UNITED
      STATES


SECURITIES
      AND EXCHANGE COMMISSION


Washington,
      DC 20549





**FORM
      10-Q**





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





For
      the
      Quarterly Period Ended **September
      30, 2008**





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, 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 filero
            Accelerated
                filerxNon-accelerated
                filero
            Smaller
                reporting companyo





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**


**9,621,559
      shares outstanding as of November 4, 2008**








Page No.**Part
                I.**
            **FINANCIAL
                INFORMATION****Item
                1 -**
            **Financial
                Statements (Unaudited)**Consolidated
                Balance Sheets
              September
                30, 2008 (unaudited) and December 31, 2007
            3Consolidated
                Statements of Operations
              Three
                and Nine Months Ended September 30, 2008 and 2007
                (unaudited)
            4Consolidated
                Statements of Cash Flows
              Nine
                Months Ended September 30, 2008 and 2007 (unaudited)
            5Notes
                to Consolidated Financial Statements
            6
                -
                10**Item
                2 -**
            **Management’s
                Discussion and Analysis of Financial Condition and Results of
                Operations**
            11 –
                26**Item 3
                -**
            **Quantitative
                and Qualitative Disclosures about Market Risk**
            27**Item
                4 -**
            **Controls
                and Procedures**
            27**Part
                II.**
            **Other
                Information****Item
                1 – Legal Proceedings**
            28**Item
                1a – Risk Factors**
            28**Item
                2 – Unregistered Sales of Equity Securities and Use of
                Proceeds**
            28**Item
                3 – Defaults Upon Senior Debt**
            28**Item
                4 – Submission of Matters to a Vote of Security
                Holders**
            28**Item
                5 – Other Information**
            28**Item
                6 - Exhibits**
            29


-
          2
          -


**Part
      I.** **FINANCIAL
      INFORMATION**


**Item
      1 - Financial Statements**




***CRESCENT
      FINANCIAL CORPORATION AND SUBSIDIARY***


***CONSOLIDATED
      BALANCE SHEETS***







September 30, 2008
            
            December 31,(Unaudited)
            
            2007***ASSETS**Cash
                and due from banks
            
            $
            12,320,380
            
            $
            12,047,600Interest-earning
                deposits with banks
            
            
            638,888
            
            
            211,804Federal
                funds sold
            
            
            9,477,000
            
            
            97,000Investment
                securities available for sale at fair value
            
            
            96,014,860
            
            
            90,758,467Loans
            
            
            769,060,117
            
            
            675,916,228Allowance
                for loan losses
            
            
            (9,988,000
            )
            
            (8,273,000
            )NET
                LOANS
            
            
            759,072,117
            
            
            667,643,228Accrued
                interest receivable
            
            
            3,327,617
            
            
            3,761,600Federal
                Home Loan Bank stock, at cost
            
            
            7,264,000
            
            
            6,790,700Bank
                premises and equipment, net
            
            
            10,296,955
            
            
            8,094,521Investment
                in life insurance
            
            
            16,516,774
            
            
            9,122,697Goodwill
            
            
            30,233,049
            
            
            30,233,049Other
                assets
            
            
            10,365,729
            
            
            6,779,390TOTAL
                ASSETS
            
            $
            955,527,369
            
            $
            835,540,056**LIABILITIES
                AND STOCKHOLDERS’ EQUITY**LIABILITIESDepositsDemand
            
            $
            69,594,108
            
            $
            69,367,630Savings
            
            
            64,213,660
            
            
            110,516,217Money
                market and NOW
            
            
            120,430,461
            
            
            80,316,251Time
            
            
            457,404,978
            
            
            345,231,215TOTAL
                DEPOSITS
            
            
            711,643,207
            
            
            605,431,313Short-term
                borrowings
            
            
            20,000,000
            
            
            13,755,000Long-term
                borrowings
            
            
            125,748,000
            
            
            121,248,000Accrued
                expenses and other liabilities
            
            
            3,985,716
            
            
            3,446,931TOTAL
                LIABILITIES
            
            
            861,376,923
            
            
            743,881,244STOCKHOLDERS’
                EQUITYPreferred
                stock, no par value, 5,000,000 shares authorized, none
                outstanding;
            
            
            -
            
            
            -Common
                stock, $1 par value, 20,000,000 shares authorized; 9,612,743 shares
                outstanding September 30, 2008; 9,404,579 shares outstanding December
                31,
                2007
            
            
            9,612,743
            
            
            9,404,579Additional
                paid-in capital
            
            
            74,255,919
            
            
            73,596,427Retained
                earnings
            
            
            11,254,847
            
            
            8,619,617Accumulated
                other comprehensive income (loss) (Note D)
            
            
            (973,063
            )
            
            38,189TOTAL
                STOCKHOLDERS’ EQUITY
            
            
            94,150,446
            
            
            91,658,812COMMITMENTS
                (Note B)TOTAL
                LIABILITIES ANDSTOCKHOLDERS’
                EQUITY
            
            $
            955,527,369
            
            $
            835,540,056




*
      Derived
      from audited consolidated financial statements.




See
      accompanying notes.


-
          3
          -


***CRESCENT
      FINANCIAL CORPORATION AND SUBSIDIARY***


***CONSOLIDATED
      STATEMENTS OF OPERATIONS (Unaudited)***


***Three
      and Nine Month Periods Ended September 30, 2008 and
      2007***





Three-month
                Periods
            
            Nine-month
                PeriodsEnded
                September 30,
            
            Ended
                September 30,2008
            
            2007
            
            2008
            
            2007INTEREST
                INCOMELoans
            
            $
            12,570,944
            
            $
            12,867,174
            
            $
            36,978,349
            
            $
            36,773,484Investment
                securities available for sale
            
            
            1,206,343
            
            
            1,142,247
            
            
            3,639,786
            
            
            3,298,657Federal
                funds sold and interest-bearing deposits
            
            
            16,763
            
            
            85,491
            
            
            74,971
            
            
            381,944TOTAL
                INTEREST INCOME
            
            
            13,794,050
            
            
            14,094,912
            
            
            40,693,106
            
            
            40,454,085INTEREST
                EXPENSEDeposits
            
            
            5,953,339
            
            
            6,120,881
            
            
            17,164,617
            
            
            17,646,841Short-term
                borrowings
            
            
            125,860
            
            
            148,877
            
            
            333,463
            
            
            647,883Long-term
                borrowings
            
            
            1,371,992
            
            
            1,016,751
            
            
            4,036,486
            
            
            2,537,350TOTAL
                INTEREST EXPENSE
            
            
            7,451,191
            
            
            7,286,509
            
            
            21,534,566
            
            
            20,832,074NET
                INTEREST INCOME
            
            
            6,342,859
            
            
            6,808,403
            
            
            19,158,540
            
            
            19,622,011PROVISION
                FOR LOAN LOSSES
            
            
            1,281,471
            
            
            665,588
            
            
            2,547,178
            
            
            1,347,184NET
                INTEREST INCOME AFTERPROVISION
                FOR LOAN LOSSES
            
            
            5,061,388
            
            
            6,142,815
            
            
            16,611,362
            
            
            18,274,827NON-INTEREST
                INCOMEMortgage
                loan origination revenue
            
            
            188,952
            
            
            145,344
            
            
            511,561
            
            
            395,845Fees
                on deposit accounts
            
            
            414,177
            
            
            336,021
            
            
            1,177,331
            
            
            1,005,665Earnings
                on life insurance
            
            
            188,824
            
            
            97,755
            
            
            431,294
            
            
            281,134Gain
                on sale of available for sale securities
            
            
            -
            
            
            -
            
            
            15,535
            
            
            -Gain
                (Loss) on disposal of assets
            
            
            (4,116
            )
            
            1
            
            
            (76,146
            )
            
            (941
            )Other
            
            
            268,973
            
            
            110,365
            
            
            622,907
            
            
            283,975TOTAL
                NON-INTEREST INCOME
            
            
            1,056,810
            
            
            689,486
            
            
            2,682,482
            
            
            1,965,678NON-INTEREST
                EXPENSESalaries
                and employee benefits
            
            
            2,881,444
            
            
            2,476,210
            
            
            8,602,773
            
            
            7,415,795Occupancy
                and equipment
            
            
            709,164
            
            
            581,815
            
            
            2,027,775
            
            
            1,693,700Data
                processing
            
            
            269,567
            
            
            277,736
            
            
            801,559
            
            
            794,992Other
            
            
            1,205,696
            
            
            1,066,330
            
            
            3,747,899
            
            
            3,341,132TOTAL
                NON-INTEREST EXPENSE
            
            
            5,065,871
            
            
            4,402,091
            
            
            15,180,006
            
            
            13,245,619INCOME
                BEFORE INCOME TAXES
            
            
            1,052,327
            
            
            2,430,210
            
            
            4,113,838
            
            
            6,994,886INCOME
                TAXES
            
            
            306,300
            
            
            867,600
            
            
            1,336,800
            
            
            2,518,400NET
                INCOME
            
            $
            746,027
            
            $
            1,562,610
            
            $
            2,777,038
            
            $
            4,476,486NET
                INCOME PER COMMON SHAREBasic
            
            $
            .08
            
            $
            .17
            
            $
            .29
            
            $
            .49Diluted
            
            $
            .08
            
            $
            .16
            
            $
            .29
            
            $
            .47WEIGHTED
                AVERAGE COMMONSHARES
                OUTSTANDING (Note C)Basic
            
            
            9,548,589
            
            
            9,246,318
            
            
            9,478,117
            
            
            9,160,582Diluted
            
            
            9,628,147
            
            
            9,642,429
            
            
            9,642,969
            
            
            9,623,399





See
      accompanying notes.


