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 June 30,
2009





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





Commission
File Number 000-32951





CRESCENT FINANCIAL
CORPORATION


(Exact
name of registrant as specified in its charter)





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





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
 ̈





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  ̈        No
 ̈





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  ̈
              Accelerated
      filer  ̈Non-accelerated
      filer  ̈
              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  ̈                  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 9,626,559 shares outstanding as of August 12,
2009.














Page No.Part
      I.
                                                    FINANCIAL
      INFORMATIONItem
      1 -
                                                    Financial
      Statements (Unaudited)Consolidated
      Balance Sheets
                                                      June
      30, 2009 (unaudited) and December 31, 2008
                                                    3Consolidated
      Statements of Operations
                                                      Three
      and Six Months Ended June 30, 2009 and 2008 (unaudited)
                                                    4Consolidated
      Statements of Comprehensive Income
                                                      Three
      and Six Months Ended June 30, 2009 and 2008 (unaudited)
                                                    5Consolidated
      Statement of Stockholders’ Equity
                                                      Six
      Months Ended June 30, 2009 (unaudited)
                                                    6Consolidated
      Statements of Cash Flows
                                                      Six
      Months Ended June 30, 2009 and 2008 (unaudited)
                                                    7Notes
      to Consolidated Financial Statements
                                                    8 -
      21Item
      2 -
                                                    Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                                                    22
      – 37Item
      3 -
                                                    Quantitative
      and Qualitative Disclosures about Market Risk
                                                    38Item
      4T -
                                                    Controls
      and Procedures
                                                    38Part
      II.
                                                    Other
      InformationItem
      1 -
                                                    Legal
      Proceedings
                                                    39Item
      1a -
                                                    Risk
      Factors
                                                    39Item
      2 -
                                                    Unregistered
      Sales of Equity Securities and Use of Proceeds
                                                    39Item
      3 -
                                                    Defaults
      Upon Senior Debt
                                                    39Item
      4 -
                                                    Submission
      of Matters to a Vote of Security Holders
                                                    39Item
      5 -
                                                    Other
      Information
                                                    40Item
      6 -
                                                    Exhibits
                                                    40


- 2
-


Part
I. FINANCIAL INFORMATION


Item 1 - Financial
Statements





CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 CONSOLIDATED
BALANCE SHEETS





June
      30, 2009
                                    
                                    
                                    December
      31,(Unaudited)
                                    
                                    
                                    
                                    2008*ASSETSCash
      and due from banks
                                    
                                    $
                                    10,394,174
                                    
                                    
                                    $
                                    9,917,277Interest-earning
      deposits with banks
                                    
                                    
                                    3,207,297
                                    
                                    
                                    
                                    266,512Federal
      funds sold
                                    
                                    
                                    15,285,000
                                    
                                    
                                    
                                    99,000Investment
      securities available for sale, at fair value
                                    
                                    
                                    193,763,988
                                    
                                    
                                    
                                    105,648,618Loans
                                    
                                    
                                    775,301,424
                                    
                                    
                                    
                                    785,377,283Allowance
      for loan losses
                                    
                                    
                                    (13,144,000
                                    )
                                    
                                    
                                    (12,585,000
                                    )NET
      LOANS
                                    
                                    
                                    762,157,424
                                    
                                    
                                    
                                    772,792,283Accrued
      interest receivable
                                    
                                    
                                    4,346,567
                                    
                                    
                                    
                                    3,341,258Federal
      Home Loan Bank stock, at cost
                                    
                                    
                                    11,776,500
                                    
                                    
                                    
                                    7,264,000Bank
      premises and equipment, net
                                    
                                    
                                    12,006,782
                                    
                                    
                                    
                                    10,845,049Investment
      in life insurance
                                    
                                    
                                    17,229,284
                                    
                                    
                                    
                                    16,811,918Goodwill
                                    
                                    
                                    30,233,049
                                    
                                    
                                    
                                    30,233,049Other
      assets
                                    
                                    
                                    12,956,980
                                    
                                    
                                    
                                    11,091,784TOTAL
      ASSETS
                                    
                                    $
                                    1,073,357,045
                                    
                                    
                                    $
                                    968,310,748LIABILITIES
      AND STOCKHOLDERS’ EQUITYLIABILITIESDepositsDemand
                                    
                                    $
                                    67,371,286
                                    
                                    
                                    $
                                    63,945,717Savings
                                    
                                    
                                    58,150,479
                                    
                                    
                                    
                                    58,833,876Money
      market and NOW
                                    
                                    
                                    136,644,058
                                    
                                    
                                    
                                    130,542,569Time
                                    
                                    
                                    444,536,803
                                    
                                    
                                    
                                    461,560,593TOTAL
      DEPOSITS
                                    
                                    
                                    706,702,626
                                    
                                    
                                    
                                    714,882,755Short-term
      borrowings
                                    
                                    
                                    128,000,000
                                    
                                    
                                    
                                    37,706,000Long-term
      borrowings
                                    
                                    
                                    113,748,000
                                    
                                    
                                    
                                    116,748,000Accrued
      expenses and other liabilities
                                    
                                    
                                    3,679,506
                                    
                                    
                                    
                                    3,882,385TOTAL
      LIABILITIES
                                    
                                    
                                    952,130,132
                                    
                                    
                                    
                                    873,219,140STOCKHOLDERS’
      EQUITYPreferred
      stock, no par value, 5,000,000 shares authorized, 24,900 shares issued and
      outstanding on June 30, 2009
                                    
                                    
                                    22,686,747
                                    
                                    
                                    
                                    -Common
      stock, $1 par value, 20,000,000 shares authorized; 9,626,559 shares
      outstanding June 30, 2009 andDecember
      31, 2008
                                    
                                    
                                    9,626,559
                                    
                                    
                                    
                                    9,626,559Common
      stock warrant
                                    
                                    
                                    2,367,368
                                    
                                    
                                    
                                    -Additional
      paid-in capital
                                    
                                    
                                    74,438,821
                                    
                                    
                                    
                                    74,349,299Retained
      earnings
                                    
                                    
                                    11,083,480
                                    
                                    
                                    
                                    10,488,628Accumulated
      other comprehensive income
                                    
                                    
                                    1,023,938
                                    
                                    
                                    
                                    627,122TOTAL
      STOCKHOLDERS’ EQUITY
                                    
                                    
                                    121,226,913
                                    
                                    
                                    
                                    95,091,608COMMITMENTS
      (Note B)TOTAL
      LIABILITIES AND STOCKHOLDERS’
      EQUITY
                                    
                                    $
                                    1,073,357,045
                                    
                                    
                                    $
                                    968,310,748




* Derived
from audited consolidated financial statements.


See
accompanying notes.


- 3
-


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 CONSOLIDATED
STATEMENTS OF OPERATIONS (Unaudited)
 Three
and Six Month Periods Ended June 30, 2009 and 2008





Three-month
      Periods
                    
                    
                    Six-month
      PeriodsEnded June 30,
                    
                    
                    Ended June 30,2009
                    
                    
                    2008
                    
                    
                    2009
                    
                    
                    2008INTEREST
      INCOMELoans
                    
                    $
                    12,025,703
                    
                    
                    $
                    11,935,814
                    
                    
                    $
                    24,102,761
                    
                    
                    $
                    24,407,406Investment
      securities available for sale
                    
                    
                    2,053,349
                    
                    
                    
                    1,227,001
                    
                    
                    
                    4,052,371
                    
                    
                    
                    2,433,443Federal
      funds sold and interest-bearing deposits
                    
                    
                    5,298
                    
                    
                    
                    14,573
                    
                    
                    
                    7,335
                    
                    
                    
                    58,207TOTAL
      INTEREST INCOME
                    
                    
                    14,084,350
                    
                    
                    
                    13,177,388
                    
                    
                    
                    28,162,467
                    
                    
                    
                    26,899,056INTEREST
      EXPENSEDeposits
                    
                    
                    5,068,731
                    
                    
                    
                    5,502,419
                    
                    
                    
                    10,311,667
                    
                    
                    
                    11,211,278Short-term
      borrowings
                    
                    
                    506,277
                    
                    
                    
                    90,924
                    
                    
                    
                    969,610
                    
                    
                    
                    207,603Long-term
      borrowings
                    
                    
                    1,240,650
                    
                    
                    
                    1,292,320
                    
                    
                    
                    2,381,108
                    
                    
                    
                    2,664,494TOTAL
      INTEREST EXPENSE
                    
                    
                    6,815,658
                    
                    
                    
                    6,885,663
                    
                    
                    
                    13,662,385
                    
                    
                    
                    14,083,375NET
      INTEREST INCOME
                    
                    
                    7,268,692
                    
                    
                    
                    6,291,725
                    
                    
                    
                    14,500,082
                    
                    
                    
                    12,815,681PROVISION
      FOR LOAN LOSSES
                    
                    
                    1,132,295
                    
                    
                    
                    459,311
                    
                    
                    
                    2,828,979
                    
                    
                    
                    1,265,707NET
      INTEREST INCOME AFTERPROVISION
      FOR LOAN LOSSES
                    
                    
                    6,136,397
                    
                    
                    
                    5,832,414
                    
                    
                    
                    11,671,103
                    
                    
                    
                    11,549,974NON-INTEREST
      INCOMEMortgage
      loan origination revenue
                    
                    
                    215,364
                    
                    
                    
                    150,701
                    
                    
                    
                    511,836
                    
                    
                    
                    322,609Fees
      on deposit accounts
                    
                    
                    395,708
                    
                    
                    
                    381,485
                    
                    
                    
                    783,711
                    
                    
                    
                    763,155Earnings
      on life insurance
                    
                    
                    227,673
                    
                    
                    
                    143,738
                    
                    
                    
                    435,128
                    
                    
                    
                    242,470Gain
      (loss) on disposal of assets
                    
                    
                    -
                    
                    
                    
                    914
                    
                    
                    
                    (500
                    )
                    
                    
                    823Gain
      on sale of available for sale securities
                    
                    
                    -
                    
                    
                    
                    15,535
                    
                    
                    
                    -
                    
                    
                    
                    15,535Loss
      on impairment of nonmarketable equity security
                    
                    
                    (218,762
                    )
                    
                    
                    -
                    
                    
                    
                    (406,802
                    )
                    
                    
                    -Other
                    
                    
                    132,414
                    
                    
                    
                    188,648
                    
                    
                    
                    217,200
                    
                    
                    
                    353,934TOTAL
      NON-INTEREST INCOME
                    
                    
                    752,397
                    
                    
                    
                    881,021
                    
                    
                    
                    1,540,573
                    
                    
                    
                    1,698,526NON-INTEREST
      EXPENSESalaries
      and employee benefits
                    
                    
                    3,017,328
                    
                    
                    
                    2,917,199
                    
                    
                    
                    5,988,426
                    
                    
                    
                    5,721,328Occupancy
      and equipment
                    
                    
                    904,160
                    
                    
                    
                    655,895
                    
                    
                    
                    1,655,120
                    
                    
                    
                    1,318,611Data
      processing
                    
                    
                    302,159
                    
                    
                    
                    260,900
                    
                    
                    
                    751,659
                    
                    
                    
                    531,993FDIC
      deposit insurance premium
                    
                    
                    772,868
                    
                    
                    
                    96,561
                    
                    
                    
                    1,021,588
                    
                    
                    
                    192,468Other
                    
                    
                    1,298,944
                    
                    
                    
                    1,226,301
                    
                    
                    
                    2,496,466
                    
                    
                    
                    2,422,589TOTAL
      NON-INTEREST EXPENSE
                    
                    
                    6,295,459
                    
                    
                    
                    5,156,856
                    
                    
                    
                    11,913,259
                    
                    
                    
                    10,186,989INCOME
      BEFORE INCOME TAXES
                    
                    
                    593,335
                    
                    
                    
                    1,556,579
                    
                    
                    
                    1,298,417
                    
                    
                    
                    3,061,511INCOME
      TAXES
                    
                    
                    19,600
                    
                    
                    
                    525,900
                    
                    
                    
                    113,700
                    
                    
                    
                    1,030,500NET
      INCOME
                    
                    
                    573,735
                    
                    
                    
                    1,030,679
                    
                    
                    
                    1,184,717
                    
                    
                    
                    2,031,011Effective
      dividend on preferred stock (Note E)
                    
                    
                    421,760
                    
                    
                    
                    -
                    
                    
                    
                    589,865
                    
                    
                    
                    -Net
      income available to common shareholders
                    
                    $
                    151,975
                    
                    
                    $
                    1,030,679
                    
                    
                    $
                    594,852
                    
                    
                    $
                    2,031,011NET
      INCOME PER COMMON SHAREBasic
                    
                    $
                    .02
                    
                    
                    $
                    .11
                    
                    
                    $
                    .06
                    
                    
                    $
                    .22Diluted
                    
                    $
                    .02
                    
                    
                    $
                    .11
                    
                    
                    $
                    .06
                    
                    
                    $
                    .21WEIGHTED
      AVERAGE COMMON SHARES OUTSTANDING (Note C)Basic
                    
                    
                    9,569,290
                    
                    
                    
                    9,467,294
                    
                    
                    
                    9,569,290
                    
                    
                    
                    9,442,494Diluted
                    
                    
                    9,599,466
                    
                    
                    
                    9,618,744
                    
                    
                    
                    9,583,903
                    
                    
                    
                    9,638,509


See
accompanying notes.


