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 **March
      31, 2007**





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





Commission
      File Number 000-32951





**CRESCENT
      FINANCIAL CORPORATION**


(Exact
      name of registrant as specified in its charter)




**NORTH
                  CAROLINA**
              **56-2259050**(State
                  or other jurisdiction 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
o





Indicate
      by check mark whether **** the
      registrant is a large accelerated filer, an accelerated filer, or a
      non-accelerated filer (as defined in Rule 12b-2 of the Exchange
      Act).




Large
      accelerated filer o  **** Accelerated
      filer o ****   Non-accelerated
      filer x





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


Yes o  **** No
x





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





**Common
      Stock, $1.00 par value**


**8,351,460
      shares outstanding as of May 8, 2007**





Page
                    No.**Part
                    I.**
                **FINANCIAL
                    INFORMATION****Item
                    1 -**
                **Financial
                    Statements (Unaudited)**Consolidated
                    Balance Sheets March 31, 2007 (unaudited) and December 31,
                    2006
                3Consolidated
                    Statements of Operations Three Month Periods Ended March 31,
                    2007 and 2006
                    (unaudited)
                4Consolidated
                    Statements of Cash Flows Three Months Ended March 31, 2007 and
                    2006
                    (unaudited)
                5Notes
                    to Consolidated Financial Statements
                6
                    -
                    7**Item
                    2 -**
                **Management’s
                    Discussion and Analysis of Financial Condition and Results of
                    Operations**
                8
                    -
                    21**Item
                    3 -**
                **Quantitative
                    and Qualitative Disclosures about Market Risk**
                22**Item
                    4 -**
                **Controls
                    and Procedures**
                22**Part
                    II.**
                **Other
                    Information****Item
                    1 - Legal Proceedings**
                23**Item
                    1a - Risk Factors**
                23**Item
                    2 - Unregistered Sales of Equity Securities and Use of
                    Proceeds**
                23**Item
                    3 - Defaults Upon Senior Debt**
                23**Item
                    4 - Submission of Matters to a Vote of Security
                    Holders**
                23**Item
                    5 - Other Information**
                23**Item
                    6 - Exhibits**
                23
  -2-
 **Part
          I.** **FINANCIAL
          INFORMATION**
  **Item
          1 - Financial Statements**
 
 ***CRESCENT
          FINANCIAL CORPORATION AND SUBSIDIARY***
 ***CONSOLIDATED
          BALANCE SHEETS***
  ****March
                        31, 2007
                    
                    December
                        31,(Unaudited)
                    
                    2006***ASSETS**Cash
                        and due from banks
                    
                    $
                    12,730,827
                    
                    $
                    14,295,053Interest-earning
                        deposits with banks
                    
                    
                    209,083
                    
                    
                    763,057Federal
                        funds sold
                    
                    
                    13,158,000
                    
                    
                    92,000Investment
                        securities available for sale at fair value
                    
                    
                    86,360,519
                    
                    
                    84,722,892Loans
                    
                    
                    586,148,571
                    
                    
                    549,818,548Allowance
                        for loan losses
                    
                    
                    (7,277,100
                    )
                    
                    (6,945,000
                    )NET
                        LOANS
                    
                    
                    578,871,471
                    
                    
                    542,873,548Accrued
                        interest receivable
                    
                    
                    3,262,650
                    
                    
                    3,045,840Federal
                        Home Loan Bank stock
                    
                    
                    4,180,700
                    
                    
                    3,582,800Bank
                        premises and equipment
                    
                    
                    6,709,507
                    
                    
                    5,907,664Investment
                        in life insurance
                    
                    
                    8,857,869
                    
                    
                    5,683,493Goodwill
                    
                    
                    30,225,549
                    
                    
                    30,225,549Other
                        assets
                    
                    
                    6,911,308
                    
                    
                    6,717,324TOTAL
                        ASSETS
                    
                    $
                    751,477,483
                    
                    $
                    697,909,220**LIABILITIES
                        AND STOCKHOLDERS’ EQUITY**LIABILITIESDepositsDemand
                    
                    $
                    74,126,816
                    
                    $
                    70,420,392Savings
                    
                    
                    95,744,462
                    
                    
                    78,379,431Money
                        market and NOW
                    
                    
                    101,087,586
                    
                    
                    97,343,128Time
                    
                    
                    319,050,421
                    
                    
                    295,738,729TOTAL
                        DEPOSITS
                    
                    
                    590,009,285
                    
                    
                    541,881,680Short-term
                        borrowings
                    
                    
                    18,000,000
                    
                    
                    24,451,000Long-term
                        borrowings
                    
                    
                    55,248,000
                    
                    
                    45,248,000Accrued
                        expenses and other liabilities
                    
                    
                    3,178,890
                    
                    
                    3,294,562TOTAL
                        LIABILITIES
                    
                    
                    666,436,175
                    
                    
                    614,875,242STOCKHOLDERS’
                        EQUITYPreferred
                        stock, no par value, 5,000,000 shares authorized, none
                        outstanding;
                    
                    
                    -
                    
                    
                    -Common
                        stock, $1 par value, 20,000,000 shares authorized; 8,301,868
                        shares
                        outstanding March 31, 2007; 8,265,136 shares outstanding
                        December 31,
                        2006
                    
                    
                    8,301,868
                    
                    
                    8,265,136Additional
                        paid-in capital
                    
                    
                    62,832,473
                    
                    
                    62,659,201Retained
                        earnings
                    
                    
                    14,076,198
                    
                    
                    12,610,588Accumulated
                        other comprehensive loss (Note D)
                    
                    
                    (169,231
                    )
                    
                    (500,947
                    )TOTAL
                        STOCKHOLDER'S EQUITY
                    
                    
                    85,041,308
                    
                    
                    83,033,978COMMITMENTS
                        (Note B)TOTAL
                          LIABILITIES AND STOCKHOLDERS’ EQUITY
                    