-
          4
          -


***CRESCENT
      FINANCIAL CORPORATION AND SUBSIDIARY***


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


***Nine
      Months Ended September 30, 2008 and 2007***








2008
            
            2007CASH
                FLOWS FROM OPERATING ACTIVITIESNet
                income
            
            $
            2,777,038
            
            $
            4,476,486Adjustments
                to reconcile net income to net cash provided by operating
                activities:Depreciation
            
            
            585,491
            
            
            526,628Provision
                for loan losses
            
            
            2,547,178
            
            
            1,347,184Deferred
                income taxes
            
            
            (479,000
            )
            
            (308,000
            )Amortization
                of core deposit premium
            
            
            100,012
            
            
            100,012Gain
                on sale of available for sale securities
            
            
            (15,535
            )
            
            -Loss
                on disposal of assets
            
            
            1,346
            
            
            941Loss
                on disposal of other real estate owned
            
            
            74,800
            
            
            -Net
                accretion on securities
            
            
            (66,910
            )
            
            (74,866
            )Accretion
                of loan discount
            
            
            (329,865
            )
            
            (329,865
            )Amortization
                of deposit premium
            
            
            139,162
            
            
            304,708Net
                increase in cash value of life insurance
            
            
            (394,077
            )
            
            (251,038
            )Stock
                based compensation
            
            
            160,457
            
            
            132,930Change
                in assets and liabilities:(Increase)
                decrease in accrued interest receivable
            
            
            433,983
            
            
            (674,912
            )Increase
                in other assets
            
            
            (1,621,266
            )
            
            (64,064
            )Increase
                in accrued interest payable
            
            
            82,915
            
            
            423,027Increase
                (decrease) in other liabilities
            
            
            314,062
            
            
            (444,853
            )TOTAL
                ADJUSTMENTS
            
            
            1,532,753
            
            
            687,832NET
                CASH PROVIDED BY OPERATING ACTIVITIES
            
            
            4,309,791
            
            
            5,164,318CASH
                FLOWS FROM INVESTING ACTIVITIESPurchases
                of investment securities available for sale
            
            
            (18,911,004
            )
            
            (12,329,358
            )Principal
                repayments of investment securities available for sale
            
            
            10,548,208
            
            
            7,375,831Proceeds
                from sale of securities available for sale
            
            
            1,543,197
            
            
            -Purchase
                of Federal Home Loan Bank stock
            
            
            (473,300
            )
            
            (2,982,900
            )Proceeds
                from disposal of foreclosed assets
            
            
            566,790
            
            
            -Net
                increase in loans
            
            
            (95,239,479
            )
            
            (101,605,913
            )Investment
                in life insurance
            
            
            (7,000,000
            )
            
            (3,100,000
            )Cash
                provided in business combination
            
            
            -
            
            
            (7,500
            )Purchases
                of bank premises and equipment
            
            
            (2,789,271
            )
            
            (1,540,825
            )NET
                CASH USED BY INVESTING ACTIVITIES
            
            
            (111,754,859
            )
            
            (114,190,665
            )CASH
                FLOWS FROM FINANCING ACTIVITIESNet
                increase (decrease) in deposits:Demand
            
            
            226,478
            
            
            2,233,009Savings
            
            
            (46,302,557
            )
            
            43,979,395Money
                market and NOW
            
            
            40,114,210
            
            
            (9,048,137
            )Time
                deposits
            
            
            112,034,601
            
            
            16,276,375Net
                increase (decrease) in short-term borrowings
            
            
            6,245,000
            
            
            (14,451,000
            )Net
                increase in long-term borrowings
            
            
            4,500,000
            
            
            71,000,000Proceeds
                from stock options exercised
            
            
            615,500
            
            
            1,050,106Cash
                paid in lieu of fractional shares
            
            
            -
            
            
            (7,687
            )Excess
                tax benefits from stock options exercised
            
            
            91,700
            
            
            390,100NET
                CASH PROVIDED BY FINANCING ACTIVITIES
            
            
            117,524,932
            
            
            111,422,161NET
                INCREASE IN CASH AND CASH EQUIVALENTS
            
            
            10,079,864
            
            
            2,395,814CASH
                AND CASH EQUIVALENTS, BEGINNING OF PERIOD
            
            
            12,356,404
            
            
            15,150,110CASH
                AND CASH EQUIVALENTS, END OF PERIOD
            
            $
            22,436,268
            
            $
            17,545,924


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
      and
      nine-month periods ended September 30, 2008 and 2007, 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 and nine-month period ended
      September 30, 2008 are not necessarily indicative of the results that may be
      expected for the fiscal year ending December 31, 2008.





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 2007 annual report on Form
      10-K. This quarterly report should be read in conjunction with such annual
      report.





**NOTE
      B – COMMITMENTS**


At
      September 30, 2008, commitments are as follows:





Undisbursed
                lines of credit
            
            $
            177,013,000Stand-by
                letters of credit
            
            
            6,345,000Undisbursed
                commitment to purchase additional investment in Small Business Investment
                Corporation
            
            
            413,000Commitment
                to purchase when issued debt securities
            
            
            1,013,000





**NOTE
      C – PER SHARE RESULTS**


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.




Basic
      earnings per share represents income available to common stockholders divided
      by
      the weighted-average number of common shares outstanding during the period.
      Diluted earnings per share reflect additional common shares that would have
      been
      outstanding if dilutive potential common shares had been issued, as well as
      any
      adjustment to income that would result from the assumed issuance. Potential
      common shares that may be issued by the Company relate to outstanding stock
      options and restricted stock and are determined using the treasury stock
      method.




-
          6
          -


***CRESCENT
      FINANCIAL CORPORATION AND SUBSIDIARY***


***Notes
      to Consolidated Financial Statements***







Three
                months ended
            
            Nine
                months endedSeptember
                30,
            
            September
                30,2008
            
            2007
            
            2008
            
            2007Weighted
                average number of shares used in computing basic net income per
                share
            
            
            9,548,589
            
            
            9,246,318
            
            
            9,478,117
            
            
            9,160,582Effect
                of dilutive stock options
            
            
            79,558
            
            
            396,111
            
            
            164,852
            
            
            462,817Weighted
                average number of shares used in computing diluted net income per
                share
            
            
            9,628,147
            
            
            9,642,429
            
            
            9,642,969
            
            
            9,623,399


For
      the
      three-month periods ended September 30, 2008 and 2007, there were 93,163 and
      56,075 options, respectively, that were anti-dilutive. For the nine-month ended
      September 30, 2008 and 2007, there were 67,029 and 42,743
      options, respectively, that were anti-dilutive.




**NOTE
      D - COMPREHENSIVE INCOME**


For
      the
      three months ended September 30, 2008 and 2007, total comprehensive income
      (loss), consisting of net income, realized and unrealized securities gains
      and
      losses, net of taxes, was approximately $(4,000) and $2,072,000, respectively.
      For the nine months ended September 30, 2008 and 2007, total comprehensive
      income was approximately $1,766,000 and $4,503,000, respectively.





**NOTE
      E – RECENT ACCOUNTING PRONOUNCEMENTS**


*Statement
      of Financial Accounting Standard (SFAS) No. 159 “The Fair Value Option Financial
      Assets and Financial Liabilities”* **


The
      Company adopted the provisions of SFAS 159 effective January 1, 2008
      which was issued in February 2007. SFAS 159 generally permits the
      measurement of selected eligible financial instruments at fair value at
      specified election dates. Changes in fair value from one period to the next
      are
      recognized through the income statement. This election can generally be applied
      on an instrument by instrument basis. The Company chose not to account for
      any
      financial assets or liabilities under the fair value option.





*Statement
      of Financial Accounting Standard (SFAS) No. 157 "Fair Value
      Measurement"* ** **


In
      connection with the adoption of SFAS 159, the Company was required to adopt
      SFAS No. 157, "Fair Value Measurement" ("SFAS 157"). SFAS 157
      defines fair value, establishes a framework for measuring fair value in
      generally accepted accounting principles, and expands disclosures about fair
      value measurements.