- 4
-





CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 CONSOLIDATED
STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
 Three
and Six Month Periods Ended June 30, 2009 and 2008


---




Three
      Months Ended
                  
                  
                  Six
      Months EndedJune 30,
                  
                  
                  June 30,2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008Net
      income
                  
                  $
                  573,735
                  
                  
                  $
                  1,030,679
                  
                  
                  $
                  1,184,717
                  
                  
                  $
                  2,031,011Other
      comprehensive income (loss):Securities
      available for sale:Unrealized
      holding gains (losses) on available for sale securities
                  
                  
                  877,459
                  
                  
                  
                  (1,428,867
                  )
                  
                  
                  797,051
                  
                  
                  
                  (409,544
                  )Tax
      effect
                  
                  
                  (338,295
                  )
                  
                  
                  550,885
                  
                  
                  
                  (307,294
                  )
                  
                  
                  157,896Reclassification
      of (gains) losses recognized in net income
                  
                  
                  -
                  
                  
                  
                  (15,535
                  )
                  
                  
                  -
                  
                  
                  
                  (15,535
                  )Tax
      effect
                  
                  
                  -
                  
                  
                  
                  5,989
                  
                  
                  
                  -
                  
                  
                  
                  5,989Net
      of tax amount
                  
                  
                  539,164
                  
                  
                  
                  (887,527
                  )
                  
                  
                  489,757
                  
                  
                  
                  (261,194
                  )Cash
      flow hedging activities:Unrealized
      holding loss on cash flow hedging activities
                  
                  
                  (151,941
                  )
                  
                  
                  -
                  
                  
                  
                  (151,941
                  )
                  
                  
                  -Tax
      effect
                  
                  
                  59,000
                  
                  
                  
                  -
                  
                  
                  
                  59,000
                  
                  
                  
                  -Net
      of tax amount
                  
                  
                  (92,941
                  )
                  
                  
                  -
                  
                  
                  
                  (92,941
                  )
                  
                  
                  -Total
      other comprehensive income (loss)
                  
                  
                  446,223
                  
                  
                  
                  (887,527
                  )
                  
                  
                  396,816
                  
                  
                  
                  (261,194
                  )COMPREHENSIVE
      INCOME
                  
                  $
                  1,019,958
                  
                  
                  $
                  143,152
                  
                  
                  $
                  1,581,533
                  
                  
                  $
                  1,769,817


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
                            
                            
                            Retained
                            
                            
                            comprehensive
                            
                            
                            stockholders’Shares
                            
                            
                            Amount
                            
                            
                            Shares
                            
                            
                            Amount
                            
                            
                            warrant
                            
                            
                            capital
                            
                            
                            earnings
                            
                            
                            income
                            
                            
                            equityBalance
      at December 31, 2008
                            
                            
                            -
                            
                            
                            $
                            -
                            
                            
                            
                            9,626,559
                            
                            
                            $
                            9,626,559
                            
                            
                            $
                            -
                            
                            
                            $
                            74,349,299
                            
                            
                            $
                            10,488,628
                            
                            
                            $
                            627,122
                            
                            
                            $
                            95,091,608Net
      income
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            1,184,717
                            
                            
                            
                            -
                            
                            
                            
                            1,184,717Other
      comprehensive income
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            396,816
                            
                            
                            
                            396,816Expense
      recognized in connection with stock options and restricted
      stock
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            89,522
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            89,522Preferred
      stock transaction:Issuance
      of preferred stock
                            
                            
                            24,900,000
                            
                            
                            
                            24,900,000
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            24,900,000Discount
      on preferred stock
                            
                            
                            -
                            
                            
                            
                            (2,367,368
                            )
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            2,367,368
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -Accretion
      of discount
                            
                            
                            -
                            
                            
                            
                            154,115
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            (154,115
                            )
                            
                            
                            -
                            
                            
                            
                            -Preferred
      stock dividend
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            (435,750
                            )
                            
                            
                            -
                            
                            
                            
                            (435,750
                            )Balance
      at June 30, 2009
                            
                            
                            24,900,000
                            
                            
                            $
                            22,686,747
                            
                            
                            
                            9,626,559
                            
                            
                            $
                            9,626,559
                            
                            
                            $
                            2,367,368
                            
                            
                            $
                            74,438,821
                            
                            
                            $
                            11,083,480
                            
                            
                            $
                            1,023,938
                            
                            
                            $
                            121,226,913


See
accompanying notes.


- 6
-


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 CONSOLIDATED
STATEMENTS OF CASH FLOWS (Unaudited)
 Six
Months Ended June 30, 2009 and 2008





2009
                
                
                2008CASH
      FLOWS FROM OPERATING ACTIVITIESNet
      income
                
                $
                1,184,717
                
                
                $
                2,031,011Adjustments
      to reconcile net income to net cash provided by operating
      activities:Depreciation
                
                
                431,904
                
                
                
                378,293Provision
      for loan losses
                
                
                2,828,979
                
                
                
                1,265,707Amortization
      of core deposit premium
                
                
                66,675
                
                
                
                66,675Deferred
      income taxes
                
                
                (541,188
                )
                
                
                (201,000
                )Loss
      on impairment of nonmarketable equity security
                
                
                406,802
                
                
                
                -Gain
      on sale of available of sale securities
                
                
                -
                
                
                
                (15,535
                )Loss
      on disposal of other real estate owned
                
                
                40,272
                
                
                
                72,854(Gain)
      loss on disposal of assets
                
                
                500
                
                
                
                (823
                )Net
      amortization (accretion) of premiums/discounts on
    securities
                
                
                457,492
                
                
                
                (49,958
                )Accretion
      of loan discount
                
                
                (146,607
                )
                
                
                (219,910
                )Amortization
      of deposit premium
                
                
                54,865
                
                
                
                92,775Net
      increase in cash value of life insurance
                
                
                (417,366
                )
                
                
                (219,801
                )Stock
      based compensation
                
                
                89,523
                
                
                
                104,795Change
      in assets and liabilities:(Increase)
      decrease in accrued interest receivable
                
                
                (1,005,309
                )
                
                
                656,500(Increase)
      decrease in other assets
                
                
                580,209
                
                
                
                (1,216,694
                )Decrease
      in accrued interest payable
                
                
                (351,517
                )
                
                
                (59,370
                )Increase
      (decrease) in other liabilities
                
                
                55,698
                
                
                
                162,655TOTAL
      ADJUSTMENTS
                
                
                2,550,932
                
                
                
                817,163NET
      CASH PROVIDED BY OPERATING
      ACTIVITIES
                
                
                3,735,649
                
                
                
                2,848,174CASH
      FLOWS FROM INVESTING ACTIVITIESPurchases
      of investment securities available for sale
                
                
                (107,377,651
                )
                
                
                (15,382,351
                )Principal
      repayments of investment securities available for sale
                
                
                19,601,789
                
                
                
                8,258,961Proceeds
      from sale of securities available for sale
                
                
                -
                
                
                
                1,543,197Purchase
      of Federal Home Loan Bank stock
                
                
                (4,512,500
                )
                
                
                (923,300
                )Proceeds
      from disposal of foreclosed real estate
                
                
                2,759,260
                
                
                
                564,290Net
      (increase) decrease in loans
                
                
                2,468,017
                
                
                
                (68,995,890
                )Investment
      in life insurance
                
                
                -
                
                
                
                (7,000,000
                )Purchases
      of bank premises and equipment
                
                
                (1,594,138
                )
                
                
                (2,511,535
                )NET
      CASH USED BY INVESTING
      ACTIVITIES
                
                
                (88,655,223
                )
                
                
                (84,446,628
                )CASH
      FLOWS FROM FINANCING ACTIVITIESNet
      increase (decrease) in deposits:Demand
                
                
                3,425,569
                
                
                
                (5,061,540
                )Savings
                
                
                (683,397
                )
                
                
                (33,925,833
                )Money
      market and NOW
                
                
                6,101,489
                
                
                
                47,957,698Time
      deposits
                
                
                (17,078,655
                )
                
                
                39,184,256Net
      increase in short-term borrowings
                
                
                90,294,000
                
                
                
                17,139,000Net
      increase (decrease) in long-term borrowings
                
                
                (3,000,000
                )
                
                
                17,000,000Proceeds
      from stock options exercised
                
                
                -
                
                
                
                584,334Proceeds
      from issuance of preferred stock
                
                
                24,900,000
                
                
                
                -Dividends
      paid on preferred stock
                
                
                (435,750
                )
                
                
                -Excess
      tax benefits from stock options exercised
                
                
                -
                
                
                
                87,400NET
      CASH PROVIDED BY FINANCING
      ACTIVITIES
                
                
                103,523,256
                
                
                
                82,965,315NET
      INCREASE IN CASH AND CASH
      EQUIVALENTS
                
                
                18,603,682
                
                
                
                1,366,861CASH
      AND CASH EQUIVALENTS, BEGINNING OF PERIOD
                
                
                10,282,789
                
                
                
                12,356,404CASH
      AND CASH EQUIVALENTS, END OF
      PERIOD
                
                $
                28,886,471
                
                
                $
                13,723,265


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
six-month periods ended June 30, 2009 and 2008, 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”) and its wholly owned subsidiary, Crescent State Bank
(the “Bank”).  All significant inter-company transactions and balances
are eliminated in consolidation.  Operating results for the three and
six-month periods ended June 30, 2009 are not necessarily indicative of the
results that may be expected for the fiscal year ending December 31,
2009.





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 2008 annual report on Form
10-K. This quarterly report should be read in conjunction with such annual
report.





Subsequent
events have been evaluated through August 14, 2009, which is the date of
financial statement issuance.





Prior
period amounts may have been reclassified for proper
presentation.  The Company reclassified $64,000 and $73,000 of net
losses on the sale of other real estate owned for the three and six month
periods ended June 30, 2008, respectively, from non-interest income to
non-interest expense.





NOTE
B - COMMITMENTS


At June
30, 2009, commitments are as follows:





Undisbursed
      lines of credit
                  
                  $
                  141,259,000Stand-by
      letters of credit
                  
                  
                  3,777,000Undisbursed
      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
                
                
                Six
      Months EndedJune 30,
                
                
                June 30,2009
                
                
                2008
                
                
                2009
                
                
                2008Weighted
      average number of shares used in computing basic net income per
      share
                
                
                9,569,290
                
                
                
                9,467,294
                
                
                
                9,569,290
                
                
                
                9,442,484Effect
      of dilutive stock options
                
                
                30,176
                
                
                
                51,450
                
                
                
                14,613
                
                
                
                196,025Weighted
      average number of shares used in computing diluted net income per
      share
                
                
                9,599,466
                
                
                
                9,618,744
                
                
                
                9,583,903
                
                
                
                9,638,509


- 8
-


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements





NOTE
C - PER SHARE RESULTS (Continued)


Options
and warrants to purchase shares that have been excluded from the determination
of diluted earnings per share because they were antidilutive (the exercise price
is higher than the average current market price for the period) amount to
1,122,082 and 67,029 shares for the three-month periods ended June 30, 2009 and
2008, respectively, and 1,249,606 and 65,720 shares for the six-month periods
ended June 30, 2009 and 2008, respectively.




NOTE
D - INVESTMENT SECURITIES


The
following is a summary of the securities portfolios 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.





