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EX-32.2 - VANTAGESOUTH BANCSHARES, INC.v184230_ex32-2.htm
EX-32.1 - VANTAGESOUTH BANCSHARES, INC.v184230_ex32-1.htm
EX-31.2 - VANTAGESOUTH BANCSHARES, INC.v184230_ex31-2.htm
EX-31.1 - VANTAGESOUTH BANCSHARES, INC.v184230_ex31-1.htm
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)

 
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 whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer o
Accelerated filer o
Non-accelerated filer o
Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o        No x

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

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

 
CRESCENT FINANCIAL CORPORATION AND SUBSIDIARY
TABLE OF CONTENTS

       
Page No.
Part I.
 
FINANCIAL INFORMATION
 
3
         
Item 1 -
 
Financial Statements (Unaudited)
 
3
         
   
Consolidated Balance Sheets March 31, 2010 (unaudited) and December 31, 2009
 
3
         
   
Consolidated Statements of Operations Three Months Ended March 31, 2010 and 2009 (unaudited)
 
4
         
   
Consolidated Statements of Comprehensive Income Three Months Ended March 31, 2010 and 2009 (unaudited)
 
5
         
   
Consolidated Statement of Stockholders’ Equity Three Months Ended March 31, 2010 (unaudited)
 
6
         
   
Consolidated Statements of Cash Flows Three Months Ended March 31, 2010 and 2009 (unaudited)
 
7
         
   
Notes to Consolidated Financial Statements
 
8 - 20
         
Item 2 -
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
21 – 35
         
Item 3 -
 
Quantitative and Qualitative Disclosures about Market Risk
 
36
         
Item 4T -
 
Controls and Procedures
 
36
         
Part II.
 
Other Information
 
37
         
Item 1 -
 
Legal Proceedings
 
37
         
Item 1a -
 
Risk Factors
 
37
         
Item 2 -
 
Unregistered Sales of Equity Securities and Use of Proceeds
 
37
         
Item 3 -
 
Defaults Upon Senior Debt
 
37
         
Item 4 -
 
(Removed and Reserved)
 
37
         
Item 5 -
 
Other Information
 
37
         
Item 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)
         
ASSETS
             
               
Cash and due from banks
  $ 9,963,573     $ 9,285,386  
Interest-earning deposits with banks
    884,184       4,616,722  
Federal funds sold
    15,785,000       17,825,000  
Investment securities available for sale, at fair value
    188,609,010       193,122,891  
                 
Loans held for sale
    137,700       -  
                 
Loans
    744,484,212       759,348,341  
Allowance for loan losses
    (16,807,000 )     (17,567,000 )
NET LOANS
    727,677,212       741,781,341  
                 
Accrued interest receivable
    4,121,131       4,260,258  
Federal Home Loan Bank stock, at cost
    11,776,500       11,776,500  
Bank premises and equipment
    12,002,461       11,861,158  
Investment in life insurance
    17,862,724       17,658,386  
Other assets
    22,315,740       20,617,367  
                 
TOTAL ASSETS
  $ 1,011,135,235     $ 1,032,805,009  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
                 
Deposits:
               
Demand
  $ 55,421,676     $ 61,041,955  
Savings
    61,893,862       58,086,102  
Money market and NOW
    182,701,744       165,994,207  
Time
    413,739,869       437,512,354  
                 
TOTAL DEPOSITS
    713,757,151       722,634,618  
                 
Short-term borrowings
    57,000,000       74,000,000  
Long-term debt
    145,748,000       142,748,000  
Accrued expenses and other liabilities
    4,157,750       3,902,185  
TOTAL LIABILITIES
    920,662,901       943,284,803  
Commitments (Note B)
               
                 
Stockholders’ Equity
               
Preferred stock, no par value, 5,000,000 shares authorized, 24,900 shares issued and outstanding
    23,043,533       22,935,514  
Common stock, $1 par value, 20,000,000 shares authorized; 9,626,559 shares issued and outstanding at both March 31, 2010 and December 31, 2009
    9,626,559       9,626,559  
Common stock warrant
    2,367,368       2,367,368  
Additional paid-in capital
    74,561,861       74,529,894  
Accumulated deficit
    (21,230,917 )     (21,354,080 )
Accumulated other comprehensive income
    2,103,930       1,414,951  
                 
