a deed of trust on local real estate. Commercial
loans generally provide greater yields and reprice more frequently than other
types of loans, such as commercial mortgage loans. More frequent repricing means
that yields on our commercial loans adjust more quickly with changes in interest
rates.
 
 Loans to Individuals, Home Equity
Lines of Credit and Residential Real Estate Loans.Loans to individuals
(consumer loans) include automobile loans, boat and recreational vehicle
financing, home equity and home improvement loans and miscellaneous secured and
unsecured personal loans. Consumer loans generally can carry significantly
greater risks than other loans, even if secured, if the collateral consists of
rapidly depreciating assets such as automobiles and equipment. Repossessed
collateral securing a defaulted consumer loan may not provide an adequate
secondary source of repayment of the loan. Consumer loan collections are
sensitive to job loss, illness and other personal factors. We attempt to manage
the risks inherent in consumer lending by following established credit
guidelines and underwriting practices designed to minimize risk of
loss.
 
 Residential
real estate loans are made for purchasing and refinancing one to four family
properties.  We offer fixed and variable rate options, but generally
limit the maximum fixed rate term to five years.  We provide customers
access to long-term conventional real estate loans through our mortgage loan
department, which originates loans and brokers them for sale in the secondary
market.  Such loans are closed by mortgage brokers and are not funded
by us.  We are currently building our Mortgage Loan Division and
anticipate that during 2010 we will move from a pure mortgage broker model to a
correspondent model.  This will allow us to close loans in CSB’s name
and be more competitive with loan pricing.  We anticipate that we will
be an active originator of mortgage loans and continue to sell loans to national
servicers only holding for our own account a small number of
well-collateralized, non-conforming residential loans. Residential real estate
loan collections are sensitive to economic market conditions, job loss and home
valuation pressures.
  4
  The
following table describes our loan portfolio composition by category, with 2008
and 2009 based on the new loan classifications discussed in Note B to the
financial statements and prior periods based on historic
classifications:
 At December 31,2009
                  
                  
                  2008
                  
                  
                  2007% of Total
                  
                  
                  
                  
                  
                  % of Total
                  
                  
                  
                  
                  
                  % of TotalAmount
                  
                  
                  Loans
                  
                  
                  Amount
                  
                  
                  Loans
                  
                  
                  Amount
                  
                  
                  Loans(Dollars in thousands)Real
      estate - commercial
                  
                  $
                  359,450
                  
                  
                  
                  47.28
                  %
                  
                  $
                  305,808
                  
                  
                  
                  38.88
                  %
                  
                  $
                  350,961
                  
                  
                  
                  51.85
                  %Real
      estate - residential
                  
                  
                  96,731
                  
                  
                  
                  12.73
                  %
                  
                  
                  89,873
                  
                  
                  
                  11.43
                  %
                  
                  
                  18,257
                  
                  
                  
                  2.70
                  %Construction
      loans
                  
                  
                  179,228
                  
                  
                  
                  23.58
                  %
                  
                  
                  242,771
                  
                  
                  
                  30.87
                  %
                  
                  
                  184,019
                  
                  
                  
                  27.18
                  %Commercial
      and industrial loans
                  
                  
                  55,360
                  
                  
                  
                  7.28
                  %
                  
                  
                  81,000
                  
                  
                  
                  10.30
                  %
                  
                  
                  72,930
                  
                  
                  
                  10.77
                  %Home
      equity loans and lines of credit
                  
                  
                  64,484
                  
                  
                  
                  8.48
                  %
                  
                  
                  63,772
                  
                  
                  
                  8.11
                  %
                  
                  
                  45,258
                  
                  
                  
                  6.69
                  %Loans
      to individuals
                  
                  
                  4,966
                  
                  
                  
                  0.65
                  %
                  
                  
                  3,199
                  
                  
                  
                  0.41
                  %
                  
                  
                  5,489
                  
                  
                  
                  0.81
                  %Total
      loans
                  
                  
                  760,219
                  
                  
                  
                  100.00
                  %
                  
                  
                  786,423
                  
                  
                  
                  100.00
                  %
                  
                  
                  676,914
                  
                  
                  
                  100.00
                  %Less:  Net
      deferred loan fees
                  
                  
                  (871
                  )
                  
                  
                  
                  
                  
                  
                  (1,046
                  )
                  
                  
                  
                  
                  
                  
                  (998
                  )Total
      loans, net
                  
                  $
                  759,348
                  
                  
                  
                  
                  
                  
                  $
                  785,377
                  
                  
                  
                  
                  
                  
                  $
                  675,916
 
 At December 31,2006
                                  
                                  
                                  2005% of Total
                                  
                                  
                                  
                                  
                                  
                                  % ofTotalAmount
                                  
                                  
                                  Loans
                                  
                                  
                                  Amount
                                  
                                  
                                  Loans(Dollars in thousands)Real
      estate - commercial
                                  
                                  $
                                  304,823
                                  
                                  
                                  
                                  55.36
                                  %
                                  
                                  $
                                  174,039
                                  
                                  
                                  
                                  52.92
                                  %Real
      estate - residential
                                  
                                  
                                  20,224
                                  
                                  
                                  
                                  3.67
                                  %
                                  
                                  
                                  14,914
                                  
                                  
                                  
                                  4.54
                                  %Construction
      loans
                                  
                                  
                                  110,033
                                  
                                  
                                  
                                  19.99
                                  %
                                  
                                  
                                  46,607
                                  
                                  
                                  
                                  14.17
                                  %Commercial
      and industrial loans
                                  
                                  
                                  67,822
                                  
                                  
                                  
                                  12.32
                                  %
                                  
                                  
                                  52,708
                                  
                                  
                                  
                                  16.03
                                  %Home
      equity loans and lines of credit
                                  
                                  
                                  42,704
                                  
                                  
                                  
                                  7.76
                                  %
                                  
                                  
                                  34,921
                                  
                                  
                                  
                                  10.62
                                  %Loans
      to individuals
                                  
                                  
                                  4,977
                                  
                                  
                                  
                                  0.90
                                  %
                                  
                                  
                                  5,670
                                  
                                  
                                  
                                  1.72
                                  %Total
      loans
                                  
                                  
                                  550,583
                                  
                                  
                                  
                                  100.00
                                  %
                                  
                                  
                                  328,859
                                  
                                  
                                  
                                  100.00
                                  %Less:  Net
      deferred loan fees
                                  
                                  
                                  (764
                                  )
                                  
                                  
                                  
                                  
                                  
                                  
                                  (537
                                  )Total
      loans, net
                                  
                                  $
                                  549,819
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  328,322
 
 The
following table presents at December 31, 2009 (i) the aggregate maturities of
loans in the named categories of our loan portfolio and (ii) the aggregate
amounts of such loans, by variable and fixed rates that mature after one
year.  For purposes of this presentation, all variable rate loans with
an interest rate floor that is currently effective are considered
fixed:
 Within
                          
                          
                          1-5
                          
                          
                          After 51 Year
                          
                          
                          Years
                          
                          
                          Years
                          
                          
                          Total(In thousands)Commercial
      mortgage
                          
                          $
                          63,343
                          
                          
                          $
                          253,028
                          
                          
                          $
                          43,079
                          
                          
                          $
                          359,450Residential
      mortgage
                          
                          
                          38,441
                          
                          
                          
                          48,796
                          
                          
                          
                          9,494
                          
                          
                          
                          96,731Construction
      loans
                          
                          
                          134,471
                          
                          
                          
                          43,712
                          
                          
                          
                          1,045
                          
                          
                          
                          179,228Commercial
      and industrial
                          
                          
                          33,723
                          
                          
                          
                          21,094
                          
                          
                          
                          543
                          
                          
                          
                          55,360Home
      equity lines and loans
                          
                          
                          4,269
                          
                          
                          
                          6,932
                          
                          
                          
                          53,283
                          
                          
                          
                          64,484Individuals
                          
                          
                          2,717
                          
                          
                          
                          2,177
                          
                          
                          
                          72
                          
                          
                          
                          4,966Total
                          
                          $
                          276,964
                          
                          
                          $
                          375,739
                          
                          
                          $
                          107,516
                          
                          
                          $
                          760,219Fixed
      rate loans
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          $
                          455,839Variable
      rate loans
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          27,416$
                          483,255
  5
 
 Loan Approvals.Our loan
policies and procedures establish the basic guidelines governing lending
operations.  Generally, the guidelines address the type of loans that
we seek, target markets, underwriting and collateral requirements, terms,
interest rate and yield considerations and compliance with laws and
regulations.  All loans and credit lines are subject to approval
procedures and amount limitations.  Depending upon the loan requested,
approval may be granted by the individual loan officer, our officers’ loan
committee or, for the largest relationships, the directors’ loan
committee.  The Bank’s full board is required to approve any single
transaction of $5.0 million or more.  The policies are reviewed and
approved at least annually by the board of directors.
 
 Responsibility
for loan review, underwriting, compliance and document monitoring resides with
the senior credit officer.  He is responsible for loan processing and
approval.  On an annual basis, the board of directors of the Bank
determines the president’s lending authority, who then delegates lending
authorities to the senior credit officer and other lending officers of the
bank.  Delegated authorities may include loans, letters of credit,
overdrafts, uncollected funds and such other authorities as determined by the
board of directors or the president within his delegated authority.
 
 Credit Cards.We
offer a credit card on an agency basis as an accommodation to our
customers.  We assume none of the underwriting risk.
 
 Loan
Participations.From time to time we purchase and sell loan
participations to or from other banks within and outside our market
area.  All loan participations purchased have been underwritten using
our standard and customary underwriting criteria.
 
 Commitments
and Contingent Liabilities
 
 In the
ordinary course of business, we enter into various types of transactions that
include commitments to extend credit.  We apply the same credit
standards to these commitments as we use in all of our lending activities and
have included these commitments in our lending risk evaluations.  Our
exposure to credit loss under commitments to extend credit is represented by the
amount of these commitments.  See Note O of the “Notes to Consolidated
Financial Statements.”
 
 Asset
Quality
 
 We
consider asset quality to be of primary importance and employ a third party loan
reviewer to ensure adherence to the lending policy as approved by our board of
directors.  It is the responsibility of each lending officer to assign
an appropriate risk grade to every loan originated.  Credit
administration, through the loan review process, validates the accuracy of the
initial risk grade assessment.  In addition, as a given loan’s credit
quality improves or deteriorates, it is credit administration’s responsibility
to change the borrower’s risk grade accordingly.  On a quarterly
basis, we undergo loan review by an outside third party who evaluates compliance
with our underwriting standards and risk grading and provides a report detailing
the conclusions of that review to our board of directors and senior
management.  The Bank’s board requires management to address any
criticisms raised during the loan review and to take appropriate actions where
warranted.
 
 Investment
Activities
 
 Our
investment portfolio plays a major role in management of liquidity and interest
rate sensitivity and, therefore, is managed in the context of the overall
balance sheet.  The securities portfolio generates a nominal
percentage of our interest income and serves as a necessary source of
liquidity.  Debt and equity securities that will be held for
indeterminate periods of time, including securities that we may sell in response
to changes in market interest or prepayment rates, needs for liquidity and
changes in the availability of and the yield of alternative investments, are
classified as available for sale.  We carry these investments at
market value, which we generally determine using published quotes or a pricing
matrix obtained at the end of each month.  Unrealized gains and losses
are excluded from our earnings and are reported, net of applicable income tax,
as a component of accumulated other comprehensive income in stockholders’ equity
until realized.
  6
  Deposit
Activities
 
 We
provide a range of deposit services, including non-interest bearing checking
accounts, interest bearing checking and savings accounts, money market accounts
and certificates of deposit.  These accounts generally earn interest
at rates established by management based on competitive market factors and
management’s desire to increase or decrease certain types or maturities of
deposits.  We use brokered deposits to supplement our funding sources,
but we have made a strategic decision to reduce our overall reliance on brokered
deposits.  We strive to establish customer relations to attract core
deposits and the establishment or continuity of a core deposit relationship is a
key factor in making a credit decision.
 
 The
following table sets forth for the years indicated the average balances
outstanding and average interest rates for each major category of
deposits:
 For the Year Ended December 31,2009
                  
                  
                  2008
                  
                  
                  2007(Dollars in thousands)Average
                  
                  
                  Average
                  
                  
                  Average
                  
                  
                  Average
                  
                  
                  Average
                  
                  
                  AverageBalance
                  
                  
                  Rate
                  
                  
                  Balance
                  
                  
                  Rate
                  
                  
                  Balance
                  
                  
                  RateNon-interest
      bearing deposits
                  
                  $
                  62,247
                  
                  
                  
                  -
                  
                  
                  $
                  64,938
                  
                  
                  
                  -
                  
                  
                  $
                  70,660
                  
                  
                  
                  -Interest
      bearing demand deposits
                  
                  
                  60,556
                  
                  
                  
                  1.74
                  %
                  
                  
                  34,073
                  
                  
                  
                  0.19
                  %
                  
                  
                  33,453
                  
                  
                  
                  0.97
                  %Money
      market deposits
                  
                  
                  75,444
                  
                  
                  
                  1.48
                  %
                  
                  
                  79,145
                  
                  
                  
                  2.80
                  %
                  
                  
                  58,214
                  
                  
                  
                  3.48
                  %Savings
      deposits
                  
                  
                  59,441
                  
                  
                  
                  1.22
                  %
                  
                  
                  78,759
                  
                  
                  
                  2.26
                  %
                  
                  
                  105,107
                  
                  
                  
                  4.29
                  %Time
      deposits over $100,000
                  
                  
                  376,260
                  
                  
                  
                  3.81
                  %
                  
                  
                  338,193
                  
                  
                  
                  4.50
                  %
                  
                  
                  254,533
                  
                  
                  
                  5.11
                  %Time
      deposits under $100,000
                  
                  
                  73,584
                  
                  
                  
                  3.60
                  %
                  
                  
                  80,397
                  
                  
                  
                  4.73
                  %
                  
                  
                  70,710
                  
                  
                  
                  5.03
                  %Total
      interest bearing deposits
                  
                  
                  645,285
                  
                  
                  
                  3.08
                  %
                  
                  
                  610,567
                  
                  
                  
                  3.78
                  %
                  
                  
                  522,017
                  
                  
                  
                  4.49
                  %Total
      average deposits
                  
                  $
                  707,532
                  
                  
                  
                  2.81
                  %
                  
                  $
                  675,505
                  
                  
                  
                  3.41
                  %
                  
                  $
                  592,677
                  
                  
                  
                  3.95
                  %
 
 For the Year Ended December 31,2006
                    
                    
                    2005(Dollars in thousands)Average
                    
                    
                    Average
                    
                    
                    Average
                    
                    
                    AverageBalance
                    
                    
                    Rate
                    
                    
                    Balance
                    
                    
                    RateNon-interest
      bearing deposits
                    
                    $
                    56,376
                    
                    
                    
                    -
                    
                    
                    $
                    42,641
                    
                    
                    
                    -Interest
      bearing demand deposits
                    
                    
                    37,876
                    
                    
                    
                    1.46
                    %
                    
                    
                    39,609
                    
                    
                    
                    1.05
                    %Money
      market deposits
                    
                    
                    51,926
                    
                    
                    
                    3.52
                    %
                    
                    
                    41,548
                    
                    
                    
                    2.16
                    %Savings
      deposits
                    
                    
                    40,694
                    
                    
                    
                    4.51
                    %
                    
                    
                    4,952
                    
                    
                    
                    1.79
                    %Time
      deposits over $100,000
                    
                    
                    154,538
                    
                    
                    
                    4.82
                    %
                    
                    
                    110,312
                    
                    
                    
                    3.30
                    %Time
      deposits under $100,000
                    
                    
                    72,440
                    
                    
                    
                    3.51
                    %
                    
                    
                    58,787
                    
                    
                    
                    3.13
                    %Total
      interest bearing deposits
                    
                    
                    357,474
                    
                    
                    
                    3.97
                    %
                    
                    
                    255,208
                    
                    
                    
                    2.70
                    %Total
      average deposits
                    
                    $
                    413,850
                    
                    
                    
                    3.43
                    %
                    
                    $
                    297,849
                    
                    
                    
                    2.31
                    %
 
 The
following table sets forth the amounts and maturities of certificates of deposit
with balances of $100,000 or more at December 31, 2009:
 
 Remaining maturity:
                      
                      (in thousands)Three
      months or less
                      
                      $
                      73,378Over
      three months through one year
                      
                      
                      146,492Over
      one year through three years
                      
                      
                      110,817Over
      three years through five years
                      
                      
                      26,693Total
                      
                      $
                      357,380
  7
 
 Borrowings
 
 As
additional sources of funding, we have established arrangements with the Federal
Home Loan Bank of Atlanta, the Federal Reserve Bank of Richmond and other
correspondent banks.
 
 We use
advances from the Federal Home Loan Bank of Atlanta under a line of credit equal
to 30% of CSB’s total assets ($309.7 million at December 31,
2009).  Outstanding advances at December 31, 2009 were $151.0 million.
Pursuant to collateral agreements with the Federal Home Loan Bank, at December
31, 2009 advances were secured by investment securities available for sale with
a fair value of $54.7 million and by loans with a carrying amount of $219.2
million, which approximates market value.
 
 We have
established a relationship to borrow at the Federal Reserve Bank’s Discount
Window.  At December 31, 2009 we had pledged $82.8 million of loans to
the discount window.  The loans pledged are construction loans,
commercial and industrial loans and consumer loans.  The Federal
Reserve Bank has established lending margins on the various collateral types and
the loans we have pledged allow us to borrow between 75% and 80% of the
collateral value.  At December 31, 2009 we had $50.0 million in
outstanding discount window borrowings.
 
 We may
purchase federal funds through unsecured federal funds lines of credit
aggregating $21.5 million.  These lines are intended for short-term
borrowings and are subject to restrictions limiting the frequency and terms of
the advances.  These lines of credit are payable on demand and bear
interest based upon the daily federal funds rate (between 0.00% and 0.25% at
December 31, 2009).  There were no federal funds purchased at December
31, 2009.
 
 Junior
Subordinated Debt
 
 In August
of 2003, $8.3 million in trust preferred securities were placed through Crescent
Financial Capital Trust I.  The trust has invested the total proceeds
from the sale of its trust preferred securities in junior subordinated
deferrable interest debentures issued by us.  The trust preferred
securities pay cumulative cash distributions quarterly at an annual contract
rate, reset quarterly, equal to three-month LIBOR plus 310 basis
points.  The dividends paid to holders of the trust preferred
securities, which are recorded as interest expense, are deductible by us for
income tax purposes.  On June 25, 2009, the Company entered into a
derivative financial instrument which effectively swapped the variable rate
payments for fixed payments.    We entered into a three year
and four year swap each for one-half of the notional amount of the trust
preferred securities for fixed rates of 5.49% and 5.97%,
respectively.  The effective interest rate is currently
5.73%.  See Note N of the “Notes to Consolidated Financial Statements”
for additional information.  The trust preferred securities mature on
October 7, 2033 and are redeemable, subject to approval by the Federal Reserve,
on January 7, April 7, July 7 or October 7 on or after October 7,
2008.  We have fully and unconditionally guaranteed the trust
preferred securities through the combined operation of the debentures and other
related documents.  Our obligation under the guarantee is unsecured
and subordinate to senior and subordinated indebtedness.  The
principal reason for issuing trust preferred securities is that the proceeds
from their sale qualify as Tier 1 capital for regulatory capital purposes
(subject to certain limitations), thereby enabling us to enhance our regulatory
capital positions without diluting the ownership of our
stockholders.
 
 Subordinated
Debt
 
 On
September 26, 2008, the Company entered into an unsecured subordinated term loan
agreement in the amount of $7.5 million.  The agreement calls for the
Company to make quarterly payments of interest at an annual contract rate, reset
quarterly, equal to three-month LIBOR plus 400 basis points.  The
subordinated term loan is deemed to be Tier 2 capital for regulatory capital
purposes.  On June 25, 2009, the Company entered into a derivative
financial instrument which effectively swapped the variable rate payments for
fixed payments.  We entered into a three year and four year swap each
for one-half of the notional amount of the trust preferred securities for fixed
rates of 6.39% and 6.87%, respectively.  The effective interest rate
is currently 6.63%.  See Note N of the “Notes to Consolidated
Financial Statements” for additional information.  The subordinated
term loan agreement matures on October 18, 2018 and can be prepaid, subject to
the approval of the FDIC and other Governmental Authorities (if applicable), in
incremental amounts not less than $500,000, by giving five business days notice
prior to prepayment.  We do not have the right to prepay all or any
portion of the loan prior to October 1, 2013 unless the loan ceases to be deemed
Tier 2 capital for regulatory capital purposes.  Should the loan cease
to be considered Tier 2 capital for regulatory capital purposes, the debt can
either be structured as senior debt of the Company or be repaid.  The
principal reason for entering into the subordinated term loan agreement was to
enhance our regulatory capital position without diluting our
shareholders.
  8
  Investment
Services
 
 Crescent
State Bank has entered into a revenue sharing agreement with Capital Investment
Group, Raleigh, North Carolina, under which it receives revenue for securities
and annuity sales generated by brokers located in our offices.  We
offer this investment service under the name “Crescent Investment
Services.”
 
 Courier
Services
 
 We
offer courier services to our customers free-of-charge as a
convenience and a demonstration of our commitment to superior
customer-service.  Our couriers travel to the customer’s
location, pick-up non-cash deposits from the customer and deliver those deposits
to the bank.  We feel our couriers serve as ambassadors for our bank and
enhance our presence in the communities we serve.
 
 Banking
Technology
 
 Because
of the level of sophistication of our markets, we commenced operations with a
full array of technology available for our customers.  Our customers
have the ability to perform on-line banking and bill paying, access on-line
check images, make transfers, initiate wire transfers, ACH originations and stop
payment orders of checks.  We provide our customers with imaged check
statements, thereby eliminating the cost of returning checks to customers and
eliminating the clutter of canceled checks.  Our customers can choose
to receive their account statement electronically which we encourage as part of
a special relationship deposit account.  The account is designed to
move customers into a more electronic, paper free environment which enhances fee
income on debit card transactions and reduces mailing and other data processing
charges.  Through branch image capture technology, CSB offers same day
credit for deposits made prior to 5:00 pm.  We offer remote merchant
capture which allows our customers to run check deposits through a scanner and
deliver the image to the Bank electronically.
 
 Strategy
 
 Our
strategy is three-fold: we are committed to achieving growth and performance
through exceptional customer service and sound asset quality; we provide a
comprehensive array of products and services; and we are able to adapt to a
rapidly changing banking environment.  We place the highest priority
on providing professional, highly personalized service – it’s the driving force
behind our business.  Over the first ten years of our Company, we
focused on loan growth as being the key to our short-term success, and although
we have historically created earnings that compare favorably to a peer group of
banks started in the late 1990’s, financial performance was secondary to asset
growth.  As we begin our twelfth year of business, the Company will
continue converting to a more mature bank whose strategy and goals are centered
on becoming a high performance bank among our peer group.  As we
continue along this new direction, asset growth will not be at the levels
previously seen, and once we emerge from this global recession which continues
to impact our asset quality, performance metrics should begin to
improve.  We feel the past strategy and actions have helped to create
a Company of size which was important in becoming a significant participant in
the markets we serve. The future strategy and actions to create a high
performing bank will leverage that size to create a Company of exceptional
long-term shareholder value.
 
 Primary
Market Area
 
 CSB’s
market area includes the four central North Carolina counties of Wake, Johnston,
Lee and Moore Counties and the coastal county of New
Hanover.
  9
  According
to the U.S. Census Bureau, the estimated 2008 population for the contiguous four
county central North Carolina area was nearly 1.2 million reflecting a 34%
increase over the last actual census data population conducted in
2000.   The largest of the four, Wake County, includes the state
capital of Raleigh as well as the area known as Research Triangle Park, one of
the nation’s leading technology centers.  Our market area is home to
several universities and institutions of higher learning, including North
Carolina State University.  Wake County has a diverse economy centered
on state government, the academic community, the technology industry, the
medical and pharmaceuticals sectors and the many small businesses that support
these enterprises as well as the people that live and work in this
area.  The estimated 2008 population in Wake County of over 866,000 is
the second most populous county in the state and experienced a 4% increase
between estimates for 2007 and those for 2008.  Johnston County is the
second largest county in CSB’s central North Carolina footprint with a
population estimate for 2008 of 163,000 and 4% growth over 2007
estimates.  Johnston County is one of the fastest growing counties in
the state and is contiguous to the southeast of Wake County.  Lee and
Moore Counties are located to the south of Raleigh in the region referred to as
the Sandhills area, which is home to the towns of Pinehurst, Sanford and
Southern Pines.  Moore County has an estimated 2008 population of
86,000 and Lee County is estimated to have a population of
59,000.  Both counties experienced 2% growth compared with 2007
estimates.  The region’s economy benefits from an emphasis on the golf
industry due to the many world class golf courses located in the vicinity and
also from a growing retiree population drawn to the mild climate and
recreational activities afforded by the Sandhills area.
 
 CSB is
headquartered in Cary, the second largest city in Wake County and the seventh
largest in North Carolina.  Cary has an estimated population of
136,000 as of June 30, 2009. Cary’ population has increased by 41,000 or 42%
since the last actual census was conducted and an increase of 5,000 or 4% since
the July 1, 2008 estimate.  The Town of Cary is served by several
major highways, Interstates 40, 440 and 540, US 1, US 64, and NC 55.
International, national, and regional airlines offer service from the
Raleigh-Durham International Airport, which is less than five miles from
Cary.  The people located in CSB’s central North Carolina footprint
are relatively diverse, young and highly educated.  As of 2000, the
latest date for which actual census data is available, over 60% of Cary’s
population and over 37% of the estimated four county population 25 years or
older had at least a bachelor’s degree. This educational level is due to the
number of higher education institutions located in our market area as well as
the Research Triangle Park’s high technology employee base.
 
 The
economic strength of the area is also reflected by the per capita
income.  Per capita income for 2008 for the Raleigh-Cary metropolitan
statistical area, as estimated by the Bureau of Economic Analysis, was $39,239
compared to $34,439 for North Carolina.  The median family income in
the Raleigh-Cary metropolitan statistical area in 2009 was $76,900 according to
the Federal Reserve Bank of Richmond compared to $62,108 for the State of North
Carolina as shown by the Federal Home Loan Mortgage Corporation.  Cary
is home to the world’s largest privately held software company, SAS Institute,
and it has attracted prominent companies such as American Airlines Reservation
Center, Western Wake Medical Center, Kellogg’s Snacks and MCI.  The
Research Triangle Park houses major facilities of IBM, GlaxoSmithKline, Verizon
Communications, the U.S. Environmental Protection Agency, Quintiles and numerous
other technology and bio-medical firms.
 
 New
Hanover County is home to Wilmington, North Carolina as well as the University
of North Carolina at Wilmington.  According to the Chamber of
Commerce, Wilmington has a 2009 estimated population of approximately 101,000
while New Hanover County has a population of approximately
193,000.  Wilmington is the eighth largest city in North
Carolina.  The median family income estimate for 2009 according to the
Department of Housing and Urban Development was $57,600 and per capita income
per the Bureau of Economic Analysis for 2008 was $33,036.  Wilmington
has a sizable seaport and is the most eastern point in the United States of
Interstate 40.  The area has become an important destination for the
entertainment industry as over 200 movies or television shows have been produced
in Wilmington.  The largest employers in Wilmington include the New
Hanover Regional Medical Center, New Hanover Public Schools, General Electric,
The University of North Carolina at Wilmington and PPD, Inc., a large
pharmaceutical and biotech company.
 
 Competition
 
 Commercial
banking in North Carolina is extremely competitive in large part due to early
adoption of statewide branching.  We compete in our market areas with
large regional and national banking organizations, other federally and state
chartered financial institutions such as savings and loan institutions and
credit unions, consumer finance companies, mortgage companies and other lenders
engaged in the business of extending credit. Many of our competitors have
broader geographic markets and higher lending limits than we do and are also
able to provide more services and make greater use of media advertising. All
markets in which we have a banking office are also served by branches of the
largest banks in North Carolina.
  10
 
 For
example, as of June 30, 2009 there were 438 offices of 42 different financial
institutions across our five county footprint.  CSB ranked ninth in
market share across that five county area with a combined 2.89% of the total
combined deposit market.  There were 253 offices of 31 different
financial institutions in Wake County, 79 offices of 20 different financial
institutions in New Hanover County, 43 offices of 13 different financial
institutions in Johnston County, 41 offices of 12 different financial
institutions in Moore County and 22 offices of 11 different financial
institutions in Lee County.  CSB’s market share in the individual
counties we serve was 3.01%, 2.25%, 0.12%, 4.79% and 2.51%,
respectively.  While we typically do not compete directly for loans
with larger banks, they do influence our deposit products.  We do
compete more directly with mid-size and small community banks that have offices
in our market areas.
 
 The
enactment of legislation authorizing interstate banking has led to increases in
the size and financial resources of some of our competitors. In addition, as a
result of interstate banking, out-of-state commercial banks have acquired North
Carolina banks and heightened the competition among banks in North
Carolina.  For example, SunTrust Bank of Georgia, a large multi-state
financial institution, has branches throughout our markets.
 
 Despite
the competition in our market areas, we believe that we have certain competitive
advantages that distinguish us from our competition. We offer customers modern
banking services without forsaking prompt, personal service and friendliness. We
also have established a local advisory board in each of our communities to help
us better understand their needs and to be “ambassadors” of the
Bank.  It is our intention to further develop advisory boards as we
expand into additional communities in our market area.  We offer many
personalized services and attract customers by being responsive and sensitive to
their individualized needs. We believe our approach to business builds goodwill
among our customers, stockholders, and the communities we serve that results in
referrals from stockholders and satisfied customers.  We also rely on
traditional marketing to attract new customers. To enhance a positive image in
the community, we support and participate in local events and our officers and
directors serve on boards of local civic and charitable
organizations.
 
 Employees
 
 At
December 31, 2009, the Registrant employed 151 full-time and 15 part-time
employees. None of the Registrant’s employees are covered by a collective
bargaining agreement. The Registrant believes its relations with its employees
to be good.
 
 REGULATION
 
 Regulation
of the Bank
 
 The Bank
is extensively regulated under both federal and state law. Generally, these laws
and regulations are intended to protect depositors and borrowers, not
shareholders. To the extent that the following information describes statutory
and regulatory provisions, it is qualified in its entirety by reference to the
particular statutory and regulatory provisions. Any change in applicable law or
regulation may have a material effect on the business of the Registrant and the
Bank.
 
 State Law. The Bank
is subject to extensive supervision and regulation by the North Carolina
Commissioner of Banks (the “Commissioner”). The Commissioner oversees state laws
that set specific requirements for bank capital and regulate deposits in, and
loans and investments by, banks, including the amounts, types, and in some
cases, rates. The Commissioner supervises and performs periodic examinations of
North Carolina-chartered banks to assure compliance with state banking statutes
and regulations, and the Bank is required to make regular reports to the
Commissioner describing in detail the resources, assets, liabilities and
financial condition of the Bank. Among other things, the Commissioner regulates
mergers and consolidations of state-chartered banks, the payment of dividends,
loans to officers and directors, record keeping, types and amounts of loans and
investments, and the establishment of branches.
  Deposit
Insurance.The Bank’s deposits are insured up to applicable limits, currently
$250,000, by the Deposit Insurance Fund, or DIF, of the FDIC. The DIF is the
successor to the Bank Insurance Fund and the Savings Association Insurance Fund,
which were merged in 2006. The Bank’s deposits, therefore, are subject to FDIC
deposit insurance assessment.
  11
  The FDIC
amended its risk-based deposit assessment system to implement authority granted
by the Federal Deposit Insurance Reform Act of 2005, or the Reform Act. Under
the revised system, insured institutions were assigned to one of four risk
categories based on supervisory evaluations, regulatory capital levels and
certain other factors.  An institution’s assessment rate depends upon
the category to which it is assigned. Risk Category I, which contains the least
risky depository institutions, was expected to include more than 90% of all
institutions. Unlike the other categories, Risk Category I contains further risk
differentiation based on the FDIC’s analysis of financial ratios, examination
component ratings and other information. Assessment rates were determined by the
FDIC and for the period effective January 1, 2009 through March 31, 2009
(payment dated June 30, 2009 based on March 31, 2009 data) range from 12 to 14
basis points for the healthiest institutions (Risk Category I) to 50 basis
points of assessable deposits for the riskiest (Risk Category IV). On February,
27, 2009, the FDIC Board of Directors adopted a final rule modifying the
risk-based assessment system and setting initial base assessment rates beginning
April 1, 2009. The FDIC has introduced three adjustments that could be made to
an institution's initial base assessment rate: (1) a potential decrease for
long-term unsecured debt, including senior and subordinated debt and, for small
institutions, a portion of Tier 1 capital; (2) a potential increase for secured
liabilities above a threshold amount; and (3) for non-Risk Category I
institutions, a potential increase for brokered deposits above a threshold
amount.  The new rates will range from seven to 24 basis points for
the healthiest institutions (Risk Category I) to 40 to 77.5 basis points of
assessable deposits for the riskiest (Risk Category IV).
  On
October 3, 2008, Congress enacted into law the Emergency Economic Stabilization
Act of 2008 (EESA).  The EESA established two major initiative
programs; the Capital Purchase Program (CPP) and the Temporary Liquidity
Guarantee Program (TLG). The TLG provided for two separate FDIC guarantee
programs in which the Company chose to participate.   For the
first program, the FDIC guaranteed newly issued senior unsecured debt issued
between October 14, 2008, and June 30, 2009, including promissory notes,
commercial paper, inter-bank funding, and any unsecured portion of secured debt.
The amount of debt covered by the guarantee could not exceed 125 percent of debt
that was outstanding as of September 30, 2008 and scheduled to mature before
June 30, 2009. If an insured depository institution had no eligible debt
outstanding at September 30, 2008, the debt guarantee limit was established at
2% of total liabilities at September 30, 2008.  For eligible debt
issued on or before June 30, 2009, coverage was only provided until June 30,
2012, even if the liability has not matured.  The second program
guaranteed non-interest bearing and low interest bearing transaction accounts to
an unlimited amount and was initially set to expire on December 31,
2009.  The program was extended to provide unlimited FDIC insurance
coverage through June 30, 2010.  Additional assessment fees apply to
funds guaranteed under these programs.
  For
eligible senior unsecured debt, an annualized fee will be collected equal to 75
basis points multiplied by the amount of debt guaranteed under this program. The
Company has not issued any debt under this program.  For non-interest
bearing transaction deposit accounts, a 10 basis point surcharge on the
institution's current assessment rate would be applied to deposits not otherwise
covered by the existing deposit insurance limit of $250,000. Fees for the 10
basis point surcharge on the non-interest bearing transaction accounts over
$250,000 will be collected through the normal assessment cycle.  The
Company anticipates paying assessments under this program.
  On
February 27, 2009, the FDIC proposed amendments to the restoration plan for the
DIF.  This amendment proposed the imposition of a 20 basis point
emergency special assessment on insured depository institutions as of June 30,
2009.  On March 5, 2009, the FDIC Chairman announced that the
FDIC intended to lower the special assessment from 20 basis points to 10 basis
points. On May 22, 2009, the FDIC adopted a final rule imposing a 5 basis point
special assessment on each insured depository institution's assets minus Tier 1
capital as of June 30, 2009. The amount of the special assessment for any
institution was not to exceed 10 basis points times the institution's assessment
base for the second quarter 2009. The assessment was collected on September 30,
2009 and totaled $493,000.  The FDIC may impose an emergency special
assessment of up to 10 basis points on all insured depository institutions
whenever, after June 30, 2009, the FDIC estimates that the fund reserve ratio
will fall to a level that the Board believes would adversely affect public
confidence or to a level close to zero or negative at the end of a calendar
quarter.  In addition, the FDIC received approval to require
prepayment of the next three years premiums.  On December 31, 2009,
the Company remitted approximately $4.2 million to prepay its premiums for 2010,
2011 and 2012.  Due to the continuing volume of bank failures, it is
possible that higher deposit insurance rates or additional special assessments
will be required to restore the DIF to the Congressionally established target
and could have a significant impact on the financial results of the Company in
future years.
  12
  The FDIC
is authorized to set the reserve ratio for the DIF annually at between 1.15% and
1.5% of estimated insured deposits, in contrast to the statutorily fixed ratio
of 1.25% under the old system. The ratio, which is viewed by the FDIC as the
level that the funds should achieve, was established by the agency at 1.25% for
2007. The Reform Act also provided for the possibility that the FDIC may pay
dividends to insured institutions once the DIF reserve ratio equals or exceeds
1.35% of estimated insured deposits.
  Capital Requirements.
The federal banking regulators have adopted certain risk-based capital
guidelines to assist in the assessment of the capital adequacy of a banking
organization’s operations for both transactions reported on the balance sheet as
assets and transactions, such as letters of credit, and recourse arrangements,
which are recorded as off balance sheet items. Under these guidelines, nominal
dollar amounts of assets and credit equivalent amounts of off balance sheet
items are multiplied by one of several risk adjustment percentages which range
from 0% for assets with low credit risk, such as certain U.S. Treasury
securities, to 100% for assets with relatively high credit risk, such as
business loans.
 
 A banking
organization’s risk-based capital ratios are obtained by dividing its qualifying
capital by its total risk- adjusted assets. The regulators measure risk-adjusted
assets, which include off balance sheet items, against both total qualifying
capital (the sum of Tier 1 capital and limited amounts of Tier 2 capital) and
Tier 1 capital. “Tier 1,” or core capital, includes common equity, qualifying
noncumulative perpetual preferred stock and minority interests in equity
accounts of consolidated subsidiaries, less goodwill and other intangibles,
subject to certain exceptions. “Tier 2,” or supplementary capital, includes
among other things, limited-life preferred stock, hybrid capital instruments,
mandatory convertible securities, qualifying subordinated debt, and the
allowance for loan and lease losses, subject to certain limitations and less
required deductions. The inclusion of elements of Tier 2 capital is subject to
certain other requirements and limitations of the federal banking agencies.
Banks and bank holding companies subject to the risk-based capital guidelines
are required to maintain a ratio of Tier 1 capital to risk-weighted assets of at
least 4% and a ratio of total capital to risk-weighted assets of at least 8%.
The appropriate regulatory authority may set higher capital requirements when
particular circumstances warrant. As of December 31, 2009, CSB was classified as
“well-capitalized” with Tier 1 and Total Risk-Based Capital of 11.16%% and
13.32%%, respectively.
 
 The
federal banking agencies have adopted regulations specifying that they will
include, in their evaluations of a bank’s capital adequacy, an assessment of the
bank’s interest rate risk exposure. The standards for measuring the adequacy and
effectiveness of a banking organization’s interest rate risk management include
a measurement of board of directors and senior management oversight, and a
determination of whether a banking organization’s procedures for comprehensive
risk management are appropriate for the circumstances of the specific banking
organization.
 
 Failure
to meet applicable capital guidelines could subject a banking organization to a
variety of enforcement actions, including limitations on its ability to pay
dividends, the issuance by the applicable regulatory authority of a capital
directive to increase capital and, in the case of depository institutions, the
termination of deposit insurance by the FDIC, as well as the measures described
under the “Federal Deposit Insurance Corporation Improvement Act of 1991” below,
as applicable to undercapitalized institutions. In addition, future changes in
regulations or practices could further reduce the amount of capital recognized
for purposes of capital adequacy. Such a change could affect the ability of the
Bank to grow and could restrict the amount of profits, if any, available for the
payment of dividends to the shareholders.
 
