Edgar Filing: CRESCENT FINANCIAL CORP

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2006

o TRANSITIONAL 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		(I.R.S. Employer
Incorporation or Organization)		Identification No.)

1005 High House Road, Cary, North Carolina

27513

(Address of Principal Executive Offices)

(Zip Code)

Registrant’s Telephone number, including area code: (919) 460-7770

Securities registered pursuant to Section 12(b) of the Act

NONE

Securities registered pursuant to Section 12(g) of the Act:

COMMON STOCK, PAR VALUE $1.00 PER SHARE

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

o Yes x No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

o Yes x No

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. x Yes o No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act Rule.

Large accelerated filer o

Accelerated filer o

Non-accelerated filer x

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

o Yes x No

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant's most recently completed second fiscal quarter: $68,324,358.

Indicate the number of shares outstanding of each of the registrant’s classes of Common Stock as of the latest practicable date: 8,298,296 shares of Common Stock outstanding as of March 15, 2007.

Documents Incorporated by Reference.

None.

PART I	FORM 10-K	PROXY STATEMENT	ANNUAL REPORT
Item 1 - Business	X
Item 1A - Risk Factors	X
Item 1B - Unresolved Staff Comments	X
Item 2 - Properties	X
Item 3 - Legal Proceedings	X
Item 4 - Submission of Matters to a Vote of Security Holders	X

PART II

Item 5 - Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	X
Item 6 - Selected Financial Data	X
Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operation	X
Item 7A - Quantitative and Qualitative Disclosures About Market Risk	X
Item 8 - Financial Statements and Supplementary Data	X
Item 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	X
Item 9A - Controls and Procedures	X
Item 9B - Other Information	X

PART III

Item 10 - Directors and Executive Officers of the Registrant	X	X
Item 11 - Executive Compensation		X
Item 12 - Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	X	X
Item 13 - Certain Relationships and Related Transactions		X
Item 14 - Principal Accounting Fees and Services		X

PART IV

Item 15 - Exhibits, Financial Statement Schedules	X

PART I

ITEM 1 - BUSINESS

General

Crescent Financial Corporation (referred to as the “Registrant,” the “Company” or by the use of “we,” “our” or “us”) was incorporated under the laws of the State of North Carolina on April 27, 2001, at the direction of the Board of Directors of Crescent State Bank (“CSB”), for the purpose of serving as the bank holding company for CSB and became the holding company for CSB on June 30, 2001. To become CSB’s holding company, Registrant received approval of the Federal Reserve Board as well as CSB’s shareholders. Upon receiving such approval, each share of $5.00 par value common stock of CSB was exchanged on a one-for-one basis for the $1.00 par value common stock of the Registrant. On August 31, 2006, the Registrant acquired Port City Capital Bank for cash and stock valued at $40.2 million. The Company now serves as a multi-bank holding company.

CSB was incorporated on December 22, 1998 as a North Carolina-chartered commercial bank and opened for business on December 31, 1998. Including its main office, CSB operates ten (10) full service branch offices in Cary (2), Apex, Clayton, Holly Springs, Pinehurst, Raleigh, Southern Pines, Sanford and Garner, North Carolina and one loan production office in Raleigh, North Carolina. The Southern Pines and Pinehurst offices were acquired through a merger with Centennial Bank of Southern Pines in August, 2003.

Port City Capital Bank (“PCCB”) was organized and incorporated under the laws of the State of North Carolina on June 13, 2002 and commenced operations on July 1, 2002. PCCB currently serves New Hanover County, North Carolina and surrounding areas through one banking office. As a state chartered bank that is not a member of the Federal Reserve, PCCB is subject to regulation by the State of North Carolina Banking Commission and the Federal Deposit Insurance Corporation.

The Registrant operates for the primary purpose of serving as the holding company for the two banks. The Registrant’s headquarters are located at 1005 High House Road, Cary, North Carolina 27513.

The banks operate for the primary purpose of serving the banking needs of individuals, and small- to medium-sized businesses in their market area. The banks offer a range of banking services including checking and savings accounts, commercial, consumer and personal loans, and mortgage services and other associated financial services.