*Fair
      Value Hierarchy*


Under
      SFAS 157, the Company groups assets and liabilities at fair value in three
      levels, based on the markets in which the assets and liabilities are traded
      and
      the reliability of the assumptions used to determine fair value. These levels
      are:





·
            Level
                1 – Valuation is based upon quoted prices for identical instruments
                traded in active markets.


-
          7
          -





·
            Level
                2 – Valuation is based upon quoted prices for similar instruments in
                active markets, quoted prices for identical or similar instruments
                in
                markets that are not active and model-based valuation techniques
                for which
                all significant assumptions are observable in the
                market.


·
            Level
                3 – Valuation is generated from model-based techniques that use at
                least one significant assumption no observable in the market. These
                unobservable assumptions reflect estimates of assumptions that market
                participants would use in pricing the asset or liability. Valuation
                techniques include use of option pricing models, discounted cash
                flows
                models and similar techniques.





Following
      is a description of valuation methodologies used for assets and liabilities
      recorded at fair value.





*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.





*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. Once a loan is identified as individually
      impaired, management measures impairment in accordance with SFAS 114,
“Accounting by Creditors for Impairment of a Loan,” (SFAS 114). The fair value
      of impaired loans is estimated using one of several methods, including
      collateral value, market value of similar debt, enterprise value, liquidation
      value and discounted cash flows. Those impaired loans not requiring an allowance
      represent loans for which the fair value of the expected repayments or
      collateral exceed the recorded investments in such loans. At September 30,
      2008,
      all of the total impaired loans were evaluated based on the fair value of the
      collateral. In accordance with SFAS 157, 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 Corporation records
      the impaired loan 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
      Corporation records the impaired loan as nonrecurring Level 3.





The
      following table summarizes quantitative disclosures about the fair value
      measurement for each category of assets carried at fair value as of June 30,
      2008:


-
          8
          -




Description
            
            Sept 30,
              2008
            
            Quoted Prices in
              Active Markets
              for Identical
              Assets
              (Level 1)
            
            Significant
              Other
              Observable
              Inputs
              (Level 2)
            
            Significant
              Unobservable
              Inputs
              (Level 3)Available
                for sale securities
            
            $
            96,014,860
            
            $
            564,517
            
            $
            95,450,343
            
            $
            -Impaired
                loans
            
            $
            4,469,428
            
            $
            -
            
            $
            3,673,524
            
            $
            795,904





As
      of
      September 30, 2008, the Bank identified $7.7 million in impaired loans. Of
      these
      impaired loans, $6.3 million had specific loss allowance aggregating $1.8
      million.





*Emerging
      Issues Task Force (EITF) No. 06-4 "Accounting for Deferred Compensation and
      Postretirement benefit Aspects of Endorsement Split-Dollar Life Insurance
      Arrangements"*


In
      September 2006, the FASB ratified the consensuses reached by the FASB’s Emerging
      Issues Task Force (“EITF”) relating to EITF 06-4. EITF 06-4 states that an
      employer accounting for endorsement split-dollar life insurance arrangements
      that provide a benefit to an employee that extends to postretirement periods
      should recognize a liability for future benefits in accordance with SFAS
      No. 106, “Employers’ Accounting for Postretirement Benefits Other Than
      Pensions”, or Accounting Principles Board (“APB”) Opinion No. 12, “Omnibus
      Opinion—1967”. The Company adopted EITF 06-4 on January 1, 2008, and in
      connection therewith recorded a liability of $142,000 as a reduction of retained
      earnings. Subsequent increases in this liability will be reflected as an expense
      in determining operating results.





*Statement
      of Financial Accounting Standard (SFAS) No. 161 “Disclosures about Derivative
      Instruments and Hedging Activities, an amendment of FASB Statement
      No. 133"* ** **


In
      March 2008, the FASB issued SFAS No. 161. SFAS 161 applies to all
      derivative instruments and related hedged items accounted for under SFAS
      No. 133, “Accounting for Derivative Instruments and Hedging Activities,”
(SFAS 133). The Company does not currently utilize derivative instruments for
      hedging activities and therefore does not expect the adoption of the provisions
      of SFAS 161 to have a material effect on the Corporation’s financial condition
      and results of operations.





**NOTE
      F – GOODWILL IMPAIRMENT**


Pursuant
      to SFAS No. 142, Goodwill and Other Intangible Assets, goodwill must be tested
      for impairment each year. If certain events occur, more than one annual
      impairment test is required. An impairment test can be performed at any date,
      as
      long as it is consistently used each year. At September 30, 2008, management
      evaluated whether any of the various events which might require more than one
      annual impairment test had occurred. While there have been certain adverse
      economic developments since December 31, 2007, the Company continues to maintain
      sound asset quality, financial strength and enjoys positive earnings, and
      therefore, management does not believe an interim impairment test is warranted.
      During October 2008, the Company changed the timing of its annual goodwill
      impairment testing from the end of the fourth quarter (December 31) to October
      31. This change allows the Company to complete its annual goodwill impairment
      testing in advance of its year-end closing. Accordingly, management believes
      that this accounting change is preferable under the circumstances.


-
          9
          -


**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 September 30,
      2008 and 2007. It should be read in conjunction with the audited consolidated
      financial statements at and for the year ended December 31, 2007 and
      accompanying notes included in this report and the supplemental financial data
      appearing throughout this discussion and analysis. Because the Company has
      no
      operations and conducts no business on its own other than owning Crescent State
      Bank, the discussion contained in this Management's Discussion and Analysis
      concerns primarily the business of the Bank. However, for ease of reading and
      because the financial statements are presented on a consolidated basis, the
      Company and the Bank are collectively referred to herein as the Company unless
      otherwise noted. All significant intercompany transactions and balances are
      eliminated in consolidation.





**COMPARISON
      OF FINANCIAL CONDITION AT SEPTEMBER 30, 2008 AND**


**DECEMBER
      31, 2007**





Total
      assets at September 30, 2008 are $955.5 million compared with $835.5 million
      at
      December 31, 2007. Earning assets are 92% of total assets at both dates with
      $882.5 million at September 30, 2008 and $773.8 million at December 31, 2007.
      Components of earning assets at September 30, 2008 are $769.1 million in gross
      loans, $103.3 million in investment securities and Federal Home Loan Bank (FHLB)
      stock, $9.5 million in Federal funds sold and $639,000 in overnight investments
      and interest bearing deposits with correspondent banks. Earning assets at
      December 31, 2007 consisted of $675.9 million in gross loans, $97.5 million
      in
      investment securities and FHLB stock and $309,000 in overnight investments
      and
      interest bearing deposits. Total deposits, borrowings and stockholders’ equity
      at September 30, 2008 were $711.6 million, $145.7 million and $94.1 million,
      respectively, compared to $605.4 million, $135.0 million and $91.7 million
      at
      December 31, 2007.





Gross
      loans outstanding increased by $93.1 million or 14% over the nine-month period.
      All categories of loans experienced net increases with the commercial real
      estate mortgage category experiencing the most significant dollar growth
      increasing $80.2 million or 23% from $350.4 million to $430.6 million.
      Commercial and industrial loans increased by $10.3 million or 14% from $72.9
      million to $83.2 million. Home equity lines and loans increased by $9.3 million
      or 20% to $54.5 million, residential real estate loans increased $702,000 or
      4%
      to $18.9 million and consumer loans increased by $216,000 or 4% to $5.7 million.
      The construction and acquisition and development category has experienced a
      decline of $7.6 million or 4% since the end of 2007. The decline reflects a
      general slowdown in the residential building and development industry as well
      as
      shifting of completed commercial construction loans into the permanent
      commercial real estate mortgage category. The composition of the loan portfolio,
      by category, as of September 30, 2008 is 56% commercial mortgage loans, 23%
      construction loans, 11% commercial loans, 7% home equity loans and lines, 2%
      residential mortgage loans and 1% consumer loans. The composition of the loan
      portfolio, by category, as of December 31, 2007 was 52% commercial mortgage
      loans, 27% construction loans, 11% commercial loans, 6% home equity loans and
      lines, 3% residential real estate mortgage loans and 1% consumer loans.


-
          10
          -


The
      Company had an allowance for loan losses at September 30, 2008 of $10.0 million
      or 1.30% of outstanding loans compared to $8.3 million or 1.24% at
      December 31, 2007. At September 30, 2008, there were eight loans totaling
      $2.8 million in non-accrual status. There were no loans past due 90 days or
      more
      and still accruing interest at September 30, 2008. Non-performing loans as
      a
      percentage of total loans at September 30, 2008 were 0.36%. At December 31,
      2007, there were twelve loans totaling $2.7 million in non accrual status,
      no
      loans past due 90 days or more and still accruing interest and non-performing
      loans as a percentage of total loans at December 31, 2007 were 0.40%. For a
      more
      detailed discussion, see the section entitled Non-Performing
      Assets.