 Federal Deposit Insurance
Corporation Improvement Act of 1991.  In December 1991,
Congress enacted the Federal Deposit Insurance Corporation Improvement Act of
1991 (the “FDIC Improvement Act”), which substantially revised the bank
regulatory and funding provisions of the Federal Deposit Insurance Act and made
significant revisions to several other federal banking statutes. The FDIC
Improvement Act provides for, among other things:
 
 -
              publicly
      available annual financial condition and management reports for certain
      financial institutions, including audits by independent
      accountants,
 
 -
              the
      establishment of uniform accounting standards by federal banking
      agencies,
  13
 
 -
              the
      establishment of a “prompt corrective action” system of regulatory
      supervision and intervention, based on capitalization levels, with greater
      scrutiny and restrictions placed on depository institutions with lower
      levels of capital,
 
 -
              additional
      grounds for the appointment of a conservator or receiver,
    and
 
 -
              restrictions
      or prohibitions on accepting brokered deposits, except for institutions
      which significantly exceed minimum capital
  requirements.
 
 The FDIC
Improvement Act also provides for increased funding of the FDIC insurance funds
and the implementation of risk-based premiums.
 
 A central
feature of the FDIC Improvement Act is the requirement that the federal banking
agencies take “prompt corrective action” with respect to depository institutions
that do not meet minimum capital requirements. Pursuant to the FDIC Improvement
Act, the federal bank regulatory authorities have adopted regulations setting
forth a five-tiered system for measuring the capital adequacy of the depository
institutions that they supervise. Under these regulations, a depository
institution is classified in one of the following capital categories: “well
capitalized,” “adequately capitalized,” “undercapitalized,” “significantly
undercapitalized” and “critically undercapitalized.” An institution may be
deemed by the regulators to be in a capitalization category that is lower than
is indicated by its actual capital position if, among other things, it receives
an unsatisfactory examination rating with respect to asset quality, management,
earnings or liquidity.
 
 The FDIC
Improvement Act provides the federal banking agencies with significantly
expanded powers to take enforcement action against institutions which fail to
comply with capital or other standards. Such action may include the termination
of deposit insurance by the FDIC or the appointment of a receiver or conservator
for the institution. The FDIC Improvement Act also limits the circumstances
under which the FDIC is permitted to provide financial assistance to an insured
institution before appointment of a conservator or receiver.
 
 Community Reinvestment
Act.  The purpose of the Community Reinvestment Act is to
encourage financial institutions to help meet the credit needs of their entire
communities, including the needs of low-and moderate-income
neighborhoods.
 
 The
federal banking agencies have implemented an evaluation system that rates an
institution based on its actual performance in meeting community credit
needs.  Under these regulations, an institution is first evaluated and
rated under three categories: a lending test, an investment test and a service
test.  For each of these three tests, the institution is given a
rating of either “outstanding,” “high satisfactory,” “low satisfactory,” “needs
to improve,” or “substantial non-compliance.”  A set of criteria for
each rating has been developed and is included in the regulation.  If
an institution disagrees with a particular rating, the institution has the
burden of rebutting the presumption by clearly establishing that the
quantitative measures do not accurately present its actual performance, or that
demographics, competitive conditions or economic or legal limitations peculiar
to its service area should be considered.  The ratings received under
the three tests will be used to determine the overall composite CRA
rating.  The composite ratings currently given are: “outstanding,”
“satisfactory,” “needs to improve” or “substantial non-compliance.”
 
 Community
Reinvestment Act ratings are a factor considered by the FRB and the FDIC in
considering applications to acquire branches or to acquire or combine with other
financial institutions and take other actions and, if such rating was less than
“satisfactory,” could result in the denial of such applications.
 
 Limits on Loans to One
Borrower.  FDIC regulations
and North Carolina law impose restrictions on the size of loans that may be made
to any one borrower, including related entities.  Under applicable
law, with certain limited exceptions, loans and extensions of credit by a state
chartered nonmember bank to a person outstanding at one time and not fully
secured by collateral having a market value at least equal to the amount of the
loan or extension of credit shall not exceed 15% of the unimpaired capital of
the bank.  Loans and extensions of credit fully secured by readily
marketable collateral having a market value at least equal to the amount of the
loan or extension of credit shall not exceed 10% of the unimpaired capital fund
of the bank.
  14
  Transactions with Related
Parties.
Transactions between a state nonmember bank and any affiliate are governed by
Sections 23A and 23B of the Federal Reserve Act.  An affiliate of a
state nonmember bank is any company or entity which controls, is controlled by
or is under common control with the state nonmember bank.  In a
holding company context, the parent holding company of a state nonmember bank
and any companies which are controlled by such parent holding company are
affiliates of the savings institution or state nonmember
bank.  Generally, Sections 23A and 23B (i) limit the extent to which
an institution or its subsidiaries may engage in “covered transactions” with any
one affiliate to an amount equal to 10% of such institution’s capital stock and
surplus, and contain an aggregate limit on all such transactions with all
affiliates to an amount equal to 20% of such capital stock and surplus and (ii)
require that all such transactions be on terms substantially the same, or at
least as favorable, to the institution or subsidiary as those provided to a
non-affiliate.  The term “covered transaction” includes the making of
loans, purchase of assets, issuance of a guarantee and similar other types of
transactions.
 
 Loans to Directors,
Executive Officers and Principal Stockholders.State nonmember banks
also are subject to the restrictions contained in Section 22(h) of the Federal
Reserve Act and the applicable regulations thereunder on loans to executive
officers, directors and principal stockholders.  Under Section 22(h),
loans to a director, executive officer and to a greater than 10% stockholder of
a state nonmember bank and certain affiliated interests of such persons, may not
exceed, together with all other outstanding loans to such person and affiliated
interests, the institution’s loans-to-one-borrower limit and all loans to such
persons may not exceed the institution’s unimpaired capital and unimpaired
surplus.  Section 22(h) also prohibits loans above amounts prescribed
by the appropriate federal banking agency to directors, executive officers and
greater than 10% stockholders of a depository institution, and their respective
affiliates, unless such loan is approved in advance by a majority of the board
of directors of the institution with any “interested” director not participating
in the voting.  Regulation O prescribes the loan amount (which
includes all other outstanding loans to such person) as to which such prior
board of director approval is required as being the greater of $25,000 or 5% of
capital and surplus (or any loans aggregating $500,000 or
more).  Further, Section 22(h) requires that loans to directors,
executive officers and principal stockholders generally be made on terms
substantially the same as offered in comparable transactions to other
persons.  Section 22(h) also generally prohibits a depository
institution from paying the overdrafts of any of its executive officers or
directors.
 
 State
nonmember banks also are subject to the requirements and restrictions of Section
22(g) of the Federal Reserve Act on loans to executive
officers.  Section 22(g) of the Federal Reserve Act requires approval
by the board of directors of a depository institution for such extensions of
credit and imposes reporting requirements for and additional restrictions on the
type, amount and terms of credits to such officers.  In addition,
Section 106 of the Bank Holding Company Act of 1956, as amended (“BHCA”)
prohibits extensions of credit to executive officers, directors, and greater
than 10% stockholders of a depository institution by any other institution which
has a correspondent banking relationship with the institution, unless such
extension of credit is on substantially the same terms as those prevailing at
the time for comparable transactions with other persons and does not involve
more than the normal risk of repayment or present other unfavorable
features.
 
 Additionally,
North Carolina statutes set forth restrictions on loans to executive officers of
state chartered banks, which provide that no bank may extend credit to any of
its executive officers nor a firm or partnership of which such executive
officers is a member, nor a company in which such executive officer owns a
controlling interest, unless the extension of credit is made on substantially
the same terms, including interest rates and collateral, as those prevailing at
the time for comparable transactions by the bank with persons who are not
employed by the bank, and provided further that the extension of credit does not
involve more than the normal risk of repayment.
 
 International Money
Laundering Abatement and Financial Anti-Terrorism Act of
2001.  On October 26, 2001, the USA Patriot Act of 2001 was
enacted.  This act contains the International Money Laundering
Abatement and Financial Anti-Terrorism Act of 2001, which sets forth anti-money
laundering measures affecting insured depository institutions, broker-dealers
and other financial institutions.  The Act requires U.S. financial
institutions to adopt new policies and procedures to combat money laundering and
grants the Secretary of the Treasury broad authority to establish regulations
and to impose requirements and restrictions on the operations of financial
institutions.
 
 Miscellaneous. The
dividends that may be paid by each bank are subject to legal limitations. In
accordance with North Carolina banking law, dividends may not be paid unless a
bank’s capital surplus is at least 50% of its paid-in capital.
  15
  The
earnings of the Bank will be affected significantly by the policies of the
Federal Reserve Board, which is responsible for regulating the United States
money supply in order to mitigate recessionary and inflationary pressures. Among
the techniques used to implement these objectives are open market transactions
in United States government securities, changes in the rate paid by banks on
bank borrowings, and changes in reserve requirements against bank deposits.
These techniques are used in varying combinations to influence overall growth
and distribution of bank loans, investments, and deposits, and their use may
also affect interest rates charged on loans or paid for deposits.
 
 The
monetary policies of the Federal Reserve Board have had a significant effect on
the operating results of commercial banks in the past and are expected to
continue to do so in the future. In view of changing conditions in the national
economy and money markets, as well as the effect of actions by monetary and
fiscal authorities, no prediction can be made as to possible future changes in
interest rates, deposit levels, loan demand or the business and earnings of the
Bank.
 
 We cannot
predict what legislation might be enacted or what regulations might be adopted,
or if enacted or adopted, the effect thereof on the Bank’s
operations.
 
 Regulation
of the Registrant
 
 Federal Regulation.
The Registrant is subject to examination, regulation and periodic reporting
under the Bank Holding Company Act of 1956, as administered by the Federal
Reserve Board. The Federal Reserve Board has adopted capital adequacy guidelines
for bank holding companies on a consolidated basis.
 
 The
Registrant is required to obtain the prior approval of the Federal Reserve Board
to acquire all, or substantially all, of the assets of any bank or bank holding
company. Prior Federal Reserve Board approval is required for the Registrant to
acquire direct or indirect ownership or control of any voting securities of any
bank or bank holding company if, after giving effect to such acquisition, it
would, directly or indirectly, own or control more than five percent of any
class of voting shares of such bank or bank holding company.
 
 The
merger or consolidation of the Bank with another bank, or the acquisition by the
Registrant of assets of another bank, or the assumption of liability by the
Registrant to pay any deposits in another bank, will require the prior written
approval of the primary federal bank regulatory agency of the acquiring or
surviving bank under the federal Bank Merger Act.  The decision is
based upon a consideration of statutory factors similar to those outlined above
with respect to the Bank Holding Company Act.  In addition, in certain
such cases an application to, and the prior approval of, the Federal Reserve
Board under the Bank Holding Company Act and/or the North Carolina Banking
Commission may be required.
 
 The
Registrant is required to give the Federal Reserve Board prior written notice of
any purchase or redemption of its outstanding equity securities if the gross
consideration for the purchase or redemption, when combined with the net
consideration paid for all such purchases or redemptions during the preceding 12
months, is equal to 10% or more of the Registrant’s consolidated net worth. The
Federal Reserve Board may disapprove such a purchase or redemption if it
determines that the proposal would constitute an unsafe and unsound practice, or
would violate any law, regulation, Federal Reserve Board order or directive, or
any condition imposed by, or written agreement with, the Federal Reserve Board.
Such notice and approval is not required for a bank holding company that would
be treated as “well capitalized” and “well managed” under applicable regulations
of the Federal Reserve Board, that has received a composite “1” or “2” rating at
its most recent bank holding company inspection by the Federal Reserve Board,
and that is not the subject of any unresolved supervisory issues.
 
 The
status of the Registrant as a registered bank holding company under the Bank
Holding Company Act does not exempt it from certain federal and state laws and
regulations applicable to corporations generally, including, without limitation,
certain provisions of the federal securities laws.
 
 In
addition, a bank holding company is prohibited generally from engaging in, or
acquiring five percent or more of any class of voting securities of any company
engaged in, non-banking activities. One of the principal exceptions to this
prohibition is for activities found by the Federal Reserve Board to be so
closely related to banking or managing or controlling banks as to be a proper
incident thereto. Some of the principal activities that the Federal Reserve
Board has determined by regulation to be so closely related to banking as to be
a proper incident thereto are:
  16
 
 -
              making
      or servicing loans;
 -
              performing
      certain data processing services;
 -
              providing
      discount brokerage services;
 -
              acting
      as fiduciary, investment or financial
advisor;
 -
              leasing
      personal or real property;
 -
              making
      investments in corporations or projects designed primarily to promote
      community welfare; and
 -
              acquiring
      a savings and loan association.
 
 In
evaluating a written notice of such an acquisition, the Federal Reserve Board
will consider various factors, including among others the financial and
managerial resources of the notifying bank holding company and the relative
public benefits and adverse effects which may be expected to result from the
performance of the activity by an affiliate of such company. The Federal Reserve
Board may apply different standards to activities proposed to be commenced de novo and activities
commenced by acquisition, in whole or in part, of a going concern. The required
notice period may be extended by the Federal Reserve Board under certain
circumstances, including a notice for acquisition of a company engaged in
activities not previously approved by regulation of the Federal Reserve Board.
If such a proposed acquisition is not disapproved or subjected to conditions by
the Federal Reserve Board within the applicable notice period, it is deemed
approved by the Federal Reserve Board.
 
 However,
with the passage of the Gramm-Leach-Bliley Financial Services Modernization Act
of 1999, which became effective on March 11, 2000, the types of activities in
which a bank holding company may engage were significantly expanded. Subject to
various limitations, the Modernization Act generally permits a bank holding
company to elect to become a “financial holding company.” A financial holding
company may affiliate with securities firms and insurance companies and engage
in other activities that are “financial in nature.”  Among the
activities that are deemed “financial in nature” are, in addition to traditional
lending activities, securities underwriting, dealing in or making a market in
securities, sponsoring mutual funds and investment companies, insurance
underwriting and agency activities, certain merchant banking activities and
activities that the Federal Reserve Board considers to be closely related to
banking.
 
 A bank
holding company may become a financial holding company under the Modernization
Act if each of its subsidiary banks is “well capitalized” under the Federal
Deposit Insurance Corporation Improvement Act prompt corrective action
provisions, is well managed and has at least a satisfactory rating under the
Community Reinvestment Act.  In addition, the bank holding company
must file a declaration with the Federal Reserve Board that the bank holding
company wishes to become a financial holding company.  A bank holding
company that falls out of compliance with these requirements may be required to
cease engaging in some of its activities.  The Registrant has not yet
elected to become a financial holding company.
 
 Under the
Modernization Act, the Federal Reserve Board serves as the primary “umbrella”
regulator of financial holding companies, with supervisory authority over each
parent company and limited authority over its subsidiaries.  Expanded
financial activities of financial holding companies generally will be regulated
according to the type of such financial activity: banking activities by banking
regulators, securities activities by securities regulators and insurance
activities by insurance regulators.  The Modernization Act also
imposes additional restrictions and heightened disclosure requirements regarding
private information collected by financial institutions.
 
 Sarbanes-Oxley Act of
2002.  On July 30, 2002, the Sarbanes-Oxley Act of 2002 was
signed into law and became some of the most sweeping federal legislation
addressing accounting, corporate governance and disclosure issues. The impact of
the Sarbanes-Oxley Act is wide-ranging as it applies to all public companies and
imposes significant new requirements for public company governance and
disclosure requirements.
  In
general, the Sarbanes-Oxley Act mandates important new corporate governance and
financial reporting requirements intended to enhance the accuracy and
transparency of public companies’ reported financial results. It establishes new
responsibilities for corporate chief executive officers, chief financial
officers and audit committees in the financial reporting process and creates a
new regulatory body to oversee auditors of public companies. It backs these
requirements with new SEC enforcement tools, increases criminal penalties for
federal mail, wire and securities fraud, and creates new criminal penalties for
document and record destruction in connection with federal investigations. It
also increases the opportunity for more private litigation by lengthening the
statute of limitations for securities fraud claims and providing new federal
corporate whistleblower protection.
  17
 
 The
economic and operational effects of this new legislation on public companies,
including us, is significant in terms of the time, resources and costs
associated with complying with the new law. Because the Sarbanes-Oxley Act, for
the most part, applies equally to larger and smaller public companies, we are
presented with additional challenges as a smaller, community-oriented financial
institution seeking to compete with larger financial institutions in our
market.
 
 Recent Regulatory
Initiatives.  Beginning in late 2008 and continuing into 2009,
the federal government took sweeping actions in response to the deepening
economic recession.  As mentioned above, President Bush signed the
Emergency Economic Stabilization Act of 2008 or “EESA” into law on October 3,
2008.  Pursuant to EESA, the Department of the Treasury created the
Troubled Asset Relief Program of “TARP” for the purpose of stabilizing the U.S.
financial markets.  On October 14, 2008, the Treasury announced the
creation of the TARP Capital Purchase Program.  The Capital Purchase
Program was designed to invest up to $250 billion (later increased to $350
billion) in certain eligible financial institutions in the form of nonvoting
senior preferred stock initially paying quarterly dividends at a five percent
annual rate.  In connection with its investment in senior preferred
stock, the Treasury also received ten-year warrants to purchase common shares of
participating institutions.
 
 The
Company applied and was approved for participation in the Capital Purchase
Program in late 2008.  On January 9, 2009, the Company issued and sold
to the Treasury (1) 24,900 shares of the Company’s Fixed Rate Cumulative
Perpetual Preferred Stock, Series A, and (2) a warrant to purchase 833,705
shares of the Company’s common stock for an aggregate purchase price of $24.9
million in cash.  The preferred stock qualifies as Tier 1
capital.
 
 As a
result of its participation in the Capital Purchase Program, the Company has
become subject to a number of new regulations and restrictions.  The
ability of the Company to declare or pay dividends or distributions on, or
purchase, redeem or otherwise acquire for consideration shares of its common
stock is subject to restrictions.  The Company is also required to
have in place certain limitations on the compensation of its senior executive
officers.
 
 On
February 17, 2009, President Obama signed the American Recovery and Reinvestment
Act of 2009 into law.  This law includes additional restrictions on
executive compensation applicable to the Company as a participant in the TARP
Capital Purchase Program.
 
 For
additional information about this transaction and the Company’s participation in
the Capital Purchase Program, please see Note R to the Company’s audited
consolidated financial statements included with this report and the Company’s
current report on Form 8-K filed with the Securities and Exchange Commission on
January 14, 2009.
 
 Capital Requirements.
The Federal Reserve Board uses capital adequacy guidelines in its examination
and regulation of bank holding companies. If capital falls below minimum
guidelines, a bank holding company may, among other things, be denied approval
to acquire or establish additional banks or non-bank businesses.
 
 The
Federal Reserve Board’s capital guidelines establish the following minimum
regulatory capital requirements for bank holding companies:
 
 -
              a
      leverage capital requirement expressed as a percentage of adjusted total
      assets;
 
 -
              a
      risk-based requirement expressed as a percentage of total risk-weighted
      assets; and
 
 -
              a
      Tier 1 leverage requirement expressed as a percentage of adjusted total
      assets.
 
 The
leverage capital requirement consists of a minimum ratio of total capital to
total assets of 4%, with an expressed expectation that banking organizations
generally should operate above such minimum level. The risk-based requirement
consists of a minimum ratio of total capital to total risk-weighted assets of
8%, of which at least one-half must be Tier 1 capital (which consists
principally of shareholders’ equity). The Tier 1 leverage requirement consists
of a minimum ratio of Tier 1 capital to total assets of 3% for the most
highly-rated companies, with minimum requirements of 4% to 5% for all
others.  As of December 31, 2009, the Registrant was classified as
“well-capitalized” with Tier 1 and Total Risk-Based Capital of 11.37% and
13.53%, respectively.
  18
  The
risk-based and leverage standards presently used by the Federal Reserve Board
are minimum requirements, and higher capital levels will be required if
warranted by the particular circumstances or risk profiles of individual banking
organizations. Further, any banking organization experiencing or anticipating
significant growth would be expected to maintain capital ratios, including
tangible capital positions (i.e., Tier 1 capital less all intangible
assets),
 well
above the minimum levels.
 
 Source of Strength for
Subsidiaries.  Bank holding companies are required to serve as
a source of financial strength for their depository institution subsidiaries,
and, if their depository institution subsidiaries become undercapitalized, bank
holding companies may be required to guarantee the subsidiaries’ compliance with
capital restoration plans filed with their bank regulators, subject to certain
limits.
 
 Dividends.  As
a bank holding company that does not, as an entity, currently engage in separate
business activities of a material nature, the Registrant’s ability to pay cash
dividends depends upon the cash dividends the Registrant receives from the
Bank.  At present, the Registrant’s only source of income is dividends
paid by the Bank and interest earned on any investment securities the Registrant
holds.  The Registrant must pay all of its operating expenses from
funds it receives from the Bank.  Therefore, shareholders may receive
dividends from the Registrant only to the extent that funds are available after
payment of our operating expenses and the board decides to declare a
dividend.  In addition, the Federal Reserve Board generally prohibits
bank holding companies from paying dividends except out of operating earnings,
and the prospective rate of earnings retention appears consistent with the bank
holding company’s capital needs, asset quality and overall financial
condition.  We expect that, for the foreseeable future, any dividends
paid by the Bank to us will likely be limited to amounts needed to pay any
separate expenses of the Registrant and/or to make required payments on our debt
obligations, including the interest payments on our junior subordinated
debt.
 
 The FDIC
Improvement Act requires the federal bank regulatory agencies biennially to
review risk-based capital standards to ensure that they adequately address
interest rate risk, concentration of credit risk and risks from non-traditional
activities and, since adoption of the Riegle Community Development and
Regulatory Improvement Act of 1994, to do so taking into account the size and
activities of depository institutions and the avoidance of undue reporting
burdens. In 1995, the agencies adopted regulations requiring as part of the
assessment of an institution’s capital adequacy the consideration of (a)
identified concentrations of credit risks, (b) the exposure of the institution
to a decline in the value of its capital due to changes in interest rates and
(c) the application of revised conversion factors and netting rules on the
institution’s potential future exposure from derivative
transactions.
 
 In
addition, the agencies in September 1996 adopted amendments to their respective
risk-based capital standards to require banks and bank holding companies having
significant exposure to market risk arising from, among other things, trading of
debt instruments, (1) to measure that risk using an internal value-at-risk model
conforming to the parameters established in the agencies’ standards and (2) to
maintain a commensurate amount of additional capital to reflect such risk. The
new rules were adopted effective January 1, 1997, with compliance mandatory from
and after January 1, 1998.
 
 Subsidiary
banks of a bank holding company are subject to certain quantitative and
qualitative restrictions imposed by the Federal Reserve Act on any extension of
credit to, or purchase of assets from, or letter of credit on behalf of, the
bank holding company or its subsidiaries, and on the investment in or acceptance
of stocks or securities of such holding company or its subsidiaries as
collateral for loans. In addition, provisions of the Federal Reserve Act and
Federal Reserve Board regulations limit the amounts of, and establish required
procedures and credit standards with respect to, loans and other extensions of
credit to officers, directors and principal shareholders of the Bank, the
Registrant, and any subsidiary of the Registrant and related interests of such
persons. Moreover, subsidiaries of bank holding companies are prohibited from
engaging in certain tie-in arrangements (with the holding company or any of its
subsidiaries) in connection with any extension of credit, lease or sale of
property or furnishing of services.
  19
  Any loans
by a bank holding company to a subsidiary bank are subordinate in right of
payment to deposits and to certain other indebtedness of the subsidiary bank. In
the event of a bank holding company’s bankruptcy, any commitment by the bank
holding company to a federal bank regulatory agency to maintain the capital of a
subsidiary bank would be assumed by the bankruptcy trustee and entitled to a
priority of payment. This priority would also apply to guarantees of capital
plans under the FDIC Improvement Act.
 
 Interstate
Branching
 
 Under the
Riegle-Neal Interstate Banking and Branching Act (the “Riegle-Neal Act”), the
Federal Reserve Board may approve bank holding company acquisitions of banks in
other states, subject to certain aging and deposit concentration limits. As of
June 1, 1997, banks in one state may merge with banks in another state, unless
the other state has chosen not to implement this section of the Riegle-Neal Act.
These mergers are also subject to similar aging and deposit concentration
limits.
 
 North
Carolina “opted-in” to the provisions of the Riegle-Neal Act. Since July 1,
1995, an out-of-state bank that did not already maintain a branch in North
Carolina was permitted to establish and maintain a de novo branch in North
Carolina, or acquire a branch in North Carolina, if the laws of the home state
of the out-of-state bank permit North Carolina banks to engage in the same
activities in that state under substantially the same terms as permitted by
North Carolina. Also, North Carolina banks may merge with out-of-state banks,
and an out-of-state bank resulting from such an interstate merger transaction
may maintain and operate the branches in North Carolina of a merged North
Carolina bank, if the laws of the home state of the out-of-state bank involved
in the interstate merger transaction permit interstate merger.
 
 We cannot
predict what legislation might be enacted or what regulations might be adopted,
or if enacted or adopted, the effect thereof on our operations.
 
 ITEM
1A – RISK FACTORS
 Item not
applicable for smaller companies.
 
 ITEM
2 – PROPERTIES
 
 The
following table sets forth the location of the Registrant’s main office and
branch offices, as well as certain information relating to these offices to
date.
  20
 
 Office Locations
                  
                  Year
                    Opened
                  
                  Approximate
                    Square Footage
                  
                  Owned or LeasedMain
      Office
                    1005
      High House Road
                    Cary,
      NC
                  
                  2000
                  
                  8,100
                  
                  LeasedCary
      Office
                    1155
      Kildaire Farm Road
                    Cary,
      NC
                  
                  1998
                  
                  2,960
                  
                  LeasedApex
      Office
                    303
      South Salem Street
                    Apex,
      NC
                  
                  1999
                  
                  3,500
                  
                  LeasedClayton
      Office
                    315
      East Main Street
                    Clayton,
      NC
                  
                  2000
                  
                  2,990
                  
                  LeasedHolly
      Springs Office
                    700
      Holly Springs Road
                    Holly
      Springs, NC
                  
                  2003
                  
                  3,500
                  
                  OwnedPinehurst
      Office
                    211-M
      Central Park Avenue
                    Pinehurst,
      NC
                  
                  2003
                  
                  2,850
                  
                  LeasedSouthern
      Pines Office
                    185
      Morganton Road
                    Southern
      Pines, NC
                  
                  2003
                  
                  3,500
                  
                  LeasedSanford
      Office
                    870
      Spring Lane
                    Sanford,
      NC
                  
                  2004
                  
                  3,500
                  
                  Structure
      owned with
                    ground
      leaseGarner
      Office
                    945
      Vandora Springs Road
                    Garner,
      NC
                  
                  2007
                  
                  3,500
                  
                  LeasedFalls
      of Neuse Office
                    6408
      Falls of Neuse Road
                    Raleigh,
      NC
                  
                  2006
                  
                  2,442
                  
                  OwnedWilmington
      Main Office
                    1508
      Military Cutoff Road
                    Wilmington,
      NC  28403
                  
                  2006
                  
                  6,634
                  
                  LeasedKnightdale
      Office
                    7120
      Knightdale Boulevard
                    Knightdale,
      NC
                  
                  2007
                  
                  2,518
                  
                  OwnedWilmington
      Independence Office
                    2506
      Independence Boulevard
                    Wilmington,
      NC
                  
                  2008
                  
                  3,712
                  
                  Structure
      owned with
                    ground
      leaseRaleigh
      Creedmoor Office
                    7100
      Creedmoor Road
                    Raleigh,
      NC
                  
                  2008
                  
                  3,712
                  
                  OwnedRaleigh
      Main Office
                    4711
      Six Forks Road
                    Raleigh,
      NC
                  
                  2009
                  
                  18,250
                  
                  LeasedRaw
      land
                    Zebulon,
      NC
                  
                  2006
                  
                  1.38
      acres
                  
                  OwnedRaw
      land
                    Sanford,
      NC
                  
                  2007
                  
                  1.37
      acres
                  
                  OwnedOperations Locations
                  
                  Year Opened
                  
                  Approximate
                    Square Footage
                  
                  Owned or Leased206
      High House Road
                    Cary,
      NC
                  
                  2005
                  
                  12,535
                  
                  Leased
 
 The total
net book value of the Company’s real property used for business purposes,
furniture, fixtures, and equipment on December 31, 2009 was
$11,861,158.  All properties are considered by Company management to
be in good condition and adequately covered by insurance.
 
 ITEM
3 - LEGAL PROCEEDINGS
 
 There are
no pending legal proceedings to which the Registrant is a party, or of which any
of its property is the subject other than routine litigation that is incidental
to its business.
  21


ITEM
4 – [REMOVED AND RESERVED]




PART
II





ITEM
5 - MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES





The
Registrant’s stock is listed on the NASDAQ Global Market under the symbol
“CRFN.”  There were 9,626,559 shares outstanding at December 31, 2009 owned
by approximately 2,600 shareholders.  The table below lists the high and
low prices at which trades were completed during each quarter for the last two
years.  The Company’s stock is considered thinly traded with less than ten
thousand shares traded, on average, per day.  Our ability to pay cash
dividends depends on the cash dividends we receive from the Bank.  However,
the Bank is restricted in the amount of dividends it may pay.  See the
section entitled Regulation in Item 1 for further disclosure regarding cash
dividend payments.  Moreover, we do not expect to pay cash dividends on our
common stock in the foreseeable future, as we intend to retain earnings in order
to enhance our capital position.





Low
                  
                  
                  HighJanuary
      1, 2008 to March 31, 2008
                  
                  $
                  7.94
                  
                  
                  $
                  9.50April
      1, 2008 to June 30, 2008
                  
                  
                  5.71
                  
                  
                  
                  8.43July
      1, 2008 to September 30, 2008
                  
                  
                  5.70
                  
                  
                  
                  6.80October
      1, 2008 to December 31, 2008
                  
                  
                  3.12
                  
                  
                  
                  6.30January
      1, 2009 to March 31, 2009
                  
                  
                  2.80
                  
                  
                  
                  4.80April
      1, 2009 to June 30, 2009
                  
                  
                  2.89
                  
                  
                  
                  4.50July
      1, 2009 to September 30, 2009
                  
                  
                  3.45
                  
                  
                  
                  4.95October
      1, 2009 to December 31, 2009
                  
                  
                  3.00
                  
                  
                  
                  4.89





See Item
12 of this Report for disclosure regarding securities authorized for issuance
under equity compensation plans.


22


ITEM
6 – SELECTED FINANCIAL DATA





At or for the Years Ended
                            December 31,2009
                          
                          
                          2008
                          
                          
                          2007
                          
                          
                          2006
                          
                          
                          2005(Dollars in thousands, except share and per share data)Summary
      of OperationsInterest
      income
                          
                          $
                          56,206
                          
                          
                          $
                          54,405
                          
                          
                          $
                          54,872
                          
                          
                          $
                          36,707
                          
                          
                          $
                          22,827Interest
      expense
                          
                          
                          26,620
                          
                          
                          
                          29,070
                          
                          
                          
                          28,217
                          
                          
                          
                          17,257
                          
                          
                          
                          8,872Net
      interest income
                          
                          
                          29,586
                          
                          
                          
                          25,335
                          
                          
                          
                          26,655
                          
                          
                          
                          19,450
                          
                          
                          
                          13,955Provision
      for loan losses
                          
                          
                          11,526
                          
                          
                          
                          6,485
                          
                          
                          
                          1,684
                          
                          
                          
                          991
                          
                          
                          
                          807Net
      interest income after the provisionfor
      loan losses
                          
                          
                          18,060
                          
                          
                          
                          18,850
                          
                          
                          
                          24,971
                          
                          
                          
                          18,459
                          
                          
                          
                          13,148Non-interest
      income
                          
                          
                          4,328
                          
                          
                          
                          3,732
                          
                          
                          
                          2,621
                          
                          
                          
                          2,612
                          
                          
                          
                          2,417Non-interest
      expense
                          
                          
                          53,943
                          
                          
                          
                          19,972
                          
                          
                          
                          17,823
                          
                          
                          
                          13,387
                          
                          
                          
                          10,762Income
      (loss) before income taxes
                          
                          
                          (31,555
                          )
                          
                          
                          2,610
                          
                          
                          
                          9,769
                          
                          
                          
                          7,684
                          
                          
                          
                          4,803Income
      taxes
                          
                          
                          (1,329
                          )
                          
                          
                          599
                          
                          
                          
                          3,520
                          
                          
                          
                          2,780
                          
                          
                          
                          1,659Net
      income (loss)
                          
                          
                          (30,226
                          )
                          
                          
                          2,011
                          
                          
                          
                          6,249
                          
                          
                          
                          4,904
                          
                          
                          
                          3,144Effective
      dividend on preferred stock
                          
                          
                          1,617
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -Net
      income available (loss attributed) to common shareholders
                          
                          $
                          (31,843
                          )
                          
                          $
                          2,011
                          
                          
                          $
                          6,249
                          
                          
                          $
                          4,904
                          
                          
                          $
                          3,144Per
      Share and Shares Outstanding(1)Net
      income (loss), basic(2)
                          
                          $
                          (3.33
                          )
                          
                          $
                          0.21
                          
                          
                          $
                          0.68
                          
                          
                          $
                          0.67
                          
                          
                          $
                          0.58Net
      income (loss), diluted(2)
                          
                          $
                          (3.33
                          )
                          
                          $
                          0.21
                          
                          
                          $
                          0.65
                          
                          
                          $
                          0.64
                          
                          
                          $
                          0.55Book
      value at end of period
                          
                          $
                          6.92
                          
                          
                          $
                          9.88
                          
                          
                          $
                          9.75
                          
                          
                          $
                          9.13
                          
                          
                          $
                          6.52Tangible
      book value
                          
                          $
                          6.83
                          
                          
                          $
                          6.64
                          
                          
                          $
                          6.42
                          
                          
                          $
                          5.67
                          
                          
                          $
                          5.93Weighted
      average shares outstanding:Basic
                          
                          
                          9,569,290
                          
                          
                          
                          9,500,103
                          
                          
                          
                          9,211,779
                          
                          
                          
                          7,281,016
                          
                          
                          
                          5,402,390Diluted
                          
                          
                          9,569,290
                          
                          
                          
                          9,680,484
                          
                          
                          
                          9,635,694
                          
                          
                          
                          7,614,804
                          
                          
                          
                          5,682,447Shares
      outstanding at period end
                          
                          
                          9,626,559
                          
                          
                          
                          9,626,559
                          
                          
                          
                          9,404,579
                          
                          
                          
                          9,091,649
                          
                          
                          
                          6,358,388Balance
      Sheet DataTotal
      assets
                          
                          $
                          1,032,805
                          
                          
                          $
                          968,311
                          
                          
                          $
                          835,540
                          
                          
                          $
                          697,909
                          
                          
                          $
                          410,788Total
      investments(3)
                          
                          
                          227,341
                          
                          
                          
                          113,278
                          
                          
                          
                          97,858
                          
                          
                          
                          89,069
                          
                          
                          
                          57,752Total
      loans, net
                          
                          
                          741,781
                          
                          
                          
                          772,792
                          
                          
                          
                          667,643
                          
                          
                          
                          542,874
                          
                          
                          
                          323,971Total
      deposits
                          
                          
                          722,635
                          
                          
                          
                          714,883
                          
                          
                          
                          605,431
                          
                          
                          
                          541,881
                          
                          
                          
                          322,081Borrowings
                          
                          
                          216,748
                          
                          
                          
                          154,454
                          
                          
                          
                          135,003
                          
                          
                          
                          69,699
                          
                          
                          
                          45,212Stockholders’
      equity
                          
                          
                          89,520
                          
                          
                          
                          95,092
                          
                          
                          
                          91,659
                          
                          
                          
                          83,034
                          
                          
                          
                          41,457Selected
      Performance RatiosReturn
      on average assets
                          
                          
                          (2.85
                          )%
                          
                          
                          0.22
                          %
                          
                          
                          0.80
                          %
                          
                          
                          0.93
                          %
                          
                          
                          0.84
                          %Return
      on average stockholders’ equity
                          
                          
                          (24.85
                          )%
                          
                          
                          2.13
                          %
                          
                          
                          7.15
                          %
                          
                          
                          8.72
                          %
                          
                          
                          10.34
                          %Net
      interest spread(4)
                          
                          
                          2.74
                          %
                          
                          
                          2.55
                          %
                          
                          
                          3.08
                          %
                          
                          
                          3.29
                          %
                          
                          
                          3.51
                          %Net
      interest margin(5)
                          
                          
                          3.09
                          %
                          
                          
                          3.05
                          %
                          
                          
                          3.79
                          %
                          
                          
                          4.03
                          %
                          
                          
                          4.01
                          %Non-interest
      income as a percentage oftotal
      revenue(6)
                          
                          
                          12.76
                          %
                          
                          
                          12.85
                          %
                          
                          
                          8.95
                          %
                          
                          
                          11.84
                          %
                          
                          
                          14.76
                          %Non-interest
      income as a percentage ofaverage
      assets
                          
                          
                          0.41
                          %
                          
                          
                          0.41
                          %
                          
                          
                          0.34
                          %
                          
                          
                          0.49
                          %
                          
                          
                          0.64
                          %Non-interest
      expense to averageassets
                          
                          
                          5.08
                          %
                          
                          
                          2.18
                          %
                          
                          
                          2.29
                          %
                          
                          
                          2.53
                          %
                          
                          
                          2.86
                          %Efficiency
      ratio(7)
                          
                          
                          159.06
                          %
                          
                          
                          68.71
                          %
                          
                          
                          60.88
                          %
                          
                          
                          60.68
                          %
                          
                          
                          65.73
                          %Average
      stockholders’ equity toaverage
      total assets
                          
                          
                          11.46
                          %
                          
                          
                          10.32
                          %
                          
                          
                          11.24
                          %
                          
                          
                          10.64
                          %
                          
                          
                          8.08
                          %Asset
      Quality RatiosNet
      charge-offs to average loansoutstanding
                          
                          
                          0.84
                          %
                          
                          
                          0.29
                          %
                          
                          
                          0.06
                          %
                          
                          
                          0.02
                          %
                          
                          
                          0.04
                          %Allowance
      for loan losses to period endloans
                          
                          
                          2.31
                          %
                          
                          
                          1.60
                          %
                          
                          
                          1.22
                          %
                          
                          
                          1.26
                          %
                          
                          
                          1.33
                          %Allowance
      for loan losses to non-performing
      loans
                          
                          
                          95
                          %
                          
                          
                          96
                          %
                          
                          
                          303
                          %
                          
                          
                          5,145
                          %
                          
                          
                          16,960
                          %Non-performing
      loans to period endloans
                          
                          
                          2.44
                          %
                          
                          
                          1.67
                          %
                          
                          
                          0.40
                          %
                          
                          
                          0.02
                          %
                          
                          
                          0.01
                          %Non-performing
      assets to total assets(8)
                          
                          
                          2.40
                          %
                          
                          
                          1.53
                          %
                          
                          
                          0.36
                          %
                          
                          
                          0.03
                          %
                          
                          
                          0.01
                          %




23





At or for the Years Ended
                  December 31,2009
                
                
                2008
                
                
                2007
                
                
                2006
                
                
                2005(Dollars in thousands, except share and per share data)Capital
      RatiosTotal
      risk-based capital ratio
                
                
                13.53
                %
                
                
                10.68
                %
                
                
                10.51
                %
                
                
                11.03
                %
                
                
                13.68
                %Tier
      1 risk-based capital ratio
                
                
                11.37
                %
                
                
                8.53
                %
                
                
                9.37
                %
                
                
                9.88
                %
                
                
                12.51
                %Leverage
      ratio
                
                
                9.03
                %
                
                
                7.67
                %
                
                
                8.56
                %
                
                
                9.13
                %
                
                
                11.51
                %Equity
      to assets ratio
                
                
                8.67
                %
                
                
                9.82
                %
                
                
                10.97
                %
                
                
                11.90
                %
                
                
                10.09
                %Other
      DataNumber
      of full-service banking offices
                
                
                15
                
                
                
                13
                
                
                
                12
                
                
                
                11
                
                
                
                9Number
      of full-time equivalentemployees
                
                
                158
                
                
                
                147
                
                
                
                126
                
                
                
                122
                
                
                
                90





(1)
            Adjusted
      to reflect the 10 % stock dividend distributed in 2007 and stock splits
      effected in the form of 15% stock dividends in
  2006.


