**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, 2007





OR





**o TRANSITIONAL
      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.


o
      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.


o 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 o 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 o





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
            **o**
            Accelerated
                filer
            xNon-accelerated
                filer
            **o**(Do not check if a smaller reporting company)
            Smaller
                reporting company
            **o**





Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act).


o 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: $91,441,019.





Indicate
      the number of shares outstanding of each of the registrant’s classes of Common
      Stock as of the latest practicable date: 9,496,555 shares of Common Stock
      outstanding as of March 7, 2008.





**Documents
      Incorporated by Reference.**


Portions
      of the registrant’s definitive proxy statement as filed with the Federal Deposit
      Insurance Corporation in connection with its 2008 annual meeting are
      incorporated into Part III of this report.








**PART
                I**
            **FORM
                10-K**
            **PROXY**
              **STATEMENT**
            **ANNUAL**
              **REPORT****Item
                1 –
                Business**
            **3****Item
                1A – Risk Factors**
            **17****Item
                1B – Unresolved Staff Comments**
            **22****Item
                2 – Properties**
            **22****Item
                3 – Legal Proceedings**
            **24****Item
                4 – Submission of Matters to a Vote****of
                Security Holders**
            **24****PART
                II****Item
                5 – Market for Registrant’s****Common
                Equity, Related****Stockholder
                Matters and Issuer****Purchases
                of Equity Securities**
            **24****Item
                6 – Selected Financial Data**
            **25****Item
                7 – Management’s Discussion and****Analysis
                of Financial Condition****and
                Results of Operation**
            **27****Item
                7A – Quantitative and Qualitative****Disclosures
                About Market****Risk******
            **45****Item
                8 – Financial Statements and****Supplementary
                Data**
            **46****Item
                9 – Changes in and Disagreements****with
                Accountants on****Accounting
                and Financial****Disclosure**
            **82****Item
                9A – Controls and Procedures**
            **82****Item
                9B – Other Information**
            **83****PART
                III****Item
                10 – Directors and Executive****Officers
                and Corporate Governance**
            **83**
            **X****Item
                11 – Executive Compensation**
            **83**
            **X****Item
                12 – Security Ownership of Certain****Beneficial
                Owners and****Management
                and Related****Stockholder
                Matters**
            **83**
            **X****Item
                13 – Certain Relationships and****Related
                Transactions, and Director Independence**
            **84**
            **X****Item
                14 – Principal Accounting Fees and****Services**
            **84**
            **X****PART
                IV****Item
                15 – Exhibits, Financial Statement****Schedules**
            **84**





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 twelve (12) full service branch offices in Cary (2), Apex, Clayton,
      Holly Springs, Pinehurst, Raleigh, Southern Pines, Sanford, Garner, Wilmington
      and Knightdale, North Carolina and one loan production office in Raleigh, 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 their market area. The Bank offers
      a
      range of banking services including checking and savings accounts, commercial,
      consumer and personal loans, and mortgage services and other associated
      financial services.





**Lending
      Activities**





*General.* We
      provide a wide range of short- to medium-term commercial, mortgage, construction
      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 52% of the loan balances
      outstanding at December 31, 2007 while fixed rate loans accounted for 48% 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 periodic loan
      audits by internal loan examiners and outside professionals experienced in
      loan
      review work.




*Commercial
      Mortgage Loans.* We
      originate and maintain 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 primary lending focuses is construction/development lending. We originate
      one to four family residential construction loans for custom homes (where the
      home buyer is the borrower) and provide financing to builders and consumers
      for
      the construction of homes. 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.





*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 anticipate that we will continue to be an active originator
      of
      mortgage loans and only hold for our own account a small number of
      well-collateralized, non-conforming residential loans.


4


The
      following table describes our loan portfolio composition by category:





At
                December 31,2007
            
            2006
            
            2005Amount
            
            %
                of Total
              Loans
            
            Amount
            
            %
                of Total
              Loans
            
            Amount
            
            %
                of Total
              Loans(Dollars
                in thousands)Real
                estate - commercial
            
            $
            350,961
            
            
            51.85
            %
            $
            304,823
            
            
            55.36
            %
            $
            174,039
            
            
            52.92
            %Real
                estate - residential
            
            
            18,257
            
            
            2.70
            %
            
            20,224
            
            
            3.67
            %
            
            14,914
            
            
            4.54
            %Construction
                loans
            
            
            184,019
            
            
            27.18
            %
            
            110,033
            
            
            19.99
            %
            
            46,607
            
            
            14.17
            %Commercial
                and industrial loans
            
            
            72,930
            
            
            10.77
            %
            
            67,822
            
            
            12.32
            %
            
            52,708
            
            
            16.03
            %Home
                equity loans and lines of credit
            
            
            45,258
            
            
            6.69
            %
            
            42,704
            
            
            7.76
            %
            
            34,921
            
            
            10.62
            %Loans
                to individuals
            
            
            5,489
            
            
            0.81
            %
            
            4,977
            
            
            0.90
            %
            
            5,670
            
            
            1.72
            %Total
                loans
            
            
            676,914
            
            
            100.00
            %
            
            550,583
            
            
            100.00
            %
            
            328,859
            
            
            100.00
            %Less:
                Net deferred loan fees
            
            
            (998
            )
            
            
            
            
            (764
            )
            
            
            
            
            (537
            )Total
                loans, net
            
            $
            675,916
            
            
            
            
            $
            549,819
            
            
            
            
            $
            328,322





At
                December 31,2004
            
            2003Amount
            
            %
                of Total
              Loans
            
            Amount
            
            %
                of Total
              Loans(Dollars
                in thousands)Real
                estate - commercial
            
            $
            121,825
            
            
            47.24
            %
            $
            101,316
            
            
            46.66
            %Real
                estate - residential
            
            
            11,604
            
            
            4.50
            %
            
            14,765
            
            
            6.80
            %Construction
                loans
            
            
            38,916
            
            
            15.09
            %
            
            31,612
            
            
            14.56
            %Commercial
                and industrial loans
            
            
            48,757
            
            
            18.90
            %
            
            38,237
            
            
            17.61
            %Home
                equity loans and lines of credit
            
            
            30,960
            
            
            12.00
            %
            
            22,985
            
            
            10.59
            %Loans
                to individuals
            
            
            5,846
            
            
            2.27
            %
            
            8,213
            
            
            3.78
            %Total
                loans
            
            
            257,908
            
            
            100.00
            %
            
            217,128
            
            
            100.00
            %Less:
                Net deferred loan fees
            
            
            (447
            )
            
            
            
            
            (382
            )Total
                loans, net
            
            $
            257,461
            
            
            
            
            $
            216,746





The
      following table presents at December 31, 2007 (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:




Within
              1
                Year
            
            1-5
              Years
            
            After
              5
                Years
            
            Total(In
                thousands)Commercial
                mortgage
            
            $
            89,698
            
            $
            240,770
            
            $
            20,493
            
            $
            350,961Residential
                mortgage
            
            
            8,116
            
            
            9,686
            
            
            454
            
            
            18,257Construction
                loans
            
            
            131,449
            
            
            40,504
            
            
            12,067
            
            
            184,019Commercial
                and industrial
            
            
            52,547
            
            
            19,319
            
            
            1,064
            
            
            72,390Home
                equity lines and loans
            
            
            1,410
            
            
            4,967
            
            
            38,881
            
            
            45,258Individuals
            
            
            3,494
            
            
            1,993
            
            
            2
            
            
            5,489Total
            
            $
            286,714
            
            $
            317,239
            
            $
            72,961
            
            $
            676,914Fixed
                rate loans
            
            
            
            
            
            
            
            
            
            
            $
            253,183Variable
                rate loans
            
            
            
            
            
            
            
            
            
            
            
            137,017$
            390,200




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 Company’s full board is required to approve
      any single transaction of $5.0 million or more. These amount limitations apply
      to the borrower’s total outstanding indebtedness to us, including the
      indebtedness of any guarantor. 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 N 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. At least annually, we undergo loan review by
      an outside third party who reviews 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. However, we strive to
      establish customer relations to attract core deposits in non-interest bearing
      transactional accounts and thus reduce our cost of funds.





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 31,2007
            
            2006
            
            2005(Dollars
                in thousands)Average
              Balance
            
            Average
              Rate
            
            Average
              Balance
            
            Average
              Rate
            
            Average
              Balance
            
            Average
              RateNon-interest
                bearing deposits
            
            $
            70,660
            
            
            -
            
            $
            56,376
            
            
            -
            
            $
            42,641
            
            
            -Interest
                bearing demand deposits
            
            
            33,453
            
            
            0.97
            %
            
            37,876
            
            
            1.46
            %
            
            39,609
            
            
            1.05
            %Money
                market deposits
            
            
            58,214
            
            
            3.48
            %
            
            51,926
            
            
            3.52
            %
            
            41,548
            
            
            2.16
            %Savings
                deposits
            
            
            105,107
            
            
            4.29
            %
            
            40,694
            
            
            4.51
            %
            
            4,952
            
            
            1.79
            %Time
                deposits over $100,000
            
            
            254,533
            
            
            5.11
            %
            
            154,538
            
            
            4.82
            %
            
            110,312
            
            
            3.30
            %Time
                deposits under $100,000
            
            
            70,710
            
            
            5.03
            %
            
            72,440
            
            
            3.51
            %
            
            58,787
            
            
            3.13
            %Total
                interest bearing deposits
            
            
            522,017
            
            
            4.49
            %
            
            357,474
            
            
            3.97
            %
            
            255,208
            
            
            2.70
            %Total
                average deposits
            
            $
            592,677
            
            
            3.95
            %
            $
            413,850
            
            
            3.43
            %
            $
            297,849
            
            
            2.31
            %




For the Year Ended December 31,2004
            
            2003(Dollars in thousands)AverageBalance
            
            AverageRate
            
            AverageBalance
            
            AverageRateNon-interest
                bearing deposits
            
            $
            37,898
            
            
            -
            
            $
            34,977
            
            
            -Interest
                bearing demand deposits
            
            
            40,931
            
            
            0.79
            %
            
            31,340
            
            
            0.94
            %Money
                market deposits
            
            
            31,537
            
            
            1.29
            %
            
            22,589
            
            
            1.37
            %Savings
                deposits
            
            
            2,758
            
            
            0.36
            %
            
            1,544
            
            
            0.40
            %Time
                deposits over $100,000
            
            
            85,961
            
            
            2.57
            %
            
            41,644
            
            
            3.15
            %Time
                deposits under $100,000
            
            
            56,445
            
            
            2.68
            %
            
            41,566
            
            
            2.95
            %Total
                interest bearing deposits
            
            
            217,632
            
            
            2.04
            %
            
            138,683
            
            
            2.21
            %Total
                average deposits
            
            $
            255,530
            
            
            1.73
            %
            $
            173,660
            
            
            1.77
            %





The
      following table sets forth the amounts and maturities of certificates of deposit
      with balances of $100,000 or more at December 31, 2007:




Remaining
                maturity:
            
            (in
                thousands)Three
                months or less
            
            $
            56,529Over
                three months through one year
            
            
            111,366Over
                one year through three years
            
            
            102,274Over
                three years through five years
            
            
            6,480Total
            
            $
            276,649





7




**Borrowings**





As
      additional sources of funding, we use advances from the Federal Home Loan Bank
      of Atlanta under a line of credit equal to 20% of CSB’s total assets ($167.1
      million at December 31, 2007). Outstanding advances at December 31, 2007 were
      $123.0 million. Pursuant to collateral agreements with the Federal Home Loan
      Bank, at December 31, 2007 advances were secured by investment securities
      available for sale with a fair value of $42.8 million and by loans with a
      carrying amount of $162.7 million, which approximates market value.





We
      may
      purchase federal funds through three
      unsecured federal funds lines of credit aggregating $53.0 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 (4.50% at
      December 31, 2007). Short-term borrowings may also consist of securities sold
      under a repurchase agreement. Securities sold under repurchase agreements
      generally mature within one to four days from the transaction date. There were
      $3.8 million in federal funds purchased at December 31, 2007.





**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 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. The trust preferred securities are
      redeemable 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.





**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 transfer requests 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. Through branch image capture technology, CSB offers
      same day credit for deposits made prior to 5:00 pm. A new technology we
      anticipate offering in the coming year is remote merchant capture. This will
      allow our customers to run check deposits through a scanner and deliver the
      image to the Bank electronically.





8





**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. Our de novo expansion strategy is to identify growth markets and
      expand into them, but only when we are able to retain the services of an
      experienced banker with  extensive
      personal knowledge of that market.





**Primary
      Market Area**





CSB’s
      market area includes the four contiguous counties of Wake, Johnston, Lee and
      Moore Counties and the coastal County of New Hanover.





According
      to the U.S. Census Bureau, the estimate 2006 population for the contiguous
      four
      county area was almost 1.1 million reflecting a 23% increase over the population
      in 2000. The largest of the four, Wake County, includes the State Capitol 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 second largest county is Johnston County
      which is just southeast of Wake. Johnston County is one of the fastest growing
      counties in the state with estimated population growth of almost 25% since
      2000.
      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. 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 125,000 as of
      October 2007. The area has a very strong and diversified economy. The total
      population estimate for Wake County in 2006 is 787,000. The total population
      of
      Johnston County is over 152,000, Moore County has an estimated population of
      over 83,000 and Lee County has an estimated population of over 57,000 in 2006.
      Our market area 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
      population of our market area is relatively diverse, young and highly educated.
      As of 2000, 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, which
      as of the year 2003 for the Raleigh-Durham-Cary metropolitan statistical area
      was $33,627 compared to $28,071 for North Carolina. The median family income
      in
      the Raleigh-Durham-Cary metropolitan statistical area in 2005 was $69,800
      compared to $56,712 for the State of North Carolina. Cary is home to the world’s
      largest privately held software company, SAS Institute, and it has attracted
      other world-class businesses including MCI, RH Donnelly, Siemens, American
      Airlines, and Oxford University Press. The Research Triangle Park houses major
      facilities of IBM, GlaxoSmithKline, Nortel, 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. Wilmington has an estimated population of
      100,000 while New Hanover County has a population of approximately 183,000.
      Wilmington is the ninth largest city in North Carolina. The median family income
      for Wilmington was $54,200 and per capita income was $21,500. 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
      population is culturally diverse and the median age is 34 years
      old.





9




**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.





For
      example, as of June 30, 2007 there were 229 offices of 29 different commercial
      banks in Wake County, 39 offices of 11 different commercial banks in Johnston
      County, 38 offices of 11 different commercial banks in Moore County, 20 offices
      of 9 different commercial banks in Lee County and 74 offices of 17 different
      commercial banks in New Hanover County. 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. There are also a number of new community banks
      in
      Wake, Durham and New Hanover Counties that have a direct competitive effect
      as
      customers tend to “shop” the terms of their loans and deposits.





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, Atlanta, Georgia, a large multi-state financial
      institution, has branches throughout North Carolina, including Wake County.





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, 2007, the Registrant employed 118 full-time and 16 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.




10




Deposit
      Insurance . The
      Bank’s deposits are insured up to applicable limits 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.




The
      FDIC
      recently amended its risk-based deposit assessment system for 2007 to implement
      authority granted by the Federal Deposit Insurance Reform Act of 2005, or the
      Reform Act. Under the revised system, insured institutions are 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, is 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 are determined by
      the
      FDIC and currently range from five to seven basis points for the healthiest
      institutions (Risk Category I) to 43 basis points of assessable deposits for
      the
      riskiest (Risk Category IV). The FDIC may adjust rates uniformly from one
      quarter to the next, except that no single adjustment can exceed three basis
      points.




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. The Reform Act also provided for a one-time
      credit for eligible institutions based on their assessment base as of December
      1996. Subject to certain limitations with respect to institutions that are
      exhibiting weaknesses, credits can be used to offset future assessments until
      exhausted.




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, 2007, CSB was classified
      as
“well-capitalized” with Tier 1 and Total Risk-Based Capital of 9.19% and 10.32%,
      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.





11




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,





-
            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.





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.





12




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.




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” 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.





13




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:





-
            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.




14




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.




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.





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, 2007, the Registrant was classified as “well-capitalized” with
      Tier 1 and Total Risk-Based Capital of 9.37% and 10.51%,
      respectively.





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.





15




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.





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.





16




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****





**Risks
      Associated with our Continued Operations**





**We
      may not be able to maintain and manage our growth, which may adversely affect
      our results of operations and financial condition and the value of our common
      stock.**





Our
      strategy has been to increase the size of our company by opening new offices
      and
      aggressively pursuing business development opportunities. We have grown rapidly
      since we commenced operations. We can provide no assurance that we will continue
      to be successful in increasing the volume of loans and deposits at acceptable
      risk levels and upon acceptable terms while managing the costs and
      implementation risks associated with our growth strategy. There can be no
      assurance that our further expansion will be profitable or that we will continue
      to be able to sustain our historical rate of growth, either through internal
      growth or through successful expansion of our markets, or that we will be able
      to maintain capital sufficient to support our continued growth. If we grow
      too
      quickly, however, and are not able to control costs and maintain asset quality,
      rapid growth also could adversely affect our financial performance. We may
      acquire other banks as a means to expand into new markets or to capture
      additional market share. We are unable to predict whether or when any
      prospective acquisitions will occur or the likelihood of completing an
      acquisition on favorable terms and conditions. Any acquisition involves certain
      risks including, but not limited to:





·
            difficulties
                assimilating acquired operations and
                personnel;


·
            potential
                disruptions of our ongoing
                business;


·
            the
                diversion of resources and management
                time;


·
            the
                possibility that uniform standards, controls, procedures and policies
                may
                not be maintained;


·
            risks
                associated with entering new markets in which we have little or no
                experience;


·
            the
                potential impairment of relationships with employees or customers
                as a
                result of changes in management;


·
            difficulties
                in evaluating the historical or future financial performance of the
                acquired business; and


·
            brand
                awareness issues related to the acquired assets or
                customers.





If
      we
      decide to make an acquisition, there can be no assurance that the acquired
      bank
      would perform as expected.





**Our
      recent operating results may not be indicative of our future operating results.**





We
      may
      not be able to sustain our historical rate of growth. Because of our size and
      shorter operating history, it will be difficult for us to replicate our
      historical earnings growth as we continue to expand. Consequently, our
      historical results of operations will not necessarily be indicative of our
      future operations. Various factors, such as economic conditions, regulatory
      and
      legislative considerations, and competition, may also impede our ability to
      expand our market presence. If we experience a significant decrease in our
      historical rate of growth, our results of operations and financial condition
      may
      be adversely affected because a high percentage of our operating costs are
      fixed
      expenses.





**A
      decrease in interest rates could adversely impact our
      profitability.**





Our
      results of operations may be significantly affected by the monetary and fiscal
      policies of the federal government and the regulatory policies of government
      authorities. A significant component of our earnings is our net interest income.
      Net interest income is the difference between income from interest-earning
      assets, such as loans, and the expense of interest-bearing liabilities, such
      as
      deposits and our borrowings. Like many financial institutions, we are subject
      to
      the risk of fluctuations in interest rates. A significant decrease in interest
      rates could have a material adverse effect on our net income as we would expect
      the yields on our earning assets to decrease more quickly than the cost of
      our
      interest-bearing deposits and borrowings.





17




**Our
      profitability depends significantly on economic conditions in our market
      area.**





Our
      success depends to a large degree on the general economic conditions in Wake,
      Johnston, Moore, Lee, and New Hanover Counties and adjoining markets. The local
      economic conditions in these areas have a significant impact on the amount
      of
      loans that we make to our borrowers, the ability of our borrowers to repay
      these
      loans and the value of the collateral securing these loans. A significant
      decline in general economic condition caused by inflation, recession,
      unemployment or other factors beyond our control would impact these local
      economic conditions and could negatively affect our financial condition and
      performance.





**The
      lack of seasoning of our loan portfolio makes it difficult to assess the
      adequacy of our loan loss reserves accurately.**





We
      attempt to maintain an appropriate allowance for loan losses to provide for
      potential losses in our loan portfolio. We periodically determine the amount
      of
      the allowance based on consideration of several factors, including:




•
            an
                ongoing review of the quality, mix, and size of our overall loan
                portfolio;




•
            our
                historical loan loss experience;




•
            evaluation
                of economic conditions;




•
            regular
                reviews of loan delinquencies and loan portfolio quality; and




•
            the
                amount and quality of collateral, including guarantees, securing
                the
                loans.




However,
      there is no precise method of predicting credit losses, since any estimate
      of
      loan losses is necessarily subjective and the accuracy depends on the outcome
      of
      future events. In addition, due to our rapid growth over the past several years
      and our limited operating history, a large portion of the loans in our loan
      portfolio was originated recently. In general, loans do not begin to show signs
      of credit deterioration or default until they have been outstanding for some
      period of time, a process referred to as “seasoning.” As a result, a portfolio
      of older loans will usually perform more predictably than a newer portfolio.
      Because our loan portfolio is relatively new, the current level of delinquencies
      and defaults may not be representative of the level that will prevail when
      the
      portfolio becomes more seasoned, which may be higher than current levels. If
      charge-offs in future periods increase, we may be required to increase our
      provision for loan losses, which would decrease our net income and possibly
      our
      capital.





**If
      we experience greater loan losses than anticipated, it will have an adverse
      effect on our net income.**





While
      the
      risk of nonpayment of loans is inherent in banking, if we experience greater
      nonpayment levels than we anticipate, our earnings and overall financial
      condition, as well as the value of our common stock, could be adversely
      affected.





We
      cannot
      assure you that our monitoring procedures and policies will reduce certain
      lending risks or that our allowance for loan losses will be adequate to cover
      actual losses. In addition, as a result of the rapid growth in our loan
      portfolio, loan losses may be greater than management’s estimates of the
      appropriate level for the allowance. Loan losses can cause insolvency and
      failure of a financial institution and, in such an event, our shareholders
      could
      lose their entire investment. In addition, future provisions for loan losses
      could materially and adversely affect our profitability. Any loan losses will
      reduce the loan loss allowance. A reduction in the loan loss allowance will
      be
      restored by an increase in our provision for loan losses. This would reduce
      our
      earnings which could have an adverse effect on our stock price.





**Liquidity
      is essential to our business and we rely, in part, on external sources to
      finance a significant portion of our operations.**





Liquidity
      is essential to our business. Our liquidity could be substantially negatively
      affected by our inability to access secured lending markets, brokered deposit
      markets or raise funding in the long-term or short-term capital markets. Factors
      that we cannot control, such as disruption of the financial markets or negative
      views about the financial services industry generally, could impair our ability
      to raise funding. In addition, our ability to raise funding could be impaired
      if
      the Federal Home Loan Bank (FHLB) or deposit brokers develop a negative
      perception of our long-term or short-term financial prospects. Such negative
      perceptions could be developed if we suffer a decline in the level of our
      business activity, regulatory authorities take significant action against us,
      or
      we discover employee misconduct or illegal activity, among other things. If
      we
      were unable to raise funds using the methods described above, we would likely
      need to liquidate unencumbered assets, such as our investment and loan
      portfolios, to meet maturing liabilities. We may be unable to sell some of
      our
      assets, or we may have to sell assets at a discount from market value, either
      of
      which could adversely affect our operations.





18




**We
      rely heavily on the services of key personnel.**





Michael
      G. Carlton, our president and chief executive officer, has substantial
      experience with our operations and has contributed significantly to our growth
      since our founding. The loss of the services of Mr. Carlton or of one or
      more of the key members of our executive management team may have a material
      adverse effect on our operations. If Mr. Carlton or other members of our
      executive management team were no longer employed by us, our ability to
      implement our growth strategy could be impaired.





**Our
      ability to retain and attract qualified employees is critical to the success
      of
      our business and the failure to do so may materially adversely affect our
      performance.**





Our
      people are our most important resource and competition for qualified employees
      is intense. In order to attract and retain qualified employees, we must
      compensate such employees at market levels. Those levels have caused employee
      compensation to be our greatest expense as compensation is highly variable
      and
      moves with performance. If we are unable to continue to attract and retain
      qualified employees, or if compensation costs required to attract and retain
      employees become more expensive, our performance, including our competitive
      position, could be materially adversely affected.





