UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
DC  20549





FORM
10-Q





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





For
      the Quarterly Period Ended March 31,
      2010





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





Commission
File Number 000-32951





CRESCENT FINANCIAL
CORPORATION


(Exact
name of registrant as specified in its charter)





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




1005 HIGH HOUSE ROAD, CARY,
NORTH CAROLINA


27513


(Address
of principal executive offices)


(Zip
Code)





(919)
460-7770


(Registrant’s
telephone number, including area code)





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.


Yes x        No
o





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





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




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





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


Yes o       No x





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





Common
Stock, $1.00 par value 9,626,559 shares outstanding as of May 12,
2010.









CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 TABLE
OF CONTENTS





Page
      No.Part
      I.
            
            FINANCIAL
      INFORMATION
            
            3Item
      1 -
            
            Financial
      Statements (Unaudited)
            
            3Consolidated
      Balance Sheets March 31, 2010 (unaudited) and December 31,
      2009
            
            3Consolidated
      Statements of Operations Three Months Ended March 31, 2010 and 2009
      (unaudited)
            
            4Consolidated
      Statements of Comprehensive Income Three Months Ended March 31, 2010
      and 2009 (unaudited)
            
            5Consolidated
      Statement of Stockholders’ Equity Three Months Ended March 31, 2010
      (unaudited)
            
            6Consolidated
      Statements of Cash Flows Three Months Ended March 31, 2010 and 2009
      (unaudited)
            
            7Notes
      to Consolidated Financial Statements
            
            8 -
      20Item
      2 -
            
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            
            21
      – 35Item
      3 -
            
            Quantitative
      and Qualitative Disclosures about Market Risk
            
            36Item
      4T -
            
            Controls
      and Procedures
            
            36Part
      II.
            
            Other
      Information
            
            37Item
      1 -
            
            Legal
      Proceedings
            
            37Item
      1a -
            
            Risk
      Factors
            
            37Item
      2 -
            
            Unregistered
      Sales of Equity Securities and Use of Proceeds
            
            37Item
      3 -
            
            Defaults
      Upon Senior Debt
            
            37Item
      4 -
            
            (Removed
      and Reserved)
            
            37Item
      5 -
            
            Other
      Information
            
            37Item
      6 -
            
            Exhibits
            
            37




-2-




Part
I. FINANCIAL INFORMATION




Item 1 - Financial
Statements





CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 CONSOLIDATED
BALANCE SHEETS





March
      31,
            
            
            December
      31,2010
            
            
            
            2009*(Unaudited)ASSETSCash
      and due from banks
            
            $
            9,963,573
            
            
            $
            9,285,386Interest-earning
      deposits with banks
            
            
            884,184
            
            
            
            4,616,722Federal
      funds sold
            
            
            15,785,000
            
            
            
            17,825,000Investment
      securities available for sale, at fair value
            
            
            188,609,010
            
            
            
            193,122,891Loans
      held for sale
            
            
            137,700
            
            
            
            -Loans
            
            
            744,484,212
            
            
            
            759,348,341Allowance
      for loan losses
            
            
            (16,807,000
            )
            
            
            (17,567,000
            )NET
      LOANS
            
            
            727,677,212
            
            
            
            741,781,341Accrued
      interest receivable
            
            
            4,121,131
            
            
            
            4,260,258Federal
      Home Loan Bank stock, at cost
            
            
            11,776,500
            
            
            
            11,776,500Bank
      premises and equipment
            
            
            12,002,461
            
            
            
            11,861,158Investment
      in life insurance
            
            
            17,862,724
            
            
            
            17,658,386Other
      assets
            
            
            22,315,740
            
            
            
            20,617,367TOTAL
      ASSETS
            
            $
            1,011,135,235
            
            
            $
            1,032,805,009LIABILITIES
      AND STOCKHOLDERS’ EQUITYDeposits:Demand
            
            $
            55,421,676
            
            
            $
            61,041,955Savings
            
            
            61,893,862
            
            
            
            58,086,102Money
      market and NOW
            
            
            182,701,744
            
            
            
            165,994,207Time
            
            
            413,739,869
            
            
            
            437,512,354TOTAL
      DEPOSITS
            
            
            713,757,151
            
            
            
            722,634,618Short-term
      borrowings
            
            
            57,000,000
            
            
            
            74,000,000Long-term
      debt
            
            
            145,748,000
            
            
            
            142,748,000Accrued
      expenses and other liabilities
            
            
            4,157,750
            
            
            
            3,902,185TOTAL
      LIABILITIES
            
            
            920,662,901
            
            
            
            943,284,803Commitments
      (Note B)Stockholders’
      EquityPreferred stock, no par value,
      5,000,000 shares authorized,24,900 shares issued and
      outstanding
            
            
            23,043,533
            
            
            
            22,935,514Common stock, $1 par value,
      20,000,000 shares authorized;9,626,559 shares issued and
      outstandingat both March 31, 2010 and
      December 31, 2009
            
            
            9,626,559
            
            
            
            9,626,559Common
      stock warrant
            
            
            2,367,368
            
            
            
            2,367,368Additional
      paid-in capital
            
            
            74,561,861
            
            
            
            74,529,894Accumulated
      deficit
            
            
            (21,230,917
            )
            
            
            (21,354,080
            )Accumulated
      other comprehensive income
            
            
            2,103,930
            
            
            
            1,414,951TOTAL
      STOCKHOLDERS’ EQUITY
            
            
            90,472,334
            
            
            
            89,520,206TOTAL
      LIABILITIES AND STOCKHOLDERS’ EQUITY
            
            $
            1,011,135,235
            
            
            $
            1,032,805,009








* Derived
from audited consolidated financial statements.





See accompanying
notes.




-3-





CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 CONSOLIDATED
STATEMENTS OF OPERATIONS (Unaudited)
 Three
Months Ended March 31, 2010 and 2009





2010
            
            
            2009INTEREST
      INCOMELoans
            
            $
            11,484,041
            
            
            $
            12,077,058Investment
      securities available for sale
            
            
            1,936,330
            
            
            
            1,999,023Federal
      funds sold and interest-earning deposits
            
            
            4,686
            
            
            
            2,037TOTAL
      INTEREST INCOME
            
            
            13,425,057
            
            
            
            14,078,118INTEREST
      EXPENSEDeposits
            
            
            4,345,601
            
            
            
            5,242,936Short-term
      borrowings
            
            
            206,281
            
            
            
            463,332Long-term
      borrowings
            
            
            1,412,155
            
            
            
            1,140,459TOTAL
      INTEREST EXPENSE
            
            
            5,964,037
            
            
            
            6,846,727NET
      INTEREST INCOME
            
            
            7,461,020
            
            
            
            7,231,391PROVISION
      FOR LOAN LOSSES
            
            
            1,801,177
            
            
            
            1,696,685NET
      INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
            
            
            5,659,843
            
            
            
            5,534,706NON-INTEREST
      INCOMEMortgage
      loan origination revenue
            
            
            192,909
            
            
            
            296,472Fees
      on deposit accounts
            
            
            431,939
            
            
            
            388,002Earnings
      on life insurance
            
            
            217,432
            
            
            
            207,455Gain
      (loss) on disposal of assets
            
            
            7,000
            
            
            
            (500
            )Gain
      on sale of loans
            
            
            44,200
            
            
            
            -Loss
      on impairment of nonmarketable equity security
            
            
            -
            
            
            
            (188,040
            )Other
            
            
            152,229
            
            
            
            84,786TOTAL
      NON-INTEREST INCOME
            
            
            1,045,709
            
            
            
            788,175NON-INTEREST
      EXPENSESalaries
      and employee benefits
            
            
            3,129,752
            
            
            
            2,971,098Occupancy
      and equipment
            
            
            957,180
            
            
            
            750,960Data
      processing
            
            
            386,328
            
            
            
            449,500FDIC
      insurance premiums
            
            
            308,680
            
            
            
            248,720Other
            
            
            1,403,980
            
            
            
            1,197,522TOTAL
      NON-INTEREST EXPENSE
            
            
            6,185,920
            
            
            
            5,617,800INCOME
      BEFORE INCOME TAXES
            
            
            519,632
            
            
            
            705,081INCOME
      TAXES (BENEFIT)
            
            
            (22,800
            )
            
            
            94,100NET
      INCOME
            
            
            542,432
            
            
            
            610,981Effective
      dividend on preferred stock (Note G)
            
            
            419,269
            
            
            
            168,105Net
      income available to common shareholders
            
            $
            123,163
            
            
            $
            442,876NET
      INCOME PER COMMON SHAREBasic
            
            $
            0.01
            
            
            $
            .05Diluted
            
            $
            0.01
            
            
            $
            .05WEIGHTED
      AVERAGE COMMON SHARES OUTSTANDING (Note C)Basic
            
            
            9,574,264
            
            
            
            9,569,290Diluted
            
            
            9,587,748
            
            
            
            9,581,873








-4-




CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 CONSOLIDATED
STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
 Three
Months Ended March 31, 2010 and 2009





2010
            
            
            2009Net
      income
            
            $
            542,432
            
            
            $
            610,981Other
      comprehensive income (loss):Securities
      available for sale:Unrealized
      holding gains (losses) on available for sale
    securities
            
            
            1,265,489
            
            
            
            (80,459
            )Tax
      effect
            
            
            (487,846
            )
            
            
            31,017Net
      of tax amount
            
            
            777,643
            
            
            
            (49,442
            )Cash
      flow hedging activities:Unrealized
      holding loss on cash flow hedging activities
            
            
            (144,287
            )
            
            
            -Tax
      effect
            
            
            55,623
            
            
            
            -Net
      of tax amount
            
            
            (88,664
            )
            
            
            -Total
      other comprehensive income (loss)
            
            
            688,979
            
            
            
            (49,442
            )COMPREHENSIVE
      INCOME
            
            $
            1,231,411
            
            
            $
            561,539







-5-





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


AccumulatedCommon
              
              
              Additional
              
              
              
              
              
              other
              
              
              TotalPreferred
      stock
              
              
              Common
      stock
              
              
              stock
              
              
              paid-in
              
              
              Accumulated
              
              
              comprehensive
              
              
              stockholders’Shares
              
              
              Amount
              
              
              Shares
              
              
              Amount
              
              
              warrants
              
              
              capital
              
              
              deficit
              
              
              income
              
              
              equityBalance
      at December 31, 2009
              
              
              24,900
              
              
              $
              22,935,514
              
              
              
              9,626,559
              
              
              $
              9,626,559
              
              
              $
              2,367,368
              
              
              $
              74,529,894
              
              
              $
              (21,354,080
              )
              
