UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
DC  20549





FORM
10-Q




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





For the
Quarterly Period Ended September 30,
2010




o
            TRANSITION
      REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
      FOR THE TRANSITION PERIOD FROM _________ TO
  ___________





Commission
File Number 000-32951





CRESCENT FINANCIAL
CORPORATION


(Exact
name of registrant as specified in its charter)





NORTH
      CAROLINA
            
            56-2259050(State
      or other jurisdiction ofIncorporation
              or
      organization)
            
            (IRS
      Employer Identification Number)




1005 HIGH HOUSE ROAD, CARY,
NORTH CAROLINA


27513


(Address
of principal executive offices)


(Zip
Code)





(919)
460-7770


(Registrant’s
telephone number, including area code)





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.


Yes x        No
o





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of
this chapter) during the preceding 12 months (or for such shorter period that
the registrant was required to submit and post such files).  Yes o        No
o





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




Large
      accelerated filer o
            
            Accelerated
      filer oNon-accelerated
      filer o
            
            Smaller
      reporting company x





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


Yes o       No x





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





Common
Stock, $1.00 par value 9,664,059 shares outstanding as of November 12,
2010.









CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 TABLE
OF CONTENTS




Page No.Part
      I.
            
            FINANCIAL
      INFORMATIONItem
      1 -
            
            Financial
      Statements (Unaudited)Consolidated
      Balance Sheets September 30, 2010 and December 31, 2009
            
            3Consolidated
      Statements of Operations Three and Nine Months Ended September 30, 2010
      and 2009
            
            4Consolidated
      Statements of Comprehensive Income (Loss)Three and Nine Months Ended
      September 30, 2010 and 2009
            
            5Consolidated
      Statement of Stockholders’ Equity Nine Months Ended September 30,
      2010
            
            6Consolidated
      Statements of Cash Flows Nine Months Ended September, 2010 and
      2009
            
            7Notes
      to Consolidated Financial Statements
            
            8 -
      20Item
      2 -
            
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            
            21
      - 39Item
      3 -
            
            Quantitative
      and Qualitative Disclosures about Market Risk
            
            40Item
      4 -
            
            Controls
      and Procedures
            
            40Part
      II.
            
            Other
      InformationItem
      1 -
            
            Legal
      Proceedings
            
            41Item
      1a -
            
            Risk
      Factors
            
            41Item
      2 -
            
            Unregistered
      Sales of Equity Securities and Use of Proceeds
            
            41Item
      3 -
            
            Defaults
      Upon Senior Debt
            
            41Item
      4 -
            
            (Removed
      and Reserved)
            
            41Item
      5 -
            
            Other
      Information
            
            41Item
      6 -
            
            Exhibits
            
            41





2





Part
I. FINANCIAL INFORMATION




Item 1 - Financial
Statements





CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 CONSOLIDATED
BALANCE SHEETS





September
      30,
              2010
            
            
            December
      31,
              2009*(Unaudited)ASSETSCash
      and due from banks
            
            $
            8,019,437
            
            
            $
            9,285,386Interest-earning
      deposits with banks
            
            
            1,490,868
            
            
            
            4,616,722Federal
      funds sold
            
            
            20,155,000
            
            
            
            17,825,000Investment
      securities available for sale, at fair value
            
            
            186,561,623
            
            
            
            193,122,891Loans
      held for sale
            
            
            2,039,246
            
            
            
            -Loans
            
            
            694,449,569
            
            
            
            759,348,341Allowance
      for loan losses
            
            
            (18,049,000
            )
            
            
            (17,567,000
            )NET
      LOANS
            
            
            676,400,569
            
            
            
            741,781,341Accrued
      interest receivable
            
            
            3,682,081
            
            
            
            4,260,258Federal
      Home Loan Bank stock, at cost
            
            
            10,932,800
            
            
            
            11,776,500Bank
      premises and equipment
            
            
            11,742,846
            
            
            
            11,861,158Investment
      in life insurance
            
            
            18,276,906
            
            
            
            17,658,386Foreclosed
      assets
            
            
            15,204,819
            
            
            
            6,305,617Other
      assets
            
            
            18,001,926
            
            
            
            14,311,750TOTAL
      ASSETS
            
            $
            972,508,121
            
            
            $
            1,032,805,009LIABILITIES
      AND STOCKHOLDERS’ EQUITYDeposits:Demand
            
            $
            61,962,241
            
            
            $
            61,041,955Savings
            
            
            65,681,108
            
            
            
            58,086,102Money
      market and NOW
            
            
            200,763,613
            
            
            
            165,994,207Time
            
            
            388,641,346
            
            
            
            437,512,354TOTAL
      DEPOSITS
            
            
            717,048,308
            
            
            
            722,634,618Short-term
      borrowings
            
            
            7,000,000
            
            
            
            74,000,000Long-term
      debt
            
            
            157,748,000
            
            
            
            142,748,000Accrued
      expenses and other liabilities
            
            
            5,144,548
            
            
            
            3,902,185TOTAL
      LIABILITIES
            
            
            886,940,856
            
            
            
            943,284,803Commitments
      (Note B)Stockholders’
      EquityPreferred stock, no par value,
      5,000,000 shares authorized,24,900 shares issued and
      outstanding at bothJune 30, 2010 and December 31,
      2009
            
            
            23,265,565
            
            
            
            22,935,514Common stock, $1 par value,
      40,000,000 shares authorized;9,664,059 and 9,626,559 shares
      issued and outstandingat June 30, 2010 and December 31,
      2009, respectively
            
            
            9,664,059
            
            
            
            9,626,559Common
      stock warrant
            
            
            2,367,368
            
            
            
            2,367,368Additional
      paid-in capital
            
            
            74,597,585
            
            
            
            74,529,894Accumulated
      deficit
            
            
            (27,968,940
            )
            
            
            (21,354,080
            )Accumulated
      other comprehensive income
            
            
            3,641,628
            
            
            
            1,414,951TOTAL
      STOCKHOLDERS’ EQUITY
            
            
            85,567,265
            
            
            
            89,520,206TOTAL
      LIABILITIES AND STOCKHOLDERS’ EQUITY
            
            $
            972,508,121
            
            
            $
            1,032,805,009







*
            Derived
      from audited consolidated financial
statements.




See
accompanying notes.




3


.


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 CONSOLIDATED
STATEMENTS OF OPERATIONS (Unaudited)
 Three
and Nine Month Periods Ended September 30, 2010 and 2009










Three-month
      Periods
              Ended
              September
      30,
            
            
            Nine-month
      Periods
              Ended
              September
      30,2010
            
            
            2009
            
            
            2010
            
            
            2009INTEREST
      INCOMELoans
            
            $
            10,420,580
            
            
            $
            11,986,538
            
            
            $
            33,400,315
            
            
            $
            36,089,299Investment
      securities available for sale
            
            
            1,843,759
            
            
            
            2,081,011
            
            
            
            5,637,237
            
            
            
            6,133,383Federal
      funds sold and interest-bearing deposits
            
            
            13,013
            
            
            
            1,014
            
            
            
            25,776
            
            
            
            8,349TOTAL
      INTEREST INCOME
            
            
            12,277,352
            
            
            
            14,068,563
            
            
            
            39,063,328
            
            
            
            42,231,031INTEREST
      EXPENSEDeposits
            
            
            3,980,369
            
            
            
            4,885,179
            
            
            
            12,558,421
            
            
            
            15,196,846Short-term
      borrowings
            
            
            57,751
            
            
            
            507,004
            
            
            
            387,706
            
            
            
            1,476,614Long-term
      borrowings
            
            
            1,427,778
            
            
            
            1,265,254
            
            
            
            4,306,638
            
            
            
            3,646,362TOTAL
      INTEREST EXPENSE
            
            
            5,465,898
            
            
            
            6,657,437
            
            
            
            17,252,765
            
            
            
            20,319,822NET
      INTEREST INCOME
            
            
            6,811,454
            
            
            
            7,411,126
            
            
            
            21,810,563
            
            
            
            21,911,209PROVISION
      FOR LOAN LOSSES
            
            
            4,948,366
            
            
            
            1,957,526
            
            
            
            15,138,616
            
            
            
            4,786,505NET
      INTEREST INCOME AFTERPROVISION
      FOR LOAN LOSSES
            
            
            1,863,088
            
            
            
            5,453,600
            
            
            
            6,671,947
            
            
            
            17,124,704NON-INTEREST
      INCOMEMortgage
      loan origination revenue
            
            
            68,511
            
            
            
            223,278
            
            
            
            372,073
            
            
            
            735,113Fees
      on deposit accounts
            
            
            464,050
            
            
            
            423,775
            
            
            
            1,370,020
            
            
            
            1,207,485Earnings
      on life insurance
            
            
            223,341
            
            
            
            225,022
            
            
            
            660,303
            
            
            
            660,150Gain
      (loss) on disposal of assets
            
            
            (13,164
            )
            
            
            20
            
            
            
            (8,306
            )
            
            
            (480
            )Gain
      on sale of loans
            
            
            408,641
            
            
            
            -
            
            
            
            601,973
            
            
            
            -Gain
      on sale of available for sale securities
            
            
            -
            
            
            
            109,777
            
            
            
            -
            
            
            
            109,777Loss
      on impairment of nonmarketable equity security
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (406,802
            )Other
            
            
            163,830
            
            
            
            146,573
            
            
            
            455,464
            
            
            
            363,774TOTAL
      NON-INTEREST INCOME
            
            
            1,315,209
            
            
            
            1,128,445
            
            
            
            3,451,527
            
            
            
            2,669,017NON-INTEREST
      EXPENSESalaries
      and employee benefits
            
            
            3,222,898
            
            
            
            3,030,101
            
            
            
            9,402,257
            
            
            
            9,018,527Occupancy
      and equipment
            
            
            998,214
            
            
            
            951,473
            
            
            
            2,949,342
            
            
            
            2,606,593Data
      processing
            
            
            388,444
            
            
            
            358,236
            
            
            
            1,167,741
            
            
            
            1,109,895FDIC
      deposit insurance premium
            
            
            429,033
            
            
            
            309,916
            
            
            
            1,012,893
            
            
            
            1,331,504Net
      loss on foreclosed assets
            
            
            134,767
            
            
            
            -
            
            
            
            1,071,175
            
            
            
            -Foreclosed
      asset related costs
            
            
            388,592
            
            
            
            -
            
            
            
            1,128,459
            
            
            
            -Other
            
            
            1,074,391
            
            
            
            1,237,467
            
            
            
            3,245,566
            
            
            
            3,733,934TOTAL
      NON-INTEREST EXPENSE
            
            
            6,636,339
            
            
            
            5,887,193
            
            
            
            19,977,433
            
            
            
            17,800,453INCOME
      (LOSS) BEFORE INCOME TAXES
            
            
            (3,458,042
            )
            
            
            694,852
            
            
            
            (9,853,959
            )
            
            
            1,993,268INCOME
      TAXES
            
            
            (1,574,000
            )
            
            
            58,100
            
            
            
            (4,502,900
            )
            
            
            171,800NET
      INCOME (LOSS)
            
            
            (1,884,042
            )
            
            
            636,752
            
            
            
            (5,351,059
            )
            
            
            1,821,468Effective
      dividend on preferred stock (Note G)
            
            
            423,277
            
            
            
            422,443
            
            
            
            1,263,801
            
            
            
            1,012,308Net
      income (loss) available to common shareholders
            
            $
            (2,307,319
            )
            
            $
            214,309
            
            
            $
            (6,614,860
            )
            
            $
            809,160NET
      INCOME (LOSS) PER COMMON SHAREBasic
            
            $
            (.24
            )
            
            $
            .02
            
            
            $
            (.69
            )
            
            $
            .08Diluted
            
            $
            (.24
            )
            
            $
            .02
            
            
            $
            (.69
            )
            
            $
            .08WEIGHTED
      AVERAGE COMMON SHARES OUTSTANDING (Note C)Basic
            
            
            9,581,390
            
            
            
            9,569,290
            
            
            
            9,579,041
            
            
            
            9,569,290Diluted
            
            
            9,581,390
            
            
            
            9,606,186
            
            
            
            9,579,041
            
            
            
            9,585,422





See
accompanying notes.




4




CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 CONSOLIDATED
STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited)
 Three
and Nine Month Periods Ended September 30, 2010 and 2009





Three
      Months Ended
              September
      30,
            
            
            Nine
      Months Ended
              September
      30,2010
            
            
            2009
            
            
            2010
            
            
            2009Net
      income (loss)
            
            $
            (1,884,042
            )
            
            $
            636,752
            
            
            $
            (5,351,059
            )
            
            $
            1,821,468Other
      comprehensive income:Securities
      available for sale:Unrealized
      holding gains on available for sale securities
            
            
            1,137,657
            
            
            
            3,429,112
            
            
            
            4,034,787
            
            
            
            4,226,163Tax
      effect
            
            
            (438,567
            )
            
            
            (1,323,950
            )
            
            
            (1,555,527
            )
            
            
            (1,631,244
            )Reclassification
      of (gains) losses recognized in net income
            
            
            -
            
            
            
            (109,777
            )
            
            
            -
            
            
            
            (109,777
            )Tax
      effect
            
            
            -
            
            
            
            42,319
            
            
            
            -
            
            
            
            42,319Net
      of tax amount
            
            
            699,090
            
            
            
            2,037,704
            
            
            
            2,479,260
            
            
            
            2,527,461Cash
      flow hedging activities:Unrealized
      holding loss on cash flow hedging activities
            
            
            (113,463
            )
            
            
            (194,916
            )
            
            
            (411,040
            )
            
            
            (346,857
            )Tax
      effect
            
            
            43,741
            
            
            
            74,714
            
            
            
            158,457
            
            
            
            133,714Net
      of tax amount
            
            
            (69,722
            )
            
            
            (120,202
            )
            
            
            (252,583
            )
            
            
            (213,143
            )Total
      other comprehensive income
            
            
            629,368
            
            
            
            1,917,502
            
            
            
            2,226,677
            
            
            
            2,314,318COMPREHENSIVE
      INCOME (LOSS)
            
            $
            (1,254,674
            )
            
            $
            2,554,254
            
            
            $
            (3,124,382
            )
            
            $
            4,135,786





See
accompanying notes.