**The
      success of our growth strategy depends on our ability to identify and retain
      individuals with experience and relationships in the markets in which we intend
      to expand.**





We
      may
      expand our banking network over the next several years, not just in our existing
      core market area, but also in other community markets throughout central North
      Carolina and other contiguous markets. To expand into new markets successfully,
      we must identify and retain experienced key management members with local
      expertise and relationships in these markets. We expect that competition for
      qualified management in the markets in which we may expand will be intense
      and
      that there will be a limited number of qualified persons with knowledge of
      and
      experience in the community banking industry in these markets. Even if we
      identify individuals that we believe could assist us in establishing a presence
      in a new market, we may be unable to recruit these individuals away from more
      established banks. In addition, the process of identifying and recruiting
      individuals with the combination of skills and attributes required to carry
      out
      our strategy is often lengthy. Our inability to identify, recruit, and retain
      talented personnel to manage new offices effectively would limit our growth
      and
      could materially adversely affect our business, financial condition, and results
      of operations.





**New
      or acquired bank office facilities and other facilities may not be
      profitable.**





We
      may
      not be able to identify profitable locations for new bank offices and the costs
      to start up new bank office facilities or to acquire existing bank offices,
      and
      the additional costs to operate these facilities, may increase our noninterest
      expense and decrease earnings in the short term. If offices of other banks
      become available for sale, we may acquire those offices. It may be difficult
      to
      adequately and profitably manage our growth through the establishment or
      purchase of bank offices. In addition, we can provide no assurance that any
      such
      offices will successfully attract enough deposits to offset the expenses of
      their operation.





**We
      are subject to operational risk and an operational failure could materially
      adversely affect our businesses.**




Operational
      risk refers to the risk of loss arising from inadequate or failed internal
      processes, people and/or systems. Operational risk also refers to the risk
      that
      external events, such as external changes (e.g., natural disasters, terrorist
      attacks and/or health epidemics), failures or frauds, will result in losses
      to
      our businesses.




19




Our
      business is highly dependent on our ability to process, on a daily basis, a
      large number of transactions and the transactions we process have become
      increasingly complex. We perform the functions required to operate our business
      either by ourselves or through agreements with third parties. We rely on the
      ability of our employees, our internal systems and systems at technology centers
      operated by third parties to process high numbers of transactions. In the event
      of a breakdown or improper operation of our or third-parties’ systems or
      improper action by third parties or employees, we could suffer financial loss,
      an impairment to our liquidity, a disruption of our businesses, regulatory
      sanctions and damage to our reputation.





**In
      order to be profitable, we must compete successfully with other financial
      institutions which have greater resources and capabilities than we
      do.**




The
      banking business in North Carolina in general, and in the Triangle area in
      particular, which is part of our market area, is extremely competitive. Most
      of
      our competitors are larger and have greater resources than we do and have been
      in existence a longer period of time. We will have to overcome historical
      bank-customer relationships to attract customers away from our competition.
      We
      compete with the following types of institutions:





-
                other commercial banks
              -
                savings banks
              -
                thrifts
              -
                credit unions
              -
                consumer finance companies
            -
                securities brokerage firms
              -
                mortgage brokers
              -
                insurance companies
              -
                mutual funds
              -
                trust companies





Some
      of
      our competitors are not regulated as extensively as we are and, therefore,
      may
      have greater flexibility in competing for business. Some of these competitors
      are subject to similar regulation but have the advantages of larger established
      customer bases, higher lending limits, extensive branch networks, numerous
      automated teller machines, greater advertising-marketing budgets or other
      factors.




Our
      legal
      lending limit is determined by law. The size of the loans which we offer to
      our
      customers may be less than the size of the loans that larger competitors are
      able to offer. This limit may affect to some degree our success in establishing
      relationships with the larger businesses in our market.





**We
      are subject to extensive regulation that could limit or restrict our activities.**





We
      operate in a highly regulated industry and are subject to examination,
      supervision, and comprehensive regulation by the North Carolina Office of the
      Commissioner of Banks, the FDIC, and the Federal Reserve Board. Our compliance
      with these regulations is costly and restricts certain of our activities,
      including payment of dividends, mergers and acquisitions, investments, loans
      and
      interest rates charged, interest rates paid on deposits, and locations of
      offices. We must also meet regulatory capital requirements. If we fail to meet
      these capital and other regulatory requirements, our financial condition,
      liquidity, and results of operations would be materially and adversely affected.
      Our failure to remain “well capitalized” and “well managed” for regulatory
      purposes could affect customer confidence, our ability to grow, our cost of
      funds and FDIC insurance, our ability to pay dividends on common stock, and
      our
      ability to make acquisitions.





The
      laws
      and regulations applicable to the banking industry could change at any time,
      and
      we cannot predict the effects of these changes on our business and
      profitability. For example, new legislation or regulation could limit the manner
      in which we may conduct our business, including our ability to obtain financing,
      attract deposits, and make loans. Many of these regulations are intended to
      protect depositors, the public, and the FDIC, not shareholders. In addition,
      the
      burden imposed by these regulations may place us at a competitive disadvantage
      compared to competitors who are less regulated. The laws, regulations,
      interpretations, and enforcement policies that apply to us have been subject
      to
      significant change in recent years, sometimes retroactively applied, and may
      change significantly in the future. Our cost of compliance could adversely
      affect our ability to operate profitably.





20





**Our
      growth may require us to raise additional capital that may not be available
      when
      it is needed, or at all.**





We
      are
      required by regulatory authorities to maintain adequate levels of capital to
      support our operations. We anticipate that our capital resources will satisfy
      our capital requirements for the foreseeable future. We may at some point,
      however, need to raise additional capital to support our continued growth.
      Our
      ability to raise additional capital, if needed, will depend in part on
      conditions in the capital markets at that time, which are outside our control,
      and on our financial performance. Accordingly, we may be unable to raise
      additional capital, if and when needed, on terms acceptable to us, or at all.
      If
      we cannot raise additional capital when needed, our ability to further expand
      our operations through internal growth and acquisitions could be materially
      impaired. In addition, if we issue additional equity capital, the interests
      of
      existing shareholders would be diluted.





**Efforts
      to comply with the Sarbanes-Oxley Act involve significant expenditures, and
      non-compliance with the Sarbanes-Oxley Act may adversely affect us.**





The
      Sarbanes-Oxley Act of 2002, and the related rules and regulations promulgated
      by
      the Securities and Exchange Commission that are now applicable to us, have
      increased the scope, complexity, and cost of corporate governance, reporting,
      and disclosure practices. We have experienced, and we expect to continue to
      experience, greater compliance costs, including costs related to internal
      controls, as a result of the Sarbanes-Oxley Act. We expect these new rules
      and
      regulations to continue to increase our accounting, legal, and other costs,
      and
      to make some activities more difficult, time consuming, and costly. In the
      event
      that we are unable to maintain compliance with the Sarbanes-Oxley Act and
      related rules, we may be adversely affected.





We
      evaluate our internal control systems in order to allow management to report
      on,
      and our independent registered public accounting firm to attest to, our internal
      controls over financial reporting, as required by Section 404 of the
      Sarbanes-Oxley Act. If we identify significant deficiencies or material
      weaknesses in our internal control over financial reporting that we cannot
      remediate in a timely manner, or if we are unable to receive a positive
      attestation from our independent registered public accounting firm with respect
      to our internal control over financial reporting, the trading price of our
      common stock could decline, our ability to obtain any necessary equity or debt
      financing could suffer, and, if accepted for listing, our common stock could
      ultimately be delisted from the NASDAQ Global Market. In this event, the
      liquidity of our common stock would be severely limited and the market price
      of
      our common stock would likely decline significantly.





In
      addition, the rules adopted as a result of the Sarbanes-Oxley Act could make
      it
      more difficult or more costly for us to obtain certain types of insurance,
      including directors’ and officers’ liability insurance, which could make it more
      difficult for us to attract and retain qualified persons to serve on our board
      of directors or as executive officers.





**Risks
      Related to an Investment in our Common Stock**





**Our
      securities are not FDIC insured.**





Our
      common stock is not a savings or deposit account or other obligation of the
      bank, and is not insured by the Federal Deposit Insurance Corporation or any
      other governmental agency and is subject to investment risk, including the
      possible loss of principal.





**We
      may not pay cash dividends for the foreseeable future.**





We
      may
      not pay cash dividends on our common stock in the foreseeable future, as we
      intend to retain earnings to provide the capital necessary to fund our growth
      strategy. You should not invest in our common stock if you need dividend income
      from this investment. Our ability to declare and pay cash dividends will be
      dependent upon, among other things, restrictions imposed by the reserve and
      capital requirements of North Carolina and federal banking regulations, our
      income and financial condition, tax considerations, and general business
      conditions. Therefore, investors should not purchase shares with a view for
      a
      current return on their investment in the form of cash dividends.





21




**We
      have implemented anti-takeover devices that could make it more difficult for
      another company to acquire us, even though such an acquisition may increase
      shareholder value.**





In
      some
      cases, shareholders would receive a premium for their shares if we were acquired
      by another company. However, state and federal law and our articles of
      incorporation and bylaws make it difficult for anyone to acquire us without
      approval of our board of directors. For example, our articles of incorporation
      require a supermajority vote of two-thirds of our outstanding common stock
      in
      order to effect a sale or merger of the company in certain circumstances. Our
      bylaws also divide the board of directors into three classes of directors
      serving staggered three-year terms with approximately one-third of the board
      of
      directors elected at each annual meeting of shareholders. The classification
      of
      directors makes it more difficult for shareholders to change the composition
      of
      the board of directors. As a result, at least two annual meetings of
      shareholders would be required for the shareholders to change a majority of
      the
      directors, whether or not a change in the board of directors would be beneficial
      and whether or not a majority of shareholders believe that such a change would
      be desirable. Consequently, a takeover attempt may prove difficult, and
      shareholders may not realize the highest possible price for their securities.





**The
      holder of our junior subordinated debenture has rights that are senior to those
      of our common shareholders.**





We
      have
      supported our continued growth through the issuance of trust preferred
      securities from a special purpose trust and an accompanying sale of an $8.2
      million junior subordinated debenture to this trust. Payments of the principal
      and interest on the trust preferred securities of this trust are conditionally
      guaranteed by us. Further, the accompanying junior subordinated debenture that
      we issued to the trust is senior to our shares of common stock. As a result,
      we
      must make payments on the junior subordinated debenture before any dividends
      can
      be paid on our common stock and, in the event of our bankruptcy, dissolution
      or
      liquidation, the holder of the junior subordinated debenture must be satisfied
      before any distributions can be made on our common stock. We have the right
      to
      defer distributions on the junior subordinated debenture (and the related trust
      preferred securities) for up to five years, during which time no dividends
      may
      be paid on our common stock.




**ITEM****1B – **UNRESOLVED STAFF
      COMMENTS****





Not
      applicable.





**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.





**Office
                Location****s**
            
            **Year**
              ******Opened**
            
            **Approximate**
              **Square
                Footage**
            
            **Owned
                or Leased**Main
                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
            
            Leased




22




Holly
                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
                leaseFormer
                Garner Office
              945
                Vandora Springs Road
              Garner,
                NC
            
            2005
            
            1,960
            
            LeasedGarner
                Office
              945
                Vandora Springs Road
              Garner,
                NC
            
            2007
            
            3,500
            
            LeasedRaleigh
                Loan Production Office
              4601
                Six Forks Road
              Raleigh,
                NC
            
            2005
            
            2,439
            
            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
            
            OwnedRaw
                land
              Sanford,
                NC
            
            2007
            
            1.37
                acres
            
            Owned**Operations
                Locations**
            
            **Year**
              ******Opened**
            
            **Approximate**
              **Square
                Footage**
            
            **Owned
                or Leased**206
                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, 2007 was $8,094,522. All
      properties are considered by Company management to be in good condition and
      adequately covered by insurance.


23


**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.





**ITEM
      4 – **SUBMISSION OF MATTERS TO A VOTE OF SECURITY
      HOLDERS****





No
      matters were submitted to a vote of shareholders in the fourth quarter of
      2007.





**PART
      II**


**ITEM
        5 – MARKET FOR 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 9,404,579 shares outstanding at
      December 31, 2007 owned by approximately 3,100 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 provide
      the capital necessary to fund our growth strategy.





Low
                (1)
            
            High
                (1)January
                1, 2006
                to March 31, 2006
            
            $
            11.90
            
            $
            12.33April
                1, 2006
                to June 30, 2006
            
            
            11.74
            
            
            13.67July
                1, 2006
                to September 30, 2006
            
            
            11.64
            
            
            13.00October
                1, 2006
                to December 31, 2006
            
            
            11.25
            
            
            12.27January
                1, 2007
                to March 31, 2007
            
            
            11.77
            
            
            12.95April
                1, 2007
                to June 30, 2007
            
            
            11.15
            
            
            12.79July
                1, 2007
                to September 30, 2007
            
            
            9.25
            
            
            11.70October
                1, 2007
                to December 31, 2007
            
            
            8.97
            
            
            11.11





(1)
            The
                2006 prices quoted above have been adjusted to reflect the 10% stock
                dividend distributed in 2007.





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


24


**ITEM 6 –
      SELECTED FINANCIAL DATA**


At
                  or for the Years Ended
                December
                  31,**2007**
              
              **2006**
              
              **2005**
              
              **2004**
              
              **2003**(Dollars
                  in thousands, except share and per share data)**Summary
                  of Operations**Interest
                  income
              
              $
              54,872
              
              $
              36,707
              
              $
              22,827
              
              $
              15,896
              
              $
              10,950Interest
                  expense
              
              
              28,217
              
              
              17,257
              
              
              8,872
              
              
              5,466
              
              
              3,749Net
                  interest income
              
              
              26,655
              
              
              19,450
              
              
              13,955
              
              
              10,430
              
              
              7,201Provision
                  for loan losses
              
              
              1,684
              
              
              991
              
              
              807
              
              
              736
              
              
              551Net
                  interest income after the provision
                for
                  loan losses
              
              
              24,971
              
              
              18,459
              
              
              13,148
              
              
              9,694
              
              
              6,650Non-interest
                  income
              
              
              2,621
              
              
              2,612
              
              
              2,417
              
              
              2,342
              
              
              1,645Non-interest
                  expense
              
              
              7,823
              
              
              13,387
              
              
              10,762
              
              
              8,531
              
              
              5,767Income
                  before income taxes
              
              
              9,769
              
              
              7,684
              
              
              4,803
              
              
              3,505
              
              
              2,528Income
                  taxes
              
              
              3,520
              
              
              2,780
              
              
              1,659
              
              
              1,172
              
              
              873Net
                  income
              
              $
              6,249
              
              $
              4,904
              
              $
              3,144
              
              $
              2,333
              
              $
              1,655**Per
                  Share and Shares Outstanding****(1)**Net
                  income, basic(2)
              
              $
              0.68
              
              $
              0.67
              
              $
              0.58
              
              $
              0.45
              
              $
              0.36Net
                  income, diluted(2)
              
              $
              0.65
              
              $
              0.64
              
              $
              0.55
              
              $
              0.43
              
              $
              0.35Book
                  value at end of period
              
              $
              9.75
              
              $
              9.13
              
              $
              6.52
              
              $
              5.16
              
              $
              4.73Tangible
                  book value
              
              $
              6.42
              
              $
              5.67
              
              $
              5.93
              
              $
              4.43
              
              $
              3.99Weighted
                  average shares outstanding:Basic
              
              
              9,211,779
              
              
              7,281,016
              
              
              5,402,390
              
              
              5,146,464
              
              
              4,558,143Diluted
              
              
              9,635,694
              
              
              7,614,804
              
              
              5,682,447
              
              
              5,417,790
              
              
              4,724,656Shares
                  outstanding at period end
              
              
              9,404,579
              
              
              9,091,649
              
              
              6,358,388
              
              
              5,188,931
              
              
              5,105,175**Balance
                  Sheet Data**Total
                  assets
              
              $
              835,540
              
              $
              697,909
              
              $
              410,788
              
              $
              331,227
              
              $
              273,714Total
                  investments(3)
              
              
              90,758
              
              
              85,578
              
              
              57,752
              
              
              54,935
              
              
              38,383Total
                  loans, net
              
              
              667,643
              
              
              542,874
              
              
              323,971
              
              
              253,793
              
              
              213,442Total
                  deposits
              
              
              605,431
              
              
              541,881
              
              
              322,081
              
              
              273,649
              
              
              218,615Borrowings
              
              
              135,003
              
              
              69,699
              
              
              45,212
              
              
              29,555
              
              
              29,003Stockholders’
                  equity
              
              
              91,659
              
              
              83,034
              
              
              41,457
              
              
              26,777
              
              
              24,150**Selected
                  Performance Ratios**Return
                  on average assets
              
              
              0.80
              %
              
              0.93
              %
              
              0.84
              %
              
              0.76
              %
              
              0.79
              %Return
                  on average stockholders’ equity
              
              
              7.15
              %
              
              8.72
              %
              
              10.34
              %
              
              9.14
              %
              
              8.25
              %Net
                  interest spread(4)
              
              
              3.08
              %
              
              3.29
              %
              
              3.51
              %
              
              3.26
              %
              
              3.09
              %Net
                  interest margin(5)
              
              
              3.72
              %
              
              3.95
              %
              
              3.94
              %
              
              3.61
              %
              
              3.64
              %Non-interest
                  income as a percentage oftotal
                  revenue(6)
              
              
              8.95
              %
              
              11.84
              %
              
              14.76
              %
              
              18.34
              %
              
              18.60
              %Non-interest
                  income as a percentage ofaverage
                  assets
              
              
              0.34
              %
              
              0.49
              %
              
              0.64
              %
              
              0.76
              %
              
              0.78
              %Non-interest
                  expense to averageassets
              
              
              2.29
              %
              
              2.53
              %
              
              2.86
              %
              
              2.76
              %
              
              2.75
              %Efficiency
                  ratio(7)
              
              
              60.88
              %
              
              60.68
              %
              
              65.73
              %
              
              66.79
              %
              
              65.19
              %Average
                  stockholders’ equity toaverage
                  total assets
              
              
              11.24
              %
              
              10.64
              %
              
              8.08
              %
              
              8.27
              %
              
              9.55
              %**Asset
                  Quality Ratios**Net
                  charge-offs to average loansoutstanding
              
              
              0.06
              %
              
              0.02
              %
              
              0.04
              %
              
              0.15
              %
              
              0.05
              %Allowance
                  for loan losses to period endloans
              
              
              1.22
              %
              
              1.26
              %
              
              1.33
              %
              
              1.42
              %
              
              1.52
              %Allowance
                  for loan losses to non-performing
                  loans
              
              
              303
              %
              
              5,145
              %
              
              16,960
              %
              
              73,360
              %
              
              2,078
              %Non-performing
                  loans to period endloans
              
              
              0.40
              %
              
              0.02
              %
              
              0.01
              %
              
              0.00
              %
              
              0.07
              %Non-performing
                  assets to total assets(8)
              
              
              0.36
              %
              
              0.03
              %
              
              0.01
              %
              
              0.09
              %
              
              0.06
              %




25




At
                or for the Years Ended
              December
                31,**2007**
            
            **2006**
            
            **2005**
            
            **2004**
            
            **2003**(Dollars
                in thousands, except share and per share data)**Capital
                Ratios**Total
                risk-based capital ratio
            
            
            10.51
            %
            
            11.03
            %
            
            13.68
            %
            
            11.61
            %
            
            12.95
            %Tier
                1 risk-based capital ratio
            
            
            9.37
            %
            
            9.88
            %
            
            12.51
            %
            
            10.38
            %
            
            11.70
            %Leverage
                ratio
            
            
            8.56
            %
            
            9.13
            %
            
            11.51
            %
            
            9.49
            %
            
            10.63
            %Equity
                to assets ratio
            
            
            10.97
            %
            
            11.90
            %
            
            10.09
            %
            
            8.08
            %
            
            8.82
            %**Other
                Data**Number
                of full-service banking offices
            
            
            12
            
            
            11
            
            
            9
            
            
            8
            
            
            7Number
                of full-time equivalentemployees
            
            
            126
            
            
            122
            
            
            90
            
            
            78
            
            
            64




(1)
            Adjusted
                to reflect the 10 % stock dividend distributed in 2007 and stock
                splits
                effected in the form of 15%, 15%, 20% and 15% stock dividends in
                each of
                the years 2006, 2005, 2004 and 2003, respectively.


(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.


(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, restructured loans, and
                    foreclosed
                    assets, where
                    applicable.


26


**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, 2007 and 2006. 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 year ended December 31, 2007,
      and the Company, Crescent State Bank and Port City Capital Bank for the years
      ended December 31, 2006 and 2005. 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, 2007 AND 2006**





The
      Company reported total assets of $835.5 million at December 31, 2007 compared
      to
      $697.9 million at December 31, 2006. The $137.6 million increase represents
      20%
      total asset growth. Total earning assets at December 31, 2007 were $773.8
      million or 21% higher than the $639.0 million reported as of December 31, 2006.
      Earning assets at December 31, 2007 consisted of $675.9 million in gross loans,
      $97.5 million in investment securities and Federal Home Loan Bank (FHLB) stock
      and $309,000 in overnight investments and interest bearing deposits. Total
      liabilities increased by 21% or $129.0 million from $614.9 million to $743.9
      million. Stockholders’ equity increased by 10% or $8.6 million to close the year
      at $91.7 million.




Loans
      comprise the largest portion of our earning assets and experienced significant
      growth during the year. Gross loans increased by $126.1 million or 23% growing
      from $549.8 million at December 31, 2006 to $675.9 million at December 31,
      2007.
      Most loan categories experienced net growth during the twelve-month period.
      The
      construction/acquisition and development loan category experienced the most
      significant net growth increasing $73.8 million or 67% from $109.8 million
      to
      $183.6 million. Net growth in other loan categories, presented in order of
      dollar growth, were as follows: commercial mortgage loans increased by $46.0
      million or 15% from $304.4 million to $350.4 million, commercial and industrial
      loans increased by $5.1 million or 8% from $67.8 million to $72.9 million,
      home
      equity lines and loans increased by $2.5 million or 6% from $42.7 million to
      $45.2 million and the consumer loan portfolio increased by $511,000 or 10%
      from
      $5.0 million to $5.5 million. The residential real estate mortgage loan
      portfolio declined by 10% or $2.0 million during the year to close at $18.2
      million.





The
      composition of the loan portfolio, by category, as of December 31, 2007 is
      as
      follows: 52% commercial mortgage loans, 27% construction/acquisition and
      development loans, 11% commercial and industrial loans, 6% home equity loans
      and
      lines of credit, 3% residential mortgage loans and 1% consumer loans. The
      composition of the loan portfolio, by category, as of December 31, 2006 is
      as
      follows: 55% commercial mortgage loans, 20% construction/acquisition and
      development loans, 12% commercial and industrial loans, 8% home equity loans
      and
      lines of credit, 4% residential mortgage loans and 1% consumer loans.





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, 2007,
      there were three industry codes for which our concentration exposure exceeded
      10% of the total loan portfolio. Loans to investors who lease non-residential
      buildings other than miniwarehouses comprised 16% of our loan portfolio, loans
      to residential home builders comprised 14% of the loan portfolio and loans
      for
      land subdivision comprised 12% of the loan portfolio. While we do have a
      significant exposure to the residential construction industry, our markets
      have
      not experienced the same magnitude of slowdown that has been experienced
      nationally. Being predominantly a real estate lending bank, we have certain
      monitoring processes in place to keep abreast of negative trends within our
      portfolio.





27




The
      allowance for loan losses was $8.3 million or 1.22% of total outstanding loans
      at December 31, 2007 compared to $6.9 million or 1.26% of total outstanding
      loans at December 31, 2006. At the time PCCB was merged into CSB, PCCB
      maintained an allowance for loan losses equal to 1.25% of the loans outstanding.
      The application of CSB’s model to the combined portfolio resulted in an
      reduction of the allowance previously attributed to PCCB. Although national
      economic trends have taken a downturn during the past year, the credit quality
      of the Company’s loan portfolio remains high and reflects the continued strength
      of the markets we serve. At December 31, 2007, there were twelve loans totaling
      $2.7 million in non-accrual status. The percentage of non-performing loans
      to
      total loans at December 31, 2007 was 0.40%. There were ten loans aggregating
      $1.4 million that were 30 days or more past due. There were no loans past due
      90
      days or more and still accruing interest at December 31, 2007. At December
      31,
      2006, there were two loans totaling approximately $135,000 in non-accrual
      status. The percentage of non-performing loans to total loans at December 31,
      2006 was 0.02%. There were eight loans aggregating $554,000 that were 30 days
      or
      more past due. There were no loans past due 90 days or more and still accruing
      interest at December 31, 2006. See the section entitled “Non Performing Assets”
for more details.