TOTAL STOCKHOLDERS’ EQUITY
    90,472,334       89,520,206  
                 
TOTAL 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
   
2009
 
             
INTEREST INCOME
           
Loans
  $ 11,484,041     $ 12,077,058  
Investment securities available for sale
    1,936,330       1,999,023  
Federal funds sold and interest-earning deposits
    4,686       2,037  
                 
TOTAL INTEREST INCOME
    13,425,057       14,078,118  
                 
INTEREST EXPENSE
               
Deposits
    4,345,601       5,242,936  
Short-term borrowings
    206,281       463,332  
Long-term borrowings
    1,412,155       1,140,459  
                 
TOTAL INTEREST EXPENSE
    5,964,037       6,846,727  
                 
NET INTEREST INCOME
    7,461,020       7,231,391  
                 
PROVISION FOR LOAN LOSSES
    1,801,177       1,696,685  
                 
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
    5,659,843       5,534,706  
                 
NON-INTEREST INCOME
               
Mortgage loan origination revenue
    192,909       296,472  
Fees on deposit accounts
    431,939       388,002  
Earnings on life insurance
    217,432       207,455  
Gain (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       84,786  
                 
TOTAL NON-INTEREST INCOME
    1,045,709       788,175  
                 
NON-INTEREST EXPENSE
               
Salaries and employee benefits
    3,129,752       2,971,098  
Occupancy and equipment
    957,180       750,960  
Data processing
    386,328       449,500  
FDIC insurance premiums
    308,680       248,720  
Other
    1,403,980       1,197,522  
                 
TOTAL NON-INTEREST EXPENSE
    6,185,920       5,617,800  
                 
INCOME BEFORE INCOME TAXES
    519,632       705,081  
                 
INCOME TAXES (BENEFIT)
    (22,800 )     94,100  
                 
NET INCOME
    542,432       610,981  
                 
Effective dividend on preferred stock (Note G)
    419,269       168,105  
                 
Net income available to common shareholders
  $ 123,163     $ 442,876  
                 
NET INCOME PER COMMON SHARE
               
Basic
  $ 0.01     $ .05  
Diluted
  $ 0.01     $ .05  
                 
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING (Note C)
               
Basic
    9,574,264       9,569,290  
Diluted
    9,587,748       9,581,873  

See accompanying notes.
-4-

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

   
2010
   
2009
 
Net income
  $ 542,432     $ 610,981  
                 
Other 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 )     31,017  
Net 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  
 
See accompanying notes.
-5-


CRESCENT FINANCIAL CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (Unaudited)
 
                                             
Accumulated
       
                           
Common
   
Additional
         
other
   
Total
 
   
Preferred stock
   
Common stock
   
stock
   
paid-in
   
Accumulated
   
comprehensive
   
stockholders’
 
   
Shares
   
Amount
   
Shares
   
Amount
   
warrants
   
capital
   
deficit
   
income
   
equity
 
Balance 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 $       89,520,206  
                                                                         
Net income
    -       -       -       -       -       -       542,432       -       542,432  
                                                                         
Other comprehensive income
    -       -       -       -       -       -       -       688,979       688,979  
                                                                         
Expense recognized in connection with stock options and restricted stock
    -       -       -       -       -       31,967       -       -       31,967  
                                                                         
Accretion 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  
 
See accompanying notes.
 
-6-

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

   
2010
   
2009
 
CASH FLOWS FROM OPERATING ACTIVITIES
           
Net income
  $ 542,432     $ 610,981  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation
    239,659       198,703  
Provision for loan losses
    1,801,177       1,696,685  
Net 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       33,337  
Deferred income taxes
    (55,622 )     169,812  
Loss on impairment of nonmarketable equity security
    -       188,040  
Loss on disposal of other real estate owned
    32,919       25,000  
(Gain) loss on disposal of assets
    (7,000 )     500  
Net amortization of premiums/discounts on securities
    333,781       174,807  
Accretion of loan discount
    (416,958 )     (109,955 )
Amortization of deposit premium
    10,108       27,433  
Net increase in cash value of life insurance
    (204,338 )     (199,014 )
Stock based compensation
    31,967       44,761  
Change in assets and liabilities:
               