June 30, 2009Gross
                        
                        
                        GrossAmortized
                        
                        
                        unrealized
                        
                        
                        unrealized
                        
                        
                        Faircost
                        
                        
                        gains
                        
                        
                        losses
                        
                        
                        valueSecurities
      available for sale:U.S.
      government securities and obligations of U.S. government
      agencies
                        
                        $
                        15,610,895
                        
                        
                        $
                        222,017
                        
                        
                        $
                        227,469
                        
                        
                        $
                        15,605,443Mortgage-backed
                        
                        
                        72,678,577
                        
                        
                        
                        1,413,858
                        
                        
                        
                        88,639
                        
                        
                        
                        74,003,796Collateralized
      mortgage obligations
                        
                        
                        63,239,061
                        
                        
                        
                        1,198,872
                        
                        
                        
                        42,110
                        
                        
                        
                        64,395,823Municipals
                        
                        
                        39,835,674
                        
                        
                        
                        388,444
                        
                        
                        
                        833,441
                        
                        
                        
                        39,390,677Other
      equity securities
                        
                        
                        582,240
                        
                        
                        
                        -
                        
                        
                        
                        213,991
                        
                        
                        
                        368,249$
                        191,946,447
                        
                        
                        $
                        3,223,191
                        
                        
                        $
                        1,405,650
                        
                        
                        $
                        193,763,988December 31, 2008Gross
                        
                        
                        GrossAmortized
                        
                        
                        unrealized
                        
                        
                        unrealized
                        
                        
                        Faircost
                        
                        
                        gains
                        
                        
                        losses
                        
                        
                        valueSecurities
      available for sale:U.S.
      government securities and obligations of U.S. government
      agencies
                        
                        $
                        10,664,833
                        
                        
                        $
                        169,315
                        
                        
                        $
                        2,313
                        
                        
                        $
                        10,831,835Mortgage-backed
                        
                        
                        67,308,567
                        
                        
                        
                        1,707,655
                        
                        
                        
                        39,863
                        
                        
                        
                        68,976,359Municipals
                        
                        
                        26,089,420
                        
                        
                        
                        177,788
                        
                        
                        
                        917,537
                        
                        
                        
                        25,349,671Other
      equity securities
                        
                        
                        565,255
                        
                        
                        
                        4,989
                        
                        
                        
                        79,491
                        
                        
                        
                        490,753$
                        104,628,075
                        
                        
                        $
                        2,059,747
                        
                        
                        $
                        1,039,204
                        
                        
                        $
                        105,648,618





Proceeds
from sales of available for sale securities in 2008 totaled $1,543,197 resulting
in gross gains of $15,535 and no losses.


- 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 June 30, 2009
and December 31, 2008. The June 30, 2009 unrealized losses on investment
securities relate to one U.S. Government agency security, ten municipal
securities and one marketable equity security. The December 31, 2008 unrealized
losses on investment securities relate to two U.S. Government agency securities,
nine mortgage-backed securities, twenty-six municipal securities and one
marketable equity security. The unrealized losses relate to debt securities that
have incurred fair value reductions due to higher market interest rates since
the securities were purchased.  The unrealized losses will reverse at
maturity or prior to maturity if market interest rates decline to levels that
existed when the securities were purchased.  Since none of the
unrealized losses relate to the marketability of the securities or the issuer’s
ability to honor redemption obligations, none of the securities are deemed to be
other than temporarily impaired.





June 30, 2009Less Than 12 Months
                    
                    
                    12 Months or More
                    
                    
                    TotalFair
                    
                    
                    Unrealized
                    
                    
                    Fair
                    
                    
                    Unrealized
                    
                    
                    Fair
                    
                    
                    Unrealizedvalue
                    
                    
                    losses
                    
                    
                    value
                    
                    
                    losses
                    
                    
                    value
                    
                    
                    lossesSecurities
      available for sale:U.S.
      government securities and obligations of U.S. government
      agencies
                    
                    $
                    6,580,081
                    
                    
                    $
                    226,812
                    
                    
                    $
                    306,478
                    
                    
                    $
                    657
                    
                    
                    $
                    6,886,559
                    
                    
                    $
                    227,469Mortgage-backed
                    
                    
                    11,434,985
                    
                    
                    
                    88,639
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    11,434,985
                    
                    
                    
                    88,639Collateralized
      mortgageObligations
                    
                    
                    8,281,389
                    
                    
                    
                    42,110
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    8,281,389
                    
                    
                    
                    42,110Municipals
                    
                    
                    16,730,334
                    
                    
                    
                    411,230
                    
                    
                    
                    5,430,136
                    
                    
                    
                    422,211
                    
                    
                    
                    22,160,470
                    
                    
                    
                    833,441Marketable
      equity
                    
                    
                    137,903
                    
                    
                    
                    141,495
                    
                    
                    
                    230,346
                    
                    
                    
                    72,496
                    
                    
                    
                    368,249
                    
                    
                    
                    213,991Total
      temporarily impaired securities
                    
                    $
                    43,164,692
                    
                    
                    $
                    910,286
                    
                    
                    $
                    5,966,960
                    
                    
                    $
                    495,364
                    
                    
                    $
                    49,131,652
                    
                    
                    $
                    1,405,650December 31, 2008Less Than 12 Months
                    
                    
                    12 Months or More
                    
                    
                    TotalFair
                    
                    
                    Unrealized
                    
                    
                    Fair
                    
                    
                    Unrealized
                    
                    
                    Fair
                    
                    
                    Unrealizedvalue
                    
                    
                    losses
                    
                    
                    value
                    
                    
                    losses
                    
                    
                    value
                    
                    
                    lossesSecurities
      available for sale:U.S.
      government securities and obligations of U.S. government
      agencies
                    
                    $
                    972,624
                    
                    
                    $
                    2,313
                    
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    972,624
                    
                    
                    $
                    2,313Mortgage-backed
                    
                    
                    1,768,974
                    
                    
                    
                    22,558
                    
                    
                    
                    1,097,179
                    
                    
                    
                    17,305
                    
                    
                    
                    2,866,153
                    
                    
                    
                    39,863Collateralized
      mortgageObligations
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Municipals
                    
                    
                    13,246,896
                    
                    
                    
                    755,550
                    
                    
                    
                    986,586
                    
                    
                    
                    161,987
                    
                    
                    
                    14,233,482
                    
                    
                    
                    917,537Marketable
      equity
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    206,366
                    
                    
                    
                    79,491
                    
                    
                    
                    206,366
                    
                    
                    
                    79,491Total
      temporarily impaired securities
                    
                    $
                    15,988,494
                    
                    
                    $
                    780,421
                    
                    
                    $
                    2,290,131
                    
                    
                    $
                    258,783
                    
                    
                    $
                    18,278,625
                    
                    
                    $
                    1,039,204


- 10
-


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements





NOTE
D - INVESTMENT SECURITIES (Continued)


At June 30, 2009 and December 31, 2008,
investment securitieswith
a carrying value of $145,661,970 and $63,602,694, 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 June 30, 2009 by expected maturity are shown
below. Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties.


Amortized
                  
                  
                  Faircost
                  
                  
                  valueDue
      within one year
                  
                  $
                  34,306,068
                  
                  
                  $
                  34,953,112Due
      after one year through five years
                  
                  
                  99,241,125
                  
                  
                  
                  100,688,027Due
      after five years through ten years
                  
                  
                  36,262,067
                  
                  
                  
                  36,419,215Due
      after ten years
                  
                  
                  21,554,947
                  
                  
                  
                  21,335,385Other
      equity securities
                  
                  
                  582,240
                  
                  
                  
                  368,249$
                  191,946,447
                  
                  
                  $
                  193,763,988





At June
30, 2009, the balance of Federal Home Loan Bank (“FHLB”) of Atlanta stock held
by the Company is $11.8 million.  On March 25, 2009 and May 8,
2009, FHLB announced that it would not pay a dividend for the fourth quarter of
2008 or first quarter of 2009, respectively, reflecting a conservative financial
management approach in light of continued volatility in the financial
markets.  On February 27, 2009, FHLB announced that it would
increase the Subclass B1 membership stock requirement cap from $25 million to
$26 million and approve excess activity-based stock repurchases on a quarterly
review cycle instead of daily in order to facilitate capital
management.  Management believes that its investment in FHLB stock was
not other-than-temporarily impaired as of June 30, 2009 or December 31,
2008.  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 has entered into several financial arrangements using derivatives
during 2009 to add stability to interest income and to manage its exposure to
interest rate movements.


- 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 G of Item 8 in Crescent’s 2008 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 G of Item 8 in the Company’s 2008 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.





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 six months ended June
30, 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 June 30, 2009, was an unrealized loss of
$151,941.





The
following table discloses the location and fair value amounts of derivative
instruments designated as hedging instruments under SFAS No. 133 in the
consolidated balance sheets.





June 30, 2009Estimated
      FairBalance
      Sheet
                    
                    Notional
                    
                    
                    Value
      ofLocation
                    
                    Asset(Liability)
                    
                    
                    AmountTrust
      preferred securities:Interest
      rate swap
                    
                    Other
      liabilities
                    
                    $
                    4,000,000
                    
                    
                    $
                    (31,951
                    )Interest
      rate swap
                    
                    Other
      liabilities
                    
                    
                    4,000,000
                    
                    
                    
                    (44,931
                    )Subordinated
      term loan agreements:Interest
      rate swap
                    
                    Other
      liabilities
                    
                    
                    3,750,000
                    
                    
                    
                    (43,777
                    )Interest
      rate swap
                    
                    Other
      liabilities
                    
                    
                    3,750,000
                    
                    
                    
                    (31,282
                    )$
                    15,500,000
                    
                    
                    $
                    (151,941
                    )





See Note
F for additional information.





The
following table discloses activity in accumulated other comprehensive income
related to the interest rate swaps during the six month period ended June 30,
2009.


- 12
-


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements





NOTE
E – DERIVATIVE FINANCIAL INSTRUMENTS (Continued)


June 30, 2009Accumulated
      other comprehensive income resulting from interest rate swaps as of
      January 1
                  
                  $
                  -Other
      comprehensive loss recognized during six month period ended June
      30
                  
                  
                  (92,941
                  )Accumulated
      other comprehensive income resulting from interest rate swaps as of June
      30
                  
                  $
                  (92,941
                  )





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. See Note G for
discussion concerning new guidance for transactions that are not orderly. The
transaction to sell the asset or transfer the liability is a hypothetical
transaction at the measurement date, considered from the perspective of a market
participant that holds the 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. 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 June 30, 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 June 30, 2009, the types of financial assets and
liabilities the Company carried at fair value hierarchy Level 2 included
securities available for sale, impaired loans secured by real estate and
derivative liabilities.





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 June 30, 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 certain
financial assets, measured on a non-recurring basis, at fair value hierarchy
Level 3.


- 13
-


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements





NOTE
F - FAIR VALUE MEASUREMENT (Continued)


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 June 30, 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.





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 June 30, 2009, substantially all of the total
impaired loans were evaluated based on the fair value of the collateral.
Impaired loans where an allowance is established based on the fair value of
collateral require classification in the fair value hierarchy. When the fair
value of the collateral is based on an observable market price or a current
appraised value, the Company records the impaired loan 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 $31.7 million in
impaired loans at June 30, 2009, of which $16.1 million in loans showed
impairment and had a specific reserve of $4.8 million.  Impaired loans
totaled $16.7 million at December 31, 2008.  Of such loans, $11.6
million had specific loss allowances aggregating $4.1 million at that
date.





- 14
-


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements





NOTE
F - FAIR VALUE MEASUREMENT (Continued)


Foreclosed
Real Estate


Foreclosed
assets are adjusted to fair value upon transfer of the loans to foreclosed
assets. Subsequently, foreclosed assets are carried at the lower of carrying
value or fair 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.