              $
              1,414,951
      $
              
              
              
              89,520,206Net
      income
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              542,432
              
              
              
              -
              
              
              
              542,432Other
      comprehensive income
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              688,979
              
              
              
              688,979Expense
      recognized in connection with stock options and restricted
      stock
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              31,967
              
              
              
              -
              
              
              
              -
              
              
              
              31,967Accretion
      of discount
              
              
              -
              
              
              
              108,019
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (108,019
              )
              
              
              -
              
              
              
              -Preferred
      stock dividend
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (311,250
              )
              
              
              -
              
              
              
              (311,250
              )Balance
      at March 31, 2010
              
              
              24,900
              
              
              $
              23,043,533
              
              
              
              9,626,559
              
              
              $
              9,626,559
              
              
              $
              2,367,368
              
              
              $
              74,561,861
              
              
              $
              (21,230,917
              )
              
              $
              2,103,930
      $
              
              
              
              90,472,334








-6-


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 CONSOLIDATED
STATEMENTS OF CASH FLOWS (Unaudited)
 Three
Months Ended March 31, 2010 and 2009





2010
            
            
            2009CASH
      FLOWS FROM OPERATING ACTIVITIESNet
      income
            
            $
            542,432
            
            
            $
            610,981Adjustments
      to reconcile net income to net cash provided by operating
      activities:Depreciation
            
            
            239,659
            
            
            
            198,703Provision
      for loan losses
            
            
            1,801,177
            
            
            
            1,696,685Net
      gain on sales of mortgage loans
            
            
            (44,200
            )
            
            
            -Originations
      of mortgage loans held-for-sale
            
            
            (1,266,561
            )
            
            
            -Proceeds
      from sales of mortgage loans
            
            
            1,140,266
            
            
            
            -Amortization
      of core deposit premium
            
            
            33,337
            
            
            
            33,337Deferred
      income taxes
            
            
            (55,622
            )
            
            
            169,812Loss
      on impairment of nonmarketable equity security
            
            
            -
            
            
            
            188,040Loss
      on disposal of other real estate owned
            
            
            32,919
            
            
            
            25,000(Gain)
      loss on disposal of assets
            
            
            (7,000
            )
            
            
            500Net
      amortization of premiums/discounts on securities
            
            
            333,781
            
            
            
            174,807Accretion
      of loan discount
            
            
            (416,958
            )
            
            
            (109,955
            )Amortization
      of deposit premium
            
            
            10,108
            
            
            
            27,433Net
      increase in cash value of life insurance
            
            
            (204,338
            )
            
            
            (199,014
            )Stock
      based compensation
            
            
            31,967
            
            
            
            44,761Change
      in assets and liabilities:(Increase)
      decrease in accrued interest receivable
            
            
            139,128
            
            
            
            (865,473
            )(Increase)
      in other assets
            
            
            (269,700
            )
            
            
            227,141Increase
      (decrease) in accrued interest payable
            
            
            25,314
            
            
            
            (200,578
            )Increase
      in other liabilities
            
            
            141,587
            
            
            
            79,973TOTAL
      ADJUSTMENTS
            
            
            1,664,864
            
            
            
            1,491,172NET
      CASH PROVIDED BY OPERATING ACTIVITIES
            
            
            2,207,296
            
            
            
            2,102,153CASH
      FLOWS FROM INVESTING ACTIVITIESPurchases
      of investment securities available for sale
            
            
            (1,009,241
            )
            
            
            (99,722,331
            )Principal
      repayments of investment securities available for sale
            
            
            6,454,830
            
            
            
            7,158,615Purchase
      of Federal Home Loan Bank stock
            
            
            -
            
            
            
            (4,646,400
            )Proceeds
      from disposal of foreclosed real estate
            
            
            2,012,883
            
            
            
            -Net
      (increase) decrease in loans
            
            
            8,819,668
            
            
            
            (2,791,339
            )Purchases
      of bank premises and equipment
            
            
            (380,962
            )
            
            
            (1,196,053
            )NET
      CASH PROVIDED (USED) BY INVESTING ACTIVITIES
            
            
            15,897,178
            
            
            
            (101,197,508
            )CASH
      FLOWS FROM FINANCING ACTIVITIESNet
      increase (decrease) in deposits:Demand
            
            
            (5,620,279
            )
            
            
            1,039,484Savings
            
            
            3,807,760
            
            
            
            558,810Money
      market and NOW
            
            
            16,707,537
            
            
            
            3,617,267Time
      deposits
            
            
            (23,782,593
            )
            
            
            11,477,871Net
      increase (decrease) in short-term borrowings
            
            
            (17,000,000
            )
            
            
            77,052,000Net
      increase in long-term borrowings
            
            
            3,000,000
            
            
            
            5,000,000Proceeds
      from issuance of preferred stock
            
            
            -
            
            
            
            24,900,000Dividends
      paid on preferred stock
            
            
            (311,250
            )
            
            
            (124,500
            )NET
      CASH PROVIDED (USED) BY FINANCING ACTIVITIES
            
            
            (23,198,825
            )
            
            
            123,520,932NET
      INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
            
            
            (5,094,351
            )
            
            
            24,425,577CASH
      AND CASH EQUIVALENTS, BEGINNING OF PERIOD
            
            
            31,727,108
            
            
            
            10,282,789CASH
      AND CASH EQUIVALENTS, END OF PERIOD
            
            $
            26,632,757
            
            
            $
            34,708,366





See
accompanying notes.




-7-


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements





NOTE
A - BASIS OF PRESENTATION




In management’s opinion, the financial
information, which is unaudited, reflects all adjustments (consisting solely of
normal recurring adjustments) necessary for a fair presentation of the financial
information as of and for thethree-month periods ended March 31, 2010
and 2009, in conformity with
accounting principles generally accepted in the United States of America. The
financial statements include the accounts of Crescent Financial Corporation (the
“Company”, “we”, “our”, “Crescent”) and its wholly owned subsidiary, Crescent
State Bank (the “Bank”).  All significant inter-company transactions
and balances are eliminated in consolidation.  Operating results forthree-month period ended


March 31, 2010 are not
necessarily indicative of the results that may be expected for the fiscal year
ending December 31, 2010.





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





Prior
period amounts may have been reclassified for proper
presentation.  The Company reclassified $25,000 of net losses on the
sale of other real estate owned for the three month period ended March 31,
2009, from non-interest income to non-interest expense.





NOTE
B - COMMITMENTS




At March
31, 2010, commitments are as follows:




Undisbursed
      lines of credit
              
              $
              117,295,000Stand-by
      letters of credit
              
              
              4,091,000Undisbursed
      commitment to purchase additionalinvestment
      in Small Business Investment Corporation
              
              
              363,000Commitments
      to sell loans Held for Sale
              
              
              137,700





NOTE
C - PER SHARE RESULTS




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




Three
      Months EndedMarch
      31,2010
              
              
              2009Weighted
      average number of shares used in computing basic net income per
      share
              
              
              9,574,264
              
              
              
              9,569,290Effect
      of dilutive stock options and restricted stock
              
              
              13,484
              
              
              
              12,583Weighted
      average number of shares used in computing diluted net income per
      share
              
              
              9,587,748
              
              
              
              9,581,873
 -8-


CRESCENT FINANCIAL CORPORATION AND
SUBSIDIARY
 Notes
to Consolidated Financial Statements





NOTE
C - PER SHARE RESULTS (Continued)




For the
three month period ended March 31, 2010, there were 426,111 options and the
warrant for 833,705 shares that were anti-dilutive.  For the three
month period ended March 31, 2009, there were 542,527 options and the warrant
for 833,705 shares that were anti-dilutive.




NOTE
D - INVESTMENT SECURITIES




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




March
      31, 2010Gross
              
              
              GrossAmortized
              
              
              unrealized
              
              
              unrealized
              
              
              Faircost
              
              
              gains
              
              
              losses
              
              
              valueSecurities
      available for sale:U.S.
      government securities and obligations of U.S. government
      agencies
              
              $
              11,618,354
              
              
              $
              525,107
              
              
              $
              -
              
              
              $
              12,143,461Mortgage-backed
      securities
              
              
              54,651,481
              
              
              
              1,834,653
              
              
              
              46,980
              
              
              
              56,439,154Collateralized
      mortgage obligations
              
              
              68,258,639
              
              
              
              1,448,014
              
              
              
              99,887
              
              
              
              69,606,766Municipals
              
              
              49,806,214
              
              
              
              714,355
              
              
              
              513,901
              
              
              
              50,006,668Marketable
      equity
              
              
              411,291
              
              
              
              1,670
              
              
              
              -
              
              
              
              412,961$
              184,745,979
              
              
              $
              4,523,799
              
              
              $
              660,768
              
              
              $
              188,609,010




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





-9-


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements





NOTE
D - INVESTMENT SECURITIES (Continued)




The
following tables show investments’ gross unrealized losses and fair values,
aggregated by investment category and length of time that the individual
securities have been in a continuous unrealized loss position, at March 31, 2010
and December 31, 2009. The March 31, 2010 unrealized losses on investment
securities relate to one mortgage backed security, five collateralized mortgage
obligations and twenty-six municipal securities. The December 31, 2009
unrealized losses on investment securities relate to three mortgage-backed
securities, twelve collateralized mortgage obligations, twenty-five municipal
securities and two marketable equity securities. The unrealized losses relate to
debt securities that have incurred fair value reductions due to higher market
interest rates since the securities were purchased.  The unrealized
losses will reverse at maturity or prior to maturity if market interest rates
decline to levels that existed when the securities were
purchased.  Since none of the unrealized losses relate to the
marketability of the securities or the issuer’s ability to honor redemption
obligations, none of the securities are deemed to be other than temporarily
impaired.