The
      Company has investment securities with an amortized cost of $97.6 million at
      September 30, 2008. All investments are accounted for as available for sale
      and
      are presented at their fair market value of $96.0 million compared with $90.8
      million at year-end 2007. The Company’s investment in available for sale
      securities at September 30, 2008, consists of U.S. Government agency securities,
      collateralized mortgage obligations, mortgage-backed securities, municipal
      bonds
      and marketable equity securities. The Company does not own any equity
      investments in the Federal Home Loan Mortgage Corporation (Freddie Mac) or
      the
      Federal National Mortgage Association (Fannie Mae). The increase during the
      first nine months of 2008 was the net result of $19.2 million in new purchases
      and $67,000 in net accretion of discounts, less $10.8 million in principal
      re-payments and called principal, the sale of $1.5 million of securities and
      a
      $1.6 million decrease in fair value. The Company has performed an analysis
      at
      September 30th and believes all unrealized losses within its securities
      portfolio are temporary in nature.





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





The
      Company owns $7.3 million of Federal Home Loan Bank stock at September 30,
      2008
      compared to $6.8 million at December 31, 2007.





There
      is
      $9.5 million in Federal funds sold at September 30, 2008 compared to $97,000
      at
      December 31, 2007. Federal funds sold are a source of short-term liquidity
      typically used to fund loans and cover deposit fluctuations.





Interest-earning
      deposits held at correspondent banks increased by approximately $427,000 from
      $212,000 at December 31, 2007 to $639,000 at September 31, 2008.





Non-earning
      and other assets increased by approximately $12.7 million between December
      31,
      2007 and September 30, 2008. The Company purchased an additional $7.0 million
      of
      bank owned life insurance in May. The earnings from increased cash value on
      the
      bank owned life insurance is used to help offset certain employee and
      supplemental retirement benefits. There was a net increase in bank premises
      and
      equipment increased of $2.2 million as we purchased land for a future branch
      location and are incurring construction costs on a branch expected to open
      in
      2009. The Company had three foreclosed properties totaling $272,000 at December
      31, 2007. During 2008, we foreclosed on seven additional properties and moved
      $2.4 million in net realizable values to other real estate owned. Four of those
      properties have been disposed of, at a combined loss of $75,000, leaving a
      balance of other real estate owned of $1.9 million. Non-interest earning cash
      due from banks, the majority of which represents checks in the process of being
      collected through the Federal Reserve payment system, increased by $273,000.
      For
      more details regarding the increase in cash and cash equivalents, see the
      Consolidated Statements of Cash Flows.


-
          11
          -


Total
      deposits increased by $106.2 million between December 31, 2007 and September
      30,
      2008 from $605.4 million to $711.6 million. The largest dollar increase occurred
      in the time deposit category, which grew by $112.2 million or 32% to $457.4
      million at September 30, 2008 from $645.2 million at year end 2007. Other
      categories experiencing growth include money market deposits increasing by
      $36.6
      million or 76% to $84.9 million, interest-bearing demand deposit balances
      increasing by $3.6 million or 11% to $35.5 million and non-interest bearing
      demand deposits increasing $226,000 to $69.6 million. Due largely to the
      expected distribution of $20.4 million from an escrow account and migration
      toward an introductory money market product, savings account balances declined
      by $46.3 million to $64.2 million.





The
      composition of the deposit base, by category, at September 30, 2008 is as
      follows: 64% time deposits, 12% money market accounts, 10% non-interest-bearing
      demand deposits, 9% savings accounts and 5% interest-bearing demand deposits.
      The composition of the deposit base, by category, at December 31, 2007 was
      57% time deposits, 18% in statement savings, 12% non-interest-bearing demand
      deposits, 8% money market and 5% in interest-bearing demand deposits. Over
      the
      past 12 months, short-term interest rates have fallen by 325 basis points.
      Rates
      on non-maturity deposit products such as interest bearing demand, savings and
      money market accounts have moved down accordingly. Due to fierce market
      competition and some irrational pricing by banks experiencing liquidity issues,
      the rates on time deposits have not dropped to the extent anticipated. This
      has
      caused a significant shift in our deposit mix from the lower cost non-maturity
      products into the time deposit category.





Time
      deposits of $100,000 or more totaled $367.1 million at September 30, 2008
      compared to $276.6 million at December 31, 2007. 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 $266.9 million at September 30, 2008 compared with $166.6 million
      at December 31, 2007.





The
      Company has $125.7 million of long-term debt outstanding at September 30, 2008
      compared to $121.2 million at December 31, 2007. The long-term debt is comprised
      of $108.0 million in FHLB term advances, $15.7 million in junior subordinated
      debt and $2.0 million outstanding on a line of credit. Short-term borrowings
      increased by $6.2 million during 2008 to $20.0 million. Short-term borrowings
      consist of FHLB term advances with remaining maturities of less than one year





Accrued
      interest payable and other liabilities increased by $539,000 and are $4.0
      million and $3.4 million at September 30, 2008 and December 31, 2007,
      respectively.





Between
      December 31, 2007 and September 30, 2008, total stockholders’ equity increased
      by $2.5 million. The increase resulted primarily from net income for the first
      nine months of $2.8 million, $707,000 in new stock issued pursuant to the
      exercise of stock options and $160,000 due to the recognition of certain stock
      award expense. Total stockholders’ equity decreased by $142,000 due to recording
      the cumulative effect of adopting EITF 06-04 and a decline in the net fair
      market value of available for sale securities of $1.1 million. The decline
      in
      the fair market value of securities available for sale is almost entirely due
      to
      the Company’s municipal securities portfolio. Due to the credit crisis and the
      impact on municipal debt issuance, the market for these securities is illiquid.
      We believe the unrealized loss on the municipal portfolio is temporary and
      due
      to market inactivity rather than the credit quality of the underlying issuers.


-
          12
          -


**COMPARISON
      OF RESULTS OF OPERATIONS FOR THE THREE MONTH PERIODS ENDED SEPTEMBER 30, 2008
      AND 2007**





**Net
      Income.** **** Net
      income for the three-month period ended September 30, 2008 is $746,000 compared
      to $1.6 million for the three-month period ended September 30, 2007. Diluted
      earnings per share for the current period are $.08 compared to $.16. Annualized
      return on average assets declined to 0.31% from 0.79% for the prior period.
      The
      decline is due to a net interest margin compression, strong loan growth funded
      by high cost money, an increase in the loan loss provision and higher
      non-interest expenses. Return on average equity for the current period is 3.12%
      compared to 7.04% for the prior period.





**Net
      Interest Income.**  Net
      interest income decreased by $466,000 from $6.8 million for the prior
      three-month period to $6.3 million for the three-month period ended September
      30, 2008. The additional interest income generated by a higher volume of earning
      assets was more than offset by the decline in net interest margin earned on
      those assets. Total interest expense from deposits and other borrowings
      increased as the cost of new interest bearing liabilities to fund earning asset
      growth was greater than the reduction experienced due to the lower interest
      rate
      environment. The Company’s net interest margin decreased from 3.72% to 2.89% due
      to a greater dependency on interest-bearing liabilities and a lower interest
      rate environment which has reduced the average yield on earning assets to a
      greater extent than the reduction in the Company’s cost of funds.





Total
      interest income decreased by $301,000 to $13.8 million for the current
      three-month period compared to $14.1 million for the prior year period. The
      net
      decline resulted from a $3.0 million decrease due to lower yields realized
      on
      earning assets and a $2.7 million increase in interest income due to the growth
      in total average earning assets. Total interest expense for the current period
      increased by $164,000 from $7.3 million to $7.6 million. The decrease was the
      net result of a $1.7 million decline due to the lower cost of money and a $1.8
      million increase due to growth in interest-bearing funds.





Total
      average earning assets increased $146.3 million or 20% from an average of $725.4
      million for the prior year three-month period to an average of $871.7 million
      for the three-month period ended September 30, 2008. The average balance of
      loans outstanding during the current quarter is $765.5 million, a $140.4 million
      or 22% increase over the $625.1 million of average outstanding loans for the
      prior year period. The average balance of the investment securities portfolio
      is
      $102.8 million, increasing by over $9.0 million or 10% compared to the prior
      period average of $93.7 million. The average balance of federal funds sold
      and
      other earning assets decreased to $3.4 million for the current three-month
      period compared to $6.5 million for the prior period.