The
      amortized cost and fair market value of the Company’s investment securities
      portfolio at December 31, 2007 were $90.7 million and $90.8 million,
      respectively compared to $85.5 million and $84.7 million, respectively, at
      December 31, 2006. All investments are accounted for as available for sale
      under
      Financial Accounting Standards Board ("FASB") No. 115 and are presented at
      their
      fair market value. Over the past twelve months, the portfolio experienced a
      net
      increase of $6.0 million or 7%. The Company’s investment in debt securities at
      December 31, 2007, 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 2007 were attributed to purchases of $14.4 million, an
      $882,000 increase in the fair market value of the portfolio, as well as net
      premium accretion of $99,000. Decreases in the portfolio were attributed to
      the
      receipt of $9.3 million in principal re-payments on CMOs and MBSs. The Company
      also owned $6.8 million of Federal Home Loan Bank stock at December 31,
      2007 compared with $3.6 million at December 31, 2006. The Company does not
      have
      any assets in its investment portfolio that have exposure to the sub-prime
      mortgage market.





Interest-earning
      deposits held at correspondent banks decreased by $551,000 from $763,000 at
      December 31, 2006 to $212,000 at December 31, 2007. Funds held in
      interest-earning deposit accounts result primarily from the receipt of principal
      and interest from the investment portfolio. As funds accumulate, they are
      reinvested in investment securities or loans.





Non-interest
      earning assets totaled $70.0 million at December 31, 2007, increasing by $4.1
      million or 6% over the past year. The asset experiencing the largest increase
      was bank owned life insurance which grew by $3.4 million during the year. Of
      the
      total increase, $3.1 million represented an additional investment and $339,000
      was attributable to the increase in cash surrender value. Premises and equipment
      experienced a net increase of $2.2 million resulting from the purchase of $2.9
      million in new assets less $695,000 of depreciation expense. Accrued interest
      receivable increased by $716,000 due to the higher volume of earning assets.
      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 $2.3 million from $14.3 million to $12.0
      million. For more details regarding the decrease in cash and cash equivalents,
      see the Consolidated Statements of Cash Flows. Goodwill is the single largest
      asset of total non-earning assets at $30.2 million. Goodwill was not impaired
      at
      December 31, 2007.





Total
      deposits at December 31, 2007 were $605.4 million reflecting a $63.5 million
      or
      12% increase over the $541.9 million reported at year end 2006. Time deposits
      increased the most growing by $49.5 million from $295.7 million to $345.2
      million. Savings accounts grew by $32.1 million or 41% during 2007 to $110.5
      million. In May 2006, the Company introduced a high-yielding statement savings
      account. At its highest balance tier, the new product pays a rate of interest
      higher than either the money market or the relationship-based interest bearing
      checking accounts. While the account was very successful in attracting new
      deposits, there was some shifting of funds from our premium interest-bearing
      checking and money market accounts into the new savings product. As a result,
      both the money market and interest-bearing checking categories experienced
      net
      declines during 2007 with money market account balances decreasing by $11.1
      million to $48.4 million and interest-bearing checking decreasing by $5.9
      million to $31.9 million. Non interest-bearing demand declined by $1.0 million
      from $70.4 million to $69.4 million. The Bank maintains a number of non interest
      and interest-bearing deposit relationships with real estate settlement
      attorneys. Balances in these escrow accounts can fluctuate significantly based
      on the amount of mortgage loan activity. At December 31, 2007, the aggregate
      balance in the real estate settlement accounts was $7.0 million compared to
      $13.1 million at December 31, 2006. The $6.1 million decline in attorney
      balances affected non interest-bearing and interest-bearing deposit categories
      by $3.2 million and $2.9 million, respectively.




28




The
      composition of the deposit base, by category, at December 31, 2007 was as
      follows: 57% in time deposits, 18% in statement savings, 12% in non
      interest-bearing demand deposits, 8% in money market deposits, and 5% in
      interest-bearing deposits. The composition of the deposit base, by category,
      at
      December 31, 2006 was as follows: 55% in time deposits, 14% in savings deposits,
      13% in non interest-bearing demand deposits, 11% in money market deposits,
      and
      7% in interest-bearing demand deposits. The Company experienced significant
      loan
      growth during 2007 and core deposit generation was not able to sustain those
      levels. Therefore, the Company had to rely more heavily on time deposits. While
      the Company has implemented a culture designed to increase the level of non-time
      deposits, we expect that time deposits will continue to play an important role
      in funding the Bank’s asset growth.





At
      December 31, 2007 the Company had $276.6 million in time deposits of $100,000
      or
      more compared to $229.8 million at December 31, 2006. 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. The Company expects to continue to
      utilize the brokered deposit market in the future. Brokered deposits at December
      31, 2007 were $166.6 million compared to $141.7 million at December 31, 2006.





Total
      borrowings increased by 94% or $65.3 million from $69.7 million at December
      31,
      2006 to $135.0 million at December 31, 2007. In the fall of 2007, global credit
      markets contracted as a result of the sub-prime mortgage problems. As a result,
      the use of commercial paper as a short-term funding source disappeared. Many
      large mortgage and financial services companies, who previously had accessed
      the
      commercial paper market to fund their operations, quickly entered the brokered
      deposit market and increased rates significantly in order to meet their needs.
      This was occurring at a time when short-term interest rates were beginning
      to
      fall. The Company shifted its funding strategy from the brokered deposit market
      to FHLB advances. The Company increased borrowing levels at the FHLB
      significantly from late August through November. Borrowings at the FHLB require
      collateralization and historically have not been as financially appealing as
      brokered funds. By mid-November, although rates had not fully adjusted to new
      short-term levels, the Company reverted to funding growth through brokered
      deposits.





Borrowings
      at December 31, 2007 consisted of $113.0 million in long-term FHLB advances,
      $10.0 million in short-term FHLB advances, $8.2 million in junior subordinated
      debt issued to an unconsolidated subsidiary, and $3.8 million in Federal funds
      purchased from a correspondent bank. The adoption of FASB Interpretation Number
      (FIN) 46, *Consolidation
      of Variable Interest Equities,* resulted
      in the deconsolidation of the trust subsidiary, Crescent Financial Capital
      Trust
      I (“Trust”), formed for the purpose of issuing trust preferred securities. As a
      result, the subordinated debt issued to the Trust for the proceeds of the trust
      preferred securities is included in long-term debt. At December 31, 2006, the
      Company had $37.0 million in long-term FHLB advances, $18.0 million in
      short-term FHLB advances, $8.2 million in junior subordinated debt issued to
      an
      unconsolidated subsidiary and $6.5 million in Federal funds purchased from
      a
      correspondent bank.





Accrued
      expenses and other liabilities increased by $152,000 to $3.4 million at December
      31, 2007 compared with $3.3 million at December 31, 2006. The increase is due
      primarily to higher levels of interest-bearing liabilities.





Total
      stockholders’ equity increased by $8.6 million between December 31, 2006 and
      December 31, 2007. The increase was the net result of net income for the year
      of
      $6.2 million, plus $1.7 million in additional capital from the exercise of
      stock
      options, a $539,000 increase in the after-tax value of investment securities
      and
      $179,000 in stock based compensation expense.





**COMPARISON
      OF RESULTS OF OPERATIONS FOR THE YEARS ENDED**


**DECEMBER
      31, 2007 AND 2006**





Net
      Income. Net income for 2007 was $6.2 million compared with $4.9 million for
      the
      prior year, reflecting a $1.3 million or 27% increase in net earnings. Net
      income per diluted share was $0.65 compared to $0.64 for the prior year. The
      percentage increase in earnings per share was not comparable to that of the
      increase in net income because average diluted shares outstanding in 2007 were
      over 2.0 million shares higher than 2006 due in part to the issuance of 2.7
      million shares for the acquisition of PCCB in August 2006. Per share data for
      2006 data has been adjusted for the 10% stock dividend distributed on May 22,
      2007 to shareholders of record on May 11, 2007. The returns on average assets
      at
      December 31, 2007 and 2006 were 0.80% and 0.93%, respectively, and the returns
      on average equity were 7.15% and 8.72%, respectively.





29




Net
      Interest Income. Net interest income increased by $7.2 million or 37% from
      $19.4
      million for the prior year to $26.6 million for the year ended December 31,
      2007. The increase in net interest income was due primarily to significant
      growth in average earning assets.





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 net interest margin for the
      year
      ended December 31, 2007 was 3.72% compared to 3.95% for the prior year. The
      average yield on earning assets for the current period was 7.66% compared to
      7.46% for the prior year and the average cost of interest-bearing funds was
      4.58% compared to 4.17%. The higher funding costs, as reflected in the decline
      in interest rate spread from 3.29% to 3.08%, and the increased reliance on
      interest-bearing liabilities to fund asset growth, as shown by a decline in
      the
      ratio of average interest-earning assets to average interest-bearing liabilities
      from 118.88% to 116.21%, is responsible for the margin compression. There are
      many factors that influence net margin.





The
      Federal Open Market Committee (FOMC) of the Federal Reserve Bank sets monetary
      policy by raising and lowering short-term interest rates. After a two year
      period of rising short-term interest rates, rates stabilized and remained
      unchanged from early July 2006 through mid September 2007. Between mid-September
      2007 and December 31, 2007, the FOMC lowered short-term interest rates on three
      occasions by a total of 100 basis points.





Approximately
      52% of the Company’s loan portfolio carry variable rate pricing based on the
      Prime lending rate or LIBOR (London Inter Bank Offering Rate). As short-term
      rates fell in the later part of 2007, variable rate loans have repriced to
      lower
      rates resulting in a lower yield on average earning assets. Prior to the rate
      cuts, rates on new loans were trending lower based on competitive forces. The
      volume of new loan originations outpaced the generation of lower cost core
      deposits causing the Company to rely more heavily on higher cost savings and
      brokered deposits. This resulted in a higher cost of funds. Furthermore, as
      short-term interest rates began to fall, rates being charged on brokered
      deposits did not respond lower by the same magnitude as other short-term rates.
      The Company expects that rates on brokered deposits will begin to adjust to
      levels more in line with historical relationships to other short-term rates.
      As
      additional rate reductions occur, as expected, the net interest margin will
      continue to experience some compression.





Total
      average interest earning assets were $716.0 million for the year ended December
      31, 2007, increasing by $224.2 million or 46% when compared to an average of
      $491.8 million for the year ended December 31, 2006. Increases in average
      balances by earning asset category are as follows: average loans increased
      by
      $200.7 million or 48% from $414.6 million for 2006 to $615.3 million for 2007,
      investment securities grew by $21.4 million or 30% from $71.2 million for 2006
      to $92.6 million for 2007 and Federal funds sold and other earning assets
      increased $2.0 million or 34% from $6.0 million for 2006 to $8.0 million in
      2007. Total average interest-bearing liabilities increased by $202.4 million
      with interest-bearing deposits increasing by $164.6 million or 46% and
      borrowings increasing by $37.8 million.





Total
      interest income for 2007 increased by $18.2 million to $54.9 million compared
      to
      $36.7 million for the prior year. The increase in total interest income was
      the
      result of a $17.4 million improvement from increased earning asset levels and
      a
      $735,000 increase due to higher rates. Interest income from the loan portfolio
      contributed the largest portion of the increase growing by $16.9 million to
      $50.0 million for the year. Total interest expense grew by $11.0 million, which
      was attributed to a $9.5 million increase from higher interest-bearing liability
      volumes and $1.5 million due to higher interest rates.





Provision
      for Loan Losses. The loan loss provision for 2007 was $1.7 million compared
      to
      $991,000 in the prior year. The increase in the loan loss provision was
      primarily due to the 23% increase in net loan growth. Provisions for loan losses
      are charged to income to bring the allowance for loan losses to a level deemed
      appropriate by management. While net growth in the loan portfolio is the primary
      driver in determining the loan loss provision, there are other factors which
      are
      more fully discussed under the section entitled “Analysis of Allowance for Loan
      Losses.”





30




Non-Interest
      Income. For both years ended December 31, 2007 and 2006, non-interest income
      was
      $2.6 million. Non-interest income from service charges on deposit accounts
      and
      other customer service fees increased by 6% or $73,000. Earnings on cash value
      of life insurance increased by 66% or $151,000. While not to the same extent
      as
      experienced nationally, our markets did have a slowing in home sales activity
      during 2007. Revenue from fees on mortgage loan originations declined by
      $130,000 or 20%. The Company recognized net losses on the disposal of real
      estate owned and other assets of $66,000 in 2007 compared to a gain of $3,000
      in
      2006. Finally, in 2006, we recorded $46,000 in non-recurring revenue from the
      final consideration on the sale of our interest in a mortgage origination
      company in 2005.





Non-Interest
      Expenses. Non-interest expenses increased by 33% or $4.4 million to $17.8
      million for 2007 compared to $13.4 million for the prior year period. The
      increase was due primarily to the acquisition of PCCB. Non-interest expenses
      for
      2007 include a full year of expenses related to our Wilmington operation,
      whereas 2006 non-interest expenses included expenses from September through
      December only. Of the $4.4 million increase, $3.1 million was in personnel,
      occupancy and data processing which are the areas most impacted by the
      acquisition.





Total
      compensation for the year ended December 31, 2007 was $9.9 million reflecting
      a
      35% increase compared to $7.3 million for the year ended December 31, 2006.
      Occupancy expenses were $2.3 million for 2007 compared to $2.0 million in 2006
      increasing by $278,000 or 14%. The Company opened one new full-service branch
      location and relocated another during 2007. During 2006, the Company opened
      one
      new full-service office as well as acquired PCCB in August. We continue to
      look
      for strategic opportunities to expand our branch network.





Data
      processing expenses increased by $223,000 or 27% to $1.1 million compared to
      $834,000 for the prior year. The increase was due to growth in account volumes,
      contractual increases in data processing costs and the additional data line
      expenses for the new offices. Because data processing expense is tied closely
      to
      transaction and account volumes, these expenses should increase as the Company
      continues to grow.





Professional
      fees and services increased by $612,000 or 68% in 2007 to $1.5 million compared
      to $899,000 in 2006. The largest components of professional fees and services
      were directors’ fees, legal expenses, and accounting and audit expenses. The
      Company was subject to Section 404 of Sarbanes-Oxley Act at December 31, 2007
      and incurred significant expense to document, review and test internal controls
      over financial reporting. The FDIC significantly increased deposit insurance
      assessments during 2007. We incurred $148,000 in non-recurring expenses to
      merge
      PCCB’s data processing systems into CSB’s. And finally, we experienced increases
      in the use of professional recruiting services and temporary employment
      staffing.





The
      total
      of all other non-interest expenses for the year ended December 31, 2007 was
      $3.1
      million compared to $2.3 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. The Company’s provision for income taxes for 2007 was $3.5
      million compared to $2.8 million for the prior year. The effective tax rates
      for
      2007 and 2006 were 36.0% and 36.2%, respectively.





**COMPARISON
      OF RESULTS OF OPERATIONS FOR THE YEARS ENDED**


**DECEMBER
      31, 2006 AND 2005**





Net
      Income. For the year ended December 31, 2006, the Company reported an increase
      in net income of 56% to $4.9 million compared to $3.1 million for the year
      ended
      December 31, 2005. Net income per diluted share increased 17% to $0.64 compared
      to $0.55 for the prior year period. The percentage increase in earnings per
      share did not mirror that of the increase in net income primarily due to the
      addition of 2.7 million shares from the acquisition of PCCB. Per share data
      for
      both 2006 and 2005 has been adjusted for the 10% stock dividend distributed
      on
      May 22, 2007 to shareholders of record on May 11, 2007. Returns on average
      assets and average equity were 0.93% and 8.72%, respectively, for the year
      ended
      December 31, 2006 compared to 0.84% and 10.34% for the prior year period.





Net
      Interest Income. Net interest income was $19.4 million for the current year
      compared to $14.0 million for the prior year. The 39% increase in net interest
      income was due primarily to significant growth in average earning
      assets.





31




The
      net
      interest margin for the year ended December 31, 2006 was 3.95% compared to
      3.94%
      for the prior year. The average yield on earning assets for the current period
      was 7.46% compared to 6.45% from the year ended December 31, 2005 and the
      average cost of interest-bearing funds was 4.17% compared to 2.94%. The decline
      in interest rate spread from 3.51% to 3.29% was partially offset by an
      improvement in the ratio of average interest-earning assets to average
      interest-bearing liabilities which increased from 117.14% at December 31, 2005
      to 118.88% at December 31, 2006.





Between
      July 1, 2004 and July 5, 2006, the Federal Reserve (the “Fed”) increased
      short-term interest rates sixteen times for a total of 400 basis points.
      Interest rates stabilized over the last five months of 2006. While several
      factors influence the level of intermediate and long-term interest rates,
      increases in short-term interest rates would generally result in a parallel
      shift in the entire yield curve across all investment horizons. The current
      rate
      increases did not impact intermediate and long-term rates in the typical manner,
      as those rates continued to trade in very tight ranges to levels seen prior
      to
      July 2004. The result has been a flat to inverted yield curve across investment
      terms. In other words, where historically interest rates for ten year terms
      were
      higher than overnight and other short-term investments, the current rate
      environment has short-term interest rates at higher levels than ten year rates.





Approximately
      55% of the Company’s loan portfolio carry variable rate pricing based on the
      Prime lending rate or LIBOR (London Inter Bank Offering Rate). As short-term
      rates have risen, variable rate loans have repriced higher resulting in a higher
      yield on average earning assets. While the yield on the variable portion of
      existing loans was rising with rate increases, rates on new loans were trending
      lower based on competition and new loan mix. Of the $93.0 million in organic
      loan growth, $51.5 million was in the commercial mortgage loan category. Due
      to
      the nature of the collateral and the competitive marketplace, this type of
      loan
      typically receives very favorable fixed-rate pricing based on the intermediate
      to long end of the yield curve. The volume of new loan originations outpaced
      the
      generation of lower cost core deposits causing the Company to rely more heavily
      on savings and brokered certificates of deposit resulting in a higher cost
      of
      funds than we would have anticipated. The Company expects to experience some
      net
      interest margin compression in the current stable rate environment. In rising
      or
      falling interest rate environments, the Company would expect moderate expansion
      or contraction of margin, respectively.





Total
      average interest earning assets were $491.8 million for the year ended December
      31, 2006, increasing by $137.9 million or 39% when compared to an average of
      $353.9 million for the year ended December 31, 2005. Increases in average
      balances by earning asset category are as follows: average loans increased
      by
      $117.6 million or 40% from $297.0 million for 2005 to $414.6 million for 2006,
      investment securities grew by $15.9 million or 29% from $55.3 million for 2005
      to $71.2 million for 2006 and Federal funds sold and other earning assets
      increased from $1.5 million in 2005 to $6.0 million for 2006. Total average
      interest-bearing liabilities increased by $111.6 million with interest-bearing
      deposits increasing by $102.2 million or 40% and borrowings increasing by $9.4
      million.





Total
      interest income for 2006 increased by $13.9 million to $36.7 million compared
      to
      $22.8 million for the prior year. The increase was the result of a $10.0 million
      improvement from increased earning asset levels and a $3.9 million increase
      due
      to the rising interest rate environment. Total interest expense grew by $8.4
      million attributed to a $4.1 million increase from higher interest bearing
      liability volumes and $4.3 million due to higher interest rates.





Provision
      for Loan Losses. The Company’s provision for loan losses for 2006 was $991,000
      compared to $807,000 recorded in the prior year. The increase in the loan loss
      provision was due to the increase in net loan growth. Organic loan growth was
      $93.0 million ($221.5 million total less $128.5 million acquired through PCCB)
      during 2006 compared to $70.9 million in 2005 and net charge-offs for 2006
      were
      $84,000 compared to $124,000 during the prior year. Provisions for loan losses
      are charged to income to bring the allowance for loan losses to a level deemed
      appropriate by management. While net growth in the loan portfolio is the primary
      driver in determining the loan loss provision, there are other factors which
      are
      more fully discussed under the section entitled “Analysis of Allowance for Loan
      Losses.”





Non-Interest
      Income. Non-interest income increased by $195,000 or 8% to $2.6 million for
      2006
      compared to $2.4 million for the prior year period. The largest components
      of
      non-interest income in 2006 were $1,090,000 in customer service fees, $642,000
      in mortgage loan origination fees, $229,000 in earnings on cash value of bank
      owned life insurance and $197,000 in service charges and fees on deposit
      accounts. For the year ended December 31, 2005, the largest components of
      non-interest income included $870,000 in customer service fees, $755,000 in
      mortgage loan origination fees, $226,000 in earnings on cash value of bank
      owned
      life insurance and $175,000 in service charges and fees on deposit accounts.
      The
      Company recognized $16,000 in losses on the disposition of available for sale
      investment securities in 2005.





32




Non-Interest
        Expenses. Non-interest expenses were $13.4 million for year ended December
        31,
        2006 compared to $10.8 million for the prior year period. The $2.6 million
        or
        24% increase reflects the continuing efforts to expand the Company’s
        infrastructure and branch network. Of the $2.6 million increase, $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, 2006 was $7.3 million reflecting
      a
      24% increase when compared to $5.9 million for the year ended December 31,
      2005.
      As of December 31, 2006, the Company employs 122 full-time equivalent employees
      in eleven full-service branch offices, one loan production office and various
      administrative support departments. In comparison, a t
      December 31, 2005, the Company employed 90 full-time equivalent employees in
      nine full-service branch offices and various administrative support departments.





Occupancy
      expenses were $2.0 million for 2006 compared to $1.7 million in 2005 increasing
      by $290,000 or 17%. During 2006, the Company opened one new full-service office
      as well as acquired PCCB in August. During 2005, the Company opened an
      operations facility, one new full-service office, one loan production office
      and
      converted one office from a temporary branch location into a permanent building.
      Additional expansion opportunities will be explored as we identify the bankers
      of choice in other communities.





Data
      processing expenses were $834,000 for 2006 compared to $648,000 for the prior
      year. The 29% increase was due to growth in account volumes, contractual
      increases in data processing costs and the additional data line expenses for
      the
      new offices. Because data processing expense is tied closely to transaction
      and
      account volumes, these expenses should increase as the Company continues to
      grow.





Professional
      fees and services totaled $899,000 in 2006, up $187,000 or 26% over the $712,000
      for 2005. The largest components of professional fees and services were
      directors’ fees, legal expenses, and accounting and audit expenses. In
      anticipation of needing to comply with the provisions of Sarbanes-Oxley Section
      404, the Company spent approximately $80,000 documenting and sample testing
      various major control processes related to financial reporting. The parameters
      and timing to implement Sarbanes-Oxley Section 404 have changed several times
      and the Company was not required, as of December 31, 2006, to provide
      management’s written assessment of the adequacy of its internal controls over
      financial reporting. The Company will need to comply with Section 404 at
      December 31, 2007. The amount budgeted in 2007 for Sarbanes-Oxley compliance
      is
      approximately $100,000.





The
      total
      of all other non-interest expenses for the year ended December 31, 2006 was
      $2.3
      million compared to $1.8 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 2006, the Company’s provision for income taxes was $2.8
      million compared to $1.7 million for the prior year. The effective tax rates
      for
      2006 and 2005 were 36.2% and 34.5%, respectively. The effective tax rate
      increased because the percentage of total income attributable to tax exempt
      sources declined as compared with the prior year period as well as the non-tax
      deductibility of stock based compensation expense of $202,000 in 2006 and none
      in 2005.