5




CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ EQUITY (Unaudited)


AccumulatedCommon
                
                
                Additional
                
                
                
                
                
                other
                
                
                TotalPreferred
      stock
                
                
                Common
      stock
                
                
                stock
                
                
                paid-in
                
                
                Accumulated
                
                
                comprehensive
                
                
                stockholders’Shares
                
                
                Amount
                
                
                Shares
                
                
                Amount
                
                
                warrants
                
                
                capital
                
                
                deficit
                
                
                income
                
                
                equityBalance
      at December 31, 2009
                
                
                24,900
                
                
                $
                22,935,514
                
                
                
                9,626,559
                
                
                $
                9,626,559
                
                
                $
                2,367,368
                
                
                $
                74,529,894
                
                
                $
                (21,354,080
                )
                
                $
                1,414,951
                
                
                $
                89,520,206Net
      loss
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (5,351,059
                )
                
                
                -
                
                
                
                (5,351,059
                )Other
      comprehensive income
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                2,226,677
                
                
                
                2,226,677Stock
      based compensation
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                105,191
                
                
                
                -
                
                
                
                -
                
                
                
                105,191Restricted
      stock issued
                
                
                -
                
                
                
                -
                
                
                
                37,500
                
                
                
                37,500
                
                
                
                -
                
                
                
                (37,500
                )
                
                
                -
                
                
                
                -
                
                
                
                -Accretion
      of discount
                
                
                -
                
                
                
                330,051
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (330,051
                )
                
                
                -
                
                
                
                -Preferred
      stock dividend
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (933,750
                )
                
                
                -
                
                
                
                (933,750
                )Balance
      at September 30, 2010
                
                
                24,900
                
                
                $
                23,265,565
                
                
                
                9,664,059
                
                
                $
                9,664,059
                
                
                $
                2,367,368
                
                
                $
                74,597,585
                
                
                $
                (27,968,940
                )
                
                $
                3,641,628
                
                
                $
                85,567,265




See
accompanying notes.




6




CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 CONSOLIDATED
STATEMENTS OF CASH FLOWS (Unaudited)
 Nine
Months Ended September 30, 2010 and 2009





2010
            
            
            2009CASH
      FLOWS FROM OPERATING ACTIVITIESNet
      income (loss)
            
            $
            (5,351,059
            )
            
            $
            2,777,038Adjustments
      to reconcile net income (loss) to net cash provided by operating
      activities:Depreciation
            
            
            747,841
            
            
            
            690,888Provision
      for loan losses
            
            
            15,138,616
            
            
            
            4,786,505Gain
      on mortgage loan commitments
            
            
            (85,969
            )
            
            
            -Net
      gain on sales of mortgage loans
            
            
            (516,004
            )
            
            
            -Originations
      of mortgage loans held-for-sale
            
            
            (38,561,051
            )
            
            
            -Proceeds
      from sales of mortgage loans
            
            
            37,037,809
            
            
            
            -Proceeds
      from sale of loan
            
            
            50,558
            
            
            
            -Amortization
      of core deposit premium
            
            
            100,012
            
            
            
            100,012Deferred
      income taxes
            
            
            (879,456
            )
            
            
            (615,901
            )Loss
      on impairment of nonmarketable equity security
            
            
            -
            
            
            
            406,802Gain
      on sale of available for sale securities
            
            
            -
            
            
            
            (109,777
            )Net
      loss on disposal of and valuation adjustments to - foreclosed
      assets
            
            
            950,874
            
            
            
            45,076(Gain)
      loss on disposal of other assets
            
            
            8,306
            
            
            
            480Net
      amortization of premiums/discounts on securities
            
            
            1,031,411
            
            
            
            727,295Accretion
      of loan discount
            
            
            (958,343
            )
            
            
            (146,607
            )Amortization
      of deposit premium
            
            
            30,323
            
            
            
            82,298Net
      increase in cash value of life insurance
            
            
            (618,520
            )
            
            
            (632,455
            )Stock
      based compensation
            
            
            105,191
            
            
            
            134,320Change
      in assets and liabilities:(Increase)
      decrease in accrued interest receivable
            
            
            578,177
            
            
            
            (914,120
            )(Increase)
      in other assets
            
            
            (4,566,147
            )
            
            
            (532,263
            )Increase
      (decrease) in accrued interest payable
            
            
            22,838
            
            
            
            (237,213
            )Increase
      in accrued expenses and other liabilities
            
            
            966,941
            
            
            
            399,763TOTAL
      ADJUSTMENTS
            
            
            10,583,407
            
            
            
            4,185,103NET
      CASH PROVIDED BY OPERATING ACTIVITIES
            
            
            5,232,348
            
            
            
            6,006,571CASH
      FLOWS FROM INVESTING ACTIVITIESPurchases
      of investment securities available for sale
            
            
            (9,500,873
            )
            
            
            (130,544,840
            )Principal
      repayments of investment securities available for sale
            
            
            19,065,327
            
            
            
            30,635,630Proceeds
      from sale of securities available for sale
            
            
            -
            
            
            
            10,743,929Redemption
      (Purchase) of Federal Home Loan Bank stock
            
            
            843,700
            
            
            
            (4,512,500
            )Proceeds
      from disposal of foreclosed real estate
            
            
            6,897,048
            
            
            
            4,559,220Proceeds
      from sale of other assets
            
            
            59,365
            
            
            
            -Net
      decrease in loans
            
            
            34,521,195
            
            
            
            1,779,126Purchases
      of bank premises and equipment
            
            
            (629,529
            )
            
            
            (1,791,930
            )NET
      CASH PROVIDED (USED) BY INVESTING ACTIVITIES
            
            
            51,256,233
            
            
            
            (89,131,365
            )CASH
      FLOWS FROM FINANCING ACTIVITIESNet
      increase (decrease) in deposits:Demand
            
            
            920,285
            
            
            
            3,001,402Savings
            
            
            7,595,006
            
            
            
            1,139,174Money
      market and NOW
            
            
            34,769,406
            
            
            
            18,017,505Time
      deposits
            
            
            (48,901,331
            )
            
            
            (22,940,596
            )Net
      increase (decrease) in short-term borrowings
            
            
            (67,000,000
            )
            
            
            50,294,000Net
      increase (decrease) in long-term borrowings
            
            
            15,000,000
            
            
            
            17,000,000Proceeds
      from issuance of preferred stock
            
            
            -
            
            
            
            24,900,000Dividends
      paid on preferred stock
            
            
            (933,750
            )
            
            
            (747,000
            )NET
      CASH PROVIDED (USED) BY FINANCING ACTIVITIES
            
            
            (58,550,384
            )
            
            
            90,664,485NET
      INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
            
            
            (2,061,803
            )
            
            
            7,539,691CASH
      AND CASH EQUIVALENTS, BEGINNING OF PERIOD
            
            
            31,727,108
            
            
            
            10,282,789CASH
      AND CASH EQUIVALENTS, END OF PERIOD
            
            $
            29,665,305
            
            
            $
            17,822,480




See
accompanying notes.




7








CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements





NOTE
A - BASIS OF PRESENTATION




In
management’s opinion, the financial information, which is unaudited, reflects
all adjustments (consisting solely of normal recurring adjustments) necessary
for a fair presentation of the financial information as of and for the three and nine-month periods ended
September 30, 2010 and 2009, in conformity with accounting principles
generally accepted in the United States of America. The financial statements
include the accounts of Crescent Financial Corporation (the “Company”, “we”,
“our”, “Crescent”) and its wholly owned subsidiary, Crescent State Bank (the
“Bank”).  All significant inter-company transactions and balances are
eliminated in consolidation.  Operating results for three and nine-month periods ended
September 30, 2010 are not necessarily indicative of the results that may
be expected for the fiscal year ending December 31, 2010.





The
organization and business of the Company, accounting policies followed by the
Company and other information are contained in the notes to the consolidated
financial statements filed as part of the Company’s 2009 annual report on Form
10-K. This quarterly report should be read in conjunction with such annual
report.





NOTE
B - COMMITMENTS




At
September 30, 2010, commitments are as follows:





Undisbursed
      lines of credit
            
            $
            116,170,000Stand-by
      letters of credit
            
            
            4,171,000Commitments
      to sell loans held for sale
            
            
            2,039,000Undisbursed
      commitment to purchase additional investment in Small Business Investment
      Corporation
            
            
            363,000




NOTE
C - PER SHARE RESULTS




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, restricted stock and the common stock
warrant issued to the US Treasury and are determined using the treasury stock
method.




Three
      Months Ended
              September
      30,
            
            
            Nine
      Months Ended
              September
      30,2010
            
            
            2009
            
            
            2010
            
            
            2009Weighted
      average number of shares used in computing basic net income per
      share
            
            
            9,581,390
            
            
            
            9,569,290
            
            
            
            9,579,041
            
            
            
            9,569,290Effect
      of dilutive stock options
            
            
            -
            
            
            
            36,896
            
            
            
            -
            
            
            
            16,132Weighted
      average number of shares used in computing diluted net income per
      share
            
            
            9,581,390
            
            
            
            9,606,186
            
            
            
            9,579,041
            
            
            
            9,585,422





8




CRESCENT FINANCIAL CORPORATION AND
SUBSIDIARY
 Notes
to Consolidated Financial Statements





NOTE
C - PER SHARE RESULTS (Continued)




For the
three month periods ended September 30, 2010 and 2009, there were 296,611 and
288,377 options and the warrant for 833,705 shares that were
anti-dilutive.  For the nine month periods ended September 30, 2010
and 2009, there were 296,611 and 415,901 options and the warrant for 833,705
shares that were anti-dilutive.




NOTE
D - INVESTMENT SECURITIES




The
following is a summary of the securities portfolio by major
classification.  All mortgage-backed securities and collateralized
mortgage obligations represent securities issued by a government sponsored
enterprise (i.e. Government National Mortgage Association, Federal Home Loan
Mortgage Corporation or Federal National Mortgage Association) where the
underlying collateral consists of conforming residential home mortgage
loans.





September
      30, 2010Gross
            
            
            GrossAmortized
            
            
            unrealized
            
            
            unrealized
            
            
            Faircost
            
            
            gains
            
            
            losses
            
            
            valueSecurities
      available for sale:U.S.
      government securities and obligations of U.S. government
      agencies
            
            $
            10,362,622
            
            
            $
            685,129
            
            
            $
            -
            
            
            $
            11,047,751Mortgage-backed
      securities
            
            
            47,109,715
            
            
            
            2,010,627
            
            
            
            8,207
            
            
            
            49,112,135Collateralized
      mortgage obligations
            
            
            70,249,174
            
            
            
            1,917,933
            
            
            
            66,053
            
            
            
            72,101,054Municipals
            
            
            50,849,418
            
            
            
            2,110,708
            
            
            
            31,861
            
            
            
            52,928,265Corporate
      debt
            
            
            917,795
            
            
            
            -
            
            
            
            585
            
            
            
            917,210Marketable
      equity
            
            
            440,757
            
            
            
            44,786
            
            
            
            30,335
            
            
            
            455,208$
            179,929,481
            
            
            $
            6,769,183
            
            
            $
            137,041
            
            
            $
            186,561,623





December
      31, 2009Gross
            
            
            GrossAmortized
            
            
            unrealized
            
            
            unrealized
            
            
            Faircost
            
            
            gains
            
            
            losses
            
            
            valueSecurities
      available for sale:U.S.
      government securities and obligations of U.S. government
      agencies
            
            $
            12,235,041
            
            
            $
            448,086
            
            
            $
            -
            
            
            $
            12,683,127Mortgage-backed
      securities
            
            
            58,766,929
            
            
            
            1,562,514
            
            
            
            126,356
            
            
            
            60,203,087Collateralized
      mortgage obligations
            
            
            70,300,750
            
            
            
            948,641
            
            
            
            386,219
            
            
            
            70,863,172Municipals
            
            
            48,820,579
            
            
            
            673,223
            
            
            
            465,397
            
            
            
            49,028,405Marketable
      equity
            
            
            402,050
            
            
            
            -
            
            
            
            56,950
            
            
            
            345,100$
            190,525,349
            
            
            $
            3,632,464
            
            
            $
            1,034,922
            
            
            $
            193,122,891





9




CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements





NOTE
D - INVESTMENT SECURITIES (Continued)




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 September 30,
2010 and December 31, 2009. The September 30, 2010 unrealized losses on
investment securities relate to six collateralized mortgage obligations, one
mortgage-backed security, two municipal securities and two marketable
securities. The December 31, 2009 unrealized losses on investment securities
relate to three mortgage-backed securities, twelve collateralized mortgage
obligations, twenty-five municipal securities and two marketable equity
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.





September
      30, 2010Less
      Than 12 Months
            
            
            12
      Months or More
            
            
            TotalFair
              value
            
            
            Unrealized
              losses
            
            
            Fair
              value
            
            
            Unrealized
              losses
            
            
            Fair
              value
            
            
            Unrealized
              lossesSecurities
      available for sale:Mortgage-backed
            
            $
            1,036,584
            
            
            $
            8,207
            
            
            $
            -
            
            
            $
            -
            
            
            $
            1,036,584
            
            
            $
            8,207Collateralized
      mortgage obligations
            
            
            7,455,348
            
            
            
            66,053
            
            
            
            -
            
            
            
            -
            
            
            
            7,455,348
            
            
            
            66,053Municipals
            
            
            -
            
            
            
            -
            
            
            
            1,043,546
            
            
            
            31,861
            
            
            
            1,043,546
            
            
            
            31,861Corporate
      debt
            
            
            917,210
            
            
            
            585
            
            
            
            -
            
            
            
            -
            
            
            
            917,210
            
            
            
            585Marketable
      equity
            
            
            51,489
            
            
            
            30,335
            
            
            
            -
            
            
            
            -
            
            
            
            51,489
            
            
            
            30,335Total
      temporarily impaired securities
            
            $
            9,460,631
            
            
            $
            105,180
            
            
            $
            1,043,546
            
            
            $
            31,861
            
            
            $
            10,504,177
            
            
            $
            137,041




December
      31, 2009Less
      Than 12 Months
            
            
            12
      Months or More
            
            
            TotalFair
              value
            
            
            Unrealized
              losses
            
            
            Fair
              value
            
            
            Unrealized
              losses
            
            
            Fair
              value
            
            
            Unrealized
              lossesSecurities
      available for sale:Mortgage-backed
            
            $
            10,253,608
            
            
            $
            126,356
            
            
            $
            -
            
            
            $
            -
            
            
            $
            10,253,608
            
            
            $
            126,356Collateralized
      mortgageobligations
            
            
            26,940,754
            
            
            
            386,219
            
            
            
            -
            
            
            
            -
            
            
            
            26,940,754
            
            
            
            386,219Municipals
            
            
            17,081,421
            
            
            
            244,125
            
            
            
            2,858,321
            
            
            
            221,272
            
            
            
            19,939,742
            
            
            
            465,397Marketable
      equity
            
            
            -
            
            
            
            -
            
            
            
            345,100
            
            
            
            56,950
            
            
            
            345,100
            
            
            
            56,950Total
      temporarily impaired securities
            
            $
            54,275,783
            
            
            $
            756,700
            
            
            $
            3,203,421
            
            
            $
            278,222
            
            
            $
            57,479,204
            
            
            $
            1,034,922





10




CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements





NOTE
D - INVESTMENT SECURITIES (Continued)




At
September 30, 2010 and December 31, 2009, investment securities with a carrying
value of $90,155,129 and $96,437,558 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 September 30,
2010 by expected maturity are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.