                    $
                    751,477,483
                    
                    $
                    697,909,220
  *
          Derived
          from audited consolidated financial statements.
 See
            accompanying notes.
  -3-
  ***CRESCENT
          FINANCIAL CORPORATION AND SUBSIDIARY***
 ***CONSOLIDATED
          STATEMENTS OF OPERATIONS (Unaudited)***
 ***Three
          Months Ended March 31, 2007 and 2006***
  2007
                  
                  2006INTEREST
                      INCOMELoans
                  
                  $
                  11,575,394
                  
                  $
                  6,433,325Investment
                      securities available for sale
                  
                  
                  1,060,455
                  
                  
                  663,212Federal
                      funds sold and interest-earning deposits
                  
                  
                  121,396
                  
                  
                  4,628TOTAL
                      INTEREST INCOME
                  
                  
                  12,757,245
                  
                  
                  7,101,165INTEREST
                      EXPENSEDeposits
                  
                  
                  5,561,000
                  
                  
                  2,391,255Short-term
                      borrowings
                  
                  
                  290,135
                  
                  
                  232,480Long-term
                      debt
                  
                  
                  661,935
                  
                  
                  403,031TOTAL
                      INTEREST EXPENSE
                  
                  
                  6,513,070
                  
                  
                  3,026,766NET
                      INTEREST INCOME
                  
                  
                  6,244,175
                  
                  
                  4,074,399PROVISION
                      FOR LOAN LOSSES
                  
                  
                  359,147
                  
                  
                  270,300NET
                      INTEREST INCOME AFTERPROVISION
                      FOR LOAN LOSSES
                  
                  
                  5,885,028
                  
                  
                  3,804,099NON-INTEREST
                      INCOMEMortgage
                      origination revenue and other loan fees
                  
                  
                  115,007
                  
                  
                  168,820Fees
                      on deposit accounts
                  
                  
                  347,654
                  
                  
                  317,667Earnings
                      on life insurance
                  
                  
                  83,470
                  
                  
                  56,345Loss
                      on disposal of assets
                  
                  
                  (941
                  )
                  
                  (127
                  )Other
                  
                  
                  83,690
                  
                  
                  52,970TOTAL
                      NON-INTEREST INCOME
                  
                  
                  628,880
                  
                  
                  595,675NON-INTEREST
                      EXPENSESalaries
                      and employee benefits
                  
                  
                  2,404,298
                  
                  
                  1,569,109Occupancy
                      and equipment
                  
                  
                  547,937
                  
                  
                  469,317Data
                      processing
                  
                  
                  260,725
                  
                  
                  182,792Other
                  
                  
                  1,007,438
                  
                  
                  649,608TOTAL
                      NON-INTEREST EXPENSE
                  
                  
                  4,220,398
                  
                  
                  2,870,826INCOME
                      BEFORE INCOME TAXES
                  
                  
                  2,293,510
                  
                  
                  1,528,948INCOME
                      TAX EXPENSE
                  
                  
                  827,900
                  
                  
                  546,500NET
                      INCOME
                  
                  $
                  1,465,610
                  
                  $
                  982,448NET
                      INCOME PER COMMON SHARE (Note C)Basic
                  
                  $
                  .16
                  
                  $
                  .15Diluted
                  
                  $
                  .15
                  
                  $
                  .15WEIGHTED
                        AVERAGE COMMON  SHARES OUTSTANDING (Note C)Basic
                  
                  
                  9,093,392
                  
                  
                  6,364,850Diluted
                  
                  
                  9,611,833
                  
                  
                  6,611,900
  -4-


***CRESCENT
      FINANCIAL CORPORATION AND SUBSIDIARY***


***CONSOLIDATED
      STATEMENTS OF CASH FLOWS (Unaudited)***


***Three
      Months Ended March 31, 2007 and 2006***




2007
              
              2006CASH
                  FLOWS FROM OPERATING ACTIVITIESNet
                  income
              
              $
              1,465,610
              
              $
              982,448Adjustments
                  to reconcile net income to net cash provided by
                  operating activities:Depreciation
              
              
              178,961
              
              
              164,297Provision
                  for loan losses
              
              
              359,147
              
              
              270,300Deferred
                  income taxes
              
              
              -
              
              
              86,168Loss
                  on disposal of assets
              
              
              941
              
              
              127Net
                  amortization (accretion) of premiums/discounts on
                  securities
              
              
              (19,827
              )
              
              11,398Increase
                  in cash value of life insurance
              
              
              (74,375
              )
              
              (49,502
              )Stock
                  based compensation
              
              
              41,812
              
              
              36,366Change
                  in assets and liabilities:(Increase)
                  in accrued interest receivable
              
              
              (216,810
              )
              
              (145,037
              )(Increase)
                  in other assets
              
              
              (406,488
              )
              
              (682,514
              )Increase
                  in accrued interest payable
              
              
              53,775
              
              
              64,718(Decrease)
                  in other liabilities
              
              
              (169,448
              )
              
              (95,631
              )TOTAL
                  ADJUSTMENTS
              
              
              (252,312
              )
              
              (339,310
              )NET
                  CASH PROVIDED BY OPERATING ACTIVITIES
              
              
              1,213,298
              
              
              643,138CASH
                  FLOWS FROM INVESTING ACTIVITIESPurchases
                  of securities available for sale
              
              
              (3,446,358
              )
              
              (5,307,255
              )Principal
                  repayments of securities available for sale
              
              
              2,372,779
              
              
              1,340,650Purchase
                  of Federal Home Loan Bank stock
              
              
              (597,900
              )
              
              (578,300
              )Net
                  increase in loans
              
              
              (36,357,071
              )
              
              (27,484,358
              )Investment
                  in bank owned life insurance
              
              
              (3,100,000
              )
              
              -Purchases
                  of bank premises and equipment
              
              
              (981,745
              )
              
              (328,402
              )NET
                  CASH USED BY INVESTING ACTIVITIES
              
              
              (42,110,295
              )
              