33


**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, 2007, 2006 and 2005. The table reflects the average 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 31,2007
            
            2006
            
            2005Average
            
            
            
            Average
            
            Average
            
            
            
            Average
            
            Average
            
            
            
            Averagebalance
            
            Interest
            
            rate
            
            balance
            
            Interest
            
            rate
            
            balance
            
            Interest
            
            rate(Dollars
                in thousands)Interest-earning
                assets:Loan
                portfolio
            
            $
            615,322
            
            $
            50,022
            
            
            8.13
            %
            $
            414,644
            
            $
            33,093
            
            
            7.98
            %
            $
            297,045
            
            $
            20,456
            
            
            6.89
            %Investment
                securities
            
            
            92,629
            
            
            4,454
            
            
            4.81
            %
            
            71,151
            
            
            3,303
            
            
            4.64
            %
            
            55,285
            
            
            2,323
            
            
            4.20
            %Federal
                funds and other interest-earning assets
            
            
            8,015
            
            
            396
            
            
            4.94
            %
            
            5,996
            
            
            310
            
            
            5.17
            %
            
            1,531
            
            
            47
            
            
            3.07
            %Total
                interest-earning assets
            
            
            715,966
            
            
            54,872
            
            
            7.66
            %
            
            491,791
            
            
            36,706
            
            
            7.46
            %
            
            353,861
            
            
            22,826
            
            
            6.45
            %Non-interest-earning
                assets
            
            
            61,425
            
            
            
            
            
            
            
            
            36,654
            
            
            
            
            
            
            
            
            22,465Total
                assets
            
            $
            777,391
            
            
            
            
            
            
            
            $
            528,445
            
            
            
            
            
            
            
            $
            376,326Interest-bearing
                liabilities:Deposits:Interest-bearing
                NOW
            
            $
            33,453
            
            
            324
            
            
            0.97
            %
            $
            37,876
            
            
            553
            
            
            1.46
            %
            $
            39,609
            
            
            416
            
            
            1.05
            %Money
                market and savings
            
            
            163,321
            
            
            6,536
            
            
            4.00
            %
            
            92,620
            
            
            3,664
            
            
            3.96
            %
            
            46,500
            
            
            985
            
            
            2.12
            %Time
                deposits
            
            
            325,243
            
            
            16,569
            
            
            5.09
            %
            
            226,978
            
            
            9,990
            
            
            4.40
            %
            
            169,099
            
            
            5,483
            
            
            3.24
            %Short-term
                borrowings
            
            
            16,398
            
            
            830
            
            
            5.06
            %
            
            16,318
            
            
            844
            
            
            5.17
            %
            
            12,239
            
            
            475
            
            
            3.88
            %Long-term
                debt
            
            
            77,670
            
            
            3,958
            
            
            5.10
            %
            
            39,906
            
            
            2,206
            
            
            5.53
            %
            
            34,626
            
            
            1,513
            
            
            4.37
            %Total
                interest-bearing liabilities
            
            
            616,085
            
            
            28,217
            
            
            4.58
            %
            
            413,698
            
            
            17,257
            
            
            4.17
            %
            
            302,073
            
            
            8,872
            
            
            2.94
            %Other
                liabilities
            
            
            73,899
            
            
            
            
            
            
            
            
            58,542
            
            
            
            
            
            
            
            
            43,843Total
                liabilities
            
            
            689,984
            
            
            
            
            
            
            
            
            472,240
            
            
            
            
            
            
            
            
            345,916Stockholders’
                equity
            
            
            87,407
            
            
            
            
            
            
            
            
            56,205
            
            
            
            
            
            
            
            
            30,410Total
                liabilities and stockholders’ equity
            
            $
            777,391
            
            
            
            
            
            
            
            $
            528,445
            
            
            
            
            
            
            
            $
            376,326Net
                interest income and interest rate spread
            
            
            
            
            $
            26,655
            
            
            3.08
            %
            
            
            
            $
            19,449
            
            
            3.29
            %
            
            
            
            $
            13,954
            
            
            3.51
            %Net
                interest margin
            
            
            
            
            
            
            
            
            3.72
            %
            
            
            
            
            
            
            
            3.95
            %
            
            
            
            
            
            
            
            3.94
            %Ratio
                of average interest-earning assets to average interest- bearing
                liabilities
            
            
            116.21
            %
            
            
            
            
            
            
            
            118.88
            %
            
            
            
            
            
            
            
            117.14
            %




34




**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, 2007 vs. 2006
            
            December
                31, 2006 vs. 2005Increase
                (Decrease) Due to
            
            Increase
                (Decrease) Due toVolume
            
            Rate
            
            Total
            
            Volume
            
            Rate
            
            Total(Dollars
                in thousands)Interest
                income:Loan
                portfolio
            
            $
            16,303
            
            $
            626
            
            $
            16,929
            
            $
            9,017
            
            $
            3,620
            
            $
            12,637Investment
                securities
            
            
            1,029
            
            
            122
            
            
            1,151
            
            
            718
            
            
            262
            
            
            980Federal
                funds and other interest-earning assets
            
            
            99
            
            
            (13
            )
            
            86
            
            
            213
            
            
            50
            
            
            263Total
                interest income
            
            
            17,431
            
            
            735
            
            
            18,166
            
            
            9,948
            
            
            3,932
            
            
            13,880Interest
                expense:Deposits:Interest-bearing
                NOW
            
            
            (59
            )
            
            (170
            )
            
            (229
            )
            
            (17
            )
            
            154
            
            
            137Money
                market and savings
            
            
            2,829
            
            
            43
            
            
            2,872
            
            
            1,429
            
            
            1,250
            
            
            2,679Time
                deposits
            
            
            4,824
            
            
            1,755
            
            
            6,579
            
            
            2,205
            
            
            2,302
            
            
            4,507Short-term
                borrowings
            
            
            4
            
            
            (18
            )
            
            (14
            )
            
            184
            
            
            185
            
            
            369Long-term
                debt
            
            
            1,909
            
            
            (157
            )
            
            1,752
            
            
            253
            
            
            440
            
            
            693Total
                interest expense
            
            
            9,507
            
            
            1,453
            
            
            10,960
            
            
            4,054
            
            
            4,331
            
            
            8,385Net
                interest income increase (decrease)
            
            $
            7,924
            
            $
            (718
            )
            $
            7,206
            
            $
            5,894
            
            $
            (399
            )
            $
            5,495





**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 collectibility 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, 2007, we identified 13 loans in
      the
      aggregate amount of $1.2 million as potential problem loans. The loans possess
      certain unfavorable characteristics which cause management some concern. These
      loans will continue to be closely monitored. At December 31, 2006, we identified
      six loans in the aggregate amount of $857,000 as potential problem loans.





35




At
      December 31, 2007, there were four foreclosed properties valued at $272,000
      and
      twelve nonaccrual loans totaling $2.7 million. Foreclosed property is valued
      at
      the lower of appraised value or the outstanding loan balance. Interest foregone
      on nonaccrual loans for the year ended December 31, 2007 was approximately
      $73,700. At December 31, 2006, there were four foreclosed properties valued
      at
      $98,000 and two nonaccrual loans totaling $135,000. Interest foregone on
      nonaccrual loans for the year ended December 31, 2006 was approximately $9,900.
      There were no loans at December 31, 2007 or 2006 that were 90 days or more
      past
      due and still accruing interest. There were no repossessed assets at December
      31, 2007 or 2006.





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 31,2007
            
            2006
            
            2005
            
            2004
            
            2003(Dollars
                in thousands)Nonaccrual
                loans
            
            $
            2,726
            
            $
            135
            
            $
            26
            
            $
            5
            
            $
            159Restructured
                loans
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -Total
                nonperforming loans
            
            
            2,726
            
            
            135
            
            
            26
            
            
            5
            
            
            159Real
                estate owned
            
            
            272
            
            
            98
            
            
            22
            
            
            245
            
            
            -Repossessed
                assets
            
            
            -
            
            
            -
            
            
            -
            
            
            48
            
            
            -Total
                nonperforming assets
            
            $
            2,998
            
            $
            233
            
            $
            48
            
            $
            298
            
            $
            159Accruing
                loans past due 90 days or more
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            647Allowance
                for loan losses
            
            
            8,273
            
            
            6,945
            
            
            4,351
            
            
            3,668
            
            
            3,304Nonperforming
                loans to period end loans
            
            
            0.40
            %
            
            0.02
            %
            
            0.01
            %
            
            0.00
            %
            
            0.07
            %Nonperforming
                loans and loans past due 90 days or more to period end
                loans
            
            
            0.40
            %
            
            0.02
            %
            
            0.01
            %
            
            0.00
            %
            
            0.37
            %Allowance
                for loan losses to period end loans
            
            
            1.22
            %
            
            1.26
            %
            
            1.33
            %
            
            1.42
            %
            
            1.52
            %Allowance
                for loan losses to nonperforming loans
            
            
            303.45
            %
            
            5,144.96
            %
            
            16,960.60
            %
            
            73,360.00
            %
            
            2,077.99
            %Allowance
                for loan losses to nonperforming loans and loans past due 90 days
                or
                more
            
            
            303.45
            %
            
            5,144.96
            %
            
            16,960.60
            %
            
            73,360.00
            %
            
            409.93
            %Nonperforming
                assets to total assets
            
            
            0.36
            %
            
            0.03
            %
            
            0.01
            %
            
            0.09
            %
            
            0.06
            %Nonperformingassets
                and loanspast
                due 90 days or more to total assets
            
            
            0.36
            %
            
            0.03
            %
            
            0.01
            %
            
            0.09
            %
            
            0.29
            %


36


**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. Using the various evaluation factors
      mentioned above, management predetermined allowance percentages for each risk
      class within each loan category. The total aggregate balance of loans in each
      risk class is multiplied by the associated allowance percentage to determine
      an
      adequate level of allowance for loan losses.





Those
      loans that are identified through the Company’s internal loan grading system as
      possessing characteristics which in the opinion of management suggest the
      highest degree of inherent risk are evaluated individually in accordance with *Statement
      of Financial Accounting Standards (SFAS) 114,*  *Accounting
      by Creditors for Impairment of a Loan* .
      Each
      loan is analyzed to determine the net value of collateral, probability of
      charge-off and finally a potential estimate of loss. Loans meeting the criteria
      for individual evaluation are specifically reserved for based on management’s
      analysis.





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
      primary reason for increases to the allowance for loan losses has been growth
      in
      total outstanding loans, however, there were other factors influencing the
      provision. Other factors influencing the level of the allowance of loan losses
      included the volume of net charge-offs experienced through the year and the
      current level of nonperforming loans. At or for the year ended December 31,
      2007, there were $356,000 in net loan charge-offs and $2.7 million in
      non-accrual loans compared with $84,000 in net loan charge-offs and $135,000
      in
      nonaccrual loans at or for the year ended December 31, 2006. The allowance
      for
      loan losses at December 31, 2007 was $8.3 million, which represents 1.22% of
      total outstanding loans compared to $6.9 million and 1.26% for the prior year.





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.





37




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





At
                December 31,2007
            
            2006
            
            2005Amount
            
            %
                of Total
              Loans
                (1)
            
            Amount
            
            %
                of Total
              Loans
                (1)
            
            Amount
            
            %
                of Total
              Loans
                (1)(Dollars
                in thousands)Real
                estate - commercial
            
            $
            3,771
            
            
            51.85
            %
            $
            3,920
            
            
            55.36
            %
            $
            1,876
            
            
            52.92
            %Real
                estate - residential
            
            
            130
            
            
            2.70
            %
            
            121
            
            
            3.67
            %
            
            90
            
            
            4.54
            %Construction
                loans
            
            
            2,362
            
            
            27.18
            %
            
            1,379
            
            
            19.99
            %
            
            735
            
            
            14.17
            %Commercial
                and industrial loans
            
            
            1,536
            
            
            10.77
            %
            
            1,161
            
            
            12.32
            %
            
            1,138
            
            
            16.03
            %Home
                equity loans and lines of credit
            
            
            334
            
            
            6.69
            %
            
            269
            
            
            7.76
            %
            
            201
            
            
            10.62
            %Loans
                to individuals
            
            
            140
            
            
            0.81
            %
            
            95
            
            
            0.90
            %
            
            311
            
            
            1.72
            %Total
                allowance
            
            $
            8,273
            
            
            100.00
            %
            $
            6,945
            
            
            100.00
            %
            $
            4,351
            
            
            100.00
            %




At
                December 31,2004
            
            2003Amount
            
            %
                of Total Loans (1)
            
            Amount
            
            %
                of Total Loans (1)(Dollars
                in thousands)Real
                estate - commercial
            
            $
            1,290
            
            
            47.24
            %
            $
            1,330
            
            
            46.66
            %Real
                estate - residential
            
            
            44
            
            
            4.50
            %
            
            54
            
            
            6.80
            %Construction
                loans
            
            
            718
            
            
            15.09
            %
            
            778
            
            
            14.56
            %Commercial
                and industrial loans
            
            
            1,105
            
            
            18.90
            %
            
            841
            
            
            17.61
            %Home
                equity loans and lines of credit
            
            
            173
            
            
            12.00
            %
            
            115
            
            
            10.59
            %Loans
                to individuals
            
            
            338
            
            
            2.27
            %
            
            186
            
            
            3.78
            %Total
                allowance
            
            $
            3,668
            
            
            100.00
            %
            $
            3,304
            
            
            100.00
            %




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


38


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





At
                or for the Year Ended December 31,2007
            
            2006
            
            2005
            
            2004
            
            2003(Dollars
                in thousands)Balance
                at beginning of period
            
            $
            6,945
            
            $
            4,351
            
            $
            3,668
            
            $
            3,304
            
            $
            1,711Charge-offs:Construction
                loans
            
            
            -
            
            
            -
            
            
            -
            
            
            15
            
            
            27Commercial
                real estate
            
            
            213
            
            
            -
            
            
            34
            
            
            21
            
            
            -Commercial
                and industrial loans
            
            
            89
            
            
            14
            
            
            140
            
            
            345
            
            
            59Residential
                real estate
            
            
            45
            
            
            64
            
            
            -
            
            
            34
            
            
            -Loans
                to individuals
            
            
            15
            
            
            8
            
            
            9
            
            
            16
            
            
            13Total
                charge-offs
            
            
            362
            
            
            86
            
            
            183
            
            
            431
            
            
            99Recoveries:Commercial
                and industrial loans
            
            
            5
            
            
            1
            
            
            22
            
            
            57
            
            
            4Construction
                loans
            
            
            -
            
            
            -
            
            
            27
            
            
            -
            
            
            -Loans
                to individuals
            
            
            1
            
            
            1
            
            
            10
            
            
            2
            
            
            8Total
                recoveries
            
            
            6
            
            
            2
            
            
            59
            
            
            59
            
            
            12Net
                charge-offs
            
            
            356
            
            
            84
            
            
            124
            
            
            372
            
            
            87Allowance
                acquired from Port City Capital Bank merger
            
            
            -
            
            
            1,687
            
            
            -
            
            
            -
            
            
            -Allowance
                acquired from Centennial Bank merger
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            1,129Provision
                for loan losses
            
            
            1,684
            
            
            991
            
            
            807
            
            
            736
            
            
            551Balance
                at the end of the year
            
            $
            8,273
            
            $
            6,945
            
            $
            4,351
            
            $
            3,668
            
            $
            3,304Total
                loans outstanding at year-end
            
            $
            675,916
            
            $
            549,819
            
            $
            328,322
            
            $
            257,908
            
            $
            217,128Average
                loans outstanding for the year
            
            $
            615,322
            
            $
            414,644
            
            $
            297,045
            
            $
            240,346
            
            $
            160,134Allowance
                for loan losses to loans outstanding
            
            
            1.22
            %
            
            1.26
            %
            
            1.33
            %
            
            1.42
            %
            
            1.52
            %Ratio
                of net loan charge-offs to average loans outstanding
            
            
            0.06
            %
            
            0.02
            %
            
            0.04
            %
            
            0.15
            %
            
            0.05
            %





**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. 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.





39




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





At
                December 31, 2007
            
            At
                December 31, 2006
            
            At
                December 31, 2005Amortized
              cost
            
            Fair
              value
            
            Amortized
              cost
            
            Fair
              value
            
            Amortized
              cost
            
            Fair
              value(In
                thousands)Securities
                available for sale:U.S.
                government securities and obligations of U.S. government
                agencies
            
            $
            8,364
            
            $
            8,312
            
            $
            7,493
            
            $
            7,385
            
            $
            5,945
            
            $
            5,793Mortgage-backed
                securities
            
            
            56,986
            
            
            57,234
            
            
            54,949
            
            
            54,274
            
            
            35,042
            
            
            34,147Municipal
            
            
            24,810
            
            
            24,695
            
            
            22,321
            
            
            22,182
            
            
            15,173
            
            
            15,110Other
            
            
            536
            
            
            517
            
            
            779
            
            
            882
            
            
            500
            
            
            500Total
                securities available for sale
            
            $
            90,696
            
            $
            90,758
            
            $
            85,542
            
            $
            84,723
            
            $
            56,660
            
            $
            55,550








**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, 2007, liquid assets (cash and due from banks, interest-earning
      deposits with banks, federal funds sold and investment securities available
      for
      sale) were approximately $109.9 million, which represents 13% of total assets
      and 18% of total deposits. Supplementing this liquidity, the Company has
      available lines of credit from various correspondent banks of approximately
      $220.1 million of which $126.8 million was outstanding. At December 31, 2007,
      outstanding commitments for undisbursed lines of credit and letters of credit
      amounted to $176.0 million. 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 57% of the Company’s total deposits at
      December 31, 2007. The Company’s growth strategy will include efforts focused at
      increasing the relative volume of transaction deposit accounts. Certificates
      of
      deposit of $100,000 or more represented 42% 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, 2007,
      the Company’s equity to asset ratio was 10.97%. All capital ratios place the
      subsidiary 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, 2007 was 9.19%.





**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”).





40




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, 2007 and 2006, 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.





41





Net
                Interest Income at Risk(dollars
                in thousands)
            
            Estimated
                Exposure toNet
                Interest IncomeRate
                change
            
            2007
            
            2006+200
                basis points shock
            
            $
            1,534
            
            $
            1,925-200
                basis point shock
            
            
            (2,175
            )
            
            (1,285
            )+200
                basis point ramp
            
            
            1,448
            
            
            1,320-200
                basis point ramp
            
            
            (1,584
            )
            
            (741
            )




**Net
      Economic Value of Equity Analysis.** The
      following table presents estimated EVE exposures, calculated as of December
      31,
      2007 and 2006, 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 toNet
                Economic Value of Equity(dollars
                in thousands)Rate
                Change
            
            2007
            
            2006+100
                basis point shock
            
            $
            (257
            )
            $
            (1,949
            )-100
                basis point shock
            
            
            (1,180
            )
            
            473+200
                basis point shock
            
            
            (3,114
            )
            
            (4,219
            )-200
                basis point shock
            
            
            (3,674
            )
            
            (973
            )




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, 2007 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.




42




Terms
                to Repricing at December 31, 20071
                Year
              or
                Less
            
            More
                Than
              1
                Year to
              3
                Years
            
            More
                Than
              3
                Years to
              5
                Years
            
            More
                Than
              5
                Years
            
            Total(Dollars
                in thousands)INTEREST-EARNING
                ASSETS:Loans
                receivable:Commercial
                mortgage loans
            
            $
            150,203
            
            $
            92,725
            
            $
            89,075
            
            $
            18,958
            
            $
            350,961Residential
                mortgage loans
            
            
            9,403
            
            
            6,449
            
            
            2,167
            
            
            238
            
            
            18,257Construction
                and development
            
            
            159,684
            
            
            8,186
            
            
            5,721
            
            
            10,428
            
            
            184,019Commercial
                and industrial loans
            
            
            57,814
            
            
            10,848
            
            
            3,969
            
            
            299
            
            
            72,930Home
                equity lines and loans
            
            
            42,897
            
            
            699
            
            
            1,510
            
            
            152
            
            
            45,258Loans
                to individuals
            
            
            3,881
            
            
            1,190
            
            
            416
            
            
            2
            
            
            5,489Interest-earning
                deposits with banks
            
            
            212
            
            
            -
            
            
            -
            
            
            -
            
            
            212Fed
                funds sold
            
            
            97
            
            
            -
            
            
            -
            
            
            -
            
            
            97Investment
                securities available for sale
            
            
            21,932
            
            
            24,786
            
            
            16,538
            
            
            27,502
            
            
            90,758Federal
                Home Loan Bank stock
            
            
            6,791
            
            
            -
            
            
            -
            
            
            -
            
            
            6,791Total
                interest-earning assets
            
            $
            452,914
            
            $
            144,883
            
            $
            119,396
            
            $
            57,579
            
            $
            774,772INTEREST-BEARING
                LIABILITIES:Deposits:Money
                market, NOW and savings
            
            $
            190,832
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            190,832Time
            
            
            221,412
            
            
            114,805
            
            
            9,014
            
            
            -
            
            
            345,231Short-term
                borrowings
            
            
            10,000
            
            
            -
            
            
            -
            
            
            -
            
            
            10,000Long-term
                borrowings
            
            
            55,000
            
            
            36,000
            
            
            10,000
            
            
            12,000
            
            
            113,000Total
                interest-bearing liabilities
            
            $
            477,244
            
            $
            150,805
            
            $
            19,014
            
            $
            12,000
            
            $
            659,063INTEREST
                SENSITIVITY GAP PER PERIOD
            
            $
            (24,330
            )
            $
            (5,922
            )
            $
            100,382
            
            $
            45,579
            
            $
            115,709CUMULATIVE
                  INTEREST SENSITIVITYGAP
            
            $
            (24,330
            )
            $
            (30,252
            )
            $
            70,130
            
            $
            115,709
            
            $
            115,709CUMULATIVE
                GAP AS A PERCENTAGE OF TOTAL INTEREST-EARNING ASSETS
            
            
            (3.14
            )%
            
            (3.90
            )%
            
            9.05
            %
            
            14.93
            %
            
            14.93
            %CUMULATIVE
                INTEREST-EARNING ASSETS AS A PERCENTAGE OF CUMULATIVE INTEREST-BEARING
                LIABILITIES
            
            
            94.90
            %
            
            95.18
            %
            
            110.84
            %
            
            117.56
            %
            
            117.56
            %


43


**CRITICAL
      ACCOUNTING POLICY**





The
      Company's most significant critical accounting policy is the determination
      of
      its allowance for loan losses. 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. Refer to the discussion within Analysis of Allowance for Loan Losses
      and Note B to the consolidated financial statements for comprehensive discussion
      regarding this accounting policy.





**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.





Quarterly
      Financial Data


(dollars
      in thousands, except per share data)





Year
                Ended December 31, 2007
            
            Year
                Ended December 31, 2006FourthQuarter
            
            ThirdQuarter
            
            SecondQuarter
            
            FirstQuarter
            
            FourthQuarter
            
            ThirdQuarter
            
            SecondQuarter
            
            FirstQuarterOperating
                Data:Total
                interest income
            
            $
            14,418
            
            $
            14,095
            
            $
            13,602
            
            $
            12,757
            
            $
            12,288
            
            $
            9,522
            
            $
            7,794
            
            $
            7,101Total
                interest expense
            
            
            7,385
            
            
            7,286
            
            
            7,033
            
            
            6,513
            
            
            6,044
            
            
            4,608
            
            
            3,578
            
            
            3,027Net
                interest income
            
            
            7,033
            
            
            6,809
            
            
            6,569
            
            
            6,244
            
            
            6,244
            
            
            4,914
            
            
            4,216
            
            
            4,074Provision
                for loan losses
            
            
            337
            
            
            666
            
            
            322
            
            
            359
            
            
            374
            
            
            182
            
            
            164
            
            
            270Net
                interest income after provision
            
            
            6,696
            
            
            6,143
            
            
            6,247
            
            
            5,885
            
            
            5,870
            
            
            4,732
            
            
            4,052
            
            
            3,804Non-interest
                income
            
            
            655
            
            
            690
            
            
            647
            
            
            629
            
            
            701
            
            
            695
            
            
            619
            
            
            596Non-interest
                expense
            
            
            4,577
            
            
            4,402
            
            
            4,623
            
            
            4,220
            
            
            3,979
            
            
            3,432
            
            
            3,104
            
            
            2,871Income
                before income taxes
            
            
            2,774
            
            
            2,431
            
            
            2,271
            
            
            2,294
            
            
            2,592
            
            
            1,995
            
            
            1,567
            
            
            1,529Provision
                for income taxes
            
            
            1,002
            
            
            868
            
            
            823
            
            
            828
            
            
            949
            
            
            721
            
            
            564
            
            
            547Net
                income
            
            $
            1,772
            
            $
            1,563
            
            $
            1,448
            
            $
            1,466
            
            $
            1,643
            
            $
            1,274
            
            $
            1,003
            
            $
            982Securities
                gains/(losses)
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -Per
                Share Data:Earnings
                per share- basic
            
            $
            0.19
            
            $
            0.17
            
            $
            0.16
            
            $
            0.16
            
            $
            0.18
            
            $
            0.17
            
            $
            0.16
            
            $
            0.15Earnings
                per share - diluted
            
            
            0.18
            
            
            0.16
            
            
            0.15
            
            
            0.15
            
            
            0.17
            
            
            0.16
            
            
            0.15
            
            
            0.15




**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 N to the consolidated
      financial statements for more information regarding these commitments and
      contingent liabilities.