Amortized
            
            
            Faircost
            
            
            valueDue
      within one year
            
            $
            25,891,126
            
            
            $
            26,723,698Due
      after one year through five years
            
            
            94,468,290
            
            
            
            97,580,115Due
      after five years through ten years
            
            
            33,249,769
            
            
            
            34,742,343Due
      after ten years
            
            
            24,961,745
            
            
            
            26,143,049Corporate
      debt
            
            
            917,795
            
            
            
            917,210Other
      equity securities
            
            
            440,757
            
            
            
            455,208$
            179,929,482
            
            
            $
            186,561,623




At
September 30, 2010, the balance of Federal Home Loan Bank (“FHLB”) of Atlanta
stock held by the Company is $10,932,800.  After a period of suspended
dividends the FHLB of Atlanta has declared and paid an annualized dividend for
the fourth quarter of 2009 and the first three quarters of 2010 of 0.27%, 0.26%,
0.44% and 0.39%, respectively.  On June 30, 2010 it was announced that
the FHLB would resume repurchasing activity-based excess capital stock held by
members, on a limited basis.  Share repurchases were made on July 15,
2010 and August 17, 2010 for 4,237 and 4,200 shares, respectively, with
additional shares to be repurchased on November 15, 2010.  The
repurchase of excess capital stock is subject to the FHLB continuing to meet all
applicable statutory and regulatory conditions for an excess stock repurchase
and all other conditions provided in the FHLB’s Capital Plan. The FHLB will
continue to evaluate on a quarterly basis whether to repurchase membership-based
excess stock. Management believes that its investment in FHLB stock was not
other-than-temporarily impaired as of September 30, 2010 or December 31,
2009.  Further, there can be no assurance that the impact of recent or
future legislation on the Federal Home Loan Banks will not also cause a decrease
in the value of the FHLB stock held by the Company.





NOTE
E – DERIVATIVE FINANCIAL INSTRUMENTS




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





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




11





CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements





NOTE
E – DERIVATIVE FINANCIAL INSTRUMENTS (Continued)




Cash
Flow Hedges




Through a
special purpose entity (see Note H of Item 8 in Crescent’s 2009 Form 10-K)
the Company issued trust preferred debentures in 2003.  In 2007, the
Company entered into a subordinated term loan agreement with a non-affiliated
financial institution.  These instruments, as more fully described in
the Note H of Item 8 in the Company’s 2009 Form 10-K, were issued as part of its
capital management strategy. These instruments are variable rate and expose the
Company to interest rate risk caused by the variability of expected future
interest expense attributable to changes in 3-month LIBOR. To mitigate this
exposure to fluctuations in cash flows resulting from changes in interest rates,
the Company entered into four pay-fixed interest rate swap agreements in June
2009.





There
were two interest rate swaps entered into for each of the two
instruments.  The notional amount of each instrument was split in two
equal halves with one half being swapped for a three year period and the second
for a four year period.  The trust preferred debentures and the
subordinated loan carry contractual variable rates of interest based on the
three-month London Inter Bank Offered Rate (LIBOR) plus 300 and 410 basis points
respectively.  The weighted average fixed rates resulting from the
swap transactions are 5.73% and 6.63%, respectively.





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





Since the floating index and reset dates are based on identical
terms, management believes that the hedge relationship of the cumulative changes
in expected future cash flows from the interest rate swaps and the cumulative
changes in expected interest cash flows from the trust-preferred debentures and
subordinated term loan agreement will be highly effective. For the three and
nine month periods ended September 30, 2010 and 2009, management has determined
that there is no hedge ineffectiveness.





The
notional amount of the debt obligations being hedged was $15.5 million and the
fair value of the interest rate swap liability, which is recorded in accrued
expenses and other liabilities at


September
30, 2010, was an unrealized loss of $705,974.





The
following tables disclose the location and fair value amounts of derivative
instruments designated as hedging instruments in the consolidated balance
sheets.





September
      30, 2010Estimated
      FairBalance
      Sheet
            
            Notional
            
            
            Value
      ofLocation
            
            Amount
            
            
            Asset
      (Liability)Trust
      preferred securities:Interest
      rate swap
            
            Other
      liabilities
            
            $
            4,000,000
            
            
            $
            (123,449
            )Interest
      rate swap
            
            Other
      liabilities
            
            
            4,000,000
            
            
            
            (217,054
            )Subordinated
      term loan agreements:Interest
      rate swap
            
            Other
      liabilities
            
            
            3,750,000
            
            
            
            (132,852
            )Interest
      rate swap
            
            Other
      liabilities
            
            
            3,750,000
            
            
            
            (232,619
            )$
            15,500,000
            
            
            $
            (705,974
            )





12




CRESCENT FINANCIAL CORPORATION AND
SUBSIDIARY
 Notes
to Consolidated Financial Statements





NOTE
E – DERIVATIVE FINANCIAL INSTRUMENTS (Continued)





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




See Note
F for additional information.





The
following table discloses activity in accumulated Other Comprehensive Income
(“OCI”) related to the interest rate swaps during the nine month period ended
September 30, 2010.




September
      30,
                2010Accumulated
      OCI resulting from interest rate swaps as of January 1, 2010, net of
      tax
              
              $
              (181,237
              )Other
      comprehensive loss recognized during nine month period ended September 30,
      2010, net of tax
              
              
              (252,583
              )Accumulated
      OCI resulting from interest rate swaps as of September 30, 2010, net of
      tax
              
              $
              (433,820
              )





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





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




The
Company monitors the credit risk of the interest rate swap
counterparty.





NOTE
F - FAIR VALUE MEASUREMENT




Fair
value is a market-based measurement and is defined as the price that would be
received to sell an asset, or paid to transfer a liability, in an orderly
transaction between market participants at the measurement date. The transaction
to sell the asset or transfer the liability is a hypothetical transaction at the
measurement date, considered from the perspective of a market participant that
holds the assets or owes the liability. In general, the transaction price will
equal the exit price and, therefore, represent the fair value of the asset or
liability at initial recognition. In determining whether a transaction price
represents the fair value of the asset or liability at initial recognition, each
reporting entity is required to consider factors specific to the transaction and
the asset or liability, the principal or most advantageous market for the asset
or liability, and market participants with whom the entity would transact in the
market. In order to determine the fair value or the exit price, entities must
determine the unit of account, highest and best use, principal market, and
market participants.




13




CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements





NOTE
F - FAIR VALUE MEASUREMENT (Continued)




These
determinations allow the reporting entity to define the inputs for fair value
and level of hierarchy.





Outlined
below is the application of the fair value hierarchy.





Level 1 –
inputs to the valuation methodology are quoted prices (unadjusted) for
identical assets or liabilities in active markets. An active market for the
asset or liability is a market in which the transactions for the asset or
liability occur with sufficient frequency and volume to provide pricing
information on an ongoing basis. As of September 30, 2010 and December 31, 2009,
the Company carried certain marketable equity securities at fair value hierarchy
Level 1.





Level 2 –
inputs to the valuation methodology include quoted prices for similar assets and
liabilities in active markets, and inputs that are observable for the asset or
liability, either directly or indirectly, for substantially the full term of the
financial instrument. As of September 30, 2010 and December 31, 2009, the types
of financial assets and liabilities the Company carried at fair value hierarchy
Level 2 included securities available for sale and derivative
liabilities.





Level 3 –
inputs to the valuation methodology are unobservable and significant to the fair
value measurement. Unobservable inputs are supported by little or no market
activity or by the entity’s own assumptions. As of September 30, 2010 and
December 31, 2009, while the Company did not carry any financial assets or
liabilities, measured on a recurring basis, at fair value hierarchy Level 3, the
Company did value impaired loans and other real estate owned, measured on a
non-recurring basis, at fair value hierarchy Level 3.





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





Investment
Securities Available-for-Sale


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





Derivative
Liabilities


Derivative
instruments at September 30, 2010 and December 31, 2009 include interest rate
swaps and are valued using models developed by third-party providers. This type
of derivative is classified as Level 2 within the valuation
hierarchy.





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





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




14





CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements





NOTE
F - FAIR VALUE MEASUREMENT (Continued)




Loans




The
Company does not record loans at fair value on a recurring basis. However, from
time to time, a loan is considered impaired and an allowance for loan losses is
established. Loans for which it is probable that payment of interest and
principal will not be made in accordance with the contractual terms of the loan
agreement are considered impaired.  The fair value of impaired loans
is estimated using one of several methods, including collateral value, market
value of similar debt, enterprise value, liquidation value and discounted cash
flows. Those impaired loans not requiring an allowance represent loans for which
the fair value of the expected repayments or collateral exceed the recorded
investments in such loans. At September 30, 2010, substantially all of the total
impaired loans were evaluated based on the fair value of the collateral.
Impaired loans where an allowance is established based on the fair value of
collateral require classification in the fair value hierarchy. When the fair
value of the collateral is based on an observable market price or a current
appraised value, the Company records the impaired loan or asset as nonrecurring
Level 2. When current appraised value is not available or management determines
the fair value of the collateral is further impaired below the appraised value
and there is no observable market price, the Company records the impaired loan
or asset as nonrecurring Level 3.   There were $61.8 million in
impaired loans at September 30, 2010, of which $38.3 million in loans showed
impairment and had a specific reserve of $8.5 million.  Impaired loans
totaled $66.1 million at December 31, 2009.  Of such loans, $35.4
million had specific loss allowances aggregating $9.1 million at that
date.





Foreclosed
Assets




Foreclosed
assets are adjusted to fair value upon transfer of the loans to foreclosed
assets. Subsequently, foreclosed assets are carried at lower of cost or net
realizable value. Fair value is based upon independent market prices, appraised
values of the collateral or management’s estimation of the value of the
collateral. When the fair value of the collateral is based on an observable
market price or a current appraised value, the Company records the foreclosed
asset as nonrecurring Level 2. When an appraised value is not available or
management determines the fair value of the collateral is further impaired below
the appraised value and there is no observable market price, the Company records
the foreclosed asset as nonrecurring Level 3.




15





CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements





NOTE
F - FAIR VALUE MEASUREMENT (Continued)




There
were no significant transfers between the valuation of financial assets or
liabilities between levels 1 and 2 in the valuation hierarchy.  Below
is a table that presents information about assets measured at fair value at
September 30, 2010, and December 31, 2009:





Fair
      Value Measurements at
              September
      30, 2010, UsingDescription
            
            Total
      Carrying Amount
              in
      The
              Consolidated
      Balance Sheet 9/30/2010
            
            
            Assets/(Liabilities) Measured at Fair
      Value 9/30/2010
            
            
            Quoted
      Prices in Active Markets for Identical Assets
              (Level
      1)
            
            
            Significant
      Other Observable Inputs
              (Level
      2)
            
            
            Significant
      Unobservable Inputs
              (Level
      3)Securities
      available for sale:U.S.
      Government obligations and agency
            
            $
            11,047,751
            
            
            $
            11,047,751
            
            
            $
            -
            
            
            $
            11,047,751
            
            
            $
            -Mortgage-backed
            
            
            49,112,136
            
            
            
            49,112,136
            
            
            
            -
            
            
            
            49,112,136
            
            
            
            -Collateralized
      mortgage obligations
            
            
            72,101,054
            
            
            
            72,101,054
            
            
            
            -
            
            
            
            72,101,054
            
            
            
            -Municipals
            
            
            52,928,265
            
            
            
            52,928,265
            
            
            
            -
            
            
            
            52,928,265
            
            
            
            -Corporate
      Debt
            
            
            917,210
            
            
            
            917,210
            
            
            
            -
            
            
            
            917,210
            
            
            
            -Marketable
      equity
            
            
            455,208
            
            
            
            455,208
            
            
            
            455,208
            
            
            
            -
            
            
            
            -Foreclosed
      assets
            
            
            15,204,819
            
            
            
            15,204,819
            
            
            
            -
            
            
            
            -
            
            
            
            15,204,819Impaired
      loans *
            
            
            29,799,073
            
            
            
            29,799,073
            
            
            
            -
            
            
            
            -
            
            
            
            29,799,073Derivative
      liabilities
            
            
            (705,974
            )
            
            
            (705,974
            )
            
            
            -
            
            
            
            (705,974
            )
            
            
            -





Fair
      Value Measurements at
              December
      31, 2009, UsingDescription
            
            Assets/(Liabilities)
      Measured at Fair Value 12/31/2009
            
            
            Quoted
      Prices in Active Markets for Identical Assets
              (Level
      1)
            
            
            Significant
      Other Observable Inputs
              (Level
      2)
            
            
            Significant
      Unobservable Inputs
              (Level
      3)Securities
      available for sale:U.S.
      Government obligations and agency
            
            $
            12,683,127
            
            
            $
            -
            
            
            $
            12,683,127
            
            
            $
            -Mortgage-backed
            
            
            60,203,087
            
            
            
            -
            
            
            
            60,203,087
            
            
            
            -Collateralized
      mortgage obligations
            
            
            70,863,172
            
            
            
            -
            
            
            
            70,863,172
            
            
            
            -Municipals
            
            
            49,028,405
            
            
            
            -
            
            
            
            49,028,405
            
            
            
            -Marketable
      equity
            
            
            345,100
            
            
            
            345,100
            
            
            
            -
            
            
            
            -Foreclosed
      assets
            
            
            6,305,617
            
            
            
            -
            
            
            
            -
            
            
            
            6,305,617Impaired
      loans *
            
            
            26,258,018
            
            
            
            -
            
            
            
            -
            
            
            
            26,258,018Derivative
      liabilities
            
            
            (294,934
            )
            
            
            -
            
            
            
            (294,934
            )
            
            
            -







*           Impaired loans secured by Real Estate
have historically been classified at fair value hierarchy Level 2, however,
based on additional review by management, it has been deemed more appropriate to
classify these loans at fair value hierarchy Level 3.  Accordingly,
$23,434,441 of impaired loans, classified at Level 2 as of December 31, 2009,
are now included in the total at fair value hierarchy Level
3.
  16
  CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements





NOTE
F - FAIR VALUE MEASUREMENT (Continued)




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





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





Cash
and Cash Equivalents




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





Investment
Securities




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.  Additional
adjustments are estimated by applying a reasonable discount to reflect the
current market for and illiquid nature of bank loan portfolios.