(Increase) decrease in accrued interest receivable
    139,128       (865,473 )
(Increase) in other assets
    (269,700 )     227,141  
Increase (decrease) in accrued interest payable
    25,314       (200,578 )
Increase in other liabilities
    141,587       79,973  
TOTAL ADJUSTMENTS
    1,664,864       1,491,172  
NET CASH PROVIDED BY OPERATING ACTIVITIES
    2,207,296       2,102,153  
                 
CASH FLOWS FROM INVESTING ACTIVITIES
               
Purchases of investment securities available for sale
    (1,009,241 )     (99,722,331 )
Principal repayments of investment securities available for sale
    6,454,830       7,158,615  
Purchase 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 ACTIVITIES
               
Net increase (decrease) in deposits:
               
Demand
    (5,620,279 )     1,039,484  
Savings
    3,807,760       558,810  
Money market and NOW
    16,707,537       3,617,267  
Time deposits
    (23,782,593 )     11,477,871  
Net increase (decrease) in short-term borrowings
    (17,000,000 )     77,052,000  
Net increase in long-term borrowings
    3,000,000       5,000,000  
Proceeds from issuance of preferred stock
    -       24,900,000  
Dividends paid on preferred stock
    (311,250 )     (124,500 )
                 
NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES
    (23,198,825 )     123,520,932  
                 
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    (5,094,351 )     24,425,577  
                 
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
    31,727,108       10,282,789  
                 
CASH 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 the three-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 for three-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
  $ 117,295,000  
Stand-by letters of credit
    4,091,000  
Undisbursed commitment to purchase additional
       
investment in Small Business Investment Corporation
    363,000  
Commitments 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 Ended
 
   
March 31,
 
   
2010
   
2009
 
Weighted average number of shares used in computing basic net income per share
    9,574,264       9,569,290  
Effect of dilutive stock options and restricted stock
    13,484       12,583  
                 
Weighted 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, 2010
 
         
Gross
   
Gross
       
   
Amortized
   
unrealized
   
unrealized
   
Fair
 
   
cost
   
gains
   
losses
   
value
 
Securities available for sale:
                       
U.S. government securities and obligations of U.S. government agencies
  $ 11,618,354     $ 525,107     $ -     $ 12,143,461  
Mortgage-backed securities
    54,651,481       1,834,653       46,980       56,439,154  
Collateralized mortgage obligations
    68,258,639       1,448,014       99,887       69,606,766  
Municipals
    49,806,214       714,355       513,901       50,006,668  
Marketable equity
    411,291       1,670       -       412,961  
                                 
    $ 184,745,979     $ 4,523,799     $ 660,768     $ 188,609,010  
 
   
December 31, 2009
 
         
Gross
   
Gross
       
   
Amortized
   
unrealized
   
unrealized
   
Fair
 
   
cost
   
gains
   
losses
   
value
 
Securities available for sale:
                       
U.S. government securities and obligations of U.S. government agencies
  $ 12,235,041     $ 448,086     $ -     $ 12,683,127  
Mortgage-backed securities
    58,766,929       1,562,514       126,356       60,203,087  
Collateralized mortgage obligations
    70,300,750       948,641       386,219       70,863,172  
Municipals
    48,820,579       673,223       465,397       49,028,405  
Marketable 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, 2010
 
   
Less Than 12 Months
   
12 Months or More
   
Total
 
   
Fair
value
   
Unrealized
losses
   
Fair
value
   
Unrealized
losses
   
Fair
value
   
Unrealized
losses
 
Securities available for sale:
                                   
Mortgage-backed
  $ 4,410,032     $ 46,980     $ -     $ -     $ 4,410,032     $ 46,980  
Collateralized mortgage obligations
    15,336,838       99,887       -       -       15,336,838       99,887  
Municipals
    17,019,845       289,393       3,747,226       224,508       20,767,071       513,901  
                                                 
Total temporarily impaired securities
  $ 36,766,715     $ 436,260     $ 3,747,226     $ 224,508     $ 40,513,941     $ 660,768  

   
December 31, 2009
 
   
Less Than 12 Months
   
12 Months or More
   
Total
 
   
Fair
value
   
Unrealized
losses
   
Fair
value
   
Unrealized
losses
   
Fair
value
   
Unrealized
losses
 
Securities available for sale:
                                   
Mortgage-backed
  $ 10,253,608     $ 126,356     $ -     $ -     $ 10,253,608     $ 126,356  
Collateralized mortgage obligations
    26,940,754       386,219       -       -       26,940,754       386,219  
Municipals
    17,081,421       244,125       2,858,321       221,272       19,939,742       465,397  
Marketable equity
    -       -       345,100       56,950       345,100       56,950  
                                                 
Total 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
   
Fair
 
   
cost
   
value
 
             
Due within one year
  $ 19,606,152     $ 20,173,489  
Due after one year through five years
    94,707,525       96,957,377  
Due after five years through ten years
    42,442,628       43,205,789  
Due after ten years
    27,578,383       27,859,394  
Other 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.