Lending Activities

General. We provide a wide range of short- to medium-term commercial, mortgage, construction and personal loans, both secured and unsecured. We also make real estate mortgage and construction loans and Small Business Administration guaranteed loans. Many of our commercial loans are collateralized with real estate in our market but such collateral is mainly a secondary, and not primary, source of repayment. We have maintained a balance between variable and fixed rate loans within our portfolio. Variable rate loans accounted for 55% of the loan balances outstanding at December 31, 2006 while fixed rate loans accounted for 45% of the balances.

Our loan policies and procedures establish the basic guidelines governing our lending operations. Generally, the guidelines address the types of loans that we seek, target markets, underwriting and collateral requirements, terms, interest rate and yield considerations and compliance with laws and regulations. All loans or credit lines are subject to approval procedures and amount limitations. These limitations apply to the borrower’s total outstanding indebtedness to us, including the indebtedness of any guarantor. The policies are reviewed and approved at least annually by the board of directors of the bank. We supplement our own supervision of the loan underwriting and approval process with periodic loan audits by internal loan examiners and outside professionals experienced in loan review work.

Commercial Mortgage Loans. We originate and maintain a significant amount of commercial real estate loans. This lending involves loans secured principally by commercial office buildings, both investment and owner occupied. We require the personal guaranty of principals and a demonstrated cash flow capability sufficient to service the debt. The real estate collateral is a secondary source of repayment. Loans secured by commercial real estate may be in greater amount and involve a greater degree of risk than one to four family residential mortgage loans. Payments on such loans are often dependent on successful operation or management of the properties. We also make loans secured by commercial/investment properties provided the subject property is either pre-leased or pre-sold before the bank commits to finance its construction.

Construction Loans. Another of our primary lending focuses is construction/development lending. We originate one to four family residential construction loans for the construction of custom homes (where the home buyer is the borrower) and provide financing to builders and consumers for the construction of homes. We finance “starter” homes as well as “high-end” homes. We generally receive a pre-arranged permanent financing commitment from an outside banking entity prior to financing the construction of pre-sold homes. The bank is active in the construction market and makes construction loans to builders of homes that are not pre-sold, but limits the number of such loans to any one builder. This type of lending is only done with local, well-established builders and not with large or national tract builders. We lend to builders in our market who have demonstrated a favorable record of performance and profitable operations. We limit the number of unsold homes for each builder but there is no limit for pre-sold homes. We will also finance small tract developments and sub-divisions; however, we seek to be only one of a number of financial institutions making construction loans in any one tract or sub-division. We endeavor to further limit our construction lending risk through adherence to established underwriting procedures and the requirement of documentation of all draw requests. We require personal guarantees of the principals and demonstrated secondary sources of repayment on construction loans.

Commercial Loans. Commercial business lending is another focus of our lending activities. Commercial loans include secured loans for working capital, expansion and other business purposes. Short-term working capital loans generally are secured by accounts receivable, inventory and/or equipment. Lending decisions are based on an evaluation of the financial strength, cash flow, management and credit history of the borrower, and the quality of the collateral securing the loan. With few exceptions, we require personal guarantees of the principals and secondary sources of repayment, primarily a deed of trust on local real estate. Commercial loans generally provide greater yields and reprice more frequently than other types of loans, such as commercial mortgage loans. More frequent repricing means that yields on our commercial loans adjust more quickly with changes in interest rates.

Loans to Individuals, Home Equity Lines of Credit and Residential Real Estate Loans. Loans to individuals (consumer loans) include automobile loans, boat and recreational vehicle financing, home equity and home improvement loans and miscellaneous secured and unsecured personal loans. Consumer loans generally can carry significantly greater risks than other loans, even if secured, if the collateral consists of rapidly depreciating assets such as automobiles and equipment. Repossessed collateral securing a defaulted consumer loan may not provide an adequate secondary source of repayment of the loan. Consumer loan collections are sensitive to job loss, illness and other personal factors. We attempt to manage the risks inherent in consumer lending by following established credit guidelines and underwriting practices designed to minimize risk of loss.

Residential real estate loans are made for purchasing and refinancing one to four family properties. We offer fixed and variable rate options, but generally limit the maximum fixed rate term to five years. We provide customers access to long-term conventional real estate loans through our mortgage loan department, which originates loans and brokers them for sale in the secondary market. Such loans are closed by mortgage brokers and are not funded by us. We anticipate that we will continue to be an active originator of mortgage loans and only hold for our own account a small number of well-collateralized, non-conforming residential loans.