44


**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.


45


**ITEM
      8 –
      FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**





***CRESCENT
      FINANCIAL CORPORATION AND SUBSIDIARY***




***CONSOLIDATED
      FINANCIAL STATEMENTS***





***Years
      Ended December 31, 200*** **7*,**2006
      and 2005***


46


CRESCENT
      FINANCIAL CORPORATION AND SUBSIDIARIES


INDEX
      TO THE CONSOLIDATED FINANCIAL ST ATEMENTS




Page
                No.Reports
                of Independent Registered Public Accounting Firm
            48Consolidated
                Balance Sheets as of December 31, 2007 and 2006
            51Consolidated
                Statements of Operations for the years ended December 31, 2007, 2006
                and
                2005
            52Consolidated
                Statements of Changes in Stockholders’ Equity for the years ended December
                31, 2007, 2006 and 2005
            53Consolidated
                Statements of Cash Flows for the years ended December 31, 2007, 2006
                and
                2005
            54Notes
                to Consolidated Financial Statements
            55




47





crescent Logo




**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 c onsolidated balance
      sheets of Crescent Financial Corporation and Subsidiary as of December 31,
      2007
      and 2006, and the related c onsolidated statements of operations, changes in stockholders’ equity and cash flows for
      each of the years in the three-year period ended December 31, 2007. 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. An audit includes examining,
      on a
      test basis, evidence supporting the amounts and disclosures in the financial
      statements. An audit also includes assessing the accounting principles used
      and
      significant estimates made by management, as well as evaluating the overall
      financial statement presentation. We believe that our audits provide a
      reasonable basis for our opinion.





In
      our
      opinion, the c onsolidated financial statements referred to above present fairly, in all material respects,
      the financial position of Crescent Financial Corporation and Subsidiary at
      December 31, 2007 and 2006 and the results of their operations and their cash
      flows for each of the years in the three-year period ended December 31, 2007
      in
      conformity with accounting principles generally accepted in the United States
      of
      America.





We
      have
      also audited, in accordance with the standards of the Public Company Accounting
      Oversight Board (United States), the effectiveness of Crescent Financial
      Corporation’s internal control over financial reporting as of December 31, 2007,
      based on criteria established in *Internal
      Control - Integrated Framework* issued
      by the Committee of Sponsoring Organizations of the Treadway Commission, and
      our
      report dated March 10, 2008 expressed an unqualified opinion on the
      effectiveness of the Company’s internal control over financial
      reporting.





crescent Logo


*Raleigh,
      North Carolina*


*March
      10, 2008*




*See
      accompanying notes.*




48




crescentlogo




**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**





To
      the
      Board of Directors and Stockholders


Crescent
      Financial Corporation





We
      have
      audited Crescent Financial Corporation and Subsidiary (the “Company”)’s internal
      control over ** financial
      reporting as of December 31, 2007, based on criteria established in *Internal Control—Integrated Framework* issued
      by
      the Committee of Sponsoring Organizations of the Treadway Commission. The
      Company’s management is responsible for maintaining effective internal control
      over ** financial
      reporting and for its assessment of the effectiveness of internal control
      over ** financial
      reporting, included in the accompanying Management’s Annual Report on Internal
      Control Over Financial Reporting. Our responsibility is to express an opinion
      on
      the Company's internal control over ** financial
      reporting based on our audit.





We
      conducted our audit in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether effective
      internal control over financial reporting was maintained in all material
      respects. Our audit included obtaining an understanding of internal control
      over
      financial reporting, assessing the risk that a material weakness exists, and
      testing and evaluating the design and operating effectiveness of internal
      control based on the assessed risk. Our audit also included, performing such
      other procedures as we considered necessary in the circumstances. We believe
      that our audit provides a reasonable basis for our opinion.





A
      company'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 generally accepted accounting principles. A company's internal control
      over
      financial reporting includes those policies and procedures that (1) pertain
      to
      the maintenance of records that, in reasonable detail, accurately and fairly
      reflect the transactions and dispositions of the assets of the company; (2)
      provide reasonable assurance that transactions are recorded as necessary to
      permit preparation of financial statements in accordance with generally accepted
      accounting principles, and that receipts and expenditures of the company are
      being made only in accordance with authorizations of management and directors
      of
      the company; and (3) provide reasonable assurance regarding prevention or timely
      detection of unauthorized acquisition, use, or disposition of the company's
      assets that could have a material effect on the financial
      statements.





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.





49





In
      our
      opinion, Crescent Financial Corporation and Subsidiary maintained, in all
      material respects, effective internal control over financial reporting as of
      December 31, 2007, based on criteria established in *Internal
      Control—Integrated Framework* issued
      by
      the Committee of Sponsoring Organizations of the Treadway
      Commission.





We
      have
      also audited, in accordance with the standards of the Public Company Accounting
      Oversight Board (United States), the consolidated financial statements of
      Crescent Financial Corporation and Subsidiary as of and for the year ended
      December, 31, 2007, and our report dated March 10, 2008, expressed an
      unqualified opinion on those consolidated financial statements.





crescent Logo


*Raleigh,
      North Carolina*


*March
      10, 2008*




*See
      accompanying notes.*





50




***CRESCENT
      FINANCIAL CORPORATION AND SUBSIDIARY***


***CONSOLIDATED
      BALANCE SHEETS***


***December
      31, 200*** **7
      *and 2006***





**ASSETS**
            
            **2007**
            
            **2006**Cash
                and due from banks
            
            $
            12,047,600
            
            $
            14,295,053Interest-earning
                deposits with banks
            
            
            211,804
            
            
            763,057Federal
                funds sold
            
            
            97,000
            
            
            92,000Investment
                securities available for sale, at fair value (Note C)
            
            
            90,758,467
            
            
            84,722,892Loans
                (Note D)
            
            
            675,916,228
            
            
            549,818,548Allowance
                for loan losses (Note D)
            
            
            (8,273,000
            )
            
            (6,945,000
            )NET
                LOANS
            
            
            667,643,228
            
            
            542,873,548Accrued
                interest receivable
            
            
            3,761,600
            
            
            3,045,840Federal
                Home Loan Bank stock, at cost
            
            
            6,790,700
            
            
            3,582,800Bank
                premises and equipment (Note E)
            
            
            8,094,521
            
            
            5,907,664Investment
                in life insurance
            
            
            9,122,697
            
            
            5,683,493Goodwill
            
            
            30,233,049
            
            
            30,225,549Other
                assets
            
            
            6,779,390
            
            
            6,717,324TOTAL
                ASSETS
            
            $
            835,540,056
            
            $
            697,909,220**LIABILITIES
                AND STOCKHOLDERS’ EQUITY**Deposits:Demand
            
            $
            69,367,630
            
            $
            70,420,392Savings
            
            
            110,516,217
            
            
            78,379,431Money
                market and NOW
            
            
            80,316,251
            
            
            97,343,128Time
                (Note F)
            
            
            345,231,215
            
            
            295,738,729TOTAL
                DEPOSITS
            
            
            605,431,313
            
            
            541,881,680Short-term
                borrowings (Note G)
            
            
            13,755,000
            
            
            24,451,000Long-term
                debt (Note G)
            
            
            121,248,000
            
            
            45,248,000Accrued
                expenses and other liabilities
            
            
            3,446,931
            
            
            3,294,562TOTAL
                LIABILITIES
            
            
            743,881,244
            
            
            614,875,242Commitments
                (Notes D, H and N)Stockholders’
                Equity (Note P)Common
                stock, $1 par value, 20,000,000 shares authorized; 9,404,579 shares
                and
                8,265,136 shares issued and outstanding at December 31, 2007 and
                2006,
                respectively
            
            
            9,404,579
            
            
            8,265,136Additional
                paid-in capital
            
            
            73,596,427
            
            
            62,659,201Retained
                earnings
            
            
            8,619,617
            
            
            12,610,588Accumulated
                other comprehensive income/(loss)
            
            
            38,189
            
            
            (500,947
            )TOTAL
                STOCKHOLDERS’ EQUITY
            
            
            91,658,812
            
            
            83,033,978TOTAL
                LIABILITIES AND STOCKHOLDERS’ EQUITY
            
            $
            835,540,056
            
            $
            697,909,220




*See
        accompanying notes.*


51





***CRESCENT
      FINANCIAL CORPORATION AND SUBSIDIARY***


***CONSOLIDATED
      STATEMENTS OF OPERATIONS***


***Years
      Ended December 31, 200*** **7*,**2006
      and 2005***





2007
            
            2006
            
            2005INTEREST
                AND FEE INCOMELoans
            
            $
            50,022,082
            
            $
            33,093,487
            
            $
            20,456,115Investment
                securities available for sale
            
            
            4,453,955
            
            
            3,302,639
            
            
            2,323,232Interest-earning
                deposits with banks
            
            
            38,161
            
            
            23,837
            
            
            15,298Federal
                funds sold
            
            
            357,878
            
            
            286,473
            
            
            31,948TOTAL
                INTEREST AND FEE INCOME
            
            
            54,872,076
            
            
            36,706,436
            
            
            22,826,593INTEREST
                EXPENSEMoney
                market, NOW and savings deposits
            
            
            6,860,622
            
            
            4,216,641
            
            
            1,401,267Time
                deposits
            
            
            16,568,529
            
            
            9,989,995
            
            
            5,483,116Short-term
                borrowings
            
            
            830,302
            
            
            843,995
            
            
            474,665Long-term
                debt
            
            
            3,957,782
            
            
            2,206,229
            
            
            1,513,180TOTAL
                INTEREST EXPENSE
            
            
            28,217,235
            
            
            17,256,860
            
            
            8,872,228NET
                INTEREST INCOME
            
            
            26,654,841
            
            
            19,449,576
            
            
            13,954,365PROVISION
                FOR LOAN LOSSES (Note D)
            
            
            1,684,219
            
            
            990,786
            
            
            806,796NET
                INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
            
            
            24,970,622
            
            
            18,458,790
            
            
            13,147,569NON-INTEREST
                INCOMEMortgage
                origination revenue
            
            
            512,152
            
            
            642,188
            
            
            755,300Fees
                on deposit accounts
            
            
            1,360,301
            
            
            1,287,476
            
            
            1,044,771Earnings
                on life insurance
            
            
            379,927
            
            
            228,573
            
            
            226,156Gain
                (loss) on sale of securities
            
            
            -
            
            
            -
            
            
            (16,422
            )Gain
                (loss) on sale or disposal of assets
            
            
            (65,685
            )
            
            2,782
            
            
            (13,000
            )Other
                (Note J)
            
            
            434,163
            
            
            450,873
            
            
            420,407TOTAL
                NON-INTEREST INCOME
            
            
            2,620,858
            
            
            2,611,892
            
            
            2,417,212NON-INTEREST
                EXPENSESalaries
                and employee benefits
            
            
            9,875,748
            
            
            7,307,183
            
            
            5,904,586Occupancy
                and equipment
            
            
            2,295,675
            
            
            2,018,079
            
            
            1,728,366Data
                processing
            
            
            1,055,640
            
            
            833,923
            
            
            647,685Other
                (Note J)
            
            
            4,595,461
            
            
            3,227,363
            
            
            2,480,871TOTAL
                NON-INTEREST EXPENSE
            
            
            17,822,524
            
            
            13,386,548
            
            
            10,761,508INCOME
                BEFORE INCOME TAXES
            
            
            9,768,956
            
            
            7,684,134
            
            
            4,803,273INCOME
                TAXES (Note I)
            
            
            3,520,200
            
            
            2,780,600
            
            
            1,658,900NET
                INCOME
            
            $
            6,248,756
            
            $
            4,903,534
            
            $
            3,144,373NET
                INCOME PER COMMON SHAREBasic
            
            $
            0.68
            
            $
            0.67
            
            $
            0.58Diluted
            
            $
            0.65
            
            $
            0.64
            
            $
            0.55WEIGHTED
                AVERAGE COMMON SHARES OUTSTANDINGBasic
            
            
            9,211,779
            
            
            7,281,016
            
            
            5,402,390Diluted
            
            
            9,635,694
            
            
            7,614,807
            
            
            5,682,447   *See
        accompanying notes.*


52





***CRESCENT
      FINANCIAL CORPORATION AND SUBSIDIARY***


***CONSOLIDATED
      STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY***


***Years
      Ended December 31, 2007, 2006 and 2005***




Common
                stock
            
            Additional
              paid-in
            
            Retained
            
            Accumulated
                other comprehensive
            
            TotalShares
            
            Amount
            
            capital
            
            earnings
            
            income
                (loss)
            
            equityBalance
                at December 31, 2004
            
            
            3,566,889
            
            $
            3,566,889
            
            $
            18,654,492
            
            $
            4,562,681
            
            $
            (6,648
            )
            $
            26,777,414Comprehensive
                income:Net
                income
            
            
            -
            
            
            -
            
            
            -
            
            
            3,144,373
            
            
            -
            
            
            3,144,373Net
                unrealized holding loss on available for sale securities
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (675,145
            )
            
            (675,145
            )Total
                comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2,469,228Common
                stock issued pursuant to:Stock
                options exercised
            
            
            75,539
            
            
            75,539
            
            
            317,373
            
            
            -
            
            
            -
            
            
            392,912Stock
                option related tax benefits
            
            
            -
            
            
            -
            
            
            199,800
            
            
            -
            
            
            -
            
            
            199,800Issuance
                of new stock
            
            
            848,000
            
            
            848,000
            
            
            10,769,858
            
            
            -
            
            
            -
            
            
            11,617,858Stock
                split effected in the form of a fifteen percent stock dividend with
                net
                cash received for fractional shares
            
            
            535,966
            
            
            535,966
            
            
            (535,964
            )
            
            -
            
            
            -
            
            
            2Balance
                at December 31, 2005
            
            
            5,026,394
            
            
            5,026,394
            
            
            29,405,559
            
            
            7,707,054
            
            
            (681,793
            )
            
            41,457,214Comprehensive
                income:Net
                income
            
            
            -
            
            
            -
            
            
            -
            
            
            4,903,534
            
            
            -
            
            
            4,903,534Net
                unrealized holding gain on available for sale securities
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            180,846
            
            
            180,846Total
                comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            5,084,380Common
                stock issued pursuant to:Stock
                options exercised
            
            
            44,029
            
            
            44,029
            
            
            211,768
            
            
            -
            
            
            -
            
            
            255,797Stock
                option related tax benefits
            
            
            -
            
            
            -
            
            
            45,401
            
            
            -
            
            
            -
            
            
            45,401Expense
                recognized in connection with stock options and restricted
                stock
            
            
            -
            
            
            -
            
            
            202,246
            
            
            -
            
            
            -
            
            
            202,246Issuance
                of restricted stock, net of deferred compensation
            
            
            7,387
            
            
            7,387
            
            
            (7,387
            )
            
            -
            
            
            -
            
            
            -Shares
                issued in connection with business combination
            
            
            2,432,374
            
            
            2,432,374
            
            
            33,566,001
            
            
            -
            
            
            -
            
            
            35,998,375Stock
                split effected in the form of a fifteen percent stock dividend with
                net
                cash paid for fractional shares
            
            
            754,952
            
            
            754,952
            
            
            (764,387
            )
            
            -
            
            
            -
            
            
            (9,435
            )Balance
                at December 31, 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 forfractional
                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
            
            $
            91,658,812


*See
        accompanying notes.*




53




***CRESCENT
      FINANCIAL CORPORATION AND SUBSIDIARY***


***CONSOLIDATED
      STATEMENTS OF CASH FLOWS***


***Years
      Ended December 31, 200*** **7*,**2006
      and 2005***





2007
            
            2006
            
            2005CASH
                FLOWS FROM OPERATING ACTIVITIESNet
                income
            
            $
            6,248,756
            
            $
            4,903,534
            
            $
            3,144,373Adjustments
                to reconcile net income to net cash provided by operating
                activities:Depreciation
            
            
            694,559
            
            
            698,754
            
            
            613,388Provision
                for loan losses
            
            
            1,684,219
            
            
            990,786
            
            
            806,796Amortization
                of core deposit intangible
            
            
            133,349
            
            
            58,384
            
            
            20,901Accretion
                of fair value discount on loans
            
            
            (439,820
            )
            
            (109,955
            )
            
            -Amortization
                of fair value premium on deposits
            
            
            406,277
            
            
            102,846
            
            
            -Deferred
                income taxes
            
            
            (502,749
            )
            
            (210,710
            )
            
            (11,549
            )(Gain)
                loss on disposition of assets
            
            
            65,685
            
            
            (2,782
            )
            
            13,000Loss
                on sale of securities
            
            
            -
            
            
            -
            
            
            16,422Net
                (accretion) amortization of premiums on securities
            
            
            (98,609
            )
            
            (20,023
            )
            
            82,702Net
                increase in cash surrender value life insurance
            
            
            (339,204
            )
            
            (200,180
            )
            
            (200,050
            )Stock
                based compensation
            
            
            178,940
            
            
            202,246
            
            
            -Change
                in assets and liabilities:Increase
                in accrued interest receivable
            
            
            (715,760
            )
            
            (592,718
            )
            
            (549,457
            )(Increase)
                decrease in other assets
            
            
            (303,339
            )
            
            (579,977
            )
            
            (116,897
            )Increase
                in accrued interest payable
            
            
            444,620
            
            
            136,282
            
            
            309,284Increase
                (decrease) in accrued expenses and other liabilities
            
            
            (292,252
            )
            
            269,732
            
            
            482,878NET
                CASH PROVIDED BY OPERATING ACTIVITIES
            
            
            7,164,672
            
            
            5,646,219
            
            
            4,611,791CASH
                FLOWS FROM INVESTING ACTIVITIESPurchase
                of investment securities available for sale
            
            
            (14,360,641
            )
            
            (25,248,980
            )
            
            (13,524,336
            )Proceeds
                from maturities and repayments of investment securities available
                for
                sale
            
            
            9,305,441
            
            
            6,646,100
            
            
            6,374,682Proceeds
                from sale of securities available for sale
            
            
            -
            
            
            6,106,354
            
            
            3,845,157Loan
                originations and principal collections, net
            
            
            (126,014,080
            )
            
            (93,267,698
            )
            
            (70,984,109
            )Purchases
                of premises and equipment
            
            
            (2,947,101
            )
            
            (1,679,226
            )
            
            (2,440,261
            )Proceeds
                from disposals of premises and equipment
            
            
            20,050
            
            
            800
            
            
            -Proceeds
                from sales of foreclosed assets
            
            
            247,996
            
            
            127,450
            
            
            297,978Purchases
                of Federal Home Loan Bank stock
            
            
            (3,207,900
            )
            
            (1,163,300
            )
            
            (686,200
            )Investment
                in life insurance
            
            
            (3,100,000
            )
            
            -
            
            
            -Net
                cash (paid)/acquired in business combination
            
            
            (7,500
            )
            
            8,221,923
            
            
            -NET
                CASH USED BY INVESTING ACTIVITIES
            
            
            (140,063,735
            )
            
            (100,256,577
            )
            
            (77,117,089
            )CASH
                FLOWS FROM FINANCING ACTIVITIESNet
                increase in deposits accounts
            
            
            63,143,356
            
            
            75,510,351
            
            
            48,431,967Net
                increase (decrease) in short-term borrowings
            
            
            (10,696,000
            )
            
            9,486,847
            
            
            13,657,048Net
                increase in long-term debt
            
            
            76,000,000
            
            
            15,000,000
            
            
            2,000,000Proceeds
                from sale of common stock, net
            
            
            -
            
            
            -
            
            
            11,617,858Proceeds
                from stock options exercised
            
            
            1,213,738
            
            
            255,797
            
            
            392,912Net
                cash (paid)/received for fractional shares
            
            
            (7,687
            )
            
            (9,435
            )
            
            2Excess
                tax benefits from stock options exercised
            
            
            451,950
            
            
            45,401
            
            
            199,800NET
                CASH PROVIDED BYFINANCING
                ACTIVITIES
            
            
            130,105,357
            
            
            100,288,961
            
            
            76,299,587NET
                INCERASE (DECREASE) IN CASH AND CASH EQUIVALENTS
            
            
            (2,793,706
            )
            
            5,678,603
            
            
            3,794,289CASH
                AND CASH EQUIVALENTS, BEGINNING
            
            
            15,150,110
            
            
            9,471,507
            
            
            5,677,218CASH
                AND CASH EQUIVALENTS, ENDING
            
            $
            12,356,404
            
            $
            15,150,110
            
            $
            9,471,507





Supplemental
      information (Notes M and R)




*See
      accompanying notes.*


54


*CRESCENT
        FINANCIAL CORPORATION AND SUBSIDIAR*Y
 ***Notes
        to Consolidated Financial Statements***
 ***December
        31, 2007, 2006 and 2005***




**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”). 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. 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. CSB undergoes periodic examinations by those
      regulatory authorities.





The
      Company formed Crescent Financial Capital Trust I during 2003 in order to
      facilitate the issuance of trust preferred securities. The Trust is a statutory
      business trust formed under the laws of the state of Delaware, of which all
      common securities are owned by the Company. Under Financial Accounting Standards
      Board (“FASB”) Interpretation No. (“FIN”) 46, *Consolidation
      of Variable Interest Entities* ,
      Crescent Financial Capital Trust I is not included in the Company’s consolidated
      financial statements. The junior subordinated debentures issued by the Company
      to the trust are included in long-term debt and the Company’s equity interest in
      the trust is included in other assets.





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 the final rule that would retain the inclusion of trust
      preferred securities in Tier 1 capital of bank holding companies, but with
      stricter quantitative limits and clearer qualitative standards. Under the new
      rule, after a three-year transition period, the aggregate amount of trust
      preferred securities and certain other capital elements would be limited to
      25
      percent of Tier 1 capital elements, net of goodwill less any associated deferred
      tax liability. The amount of trust preferred securities and certain other
      elements in excess of the limit could be included in Tier 2 capital, subject
      to
      restrictions.





**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. Crescent Financial Corporation and its
      subsidiary are collectively referred to herein as the “Company.”





***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.


55


*CRESCENT
        FINANCIAL CORPORATION AND SUBSIDIAR*Y
 ***Notes
        to Consolidated Financial Statements***
 ***December
        31, 2007, 2006 and 2005***




**NOTE
      B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)**





***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 borrower may be unable to meet payments as they become due.
      Generally, loans are placed on nonaccrual when they are past due 90 days. While
      a loan is classified as nonaccrual and the future collectibility of the recorded
      loan balance is doubtful, collections of interest and principal are generally
      applied as a reduction to the principal outstanding. When the future
      collectibility of the recorded loan balance is not in doubt, interest income
      may
      be recognized on a cash basis. When a loan is charged-off, all unpaid accrued
      interest is reversed.





***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 uncollectibility
      of a
      loan balance is confirmed. Subsequent recoveries, if any, are credited to the
      allowance.





The
      allowance for loan losses is evaluated on a regular basis by management and
      is
      based upon management’s periodic review of the collectibility of the loans in
      light of 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.


56


*CRESCENT
        FINANCIAL CORPORATION AND SUBSIDIAR*Y
 ***Notes
        to Consolidated Financial Statements***
 ***December
        31, 2007, 2006 and 2005***


**NOTE
      B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)**





***Allowance
      for Loan Losses (Continued)***





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***





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.





***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 equals
      cost and that this investment was not impaired at December 31,
      2007.