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.




17





CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements





NOTE
F - FAIR VALUE MEASUREMENT (Continued)




Short-term
Borrowings and Long-term Debt




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





Accrued
Interest Receivable and Accrued Interest Payable




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





Derivative
financial instruments




Fair
values for interest rate swaps are based upon the estimated amounts required to
settle the contracts.





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
September 30, 2010 and December 31, 2009:





September
      30, 2010
            
            
            December
      31, 2009Carrying
              amount
            
            
            Estimated
              fair
      value
            
            
            Carrying
              amount
            
            
            Estimated
              fair
      valueFinancial
      assets:Cash
      and cash equivalents
            
            $
            29,665,305
            
            
            $
            29,665,305
            
            
            $
            31,727,108
            
            
            $
            31,727,108Investment
      securities
            
            
            186,561,623
            
            
            
            186,561,623
            
            
            
            193,122,891
            
            
            
            193,122,891Federal
      Home Loan Bank stock
            
            
            10,932,800
            
            
            
            10,932,800
            
            
            
            11,776,500
            
            
            
            11,776,500Loans,
      net
            
            
            676,400,569
            
            
            
            639,550,800
            
            
            
            741,781,341
            
            
            
            701,738,000Investment
      in life insurance
            
            
            18,276,906
            
            
            
            18,276,906
            
            
            
            17,658,386
            
            
            
            17,658,386Accrued
      interest receivable
            
            
            3,682,081
            
            
            
            3,682,081
            
            
            
            4,260,258
            
            
            
            4,260,258Financial
      liabilities:Deposits
            
            
            717,048,308
            
            
            
            738,100,622
            
            
            
            722,634,618
            
            
            
            742,001,000Short-term
      borrowings
            
            
            7,000,000
            
            
            
            7,400,315
            
            
            
            74,000,000
            
            
            
            74,260,000Long-term
      borrowings
            
            
            157,748,000
            
            
            
            162,782,685
            
            
            
            142,748,000
            
            
            
            139,457,000Interest
      rate swaps
            
            
            705,974
            
            
            
            705,974
            
            
            
            294,934
            
            
            
            294,934Accrued
      interest payable
            
            
            1,497,966
            
            
            
            1,497,966
            
            
            
            1,475,128
            
            
            
            1,475,128




NOTE
G - CUMULATIVE PERPETUAL PREFERRED STOCK




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




18




CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements





NOTE
G - CUMULATIVE PERPETUAL PREFERRED STOCK (Continued)




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


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




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





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





NOTE
H - RECENT ACCOUNTING PRONOUNCEMENTS




In June
2009, the Financial Accounting Standards Board (“FASB”) issued Statement of
Financial Accounting Standards (SFAS) No. 166 “Accounting for Transfers of
Financial Assets – an amendment of the FASB Statement No. 140” (“ASC 860”),
which eliminates the concept of a qualifying special purpose entity (QSPE),
changes the requirements for derecognizing financial assets, and requires
additional disclosures including information about continuing exposure to risks
related to transferred financial assets. ASC 860 is effective for financial
asset transfers occurring after the beginning of fiscal years beginning after
November 15, 2009. The disclosure requirements must be applied to transfers that
occurred before and after the effective date.  The adoption on January
1, 2010, did not have a material impact on the Company's consolidated financial
statements.





In June
2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)
(“ASC 810”), which contains new criteria for determining the primary
beneficiary, eliminates the exception to consolidating QSPEs, requires continual
reconsideration of conclusions reached in determining the primary beneficiary,
and requires additional disclosures. ASC 810 is effective as of the beginning of
fiscal years beginning after November 15, 2009 and is applied using a cumulative
effect adjustment to retained earnings for any carrying amount adjustments
(e.g., for newly-consolidated VIEs). The adoption on January 1, 2010, did not
have a material impact on the Company's consolidated financial
statements.





ASU No.
2010-06, Fair Value Measurements and Disclosures (“ASC 820”): Improving
Disclosures about Fair Value Measurements. This ASU requires some new
disclosures and clarifies some existing disclosure requirements about fair value
measurement as set forth in Codification Subtopic 820-10. The FASB’s objective
is to improve these disclosures and, thus, increase the transparency in
financial reporting. Specifically, ASU 2010-06 amends Codification Subtopic
820-10 to now require:





A
reporting entity should disclose separately the amounts of significant transfers
in and out of Level 1 and Level 2 fair value measurements and describe the
reasons for the transfers, and in the reconciliation for fair value measurements
using significant unobservable inputs, a reporting entity should present
separately information about purchases, sales, issuances, and settlements. In
addition, ASU 2010-06 clarifies the requirements of the following existing
disclosures:





·
            For
      purposes of reporting fair value measurement for each class of assets and
      liabilities, a reporting entity needs to use judgment in determining the
      appropriate classes of assets and liabilities;
  and




19






·
            A
      reporting entity should provide disclosures about the valuation techniques
      and inputs used to measure fair value for both recurring and nonrecurring
      fair value measurements.





ASU
2010-06 is effective for interim and annual reporting periods beginning after
December 15, 2009, except for the disclosures about purchases, sales, issuances,
and settlements in the roll forward of activity in Level 3 nonrecurring fair
value measurements. Those disclosures are effective for fiscal years beginning
after December 15, 2010, and for interim periods within those fiscal years.
Early application is permitted.  Adoption as of January 1, 2010 did
not have a material effect on the Company’s financial
statements.  Additional disclosures have been considered in this
report.





ASU
2010-20, Receivables (Topic
310): Disclosure about the Credit Quality of Financing Receivables and the
Allowance for Credit Losses.The objective of this ASU is for an entity
to provide disclosures that facilitate financial statement users’ evaluation of
the following:





·
            The
      nature of credit risk inherent in the entity’s portfolio of financing
      receivables;


·
            How
      that risk is analyzed and assessed in arriving at the allowance for credit
      losses; and


·
            The
      changes and reasons for those changes in the allowance for credit
      losses.





To
achieve these objectives, an entity should provide disclosures on a
disaggregated basis on two defined levels: (1) portfolio segment; and (2) class
of financing receivable. The ASU makes changes to existing disclosure
requirements and includes additional disclosure requirements about financing
receivables, including:





·
            Credit
      quality indicators of financing receivables at the end of the reporting
      period by class of financing receivables;


·
            The
      aging of past due financing receivables at the end of the reporting period
      by class of financing receivables; and


·
            The
      nature and extent of troubled debt restructurings that occurred during the
      period by class of financing receivables and their effect on the allowance
      for credit losses.





For
public entities, the disclosures as of the end of a reporting period are
effective for interim and annual reporting periods ending on or after December
15, 2010. The disclosures about activity that occurs during a reporting period
are effective for interim and annual reporting periods beginning on or after
December 15, 2010. Additional disclosures will be considered for year-end 2010
reporting.




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




20




Item
2.  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 (the “Company”). The analysis includes detailed
discussions for each of the factors affecting Crescent Financial Corporation’s
operating results for periods ended September 30, 2010 and 2009 and financial
condition for the periods ended September 30, 2010 and December 31, 2009. It
should be read in conjunction with the unaudited consolidated financial
statements and accompanying notes included in this report and the supplemental
financial data appearing throughout this discussion and analysis. Because the
Company has no operations and conducts no business on its own other than owning
Crescent State Bank, the discussion contained in this Management's Discussion
and Analysis concerns primarily the business of the Bank. However, for ease of
reading and because the financial statements are presented on a consolidated
basis, the Company and the Bank are collectively referred to herein as the
Company unless otherwise noted.  All significant intercompany
transactions and balances are eliminated in consolidation.





COMPARISON
OF FINANCIAL CONDITION AT


September
30, 2010 AND DECEMBER 31, 2009





Total
assets at September 30, 2010 are $972.5 million reflecting a $60.3 million
decline from $1.0 billion at December 31, 2009.  Earning assets at
September 30, 2010 are 94% or $915.6 million compared to 95% or $986.7 million
at December 31, 2009.   Components of earning assets at September
30, 2010 are $694.5 million in gross loans held for investment, $2.0 million in
mortgage loans held for sale, $197.5 million in investment securities and
Federal Home Loan Bank (FHLB) stock and $21.6 in overnight investments and
interest-earning deposits with correspondent banks.  Earning assets at
December 31, 2009 consisted of $759.3 million in gross loans held for
investment, $204.9 million in investment securities and FHLB stock and $22.4
million in overnight investments and interest-earning deposits. Total deposits
and stockholders’ equity at September 30, 2010 are $717.0 million and $85.6
million, respectively, compared to $722.6 million and $89.5 million at December
31, 2009.





Gross
loans held for investment declined by $64.9 million between December 31, 2009
and September 30, 2010.  The Company just began originating mortgage
loans for sale in March 2010 and therefore no loans were held for sale at
December 31, 2009.  All loan categories experienced a decline due to
normal principal payments, a reduction in new originations due to continued
softness in loan demand and the transfer of assets from loans to foreclosed
assets.  The net decline by loan category is as follows: $28.1 million
in construction, land acquisition and development, $14.1 million in commercial
real estate, $10.7 million in residential mortgage, $6.3 million in home equity
loans and lines, $4.6 million in commercial and industrial and $1.1 million in
consumer loans. Of the total $64.9 million decline, $16.6 million is attributed
to transferring assets from the loan account into other asset categories, $15.1
million has been charged-off and $69.7 million represent normal principal
payments on the loan portfolio.  These declines have been partially
offset through the production and funding of $36.5 million in new
loans.  See the discussions on Nonperforming Assets and Allowance for
Loan Losses for additional details on nonperforming assets and
charge-offs.  The composition of the loan portfolio, by category, as
of September 30, 2010 is 50% commercial mortgage loans, 22% construction loans,
12% residential mortgage loans, 8% home equity loans and lines, 7% commercial
loans and 1% consumer loans.  The composition of the loan portfolio,
by category, as of December 31, 2009 was 47% commercial mortgage loans, 24%
construction loans, 13% residential real estate mortgage loans, 8% home equity
loans and lines, 7% commercial loans and 1% consumer loans.




21





Loans for
commercial real estate, construction and land acquisition and development
comprise 72% of the total loan portfolio at September 30, 2010.  A
more detailed breakdown of loans in those sectors is presented in the table
below:







Breakdown
of Commercial Real Estate


Total
      AggregateExposureLoan
      Type
            
            (in thousands)Non
      owner occupied investment property
            
            $
            193,264Owner
      occupied commercial property
            
            
            133,774Multi-family
      investment property
            
            
            17,468Agriculture/Farmland
            
            
            784Subtotal
            
            
            345,290Deferred
      unearned interest
            
            
            (482
            )Total
      commercial real estate loans
            
            $
            344,808


Breakdown
of Construction, Acquisition & Development




Total
      AggregateExposure(in thousands)Loan
      TypeLand
      acquisition and development - commercial purposes
            
            $
            77,366Land
      acquisition and development - residential purposes
            
            $
            47,8651
      to 4 family residential construction
            
            
            14,769Commercial
      construction
            
            
            11,089Subtotal
            
            
            151,089Deferred
      unearned interest
            
            
            (105
            )Total
      construction, acquistition & development
            
            $
            150,984





The
Company has an allowance for loan losses at September 30, 2010 of $18.0 million
or 2.60% of outstanding loans held for investment compared to $17.6 million or
2.31% at December 31, 2009. The increase was primarily due to the impact of
current year net charge-offs on the historical charge-off experience ratios
utilized within the loan loss provision model and the specific provisions taken
on impaired loans.  At September 30, 2010, there are seventy loans
totaling $30.7 million in non-accrual status.    There are
no loans past due 90 days or more still accruing interest at September 30,
2010.  Non-performing loans as a percentage of total loans held for
investment at September 30, 2010 are 4.42%.  At December 31, 2009,
there were sixty-six loans totaling approximately $18.1 million in non-accrual
status. Year-to-date, collateral for twenty-nine of the sixty-six loans in
nonaccrual status at year end had been foreclosed or repossessed, eleven of
which were then sold.   Thirteen loans have been either partially
paid or paid in full, nine loans were charged-off and fifteen loans remained in
non-accrual status at September 30, 2010.  The percentage of
non-performing loans to total loans at December 31, 2009 was
2.44%.  For a more detailed discussion, see the section entitled
Nonperforming Assets.





The
Company has investment securities with an amortized cost of $179.9 million at
September 30, 2010.  All investments are accounted for as available
for sale and are presented at their fair market value of $186.6 million compared
to $193.1 million at year-end 2009.  The Company’s investment
securities at September 30, 2010, consist of U.S. Government agency securities,
collateralized mortgage obligations, mortgage-backed securities, corporate debt,
municipal bonds and marketable equity securities.  All of the
Company’s mortgage-backed and collateralized mortgage obligations are issued by
a Government Sponsored Enterprise (GSE). The decrease in the available for sale
portfolio during the first half of 2010 was the net result of $9.5 million in
new purchases and a $4.0 million increase in the fair value of the portfolio,
less $19.1 million in principal re-payments and $1.0 million in net amortization
of premiums.  The Company performs an impairment analysis on a
quarterly basis and has no securities at September 30, 2010 that display other
than temporary impairment.