(2)
            Computed
      based on the weighted average number of shares outstanding during each
      period.


(3)
            Consists
      of interest-earning deposits, federal funds sold, investment securities
      and FHLB stock.


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


(5)
            Net
      interest margin is net interest income divided by average interest-earning
      assets on a tax equivalent basis.


(6) 
         Total revenue consists of net interest income
and non-interest income.


(7)
            Efficiency
      ratio is non-interest expense divided by the sum of net interest income
      and non-interest income.


(8)
            Non-performing
      assets consist of non-accrual loans, accruing loans 90 days or more past
      due, restructured loans only if in non-accrual status, and foreclosed
      assets, where applicable.




24


ITEM
7 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS





Management’s
discussion and analysis is intended to assist readers in the understanding and
evaluation of the financial condition and consolidated results of operations of
Crescent Financial Corporation (“Crescent” or the “Company”). The analysis
includes detailed discussions for each of the factors affecting Crescent
Financial Corporation’s operating results and financial condition for the years
ended December 31, 2009 and 2008. It should be read in conjunction with the
audited consolidated financial statements and accompanying notes included in
this report and the supplemental financial data appearing throughout this
discussion and analysis.





The
following discussion and analysis contains the consolidated financial results
for the Company and Crescent State Bank for the years ended December 31, 2009,
2008 and 2007.  The Company had previously discontinued the consolidation
of Crescent Financial Capital Trust I and began reporting the junior
subordinated debentures that the Company issued in exchange for the proceeds
that resulted from the issuance of the trust preferred securities.  The
trust preferred securities are classified as long-term debt obligations. 
Except for the accounting treatment, the relationship between the Company and
Crescent Financial Capital Trust I has not changed.   Crescent
Financial Capital Trust I continues to be a wholly owned subsidiary of the
Company and the full and unconditional guarantee of the Company for the
repayment of the trust preferred securities remains in effect.  The
financial statements presented contain the consolidation of Crescent Financial
Corporation and the Banks only.  The Company and its consolidated
subsidiaries are collectively referred to herein as the Company unless otherwise
noted.





COMPARISON
OF FINANCIAL CONDITION AT DECEMBER 31, 2009 AND 2008





At
December 31, 2009, the Company reported total assets of $1,032.8 million
compared with $968.3 million at December 31, 2008.  Total assets increased
by $64.5 million or 7% during the twelve month period.  Total earning
assets increased by $86.5 million or 10% to $984.1 million compared with $897.6
million at the prior year end.  Earning assets at December 31, 2009
consisted of $759.3 million in gross loans, $190.5 million in investment
securities, $11.8 million in Federal Home Loan Bank (FHLB) stock and $22.4
million in overnight investments and interest bearing deposits.  Total
deposits increased to $722.6 million at December 31, 2009 from $714.9 million
reflecting a $7.7 million or 1% increase.  Borrowings increased by $62.2
million or 40% from $154.5 million to $216.7 million.  Stockholders’ equity
decreased by 6% or $5.6 million to $89.5 million compared with $95.1
million.





Gross
loans outstanding declined by $26.0 million or 3% totaling $759.3 million at
year end 2009 compared to $785.4 million at December 31, 2008.  In
conjunction with a core data processing conversion occurring in early March, the
Company reclassified certain loans within the portfolio so that reporting is
more consistent with the collateral of a particular loan rather than the
purpose.  For instance, loans secured by homes purchased as investment
property or for a commercial business purpose were previously reported as
commercial real estate whereas they are now reported as residential real estate
mortgages.  Loans secured by commercial building lots were previously
reported as commercial real estate and are now reported as construction and land
development.  Reclassifications of loan types through the conversion
process resulted in $164.6 million of commercial real estate loans and $2.1
million consumer loans being shifted to $81.8 million of construction and land
development, $70.7 million residential mortgages, $9.3 million home equity loans
and $4.9 million commercial and industrial.





When
considering these reclassifications, the net decrease in the portfolio for 2009,
by category and net of unearned income, was comprised of the following changes:
the commercial real estate portfolio increased by $53.7 million or 18% to $358.9
million from $305.2 million; residential mortgage loans increased by $6.9
million or 8% to $96.6 million from $89.7 million; home equity lines and loans
increased by $.7 million or 1% to $64.5 million from $63.8 million; consumer
loans increased by $1.8 million or 55% to $5.0 million from $3.2 million; the
construction, land acquisition and development portfolio declined by $63.4
million or 26% to $179.1 million from $242.5 million; and the commercial and
industrial portfolio decreased by $25.7 million or 32% to $55.3 million from
$81.0 million.  The composition of the loan portfolio, by category, as of
December 31, 2009 is as follows: 47% commercial mortgage loans, 24%
construction/acquisition and development loans, 13% residential mortgage loans,
8% home equity loans and lines of credit, 7% commercial and industrial loans,
and 1% consumer loans.  The composition of the loan portfolio, by category
and as adjusted for the reclassifications, as of December 31, 2008 was 39%
commercial mortgage loans, 31% construction loans, 11% residential real estate
mortgage loans, 10% commercial loans, 8% home equity loans and lines and 1%
consumer loans.


25




We track
each loan we originate using the North American Industry Classification System
(NAICS) code.  Through the use of this code, we can monitor those
industries for which we have a significant concentration of exposure.  At
December 31, 2009, there was one industry code for which our concentration
exposure equaled or exceeded 10% of the total loan portfolio.  Loans to
investors who lease non-residential buildings other than miniwarehouses
comprised 19% of our loan portfolio.  We also have significant
concentrations of 9% in both the residential land development and residential
construction which require continuous monitoring.  While the markets we
operate in have not experienced the same extent of problems experienced in other
markets nationally, the impact of the housing slowdown has and could continue to
impact the financial performance of the Company.





The
allowance for loan losses was $17.6 million or 2.31% of total outstanding loans
at December 31, 2009 compared to $12.6 million or 1.60% of total outstanding
loans at December 31, 2008.  The current economic climate, and its
impact on the housing market and general business conditions, has resulted in
some deterioration of quality within the construction, land acquisition,
development, commercial and home equity sectors of our loan portfolio. 
Additionally, management makes adjustments to its loan loss reserve methodology
to account for a variety of factors such as loan concentration, current
delinquency levels, adverse conditions that might affect a borrower’s ability to
repay the loan, prevailing economic conditions and all other relevant factors
derived from our history of operations. There is a more detailed discussion of
the methodology in the section entitled “Analysis of Allowance for Loan
Losses.”





At
December 31, 2009, there were sixty eight loans totaling approximately $18.1
million in non-accrual status.  Twenty of those loans totaling
approximately $6.7 million are in the construction, land acquisition and
development sector. Of the remaining $11.4 million, $4.6 million was commercial
real estate, $2.8 million was 1-4 family residential loans, $2.7 million was
attributable to the commercial loan portfolio, and $1.3 million were home equity
lines of credit.  The percentage of non-performing loans to total loans at
December 31, 2009 was 2.39%.  There were twenty-three performing loans
aggregating $6.2 million that were 30 days or more past due and of those, two
loans with a balance of $381,000 were past due 90 days or more and still
accruing interest at December 31, 2009.  At December 31, 2008, there were
fifty loans totaling $13.1 million in non-accrual status.  Of the total
$13.1 million, $7.7 million were concentrated in the construction, land
acquisition and development sectors and $4.4 million was residential
mortgages.  Of the original fifty loans, six remain in non-accrual at
December 31, 2009 and the remaining loans were paid, charged-off, foreclosed or
foreclosed and subsequently sold.  The percentage of non-performing loans
to total loans at December 31, 2008 was 1.53%.  There were twelve loans
aggregating $738,000 that were 30 days or more past due and no loans past due 90
days or more and still accruing interest at December 31, 2008.    See
the section entitled “Non Performing Assets” for more details.





Loans are
classified as Troubled Debt Restructurings (“TDRs”) by the Company when certain
modifications are made to the loan terms and concessions are granted to the
borrowers due to financial difficulty experienced by those borrowers.  All
$13.7 million of TDRs at December 31, 2009 were accruing interest, were not past
due 30 days or more and were not included in nonperforming loans.  The
Company only restructures loans for borrowers in financial difficulty that have
designed a viable business plan to fully pay off all obligations, including
outstanding debt, interest, and fees, either by generating additional income
from the business or through liquidations of assets.  Generally these loans
are restructured to provide the borrower additional time to execute their
plans.  The TDRs were not placed in nonaccrual status prior to the
restructuring, and since the Company expects the borrowers to perform after the
restructuring (based on modified note terms), the loans continue to accrue
interest at the restructured rate.  The Company will continue to closely
monitor these loans and will cease accruing interest on them if management
believes that the borrowers may not continue performing based on the
restructured note terms.  All TDR’s are considered impaired and at year end
there were $3.6 million in TDRs which demonstrated impairment and accordingly
were evaluated as such in the allowance calculation.  As of December 31,
2009, allowance for loan losses allocated to TDRs totaled approximately
$858,000.




26


The
amortized cost and fair market value of the Company’s investment securities
portfolio at December 31, 2009 were $190.5 million and $193.1 million,
respectively compared to $104.6 million and $105.6 million, respectively, at
December 31, 2008.  All investments are accounted for as available for sale
and are presented at their fair market value. Over the past twelve months, the
portfolio experienced a net increase of $87.5 million or 83%.  The
Company’s investment in debt securities at December 31, 2009, consisted of U.S.
Government agency securities, collateralized mortgage obligations (CMOs),
mortgage-backed securities (MBSs), municipal bonds and common stock of two
publicly traded entities.   Increases in the portfolio during 2009
were attributed to new securities purchases of $167.7 million, a $1.6 million
increase in the fair market value of the portfolio, and an $870,000 gain on the
disposal of available for sale securities.  Decreases in the portfolio were
attributed to the receipt of $38.7 million in principal re-payments on CMOs and
MBSs, a net premium decline of $970,000, a $198,000 impairment on marketable
securities, and $42.8 million in proceeds from the disposal of available for
sale securities.  The Company also owned $11.8 million of Federal Home Loan
Bank stock at December 31, 2009 compared with $7.3 million at December 31,
2008.





During
the first quarter of 2009 the Company implemented a leverage strategy to offset
the impact on earnings per share anticipated as a result of having to pay
dividends on the investment made by the US Treasury pursuant to the Capital
Purchase Plan (CPP). While the funds received through the CPP have been
allocated for the purpose of making loans to purchasers of completed properties
held in inventory by our residential construction customers, an amount equal to
the CPP funds was leveraged four times and used to purchase investment
securities. The additional spread earned on the strategy is meant to offset the
reduction in earnings per share for common shareholders due to payment of the
preferred dividend.





All of
our mortgage-backed and collateralized mortgage obligation securities are issued
through either a Government Sponsored Enterprise (GSEs) such as Federal Home
Loan Mortgage Corporation (Freddie Mac) or the Federal National Mortgage
Association (Fannie Mae) or the government-owned Government National Mortgage
Association (Ginnie Mae).  Prior to September 7, 2008, only those
securities issued by Ginnie Mae were backed by the full faith of the US
Government.  There was an implied guarantee on securities issued through
the other two GSEs, but not an explicit guarantee. On September 7, 2008, the US
Department of Treasury and the Federal Housing Finance Agency announced that
Freddie Mac and Fannie Mae were being placed into conservatorship.  As a
result, the US Government effectively has guaranteed the securities issued by
the GSEs.  Therefore, the credit risk associated with owning debt
securities issued through these two entities has been significantly
mitigated.





Non-interest
earning assets totaled $63.7 million at December 31, 2009, decreasing by $18.6
million or 23% over the past year.  The other asset category experiencing
the largest increase was other real estate owned which grew by $4.6 million
during the year as the Company foreclosed on real estate collateral used to
secure certain loans.  Prepaid expenses increased by approximately $3.9
million between December 31, 2008 and December 31, 2009 primarily due to the
prepayment of three years of FDIC insurance premiums.  Premises and
equipment experienced a net increase of $1.0 million resulting from the purchase
of $1.9 million in new assets less $938,000 of depreciation expense. 
  The net deferred income tax asset increased by $1.6 million due primarily
to the significant increase in the loan loss provision.  For tax purposes,
the amount provided for loan losses is only deductible when a loan is actually
charged-off.  Therefore, the tax benefit to be derived is deferred. 
 Accrued interest receivable increased by $919,000 due to a higher volume
of earning assets.  The cash value of bank owned life insurance increased
by $846,000 during the period.  Cash and due from banks, which represents
cash on hand in branches and amounts represented by checks in the process of
being collected through the Federal Reserve payment system, declined by $632,000
from $9.9 million to $9.3 million.  For more details regarding the decrease
in cash and cash equivalents, see the Consolidated Statements of Cash
Flows.  Goodwill which was valued at $30.2 million at the end of 2008 was
deemed totally impaired as of December 31, 2009 and completely written
off.  See Note F for a more detailed discussion of our Goodwill testing
methodology and conclusions.





Total
deposits at December 31, 2009 were $722.6 million compared to $714.9 million at
December 31, 2008 increasing by $7.7 million or 1% during the past twelve
months.  We experienced strong growth in our interest bearing demand
deposits which increased by $50.6 million or 119% from $42.6 million to $93.2
million at year end.    In late 2008, we introduced a checking account
product designed to reward customers for modifying the activity related to their
account.  In return for receiving electronic account statements and
performing more debit card and other electronic transactions they receive a
premium rate of interest.  The response has been very good and has allowed
us to increase our core deposit base while reducing our reliance on brokered
funds.  Time deposits decreased by $24.0 million or 5% from $461.5 million
to $437.5 million.  Of the total $24.0 million decrease, $52.7 million
represented a decline in brokered time deposits with an offsetting $28.7 million
net growth in retail time deposits. Money market accounts decreased $15.1
million or 17% to $72.8 million at December 31, 2009 from $87.9 million the
prior year.  Early in 2009 we lost one large money market relationship of
approximately $14.0 million and we had served as the escrow agent for a new
financial institution which received approval and withdrew the funds during the
first quarter of 2009.   Non interest-bearing demand deposits declined
by $2.9 million from $63.9 million to $61.0 million and savings account balances
declined by $748,000 to $58.1 million at year-end.  The statement savings
product did suffer some disintermediation into the new interest bearing checking
product.


27




The
composition of the deposit base, by category, at December 31, 2009 was as
follows:  61% in time deposits, 13% in interest-bearing deposits, 10% in
money market, and 8% in both non interest-bearing demand deposits and statement
savings.  The composition of the deposit base, by category, at December 31,
2008 was as follows:  65% in time deposits, 12% in money market deposits,
9% in non interest-bearing demand deposits, 8% in statement savings, and 6% in
interest-bearing deposits.





At
December 31, 2009 the Company had $357.4 million in time deposits of $100,000 or
more compared to $359.3 million at December 31, 2008. The Company uses brokered
certificates of deposit as an alternative funding source.  Brokered
deposits represent a source of fixed rate funds that do not need to be
collateralized like Federal Home Loan Bank borrowings.  While we expect to
continue to utilize the brokered deposit market in the future, we anticipate
being more focused on increasing our market share of local deposits and focusing
on improving our earnings. There are times when obtaining money in the brokered
arena is less expensive than offering high rate specials in our markets. 
The Company will aim to balance the need for a higher concentration of local
money against the cost of funds. Brokered deposits at December 31, 2009 were
$203.3 million compared to $256.1 million at December 31, 2008.





Total
borrowings increased by 40% or $62.2 million from $154.5 million at December 31,
2008 to $216.7 million at December 31, 2009  Borrowings at December 31,
2009 consisted of $127.0 million in long-term FHLB advances, $24.0 million in
short-term FHLB advances, $50.0 million in short-term Fed Discount Window
advances, $8.2 million in junior subordinated debt issued to an unconsolidated
subsidiary, and $7.5 million in subordinated term loans secured from a
non-affiliated financial institution.   Borrowings at December 31,
2008 consisted of $99.0 million in long-term FHLB advances, $29.0 million in
short-term FHLB advances, $8.2 million in junior subordinated debt issued to an
unconsolidated subsidiary, $7.5 million in subordinated term loans secured from
a non-affiliated financial institution, $2.0 million outstanding on a holding
company line of credit and $8.7 million in Federal funds purchased from a
correspondent bank.





Accrued
expenses and other liabilities were $3.9 million at both December 31, 2009 and
2008.





Total
stockholders’ equity decreased by $5.6 million between December 31, 2008 and
December 31, 2009. The decrease was the net result of the issuance of $24.9
million preferred stock, a $788,000 increase in other comprehensive income and
$181,000 in stock based compensation, offset by a net loss for the year of $30.2
million and $1.2 million in preferred stock dividends.





COMPARISON
OF RESULTS OF OPERATIONS FOR THE YEARS ENDED


DECEMBER
31, 2009 AND 2008





Net
Income. For the year ended December 31, 2009, the Company reported a net loss,
before adjusting for the effective dividend on the preferred stock, of $30.2
million compared to net income of $2.0 million for the year ended December 31,
2008.  After adjusting for $1.6 million in dividends and discount accretion
on preferred stock, the net loss attributable to common shareholders for the
current period was $31.8 million or $(3.33) per diluted share compared with net
income of $0.21 per diluted share for the year ended December 31, 2008. 
Annualized return on average assets declined to (2.85)% from 0.22% for the prior
period.  Earnings in the current period were positively impacted by
slightly improved net interest margin, which was more than offset by a higher
loan loss provision in response to current economic conditions and an increase
in non-interest operating expenses. Additionally, the Company recorded a
non-cash goodwill impairment charge of $30.2 million during the fourth
quarter.  Return on total average equity for the current period was
(24.85)% compared to 2.13% for the prior period.  The decline in return on
average equity is due to the lower level of earnings combined with higher
capital from the issuance of the preferred stock.





Net
Interest Income.  Net interest income was $29.6 million for the current
year compared to $25.3 million for the prior year reflecting a 17% increase. The
increase in interest income was primarily attributed to the $136.8 million rise
in average earning assets and was partially offset by the impact of a 68 basis
point decline on the yield on earning assets.


28




Net
interest margin is interest income earned on loans, securities and other earning
assets, less interest expense paid on deposits and borrowings, expressed as a
percentage of total average earning assets.  The tax equivalent net
interest margin for the year ended December 31, 2009 was 3.09% compared to 3.05%
for the prior year. The average yield on earning assets for the current period
was 5.79% compared to 6.47% from the year ended December 31, 2008 and the
average cost of interest-bearing funds was 3.05% compared to 3.86%. The positive
impact on net interest income margin came in part due to the increase in
interest rate spread from 2.61% to 2.74%.





While the
interest rate environment in 2009 was stable, it followed a fifteen month period
of sharply falling interest rates.  Between September 19, 2007 and December
31, 2008, the Federal Reserve (the “Fed”) cut short-term interest rates ten
times for a total of 500 basis points.  Approximately 42% of the Company’s
loan portfolio has variable rate pricing based on the Prime lending rate or
LIBOR (London Inter Bank Offered Rate).  The percentage of variable rate to
total loans has declined from 49% at December 31, 2008.  In light of the
historically low level of interest rates in conjunction with current economic
conditions, for those new variable rate loans and variable rate loans that are
renewed we have instituted rate floors in many instances.  Approximately
88% of the total variable rate loans have a rate floor with the majority of
those floors in the 5.00% to 6.50% range.  Therefore, only 5% of the total
loan portfolio is variable with no interest rate floors.





The
Company has shifted its strategic focus from a growth orientation to a more
performance-related, relationship orientation.  The Company is being more
disciplined with loan pricing and implementing interest rate floors on variable
rate loans when feasible.  As a result, the loan portfolio will not
experience the same growth rates as has been seen in recent years, but should
provide better yields.  This should also ease reliance on wholesale forms
of funding.  While there is an attempt to focus on local market
relationships, wholesale forms of funding will continue to make more sense from
an economic standpoint at certain times.





The
Company expects that net interest margin will continue to expand in a stable
interest rate environment as approximately 62% of the time deposit portfolio
carrying a weighted average rate of 2.97% matures in the next year and is
subject to being renewed at lower rates.  The Company entered into interest
rate swap agreements on $7.5 million subordinated loan agreement and $8.0
million trust preferred securities.  These two borrowings carry variable
rates of interest based on three-month LIBOR.  We have swapped these
variable cash flows for fixed rate cash flows for an average period of three and
a half years.  In addition to adopting a funding strategy that pushes
funding maturities further out into the future, these swaps will further protect
the Company when rates do begin to rise.





Total
average interest earning assets were $985.6 million for the year ended December
31, 2009, increasing by $136.8 million or 16% when compared to an average of
$848.8 million for the year ended December 31, 2008. Increases in average
balances by earning asset category are as follows: average loans increased by
$35.4 million or 5% from $741.8 million for 2008 to $777.3 million for 2009,
investment securities grew by $98.1 million or 95% from $103.1 million to $201.2
million and Federal funds sold and other earning assets increased by $3.3
million or 84% from $3.9 million to $7.2 million.  Total average
interest-bearing liabilities increased by $120.9 million with interest-bearing
deposits increasing by $34.7 million or 6% and borrowings increasing by $86.2
million or 61%.





Total
interest income for 2009 increased by $1.8 million from $54.4 million to $56.2
million. The increase was the net result of a $7.4 million increase in interest
income from the higher volume of earning assets and a $5.6 million decrease due
to the falling interest rate environment. Total interest expense declined by
$2.4 million which resulted from a net increase of $2.5 million from higher
interest bearing liability volumes and a $4.9 million decrease due to lower
interest rates.





Provision
for Loan Losses. The Company’s provision for loan losses for 2009 was $11.5
million compared to $6.5 recorded in the prior year. The increase in the loan
loss provision was attributable completely to the deterioration of loan quality
due to current economic conditions as the total loan portfolio actually declined
by $26.0 million from December 31, 2008 to December 31, 2009.  Economic
conditions in communities we serve stemming primarily from the weakening housing
market and unemployment have caused us to be more aggressive in monitoring the
quality of our loan assets and to take proactive steps to identify loans that
are impaired.  Once a loan is deemed to be impaired, we must evaluate what
degree of impairment exists, if any, and recognize that deficiency as a specific
reserve.  Provisions for loan losses are charged to income to bring the
allowance for loan losses to a level deemed appropriate by management. 
 For a more detailed discussion of the provision of loan losses and the
established reserve, see the section entitled “Analysis of Allowance for Loan
Losses.”


29




Non-Interest
Income. Non-interest income increased by $523,000 or 14% to $4.3 million for
2009 compared to $3.8 million for the prior year period. The largest components
of non-interest income in 2009 were $1.40 million in customer service fees
(which include non sufficient funds fees, debit card commissions, ATM surcharges
and other deposit account related fees), $886,000 in earnings on cash value of
bank owned life insurance, $923,000 in mortgage loan origination fees, and
$247,000 in service charges on deposit accounts.  For the year ended
December 31, 2008, the largest components of non-interest income included $1.4
million in customer service fees, $718,000 in mortgage loan origination fees,
$736,000 in earnings on cash value of bank owned life insurance and $254,000 in
service charges on deposit accounts.  During 2009, the Company recognized
$870,000 in gains on the disposal of available for sale securities, a $407,000
impairment on non-marketable securities, a $197,000 impairment on marketable
equity securities, a $75,000 gain on sale of a loan and $3,000 in losses on the
disposal of fixed assets.   The Company recognized $16,000 in gains on
the disposal of available for sale securities and $1,000 in losses on the
disposal of fixed assets in 2008.





Non-Interest
Expenses. Non-interest expenses were $53.9 million for year ended December 31,
2009 compared to $20.0 million for the prior year period.  The $33.9
million or 170% increase reflects a $30.2 million write-off of Goodwill, the
continuing efforts to expand the Company’s infrastructure and branch network and
an increase in FDIC premiums.  Of the $3.7 million non-goodwill related
increase, $1.5 million is attributed to FDIC premiums and $1.9 million was in
personnel, occupancy and data processing which are the areas most impacted by
the branch network and infrastructure improvements.





Total
compensation for the year ended December 31, 2009 was $11.8 million reflecting a
7% increase when compared to $11.1 million for the year ended December 31,
2008.  As of December 31, 2009, the Company employs 158 full-time
equivalent employees in fifteen full-service branch offices and various
administrative support departments.  In comparison, at December 31, 2008,
the Company employed 147 full-time equivalent employees in thirteen full-service
branch offices, one loan production office and various administrative support
departments.





Occupancy
expenses were $3.5 million for 2009 compared to $2.7 million in 2008 increasing
by $816,000 or 30%.  During 2009, the Company opened two new full-service
offices in Raleigh.  Additionally, in March 2008, one new branch office was
opened.  There are currently no new de novo branch openings planned for
2010; however, other expansion opportunities might present themselves which
would impact occupancy expense.





Data
processing expenses were $1.4 million for 2009 increasing by $337,000 or
31%.  The Company completed a full data processing system conversion during
the first quarter of 2009 and $156,000 of the total increase is attributable to
non-recurring expenses.  The Company added several new important
technologies as part of the data processing conversion such as loan document
imaging and a more automated and enhanced credit underwriting tool.





FDIC
deposit insurance premiums increased to $1.9 million in 2009 from $402,000 for
the prior year.  As previously discussed, the Company was subject to both
higher regular deposit premiums and a special assessment collected on September
30, 2009 in the amount of $493,000.  While there has been no mention of
additional special assessments, the FDIC has the authority to levy additional
assessments based on the level of the Deposit Insurance Fund.  Additional
assessments could have a significant impact on the financial results of the
Company.





In
accordance with Generally Accepted Accounting Principles, the Company had been
analyzing for impairment the goodwill created through the prior bank
acquisitions in 2003 and 2007.  During the fourth quarter, it was
determined that the appropriate course of action was to recognize the entire
goodwill amount as impaired.  This resulted in a non-cash expense of $30.2
million.





The total
of all other expenses increased by $271,000 in 2009 compared to 2008.  The
largest components of other noninterest expenses include professional fees
(legal, accounting and audit expenses and director fees), loan related expenses,
advertising and marketing related and office supplies.  Loan related
expenses increased to $725,000 for 2009 from $403,000 the prior year. 
Expenses increased by $322,000 or 80% as the Company experienced additional
legal and appraisal valuation fees related to the foreclosure process.  The
Company realized a $45,000 loss on the sale and write-down of other real estate
owned in 2009.   Professional fees and services totaled $1.5 million
in 2009, down $155,000 or 10% from the $1.6 million for 2008.  The auditor
reporting requirements of Section 404 of Sarbanes-Oxley Act (SOX) were delayed
for 2009 and therefore the company did not incur additional audit fees as a
result.  The Company is currently subject to certain provisions of the FDIC
Improvement Act related to management’s report of financial results and will be
subject to additional provisions beginning in 2010, which will require
certification for the effectiveness of internal controls over financial
reporting by the external auditors.   Office supplies  and
printing expense increased by $41,000 due to the increased number of offices and
advertising and marketing expenses declined by $26,000.


30




Provision
for Income Taxes. For 2009, the Company’s provision for income taxes was $(1.3)
million compared to $599,000 for the prior year. The effective tax rates for
2009 and 2008 were 4.21% and 22.9%, respectively.  The significant decline
in effective tax rate was due to a pre-tax loss and the volume of tax-exempt
income.




COMPARISON
OF RESULTS OF OPERATIONS FOR THE YEARS ENDED


DECEMBER
31, 2008 AND 2007





Net
Income. For the year ended December 31, 2008, the Company reported net income of
$2.0 million compared to $6.2 million for the year ended December 31,
2007.  The 68% decline in net income resulted in a decrease of diluted
earnings per share of $0.44 to $0.21 for the year ended December 31, 2008
compared to $0.65 for the prior year period.  The decrease in earnings year
over year was primarily the result of a higher provision for loan losses and a
compressing net interest rate margin due to the falling interest rate
environment.  Returns on average assets and average equity were 0.22% and
2.13%, respectively, for the year ended December 31, 2008 compared to 0.80% and
7.15% for the prior year period.





Net
Interest Income.  Net interest income was $25.3 million for the current
year compared to $26.7 million for the prior year reflecting a 5% decrease.
Increases to be expected from the significant increase in total earning assets
were more than offset by the impact of falling interest rates on the spread
between rates earned on the assets and the cost of funding those
assets.





The tax
equivalent net interest margin for the year ended December 31, 2008 was 3.05%
compared to 3.79% for the prior year. The average yield on earning assets for
the current period was 6.47% compared to 7.73% from the year ended December 31,
2007 and the average cost of interest-bearing funds was 3.86% compared to 4.58%.
The impact on net interest income from the decline in interest rate spread from
3.15% to 2.61% was exacerbated by a decline in the ratio of average interest
earning assets to average interest bearing liabilities from 116.21% to
112.74%.





The
interest rate environment between September 2007 and December 2008 had a
significant impact on the Company’s net interest margin.  Beginning on
September 19, 2007, the Federal Reserve (the “Fed”) began cutting short-term
interest rates.  The December 17, 2008 cut was the tenth such reduction
since September 2007 and placed the total interest rate cuts at 500 basis
points.   During the course of 2008, the percentage of our total loan
portfolio that carried variable rates of interest based on the Prime rate or
LIBOR (London Inter Bank Offered Rate) ranged from a high of 52% a year ago to
49% at December 31, 2008.  As short-term rates declined, the interest rates
on variable rate loans fell resulting in a lower yield on average earning
assets.  Whereas this segment of our loan portfolio was subject to
immediate repricing, large portions of our funding liabilities were subject to
repricing over some length of time.  Many of the Company’s borrowings and
all time deposits carried a fixed rate of interest to a fixed future maturity
date.  The rates on those fixed rate, fixed maturity instruments become
subject to change only at maturity.  Therefore, it takes a longer period of
time to realize decreases in our cost of funds.  Other non-maturity
deposits such as interest-bearing demand deposits, savings and money market
carried variable rates of interest which we can change at our discretion. 
Typically rates on those instruments do not change at the same magnitude as a
change in the Prime rate of interest might.  These factors resulted in a
decline in the net interest margin for 2008.





Total
average interest earning assets were $848.8 million for the year ended December
31, 2008, increasing by $132.9 million or 19% when compared to an average of
$716.0 million for the year ended December 31, 2007. Increases in average
balances by earning asset category are as follows: average loans increased by
$126.5 million or 21% from $615.3 million for 2007 to $741.8 million for 2008,
investment securities grew by $10.5 million or 11% from $92.6 million to $103.1
million and Federal funds sold and other earning assets decreased from $8.0
million to $3.9 million.  Total average interest-bearing liabilities
increased by $136.8 million with interest-bearing deposits increasing by $88.6
million or 17% and borrowings increasing by $48.3 million or 51%.




Total
interest income for 2008 decreased by $467,000 from $54.9 million to $54.4
million. The decrease was the net result of a $9.6 million increase in interest
income from the higher volume of earning asset and a $10.1 million decrease due
to the falling interest rate environment. Total interest expense grew by
$853,000 which resulted from a net increase of $6.3 million from higher interest
bearing liability volumes and a $5.5 million decrease due to lower interest
rates.





31




Provision
for Loan Losses. The Company’s provision for loan losses for 2008 was $6.5
million compared to $1.7 recorded in the prior year. The increase in the loan
loss provision was due to the net increase in the loan portfolio and the
deterioration of loan quality due to current economic conditions.  Net loan
growth was $109.5 million during 2008 compared to $126.1 million in 2007. 
Economic conditions in communities we serve stemming primarily from the
weakening housing market have caused us to be more aggressive in monitoring the
quality of our loan assets and to take proactive steps to identify loans that
are impaired.





Non-Interest
Income. Non-interest income increased by $1.1 million or 42% to $3.8 million for
2008 compared to $2.7 million for the prior year period. The largest components
of non-interest income in 2008 were $1.4 million in customer service fees,
$736,000 in earnings on cash value of bank owned life insurance, $718,000 in
mortgage loan origination fees, and $254,000 in service charges and fees on
deposit accounts. For the year ended December 31, 2007, the largest components
of non-interest income included $1.1 million in customer service fees, $512,000
in mortgage loan origination fees, $380,000 in earnings on cash value of bank
owned life insurance and $227,000 in service charges and fees on deposit
accounts.  During 2008, the Company recognized $16,000 in gains on the
disposal of available for sale securities and $1,000 in losses on the disposal
of fixed assets.   The Company recognized net losses on the disposal
of other assets of $8,000 in 2007





Non-Interest
Expenses. Non-interest expenses were $20.0 million for year ended December 31,
2008 compared to $17.9 million for the prior year period.  The $2.1 million
or 12% increase reflects the continuing efforts to expand the Company’s
infrastructure and branch network.  Of the total increase, $1.7 million was
in personnel, occupancy and data processing which are the areas most impacted by
the branch network and infrastructure improvements.





Total
compensation for the year ended December 31, 2008 was $11.1 million reflecting a
13% increase when compared to $9.9 million for the year ended December 31,
2007.  As of December 31, 2008, the Company employs 147 full-time
equivalent employees in thirteen full-service branch offices, one loan
production office and various administrative support departments.  In
comparison, at December 31, 2007, the Company employed 126 full-time equivalent
employees in twelve full-service branch offices, one loan production office and
various administrative support departments.





Occupancy
expenses were $2.7 million for 2008 compared to $2.3 million in 2007 increasing
by $431,000 or 19%.  During 2008, the Company opened one new full-service
office in March.  Additionally, in December 2007, one new branch office was
opened and another was relocated to a more desirable location.





Data
processing expenses were $1.1 million for 2008 increasing by only $26,000 or
2%.  While data processing expense, which includes data lines to new
offices, is closely tied to both account volume growth and branch expansion, the
introduction of remote merchant capture in 2008 and branch item capture in 2007
helped contain total data processing expenses.





Professional
fees and services totaled $1.6 million in 2008, up $109,000 or 7% over the $1.5
million for 2007.  The largest components of professional fees and services
were directors’ fees, legal expenses, and accounting and audit
expenses.





The total
of all other non-interest expenses for the year ended December 31, 2008 was $3.5
million compared to $3.1 million for the prior year. The increase was primarily
the result of the Company’s continued growth. The largest components of other
non-interest expenses include office supplies and printing, advertising, and
loan related fees. Management expects that as the Company continues to expand,
expenses associated with these categories will increase.




Provision
for Income Taxes. For 2008, the Company’s provision for income taxes was
$599,000 compared to $3.5 million for the prior year. The effective tax rates
for 2008 and 2007 were 22.9% and 36.0%, respectively.  The effective tax
rate decreased significantly due to a higher percentage of tax-exempt income as
a percentage of total income.




32




NET
INTEREST INCOME





Net
interest income represents the difference between income derived from
interest-earning assets and interest expense incurred on interest-bearing
liabilities. Net interest income is affected by both (1) the difference between
the rates of interest earned on interest-earning assets and the rates paid on
interest-bearing liabilities (“interest rate spread”) and (2) the relative
amounts of interest-earning assets and interest-bearing liabilities (“net
interest-earning balance”). The following table sets forth information relating
to average balances of the Company's assets and liabilities for the years ended
December 31, 2009, 2008 and 2007. The table reflects the average tax-equivalent
yield on interest-earning assets and the average cost of interest-bearing
liabilities (derived by dividing income or expense by the daily average balance
of interest-earning assets or interest-bearing liabilities, respectively) as
well as the net interest margin. In preparing the table, non-accrual loans are
included in the average loan balance.