              (32,357,665
              )CASH
                  FLOWS FROM FINANCING ACTIVITIESNet
                  increase in deposits:Noninterest-bearing
                  demand
              
              
              3,706,424
              
              
              3,049,495Savings
              
              
              17,365,031
              
              
              2,745,488Money
                  market and NOW
              
              
              3,744,458
              
              
              1,776,071Time
                  deposits
              
              
              23,311,692
              
              
              19,912,091Net
                  increase (decrease) in short-term borrowings
              
              
              (6,451,000
              )
              
              (4,188,965
              )Net
                  increase (decrease) in long-term debt
              
              
              10,000,000
              
              
              10,000,000Proceeds
                  from stock options exercised
              
              
              106,492
              
              
              79,045Excess
                  tax benefits from stock options exercised
              
              
              61,700
              
              
              18,200NET
                  CASH PROVIDED BY FINANCING ACTIVITIES
              
              
              51,844,797
              
              
              33,391,425NET
                  INCREASE IN CASH AND CASH EQUIVALENTS
              
              
              10,947,800
              
              
              1,676,898CASH
                  AND CASH EQUIVALENTS, BEGINNING OF PERIOD
              
              
              15,150,110
              
              
              9,471,507CASH
                  AND CASH EQUIVALENTS, END OF PERIOD
              
              $
              26,097,910
              
              $
              11,148,405




See
      accompanying notes.





-5-


***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-month periods ended March 31, 2007 and 2006, 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”) 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-month period ended March 31,
      2007
      are not necessarily indicative of the results that may be expected for the
      fiscal year ending December 31, 2007.





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 2006 annual report on Form
      10-K. This quarterly report should be read in conjunction with such annual
      report.





**NOTE
      B - COMMITMENTS**




At
      March
      31, 2007, commitments are as follows




Undisbursed
                  lines of credit
              
              $
              175,890,000Stand-by
                  letters of credit
              
              
              5,673,000Undisbursed
                  commitment to purchase additionalinvestment
                  in Small Business Investment Corporation
              
              
              563,000





**NOTE
      C - PER SHARE RESULTS**




On
      April
      18, 2007, the Company declared a stock split in the form of a 10% stock dividend
      payable on May 22, 2007 to stockholders of record May 11, 2007. Weighted average
      share and per share data for the periods presented have been adjusted to reflect
      the effects of the stock split. Basic and diluted net income per common share
      have been computed by dividing net income for each period by the weighted
      average number of shares of common stock outstanding during each period after
      retroactively adjusting for this stock split.




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 solely to outstanding
      stock options and are determined using the treasury stock method.




-6-


***CRESCENT
      FINANCIAL CORPORATION AND SUBSIDIARY***


***Notes
      to Consolidated Financial Statements***




Three
                  months ended March 31,2007
              
              2006Weighted
                  average number of shares used in computingbasic
                  net income per share
              
              
              9,093,392
              
              
              6,364,850Effect
                  of dilutive stock options
              
              
              518,441
              
              
              247,050Weighted
                  average number of shares used in computingdiluted
                  net income per share
              
              
              9,611,833
              
              
              6,611,900




For
      the
      three month periods ended March 31, 2007, there were 1,725 options that were
      anti-dilutive. For the three month period ended March 31, 2006, there were 3,000
      options that were anti-dilutive.




**NOTE
      D - COMPREHENSIVE INCOME**




For
      the
      three months ended March 31, 2007 and 2006, total comprehensive income,
      consisting of net income and unrealized securities gains and losses, net of
      taxes, was approximately $1,797,000 and $833,000, respectively.





**NOTE
      E - INCOME TAXES**




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





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





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





Crescent’s
      federal and state income tax returns are open and subject to examination from
      the 2003 tax return year and forward.





-7-


**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 March 31, 2007
      and 2006. It should be read in conjunction with the audited consolidated
      financial statements and accompanying notes included in this report and the
      supplemental financial data appearing throughout this discussion and analysis.
      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 MARCH 31, 2007 AND**


**DECEMBER
      31, 2006**





Total
      assets at March 31, 2007 were $751.5 million compared with $697.9 million at
      December 31, 2006. Earning assets are $690.1 million or 92% of total assets
      as
      of March 31, 2007 compared to $639.0 million or 91% at December 31, 2006.
      Components of earning assets at March 31, 2007 are $586.1 million in gross
      loans, $90.5 million in investment securities and Federal Home Loan Bank (FHLB)
      stock and $13.4 million in overnight investments and interest bearing deposits
      with correspondent banks. Earning assets at December 31, 2006 consisted of
      $549.8 million in gross loans, $88.3 million in investment securities and FHLB
      stock and $855,000 in overnight investments and interest bearing deposits.
      Total
      deposits and stockholders’ equity at March 31, 2007 were $590.0 million and
      $85.0 million, respectively, compared to $541.9 million and $83.0 million at
      December 31, 2006.





Gross
      loans outstanding at March 31, 2007 increased by $36.3 million or 7% to $586.1
      million at March 31, 2007. The commercial mortgage category experienced the
      most
      significant dollar growth during the three-month period increasing $19.5 million
      or 6% from $304.4 million to $323.9 million. Construction and development loans
      grew by $16.1 million or 15% from $109.8 million to $125.9 million. Other
      categories experiencing growth include the commercial loan portfolio increasing
      by $898,000, consumer loans increasing by $811,000 and residential mortgage
      loans increasing by $189,000. Home equity loans and lines outstanding declined
      by $1.2 million during the quarter. The composition of the loan portfolio,
      by
      category, as of March 31, 2007 is 55% commercial mortgage loans, 22%
      construction loans, 12% commercial loans, 7% home equity loans and lines, 3%
      residential mortgage loans and 1% consumer loans. The composition of the loan
      portfolio, by category, as of December 31, 2006 was 55% commercial mortgage
      loans, 20% construction loans, 12% commercial loans, 8% home equity loans and
      lines, 4% residential real estate mortgage loans and 1% consumer loans.