Below is
a table that presents information about assets measured at fair value at June
30, 2009 and December 31, 2008:





Fair
      Value Measurements atJune 30, 2009, UsingTotal
      CarryingAmount
      in The
                
                
                
                
                
                Quoted
      Prices
                
                
                SignificantConsolidated
                
                
                Assets/(Liabilities)
                
                
                in
      Active
                
                
                Other
                
                
                SignificantBalance
                
                
                Measured
      at
                
                
                Markets
      for
                
                
                Observable
                
                
                UnobservableSheet
                
                
                Fair
      Value
                
                
                Identical
      Assets
                
                
                Inputs
                
                
                InputsDescription
                
                6/30/2009
                
                
                6/30/2009
                
                
                (Level 1)
                
                
                (Level 2)
                
                
                (Level 3)Securities
      available for sale:U.S.
      Government obligations and agency
                
                $
                15,605,443
                
                
                $
                15,605,443
                
                
                $
                -
                
                
                $
                15,605,443
                
                
                $
                -Mortgage-backed
                
                
                74,003,796
                
                
                
                74,003,796
                
                
                
                -
                
                
                
                74,003,796
                
                
                
                -Collateralized
      mortgage obligations
                
                
                64,395,823
                
                
                
                64,395,823
                
                
                
                -
                
                
                
                64,395,823
                
                
                
                -Municipals
                
                
                39,390,677
                
                
                
                39,390,677
                
                
                
                -
                
                
                
                39,390,677
                
                
                
                -Marketable
      equity
                
                
                368,249
                
                
                
                368,249
                
                
                
                368,249
                
                
                
                -
                
                
                
                -Foreclosed
      real estate
                
                
                4,401,154
                
                
                
                4,401,154
                
                
                
                -
                
                
                
                -
                
                
                
                4,401,154Impaired
      loans
                
                
                11,346,473
                
                
                
                11,346,473
                
                
                
                -
                
                
                
                11,023,063
                
                
                
                323,410Derivative
      liabilities
                
                
                (151,941
                )
                
                
                (151,941
                )
                
                
                -
                
                
                
                (151,941
                )
                
                
                -





Fair
      Value Measurements atDecember 31, 2008, UsingTotal
      CarryingAmount
      in The
                
                
                
                
                
                Quoted
      Prices
                
                
                SignificantConsolidated
                
                
                Assets/(Liabilities)
                
                
                in
      Active
                
                
                Other
                
                
                SignificantBalance
                
                
                Measured
      at
                
                
                Markets
      for
                
                
                Observable
                
                
                UnobservableSheet
                
                
                Fair
      Value
                
                
                Identical
      Assets
                
                
                Inputs
                
                
                InputsDescription
                
                12/31/2008
                
                
                12/31/2008
                
                
                (Level 1)
                
                
                (Level 2)
                
                
                (Level 3)Securities
      available for sale
                
                $
                105,648,618
                
                
                $
                105,648,618
                
                
                $
                490,753
                
                
                $
                105,157,865
                
                
                $
                -Foreclosed
      real estate
                
                
                1,716,207
                
                
                
                1,716,207
                
                
                
                -
                
                
                
                -
                
                
                
                1,716,207Impaired
      loans
                
                
                7,556,644
                
                
                
                7,556,644
                
                
                
                -
                
                
                
                6,787,739
                
                
                
                768,905


- 15
-


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements





NOTE
F - FAIR VALUE MEASUREMENT (Continued)


FSP FAS
107-1 and APB 28-1, Interim
Disclosures about Fair Value of 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. SFAS No. 107, Disclosures About Fair Value of
Financial Instruments, 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.


- 16
-


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 June
30, 2009 and December 31, 2008:





June 30, 2009
                
                
                December 31, 2008Carrying
                
                
                Estimated
                
                
                Carrying
                
                
                Estimatedamount
                
                
                fair value
                
                
                amount
                
                
                fair valueFinancial
      assets:Cash
      and cash equivalents
                
                $
                28,886,471
                
                
                $
                28,886,471
                
                
                $
                10,282,789
                
                
                $
                10,282,789Investment
      securities
                
                
                193,763,988
                
                
                
                193,763,988
                
                
                
                105,648,618
                
                
                
                105,648,618FHLB
      stock
                
                
                11,776,500
                
                
                
                11,776,500
                
                
                
                7,264,000
                
                
                
                7,264,000Loans,
      net
                
                
                762,157,425
                
                
                
                743,495,000
                
                
                
                772,792,283
                
                
                
                784,667,000Investment
      in life insurance
                
                
                17,229,284
                
                
                
                17,229,284
                
                
                
                16,811,918
                
                
                
                16,811,918Accrued
      interest receivable
                
                
                4,346,567
                
                
                
                4,346,567
                
                
                
                3,341,258
                
                
                
                3,341,258Financial
      liabilities:Deposits
                
                
                706,702,626
                
                
                
                716,728,000
                
                
                
                714,882,755
                
                
                
                718,590,000Short-term
      borrowings
                
                
                128,000,000
                
                
                
                128,917,000
                
                
                
                37,706,000
                
                
                
                39,925,000Long-term
      borrowings
                
                
                113,748,000
                
                
                
                107,348,000
                
                
                
                116,748,000
                
                
                
                121,748,000Interest
      rate swaps
                
                
                151,941
                
                
                
                151,941
                
                
                
                -
                
                
                
                -Accrued
      interest payable
                
                
                1,606,827
                
                
                
                1,606,827
                
                
                
                1,958,344
                
                
                
                1,958,344





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.





Based on
a Black-Scholes options 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:




- 17
-





CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements





NOTE
G - CUMULATIVE PERPETUAL PREFERRED STOCK (Continued)





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





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





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





NOTE
H - RECENT ACCOUNTING PRONOUNCEMENTS


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





In most
business combinations, goodwill will be recognized to the extent that the
consideration transferred plus the fair value of any noncontrolling interests in
the acquiree at the acquisition date exceeds the fair values of the identifiable
net assets acquired. Under SFAS No. 141(R), acquisition-related transaction and
restructuring costs will be expensed as incurred rather than treated as part of
the cost of the acquisition and included in the amount recorded for assets
acquired. SFAS No. 141(R) is effective for fiscal years beginning after
December 15, 2008. The adoption of SFAS No. 141(R) on January 1, 2009, had
no effect on the Company’s consolidated financial statements.





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





- 18
-





CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements


---




NOTE
H - RECENT ACCOUNTING PRONOUNCEMENTS (continued)


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




In May
2009, the FASB issued SFAS No. 165, Subsequent Events, which sets
forth the circumstances under which an entity should recognize events occurring
after the balance sheet date and the disclosures that should be
made.  Also, this statement requires disclosure of the date through
which the entity has evaluated subsequent events (for public companies, and
other companies that expect to widely distribute their financial statements,
this date is the date of financial statement issuance, and for nonpublic
companies, the date the financial statements are available to be
issued).  The statement was effective and adopted for the period ended
June 30, 2009.




In June
2009, the FASB issued the following three standards:




SFAS No.
166, Accounting for Transfers
of Financial Assets, a
revision to SFAS No. 140 (“SFAS No. 166”), 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.  SFAS 166 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.  Management is currently
evaluating the effect that the provisions of SFAS No. 166 may have on the
Company's consolidated financial statements.




SFAS No.
167, Amendments to FASB
Interpretation No. 46(R)(“SFAS No. 167”), is a revision to FIN 46(R),
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.  SFAS No. 167 effective as of the beginning of
fiscal years beginning after November 15, 2009 and is applied using a cumulative
effect adjustment to retained earnings for any carrying amount adjustments
(e.g., for newly-consolidated VIEs).  Management is currently
evaluating the effect that the provisions of SFAS No. 167 may have on the
Company's consolidated financial statements.


- 19
-


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements





NOTE
H - RECENT ACCOUNTING PRONOUNCEMENTS (continued)


SFAS No.
168, The FASB Accounting
Standards Codification and the Hierarchy of Generally Accepted Accounting
Principles,  will become the source of authoritative US GAAP
recognized by the FASB to be applied by nongovernmental entities and will
supersede all non-SEC accounting and reporting standards.  This
statement is effective for financial statements issued for interim and annual
financial statements ending after September 15, 2009.  Management is
currently evaluating the effect that the provisions of SFAS No. 168 may have on
the Company's consolidated financial statements.





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





FSP FAS
157-4, Determining Fair Value
When the Volume and Level of Activity for the Asset or Liability Have
Significantly Decreased and Identifying Transactions That Are Not Orderly(“FSP FAS 157-4”), provides additional guidance for estimating fair value
in accordance with SFAS No. 157 when the volume and level of activity for
the asset or liability have decreased significantly.  FSP FAS 157-4 also
provides guidance on identifying circumstances that indicate a transaction is
not orderly.  The provisions of FSP FAS 157-4 are effective for the
Company’s interim period ending on June 30, 2009.  The adoption of FSP
FAS 157-4 did not materially effect the Company’s consolidated financial
statements.





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





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




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





- 20
-


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements


---




NOTE
I - GOODWILL IMPAIRMENT


Pursuant
to SFAS No. 142, Goodwill and
Other Intangible Assets, goodwill must be tested for impairment each
year.  An impairment test can be performed at any date, as long as it
is consistently used each year.  In 2008, the Company changed its
annual testing date from December 31 to October 31.  If certain events
occur prior to the annual impairment date, interim impairment tests are required
to be performed.  Given the continued trading range of the Company’s
stock price during the first six months of 2009, management re-evaluated and
updated the goodwill impairment test performed at December 31, 2008 and March
31, 2009.





In
performing the first step (“Step 1”) of the goodwill impairment testing and
measurement process to identify possible impairment, in accordance with SFAS No.
142, Goodwill and Other Intangible Assets, the estimated fair value of the
reporting unit (determined to be Company-level) was developed using both the
income and market approaches to value the Company. The income approach consists
of discounting projected long-term future cash flows, which are derived from
internal forecasts and economic expectations for the Company. The significant
inputs to the income approach include the long-term target tangible equity to
tangible assets ratio and the discount rate, which is determined utilizing the
Company’s cost of capital adjusted for a company-specific risk factor. The
company-specific risk factor is used to address the uncertainty of growth
estimates and earnings projections of management. Under one market approach, a
value is calculated from an analysis of comparable acquisition transactions
based on earnings, book value, assets and deposit premium multiples from the
sale of similar financial institutions. Another market valuation approach
utilizes the current stock price adjusted by an appropriate control premium as
an indicator of fair market value.





Based on
the testing described above, the Company concludes that sufficient evidence
exists to indicate goodwill remained not impaired as of June 30,
2009.  The Company will continue to monitor stock price, financial
performance and general economic conditions and perform additional testing to
evaluate the possible impairment of goodwill as necessary.


- 21
-


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 and financial condition for the periods ended June 30, 2009
and 2008. 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 JUNE 30, 2009 AND


DECEMBER
31, 2008





Total
assets increased by $105.0 million to $1.1 billion at June 30, 2009 from $968.3
million at December 31, 2008.  Earning assets are $999.3 million or
93% of total assets compared to $898.7 million or 92% at December 31,
2008.   Components of earning assets at June 30, 2009 are $775.3
million in gross loans, $205.5 million in investment securities and Federal Home
Loan Bank (FHLB) stock and $18.5 in overnight investments and interest–earning
deposits with correspondent banks.  Earning assets at December 31,
2008 consisted of $785.4 million in gross loans, $112.9 million in investment
securities and FHLB stock and $366,000 in overnight investments and
interest–earning deposits. Total deposits and stockholders’ equity at June 30,
2009 were $706.7 million and $121.2 million, respectively, compared to $714.9
million and $95.1 million at December 31, 2008.





Gross
loans outstanding declined by $10.1 million over the first six months of 2009.
In conjunction with a core data processing conversion occurring in early March,
the Company reclassified certain loans within the portfolio so that reporting is
more consistent with the collateral of a particular loan rather than the
purpose.  For instance, loans secured by homes purchased as investment
property were previously reported as commercial real estate whereas they are now
reported as residential real estate mortgages.  Loans secured by
commercial building lots were previously reported as commercial real estate and
are now reported as construction and land development.  As a result,
the comparison of the loan compositions at June 30, 2009 and December 31, 2008
can be misleading.    Reclassifications of loan types
through the conversion process resulted in $164.6 million of commercial real
estate loans and $2.1 million consumer loans being shifted to $81.8 million of
construction and land development, $70.7 million residential mortgages, $9.3
million home equity loans and $4.9 million commercial and
industrial.  When considering these reclassifications, the net growth
in the portfolio for the first half of 2009 by category was as follows:
increases in commercial real estate, residential mortgage and consumer loans of
$8.2 million, $5.9 million and $1.3 million, respectively, and decreases in
construction and land development, home equity loans and lines and commercial
and industrial loans of $21.9 million, $2.7 million and $0.9 million,
respectively. The composition of the loan portfolio, by category, as of June 30,
2009 is 40% commercial mortgage loans, 28% construction loans, 12% residential
mortgage loans. 10% commercial loans, 8% home equity loans and lines, and 1%
consumer loans.  The composition of the loan portfolio, by category,
as of December 31, 2008 and before conversion was 60% commercial mortgage loans,
20% construction loans, 10% commercial loans, 7% home equity loans and lines, 2%
residential real estate mortgage loans and 1% consumer loans.