The following table describes our loan portfolio composition by category:

	At December 31,
	2006						2005						2004
				% of Total						% of Total						% of Total
	Amount			Loans			Amount			Loans			Amount			Loans
	(Dollars in thousands)
Real estate - commercial	$	304,823			55.36	%	$	174,039			52.92	%		121,825			47.24	%
Real estate - residential		20,224			3.67	%		14,914			4.54	%		11,604			4.50	%
Construction loans		110,033			19.99	%		46,607			14.17	%		38,916			15.09	%
Commercial and industrial loans		67,822			12.32	%		52,708			16.03	%		48,757			18.90	%
Home equity loans and lines of credit		42,704			7.76	%		34,921			10.62	%		30,960			12.00	%
Loans to individuals		4,977			0.90	%		5,670			1.72	%		5,846			2.27	%
Total loans		550,583			100.00	%		328,859			100.00	%		257,908			100.00	%
Less: Net deferred loan fees		(764	)					(537	)					(447	)
Total loans, net	$	549,819					$	328,322					$	257,461

	At December 31,
	2003						2002
				% of Total						% of Total
	Amount			Loans			Amount			Loans
	(Dollars in thousands)
Real estate - commercial	$	101,316			46.66	%	$	52,361			41.59	%
Real estate - residential		14,765			6.80	%		2,319			1.84	%
Construction loans		31,612			14.56	%		27,503			21.84	%
Commercial and industrial loans		38,237			17.61	%		24,682			19.60	%
Home equity loans and lines of credit		22,985			10.59	%		16,051			12.75	%
Loans to individuals		8,213			3.78	%		3,002			2.38	%
Total loans		217,128			100.00	%		125,917			100.00	%
Less: Net deferred loan fees		(382	)					(244	)
Total loans, net	$	216,746					$	125,673

The following table presents at December 31, 2006 (i) the aggregate maturities of loans in the named categories of our loan portfolio and (ii) the aggregate amounts of such loans, by variable and fixed rates that mature after one year:

	Within		1-5		After 5
	1 Year		Years		Years		Total
			(In thousands)
Commercial mortgage	$	101,268	$	196,840	$	6,715	$	304,823
Residential mortgage		9,425		10,623		176		20,224
Construction loans		78,101		29,085		2,847		110,033
Commercial and industrial		47,266		20,420		136		67,822
Home equity lines and loans		4,320		12,569		25,815		42,704
Individuals		2,534		2,124		319		4,977

Total	$	242,914	$	271,661	$	36,008	$	550,583

Fixed rate loans							$	190,301
Variable rate loans								117,368

							$	307,669

Loan Approvals. Our loan policies and procedures establish the basic guidelines governing lending operations. Generally, the guidelines address the type of loans that we seek, target markets, underwriting and collateral requirements, terms, interest rate and yield considerations and compliance with laws and regulations. All loans and credit lines are subject to approval procedures and amount limitations. Depending upon the loan requested, approval may be granted by the individual loan officer, our officers’ loan committee or, for the largest relationships, the directors’ loan committee. The Company’s full board is required to approve any single transaction of $2.5 million or more. These amount limitations apply to the borrower’s total outstanding indebtedness to us, including the indebtedness of any guarantor. The policies are reviewed and approved at least annually by the board of directors.

Responsibility for loan review, underwriting, compliance and document monitoring resides with the senior credit officer. He is responsible for loan processing and approval. On an annual basis, the board of directors of the bank determines the president’s lending authority, who then delegates lending authorities to the senior credit officer and other lending officers of the bank. Delegated authorities may include loans, letters of credit, overdrafts, uncollected funds and such other authorities as determined by the board of directors or the president within his delegated authority.

Credit Cards. We offer a credit card on an agency basis as an accommodation to our customers. We assume none of the underwriting risk.

Loan Participations. From time to time we purchase and sell loan participations to or from other banks within and outside our market area. All loan participations purchased have been underwritten using our standard and customary underwriting criteria.

Commitments and Contingent Liabilities

In the ordinary course of business, we enter into various types of transactions that include commitments to extend credit. We apply the same credit standards to these commitments as we use in all of our lending activities and have included these commitments in our lending risk evaluations. Our exposure to credit loss under commitments to extend credit is represented by the amount of these commitments. See Note M of the “Notes to Consolidated Financial Statements.”