March
      31, 2010Less
      Than 12 Months
              
              
              12
      Months or More
              
              
              TotalFair
                value
              
              
              Unrealized
                losses
              
              
              Fair
                value
              
              
              Unrealized
                losses
              
              
              Fair
                value
              
              
              Unrealized
                lossesSecurities
      available for sale:Mortgage-backed
              
              $
              4,410,032
              
              
              $
              46,980
              
              
              $
              -
              
              
              $
              -
              
              
              $
              4,410,032
              
              
              $
              46,980Collateralized
      mortgage obligations
              
              
              15,336,838
              
              
              
              99,887
              
              
              
              -
              
              
              
              -
              
              
              
              15,336,838
              
              
              
              99,887Municipals
              
              
              17,019,845
              
              
              
              289,393
              
              
              
              3,747,226
              
              
              
              224,508
              
              
              
              20,767,071
              
              
              
              513,901Total
      temporarily impaired securities
              
              $
              36,766,715
              
              
              $
              436,260
              
              
              $
              3,747,226
              
              
              $
              224,508
              
              
              $
              40,513,941
              
              
              $
              660,768
  December
      31, 2009Less
      Than 12 Months
              
              
              12
      Months or More
              
              
              TotalFair
                value
              
              
              Unrealized
                losses
              
              
              Fair
                value
              
              
              Unrealized
                losses
              
              
              Fair
                value
              
              
              Unrealized
                lossesSecurities
      available for sale:Mortgage-backed
              
              $
              10,253,608
              
              
              $
              126,356
              
              
              $
              -
              
              
              $
              -
              
              
              $
              10,253,608
              
              
              $
              126,356Collateralized
      mortgage obligations
              
              
              26,940,754
              
              
              
              386,219
              
              
              
              -
              
              
              
              -
              
              
              
              26,940,754
              
              
              
              386,219Municipals
              
              
              17,081,421
              
              
              
              244,125
              
              
              
              2,858,321
              
              
              
              221,272
              
              
              
              19,939,742
              
              
              
              465,397Marketable
      equity
              
              
              -
              
              
              
              -
              
              
              
              345,100
              
              
              
              56,950
              
              
              
              345,100
              
              
              
              56,950Total
      temporarily impaired securities
              
              $
              54,275,783
              
              
              $
              756,700
              
              
              $
              3,203,421
              
              
              $
              278,222
              
              
              $
              57,479,204
              
              
              $
              1,034,922
  -10-


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements





NOTE
D - INVESTMENT SECURITIES (Continued)




At March
31, 2010 and December 31, 2009, investment securities with a carrying value of
$103,680,785 and $96,437,558 respectively, were pledged to secure public
deposits, borrowings and for other purposes required or permitted by
law.





The
amortized cost and fair values of securities available for sale at March 31,
2010 by expected maturity are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.




Amortized
              
              
              Faircost
              
              
              valueDue
      within one year
              
              $
              19,606,152
              
              
              $
              20,173,489Due
      after one year through five years
              
              
              94,707,525
              
              
              
              96,957,377Due
      after five years through ten years
              
              
              42,442,628
              
              
              
              43,205,789Due
      after ten years
              
              
              27,578,383
              
              
              
              27,859,394Other
      equity securities
              
              
              411,291
              
              
              
              412,961$
              184,745,979
              
              
              $
              188,609,010




At March
31, 2010, the balance of Federal Home Loan Bank (“FHLB”) of Atlanta stock held
by the Company is $11,776,500.  On March 25, 2010, FHLB declared an
annualized dividend for the fourth quarter of 2009 of 0.27% and announced that
it would continue its previously disclosed practice of not repurchasing
activity-based excess capital stock held by members.  The FHLB will
continue to evaluate quarterly whether to repurchase excess
stock.  Management believes that its investment in FHLB stock was not
other-than-temporarily impaired as of March 31, 2010 or December 31,
2009.  Further, there can be no assurance that the impact of recent or
future legislation on the Federal Home Loan Banks will not also cause a decrease
in the value of the FHLB stock held by the Company.





NOTE
E – DERIVATIVE FINANCIAL INSTRUMENTS




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





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





-11-


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements





NOTE
E – DERIVATIVE FINANCIAL INSTRUMENTS (Continued)




Cash
Flow Hedges




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





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





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





Since the floating index and reset dates are based on identical
terms, management believes that the hedge relationship of the cumulative changes
in expected future cash flows from the interest rate swaps and the cumulative
changes in expected interest cash flows from the trust-preferred debentures and
subordinated term loan agreement will be highly effective. For the three months
ended March 31, 2010, management has determined that there is no hedge
ineffectiveness.





The
notional amount of the debt obligations being hedged was $15.5 million and the
fair value of the interest rate swap liability, which is recorded in accrued
expenses and other liabilities at March 31,
2010, was an unrealized loss of $439,221.





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




March
      31, 2010Balance
      Sheet Location
              
              Notional
      Amount
              
              
              Estimated
      Fair Value of Asset (Liability)Trust
      preferred securities:Interest
      rate swap
              
              Other
      liabilities
              
              $
              4,000,000
              
              
              $
              (98,284
              )Interest
      rate swap
              
              Other
      liabilities
              
              
              4,000,000
              
              
              
              (128,171
              )Subordinated
      term loan agreements:Interest
      rate swap
              
              Other
      liabilities
              
              
              3,750,000
              
              
              
              (92,226
              )Interest
      rate swap
              
              Other
      liabilities
              
              
              3,750,000
              
              
              
              (120,540
              )$
              15,500,000
              
              
              $
              (439,221
              )




-12-


CRESCENT FINANCIAL CORPORATION AND
SUBSIDIARY
 Notes
to Consolidated Financial Statements





NOTE
E – DERIVATIVE FINANCIAL INSTRUMENTS (Continued)




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




See Note
F for additional information.





The
following table discloses activity in accumulated OCI related to the interest
rate swaps during the three month period ended March 31, 2010.




March
      31,
                2010Accumulated
      OCI resulting from interest rate swaps as of January 1, 2010, net of
      tax
              
              $
              (181,237
              )Other
      comprehensive loss recognized during three month period ended March 31,
      net of tax
              
              
              (88,664
              )Accumulated
      OCI resulting from interest rate swaps as of March 31, 2010, net of
      tax
              
              $
              (269,901
              )





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




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


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





NOTE
F - FAIR VALUE MEASUREMENT




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




-13-


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements





NOTE
F - FAIR VALUE MEASUREMENT (Continued)




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





Outlined
below is the application of the fair value hierarchy.





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





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





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





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





Investment
Securities Available-for-Sale




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





Derivative
Liabilities




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





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





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





-14-


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements





NOTE
F - FAIR VALUE MEASUREMENT (Continued)




Loans




The
Company does not record loans at fair value on a recurring basis. However, from
time to time, a loan is considered impaired and an allowance for loan losses is
established. Loans for which it is probable that payment of interest and
principal will not be made in accordance with the contractual terms of the loan
agreement are considered impaired.  The fair value of impaired loans
is estimated using one of several methods, including collateral value, market
value of similar debt, enterprise value, liquidation value and discounted cash
flows. Those impaired loans not requiring an allowance represent loans for which
the fair value of the expected repayments or collateral exceed the recorded
investments in such loans. At March 31, 2010, substantially all of the total
impaired loans were evaluated based on the fair value of the collateral.
Impaired loans where an allowance is established based on the fair value of
collateral require classification in the fair value hierarchy. When the fair
value of the collateral is based on an observable market price or a current
appraised value, the Company records the impaired loan or asset as nonrecurring
Level 2. When current appraised value is not available or management determines
the fair value of the collateral is further impaired below the appraised value
and there is no observable market price, the Company records the impaired loan
or asset as nonrecurring Level 3.   There were $67.8 million in
impaired loans at March 31, 2010, of which $38.9 million in loans showed
impairment and had a specific reserve of $9.3 million.  Impaired loans
totaled $66.1 million at December 31, 2009.  Of such loans, $35.4
million had specific loss allowances aggregating $9.1 million at that
date.





Foreclosed
Real Estate




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





-15-


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements





NOTE
F - FAIR VALUE MEASUREMENT (Continued)




Below is
a table that presents information about assets measured at fair value at March
31, 2010, and December 31, 2009:




Fair
      Value Measurements atMarch
      31, 2010, UsingDescription
              
              Total
      Carrying Amount in The Consolidated Balance Sheet
                3/31/2010
              
              
              Assets/(Liabilities)
      Measured at
                Fair
      Value
                3/31/2010
              
              
              Quoted
      Prices in Active Markets for Identical Assets
                (Level
      1)
              
              
              Significant
      Other Observable Inputs
                (Level
      2)
              
              
              Significant
      Unobservable Inputs
                (Level
      3)Securities
      available for sale:U.S.
      Government obligations and agency
              
              $
              12,143,461
              
              
              $
              12,143,461
              
              
              $
              -
              
              
              $
              12,143,461
              
              
              $
              -Mortgage-backed
              
              
              56,439,154
              
              
              
              56,439,154
              
              
              
              -
              
              
              
              56,439,154
              
              
              
              -Collateralized
      mortgage obligations
              
              
              69,606,766
              
              
              
              69,606,766
              
              
              
              -
              
              
              
              69,606,766
              
              
              
              -Municipals
              
              
              50,006,668
              
              
              
              50,006,668
              
              
              
              -
              
              
              
              50,006,668
              
              
              
              -Marketable
      equity
              
              
              412,961
              
              
              
              412,961
              
              
              
              412,961
              
              
              
              -
              
              
              
              -Foreclosed
      real estate
              
              
              8,121,813
              
              
              
              8,121,813
              
              
              
              -
              
              
              
              -
              
              
              
              8,121,813Impaired
      loans
              
              
              29,672,994
              
              
              
              29,672,994
              
              
              
              -
              
              
              
              26,622,848
              
              
              
              3,050,146Derivative
      liabilities
              
              
              (439,221
              )
              
              
              (439,221
              )
              
              
              -
              
              
              
              (439,221
              )
              
              
              -


Fair
      Value Measurements atDecember
      31, 2009, UsingDescription
              
              Assets/(Liabilities)
      Measured at
                Fair
      Value
                12/31/2009
              
              
              Quoted
      Prices in Active Markets for Identical Assets
                (Level
      1)
              
              
              Significant
      Other Observable Inputs
                (Level
      2)
              
              
              Significant
      Unobservable Inputs
                (Level
      3)Securities
      available for sale:U.S.
      Government obligations and agency
              
              $
              12,683,127
              
              
              $
              -
              
              
              $
              12,683,127
              
              
              $
              -Mortgage-backed
              
              
              60,203,087
              
              
              
              -
              
              
              
              60,203,087
              
              
              
              -Collateralized
      mortgage obligations
              
              
              70,863,172
              
              
              
              -
              
              
              
              70,863,172
              
              
              
              -Municipals
              
              
              49,028,405
              
              
              
              -
              
              
              
              49,028,405
              
              
              
              -Marketable
      equity
              
              
              345,100
              
              
              
              345,100
              
              
              
              -
              
              
              
              -Foreclosed
      assets
              
              
              6,305,617
              
              
              
              -
              
              
              
              -
              
              
              
              6,305,617Impaired
      loans
              
              
              26,258,018
              
              
              
              -
              
              
              
              23,434,441
              
              
              
              2,823,577Derivative
      liabilities
              
              
              (294,934
              )
              
              
              -
              
              
              
              (294,934
              )
              
              
              -




-16-




CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements





NOTE
F - FAIR VALUE MEASUREMENT (Continued)




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





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





Cash
and Cash Equivalents




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





Investment
Securities




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





Loans




For
certain homogenous categories of loans, such as residential mortgages, fair
value is estimated using the quoted market prices for securities backed by
similar loans, adjusted for differences in loan characteristics. The fair value
of other types of loans is estimated by discounting the future cash flows using
the current rates at which similar loans would be made to borrowers with similar
credit ratings and for the same remaining maturities.  Additional
adjustments are estimated by applying a reasonable discount to reflect the
current market for and illiquid nature of bank loan portfolios.