The
      Company had an allowance for loan losses at March 31, 2007 of $7.3 million
      or
      1.24% of total outstanding loans compared to $6.9 million or 1.26% of total
      outstanding loans at December 31, 2006. At March 31, 2007, there were four
      loans totaling $604,000 in non-accrual status. There were no loans past due
      90
      days or more and still accruing interest at March 31, 2007. Non-performing
      loans
      as a percentage of total loans at March 31, 2007 were 0.10%. There were two
      loans totaling $135,000 in non accrual status at December 31, 2006. There were
      no loans past due 90 days or more and still accruing interest at December 31,
      2006. Non-performing loans as a percentage of total loans at December 31, 2005
      were 0.02%. For a more detailed discussion, see the section entitled
      Non-Performing Assets.





-8-


The
      Company has investment securities with an amortized cost of $86.6 million at
      March 31, 2007. All investments are accounted for as available for sale under
      Financial Accounting Standards Board (FASB) No. 115 and are presented at their
      fair market value of $86.4 million compared with $84.7 million at year-end
      2006.
      The Company’s investment in debt securities at March 31, 2007, consists of U.S.
      Government agency securities, collateralized mortgage obligations,
      mortgage-backed securities, municipal bonds and marketable equity securities.
      The increase during the first three months of 2007 was the net result of $3.4
      million in new purchases, a $540,000 increase in the fair value of the portfolio
      and $20,000 in net amortization of premiums, less $2.4 million in principal
      re-payments.





The
      Company owns $4.2 million of Federal Home Loan Bank stock at March 31, 2007
      compared to $3.6 million at December 31, 2006.





There
      were $13.2 million in Federal funds sold at March 31, 2007 compared to $92,000
      at December 31, 2006. Federal funds sold were at an unusually high level at
      March 31, 2007 due to a significant increase in attorney and real estate escrow
      deposits at month end.





Interest-earning
      deposits held at correspondent banks decreased by approximately $554,000 from
      $763,000 at December 31, 2006 to $209,000 at March 31, 2007.





Non-earning
      and other assets increased by approximately $2.6 million between December 31,
      2006 and March 31, 2007. Non-interest bearing cash due from banks decreased
      by
      $1.6 million during the three months ended March 31, 2007. Cash and due from
      banks includes amounts represented by checks in the process of being collected
      through the Federal Reserve payment system. Funds represented by these checks
      were not yet collected and therefore could not be invested overnight. For more
      details regarding the increase in cash and cash equivalents, see the
      Consolidated Statement of Cash Flows. The Company invested an additional $3.1
      million in bank owned life insurance during the quarter. Categories of other
      assets experiencing increases between December 31, 2006 and March 31, 2007
      include interest receivable and bank premises and equipment.





Total
      deposits increased by $48.1 million between December 31, 2006 and March 31,
      2007
      from $541.9 million to $590.0 million. The largest dollar increase occurred
      in
      the time deposit category, which grew by $23.3 million or 8% to $319.0 million
      at March 31, 2007 from $295.7 million at year end 2006. Increases to other
      deposit categories were as follows: savings increased by almost $17.4 million
      from $78.4 million to $95.7 million, non-interest bearing demand deposits
      increased by $3.7 million from $70.4 million to $74.1 million, money market
      account balances increased by $3.0 million from $59.5 million to $62.5 million
      and interest-bearing demand deposits increased by $759,000 from $37.8 million
      to
      $38.6 million.





The
      composition of the deposit base, by category, at March 31, 2007 is as follows:
      54% time deposits, 16% statement savings accounts, 13% non-interest-bearing
      demand deposits, 11% money market and 6% interest-bearing demand deposits.
      The
      composition of the deposit base, by category, at December 31, 2006 was 55%
      time deposits, 14% in statement savings, 13% non-interest-bearing demand
      deposits, 11% money market and 7% in interest-bearing demand deposits. Time
      deposits of $100,000 or more totaled $251.2 million at March 31, 2007 compared
      to $229.8 million at December 31, 2006. The Company uses brokered certificates
      of deposit as an alternative funding source. Brokered deposits represent a
      source of fixed rate funds priced competitively with FHLB borrowings, but do
      not
      require collateralization like FHLB borrowings. Brokered deposits were $161.6
      million at March 31, 2007 compared with $141.7 million at December 31,
      2006.





-9-


The
      Company had $55.2 million of long-term debt outstanding at March 31, 2007
      compared to $45.2 million at December 31, 2006. The long-term debt is comprised
      of $47.0 million in FHLB term advances and $8.2 million in junior subordinated
      debt. Short-term borrowings declined by $6.5 million during the first quarter
      of
      2007 to $18.0 million from $24.5 million. Short-term borrowings consist of
      FHLB
      term advances with remaining maturities of less than one year and Federal funds
      purchased from correspondent banks.





Accrued
      interest payable and other liabilities decreased by $116,000 and were $3.2
      million and $3.3 million at March 31, 2007 and December 31, 2006, respectively.





Between
      December 31, 2006 and March 31, 2007, total stockholders’ equity increased by
      $2.0 million. The increase resulted primarily from net income for the first
      three months of $1,466,000, improvement in the fair value of available for
      sale
      securities of $332,000, $106,000 in new stock issued pursuant to the exercise
      of
      stock options and $62,000 in tax benefits recognized on the exercise of
      non-qualified stock options.




**COMPARISON
      OF RESULTS OF OPERATIONS FOR THE THREE MONTH PERIODS ENDED MARCH 31, 2007 AND
      2006**





**Net
      Income.** **** Net
      income for the three-month period ended March 31, 2007 was $1,466,000 or $0.15
      per diluted share compared with $982,000 or $0.15 per diluted share for the
      three-month period ended March 31, 2006. All per share data has been adjusted
      to
      reflect the 11-for-10 stock split effected as a 10% stock dividend payable
      on
      May 22, 2007 to shareholders on May 11, 2007. Annualized return on average
      assets was 0.82% and 0.93% for the two periods ended March 31, 2007 and 2006,
      respectively. The decline in return on average assets is primarily due to a
      lower net interest margin and higher non-interest expenses. Return on average
      equity for the current period was 7.06% compared to 9.38% for the prior period.
      Return on average equity for the current period decreased due to a lower return
      on average assets and the issuance of 2,432,000 shares in August 2006 for the
      acquisition of Port City Capital Bank.