- 22
-





The
Company had an allowance for loan losses at June 30, 2009 of $13.1 million or
1.70% of outstanding loans compared to $12.6 million or 1.60% at
December 31, 2008.  At June 30, 2009, there were eighty-three
loans totaling $13.3 million in non-accrual status.  Thirty-one loans
totaling $4.3 million represent one borrowing relationship.  Of the
$13.3 million in non-accrual loans, $4.9 million are one-to-four family
residential related including mortgages, home equity loans and lines or
construction loans.  There were no loans past due 90 days or more
still accruing interest at June 30, 2009.  Non-performing loans as a
percentage of total loans at June 30, 2009 were 1.72%.  At December
31, 2008, there were fifty loans totaling approximately $13.1 million in
non-accrual status.  Thirty-five of those loans totaling approximately
$5.7 million represent one borrowing relationship. Of the remaining $7.4
million, an additional $4.5 million of loans were to land developers or
residential builders.  The remaining $2.9 million of non-accrual loans
were spread between commercial loans and residential investment
properties.  The percentage of non-performing loans to total loans at
December 31, 2008 was 1.67%.  For a more detailed discussion, see the
section entitled Non-Performing Assets.





The
Company has investment securities with an amortized cost of $191.9 million at
June 30, 2009.  All investments are accounted for as available for
sale and are presented at their fair market value of $193.8 million compared
with $105.6 million at year-end 2008.  The Company’s investment
securities at June 30, 2009, consist of U.S. Government agency securities,
collateralized mortgage obligations, mortgage-backed securities, municipal bonds
and marketable equity securities.  The increase during the first half
of 2009 was the net result of $107.4 million in new purchases, a $797,000
increase in the fair value of the portfolio, less $19.6 million in principal
re-payments and called principal and $457,000 in net amortization of
premiums.  The Company implemented a leverage strategy to offset the
impact on earnings per share anticipated as a result of having to pay dividends
on the investment made by the US Treasury pursuant to the Capital Purchase Plan
(CPP).  While the funds received through the CPP has been allocated
for the purpose of making loans to purchasers of completed properties held in
inventory by residential construction customers, an amount equal to the CPP
funds was leveraged four times and used to purchase investment securities. The
additional spread earned on the strategy will offset reduction in earnings per
share for common shareholders due to payment of the preferred
dividend.





The
Company owns $11.8 million of Federal Home Loan Bank stock at June 30, 2009
compared to $7.3 million at December 31, 2008.  The increase was
required due to the increased level of borrowing necessitated by the leverage
strategy discussed above.





There
were $15.3 million in Federal funds sold at June 30, 2009 compared to $99,000 at
December 31, 2008.  The increase in Fed funds sold reflects on-balance
sheet liquidity used to fund loans, redeem maturing deposits and borrowings and
for deposit fluctuations of non-maturing deposit types.





Interest-earning
deposits held at correspondent banks increased by approximately $2.9 million
from $267,000 at December 31, 2008 to $3.2 million at June 30,
2009.  Interest-earning funds held at correspondent bank accounts are
used primarily for the purchase of new investment securities and for other
liquidity purposes.





Non-earning
and other assets increased by approximately $4.9 million between December 31,
2008 and June 30, 2009.  Bank premises and equipment had a net
increase of $1.2 million as the Company completed building construction and
finished the build-out on two branches opened during the second
quarter.  Interest receivable on loans, securities and other
interest-earning assets increased by $1.0 million to $4.3 million. Non-interest
bearing cash due from banks, the majority of which represents checks in the
process of being collected through the Federal Reserve payment system, increased
by $477,000.  For more details regarding the increase in cash and cash
equivalents, see the Consolidated Statement of Cash Flows.  There was
a net increase in other real estate owned of $2.7 million which was comprised of
new foreclosed property of $5.5 million, proceeds from the sale of properties of
$2.8 million and losses recognized on the disposals of $40,000.  The
Company wrote-off a non-marketable equity investment of $407,000 during the six
month period ended June 30, 2009.




- 23
-





Total
deposits decreased by $8.2 million between December 31, 2008 and June 30, 2009
from $714.9 million to $706.7 million.  The Company has been focusing
its efforts on improving core deposit volumes and introduced a new
interest-bearing checking account that rewards depositors with a higher rate of
interest if they modify their account activity behavior to include more
electronic methods of transactions and statement receipt.  As a
result, interest-bearing checking balances have increased by $20.0 million
between December 31, 2008 and June 30, 2009.  The new account product
has resulted in some disintermediation between product types and therefore
savings balances have declined by $683,000.  Money market account
balances have declined by $13.9 million; however, the Company lost one account
in the amount of $14.0 million in January and an escrow account in the amount of
$10.1 million for a denovo financial institution in April.  Time
deposit account balances have declined by $17.0 million over the first six
months of 2009, reflecting a decrease in brokered time deposits of $32.0
million, which was partially offset by an increase of $15.0 million in other
time deposits.  The renewed focus on relationships, core deposit
generation and a more conservative growth strategy has resulted in reduced
dependence on brokered money.





The
composition of the deposit base, by category, at June 30, 2009 is as follows:
63% time deposits, 10% money market, 10% non-interest-bearing demand deposits,
9% interest-bearing demand deposits and 8% statement savings
accounts.  The composition of the deposit base, by category, at
December 31, 2008 was 65% time deposits, 12% money market, 9%
non-interest-bearing demand deposits, 8% in statement savings and 6% in
interest-bearing demand deposits.  Time deposits of $100,000 or more
totaled $350.9 million at June 30, 2009 compared to $359.3 million at December
31, 2008.  The Company uses brokered certificates of deposit as an
alternative funding source.  Brokered deposits represent a source of
fixed rate funds priced competitively with FHLB borrowings, but do not require
collateralization like FHLB borrowings.  Brokered deposits were $224.1
million at June 30, 2009 compared with $256.1 million at December 31,
2008.





The
Company had total borrowings of $241.7 million at June 30, 2009 compared with
$154.5 million at December 31, 2008.  The composition of borrowings at
June 30, 2009 is $98.0 million in long-term advances and $53.0 million in
short-term advances from the Federal Home Loan Bank of Atlanta (FHLB), $75.0
million in Federal Reserve Bank discount window funds, $8.2 million in junior
subordinated debt issued to an unconsolidated subsidiary and $7.5 million in a
subordinated term loan issued to a non-affiliated financial
institution.  Borrowings at December 31, 2008 included $99.0 million
in long-term FHLB advances, $29.0 million in short-term FHLB advances, $8.2
million in junior subordinated debt, $7.5 million in a subordinated term loan,
$2.0 million outstanding on a holding company line of credit and $8.7 million in
federal funds purchased.  Of the $99.0 million increase in total
borrowings, $75.0 million in short-term advances were attributable to the
leverage strategy previously discussed.





Accrued
interest payable and other liabilities decreased by $203,000 and were $3.7
million and $3.9 million at June 30, 2009 and December 31, 2008,
respectively.





Between
December 31, 2008 and June 30, 2009, total stockholders’ equity increased by
$26.1 million. On January 9, 2009, the Company issued $24.9 million in Fixed
Rate Cumulative Perpetual Preferred Stock, Series A under the US Treasury’s
Capital Purchase Program.  In addition, the Company issued a warrant
to purchase 833,705 shares of the Company’s common stock at an exercise price of
$4.48 per share.  The warrant is immediately exercisable and expires
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% thereafter.  The preferred shares are redeemable at the
option of the Company subject to regulatory approval.




- 24
-





COMPARISON
OF RESULTS OF OPERATIONS FOR THE THREE MONTH PERIODS ENDED


JUNE
30, 2009 AND 2008





Net Income.Net
income for the three-month period ended June 30, 2009, before adjusting for the
effective dividend on preferred stock, was $574,000 compared to $1.0 million for
the prior year three-month period ended June 30, 2008. After adjusting for
$422,000 in dividends and discount accretion on preferred stock, net income
available for common shareholders for the current period was $152,000 or $0.02
per diluted share compared with $0.11 per diluted share for the quarter ended
June 30, 2008.  Annualized
return on average assets declined to 0.21% from 0.46% for the prior
period.  Earnings in the current period were impacted by net interest
margin compression resulting from the lower interest rate environment, higher
loan loss provisions in response to current economic conditions and an increase
in non-interest operating expenses.Return
on average equity for the current period was 1.89% compared to 4.37% for the
prior period.  The decline in return on average equity is due to the
lower level of earnings combined with higher capital from the issuance of the
preferred stock.





Net Interest Income.Net interest
income increased by 16% or $977,000 from $6.3 million for the prior three-month
period to $7.3 million for the three-month period ended June 30,
2009.  The additional interest income generated by a higher volume of
earning assets more than offset the impact of declining interest rates. Total
interest expense from deposits and other borrowings was slightly lower due to a
continuing decline in cost of funds despite a sharp increase in volume to fund
earning assets.  Despite the improvement, the Company’s net interest
margin decreased from 3.05% to 2.92% due to a greater percentage of earning
assets coming from lower yielding investment securities and other
interest-earning categories.





Total
interest income increased by 7% or $907,000 to $14.1 million for the current
three-month period compared to $13.2 million for the prior year
period.  The net improvement resulted from a $2.1 million increase due
to growth in earning assets and a $1.2 million decrease due to lower yields
realized on those assets.  Total interest expense for the current
period declined by $70,000 from $6.9 million to $6.8 million.  The
decrease was the net result of a $1.1 million decline due to the lower cost of
funding and a $1.0 million increase due to growth in interest-bearing
funds.





Total
average earning assets increased $168.8 million or 20% from an average of $830.1
million to an average of $998.9 million for the current three-month period. The
average balance of loans outstanding increased by 8% or $58.9 million from
$724.0 million to $782.9 million.  The average balance of the
investment securities portfolio for the three-month period ended June 30, 2009
was $208.0 million, increasing by $104.8 million or 102% compared to an average
of $103.2 million at June 30, 2008.  During the first quarter of 2009,
the Company implemented the leverage strategy previously discussed to offset the
impact on earnings available to common shareholders from paying the effective
dividend on the preferred stock. As a result, the percentage of loans to average
earning assets for the current period declined by 9 basis points to 78% compared
to 87% for the prior period. The average balance of federal funds sold and other
earning assets increased to $8.0 million for the current three-month period
compared to $2.9 million for the prior period.





Average
interest-bearing liabilities increased by $147.9 million or 20% from $734.2
million for the quarter ended June 30, 2008 to $882.1 million for the current
quarter.  Total interest-bearing deposits increased by $47.1 million
or 8% from $594.3 million to $641.4 million.  Time deposits
experienced the largest increase averaging $455.2 million during the current
year period compared to $394.0 million for the prior period.  Total
borrowings increased by 72% or $100.8 million from $139.8 million to $240.7
million.  A significant portion of the increase resulted from the
leverage strategy and rates on FHLB advances have been attractive in comparison
to alternative forms of funding.




- 25
-





Net
interest margin is interest income earned on loans, securities and other earning
assets, less interest expense paid on deposits and borrowings, expressed as a
percentage of total average earning assets.  The net interest margin
for the three-month period ended June 30, 2009 was 2.92% compared to 3.05% for
the three-month period ended June 30, 2008.  The average yield on
earning assets for the current three-month period decreased 72 basis points to
5.66% compared with 6.68% for the prior year period, while the average cost of
interest-bearing funds decreased by 67 basis points to 3.10% from
3.77%.  The interest rate spread, which is the difference between the
average yield on earning assets and the cost of interest-bearing funds,
decreased by 5 basis points from 2.61% to 2.56%.  The percentage of
interest earning assets to average interest-bearing liabilities increased from
113.06% for the prior year period to 113.24% for the three months ended June 30,
2009.  An increase in the ratio of average earning assets to average
interest-bearing liabilities indicates a decreased dependency on
interest-bearing forms of funding to meet the demand of earning asset
growth.  The Company issued the preferred stock to the US Treasury
which reduced the dependency on interest-bearing liabilities.





In the
short period of time between mid September 2007 and April 30, 2008, the Federal
Reserve (the “Fed”) cut short-term interest rates seven times for a total of 325
basis points.  After a waiting a period to determine the impact of
those decreases, the Fed resumed the cuts by lowering short-term rates another
175 basis points between October 2008 and December 2008. The interest rate cuts
were in response to weakness being experienced in the US economy.