Average
      interest-bearing liabilities increased by $152.9 million or 24% from $625.6
      million for the quarter ended September 30, 2007 to $778.5 million for the
      current quarter. Total interest-bearing deposits increased by $95.5 million
      or
      18% from $535.1 million to $630.6 million. Time deposits experienced the largest
      increase averaging $437.8 million during the current year period compared to
      $326.0 million for the prior period. Total borrowings increased by 63% or $57.4
      million from $90.5 million to $147.9 million.





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 September 30, 2008 is 2.89% compared to 3.72% for
      the
      three-month period ended September 30, 2007. The average yield on earning assets
      for the current three-month period decreased 141 basis points to 6.30% compared
      with 7.71% for the prior year period, while the average cost of interest-bearing
      funds decreased by only 81 basis points to 3.81% from 4.62%. The interest rate
      spread, which is the difference between the average yield on earning assets
      and
      the cost of interest-bearing funds, decreased by 61 basis points from 3.10%
      for
      the quarter ended September 30, 2007 to 2.49% for the quarter ended September
      30, 2008. The percentage of interest earning assets to average interest-bearing
      liabilities declined from 115.95% for the prior year period to 111.97% for
      the
      three months ended September 30, 2008. A decrease in the ratio of average
      earning assets to average interest-bearing liabilities indicates an increased
      dependency on interest-bearing forms of funding to meet the demand of earning
      asset growth.


-
          13
          -


Between
      mid September 2007 and April 30, 2008, the Federal Reserve (the “Fed”) decreased
      short-term interest rates seven times for a total of 325 basis points. Unlike
      the slow, measured approach to increasing interest rates between July 2004
      and
      July 2006, when each increase was in 25 basis point increments, four of the
      seven decreases came in the 50 to 75 basis point range. The interest rate cuts
      were in response to weakness being experienced in the US economy. Approximately
      50% 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 declined, variable rate loans have repriced downward resulting in a lower
      yield on average earning assets. While the yield on the variable portion of
      existing loans was falling with rate decreases, rates on new fixed rate loans
      were experiencing significant downward pressure due to loan competition in
      our
      high growth markets. On the liability side of the balance sheet, while we have
      decreased rates on our non-maturity deposits categories, our time deposits
      have
      fixed rates and are subject to contractual maturities and therefore reprice
      at a
      slower rate. Irrational time deposit pricing in our markets by banks
      experiencing liquidity problems have not permitted us to lower offering rates
      on
      new time deposits to the extent we would have anticipated in the falling rate
      environment. For these reasons, net interest margin has fallen over the past
      year.





Since
      the
      Company began almost ten years ago, we have focused on asset growth as the
      main
      driver of value. We are in the process of implementing a new strategic
      initiative which will focus our efforts towards becoming a high performing
      bank
      in terms of earnings and profitability measures. As a result of this new
      strategy, where risk-based loan pricing and core deposit generation play a
      more
      prevalent role, the rate of asset growth is likely to decline from our
      historical percentage growth rates. We would expect that over time, this
      strategy will yield higher net interest margins due to better loan pricing
      and a
      reduced reliance on high cost forms of funding. However, subsequent to September
      30 th ,
      the Fed
      lowered short-term interest rates by another 50 basis point which is likely
      to
      have an unfavorable impact on net interest margin in the short run.





**Provision
      for Loan Losses.** **** The
      Company’s provision for loan losses for the three-month period ended September
      30, 2008 is $1.3 million compared to $666,000 for the same period in 2007.
      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 due in part to the increase in loans outstanding during the quarter
      and specific reserves identified for individual credits whose quality showed
      some deterioration. The allowance for loan losses was $10.0 million at September
      30, 2008, representing 1.30% of total outstanding loans.





**Non-Interest
      Income.** **** For
      the
      three-month period ended September 30, 2008, non-interest income increased
      by
      $367,000 or 53% to $1.1 million compared to $689,000 for the same period in
      2007. Categories experiencing increases over the prior period include earnings
      on cash value of bank owned life insurance, customer service fees and mortgage
      loan origination fees. There are $121,000 of miscellaneous non-recurring fees
      included in other non-interest income.


-
          14
          -


**Non-Interest
      Expenses.** **** For
      the
      current three-month period, non-interest expenses increased by $664,000 or
      15%
      from $4.4 million to $5.1 million. The personnel and occupancy expense
      categories attribute $532,000 of the total increase reflecting the costs
      associated with branch expansion and additional lending and support staff.
      The
      Company has opened two new branch offices during the past year and moved one
      office to a more visible location. Salaries and benefits expense increased
      by
      $405,000 or 16% to $2.9 million for the current year period compared to $2.5
      million, and occupancy increased by $127,000 or 22% to $709,000 from $582,000.





**Provision
      for Income Taxes.** **** The
      Company has income tax expense of $306,000 for the three-months ended September
      30, 2008 compared with $868,000 for the prior year period. The effective tax
      rate for the three-month period ended September 30, 2008 was 29.1% compared
      with
      35.7% for the prior year period. The decrease in the effective tax rate is
      attributable to a larger percentage of tax exempt income compared with pre-tax
      income in the current quarter.





**COMPARISON
      OF RESULTS OF OPERATIONS FOR THE NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2008
      AND
      2007**





**Net
      Income.** **** Net
      income for the nine-month period ended September 30, 2008 is $2.8 million or
      $.29 per diluted share compared to $4.5 million or $0.47 per diluted share
      for
      the nine-month period ended September 30, 2007. Annualized return on average
      assets is 0.41% and 0.79% for the two periods ended September 30, 2008 and
      2007,
      respectively. The decline in return on assets is primarily attributed to the
      effects of a lower interest rate environment, the narrowing of spread between
      pricing on new loans and the cost to fund the loan growth and an increase in
      non-interest expenses. Return on average equity for the current period is 3.94%
      compared to 6.94% for the prior period. Return on average equity decreased
      due
      to a lower return on average assets.




**Net
      Interest Income.**  Net
      interest income is $19.2 million for the current nine-month period compared
      to
      $19.9 million for the prior period. Increased interest income that would be
      expected from strong growth in earning assets has been offset by both the lower
      interest rate environment and the increased volume of high cost deposits to
      fund
      the asset growth.





Total
      interest income is $40.7 million for the current nine-month period compared
      to
      $40.5 million for the prior year period, an increase of $239,000 or less than
      1%. The increase is comprised of a $7.6 million increase due to growth in
      average earning assets and a $7.4 million decrease due to the lower average
      yield earned on those assets. Total interest expense increased by $702,000
      or 3%
      from $20.8 million for the prior year period to $21.5 million for the current
      period. The increase is the result of a $5.0 million increase due to growth
      in
      interest-bearing liabilities and a $4.3 million decrease due to the lower
      interest rate environment.





Total
      average earning assets increased $136.1 million or 19% from an average of $698.6
      million as of September 30, 2007 to an average of $834.7 million for the
      nine-month period ended September 30, 2008. The average balance of loans
      outstanding during the current nine-month period is $728.9 million reflecting
      a
      $131.9 million or 22% increase over the $597.0 million for the prior year
      period. The average balance of the investment securities portfolio for the
      current period is $101.9 million, increasing by $10.6 million or 12% compared
      to
      an average of $91.3 million at September 30, 2007. The average balance of
      federal funds sold and other earning assets decreased to $3.9 million for the
      nine-month period ended September 30, 2008 compared to $10.3 million for the
      prior period.





Total
      average interest-bearing liabilities increased by $138.0 million or 23% from
      an
      average of $600.3 million for the period ended September 30, 2007 to $738.3
      million for the current nine-month period. Average interest-bearing deposits
      increased by $78.3 million or 15% growing from $519.2 million at September
      30,
      2007 to $597.5 million at September 30, 2008. Total average borrowings increased
      by $59.7 million or 74% to $140.7 million for the current nine-month period
      from
      $81.0 million for the prior year period.


-
          15
          -





The
      net
      interest margin for the nine-month period ended September 30, 2008 is 3.07%
      compared to 3.76% for the prior year nine-month period. The average yield on
      earning assets for the current nine-month period decline by 125 basis points
      to
      6.49% compared with 7.74% for the prior year period, while the average cost
      of
      interest-bearing funds decreased by only 74 basis points to 3.90% from 4.64%.
      The spread between the rates paid on earning assets and the cost of
      interest-bearing funds decreased by 50 basis points from 3.10% to 2.60%. The
      Company’s reliance on interest-bearing liabilities to fund earning asset growth
      increased as the percentage of interest earning assets to interest bearing
      liabilities declined from 116.39% to 113.07%.





**Provision
      for Loan Losses.** **** The
      Company’s provision for loan losses for the nine-month period ended September
      30, 2008 is $2.5 million compared to $1.3 million for the same period in 2007.
      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 nine-month period is primarily due to the increase in net loan
      growth and reserves for specific credits experiencing quality deterioration.
      See
      the section entitled “Non Performing Assets” for more details.