Asset Quality

We consider asset quality to be of primary importance, and employ a third party loan reviewer to ensure adherence to the lending policy as approved by our board of directors. It is the responsibility of each lending officer to assign an appropriate risk grade to every loan originated. Credit administration, through the loan review process, validates the accuracy of the initial risk grade assessment. In addition, as a given loan’s credit quality improves or deteriorates, it is credit administration’s responsibility to change the borrower’s risk grade accordingly. At least annually we undergo loan review by an outside third party who reviews compliance with our underwriting standards and risk grading and provides a report detailing the conclusions of that review to our board of directors and senior management. The banks’ boards requires management to address any criticisms raised during the loan review and to take appropriate actions where warranted.

Investment Activities

Our investment portfolio plays a major role in management of liquidity and interest rate sensitivity and, therefore, is managed in the context of the overall balance sheet. The securities portfolio generates a nominal percentage of our interest income and serves as a necessary source of liquidity. Debt and equity securities that will be held for indeterminate periods of time, including securities that we may sell in response to changes in market interest or prepayment rates, needs for liquidity and changes in the availability of and the yield of alternative investments, are classified as available for sale. We carry these investments at market value, which we generally determine using published quotes or a pricing matrix obtained at the end of each month. Unrealized gains and losses are excluded from our earnings and are reported, net of applicable income tax, as a component of accumulated other comprehensive income in stockholders’ equity until realized.

Deposit Activities

We provide a range of deposit services, including non-interest bearing checking accounts, interest bearing checking and savings accounts, money market accounts and certificates of deposit. These accounts generally earn interest at rates established by management based on competitive market factors and management’s desire to increase or decrease certain types or maturities of deposits. We use brokered deposits to supplement our funding sources. However, we strive to establish customer relations to attract core deposits in non-interest bearing transactional accounts and thus reduce our cost of funds.

The following table sets forth for the years indicated the average balances outstanding and average interest rates for each major category of deposits:

	For the Year Ended December 31,
	2006					2005			2004
	(Dollars in thousands)
		Average	Average			Average	Average			Average	Average
		Balance	Rate			Balance	Rate			Balance	Rate
Non-interest bearing deposits	$	56,376	-		$	42,641	-		$	37,898	-
Interest bearing demand deposits		37,876	1.46	%		39,609	1.05	%		40,931	0.79	%
Money market deposits		51,926	3.52	%		41,548	2.16	%		31,537	1.29	%
Savings deposits		40,694	4.51	%		4,952	1.79	%		2,758	0.36	%
Time deposits over $100,000		154,538	4.82	%		110,312	3.30	%		85,961	2.57	%
Time deposits under $100,000		72,440	3.51	%		58,787	3.13	%		56,445	2.68	%

Total interest bearing deposits		357,474	3.97	%		255,208	2.70	%		217,632	2.04	%

Total average deposits	$	413,850	3.43	%	$	297,849	2.31	%	$	255,530	1.73	%

	For the Year Ended December 31,
	2003					2002
			(Dollars in thousands)
	Average		Average			Average		Average
	Balance		Rate			Balance		Rate
Non-interest bearing deposits	$	34,977		-		$	24,086		-
Interest bearing demand deposits		31,340		0.94	%		19,668		1.61	%
Money market deposits		22,589		1.37	%		21,144		1.90	%
Savings deposits		1,544		0.40	%		1,154		0.69	%
Time deposits over $100,000		41,644		3.15	%		30,627		3.65	%
Time deposits under $100,000		41,566		2.95	%		28,218		3.76	%

Total interest bearing deposits		138,683		2.21	%		100,811		2.85	%

Total average deposits	$	173,660		1.77	%	$	124,897		2.30	%

The following table sets forth the amounts and maturities of certificates of deposit with balances of $100,000 or more at December 31, 2006:

Remaining maturity:	(in thousands)
Three months or less	$	55,900
Over three months through one year		93,602
Over one year through three years		66,766
Over three years through five years		13,498
Total	$	229,766

Borrowings

As additional sources of funding, we use advances from the Federal Home Loan Bank of Atlanta under a line of credit equal to 20% of the CSB’s total assets ($101.5 million at December 31, 2006). Outstanding advances at December 31, 2006 were $55.0 million. Pursuant to collateral agreements with the Federal Home Loan Bank, at December 31, 2006 advances were secured by investment securities available for sale with a fair value of $9.8 million and by loans with a carrying amount of $116.1 million, which approximates market value. PCCB does not utilize the FHLB as a funding source.