The
Company owns $10.9 million of Federal Home Loan Bank (FHLB) stock at September
30, 2010 compared to $11.8 million at December 31, 2009.  The FHLB has
resumed redeeming some portion of excess stock as determined by the level of the
Company’s advances outstanding.  The Company has redeemed $844,000 in
stock during 2010.




22





There are
$20.2 million in Federal funds sold at September 30, 2010 compared to $17.8
million at December 31, 2009.  Fed funds sold provide on-balance sheet
liquidity used to redeem maturing time deposits and borrowings and for deposit
fluctuations of non-maturing deposit types.





Interest-earning
deposits held at correspondent banks are $1.5 million at September 30, 2010
compared with $4.6 million at December 31, 2009.  Interest-earning
funds held at correspondent bank accounts are used primarily to redeem maturing
time deposits and borrowings and to meet liquidity requirements for deposit
fluctuations of non-maturing deposit types.





Foreclosed
assets consist of other real estate owned and loan collateral which has been
repossessed.  Other real estate owned by the Company is $13.3 million
at September 30, 2010 compared with $6.3 million at December 31,
2009.  The net increase in other real estate owned of $7.0 million was
comprised of $14.6 million in new foreclosed property plus $171,000 in
additional capitalized costs related to finishing foreclosed property less $6.9
million in proceeds from the sale of properties, $943,000 in additional
valuation write-downs on properties and $8,000 in net loss on disposal of sold
assets.  The value of repossessed assets is $2 million at September
30, 2010 and there were no repossessed assets at December 31, 2009.





Non-earning
and other assets increased by approximately $4.3 million between December 31,
2009 and September 30, 2010.  There were increases in other assets and
bank owned life insurance and premises and equipment of $3.7 million and
$619,000, respectively.  The change in other assets was due primarily
to recording income tax benefits during the first nine months of $4.1
million.  The net deferred tax asset decreased by $676,000 due
primarily to the impact of the unrealized gain on
investments.  Accrued interest receivable declined by $578,000 due to
lower volumes of and yields on earning assets.  For more details
regarding the increase in cash and cash equivalents, see the Consolidated
Statement of Cash Flows.





Total
deposits decreased by $5.6 million between December 31, 2009 and September 30,
2010 from $722.6 million to $717.0 million.  The Company has continued
to focus on reducing its reliance on brokered deposits and shifting its deposit
mix more in favor of non-maturity deposit types.  Brokered time
deposits have decreased by $39.4 million from $203.4 million at year end 2009 to
$164.0 million at September 30, 2010.  Customer reciprocal time
deposits entered into the CDARS (Certificate of Deposit Account Registry
Service) program have declined by $3.3 million from $23.6 million to $20.3
million.  Other retail time deposits decreased by $6.3 million from
$210.6 million to $204.3 million.  Time deposits as a percentage of
total deposits have declined from 61% to 54%.  In an effort to improve
core deposit volumes, the Company introduced a new interest-bearing checking
account in December 2008 that rewards depositors with a higher rate of interest
if they modify their account activity behavior to include more electronic
methods of transactions and account statement receipt.  As a result,
interest-bearing checking balances have increased by $45.8 million to $138.9 at
September 30, 2010 compared to $93.2 million at year end. Savings account
balances have increased by $7.6 million and money market account balances have
declined by $11.0 million over the first nine months of 2010.  The
increase in savings is due primarily to customers’ desire to keep their deposits
in more liquid, short-term deposit types in anticipation of future interest rate
increases.  The decline in money market balances is in both business
and personal account types.  The decline in personal is due in part to
disintermediation related to the new interest-bearing checking product and
business declines are driven by economic conditions and seasonal
fluctuations.  Non-interest bearing deposit balances have increased by
$920,000 from $61.0 million to $62.0 million.





The
composition of the deposit base, by category, at September 30, 2010 is as
follows: 54% time deposits, 19% interest-bearing demand deposits, 9% money
market, 9% statement savings accounts and 9% non-interest-bearing demand
deposits.  The composition of the deposit base, by category, at
December 31, 2009 was as follows:  61% in time deposits, 13% in
interest-bearing deposits, 10% in money market, and 8% in both non
interest-bearing demand deposits and statement savings. Time deposits of
$100,000 or more totaled $318.9 million at September 30, 2010 compared to $357.4
million at December 31, 2009.




23





The
Company has total borrowings of $164.7 million at September 30, 2010 compared
with $216.7 million at December 31, 2009.  The composition of
borrowings is $142.0 million in long-term advances and $7.0 million in
short-term advances from the Federal Home Loan Bank of Atlanta (FHLB), $8.2
million in junior subordinated debt issued to an unconsolidated subsidiary and
$7.5 million in a subordinated term loan from a non-affiliated financial
institution.  Borrowings at December 31, 2009 consisted of $127.0
million in long-term FHLB advances, $24.0 million in short-term FHLB advances,
$50.0 million in short-term Fed Discount Window advances, $8.2 million in junior
subordinated debt issued to an unconsolidated subsidiary, and $7.5 million in a
subordinated term loan.  The $50.0 million in Fed Discount Window
advances at December 31, 2009 were part of the Company’s strategy to leverage
the funds received through the Capital Purchase Program.  As
additional liquidity has been made available through deposit gathering and
normal principal pay downs from loan portfolio, we were able to repay the $50.0
million during the first nine months of 2010.  There were no Federal
funds purchased at either balance sheet date.





Accrued
interest payable and other liabilities increased by $1.2 million and are $5.1
million and $3.9 million at September 30, 2010 and December 31, 2009,
respectively.





Total
stockholders’ equity declined by $4.0 million between December 31, 2009 and
September 30, 2010. The decrease was primarily due to the net loss for the nine
month period of $5,351,000 and the $934,000 dividend paid on preferred
stock.  This was partially offset by a $2,227,000 increase in the
other comprehensive income.





COMPARISON
OF RESULTS OF OPERATIONS FOR THE THREE-MONTH PERIODS ENDED SEPTEMBER 30,
2010 AND 2009





Net Income(Loss).Net loss for
the three-month period ended September 30, 2010, before adjusting for the
effective dividend on preferred stock, was ($1,844,000) compared to net income
of $637,000 for the prior year three-month period ended September 30, 2009.
After adjusting for dividends and discount accretion on preferred stock of
$423,000 and $422,000, respectively, net loss attributable to common
shareholders for the current period was ($2,307,000) or ($0.24) per diluted
share compared with net income available to common shareholders of $214,000 or
$0.02 per diluted share for the quarter ended September 30,
2009.  Annualized return on average assets declined to (0.77%) from
0.24% for the prior period.  Earnings in the current period were
negatively impacted by higher loan loss provisions in response to current
economic conditions, increased non-interest operating expenses and the reversal
of accrued but uncollected interest income on loans transferred to nonaccrual
status. Return on average equity for the current period was (8.49%) compared to
1.89% for the prior period.  The decline in return on average equity
is due to the lower level of earnings.





Net Interest
Income.  Net interest income declined by 8% or $600,000 from
$7.4 million for the quarter ended September 30, 2009 to $6.8 million for the
current period.  The decrease in interest income from lower earning
asset levels and reduced yields was larger than the decrease in interest expense
primarily from a lower cost of funds.  Although the Company
experienced a widening of interest rate spread, the positive impact was offset
by a reduction in the percentage of earning assets to interest-bearing
liabilities resulting in no change in net interest margin over the comparative
periods.





Total
interest income decreased by 13% or $1.8 million to $12.3 million for the
current period from $14.1 million for the prior year period.  The
decline resulted from a $1.3 million decrease due to the reduction in earning
assets and a $531,000 decrease due to lower yields realized on those
assets.  Total interest expense for the current period declined by
$1.2 million from $6.7 million to $5.5 million.  The decrease was
comprised of a $1.0 million decline due to the lower cost of funding and a
$155,000 decrease due to the decline in interest-bearing funds.





Total
average earning assets decreased $67.8 million or 7% from an average of $983.0
million to an average of $915.2 million for the current three-month period. The
composition of the decrease was as follows: the average balance of loans
outstanding decreased by 9% or $68.2 million from $772.4 million to $704.2
million, the average balance of the investment securities portfolio decreased by
8% or $15.9 million from $207.6 million to $191.7 million and the average
balance of federal funds sold and other interest-earning assets increased by
$16.3 million to $19.3 million from $3.0 million.  Loan demand remains
soft across our market footprint resulting in fewer new origination
opportunities and the deterioration in quality of some existing loans resulted
in the transfer to foreclosed or charge-off status.  While we have
reinvested some principal cash flows from the investment portfolio, other cash
flows have been used to reduce our reliance on wholesale forms of funding or
been kept in shorter term investments.




24





Average
interest-bearing liabilities experienced a net decrease of $46.8 million or 5%
from $870.7 million for the prior year quarter to $823.9 million for the
three-months ending September 30, 2010.  Total interest-bearing
deposits increased by $13.6 million or 2% from $642.8 million to $656.4
million.  Interest-bearing NOW accounts deposits experienced the
largest increase averaging $130.7 million for the current three-month period
compared to $65.4 million for the prior period.  This is the result of
the new interest bearing checking product previously discussed.  Total
borrowings decreased by 27% or $60.4 million from $227.9 million to $167.5
million.  A significant portion of the decrease in borrowings resulted
from the repayment of short-term borrowings used to implement a securities
leverage strategy in early 2009.





Net
interest margin is interest income earned on loans, securities and other earning
assets, less interest expense paid on deposits and borrowings, expressed as a
percentage of total average earning assets.  The tax equivalent net
interest margin for the three-month periods ended September 30, 2010 and 2009
was 3.08%.  The average yield on earning assets for the current
three-month period decreased 32 basis points to 5.45% compared with 5.77% for
the prior year period, while the average cost of interest-bearing funds
decreased by 40 basis points to 2.63% from 3.03%.  The interest rate
spread is the difference between the average yield on earning assets and the
cost of interest-bearing funds.  The spread improved by 8 basis points
from 2.74% to 2.82%. However, the decline in the percentage of interest earning
assets to average interest-bearing liabilities from 112.90% to 111.08% offset
the positive impact of the widening interest rate spread resulting in no change
in the net interest margin.





Short-term
interest rates have been stable since January 2009.  The yield on
earning assets has declined over the comparative three and nine month periods
primarily due to the reversal of previously accrued interest income on loans
moved to nonaccrual status.  Approximately $453,000 of previously
recorded interest income was reversed in the current
quarter.  Quantitatively, the interest reversal reduced the yield on
total earning assets by 20 basis points for the three-month period ended
September 30, 2010.  The impact of the reversals has been somewhat
mitigated by the implementation of loan floors on many variable rate
loans.  The yield on the investment portfolio has risen due to a
higher percentage of investments in longer term municipal
securities.





The cost
of interest bearing funds continues to trend lower in this stable interest rate
environment.    The cost of time deposits has declined by 88
basis points over the comparative periods.  Somewhat offsetting this
positive trend is a higher cost of funds on the new interest-bearing checking
product.  The overall cost of interest-bearing checking accounts has
increased by 64 basis points.  The Company restructured a portion of
its FHLB borrowings during the three months ending September 30,
2010.  The restructuring was primarily aimed at reducing potential
interest rate risk in 2012.  The Company was able to increase the
duration by laddering advances to future periods and reduce the cost of the
borrowings portfolio by 31 basis points.





Approximately
43% of the Company’s loan portfolio has variable rate pricing based on the Prime
lending rate or LIBOR (London Inter Bank Offering Rate).  The
percentage of variable rate to total loans has declined from 44% at September
30, 2009.  In the current low interest rate environment, borrowers are
more inclined to desire a fixed rate loan option as opposed to a variable rate
even if the variable rate has a lower starting point.  The Company has
shifted its strategic focus from a growth orientation to a more
performance-related, relationship orientation.  The Company is being
more disciplined with loan pricing.  As a result, the loan portfolio
will not experience the same growth rates as has been seen in recent years, but
should provide better yields.  This should also ease reliance on
wholesale forms of funding.  While there is an attempt to focus on
local market relationships, wholesale forms of funding will continue to make
sense from an economic standpoint at certain times.




25





The
Company expects that net interest margin will continue to expand during this
period of stable interest rates.   While the interest rate floors
on variable rate loans have helped protect the yield on earnings assets, these
same floors will prevent the yield from expanding quickly in a rising interest
rate environment.  While rates are still stable, we are implementing a
strategy to begin to reduce the gap between the underlying contractual rate and
the floor.  This could have an unfavorable impact on the yield on the
loan portfolio; however, the cost of interest bearing funds should continue to
decline at a faster rate.  Approximately 51% or $197.9 million of time
deposits carrying a weighted average rate of 2.31% will mature over the coming
twelve months and can be renewed at lower rates.  The Company has also
begun to reduce the rate being paid on the new checking account product
introduced in December 2008.  The product was introduced at an annual
percentage yield (APY) of 5.01% and was reduced in September 2010 to an APY of
3.75%.





Provision for Loan
Losses.The
Company’s provision for loan losses for the three-month period ended September
30, 2010 was $4.9 million compared to $2.0 million for the same period in
2009.    The increase in the loan loss provision is
primarily due to specific reserves on impaired loans and the impact of current
year charge-offs on our loan loss model. Provision for loan losses is charged to
income to bring the allowance for loan losses to a level deemed appropriate by
management based on factors discussed under “Analysis of Allowance for Loan
Losses.”  The allowance for loan losses is $18.0 million representing
2.60% of total loans held for investment at September 30, 2010.  See
the sections on Nonperforming Assets and Analysis of Allowance for Loan Losses
for additional details.





Non-Interest Income.Non-interest income increased by 17% or $187,000 to $1.3 million at
September 30, 2010 compared to $1.1 million for the prior year
period.  Mortgage loan related revenue, which includes both brokered
origination fees and gains on the sale of loans, increased by 114% or $254,000
to $477,000 from $223,000.  The low level of interest rates on
mortgage loans has resulted in significant refinance
activity.  Service charges and other customer service fees on deposit
accounts increased by 10% or $40,000 and other miscellaneous noninterest income
increased by 12% or $17,000, of which $9,000 related to brokerage referral
fees.  Non-recurring items include realizing a $13,000 loss on the
disposal of fixed assets during the current quarter and a $110,000 gain on the
sale of available for sale securities during the third quarter of
2009.