**Non-Interest
      Income.** **** For
      the
      nine-month period ended September 30, 2008, non-interest income increased by
      $717,000 to $2.7 million. The largest components of non-interest income are
      $996,000 in customer service fees, $512,000 in mortgage loan origination fees,
      $431,000 in earnings on cash value of bank owned life insurance and $181,000
      in
      deposit service charges. For the prior nine-month period, we recorded $829,000
      in customer service fees, $396,000 in mortgage loan origination fees, $281,000
      increase in cash surrender value on life insurance, and $177,000 in service
      charges and fees on deposit accounts. Other non interest income increased by
      $339,000 of which $238,000 represents non-recurring revenue.





**Non-Interest
      Expenses.** **** Non-interest
      expenses increased by 15% to $15.2 million for the nine-month period ended
      September 30, 2008 compared with $13.2 million for the same period ended
      September 30, 2007. The Company has added two branch locations, moved one office
      to a more visible location and increased both lending and support staff during
      the past twelve months. Increases in personnel and occupancy expenses account
      for 79% of the total rise in non-interest expenses. Salaries and benefits
      expense increased by $1.2 million or 16% to $8.6 million for the current
      nine-month period compared to $7.4 million for the prior year. Occupancy and
      equipment expenses increased by $334,000 or 19% to $2.0 for the current period
      compared to $1.7 million for the prior year period. Management anticipates
      both
      personnel and occupancy expense to increase in early to mid 2009 as we plan
      to
      open two new locations in Raleigh, North Carolina. Data processing costs
      increased by only $7,000 to $802,000.





Other
      non-interest expenses increased by $407,000 to $3.7 million for the first nine
      months of 2008 compared with $3.3 million for the prior year. The largest
      components of other non-interest expenses include professional fees and
      services, office supplies and printing, advertising, FDIC deposit insurance
      premiums 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. Due to changes in the assessment calculation and an
      increased deposit base, FDIC insurance premiums increased from $124,000 to
      $295,000. As the new temporary FDIC insurance limits of $250,000 are
      implemented, we anticipate that our assessments will increase two-fold.
      Approximately $218,000 of non-interest expense for the nine-month period ended
      September 30, 2007 were non-recurring in nature resulting from the conversion
      of
      Port City Capital Bank into Crescent State Bank and other professional services
      performed in conjunction with a regulatory compliance review.


-
          16
          -





**Provision
      for Income Taxes** **.** The
      Company recorded income tax expense of $1.3 million during the nine-months
      ended
      September 30, 2008 compared to $2.5 million for the prior year period. The
      effective tax rates for the two periods were 32.5% and 36.0%, respectively.
      The
      decrease is due to a larger percentage of income earned from tax exempt sources
      in the current nine-month period.


-
          17
          -




**NET
      INTEREST INCOME**





Net
      interest income represents the difference between income derived from
      interest-earning assets and interest expense incurred on interest-bearing
      liabilities. Net interest income is affected by both (1) the difference between
      the rates of interest earned on interest-earning assets and the rates paid
      on
      interest-bearing liabilities (“interest rate spread”) and (2) the relative
      amounts of interest-earning assets and interest-bearing liabilities (“net
      interest-earning balance”). The following tables set forth information relating
      to average balances of the Company's assets and liabilities for the three and
      nine-month periods ended September 30, 2008 and 2007. The tables reflect the
      average yield on interest-earning assets and the average cost of
      interest-bearing liabilities (derived by dividing income or expense by the
      daily
      average balance of interest-earning assets or interest-bearing liabilities,
      respectively) as well as the net interest margin. In preparing the tables,
      non-accrual loans are included, when applicable, in the average loan balance.
      For purposes of the analysis, Federal Home Loan Bank stock is included in
      Investment Securities totals.





Average
      Balances, Interest and Average Yields/Cost


(Dollars
      in Thousands)





For
                the Three Months Ended September 30,2008
            
            2007Average
            
            
            
            Average
            
            Average
            
            
            
            AverageBalance
            
            Interest
            
            Yield/Cost
            
            Balance
            
            Interest
            
            Yield/CostInterest-earnings
                assetsLoan
                portfolio
            
            $
            765,539
            
            $
            12,571
            
            
            6.53
            %
            $
            625,116
            
            $
            12,867
            
            
            8.17
            %Investment
                securities
            
            
            102,764
            
            
            1,206
            
            
            4.69
            %
            
            93,739
            
            
            1,142
            
            
            4.87
            %Fed
                funds and other interest-earning assets
            
            
            3,420
            
            
            17
            
            
            1.98
            %
            
            6,541
            
            
            86
            
            
            5.22
            %Total
                interest-earning assets
            
            
            871,723
            
            
            13,794
            
            
            6.30
            %
            
            725,396
            
            
            14,095
            
            
            7.71
            %Noninterest-bearing
                assets
            
            
            69,594
            
            
            
            
            
            
            
            
            62,133Total
                Assets
            
            $
            941,317
            
            
            
            
            
            
            
            $
            787,529Interest-bearing
                liabilitiesInterest-bearing
                NOW
            
            $
            34,506
            
            
            10
            
            
            0.12
            %
            $
            32,879
            
            
            83
            
            
            1.00
            %Money
                market and savings
            
            
            158,346
            
            
            1,067
            
            
            2.68
            %
            
            176,243
            
            
            1,827
            
            
            4.11
            %Time
                deposits
            
            
            437,762
            
            
            4,876
            
            
            4.43
            %
            
            325,972
            
            
            4,211
            
            
            5.13
            %Short-term
                borrowings
            
            
            14,803
            
            
            126
            
            
            3.39
            %
            
            10,982
            
            
            149
            
            
            5.31
            %Long-term
                debt
            
            
            133,112
            
            
            1,372
            
            
            4.03
            %
            
            79,509
            
            
            1,017
            
            
            5.01
            %Total
                interest-bearing liabilities
            
            
            778,529
            
            
            7,451
            
            
            3.81
            %
            
            625,585
            
            
            7,287
            
            
            4.62
            %Non-interest
                bearing deposits
            
            
            64,469
            
            
            
            
            
            
            
            
            70,640Other
                liabilities
            
            
            3,495
            
            
            
            
            
            
            
            
            3,287Total
                Liabilities
            
            
            846,493
            
            
            
            
            
            
            
            
            699,512Stockholders'
                Equity
            
            
            94,824
            
            
            
            
            
            
            
            
            88,017Total
                Liabilities & Stockholders' Equity
            
            $
            941,317
            
            
            
            
            
            
            
            $
            787,529Net
                interest income
            
            
            
            
            $
            6,343
            
            
            
            
            
            
            
            $
            6,808Interest
                rate spread
            
            
            
            
            
            
            
            
            2.49
            %
            
            
            
            
            
            
            
            3.10
            %Net
                interest-margin
            
            
            
            
            
            
            
            
            2.89
            %
            
            
            
            
            
            
            
            3.72
            %Percentage
                of average interest-earning assets to average interest-bearing
                liabilities
            
            
            
            
            
            
            
            
            111.97
            %
            
            
            
            
            
            
            
            115.95
            %


-
          18
          -





Average
      Balances, Interest and Average Yields/Cost


(Dollars
      in Thousands)





For
                the Nine Months Ended September 30,2008
            
            2007Average
            
            
            
            Average
            
            Average
            
            
            
            AverageBalance
            
            Interest
            
            Yield/Cost
            
            Balance
            
            Interest
            
            Yield/CostInterest-earnings
                assetsLoan
                portfolio
            
            $
            728,901
            
            $
            36,978
            
            
            6.78
            %
            $
            597,043
            
            $
            36,773
            
            
            8.23
            %Investment
                securities
            
            
            101,916
            
            
            3,640
            
            
            4.76
            %
            
            91,300
            
            
            3,299
            
            
            4.82
            %Fed
                funds and other interest-earning assets
            
            
            3,920
            
            
            75
            
            
            2.56
            %
            
            10,291
            
            
            382
            
            
            4.96
            %Total
                earning assets
            
            
            834,737
            
            
            40,693
            
            
            6.49
            %
            
            698,634
            
            
            40,454
            
            
            7.74
            %Noninterest-bearing
                assets
            
            
            66,405
            
            
            
            
            
            
            
            
            61,377Total
                Assets
            
            $
            901,142
            
            
            
            
            
            
            
            $
            760,011Interest-bearing
                liabilitiesInterest-bearing
                NOW
            