Approximately
46% 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 51% at June 30,
2008.  As short-term rates have declined, variable rate loans repriced
downward and new loans were made at the lower interest rate
levels.  The Company has shifted its strategic focus from a growth
orientation to a more performance-related, relationship
orientation.  The Company is being more disciplined with loan pricing
and implementing interest rate floors on variable rate loans when
feasible.  As a result, the loan portfolio will not experience the
same growth rates as has been seen to in recent years, but should provide better
yields.  This should also ease reliance on wholesale forms of
funding.  While there is an attempt to focus on local market
relationships, wholesale forms of funding will continue to make more sense from
an economic standpoint at certain times.





The
Company expects that net interest margin will expand in the coming months as
approximately 62% of the time deposit portfolio carrying a weighted average rate
of 3.80% matures in the next year and is subject to being renewed at lower
rates.  The Company entered into interest rate swap agreements on $7.5
million subordinated loan agreement and $8.0 million trust preferred
securities.  These two borrowings carry variable rates of interest
based on three-month LIBOR.  We have swapped these variable cash flows
for fixed rate cash flows for an average period of three and a half
years.  In addition to adopting a funding strategy that pushes funding
maturities further out into the future, these swaps will further protect the
Company when rates do begin to rise.





Provision for Loan
Losses.The
Company’s provision for loan losses for the three-month period ended June 30,
2009 was $1.1 million compared to $459,000 for the same period in
2008.  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
increase in the loan loss provision is primarily due to continuing credit
quality issues resulting from the current economic conditions. The allowance for
loan losses was $13.1 million at June 30, 2009, representing 1.70% of total
outstanding loans.  See the sections on Nonperforming Assets and
Analysis of Allowance for Loan Losses for additional details.




- 26
-





Non-Interest Income.For
the three-month period ended June 30, 2009, non-interest income decreased by
$129,000 to $752,000 compared to $881,000 for the same period in 2008. The
primary reason for the decline was a $219,000 write-down of a non-marketable
equity security where the impairment was deemed to be
other-than-temporary.  The following categories experienced increases
over the prior period: earnings on cash value of bank owned life insurance, 58%
or $84,000; mortgage loan origination fees, 43% or $65,000; and fees on deposit
accounts, 4% or $14,000.  The increase in mortgage loan origination
fee income is attributable to increasing the number of loan officers over the
past twelve months and the increase in bank owned life insurance cash value is
attributable to exchanging several older policies into higher yielding
products.  During the second quarter of 2008, there were $45,000 of
miscellaneous non-recurring fees included in other non-interest income and the
Company recorded a $15,000 gain on the disposition of available for sale
securities.  We reclassified $64,000 of net losses on the sale of
other real estate owned for the three month period ended June 30, 2008 to other
loan collection expenses.





Non-Interest Expenses.For
the current three-month period, non-interest expenses increased by $1.1 million
or 22% from $5.1 million to $6.3 million. The categories experiencing the
greatest increases were personnel, occupancy and FDIC deposit insurance premium
expense.   FDIC deposit insurance premiums increased by 700% or
$676,000.  The increase reflects higher insurance rates on deposits as
well as the estimated special assessment of $493,000.  Total occupancy
expenses have increased by 38% or $248,000 to $904,000 from
$656,000.  The Company opened two new facilities during the second
quarter of 2009, one of which serves as our main location in the City of
Raleigh, North Carolina and houses a branch, the Raleigh Commercial Lending
team, our mortgage and investment divisions as well as human resource
staff.    Despite opening two new offices during the quarter
and hiring additional support staff, total personnel expenses have increased by
a modest 3% or $100,000 to $3.0 million for the quarter ended June 30,
2009.  During the three-month period ended June 30, 2008, the Company
received a reimbursement for previously incurred expenses causing non-interest
expenses to be $65,000 lower than normal.  As previously mentioned,
$64,000 in losses on the sale of other real estate was reclassified from
non-interest income to non-interest expense for the three month period ended
June 30, 2008.





Provision for Income
Taxes.The
Company recorded income tax expense of $20,000 for the three-months ended June
30, 2009 compared with $526,000 for the prior year period.  The
effective tax rate for the three-month period ended June 30, 2009 was 3.3%
compared with 33.8% for the prior year period.  The significant
decrease in the effective tax rate is attributable to lower pre-tax income and a
larger percentage of income coming from tax exempt sources in the current
quarter.





- 27
-


COMPARISON
OF RESULTS OF OPERATIONS FOR THE SIX-MONTH PERIODS ENDED JUNE 30, 2009 AND
2008





Net Income.Net
income for the six-month period ended June 30, 2009, before adjusting for the
effective dividend on preferred stock, was $1.2 million compared to $2.0 million
for the six-month period ended June 30, 2008.  After adjusting for
$590,000 in dividends and discount accretion on preferred stock, net income
available for common shareholders for the current period was $595,000 or $0.06
per diluted share compared with $0.21 per diluted share for the quarter ended
June 30, 2008.  Annualized
return on average assets declined to 0.22% from 0.46% for the prior
period.  Earnings in the current period were negatively impacted by a
declining net interest margin, higher loan loss provisions due to an increase in
credit quality issues and an increase in non-interest operating expenses.Return
on average equity for the current period was 1.98% compared to 4.35% for the
prior period.  The decline in return on average equity is due to the
lower level of earnings combined with higher capital from the issuance of the
preferred stock.





Net Interest Income.Net interest
income increased by 13% or $1.7 million to $14.5 million for the current period
compared to $12.8 million for the prior six-month period.  Increased
interest income from strong growth in earning assets was only partially offset
by the impact of the lower interest rate environment and the increased volume of
high cost deposits to fund the asset growth.





Total
interest income was $28.2 million for the current six-month period compared to
$26.9 million for the prior year period, an increase of $1.3 million or
5%.  The increase was comprised of a $4.6 million increase due to
growth in average earning assets and a $3.3 million decrease due to the lower
average yield earned on those assets.  Total interest expense declined
by $421,000 or 3% from $14.1 million for the prior year period to $13.7 million
for the current period.  The decrease was the net result of a $2.9
million decrease due to the lower interest rate environment partially offset by
a $2.5 million increase due to growth in interest-bearing
liabilities.





Total
average earning assets increased $176.3 million or 22% from an average of $816.0
million as of June 30, 2008 to an average of $992.4 million as of June 30,
2009.  The average balance of loans outstanding during the current
six-month period was $785.8 million reflecting a $75.4 million or 11% increase
over the $710.4 million for the prior year period. The average balance of the
investment securities portfolio for the current period was $200.0 million,
increasing by $98.5 million or 97% compared to an average of $101.5 million at
June 30, 2007.  The average balance of federal funds sold and other
earning assets increased to $6.5 million for the six-month period ended June 30,
2009 compared to $4.2 million for the prior period.





Total
average interest-bearing liabilities increased by $159.2 million or 22% from an
average of $717.9 million for the prior period to $877.1 million for the current
period.  Average interest-bearing deposits increased by $62.2 million
or 11% growing from an average of $580.8 million at June 30, 2008 to $643.0
million at June 30, 2009.  Total average borrowings increased by $97.0
million or 71% to $234.1 million for the current six-month period from $137.1
million for the prior year period.





The net
interest margin for the six-month period ended June 30, 2009 was 2.95% compared
to 3.16% for the prior year six-month period.  The average yield on
earning assets for the current six-month period decline by 89 basis points to
5.74% compared with 6.63% for the prior year period, while the average cost of
interest-bearing funds decreased by 81 basis points to 3.14% from
3.95%.  The spread between the rates paid on earning assets and the
cost of interest-bearing funds decreased by 8 basis points from 2.68% to
2.60%.  The percentage of interest earning assets to interest bearing
liabilities declined to 113.14% from 113.68%.




- 28
-





Provision for Loan
Losses.The
Company’s provision for loan losses for the six-month period ended June 30, 2009
was $2.8 million compared to $1.3 million for the same period in
2008.  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
increased loan loss provision for the current six-month period is primarily due
to a decline in credit quality and increased net charge-offs resulting from the
current economic environment.  See the section entitled “Non
Performing Assets” for more details.  The allowance for loan losses
was $13.1 million at June 30, 2009, representing 1.70% of total outstanding
loans.





Non-Interest Income.For
the six-month period ended June 30, 2009, non-interest income decreased by
$158,000 to $1.5 million from $1.6 million.  The largest components of
non-interest income in the first half of 2009 were $661,000 in customer service
fees, $512,000 in mortgage loan origination fees, $435,000 in earnings on cash
value of bank owned life insurance and $123,000 in service charge revenue from
deposit accounts.  For the prior six-month period the Company recorded
$640,000 in customer service fees, $323,000 in mortgage loan origination fees,
$242,000 in earnings on cash value of bank owned life insurance and $123,000 in
deposit service charges.  The increase in mortgage loan origination
fee income is attributable to increasing the number of loan officers over the
past twelve months and the increase in bank owned life insurance cash value is
attributable to exchanging several older policies into higher yielding products.
During the first half of 2009, the Company wrote-off $407,000 of a
non-marketable equity investment that was deemed other
than-temporarily-impaired.  During the first half of 2008, there were
two items totaling $117,000 reported as non-recurring revenue.  Losses
on the sale of other real estate owned amounting to $73,000 in 2008 were
reclassified from non-interest income to non-interest expense.





Non-Interest Expenses.Non-interest
expenses increased by 17% to $11.9 million for the six-month period ended June
30, 2009 compared with $10.2 million for the prior year period. The Company has
added two branch locations and increased support staff during the past twelve
months.  The four largest components of non-interest expense are
personnel, occupancy, data processing and FDIC deposit insurance
premiums.  Increases in these four categories accounted for virtually
all of the total increase in non-interest expenses for the comparative
periods.  Due to changes in the regular quarterly premiums and a
$493,000 special assessment, FDIC deposit insurance premiums increased from
$192,000 to $1.0 million.  Salaries and benefits expense increased
$267,000 and was $6.0 million for the current six-month period compared to $5.7
million for the same period in the prior year.  Occupancy and
equipment expenses increased by $337,000 or 26% from $1.3 for the six-month
period ended June 30, 2008 to $1.7 million for the current year
period.   The Company converted all data processing platforms in
March 2009 and incurred some on-time, non-recurring expenses of $156,000 which
was the primary reason data processing costs increased by $220,000 to
$752,000.





Other
non-interest expenses increased by $74,000 to $2.5 million for the first half of
2009 compared with $2.4 million for the first half of the prior
year.  The largest components of other non-interest expenses include
professional fees and services, office supplies and printing, advertising, and
loan related fees.  Management expects that as the complexity and size
of the Company increases, expenses associated with these categories will
continue to increase.    As previously mentioned, losses
recognized on the disposal of other real estate owned were reclassified from
non-interest income to non-interest expenses for 2008.





Provision for Income
Taxes.The Company recorded income tax expense of $114,000 during the six-months
ended June 30, 2009 compared to $1.0 million for the prior year
period.  The effective tax rates for the two periods were 8.8% and
33.7%, respectively.  The decrease is due to a combination of lower
levels of pre-tax income and a larger percentage of income earned from tax
exempt sources in the current six-month period.