Federal
Home Loan Bank Stock




The
carrying value of Federal Home Loan Bank stock approximates fair value based on
the redemption provisions of the Federal Home Loan Bank.





Investment
in Life Insurance




The
carrying value of life insurance approximates fair value because this investment
is carried at cash surrender value, as determined by the insurers.





Deposits




The fair
value of demand deposits, savings, money market and NOW accounts is the amount
payable on demand at the reporting date. The fair value of time deposits is
estimated using the rates currently offered for instruments of similar remaining
maturities.




-17-


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements





NOTE
F - FAIR VALUE MEASUREMENT (Continued)




Short-term
Borrowings and Long-term Debt




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





Accrued
Interest Receivable and Accrued Interest Payable




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





Derivative
financial instruments




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





The
carrying amounts and estimated fair values of the Company’s financial
instruments, none of which are held for trading purposes, are as follows at
March 31, 2010 and December 31, 2009:





March
      31, 2010
              
              
              December
      31, 2009Carrying
              
              
              Estimated
              
              
              Carrying
              
              
              Estimatedamount
              
              
              fair
      value
              
              
              amount
              
              
              fair
      valueFinancial
      assets:Cash
      and cash equivalents
              
              $
              26,632,757
              
              
              $
              26,632,757
              
              
              $
              31,727,108
              
              
              $
              31,727,108Investment
      securities
              
              
              188,609,010
              
              
              
              188,609,010
              
              
              
              193,122,891
              
              
              
              193,122,891Federal
      Home Loan Bank stock
              
              
              11,776,500
              
              
              
              11,776,500
              
              
              
              11,776,500
              
              
              
              11,776,500Loans,
      net
              
              
              727,677,212
              
              
              
              689,831,000
              
              
              
              741,781,341
              
              
              
              701,738,000Investment
      in life insurance
              
              
              17,862,724
              
              
              
              17,862,724
              
              
              
              17,658,386
              
              
              
              17,658,386Accrued
      interest receivable
              
              
              4,121,131
              
              
              
              4,121,131
              
              
              
              4,260,258
              
              
              
              4,260,258Financial
      liabilities:Deposits
              
              
              713,757,152
              
              
              
              732,665,000
              
              
              
              722,634,618
              
              
              
              742,001,000Short-term
      borrowings
              
              
              57,000,000
              
              
              
              57,504,000
              
              
              
              74,000,000
              
              
              
              74,260,000Long-term
      borrowings
              
              
              145,748,000
              
              
              
              144,480,000
              
              
              
              142,748,000
              
              
              
              139,457,000Interest
      rate swaps
              
              
              439,221
              
              
              
              439,221
              
              
              
              294,934
              
              
              
              294,934Accrued
      interest payable
              
              
              1,500,442
              
              
              
              1,500,442
              
              
              
              1,475,128
              
              
              
              1,475,128


NOTE
G - CUMULATIVE PERPETUAL PREFERRED STOCK




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




-18-


CRESCENT
FINANCIAL CORPORATION AND SUBSIDIARY
 Notes
to Consolidated Financial Statements





NOTE
G - CUMULATIVE PERPETUAL PREFERRED STOCK (Continued)






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


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





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





NOTE
H - RECENT ACCOUNTING PRONOUNCEMENTS




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





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





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





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





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




-19-




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





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




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





-20-


Item
2.  Management’s Discussion and Analysis of Financial Condition and
Results of Operations
 
 Management’s
discussion and analysis is intended to assist readers in the understanding and
evaluation of the financial condition and consolidated results of operations of
Crescent Financial Corporation (the “Company”). The analysis includes detailed
discussions for each of the factors affecting Crescent Financial Corporation’s
operating results for periods ended March 31, 2010 and 2009 and financial
condition for the periods ended March 31, 2010 and December 31, 2009. It should
be read in conjunction with the unaudited consolidated financial statements and
accompanying notes included in this report and the supplemental financial data
appearing throughout this discussion and analysis. Because the Company has no
operations and conducts no business on its own other than owning Crescent State
Bank, the discussion contained in this Management's Discussion and Analysis
concerns primarily the business of the Bank. However, for ease of reading and
because the financial statements are presented on a consolidated basis, the
Company and the Bank are collectively referred to herein as the Company unless
otherwise noted.  All significant intercompany transactions and
balances are eliminated in consolidation.
 
 COMPARISON
OF FINANCIAL CONDITION AT
 MARCH
31, 2010 AND DECEMBER 31, 2009
 
 Total
assets decreased by $21.7 million or 2% to $1.0 billion at March 31,
2010.  Earning assets at both March 31, 2010 and December 31, 2009
were 95% of total assets and totaled $961.7 million at the end of the first
quarter of 2010 compared with $986.7 million at year
end.   Components of earning assets at March 31, 2010 are $744.6
million in gross loans and loans and mortgage loans held for sale, $200.4
million in investment securities and Federal Home Loan Bank (FHLB) stock and
$16.7 in overnight investments and interest-earning deposits with correspondent
banks.  Earning assets at December 31, 2009 consisted of $759.3
million in gross loans, $204.9 million in investment securities and FHLB stock
and $22.4 million in overnight investments and interest-earning deposits. Total
deposits and stockholders’ equity at March 31, 2010 were $713.8 million and
$90.5 million, respectively, compared to $722.6 million and $89.5 million at
December 31, 2009.
 
 Gross
loans outstanding declined by $14.9 million over the first three months of 2010.
All loan categories experienced a decline due to normal principal payments, the
continued softness in loan demand and the movement of assets from the loan
account into other real estate owned.  The net decline by loan
category is as follows: $4.6 million in construction, land acquisition and
development, $3.4 million in commercial real estate, $2.7 million in residential
mortgage, $2.1 million in commercial and industrial, $1.6 million in home equity
loans and lines and $437,000 in consumer loans. Of the total $14.9 million
decline, $3.8 million was transferred into other real estate owned and $2.6
million represents charge-offs on those loans in conjunction with
the  transfer. See the discussions on Nonperforming Assets and
Allowance For Loan Losses for additional details.  The composition of
the loan portfolio, by category, as of March 31, 2010 is 48% commercial mortgage
loans, 23% construction loans, 13% residential mortgage loans, 8% home equity
loans and lines, 7% commercial loans and 1% consumer loans.  The
composition of the loan portfolio, by category, as of December 31, 2009 was 47%
commercial mortgage loans, 24% construction loans, 13% residential real estate
mortgage loans, 8% home equity loans and lines, 7% commercial loans and 1%
consumer loans.
 
 Loans for
commercial real estate, construction, acquisition and development and land
comprised 71% of the total loan portfolio at March 31, 2010.  A more
detailed breakdown of loans in those sectors is presented in the table
below:
  -21-
  Breakdown
      of Commercial Real EstateTotal
      AggregateExposureLoan
      Type
              
              (in
      thousands)Non
      owner occupied investment property
              
              $
              187,320Owner
      occupied commercial property
              
              
              149,025Multi-family
      investment property
              
              
              18,865Agriculture/Farmland
              
              
              795Subtotal
              
              
              356,005Deferred
      unearned interest
              
              
              (556
              )Total
      commercial real estate loans
              
              $
              355,449Breakdown
      of Construction, Acquisition & DevelopmentTotal
      AggregateExposureLoan
      Type
              
              (in
      thousands)Land
      acquisition and development -commercial purposes
              
              $
              82,321Land
      acquisition and development - residential purposes
              
              $
              55,1781
      to 4 family residential construction
              
              
              16,754Commercial
      construction
              
              
              20,339Subtotal
              
              
              174,592Deferred
      unearned interest
              
              
              (137
              )Total
      construction, acquistition & development
              
              $
              174,455
  The
Company had an allowance for loan losses at March 31, 2010 of $16.8 million or
2.26% of outstanding loans compared to $17.6 million or 2.31% at
December 31, 2009. The decline was primarily due to the net charge-off of
$2.6 million during the first quarter for which specific reserves had been
identified at December 31, 2009. At March 31, 2010, there were eighty-two loans
totaling $29.4 million in non-accrual status.    There were
no loans past due 90 days or more still accruing interest at March 31,
2010.  Non-performing loans as a percentage of total loans at March
31, 2010 were 3.95%.  At December 31, 2009, there were sixty-six loans
totaling approximately $18.1 million in non-accrual status. During the first
quarter, nine of the sixty-six loans in nonaccrual status at year end had been
foreclosed, two of which were then sold.   A property securing
one of the non-accrual loans was sold by the borrower prior to the foreclosure
process, five loans were paid in full, four loans were charged-off, three loans
were returned to accrual status and forty-four loans remained in non-accrual
status.  The percentage of non-performing loans to total loans at
December 31, 2009 was 2.44%.  For a more detailed discussion, see the
section entitled Nonperforming Assets.
 
 The
Company has investment securities with an amortized cost of $184.7 million at
March 31, 2010.  All investments are accounted for as available for
sale and are presented at their fair market value of $188.6 million compared
with $193.1 million at year-end 2009.  The Company’s investment
securities at March 31, 2010, consist of U.S. Government agency securities,
collateralized mortgage obligations, mortgage-backed securities, municipal bonds
and marketable equity securities.  The decrease in the available for
sale portfolio during the first quarter of 2010 was the net result of $1.0
million in new purchases, a $1.3 million increase in the fair value of the
portfolio, less $6.5 million in principal re-payments and maturities and
$334,000 in net amortization of premiums.
 
 The
Company owned $11.8 million of Federal Home Loan Bank stock at both March 31,
2010 and December 31, 2009.
 