***Income
      Taxes***





Deferred
      tax assets and liabilities are recognized for the estimated future tax
      consequences attributable to differences between the tax bases of assets and
      liabilities and their carrying amounts for financial reporting purposes.
      Deferred tax assets are also recognized for operating loss carryforwards.
      Deferred tax assets and liabilities are measured using enacted tax rates in
      effect for the year in which the temporary differences are expected to be
      recovered or settled. Deferred tax assets are reduced by a valuation allowance
      if it is more likely than not that the tax benefits will not be
      realized.





***Goodwill***





Goodwill
      of $26,632,751 arose from the 2006 purchase of Port City Capital Bank. Goodwill
      of $3,600,298 arose from the 2003 purchase of Centennial Bank. Pursuant to
      Statement of Financial Accounting Standards (“SFAS”) No. 142, *Goodwill
      and Other Intangible Assets,* goodwill
      acquired will not be amortized but will be subject to an annual impairment
      test.
      Goodwill recorded by the Company amounted to $30,233,049 and $30,225,549 at December
      31, 2007 and 2006, respectively. During early 2007, $7,500 of Port City Capital
      Bank acquisition related charges were determined to relate to goodwill. There
      were no impairment charges recorded in 2007 or 2006 as a result of the goodwill
      testing.


57


*CRESCENT
        FINANCIAL CORPORATION AND SUBSIDIAR*Y
 ***Notes
        to Consolidated Financial Statements***
 ***December
        31, 2007, 2006 and 2005***


**NOTE
      B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)**





***Other
      Intangible Assets***





Other
      intangible assets were acquired in conjunction with the 2006 purchase of Port
      City Capital Bank and the 2003 purchase of Centennial Bank. Subject to the
      provisions of SFAS No. 142, such other intangible assets, which consist solely
      of the deposit base premiums acquired through the purchase of these banks,
      are
      amortized over the approximate estimated lives of the related acquired deposit
      relationships. In accordance with the Company's estimate of the approximate
      lives of the acquired deposit relationships, a 10 year straight-line
      amortization schedule has been established for these intangible assets. The
      Company will continue to evaluate the amortization period and such amortization
      period could be revised downwards (but not upwards) in the future if
      circumstances warrant. The initial deposit premium related to the purchase
      of
      Port City Capital Bank was $1,124,481 and the premium related to the purchase
      of
      Centennial Bank was $209,012. The balance of the unamortized deposit premiums
      was $1,092,990 and $1,226,339 at December 31, 2007 and 2006, respectively.
      Amortization of the deposit premium amounted to $133,349, $58,384 and $20,901
      for the years ended December 31, 2007, 2006 and 2005, respectively. Amortization
      of the core deposit intangible is estimated to be $133,349 per year for each
      of
      the next five years, $126,383 in year six, and $112,448 annually thereafter
      until fully amortized.





***Stock
      Compensation Plans***





Effective
      January 1, 2006, the Company adopted SFAS No. 123 (revised 2004), *Share-Based
      Payment* ("SFAS
      No. 123R"), which was issued by the FASB in December 2004. SFAS No. 123R revises
      SFAS No. 123 *Accounting
      for Stock Based Compensation* ,
      and
      supersedes Accounting Principles Board Opinion (“APB”) No. 25, *Accounting
      for Stock Issued to Employees* ,
      and its
      related interpretations. SFAS No. 123R requires recognition of the cost of
      employee services received in exchange for an award of equity instruments in
      the
      financial statements over the period the employee is required to perform the
      services in exchange for the award (usually the vesting period). SFAS No. 123R
      also requires measurement of the cost of employee services received in exchange
      for an award based on the grant-date fair value of the award. SFAS No. 123R
      also
      amends SFAS No. 95, *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.





The
      Company adopted SFAS No. 123R using the modified prospective application as
      permitted under SFAS No. 123R. Accordingly, prior period amounts have not been
      restated. Under this application, the Company is required to record compensation
      expense for all awards granted after the date of adoption and for the unvested
      portion of previously granted awards that remain outstanding at the date of
      adoption. Prior to the adoption of SFAS No. 123R, the Company used the intrinsic
      value method as prescribed by APB No. 25 and thus recognized no compensation
      expense for options granted with exercise prices equal to the fair market value
      of the Company's common stock on the date of grant.





The
      following table illustrates the effect on net income and earnings per share
      if
      the Company had applied the fair value recognition provisions of SFAS 123R
      to
      options granted under the Company’s stock option plans for the year ended
      December 31, 2005. For purposes of this pro forma disclosure, the value of
      the
      options is estimated using the Black-Scholes option-pricing model and amortized
      to expense over the options’ vesting periods.





58


*CRESCENT
          FINANCIAL CORPORATION AND SUBSIDIAR*Y
 ***Notes
          to Consolidated Financial Statements***
 ***December
          31, 2007, 2006 and 2005***


**NOTE
      B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)**





***Stock
      Compensation Plans (Continued)***





2005(Dollars in thousands)Net
                income:As
                reported
            
            $
            3,144Deduct:
                Total stock-based employee compensation expense determined under
                fair
                value method for all awards, net of related tax effects
            
            
            (135
            )Pro
                forma
            
            $
            3,009Basic
                earnings per share:As
                reported
            
            $
            .58Pro
                forma
            
            $
            .56Diluted
                earnings per share:As
                reported
            
            $
            .55Pro
                forma
            
            $
            .53





***Per
      Share Results***





During
      2007, the Company declared and distributed a 10% stock dividend. During 2006
      and
      2005, the Company effected 23-for-20 stock splits in the form of 15% stock
      dividends, respectively. Basic and diluted net income per common share have
      been
      computed by dividing net income for each period by the weighted average number
      of shares of common stock outstanding during each period after retroactively
      adjusting for these stock distributions. All references herein to net income
      per
      share and weighted average shares outstanding have been adjusted to give effect
      to these stock distributions.





Basic
      earnings per share represents income available to common stockholders divided
      by
      the weighted-average number of common shares outstanding during the period.
      Diluted earnings per share reflect additional common shares that would have
      been
      outstanding if dilutive potential common shares had been issued, as well as
      any
      adjustment to income that would result from the assumed issuance. Potential
      common shares that may be issued by the
      Company relate to outstanding stock options and restricted stock and are
      determined using the treasury stock method. For the years ended December 31,
      2007, 2006 and 2005, there were 62,627, 40,791 and 9,900 outstanding stock
      options, respectively, which were not included in the computation of diluted
      earnings per share because they had no dilutive effect.





***Comprehensive
      Income***





The
      Company reports as comprehensive income all changes in stockholders’ equity
      during the year from sources other than shareholders. Other comprehensive income
      refers to all components (revenues, expenses, gains, and losses) of
      comprehensive income that are excluded from net income. The Company’s only
      component of other comprehensive income is unrealized gains and losses on
      investment securities available for sale.


59


*CRESCENT
        FINANCIAL CORPORATION AND SUBSIDIAR*Y
 ***Notes
        to Consolidated Financial Statements***
 ***December
        31, 2007, 2006 and 2005***


**NOTE
      B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)**





***Comprehensive
      Income (Continued)***





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





2007
            
            2006
            
            2005Change
                in unrealized holding gains (losses) on available for sale
                securities
            
            $
            881,765
            
            $
            289,891
            
            $
            (1,115,858
            )Realized
                loss on sale of available for sale securities
            
            
            -
            
            
            -
            
            
            16,422Tax
                effect
            
            
            (342,629
            )
            
            (109,045
            )
            
            424,291Net
                of tax amount
            
            $
            539,136
            
            $
            180,846
            
            $
            (675,145
            )





***Mortgage
      Loan Origination and Other Fees***





Mortgage
      loan origination fees represent fees received for the origination of loans
      for
      sale 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.





Fees
      derived from leasing and investment transactions with Technology Capital
      Partners and the Capital Investment


Group,
      Inc., respectively, are recognized in income as these transactions are
      consummated.





***Segment
      Reporting***





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.




***New
      Accounting Standards***





In
      September 2006, the FASB issued SFAS No. 157, “ *Fair
      Value Measurements* ”
      (“SFAS 157”) which defines fair value, establishes guidelines for measuring
      fair value and expands disclosures regarding fair value measurements.
      SFAS 157 does not require any new fair value measurements but rather
      eliminates inconsistencies in guidance found in various prior accounting
      pronouncements. SFAS 157 is effective for fiscal years beginning after
      November 15, 2007. However, on December 14, 2007, the FASB issued
      proposed FASB Staff Position (“FSP”) SFAS 157-b (“FSP 157-b”), which would
      delay the effective date of SFAS 157 for all non-financial assets and
      non-financial liabilities, except those that are recognized or disclosed at
      fair
      value in the financial statements on a recurring basis (at least annually).
      FSP
      157-b partially defers the effective date of SFAS 157 to fiscal years
      beginning after November 15, 2008, and interim periods within those fiscal
      years for items within the scope of FSP 157-b. The Company will adopt
      SFAS 157 during 2008, except as it applies to those non-financial assets
      and non-financial liabilities as noted in proposed FSP 157-b. The partial
      adoption of SFAS 157 is not expected to have a material impact on the
      Company’s financial position, results of operations or cash flows.


60


*CRESCENT
        FINANCIAL CORPORATION AND SUBSIDIAR*Y
 ***Notes
        to Consolidated Financial Statements***
 ***December
        31, 2007, 2006 and 2005***


**NOTE
      B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)**





***New
      Accounting Standards (Continued)***




In
      July
      2006, the FASB issued FIN 48, “ *Accounting
      for Uncertainty in Income Taxes* ”
(“FIN
      48”). FIN 48 is an interpretation of SFAS No. 109, “ *Accounting
      for Income Taxes* ”
(“SFAS
      109”). FIN 48 provides interpretive guidance for the financial statement
      recognition and measurement of a tax position taken, or expected to be taken,
      in
      a tax return. FIN 48 requires the affirmative evaluation that it is more likely
      than not, based on the technical merits of a tax position, that an enterprise
      is
      entitled to economic benefits resulting from positions taken in income tax
      returns. If a tax position does not meet the “more-likely-than-not” recognition
      threshold, the benefit of that position is not recognized in the financial
      statements. FIN 48 also requires companies to disclose additional quantitative
      and qualitative information in their financial statements about uncertain tax
      positions. FIN 48 was effective for fiscal year beginning January 1, 2007,
      and there was no cumulative effect of applying FIN 48.




In
      February 2007, the FASB issued SFAS No. 159, “ *The
      Fair Value Option for Financial Assets and Financial Liabilities, Including
      an
      amendment of FASB Statement No. 115* ”
(“SFAS
      159”). SFAS 159 permits entities to choose to measure many financial instruments
      and certain other items at fair value that are not currently required to be
      measured at fair value and establishes presentation and disclosure requirements
      designed to facilitate comparisons between entities that choose different
      measurement attributes for similar types of assets and liabilities. SFAS 159
      is
      effective for financial statements issued for fiscal years beginning after
      November 15, 2007. The Company does not expect SFAS 159 to have a material
      impact on its financial position, results of operations or cash flows upon
      adoption.




In
      November 2007, the SEC issued SAB No. 109, “ *Written
      Loan Commitments Recorded at Fair Value Through Earnings* ”
(“SAB
      109”). SAB 109 supersedes guidance provided by SAB No. 105, “Loan
      Commitments Accounted for as Derivative Instruments” (“SAB 105”) and provides
      guidance on written loan commitments accounted for at fair value through
      earnings. Specifically, SAB 109 addresses the inclusion of expected net future
      cash flows related to the associated servicing of a loan in the measurement
      of
      all written loan commitments accounted for at fair value through earnings.
      In
      addition, SAB 109 retains the SEC’s position on the exclusion of
      internally-developed intangible assets as part of the fair value of a derivative
      loan commitment originally established in SAB 105. SAB 109 is effective for
      fiscal years ending after December 15, 2007. The Company currently is
      evaluating the impact, if any, that SAB 109 may have on its financial position,
      results of operations or cash flows.





In
      December 2007, the FASB issued SFAS 141(R), Business Combinations.
      SFAS 141(R) will significantly change how entities apply the acquisition
      method to business combinations. The most significant changes affecting how
      the
      Corporation will account for business combinations under this Statement include:
      the acquisition date will be date the acquirer obtains control; all (and only)
      identifiable assets acquired, liabilities assumed, and noncontrolling interests
      in the acquiree will be stated at fair value on the acquisition date; assets
      or
      liabilities arising from noncontractual contingencies will be measured at their
      acquisition date fair value only if it is more likely than not that they meet
      the definition of an asset or liability on the acquisition date; adjustments
      subsequently made to the provisional amounts recorded on the acquisition date
      will be made retroactively during a measurement period not to exceed one year;
      acquisition-related restructuring costs that do not meet the criteria in
      SFAS 146, Accounting for Costs Associated with Exit or Disposal Activities,
      will be expensed as incurred; transaction costs will be expensed as incurred;
      reversals of deferred income tax valuation allowances and income tax
      contingencies will be recognized in earnings subsequent to the measurement
      period; and the allowance for loan losses of an acquiree will not be permitted
      to be recognized by the acquirer. Additionally, SFAS 141(R) will require
      new and modified disclosures surrounding subsequent changes to
      acquisition-related contingencies, contingent consideration, noncontrolling
      interests, acquisition-related transaction costs, fair values and cash flows
      not
      expected to be collected for acquired loans, and an enhanced
      goodwill rollforward.





The
      Corporation will be required to prospectively apply SFAS 141(R) to all
      business combinations completed on or after January 1, 2009. Early adoption
      is not permitted. For business combinations in which the acquisition date was
      before the effective date, the provisions of SFAS 141(R) will apply to the
      subsequent accounting for deferred income tax valuation allowances and income
      tax contingencies and will require any changes in those amounts to be recorded
      in earnings. Management is currently evaluating the effects that
      SFAS 141(R) will have on the financial condition, results of operations,
      liquidity, and the disclosures that will be presented in the consolidated
      financial statements.


61


*CRESCENT
        FINANCIAL CORPORATION AND SUBSIDIAR*Y
 ***Notes
        to Consolidated Financial Statements***
 ***December
        31, 2007, 2006 and 2005***




**NOTE
      B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)**





***New
      Accounting Standards (Continued)***




In
      December 2007, the FASB issued SFAS 160, Noncontrolling interests in
      Consolidated Financial Statements, an Amendment of ARB 51. SFAS 160
      establishes new accounting and reporting standards for noncontrolling interests
      in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 will
      require entities to classify noncontrolling interests as a component of
      stockholders’ equity and will require subsequent changes in ownership interests
      in a subsidiary to be accounted for as an equity transaction. Additionally,
      SFAS 160 will require entities to recognize a gain or loss upon the loss of
      control of a subsidiary and to remeasure any ownership interest retained at
      fair
      value on that date. This statement also requires expanded disclosures that
      clearly identify and distinguish between the interests of the parent and the
      interests of the noncontrolling owners. SFAS 160 is effective on a
      prospective basis for fiscal years, and interim periods within those fiscal
      years, beginning on or after December 15, 2008, except for the presentation
      and disclosure requirements, which are required to be applied retrospectively.
      Early adoption is not permitted. At December 31, 2007, the Company had no
      noncontrolling interests in subsidiaries. Management is currently evaluating
      the
      effects, if any, that SFAS 160 will have upon adoption.





The
      Emerging Issues Task Force (EITF) reached a consensus at its September 2006
      meeting regarding EITF 06-4, Accounting for Deferred Compensation and
      Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance
      Arrangements. The scope of EITF 06-4 is limited to the recognition of a
      liability and related compensation costs for endorsement split-dollar life
      insurance policies that provide a benefit to an employee that extends to
      postretirement periods. Therefore, this EITF would not apply to a split-dollar
      life insurance arrangement that provides a specified benefit to an employee
      that
      is limited to the employee’s active service period with an employer. This EITF
      06-4 is effective for fiscal years beginning after December 15, 2007, with
      earlier application permitted. The Company has adopted the provisions of this
      EITF and does not believe it will have a material effect on the Company’s
      financial position, results of operations or cash flows.





The
      EITF
      reached a consensus at its September 2006 meeting regarding EITF 06-5,
      Accounting for Purchases of Life Insurance Determining the Amount That Could
      be
      Realized in Accordance with FASB Technical Bulletin No. 85-5. The scope of
      EITF
      06-5 is limited to the determination of net cash surrender value of a life
      insurance contract in accordance with Technical Bulletin 85-4. This EITF
      outlines when contractual limitations of the policy should be considered when
      determining the net realizable value of the contract. EITF 06-5 is effective
      for
      fiscal years beginning after December 15, 2006, with earlier application
      permitted. The Company has evaluated this EITF and has determined that it is
      not
      applicable.





The
      Emerging Issues Task Force (EITF) reached a consensus at its March
      2007 meeting regarding EITF 06-10, Accounting for Collateral
      Assignment Split-Dollar Life Insurance Agreements (EITF 06-10). EITF
      06-10 provides guidance for determining a liability for the postretirement
      benefit obligation as well as recognition and measurement of the associated
      asset on the basis of the terms of the collateral assignment agreement. EITF
      06-10 is effective for fiscal years beginning after December 15, 2007. The
      Company has evaluated this EITF and has determined that it is not applicable.





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.




***Reclassifications***





Certain
      amounts in the 2006 and 2005 consolidated financial statements have been
      reclassified to conform to the 2007 presentation. The reclassifications had
      no
      effect on net income or stockholders’ equity as previously
      reported.


62


*CRESCENT
        FINANCIAL CORPORATION AND SUBSIDIAR*Y
 ***Notes
        to Consolidated Financial Statements***
 ***December
        31, 2007, 2006 and 2005***




**NOTE
      C - INVESTMENT SECURITIES**





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





December 31, 2007Amortized
              cost
            
            Gross
              unrealized
              gains
            
            Gross
              unrealized
              losses
            
            Fair
              valueSecurities
                available for sale:U.S.
                government securities and obligations of U.S. government
                agencies
            
            $
            8,363,741
            
            $
            18,464
            
            $
            69,981
            
            $
            8,312,224Mortgage-backed
            
            
            56,986,240
            
            
            565,175
            
            
            317,786
            
            
            57,233,629Municipals
            
            
            24,810,061
            
            
            136,974
            
            
            251,986
            
            
            24,695,049Other
                equity securities
            
            
            536,278
            
            
            -
            
            
            18,713
            
            
            517,565$
            90,696,320
            
            $
            720,613
            
            $
            658,466
            
            $
            90,758,467





December
                31, 2006Amortized
              cost
            
            Gross
              unrealized
              gains
            
            Gross
              unrealized
              losses
            
            Fair
              valueSecurities
                available for sale:U.S.
                government securities and obligations of U.S. government
                agencies
            
            $
            7,493,079
            
            $
            5,790
            
            $
            113,998
            
            $
            7,384,871Mortgage-backed
            
            
            54,949,049
            
            
            154,157
            
            
            828,909
            
            
            54,274,297Municipals
            
            
            22,320,984
            
            
            67,266
            
            
            206,104
            
            
            22,182,146Other
                equity securities
            
            
            779,398
            
            
            102,180
            
            
            -
            
            
            881,578$
            85,542,510
            
            $
            329,393
            
            $
            1,149,011
            
            $
            84,722,892





There
      were no security gains or losses in 2007 or 2006. There were gross gains from
      sales of securities of $538 and gross losses of $16,960 in 2005.





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,
      2007 and 2006. The 2007 unrealized losses on investment securities relate to
      eleven U.S. Government agency securities, forty-one mortgage-backed securities,
      and twenty-six municipal securities. The 2006 unrealized losses on investment
      securities relate to nine U.S. Government agency securities, fifty-seven
      mortgage-backed securities, and thirty municipal securities. 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.


63


*CRESCENT
        FINANCIAL CORPORATION AND SUBSIDIAR*Y
 ***Notes
        to Consolidated Financial Statements***
 ***December
        31, 2007, 2006 and 2005***




**NOTE
      C - INVESTMENT SECURITIES (Continued)**





December 31, 2007Less Than 12 Months
            
            12 Months or More
            
            TotalFair
              value
            
            Unrealized
              losses
            
            Fair
              value
            
            Unrealized
              losses
            
            Fair
              value
            
            Unrealized
              lossesSecurities
                available for sale:U.S.
                government securities and obligations of U.S. government
                agencies
            
            $
            1,203,508
            
            $
            3,656
            
            $
            5,061,756
            
            $
            66,325
            
            $
            6,265,264
            
            $
            69,981Mortgage-backed
            
            
            631,014
            
            
            1,868
            
            
            20,335,222
            
            
            315,918
            
            
            20,966,236
            
            
            317,786Municipals
            
            
            11,201,733
            
            
            206,927
            
            
            4,175,358
            
            
            45,059
            
            
            15,377,091
            
            
            251,986Other
                equity securities
            
            
            517,565
            
            
            18,713
            
            
            -
            
            
            -
            
            
            517,565
            
            
            18,713Total
                    temporarily impairedsecurities
            
            $
            13,553,820
            
            $
            231,164
            
            $
            29,572,336
            
            $
            427,302
            
            $
            43,126,156
            
            $
            658,466





December 31, 2006Less Than 12 Months
            
            12 Months or More
            
            TotalFair
              value
            
            Unrealized
              losses
            
            Fair
              value
            
            Unrealized
              losses
            
            Fair
              value
            
            Unrealized
              lossesSecurities
                available for sale:U.S.
                government securities and obligations of U.S. government
                agencies
            
            $
            -
            
            $
            -
            
            $
            5,350,947
            
            $
            113,998
            
            $
            5,350,947
            
            $
            113,998Mortgage-backed
            
            
            6,823,616
            
            
            32,598
            
            
            27,048,461
            
            
            796,311
            
            
            33,872,077
            
            
            828,909Municipals
            
            
            11,531,302
            
            
            79,878
            
            
            4,255,378
            
            
            126,226
            
            
            15,786,680
            
            
            206,104Total
                temporarily impaired securities
            
            $
            18,354,918
            
            $
            112,476
            
            $
            36,654,786
            
            $
            1,036,535
            
            $
            55,009,704
            
            $
            1,149,011





At
      December 31, 2007 and 2006, investment securities with a carrying value of
      $52,731,007 and $12,146,961, respectively, were pledged to secure public
      deposits, borrowings and for other purposes required or permitted by
      law.





The
      amortized cost and fair values of securities available for sale at December
      31,
      2007 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
              cost
            
            Fair
              valueDue
                within one year
            
            $
            9,905,516
            
            $
            9,904,522Due
                after one year through five years
            
            
            41,876,983
            
            
            41,942,467Due
                after five years through ten years
            
            
            24,693,829
            
            
            24,752,325Due
                after ten years
            
            
            13,683,714
            
            
            13,641,588Other
                equity securities
            
            
            536,278
            
            
            517,565$
            90,696,320
            
            $
            90,758,467




64


*CRESCENT
        FINANCIAL CORPORATION AND SUBSIDIAR*Y
 ***Notes
        to Consolidated Financial Statements***
 ***December
        31, 2007, 2006 and 2005***


**NOTE
      C - INVESTMENT SECURITIES (Continued)**





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, 2007:





Repricing or MaturingLess than
              one year
            
            One
                to
              five
                years
            
            Five
                to
              ten
                years
            
            Over
                ten
              years
            
            Total(Dollars in thousands)Securities
                available for sale:U.
                S. government agenciesBalance
            
            $
            1,485
            
            $
            4,594
            
            $
            2,233
            
            $
            -
            
            $
            8,312Weighted
                average yield
            
            
            3.89
            %
            
            4.73
            %
            
            5.09
            %
            
            -
            
            
            4.26
            %Mortgage-backed
                securitiesBalance
            
            $
            8,420
            
            $
            31,744
            
            $
            11,776
            
            $
            5,294
            
            $
            57,234Weighted
                average yield
            
            
            4.81
            %
            
            4.99
            %
            
            5.21
            %
            
            5.40
            %
            
            5.05
            %Municipal
                securitiesBalance
            
            $
            -
            
            $
            5,604
            
            $
            10,743
            
            $
            8,348
            
            $
            24,695Weighted
                average yield
            
            
            -
            
            
            5.48
            %
            
            6.29
            %
            
            6.48
            %
            
            6.17
            %OtherBalance
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            517
            
            $
            517Weighted
                average yield
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -TotalBalance
            
            $
            9,905
            
            $
            41,942
            
            $
            24,752
            
            $
            14,159
            
            $
            90,758Weighted
                average yield
            
            
            4.67
            %
            
            5.03
            %
            
            5.67
            %
            
            5.84
            %
            
            5.29
            %




**NOTE
      D - LOANS**





Following
      is a summary of loans at December 31, 2007 and 2006.