For
      the Years Ended December 31,2009
                                    
                                    
                                    2008
                                    
                                    
                                    2007Average
                                    
                                    
                                    
                                    
                                    
                                    Average
                                    
                                    
                                    Average
                                    
                                    
                                    
                                    
                                    
                                    Average
                                    
                                    
                                    Average
                                    
                                    
                                    
                                    
                                    
                                    Averagebalance
                                    
                                    
                                    Interest
                                    
                                    
                                    rate
                                    
                                    
                                    balance
                                    
                                    
                                    Interest
                                    
                                    
                                    rate
                                    
                                    
                                    balance
                                    
                                    
                                    Interest
                                    
                                    
                                    rate(Dollars
      in thousands)Interest-earning
      assets:Loan
      portfolio
                                    
                                    $
                                    777,275
                                    
                                    
                                    $
                                    47,989
                                    
                                    
                                    
                                    6.17
                                    %
                                    
                                    $
                                    741,829
                                    
                                    
                                    $
                                    49,479
                                    
                                    
                                    
                                    6.67
                                    %
                                    
                                    $
                                    615,322
                                    
                                    
                                    $
                                    50,022
                                    
                                    
                                    
                                    8.13
                                    %Investment
      securities
                                    
                                    
                                    201,204
                                    
                                    
                                    
                                    8,203
                                    
                                    
                                    
                                    4.51
                                    %
                                    
                                    
                                    103,101
                                    
                                    
                                    
                                    4,843
                                    
                                    
                                    
                                    5.19
                                    %
                                    
                                    
                                    92,629
                                    
                                    
                                    
                                    4,454
                                    
                                    
                                    
                                    5.32
                                    %Federal
      funds and otherinterest-earning
      assets
                                    
                                    
                                    7,177
                                    
                                    
                                    
                                    14
                                    
                                    
                                    
                                    0.20
                                    %
                                    
                                    
                                    3,896
                                    
                                    
                                    
                                    83
                                    
                                    
                                    
                                    2.13
                                    %
                                    
                                    
                                    8,015
                                    
                                    
                                    
                                    396
                                    
                                    
                                    
                                    4.94
                                    %Total
      interest-earning assets
                                    
                                    
                                    985,656
                                    
                                    
                                    
                                    56,206
                                    
                                    
                                    
                                    5.79
                                    %
                                    
                                    
                                    848,826
                                    
                                    
                                    
                                    54,405
                                    
                                    
                                    
                                    6.47
                                    %
                                    
                                    
                                    715,966
                                    
                                    
                                    
                                    54,872
                                    
                                    
                                    
                                    7.73
                                    %Non-interest-earning
      assets
                                    
                                    
                                    75,317
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    66,746
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    61,425Total
      assets
                                    
                                    $
                                    1,060,973
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    $
                                    915,572
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    $
                                    777,391Interest-bearing
      liabilities:Deposits:Interest-bearing
      NOW
                                    
                                    $
                                    60,556
                                    
                                    
                                    
                                    1,053
                                    
                                    
                                    
                                    1.74
                                    %
                                    
                                    $
                                    34,073
                                    
                                    
                                    
                                    64
                                    
                                    
                                    
                                    0.19
                                    %
                                    
                                    $
                                    33,453
                                    
                                    
                                    
                                    324
                                    
                                    
                                    
                                    0.97
                                    %Money
      market and savings
                                    
                                    
                                    134,885
                                    
                                    
                                    
                                    1,848
                                    
                                    
                                    
                                    1.37
                                    %
                                    
                                    
                                    157,904
                                    
                                    
                                    
                                    3,995
                                    
                                    
                                    
                                    2.53
                                    %
                                    
                                    
                                    163,321
                                    
                                    
                                    
                                    6,536
                                    
                                    
                                    
                                    4.00
                                    %Time
      deposits
                                    
                                    
                                    449,844
                                    
                                    
                                    
                                    16,970
                                    
                                    
                                    
                                    3.77
                                    %
                                    
                                    
                                    418,590
                                    
                                    
                                    
                                    19,003
                                    
                                    
                                    
                                    4.54
                                    %
                                    
                                    
                                    325,243
                                    
                                    
                                    
                                    16,569
                                    
                                    
                                    
                                    5.09
                                    %Short-term
      borrowings
                                    
                                    
                                    102,227
                                    
                                    
                                    
                                    1,705
                                    
                                    
                                    
                                    1.67
                                    %
                                    
                                    
                                    17,830
                                    
                                    
                                    
                                    657
                                    
                                    
                                    
                                    3.68
                                    %
                                    
                                    
                                    16,398
                                    
                                    
                                    
                                    830
                                    
                                    
                                    
                                    5.06
                                    %Long-term
      debt
                                    
                                    
                                    126,255
                                    
                                    
                                    
                                    5,045
                                    
                                    
                                    
                                    4.00
                                    %
                                    
                                    
                                    124,493
                                    
                                    
                                    
                                    5,351
                                    
                                    
                                    
                                    4.30
                                    %
                                    
                                    
                                    77,670
                                    
                                    
                                    
                                    3,958
                                    
                                    
                                    
                                    5.10
                                    %Total
      interest-bearingliabilities
                                    
                                    
                                    873,767
                                    
                                    
                                    
                                    26,621
                                    
                                    
                                    
                                    3.05
                                    %
                                    
                                    
                                    752,890
                                    
                                    
                                    
                                    29,070
                                    
                                    
                                    
                                    3.86
                                    %
                                    
                                    
                                    616,085
                                    
                                    
                                    
                                    28,217
                                    
                                    
                                    
                                    4.58
                                    %Other
      liabilities
                                    
                                    
                                    65,579
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    68,156
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    73,899Total
      liabilities
                                    
                                    
                                    939,346
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    821,046
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    689,984Stockholders’
      equity
                                    
                                    
                                    121,627
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    94,526
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    87,407Total
      liabilities andstockholders’
      equity
                                    
                                    $
                                    1,060,973
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    $
                                    915,572
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    $
                                    777,391Net
      interest income andinterest
      rate spread
                                    
                                    
                                    
                                    
                                    
                                    $
                                    29,585
                                    
                                    
                                    
                                    2.74
                                    %
                                    
                                    
                                    
                                    
                                    
                                    $
                                    25,335
                                    
                                    
                                    
                                    2.61
                                    %
                                    
                                    
                                    
                                    
                                    
                                    $
                                    26,655
                                    
                                    
                                    
                                    3.15
                                    %Net
      interest margin
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    3.09
                                    %
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    3.05
                                    %
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    3.79
                                    %Ratio
      of average interest-earningassets
      to average interest-bearing
      liabilities
                                    
                                    
                                    112.81
                                    %
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    112.74
                                    %
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    116.21
                                    %




33


VOLUME/RATE
VARIANCE ANALYSIS





The
following table analyzes the dollar amount of changes in interest income and
interest expense for major components of interest-earning assets and
interest-bearing liabilities.  The table distinguishes between (i) changes
attributable to volume (changes in volume multiplied by the prior period’s
rate), (ii) changes attributable to rate (changes in rate multiplied by the
prior period’s volume), and (iii) net change (the sum of the previous columns).
The change attributable to both rate and volume (changes in rate multiplied by
changes in volume) has been allocated proportionately to both the changes
attributable to volume and the changes attributable to rate.





Year
      Ended
                        
                        
                        Year
      EndedDecember 31, 2009 vs. 2008
                        
                        
                        December 31, 2008 vs. 2007Increase (Decrease) Due to
                        
                        
                        Increase (Decrease) Due toVolume
                        
                        
                        Rate
                        
                        
                        Total
                        
                        
                        Volume
                        
                        
                        Rate
                        
                        
                        Total(Dollars
      in thousands)Interest
      income:Loan
      portfolio
                        
                        $
                        2,295
                        
                        
                        $
                        (3,785
                        )
                        
                        $
                        (1,490
                        )
                        
                        $
                        9,299
                        
                        
                        $
                        (9,842
                        )
                        
                        $
                        (543
                        )Investment
      securities
                        
                        
                        4,185
                        
                        
                        
                        (825
                        )
                        
                        
                        3,360
                        
                        
                        
                        494
                        
                        
                        
                        (105
                        )
                        
                        
                        389Federal
      funds and otherinterest-earning
      assets
                        
                        
                        966
                        
                        
                        
                        (1,035
                        )
                        
                        
                        (69
                        )
                        
                        
                        (149
                        )
                        
                        
                        (164
                        )
                        
                        
                        (313
                        )Total
      interest income
                        
                        
                        7,446
                        
                        
                        
                        (5,645
                        )
                        
                        
                        1,801
                        
                        
                        
                        9,644
                        
                        
                        
                        (10,111
                        )
                        
                        
                        (467
                        )Interest
      expense:Deposits:Interest-bearing
      NOW
                        
                        
                        7
                        
                        
                        
                        982
                        
                        
                        
                        989
                        
                        
                        
                        6
                        
                        
                        
                        (266
                        )
                        
                        
                        (260
                        )Money
      market and savings
                        
                        
                        (518
                        )
                        
                        
                        (1,629
                        )
                        
                        
                        (2,147
                        )
                        
                        
                        (210
                        )
                        
                        
                        (2,331
                        )
                        
                        
                        (2,541
                        )Time
      deposits
                        
                        
                        1,345
                        
                        
                        
                        (3,378
                        )
                        
                        
                        (2,033
                        )
                        
                        
                        4,380
                        
                        
                        
                        (1,946
                        )
                        
                        
                        2,434Short-term
      borrowings
                        
                        
                        1,585
                        
                        
                        
                        (537
                        )
                        
                        
                        1,048
                        
                        
                        
                        67
                        
                        
                        
                        (240
                        )
                        
                        
                        (173
                        )Long-term
      debt
                        
                        
                        75
                        
                        
                        
                        (381
                        )
                        
                        
                        (306
                        )
                        
                        2090
                        
                        
                        
                        (697
                        )
                        
                        
                        1,393Total
      interest expense
                        
                        
                        2,494
                        
                        
                        
                        (4,943
                        )
                        
                        
                        (2,449
                        )
                        
                        
                        6,333
                        
                        
                        
                        (5,480
                        )
                        
                        
                        853Net
      interest income increase(decrease)
                        
                        $
                        4,952
                        
                        
                        $
                        (702
                        )
                        
                        $
                        4,250
                        
                        
                        $
                        3,311
                        
                        
                        $
                        (4,631
                        )
                        
                        $
                        (1,320
                        )




NONPERFORMING
ASSETS


Our
financial statements are prepared on the accrual basis of accounting, including
the recognition of interest income on loans, unless we place a loan in
nonaccrual status.  We account for loans on a nonaccrual basis when we have
serious doubts about the collectability of principal or interest. 
Generally, our policy is to place a loan on nonaccrual status when the loan
becomes past due 90 days.  We also place loans on nonaccrual status in
cases where we are uncertain whether the borrower can satisfy the contractual
terms of the loan agreement.  Amounts received on nonaccrual loans
generally are applied first to principal and then to interest only after all
principal has been collected.  Restructured loans are those for which
concessions, including the reduction of interest rates below a rate otherwise
available to that borrower or the deferral of interest or principal have been
granted due to the borrower’s weakened financial condition.  We accrue
interest on restructured loans at the restructured rates when we anticipate that
no loss of original principal will occur.  Potential problem loans are
loans which are currently performing and are not included as nonaccrual or
restructured loans above, but about which we have serious doubts as to the
borrower’s ability to comply with present repayment terms.  These loans are
likely to be included later in nonaccrual, past due or restructured loans, so
they are considered by our management in assessing the adequacy of our allowance
for loan losses.  At December 31, 2009, we identified 27 loans in the
aggregate amount of $19.5 million as potential problem loans.  The loans
possess certain unfavorable characteristics which cause management some concern
such a past due trends, the deteriorating financial condition of the borrower
and softness in the residential real estate market.  Of these 27 loans, 15
loans totaling approximately $6.8 million are related to the land acquisition,
development and residential construction industries and 5 loans totaling $11.4
million are secured by commercial real estate.  These loans will continue
to be closely monitored.  At December 31, 2008, we identified 34 loans in
the aggregate amount of $7.9 million as potential problem loans.





34




At
December 31, 2009, there were thirty-seven foreclosed properties valued at $6.3
million and 68 nonaccrual loans totaling $18.1 million.  Foreclosed
property is initially recorded at fair value at the date of foreclosure or
repossession.  Interest foregone on nonaccrual loans for the year ended
December 31, 2009 was approximately $928,000. At December 31, 2008, there were
eight foreclosed properties valued at $1.7 million and fifty nonaccrual loans
totaling $13.1 million.  Interest foregone on nonaccrual loans for the year
ended December 31, 2008 was approximately $554,500.   There were two
loans totaling $382,400 at December 31, 2009 and none at 2008 that were 90 days
or more past due and still accruing interest.  There were no repossessed
assets at December 31, 2009 and 2008.





The table
sets forth, for the period indicated, information about our nonaccrual loans,
loans past due 90 days or more and still accruing interest, total nonperforming
loans (nonaccrual loans plus loans past due 90 days or more and still accruing
interest), and total nonperforming assets.





At December 31,2009
                                                      
                                                      
                                                      2008
                                                      
                                                      
                                                      2007
                                                      
                                                      
                                                      2006
                                                      
                                                      
                                                      2005(Dollars
      in thousands)Nonaccrual
      loansConstruction
                                                      
                                                      $
                                                      6,692
                                                      
                                                      
                                                      $
                                                      7,696
                                                      
                                                      
                                                      $
                                                      2,190
                                                      
                                                      
                                                      $
                                                      127
                                                      
                                                      
                                                      $
                                                      -Commercial
      real estate
                                                      
                                                      
                                                      4,655
                                                      
                                                      
                                                      
                                                      365
                                                      
                                                      
                                                      
                                                      417
                                                      
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      -Residential
      mortgage
                                                      
                                                      
                                                      2,758
                                                      
                                                      
                                                      
                                                      4,448
                                                      
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      -Home
      equity loans and lines
                                                      
                                                      
                                                      1,314
                                                      
                                                      
                                                      
                                                      82
                                                      
                                                      
                                                      
                                                      106
                                                      
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      -Commercial
      and industrial
                                                      
                                                      
                                                      2,706
                                                      
                                                      
                                                      
                                                      503
                                                      
                                                      
                                                      
                                                      13
                                                      
                                                      
                                                      
                                                      8
                                                      
                                                      
                                                      
                                                      25Consumer
      loans
                                                      
                                                      
                                                      9
                                                      
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      1Total
      nonaccrual loans
                                                      
                                                      
                                                      18,134
                                                      
                                                      
                                                      
                                                      13,094
                                                      
                                                      
                                                      
                                                      2,726
                                                      
                                                      
                                                      
                                                      135
                                                      
                                                      
                                                      
                                                      26Accruing
      loans past due90
      days or more
                                                      
                                                      
                                                      381
                                                      
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      -Total
      nonperforming loans
                                                      
                                                      
                                                      18,515
                                                      
                                                      
                                                      
                                                      13,094
                                                      
                                                      
                                                      
                                                      2,726
                                                      
                                                      
                                                      
                                                      135
                                                      
                                                      
                                                      
                                                      26Real
      estate owned
                                                      
                                                      
                                                      6,306
                                                      
                                                      
                                                      
                                                      1,716
                                                      
                                                      
                                                      
                                                      272
                                                      
                                                      
                                                      
                                                      98
                                                      
                                                      
                                                      
                                                      22Repossessed
      assets
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      -Total
      nonperforming assets
                                                      
                                                      $
                                                      24,821
                                                      
                                                      
                                                      $
                                                      14,810
                                                      
                                                      
                                                      $
                                                      2,998
                                                      
                                                      
                                                      $
                                                      233
                                                      
                                                      
                                                      $
                                                      48Restructured
      loans in accrualstatus
      not included above
                                                      
                                                      $
                                                      13,691
                                                      
                                                      
                                                      $
                                                      -
                                                      
                                                      
                                                      $
                                                      -
                                                      
                                                      
                                                      $
                                                      -
                                                      
                                                      
                                                      $
                                                      -Allowance
      for loan losses
                                                      
                                                      $
                                                      17,567
                                                      
                                                      
                                                      $
                                                      12,585
                                                      
                                                      
                                                      $
                                                      8,273
                                                      
                                                      
                                                      $
                                                      6,945
                                                      
                                                      
                                                      $
                                                      4,351Nonperforming
      loans toperiod
      end loans
                                                      
                                                      
                                                      2.39
                                                      %
                                                      
                                                      
                                                      1.53
                                                      %
                                                      
                                                      
                                                      0.40
                                                      %
                                                      
                                                      
                                                      0.02
                                                      %
                                                      
                                                      
                                                      0.01
                                                      %Nonperforming
      loans and loanspast
      due 90 days or more toperiod
      end loans
                                                      
                                                      
                                                      2.44
                                                      %
                                                      
                                                      
                                                      1.53
                                                      %
                                                      
                                                      
                                                      0.40
                                                      %
                                                      
                                                      
                                                      0.02
                                                      %
                                                      
                                                      
                                                      0.01
                                                      %Allowance
      for loan losses toperiod
      end loans
                                                      
                                                      
                                                      2.31
                                                      %
                                                      
                                                      
                                                      1.60
                                                      %
                                                      
                                                      
                                                      1.22
                                                      %
                                                      
                                                      
                                                      1.26
                                                      %
                                                      
                                                      
                                                      1.33
                                                      %Allowance
      for loan losses tononaccrual
      loans
                                                      
                                                      
                                                      96.87
                                                      %
                                                      
                                                      
                                                      96.12
                                                      %
                                                      
                                                      
                                                      303.45
                                                      %
                                                      
                                                      
                                                      5,144.96
                                                      %
                                                      
                                                      
                                                      16,960.60
                                                      %Allowance
      for loan losses tononperforming
      loans
                                                      
                                                      
                                                      94.88
                                                      %
                                                      
                                                      
                                                      96.12
                                                      %
                                                      
                                                      
                                                      303.45
                                                      %
                                                      
                                                      
                                                      5,144.96
                                                      %
                                                      
                                                      
                                                      16,960.60
                                                      %Nonperforming
      loans to total assets
                                                      
                                                      
                                                      1.79
                                                      %
                                                      
                                                      
                                                      1.35
                                                      %
                                                      
                                                      
                                                      0.33
                                                      %
                                                      
                                                      
                                                      0.02
                                                      %
                                                      
                                                      
                                                      0.01
                                                      %Nonperforming
      assets tototal
      assets
                                                      
                                                      
                                                      2.40
                                                      %
                                                      
                                                      
                                                      1.67
                                                      %
                                                      
                                                      
                                                      0.36
                                                      %
                                                      
                                                      
                                                      0.03
                                                      %
                                                      
                                                      
                                                      0.01
                                                      %


35


ANALYSIS
OF ALLOWANCE FOR LOAN LOSSES





The
allowance for loan losses is established through periodic charges to earnings in
the form of a provision for loan losses.  Increases to the allowance for
loan losses occur as a result of provisions charged to operations and recoveries
of amounts previously charged-off, and decreases to the allowance occur when
loans are charged-off.  Management evaluates the adequacy of our allowance
for loan losses on a monthly basis.  The evaluation of the adequacy of the
allowance for loan losses involves the consideration of loan growth, loan
portfolio composition and industry diversification, historical loan loss
experience, current delinquency levels, adverse conditions that might affect a
borrower’s ability to repay the loan, estimated value of underlying collateral,
prevailing economic conditions and all other relevant factors derived from our
history of operations.  Additionally, as an important component of their
periodic examination process, regulatory agencies review our allowance for loan
losses and may require additional provisions for estimated losses based on
judgments that differ from those of management.





We use an
internal grading system to assign the degree of inherent risk on each individual
loan.  The grade is initially assigned by the lending officer and reviewed
by the loan administration function.  The internal grading system is
reviewed and tested periodically by an independent third party credit review
firm.  The testing process involves the evaluation of a sample of new
loans, loans having been identified as possessing potential weakness in credit
quality, past due loans and nonaccrual loans to determine the ongoing
effectiveness of the internal grading system.  The loan grading system is
used to assess the adequacy of the allowance for loan losses.





Management
has developed a model for evaluating the adequacy of the allowance for loan
losses.  The model uses the Company’s internal loan grading system to
segment each category of loans by risk class. The Company’s internal grading
system is compromised of nine different risk classifications.  Loans
possessing a risk class of 1 through 6 demonstrate various degrees of risk, but
each is considered to have the capacity to perform in accordance with the terms
of the loan.  Loans possessing a risk class of 7 to 9 are considered
impaired and are individually evaluated for impairment.  Additionally, we
are evaluating loans that migrate to a risk class 6 status and provide for
possible losses if the loan is unsecured or secured by a General Security
Agreement on business assets.





The
predetermined allowance percentages to be applied to loans possessing risk grade
1 through 6 are determined by using the historical charge-off percentages and
adding management’s qualitative factors.  For each individual loan type, we
calculate the average historical charge-off percentage over a five year
period.  The current year charge-offs are annualized and included as one of
the five years under consideration.  The resulting averages represent a
charge-off in a more normalized environment.  To those averages, management
adds qualitative factors which are more a reflection of current economic
conditions and trends.  Together, these two components comprise the
reserve.





Those
loans that are identified through the Company’s internal loan grading system as
impaired are evaluated individually.  Each loan is analyzed to determine
the net value of collateral, probability of charge-off and finally a potential
estimate of loss.  When management believes a real estate
collateral-supported loan will move from a risk grade 6 to a risk grade 7, a new
appraisal is ordered.  The analysis is performed using current collateral
values as opposed to values shown on appraisals which were obtained at the time
the loan was made.  If the analysis of a real estate collateral-supported
loan results in an estimated loss, a specific reserve is recorded.  Loans
with risk grade 7 and 8 are re-evaluated periodically to determine the adequacy
of specific reserves.  Fair values on real estate collateral are subject to
constant change and management makes certain assumptions about how the age of an
appraisal impacts current value.  Loans with risk grade codes of 7 or 8
that are either unsecured or secured by a general security agreement on business
assets are generally reserved for at 100% of the loan balance.





Using the
data gathered during the monthly evaluation process, the model calculates an
acceptable range for allowance for loan losses.  Management and the Board
of Directors are responsible for determining the appropriate level of the
allowance for loan losses within that range.





The
provision for 2009 was primarily the result of credit quality deterioration due
to the current economic conditions in our markets.  The sectors of the loan
portfolio being impacted most by the economic climate are residential
construction and land acquisition and development. Other factors influencing the
provision include net loan charge-offs.  For the year ended December 31,
2009, net loan charge-offs were $6.5 million compared with $2.2 million for the
prior year period and non-accrual loans were $18.1 million and $13.1 million at
December 31, 2009 and 2008, respectively.  The allowance for loan losses at
December 31, 2009 was $17.6 million, which represents 2.31% of total loans
outstanding compared to $12.6 million or 1.60% as of December 31,
2008.


36




The
allowance for loan losses represents management’s estimate of an amount adequate
to provide for known and inherent losses in the loan portfolio in the normal
course of business.  While management believes the methodology used to
establish the allowance for loan losses incorporates the best information
available at the time, future adjustments to the level of the allowance may be
necessary and the results of operations could be adversely affected should
circumstances differ substantially from the assumptions initially used.  We
believe that the allowance for loan losses was established in conformity with
generally accepted accounting principles; however, there can be no assurances
that the regulatory agencies, after reviewing the loan portfolio, will not
require management to increase the level of the allowance.  Likewise, there
can be no assurance that the existing allowance for loan losses is adequate
should there be deterioration in the quality of any loans or changes in any of
the factors discussed above.  Any increases in the provision for loan
losses resulting from such deterioration or change in condition could adversely
affect our financial condition and results of operations.





The
following table describes the allocation of the allowance for loan losses among
various categories of loans for the dates indicated:





At December 31,2009
                  
                  
                  2008
                  
                  
                  2007%
      of Total
                  
                  
                  
                  
                  
                  %
      of Total
                  
                  
                  
                  
                  
                  %
      of TotalAmount
                  
                  
                  Loans (1)
                  
                  
                  Amount
                  
                  
                  Loans (1)
                  
                  
                  Amount
                  
                  
                  Loans (1)(Dollars
      in thousands)Real
      estate - commercial
                  
                  $
                  5,811
                  
                  
                  
                  47.28
                  %
                  
                  $
                  6,003
                  
                  
                  
                  59.82
                  %
                  
                  $
                  3,771
                  
                  
                  
                  51.85
                  %Real
      estate - residential
                  
                  
                  1,075
                  
                  
                  
                  12.73
                  %
                  
                  
                  103
                  
                  
                  
                  2.43
                  %
                  
                  
                  130
                  
                  
                  
                  2.70
                  %Construction
      loans
                  
                  
                  6,439
                  
                  
                  
                  23.58
                  %
                  
                  
                  3,694
                  
                  
                  
                  20.47
                  %
                  
                  
                  2,362
                  
                  
                  
                  27.18
                  %Commercial
      and industrial loans
                  
                  
                  2,854
                  
                  
                  
                  7.28
                  %
                  
                  
                  1,953
                  
                  
                  
                  9.68
                  %
                  
                  
                  1,536
                  
                  
                  
                  10.77
                  %Home
      equity loans and lines of credit
                  
                  
                  1,134
                  
                  
                  
                  8.48
                  %
                  
                  
                  469
                  
                  
                  
                  6.91
                  %
                  
                  
                  334
                  
                  
                  
                  6.69
                  %Loans
      to individuals
                  
                  
                  254
                  
                  
                  
                  0.65
                  %
                  
                  
                  363
                  
                  
                  
                  0.69
                  %
                  
                  
                  140
                  
                  
                  
                  0.81
                  %Total
      allowance
                  
                  $
                  17,567
                  
                  
                  
                  100.00
                  %
                  
                  $
                  12,585
                  
                  
                  
                  100.00
                  %
                  
                  $
                  8,273
                  
                  
                  
                  100.00
                  %




At December 31,2006
                          
                          
                          2005%
      of Total
                          
                          
                          
                          
                          
                          %
      of TotalAmount
                          
                          
                          Loans (1)
                          
                          
                          Amount
                          
                          
                          Loans (1)(Dollars
      in thousands)Real
      estate - commercial
                          
                          $
                          3,920
                          
                          
                          
                          55.36
                          %
                          
                          $
                          1,876
                          
                          
                          
                          52.92
                          %Real
      estate - residential
                          
                          
                          121
                          
                          
                          
                          3.67
                          %
                          
                          
                          90
                          
                          
                          
                          4.54
                          %Construction
      loans
                          
                          
                          1,379
                          
                          
                          
                          19.99
                          %
                          
                          
                          735
                          
                          
                          
                          14.17
                          %Commercial
      and industrial loans
                          
                          
                          1,161
                          
                          
                          
                          12.32
                          %
                          
                          
                          1,138
                          
                          
                          
                          16.03
                          %Home
      equity loans and lines of credit
                          
                          
                          269
                          
                          
                          
                          7.76
                          %
                          
                          
                          201
                          
                          
                          
                          10.62
                          %Loans
      to individuals
                          
                          
                          95
                          
                          
                          
                          0.90
                          %
                          
                          
                          311
                          
                          
                          
                          1.72
                          %Total
      allowance
                          
                          $
                          6,945
                          
                          
                          
                          100.00
                          %
                          
                          $
                          4,351
                          
                          
                          
                          100.00
                          %




(1)
            Represents
      total of all outstanding loans in each category as a percent of total
      loans outstanding.




37


The
following table presents information regarding changes in the allowance for loan
losses for the years indicated:





At or for the Year Ended December
      31,2009
                      
                      
                      2008
                      
                      
                      2007
                      
                      
                      2006
                      
                      
                      2005(Dollars
      in thousands)Balance
      at beginning of period
                      
                      $
                      12,585
                      
                      
                      $
                      8,273
                      
                      
                      $
                      6,945
                      
                      
                      $
                      4,351
                      
                      
                      $
                      3,668Charge-offs:Construction
      loans
                      
                      
                      3,290
                      
                      
                      
                      277
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Commercial
      real estate
                      
                      
                      24
                      
                      
                      
                      503
                      
                      
                      
                      213
                      
                      
                      
                      -
                      
                      
                      
                      34Commercial
      and industrial loans
                      
                      
                      1,819
                      
                      
                      
                      1,363
                      
                      
                      
                      89
                      
                      
                      
                      14
                      
                      
                      
                      140Residential
      real estate
                      
                      
                      1,717
                      
                      
                      
                      -
                      
                      
                      
                      45
                      
                      
                      
                      64
                      
                      
                      
                      -Loans
      to individuals
                      
                      
                      90
                      
                      
                      
                      44
                      
                      
                      
                      15
                      
                      
                      
                      8
                      
                      
                      
                      9Total
      charge-offs
                      
                      
                      6,940
                      
                      
                      
                      2,187
                      
                      
                      
                      362
                      
                      
                      
                      86
                      
                      
                      
                      183Recoveries:Commercial
      and industrial loans
                      
                      
                      116
                      
                      
                      
                      4
                      
                      
                      
                      5
                      
                      
                      
                      1
                      
                      
                      
                      22Commercial
      real estate
                      
                      
                      -
                      
                      
                      
                      3
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Construction
      loans
                      
                      
                      270
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      27Residential
      real estate
                      
                      
                      10
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Loans
      to individuals
                      
                      
                      -
                      
                      
                      
                      7
                      
                      
                      
                      1
                      
                      
                      
                      1
                      
                      
                      
                      10Total
      recoveries
                      
                      
                      396
                      
                      
                      
                      14
                      
                      
                      
                      6
                      
                      
                      
                      2
                      
                      
                      
                      59Net
      charge-offs
                      
                      
                      6,544
                      
                      
                      
                      2,173
                      
                      
                      
                      356
                      
                      
                      
                      84
                      
                      
                      
                      124Allowance
      acquired from Port CityCapital
      Bank merger
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      1,687
                      
                      
                      
                      -Provision
      for loan losses
                      
                      
                      11,526
                      
                      
                      
                      6,485
                      
                      
                      
                      1,684
                      
                      
                      
                      991
                      
                      
                      
                      807Balance
      at the end of the year
                      
                      $
                      17,567
                      
                      
                      $
                      12,585
                      
                      
                      $
                      8,273
                      
                      
                      $
                      6,945
                      
                      
                      $
                      4,351Total
      loans outstanding at year-end
                      
                      $
                      759,348
                      
                      
                      $
                      785,377
                      
                      
                      $
                      675,916
                      
                      
                      $
                      549,819
                      
                      
                      $
                      328,322Average
      loans outstanding for the year
                      
                      $
                      777,275
                      
                      
                      $
                      741,629
                      
                      
                      $
                      615,322
                      
                      
                      $
                      414,644
                      
                      
                      $
                      297,045Allowance
      for loan losses toloans
      outstanding
                      
                      
                      2.31
                      %
                      
                      
                      1.60
                      %
                      
                      
                      1.22
                      %
                      
                      
                      1.26
                      %
                      
                      
                      1.33
                      %Ratio
      of net loan charge-offs toaverage
      loans outstanding
                      
                      
                      0.84
                      %
                      
                      
                      0.29
                      %
                      
                      
                      0.06
                      %
                      
                      
                      0.02
                      %
                      
                      
                      0.04
                      %




INVESTMENT
ACTIVITIES





The
Company’s investment portfolio plays a major role in management of liquidity and
interest rate sensitivity and, therefore, is managed in the context of the
overall balance sheet.  The securities portfolio generates a nominal
percentage of our interest income and serves as a necessary source of
liquidity.  We account for investment securities as follows:




Available for sale. 
Debt and equity securities that will be held for indeterminate periods of time,
including securities that we may sell in response to changes in market interest
or prepayment rates, needs for liquidity and changes in the availability of and
the yield of alternative investments are classified as available for sale. 
The Company carries these investments at market value, which we generally
determine using published quotes as of the close of business, information
obtained from established third-party pricing vendors or information from matrix
pricing methods developed in accordance with Bond Market Association industry
standards.  Unrealized gains and losses are excluded from our earnings and
are reported, net of applicable income tax, as a component of accumulated other
comprehensive income in stockholders’ equity until realized.





38




The
following table summarizes the amortized costs and market value of available for
sale securities at the dates indicated:





At December 31, 2009
                
                
                At December 31, 2008
                
                
                At December 31, 2007Amortized
                
                
                Fair
                
                
                Amortized
                
                
                Fair
                
                
                Amortized
                
                
                Faircost
                
                
                value
                
                
                cost
                
                
                value
                
                
                cost
                
                
                value(In
      thousands)Securities
      available for sale:U.S.
      government securities and obligations of U.S. government
      agencies
                
                $
                12,235
                
                
                $
                12,683
                
                
                $
                10,665
                
                
                $
                10,832
                
                
                $
                8,364
                
                
                $
                8,312Mortgage-backed
                
                
                58,767
                
                
                
                60,203
                
                
                
                67,309
                
                
                
                68,976
                
                
                
                56,986
                
                
                
                57,234Collateralized
      mortgage obligations
                
                
                70,301
                
                
                
                70,863
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Municipal
                
                
                48,820
                
                
                
                49,029
                
                
                
                26,089
                
                
                
                25,350
                
                
                
                24,810
                
                
                
                24,695Marketable
      equity
                
                
                402
                
                
                
                345
                
                
                
                565
                
                
                
                491
                
                
                
                536
                
                
                
                517Total
      securities available  for sale
                
                $
                190,525
                
                
                $
                193,123
                
                
                $
                104,628
                
                
                $
                105,649
                
                
                $
                90,696
                
                
                $
                90,758





LIQUIDITY
AND CAPITAL RESOURCES





Maintaining
adequate liquidity while managing interest rate risk is the primary goal of the
Company’s asset and liability management strategy. Liquidity is the ability to
fund the needs of the Company’s borrowers and depositors, pay operating
expenses, and meet regulatory liquidity requirements. Maturing investments, loan
and mortgage-backed securities principal repayments, deposit growth, the
brokered deposit market, and borrowings from the Federal Home Loan Bank are
presently the main sources of the Company’s liquidity. The Company’s primary
uses of liquidity are to fund loans and to make investments.





At
December 31, 2009, liquid assets (cash and due from banks, interest-earning
deposits with banks, federal funds sold and investment securities available for
sale) were approximately $224.8 million, which represents 22% of total assets
and 31% of total deposits. Supplementing this liquidity, the Company has
available lines of credit from various correspondent banks of approximately
$393.3 million of which $201.0 million was outstanding. At December 31, 2009,
outstanding commitments for undisbursed lines of credit and letters of credit
amounted to $127.2 million and outstanding commitments to make additional
investments in a Small Business Investment Corporation were $363,000. Management
believes that the combined aggregate liquidity position of the Company is
sufficient to meet the funding requirements of loan demand and deposit
maturities and withdrawals in the near term. Certificates of deposit represented
61% of the Company’s total deposits at December 31, 2009. The Company’s strategy
will include efforts focused at increasing the relative volume of transaction
deposit accounts. Certificates of deposit of $100,000 or more represented 48% of
the Company’s total deposits at year-end. While these deposits are generally
considered rate sensitive and the Company will need to pay competitive rates to
retain these deposits at maturity, there are other subjective factors that will
determine the Company’s continued retention of those deposits.





Under
federal capital regulations, the Company must satisfy certain minimum leverage
ratio requirements and risk-based capital requirements. At December 31, 2009,
the Company’s equity to asset ratio was 8.67%. All capital ratios place the Bank
in excess of the minimum required to be deemed a well-capitalized bank by
regulatory measures. CSB’s ratio of Tier 1 capital to risk-weighted assets
at December 31, 2009 was 11.16%


39





ASSET/LIABILITY
MANAGEMENT





The
primary objective of asset and liability management is to provide sustainable
and growing net interest income under varying economic environments, while
protecting the economic values of our balance sheet assets and liabilities from
the adverse effects of changes in interest rates.  Our overall
interest-rate risk position is maintained within a series of policies approved
by the Board and guidelines established and monitored by the Asset Liability
Committee (“ALCO”).




Because
no one individual measure can accurately assess all of our risks to changes in
rates, we use several quantitative measures in our assessment of current and
potential future exposures to changes in interest rates and their impact on net
interest income and balance sheet values. Net interest income simulation is the
primary tool used in our evaluation of the potential range of possible net
interest income results that could occur under a variety of interest-rate
environments. We also use market valuation and duration analysis to assess
changes in the economic value of balance sheet assets and liabilities caused by
assumed changes in interest rates. Finally, gap analysis — the difference
between the amount of balance sheet assets and liabilities repricing within a
specified time period — is used as a measurement of our interest-rate risk
position.





To
measure, monitor, and report on our interest-rate risk position, we begin with
two models: (1) net interest income at risk which measures the impact on net
interest income over the next twelve months to immediate, or “rate shock,” and
slow, or “rate ramp,” changes in market interest rates; and (2) net economic
value of equity that measures the impact on the present value of all net
interest income-related principal and interest cash flows of an immediate change
in interest rates. Net interest income at risk is designed to measure the
potential impact of changes in market interest rates on net interest revenue in
the short term. Net economic value of equity, on the other hand, is a long-term
view of interest-rate risk, but with a liquidation view of the Company. Both of
these models are subject to ALCO-established guidelines, and are monitored
regularly.





In
calculating our net interest income at risk, we start with a base amount of net
interest revenue that is projected over the next twelve months, assuming that
the then-current yield curve remains unchanged over the period. Our existing
balance sheet assets and liabilities are adjusted by the amount and timing of
transactions that are forecasted to occur over the next twelve months. That
yield curve is then “shocked,” or moved immediately, ±200 basis points in a
parallel fashion, or at all points along the yield curve. Two new twelve-month
net interest income projections are then developed using the same balance sheet
and forecasted transactions, but with the new yield curves, and compared to the
base scenario. We also perform the calculations using interest rate ramps, which
are ±100, ±200 and ±300 basis point changes in interest rates that are assumed
to occur gradually over the next twelve-month period, rather than immediately as
we do with interest-rate shocks.





Net
economic value of equity is based on the change in the present value of all net
interest income-related principal and interest cash flows for changes in market
rates of interest. The present value of existing cash flows with a then-current
yield curve serves as the base case. We then apply an immediate parallel shock
to that yield curve of ±100 and ±200 basis points and recalculate the cash flows
and related present values.





Key
assumptions used in the models described above include the timing of cash flows;
the maturity and repricing of balance sheet assets and liabilities, especially
option-embedded financial instruments like mortgage-backed securities and FHLB
advances; changes in market conditions; and interest-rate sensitivities of our
customer liabilities with respect to the interest rates paid and the level of
balances. These assumptions are inherently uncertain and, as a result, the
models cannot precisely calculate future net interest income or predict the
impact of changes in interest rates on net interest income and economic value.
Actual results could differ from simulated results due to the timing, magnitude
and frequency of changes in interest rates and market conditions, changes in
spreads and management strategies, among other factors. Projections of potential
future streams of net interest income are assessed as part of our forecasting
process.





Net Interest Income at Risk Analysis.The following table presents the estimated exposure of net interest
income for the next twelve months, calculated as of December 31, 2009 and 2008,
due to an immediate and gradual ± 200 basis point shift in then-current interest
rates. Estimated incremental exposures set forth below are dependent on
management’s assumptions about asset and liability sensitivities under various
interest-rate scenarios, such as those previously discussed, and do not reflect
any actions management may undertake in order to mitigate some of the adverse
effects of interest-rate changes on the Company’s financial
performance.


40





Net Interest Income
      at
      Risk(dollars in
      thousands)
                    
                    Estimated
      Exposure toNet
      Interest IncomeRate
      change
                    
                    2009
                    
                    
                    2008+200
      basis points shock
                    
                    $
                    (775
                    )
                    
                    $
                    847-200
      basis point shock
                    
                    
                    (1,002
                    )
                    
                    
                    (2,098
                    )+200
      basis point ramp
                    
                    
                    136
                    
                    
                    
                    31-200
      basis point ramp
                    
                    
                    44
                    
                    
                    
                    (230
                    )





Net Economic Value of Equity
Analysis.The following table presents estimated EVE exposures,
calculated as of December 31, 2009 and 2008, assuming an immediate and prolonged
shift in interest rates, the impact of which would be spread over a number of
years.





Net
      Economic Value of Equity
                      
                      Estimated
      Exposure to(dollars
      in thousands)
                      
                      Net
      Economic Value of EquityRate
      Change
                      
                      2009
                      
                      
                      2008+100
      basis point shock
                      
                      $
                      (6,268
                      )
                      
                      $
                      (2,594
                      )-100
      basis point shock
                      
                      
                      6,108
                      
                      
                      
                      7,531+200
      basis point shock
                      
                      
                      (20,293
                      )
                      
                      
                      (7,868
                      )-200
      basis point shock
                      
                      
                      10,077
                      
                      
                      
                      10,931





While
the measures presented in the tables above are not a prediction of future net
interest income or valuations, they do suggest that if all other variables
remained constant, in the short term, falling interest rates would lead to net
interest income that is lower than it would otherwise have been, and rising
rates would lead to higher net interest income. Other important factors that
impact the levels of net interest income are balance sheet size and mix;
interest-rate spreads; the slope, how quickly or slowly market interest rates
change and management actions taken in response to the preceding
conditions.





Interest Rate Gap Analysis.As
a part of its interest rate risk management policy, the Company calculates an
interest rate “gap.” Interest rate “gap” analysis is a common, though imperfect,
measure of interest rate risk, which measures the relative dollar amounts of
interest-earning assets and interest-bearing liabilities which reprice within a
specific time period, either through maturity or rate adjustment. The “gap” is
the difference between the amounts of such assets and liabilities that are
subject to repricing. A “positive” gap for a given period means that the amount
of interest-earning assets maturing or otherwise repricing within that period
exceeds the amount of interest-bearing liabilities maturing or otherwise
repricing within the same period. Accordingly, in a declining interest rate
environment, an institution with a positive gap would generally be expected,
absent the effects of other factors, to experience a decrease in the yield on
its assets greater than the decrease in the cost of its liabilities and its net
interest income should be negatively affected. Conversely, the yield on its
assets for an institution with a positive gap would generally be expected to
increase more quickly than the cost of funds in a rising interest rate
environment, and such institution’s net interest income generally would be
expected to be positively affected by rising interest rates. Changes in interest
rates generally have the opposite effect on an institution with a “negative
gap.”





The table
below sets forth the amounts of interest-earning assets and interest-bearing
liabilities outstanding at December 31, 2009 that are projected to reprice
or mature in each of the future time periods shown. Except as stated below, the
amounts of assets and liabilities shown which reprice or mature within a
particular period were determined in accordance with the contractual terms of
the assets or liabilities. Loans with adjustable rates are shown as being due at
the end of the next upcoming adjustment period. Money market deposit accounts
and negotiable order of withdrawal or other transaction accounts are assumed to
be subject to immediate repricing and depositor availability and have been
placed in the shortest period. In making the gap computations, none of the
assumptions sometimes made regarding prepayment rates and deposit decay rates
have been used for any interest-earning assets or interest-bearing liabilities.
In addition, the table does not reflect scheduled principal payments that will
be received throughout the lives of the loans or investments. The interest rate
sensitivity of the Company’s assets and liabilities illustrated in the following
table would vary substantially if different assumptions were used or if actual
experience differs from that indicated by such assumptions.  Variable rate
loans which have interest rate floors that are currently in effect are presented
as if they were fixed rate loans and repricing is presented at
maturity.