 There
were $15.8 million in Federal funds sold at March 31, 2010 compared to $17.8
million at December 31, 2009.  The decrease in Fed funds sold reflects
on-balance sheet liquidity used to redeem maturing time deposits and borrowings
and for deposit fluctuations of non-maturing deposit types.
  -22-
 
 Interest-earning
deposits held at correspondent banks declined by approximately $3.7 million from
$4.6 million at December 31, 2009 to $884,000 at March 31,
2010.  Interest-earning funds held at correspondent bank accounts were
used primarily to redeem maturing time deposits and borrowings and to meet
liquidity requirements for deposit fluctuations of non-maturing deposit
types.
 
 Non-earning
and other assets increased by approximately $767,000 between December 31, 2009
and March 31, 2010.  There were increases in non-interest bearing cash
and cash due from banks, other assets, bank owned life insurance and premises
and equipment of $678,000, $314,000, $204,000 and $141,000,
respectively.  The deferred tax asset decreased by $432,000 and
accrued interest receivable declined by $139,000.  For more details
regarding the increase in cash and cash equivalents, see the Consolidated
Statement of Cash Flows.
 
 Other
real estate owned by the Company was $8.1 million at March 31, 2010 compared
with $6.3 million at December 31, 2009.  The net increase in other
real estate owned of $1.8 million was comprised of $3.8 million in new
foreclosed property less $2.0 million in proceeds from the sale of properties
and $33,000 in net losses recognized on the disposals.
 
 Total
deposits decreased by $8.9 million between December 31, 2009 and March 31, 2010
from $722.6 million to $713.8 million.  The Company has continued to
focus on reducing its reliance on brokered deposits and shifting its deposit mix
more in favor of non-maturity deposit types.  Brokered time deposits
have decreased by $12.2 million from $203.4 million at year end 2009 to
$191.2 million at March 31, 2010.  Other retail time deposits
decreased by $11.6 million from $234.1 million to $222.6
million.  Total time deposits as a percentage of total deposits have
declined from 61% to 58%.  In an effort to improve core deposit
volumes, the Company introduced a new interest-bearing checking account in
December 2008 that rewards depositors with a higher rate of interest if they
modify their account activity behavior to include more electronic methods of
transactions and statement receipt.  As a result, interest-bearing
checking balances increased during the first quarter by $19.0 million to $112.2
at March 31, 2010. Savings account balances have increased by $3.8 million and
money market account balances have declined by $2.3 million over the first
quarter of 2010.  Total savings and money market account balances at
March 31, 2010 were $61.9 million and $70.5 million,
respectively.    Non-interest bearing deposit balances have
declined by $5.6 million from $61.0 million to $55.4 million.  The
decline is attributable primarily attributable to the business checking products
as sales for many of our small business customers have been negatively impacted
by the economy.
 
 The
composition of the deposit base, by category, at March 31, 2010 is as follows:
58% time deposits, 15% interest-bearing demand deposits, 10% money market, 9%
statement savings accounts and 8% non-interest-bearing demand
deposits.  The composition of the deposit base, by category, at
December 31, 2009 was as follows:  61% in time deposits, 13% in
interest-bearing deposits, 10% in money market, and 8% in both non
interest-bearing demand deposits and statement savings. Time deposits of
$100,000 or more totaled $339.5 million at March 31, 2010 compared to $357.4
million at December 31, 2009.
 
 The
Company had total borrowings of $202.8 million at March 31, 2010 compared with
$216.7 million at December 31, 2009.  The composition of borrowings is
$130.0 million in long-term advances and $21.0 million in short-term advances
from the Federal Home Loan Bank of Atlanta (FHLB), $36.0 million in Federal
Reserve Bank discount window funds, $8.2 million in junior subordinated debt
issued to an unconsolidated subsidiary and $7.5 million in a subordinated term
loan issued to a non-affiliated financial institution.  Borrowings at
December 31, 2009 consisted of $127.0 million in long-term FHLB advances, $24.0
million in short-term FHLB advances, $50.0 million in short-term Fed Discount
Window advances, $8.2 million in junior subordinated debt issued to an
unconsolidated subsidiary, and $7.5 million in a subordinated term
loan.  There were no Federal funds purchased at either balance sheet
date.
  -23-
 
 Accrued
interest payable and other liabilities increased by $256,000 and were $4.2
million and $3.9 million at March 31, 2010 and December 31, 2009,
respectively.
 
 Between
December 31, 2009 and March 31, 2010, total stockholders’ equity increased by
$1.0 million. The increase was primarily due to a $778,000 increase in the
unrealized gain, net of tax, on available for sale securities and net income of
$542,000 less the $311,000 dividend paid on preferred stock.
 
 COMPARISON
OF RESULTS OF OPERATIONS FOR THE THREE MONTH PERIODS ENDED MARCH 31, 2010 AND
2009
 
 Net Income.Net income for the
three-month period ended March 31, 2010, before adjusting for the effective
dividend on preferred stock, was $542,000 compared to $611,000 for the prior
year three-month period ended March 31, 2009. After adjusting for $419,000 and
$168,000 in dividends and discount accretion on preferred stock for the two
respective periods, net income attributable for common shareholders for the
current period was $123,000 or $0.01 per diluted share compared with $443,000 or
$0.05 per diluted share for the first quarter of the prior
year.  Annualized return on average assets declined to 0.21% from
0.24% for the prior period.  Earnings in the current period were
positively impacted by an improved net interest margin and higher non-interest
revenue, but were offset by a higher loan loss provision and an increase in
non-interest operating expenses. Return on average equity for the current period
was 2.36% compared to 2.08% for the prior period.  The increase in
return on average equity is due primarily to the lower level of average equity
resulting from the goodwill impairment charge recorded in the fourth quarter of
2009.
 
 Net Interest
Income.  Net interest income increased by 3% or $230,000 from
$7.2 million for the prior year three-month period to $7.5 million for the
current period ended March 31, 2010.  The increase was attributable to
a larger decline in interest expense, due to the lower cost of funds, than the
decline in interest income resulting from the lower volume of earning
assets.  The improved cost of funds combined with a more stable yield
on earning assets helped offset the impact of  a lower percentage of
average interest-earning assets to average interest-bearing liabilities ratio
and resulted in an increase in tax equivalent net interest margin to 3.27% from
3.05%.
 
 Total
interest income decreased by 5% or $653,000 to $13.4 million for the current
three-month period compared to $14.1 million for the prior year
period.  The results were comprised of a $527,000 decrease due to a
drop in average earning assets volume and a $126,000 decrease due to lower
yields on those assets.  Total interest expense for the current period
declined by $883,000 to $6.0 million from $6.8 million.  The decrease
was comprised of a $728,000 decline due to the lower cost of funding and a
$155,000 decline due to a lower volume of interest-bearing funds.
 
 Total
average earning assets decreased $24.8 million or 3% from an average of $985.7
million to an average of $960.9 million for the current three-month period. The
composition of the decrease was as follows: the average balance of loans
outstanding decreased by 5% or $36.7 million from $788.8 million to $752.1
million, the average balance of the investment securities portfolio increased by
4% or $7.6 million from $191.9 million to $199.5 million and the average balance
of federal funds sold and other interest-earning assets increased by $4.2
million to $9.3 million from $5.0 million.  The average of gross loans
outstanding has declined due to a combination of the Company trying to reduce
its exposure to construction, land acquisition and development lending and the
overall weakness for new loan demand due to economic conditions over the past
eighteen months.
  -24-
 
 Average
interest-bearing liabilities decreased by $9.7 million or 1% from $872.1 million
for the quarter ended March 31, 2009 to $862.4 million for the current
quarter.  Total interest-bearing deposits increased by $5.2 million or
1% from $644.6 million to $649.8 million.  Interest-bearing NOW
account deposits increased by $54.0 million to $96.8 million largely due to the
new checking product introduced in December 2008.    Total
average time deposits declined by over $38.8 million primarily due to the
Company reducing its exposure to brokered deposits by $59.2 million over the
last twelve months.  Average total borrowings decreased by $14.8
million or 7% from $227.4 million to $212.6 million.  The Company is
making a concerted effort to reduce its exposure to wholesale
funding.  The reduction came in a borrowing category whose interest
rate was short-term in nature, but was subject to significant volatility in a
rising interest rate environment.
 
 Net
interest margin is interest income earned on loans, securities and other earning
assets, less interest expense paid on deposits and borrowings, expressed as a
percentage of total average earning assets.  The tax equivalent net
interest margin for the three-month period ended March 31, 2010 was 3.27%
compared to 3.05% for the prior year period.  The average yield on
earning assets for the current three-month period decreased 9 basis points to
5.78% compared with 5.87% for the prior year period, while the average cost of
interest-bearing funds decreased by 38 basis points to 2.80% from
3.18%.  The interest rate spread, which is the difference between the
average yield on earning assets and the cost of interest-bearing funds, improved
by 30 basis points from 2.68% to 2.98%.  The percentage of interest
earning assets to average interest-bearing liabilities decreased from 113.04%
for the prior year period to 111.43% for the three months ended March 31,
2010.  A decrease in the ratio of average earning assets to average
interest-bearing liabilities indicates an increased dependency on
interest-bearing forms of funding and otherwise has a negative impact on the
margin.
 
 After a
sixteen month period from September 2007 through December 2008 which saw
short-term interest rates decline by 500 basis points, we have been in a stable
rate environment since January 2009.  Despite being in a lower rate
environment than that experienced leading up to the prior three month period,
rates on new and renewed loans over the past twelve months have been originated
at rates averaging at or above previous yield levels.  This can be
attributed to the use of a more risk-based pricing approach on fixed rate loans
and rate floors being implemented for variable rate loans.  The
decline in yield on loans over the two comparative periods is primarily due to
the transferring of loans into nonaccrual status.
 
 Approximately
43% of the Company’s loan portfolio has variable rate pricing based on the Prime
lending rate or LIBOR (London Inter Bank Offering Rate).  The
percentage of variable rate to total loans has increased slightly from 42% at
December 31, 2009.  Approximately 88% of total variable rate loans
have terms that include an interest rate floor.  The majority of those
floors are in the 5% to 6% range.    As a result, when
interest rates do begin to increase, a large portion of the loan portfolio will
not be subject to immediate repricing as has been the case in previous rising
rate cycles.  Therefore, the Company has made a concerted effort to
lock in more long-term funding to minimize the volume of interest-bearing
liabilities which will be subject to repricing as rates
increase.  This has kept the overall cost of funds higher than it
otherwise could have been had the Company taken a more short-term outlook on
interest rate management.
 