- 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
six-month periods ended June 30, 2009 and 2008. 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 June
      30,2009
                                                  
                                                  
                                                  2008Average
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  Average
                                                  
                                                  
                                                  Average
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  AverageBalance
                                                  
                                                  
                                                  Interest
                                                  
                                                  
                                                  Yield/Cost
                                                  
                                                  
                                                  Balance
                                                  
                                                  
                                                  Interest
                                                  
                                                  
                                                  Yield/CostInterest-earnings assetsLoan
      portfolio
                                                  
                                                  $
                                                  782,886
                                                  
                                                  
                                                  $
                                                  12,026
                                                  
                                                  
                                                  
                                                  6.16
                                                  %
                                                  
                                                  $
                                                  724,011
                                                  
                                                  
                                                  $
                                                  11,936
                                                  
                                                  
                                                  
                                                  6.63
                                                  %Investment
      securities
                                                  
                                                  
                                                  208,028
                                                  
                                                  
                                                  
                                                  2,053
                                                  
                                                  
                                                  
                                                  3.95
                                                  %
                                                  
                                                  
                                                  103,207
                                                  
                                                  
                                                  
                                                  1,227
                                                  
                                                  
                                                  
                                                  4.76
                                                  %Fed
      funds and other interest-earning assets
                                                  
                                                  
                                                  7,978
                                                  
                                                  
                                                  
                                                  5
                                                  
                                                  
                                                  
                                                  0.25
                                                  %
                                                  
                                                  
                                                  2,866
                                                  
                                                  
                                                  
                                                  14
                                                  
                                                  
                                                  
                                                  1.96
                                                  %Total
      interest-earning assets
                                                  
                                                  
                                                  998,892
                                                  
                                                  
                                                  
                                                  14,084
                                                  
                                                  
                                                  
                                                  5.66
                                                  %
                                                  
                                                  
                                                  830,084
                                                  
                                                  
                                                  
                                                  13,177
                                                  
                                                  
                                                  
                                                  6.38
                                                  %Noninterest-bearing
      assets
                                                  
                                                  
                                                  71,627
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  66,570Total
      Assets
                                                  
                                                  $
                                                  1,070,519
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  $
                                                  896,654Interest-bearing
liabilitiesInterest-bearing
      NOW
                                                  
                                                  $
                                                  53,873
                                                  
                                                  
                                                  
                                                  183
                                                  
                                                  
                                                  
                                                  1.36
                                                  %
                                                  
                                                  $
                                                  36,703
                                                  
                                                  
                                                  
                                                  10
                                                  
                                                  
                                                  
                                                  0.11
                                                  %Money
      market and savings
                                                  
                                                  
                                                  132,295
                                                  
                                                  
                                                  
                                                  476
                                                  
                                                  
                                                  
                                                  1.44
                                                  %
                                                  
                                                  
                                                  163,598
                                                  
                                                  
                                                  
                                                  986
                                                  
                                                  
                                                  
                                                  2.42
                                                  %Time
      deposits
                                                  
                                                  
                                                  455,243
                                                  
                                                  
                                                  
                                                  4,410
                                                  
                                                  
                                                  
                                                  3.89
                                                  %
                                                  
                                                  
                                                  394,050
                                                  
                                                  
                                                  
                                                  4,506
                                                  
                                                  
                                                  
                                                  4.60
                                                  %Short-term
      borrowings
                                                  
                                                  
                                                  118,239
                                                  
                                                  
                                                  
                                                  506
                                                  
                                                  
                                                  
                                                  1.72
                                                  %
                                                  
                                                  
                                                  14,945
                                                  
                                                  
                                                  
                                                  91
                                                  
                                                  
                                                  
                                                  2.45
                                                  %Long-term
      debt
                                                  
                                                  
                                                  122,429
                                                  
                                                  
                                                  
                                                  1,241
                                                  
                                                  
                                                  
                                                  4.01
                                                  %
                                                  
                                                  
                                                  124,874
                                                  
                                                  
                                                  
                                                  1,292
                                                  
                                                  
                                                  
                                                  4.09
                                                  %Total
      interest-bearing liabilities
                                                  
                                                  
                                                  882,079
                                                  
                                                  
                                                  
                                                  6,816
                                                  
                                                  
                                                  
                                                  3.10
                                                  %
                                                  
                                                  
                                                  734,170
                                                  
                                                  
                                                  
                                                  6,885
                                                  
                                                  
                                                  
                                                  3.77
                                                  %Non-interest
      bearing deposits
                                                  
                                                  
                                                  63,380
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  65,150Other
      liabilities
                                                  
                                                  
                                                  2,913
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  2,716Total
      Liabilities
                                                  
                                                  
                                                  948,372
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  802,036Stockholders'
      Equity
                                                  
                                                  
                                                  122,147
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  94,618Total
      Liabilities & Stockholders' Equity
                                                  
                                                  $
                                                  1,070,519
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  $
                                                  896,654Net
      interest income
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  $
                                                  7,268
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  $
                                                  6,292Interest
      rate spread
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  2.56
                                                  %
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  2.61
                                                  %Net
      interest-margin
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  2.92
                                                  %
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  3.05
                                                  %Percentage
      of average interest-earning assets to average interest-bearing
      liabilities
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  113.24
                                                  %
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  113.06
                                                  %


- 30
-





Average
Balances, Interest and Average Yields/Cost


(Dollars
in Thousands)


For the Six Months Ended June
      30,2009
                                                  
                                                  
                                                  2008Average
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  Average
                                                  
                                                  
                                                  Average
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  AverageBalance
                                                  
                                                  
                                                  Interest
                                                  
                                                  
                                                  Yield/Cost
                                                  
                                                  
                                                  Balance
                                                  
                                                  
                                                  Interest
                                                  
                                                  
                                                  Yield/CostInterest-earnings assetsLoan
      portfolio
                                                  
                                                  $
                                                  785,832
                                                  
                                                  
                                                  $
                                                  24,103
                                                  
                                                  
                                                  
                                                  6.19
                                                  %
                                                  
                                                  $
                                                  710,381
                                                  
                                                  
                                                  $
                                                  24,407
                                                  
                                                  
                                                  
                                                  6.91
                                                  %Investment
      securities
                                                  
                                                  
                                                  200,013
                                                  
                                                  
                                                  
                                                  4,052
                                                  
                                                  
                                                  
                                                  4.05
                                                  %
                                                  
                                                  
                                                  101,487
                                                  
                                                  
                                                  
                                                  2,434
                                                  
                                                  
                                                  
                                                  4.80
                                                  %Fed
      funds and other interest-earning assets
                                                  
                                                  
                                                  6,515
                                                  
                                                  
                                                  
                                                  7
                                                  
                                                  
                                                  
                                                  0.22
                                                  %
                                                  
                                                  
                                                  4,173
                                                  
                                                  
                                                  
                                                  58
                                                  
                                                  
                                                  
                                                  2.80
                                                  %Total
      earning assets
                                                  
                                                  
                                                  992,360
                                                  
                                                  
                                                  
                                                  28,162
                                                  
                                                  
                                                  
                                                  5.74
                                                  %
                                                  
                                                  
                                                  816,041
                                                  
                                                  
                                                  
                                                  26,899
                                                  
                                                  
                                                  
                                                  6.63
                                                  %Noninterest-bearing
      assets
                                                  
                                                  
                                                  69,670
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  64,793Total
      Assets
                                                  
                                                  $
                                                  1,062,030
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  $
                                                  880,834Interest-bearing
liabilitiesInterest-bearing
      NOW
                                                  
                                                  $
                                                  48,352
                                                  
                                                  
                                                  
                                                  279
                                                  
                                                  
                                                  
                                                  1.15
                                                  %
                                                  
                                                  $
                                                  34,838
                                                  
                                                  
                                                  
                                                  32
                                                  
                                                  
                                                  
                                                  0.18
                                                  %Money
      market and savings
                                                  
                                                  
                                                  136,292
                                                  
                                                  
                                                  
                                                  970
                                                  
                                                  
                                                  
                                                  1.42
                                                  %
                                                  
                                                  
                                                  159,162
                                                  
                                                  
                                                  
                                                  2,071
                                                  
                                                  
                                                  
                                                  2.62
                                                  %Time
      deposits
                                                  
                                                  
                                                  458,374
                                                  
                                                  
                                                  
                                                  9,063
                                                  
                                                  
                                                  
                                                  3.95
                                                  %
                                                  
                                                  
                                                  386,788
                                                  
                                                  
                                                  
                                                  9,108
                                                  
                                                  
                                                  
                                                  4.74
                                                  %Short-term
      borrowings
                                                  
                                                  
                                                  112,280
                                                  
                                                  
                                                  
                                                  969
                                                  
                                                  
                                                  
                                                  1.73
                                                  %
                                                  
                                                  
                                                  14,006
                                                  
                                                  
                                                  
                                                  208
                                                  
                                                  
                                                  
                                                  2.99
                                                  %Long-term
      debt
                                                  
                                                  
                                                  121,797
                                                  
                                                  
                                                  
                                                  2,381
                                                  
                                                  
                                                  
                                                  3.89
                                                  %
                                                  
                                                  
                                                  123,061
                                                  
                                                  
                                                  
                                                  2,664
                                                  
                                                  
                                                  
                                                  4.28
                                                  %Total
      interest-bearing liabilities
                                                  
                                                  
                                                  877,095
                                                  
                                                  
                                                  
                                                  13,662
                                                  
                                                  
                                                  
                                                  3.14
                                                  %
                                                  
                                                  
                                                  717,855
                                                  
                                                  
                                                  
                                                  14,083
                                                  
                                                  
                                                  
                                                  3.95
                                                  %Non
      interest-bearing deposits
                                                  
                                                  
                                                  61,316
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  66,115Other
      liabilities
                                                  
                                                  
                                                  3,002
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  2,959Total
      Liabilities
                                                  
                                                  
                                                  941,413
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  786,929Stockholders'
      Equity
                                                  
                                                  
                                                  120,617
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  93,905Total
      Liabilities & Stockholders' Equity
                                                  
                                                  $
                                                  1,062,030
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  $
                                                  880,834Net
      interest income
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  $
                                                  14,500
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  $
                                                  12,816Interest
      rate spread
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  2.60
                                                  %
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  2.68
                                                  %Net
      margin
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  2.95
                                                  %
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  3.16
                                                  %Percentage
      of average interest-earning assets to average interest bearing
      liabilities
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  113.14
                                                  %
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  113.68
                                                  %





VOLUME/RATE
VARIANCE ANALYSIS





The
following tables analyze 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 six-month periods ended June 30,
2009 and 2008. 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 June 30,2009 vs. 2008(inThousands)Increase(Decrease)DuetoVolume
                            
                            
                            Rate
                            
                            
                            TotalInterest IncomeLoan
      portfolio
                            
                            $
                            953
                            
                            
                            $
                            (863
                            )
                            
                            $
                            90Investment
      Securities
                            
                            
                            1,136
                            
                            
                            
                            (310
                            )
                            
                            
                            826Fed
      funds and other interest-earning assets
                            
                            
                            14
                            
                            
                            
                            (23
                            )
                            
                            
                            (9
                            )Total
      interest-earning assets
                            
                            
                            2,103
                            
                            
                            
                            (1,196
                            )
                            
                            
                            907Interest ExpenseInterest-bearing
      NOW
                            
                            
                            32
                            
                            
                            
                            141
                            
                            
                            
                            173Money
      market and savings
                            
                            
                            (150
                            )
                            
                            
                            (360
                            )
                            
                            
                            (510
                            )Time
      deposits
                            
                            
                            652
                            
                            
                            
                            (748
                            )
                            
                            
                            (96
                            )Short-term
      borrowings
                            
                            
                            536
                            
                            
                            
                            (121
                            )
                            
                            
                            415Long-term
      debt
                            
                            
                            (25
                            )
                            
                            
                            (27
                            )
                            
                            
                            (52
                            )Total
      interest-bearing liabilities
                            
                            
                            1,045
                            
                            
                            
                            (1,115
                            )
                            
                            
                            (70
                            )Net
      interest income
                            
                            $
                            1,058
                            
                            
                            $
                            (81
                            )
                            
                            $
                            977





Rate/Volume
Analysis


Six Months Ended June 30,2009 vs. 2008(in Thousands)Increase (Decrease) Due toVolume
                          
                          
                          Rate
                          
                          
                          TotalInterest IncomeLoan
      portfolio
                          
                          $
                          2,423
                          
                          
                          $
                          (2,727
                          )
                          
                          $
                          (304
                          )Investment
      Securities
                          
                          
                          2,172
                          
                          
                          
                          (554
                          )
                          
                          
                          1,618Fed
      funds and other interest-earning assets
                          
                          
                          18
                          
                          
                          
                          (69
                          )
                          
                          
                          (51
                          )Total
      interest-earning assets
                          
                          
                          4,613
                          
                          
                          
                          (3,350
                          )
                          
                          
                          1,263Interest ExpenseInterest-bearing
      NOW
                          
                          
                          46
                          
                          
                          
                          202
                          
                          
                          
                          248Money
      market and savings
                          
                          
                          (228
                          )
                          
                          
                          (874
                          )
                          
                          
                          (1,102
                          )Time
      deposits
                          
                          
                          1,572
                          
                          
                          
                          (1,617
                          )
                          
                          
                          (45
                          )Short-term
      borrowings
                          
                          
                          1,154
                          
                          
                          
                          (393
                          )
                          
                          
                          761Long-term
      debt
                          
                          
                          (35
                          )
                          
                          
                          (248
                          )
                          