            $
            34,727
            
            
            41
            
            
            0.16
            %
            $
            34,025
            
            
            280
            
            
            1.10
            %Money
                market and savings
            
            
            158,888
            
            
            3,140
            
            
            2.64
            %
            
            161,317
            
            
            5,050
            
            
            4.19
            %Time
                deposits
            
            
            403,903
            
            
            13,984
            
            
            4.62
            %
            
            323,869
            
            
            12,317
            
            
            5.08
            %Short-term
                borrowings
            
            
            14,274
            
            
            333
            
            
            3.12
            %
            
            16,856
            
            
            648
            
            
            5.14
            %Long-term
                debt
            
            
            126,436
            
            
            4,036
            
            
            4.19
            %
            
            64,193
            
            
            2,537
            
            
            5.21
            %Total
                interest-bearing liabilities
            
            
            738,228
            
            
            21,534
            
            
            3.90
            %
            
            600,260
            
            
            20,832
            
            
            4.64
            %Non
                interest-bearing deposits
            
            
            65,562
            
            
            
            
            
            
            
            
            70,387Other
                liabilities
            
            
            3,138
            
            
            
            
            
            
            
            
            3,159Total
                Liabilities
            
            
            806,928
            
            
            
            
            
            
            
            
            673,806Stockholders'
                Equity
            
            
            94,214
            
            
            
            
            
            
            
            
            86,205Total
                Liabilities & Stockholders' Equity
            
            $
            901,142
            
            
            
            
            
            
            
            $
            760,011Net
                interest income
            
            
            
            
            $
            19,159
            
            
            
            
            
            
            
            $
            19,622Interest
                rate spread
            
            
            
            
            
            
            
            
            2.60
            %
            
            
            
            
            
            
            
            3.10
            %Net
                margin
            
            
            
            
            
            
            
            
            3.07
            %
            
            
            
            
            
            
            
            3.76
            %Percentage
                of average interest-earning assets to average interest bearing
                liabilities
            
            
            
            
            
            
            
            
            113.07
            %
            
            
            
            
            
            
            
            116.39
            %





**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 nine-month periods ended
      September 30, 2008 and 2007. 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.


-
          19
          -





Rate/Volume
      Analysis





Three
                Months Ended September 30,2008
                vs. 2007(in
                Thousands)Increase
                (Decrease) Due toVolume
            
            Rate
            
            Total**Interest
                Income**Loan
                portfolio
            
            
            2,577
            
            
            (2,873
            )
            
            (296
            )Investment
                Securities
            
            
            109
            
            
            (45
            )
            
            64Fed
                funds and other interest-earning assets
            
            
            (29
            )
            
            (40
            )
            
            (69
            )Total
                interest-earning assets
            
            
            2,657
            
            
            (2,958
            )
            
            (301
            )**Interest
                Expense**Interest-bearing
                NOW
            
            
            2
            
            
            (75
            )
            
            (73
            )Money
                market and savings
            
            
            (156
            )
            
            (604
            )
            
            (760
            )Time
                deposits
            
            
            1,337
            
            
            (672
            )
            
            665Short-term
                borrowings
            
            
            41
            
            
            (64
            )
            
            (23
            )Long-term
                debt
            
            
            612
            
            
            (257
            )
            
            355Total
                interest-bearing liabilities
            
            
            1,836
            
            
            (1,672
            )
            
            164**Net
                interest income**
            
            
            821
            
            
            (1,286
            )
            
            (465
            )





Rate/Volume
      Analysis





Nine
                Months Ended September 30,2008
                vs. 2007(in
                Thousands)Increase
                (Decrease) Due toVolume
            
            Rate
            
            Total**Interest
                Income**Loan
                portfolio
            
            
            7,426
            
            
            (7,221
            )
            
            205Investment
                Securities
            
            
            381
            
            
            (40
            )
            
            341Fed
                funds and other interest-earning assets
            
            
            (179
            )
            
            (128
            )
            
            (307
            )Total
                interest-earning assets
            
            
            7,628
            
            
            (7,389
            )
            
            239**Interest
                Expense**Interest-bearing
                NOW
            
            
            4
            
            
            (243
            )
            
            (239
            )Money
                market and savings
            
            
            (60
            )
            
            (1,850
            )
            
            (1,910
            )Time
                deposits
            
            
            2,915
            
            
            (1,248
            )
            
            1,667Short-term
                borrowings
            
            
            (80
            )
            
            (235
            )
            
            (315
            )Long-term
                debt
            
            
            2,208
            
            
            (709
            )
            
            1,499Total
                interest-bearing liabilities
            
            
            4,987
            
            
            (4,285
            )
            
            702**Net
                interest income**
            
            
            2,641
            
            
            (3,104
            )
            
            (463
            )


-
          20
          -


**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
                September 30,
            
            At
                December 31,2008
            
            2007
            
            2007
            
            2006(Dollars
                in thousands)Nonaccrual
                loans
            
            $
            2,771
            
            $
            1,428
            
            $
            2,726
            
            $
            135Restructured
                loans
            
            
            -
            
            
            -
            
            
            -
            
            
            -Total
                nonperforming loans
            
            
            2,771
            
            
            1,428
            
            
            2,726
            
            
            135Real
                estate owned
            
            
            1,870
            
            
            249
            
            
            272
            
            
            98Repossessed
                assets
            
            
            -
            
            
            14
            
            
            -
            
            
            -Total
                nonperforming assets
            
            $
            4,641
            
            $
            1,691
            
            $
            2,998
            
            $
            233Accruing
                loans past due 90 days or more
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -Allowance
                for loan losses
            
            
            9,988
            
            
            8,190
            
            
            8,273
            
            
            6,945Nonperforming
                loans to period end loans
            
            
            0.36
            %
            
            0.22
            %
            
            0.40
            %
            
            0.02
            %Allowance
                for loan losses to period end loans
            
            
            1.30
            %
            
            1.26
            %
            
            1.22
            %
            
            1.26
            %Allowance
                for loan losses to nonperforming loans
            
            
            360
            %
            
            573
            %
            
            303
            %
            
            5,145
            %Nonperforming
                assets to total assets
            
            
            0.49
            %
            
            0.21
            %
            
            0.36
            %
            
            0.03
            %Nonperforming
                assets and loans past due 90 days or more to total assets
            
            
            0.49
            %
            
            0.21
            %
            
            0.36
            %
            
            0.03
            %





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 September 30, 2008, we identified sixteen loans
      totaling $4.9 million as potential problem loans.


-
          21
          -


At
      September 30, 2008, there were seven foreclosed properties valued at a total
      of
      $1.9 million and eight nonaccrual loans totaling $2.8 million. Interest foregone
      on nonaccrual loans for the nine-month period ended September 30, 2008 was
      $115,000. At September 30, 2007, there were six foreclosed properties valued
      at
      $249,000 and eleven nonaccrual loans totaling $1.4 million. Interest foregone
      on
      nonaccrual loans for the nine-month period ended September 30, 2007 was
      approximately $45,100.





**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.





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 with *Statement
      of Financial Accounting Standards (SFAS) 114, “Accounting by Creditors for
      Impairment of a Loan.”* Each
      collateral dependent 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.


-
          22
          -


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 nine-month period ended September 30, 2008, there were net
      loan charge-offs of $832,000 compared with $102,000 for the prior year.
      Charge-offs have increased due to softening economic conditions throughout
      our
      franchise. The allowance for loan losses at September 30, 2008 was $10.0
      million, which represents 1.30% of total loans outstanding compared to $8.2
      million or 1.26% for the prior year.





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





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





Allocation
      of Allowance for Loan Losses





At
                September 30,
            
            At
                December 31,2008
            
            2007%
                of Total
            
            
            
            %
                of TotalAmount
            
            Loans
                (1)
            
            Amount
            
            Loans
                (1)(Dollars
                in thousands)Residential
                real estate loans
            
            $
            92
            
            
            2.46
            %
            $
            130
            
            
            2.70
            %Home
                equity loans and lines
            
            
            405
            
            
            7.08
            %
            
            334
            
            
            6.69
            %Commercial
                mortgage loans
            
            
            5,120
            
            
            56.00
            %
            
            3,771
            
            
            51.85
            %Construction
                loans
            
            
            2,235
            
            
            22.89
            %
            
            2,362
            
            
            27.18
            %Commercial
                and industrial loans
            
            
            1,999
            
            
            10.83
            %
            
            1,536
            
            
            10.77
            %Loans
                to individuals
            
            
            137
            
            
            0.74
            %
            
            140
            
            
            0.81
            %Total
                allowance
            
            $
            9,988
            
            
            100.00
            %
            $
            8,273
            
            
            100.00
            %





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


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          23
          -


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





Changes
      in Allowance for Loan Losses





**For the Nine-Month Period Ended September 30,**2008
            
            2007(Dollars
                in thousands)Balance
                at the beginning of the period
            