 The
Company expects that the net interest margin will continue to expand moderately
in the coming months as approximately 54% of the time deposit portfolio,
carrying a weighted average rate of 2.81%, matures over the next twelve months
and is subject to being renewed at lower rates.  The Company entered
into interest rate swap agreements on a $7.5 million subordinated loan agreement
and $8.0 million in trust preferred securities.  These two borrowings
carry variable rates of interest based on three-month LIBOR.  We have
swapped these variable cash flows for fixed rate cash flows for an average
period of three and a quarter years.  In addition to adopting a
funding strategy that pushes funding maturities further out into the future,
these swaps will further protect the Company when rates do begin to
rise.
  -25-
 
 Provision for Loan
Losses.The
Company’s provision for loan losses for the three-month period ended March 31,
2010 was $1.8 million compared to $1.7 million for the same period in
2009.  Provision for loan losses is charged to income to bring the
allowance for loan losses to a level deemed appropriate by management based on
factors discussed under “Analysis of Allowance for Loan Losses.”  The
increase in the loan loss provision is primarily due to continuing credit
quality issues resulting from the current economic conditions. The allowance for
loan losses was $16.8 million at March 31, 2010, representing 2.26% of total
outstanding loans.  See the sections on Nonperforming Assets and
Analysis of Allowance for Loan Losses for additional details.
 
 Non-Interest Income.Non-interest income increased by $258,000 or 33% to $1.0 million from
$788,000 for the prior year period.  The following categories
experienced increases: investment services revenue, $34,000 or 126%; customer
service fees, $33,000 or 10%; fees on deposit accounts, $11,000 or 21%; income
on non-marketable equity investments, $12,000 or 377%; and earnings on cash
value of bank owned life insurance, $10,000 or 5%.  During the first
quarter of 2010, the Company began transforming its mortgage loan division from
a brokerage operation to a correspondent operation.  This will allow
Crescent to originate mortgages in our own name and sell them in the secondary
market.  For the three months ended March 31, 2010, we recognized
$193,000 in origination revenue and $44,000 in gains on the sale of mortgages
for a total of $237,000 attributable to mortgage activity.  The
Company recognized $296,000 in mortgage origination revenue for the prior year
period as the level of interest rates during the first quarter of 2009 created a
surge of refinance activity.  During the first quarter of 2009, the
Company recorded a $188,000 impairment loss on a non-marketable equity
investment.
 
 Non-Interest Expenses.For the
current three-month period, non-interest expenses increased by $568,000 or 10%
from $5.6 million to $6.2 million. The four expense categories of personnel,
occupancy, FDIC insurance premiums and loan related professional and collection
expenses accounted for a total increase of $671,000.   Loan and
collection expenses have increased by $246,000 or 227% primarily as a result of
expenses related to collections, foreclosures and losses pursuant to the
disposition of assets acquired. Total occupancy expenses have increased by 28%
or $206,000 due to the opening of two new branch offices in Raleigh, NC and the
expansion of our operations facility in Cary, NC.  The new facilities
and the expansion of the company’s mortgage operations accounted for the 5% or
$159,000 increase in personnel expenses.  FDIC deposit insurance
premiums increased by 24% or $60,000 due to a new assessment
schedule.  Several categories of expenses declined when compared to
the prior period including data processing, travel, postage, office supplies and
printing, other professional fees and corporate legal expenses.  For
the period ended March 31, 2009, there were $156,000 in data processing expenses
related to the conversion of core and ancillary systems and therefore the
decrease in data processing expenses realized for the period ended March 31,
2010 is not anticipated to continue.
 
 Provision for Income Taxes.The Company recorded an income tax benefit of $23,000 for the
three-months ended March 31, 2010 compared to expense of $94,000 for the prior
year period.  The effective tax rate for the current three-month
period was (4.39%) compared with 13.35% for the prior year
period.  The significant decrease in the effective tax rate is
attributable to lower pre-tax income and a larger percentage of income coming
from tax exempt sources in the current quarter.
  -26-
  NET
INTEREST INCOME
 
 Net
interest income represents the difference between income derived from
interest-earning assets and interest expense incurred on interest-bearing
liabilities. Net interest income is affected by both (1) the difference between
the rates of interest earned on interest-earning assets and the rates paid on
interest-bearing liabilities (“interest rate spread”) and (2) the relative
amounts of interest-earning assets and interest-bearing liabilities (“net
interest-earning balance”). The following tables set forth information relating
to average balances of the Company's assets and liabilities for the three-month
periods ended March 31, 2010 and 2009. The tables reflect the average yield on
interest-earning assets and the average cost of interest-bearing liabilities
(derived by dividing income or expense by the daily average balance of
interest-earning assets or interest-bearing liabilities, respectively) as well
as the net interest margin. In preparing the tables, non-accrual loans are
included, when applicable, in the average loan balance.  For purposes
of the analysis, Federal Home Loan Bank stock is included in Investment
Securities totals.
 
 
 Average
      Balances, Interest and Average Yields/Cost
 (Dollars
      in Thousands)
 
 For
      the Three Months Ended March 31,2010
              
              
              2009Average
              
              
              
              
              
              Average
              
              
              Average
              
              
              
              
              
              AverageBalance
              
              
              Interest
              
              
              Yield/Cost
              
              
              Balance
              
              
              Interest
              
              
              Yield/CostInterest-earnings
      assetsLoan
      portfolio
              
              $
              752,131
              
              
              $
              11,484
              
              
              
              6.19
              %
              
              $
              788,810
              
              
              $
              12,077
              
              
              
              6.21
              %Investment
      securities
              
              
              199,542
              
              
              
              1,936
              
              
              
              4.44
              %
              
              
              191,909
              
              
              
              1,999
              
              
              
              4.54
              %Fed
      funds and other interest-earning assets
              
              
              9,270
              
              
              
              5
              
              
              
              0.21
              %
              
              
              5,036
              
              
              
              2
              
              
              
              0.16
              %Total
      interest-earning assets
              
              
              960,943
              
              
              
              13,425
              
              
              
              5.78
              %
              
              
              985,755
              
              
              
              14,078
              
              
              
              5.87
              %Noninterest-earning
      assets
              
              
              51,131
              
              
              
              
              
              
              
              
              
              
              
              67,692Total
      Assets
              
              $
              1,012,074
              
              
              
              
              
              
              
              
              
              
              $
              1,053,447Interest-bearing
      liabilitiesInterest-bearing
      NOW
              
              $
              96,841
              
              
              
              625
              
              
              
              2.62
              %
              
              $
              42,771
              
              
              
              96
              
              
              
              0.91
              %Money
      market and savings
              
              
              130,300
              
              
              
              405
              
              
              
              1.26
              %
              
              
              140,333
              
              
              
              495
              
              
              
              1.43
              %Time
      deposits
              
              
              422,701
              
              
              
              3,316
              
              
              
              3.18
              %
              
              
              461,539
              
              
              
              4,652
              
              
              
              4.09
              %Short-term
      borrowings
              
              
              65,300
              
              
              
              206
              
              
              
              1.28
              %
              
              
              106,254
              
              
              
              463
              
              
              
              1.74
              %Long-term
      debt
              
              
              147,259
              
              
              
              1,412
              
              
              
              3.84
              %
              
              
              121,159
              
              
              
              1,141
              
              
              
              3.77
              %Total
      interest-bearing liabilities
              
              
              862,401
              
              
              
              5,964
              
              
              
              2.80
              %
              
              
              872,056
              
              
              
              6,847
              
              
              
              3.18
              %Non-interest
      bearing deposits
              
              
              55,206
              
              
              
              
              
              
              
              
              
              
              
              59,229Other
      liabilities
              
              
              3,687
              
              
              
              
              
              
              
              
              
              
              
              3,092Total
      Liabilities
              
              
              921,294
              
              
              
              
              
              
              
              
              
              
              
              934,377Stockholders'
      Equity
              
              
              90,780
              
              
              
              
              
              
              
              
              
              
              
              119,070Total
      Liabilities & Stockholders' Equity
              
              $
              1,012,074
              
              
              
              
              
              
              
              
              
              
              $
              1,053,447Net
      interest income
              
              
              
              
              
              $
              7,461
              
              
              
              
              
              
              
              
              
              
              $
              7,231Interest
      rate spread
              
              
              
              
              
              
              
              
              
              
              2.98
              %
              
              
              
              
              
              
              
              
              
              
              2.68
              %Net
      interest-margin
              
              
              
              
              
              
              
              
              
              
              3.27
              %
              
              
              
              
              
              
              
              
              
              
              3.05
              %Percentage
      of average interest-earning assetsto average interest-bearing
      liabilities
              
              
              
              
              
              
              
              
              
              
              111.43
              %
              
              
              
              
              
              
              
              
              
              
              113.04
              %
  -27-
  VOLUME/RATE
VARIANCE ANALYSIS
 
 The
following table analyzes the dollar amount of changes in interest income and
interest expense for major components of interest-earning assets and
interest-bearing liabilities for the three-month periods ended March 31, 2010
and 2009.  The table distinguishes between (i) changes attributable to
volume (changes in volume multiplied by the prior period’s rate), (ii) changes
attributable to rate (changes in rate multiplied by the prior period’s volume),
and (iii) net change (the sum of the previous columns).  The change
attributable to both rate and volume (changes in rate multiplied by changes in
volume) has been allocated equally to both the changes attributable to volume
and the changes attributable to rate.
    Three
      Months Ended March 31,2010
      vs. 2009(in
      Thousands)Increase
      (Decrease) Due toVolume
              
              
              Rate
              
              
              TotalInterest
      IncomeLoan
      portfolio
              
              
              (566
              )
              
              
              (27
              )
              
              
              (593
              )Investment
      Securities
              
              
              37
              
              
              
              (100
              )
              
              
              (63
              )Fed
      funds and other interest-earning assets
              
              
              2
              
              
              
              1
              
              
              
              3Total
      interest-earning assets
              
              
              (527
              )
              
              
              (126
              )
              
              
              (653
              )Interest
      ExpenseInterest-bearing
      NOW
              
              
              124
              
              
              
              405
              
              
              
              529Money
      market and savings
              
              
              (33
              )
              
              
              (57
              )
              
              
              (90
              )Time
      deposits
              
              
              (341
              )
              
              
              (995
              )
              
              
              (1,336
              )Short-term
      borrowings
              
              
              (154
              )
              
              
              (103
              )
              
              
              (257
              )Long-term
      debt
              
              
              249
              
              
              
              22
              
              
              
              271Total
      interest-bearing liabilities
              
              
              (155
              )
              
              
              (728
              )
              
              
              (883
              )Net
      interest income
              
              
              (372
              )
              
              
              602
              
              
              
              230
 
 -28-
  NONPERFORMING
ASSETS
 
 The table
below sets forth, for the periods indicated, information about our nonaccrual
loans, restructured loans, total nonperforming loans, and total nonperforming
assets.
 