41





Terms to Repricing at December 31, 2009More Than
                
                
                More Than1 Year
                
                
                1 Year to
                
                
                3 Years to
                
                
                More Thanor Less
                
                
                3 Years
                
                
                5 Years
                
                
                5 Years
                
                
                Total(Dollars
      in thousands)INTEREST-EARNING
      ASSETS:Loans
      receivable:Commercial
      mortgage loans
                
                $
                72,057
                
                
                $
                135,643
                
                
                $
                110,414
                
                
                $
                41,336
                
                
                $
                359,450Residential
      mortgage loans
                
                
                41,420
                
                
                
                34,063
                
                
                
                11,986
                
                
                
                9,262
                
                
                
                96,731Construction
      and development
                
                
                136,177
                
                
                
                33,239
                
                
                
                8,766
                
                
                
                1,046
                
                
                
                179,228Commercial
      and industrial loans
                
                
                34,469
                
                
                
                14,266
                
                
                
                6,082
                
                
                
                543
                
                
                
                55,360Home
      equity lines and loans
                
                
                17,714
                
                
                
                4,904
                
                
                
                2,008
                
                
                
                39,858
                
                
                
                64,484Loans
      to individuals
                
                
                2,765
                
                
                
                1,540
                
                
                
                594
                
                
                
                67
                
                
                
                4,966Interest-earning
      deposits with banks
                
                
                4,617
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                4,617Fed
      funds sold
                
                
                17,825
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                17,825Investment
      securities available for sale
                
                
                18,311
                
                
                
                51,544
                
                
                
                40,289
                
                
                
                79,979
                
                
                
                190,123Federal
      Home Loan Bank stock
                
                
                11,777
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                11,777Total
      interest-earning assets
                
                $
                357,132
                
                
                $
                275,199
                
                
                $
                180,139
                
                
                $
                172,091
                
                
                $
                984,561INTEREST-BEARING
      LIABILITIES:Deposits:Money
      market, NOW and savings
                
                $
                224,080
                
                
                $
                -
                
                
                $
                -
                
                
                $
                -
                
                
                $
                224,080Time
                
                
                270,916
                
                
                
                126,894
                
                
                
                39,652
                
                
                
                50
                
                
                
                437,512Short-term
      borrowings
                
                
                74,000
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                74,000Long-term
      borrowings
                
                
                -
                
                
                
                75,000
                
                
                
                30,000
                
                
                
                37,748
                
                
                
                142,748Total
      interest-bearing liabilities
                
                $
                568,996
                
                
                $
                201,894
                
                
                $
                69,652
                
                
                $
                37,798
                
                
                $
                878,340INTEREST
      SENSITIVITY GAP PER PERIOD
                
                $
                (211,864
                )
                
                $
                73,305
                
                
                $
                110,487
                
                
                $
                134,293
                
                
                $
                106,221CUMULATIVE
      INTEREST SENSITIVITY GAP
                
                $
                (211,864
                )
                
                $
                (138,559
                )
                
                $
                (28,072
                )
                
                $
                106,221
                
                
                $
                106,221CUMULATIVE
      GAP AS A PERCENTAGE OF TOTAL INTEREST-EARNING ASSETS
                
                
                -21.52
                %
                
                
                -14.07
                %
                
                
                -2.85
                %
                
                
                10.79
                %
                
                
                10.79
                %CUMULATIVE
      INTEREST-EARNING ASSETS AS A PERCENTAGE OF CUMULATIVE INTEREST-BEARING
      LIABILITIES
                
                
                62.77
                %
                
                
                82.03
                %
                
                
                96.66
                %
                
                
                112.09
                %
                
                
                112.09
                %


42


CRITICAL
ACCOUNTING POLICY





The
Company's most significant critical accounting policies are the determination of
its allowance for loan losses, evaluation of investment securities for other
than temporary impairment, valuation of foreclosed assets and the impairment
testing of its goodwill. A critical accounting policy is one that is both very
important to the portrayal of the Company's financial condition and results, and
requires management's most difficult, subjective or complex judgments. What
makes these judgments difficult, subjective and/or complex is the need to make
estimates about the effects of matters that are inherently
uncertain.





QUARTERLY
FINANCIAL INFORMATION




The
following table sets forth, for the periods indicated, certain of our
consolidated quarterly financial information. This information is derived from
our unaudited financial statements, which include, in the opinion of management,
all normal recurring adjustments which management considers necessary for a fair
presentation of the results for such periods. This information should be read in
conjunction with our consolidated financial statements included elsewhere in
this report. The results for any quarter are not necessarily indicative of
results for any future period. Due to rounding, the sum of the results for the
four quarters of a given year may not agree with the annual results for that
year.





Year
      Ended December 31, 2009
                
                
                Year
      Ended December 31, 2008Fourth
                
                
                Third
                
                
                Second
                
                
                First
                
                
                Fourth
                
                
                Third
                
                
                Second
                
                
                FirstQuarter
                
                
                Quarter
                
                
                Quarter
                
                
                Quarter
                
                
                Quarter
                
                
                Quarter
                
                
                Quarter
                
                
                QuarterOperating
      Data:Total
      interest income
                
                $
                13,975
                
                
                $
                14,069
                
                
                $
                14,084
                
                
                $
                14,078
                
                
                $
                13,711
                
                
                $
                13,794
                
                
                $
                13,177
                
                
                $
                13,722Total
      interest expense
                
                
                6,301
                
                
                
                6,657
                
                
                
                6,816
                
                
                
                6,847
                
                
                
                7,536
                
                
                
                7,451
                
                
                
                6,885
                
                
                
                7,198Net
      interest income
                
                
                7,674
                
                
                
                7,412
                
                
                
                7,268
                
                
                
                7,231
                
                
                
                6,175
                
                
                
                6,343
                
                
                
                6,292
                
                
                
                6,524Provision
      for loan losses
                
                
                6,740
                
                
                
                1,958
                
                
                
                1,132
                
                
                
                1,696
                
                
                
                3,937
                
                
                
                1,282
                
                
                
                459
                
                
                
                806Net
      interest income after provision
                
                
                934
                
                
                
                5,454
                
                
                
                6,136
                
                
                
                5,535
                
                
                
                2,238
                
                
                
                5,061
                
                
                
                5,833
                
                
                
                5,718Non-interest
      income
                
                
                1,659
                
                
                
                1,128
                
                
                
                752
                
                
                
                789
                
                
                
                1,050
                
                
                
                1,057
                
                
                
                817
                
                
                
                808Non-interest
      expense
                
                
                36,142
                
                
                
                5,887
                
                
                
                6,295
                
                
                
                5,619
                
                
                
                4,792
                
                
                
                5,066
                
                
                
                5,093
                
                
                
                5,021Income
      (loss) before income taxes
                
                
                (33,549
                )
                
                
                695
                
                
                
                593
                
                
                
                705
                
                
                
                (1,504
                )
                
                
                1,052
                
                
                
                1,557
                
                
                
                1,505Provision
      for income taxes
                
                
                (1,500
                )
                
                
                58
                
                
                
                19
                
                
                
                94
                
                
                
                (738
                )
                
                
                306
                
                
                
                526
                
                
                
                505Net
      income (loss)
                
                $
                (32,049
                )
                
                $
                637
                
                
                $
                574
                
                
                $
                611
                
                
                $
                (766
                )
                
                $
                746
                
                
                $
                1,031
                
                
                $
                1,000Efective
      dividend on preferred stock
                
                
                (604
                )
                
                
                (422
                )
                
                
                (422
                )
                
                
                (168
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Net
      income (loss) for common shares
                
                $
                (32,653
                )
                
                $
                215
                
                
                $
                152
                
                
                $
                443
                
                
                $
                (766
                )
                
                $
                746
                
                
                $
                1,031
                
                
                $
                1,000Securities
      gains/(losses)
                
                $
                563
                
                
                $
                110
                
                
                $
                (219
                )
                
                $
                (188
                )
                
                $
                -
                
                
                $
                -
                
                
                $
                15
                
                
                $
                -Per
      Share Data:Earnings
      (loss) per share- basic
                
                $
                (3.41
                )
                
                $
                0.02
                
                
                $
                0.02
                
                
                $
                0.05
                
                
                $
                (0.08
                )
                
                $
                0.08
                
                
                $
                0.11
                
                
                $
                0.19Earnings
      (loss) per share - diluted
                
                
                (3.41
                )
                
                
                0.02
                
                
                
                0.02
                
                
                
                0.05
                
                
                
                (0.08
                )
                
                
                0.08
                
                
                
                0.11
                
                
                
                0.18




RECENT
ACCOUNTING PRONOUNCEMENTS




For
recently issued accounting pronouncements that may affect the Company, see Note
B of Notes to Consolidated Financial Statements.





OFF-BALANCE
SHEET ARRANGEMENTS





The
Company has various financial instruments (outstanding commitments) with
off-balance sheet risk that are issued in the normal course of business to the
meet the financing needs of its customers. See Note O to the consolidated
financial statements for more information regarding these commitments and
contingent liabilities.


43


FORWARD-LOOKING
INFORMATION





This
annual report may contain, in addition to historical information, certain
“forward-looking statements” that represent management’s judgment concerning the
future and are subject to risks and uncertainties that could cause the Company’s
actual operating results and financial position to differ materially from those
projected in the forward-looking statements.  Such forward-looking
statements can be identified by the use of forward-looking terminology such as
“may,” “will,” “expect,” “anticipate,” “estimate” or “continue” or the negative
thereof or other variations thereof or comparable terminology. Factors that
could influence the estimates include changes in national, regional and local
market conditions, legislative and regulatory conditions, and the interest rate
environment.





ITEM
7A – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK





Market
risk reflects the risk of economic loss resulting from adverse changes in market
price and interest rates. This risk of loss can be reflected in diminished
current market values and/or reduced potential net interest income in future
periods. Our market risk arises primarily from interest rate risk inherent in
our lending and deposit-taking activities. The structure of our loan and deposit
portfolios is such that a significant decline in interest rates may adversely
impact net market values and net interest income. We do not maintain a trading
account nor are we subject to currency exchange risk or commodity price risk.
Interest rate risk is monitored as part of the Bank’s asset/liability management
function.





See the
section entitled Asset/Liability Management in Item 7 for a more detailed
discussion of market risk.


44


ITEM
8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA





CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY


CONSOLIDATED
FINANCIAL STATEMENTS





Years
Ended December 31, 2009, 2008 and 2007


45


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY


INDEX TO THE CONSOLIDATED
FINANCIAL STATEMENTS





Page No.Report
      of Independent Registered Public Accounting Firm
                  47Consolidated
      Balance Sheets as of December 31, 2009 and 2008
                  48Consolidated
      Statements of Operations for the years ended December 31, 2009, 2008 and
      2007
                  49Consolidated
      Statements of Comprehensive Income (Loss) for the years ended December 31,
      2009, 2008 and 2007
                  50Consolidated
      Statements of Changes in Stockholders’ Equity for the years ended December
      31, 2009, 2008 and 2007
                  51Consolidated
      Statements of Cash Flows for the years ended December 31, 2009, 2008 and
      2007
                  53Notes
      to Consolidated Financial Statements
                  55


46








REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





To the
Stockholders and the Board of Directors


Crescent
Financial Corporation and Subsidiary


Cary,
North Carolina





We have
audited the accompanying consolidated balance sheets of Crescent Financial
Corporation and Subsidiary as of December 31, 2009 and 2008, and the related
consolidated statements of operations, comprehensive income (loss), changes in
stockholders’ equity and cash flows for each of the years in the three-year
period ended December 31, 2009.  These consolidated financial
statements are the responsibility of the Company’s management.  Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.





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





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Crescent Financial
Corporation and Subsidiary at December 31, 2009 and 2008 and the results of
their operations and their cash flows for each of the years in the three-year
period ended December 31, 2009 in conformity with accounting principles
generally accepted in the United States of America.











Raleigh,
North Carolina


March
31, 2010


47


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 CONSOLIDATED
BALANCE SHEETS
 December
31, 2009 and 2008





2009
                              
                              
                              2008ASSETSCash
      and due from banks
                              
                              $
                              9,285,386
                              
                              
                              $
                              9,917,277Interest-earning
      deposits with banks
                              
                              
                              4,616,722
                              
                              
                              
                              266,512Federal
      funds sold
                              
                              
                              17,825,000
                              
                              
                              
                              99,000Investment
      securities available for sale, at fair value (Note C)
                              
                              
                              193,122,891
                              
                              
                              
                              105,648,618Loans
      (Note D)
                              
                              
                              759,348,341
                              
                              
                              
                              785,377,283Allowance
      for loan losses (Note D)
                              
                              
                              (17,567,000
                              )
                              
                              
                              (12,585,000
                              )NET
      LOANS
                              
                              
                              741,781,341
                              
                              
                              
                              772,792,283Accrued
      interest receivable
                              
                              
                              4,260,258
                              
                              
                              
                              3,341,258Federal
      Home Loan Bank stock, at cost
                              
                              
                              11,776,500
                              
                              
                              
                              7,264,000Bank
      premises and equipment (Note E)
                              
                              
                              11,861,158
                              
                              
                              
                              10,845,049Investment
      in life insurance
                              
                              
                              17,658,386
                              
                              
                              
                              16,811,918Goodwill
      (Note F)
                              
                              
                              -
                              
                              
                              
                              30,233,049Other
      assets
                              
                              
                              20,617,367
                              
                              
                              
                              11,091,784TOTAL
      ASSETS
                              
                              $
                              1,032,805,009
                              
                              
                              $
                              968,310,748LIABILITIES
      AND STOCKHOLDERS’ EQUITYDeposits:Demand
                              
                              $
                              61,041,955
                              
                              
                              $
                              63,945,717Savings
                              
                              
                              58,086,102
                              
                              
                              
                              58,833,876Money
      market and NOW
                              
                              
                              165,994,207
                              
                              
                              
                              130,542,569Time
      (Note G)
                              
                              
                              437,512,354
                              
                              
                              
                              461,560,593TOTAL
      DEPOSITS
                              
                              
                              722,634,618
                              
                              
                              
                              714,882,755Short-term
      borrowings (Note H)
                              
                              
                              74,000,000
                              
                              
                              
                              37,706,000Long-term
      debt (Note H)
                              
                              
                              142,748,000
                              
                              
                              
                              116,748,000Accrued
      expenses and other liabilities
                              
                              
                              3,902,185
                              
                              
                              
                              3,882,385TOTAL
      LIABILITIES
                              
                              
                              943,284,803
                              
                              
                              
                              873,219,140Commitments
      (Notes D, I and O)Stockholders’
      Equity (Note Q)Preferred
      stock, no par value, 5,000,000 shares authorized, 24,900 shares issued and
      outstanding on December 31, 2009
                              
                              
                              22,935,514
                              
                              
                              
                              -Common
      stock, $1 par value, 20,000,000 shares authorized; 9,626,559 shares issued
      and outstanding at both December 31, 2009 and 2008
                              
                              
                              9,626,559
                              
                              
                              
                              9,626,559Common
      stock warrant
                              
                              
                              2,367,368
                              
                              
                              
                              -Additional
      paid-in capital
                              
                              
                              74,529,894
                              
                              
                              
                              74,349,299Retained
      earnings (deficit)
                              
                              
                              (21,354,080
                              )
                              
                              
                              10,488,628Accumulated
      other comprehensive income
                              
                              
                              1,414,951
                              
                              
                              
                              627,122TOTAL
      STOCKHOLDERS’ EQUITY
                              
                              
                              89,520,206
                              
                              
                              
                              95,091,608TOTAL
      LIABILITIES AND STOCKHOLDERS’ EQUITY
                              
                              $
                              1,032,805,009
                              
                              
                              $
                              968,310,748


See
accompanying notes.
 48


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 CONSOLIDATED
STATEMENTS OF OPERATIONS
 Years
Ended December 31, 2009, 2008 and 2007





2009
                
                
                2008
                
                
                2007INTEREST
      AND FEE INCOMELoans
                
                $
                47,989,636
                
                
                $
                49,478,663
                
                
                $
                50,022,082Investment
      securities available for sale
                
                
                8,202,708
                
                
                
                4,842,624
                
                
                
                4,453,955Interest-earning
      deposits with banks
                
                
                8,227
                
                
                
                10,653
                
                
                
                38,161Federal
      funds sold
                
                
                5,827
                
                
                
                72,878
                
                
                
                357,878TOTAL
      INTEREST AND FEE INCOME
                
                
                56,206,398
                
                
                
                54,404,818
                
                
                
                54,872,076INTEREST
      EXPENSEMoney
      market, NOW and savings deposits
                
                
                2,900,719
                
                
                
                4,059,475
                
                
                
                6,860,622Time
      deposits
                
                
                16,969,642
                
                
                
                19,002,942
                
                
                
                16,568,529Short-term
      borrowings
                
                
                1,704,511
                
                
                
                656,549
                
                
                
                830,302Long-term
      debt
                
                
                5,045,638
                
                
                
                5,351,459
                
                
                
                3,957,782TOTAL
      INTEREST EXPENSE
                
                
                26,620,510
                
                
                
                29,070,425
                
                
                
                28,217,235NET
      INTEREST INCOME
                
                
                29,585,888
                
                
                
                25,334,393
                
                
                
                26,654,841PROVISION
      FOR LOAN LOSSES (Note D)
                
                
                11,526,066
                
                
                
                6,484,543
                
                
                
                1,684,219NET
      INTEREST INCOME AFTERPROVISION
      FOR LOAN LOSSES
                
                
                18,059,822
                
                
                
                18,849,850
                
                
                
                24,970,622NON-INTEREST
      INCOMEMortgage
      origination revenue
                
                
                922,615
                
                
                
                718,433
                
                
                
                512,152Fees
      on deposit accounts
                
                
                1,662,949
                
                
                
                1,606,062
                
                
                
                1,360,301Earnings
      on life insurance
                
                
                885,858
                
                
                
                735,770
                
                
                
                379,927Gain
      on sale of available for sale securities
                
                
                870,072
                
                
                
                15,535
                
                
                
                -Gain
      on sale of loans
                
                
                74,595
                
                
                
                -
                
                
                
                -Loss
      on sale or disposal of assets
                
                
                (3,024
                )
                
                
                (1,346
                )
                
                
                (7,341
                )Impairment
      of marketable equity security
                
                
                (197,575
                )
                
                
                -
                
                
                
                -Impairment
      of nonmarketable equity security
                
                
                (406,802
                )
                
                
                -
                
                
                
                -Other
      (Note K)
                
                
                519,474
                
                
                
                730,219
                
                
                
                434,163TOTAL
      NON-INTEREST INCOME
                
                
                4,328,162
                
                
                
                3,804,673
                
                
                
                2,679,202NON-INTEREST
      EXPENSESalaries
      and employee benefits
                
                
                11,834,747
                
                
                
                11,110,281
                
                
                
                9,875,748Occupancy
      and equipment
                
                
                3,542,206
                
                
                
                2,726,669
                
                
                
                2,295,675Data
      processing
                
                
                1,418,308
                
                
                
                1,081,290
                
                
                
                1,055,640FDIC
      insurance premiums
                
                
                1,918,712
                
                
                
                402,158
                
                
                
                210,675Foreclosed
      asset related expenses, net
                
                
                498,572
                
                
                
                148,150
                
                
                
                83,100Goodwill
      impairment
                
                
                30,233,049
                
                
                
                -
                
                
                
                -Other
      (Note K)
                
                
                4,497,041
                
                
                
                4,576,456
                
                
                
                4,360,030TOTAL
      NON-INTEREST EXPENSE
                
                
                53,942,635
                
                
                
                20,045,004
                
                
                
                17,880,868INCOME
      (LOSS) BEFORE INCOME TAXES
                
                
                (31,554,651
                )
                
                
                2,609,519
                
                
                
                9,768,956INCOME
      TAXES (Note J)
                
                
                (1,328,700
                )
                
                
                598,700
                
                
                
                3,520,200NET
      INCOME (LOSS)
                
                
                (30,225,951
                )
                
                
                2,010,819
                
                
                
                6,248,756Effective
      dividend on preferred stock (Note G)
                
                
                1,616,757
                
                
                
                -
                
                
                
                -Net
      income available (loss attributed) to common shareholders
                
                $
                (31,842,708
                )
                
                $
                2,010,819
                
                
                $
                6,248,756NET
      INCOME (LOSS) PER COMMON SHAREBasic
                
                $
                (3.33
                )
                
                $
                0.21
                
                
                $
                0.68Diluted
                
                $
                (3.33
                )
                
                $
                0.21
                
                
                $
                0.65WEIGHTED
      AVERAGE COMMON SHARES OUTSTANDINGBasic
                
                
                9,569,290
                
                
                
                9,500,103
                
                
                
                9,211,779Diluted
                
                
                9,569,290
                
                
                
                9,680,484
                
                
                
                9,635,694


See
accompanying notes.
 49


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 CONSOLIDATED
STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
 Years
Ended December 31, 2009, 2008 and 2007





2009
                        
                        
                        2008
                        
                        
                        2007Net
      (loss) income
                        
                        $
                        (30,225,951
                        )
                        
                        $
                        2,010,819
                        
                        
                        $
                        6,248,756Other
      comprehensive income:Securities
      available for sale:Unrealized
      holding gains on availablefor
      sale securities
                        
                        
                        2,249,496
                        
                        
                        
                        973,930
                        
                        
                        
                        881,765Tax
      effect
                        
                        
                        (867,181
                        )
                        
                        
                        (375,451
                        )
                        
                        
                        (342,629
                        )Reclassification
      of losses recognizeddue to
      impairment in net income
                        
                        
                        197,575
                        
                        
                        
                        -
                        
                        
                        
                        -Tax
      effect
                        
                        
                        (76,165
                        )
                        
                        
                        -
                        
                        
                        
                        -Reclassification
      of gains recognizedin net
      income
                        
                        
                        (870,072
                        )
                        
                        
                        (15,535
                        )
                        
                        
                        -Tax
      effect
                        
                        
                        335,413
                        
                        
                        
                        5,989
                        
                        
                        
                        -Net
      of tax amount
                        
                        
                        969,066
                        
                        
                        
                        588,933
                        
                        
                        
                        539,136Cash
      flow hedging activities:Unrealized
      holding loss on cash flow hedgingactivities
                        
                        
                        (294,934
                        )
                        
                        
                        -
                        
                        
                        
                        -Tax
      effect
                        
                        
                        113,697
                        
                        
                        
                        -
                        
                        
                        
                        -Net
      of tax amount
                        
                        
                        (181,237
                        )
                        
                        
                        -
                        
                        
                        
                        -Total
      other comprehensive income
                        
                        
                        787,829
                        
                        
                        
                        588,933
                        
                        
                        
                        539,136COMPREHENSIVE
      INCOME (LOSS)
                        
                        $
                        (29,438,122
                        )
                        
                        $
                        2,599,752
                        
                        
                        $
                        6,787,892




See
accompanying notes.


50


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 CONSOLIDATED
STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
 Years
Ended December 31, 2009, 2008 and 2007





AccumulatedCommon
                  
                  
                  Additional
                  
                  
                  Retained
                  
                  
                  other
                  
                  
                  TotalPreferred stock
                  
                  
                  Common stock
                  
                  
                  stock
                  
                  
                  paid-in
                  
                  
                  earnings
                  
                  
                  comprehensive
                  
                  
                  stockholders’Shares
                  
                  
                  Amount
                  
                  
                  Shares
                  
                  
                  Amount
                  
                  
                  warrants
                  
                  
                  capital
                  
                  
                  (deficit)
                  
                  
                  income (loss)
                  
                  
                  equityBalance
      at December31,
      2006
                  
                  
                  -
                  
                  
                  $
                  -
                  
                  
                  
                  8,265,136
                  
                  
                  $
                  8,265,136
                  
                  
                  $
                  -
                  
                  
                  $
                  62,659,201
                  
                  
                  $
                  12,610,588
                  
                  
                  $
                  (500,947
                  )
                  
                  $
                  83,033,978Comprehensive
      income:Net
      income
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  6,248,756
                  
                  
                  
                  -
                  
                  
                  
                  6,248,756Net
      unrealized holding gain on available for sale securities
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  539,136
                  
                  
                  
                  539,136Total
      comprehensive income
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  6,787,892Common
      stock issued pursuant to:Stock
      options exercised
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  292,790
                  
                  
                  
                  292,790
                  
                  
                  
                  -
                  
                  
                  
                  920,948
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  1,213,738Stock
      option related tax benefits
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  451,950
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  451,950Expense
      recognized in connection with stock options and restricted
      stock
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  178,940
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  178,940Issuance
      of restricted stock, net of deferred compensation
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  17,050
                  
                  
                  
                  17,050
                  
                  
                  
                  -
                  
                  
                  
                  (17,050
                  )
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Forfeiture
      of restricted stock
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (3,406
                  )
                  
                  
                  (3,406
                  )
                  
                  
                  -
                  
                  
                  
                  3,406
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Ten
      percent stock dividend with net cash paid for fractional
      shares
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  833,009
                  
                  
                  
                  833,009
                  
                  
                  
                  -
                  
                  
                  
                  9,399,032
                  
                  
                  
                  (10,239,727
                  )
                  
                  
                  -
                  
                  
                  
                  (7,686
                  )Balance
      at December 31, 2007
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  9,404,579
                  
                  
                  
                  9,404,579
                  
                  
                  
                  -
                  
                  
                  
                  73,596,427
                  
                  
                  
                  8,619,617
                  
                  
                  
                  38,189
                  
                  
                  
                  91,658,812Cumulative
      adjustment for split dollar pursuant to adoption of EITF
    06-04
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (141,808
                  )
                  
                  
                  -
                  
                  
                  
                  (141,808
                  )Comprehensive
      income:Net
      income
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  2,010,819
                  
                  
                  
                  -
                  
                  
                  
                  2,010,819Net
      unrealized holding gain on available for sale securities
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  588,933
                  
                  
                  
                  588,933Total
      comprehensive income
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  2,599,752Common
      stock issued pursuant to:Stock
      options exercised
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  186,480
                  
                  
                  
                  186,480
                  
                  
                  
                  -
                  
                  
                  
                  483,774
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  670,254Stock
      option related tax benefits
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  95,500
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  95,500Expense
      recognized in connection with stock options and restricted
      stock
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  209,098
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  209,098Issuance
      of restricted stock, net of deferred compensation
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  35,500
                  
                  
                  
                  35,500
                  
                  
                  
                  -
                  
                  
                  
                  (35,500
                  )
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Balance
      at December 31, 2008
                  
                  
                  -
                  
                  
                  $
                  -
                  
                  
                  
                  9,626,559
                  
                  
                  $
                  9,626,559
                  
                  
                  $
                  -
                  
                  
                  $
                  74,349,299
                  
                  
                  $
                  10,488,628
                  
                  
                  $
                  627,122
                  
                  
                  $
                  95,091,608




See
accompanying notes.


51


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 CONSOLIDATED
STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (Continued)
 Years
Ended December 31, 2009, 2008 and 2007





AccumulatedCommon
                        
                        
                        Additional
                        
                        
                        Retained
                        
                        
                        other
                        
                        
                        TotalPreferred stock
                        
                        
                        Common stock
                        
                        
                        stock
                        
                        
                        paid-in
                        
                        
                        earnings
                        
                        
                        comprehensive
                        
                        
                        stockholders’Shares
                        
                        
                        Amount
                        
                        
                        Shares
                        
                        
                        Amount
                        
                        
                        warrant
                        
                        
                        capital
                        
                        
                        (deficit)
                        
                        
                        income (loss)
                        
                        
                        equityBalance
      at December31,
      2008
                        
                        
                        -
                        
                        
                        $
                        -
                        
                        
                        
                        9,626,559
                        
                        
                        $
                        9,626,559
                        
                        
                        $
                        -
                        
                        
                        $
                        74,349,299
                        
                        
                        $
                        10,488,628
                        
                        
                        $
                        627,122
                        
                        
                        $
                        95,091,608Net
      loss
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        (30,225,951
                        )
                        
                        
                        -
                        
                        
                        
                        (30,225,951
                        )Other
      comprehensive income
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        787,829
                        
                        
                        
                        787,829Expense
      recognized in connection with stock options and restricted
      stock
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        180,595
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        180,595Preferred
      stock transaction:Issuance
      of preferred stock
                        
                        
                        24,900
                        
                        
                        
                        24,900,000
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        24,900,000Issuance
      of warrant
                        
                        
                        -
                        
                        
                        
                        (2,367,368
                        )
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        2,367,368
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -Accretion
      of discount on warrant
                        
                        
                        -
                        
                        
                        
                        402,882
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        (402,882
                        )
                        
                        
                        -
                        
                        
                        
                        -Preferred
      stock dividend
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        (1,213,875
                        )
                        
                        
                        -
                        
                        
                        
                        (1,213,875
                        )Balance
      at December 31, 2009
                        
                        
                        24,900
                        
                        
                        $
                        22,935,514
                        
                        
                        
                        9,626,559
                        
                        
                        $
                        9,626,559
                        
                        
                        $
                        2,367,368
                        
                        
                        $
                        74,529,894
                        
                        
                        $
                        (21,354,080
                        )
                        
                        $
                        1,414,951
                        
                        
                        $
                        89,520,206


See
accompanying notes.


52


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 Years
Ended December 31, 2009, 2008 and 2007





2009
                
                
                2008
                
                
                2007CASH
      FLOWS FROM OPERATING ACTIVITIESNet
      income (loss)
                
                $
                (30,225,951
                )
                
                $
                2,010,819
                
                
                $
                6,248,756Adjustments
      to reconcile net income (loss) to net cash provided by operating
      activities:Depreciation
                
                
                938,178
                
                
                
                786,668
                
                
                
                694,559Provision
      for loan losses
                
                
                11,526,066
                
                
                
                6,484,543
                
                
                
                1,684,219Amortization
      of core deposit intangible
                
                
                133,349
                
                
                
                133,349
                
                
                
                133,349Accretion
      of fair value discount on loans
                
                
                (285,593
                )
                
                
                (439,820
                )
                
                
                (439,820
                )Amortization
      of fair value premium on deposits
                
                
                109,730
                
                
                
                185,550
                
                
                
                406,277Deferred
      income taxes
                
                
                (2,077,407
                )
                
                
                (1,788,197
                )
                
                
                (502,749
                )Loss
      on impairment of marketable equity security
                
                
                197,575
                
                
                
                -
                
                
                
                -Loss
      on impairment of nonmarketable equity security
                
                
                406,802
                
                
                
                -
                
                
                
                -Loss
      on impairment of goodwill
                
                
                30,233,049
                
                
                
                -
                
                
                
                -Loss
      on disposition of assets
                
                
                3,024
                
                
                
                74,032
                
                
                
                65,685Gain
      on sale of available for sale securities
                
                
                (870,072
                )
                
                
                (15,535
                )
                
                
                -Net
      gain on disposal of foreclosed assets
                
                
                (3,741
                )
                
                
                -
                
                
                
                -Valuation
      adjustments related to foreclosed assets
                
                
                48,349
                
                
                
                -
                
                
                
                -Net
      (accretion of discounts) amortization of premiums on available for sale
      securities
                
                
                970,221
                
                
                
                (80,314
                )
                
                
                (98,609
                )Net
      increase in cash surrender value life insurance
                
                
                (846,468
                )
                
                
                (689,221
                )
                
                
                (339,204
                )Stock
      based compensation
                
                
                180,595
                
                
                
                209,098
                
                
                
                178,940Purchase
      of loan to be held for sale
                
                
                (3,651,505
                )
                
                
                -
                
                
                
                -Proceeds
      from sale of loan held for sale
                
                
                3,726,100
                
                
                
                -
                
                
                
                -Gain
      on sale of loan
                
                
                (74,595
                )
                
                
                -
                
                
                
                -Change
      in assets and liabilities:(Increase)
      decrease in accrued interest receivable
                
                
                (919,000
                )
                
                
                420,342
                
                
                
                (715,760
                )Increase
      in other assets
                
                
                (4,006,862
                )
                
                
                (1,621,319
                )
                
                
                (303,339
                )Increase
      (decrease) in accrued interest payable
                
                
                (483,216
                )
                
                
                275,916
                
                
                
                444,620Increase
      (decrease) in accrued expenses and other liabilities
                
                
                166,153
                
                
                
                17,730
                
                
                
                (292,252
                )NET
      CASH PROVIDED BY OPERATING ACTIVITIES
                
                
                5,194,781
                
                
                
                5,963,641
                
                
                
                7,164,672CASH
      FLOWS FROM INVESTING ACTIVITIESPurchase
      of investment securities available for sale
                
                
                (167,674,519
                )
                
                
                (28,064,996
                )
                
                
                (14,360,641
                )Proceeds
      from maturities and repayments of investment securities available for
      sale
                
                
                38,659,372
                
                
                
                12,685,891
                
                
                
                9,305,441Proceeds
      from sale of securities available for sale
                
                
                42,820,152
                
                
                
                1,543,197
                
                
                
                -Loan
      originations and principal collections, net
                
                
                9,964,259
                
                
                
                (113,399,801
                )
                
                
                (126,014,080
                )Purchases
      of premises and equipment
                
                
                (1,957,311
                )
                
                
                (3,538,541
                )
                
                
                (2,947,101
                )Proceeds
      from disposals of premises and equipment
                
                
                -
                
                
                
                -
                
                
                
                20,050Proceeds
      from sales of foreclosed assets
                
                
                5,172,202
                
                
                
                727,648
                
                
                
                247,996Purchases
      of Federal Home Loan Bank stock
                
                
                (4,512,500
                )
                
                
                (473,300
                )
                
                
                (3,207,900
                )Investment
      in life insurance
                
                
                -
                
                
                
                (7,000,000
                )
                
                
                (3,100,000
                )Net
      cash paid in business combination
                
                
                -
                
                
                
                -
                
                
                
                (7,500
                )NET
      CASH USED BY INVESTING ACTIVITIES
                
                
                (77,528,345
                )
                
                
                (137,519,902
                )
                
                
                (140,063,735
                )




See
accompanying notes.




53


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 CONSOLIDATED
STATEMENTS OF CASH FLOWS (Continued)
 Years
Ended December 31, 2009, 2008 and 2007





2009
                
                
                2008
                
                
                2007CASH
      FLOWS FROM FINANCING ACTIVITIESNet
      increase in deposits accounts
                
                $
                7,642,133
                
                
                $
                109,265,892
                
                
                $
                63,143,356Net
      increase (decrease) in short-term borrowings
                
                
                36,294,000
                
                
                
                23,951,000
                
                
                
                (10,696,000
                )Net
      increase (decrease) in long-term debt
                
                
                26,000,000
                
                
                
                (4,500,000
                )
                
                
                76,000,000Proceeds
      from stock options exercised
                
                
                -
                
                
                
                670,254
                
                
                
                1,213,738Proceeds
      from issuance of preferred stock and common stock warrant
                
                
                24,900,000
                
                
                
                -
                
                
                
                -Dividends
      paid on preferred stock
                
                
                (1,058,250
                )
                
                
                -
                
                
                
                -Net
      cash paid for fractional shares
                
                
                -
                
                
                
                -
                
                
                
                (7,687
                )Excess
      tax benefits from stock options exercised
                
                
                -
                
                
                
                95,500
                
                
                
                451,950NET
      CASH PROVIDED BY FINANCING ACTIVITIES
                
                
                93,777,883
                
                
                
                129,482,646
                
                
                
                130,105,357NET
      INCERASE (DECREASE) IN CASH AND CASH EQUIVALENTS
                
                
                21,444,319
                
                
                
                (2,073,615
                )
                
                
                (2,793,706
                )CASH
      AND CASH EQUIVALENTS, BEGINNING
                
                
                10,282,789
                
                
                
                12,356,404
                
                
                
                15,150,110CASH
      AND CASH EQUIVALENTS, ENDING
                
                $
                31,727,108
                
                
                $
                10,282,789
                
                
                $
                12,356,404





Supplemental
information (Notes S and T)




See
accompanying notes.


54


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007





NOTE
A - ORGANIZATION AND OPERATIONS





On June
29, 2001, Crescent Financial Corporation (the “Company”) was formed as a holding
company for Crescent State Bank (“CSB”) or (the “Bank”). Upon formation, one
share of the Company’s $1 par value common stock was exchanged for each of the
outstanding shares of CSB’s $5 par value common stock.





CSB was
incorporated December 22, 1998 and began banking operations on December 31,
1998. CSB is engaged in general commercial and retail banking in Wake, Johnston,
Lee, Moore and New Hanover Counties, North Carolina, operating under the banking
laws of North Carolina and the rules and regulations of the Federal Deposit
Insurance Corporation and the North Carolina Commissioner of
Banks.  CSB undergoes periodic examinations by those regulatory
authorities.  The Bank’s operations in Moore and New Hanover Counties
are the result of the 2003 acquisition of Centennial Bank and Trust and the 2006
acquisition of Port City Capital Bank, respectively.





NOTE
B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





Basis
of Presentation





The
accompanying consolidated financial statements include the accounts and
transactions of Crescent Financial Corporation and its wholly-owned subsidiary
Crescent State Bank. All significant intercompany transactions and balances have
been eliminated in consolidation.





Use
of Estimates





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





Cash
and Cash Equivalents





For
purposes of the consolidated statements of cash flows, cash and cash equivalents
include cash and due from banks, interest-earning deposits with banks and
federal funds sold.





Securities
Available for Sale





Available
for sale securities are carried at fair value and consist of bonds, notes, and
marketable equity securities not classified as trading securities or as held to
maturity securities. Unrealized holding gains and losses on available for sale
securities are reported as a net amount in other comprehensive income, net of
related tax effects. Gains and losses on the sale of available for sale
securities are determined using the specific-identification method. Declines in
the fair value of individual held to maturity and available for sale securities
below their cost that are other than temporary would result in write-downs of
the individual securities to their fair value. Such write-downs would be
included in earnings as realized losses. Premiums and discounts are recognized
in interest income using the interest method over the period to
maturity.





Loans





Loans
that management has the intent and ability to hold for the foreseeable future,
or until maturity, are reported at their outstanding principal adjusted for any
charge-offs, the allowance for loan losses, and any deferred fees or costs on
originated loans and unamortized premiums or discounts on purchased or acquired
loans. Loan origination fees and certain direct origination costs are
capitalized and recognized as an adjustment of the yield of the related
loan.  Interest on loans is recorded based on the principal amount
outstanding.  The accrual of interest on impaired loans is
discontinued when, in management’s opinion, the future collectability of the
recorded loan balance is in doubt.  When the future collectability of
the recorded loan balance is not in doubt, interest income may be recognized on
the cash basis.   Generally, loans are placed on nonaccrual when
they are past due 90 days. When a loan is place in nonaccrual status, all unpaid
accrued interest is reversed.


55


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007





NOTE
B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)





Loans
(Continued)





Subsequent
collections of interest and principal are generally applied as a reduction to
the principal outstanding.





Allowance
for Loan Losses





The
allowance for loan losses is established as losses are estimated to have
occurred through a provision for loan losses charged to earnings. The provision
for loan losses is based upon management’s best estimate of the amount needed to
maintain the allowance for loan losses at an adequate level. Loan losses are
charged against the allowance when management believes the uncollectability of a
loan balance is confirmed. Subsequent recoveries, if any, are credited to the
allowance.