Non-Interest Expenses.Non-interest expenses increased by 13% or $749,000 from $5.9 million to
$6.6 million. The categories experiencing the greatest increases were loan
related professional and collection expense, personnel, FDIC deposit insurance
premium expense and other professional fees.   Loan related
professional and collection expenses increased by $309,000 from $180,000 to
$489,000.  Of the total increase, $246,000 is related to the costs
associated with the acquisition and ongoing servicing of foreclosed assets and
$42,000 was due to valuation write-downs.  The net loss on disposal of
foreclosed assets during the current three-month period was $39,000 compared to
$5,000 in the prior period. Personnel expenses were up $193,000 due primarily to
salary expenses related to the increased level of mortgage loan origination
activity.  FDIC deposit premiums were up $119,000 from $310,000 in the
prior year’s quarter compared to $429,000 for the current three month
period.  Other professional fees were $89,000 higher due to the
payment of consulting fees related to the FHLB advance
restructuring.





Provision for Income Taxes.The Company recorded an income tax benefit of $1,574,000 for the
three-months ended September 30, 2010 compared with income tax expense of
$58,000 for the prior year period.  The current period benefit was
approximately 45.52% of the quarterly loss.  The impact of tax exempt
interest income increased the taxable loss and therefore increased the
benefit.  The effective tax rate for the three-month period ended
September 30, 2009 was 8.36%.  The small effective tax rate in 2009
was attributable to lower pre-tax income and a large percentage of income coming
from tax exempt sources.




26





Deferred
tax assets are recognized for temporary deductible differences and operating
loss and tax credit carryforwards.  A valuation allowance is
established when it is more likely than not that all or some portion of the
deferred tax asset will not be realized.  Evaluating the need for and
amount of a valuation allowance requires judgment and analysis of the positive
and negative evidence. Included in our analysis, which receives significant
weight, is the 3-year cumulative loss test.  The cumulative loss test
calculates the cumulative pre-tax income (loss) over the preceding twelve
quarter period.  If the Company is in a cumulative loss position,
management performs an evaluation of the positive and negative evidence to
determine whether a valuation allowance is necessary.  As of
September 30, 2010, the Company did not pass the cumulative loss test by
$5.8 million.  Management has evaluated, among other factors,
projected future earnings, credit quality trends, taxable temporary differences
and the cause and probability of recurrence of those circumstances leading to
current taxable losses in evaluating the need for a valuation
allowance.




As of
September 30, 2010, our recorded net deferred tax asset was $5.5 million
and at this time management has concluded that the net deferred tax asset is
fully realizable. The Company will continue to monitor deferred tax assets
closely to evaluate whether we will be able to realize the full benefit of our
net deferred tax asset and need for valuation allowance. Significant negative
trends in credit quality, losses from operations, or significant deviations from
forecasted future financial results could impact our ability to realize the
deferred tax asset in the future.





COMPARISON
OF RESULTS OF OPERATIONS FOR THE NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2010
AND 2009





Net Income(Loss).Net loss for
the nine-month period ended September 30, 2010, before adjusting for the
effective dividend on preferred stock, was ($5,351,000) compared to net income
of $1,821,000 for the prior year period.  After adjusting for
$1,264,000 and $1,012,000, respectively, in dividends and discount accretion on
preferred stock, net loss attributable to common shareholders for the current
period was ($6,615,000) or ($0.69) per diluted share compared with net income
available for common shareholders of $809,000 or $0.08  per diluted
share for the nine-month period ended September 30, 2009.  Annualized
return on average assets for the current nine-month period was (0.72%) compared
to 0.23% for the prior period.  The large increases in loan loss
provision and noninterest expenses related, in part, to real estate market
conditions, overshadowed the improvement in net interest margin and higher
noninterest revenues.  Return on average equity for the current period
was (8.00%) compared to 2.01% for the prior period.  The decline in
return on average equity is due to the lower level of earnings.





Net Interest
Income.  Net interest income declined slightly by $101,000 to
$21.8 million for the current period compared to $21.9 million for the prior
nine-month period.  The reduction in interest income from lower
earning asset volumes and a declining yield on those assets was greater than the
interest expense savings from the lower level of interest bearing liabilities
and reduced cost of funds.





Total
interest income was $39.1 million for the nine-month period ended September 30,
2010 compared to $42.2 million for the prior year period.  The
decrease was comprised of a $1.9 million decline due to a smaller average
earning assets base and a $1.2 million decline due to the lower average yield
earned on those assets.  Total interest expense declined by $3.1
million or 15% from $20.3 million for the prior year period to $17.3 million for
the current period.  The decrease was the result of a $2.0 million
decline due to lower cost of funds and a $1.1 million decline due to a reduction
in interest-bearing liabilities.





Total
average earning assets decreased $50.3 million or 5% from an average of $989.2
million as of September 30, 2009 to an average of $938.9 million as of September
30, 2010.  The average balance of loans outstanding decreased by $50.7
million or 6% to $730.6 million compared to $781.3 million for the prior year
period. The average balance of the investment securities portfolio for the
current period was $195.1 million, decreasing by $7.4 million or 4% compared to
the prior year average of $202.6 million.  The average balance of
federal funds sold and other earning assets increased to $13.2 million compared
to $5.3 million for the prior period. Principal repayments on both loans and
investments have been used to reduce the company’s reliance on wholesale forms
of funding or shifted to more short-term investment accounts.




27





Total
average interest-bearing liabilities decreased by $32.6 million or 4% from an
average of $874.9 million for the prior period to $842.3 million for the current
period.  Average interest-bearing deposits increased by $12.7 million
or 2% growing from an average of $642.9 million at September 30, 2009 to $655.6
million at September 30, 2010.  Total average borrowings decreased by
$45.3 million or 20% to $186.7 million from $232.0 million for the prior year
period.





The tax
equivalent net interest margin for the period ended September 30, 2010 was 3.23%
compared to 3.04% for the prior year period.  The average yield on
earning assets declined 11 basis points to 5.68% compared with 5.79% for the
prior year period, while the average cost of interest-bearing funds decreased by
37 basis points to 2.74% from 3.11%.  The spread between the rates
paid on earning assets and the cost of interest-bearing funds increased by 26
basis points from 2.68% to 2.94%.  The increase in net interest margin
was less than the increase in interest rate spread because the percentage of
interest earning assets to interest bearing liabilities declined from 113.06% to
111.47%.





Provision for Loan
Losses.The
Company’s provision for loan losses for the nine-month period ended September
30, 2010 was $15.1 million compared to $4.8 million for the prior year
period.  The increased loan loss provision for the current period is
primarily due to the specific reserves resulting from our analysis of impaired
loans and the impact of current year charge-offs on the loan loss reserve
model.  Provision for loan losses is charged to income to bring the
allowance for loan losses to a level deemed appropriate by management based on
factors discussed under “Analysis of Allowance for Loan Losses.” See the section
entitled “Non Performing Assets” for more details.





Non-Interest Income.For the
current nine-month period, non-interest income increased by $783,000 or 29% to
$3.5 million from $2.7 million.  The components of non-interest income
experiencing the largest period-over-period increases are as follows: mortgage
related revenue has increased by $239,000 to $974,000 from $735,000, service
charges and other customer service fees on deposit accounts increased by
$163,000 to $1.4 million from $1.2 million and brokerage referral fees have
increased by $48,000 to $148,000 from $100,000.  The non-recurring
items impacting the comparison of noninterest income for the two periods include
$8,000 in net losses on the disposal of fixed assets for the current nine-month
period and an impairment charge of $407,000 on a non-marketable equity security,
partially offset by a $110,000 realized gain on the sale of available for sale
debt securities, for the nine-month period ended September 30,
2009.





Non-Interest Expenses.Non-interest expenses increased by 12% or $2.2 million to $20.0 million
for the period ended September 30, 2010 compared with $17.8 million for the
prior year period. The Company has added two branch locations and increased
support staff during the past twelve months.  The largest component of
the increase is due to loan related professional and collection
fees.  Expenses related to the acquisition, ongoing servicing and
disposition of foreclosed assets has increased by over $1.6 million during the
current nine-month period.  Attorney fees, expenses for loan
appraisals in order to properly value foreclosed assets, on-going maintenance
costs and property tax expenses have increased by $740,000 from $314,000 to
almost $1.1 million.  Valuation write-downs on existing foreclosed
assets total $943,000 for the current period compared to $19,000 for the prior
period and net losses on the disposition of foreclosed assets were $9,000 for
the current period compared to $26,000 a year ago.





Personnel
expenses are $384,000 higher in the current period growing to $9.4 million from
$9.0 million and occupancy expenses have increased by $343,000 from $2.6 million
to $2.9 million.  The Company opened two new branch locations in April
and May, 2009 and expanded our operations facility in early
2010.  Personnel expenses have been further impacted by the
establishment of a correspondent mortgage division and the hiring of additional
staff in the Credit administration area.  FDIC deposit insurance has
decreased by $319,000 primarily due to the special assessment levied in
2009.  Several other expense categories have experienced decreases
including postage, printing and supplies, travel and the cost of attending
seminars and conferences.  The Company converted all data processing
platforms in March 2009 and incurred one-time, non-recurring expenses of
$156,000.




28





Provision for Income Taxes.The Company recorded an income tax benefit of $4,503,000 during the
nine-months ended September 30, 2010 compared to tax expense of $172,000 for the
prior year period.  The current period benefit was approximately
45.70% of the quarterly loss.  The impact of tax exempt interest
income increased the taxable loss and therefore increased the
benefit.  The effective tax rate for the nine-month period ended
September 30, 2009 was 8.62%.  The small effective tax rate in 2009
was attributable to lower pre-tax income and a large percentage of income coming
from tax exempt sources.





Please
see comments related to the deferred tax asset and related valuation allowance
analysis under this same caption on pages 26 and 27.




29




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 tables set forth information relating
to average balances of the Company's assets and liabilities for the three and
nine-month periods ended September 30, 2010 and 2009. The tables reflect 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 tables,
non-accrual loans are included, when applicable, in the average loan
balance.  For purposes of the analysis, Federal Home Loan Bank stock
is included in Investment Securities totals.





Average
      Balances, Interest and Average Yields/Cost(Dollars
      in Thousands)





For
      the Three Months Ended September 30,2010
            
            
            2009Average
            
            
            
            
            
            Average
            
            
            Average
            
            
            
            
            
            AverageBalance
            
            
            Interest
            
            
            Yield/Cost
            
            
            Balance
            
            
            Interest
            
            
            Yield/CostInterest-earnings
      assetsLoan
      portfolio
            
            $
            704,177
            
            
            $
            10,420
            
            
            
            5.87
            %
            
            $
            772,419
            
            
            $
            11,986
            
            
            
            6.16
            %Investment
      securities
            
            
            191,714
            
            
            
            1,844
            
            
            
            4.57
            %
            
            
            207,599
            
            
            
            2,081
            
            
            
            4.46
            %Fed
      funds and other interest-earning assets
            
            
            19,278
            
            
            
            13
            
            
            
            0.27
            %
            
            
            2,987
            
            
            
            1
            
            
            
            0.13
            %Total
      earning assets
            
            
            915,169
            
            
            
            12,277
            
            
            
            5.45
            %
            
            
            983,005
            
            
            
            14,068
            
            
            
            5.77
            %Noninterest-earning
      assets
            
            
            61,465
            
            
            
            
            
            
            
            
            
            
            
            76,990Total
      Assets
            
            $
            976,634
            
            
            
            
            
            
            
            
            
            
            $
            1,059,995Interest-bearing
      liabilitiesInterest-bearing
      NOW
            
            $
            130,712
            
            
            
            845
            
            
            
            2.56
            %
            
            $
            65,362
            
            
            
            316
            
            
            
            1.92
            %Money
      market and savings
            
            
            130,824
            
            
            
            351
            
            
            
            1.06
            %
            
            
            134,105
            
            
            
            456
            
            
            
            1.35
            %Time
      deposits
            
            
            394,895
            
            
            
            2,784
            
            
            
            2.80
            %
            
            
            443,337
            
            
            
            4,113
            
            
            
            3.68
            %Short-term
      borrowings
            
            
            12,174
            
            
            
            58
            
            
            
            1.89
            %
            
            
            107,389
            
            
            
            507
            
            
            
            1.87
            %Long-term
      debt
            
            
            155,313
            
            
            
            1,428
            
            
            
            3.60
            %
            
            
            120,487
            
            
            
            1,265
            
            
            
            4.11
            %Total
      interest-bearing liabilities
            
            
            823,918
            
            
            
            5,466
            
            
            
            2.63
            %
            
            
            870,680
            
            
            
            6,657
            
            
            
            3.03
            %Non
      interest-bearing deposits
            
            
            60,301
            
            
            
            
            
            
            
            
            
            
            
            63,551Other
      liabilities
            
            
            4,334
            
            
            
            
            
            
            
            
            
            
            
            3,268Total
      Liabilities
            
            
            888,553
            
            
            
            
            
            
            
            
            
            
            
            937,499Stockholders'
      Equity
            
            
            88,081
            
            
            
            
            
            
            
            
            
            
            
            122,496Total
      Liabilities & Stockholders' Equity
            
            $
            976,634
            
            
            
            
            
            
            
            
            
            
            $
            1,059,995Net
      interest income
            
            
            
            
            
            $
            6,811
            
            
            
            
            
            
            
            
            
            
            $
            7,411Interest
      rate spread
            
            
            
            
            
            
            
            
            
            
            2.82
            %
            
            
            
            
            
            
            
            
            
            
            2.74
            %Net
      margin
            
            
            
            
            
            
            
            
            
            
            3.08
            %
            
            
            
            
            
            
            
            
            
            
            3.08
            %Percentage
      of average interest-earningassets to average interest
      bearing liabilities
            
            
            
            
            
            
            
            
            
            
            111.08
            %
            
            
            
            
            
            
            
            
            