 At
      March 31,
              
              
              At
      December 31,2010
              
              
              2009
              
              
              2009
              
              
              2008(Dollars
      in thousands)Nonaccrual
      loansConstruction
      and A&D
              
              
              5,435
              
              
              
              10,963
              
              
              $
              6,692
              
              
              
              7,696Commercial
      real estate
              
              
              14,025
              
              
              
              359
              
              
              
              4,655
              
              
              
              365Residential
      mortgage
              
              
              5,301
              
              
              
              4,251
              
              
              
              2,758
              
              
              
              4,448Home
      equity lines and loans
              
              
              1,540
              
              
              
              82
              
              
              
              1,314
              
              
              
              82Commercial
      and industrial
              
              
              3,097
              
              
              
              736
              
              
              
              2,706
              
              
              
              503Consumer
              
              
              12
              
              
              
              30
              
              
              
              9
              
              
              
              -Total
      nonaccrual loans
              
              $
              29,410
              
              
              $
              16,421
              
              
              $
              18,134
              
              
              $
              13,094Accruing
      loans past due90
      days or more
              
              
              -
              
              
              
              4
              
              
              
              381
              
              
              
              -Total
      nonperforming loans
              
              
              29,410
              
              
              
              16,425
              
              
              
              18,515
              
              
              
              13,094Real
      estate owned
              
              
              8,122
              
              
              
              1,911
              
              
              
              6,306
              
              
              
              1,716Repossessed
      assets
              
              
              6
              
              
              
              -
              
              
              
              -
              
              
              
              -Total
      nonperforming assets
              
              $
              37,538
              
              
              $
              18,336
              
              
              $
              24,821
              
              
              $
              14,810Restructured
      loans in accrual statusnot
      in categories listed above
              
              $
              10,685
              
              
              $
              89
              
              
              $
              13,691
              
              
              $
              -Allowance
      for loan losses
              
              
              16,807
              
              
              
              13,855
              
              
              
              17,567
              
              
              
              12,585Nonperforming
      loans toperiod
      end loans
              
              
              3.95
              %
              
              
              2.08
              %
              
              
              2.44
              %
              
              
              1.53
              %Allowance
      for loan lossesto
      period end loans
              
              
              2.26
              %
              
              
              1.76
              %
              
              
              2.31
              %
              
              
              1.60
              %Allowance
      for loan lossesto
      nonperforming loans
              
              
              57
              %
              
              
              84
              %
              
              
              95
              %
              
              
              96
              %Nonperforming
      loansto
      period end total assets
              
              
              2.91
              %
              
              
              1.50
              %
              
              
              1.79
              %
              
              
              1.35
              %Nonperforming
      assetsTo
      period end total assets
              
              
              3.71
              %
              
              
              1.68
              %
              
              
              2.40
              %
              
              
              1.67
              %
 
 The table
below summarizes our nonperforming loan portfolio by region.  The
Company considers our total footprint to be comprised of three primary
regions:  the Triangle region which encompasses our Wake and Johnston
county offices, the Sandhills region which encompasses our Lee and Moore county
offices and the Wilmington region.
  -29-
  Nonperforming
Loans by Region
 As
      of March 31, 2010Nonperforming%
      of Total
              
              
              
              
              
              Loans
      toLoans
              
              
              Loans
              
              
              Nonperforming
              
              
              LoansOutstanding
              
              
              Outstanding
              
              
              Loans
              
              
              Outstadnding(Dollars
      in thousands)Triangle
      Region
              
              $
              441,409
              
              
              
              59.29
              %
              
              $
              20,012
              
              
              
              4.53
              %Sandhills
      Region
              
              
              112,909
              
              
              
              15.17
              %
              
              
              663
              
              
              
              0.59
              %Wilmington
      Region
              
              
              190,166
              
              
              
              25.54
              %
              
              
              8,735
              
              
              
              4.59
              %Total
      allowance
              
              $
              744,484
              
              
              
              100.00
              %
              
              $
              29,410
              
              
              
              3.95
              %
  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.
 
 The table
below summarizes performing restructured loans, which are classified as impaired
for purposes of the loan loss allowance calculation.
 
 At
      March 31,
              
              
              At
      December 31,2010
              
              
              2009
              
              
              2009
              
              
              2008(Dollars
      in thousands)Performing
      restructured loans:Construction
      and A&D
              
              $
              -
              
              
              
              -
              
              
              $
              1,097
              
              
              
              -Commercial
      real estate
              
              
              5,879
              
              
              
              -
              
              
              
              6,286
              
              
              
              -Residential
      mortgage
              
              
              4,654
              
              
              
              -
              
              
              
              5,936
              
              
              
              -Home
      equity lines and loans
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Commercial
      and industrial
              
              
              152
              
              
              
              89
              
              
              
              372
              
              
              
              -Consumer
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Total
      performing restructured loans
              
              $
              10,685
              
              
              $
              89
              
              
              $
              13,691
              
              
              $
              -
  Restructured
loans are those for which concessions, including the reduction of interest rates
below a rate otherwise available to that borrower or the deferral of interest or
principal have been granted due to the borrower’s weakened financial
condition.  We accrue interest on restructured loans at the
restructured rates when we anticipate that no loss of original principal will
occur.  The Company will continue to closely monitor these loans and
will cease accruing interest on them if management believes that the borrowers
may not continue performing based on the restructured note terms. All TDRs are
considered to be impaired and are evaluated as such in the quarterly allowance
calculation. As of March 31, 2010, the allowance for loan losses allocated
to TDRs totaled $1.2 million.
  -30-
 
 Potential
problem loans are loans which are currently performing and are not included as
nonaccrual or restructured loans above, but about which we have serious doubts
as to the borrower’s ability to comply with present repayment
terms.  These loans are likely to be included later in nonaccrual,
past due or restructured loans, so they are considered by our management in
assessing the adequacy of our allowance for loan losses.  At March 31,
2010, we identified twenty-four loans totaling $7.5 million as potential
problems loans.  Of the $7.5 million in potential problem loans,
eleven loans totaling $3.9 million are concentrated in the residential
construction, land acquisition and development sectors and two loans totaling
$2.0 million are commercial real estate. There were thirty-four foreclosed
properties valued at a total of $8.1 million and eighty-seven nonaccrual loans
totaling $29.4 million.  Foreclosed property is valued at fair value
at the date of foreclosure or acquisition. Interest foregone on nonaccrual and
charged-off loans for the three-month period ended March 31, 2010 was
$686,000.
 
 At March
31, 2009, we identified thirty-one loans totaling $8.1 million as potential
problems loans.  Of the $8.1 million in potential problem loans, $4.9
million are concentrated in the residential construction and land acquisition
and development sectors. There were nine foreclosed properties valued at a total
of $1.9 million and fifty-six nonaccrual loans totaling $16.4
million.  Foreclosed property is valued at the lower of appraised
value or the outstanding loan balance. Interest foregone on nonaccrual loans for
the three-month period ended March 31, 2009 was $297,000.
 
 ANALYSIS
OF ALLOWANCE FOR LOAN LOSSES
 
 The
allowance for loan losses is established through periodic charges to earnings in
the form of a provision for loan losses.  Increases to the allowance
for loan losses occur as a result of provisions charged to operations and
recoveries of amounts previously charged-off, and decreases to the allowance
occur when loans are charged-off.  Management evaluates the adequacy
of our allowance for loan losses on a monthly basis.  The evaluation
of the adequacy of the allowance for loan losses involves the consideration of
loan growth, loan portfolio composition and industry diversification, historical
loan loss experience, current delinquency levels, adverse conditions that might
affect a borrower’s ability to repay the loan, estimated value of underlying
collateral, prevailing economic conditions and all other relevant factors
derived from our history of operations.  Additionally, as an important
component of their periodic examination process, regulatory agencies review our
allowance for loan losses and may require additional provisions for estimated
losses based on judgments that differ from those of management.
 
 We use an
internal grading system to assign the degree of inherent risk on each individual
loan.  The grade is initially assigned by the lending officer and
reviewed by the loan administration function.  The internal grading
system is reviewed and tested periodically by an independent third party credit
review firm.  The testing process involves the evaluation of a sample
of new loans, loans having been identified as possessing potential weakness in
credit quality, past due loans and nonaccrual loans to determine the ongoing
effectiveness of the internal grading system.  The loan grading system
is used to assess the adequacy of the allowance for loan losses.
 
 Management
has developed a model for evaluating the adequacy of the allowance for loan
losses.  The model uses the Company’s internal loan grading system to
segment each category of loans by risk class. The Company’s internal grading
system is compromised of nine different risk classifications.  Loans
possessing a risk class of 1 through 6 demonstrate various degrees of risk, but
each is considered to have the capacity to perform in accordance with the terms
of the loan.  Loans possessing a risk class of 7 to 9 are considered
impaired and are individually evaluated for impairment.  Additionally,
we are evaluating loans that migrate to a risk class 6 status and provide for
possible losses if the loan is unsecured or secured by a General Security
Agreement on business assets.
  -31-
 
 The
predetermined allowance percentages to be applied to loans possessing risk grade
1 through 6 are determined by using the historical charge-off percentages and
adding management’s qualitative factors.  For each individual loan
type, we calculate the average historical charge-off percentage over a five year
period.  The current year charge-offs are annualized and included as
one of the five years under consideration.  The resulting averages
represent a charge-off rate in a more normalized environment.  To
those averages, management adds qualitative factors which are more a reflection
of current economic conditions and trends.  Together, these two
components comprise the reserve.
 
 Those
loans that are identified through the Company’s internal loan grading system as
impaired are evaluated individually.  Each loan is analyzed to
determine the net value of collateral, probability of charge-off and finally a
potential estimate of loss.  When management believes a real estate
collateral-supported loan will move from a risk grade 6 to a risk grade 7, a new
appraisal is ordered.  The analysis is performed using current
collateral values as opposed to values shown on appraisals which were obtained
at the time the loan was made.  If the analysis of a real estate
collateral-supported loan results in an estimated loss, a specific reserve is
recorded.  Loans with risk grade 7 and 8 are re-evaluated periodically
to determine the adequacy of specific reserves.  Fair values on real
estate collateral are subject to constant change and management makes certain
assumptions about how the age of an appraisal impacts current
value.  Loans with risk grade codes of 7 or 8 that are either
unsecured or secured by a general security agreement on business assets are
generally reserved for at 100% of the loan balance.
 