2007
            
            2006Real
                estate - commercial
            
            $
            350,961,251
            
            $
            304,822,939Real
                estate - residential
            
            
            18,256,566
            
            
            20,223,856Construction
                loans
            
            
            184,019,364
            
            
            110,032,772Commercial
                and industrial loans
            
            
            72,930,108
            
            
            67,822,285Home
                equity loans and lines of credit
            
            
            45,258,071
            
            
            42,704,279Loans
                to individuals
            
            
            5,488,818
            
            
            4,976,566Total
                loans
            
            
            676,914,178
            
            
            550,582,697Less:Deferred
                loan fees
            
            
            (997,948
            )
            
            (764,149
            )Allowance
                for loan losses
            
            
            (8,273,000
            )
            
            (6,945,000
            )Total
            
            $
            667,643,228
            
            $
            542,873,548





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.


65


*CRESCENT
        FINANCIAL CORPORATION AND SUBSIDIAR*Y
 ***Notes
        to Consolidated Financial Statements***
 ***December
        31, 2007, 2006 and 2005***




**NOTE
      D - LOANS (Continued)**





No
      loans
      have been restructured during 2007 or 2006. At December 31, 2007, the recorded
      investment in loans considered impaired in accordance with SFAS No. 114 totaled
      $4.2 million. The corresponding valuation allowance for impaired loans with
      a
      recorded investment of $3.9 million amounted to $1.1 million; no valuation
      allowance for the other impaired loans was considered necessary. For the year
      ended December 31, 2007, the average recorded investment in impaired loans
      was
      approximately $3.8 million. The amount of interest recognized on impaired loans
      during the portion of the year that they were considered impaired was not
      material.





At
      December 31, 2006, the recorded investment in loans considered impaired in
      accordance with SFAS No. 114 totaled $2.5 million. The corresponding valuation
      allowance for impaired loans with a recorded investment of $2.5 million amounted
      to $669,000. For the year ended December 31, 2007, the average recorded
      investment in impaired loans was approximately $1.5 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 collectibility. 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, 2006
            
            $
            28,249,708Net
                disbursements during year ended December 31, 2007
            
            
            2,119,703Loans
                to directors and officers as a group at December 31, 2007
            
            $
            30,369,411





At
      December 31, 2007, the Company had pre-approved but unused lines of credit
      totaling $9.4 million to executive officers, directors and their related
      interests. No additional funds were committed to be advanced at December 31,
      2007.





An
      analysis of the allowance for loan losses follows:





2007
            
            2006
            
            2005Balance
                at beginning of year
            
            $
            6,945,000
            
            $
            4,351,000
            
            $
            3,668,000Provision
                for loan losses
            
            
            1,684,219
            
            
            990,786
            
            
            806,796Charge-offs
            
            
            (362,363
            )
            
            (85,571
            )
            
            (182,973
            )Recoveries
            
            
            6,144
            
            
            2,168
            
            
            59,177Net
                charge-offs
            
            
            (356,219
            )
            
            (83,403
            )
            
            (123,796
            )Allowance
                recorded related to loans acquired in acquisition of Port City Capital
                Bank
            
            
            -
            
            
            1,686,617
            
            
            -Balance
                at end of year
            
            $
            8,273,000
            
            $
            6,945,000
            
            $
            4,351,000


66


*CRESCENT
        FINANCIAL CORPORATION AND SUBSIDIAR*Y
 ***Notes
        to Consolidated Financial Statements***
 ***December
        31, 2007, 2006 and 2005***




**NOTE
      E - PREMISES AND EQUIPMENT**





Following
      is a summary of premises and equipment at December 31, 2007 and
      2006:





2007
            
            2006Land
            
            $
            2,997,306
            
            $
            2,102,283Buildings
                and leasehold improvements
            
            
            3,937,770
            
            
            3,298,026Furniture
                and equipment
            
            
            4,360,112
            
            
            3,081,514Less
                accumulated depreciation
            
            
            (3,200,667
            )
            
            (2,574,159
            )Total
            
            $
            8,094,521
            
            $
            5,907,664





Depreciation
      and amortization amounting to $694,559 in 2007, $698,754 in 2006 and $613,388
      in
      2005 is included in occupancy and equipment expense.





**NOTE
      F - DEPOSITS**





The
      weighted average cost of time deposits was 5.09% and 4.40% at December 31,
      2007
      and 2006, respectively.





At
      December 31, 2007, the scheduled maturities of certificates of deposit are
      as
      follows:





Less than
              $100,000
            
            $100,000
              or
                more
            
            Total(In thousands)Three
                months or less
            
            $
            15,010
            
            $
            56,529
            
            $
            71,539Over
                three months through one year
            
            
            38,370
            
            
            111,366
            
            
            149,736Over
                one year through three years
            
            
            12,670
            
            
            102,274
            
            
            114,944Over
                three years to five years
            
            
            2,532
            
            
            6,480
            
            
            9,012Total
            
            $
            68,582
            
            $
            276,649
            
            $
            345,231





**NOTE
      G - BORROWINGS**





Borrowings
      are comprised of the following at December 31, 2007 and 2006:




2007
            
            2006Short-term
                borrowings:Federal
                funds purchased
            
            $
            3,755,000
            
            $
            6,451,000Federal
                Home Loan Bank advances maturing within one year
            
            
            10,000,000
            
            
            18,000,000Total
                short-term borrowings
            
            $
            13,755,000
            
            $
            24,451,000Long-term
                debt:Federal
                Home Loan Bank advances maturing beyond one year
            
            $
            113,000,000
            
            $
            37,000,000Junior
                subordinated debentures
            
            
            8,248,000
            
            
            8,248,000Total
                long-term debt
            
            $
            121,248,000
            
            $
            45,248,000




67


*CRESCENT
        FINANCIAL CORPORATION AND SUBSIDIAR*Y
 ***Notes
        to Consolidated Financial Statements***
 ***December
        31, 2007, 2006 and 2005***




**NOTE
      G - BORROWINGS (Continued)**





***Short-term
      Borrowings***





The
      Company may purchase federal funds through unsecured federal funds guidance
      lines of credit totaling $53.0 million at December 31, 2007. 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
      $3,755,000 outstanding balance on the lines of credit as of December 31, 2007
      compared to $6,451,000 at December 31, 2006.





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





For the Year Ended December 31,2007
            
            2006(Dollars in thousands)Short-term
                borrowings:Federal
                funds purchased:Balance
                outstanding at end of year
            
            $
            3,755
            
            $
            6,451Maximum
                amount outstanding at any month end during the year
            
            
            6,652
            
            
            7,603Average
                balance outstanding during the year
            
            
            3,661
            
            
            3,258Weighted-average
                interest rate during the year
            
            
            5.40
            %
            
            5.33
            %Weighted-average
                interest rate at end of year
            
            
            4.57
            %
            
            5.63
            %





***Federal
      Home Loan Bank Advances***





The
      Company has a $167.1 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 $42.8 million.





At
      December 31, 2007 and 2006, the Company had the following advances outstanding
      from the Federal Home Loan Bank of Atlanta:





Maturity
            
            Interest Rate
            
            
            Rate Type
            
            2007
            
            2006December
                6, 2012
            
            
            4.22
            %
            
            Fixed
            
            $
            5,000,000
            
            $
            -July
                16, 2012
            
            
            3.84
            %
            
            Convertible
            
            
            5,000,000
            
            
            5,000,000April
                12, 2010
            
            
            4.58
            %
            
            Fixed
            
            
            7,000,000
            
            
            -May
                18, 2007
            
            
            5.44
            %
            
            Prime
              Based
            
            
            -
            
            
            8,000,000October
                21, 2009
            
            
            4.72
            %
            
            Fixed
            
            
            9,000,000
            
            
            -December
                31, 2007
            
            
            5.09
            %
            
            Convertible
            
            
            -
            
            
            10,000,000July
                28, 2008
            
            
            4.40
            %
            
            Prime
              Based
            
            
            10,000,000
            
            
            10,000,000August
                21, 2009
            
            
            4.71
            %
            
            Fixed
            
            
            10,000,000
            
            
            -September
                10, 2009
            
            
            4.62
            %
            
            Fixed
            
            
            10,000,000
            
            
            -March
                9, 2012
            
            
            4.29
            %
            
            Convertible
            
            
            10,000,000
            
            
            -March
                25, 2019
            
            
            4.36
            %
            
            Convertible
            
            
            10,000,000
            
            
            10,000,000January
                28, 2019
            
            
            4.43
            %
            
            Convertible
            
            
            12,000,000
            
            
            12,000,000August
                29, 2012
            
            
            4.00
            %
            
            Convertible
            
            
            15,000,000
            
            
            -May
                18, 2012
            
            
            4.49
            %
            
            Convertible
            
            
            20,000,000
            
            
            -$
            123,000,000
            
            $
            55,000,000


68


*CRESCENT
        FINANCIAL CORPORATION AND SUBSIDIAR*Y
 ***Notes
        to Consolidated Financial Statements***
 ***December
        31, 2007, 2006 and 2005***




**NOTE
      G - BORROWINGS (Continued)**





***Federal
      Home Loan Bank Advances (Continued)***





At
      December 31, 2007 and 2006, the weighted average interest rates on the above
      advances were 4.40% and 5.01%, respectively. The advance maturing on July 16,
      2012 and bearing interest at 3.84%, is continuously convertible every three
      months to a variable rate at the three month London Inter-Bank Offering Rate
      (“LIBOR”) if this rate is equal to or exceeds 7%. The advance maturing on July
      28, 2008 bears interest at Prime less 2.81%. The advance maturing March 9,
      2012
      bears a fixed interest rate of 4.23% and is convertible on March 9, 2008 and
      every three months thereafter to a variable rate based on LIBOR. The advance
      maturing on March 25, 2019 bears interest at the three month LIBOR minus 50
      basis points until March 25, 2009 and then will bear interest at 4.26%, at
      which
      time it becomes subject to conversion to a variable rate at the three month
      LIBOR. The advance maturing on January 28, 2019 bears interest at the 1 month
      LIBOR minus 42.5 basis points until January 27, 2009 and then bears interest
      at
      3.90%, at which time it becomes subject to conversion to a variable rate at
      the
      three month LIBOR. The advance maturing August 29, 2012 bears a fixed interest
      rate of 4.00% and is convertible every three months to a variable rate based
      on
      LIBOR. The advance maturing May 18, 2012 bears a fixed interest rate of 4.49%
      and is convertible on May 18, 2008 and every three months thereafter to a
      variable rate based on LIBOR. All fixed rate advances bear the stated interest
      rate throughtout the life of the advance with no embedded optionality.





At
      December 31 ,2007, one note totaling $10,000,000, with a stated maturity of
      less
      than one year, was classified as a short-term borrowing. At December 31, 2006,
      two notes with maturities of less than one year were classified as short-term
      borrowings, totaling $18,000,000.





***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 LIBOR plus 3.10%. 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.





**NOTE
      H - 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:





2008
            
            $
            1,224,0002009
            
            
            1,234,0002010
            
            
            2,062,0002011
            
            
            1,993,0002012
            
            
            1,886,000Thereafter
            
            
            26,971,000Total
            
            $
            35,370,000




69


*CRESCENT
          FINANCIAL CORPORATION AND SUBSIDIAR*Y
 ***Notes
          to Consolidated Financial Statements***
 ***December
          31, 2007, 2006 and 2005***
  **NOTE
        H - LEASES (Continued)**





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, 2007, 2006 and 2005
      amounted to $1,090,669, $892,734 and $743,095, respectively.





**NOTE
      I - INCOME TAXES**





The
      significant components of the provision for income taxes for the years ended
      December 31, 2007, 2006 and 2005 are as follows:




2007
            
            2006
            
            2005Current
                tax provision:Federal
            
            $
            3,246,706
            
            $
            2,422,394
            
            $
            1,366,832State
            
            
            776,243
            
            
            568,916
            
            
            303,6174,022,949
            
            
            2,991,310
            
            
            1,670,449Deferred
                tax provision (benefit):Federal
            
            
            (404,347
            )
            
            (153,224
            )
            
            (34,424
            )State
            
            
            (98,402
            )
            
            (57,486
            )
            
            22,875(502,749
            )
            
            (210,710
            )
            
            (11,549
            )Provision
                for income taxes
            
            $
            3,520,200
            
            $
            2,780,600
            
            $
            1,658,900





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:





2007
            
            2006
            
            2005Tax
                computed at statutory rate of 34%
            
            $
            3,321,445
            
            $
            2,612,868
            
            $
            1,633,113Effect
                of state income taxes
            
            
            447,375
            
            
            337,544
            
            
            235,976Non-taxable
                income
            
            
            (256,218
            )
            
            (217,265
            )
            
            (158,773
            )Non-taxable
                Bank Owned Life Insurance
            
            
            (115,329
            )
            
            (77,169
            )
            
            (77,119
            )Other
            
            
            122,927
            
            
            124,622
            
            
            25,703$
            3,520,200
            
            $
            2,780,600
            
            $
            1,658,900





Significant
      components of deferred taxes at December 31, 2007 and 2006 are as
      follows:





2007
            
            2006Deferred
                tax assets:Allowance
                for loan losses
            
            $
            3,082,684
            
            $
            2,540,149Net
                operating loss carryforwards
            
            
            -
            
            
            76,390Premises
                and equipment
            
            
            158,062
            
            
            147,092Rent
                abatement
            
            
            7,759
            
            
            11,807Unrealized
                (gain) loss on securities
            
            
            -
            
            
            318,671Fair
                value adjustments
            
            
            250,521
            
            
            305,377Deferred
                compensation
            
            
            342,897
            
            
            260,443Other
            
            
            115,268
            
            
            86,833Net
                deferred tax assets
            
            
            3,957,191
            
            
            3,746,762Deferred
                tax liabilities:Intangible
                assets
            
            
            (421,391
            )
            
            (472,803
            )Deferred
                loan costs
            
            
            (80,021
            )
            
            (30,062
            )Unrealized
                gain on securities
            
            
            (23,958
            )
            
            -Prepaid
                expenses
            
            
            (135,117
            )
            
            (107,316
            )Net
                deferred tax liabilities
            
            
            (660,487
            )
            
            (610,181
            )Net
                deferred tax asset included in other assets
            
            $
            3,296,704
            
            $
            3,136,581


70


*CRESCENT
        FINANCIAL CORPORATION AND SUBSIDIAR*Y
 ***Notes
        to Consolidated Financial Statements***
 ***December
        31, 2007, 2006 and 2005***




**NOTE
      I - INCOME TAXES (Continued)**





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 Financial Accounting Standards Board
      Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an
      interpretation of FASB Statement 109 (FIN 48). FIN 48 provides guidance on
      financial statement recognition and measurements of tax positions taken, or
      expected to be taken, in tax returns. The initial adoption of FIN 48 had no
      impact on the Company’s financial statements. As of January 1, 2007, there were
      no unrecognized tax benefits.





The
      amount of unrecognized tax benefits may increase or decrease for various reasons
      including adding amounts for current year tax positions, expiration of open
      income tax returns due to statue of limitations, changes in management’s
      judgment about the level of uncertainty, status of examinations, litigation
      and
      legislative activity and the addition or elimination of uncertain tax
      positions.





Crescent’s
      policy is to report interest and penalties, if any, related to unrecognized
      tax
      benefits in other non-interest expense in the Consolidated Statement of
      Operations.





Crescent’s
      federal and state income tax returns are open and subject to examination from
      the 2004 tax return year and forward.





**NOTE
      J - NON-INTEREST INCOME AND OTHER NON-INTEREST EXPENSE**





The
      major
      components of non-interest income for the years ended December 31, 2007, 2006
      and 2005 are as follows:





2007
            
            2006
            
            2005Distribution
                from mortgage company
            
            $
            -
            
            $
            46,099
            
            $
            38,152Brokerage
                referral fees
            
            
            164,665
            
            
            78,510
            
            
            203,168Other
            
            
            269,498
            
            
            326,264
            
            
            179,087Total
            
            $
            434,163
            
            $
            450,873
            
            $
            420,407





The
      major
      components of other non-interest expense for the years ended December 31, 2007,
      2006 and 2005 are as follows:





2007
            
            2006
            
            2005Postage,
                printing and office supplies
            
            $
            550,724
            
            $
            472,542
            
            $
            411,673Advertising
                and promotions
            
            
            606,667
            
            
            517,015
            
            
            396,772Professional
                fees and services
            
            
            1,511,404
            
            
            899,389
            
            
            711,805Other
            
            
            1,926,666
            
            
            1,328,417
            
            
            960,621Total
            
            $
            4,595,461
            
            $
            3,227,363
            
            $
            2,480,871




**NOTE
      K - RESERVE REQUIREMENTS**





The
      aggregate net reserve balance maintained under the requirements of the Federal
      Reserve, which is non-interest bearing, was approximately $5.6 million at
      December 31, 2007.


71


*CRESCENT
        FINANCIAL CORPORATION AND SUBSIDIAR*Y
 ***Notes
        to Consolidated Financial Statements***
 ***December
        31, 2007, 2006 and 2005***




**NOTE
      L - 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, 2007 and 2006, that the
      Company and the Bank met all capital adequacy requirements to which they are
      subject.





As
      of
      December 31, 2007, 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, 2007 and 2006 are presented in the table
      below.




Actual
            
            Minimum for capital
              adequacy purposes
            
            Minimum to be well
              capitalized under prompt
              corrective action provisionsAmount
            
            Ratio
            
            Amount
            
            Ratio
            
            Amount
            
            Ratio(Dollars in thousands)Crescent
                State BankAs
                of December 31, 2007:Total
                Capital (to Risk-Weighted Assets)
            
            $
            75,165
            
            
            10.32
            %
            $
            58,253
            
            
            8.00
            %
            $
            72,216
            
            
            10.00
            %Tier
                I Capital (to Risk-Weighted Assets)
            
            
            66,892
            
            
            9.19
            %
            
            29,126
            
            
            4.00
            %
            
            43,689
            
            
            6.00
            %Tier
                I Capital (to Average Assets)
            
            
            66,892
            
            
            8.39
            %
            
            31,913
            
            
            4.00
            %
            
            39,877
            
            
            5.00
            %As
                of December 31, 2006:Total
                Capital (to Risk-Weighted Assets)
            
            $
            46,980
            
            
            10.26
            %
            $
            36,640
            
            
            8.00
            %
            $
            45,800
            
            
            10.00
            %Tier
                I Capital (to Risk-Weighted Assets)
            
            
            41,774
            
            
            9.12
            %
            
            18,320
            
            
            4.00
            %
            
            27,480
            
            
            6.00
            %Tier
                I Capital (to Average Assets)
            
            
            41,774
            
            
            8.47
            %
            
            19,717
            
            
            4.00
            %
            
            24,646
            
            
            5.00
            %Port
                City Capital BankAs
                of December 31, 2006:Total
                Capital (to Risk-Weighted Assets)
            
            $
            16,002
            
            
            10.69
            %
            $
            11,971
            
            
            8.00
            %
            $
            14,964
            
            
            10.00
            %Tier
                I Capital (to Risk-Weighted Assets)
            
            
            14,217
            
            
            9.50
            %
            
            5,985
            
            
            4.00
            %
            
            8,978
            
            
            6.00
            %Tier
                I Capital (to Average Assets)
            
            
            14,217
            
            
            8.64
            %
            
            6,585
            
            
            4.00
            %
            
            8,232
            
            
            5.00
            %




72


*CRESCENT
        FINANCIAL CORPORATION AND SUBSIDIAR*Y
 ***Notes
        to Consolidated Financial Statements***
 ***December
        31, 2007, 2006 and 2005***




**NOTE
      L - REGULATORY MATTERS (Continued)**





The
      Company is also subject to these requirements. At December 31, 2007, the
      Company’s total capital to risk-weighted assets, Tier I capital to risk-weighted
      assets and Tier I capital to average assets were 10.51%, 9.37% and 8.56%,
      respectively. At December 31, 2006, the Company’s total capital to risk-weighted
      assets, Tier I capital to risk-weighted assets and Tier I capital to average
      assets were 11.03%, 9.88% and 9.13%, respectively.





**NOTE
      M - BUSINESS COMBINATION**





On
      April
      6, 2006, the Company entered into a definitive agreement to acquire Port City
      Capital Bank in Wilmington, North Carolina. The acquisition was approved at
      the
      annual shareholders’ meeting on July 11, 2006 and the transaction took place
      effective with the close of business on August 31, 2006. Port City Capital
      Bank
      operated under its current name as a wholly-owned subsidiary of Crescent
      Financial Corporation, and with its current board of directors and management,
      through June 15, 2007. After close of business June 15, 2007, Port City Capital
      Bank was merged into Crescent State Bank. Port City Capital Bank shareholders
      received $3.30 in cash for each share of Port City Capital Bank stock they
      owned, and exchanged each share of Port City Capital Bank stock for 2.262 shares
      of Crescent Financial Corporation common stock. As a result of the acquisition,
      the Company paid $3.6 million in cash and issued 2,675,611 (adjusted for the
      11-for-10 split) additional shares of stock. The acquisition was accounted
      for
      using the purchase method of accounting, with the operating results of Port
      City
      Capital Bank subsequent to August 31, 2006 included in the Company’s financial
      statements **.**





The
      following table reflects the unaudited proforma combined results of operations
      for the years ended December
      31, 2006 and 2005, assuming the acquisition had occurred at the beginning of
      fiscal year 2005.





2006
            
            2005Net
                interest income
            
            $
            26,250,692
            
            $
            18,802,822Net
                income
            
            
            6,833,502
            
            
            4,960,512Net
                income per share:Basic
            
            $
            0.68
            
            $
            0.62Diluted
            
            
            0.65
            
            
            0.59





The
      proforma net income for the year ended December 31, 2006 does not reflect
      approximately $1,575,000 in merger related costs incurred by Port City Capital
      Bank. In management’s opinion, these unaudited results are not necessarily
      indicative of what actual combined results of operations might have been if
      the
      acquisition had been effective at the beginning of fiscal 2005.





A
      summary
      of the total purchase price of the transaction is as follows:





Fair
                value of common stock issued
            
            $
            31,669,470Fair
                value of common stock options issued
            
            
            4,328,905Cash
                paid for shares
            
            
            3,550,620Transaction
                costs paid in cash
            
            
            617,005Total
                purchase price
            
            $
            40,166,000




73


*CRESCENT
        FINANCIAL CORPORATION AND SUBSIDIAR*Y
 ***Notes
        to Consolidated Financial Statements***
 ***December
        31, 2007, 2006 and 2005***




**NOTE
      M - BUSINESS COMBINATION (Continued)**





A
      summary
      of the fair value of assets acquired and liabilities assumed is as
      follows:





Cash
                and cash equivalents
            
            $
            12,382,048Investment
                securities available for sale
            
            
            16,366,192Stock
                in FHLB of Atlanta
            
            
            286,100Loans
                receivable, net
            
            
            126,715,970Premises
                and equipment
            
            
            84,775Deferred
                tax asset
            
            
            817,430Goodwill
            
            
            26,632,751Core
                deposit intangible
            
            
            1,124,481Other
                assets
            
            
            794,477Deposits
            
            
            (144,187,695
            )Other
                liabilities
            
            
            (850,529
            )Net
                assets acquired
            
            $
            40,166,000





**NOTE
      N - 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.





A
      summary
      of the contract amount of the Company’s exposure to off-balance sheet credit
      risk as of December 31, 2007 is as follows (amounts in
      thousands):





Financial
                instruments whose contract amounts represent credit risk:Commitments
                to extend credit
            
            $
            125,321Undisbursed
                equity lines of credit
            
            
            45,242Financial
                standby letters of credit
            
            
            5,771Commitment
                to invest in Small Business Investment Corporation
            
            
            413




74


*CRESCENT
        FINANCIAL CORPORATION AND SUBSIDIAR*Y
 ***Notes
        to Consolidated Financial Statements***
 ***December
        31, 2007, 2006 and 2005***




**NOTE
      O - DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS**





Financial
      instruments include cash and due from banks, interest-earning deposits with
      banks, federal funds sold, investment securities, loans, Federal Home Loan
      Bank
      stock, investment in life insurance, accrued interest receivable, accrued
      interest payable, deposit accounts, and borrowings. Fair value estimates are
      made at a specific moment in time, based on relevant market information and
      information about the financial instrument. These estimates do not reflect
      any
      premium or discount that could result from offering for sale at one time the
      Company’s entire holdings of a particular financial instrument. Because no
      active market readily exists for a portion of the Company’s financial
      instruments, fair value estimates are based on judgments regarding future
      expected loss experience, current economic conditions, risk characteristics
      of
      various financial instruments, and other factors. These estimates are subjective
      in nature and involve uncertainties and matters of significant judgment and,
      therefore, cannot be determined with precision. Changes in assumptions could
      significantly affect the estimates.