**Net
      Interest Income.** Net
      interest income increased by almost $2.2 million or 53% from $4.1 million for
      the prior three-month period to $6.2 million for the three-month period ended
      March 31, 2007. Total interest income for the current three month period
      benefited from a higher volume of earning assets despite a lower yield earned
      on
      those assets. Total interest expense from deposits and other borrowings
      increased due to growth in interest-bearing liabilities needed to fund the
      higher volume of assets. Although the current interest rate environment has
      been
      stable, the yield curve has been flat to inverted over the past twelve months
      and the incremental cost to fund the Company’s earning asset growth coupled with
      a decline in the ratio of interest earning assets to interest bearing
      liabilities has caused a decrease in the net interest margin.




Total
        average earning assets increased by more than $260.2 million or 65% from
        an
        average of $403.9 million for the prior year three-month period to an average
        of
        $664.2 million for the three-month period ended March 31, 2007. Approximately
        $153.9 million of the increase is attributable to the acquisition of Port
        City
        Capital Bank of Wilmington, North Carolina in August, 2006. The average balance
        of loans outstanding increased by $222.0 million to $565.8 million at March
        31,
        2007, a 65% increase over the $343.8 million of average outstanding loans
        for
        the prior period. The average balance of the investment securities portfolio
        for
        the three-month period ended March 31, 2007 was $88.9 million, increasing
        by
        $29.2 million or 49% compared to an average of $59.7 million at March 31,
        2006.
        The average balance of federal funds sold and other earning assets increased
        from $411,000 for the prior three-month period to $9.4 million for the current
        period.


-10-


Average
      interest-bearing liabilities increased by $229.7 million or 68% from $338.9
      million for the quarter ended March 31, 2006 to $568.6 million for the current
      quarter. The acquisition accounted for $129.4 million of the total increase.
      The
      total increase is comprised of a $211.4 million increase in interest bearing
      deposits and an $18.3 million increase in borrowed funds. Time deposits
      experienced the largest increase averaging $313.5 million during the current
      year period compared to $192.3 million for the prior period.





Total
      interest income increased by $5.7 million for the current three-month period
      compared to the same period from the prior year. The increase is comprised
      of
      $4.8 million due to the growth in total average earning assets and an $861,000
      increase due to higher yields realized on earning assets. Total interest expense
      for the current period rose by $3.5 million compared to prior period. The
      increase is the result of a $2.4 million increase due to growth in
      interest-bearing funds and a $1.1 million increase due to the higher interest
      rate environment.





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 March 31, 2007 was 3.81% compared to 4.09% for the
      three-month period ended March 31, 2006. The average yield on earning assets
      for
      the current three-month period increased 66 basis points to 7.79% compared
      with
      7.13% for the prior year period, while the average cost of interest-bearing
      funds increased by 103 basis points to 4.65% from 3.62%. The interest rate
      spread, which is the difference between the average yield on earning assets
      and
      the cost of interest-bearing liabilities, decreased by 37 basis points from
      3.51% for the quarter ended March 31, 2006 to 3.14% for the quarter ended March
      31, 2007. The percentage of interest earning assets to average interest-bearing
      liabilities declined to 116.81% from 119.19%.





Between
      July 1, 2004 and July 5, 2006, the Federal Reserve (the “Fed”) increased
      short-term interest rates seventeen times for a total of 425 basis points.
      Interest rates have stabilized over the last eight months. While several factors
      influence the level of intermediate and long-term interest rates, increases
      in
      short-term interest rates would generally result in a more parallel shift in
      the
      entire yield curve across all investment horizons. The most recent rate
      increases did not impact intermediate and long-term rates in the typical manner,
      as those rates continued to trade in very tight ranges to levels seen prior
      to
      July 2004. The result has been a flat to inverted yield curve across investment
      terms. Rates on longer term assets have been at or lower than those on overnight
      and other short-term investments.




Approximately
        56% of the Company’s loan portfolio has variable rate pricing based on the Prime
        lending rate or LIBOR (London Inter Bank Offering Rate). As short-term rates
        have risen, variable rate loans have repriced upward resulting in a higher
        yield
        on average earning assets. While the yield on the variable portion of existing
        loans was rising with rate increases, rates on new loans were trending lower
        based on competition and new loan mix. Of the $101.9 million in organic loan
        growth, $51.4 million was in the commercial mortgage loan category. Due to
        the
        nature of the collateral and the competitive marketplace, this type of loan
        typically receives very favorable fixed-rate pricing based on the intermediate
        to long end of the yield curve. The volume of new loan originations outpaced
        the
        generation of lower cost core deposits causing the Company to rely more heavily
        on savings and brokered certificates of deposit resulting in a higher cost
        of
        funds than we would have anticipated. The Company expects to continue to
        experience net interest margin compression in the current stable rate
        environment. In rising or falling interest rate environments, the Company
        would
        expect moderate expansion or contraction of margin,
        respectively.





-11-


**Provision
      for Loan Losses.** The
      Company’s provision for loan losses for the three-month period ended March 31,
      2007 was $359,000 compared to $270,000 for the same period in 2006. 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 loan growth, although the analysis discussion outlines
      additional factors impacting the provision. The allowance for loan losses was
      $7.3 million at March 31, 2007, representing 1.24% of total outstanding loans.





**Non-Interest
      Income.** For
      the
      three-month period ended March 31, 2007, non-interest income increased by more
      than $33,000 to $629,000 compared to $596,000 for the same period in 2006.