            $
            8,273
            
            $
            6,945Charge-offs:Commercial
                and industrial loans
            
            
            167
            
            
            88Home
                equity loans and lines
            
            
            -
            
            
            11Commercial
                real estate loans
            
            
            91
            
            
            -Construction,
                acquisition and development
            
            
            569
            
            
            -Consumer
                loans
            
            
            17
            
            
            4Total
                charge-offs
            
            
            844
            
            
            103Recoveries
            
            
            12
            
            
            1Net
                charge-offs
            
            
            832
            
            
            102Provision
                for loan losses
            
            
            2,547
            
            
            1,347Balance
                at the end of the period
            
            $
            9,988
            
            $
            8,190Total
                loans outstanding at period-end
            
            $
            769,060
            
            $
            651,652Average
                loans outstanding for the period
            
            $
            728,901
            
            $
            597,043Allowance
                for loan losses to total loans outstanding
            
            
            1.30
            %
            
            1.26
            %Annualized
                ratio of net charge-offs to average loans outstanding
            
            
            0.15
            %
            
            0.02
            %





**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.


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          24
          -


As
      of
      September 30, 2008, liquid assets (cash and due from banks, interest-earning
      deposits with banks and investment securities available for sale) were
      approximately $118.5 million, which represents 12% of total assets and 17%
      of
      total deposits. Supplementing this liquidity, the Company has available lines
      of
      credit from various correspondent banks of approximately $256.0 million of
      which
      $137.5 million is outstanding at September 30, 2008. Outstanding commitments
      for
      undisbursed lines of credit, letters of credit and undisbursed investment
      commitments amounted to approximately $184.5 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 64% of the Company’s total
      deposits at September 30, 2008 compared with 57% at December 31, 2007. 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 52% and 42%
      of
      the Company’s total deposits at September 30, 2008 and December 31, 2007,
      respectively. While these deposits are generally considered rate sensitive
      and
      the Company will need to pay competitive rates to retain these deposits at
      maturity, there are other subjective factors that will determine the Company’s
      continued retention of those deposits.





Under
      federal capital regulations, Crescent Financial Corporation must satisfy certain
      minimum leverage ratio requirements and risk-based capital requirements. At
      September 30, 2008, the Company’s equity to asset ratio is 9.85%. The Company’s
      ratios of Tier 1 capital to risk-weighted assets and total capital to risk-based
      assets are 8.66% and 10.77%, 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 8.84%
      and
      10.95%, 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.





*Emergency
      Economic Stabilization Act*


The
      Emergency Economic Stabilization Act of 2008 (EESA) was enacted on October
      3,
      2008. The purpose of this law is to restore liquidity and stability to the
      financial system, while minimizing any potential long term negative impact
      on
      taxpayers. The law authorizes the United States Secretary of Treasury to spend
      up to $700 billion to purchase distressed assets, especially mortgage-backed
      securities, from the nation's banks. The program under which the asset purchase
      will be administered is referred to as the Troubled Asset Relief Program
      (TARP).


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          25
          -


The
      law
      also temporarily raises the basic limit on federal deposit insurance coverage
      from $100,000 to $250,000 per depositor. The higher insurance limits took effect
      immediately and will be in effect through December 31, 2009. Additionally,
      the
      Federal Deposit Insurance Corporation (FDIC) announced on October 14, 2008,
      a
      new program aimed at strengthening consumer confidence and encouraging liquidity
      in the banking system.





The
      Temporary Liquidity Guarantee Program (TLGP) guarantees newly issued senior
      unsecured debt of banks, thrifts, and certain holding companies, and provides
      full coverage of non-interest bearing deposit transaction accounts, regardless
      of dollar amount. The program provides a three year guarantee of newly issued
      debt and increased insurance coverage through December 31, 2009. This
      two-pronged program will be funded through special fees paid by the financial
      institutions participating. The Company must decide whether to participate
      in
      one, both or none of these phases of the program by December 5, 2008.




Also
      on
      October 14, 2008, the US Department of Treasury announced a voluntary Capital
      Purchase Program (CPP) to encourage U.S. financial institutions to build capital
      to increase the flow of financing to U.S. businesses and consumers and to
      support the U.S. economy. Treasury will purchase up to $250 billion of senior
      preferred stock. The program will be available to qualifying U.S. controlled
      banks, savings associations, and certain bank and savings and loan holding
      companies engaged only in financial activities that elect to participate on
      November 14, 2008. Treasury will determine eligibility and allocations for
      interested parties after consultation with the appropriate federal banking
      agency. The minimum subscription amount available to a participating institution
      is 1 percent of risk-weighted assets. The maximum subscription amount is the
      lesser of $25 billion or 3 percent of risk-weighted assets. Treasury will fund
      the senior preferred shares purchased under the program by year-end
      2008.




The
      senior preferred shares will qualify as Tier 1 capital and will rank senior
      to
      common stock. The senior preferred shares will pay a cumulative dividend rate
      of
      5 percent per annum for the first five years and will reset to a rate of 9
      percent per annum after year five. The senior preferred shares will be
      non-voting, other than class voting rights on matters that could adversely
      affect the shares. The senior preferred shares will be callable at par after
      three years. Prior to the end of three years, the senior preferred may be
      redeemed with the proceeds from a qualifying equity offering of any Tier 1
      perpetual preferred or common stock. Treasury may also transfer the senior
      preferred shares to a third party at any time. In conjunction with the purchase
      of senior preferred shares, Treasury will receive warrants to purchase common
      stock with an aggregate market price equal to 15 percent of the senior preferred
      investment. The exercise price on the warrants will be the market price of
      the
      participating institution's common stock at the time of issuance, calculated
      on
      a 20-trading day trailing average. Only institutions deemed to be “healthy” will
      be eligible to participate in the CPP.




Participation
      in these various programs carries certain restrictions with respect to the
      payment of dividends to common shareholders and executive compensation.
      Management and the Board are currently evaluating the programs but believe
      it
      may participate in the CPP and at least one aspect of the TLGP.


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          26
          -


**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, 2007.





**Item
      4. Controls and Procedures**





Crescent
      Financial Corporation’s management, with the participation of the Chief
      Executive Officer and Principal Financial Officer, has evaluated the
      effectiveness of the Company’s disclosure controls and procedures as of
      September 30, 2008. Based on that evaluation, the Company’s Chief Executive
      Officer and Principal Financial Officer concluded that the Company’s disclosure
      controls and procedures were effective, as of September 30, 2008, to provide
      reasonable assurance that information required to be disclosed by the Company
      in
      the reports filed or submitted by it under the Exchange Act is recorded,
      processed, summarized and reported within the time periods specified in the
      SEC’s rules and forms, and to provide reasonable assurance that information
      required to be disclosed by the Company in such reports is accumulated and
      communicated to the Company’s management, including its principal executive
      officer and principal financial officer, as appropriate to allow timely
      decisions regarding required disclosure.





The
      Company assesses the adequacy of its internal control over financial reporting
      quarterly and enhances its controls in response to internal control assessments
      and internal and external audit and regulatory recommendations. There have
      been
      no changes in the Company’s internal controls during the quarter ended September
      30, 2008 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.


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          27
          -


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





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


None.





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





***The
      effects of the U.S. government’s plan to purchase large amounts of illiquid,
      mortgage-backed and other securities from financial institutions are unknown
      at
      this time.***





In
      response to the financial crises affecting the banking system and financial
      markets and the going concern threats to the ability of investment banks and
      other financial institutions, the U.S. Congress adopted the new Emergency
      Economic Stabilization Act of 2008 (“EESA”). The primary feature of the EESA is
      the establishment of a troubled asset relief program (“TARP”), under which the
      U.S. Treasury Department will purchase up to $700 billion of troubled assets,
      including mortgage-backed and other securities, from financial institutions
      for
      the purpose of stabilizing the financial markets and to purchase capital stock
      from these financial institutions. There can be no assurance as to what impact
      it will have on the financial markets, including the extreme levels of
      volatility currently being experienced. The failure of the U.S. government
      to
      execute this program expeditiously could have a material adverse effect on
      the
      financial markets, which in turn could materially and adversely affect the
      Company’s business, financial condition and results of operations. Since all the
      rules and guidelines of the TARP have not yet been published, the Company is
      unable to fully assess the program at this time.





***The
      U.S. government’s plan to provide TARP Senior Preferred Stock capital to
      financial institutions may not be available to the
      Company.***





The
      Company is considering whether to apply for TARP Senior Preferred Stock capital
      which may be furnished by the U. S. Treasury, however, no assurances can be
      given that this capital will be available to the Company.





**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.


-
          28
          -


**Item
      6.**  **Exhibits**





(a)  Exhibits.





18.1
            
            Preferability
                Letter Regarding Change in Accounting Policy Relating to
                Goodwill31.1
            
            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 200232.2
            
            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


-
          29
          -





**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:
                November 5, 2008
            By:
            /s/
                Michael G. CarltonMichael
                G. CarltonPresident
                and Chief Executive OfficerDate:
                November 5, 2008
            By:
            /s/
                Bruce W. ElderBruce
                W. ElderPrincipal
                Financial Officer


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          30
          -