The
allowance for loan losses is evaluated on a regular basis by management and is
based upon management’s periodic review of the collectability of the loans in
light of the current status of the portfolio, historical experience, the nature
and volume of the loan portfolio, adverse situations that may affect the
borrower’s ability to repay, estimated value of any underlying collateral, and
prevailing economic conditions. Management segments the loan portfolio by loan
type in considering each of the aforementioned factors and their impact upon the
level of the allowance for loan losses.





A loan is
considered impaired when, based on current information and events, it is
probable that the Company will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement. Factors considered by management in determining impairment include
payment status, collateral value, and the probability of collecting scheduled
principal and interest payments when due. Loans that experience insignificant
payment delays and payment shortfalls generally are not classified as
impaired.





Management
determines the significance of payment delays and payment shortfalls on a
case-by-case basis, taking into consideration all of the circumstances
surrounding the loan and the borrower, including the length of the delay, the
reasons for the delay, the borrower’s prior payment record, and the amount of
the shortfall in relation to the principal and interest
owed.  Impairment is measured on a loan by loan basis by either the
present value of expected future cash flows discounted at the loan’s effective
interest rate, the loan’s obtainable market price, or the fair value of the
collateral if the loan is collateral dependent.





Premises
and Equipment





Land is
carried at cost. Other components of premises and equipment are stated at cost
less accumulated depreciation. Depreciation is calculated on the straight-line
method over the estimated useful lives of the assets which are 37 - 40 years for
buildings and 3 - 10 years for furniture and equipment. Leasehold improvements
are amortized over the terms of the respective leases or the estimated useful
lives of the improvements, whichever is shorter. Repairs and maintenance costs
are charged to operations as incurred, and additions and improvements to
premises and equipment are capitalized. Upon sale or retirement, the cost and
related accumulated depreciation are removed from the accounts and any gains or
losses are reflected in current operations.





Foreclosed
Assets





Foreclosed
assets includes repossessed assets and other real estate
owned.  Assets acquired through, or in lieu of, loan foreclosure are
held for sale and are initially recorded at fair value at the date of
foreclosure, establishing a new cost basis.  Subsequent to
foreclosure, valuations are periodically performed by management and the assets
are carried at the lower of carrying amount or fair value less cost to
sell.  Revenue and expenses from operations and changes in the
valuation allowance are included in net expenses from foreclosed
assets.


56


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007





NOTE
B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)





Stock
in Federal Home Loan Bank of Atlanta





As a
requirement for membership, the Company invests in stock of the Federal Home
Loan Bank of Atlanta (“FHLB”). This investment is carried at
cost.  Due to the redemption provisions of the FHLB, the Company
estimated that fair value approximates cost and that this investment was not
impaired at December 31, 2009.





Income
Taxes





Deferred
income taxes are recognized for the tax consequences of temporary differences
between financial statement carrying amounts and the tax bases of existing
assets and liabilities that will result in taxable or deductible amounts in
future years. These temporary differences are multiplied by the enacted income
tax rate expected to be in effect when the taxes become payable or receivable.
The effect on deferred taxes of a change in tax rates is recognized in income in
the period that includes the enactment date. Deferred tax assets are reduced, if
necessary, by the amount of such benefits that are not expected to be realized
based on available evidence.





The
Company adopted the provisions of ASC 740-10 with respect
to  Accounting for Uncertainty in Income Taxes, on January 1, 2007
with no impact on the consolidated financial statements.  The Company
did not recognize any interest or penalties related to income tax during the
years ended December 31, 2007, 2008 and 2009, and did not accrue any interest or
penalties as of December 31, 2009 or 2008.  The Company did not have
an accrual for uncertain tax positions as deductions taken and benefits accrued
are based on widely understood administrative practices and procedures, and are
based on clear and unambiguous tax law.  Tax returns for all years
2006 and thereafter are subject to possible future examinations by tax
authorities.





Goodwill
and Other
Intangibles





Goodwill
and indeterminate lived intangibles are evaluated for impairment at least
annually.  Based on circumstances which indicated impairment may have
taken place, evaluations have been performed on a quarterly basis since October
31, 2008.  In the final analysis, a full goodwill impairment charge of
$30,233,049 represented the appropriate course of action.  Other
intangible assets, consisting of premiums on purchased core deposits, are being
amortized over ten years principally using the straight-line
method.  The carrying amount of other intangible assets at December
31, 2009 amounted to $826,291.  The carrying amount of goodwill and
other intangible assets at December 31, 2008 amounted to $30,233,049 and
$959,641, respectively.  See Note F for a more detailed discussion of
this topic.





Impairment
or Disposal of Long-Lived Assets





The
Company’s long-lived assets are reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable.  Recoverability of assets to be held and used, such as
bank premises and equipment, is measured by a comparison of the carrying amount
of an asset to future net cash flows expected to be generated by the
asset.  If the carrying amount of an asset exceeds its estimated
future cash flows, an impairment charge is recognized in the amount by which the
carrying amount of the asset exceeds the fair value of the
asset.  Assets to be disposed of, such as foreclosed properties, are
reported at the lower of the carrying amount or fair value less costs to
sell.





Stock
Compensation Plans





Employee
awards of equity instruments are recognized in the financial statements over the
period the employee is required to perform the services in exchange for the
award.  The measurement of the cost of employee services received in
exchange for an award is based on the grant-date fair value of the
award.  ASC 718 amends ASC 230, Statement of Cash Flows, to
require that excess tax benefits be reported as financing cash inflows, rather
than as a reduction of taxes paid, which is included within operating cash
flows.


57


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007





NOTE
B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)





Per
Share Results





Basic and
diluted net income per share are computed by dividing net income (loss)
attributable to common shareholders by the weighted average number of common
shares outstanding during each period.  Diluted net income per share
reflects the potential dilution that could occur if common stock options and
warrants were exercised, resulting in the issuance of common stock that then
shared in the net income of the Company.





Basic and
diluted net income (loss) per share have been computed based upon net income
available (loss attributed) to common shareholders as presented in the
accompanying consolidated statements of operations divided by the weighted
average number of common shares outstanding or assumed to be outstanding as
summarized below:





2009
                
                
                2008
                
                
                2007Weighted
      average number of common shares used in computing basic net income per
      share
                
                
                9,569,290
                
                
                
                9,500,103
                
                
                
                9,211,779Effect
      of dilutive stock options
                
                
                -
                
                
                
                174,540
                
                
                
                400,665Effects
      of restricted stock
                
                
                -
                
                
                
                5,841
                
                
                
                23,250Weighted average number of common
      shares and dilutive potential common shares used in computingdiluted net income per share
                
                
                9,569,290
                
                
                
                9,680,484
                
                
                
                9,635,694





For the
years ended December 31, 2009, there were 430,118 stock options and the warrant
for 833,705 shares which were not included in the computation of diluted
earnings per share because they had no dilutive effect.  For the years
ended December 31, 2008 and 2007, there were 90,109 and 62,627 outstanding stock
options, respectively, which were not included in the computation of diluted
earnings per share because they had no dilutive effect.





Mortgage
Loan Origination and Other Fees





Mortgage
loan origination fees represent fees received for the origination of loans that
are pre-sold in the secondary market through the Company’s relationship with
various mortgage brokers.  These fees are recognized in income as they
are earned upon the closing of each loan.





Brokerage
referral fees derived from investment transactions with Capital Investment
Group, Inc. are recognized in income as these transactions are
consummated.





Segment
Reporting





ASC 280.
formerly SFAS No. 131, Disclosure about Segments of an
Enterprise and Related Information, requires that public entities
disclose information about products and services provided by operating segments,
geographic areas and major customers, differences between the measurements used
in reporting segment information and those used in the entity’s general-purpose
financial statements, and changes in the measurement of segment amounts from
period to period.





Operating
segments are components of an enterprise with separate financial information
available for use by the chief operating decision maker to allocate resources
and to assess performance.  The Company has determined that it has one
significant operating segment, the providing of financial services, including
commercial and retail banking, mortgage, and investment services, to customers
located in its market areas.  The various products are those generally
offered by community banks, and the allocation of resources is based on the
overall performance of the Company, rather than the performance of individual
branches or products.


58


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007





NOTE
B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)





Loan
Reclassification





On March
9, 2009, the Company converted all core and ancillary data processing
systems.  As a result of that conversion, we reclassified certain
loans within the portfolio so that reporting is more consistent with the
collateral of a particular loan rather than the purpose.  Loans
secured by homes purchased as investment property or for a commercial business
purpose were previously reported as commercial real estate whereas they were
reclassified as residential real estate mortgages.  Loans secured by
commercial building lots were previously reported as commercial real estate and
were reclassified as construction and land development.  The 2008 loan
classification balances as previously reported in Note D have been reclassified
through the conversion process as follows: $164.6 million of commercial real
estate loans and $2.1 million consumer loans being shifted to $81.8 million of
construction and land development, $70.7 million residential mortgages, $9.3
million home equity loans and $4.9 million commercial and
industrial.





The
Company reclassified approximately $73,000 and $58,000 of net losses on the sale
of other real estate owned for the years ended December 31, 2008 and 2007,
respectively, from non-interest income to non-interest expense.





Recently
Adopted and Issued Accounting Standards





In June
2009, the Financial Accounting Standards Board (FASB) issued Accounting
Standards Update No. 2009-01, Generally Accepted Accounting
Principles (ASC Topic 105), which establishes the FASB Accounting
Standards Codification (“the Codification” or “ASC”) as the official single
source of authoritative U.S. generally accepted accounting principles
(“GAAP”).  All existing accounting standards are
superseded.  All other accounting guidance not included n the
Codification will be considered non-authoritative.  The Codification
also includes all relevant Securities and Exchange Commission (“SEC”) guidance
organized using the same topical structure in separate sections within the
Codification.  The Board will not issue new standards in the form of
Statements, FASB Staff Positions or Emerging Issues Task Force
Abstracts.  Instead, it will issue Accounting Standards Updates
(“ASU”) which will serve to update the Codification, provide background
information about the guidance and provide the basis for conclusions on the
changes to the Codification.





The
Codification is not intended to change GAAP, but it will change the way GAAP is
organized and presented.  The Codification is effective for our
year-end 2009 financial statements and the principal impact on the Company’s
financial statements is limited to disclosures as all future references to
authoritative accounting literature will be referenced in accordance with the
Codification.





In
December 2007, FASB issued SFAS No. 141(revised
2007), Business
Combinations, (“ASC 805-10-65”), which establishes principles and
requirements for recognition and measurement of assets, liabilities and any
noncontrolling interest acquired due to a business combination. This guidance
expands the definitions of a business and a business combination, resulting in
an increased number of transactions or other events that will qualify as
business combinations. The entity that acquires the business (the “acquirer”)
will record 100 percent of all assets and liabilities of the acquired
business, including goodwill, generally at their fair values. As such, an
acquirer will not be permitted to recognize the allowance for loan losses of the
acquiree. This guidance requires the acquirer to recognize goodwill as of the
acquisition date, measured as a residual.





In most
business combinations, goodwill will be recognized to the extent that the
consideration transferred plus the fair value of any noncontrolling interests in
the acquiree at the acquisition date exceeds the fair values of the identifiable
net assets acquired. Acquisition-related transaction and restructuring costs
will be expensed as incurred rather than treated as part of the cost of the
acquisition and included in the amount recorded for assets acquired. ASC
805-10-65 is effective for fiscal years beginning after December 15, 2008.
The adoption on January 1, 2009, had no effect on the Company’s consolidated
financial statements.


59


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007





NOTE
B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)





Recently
Adopted and Issued Accounting Standards (Continued)





In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements, an amendment of ARB 51(“ASC
810-10-65”), which defines noncontrolling interest as the portion of equity in a
subsidiary not attributable, directly or indirectly, to the parent. This
guidance requires the ownership interests in subsidiaries held by parties other
than the parent (previously referred to as minority interest) to be clearly
presented in the consolidated statement of financial position within equity, but
separate from the parent’s equity. The amount of consolidated net income
attributable to the parent and to any noncontrolling interest must be clearly
presented on the face of the consolidated statement of income. Changes in the
parent’s ownership interest while the parent retains its controlling financial
interest (greater than 50 percent ownership) are to be accounted for as equity
transactions. Upon a loss of control, any gain or loss on the interest sold will
be recognized in earnings. Additionally, any ownership interest retained will be
remeasured at fair value on the date control is lost, with any gain or loss
recognized in earnings. ASC 810-10-65 is effective for fiscal years beginning
after December 15, 2008. Accordingly, the Company adopted the provisions of
this guidance in the first quarter of 2009. The adoption on January 1, 2009, had
no effect on the Company’s consolidated financial statements.




In March
2008, the FASB issued SFAS
No. 161, Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB Statement
No. 133 (“ASC 815-10-65”) which requires entities to provide greater
transparency about (a) how and why an entity uses derivative instruments, (b)
how derivative instruments and related hedged items are accounted for its
related interpretations, and (c) how derivative instruments and related hedged
items affect an entity’s financial position, results of operations and cash
flows.  To meet those objectives, ASC 815-10-65 requires (1)
qualitative disclosures about objectives for using derivatives by primary
underlying risk exposure (e.g., interest rate, credit or foreign exchange rate)
and by purpose or strategy (fair value hedge, cash flow hedge, net investment
hedge, and non-hedges), (2) information about the volume of derivative activity
in a flexible format that the preparer believes is the most relevant and
practicable, (3) tabular disclosures about balance sheet location and gross fair
value amounts of derivative instruments, income statement and other
comprehensive income location of gain and loss amounts on derivative instruments
by type of contract, and (4) disclosures about credit-risk related contingent
features in derivative agreements.  ASC 815-10-65 is effective for
financial statements issued for fiscal years beginning after November 15,
2008. Accordingly, the Company adopted the provisions of this guidance in the
first quarter 2009.  The Company provided the required disclosure in
Note N.





In April
2009, the FASB issued the following three FSP’s intended to provide additional
application guidance and enhance disclosures regarding fair value measurements
and impairments of securities:





FSP FAS
157-4, Determining Fair Value
When the Volume and Level of Activity for the Asset or Liability Have
Significantly Decreased and Identifying Transactions That Are Not Orderly(“ASC 820-10-65”),provides additional
guidance for estimating fair value when the volume and level of activity for the
asset or liability have decreased significantly.  This update also
provides guidance on identifying circumstances that indicate a transaction is
not orderly.  The provisions of this update are effective for the
Company’s interim period ending on June 30, 2009.  The adoption of
this update did not materially affect the Company’s consolidated financial
statements.





FSP FAS
107-1 and APB 28-1, Interim
Disclosures about Fair Value of Financial Instruments(“ASC 825-10-65”),
requires disclosures about fair value of financial instruments in interim
reporting periods of publicly traded companies that were previously only
required to be disclosed in annual financial statements.  ASC
825-10-65 is effective for the Company’s interim period ending on June 30,
2009.  As ASC 825-10-65 amends only the disclosure requirements about
fair value of financial instruments in interim periods, the adoption did not
materially affect the Company’s consolidated financial
statements.


60


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007





NOTE
B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)





Recently
Adopted and Issued Accounting Standards (Continued)





FSP FAS
115-2 and FAS 124-2, Recognition and Presentation of
Other-Than-Temporary Impairments (“ASC 320-10-65”), amends current
other-than-temporary impairment guidance in GAAP for debt securities to make the
guidance more operational and to improve the presentation and disclosure of
other-than-temporary impairments on debt and equity securities in the financial
statements.  This FSP does not amend existing recognition and
measurement guidance related to other-than-temporary impairments of equity
securities.  The adoption did not materially affect the Company’s
consolidated financial statements.





In May
2009, the FASB issued ASC 855-10-06 through ASC 855-10-55 (“ASC 855-10”), Subsequent Events, which sets
forth the circumstances under which an entity should recognize events occurring
after the balance sheet date and the disclosures that should be
made.  The guidance was in effect and adopted for the period ended
June 30, 2009.





In June
2009, the FASB issued the following standards:





Statement
of Financial Accounting Standards (SFAS) No. 166 “Accounting for Transfer of
Financial Assets – an amendment of the FASB Statement No. 140”(“ASC
860”), which eliminates the concept of a qualifying special purpose entity
(QSPE), changes the requirements for derecognizing financial assets, and
requires additional disclosures including information about continuing exposure
to risks related to transferred financial assets.  ASC 860 is
effective for financial asset transfers occurring after the beginning of fiscal
years beginning after November 15, 2009.  The disclosure requirements
must be applied to transfers that occurred before and after the effective
date.




Statement
of Financial Accounting Standards (SFAS) No. 167, “Amendments for FASB Interpretation
No. 46(R)” (“ASC 810”), which contains new criteria for determining the
primary beneficiary, eliminates the exception to consolidating SQPEs, requires
continual reconsideration of conclusions reached in determining the primary
beneficiary, and requires additional disclosures.  ASC 810 is
effective as of the beginning of fiscal years beginning after November 15, 2009
and is applied using a cumulative effect adjustment to retained earnings for any
carrying amount adjustments (e.g., for newly-consolidated
VIEs).  Management is currently evaluating any effect this may have on
the accounting for the Company’s trust preferred securities though none is
expected.





In August
2009, the FASB issued Accounting Standards Update (ASU) No 2009-05, Fair Value Measurements and
Disclosures Overall (ASC Topic 820-10) - “Measuring Liabilities at Fair
Value”.  This ASU clarifies the application of certain valuation
techniques in circumstances in which a quoted price in an active market for the
identical liability is not available and clarifies that when estimating the fair
value of a liability, the fair value is not adjusted to reflect the impact of
contractual restrictions that prevent its transfer.  The adoption did
not materially affect the Company’s consolidated financial
statements.





Other
accounting standards that have been issued or proposed by the FASB or other
standards-setting bodies are not expected to have a material impact on the
Company’s financial position, results of operations and cash flows.





From time
to time the FASB issues exposure drafts for proposed statements of financial
accounting standards. Such exposure drafts are subject to comment from the
public, to revisions by the FASB and to final issuance by the FASB as statements
of financial accounting standards. Management considers the effect of the
proposed statements on the consolidated financial statements of the Company and
monitors the status of changes to and proposed effective dates of exposure
drafts.


61


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007





NOTE
C - INVESTMENT SECURITIES





The
following is a summary of the securities portfolios by major
classification:





December 31, 2009Gross
                        
                        
                        GrossAmortized
                        
                        
                        unrealized
                        
                        
                        unrealized
                        
                        
                        Faircost
                        
                        
                        gains
                        
                        
                        losses
                        
                        
                        valueSecurities
      available for sale:U.S.
      government securities and obligations of U.S. government
      agencies
                        
                        $
                        12,235,041
                        
                        
                        $
                        448,086
                        
                        
                        $
                        -
                        
                        
                        $
                        12,683,127Mortgage-backed
      securities
                        
                        
                        58,766,929
                        
                        
                        
                        1,562,514
                        
                        
                        
                        126,356
                        
                        
                        
                        60,203,087Collateralized
      mortgage obligations
                        
                        
                        70,300,750
                        
                        
                        
                        948,641
                        
                        
                        
                        386,219
                        
                        
                        
                        70,863,172Municipals
                        
                        
                        48,820,579
                        
                        
                        
                        673,223
                        
                        
                        
                        465,397
                        
                        
                        
                        49,028,405Marketable
      equity
                        
                        
                        402,050
                        
                        
                        
                        -
                        
                        
                        
                        56,950
                        
                        
                        
                        345,100$
                        190,525,349
                        
                        
                        $
                        3,632,464
                        
                        
                        $
                        1,034,922
                        
                        
                        $
                        193,122,891December 31, 2008Gross
                        
                        
                        GrossAmortized
                        
                        
                        unrealized
                        
                        
                        unrealized
                        
                        
                        Faircost
                        
                        
                        gains
                        
                        
                        losses
                        
                        
                        valueSecurities
      available for sale:U.S.
      government securities and obligations of U.S. government
      agencies
                        
                        $
                        10,664,833
                        
                        
                        $
                        169,315
                        
                        
                        $
                        2,313
                        
                        
                        $
                        10,831,835Mortgage-backed
      securities
                        
                        
                        67,308,567
                        
                        
                        
                        1,707,655
                        
                        
                        
                        39,863
                        
                        
                        
                        68,976,359Municipals
                        
                        
                        26,089,420
                        
                        
                        
                        177,788
                        
                        
                        
                        917,537
                        
                        
                        
                        25,349,671Marketable
      equity
                        
                        
                        565,255
                        
                        
                        
                        4,989
                        
                        
                        
                        79,491
                        
                        
                        
                        490,753$
                        104,628,075
                        
                        
                        $
                        2,059,747
                        
                        
                        $
                        1,039,204
                        
                        
                        $
                        105,648,618





Proceeds
from sales of available for sale securities in 2009 totaled $42,820,152
resulting in gross gains of $870,072. Proceeds from sales of available for sale
securities in 2008 totaled $1,543,197 resulting in gross gains of $15,535 and no
losses. There were no sales of available for sale securities in
2007.





The
following tables show investments’ gross unrealized losses and fair values,
aggregated by investment category and length of time that the individual
securities have been in a continuous unrealized loss position, at December 31,
2009 and 2008. The 2009 unrealized losses on investment securities relate to
twelve collateralized mortgage obligations, three mortgage-backed securities,
twenty-five municipal securities and two marketable equity
securities.


62


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007


NOTE
C - INVESTMENT SECURITIES (Continued)





The 2008
unrealized losses on investment securities relate to two U.S. Government agency
securities, nine mortgage-backed securities, twenty-six municipal securities and
one marketable equity security. The unrealized losses relate to debt securities
that have incurred fair value reductions due to higher market interest rates
since the securities were purchased.  The unrealized losses will
reverse at maturity or prior to maturity if market interest rates decline to
levels that existed when the securities were purchased.  Since none of
the unrealized losses relate to the marketability of the securities or the
issuer’s ability to honor redemption obligations, none of the securities are
deemed to be other than temporarily impaired.





December 31, 2009Less Than 12 Months
                          
                          
                          12 Months or More
                          
                          
                          TotalFair
                          
                          
                          Unrealized
                          
                          
                          Fair
                          
                          
                          Unrealized
                          
                          
                          Fair
                          
                          
                          Unrealizedvalue
                          
                          
                          losses
                          
                          
                          value
                          
                          
                          losses
                          
                          
                          value
                          
                          
                          lossesSecurities
      available for sale:Mortgage-backed
                          
                          $
                          10,253,608
                          
                          
                          $
                          126,356
                          
                          
                          $
                          -
                          
                          
                          $
                          -
                          
                          
                          $
                          10,253,608
                          
                          
                          $
                          126,356Collateralized
      mortgage obligations
                          
                          
                          26,940,754
                          
                          
                          
                          386,219
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          26,940,754
                          
                          
                          
                          386,219Municipals
                          
                          
                          17,081,421
                          
                          
                          
                          244,125
                          
                          
                          
                          2,858,321
                          
                          
                          
                          221,272
                          
                          
                          
                          19,939,742
                          
                          
                          
                          465,397Marketable
      equity
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          345,100
                          
                          
                          
                          56,950
                          
                          
                          
                          345,100
                          
                          
                          
                          56,950Total
      temporarily impaired securities
                          
                          $
                          54,275,783
                          
                          
                          $
                          756,700
                          
                          
                          $
                          3,203,421
                          
                          
                          $
                          278,222
                          
                          
                          $
                          57,479,204
                          
                          
                          $
                          1,034,922December 31, 2008Less Than 12 Months
                          
                          
                          12 Months or More
                          
                          
                          TotalFair
                          
                          
                          Unrealized
                          
                          
                          Fair
                          
                          
                          Unrealized
                          
                          
                          Fair
                          
                          
                          Unrealizedvalue
                          
                          
                          losses
                          
                          
                          value
                          
                          
                          losses
                          
                          
                          value
                          
                          
                          lossesSecurities
      available for sale:U.S.
      government securities and obligations of U.S. government
      agencies
                          
                          $
                          972,624
                          
                          
                          $
                          2,313
                          
                          
                          $
                          -
                          
                          
                          $
                          -
                          
                          
                          $
                          972,624
                          
                          
                          $
                          2,313Mortgage-backed
                          
                          
                          1,768,974
                          
                          
                          
                          22,558
                          
                          
                          
                          1,097,179
                          
                          
                          
                          17,305
                          
                          
                          
                          2,866,153
                          
                          
                          
                          39,863Municipals
                          
                          
                          13,246,896
                          
                          
                          
                          755,550
                          
                          
                          
                          986,586
                          
                          
                          
                          161,987
                          
                          
                          
                          14,233,482
                          
                          
                          
                          917,537Marketable
      equity
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          206,366
                          
                          
                          
                          79,491
                          
                          
                          
                          206,366
                          
                          
                          
                          79,491Total
      temporarily impaired securities
                          
                          $
                          15,988,494
                          
                          
                          $
                          780,421
                          
                          
                          $
                          2,290,131
                          
                          
                          $
                          258,783
                          
                          
                          $
                          18,278,625
                          
                          
                          $
                          1,039,204





For the
year ended December 31, 2009, the Company determined one marketable equity
security was other than temporarily impaired and recognized a $197,575
write-down on the investment.  The investment had been carried at a
basis of $279,398.  The per share basis was well above the trailing
fifty-two week range and the prospects of recovery were limited.  The
fair value of the investment at December 31, 2009 is $73,043.  The
Company also took an impairment charge of $406,802 on a non-marketable
equity security.  The investment was written off in its entirety since
the issuing company was taken into receivership.  There were no
investments determined to be other than temporarily impaired during
2008.





At
December 31, 2009 and 2008, investment securities with a carrying value of
$96,437,558 and $63,602,694, respectively, were pledged to secure public
deposits, borrowings and for other purposes required or permitted by
law.


63


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007


NOTE
C - INVESTMENT SECURITIES (Continued)





The
amortized cost and fair values of securities available for sale at December 31,
2009 by expected maturity are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.





Amortized
                  
                  
                  Faircost
                  
                  
                  valueDue
      within one year
                  
                  $
                  18,311,207
                  
                  
                  $
                  18,698,363Due
      after one year through five years
                  
                  
                  91,833,128
                  
                  
                  
                  93,371,396Due
      after five years through ten years
                  
                  
                  47,642,887
                  
                  
                  
                  48,110,466Due
      after ten years
                  
                  
                  32,336,077
                  
                  
                  
                  32,597,566Other
      equity securities
                  
                  
                  402,050
                  
                  
                  
                  345,100$
                  190,525,349
                  
                  
                  $
                  193,122,891





The
following table presents the carrying values, intervals of maturities or
repricings, and weighted average tax equivalent yields of our investment
portfolio at December 31, 2009:





Repricing or MaturingLess than
                  
                  
                  One to
                  
                  
                  Five to
                  
                  
                  Over tenone year
                  
                  
                  five years
                  
                  
                  ten years
                  
                  
                  years
                  
                  
                  Total(Dollars in thousands)Securities available for sale:U.
      S. government agenciesBalance
                  
                  $
                  -
                  
                  
                  $
                  6,961
                  
                  
                  $
                  5,274
                  
                  
                  $
                  -
                  
                  
                  $
                  12,235Weighted
      average yield
                  
                  
                  -
                  %
                  
                  
                  4.63
                  %
                  
                  
                  4.66
                  %
                  
                  
                  -
                  %
                  
                  
                  4.64
                  %Mortgage-backed
      securitiesBalance
                  
                  $
                  12,213
                  
                  
                  $
                  27,340
                  
                  
                  $
                  12,871
                  
                  
                  $
                  6,343
                  
                  
                  $
                  58,767Weighted
      average yield
                  
                  
                  4.30
                  %
                  
                  
                  4.35
                  %
                  
                  
                  4.40
                  %
                  
                  
                  4.66
                  %
                  
                  
                  4.38
                  %Collateralized
      mortgage obligationsBalance
                  
                  $
                  6,098
                  
                  
                  $
                  51,786
                  
                  
                  $
                  12,406
                  
                  
                  $
                  11
                  
                  
                  $
                  70,301Weighted
      average yield
                  
                  
                  2.52
                  %
                  
                  
                  3.59
                  %
                  
                  
                  4.04
                  %
                  
                  
                  6.00
                  %
                  
                  
                  3.58
                  %Municipal
      securitiesBalance
                  
                  $
                  -
                  
                  
                  $
                  5,746
                  
                  
                  $
                  17,092
                  
                  
                  $
                  25,982
                  
                  
                  $
                  48,820Weighted
      average yield
                  
                  
                  -
                  %
                  
                  
                  3.93
                  %
                  
                  
                  4.39
                  %
                  
                  
                  4.53
                  %
                  
                  
                  4.41
                  %Marketable
      equityBalance
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  402
                  
                  
                  $
                  402Weighted
      average yield
                  
                  
                  -
                  %
                  
                  
                  -
                  %
                  
                  
                  -
                  %
                  
                  
                  -
                  %
                  
                  
                  -
                  %TotalBalance
                  
                  $
                  18,311
                  
                  
                  $
                  91,833
                  
                  
                  $
                  47,643
                  
                  
                  $
                  32,738
                  
                  
                  $
                  190,525Weighted
      average yield
                  
                  
                  3.70
                  %
                  
                  
                  3.92
                  %
                  
                  
                  4.33
                  %
                  
                  
                  4.55
                  %
                  
                  
                  4.11
                  %


64


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007


NOTE
D - LOANS





Following
is a summary of loans at December 31, 2009 and 2008.  See Note B for a
discussion regarding the reclassification of loans that took place during
2009.


2009
                  
                  
                  2008Real
      estate - commercial
                  
                  $
                  359,450,529
                  
                  
                  $
                  305,808,295Real
      estate - residential
                  
                  
                  96,730,537
                  
                  
                  
                  89,872,388Construction
      loans
                  
                  
                  179,227,518
                  
                  
                  
                  242,771,248Commercial
      and industrial loans
                  
                  
                  55,360,111
                  
                  
                  
                  81,000,300Home
      equity loans and lines of credit
                  
                  
                  64,484,524
                  
                  
                  
                  63,772,120Loans
      to individuals
                  
                  
                  4,965,873
                  
                  
                  
                  3,198,606Total
      loans
                  
                  
                  760,219,092
                  
                  
                  
                  786,422,957Less:Deferred
      loan fees
                  
                  
                  (870,751
                  )
                  
                  
                  (1,045,674
                  )Allowance
      for loan losses
                  
                  
                  (17,567,000
                  )
                  
                  
                  (12,585,000
                  )Total
                  
                  $
                  741,781,341
                  
                  
                  $
                  772,792,283





Loans are
primarily made in the Company’s market area of North Carolina, principally Wake,
Johnston, Lee, Moore, and New Hanover counties. Real estate loans can be
affected by the condition of the local real estate market. Commercial and
consumer and other loans can be affected by the local economic
conditions.





At
December 31, 2009 there were fifteen restructured loans totaling $13.7 million.
Five of these loans totaling $8 million are commercial real estate, three loans
totaling $2.8 million are construction, land acquisition and development, one
loan for $2.6 million is residential real estate and six loans totaling $372,000
were commercial and industrial.  All fifteen loans are accruing
interest, are not past due 30 days or more and are performing in accordance with
the modified terms.  There were no restructured loans as of December
31, 2008. At December 31, 2009, the recorded investment in loans considered
impaired totaled $66.1 million. Of the total investment in loans considered
impaired, $35.4 million were found to show specific impairment for which $9.1
million in valuation allowance was recorded; no valuation allowance for the
other impaired loans was considered necessary.  For the year ended
December 31, 2009, the average recorded investment in impaired loans was
approximately $39.6 million.  The amount of interest recognized on
impaired loans during the portion of the year that they were considered impaired
was approximately $1.3 million.





At
December 31, 2008, the recorded investment in loans considered impaired totaled
$16.7 million. Of the total investment in loans considered
impaired,  $11.6 million were found to show specific impairment for
which $4.1 million in valuation allowance was recorded; no valuation allowance
for the other impaired loans was considered necessary.  For the year
ended December 31, 2008, the average recorded investment in impaired loans was
approximately $3.6 million.  The amount of interest recognized on
impaired loans during the portion of the year that they were considered impaired
was not material.





The
Company has granted loans to certain directors and executive officers of the
Company and their related interests. Such loans are made on substantially the
same terms, including interest rates and collateral, as those prevailing at the
time for comparable transactions with other borrowers and, in management’s
opinion, do not involve more than the normal risk of collectability. All loans
to directors and executive officers or their related interests are submitted to
the Board of Directors for approval. A summary of loans to directors, executive
officers and their interests follows:





Loans
      to directors and officers as a group at December 31, 2008
                  
                  $
                  43,180,789Net
      payments during the year-ended December 31, 2009
                  
                  
                  (389,140
                  )Loans
      to directors and officers as a group at December 31, 2009
                  
                  $
                  42,791,649


65


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007


NOTE
D - LOANS (Continued)





At
December 31, 2009, the Company had pre-approved but unused lines of credit
totaling $3.7 million to executive officers, directors and their related
interests. No additional funds were committed to be advanced at December 31,
2009.





An
analysis of the allowance for loan losses follows:





2009
                    
                    
                    2008
                    
                    
                    2007Balance
      at beginning of year
                    
                    $
                    12,585,000
                    
                    
                    $
                    8,273,000
                    
                    
                    $
                    6,945,000Provision
      for loan losses
                    
                    
                    11,526,066
                    
                    
                    
                    6,484,543
                    
                    
                    
                    1,684,219Charge-offs
                    
                    
                    (6,940,583
                    )
                    
                    
                    (2,187,104
                    )
                    
                    
                    (362,363
                    )Recoveries
                    
                    
                    396,517
                    
                    
                    
                    14,561
                    
                    
                    
                    6,144Net
      charge-offs
                    
                    
                    (6,544,066
                    )
                    
                    
                    (2,172,543
                    )
                    
                    
                    (356,219
                    )Balance
      at end of year
                    
                    $
                    17,567,000
                    
                    
                    $
                    12,585,000
                    
                    
                    $
                    8,273,000





NOTE
E - PREMISES AND EQUIPMENT





Following
is a summary of premises and equipment at December 31, 2009 and
2008:





2009
                  
                  
                  2008Land
                  
                  $
                  4,280,213
                  
                  
                  $
                  4,280,213Buildings
      and leasehold improvements
                  
                  
                  7,014,872
                  
                  
                  
                  4,940,581Furniture
      and equipment
                  
                  
                  5,155,849
                  
                  
                  
                  5,354,601Less
      accumulated depreciation
                  
                  
                  (4,589,776
                  )
                  
                  
                  (3,730,346
                  )Total
                  
                  $
                  11,861,158
                  
                  
                  $
                  10,845,049





Depreciation
and amortization amounting to $938,178 in 2009, $786,668 in 2008 and $694,559 in
2007 is included in occupancy and equipment expense.





NOTE
F - GOODWILL AND OTHER INTANGIBLES





There was
no accumulated impairment loss for goodwill as of January 1, 2009 and 2008,
respectively.  The following is a summary of goodwill and other
intangible assets at December 31, 2009 and 2008:





2009
                  
                  
                  2008Goodwill,
      beginning of year
                  
                  $
                  30,233,049
                  
                  
                  $
                  30,233,049Goodwill
      impairment write-off
                  
                  
                  30,233,049
                  
                  
                  
                  -Goodwill,
      end of year
                  
                  $
                  -
                  
                  
                  $
                  30,233,049Other
      intangibles – gross
                  
                  $
                  1,333,493
                  
                  
                  $
                  1,333,493Less
      accumulated amortization
                  
                  
                  507,201
                  
                  
                  
                  373,852Other
      intangibles – net
                  
                  $
                  826,292
                  
                  
                  $
                  959,641


66


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007


NOTE
F - GOODWILL AND OTHER INTANGIBLES (Continued)





Management
is required to test goodwill for impairment on an annual basis, or more often if
events or circumstances indicate there may be impairment. If the carrying amount
of the reporting unit’s goodwill is found to exceed its implied fair value, the
Company would recognize an impairment loss in an amount equal to that
excess.





The
Company completed its annual test of goodwill for impairment as of October 31,
2008 which test indicated that none of the Company's goodwill was impaired.
Management updated its test for impairment of goodwill at December 31, 2008 due
to the decline in the price of our common stock and the net loss in the fourth
quarter of 2008. The results of that test indicated that none of the Company's
goodwill was impaired. At both March 31 and June 30, 2009, due to the decline in
the price of our common stock and the disparity between the stock price and
stated book value, management again tested for impairment of goodwill. The
results of these tests indicated that none of the Company's goodwill was
impaired.





In early
August, management engaged external valuation specialists to assist in its
goodwill assessments. At August 31, 2009 the Company again tested its goodwill
for impairment due to the continued disparity between the value of the Company's
stock and stated book value. The indicative fair value of the Company at August
31, 2009 was determined using two methods. The first is a market approach based
on the actual market capitalization of the Company, adjusted for a control
premium. The second is an income approach based on discounted cash flow models
with estimated cash flows based on internal forecasts of net income. Both
methods were considered and weighted to estimate the fair value of the
Company.  Based on testing, management determined that the indicative
fair value of the Company exceeded its carrying value and management performed a
second step analysis to compare the implied fair value of the goodwill with the
carrying amount of that goodwill. The results of this second step analysis,
which were finalized in the fourth quarter of 2009, indicated a range of
goodwill impairment that supported a charge of $30.2 million to write off all of
its goodwill.





There
were several significant assumption changes between the analysis performed at
June 30 and August 31, 2009.  The discount rate used in the income
approach based on discounted cash flows increased from 15% to
18.5%.  The external valuation specialist had an established method of
determining the discounted rate which considered factors not previously
utilized.  Between the higher discount rate to compensate for
increased risk due to higher levels of nonperforming loans and adjustments made
to projected cash flows as we looked forward to the fourth quarter, the
indicative value per the income approach declined by $38.1
million.  The results of the market approach between June 30 and
August 31, 2009 declined by $42.3 million primarily due to a continued drop in
control premiums on merger transactions.  When considering how to
weight the two approaches, greater consideration was given to the market
approach during the August analysis.  These factors led to a lower
estimated fair value of equity at August 31, 2009 compared to June 30,
2009.





This
write off of goodwill has no effect on our cash flows, our regulatory capital,
and the operation of our business or our ability to service our
customers.





Other
intangibles amortization expense for the years ended December 31, 2009, 2008 and
2007 amounted to $133,349, $133,349 and $133,349, respectively.  The
following table presents estimated amortization expense for other
intangibles.


Estimated Amortization ExpenseFor
      the Year Ending December 31:2010
                
                $
                133,3492011
                
                
                133,3492012
                
                
                133,3492013
                
                
                126,3832014
                
                
                112,448Thereafter
                
                
                187,414$
                826,292


67


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007


NOTE
G - DEPOSITS





The
weighted average cost of time deposits was 3.12% and 4.54% at December 31, 2009
and 2008, respectively.