The
      following methods and assumptions were used to estimate the fair value of each
      class of financial instruments for which it is practicable to estimate that
      value:





***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***





Fair
      value for investment securities equals quoted market price if such information
      is available. If a quoted market price is not available, fair value is estimated
      using quoted market prices for similar securities.





***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.


75


*CRESCENT
        FINANCIAL CORPORATION AND SUBSIDIAR*Y
 ***Notes
        to Consolidated Financial Statements***
 ***December
        31, 2007, 2006 and 2005***




**NOTE
      O - DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS
      (Continued)**





***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.





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, 2007 and 2006:





2007
            
            2006Carrying
              amount
            
            Estimated
              fair
                value
            
            Carrying
              amount
            
            Estimated
              fair
                valueFinancial
                assets:Cash
                and cash equivalents
            
            $
            12,356,404
            
            $
            12,356,404
            
            $
            15,150,110
            
            $
            15,150,110Investment
                securities
            
            
            90,758,467
            
            
            90,758,467
            
            
            84,722,892
            
            
            84,722,892Federal
                Home Loan Bank stock
            
            
            6,790,700
            
            
            6,790,700
            
            
            3,582,800
            
            
            3,582,800Loans,
                net
            
            
            667,643,228
            
            
            667,893,000
            
            
            542,873,548
            
            
            538,653,000Investment
                in life insurance
            
            
            9,122,697
            
            
            9,122,697
            
            
            5,683,493
            
            
            5,683,493Accrued
                interest receivable
            
            
            3,761,600
            
            
            3,761,600
            
            
            3,045,840
            
            
            3,045,840Financial
                liabilities:Deposits
            
            
            605,431,312
            
            
            593,257,000
            
            
            541,881,680
            
            
            523,783,000Short-term
                borrowings
            
            
            13,755,000
            
            
            13,755,000
            
            
            24,451,000
            
            
            24,451,000Long-term
                borrowings
            
            
            121,248,000
            
            
            134,589,000
            
            
            45,248,000
            
            
            38,620,000Accrued
                interest payable
            
            
            1,682,428
            
            
            1,682,428
            
            
            1,237,808
            
            
            1,237,808





**NOTE
      P - EMPLOYEE AND DIRECTOR BENEFIT PLANS**





All
      information presented under this caption has been adjusted for the effects
      of
      the stock dividend and the stock splits effected in the form of stock dividends
      discussed in Note B under the caption ***Per
      Share Results*** .
      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 368,500 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. In the event that the number
      of shares of common stock that remain available for future issuance under the
      Plan as of December 31, 2007 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, 2007, there were 307,886
      unissued options in this plan.


76


*CRESCENT
        FINANCIAL CORPORATION AND SUBSIDIAR*Y
 ***Notes
        to Consolidated Financial Statements***
 ***December
        31, 2007, 2006 and 2005***




**NOTE
      P - 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. 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 years ended December 31, 2007,
      adjusted for the stock split effected in the form of a 10% stock dividend
      distributed in May 2007, is as follows:





**Outstanding Options**
            
            **Exercisable Options**Number
            
            Weighted
              Average
              Option
              Price
            
            Number
            
            Weighted
              Average
              Option
              PriceOptions
                outstanding, beginning of year
            
            
            1,057,370
            
            $
            4.90
            
            
            1,031,499
            
            $
            4.75Granted/vested
            
            
            24,050
            
            
            11.16
            
            
            22,383
            
            
            11.16Exercised
            
            
            (322,900
            )
            
            4.54
            
            
            (322,900
            )
            
            4.54Forfeited
            
            
            (3,981
            )
            
            11.20
            
            
            (2,049
            )
            
            11.70Options
                outstanding, end of year
            
            
            754,539
            
            $
            5.22
            
            
            728,933
            
            $
            5.00





The
      weighted average remaining life of options outstanding and options exercisable
      at December 31, 2007 is 4.51 years and 4.35 years, respectively.





The
      following table provides the range of exercise prices for options outstanding
      and exercisable at December 31, 2007:





Range of Exercise Prices
            
            Stock Options Outstanding
            
            Stock Options Exercisable$ 
                3.93     -     $ 6.13
            
            
            657,375
            
            
            657,375$ 
                6.14     -     $ 8.33
            
            
            21,444
            
            
            21,444$ 
                8.34     -     $ 10.53
            
            
            13,093
            
            
            13,093$
                10.54    -     $ 12.72
            
            
            62,627
            
            
            37,021754,539
            
            
            728,933





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.





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





2007
            
            2006
            
            2005Assumptions
                in estimating option values:Risk-free
                interest rate
            
            
            4.68
            %
            
            4.58
            %
            
            4.36
            %Dividend
                yield
            
            
            0
            %
            
            0
            %
            
            0
            %Volatility
            
            
            31.63
            %
            
            34.24
            %
            
            36.50
            %Expected
                life
            
            
            7
                years
            
            
            7
                years
            
            
            7
                yearsThe
                weighted average grant date fair value of options
            
            $
            4.88
            
            $
            5.48
            
            $
            5.68


77


*CRESCENT
        FINANCIAL CORPORATION AND SUBSIDIAR*Y
 ***Notes
        to Consolidated Financial Statements***
 ***December
        31, 2007, 2006 and 2005***




**NOTE
      P - EMPLOYEE AND DIRECTOR BENEFIT PLANS (Continued)**





***Stock
      Option Plans (Continued)***





Compensation
      cost charged to income was approximately $99,000 and $196,000 for the years
      end
      December 31, 2007, 2006 in accordance with SFAS No. 123R. SFAS No. 123R was
      adopted beginning in 2006 and therefore no compensation expense was recognized
      in 2005. Cash received from option exercise under all share-based payment
      arrangements for the years ended December 31, 2007, 2006 and 2005 were
      $1,214,000, $256,000 and $393,000, respectively. 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, 2007, 2006
      and
      2005 totaled $452,000, $45,000 and $200,000, respectively.





The
      total
      intrinsic value of options exercised during the years ended December 31, 2007,
      2006 and 2005 was $1,987,000, $351,000 and $772,000, respectively. The aggregate
      intrinsic value of both total options outstanding and exercisable options at
      December 31, 2007 was $3,098,000. As of December 31, 2007, there was $142,000
      of
      unrecognized compensation cost related to the nonvested stock option plans.
      That
      cost is expected to be recognized as follows: $82,000 in 2008, $43,000 in 2009
      and $17,000 in 2010.





***Stock
      Award Plans***





A
      summary
      of the status of the Company’s non-vested stock awards as of December 31, 2007,
      and changes during the year then ended is presented below:





Shares
            
            Weighted
              average
              grant date
              fair valueNon-vested –
                December 31, 2006
            
            
            8,125
            
            $
            12.31Granted
            
            
            17,050
            
            
            12.62Vested
            
            
            -
            
            
            -Forfeited
            
            
            3,406
            
            
            12.33Non-vested –
                December 31, 2007
            
            
            21,769
            
            $
            12.55





The
      total
      fair value of restricted stock grants issued during the year ended December
      31,
      2007 was $201,550. There were no restricted stock grants vested during the
      year.





As
      of
      December 31, 2007, there was $193,082 of unrecognized compensation cost related
      to the nonvested stock award plan. That cost is expected to be recognized over
      a
      weighted average period of 3.7 years.





***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, 2007, 2006 and 2005
      were
      $241,934, $87,657 and $80,022, respectively. The accrued liability of the plan
      at December 31, 2007 and 2006 was $505,818 and $263,884,
      respectively.


78


*CRESCENT
        FINANCIAL CORPORATION AND SUBSIDIAR*Y
 ***Notes
        to Consolidated Financial Statements***
 ***December
        31, 2007, 2006 and 2005***




**NOTE
      P - EMPLOYEE AND DIRECTOR BENEFIT PLANS (Continued)**





***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.
      The
      Company may make additional discretionary profit sharing contributions to the
      plan on behalf of all participants; in 2005 the Company declared an $80,000
      discretionary contribution. There were no discretionary contributions for 2007
      or 2006. 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, 2007,
      2006 and 2005 were $286,778, $269,058 and $172,450, 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
      Q - PARENT COMPANY FINANCIAL DATA**





Condensed
      balance sheets as of December 31, 2007 and 2006, and related condensed
      statements of operations and cash flows for each of the years in the three-year
      period ended December 31, 2007 are as follows:




**Condensed
      Balance Sheets**


**December
      31, 2007 and 2006**





2007
            
            2006ASSETSCash
                and due from banks
            
            $
            1,475,753
            
            $
            4,218,479Investment
                in subsidiaries
            
            
            98,514,864
            
            
            87,188,534Other
                assets
            
            
            96,046
            
            
            73,694TOTAL
                ASSETS
            
            $
            100,086,663
            
            $
            91,480,707LIABILITIES
                  AND STOCKHOLDERS' EQUITYLiabilities:Accrued
                  interest payable
            
            $
            164,377
            
            $
            166,963Due
                to former Centennial Shareholders
            
            
            15,474
            
            
            27,113Accrued
                expenses and other liabilities
            
            
            -
            
            
            4,653Subordinated
                debentures
            
            
            8,248,000
            
            
            8,248,000TOTAL
                LIABILITIES
            
            
            8,427,851
            
            
            8,446,729Stockholders'
                equity:Common
                stock
            
            
            9,404,579
            
            
            8,265,136Additional
                paid-in capital
            
            
            73,596,427
            
            
            62,659,201Retained
                earnings
            
            
            8,619,617
            
            
            12,610,588Accumulated
                other comprehensive income/(loss)
            
            
            38,189
            
            
            (500,947
            )TOTAL
                STOCKHOLDERS’ EQUITY
            
            
            91,658,812
            
            
            83,033,978TOTAL
                  LIABILITIES AND STOCKHOLDERS’ EQUITY
            
            $
            100,086,663
            
            $
            91,480,707





79


*CRESCENT
          FINANCIAL CORPORATION AND SUBSIDIAR*Y
 ***Notes
          to Consolidated Financial Statements***
 ***December
          31, 2007, 2006 and 2005***


**NOTE
      Q - PARENT COMPANY FINANCIAL DATA (Continued)**





**Condensed
      Statements of Operations**


**Years
      Ended December 31, 2007, 2006 and 2005**





2007
            
            2006
            
            2005Equity
                in earnings of subsidiaries
            
            $
            6,688,256
            
            $
            4,988,649
            
            $
            3,397,675Interest
                income
            
            
            169,130
            
            
            630,505
            
            
            233,179Dividend
                income
            
            
            21,200
            
            
            20,669
            
            
            16,238Other
                miscellaneous income
            
            
            -
            
            
            23,286
            
            
            803Interest
                expense
            
            
            (738,485
            )
            
            (720,822
            )
            
            (573,438
            )Other
                operating expenses
            
            
            (118,245
            )
            
            (81,853
            )
            
            (59,784
            )Income
                tax benefit (expense)
            
            
            226,900
            
            
            43,100
            
            
            129,700Net
                income
            
            $
            6,248,756
            
            $
            4,903,534
            
            $
            3,144,373




**Condensed
      Statements of Cash Flows**


**Years
      Ended December 31, 2007, 2006 and 2005**





2007
            
            2006
            
            2005Cash
                flows from operating activities:Net
                income
            
            $
            6,248,756
            
            $
            4,903,534
            
            $
            3,144,373Adjustments
                to reconcile net income to net cash provided (used) by operating
                activities:Amortization
            
            
            33,400
            
            
            33,400
            
            
            33,400Stock
                based compensation
            
            
            178,940
            
            
            202,246
            
            
            -Equity
                in earnings of Crescent State Bank
            
            
            (6,688,256
            )
            
            (4,194,284
            )
            
            (3,397,675
            )Equity
                in earnings of Port City Capital Bank
            
            
            -
            
            
            (794,365
            )
            
            -Changes
                in assets and liabilities:Increase
                in other assets
            
            
            (55,752
            )
            
            5,068
            
            
            (10,765
            )Increase
                (decrease) in accrued interest payable
            
            
            (2,586
            )
            
            24,112
            
            
            40,983Increase
                (decrease) in accrued expenses and other liabilities
            
            
            (16,292
            )
            
            (17,660
            )
            
            (76,467
            )Net
                cash provided (used) by operating activities
            
            
            (301,790
            )
            
            162,051
            
            
            (266,151
            )Cash
                flows from investing activities:Investment
                in Subsidiaries
            
            
            (4,098,938
            )
            
            (8,770,879
            )
            
            (1,750,000
            )Cash
                flows from financing activities:Net
                proceeds from issuance of common stock
            
            
            -
            
            
            -
            
            
            11,617,858Proceeds
                from exercise of stock options
            
            
            1,213,738
            
            
            255,797
            
            
            392,912Excess
                tax benefits from stock options exercised
            
            
            451,950
            
            
            45,401
            
            
            199,800Cash
                (paid) received in lieu of fractional shares
            
            
            (7,686
            )
            
            (9,435
            )
            
            2Net
                cash provided by financing activities
            
            
            1,658,002
            
            
            291,763
            
            
            12,210,572Net
                increase (decrease) in cash and cash equivalents
            
            
            (2,742,726
            )
            
            (8,317,065
            )
            
            10,194,421Cash
                and cash equivalents, beginning
            
            
            4,218,479
            
            
            12,535,544
            
            
            2,341,123Cash
                and cash equivalents, ending
            
            $
            1,475,753
            
            $
            4,218,479
            
            $
            12,535,544


80


*CRESCENT
        FINANCIAL CORPORATION AND SUBSIDIAR*Y
 ***Notes
        to Consolidated Financial Statements***
 ***December
        31, 2007, 2006 and 2005***




**NOTE
      R - SUPPLEMENTAL DISCLOSURE FOR STATEMENT OF CASH FLOWS**





2007
            
            2006
            
            2005Supplemental
                Disclosure of Cash Flow Information:Cash
                paid during the year for:Interest
            
            $
            27,772,615
            
            $
            17,120,578
            
            $
            8,562,944Income
                taxes
            
            $
            3,928,000
            
            $
            2,655,001
            
            $
            1,330,000Supplemental
                Disclosure of Noncash Investing and Financing Activities:Transfer
                of loans to foreclosed assets
            
            $
            479,814
            
            $
            199,900
            
            $
            48,300Increase
                (decrease) in fair value of securities available for sale, net of
                tax
            
            $
            539,136
            
            $
            180,846
            
            $
            (675,145
            )





The
      fair
      value of assets acquired and liabilities assumed in the PCCB merger are
      presented in Note M.


81





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





Not
      applicable.





**ITEM** **9A
      - 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, 2007. 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, 2007. 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, 2007, it maintained effective internal control over financial
      reporting.





The
      effectiveness of the Registrant's internal control over financial reporting
      as
      of December 31, 2007, has been audited by Dixon Hughes PLLC, an independent
      registered public accounting firm, as stated in their report, which is included
      in Item 8 and is incorporated into this Item 9A by reference.




82




**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 subsequent to the date of the most recent
      evaluation of these controls by the Registrant’s Chief Executive Officer and
      Chief Financial Officer, including any corrective actions with regard to
      deficiencies and weaknesses.





**ITEM** **9B –
      OTHER INFORMATION**





Not
      applicable.




**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,” “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 2008 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,” “Compensation Committee Interlocks and Insider
      Participation” and “Compensation Committee Report” in the Registrant’s Proxy
      Statement for the 2008 Annual Meeting of Shareholders to be filed with the
      SEC.





**ITEM
      1** **2
      - 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 2008 Annual
      Meeting of Shareholders to be filed with the SEC.


83


**Stock
      Option Plans**





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





**EQUITY COMPENSATION PLAN INFORMATION**





Plan Category
            
            Number of securities to be
              issued upon exercise of
              outstanding options,
              warrants, and rights
              (a)
            
            Weighted-average exercise
              price of outstanding
              options, warrants, and
              rights
              (b)
            
            Number of securities
              remaining available for
              future issuance under
              equity compensation plans
              (excluding securities
              reflected in column (a))
              (c)Equity
                compensation plans approved by security holders
            
            
            754,539
            
            $
            5.22
            
            
            307,886Equity
                compensation plans not approved by security holders
            
            
            None
            
            
            None
            
            
            NoneTotal
            
            
            754,539
            
            $
            5.22
            
            
            307,886





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





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





Incorporated
      by reference from the discussion under the headings “Director Independence” and
“Indebtedness of and Transactions with Management” in the Registrant’s Proxy
      Statement for the 2008 Annual Meeting of Shareholders to be filed with the
      SEC.





**ITEM
      14 – PRINCIPAL ACCOUNTING FEES AND SERVICES**





Incorporated
      by reference from pages the discussion under the heading “Proposal 2:
      Ratification of Independent Public Accountants” and “Audit Committee Report” in
      the Registrant’s Proxy Statement for the 2008 Annual Meeting of Shareholders to
      be filed with the SEC.





**ITEM
      1** **5 –
      EXHIBITS,
      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, 2007 and December 31,
              2006 ·
            Consolidated
              Statements of Operations for the years ended December 31, 2007, 2006
              and
              2005 ·
            Consolidated
              Statements of Changes in Stockholders’ Equity for the years ended December
              31, 2007, 2006 and 2005 ·
            Consolidated
                Statements of Cash Flows for the years ended December 31, 2007, 2006
                and
                2005


·
            Notes
                to Consolidated Financial
                Statements


·
            Report
                of Independent Registered Public Accounting
                Firm




84


**(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·
              Employment
                  Agreement between the Registrant and Michael G. Carlton·
              Employment
                  Agreement between the Registrant and Bruce W. Elder·
              Employment
                  Agreement between the Registrant and Thomas E. Holder,
                  Jr.·
              Employment
                  Agreement between the Registrant and Ray D. Vaughn·
              Employment
                  Agreement between the Registrant and W. Keith Betts·
              Salary
                  Continuation Agreement with Michael G. Carlton·
              Salary
                  Continuation Agreement with Bruce W. Elder·
              Salary
                  Continuation Agreement with Thomas E. Holder, Jr.·
              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





**(b)**  **Exhibits**





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


85





**SIGNATURES**





In
      accordance with the requirements of Section 13 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 CORPORATION**RegistrantBy:
            /s/
                Michael G. CarltonMichael
                G. CarltonDate:
                March 10, 2008
            
            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
                Michael
                  G. Carlton, President and
                Chief
                  Executive Officer, Director
              March
                  7, 2008/s/
                  Bruce W. Elder
                Bruce
                  W. Elder, Vice President
                (Principal
                  Accounting Officer)
              March
                  7, 2008/s/
                  Brent D. Barringer
                Brent
                  D. Barringer, Director
              March
                  7, 2008/s/
                  William H. Cameron
                William
                  H. Cameron, Director
              March
                  7, 2008/s/
                  Bruce I. Howell
                Bruce
                  I. Howell, Director
              March
                  7, 2008/s/
                  James A. Lucas
                James
                  A. Lucas, Director
              March
                  7, 2008/s/
                  Kenneth A. Lucas
                Kenneth
                  A. Lucas, Director
              March
                  7, 2008/s/
                  Sheila Hale Ogle
                  Sheila
                  Hale Ogle, Director
              March
                  7, 2008/s/
                  Charles A. Paul
                Charles
                  A. Paul, Director
              March
                  7, 2008/s/
                  Francis R. Quis, Jr.
                  Francis
                  R. Quis, Jr., Director
              March
                  7, 2008/s/
                  Jon S. Rufty
                  Jon
                  S. Rufty, Director
              March
                  7, 2008/s/
                  Jon T. Vincent
                  Jon
                  T. Vincent, Director
              March
                  7, 2008/s/
                  Stephen K. Zaytoun
                Stephen
                  K. Zaytoun, Director
              March
                  7, 2008


86


**EXHIBIT
      INDEX**





**Exhibit********Number**
            
            **Exhibit**3(i)
            
            Articles
                of Incorporation.
            
            *3(ii)
            
            Bylaws
            
            *4
            
            Form
                of Stock Certificate
            
            *10(i)
            
            1999
                Incentive Stock Option Plan
            
            **10(ii)
            
            1999
                Nonqualified Stock Option Plan
            
            **10(iii)
            
            Employment
                Agreement Michael G. Carlton
            
            Filed
                Herewith10(iv)
            
            Employment
                Agreement of Bruce W. Elder
            
            Filed
                Herewith10(v)
            
            Employment
                Agreement of Thomas E. Holder, Jr.
            
            Filed
                Herewith10(vi)
            
            Amended
                and Restated Trust Agreement of Crescent Financial Capital Trust
                I
            
            ***10(vii)
            
            Indenture
            
            ***10(viii)
            
            Junior
                Subordinated Debenture
            
            ***10(ix)
            
            Guarantee
                Agreement
            
            ***10(x)
            
            Salary
                Continuation Agreement with Michael G. Carlton
            
            Filed
                Herewith10(xi)
            
            Salary
                Continuation Agreement with Bruce W. Elder
            
            Filed
                Herewith10(xii)
            
            Salary
                Continuation Agreement with Thomas E. Holder, Jr.
            
            Filed
                Herewith10(xiii)
            
            Endorsement
                Split Dollar Agreement with Michael G. Carlton
            
            ***10(xiv)
            
            Endorsement
                Split Dollar Agreement with Bruce W. Elder
            
            ***10(xv)
            
            Endorsement
                Split Dollar Agreement with Thomas E. Holder, Jr.
            
            ***10(xvi)
            
            Crescent
                State Bank Directors’ Compensation Plan
            
            ****10(xvii)
            
            Salary
                Continuation Agreement with Ray D. Vaughn
            
            Filed
                herewith10(xviii)
            
            Salary
                Continuation Agreement with W. Keith Betts
            
            Filed
                herewith10(xix)
            
            Employment
                Agreement with Ray D. Vaughn
            
            Filed
                herewith10(xx)
            
            Employment
                Agreement of W. Keith Betts
            
            Filed
                herewith10(xxi)
            
            Endorsement
                Split Dollar Agreement with Ray D. Vaughn.
            
            Filed
                Herewith10(xxii)
            
            Endorsement
                Split Dollar Agreement with W. Keith Betts.
            
            Filed
                Herewith21
            
            Subsidiaries
            
            Filed
                herewith




87




23
            
            Consent
                of Dixon Hughes PLLC
            
            Filed
                herewith31(i)
            
            Certification
                of Principal Executive Officer Pursuant to Section 302 of the Sarbanes
                Oxley Act
            
            Filed
                herewith31(ii)
            
            Certification
                of Principal Accounting Officer Pursuant to Section 302 of the Sarbanes
                Oxley Act
            
            Filed
                herewith32(i)
            
            Certification
                of Principal Executive Officer Pursuant to Section 906 of the Sarbanes
                Oxley Act
            
            Filed
                herewith32(ii)
            
            Certification
                of Principal Accounting Officer Pursuant to Section 906 of the Sarbanes
                Oxley Act
            
            Filed
                herewith99(i)
            
            Registrant’s
                Proxy Statement for the 2007 Annual Meeting of
                Shareholders
            
            *****





*  Incorporated
      by reference to the Registrant’s 10-KSB for the year ended December 31, 2001, as
      filed with the SEC on March 27, 2002.





**  Incorporated
      by reference to the Registrant’s Registration Statement on Form S-8 as filed
      with the SEC on September 5, 2001.





***  Incorporated
      by reference from Annual Report on Form 10-KSB filed with the SEC on March
      30,
      2004.





****  Incorporated
      by reference from Annual Report on Form 10-K filed with the SEC on March 28,
      2006.





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





88