Customer
      service fees on deposit accounts increased by $30,000 from $318,000 to $348,000.
      Earnings on cash value of life insurance increased by $27,000 due to an
      additional $3.1 million investment in late January, 2007 and fees from brokerage
      referrals increased by $13,000 from $18,000 to $31,000. Revenue earned on
      brokered mortgage loan originations declined by $30,000. Residential mortgage
      loan originations have slowed, although not to the same extent as other area
      of
      the country. Our markets continue to be attractive places for people relocating
      and we would anticipate mortgage loan brokerage revenue to increase as we enter
      the busy summer months.





**Non-Interest
      Expenses.** Non-interest
      expenses were $4.2 million for the three-month period ended March 31, 2007
      compared with $2.9 million for the same period ended March 31, 2006. The largest
      component of non-interest expense for the current period was personnel expense.
      Salaries and benefits expense increased by $835,000 or 53% to $2.4 million
      for
      the current year period compared to $1.6 million for the same period in the
      prior year. The acquisition of Port City Capital Bank in August 2006 and the
      addition of operational staff during the first quarter of 2007 were the primary
      drivers of the increase. Management anticipates personnel expense to continue
      to
      increase as we identify new opportunities for expansion.





Occupancy
      and equipment expenses increased by $79,000 or 17% from $469,000 for the
      three-month period ended March 31, 2006 to $548,000 for the current year period
      and data
      processing costs increased by $78,000 or 43% to $261,000 from $183,000.
      Increases for both categories were directly related to the acquisition. As
      the
      Company continues to grow in accordance with its strategic plan, management
      expects both occupancy and data processing costs to increase.




Other
      non-interest expenses increased by $358,000
      million to $1.0 million for the first quarter of 2007 compared with $650,000
      for
      the prior year quarter. The increase was primarily a result of the Company’s
      continued growth and expansion. 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.


-12-


**Provision
      for Income Taxes.** The
      Company recorded income tax expense of $828,000 for the three-months ended
      March
      31, 2007 compared with $547,000 for the prior year period. The
      effective tax rate for the three-month period ended March 31, 2007 was 36.1%
      compared with 35.7% for the prior year period. The increase in the effective
      tax
      rate is attributable to a smaller percentage of income coming from tax exempt
      sources.





-13-


**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-month
      periods ended March 31, 2007 and 2006. 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 March 31,2007
              
              2006Average
              
              
              
              Average
              
              Average
              
              
              
              AverageBalance
              
              Interest
              
              Yield/Cost
              
              Balance
              
              Interest
              
              Yield/Cost(Dollars
                  in thousands)Interest-earnings
                  assetsLoan
                  portfolio
              
              $
              565,827
              
              $
              11,575
              
              
              8.30
              %
              $
              343,818
              
              $
              6,433
              
              
              7.59
              %Investment
                  securities
              
              
              88,901
              
              
              1,061
              
              
              4.77
              %
              
              59,718
              
              
              663
              
              
              4.44
              %Fed
                  funds and other interest-earning assets
              
              
              9,449
              
              
              121
              
              
              5.19
              %
              
              411
              
              
              5
              
              
              4.93
              %Total
                  interest-earning assets
              
              
              664,177
              
              
              12,757
              
              
              7.79
              %
              
              403,947
              
              
              7,101
              
              
              7.13
              %Noninterest-bearing
                  assets
              
              
              60,459
              
              
              
              
              
              
              
              
              24,568Total
                  Assets
              
              $
              724,636
              
              
              
              
              
              
              
              $
              428,515Interest-bearing
                  liabilitiesInterest-bearing
                  NOW
              
              $
              34,684
              
              
              98
              
              
              1.15
              %
              $
              38,758
              
              
              147
              
              
              1.54
              %Money
                  market and savings
              
              
              150,813
              
              
              1,577
              
              
              4.24
              %
              
              56,580
              
              
              426
              
              
              3.05
              %Time
                  deposits
              
              
              313,499
              
              
              3,886
              
              
              5.03
              %
              
              192,286
              
              
              1,818
              
              
              3.83
              %Short-term
                  borrowings
              
              
              21,818
              
              
              290
              
              
              5.32
              %
              
              20,147
              
              
              233
              
              
              4.69
              %Long-term
                  debt
              
              
              47,803
              
              
              662
              
              
              5.54
              %
              
              31,137
              
              
              403
              
              
              5.13
              %Total
                  interest-bearing liabilities
              
              
              568,617
              
              
              6,513
              
              
              4.65
              %
              
              338,908
              
              
              3,027
              
              
              3.62
              %Non-interest
                  bearing deposits
              
              
              68,649
              
              
              
              
              
              
              
              
              45,515Other
                  liabilities
              
              
              3,125
              
              
              
              
              
              
              
              
              1,622Total
                  Liabilities
              
              
              640,391
              
              
              
              
              
              
              
              
              386,045Stockholders'
                  Equity
              
              
              84,245
              
              
              
              
              
              
              
              
              42,470Total
                  Liabilities & Stockholders' Equity
              
              $
              724,636
              
              
              
              
              
              
              
              $
              428,515Net
                  interest income
              
              
              
              
              $
              6,244
              
              
              
              
              
              
              
              $
              4,074Interest
                  rate spread
              
              
              
              
              
              
              
              
              3.14
              %
              
              
              
              
              
              
              
              3.51
              %Net
                  interest-margin
              
              
              
              
              
              
              
              
              3.81
              %
              
              
              
              
              
              
              
              4.09
              %Percentage
                  of average interest-earning assetsto
                  average interest-bearing liabilities
              
              
              
              
              
              
              
              
              116.81
              %
              
              
              
              
              
              
              
              119.19
              %
  -14-


**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-month periods ended March 31, 2007
      and 2006. The table distinguishes between (i) changes attributable to volume
      (changes in volume multiplied by the prior period’s rate), (ii) changes
      attributable to rate (changes in rate multiplied by the prior period’s volume),
      and (iii) net change (the sum of the previous columns). The change attributable
      to both rate and volume (changes in rate multiplied by changes in volume) has
      been allocated proportionately to both the changes attributable to volume and
      the changes attributable to rate.