At
December 31, 2009, the scheduled maturities of certificates of deposit are as
follows:





Less than
                  
                  
                  $100,000$100,000
                  
                  
                  or more
                  
                  
                  TotalThree
      months or less
                  
                  $
                  17,432,487
                  
                  
                  $
                  73,378,094
                  
                  
                  $
                  90,810,581Over
      three months through one year
                  
                  
                  33,653,542
                  
                  
                  
                  146,451,842
                  
                  
                  
                  180,105,384Over
      one year through three years
                  
                  
                  16,077,254
                  
                  
                  
                  110,817,186
                  
                  
                  
                  126,894,440Over
      three years to five years
                  
                  
                  12,959,296
                  
                  
                  
                  26,692,653
                  
                  
                  
                  39,651,949Over
      five years
                  
                  
                  50,000
                  
                  
                  
                  -
                  
                  
                  
                  50,000Total
                  
                  $
                  80,172,579
                  
                  
                  $
                  357,339,775
                  
                  
                  $
                  437,512,354





NOTE
H - BORROWINGS





Borrowings
are comprised of the following at December 31, 2009 and 2008:





2009
                  
                  
                  2008Short-term
      borrowings:Federal
      funds purchased
                  
                  $
                  -
                  
                  
                  $
                  8,706,000Federal
      Reserve Bank discount window
                  
                  
                  50,000,000
                  
                  
                  
                  -Federal
      Home Loan Bank advances maturing within one year
                  
                  
                  24,000,000
                  
                  
                  
                  29,000,000Total
      short-term borrowings
                  
                  $
                  74,000,000
                  
                  
                  $
                  37,706,000Long-term
      debt:Federal
      Home Loan Bank advances maturing beyond one year
                  
                  $
                  127,000,000
                  
                  
                  $
                  99,000,000Junior
      subordinated debentures
                  
                  
                  8,248,000
                  
                  
                  
                  8,248,000Subordinated
      term loan
                  
                  
                  7,500,000
                  
                  
                  
                  7,500,000Holding
      company line of credit
                  
                  
                  -
                  
                  
                  
                  2,000,000Total
      long-term debt
                  
                  $
                  142,748,000
                  
                  
                  $
                  116,748,000





Short-term
Borrowings





The
Company may purchase federal funds through unsecured federal funds guidance
lines of credit totaling $21.5 million at December 31, 2009. These lines are
intended for short-term borrowings and are subject to restrictions limiting the
frequency and terms of advances. These lines of credit are payable on demand and
bear interest based upon the daily federal funds rate. The Company had no
outstanding balance on the lines of credit as of December 31, 2009 compared to
$8,706,000 at December 31, 2008.





The
Company may borrow funds through the Federal Reserve Bank’s discount
window.  These borrowings are secured by a blanket floating lien on
qualifying construction, land acquisition and development loans, commercial and
industrial loans and consumer loans collateral value of $82.8 million. Depending
on the type of loan collateral, the Company may borrow between 75% and 80% of
the collateral value pledged.  The Company had $50.0 million
outstanding as of December 31, 2009.


68


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007


NOTE
H - BORROWINGS (Continued)





A summary
of selected data related to short-term borrowed funds follows:





For the Year Ended December 31,2009
                
                
                2008(Dollars in thousands)Short-term
      borrowings:Federal
      funds purchased:Balance
      outstanding at end of year
                
                $
                -
                
                
                $
                8,706Maximum
      amount outstanding at any month end during the year
                
                
                101,222
                
                
                
                20,894Average
      balance outstanding during the year
                
                
                16,037
                
                
                
                4,010Weighted-average
      interest rate during the year
                
                
                0.61
                %
                
                
                2.87
                %Weighted-average
      interest rate at end of year
                
                
                0
                %
                
                
                1.00
                %Federal
      Reserve Bank discount window:Balance
      outstanding at end of year
                
                $
                50,000
                
                
                $
                -Maximum
      amount outstanding at any month end during the year
                
                
                75,000
                
                
                
                -Average
      balance outstanding during the year
                
                
                48,039
                
                
                
                -Weighted-average
      interest rate during the year
                
                
                0.42
                %
                
                
                -Weighted-average
      interest rate at end of year
                
                
                0.25
                %
                
                
                -





Junior
Subordinated Debentures





In 2003,
the Company issued $8,248,000 of junior subordinated debentures to Crescent
Financial Capital Trust I (the “Trust”) in exchange for the proceeds of trust
preferred securities issued by the Trust.  The junior subordinated
debentures are included in long-term debt and the Company’s equity interest in
the trust is included in other assets.





The
junior subordinated debentures pay interest quarterly at an annual rate, reset
quarterly, equal to three month LIBOR plus 3.10%.  On June 25, 2009,
the Company entered into a derivative financial instrument which effectively
swapped the variable rate payments for fixed payments.    We
entered into a three year and four year swap each for one-half of the notional
amount of the trust preferred securities for fixed rates of 5.49% and 5.97%,
respectively.  The effective interest rate is currently 5.73%.The
debentures are redeemable on October 7, 2008 or afterwards, in whole or in part,
on any January 7, April 7, July 7, or October 7.  Redemption is
mandatory at October 7, 2033.  The Company guarantees the trust
preferred securities through the combined operation of the junior subordinated
debentures and other related documents.  The Company’s obligation
under the guarantee is unsecured and subordinate to senior and subordinated
indebtedness of the Company.





The trust
preferred securities presently qualify as Tier 1 regulatory capital and are
reported in Federal Reserve regulatory reports as a minority interest in a
consolidated subsidiary. The junior subordinated debentures do not qualify as
Tier 1 regulatory capital.  On March 1, 2005, the Board of Governors
of the Federal Reserve issued a final rule stating that trust preferred
securities will continue to be included in Tier 1 capital, subject to stricter
quantitative and qualitative standards.  For Bank Holding Companies,
trust preferred securities will continue to be included in Tier 1 capital up to
25% of core capital elements (including trust preferred securities) net of
goodwill less any associate deferred tax liability.





Subordinated
Term Loan Agreement





On
September 26, 2008, the Company entered into a $7.5 million subordinated term
loan agreement with a non-affiliated financial institution.  The
subordinated term loan is included in long-term debt.


69


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007


NOTE
H - BORROWINGS (Continued)





The
subordinated term loan pays interest quarterly at an annual rate, reset
quarterly, equal to three month LIBOR plus 4.00%.On June 25, 2009, the
Company entered into a derivative financial instrument which effectively swapped
the variable rate payments for fixed payments.  We entered into a
three year and four year swap each for one-half of the notional amount of the
trust preferred securities for fixed rates of 6.39% and 6.87%,
respectively.  The subordinated term loan agreement matures on October
18, 2018 and can be prepaid, subject to the approval of the FDIC and other
Governmental Authorities (if applicable), in incremental amounts not less than
$500,000, by giving five business days notice prior to
prepayment.  The Company does not have the right to prepay all or any
portion of the loan prior to October 1, 2013 unless the loan ceases to be deemed
Tier 2 capital for regulatory capital purposes.





Should
the loan cease to be considered Tier 2 capital for regulatory capital purposes,
the debt can either be structured as senior debt of the Company or be
repaid.  The principal reason for entering into the subordinated term
loan agreement was to enhance our regulatory capital position.





Federal
Home Loan Bank Advances





The
Company has a $309.7 million credit line available with the Federal Home Loan
Bank for advances.  These advances are secured by a blanket floating
lien on qualifying commercial real estate, first mortgage loans and pledged
investment securities with a market value of $273.9 million.





At
December 31, 2009 and 2008, the Company had the following advances outstanding
from the Federal Home Loan Bank of Atlanta:





Maturity
                            
                            Interest Rate
                            
                            
                            Rate Type
                            
                            2009
                            
                            
                            2008August
      21, 2009
                            
                            
                            4.71
                            %
                            
                            
                            Fixed
                            
                            $
                            -
                            
                            
                            $
                            10,000,000September
      10, 2009
                            
                            
                            4.62
                            %
                            
                            
                            Fixed
                            
                            
                            -
                            
                            
                            
                            10,000,000October
      21, 2009
                            
                            
                            4.72
                            %
                            
                            
                            Fixed
                            
                            
                            -
                            
                            
                            
                            9,000,000January
      7, 2010
                            
                            
                            1.11
                            %
                            
                            
                            Fixed
                            
                            
                            10,000,000
                            
                            
                            
                            -April
      12, 2010
                            
                            
                            4.58
                            %
                            
                            
                            Fixed
                            
                            
                            7,000,000
                            
                            
                            
                            7,000,000June
      9, 2010
                            
                            
                            3.58
                            %
                            
                            
                            Fixed
                            
                            
                            7,000,000
                            
                            
                            
                            7,000,000January
      12, 2011
                            
                            
                            1.75
                            %
                            
                            
                            Fixed
                            
                            
                            7,000,000
                            
                            
                            
                            -June
      9, 2011
                            
                            
                            3.94
                            %
                            
                            
                            Fixed
                            
                            
                            8,000,000
                            
                            
                            
                            8,000,000February
      10, 2012
                            
                            
                            1.68
                            %
                            
                            
                            Fixed
                            
                            
                            5,000,000
                            
                            
                            
                            -March
      9, 2012
                            
                            
                            4.29
                            %
                            
                            
                            Convertible
                            
                            
                            10,000,000
                            
                            
                            
                            10,000,000May
      18, 2012
                            
                            
                            4.49
                            %
                            
                            
                            Convertible
                            
                            
                            20,000,000
                            
                            
                            
                            20,000,000July
      16, 2012
                            
                            
                            3.84
                            %
                            
                            
                            Convertible
                            
                            
                            5,000,000
                            
                            
                            
                            5,000,000August
      29, 2012
                            
                            
                            4.00
                            %
                            
                            
                            Convertible
                            
                            
                            15,000,000
                            
                            
                            
                            15,000,000December
      6, 2012
                            
                            
                            4.22
                            %
                            
                            
                            Fixed
                            
                            
                            5,000,000
                            
                            
                            
                            5,000,000February
      11, 2013
                            
                            
                            2.29
                            %
                            
                            
                            Fixed
                            
                            
                            5,000,000
                            
                            
                            
                            -April
      22, 2013
                            
                            
                            2.55
                            %
                            
                            
                            Fixed
                            
                            
                            6,000,000
                            
                            
                            
                            -March
      21, 2014
                            
                            
                            2.76
                            %
                            
                            
                            Fixed
                            
                            
                            5,000,000
                            
                            
                            
                            -August
      21, 2014
                            
                            
                            2.90
                            %
                            
                            
                            Fixed
                            
                            
                            5,000,000
                            
                            
                            
                            -October
      21, 2014
                            
                            
                            2.91
                            %
                            
                            
                            Fixed
                            
                            
                            9,000,000
                            
                            
                            
                            -January
      28, 2019
                            
                            
                            3.90
                            %
                            
                            
                            Fixed
                            
                            
                            12,000,000
                            
                            
                            
                            12,000,000March
      25, 2019
                            
                            
                            4.26
                            %
                            
                            
                            Fixed
                            
                            
                            10,000,000
                            
                            
                            
                            10,000,000Totals
                            
                            
                            
                            
                            
                            
                            
                            
                            $
                            151,000,000
                            
                            
                            $
                            128,000,000





70


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007


NOTE
H - BORROWINGS (Continued)





Borrowings
maturing on March 9, 2012, May 18, 2012 and August 29, 2012 are fixed rate
advances, convertible quarterly, at the discretion of the Federal Home Loan
Bank, to a variable rate based on 3-month LIBOR.  The borrowing
maturing on July 16, 2012 is a fixed rate advance, convertible quarterly to a
variable rate based on 3-month LIBOR, only if 3-month LIBOR is greater than or
equal to 7%.  All other advances are fixed rate
facilities.





Holding
Company Line of Credit





On June
27, 2008, the Company entered into a $10.0 million holding company line of
credit with a correspondent financial institution.There was $2.0
million outstanding on this line at December 31, 2008 and is included in
long-term debt.  The line was revolving and paid interest quarterly at
an annual rate, reset daily, equal to the Prime rate of interest minus
1.125%.  The line was secured by 258,000 shares of Crescent State Bank
stock.   The line was paid in full and cancelled at the Company’s
request prior to March 31, 2009.





NOTE
I - LEASES





The
Company has entered into fourteen non-cancelable operating leases for its main
office, operations center, and branch facilities. Future minimum lease payments
under these leases for the years ending December 31 are approximately as
follows:





2010
                  
                  $
                  1,922,0002011
                  
                  
                  1,945,0002012
                  
                  
                  1,824,0002013
                  
                  
                  1,775,0002014
                  
                  
                  1,711,000Thereafter
                  
                  
                  8,296,000Total
                  
                  $
                  17,473,000





The
leases contain renewal options for various additional terms after the expiration
of the initial term of each lease.  The cost of such renewals is not
included above.  Total rent expense for the years ended December 31,
2009, 2008 and 2007  amounted to $1,650,367, $1,308,210 and
$1,090,669, respectively.





Two of
the properties used for bank branch operations are leased from related
parties.  Lease payments made to related parties in 2009, 2008 and
2007 were $242,094, $150,115 and $48,385, respectively.





NOTE
J - INCOME TAXES





The
significant components of the provision for income taxes for the years ended
December 31, 2009, 2008 and 2007 are as follows:


2009
                  
                  
                  2008
                  
                  
                  2007Current
      tax provision:Federal
                  
                  $
                  499,168
                  
                  
                  $
                  1,910,369
                  
                  
                  $
                  3,246,706State
                  
                  
                  249,539
                  
                  
                  
                  476,528
                  
                  
                  
                  776,243748,707
                  
                  
                  
                  2,386,897
                  
                  
                  
                  4,022,949Deferred
      tax provision (benefit):Federal
                  
                  
                  (1,717,793
                  )
                  
                  
                  (1,473,490
                  )
                  
                  
                  (404,347
                  )State
                  
                  
                  (359,614
                  )
                  
                  
                  (314,707
                  )
                  
                  
                  (98,402
                  )(2,077,407
                  )
                  
                  
                  (1,788,197
                  )
                  
                  
                  (502,749
                  )Provision
      for income taxes (benefit)
                  
                  $
                  (1,328,700
                  )
                  
                  $
                  598,700
                  
                  
                  $
                  3,520,200


71


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007


NOTE
J - INCOME TAXES (Continued)





The
difference between the provision for income taxes and the amounts computed by
applying the statutory federal income tax rate of 34% to income before income
taxes is summarized below:





2009
                  
                  
                  2008
                  
                  
                  2007Tax
      computed at statutory rate of 34%
                  
                  $
                  (10,728,581
                  )
                  
                  $
                  887,237
                  
                  
                  $
                  3,321,445Effect
      of state income taxes
                  
                  
                  (72,649
                  )
                  
                  
                  106,802
                  
                  
                  
                  447,375Non-taxable
      interest income
                  
                  
                  (501,847
                  )
                  
                  
                  (279,751
                  )
                  
                  
                  (256,218
                  )Non-taxable
      bank owned life insurance
                  
                  
                  (287,799
                  )
                  
                  
                  (234,335
                  )
                  
                  
                  (115,329
                  )Goodwill
      impairment
                  
                  
                  10,279,235
                  
                  
                  
                  -
                  
                  
                  
                  -Other
                  
                  
                  (17,059
                  )
                  
                  
                  118,747
                  
                  
                  
                  122,927$
                  (1,328,700
                  )
                  
                  $
                  598,700
                  
                  
                  $
                  3,520,200





Significant
components of deferred taxes at December 31, 2009 and 2008 are as
follows:





2009
                  
                  
                  2008Deferred
      tax assets:Allowance
      for loan losses
                  
                  $
                  6,522,001
                  
                  
                  $
                  4,792,148Premises
      and equipment
                  
                  
                  41,051
                  
                  
                  
                  180,587Rent
      abatement
                  
                  
                  -
                  
                  
                  
                  3,711Fair
      value adjustments
                  
                  
                  54,425
                  
                  
                  
                  110,567Unrealized
      loss on hedges
                  
                  
                  113,697
                  
                  
                  
                  -Deferred
      compensation
                  
                  
                  632,559
                  
                  
                  
                  475,521Other
                  
                  
                  418,835
                  
                  
                  
                  155,802Net
      deferred tax assets
                  
                  
                  7,782,568
                  
                  
                  
                  5,718,336Deferred
      tax liabilities:Intangible
      assets
                  
                  
                  (318,568
                  )
                  
                  
                  (369,980
                  )Deferred
      loan costs
                  
                  
                  -
                  
                  
                  
                  (76,280
                  )Unrealized
      gain on securities
                  
                  
                  (1,001,457
                  )
                  
                  
                  (393,420
                  )Prepaid
      expenses
                  
                  
                  (164,037
                  )
                  
                  
                  (163,217
                  )Net
      deferred tax liabilities
                  
                  
                  (1,484,062
                  )
                  
                  
                  (1,002,897
                  )Net
      deferred tax asset included in other assets
                  
                  $
                  6,298,506
                  
                  
                  $
                  4,715,439





It is
management’s opinion that realization of the net deferred tax asset is more
likely than not based on the Company’s history of taxable income and estimates
of future taxable income.





Effective
January 1, 2007, the Company adopted new guidance related to accounting for
uncertain income tax positions, which provides guidance on financial statement
recognition and measurements of tax positions taken, or expected to be taken, in
tax returns.  The initial adoption of ASC 740-10 had no impact on the
Company’s financial statements.  As of January 1, 2009, there were no
unrecognized tax benefits.


72


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007


NOTE
J - INCOME TAXES (Continued)


When tax
returns are filed, it is highly certain that some positions taken would be
sustained upon examination by the taxing authorities, while others are subject
to uncertainty about the merits of the position taken or the amount of the
position that would be ultimately sustained. The benefit of a tax position is
recognized in the financial statements in the period during which, based on all
available evidence, management believes it is more likely than not that the
position will be sustained upon examination, including the resolution of appeals
or litigation processes, if any. Tax positions taken are not offset or
aggregated with other positions. Tax positions that meet the
more-likely-than-not recognition
threshold are measured as the largest amount of tax benefit that is more than 50
percent likely of being realized upon settlement with the applicable taxing
authority. The portion of the benefits associated with tax positions taken that
exceeds the amount measured as described above is reflected as a liability for
unrecognized tax benefits in the accompanying consolidated balance sheet along
with any associated interest and penalties that would be payable to the taxing
authorities upon examination.





The
Company’s federal and state income tax returns are open and subject to
examination from the 2006 tax return year and forward.





NOTE
K - NON-INTEREST INCOME AND OTHER NON-INTEREST EXPENSE





The major
components of other non-interest income for the years ended December 31, 2009,
2008 and 2007 are as follows:


2009
                  
                  
                  2008
                  
                  
                  2007Brokerage
      referral fees
                  
                  $
                  163,858
                  
                  
                  $
                  172,159
                  
                  
                  $
                  164,665Other
                  
                  
                  355,616
                  
                  
                  
                  558,060
                  
                  
                  
                  269,498Total
                  
                  $
                  519,474
                  
                  
                  $
                  730,219
                  
                  
                  $
                  434,163





The major
components of other non-interest expense for the years ended December 31, 2009,
2008 and 2007 are as follows:


2009
                  
                  
                  2008
                  
                  
                  2007Postage,
      printing and office supplies
                  
                  $
                  620,467
                  
                  
                  $
                  560,192
                  
                  
                  $
                  550,724Advertising,
      marketing and business development
                  
                  
                  613,456
                  
                  
                  
                  639,129
                  
                  
                  
                  606,667Professional
      fees and services
                  
                  
                  1,465,114
                  
                  
                  
                  1,620,339
                  
                  
                  
                  1,511,404Loan
      servicing and collection expenses
                  
                  
                  226,490
                  
                  
                  
                  255,105
                  
                  
                  
                  222,989Other
                  
                  
                  1,571,514
                  
                  
                  
                  1,501,691
                  
                  
                  
                  1,468,246Total
                  
                  $
                  4,497,041
                  
                  
                  $
                  4,576,456
                  
                  
                  $
                  4,360,030





NOTE
L - RESERVE REQUIREMENTS





The
aggregate net reserve balance maintained under the requirements of the Federal
Reserve, which is currently interest bearing, was $351,000 at December 31, 2009.
During 2008, Crescent began utilizing a deposit reclassification program. This
program, in compliance with Federal Reserve Bank regulations, allowed a portion
of Crescent’s reservable transaction accounts to be reclassified as savings
which are not subject to reserve requirements.


73


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007


NOTE
M - REGULATORY MATTERS





The
Company (on a consolidated basis) and the Bank are subject to various regulatory
capital requirements administered by the federal banking agencies. Failure to
meet minimum capital requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if undertaken, could have a
direct material effect on the Company’s and Bank’s financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt corrective
action, the Company and the Bank must meet specific capital guidelines that
involve quantitative measures of their assets, liabilities and certain
off-balance sheet items as calculated
under regulatory accounting practices. The capital amounts and classification
are also subject to qualitative judgments by the regulators about components,
risk weightings, and other factors. Prompt corrective action provisions are not
applicable to bank holding companies.





The Bank,
as  a North Carolina banking corporation, may pay dividends to the
Company only out of undivided profits as determined pursuant to North Carolina
General Statutes Section 53-87. However, regulatory authorities may limit
payment of dividends by any bank when it is determined that such a limitation is
in the public interest and is necessary to ensure the financial soundness of the
bank.





Quantitative
measures established by regulation to ensure capital adequacy require the
Company and the Bank to maintain minimum amounts and ratios (set forth in the
following table) of total and Tier I capital (as defined) to average assets (as
defined). Management believes, as of December 31, 2009 and 2008, that the
Company and the Bank met all capital adequacy requirements to which they are
subject.





As of
December 31, 2009, the most recent notification from the Federal Deposit
Insurance Corporation categorized Crescent State Bank as well capitalized under
the regulatory framework for prompt corrective action. To be categorized as well
capitalized, an institution must maintain minimum total risk-based, Tier 1
risk-based and Tier 1 leverage ratios as set forth in the following tables.
There are no conditions or events since the notification that management
believes have changed the Bank’s category. The Banks’ actual capital amounts and
ratios as of December 31, 2009 and 2008 are presented in the table
below.





Minimum to be wellMinimum for capital
                  
                  
                  capitalized under promptActual
                  
                  
                  adequacy purposes
                  
                  
                  corrective action provisionsAmount
                  
                  
                  Ratio
                  
                  
                  Amount
                  
                  
                  Ratio
                  
                  
                  Amount
                  
                  
                  Ratio(Dollars in thousands)Crescent
      State BankAs
      of December 31, 2009:Total
      Capital (to Risk-Weighted Assets)
                  
                  $
                  111,463
                  
                  
                  
                  13.32
                  %
                  
                  $
                  66,945
                  
                  
                  
                  8.00
                  %
                  
                  $
                  83,682
                  
                  
                  
                  10.00
                  %Tier
      I Capital (to Risk-Weighted Assets)
                  
                  
                  93,415
                  
                  
                  
                  11.16
                  %
                  
                  
                  33,473
                  
                  
                  
                  4.00
                  %
                  
                  
                  50,209
                  
                  
                  
                  6.00
                  %Tier
      I Capital (to Average Assets)
                  
                  
                  93,415
                  
                  
                  
                  8.86
                  %
                  
                  
                  42,170
                  
                  
                  
                  4.00
                  %
                  
                  
                  52,712
                  
                  
                  
                  5.00
                  %As
      of December 31, 2008:Total
      Capital (to Risk-Weighted Assets)
                  
                  $
                  90,644
                  
                  
                  
                  10.87
                  %
                  
                  $
                  66,740
                  
                  
                  
                  8.00
                  %
                  
                  $
                  83,425
                  
                  
                  
                  10.00
                  %Tier
      I Capital (to Risk-Weighted Assets)
                  
                  
                  72,693
                  
                  
                  
                  8.71
                  %
                  
                  
                  33,370
                  
                  
                  
                  4.00
                  %
                  
                  
                  50,055
                  
                  
                  
                  6.00
                  %Tier
      I Capital (to Average Assets)
                  
                  
                  72,693
                  
                  
                  
                  7.83
                  %
                  
                  
                  37,122
                  
                  
                  
                  4.00
                  %
                  
                  
                  46,402
                  
                  
                  
                  5.00
                  %





The
Company is also subject to these requirements.  At December 31, 2009,
the Company’s total capital to risk-weighted assets, Tier I capital to
risk-weighted assets and Tier I capital to average assets were 13.53%, 11.37%
and 9.03%, respectively.  At December 31, 2008, the Company’s total
capital to risk-weighted assets, Tier I capital to risk-weighted assets and Tier
I capital to average assets were 10.68%, 8.53% and 7.67%,
respectively.


74


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007


NOTE
M - REGULATORY MATTERS (Continued)





On
February 27, 2009, the Board of Directors of the FDIC proposed amendments to the
restoration plan for the DIF.  This amendment proposed the imposition
of a 20 basis point emergency special assessment on insured depository
institutions as of June 30, 2009.





On
March 5, 2009, the FDIC Chairman announced that the FDIC intended to lower
the special assessment from 20 basis points to 10 basis points. On May 22, 2009,
the FDIC adopted a final rule imposing a 5 basis point special assessment on
each insured depository institution's assets minus Tier 1 capital as of June 30,
2009. The amount of the special assessment for any institution was not to exceed
10 basis points times the institution's assessment base for the second quarter
2009. The assessment was collected on September 30, 2009 and totaled
$493,000.





In
addition, the FDIC received approval to require prepayment of the next three
years premiums by December 31, 2009.  The Company remitted $4.2
million to prepay its premiums for 2010, 2011 and 2012.  The FDIC may
impose an emergency special assessment of up to 10 basis points on all insured
depository institutions whenever, after June 30, 2009, the FDIC estimates that
the fund reserve ratio will fall to a level that the Board believes would
adversely affect public confidence or to a level close to zero or negative at
the end of a calendar quarter.  Additional assessments could have a
significant impact on the financial results of the Company in future
years.  The assessment rates, including any special assessments, are
subject to change at the discretion of the Board of Directors of the
FDIC.





NOTE
N - DERIVATIVE FINANCIAL INSTRUMENTS





The
Company uses derivative financial instruments, currently in the form of interest
rate swaps, to manage its interest rate risk. These instruments carry varying
degrees of credit, interest rate, and market or liquidity risks. Derivative
instruments are recognized as either assets or liabilities in the accompanying
financial statements and are measured at fair value. Subsequent changes in the
derivatives’ fair values are recognized in earnings unless specific hedge
accounting criteria are met.





Crescent
has established objectives and strategies that include interest-rate risk
parameters for maximum fluctuations in net interest income and market value of
portfolio equity. Interest rate risk is monitored via simulation modeling
reports. The goal of the Company’s asset/liability management efforts is to
maintain profitable financial leverage within established risk parameters.
Crescent has entered into several financial arrangements using derivatives
during 2009 to add stability to interest income and to manage its exposure to
interest rate movements.





Cash
Flow Hedges


Through a
special purpose entity (see Note H) the Company issued trust preferred
debentures in 2003.  In 2007, the Company entered into a subordinated
term loan agreement with a non-affiliated financial
institution.  These instruments, as more fully described in Note H,
were issued as part of its capital management strategy. These instruments are
variable rate and expose the Company to interest rate risk caused by the
variability of expected future interest expense attributable to changes in
3-month LIBOR. To mitigate this exposure to fluctuations in cash flows resulting
from changes in interest rates, the Company entered into four pay-fixed interest
rate swap agreements in June 2009.





Based on
the evaluation performed at inception and through December 31, 2009, these
derivative instruments qualify for cash flow hedge accounting. Therefore, the
cumulative change in fair value of the interest rate swaps, to the extent that
it is expected to be offset by the cumulative change in anticipated interest
cash flows from the hedged trust preferred debenture and subordinated term loan,
will be deferred and reported as a component of other comprehensive income
(“OCI”). Any hedge ineffectiveness will be charged to current
earnings.





Since the floating index and reset dates are based on identical
terms, management believes that the hedge relationship of the cumulative changes
in expected future cash flows from the interest rate swaps and the cumulative
changes in expected interest cash flows from the trust-preferred debentures and
subordinated term loan agreement will be highly effective. For the period ended
December 31, 2009, management has determined that there is no hedge
ineffectiveness.


75


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007


NOTE
N -DERIVATIVE FINANCIAL INSTRUMENTS (Continued)





The
notional amount of the debt obligations being hedged was $15.5 million and the
fair value of the interest rate swap liability, which is recorded in accrued
expenses and other liabilities at December 31, 2009, was an unrealized loss of
$294,934.





The
following table discloses the location and fair value amounts of derivative
instruments designated as hedging instruments under ASC 815 in the consolidated
balance sheets.





December 31, 2009Estimated FairBalance Sheet
                  
                  Notional
                  
                  
                  Value ofLocation
                  
                  Asset(Liability)
                  
                  
                  AmountTrust
      preferred securities:Interest
      rate swap
                  Other
      liabilities
                  
                  $
                  4,000,000
                  
                  
                  $
                  (67,847
                  )Interest
      rate swap
                  Other
      liabilities
                  
                  
                  4,000,000
                  
                  
                  
                  (83,652
                  )Subordinated
      term loan agreements:Interest
      rate swap
                  Other
      liabilities
                  
                  
                  3,750,000
                  
                  
                  
                  (64,216
                  )Interest
      rate swap
                  Other
      liabilities
                  
                  
                  3,750,000
                  
                  
                  
                  (79,219
                  )$
                  15,500,000
                  
                  
                  $
                  (294,934
                  )





See Note
H for additional information.





The
following table discloses activity in accumulated OCI related to the interest
rate swaps during the year ended December 31, 2009.


December 31, 2009Accumulated
      OCI resulting from interest rate swaps as of January 1, 2009, net of
      tax
                  
                  $
                  -Other
      comprehensive loss recognized, net of tax
                  
                  
                  (181,237
                  )Accumulated
      OCI resulting from interest rate swaps as of December 31, 2009, net of
      tax
                  
                  $
                  (181,237
                  )





The
Company monitors the credit risk of the interest rate swap
counterparty.  The Company has pledged $310,000 to the counterparty to
the swaps.





NOTE
O - OFF-BALANCE SHEET RISK





The
Company is a party to financial instruments with off-balance sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit and standby letters
of credit. Those instruments involve, to varying degrees, elements of credit and
interest rate risk in excess of the amount recognized in the balance sheet. The
contract or notional amounts of those instruments reflect the extent of
involvement the Company has in particular classes of financial instruments. The
Company uses the same credit policies in making commitments and conditional
obligations as it does for on-balance sheet instruments.





Commitments
to extend credit are agreements to lend to a customer as long as there is no
violation of conditions established in the contract. Commitments generally have
fixed expiration dates or other termination clauses and may require payment of a
fee. Since some of the commitments are expected to expire without being drawn
upon, the total commitment amounts do not necessarily represent future cash
requirements. The Company evaluates each customer’s creditworthiness on a
case-by-case basis. The amount of collateral obtained, if deemed necessary by
the Bank, upon extension of credit is based on management’s credit evaluation of
the borrower. Collateral obtained varies but may include real estate, stocks,
bonds, and certificates of deposit.


76


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007


NOTE
O - OFF-BALANCE SHEET RISK (Continued)





A summary
of the contract amount of the Company’s exposure to off-balance sheet credit
risk as of December 31, 2009 is as follows (amounts in
thousands):





Financial
      instruments whose contract amounts represent credit risk:Commitments
      to extend credit
                  
                  $
                  91,452Undisbursed
      equity lines of credit
                  
                  
                  35,706Financial
      standby letters of credit
                  
                  
                  4,111Commitment
      to invest in Small Business Investment Corporation
                  
                  
                  363





NOTE
P - FAIR VALUE MEASUREMENT





The
Company adopted ASC 820 and ASC 825 on January 1, 2008. ASC 820 defines
fair value, establishes a framework for measuring fair value under GAAP and
expands disclosures about fair value measurements. ASC 820 applies whenever
other accounting pronouncements require or permit assets or liabilities to be
measured at fair value. Accordingly, ASC 820 does not expand the use of fair
value in any new circumstances. ASC 825 provides companies with an option to
report selected financial assets and liabilities at fair value. As of December
31, 2009 and 2008, the Company had not elected to measure any financial assets
or liabilities using the fair value option under ASC 825; therefore the adoption
of ASC 825 had no effect on the Company’s financial condition or results of
operations.





Fair
value is a market-based measurement and is defined as the price that would be
received to sell an asset, or paid to transfer a liability, in an orderly
transaction between market participants at the measurement date.  See
Note B for discussion concerning recent guidance for transactions that are not
orderly.  The transaction to sell the asset or transfer the liability
is a hypothetical transaction at the measurement date, considered from the
perspective of a market participant that holds the asset or owes the
liability.  In general, the transaction price will equal the exit
price and, therefore, represent the fair value of the asset or liability at
initial recognition.  In determining whether a transaction price
represents the fair value of the asset or liability at initial recognition, each
reporting entity is required to consider factors specific to the transaction and
the asset or liability, the principal or most advantageous market for the asset
or liability, and market participants with whom the entity would transact in the
market.  In order to determine the fair value or the exit price,
entities must determine the unit of account, highest and best use, principal
market, and market participants.  These determinations allow the
reporting entity to define the inputs for fair value and level of
hierarchy.





Outlined
below is the application of the fair value hierarchy established by ASC 820 to
the Company’s financial assets that are carried at fair value.





Level 1 – inputs to the
valuation methodology are quoted prices (unadjusted) for identical assets
or liabilities in active markets. An active market for the asset or liability is
a market in which the transactions for the asset or liability occur with
sufficient frequency and volume to provide pricing information on an ongoing
basis. As of December 31, 2009 and 2008, the Company carried certain marketable
equity securities at fair value hierarchy Level 1.





Level 2 – inputs to the
valuation methodology include quoted prices for similar assets and liabilities
in active markets, and inputs that are observable for the asset or liability,
either directly or indirectly, for substantially the full term of the financial
instrument. As of December 31, 2009 and 2008, the types of financial assets and
liabilities the Company carried at fair value hierarchy Level 2 included
securities available for sale, impaired loans secured by real estate and
derivative liabilities.


77


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007


NOTE
P – ESTIMATED FAIR VALUES (Continued)





Level 3 – inputs to the
valuation methodology are unobservable and significant to the fair value
measurement. Unobservable inputs are supported by little or no market activity
or by the entity’s own assumptions. As of December 31, 2009 and 2008, while the
Company did not carry any financial assets or liabilities, measured on a
recurring basis, at fair value hierarchy Level 3, the Company did value certain
financial assets, measured on a non-recurring basis, at fair value hierarchy
Level 3.




Fair Value on a Recurring
Basis.  The Company measures certain assets at fair value on a
recurring basis, as described below.





Investment
Securities Available-for-Sale


Investment
securities available-for-sale are recorded at fair value on a recurring basis.
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.





Derivative
Liabilities


Derivative
instruments at December 31, 2009 include interest rate swaps and are valued
using models developed by third-party providers.  This type of
derivative is classified as Level 2 within the hierarchy.





The
Company utilizes valuation techniques that maximize the use of observable inputs
and minimize the use of unobservable inputs.





Fair Value on a Nonrecurring
Basis.  The Company measures certain assets at fair value on a
nonrecurring basis, as described below.





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. The fair value of impaired loans is estimated
using one of several methods, including collateral value, market value of
similar debt, enterprise value, liquidation value and discounted cash flows.
Those 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 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 current 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. There were $66.1 million in impaired loans at December 31,
2009, of which $35.4 million in loans showed impairment and had a specific
reserve of $9.1 million.  Impaired loans totaled $16.7 million at
December 31, 2008.  Of such loans, $11.6 million had specific loss
allowances aggregating $4.1 million at that date.


78


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007


NOTE
P - ESTIMATED FAIR VALUES (Continued)





Below is
a table that presents information about assets measured at fair value at
December 31, 2009 and 2008:





Fair Value Measurements atDecember 31, 2009, UsingQuoted Prices
                    
                    
                    SignificantAssets/(Liabilities)
                    
                    
                    in Active
                    
                    
                    Other
                    
                    
                    SignificantMeasured at
                    
                    
                    Markets for
                    
                    
                    Observable
                    
                    
                    UnobservableFair Value
                    
                    
                    Identical Assets
                    
                    
                    Inputs
                    
                    
                    InputsDescription
                    
                    12/31/2009
                    
                    
                    (Level 1)
                    
                    
                    (Level 2)
                    
                    
                    (Level 3)Securities
      available for sale:U.S.
      Government obligations and agency
                    
                    $
                    12,683,127
                    
                    
                    $
                    -
                    
                    
                    $
                    12,683,127
                    
                    
                    $
                    -Mortgage-backed
                    
                    
                    60,203,087
                    
                    
                    
                    -
                    
                    
                    
                    60,203,087
                    
                    
                    
                    -Collateralized
      mortgage obligations
                    
                    
                    70,863,172
                    
                    
                    
                    -
                    
                    
                    
                    70,863,172
                    
                    
                    
                    -Municipals
                    
                    
                    49,028,405
                    
                    
                    
                    -
                    
                    
                    
                    49,028,405
                    
                    
                    
                    -Marketable
      equity
                    
                    
                    345,100
                    
                    
                    
                    345,100
                    
                    
                    
                    -
                    
                    
                    
                    -Foreclosed
      assets
                    
                    
                    6,305,617
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    6,305,617Impaired
      loans
                    
                    
                    26,258,018
                    
                    
                    
                    -
                    
                    
                    
                    23,434,441
                    
                    
                    
                    2,823,577Derivative
      liabilities
                    
                    
                    (294,934
                    )
                    
                    
                    -
                    
                    
                    
                    (294,934
                    )
                    
                    
                    -Fair Value Measurements atDecember 31, 2008, UsingQuoted Prices
                    
                    
                    SignificantAssets/(Liabilities)
                    
                    
                    in Active
                    
                    
                    Other
                    
                    
                    SignificantMeasured at
                    
                    
                    Markets for
                    
                    
                    Observable
                    
                    
                    UnobservableFair Value
                    
                    
                    Identical Assets
                    
                    
                    Inputs
                    
                    
                    InputsDescription
                    
                    12/31/2009
                    
                    
                    (Level 1)
                    
                    
                    (Level 2)
                    
                    
                    (Level 3)Securities
      available for sale
                    
                    $
                    105,648,618
                    
                    
                    $
                    490,753
                    
                    
                    $
                    105,157,865
                    
                    
                    $
                    -Foreclosed
      assets
                    
                    
                    1,716,207
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    1,716,207Impaired
      loans
                    
                    
                    7,556,644
                    
                    
                    
                    -
                    
                    
                    
                    6,787,739
                    
                    
                    
                    768,905





ASC Topic
825Financial
Instruments, requires disclosure of fair value information about
financial instruments, whether or not recognized in the balance sheet, for which
it is practicable to estimate that value. In cases where quoted market prices
are not available, fair values are based on estimates using present value or
other valuation techniques.





Those
techniques are significantly affected by the assumptions used, including the
discount rate and estimates of future cash flows. In that regard, the derived
fair value estimates cannot be substantiated by comparison to independent
markets and, in many cases, could not be realized in immediate settlement of the
instruments. ASC Topic 825 excludes certain financial instruments and all
nonfinancial instruments from its disclosure requirements. Accordingly, the
aggregate fair value amounts presented do not represent the underlying value of
the Company. In addition to the valuation methods previously described for
investments available for sale and derivative assets and


79


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007


NOTE
P - ESTIMATED FAIR VALUES (Continued)





liabilities,
the following methods and assumptions were used by the Company in estimating its
fair value disclosures for financial instruments:





Cash
and Cash Equivalents





The
carrying amounts for cash and cash equivalents approximate fair value because of
the short maturities of those instruments.





Investment
Securities





See
previous discussion in Note P.





Loans





For
certain homogenous categories of loans, such as residential mortgages, fair
value is estimated using the quoted market prices for securities backed by
similar loans, adjusted for differences in loan characteristics. The fair value
of other types of loans is estimated by discounting the future cash flows using
the current rates at which similar loans would be made to borrowers with similar
credit ratings and for the same remaining maturities.





Federal
Home Loan Bank Stock





The
carrying value of Federal Home Loan Bank stock approximates fair value based on
the redemption provisions of the Federal Home Loan Bank.