                          
                          (283
                          )Total
      interest-bearing liabilities
                          
                          
                          2,509
                          
                          
                          
                          (2,930
                          )
                          
                          
                          (421
                          )Net
      interest income
                          
                          $
                          2,104
                          
                          
                          $
                          (420
                          )
                          
                          $
                          1,684


- 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 June 30,
                          
                          
                          At December 31,2009
                          
                          
                          2008
                          
                          
                          2008
                          
                          
                          2007(Dollars in thousands)Nonaccrual
      loans
                          
                          $
                          13,335
                          
                          
                          $
                          746
                          
                          
                          $
                          13,094
                          
                          
                          $
                          2,726Accruing
      loans past due 90 days or more
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -Total
      nonperforming loans
                          
                          
                          13,335
                          
                          
                          
                          746
                          
                          
                          
                          13,094
                          
                          
                          
                          2,726Real
      estate owned
                          
                          
                          4,401
                          
                          
                          
                          1,865
                          
                          
                          
                          1,716
                          
                          
                          
                          272Repossessed
      assets
                          
                          
                          -
                          
                          
                          
                          25
                          
                          
                          
                          -
                          
                          
                          
                          -Total
      nonperforming assets
                          
                          $
                          17,736
                          
                          
                          $
                          2,636
                          
                          
                          $
                          14,810
                          
                          
                          $
                          2,998Restructured
      loans not incategories
      listed above
                          
                          $
                          4,482
                          
                          
                          $
                          -
                          
                          
                          $
                          -
                          
                          
                          $
                          -Allowance
      for loan losses
                          
                          
                          13,144
                          
                          
                          
                          8,855
                          
                          
                          
                          12,585
                          
                          
                          
                          8,273Nonperforming
      loans to period end loans
                          
                          
                          1.72
                          %
                          
                          
                          0.10
                          %
                          
                          
                          1.53
                          %
                          
                          
                          0.40
                          %Allowance
      for loan losses to period end loans
                          
                          
                          1.70
                          %
                          
                          
                          1.19
                          %
                          
                          
                          1.60
                          %
                          
                          
                          1.22
                          %Allowance
      for loan losses to nonperforming loans
                          
                          
                          99
                          %
                          
                          
                          1,187
                          %
                          
                          
                          96
                          %
                          
                          
                          303
                          %Nonperforming
      assets to total assets
                          
                          
                          1.65
                          %
                          
                          
                          0.29
                          %
                          
                          
                          1.67
                          %
                          
                          
                          0.36
                          %Nonperforming
      assets and loanspast
      due 90 days or more tototal
      assets
                          
                          
                          1.65
                          %
                          
                          
                          0.29
                          %
                          
                          
                          1.67
                          %
                          
                          
                          0.36
                          %





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. We account for loans on a nonaccrual basis when we have
serious doubts about the collectability of principal or interest. Generally, our
policy is to place a loan on nonaccrual status when the loan becomes past due 90
days. We also place loans on nonaccrual status in cases where we are uncertain
whether the borrower can satisfy the contractual terms of the loan agreement.
Amounts received on nonaccrual loans generally are applied first to principal
and then to interest only after all principal has been collected. Restructured
loans are those for which concessions, including the reduction of interest rates
below a rate otherwise available to that borrower or the deferral of interest or
principal have been granted due to the borrower’s weakened financial condition.
We accrue interest on restructured loans at the restructured rates when we
anticipate that no loss of original principal will occur. Potential problem
loans are loans which are currently performing and are not included as
nonaccrual or restructured loans above, but about which we have serious doubts
as to the borrower’s ability to comply with present repayment terms. These loans
are likely to be included later in nonaccrual, past due or restructured loans,
so they are considered by our management in assessing the adequacy of our
allowance for loan losses. At June 30, 2009, we identified twenty-eight loans
totaling $7.1 million as potential problems loans. Of the $7.1 million in
potential problem loans, seventeen loans totaling $6.2 million are concentrated
in the residential construction and land acquisition and development sectors.
There were thirteen foreclosed properties valued at a total of $4.4 million and
eighty-three nonaccrual loans totaling $13.3 million. Foreclosed property is
valued at the lower of appraised value or the outstanding loan balance. Interest
foregone on nonaccrual and charged-off loans for the six-month period ended June
30, 2009 was $601,000.




- 33
-




At June
30, 2008, we identified eight loans totaling $3.7 million as potential problems
loans. There were seven foreclosed properties valued at a total of $1.9 million
and six nonaccrual loans totaling $746,000. Foreclosed property is valued at the
lower of appraised value or the outstanding loan balance. Interest foregone on
nonaccrual loans for the six-month period ended June 30, 2008 was
$64,000.





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.





Using the
various evaluation factors mentioned above, management predetermined allowance
percentages for all risk classes 1 through 6 for each loan category. The total
aggregate balance of loans in the group is multiplied by the associated
allowance percentage to determine an adequate level of allowance for loan losses
for unimpaired loans. Those loans that are identified through the Company’s
internal loan grading system as impaired are evaluated individually in
accordance SFAS No. 114. Each loan is analyzed to determine the net value of
collateral, probability of charge-off and finally a potential estimate of loss.
Loans meeting the criteria for individual evaluation are specifically reserved
for based on management’s analysis.




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


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The
provision for the first half of 2009 was primarily the result of credit quality
deterioration due to the current economic conditions in our markets. The sectors
of the loan portfolio being impacted most by the economic climate are
residential construction and land acquisition and development. Other factors
influencing the provision include net loan charge-offs. For the six-month period
ended June 30, 2009, there were net loan charge-offs of $2.3 million compared
with $684,000 at June 30, 2008. The allowance for loan losses at June 30, 2009
was $13.1 million, which represents 1.70% of total loans outstanding compared to
$8.9 million or 1.19% as of June 30, 2008.




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




The
following table describes the allocation of the allowance for loan losses among
various categories of loans for the dates indicated. The changes in percentage
of total loans reflects the reclassifications of loans during the conversion
previously discussed.





At June 30,
                
                At December 31,2009
                
                2008% of Total
                
                
                
                
                % of TotalAmount
                
                
                Loans (1)
                
                Amount
                
                
                Loans (1)(Dollars in thousands)Residential
      real estate loans
                
                $
                880
                
                
                
                6.70
                %
                
                $
                103
                
                
                
                2.43
                %Home
      equity loans and lines
                
                
                703
                
                
                
                5.35
                %
                
                
                469
                
                
                
                6.91
                %Commercial
      mortgage loans
                
                
                3,377
                
                
                
                25.69
                %
                
                
                6,003
                
                
                
                59.82
                %Construction
      loans
                
                
                4,928
                
                
                
                37.49
                %
                
                
                3,694
                
                
                
                20.47
                %Commercial
      and industrial loans
                
                
                2,708
                
                
                
                20.60
                %
                
                
                1,953
                
                
                
                9.68
                %Loans
      to individuals
                
                
                548
                
                
                
                4.17
                %
                
                
                363
                
                
                
                0.69
                %Total
      allowance
                
                $
                13,144
                
                
                
                100.00
                %
                
                $
                12,585
                
                
                
                100.00
                %





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


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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 Six-Month Period Ended june 30,2009
                        
                        
                        2008(Dollars in thousands)Balance
      at the beginning of the year
                        
                        $
                        12,585
                        
                        
                        $
                        8,273Charge-offs:Commercial
      and industrial loans
                        
                        
                        616
                        
                        
                        
                        -Commercial
      real estate loans
                        
                        
                        -
                        
                        
                        
                        91Construction,
      acquisition and development
                        
                        
                        1,022
                        
                        
                        
                        564Residential
      mortgage loans
                        
                        
                        768
                        
                        
                        
                        -Home
      equity lines and loans
                        
                        
                        112
                        
                        
                        
                        -Consumer
      loans
                        
                        
                        58
                        
                        
                        
                        -Total
      charge-offs
                        
                        
                        2,576
                        
                        
                        
                        655RecoveriesCommercial
      and industrial loans
                        
                        
                        28
                        
                        
                        
                        -Construction,
      acquisition and development
                        
                        
                        269
                        
                        
                        
                        -Residential
      mortgage loans
                        
                        
                        9
                        
                        
                        
                        -Consumer
      loans
                        
                        
                        -
                        
                        
                        
                        1Total
      recoveries
                        
                        
                        306
                        
                        
                        
                        1Net
      charge-offs
                        
                        
                        2,270
                        
                        
                        
                        654Provision
      for loan losses
                        
                        
                        2,829
                        
                        
                        
                        806Balance
      at the end of the period
                        
                        $
                        13,144
                        
                        
                        $
                        8,425Total
      loans outstanding at period-end
                        
                        $
                        775,301
                        
                        
                        $
                        710,545Average
      loans outstanding for the period
                        
                        $
                        785,832
                        
                        
                        $
                        696,751Allowance
      for loan losses tototal
      loans outstanding
                        
                        
                        1.70
                        %
                        
                        
                        1.19
                        %Annualized
      ratio of net charge-offs to average loans outstanding
                        
                        
                        0.58
                        %
                        
                        
                        0.38
                        %





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.


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-


As of
June 30, 2009, liquid assets (cash and due from banks, interest-earning deposits
with banks and investment securities available for sale) were approximately
$234.3 million, which represents 22% of total assets and 33% of total deposits.
Supplementing this liquidity, the Company has available lines of credit from
various correspondent banks of approximately $492.4 million of which $226.0
million is outstanding at June 30, 2009. Outstanding commitments for undisbursed
lines of credit, letters of credit and undisbursed investment commitments
amounted to approximately $135.4 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 63% of the Company’s total deposits at both June 30, 2009
and 65% at December 31, 2008. 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 50% of the Company’s total deposits at both June 30, 2009 and
December 31, 2008. 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 June
30, 2009, the Company’s equity to asset ratio is 11.29%. The Company’s ratios of
Tier 1 capital to risk-weighted assets and total capital to risk-based assets
are 11.43% and 13.56%, 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 10.24% and
12.38%, 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.


- 37
-


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, 2008.




Item 4T. 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 June 30,
2009. 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 June 30, 2009, 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 June 30,
2009 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.




- 38
-




Part II.
            OTHER
      INFORMATION





Item
      1.
            Legal
      Proceedings.


None that are material.





Item1a.
            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.
            Submission
      of Matters to a Vote of Security
Holders


The
Annual Meeting of the Stockholders was held on May 19, 2009. Of 9,626,558 shares
entitled to vote at the meeting, 7,331,528 shares voted. The following matters
were voted on at the meeting:





1.
            Election
      of Directors





The
following individuals were elected to various terms:





Nominee
                              
                              Term
                              
                              For
                              
                              Against
                              
                              WithheldBrent
      B. Barringer
                              
                              Three
      Years
                              
                              6,828,324
                              
                              -
                              
                              503,204Kenneth
      A. Lucas
                              
                              Three
      Years
                              
                              7,268,366
                              
                              -
                              
                              63,162Charles
      A. Paul III
                              
                              Three
      Years
                              
                              7,189,358
                              
                              -
                              
                              142,170Francis
      R. Quis, Jr.
                              
                              Three
      Years
                              
                              7,064,198
                              
                              -
                              
                              267,330





The
following directors continue in office after the meeting: William H. Cameron,
Michael G. Carlton, Bruce I. Howell, James A. Lucas, Jr., Sheila Hale Ogle, Jon
S. Rufty, Jon T. Vincent and Stephen K. Zaytoun.





2.
            Advisory
      Vote On Executive Compensation





The
American Recovery and Reinvestment Act of 2009 required that shareholders of
participants in the U.S. Department of Treasury’s Troubled Asset Relief Program
have an opportunity for a non-binding vote on executive compensation. Executive
compensation paid and policies and practices over executive compensation were
ratified and approved with 6,641,890 votes for, 435,277 votes against and
254,361 votes abstaining.




3.
            Ratification
      of Appointment of Independent Public
Accountants





Management’s
appointment of Dixon Hughes PLLC as the Company’s independent public accountants
for 2009 was approved with 7,214,147 shares voting for, 104,544 shares voting
against, and 12,837 shares abstaining.


- 39
-


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


- 40
-





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:     August
      13, 2009
              By:
              /s/ Michael G. CarltonMichael
      G. CarltonPresident
      and Chief Executive OfficerDate:     August
      13, 2009
              By:
              /s/ Bruce W. ElderBruce
      W. ElderPrincipal
      Financial Officer


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