Rate/Volume
                  AnalysisThree
                  Months Ended March 31,2007
                  vs. 2006(in
                  Thousands)Increase
                  (Decrease) Due toVolume
              
              Rate
              
              Total**Interest
                  Income**Loan
                  portfolio
              
              
              4,348
              
              
              794
              
              
              5,142Investment
                  Securities
              
              
              334
              
              
              64
              
              
              398Fed
                  funds and other interest-earning assets
              
              
              113
              
              
              3
              
              
              116Total
                  interest-earning assets
              
              
              4,795
              
              
              861
              
              
              5,656**Interest
                  Expense**Interest-bearing
                  NOW
              
              
              (14
              )
              
              (36
              )
              
              (50
              )Money
                  market and savings
              
              
              847
              
              
              303
              
              
              1,150Time
                  deposits
              
              
              1,325
              
              
              744
              
              
              2,069Short-term
                  borrowings
              
              
              20
              
              
              37
              
              
              57Long-term
                  debt
              
              
              217
              
              
              43
              
              
              260Total
                  interest-bearing liabilities
              
              
              2,395
              
              
              1,091
              
              
              3,486**Net
                  interest income**
              
              
              2,400
              
              
              (230
              )
              
              2,170
  -15-


**NONPERFORMING
      ASSETS**





The
      table
      below sets forth, for the period indicated, information about our nonaccrual
      loans, restructured loans, total nonperforming loans (nonaccrual loans plus
      restructured loans), and total nonperforming assets.


At
                  March 31,
              
              At
                  December 312007
              
              2006
              
              2006
              
              2005(Dollars
                  in thousands)Nonaccrual
                  loans
              
              $
              604
              
              $
              19
              
              $
              135
              
              $
              26Restructured
                  loans
              
              
              -
              
              
              -
              
              
              -
              
              
              -Total
                  nonperforming loans
              
              
              604
              
              
              19
              
              
              135
              
              
              26Real
                  estate owned
              
              
              98
              
              
              22
              
              
              98
              
              
              22Repossessed
                  assets
              
              
              14
              
              
              -
              
              
              -
              
              
              -Total
                  nonperforming assets
              
              $
              716
              
              $
              41
              
              $
              233
              
              $
              48Accruing
                  loans past due90
                  days or more
              
              $
              -
              
              $
              -
              
              $
              -
              
              $
              -Allowance
                  for loan losses
              
              
              7,277
              
              
              4,621
              
              
              6,945
              
              
              4,351Nonperforming
                  loans toperiod
                  end loans
              
              
              0.10
              %
              
              0.01
              %
              
              0.02
              %
              
              0.01
              %Allowance
                  for loan lossesto
                  period end loans
              
              
              1.24
              %
              
              1.30
              %
              
              1.26
              %
              
              1.33
              %Allowance
                  for loan lossesto
                  nonperforming loans
              
              
              1,204.61
              %
              
              24,078.05
              %
              
              5,144.96
              %
              
              16,960.60
              %Nonperforming
                  assetsto
                  total assets
              
              
              0.10
              %
              
              0.01
              %
              
              0.03
              %
              
              0.01
              %Nonperforming
                  assets and loanspast
                  due 90 days or more tototal
                  assets
              
              
              0.10
              %
              
              0.01
              %
              
              0.03
              %
              
              0.01
              %


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 collectibility of principal or interest. Generally,
      our
      policy is to place a loan on nonaccrual status when the loan becomes past due
      90
      days. We also place loans on nonaccrual status in cases where we are uncertain
      whether the borrower can satisfy the contractual terms of the loan agreement.
      Amounts received on nonaccrual loans generally are applied first to principal
      and then to interest only after all principal has been collected. Restructured
      loans are those for which concessions, including the reduction of interest
      rates
      below a rate otherwise available to that borrower or the deferral of interest
      or
      principal have been granted due to the borrower’s weakened financial condition.
      We accrue interest on restructured loans at the restructured rates when we
      anticipate that no loss of original principal will occur. Potential problem
      loans are loans which are currently performing and are not included as
      nonaccrual or restructured loans above, but about which we have serious doubts
      as to the borrower’s ability to comply with present repayment terms. These loans
      are likely to be included later in nonaccrual, past due or restructured loans,
      so they are considered by our management in assessing the adequacy of our
      allowance for loan losses. At March 31, 2007, we identified six loans in the
      aggregate amount of $343,000 as potential problem loans. Management has
      evaluated these credits and estimated the potential losses net of the collateral
      value for these loans. A specific amount has been reserved in the allowance
      for
      loan losses for this total exposure amount.




-16-





At
      March
      31, 2007, there were four foreclosed properties valued at a total of $98,000
      and
      four nonaccrual loans totaling $604,000. Foreclosed property is valued at the
      lower of appraised value or the outstanding loan balance. Interest foregone
      on
      nonaccrual loans for the three-month period ended March 31, 2007 was $10,100.
      At
      March 31, 2006, there was one foreclosed property valued at $22,000 and three
      nonaccrual loans totaling $19,000. Interest foregone on nonaccrual loans for
      the
      three-month period ended March 31, 2006 was $705.





**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 distinguishes between loans that will be evaluated as a group
      by loan category and those loans to be evaluated individually. Management has
      assigned a range of predetermined allowance percentages for each major loan
      category. Loans that exhibit an acceptable level of risk per the internal loan
      grading system are grouped by loan category and multiplied by the associated
      allowance percentage to determine an adequate level of allowance for loan
      losses.





Based
      on
      the loan grading system, management maintains an internally classified watch
      list. Loans classified as watch list credits, and those loans that are not
      watch
      list credits but possess other characteristics which in the opinion of
      management suggest a higher degree of inherent risk, are evaluated individually,
      by loan category, using higher allowance percentages. 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.