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, 2010
 
   
Balance 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, 2009
 
   
Balance 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,
 2010
 
       
Accumulated 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,
2009
 
Accumulated 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 at
 
               
March 31, 2010, Using
 
Description
 
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       -       -       8,121,813  
Impaired loans
    29,672,994       29,672,994       -       26,622,848       3,050,146  
Derivative liabilities
    (439,221 )     (439,221 )     -       (439,221 )     -  

             
         
Fair Value Measurements at
 
         
December 31, 2009, Using
 
Description
 
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       -       -       6,305,617  
Impaired loans
    26,258,018       -       23,434,441       2,823,577  
Derivative 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, 2009
 
   
Carrying
   
Estimated
   
Carrying
   
Estimated
 
   
amount
   
fair value
   
amount
   
fair value
 
Financial assets:
                       
Cash and cash equivalents
  $ 26,632,757     $ 26,632,757     $ 31,727,108     $ 31,727,108  
Investment securities
    188,609,010       188,609,010       193,122,891       193,122,891  
Federal Home Loan Bank stock
    11,776,500       11,776,500       11,776,500       11,776,500  
Loans, net
    727,677,212       689,831,000       741,781,341       701,738,000  
Investment in life insurance
    17,862,724       17,862,724       17,658,386       17,658,386  
Accrued interest receivable
    4,121,131       4,121,131       4,260,258       4,260,258  
                                 
Financial liabilities:
                               
Deposits
    713,757,152       732,665,000       722,634,618       742,001,000  
Short-term borrowings
    57,000,000       57,504,000       74,000,000       74,260,000  
Long-term borrowings
    145,748,000       144,480,000       142,748,000       139,457,000  
Interest rate swaps
    439,221       439,221       294,934       294,934  
Accrued 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)
 
Based on a Black-Scholes option pricing model, the common stock warrants have been assigned a fair value of $2.28 per share or $2.4 million in the aggregate as of January 9, 2009.  Based on relative fair value, $2.4 million has been recorded as the discount on the preferred stock and will be accreted as a reduction in net income available for common shareholders over the next five years at approximately $0.5 million per year.  Correspondingly, $22.5 million was initially assigned to the preferred stock.  Through the discount accretion over the next five years, the preferred stock will be accreted up to the redemption amount of $24.9 million.  For purposes of these calculations, the fair value of the common stock warrant as of January 9, 2009 was estimated using the Black-Scholes option pricing model and the following assumptions:
 
Risk-free interest rate
    2.49 %
Expected life of warrants
 
10 years
 
Expected 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.

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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:
 
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Breakdown of Commercial Real Estate
     
       
   
Total Aggregate
 
   
Exposure
 
Loan Type
 
(in thousands)
 
Non owner occupied investment property
  $ 187,320  
Owner occupied commercial property
    149,025  
Multi-family investment property
    18,865  
Agriculture/Farmland
    795  
Subtotal
    356,005  
Deferred unearned interest
    (556 )
Total commercial real estate loans
  $ 355,449  
         
Breakdown of Construction, Acquisition & Development
       
   
Total Aggregate
 
   
Exposure
 
Loan Type
 
(in thousands)
 
Land acquisition and development -commercial purposes
  $ 82,321  
Land acquisition and development - residential purposes
  $ 55,178  
1 to 4 family residential construction
    16,754  
Commercial construction
    20,339  
Subtotal
    174,592  
Deferred 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.
 
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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.
 
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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.
 
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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
   
  2009
 
   
Average
         
Average
   
Average
         
Average
 
   
Balance
   
Interest
   
Yield/Cost
   
Balance
   
Interest
   
Yield/Cost
 
                                     
Interest-earnings assets
                                   
Loan 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                       67,692                  
Total Assets
  $ 1,012,074                     $ 1,053,447                  
                                                 
Interest-bearing liabilities
                                               
Interest-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                       59,229                  
Other liabilities
    3,687