 Using the
data gathered during the monthly evaluation process, the model calculates an
acceptable range for the allowance for loan losses.  Management and
the Board of Directors are responsible for determining the appropriate level of
the allowance for loan losses within that range.
 
 The
provision for the first three months of 2010 was primarily the result of credit
quality deterioration due to current economic conditions in our
markets.  The sectors of the loan portfolio being impacted most by the
economic climate are commercial real estate and residential construction, land
acquisition and development. Other factors influencing the provision include net
loan charge-offs.  For the three-month period ended March 31, 2010,
there were net loan charge-offs of $2.6 million compared with $427,000 at March
31, 2009.  The allowance for loan losses at March 31, 2010 was $16.8
million, which represents 2.26% of total loans outstanding compared to $13.9
million or 1.76% one year ago.
 
 The
allowance for loan losses represents management’s estimate of an amount adequate
to provide for known and inherent losses in the loan portfolio in the normal
course of business.  While management believes the methodology used to
establish the allowance for loan losses incorporates the best information
available at the time, future adjustments to the level of the allowance may be
necessary and the results of operations could be adversely affected should
circumstances differ substantially from the assumptions initially
used.  We believe that the allowance for loan losses was established
in conformity with generally accepted accounting principles; however, there can
be no assurances that the regulatory agencies, after reviewing the loan
portfolio, will not require management to increase the level of the
allowance.  Likewise, there can be no assurance that the existing
allowance for loan losses is adequate should there be deterioration in the
quality of any loans or changes in any of the factors discussed
above.  Any increases in the provision for loan losses resulting from
such deterioration or change in condition could adversely affect our financial
condition and results of operations.
  -32-
 
 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
      March 31,
              
              
              At
      December 31,2010
              
              
              2009%
      of Total
              
              
              
              
              
              %
      of TotalAmount
              
              
              Loans
      (1)
              
              
              Amount
              
              
              Loans
      (1)(Dollars
      in thousands)Residential
      real estate loans
              
              $
              1,855
              
              
              
              12.62
              %
              
              $
              1,075
              
              
              
              12.73
              %Home
      equity loans and lines
              
              
              1,237
              
              
              
              8.44
              %
              
              
              1,134
              
              
              
              8.48
              %Commercial
      real estate loans
              
              
              5,056
              
              
              
              47.77
              %
              
              
              5,811
              
              
              
              47.28
              %Construction
      loans
              
              
              5,239
              
              
              
              23.42
              %
              
              
              6,439
              
              
              
              23.58
              %Commercial
      and industrial loans
              
              
              3,158
              
              
              
              7.14
              %
              
              
              2,854
              
              
              
              7.28
              %Loans
      to individuals
              
              
              262
              
              
              
              0.61
              %
              
              
              254
              
              
              
              0.65
              %Total
      allowance
              
              $
              16,807
              
              
              
              100.00
              %
              
              $
              17,567
              
              
              
              100.00
              %
 
 (1)
      Represents total of all outstanding loans in each category as a percent of
      total loans outstanding.
 
 -33-
  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 Three-Month Period Ended March 31,2010
              
              
              
              2009(Dollars
      in thousands)Balance
      at the beginning of the year
              
              $
              17,567
              
              
              $
              12,585Charge-offs:Commercial
      and industrial loans
              
              
              67
              
              
              
              363Commercial
      real estate loans
              
              
              1,026
              
              
              
              -Construction,
      acquisition and development
              
              
              1,425
              
              
              
              39Residential
      mortgage loans
              
              
              29
              
              
              
              47Home
      equity lines and loans
              
              
              112
              
              
              
              -Consumer
      loans
              
              
              8
              
              
              
              1Total
      charge-offs
              
              
              2,667
              
              
              
              450RecoveriesCommercial
      and industrial loans
              
              
              105
              
              
              
              23Commercial
      real estate
              
              
              -
              
              
              
              -Construction,
      acquisition and development
              
              
              -
              
              
              
              -Residential
      mortgage loans
              
              
              -
              
              
              
              -Home
      equity lines and loans
              
              
              1
              
              
              
              -Consumer
      loans
              
              
              -
              
              
              
              -Total
      recoveries
              
              
              106
              
              
              
              23Net
      charge-offs
              
              
              2,561
              
              
              
              427Provision
      for loan losses
              
              
              1,801
              
              
              
              1,697Balance
      at the end of the period
              
              $
              16,807
              
              
              $
              13,855Total
      loans outstanding at period-end
              
              $
              744,484
              
              
              $
              787,657Average
      loans outstanding for the period
              
              $
              752,131
              
              
              $
              788,810Allowance
      for loan losses tototal
      loans outstanding
              
              
              2.26
              %
              
              
              1.76
              %Annualized
      ratio of net charge-offs to average loans outstanding
              
              
              1.38
              %
              
              
              0.22
              %
  LIQUIDITY
AND CAPITAL RESOURCES
 
 Maintaining
adequate liquidity while managing interest rate risk is the primary goal of the
Company’s asset and liability management strategy. Liquidity is the ability to
fund the needs of the Company’s borrowers and depositors, pay operating
expenses, and meet regulatory liquidity requirements. Maturing investments, loan
and mortgage-backed security principal repayments, deposit growth, brokered time
deposits and borrowings from the Federal Home Loan Bank, Federal Reserve Bank
and other correspondent banks are presently the main sources of the Company’s
liquidity. The Company’s primary uses of liquidity are to fund loans and to make
investments.
  -34-
 
 As of
March 31, 2010, liquid assets (cash and due from banks, interest-earning
deposits with banks, fed funds sold and investment securities available for
sale) were approximately $215.2 million, which represents 21% of total assets
and 30% of total deposits. Supplementing this liquidity, the Company has
available lines of credit from various correspondent banks of approximately
$414.7 million of which $187.0 million is outstanding.  Outstanding
commitments for undisbursed lines of credit, letters of credit and undisbursed
investment commitments amounted to approximately $121.4
million.  Management intends to fund anticipated loan closings and
operational needs through cash and cash equivalents on hand, brokered deposits,
scheduled principal repayments from the loan and securities portfolios, and
anticipated increases in deposits and borrowings.  Certificates of
deposit represented 58% of the Company’s total deposits at March 31, 2010 and
61% at December 31, 2009. The Company’s growth strategy will include marketing
efforts focused at increasing the relative volume of transaction deposit
accounts; however, time deposits will continue to play an important role in the
Company’s funding strategy. Certificates of deposit of $100,000 or more
represented 49% and 48% of the Company’s total deposits at March 31, 2010 and
December 31, 2009, respectively.  While these deposits are generally
considered rate sensitive and the Company will need to pay competitive rates to
retain these deposits at maturity, there are other subjective factors that will
determine the Company’s continued retention of those deposits.
 
 Under
federal capital regulations, Crescent Financial Corporation must satisfy certain
minimum leverage ratio requirements and risk-based capital requirements. At
March 31, 2010, the Company’s equity to asset ratio is 8.95%.  The
Company’s ratios of Tier 1 capital to risk-weighted assets and total capital to
risk-based assets are 11.63% and 13.80%, respectively.  The bank
subsidiary is required to maintain capital adequacy ratios.  Crescent
State Bank has Tier I capital to risk-weighted assets and total capital to
risk-based assets ratios of 11.46% and 13.63%, 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.
  -35-
  Item 3. Quantitative and
Qualitative Disclosures about Market Risk
 
 The
Company’s primary market risk is interest rate risk. Interest rate risk is the
result of differing maturities or repricing intervals of interest earning assets
and interest bearing liabilities and the fact that rates on these financial
instruments do not change uniformly. These conditions may impact the earnings
generated by the Company’s interest earning assets or the cost of its interest
bearing liabilities, thus directly impacting the Company’s overall earnings. The
Company’s management actively monitors and manages interest rate risk. One way
this is accomplished is through the development of and adherence to the
Company’s asset/liability policy. This policy sets forth management’s strategy
for matching the risk characteristics of the Company’s interest earning assets
and liabilities so as to mitigate the effect of changes in the rate environment.
The Company’s market risk profile has not changed significantly since December
31, 2009.
 
 Item 4T. Controls and
Procedures
 
 Crescent
Financial Corporation’s management, with the participation of the Chief
Executive Officer and Principal Financial Officer, has evaluated the
effectiveness of the Company’s disclosure controls and procedures as of March
31, 2010. Based on that evaluation, the Company’s Chief Executive Officer and
Principal Financial Officer concluded that the Company’s disclosure controls and
procedures were effective, as of March 31, 2010, to provide reasonable assurance
that information required to be disclosed by the Company in the reports filed or
submitted by it under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the SEC’s rules and forms, and to
provide reasonable assurance that information required to be disclosed by the
Company in such reports is accumulated and communicated to the Company’s
management, including its principal executive officer and principal financial
officer, as appropriate to allow timely decisions regarding required
disclosure.
 
 The
Company assesses the adequacy of its internal control over financial reporting
quarterly and enhances its controls in response to internal control assessments
and internal and external audit and regulatory recommendations. There have been
no changes in the Company’s internal controls during the quarter ended March 31,
2010 or through the date of this Quarterly Report on Form 10-Q that have
materially affected, or are reasonably likely to materially affect, the
Company’s internal control over financial reporting.
  -36-
  Part
II. OTHER INFORMATION
 
 Item
1. Legal Proceedings.
  None that
are material.
 
 Item
1a. Risk Factors.
  Not
Applicable.
 
 Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds.
  None.
 
 Item
3. Defaults Upon Senior Debt.
  None.
 
 Item
4. (Removed and Reserved)
 
 Item
5. Other Information.
  None.
 
 Item
6. Exhibits
 
 (a)       Exhibits.
  31.1
                
                Certification
      of Principal Executive Officer pursuant to Rule 13a –
  14(a)31.2
                
                Certification
      of Principal Financial Officer pursuant to Rule 13a –
  14(a)32.1
                
                Certification
      of Chief Executive Officer pursuant to 18 U.S.C. 1350 as adopted pursuant
      to Section 906 of the  Sarbanes-Oxley Act of
  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
  -37-
  SIGNATURES
 
 Under the
requirements of the Securities Exchange Act of 1934, the Registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly
authorized.
  CRESCENT FINANCIAL
      CORPORATIONDate:    May 12,
      2010
                By:
                /s/ Michael
      G. CarltonMichael
      G. CarltonPresident
      and Chief Executive Officer
 Date:    May
      12, 2010
                By:
                /s/ Bruce
      W. ElderBruce
      W. ElderPrincipal
      Financial Officer
  -38-