-17-





The
      primary reason for increases to the allowance for loan losses has been growth
      in
      total outstanding loans; however, there were other factors influencing the
      provision. For the three-month period ended March 31, 2007, there were net
      loan
      charge-offs of $27,000 and $604,000 in nonaccrual loans compared with no net
      charge-offs and $19,000 in non-accrual loans compared at March 31, 2006. The
      allowance for loan losses at March 31, 2007 was $7.3 million, which represents
      1.24% of total outstanding loans compared to $4.6 million and 1.30% for the
      prior year. The allowance for loan losses as a percentage of total outstanding
      loans declined from the prior year primarily due to improvement in the asset
      quality of the portfolio.





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 the financial condition of the
      Company and results of its operations.




-18-





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


Allocation
                  of Allowance for Loan LossesAt
                  March 31,
              
              At
                  December 31,2007
              
              2006%
                  of Total
              
              
              
              %
                  of TotalAmount
              
              Loans
                  (1)
              
              Amount
              
              Loans
                  (1)(Dollars
                  in thousands)Residential
                  real estate loans
              
              $
              121
              
              
              3.48
              %
              $
              121
              
              
              3.67
              %Home
                  equity loans and lines
              
              
              289
              
              
              7.07
              %
              
              269
              
              
              7.76
              %Commercial
                  mortgage loans
              
              
              4,028
              
              
              55.25
              %
              
              3,920
              
              
              55.36
              %Construction
                  loans
              
              
              1,591
              
              
              21.50
              %
              
              1,379
              
              
              19.99
              %Commercial
                  and industrial loans
              
              
              1,080
              
              
              11.71
              %
              
              1,161
              
              
              12.32
              %Loans
                  to individuals
              
              
              168
              
              
              0.99
              %
              
              95
              
              
              0.90
              %Total
                  allowance
              
              $
              7,277
              
              
              100.00
              %
              $
              6,945
              
              
              100.00
              %
  (1)
        Represents total of all outstanding loans in each category as a percent of
        total
        loans outstanding
  -19-


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


Changes
                  in Allowance for Loan LossesFor
                  the Three-Month Period Ended March 31,2007
              
              2006(Dollars
                  in thousands)Balance
                  at the beginning of the year
              
              $
              6,945
              
              $
              4,351Charge-offs:Commercial
                  and industrial loans
              
              
              28
              
              
              -Total
                  charge-offs
              
              
              28
              
              
              -Recoveries
              
              
              1
              
              
              -Net
                  charge-offs (recoveries)
              
              
              27
              
              
              -Provision
                  for loan losses
              
              
              359
              
              
              270Balance
                  at the end of the year
              
              $
              7,277
              
              $
              4,621Total
                  loans outstanding at period-end
              
              $
              586,149
              
              $
              355,806Average
                  loans outstanding for the period
              
              $
              565,827
              
              $
              343,818Allowance
                  for loan losses tototal
                  loans outstanding
              
              
              1.24
              %
              
              1.30
              %Ratio
                  of net charge-offs to average loans outstanding
              
              
              0.00
              %
              
              0.00
              %





**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 and other correspondent
      banks are presently the main sources of the Company’s liquidity. The Company’s
      primary uses of liquidity are to fund loans and to make
      investments.





As
      of
      March 31, 2007, liquid assets (cash and due from banks, interest-earning
      deposits with banks and investment securities available for sale) were
      approximately $112.5 million, which represents 15% of total assets and 19%
      of
      total deposits. Supplementing this liquidity, the Company has available lines
      of
      credit from various correspondent banks of approximately $157.3 million of
      which
      $65.0 million is outstanding at March 31, 2007. At March 31, 2007, outstanding
      commitments for undisbursed lines of credit, letters of credit and undisbursed
      investment commitments amounted to approximately $182.1 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 deposits represented 53% of the Company’s total
      deposits at March 31, 2007 compared with 55% at December 31, 2006. The Company’s
      growth strategy will include marketing efforts focused at increasing the
      relative volume of low cost 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 43% and 42% of the
      Company’s total deposits at March 31, 2007 and December 31, 2006, respectively.
      While these deposits are generally considered rate sensitive and the Company
      will need to pay competitive rates to retain these deposits at maturity, there
      are other subjective factors that will determine the Company’s continued
      retention of those deposits.




-20-





Under
      federal capital regulations, Crescent Financial Corporation must satisfy certain
      minimum leverage ratio requirements and risk-based capital requirements. At
      March 31, 2007, the Company’s equity to asset ratio is 11.32%. The Company’s
      ratios of Tier 1 capital to risk-weighted assets and total capital to risk-based
      assets are 9.58% and 10.71%, respectively. The two bank subsidiaries are also
      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 9.21% and 10.34%, respectively, and Port City Capital Bank
      has
      Tier I capital to risk-weighted assets and total capital to risk-based
      assets ratios of 9.35% and 10.51%, 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.





-21-


**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, 2006.





**Item
      4. Controls and Procedures**





Crescent
      Financial Corporation’s management, with the participation of the Chief
      Executive Officer and Principal Financial Officer, has evaluated the
      effectiveness of the Company’s disclosure controls and procedures as of March
      31, 2007. 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 March 31, 2007, 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 March 31,
      2007 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.




-22-


**Part
      II.**  **OTHER
      INFORMATION**





**Item
      1.**  **Legal
      Proceedings.**




None.





**Item
      1a.**  **Risk
      Factors.**




There
      have been no material changes in our risk factors from those disclosed in our
      Annual Report on Form 10-K for the year ended December 31,
      2006.





**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**




None.





**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





-23-





**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 CORPORATION**Date:
              May 8, 2007
            By:
            /s/
              Michael G. CarltonMichael
                G. Carlton
              President
                and Chief Executive Officer Date:
              May 8, 2007
            By:
            /s/
              Bruce W. ElderBruce
                W. Elder
              Principal
                Financial Officer


-24-