            
            112.90
            %





30





Average
Balances, Interest and Average Yields/Cost
 (Dollars
in Thousands)
 For
      the Nine Months Ended September 30,2010
                
                
                2009Average
                  Balance
                
                
                Interest
                
                
                Average
                  Yield/Cost
                
                
                Average
                  Balance
                
                
                Interest
                
                
                AverageYield/CostInterest-earnings
      assetsLoan
      portfolio
                
                $
                730,611
                
                
                $
                33,400
                
                
                
                6.11
                %
                
                $
                781,311
                
                
                $
                36,089
                
                
                
                6.18
                %Investment
      securities
                
                
                195,132
                
                
                
                5,637
                
                
                
                4.43
                %
                
                
                202,570
                
                
                
                6,134
                
                
                
                4.44
                %Fed
      funds and other interest-earning assets
                
                
                13,161
                
                
                
                26
                
                
                
                0.26
                %
                
                
                5,326
                
                
                
                8
                
                
                
                0.20
                %Total
      earning assets
                
                
                938,904
                
                
                
                39,063
                
                
                
                5.68
                %
                
                
                989,207
                
                
                
                42,231
                
                
                
                5.79
                %Noninterest-earning
      assets
                
                
                54,603
                
                
                
                
                
                
                
                
                
                
                
                72,136Total
      Assets
                
                $
                993,507
                
                
                
                
                
                
                
                
                
                
                $
                1,061,343Interest-bearing
      liabilitiesInterest-bearing
      NOW
                
                $
                115,043
                
                
                
                2,270
                
                
                
                2.64
                %
                
                $
                54,085
                
                
                
                594
                
                
                
                1.47
                %Money
      market and savings
                
                
                131,475
                
                
                
                1,151
                
                
                
                1.17
                %
                
                
                135,555
                
                
                
                1,427
                
                
                
                1.41
                %Time
      deposits
                
                
                409,091
                
                
                
                9,137
                
                
                
                2.99
                %
                
                
                453,306
                
                
                
                13,176
                
                
                
                3.89
                %Short-term
      borrowings
                
                
                35,411
                
                
                
                388
                
                
                
                1.46
                %
                
                
                110,631
                
                
                
                1,477
                
                
                
                1.78
                %Long-term
      debt
                
                
                151,279
                
                
                
                4,307
                
                
                
                3.80
                %
                
                
                121,356
                
                
                
                3,646
                
                
                
                3.96
                %Total
      interest-bearing liabilities
                
                
                842,299
                
                
                
                17,253
                
                
                
                2.74
                %
                
                
                874,933
                
                
                
                20,320
                
                
                
                3.11
                %Non
      interest-bearing deposits
                
                
                57,717
                
                
                
                
                
                
                
                
                
                
                
                62,069Other
      liabilities
                
                
                4,010
                
                
                
                
                
                
                
                
                
                
                
                3,092Total
      Liabilities
                
                
                904,026
                
                
                
                
                
                
                
                
                
                
                
                940,094Stockholders'
      Equity
                
                
                89,481
                
                
                
                
                
                
                
                
                
                
                
                121,249Total
      Liabilities & Stockholders' Equity
                
                $
                993,507
                
                
                
                
                
                
                
                
                
                
                $
                1,061,343Net
      interest income
                
                
                
                
                
                $
                21,810
                
                
                
                
                
                
                
                
                
                
                $
                21,911Interest
      rate spread
                
                
                
                
                
                
                
                
                
                
                2.94
                %
                
                
                
                
                
                
                
                
                
                
                2.68
                %Net
      margin
                
                
                
                
                
                
                
                
                
                
                3.23
                %
                
                
                
                
                
                
                
                
                
                
                3.04
                %Percentage
      of average interest-earningassets
      to average interest bearingliabilities
                
                
                
                
                
                
                
                
                
                
                111.47
                %
                
                
                
                
                
                
                
                
                
                
                113.06
                %


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 for the three and nine-month periods ended
September 30, 2010 and 2009.  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 equally to both the
changes attributable to volume and the changes attributable to
rate.




31
 
 Rate/Volume
Analysis


Three
      Months Ended September 30,2010
      vs. 2009(in
      Thousands)Increase
      (Decrease) Due toVolume
            
            
            Rate
            
            
            TotalInterest
      IncomeLoan
      portfolio
            
            
            (1,031
            )
            
            
            (535
            )
            
            
            (1,566
            )Investment
      Securities
            
            
            (237
            )
            
            
            0
            
            
            
            (237
            )Fed
      funds and other interest-earning assets
            
            
            8
            
            
            
            4
            
            
            
            12Total
      interest-earning assets
            
            
            (1,260
            )
            
            
            (531
            )
            
            
            (1,791
            )Interest
      ExpenseInterest-bearing
      NOW
            
            
            369
            
            
            
            160
            
            
            
            529Money
      market and savings
            
            
            (11
            )
            
            
            (96
            )
            
            
            (105
            )Time
      deposits
            
            
            (395
            )
            
            
            (934
            )
            
            
            (1,329
            )Short-term
      borrowings
            
            
            (452
            )
            
            
            3
            
            
            
            (449
            )Long-term
      debt
            
            
            332
            
            
            
            (169
            )
            
            
            163Total
      interest-bearing liabilities
            
            
            (155
            )
            
            
            (1,036
            )
            
            
            (1,191
            )Net
      interest income
            
            
            (1,105
            )
            
            
            505
            
            
            
            (600
            )




Rate/Volume
Analysis


Nine
      Months Ended September 30,2010
      vs. 2009(in
      Thousands)Increase
      (Decrease) Due toVolume
            
            
            Rate
            
            
            TotalInterest
      IncomeLoan
      portfolio
            
            
            (1,672
            )
            
            
            (1,017
            )
            
            
            (2,689
            )Investment
      Securities
            
            
            (288
            )
            
            
            (211
            )
            
            
            (497
            )Fed
      funds and other interest-earning assets
            
            
            11
            
            
            
            7
            
            
            
            18Total
      interest-earning assets
            
            
            (1,949
            )
            
            
            (1,221
            )
            
            
            (3,168
            )Interest
      ExpenseInterest-bearing
      NOW
            
            
            872
            
            
            
            804
            
            
            
            1,676Money
      market and savings
            
            
            (105
            )
            
            
            (171
            )
            
            
            (276
            )Time
      deposits
            
            
            (1,720
            )
            
            
            (2,319
            )
            
            
            (4,039
            )Short-term
      borrowings
            
            
            (669
            )
            
            
            (420
            )
            
            
            (1,089
            )Long-term
      debt
            
            
            505
            
            
            
            156
            
            
            
            661Total
      interest-bearing liabilities
            
            
            (1,118
            )
            
            
            (1,951
            )
            
            
            (3,067
            )Net
      interest income
            
            
            (831
            )
            
            
            730
            
            
            
            (101
            )


32






NONPERFORMING
ASSETS
 
 The table
below sets forth, for the periods indicated, information about our nonaccrual
loans, restructured loans, total nonperforming loans, and total nonperforming
assets.
 
 At
      September 30,
                
                
                At
      December 31,2010
                
                
                2009
                
                
                2009
                
                
                2008(Dollars
      in thousands)Nonaccrual
      loansConstruction
      and A&D
                
                $
                18,680
                
                
                $
                8,596
                
                
                $
                6,692
                
                
                $
                7,696Commercial
      real estate
                
                
                7,990
                
                
                
                827
                
                
                
                4,655
                
                
                
                365Residential
      mortgage
                
                
                2,812
                
                
                
                2,002
                
                
                
                2,758
                
                
                
                4,448Home
      equity lines and loans
                
                
                896
                
                
                
                1,951
                
                
                
                1,314
                
                
                
                82Commercial
      and industrial
                
                
                272
                
                
                
                3,153
                
                
                
                2,706
                
                
                
                503Consumer
                
                
                12
                
                
                
                11
                
                
                
                9
                
                
                
                -Total
      nonaccrual loans
                
                
                30,662
                
                
                
                16,540
                
                
                
                18,134
                
                
                
                13,094Accruing
      loans past due90
      days or more
                
                
                -
                
                
                
                -
                
                
                
                381
                
                
                
                -Total
      nonperforming loans
                
                
                30,662
                
                
                
                16,540
                
                
                
                18,515
                
                
                
                13,094Real
      estate owned
                
                
                13,255
                
                
                
                5,296
                
                
                
                6,306
                
                
                
                1,716Repossessed
      assets
                
                
                1,950
                
                
                
                2
                
                
                
                -
                
                
                
                -Total
      nonperforming assets
                
                $
                45,867
                
                
                $
                21,838
                
                
                $
                24,821
                
                
                $
                14,810Restructured
      loans in accrual statusnot
      in categories listed above
                
                $
                5,628
                
                
                $
                9,525
                
                
                $
                13,691
                
                
                $
                -Allowance
      for loan losses
                
                $
                18,049
                
                
                $
                13,782
                
                
                $
                17,567
                
                
                $
                12,585Nonperforming
      loans toperiod
      end loans
                
                
                4.42
                %
                
                
                2.14
                %
                
                
                2.44
                %
                
                
                1.53
                %Allowance
      for loan lossesto
      period end loans
                
                
                2.60
                %
                
                
                1.79
                %
                
                
                2.31
                %
                
                
                1.60
                %Allowance
      for loan lossesto
      nonperforming loans
                
                
                59
                %
                
                
                83
                %
                
                
                95
                %
                
                
                96
                %Nonperforming
      loansto
      period end total assets
                
                
                3.15
                %
                
                
                2.05
                %
                
                
                1.79
                %
                
                
                1.35
                %Nonperforming
      assetsto
      period end total assets
                
                
                4.72
                %
                
                
                2.05
                %
                
                
                2.40
                %
                
                
                1.67
                %
 
 The table
below summarizes our nonperforming loan portfolio by region.  The
Company considers our total footprint to be comprised of three primary
regions:  the Triangle region which encompasses our Wake and Johnston
county offices, the Sandhills region which encompasses our Lee and Moore county
offices and the Wilmington region.
  33
  Nonperforming
Loans by Region
  As
      of September 30, 2010NonperformingLoans
                
                
                %
      of Total
                
                
                
                
                
                Loans
      toHeld
      for
                
                
                Loans
                
                
                Nonperforming
                
                
                Loans
      Held forInvestment
                
                
                Outstanding
                
                
                Loans
                
                
                Investment(Dollars
      in thousands)Triangle
      Region
                
                $
                408,981
                
                
                
                58.88
                %
                
                $
                17,198
                
                
                
                4.21
                %Sandhills
      Region
                
                
                109,215
                
                
                
                15.73
                %
                
                
                6,814
                
                
                
                6.24
                %Wilmington
      Region
                
                
                176,254
                
                
                
                25.38
                %
                
                
                6,650
                
                
                
                3.77
                %Total
      allowance
                
                $
                694,450
                
                
                
                100.00
                %
                
                $
                30,662
                
                
                
                4.42
                %
 Our
financial statements are prepared on the accrual basis of accounting, including
the recognition of interest income on loans, unless we place a loan on
nonaccrual basis.  Generally, our policy is to place a loan on
nonaccrual status when the loan becomes past due 90 days. We also account for
loans on a nonaccrual basis when it is probable that we will be unable to
collect all contractual payments of principal or interest. Amounts received on
nonaccrual loans generally are applied first to principal and then to interest
only after all principal has been collected.
 
 The table
below summarizes performing restructured loans, which are classified as impaired
for purposes of the loan loss allowance calculation.
  At
      September 31,
                
                
                At
      December 31,2010
                
                
                2009
                
                
                2009
                
                
                2008(Dollars
      in thousands)Performing
      restructured loans:Construction
      and A&D
                
                $
                4,703
                
                
                
                2,780
                
                
                $
                1,097
                
                
                
                -Commercial
      real estate
                
                
                389
                
                
                
                2,111
                
                
                
                6,286
                
                
                
                -Residential
      mortgage
                
                
                408
                
                
                
                4,261
                
                
                
                5,936
                
                
                
                -Home
      equity lines and loans
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Commercial
      and industrial
                
                
                148
                
                
                
                373
                
                
                
                372
                
                
                
                -Consumer
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Total
      performing restructured loans
                
                $
                5,648
                
                
                $
                9,525
                
                
                $
                13,691
                
                
                $
                -
 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 sustained payment performance has been
established.  The Company will continue to closely monitor these loans
and will cease accruing interest on them if management believes that the
borrowers may not continue performing based on the restructured note terms. All
troubled debt restructurings (TDRs) are considered to be impaired and are
evaluated as such in the quarterly allowance calculation. As of September 30,
2010, the allowance for loan losses allocated to TDRs totaled
$388,000.
 
 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 September
30, 2010, we identified seventeen loans totaling $13.0 million as potential
problems loans.  Of the $13.0 million in potential problem loans,
eight loans totaling $11.0 million are concentrated in the residential
construction, land acquisition and development sectors and three loans totaling
$1.1 million are commercial real estate. Foreclosed assets at September 30, 2010
consist of collateral for thirty-eight loans valued at a total of $15.2 million
and there were seventy nonaccrual loans totaling $30.7
million.  Foreclosed property is valued at fair value at the date of
foreclosure or acquisition and periodically evaluated to determine whether
further valuation write-downs are warranted. Interest foregone on nonaccrual and
charged-off loans for the nine-month period ended September 30, 2010 was $2.0
million.
  34
 
 At
December 31, 2009, we identified 27 loans in the aggregate amount of $19.5
million as potential problem loans.  Of these 27 loans, 15 loans
totaling approximately $6.8 million are related to the land acquisition,
development and residential construction industries and 5 loans totaling $11.4
million are secured by commercial real estate.  There were
thirty-seven foreclosed properties valued at $6.3 million and 68 nonaccrual
loans totaling $18.1 million.  Foreclosed property is initially
recorded at fair value at the date of foreclosure or
repossession.  Interest foregone on nonaccrual loans for the year
ended December 31, 2009 was approximately $928,000.
 