Investment
in Life Insurance





The
carrying value of life insurance approximates fair value because this investment
is carried at cash surrender value, as determined by the insurers.





Deposits





The fair
value of demand deposits, savings, money market and NOW accounts is the amount
payable on demand at the reporting date. The fair value of time deposits is
estimated using the rates currently offered for instruments of similar remaining
maturities.





Short-term
Borrowings and Long-term Debt





The fair
value of short-term borrowings and long-term debt are based upon the discounted
value when using current rates at which borrowings of similar maturity could be
obtained.





Accrued
Interest Receivable and Accrued Interest Payable





The
carrying amounts of accrued interest receivable and payable approximate fair
value, because of the short maturities of these instruments.





Derivative
financial instruments





See
previous discussion in Note P.


80


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007


NOTE
P - ESTIMATED FAIR VALUES (Continued)





The
carrying amounts and estimated fair values of the Company’s financial
instruments, none of which are held for trading purposes, are as follows at
December 31, 2009 and 2008:





2009
                  
                  
                  2008Carrying
                  
                  
                  Estimated
                  
                  
                  Carrying
                  
                  
                  Estimatedamount
                  
                  
                  fair value
                  
                  
                  amount
                  
                  
                  fair valueFinancial
      assets:Cash
      and cash equivalents
                  
                  $
                  13,902,108
                  
                  
                  $
                  13,902,108
                  
                  
                  $
                  10,282,789
                  
                  
                  $
                  10,282,789Investment
      securities
                  
                  
                  193,122,891
                  
                  
                  
                  193,122,891
                  
                  
                  
                  105,648,618
                  
                  
                  
                  105,648,618Federal
      Home Loan Bank stock
                  
                  
                  11,776,500
                  
                  
                  
                  11,776,500
                  
                  
                  
                  7,264,000
                  
                  
                  
                  7,264,000Loans,
      net
                  
                  
                  741,781,341
                  
                  
                  
                  701,738,000
                  
                  
                  
                  772,792,283
                  
                  
                  
                  784,667,000Investment
      in life insurance
                  
                  
                  17,658,386
                  
                  
                  
                  17,658,386
                  
                  
                  
                  16,811,918
                  
                  
                  
                  16,811,918Accrued
      interest receivable
                  
                  
                  4,260,258
                  
                  
                  
                  4,260,258
                  
                  
                  
                  3,341,258
                  
                  
                  
                  3,341,258Financial
      liabilities:Deposits
                  
                  
                  722,634,618
                  
                  
                  
                  742,001,000
                  
                  
                  
                  714,882,755
                  
                  
                  
                  718,590,000Short-term
      borrowings
                  
                  
                  74,000,000
                  
                  
                  
                  74,260,000
                  
                  
                  
                  37,706,000
                  
                  
                  
                  39,925,000Long-term
      borrowings
                  
                  
                  142,748,000
                  
                  
                  
                  139,457,000
                  
                  
                  
                  116,748,000
                  
                  
                  
                  121,748,000Interest
      rate swaps
                  
                  
                  294,934
                  
                  
                  
                  294,934
                  
                  
                  
                  -
                  
                  
                  
                  -Accrued
      interest payable
                  
                  
                  1,475,128
                  
                  
                  
                  1,475,128
                  
                  
                  
                  1,958,344
                  
                  
                  
                  1,958,344





NOTE
Q - EMPLOYEE AND DIRECTOR BENEFIT PLANS





During
1999 the Company adopted, with shareholder approval, an Employee Stock Option
Plan (the “Employee Plan”) and a Director Stock Option Plan (the “Director
Plan”). During 2002 and 2005, with shareholder approval, the Company amended the
Employee plan to increase the number of shares available under the plan. In
2003, in conjunction with the merger between Crescent and Centennial Bank of
Southern Pines, stock options approved under Centennial’s Plan were acquired by
Crescent. Certain of the options granted under the Director Plan vested
immediately at the time of grant. All other options granted vested twenty-five
percent at the grant date, with the remainder vesting over a three-year period.
All unexercised options expire ten years after the date of grant.





At the
time of the PCCB merger, PCCB had two stock option plans, the 2002 Incentive
Stock Option Plan and the 2002 Nonstatutory Stock Option Plans, whose options
were converted to options to purchase Crescent Financial Corporation stock at an
exchange rate of 2.5133.  There were 225,954 incentive stock options
and 228,459 non-statutory stock options converted.  Since all options
authorized under the PCCB plans had been granted, there will be no more options
granted under either of these plans.





At the
Company’s annual meeting on July 11, 2006, the shareholders approved the 2006
Omnibus Stock Ownership and Long Term Incentive Plan (the “Omnibus Plan”) to
replace the previous plans.  This plan authorizes 335,000 shares of
the common stock of Crescent to be issued in the form of incentive stock option
grants, non-statutory stock option grants, restricted stock grants, long term
incentive compensation units, or stock appreciation rights.   The
company declared and distributed a 10% stock dividend in 2007 which increased
the shares available for issuance to 368,500.  In the event that the
number of shares of common stock that remain available for future issuance under
the Plan as of December 31, 2008 and as of the last day of each calendar year
commencing thereafter, is less than 1.5% of the total number of shares of common
stock issued and outstanding as of such date (the “Replacement Amount”),then the Plan Pool shall be increased as of such date by a number of
shares of common stock equal to the Replacement Amount.  At December
31, 2009, there were 236,379 unissued options in this plan.  Vesting
provisions for granted stock options are at the discretion of the Compensation
Committee of the Board of Directors.  At December 31, 2009, all
outstanding options were granted with a three year vesting schedule; 25% at date
of grant and 25% at each of the next three grant date
anniversaries.


81


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007


NOTE
Q - EMPLOYEE AND DIRECTOR BENEFIT PLANS (Continued)





The
share-based awards granted under the aforementioned plans have similar
characteristics, except that some awards have been granted in options and
certain awards have been granted in restricted stock. Therefore, the following
disclosures have been disaggregated for the stock option and restricted stock
awards of the plans due to their dissimilar characteristics. Vesting provisions
for granted restricted stock awards are at the discretion of the Compensation
Committee of the Board of Directors. At December 31, 2009, all outstanding
restricted stock awards vest in full at either the three year of five year
anniversary date of the grant. The Company funds the option shares and
restricted stock from authorized but un-issued shares.





Stock
Option Plans





A summary
of the Company’s option plans as of and for the year ended December 31, 2009,
adjusted for the stock split effected in the form of a 10% stock dividend
distributed in May 2007, is as follows:





Outstanding Options
                  
                  
                  Exercisable OptionsWeighted
                  
                  
                  
                  
                  
                  WeightedAverage
                  
                  
                  
                  
                  
                  AverageOption
                  
                  
                  
                  
                  
                  OptionNumber
                  
                  
                  Price
                  
                  
                  Number
                  
                  
                  PriceOptions
      outstanding, beginning of year
                  
                  
                  543,352
                  
                  
                  $
                  5.55
                  
                  
                  
                  528,904
                  
                  
                  $
                  5.45Granted/vested
                  
                  
                  22,500
                  
                  
                  
                  4.40
                  
                  
                  
                  5,625
                  
                  
                  
                  4.40Exercised
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Expired
                  
                  
                  125,899
                  
                  
                  
                  3.94
                  
                  
                  
                  125,899
                  
                  
                  
                  3.94Forfeited
                  
                  
                  9,835
                  
                  
                  
                  8.13
                  
                  
                  
                  9,629
                  
                  
                  
                  8.04Options
      outstanding, end of year
                  
                  
                  430,118
                  
                  
                  $
                  5.90
                  
                  
                  
                  405,712
                  
                  
                  $
                  5.91





The
weighted average remaining life of options outstanding and options exercisable
at December 31, 2009 is 3.92 years and 3.60 years, respectively.





The
following table provides the range of exercise prices for options outstanding
and exercisable at December 31, 2009:


Range of Exercise Prices
                        
                        
                        Stock Options Outstanding
                        
                        
                        Stock Options Exercisable$
                        3.94
      - $ 6.13
                        
                        
                        
                        344,845
                        
                        
                        
                        326,470$
                        6.14
      - $ 8.32
                        
                        
                        
                        26,570
                        
                        
                        
                        23,570$
                        8.33
      - $ 10.51
                        
                        
                        
                        8,001
                        
                        
                        
                        8,001$
                        10.52
      - $ 12.71
                        
                        
                        
                        50,702
                        
                        
                        
                        47,671430,118
                        
                        
                        
                        405,712





The fair
market value of each option award is estimated on the date of grant using the
Black-Scholes option pricing model. The risk-free interest rate is based upon a
U.S. Treasury instrument with a life that is similar to the expected life of the
option grant.  Expected volatility is based upon the historical
volatility of the Company’s stock price based upon the previous 3 years trading
history.  The expected term of the options is based upon the average
life of previously issued stock options.


82


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007


NOTE
Q - EMPLOYEE AND DIRECTOR BENEFIT PLANS (Continued)





Stock
Option Plans (Continued)





The
assumptions used in estimating fair values, together with the estimated per
share value of options granted are displayed below:


2009
                
                
                2008
                
                
                2007Assumptions
      in estimating option values:Risk-free
      interest rate
                
                
                2.50
                %
                
                
                3.12
                %
                
                
                4.68
                %Dividend
      yield
                
                
                0
                %
                
                
                0
                %
                
                
                0
                %Volatility
                
                
                37.23
                %
                
                
                26.80
                %
                
                
                31.63
                %Expected
      life
                
                7
      years
                
                
                7
      years
                
                
                7
      yearsThe
      weighted average grant date fair value of options
                
                $
                1.90
                
                
                $
                2.44
                
                
                $
                4.88





Compensation
cost charged to income was approximately $38,000, $72,000 and $99,000 for the
years ended December 31, 2009, 2008 and 2007, respectively.  Cash
received from options exercised under share-based payment arrangements for the
years ended December 31, 2008 and 2007 were $670,000 and $1,214,000,
respectively.  There were no options exercised for the year ended
December 31, 2009   The actual tax benefit in stockholders equity
realized for the tax deductions from option exercise of the share-based payment
arrangements for the years ended December 31, 2008,  and 2007 totaled
$95,500 and $452,000, respectively.





The total
intrinsic value of options exercised during the years ended December 31, 2008
and 2007 was $650,047 and $1,987,000, respectively.  Since all options
outstanding under the Company’s stock option plans had an exercise price which
exceeded the market price at December 31, 2009, there was no intrinsic value of
both total options outstanding and exercisable options.  As of
December 31, 2009, there was $56,000 of unrecognized compensation cost related
to the nonvested stock option plans.  That cost is expected to be
recognized as follows: $30,000 in 2010, $17,000 in 2011and $9,000 in
2012.





Stock
Award Plans





A summary
of the status of the Company’s non-vested stock awards as of December 31, 2009,
and changes during the year then ended is presented below:


Weightedaveragegrant dateShares
                  
                  
                  fair valueNon-vested
      – December 31, 2008
                  
                  
                  57,269
                  
                  
                  $
                  10.19Granted
                  
                  
                  -
                  
                  
                  
                  -Vested
                  
                  
                  -
                  
                  
                  
                  -Forfeited
                  
                  
                  -
                  
                  
                  
                  -Non-vested
      – December 31, 2009
                  
                  
                  57,269
                  
                  
                  $
                  10.19





There
were no restricted stock grants issued or vested during the year.





As of
December 31, 2009, there was $223,445 of unrecognized compensation cost related
to the nonvested stock award plan.  That cost is expected to be
recognized over a weighted average period of 2.09 years.


83


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007





NOTE
Q - EMPLOYEE AND DIRECTOR BENEFIT PLANS (Continued)





Supplemental
Retirement





During
2003, the Company adopted a Supplemental Executive Retirement Plan (SERP) for
its senior executives. The Company has purchased life insurance policies in
order to provide future funding of benefit payments. Plan benefits will accrue
and vest during the period of employment and will be paid in monthly benefit
payments over the officer’s remaining life commencing with the officer’s
retirement at any time after attainment of age sixty to sixty-five, depending on
the officer.  Expenses for the years ended December 31, 2009, 2008 and
2007 were $435,385, $372,062 and $241,934, respectively.  The accrued
liability of the plan at December 31, 2009 and 2008 was $1,313,265 and $877,880,
respectively.  The Company also provides post retirement split dollar
life insurance benefits to certain executives.  On January 1, 2008,
the Company recorded, as an opening adjustment to retained earnings, the
cumulative effect of the split dollar liability for future
benefits.  The adjustment was in the amount of $141,808 which
represented the accrued liability from the date of adoption in 2003 through
December 31, 2007.  Expenses for the years ended December 31, 2009 and
2008 were $37,632 and $21,853, respectively.  The accrued liability of
the plan at December 31, 2009 and 2008 was $191,035 and $163,661,
respectively.





Defined
Contribution Plan





The
Company sponsors a contributory profit-sharing plan which provides for
participation by substantially all employees.  Participants may make
voluntary contributions resulting in salary deferrals in accordance with Section
401(k) of the Internal Revenue Code.  The plans provide for employee
contributions up to $15,500 of the participant's annual salary and an employer
contribution of 100% matching of the first 6% of pre-tax salary contributed by
each participant. Anyone who turned 50 years old in 2009 could also add a
catch-up contribution of $5,000 above the normal limit bringing the maximum
contribution to $20,500 for those employees.  The Company may make
additional discretionary profit sharing contributions to the plan on behalf of
all participants.  There were no discretionary contributions for 2009,
2008 or 2007.  Amounts deferred above the first 6% of salary are not
matched by the Company.  Expenses related to these plans for the years
ended December 31, 2009, 2008 and 2007 were $420,513, $369,939 and $286,778,
respectively.





Employment
Agreements





The
Company has entered into employment agreements with certain of its executive
officers to ensure a stable and competent management base. The agreements
provide for benefits as spelled out in the contracts and cannot be terminated by
the Board of Directors, except for cause, without prejudicing the officers’
rights to receive certain vested rights, including compensation. In the event of
a change in control of the Company, as outlined in the agreements, the acquirer
will be bound to the terms of the contracts.





NOTE
R – CUMULATIVE PERPETUAL PREFERRED STOCK





Under the
United States Treasury’s Capital Purchase Program (CPP), the Company issued
$24.9 million in Fixed Rate Cumulative Perpetual Preferred Stock, Series A, on
January 9, 2009.  In addition, the Company provided a warrant to the
Treasury to purchase 833,705 shares of the Company’s common stock at an exercise
price of $4.48 per share.  These warrants are immediately exercisable
and expire ten years from the date of issuance.  The preferred stock
is non-voting, other than having class voting rights on certain matters, and
pays cumulative dividends quarterly at a rate of 5% per annum for the first five
years and 9% per annum thereafter.  The preferred shares are
redeemable at the option of the Company subject to regulatory
approval.





Based on
a Black-Scholes option pricing model, the common stock warrants have been
assigned a fair value of $2.28 per share or $2.4 million in the aggregate as of
January 9, 2009.  Based on relative fair value, $2.4 million has been
recorded as the discount on the preferred stock and will be accreted as a
reduction in net income available for common shareholders over the next five
years at approximately $0.5 million per year.  Correspondingly, $22.5
million was initially assigned to the preferred stock.  Through the
discount accretion over the next five years, the preferred stock will be
accreted up to the redemption amount of $24.9 million.  For purposes
of these calculations, the fair value of the common stock warrant as of January
9, 2009 was estimated using the Black-Scholes option pricing model and the
following assumptions:


84


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007





NOTE
R - CUMULATIVE PERPETUAL PREFERRED STOCK (Continued)




Risk-free
      interest rate
                    
                    
                    2.49
                    %Expected
      life of warrants
                    
                    10 yearsExpected
      dividend yield
                    
                    
                    0.00
                    %Expected
      volatility
                    
                    
                    37.27
                    %




The
Company’s computation of expected volatility is based on daily historical
volatility since January 1999.  The risk-free interest rate is based
on the market yield for ten year U.S. Treasury securities as of January 9,
2009.





As a
condition of the CPP, the Company must obtain consent from the United States
Department of the Treasury to repurchase its common stock or to pay a cash
dividend on its common stock.  Furthermore, the Company has agreed to
certain restrictions on executive compensation and corporate
governance.





NOTE
S - PARENT COMPANY FINANCIAL DATA





Condensed
balance sheets as of December 31, 2009 and 2008, and related condensed
statements of operations and cash flows for each of the years in the three-year
period ended December 31, 2009 are as follows:





Condensed
Balance Sheets


December
31, 2009 and 2008





2009
                            
                            
                            2008ASSETSCash
      and due from banks
                            
                            $
                            2,052,005
                            
                            
                            $
                            550,126Investment
      in subsidiaries
                            
                            
                            96,054,355
                            
                            
                            
                            104,840,989Other
      assets
                            
                            
                            79,208
                            
                            
                            
                            124,558TOTAL
      ASSETS
                            
                            $
                            98,185,568
                            
                            
                            $
                            105,515,673LIABILITIES
      AND STOCKHOLDERS' EQUITYLiabilities:Accrued
      interest payable
                            
                            $
                            110,238
                            
                            
                            $
                            170,972Due
      to former Centennial Shareholders
                            
                            
                            -
                            
                            
                            
                            5,093Accrued
      expenses and other liabilities
                            
                            
                            307,124
                            
                            
                            
                            2,000,000Subordinated
      debentures
                            
                            
                            8,248,000
                            
                            
                            
                            8,248,000TOTAL
      LIABILITIES
                            
                            
                            8,665,362
                            
                            
                            
                            10,424,065Stockholders'
      equity:Preferred
      stock
                            
                            
                            22,935,514
                            
                            
                            
                            -Common
      stock
                            
                            
                            9,626,559
                            
                            
                            
                            9,626,559Warrant
                            
                            
                            2,367,368
                            
                            
                            
                            -Additional
      paid-in capital
                            
                            
                            74,529,894
                            
                            
                            
                            74,349,299Retained
      earnings (deficit)
                            
                            
                            (21,354,080
                            )
                            
                            
                            10,488,628Accumulated
      other comprehensive income
                            
                            
                            1,414,951
                            
                            
                            
                            627,122TOTAL
      STOCKHOLDERS’ EQUITY
                            
                            
                            89,520,206
                            
                            
                            
                            95,091,608TOTAL
      LIABILITIES AND STOCKHOLDERS’ EQUITY
                            
                            $
                            98,185,568
                            
                            
                            $
                            105,515,673


85


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007





NOTE
S - PARENT COMPANY FINANCIAL DATA (Continued)





Condensed
Statements of Operations


Years
Ended December 31, 2009, 2008 and 2007





2009
                  
                  
                  2008
                  
                  
                  2007Equity
      in earnings (loss) of subsidiaries
                  
                  $
                  (30,205,191
                  )
                  
                  $
                  2,467,201
                  
                  
                  $
                  6,688,256Interest
      income
                  
                  
                  498,375
                  
                  
                  
                  39,808
                  
                  
                  
                  169,130Dividend
      income
                  
                  
                  9,873
                  
                  
                  
                  17,026
                  
                  
                  
                  21,200Other
      miscellaneous income
                  
                  
                  13
                  
                  
                  
                  5,024
                  
                  
                  
                  -Interest
      expense
                  
                  
                  (416,833
                  )
                  
                  
                  (623,487
                  )
                  
                  
                  (738,485
                  )Other
      operating expenses
                  
                  
                  (114,288
                  )
                  
                  
                  (132,853
                  )
                  
                  
                  (118,245
                  )Income
      tax benefit
                  
                  
                  2,100
                  
                  
                  
                  238,100
                  
                  
                  
                  226,900Net
      income (loss)
                  
                  $
                  (30,225,951
                  )
                  
                  $
                  2,010,819
                  
                  
                  $
                  6,248,756





Condensed
Statements of Cash Flows


Years
Ended December 31, 2009, 2008 and 2007





2009
                
                
                2008
                
                
                2007Cash
      flows from operating activities:Net
      income (loss)
                
                $
                (30,225,951
                )
                
                $
                2,010,819
                
                
                $
                6,248,756Adjustments
      to reconcile net income to net cash provided (used) by operating
      activities:Amortization
                
                
                -
                
                
                
                22,266
                
                
                
                33,400Stock
      based compensation
                
                
                180,595
                
                
                
                209,098
                
                
                
                178,940Equity
      in earnings of Crescent State Bank
                
                
                30,205,191
                
                
                
                (2,467,201
                )
                
                
                (6,688,256
                )Changes
      in assets and liabilities:(Increase)
      decrease in other assets
                
                
                45,350
                
                
                
                (50,779
                )
                
                
                (55,752
                )Increase
      (decrease) in accrued interest payable
                
                
                (60,734
                )
                
                
                6,595
                
                
                
                (2,586
                )Increase
      (decrease) in accrued expenses and other liabilities
                
                
                (1,853,594
                )
                
                
                1,989,619
                
                
                
                (16,292
                )Net
      cash provided (used) by operating activities
                
                
                (1,709,143
                )
                
                
                1,720,418
                
                
                
                (301,790
                )Cash
      flows from investing activities:Investment
      in Subsidiaries
                
                
                (20,630,728
                )
                
                
                (3,411,798
                )
                
                
                (4,098,938
                )Cash
      flows from financing activities:Proceeds
      from issuance of preferred stock and common stock warrant
                
                
                24,900,000
                
                
                
                -
                
                
                
                -Dividends
      paid on preferred stock
                
                
                (1,058,250
                )
                
                
                -
                
                
                
                -Proceeds
      from exercise of stock options
                
                
                -
                
                
                
                670,254
                
                
                
                1,213,738Excess
      tax benefits from stock options exercised
                
                
                -
                
                
                
                95,500
                
                
                
                451,950Cash
      paid in lieu of fractional shares
                
                
                -
                
                
                
                -
                
                
                
                (7,686
                )Net
      cash provided by financing activities
                
                
                23,841,750
                
                
                
                765,754
                
                
                
                1,658,002Net
      increase (decrease) in cash and cash equivalents
                
                
                1,501,879
                
                
                
                (925,627
                )
                
                
                (2,742,726
                )Cash
      and cash equivalents, beginning
                
                
                550,126
                
                
                
                1,475,753
                
                
                
                4,218,479Cash
      and cash equivalents, ending
                
                $
                2,052,005
                
                
                $
                550,126
                
                
                $
                1,475,753


86


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements
 December
31, 2009, 2008 and 2007





NOTE
T - SUPPLEMENTAL DISCLOSURE FOR STATEMENT OF CASH FLOWS





The
following information is for the consolidated Statement of Cash
Flows





2009
                              
                              
                              2008
                              
                              
                              2007Supplemental
      Disclosure of Cash Flow Information:Cash
      paid during the year for:Interest
                              
                              $
                              27,103,726
                              
                              
                              $
                              28,794,509
                              
                              
                              $
                              27,772,615Income
      taxes
                              
                              $
                              923,000
                              
                              
                              $
                              2,559,000
                              
                              
                              $
                              3,928,000Supplemental
      Disclosure of Noncash InvestingActivities:Transfer
      of loans to foreclosed assets
                              
                              $
                              9,806,211
                              
                              
                              $
                              2,206,023
                              
                              
                              $
                              479,814Increase
      in fair value of securitiesavailable
      for sale, net of tax
                              
                              $
                              969,066
                              
                              
                              $
                              588,933
                              
                              
                              $
                              539,136Decrease
      in fair value of cash flow hedge,net of tax
                              
                              $
                              (181,237
                              )
                              
                              $
                              -
                              
                              
                              $
                              -





The
following information is for the parent company only Statement of Cash
Flows





2009
                      
                      
                      2008
                      
                      
                      2007Supplemental
      Disclosure of Noncash Investing Activities:Decrease
      in fair value of cash flow hedge, net of tax
                      
                      $
                      (93,096
                      )
                      
                      $
                      -
                      
                      
                      $
                      -


87


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





none.





ITEM
9A(T)  - CONTROLS AND PROCEDURES





Evaluation
of Disclosure Controls and Procedures





The
Registrant’s Chief Executive Officer and Chief Financial Officer have conducted
an evaluation of the Registrant’s disclosure controls and procedures as of
December 31, 2009.  Based on their evaluation, the Registrant’s Chief
Executive Officer and Chief Financial Officer have concluded that the
Registrant’s disclosure controls and procedures are effective to ensure that
information required to be disclosed by the Registrant in reports that it files
or submits under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in the applicable
Securities and Exchange Commission rules and forms.





Management’s
Report on Internal Control Over Financial Reporting





Management
is responsible for establishing and maintaining adequate internal control over
financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the
Securities Exchange Act of 1934, as amended. The Registrant’s internal control
over financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with accounting
principles generally accepted in the United States of America. The Registrant’s
internal control over financial reporting includes those written policies and
procedures that:





·
            pertain
      to the maintenance of records that, in reasonable detail, accurately and
      fairly reflect the transactions and dispositions of
  assets;


·
            provide
      reasonable assurance that transactions are recorded as necessary to permit
      preparation of financial statements in accordance with accounting
      principles generally accepted in the United States of
    America;


·
            provide
      reasonable assurance that receipts and expenditures are being made only in
      accordance with management and director authorization;
  and


·
            provide
      reasonable assurance regarding prevention or timely detection of
      unauthorized acquisition, use or disposition of assets that could have a
      material effect on the consolidated financial
  statements.





Internal
control over financial reporting includes the controls themselves, monitoring
and internal auditing practices and actions taken to correct deficiencies as
identified.





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





Management
assessed the effectiveness of the Registrant’s internal control over financial
reporting as of December 31, 2009. Management based this assessment on
criteria for effective internal control over financial reporting described in
Internal Control-Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (“COSO”). Management’s assessment included an evaluation of
the design of the Registrant’s internal control over financial reporting and
testing of the operational effectiveness of its internal control over financial
reporting.





Management
reviewed the results of its assessment with the Audit Committee of the Board of
Directors. Based on this assessment, management determined that, as of
December 31, 2009, it maintained effective internal control over financial
reporting.


88


This
annual report does not include an attestation report of the Company’s registered
public accounting firm regarding internal control over financial
reporting.  Management’s report was not subject to attestation by the
Company’s registered public accounting firm pursuant to temporary rules of the
Securities and Exchange Commission that permits the Company to provide only
management’s report in this annual report.





Changes
in Internal Control Over Financial Reporting





There
were no changes in the Registrant’s internal controls or in other factors that
could materially affect these controls during the three-month period ended
December 31, 2009.





ITEM
9B – OTHER INFORMATION





None.





PART
III





ITEM
10 – DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE





Incorporated
by reference from the discussion under the headings “Proposal 1: Election of
Directors,” “Executive Compensation – Executive Officers,” “Director
Relationships,” “Director Independence,” “Qualifications of Directors,” “Board
Leadership Structure and Role in Risk Oversight,” “Section 16(a) Beneficial
Ownership Reporting Compliance” and “Meetings and Committees of the Board of
Directors – Audit Committee” in the Registrant’s Proxy Statement for the 2010
Annual Meeting of Shareholders to be filed with the SEC.





The
Registrant has adopted a Code of Ethics that applies, among others, to its
principal executive officer and principal financial officer.  The
Registrant’s Code of Ethics is available at www.crescentstatebank.com.





ITEM
11 - EXECUTIVE COMPENSATION





Incorporated
by reference from the discussion under the heading “Executive Compensation,”
“Director Compensation,” and “Meetings and Committees of the Board of Directors”
in the Registrant’s Proxy Statement for the 2010 Annual Meeting of Shareholders
to be filed with the SEC.


89


ITEM
12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS





Incorporated
by reference from the discussion under the heading “Beneficial Ownership of
Voting Securities” in the  Registrant’s Proxy Statement for the 2010
Annual Meeting of Shareholders to be filed with the SEC.





Stock
Option Plans





Set forth
below is certain information regarding the Registrant’s various stock option
plans.





EQUITY COMPENSATION PLAN INFORMATIONNumber of securities to be
                                                issued upon exercise of
                                                outstanding options,
                                                warrants, and rights
                                              
                                              
                                              Weighted-average exercise
                                                price of outstanding
                                                options, warrants, and
                                                rights
                                              
                                              
                                              Number of securities
                                                remaining available for
                                                future issuance under
                                                equity compensation plans
                                                (excluding securities
                                                reflected in column (a))Plan Category
                                              
                                              (a)
                                              
                                              
                                              (b)
                                              
                                              
                                              (c)Equity
      compensation plans approved by security holders
                                              
                                              
                                              430,118
                                              
                                              
                                              $
                                              5.90
                                              
                                              
                                              
                                              236,379Equity
      compensation plans not approved by security holders
                                              
                                              None
                                              
                                              
                                              None
                                              
                                              
                                              NoneTotal
                                              
                                              
                                              430,118
                                              
                                              
                                              $
                                              5.90
                                              
                                              
                                              
                                              236,379





See
additional information in Note Q under the heading "Employee and Director
Benefit Plans - Stock Option Plans" in Item 8 of this
report.


90


ITEM
13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE





Incorporated
by reference from the discussion under the headings “Director Independence,”
“Director Relationships” and “Indebtedness of and Transactions with Management”
in the Registrant’s Proxy Statement for the 2010 Annual Meeting of Shareholders
to be filed with the SEC.





ITEM
14 – PRINCIPAL ACCOUNTANT FEES AND SERVICES





Incorporated
by reference from pages the discussion under the heading “Proposal 4:
Ratification of Independent Registered Public Accounting Firm” and “Report of
the Audit Committee” in the Registrant’s Proxy Statement for the 2010 Annual
Meeting of Shareholders to be filed with the SEC.





ITEM
15 – EXHIBITS AND FINANCIAL STATEMENT SCHEDULES





(a)





(1)
and (2)       Lists of Financial Statements
and Schedules





The
following consolidated financial statements of the Registrant are filed as a
part of this report:





·
            Consolidated
      Balance Sheets as of December 31, 2009 and December 31,
    2008


·
            Consolidated
      Statements of Operations for the years ended December 31, 2009, 2008 and
      2007


·
            Consolidated
      Statements of Comprehensive Income (Loss) for the years ended December 31,
      2009, 2008 and 2007


·
            Consolidated
      Statements of Changes in Stockholders’ Equity for the years ended December
      31, 2009, 2008 and 2007


·
            Consolidated
      Statements of Cash Flows for the years ended December 31, 2009, 2008 and
      2007


·
            Notes
      to Consolidated Financial
Statements


·
            Report
      of Independent Registered Public Accounting
Firm





(3)           Listing
of Exhibits





Exhibits
filed with this report are listed in the Index to Exhibits.  The
following management contracts or compensatory plans or arrangements are
required to be filed as exhibits to this report:





·
            1999
      Incentive Stock Option Plan


·
            1999
      Nonqualified Stock Option Plan for
Directors


·
            Form
      of Employment Agreement between the Registrant and Michael G.
      Carlton


·
            Form
      of Employment Agreement between the Registrant and Bruce W.
      Elder


·
            Form
      of Employment Agreement between the Registrant and Thomas E. Holder,
      Jr.


·
            Form
      of Employment Agreement between the Registrant and Ray D.
      Vaughn


·
            Form
      of Employment Agreement between the Registrant and W. Keith
      Betts


·
            Form
      of Salary Continuation Agreement with Michael G.
  Carlton


·
            Salary
      Continuation Agreement with Bruce W.
Elder


·
            Salary
      Continuation Agreement with Thomas E. Holder,
  Jr.


·
            Form
      of Salary Continuation Agreement with Ray D.
  Vaughn


·
            Salary
      Continuation Agreement with W. Keith
Betts


·
            Endorsement
      Split Dollar Agreement with Michael G.
Carlton


·
            Endorsement
      Split Dollar Agreement with Bruce W.
Elder


·
            Endorsement
      Split Dollar Agreement with Thomas E. Holder,
  Jr.


·
            Endorsement
      Split Dollar Agreement with Ray D.
Vaughn


·
            Endorsement
      Split Dollar Agreement with W. Keith
Betts


·
            Crescent
      State Bank Directors’ Compensation
Plan


·
            2006
      Omnibus Stock Ownership and Long Term Incentive
  Plan


·
            Form
      of Executive Compensation Modification
Agreement





(b)           Exhibits





Exhibits
filed with this report are listed in the Index to Exhibits.


91


SIGNATURES





Pursuant
to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of
1934, the Registrant has duly caused this Report to be signed on its behalf by
the undersigned, thereunto duly authorized.





CRESCENT FINANCIAL
    CORPORATIONRegistrantBy:
              /s/ Michael G. CarltonMichael
      G. CarltonDate:
      March 31, 2010
              
              President
      and Chief Executive Officer





In
accordance with the Securities Exchange Act of 1934, this Report has been signed
below by the following persons on behalf of the Registrant and in the capacities
and on the dates indicated.





/s/ Michael G.
    Carlton
              March
      31, 2010Michael
      G. Carlton, President and Chief Executive Officer, Director (Principle
      Executive Officer)/s/  Bruce W.
      Elder
              March
      31, 2010Bruce
      W. Elder, Vice President(Principal
      Financial Officer and Principle Accounting Officer)/s/ Brent D.
    Barringer
              March
      31, 2010Brent
      D. Barringer, Director/s/ William H.
    Cameron
              March
      31, 2010William
      H. Cameron, Director/s/ Bruce I. Howell
              March
      31, 2010Bruce
      I. Howell, Director/s/ James A. Lucas
              March
      31, 2010James
      A. Lucas, Director/s/ Kenneth A. Lucas
              March
      31, 2010Kenneth
      A. Lucas, Director_/s/ Sheila Hale Ogle
              March
      31, 2010Sheila
      Hale Ogle, Director/s/ Charles A. Paul
              March
      31, 2010Charles
      A. Paul, Director/s/ Francis R. Quis,
    Jr.
              March
      31, 2010Francis
      R. Quis, Jr., Director/s/ Jon S. Rufty
              March
      31, 2010Jon
      S. Rufty, Director/s/ Stephen K.
    Zaytoun
              March
      31, 2010Stephen
      K. Zaytoun, Director


92





Exhibit Number
                                                                      
                                                                      Exhibit3(i)
                                                                      
                                                                      Articles
      of Incorporation, as amended(11)3(ii)
                                                                      
                                                                      Bylaws(1)4
                                                                      
                                                                      Form
      of Common Stock Certificate(1)4(ii)
                                                                      
                                                                      Form
      of Stock Certificate for Series A Preferred Stock(11)4(iii)
                                                                      
                                                                      Warrant
      to Purchase Common Stock(11)10(i)
                                                                      
                                                                      1999
      Incentive Stock Option Plan(2)10(ii)
                                                                      
                                                                      1999
      Nonqualified Stock Option Plan(2)10(iii)
                                                                      
                                                                      Employment
      Agreement Michael G. Carlton(10)10(iv)
                                                                      
                                                                      Employment
      Agreement of Bruce W. Elder (10)10(v)
                                                                      
                                                                      Employment
      Agreement of Thomas E. Holder, Jr. (10)10(vi)
                                                                      
                                                                      Amended
      and Restated Trust Agreement of Crescent Financial Capital Trust I(3)10(vii)
                                                                      
                                                                      Indenture(3)10(viii)
                                                                      
                                                                      Junior
      Subordinated Debenture(3)10(ix)
                                                                      
                                                                      Guarantee
      Agreement(3)10(x)
                                                                      
                                                                      Salary
      Continuation Agreement with Michael G. Carlton (10)10(xi)
                                                                      
                                                                      Salary
      Continuation Agreement with Bruce W. Elder(6)10(xii)
                                                                      
                                                                      Salary
      Continuation Agreement with Thomas E. Holder, Jr.(6)10(xiii)
                                                                      
                                                                      Endorsement
      Split Dollar Agreement with Michael G. Carlton(3)10(xiv)
                                                                      
                                                                      Endorsement
      Split Dollar Agreement with Bruce W. Elder(3)10(xv)
                                                                      
                                                                      Endorsement
      Split Dollar Agreement with Thomas E. Holder, Jr.(3)10(xvi)
                                                                      
                                                                      Crescent
      State Bank Directors’ Compensation Plan(4)10(xvii)
                                                                      
                                                                      Salary
      Continuation Agreement with Ray D. Vaughn (10)10(xviii)
                                                                      
                                                                      Salary
      Continuation Agreement with W. Keith Betts(7)10(xix)
                                                                      
                                                                      Employment
      Agreement with Ray D. Vaughn (10)10(xx)
                                                                      
                                                                      Employment
      Agreement of W. Keith Betts(7)10(xxi)
                                                                      
                                                                      Endorsement
      Split Dollar Agreement with Ray D. Vaughn(6)




93





10(xxii)
                  
                  Endorsement
      Split Dollar Agreement with W. Keith Betts(6)10(xxiii)
                  
                  Subordinated
      Term Loan Agreement dated September 26, 2008, by and between Crescent
      State Bank and United Community Bank(8)10(xxiv)
                  
                  2006
      Omnibus Stock Ownership and Long Term Incentive Plan(9)10(xxv)
                  
                  Form
      of Executive Compensation Modification Agreement(11)21
                  
                  Subsidiaries
      (Filed herewith)23
                  
                  Consent
      of Dixon Hughes PLLC (Filed herewith)31(i)
                  
                  Certification
      of Principal Executive Officer Pursuant to Section 302 of the Sarbanes
      Oxley Act (Filed herewith)31(ii)
                  
                  Certification
      of Principal Accounting Officer Pursuant to Section 302 of the Sarbanes
      Oxley Act (Filed herewith)32(i)
                  
                  Certification
      of Principal Executive Officer Pursuant to Section 906 of the Sarbanes
      Oxley Act (Filed herewith)32(ii)
                  
                  Certification
      of Principal Accounting Officer Pursuant to Section 906 of the Sarbanes
      Oxley Act (Filed herewith)99(i)
                  
                  Registrant’s
      Proxy Statement for the 2010 Annual Meeting of Shareholders(5)99(ii)
                  
                  Certification
      pursuant to Emergency Economic Stabilization Act of 2008, as amended
      (Filed herewith)99(iii)
                  
                  Certification
      pursuant to Emergency Economic Stabilization Act of 2008, as amended
      (Filed herewith)








1.
            Incorporated
      by reference to the Registrant’s 10-KSB for the year ended December 31,
      2001, as filed with the Securities and Exchange Commission on March 27,
      2002.





2.
            Incorporated
      by reference to the Registrant’s Registration Statement on Form S-8 as
      filed with the Securities and Exchange Commission on September 5,
      2001.





3.
            Incorporated
      by reference from Annual Report on Form 10-KSB filed with the Securities
      and Exchange Commission on March 30,
2004.





4.
            Incorporated
      by reference from Annual Report on Form 10-K filed with the Securities and
      Exchange Commission on March 28,
2006.





5.
            Filed
      with the Securities and Exchange Commission pursuant to Rule
      14a-6.





6.
            Incorporated
      by reference from Annual Report on Form 10-K filed with the Securities and
      Exchange Commission on March 11,
2008.





7.
            Incorporated
      by reference from the Registrant’s Current Report on Form 8-K filed with
      the Securities and Exchange Commission on December 31,
    2008.


94





8.
            Incorporated
      by reference from the Registrant’s Current Report on Form 8-K filed with
      the Securities and Exchange Commission on September 30,
    2008.





9.
            Incorporated
      by reference from Exhibit 99.1 to the Registration Statement on Form S-8,
      filed with the Securities and Exchange Commission on August 11,
      2006.





10.
            Incorporated
      by reference from Annual Report on Form 10-K filed with the Securities and
      Exchange Commission on March 27,
2009.





11.
            Incorporated
      by reference from Current Report on Form 8-K filed with the Securities and
      Exchange Commission on January 14,
2009.


95