 ANALYSIS
OF ALLOWANCE FOR LOAN LOSSES
 
 The
allowance for loan losses is established through periodic charges to earnings in
the form of a provision for loan losses.  Increases to the allowance
for loan losses occur as a result of provisions charged to operations and
recoveries of amounts previously charged-off, and decreases to the allowance
occur when loans are charged-off.  Management evaluates the adequacy
of our allowance for loan losses on a monthly basis.  The evaluation
of the adequacy of the allowance for loan losses involves the consideration of
loan growth, loan portfolio composition and industry diversification, historical
loan loss experience, current delinquency levels, adverse conditions that might
affect a borrower’s ability to repay the loan, estimated value of underlying
collateral, prevailing economic conditions and all other relevant factors
derived from our history of operations.  Additionally, as an important
component of their periodic examination process, regulatory agencies review our
allowance for loan losses and may require additional provisions for estimated
losses based on judgments that differ from those of management.
 
 We use an
internal grading system to assign the degree of inherent risk on each individual
loan.  The grade is initially assigned by the lending officer and
reviewed by the loan administration function.  The internal grading
system is reviewed and tested periodically by an independent third party credit
review firm.  The testing process involves the evaluation of a sample
of new loans, loans having been identified as possessing potential weakness in
credit quality, past due loans and nonaccrual loans to determine the ongoing
effectiveness of the internal grading system.  The loan grading system
is used to assess the adequacy of the allowance for loan losses.
 
 Management
has developed a model for evaluating the adequacy of the allowance for loan
losses.  The model uses the Company’s internal loan grading system to
segment each category of loans by risk class. The Company’s internal grading
system is compromised of nine different risk classifications.  Loans
possessing a risk class of 1 through 6 demonstrate various degrees of risk, but
each is considered to have the capacity to perform in accordance with the terms
of the loan.  Loans possessing a risk class of 7 to 9 are considered
impaired and are individually evaluated for impairment.  Additionally,
we are evaluating loans that migrate to a risk class 6 status and provide for
possible losses if the loan is unsecured or secured by a General Security
Agreement on business assets.
 
 The
predetermined allowance percentages to be applied to loans possessing risk grade
1 through 6 are determined by using the historical charge-off percentages and
adding management’s qualitative factors.  For each individual loan
type, we calculate the average historical charge-off percentage over a five year
period.  The current year charge-offs are annualized and included as
one of the five years under consideration.  The resulting averages
represent a charge-off rate in a more normalized environment.  To
those averages, management adds qualitative factors which are more a reflection
of current economic conditions and trends.  Together, these two
components comprise the reserve.
  35
 
 Those
loans that are identified through the Company’s internal loan grading system as
impaired are evaluated individually.  Each loan is analyzed to
determine the net value of collateral, probability of charge-off and finally a
potential estimate of loss.  When management believes a real estate
collateral-supported loan will move from a risk grade 6 to a risk grade 7, a new
appraisal is ordered.  The analysis is performed using current
collateral values as opposed to values shown on appraisals which were obtained
at the time the loan was made.  If the analysis of a real estate
collateral-supported loan results in an estimated loss, a specific reserve is
recorded.  Loans with risk grade 7 and 8 are re-evaluated periodically
to determine the adequacy of specific reserves.  Fair values on real
estate collateral are subject to constant change and management makes certain
assumptions about how the age of an appraisal impacts current
value.  Loans with risk grade codes of 7 or 8 that are either
unsecured or secured by a general security agreement on business assets are
generally reserved for at 100% of the loan balance.  When a
collateral-supported loan is deemed to be collateral dependent, management will
charge off the amount of confirmed loss represented by the difference between
the loan balance and the appraised value.  After the partial
charge-off, there may still be a reserve associated with the impaired loan equal
to an amount representing estimated selling costs and any management determined
discount.  If the collateral is subsequently foreclosed, the property
is transferred to other real estate owned at its estimated fair value and
additional charge-offs may be recorded at that time.
 
 Using the
data gathered during the monthly evaluation process, the model calculates an
acceptable range for the allowance for loan losses.  Management and
the Board of Directors are responsible for determining the appropriate level of
the allowance for loan losses within that range.
 
 The
provision for the first nine months of 2010 was primarily due to the level of
impact of current year charge-offs on the historical charge-off rates, the
higher qualitative factors assigned due to current economic conditions and the
level of specific reserves required as a result of our analysis of impaired
loans.  The sectors of the loan portfolio being impacted most by the
economic climate are commercial real estate and residential construction, land
acquisition and development. Other factors influencing the provision include net
loan charge-offs.  For the nine-month period ended September 30, 2010,
there were net loan charge-offs of $14.7 million compared with $3.6 million at
September 30, 2009.  The allowance for loan losses at September 30,
2010 was $18.0 million, which represents 2.60% of total loans held for
investment compared to $13.8 million or 1.79% one year ago.
 
 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.
  36
 
 The
following table describes the allocation of the allowance for loan losses among
various categories of loans for the dates indicated.
  Allocation
of Allowance for Loan Losses
  At
      September 30,
              
              
              At
      December 31,2010
              
              
              2009%
      of Total
              
              
              
              
              
              %
      of TotalAmount
              
              
              Loans
      (1)
              
              
              Amount
              
              
              Loans
      (1)(Dollars
      in thousands)Residential
      real estate loans
              
              $
              1,975
              
              
              
              12.64
              %
              
              $
              1,075
              
              
              
              12.73
              %Home
      equity loans and lines
              
              
              1,296
              
              
              
              8.52
              %
              
              
              1,134
              
              
              
              8.48
              %Commercial
      real estate loans
              
              
              5,107
              
              
              
              48.71
              %
              
              
              5,811
              
              
              
              47.28
              %Construction
      loans
              
              
              7,157
              
              
              
              22.17
              %
              
              
              6,439
              
              
              
              23.58
              %Commercial
      and industrial loans
              
              
              2,432
              
              
              
              7.33
              %
              
              
              2,854
              
              
              
              7.28
              %Loans
      to individuals
              
              
              82
              
              
              
              0.63
              %
              
              
              254
              
              
              
              0.65
              %Total
      allowance
              
              $
              18,049
              
              
              
              100.00
              %
              
              $
              17,567
              
              
              
              100.00
              %





(1)
                Represents
      total of all outstanding loans in each category as a percent of total
      loans outstanding.
 37
  The
following table presents information regarding changes in the allowance for loan
losses for the periods indicated:
  Changes
in Allowance for Loan Losses
 For
      the Nine-Month Period Ended September 30,2009
                  
                  
                  2009(Dollars
      in thousands)Balance
      at the beginning of the year
                  
                  $
                  17,567
                  
                  
                  $
                  12,585Charge-offs:Commercial
      and industrial loans
                  
                  
                  1,769
                  
                  
                  
                  1,205Commercial
      real estate loans
                  
                  
                  3,841
                  
                  
                  
                  -Construction,
      acquisition and development
                  
                  
                  3,895
                  
                  
                  
                  1,736Residential
      mortgage loans
                  
                  
                  3,549
                  
                  
                  
                  721Home
      equity lines and loans
                  
                  
                  1,992
                  
                  
                  
                  195Consumer
      loans
                  
                  
                  56
                  
                  
                  
                  76Total
      charge-offs
                  
                  
                  15,102
                  
                  
                  
                  3,933RecoveriesCommercial
      and industrial loans
                  
                  
                  192
                  
                  
                  
                  65Commercial
      real estate
                  
                  
                  39
                  
                  
                  
                  -Construction,
      acquisition and development
                  
                  
                  108
                  
                  
                  
                  269Residential
      mortgage loans
                  
                  
                  10
                  
                  
                  
                  9Home
      equity lines and loans
                  
                  
                  94
                  
                  
                  
                  -Consumer
      loans
                  
                  
                  2
                  
                  
                  
                  -Total
      recoveries
                  
                  
                  445
                  
                  
                  
                  343Net
      charge-offs
                  
                  
                  14,657
                  
                  
                  
                  3,590Provision
      for loan losses
                  
                  
                  15,139
                  
                  
                  
                  4,787Balance
      at the end of the period
                  
                  $
                  18,049
                  
                  
                  $
                  13,782Total
      loans held for investment outstanding at period-end
                  
                  $
                  694,450
                  
                  
                  $
                  771,997Average
      loans held for investment outstanding for the period
                  
                  $
                  730,611
                  
                  
                  $
                  781,311Allowance
      for loan losses tototal
      loans outstanding
                  
                  
                  2.60
                  %
                  
                  
                  1.79
                  %Annualized
      ratio of net charge-offs to average loans outstanding
                  
                  
                  2.68
                  %
                  
                  
                  0.61
                  %
 38
 
 
 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 security principal repayments, deposit growth, brokered time
deposits and borrowings from the Federal Home Loan Bank, Federal Reserve Bank
and other correspondent banks 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.
 
 As of
September 30, 2010, liquid assets (cash and due from banks, interest-earning
deposits with banks, fed funds sold and investment securities available for
sale) were approximately $227.2 million, which represents 23% of total assets
and 32% of total deposits. Supplementing this liquidity, the Company has
available lines of credit from various correspondent banks of approximately
$382.6 million of which $149.0 million is outstanding.  Outstanding
commitments for undisbursed lines of credit, letters of credit and undisbursed
investment commitments amounted to approximately $120.3
million.  Management intends to fund anticipated loan closings and
operational needs through cash and cash equivalents on hand, brokered deposits,
scheduled principal repayments from the loan and securities portfolios, and
anticipated increases in deposits and borrowings.  Certificates of
deposit represented 54% of the Company’s total deposits at September 30, 2010
and 61% at December 31, 2009. The Company’s growth strategy will include
marketing efforts focused at increasing the relative volume of transaction
deposit accounts; however, time deposits will continue to play an important role
in the Company’s funding strategy. Certificates of deposit of $100,000 or more
represented 44% and 50% of the Company’s total deposits at September 30, 2010
and December 31, 2009, respectively.  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, Crescent Financial Corporation must satisfy certain
minimum leverage ratio requirements and risk-based capital requirements. At
September 30, 2010, the Company’s equity to asset ratio is 8.80%.  The
Company’s ratios of Tier 1 capital to risk-weighted assets and total capital to
risk-based assets are 11.36% and 13.57%, respectively.  The bank
subsidiary is required to maintain capital adequacy ratios.  Crescent
State Bank has Tier I capital to risk-weighted assets and total capital to
risk-based assets ratios of 11.02% and 13.24%, respectively.
 
 IMPACT
OF INFLATION AND CHANGING PRICES
 
 A
commercial bank has an asset and liability composition that is distinctly
different from that of a company with substantial investments in plant and
inventory because the major portions of its assets are monetary in nature. As a
result, a bank’s performance may be significantly influenced by changes in
interest rates. Although the banking industry is more affected by changes in
interest rates than by inflation in the prices of goods and services, inflation
is a factor that may influence interest rates. However, the frequency and
magnitude of interest rate fluctuations do not necessarily coincide with changes
in the general inflation rate. Inflation does affect operating expenses in that
personnel expenses and the cost of supplies and outside services tend to
increase more during periods of high inflation.
 
 FORWARD-LOOKING
INFORMATION
 
 This
quarterly report to stockholders 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.
  39
 
 Item 3. Quantitative and
Qualitative Disclosures about Market Risk
 
 The
Company’s primary market risk is interest rate risk. Interest rate risk is the
result of differing maturities or repricing intervals of interest earning assets
and interest bearing liabilities and the fact that rates on these financial
instruments do not change uniformly. These conditions may impact the earnings
generated by the Company’s interest earning assets or the cost of its interest
bearing liabilities, thus directly impacting the Company’s overall earnings. The
Company’s management actively monitors and manages interest rate risk. One way
this is accomplished is through the development of and adherence to the
Company’s asset/liability policy. This policy sets forth management’s strategy
for matching the risk characteristics of the Company’s interest earning assets
and liabilities so as to mitigate the effect of changes in the rate environment.
The Company’s market risk profile has not changed significantly since December
31, 2009.
 
 Item 4. Controls and
Procedures
 
 Crescent
Financial Corporation’s management, with the participation of the Chief
Executive Officer and Principal Financial Officer, has evaluated the
effectiveness of the Company’s disclosure controls and procedures as of
September 30, 2010. Based on that evaluation, the Company’s Chief Executive
Officer and Principal Financial Officer concluded that the Company’s disclosure
controls and procedures were effective, as of September 30, 2010, to provide
reasonable assurance that information required to be disclosed by the Company in
the reports filed or submitted by it under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
SEC’s rules and forms, and to provide reasonable assurance that information
required to be disclosed by the Company in such reports is accumulated and
communicated to the Company’s management, including its principal executive
officer and principal financial officer, as appropriate to allow timely
decisions regarding required disclosure.
 
 The
Company assesses the adequacy of its internal control over financial reporting
quarterly and enhances its controls in response to internal control assessments
and internal and external audit and regulatory recommendations. There have been
no changes in the Company’s internal controls during the quarter ended September
30, 2010 or through the date of this Quarterly Report on Form 10-Q that have
materially affected, or are reasonably likely to materially affect, the
Company’s internal control over financial reporting.
  40
 
 Part
II. OTHER INFORMATION
 
 Item
1. Legal Proceedings.
  None that
are material.
 
 Item
1a. Risk Factors.
  Not
Applicable.
 
 Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds.
  None.
 
 Item
3. Defaults Upon Senior Debt.
  None.
 
 Item
4. (Removed and Reserved)
 
 Item
5. Other Information.
  None.
 
 Item
6. Exhibits
 
 (a) Exhibits.
 
 31.1
                Certification
      of Principal Executive Officer pursuant to Rule 13a –
  14(a)
 
 31.2
                Certification
      of Principal Financial Officer pursuant to Rule 13a –
  14(a)
 
 32.1
                Certification
      of Chief Executive Officer pursuant to 18 U.S.C. 1350 as adopted pursuant
      to Section 906 of the  Sarbanes-Oxley Act of
  2002
 
 32.2
                Certification
      of Principal Financial Officer pursuant to 18 U.S.C. 1350 as adopted
      pursuant to Section 906 of the  Sarbanes-Oxley Act of
      2002
  41
  SIGNATURES
 
 Under the
requirements 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 CORPORATIONDate: November
      12, 2010
                By:
                /s/
      Michael G. CarltonMichael
      G. CarltonPresident
      and Chief Executive OfficerDate: November
      12, 2010
                By:
                /s/
      Bruce W. ElderBruce
      W. ElderPrincipal
      Financial Officer
 
 42