We may purchase federal funds through five unsecured federal funds lines of credit aggregating $44.2 million. These lines are intended for short-term borrowings and are subject to restrictions limiting the frequency and terms of the advances. These lines of credit are payable on demand and bear interest based upon the daily federal funds rate (5.63% at December 31, 2006). Short-term borrowings may also consist of securities sold under a repurchase agreement. Securities sold under repurchase agreements generally mature within one to four days from the transaction date. There were $6.5 million in federal funds purchased at December 31, 2006.

Junior Subordinated Debt

In August of 2003, $8.0 million in trust preferred securities were placed through Crescent Financial Capital Trust I. The trust has invested the total proceeds from the sale of its trust preferred securities in junior subordinated deferrable interest debentures issued by us. The trust preferred securities pay cumulative cash distributions quarterly at an annual rate, reset quarterly, equal to three-month LIBOR plus 310 basis points. The dividends paid to holders of the trust preferred securities, which are recorded as interest expense, are deductible by us for income tax purposes. The trust preferred securities are redeemable on or after October 7, 2008. We have fully and unconditionally guaranteed the trust preferred securities through the combined operation of the debentures and other related documents. Our obligation under the guarantee is unsecured and subordinate to senior and subordinated indebtedness. The principal reason for issuing trust preferred securities is that the proceeds from their sale qualify as Tier 1 capital for regulatory capital purposes (subject to certain limitations), thereby enabling us to enhance our regulatory capital positions without diluting the ownership of our stockholders.

Investment Services

Crescent State Bank has entered into a revenue sharing agreement with Capital Investment Group, Raleigh, North Carolina, under which it receives revenue for securities and annuity sales generated by brokers located in our offices. We offer this investment service under the name “Crescent Investment Services.”

Port City Capital Bank has entered into a revenue sharing agreement with Fountain Financial Associates, Wilmington, North Carolina, under which it receives revenue for securities and annuity sales generated by brokers located in its office.

Courier Services

We offer courier services to our customers free-of-charge as a convenience and a demonstration of our commitment to superior customer-service. Our couriers travel to the customer’s location, pick-up non-cash deposits from the customer and deliver those deposits to the bank. We feel our couriers serve as ambassadors for our bank and enhance our presence in the communities we serve.

Banking Technology

Because of the level of sophistication of our markets, we commenced operations with a full array of technology available for our customers. Our customers have the ability to perform on-line banking and bill paying, access on-line check images, make transfers, initiate wire transfer requests and stop payment orders of checks. We provide our customers with imaged check statements, thereby eliminating the cost of returning checks to customers and eliminating the clutter of canceled checks. Through branch image capture technology, both CSB and PCCB offer same day credit for deposits made prior to 5:00 pm.

Strategy

Our strategy is three-fold: we are committed to achieving growth and performance through exceptional customer service and sound asset quality; we provide a comprehensive array of products and services; and we are able to adapt to a rapidly changing banking environment. We place the highest priority on providing professional, highly personalized service - it’s the driving force behind our business. Our de novo expansion strategy is to identify growth markets and expand into them, but only when we are able to retain the services of an experienced banker with extensive personal knowledge of that market.

Primary Market Area

CSB’s market area includes the four contiguous counties of Wake, Johnston, Lee and Moore Counties. This area includes the State Capitol of Raleigh as well as the area known as Research Triangle Park, one of the nation’s leading technology centers. Our market area is home to several universities and institutions of higher learning, including North Carolina State University. The four counties comprising our market area have a diverse economy centered on state government, the academic community, the technology industry, the medical and pharmaceuticals sectors and the many small businesses that support these enterprises as well as the people that live and work in this area. According to the U.S. Census Bureau, the Raleigh-Durham-Cary Metropolitan Statistical Area, which includes the Town of Cary, had a population of approximately 1.5 million people in 2005. Lee and Moore Counties are located to the south of Raleigh in the region referred to as the Sandhills area, which is home to the towns of Pinehurst, Sanford and Southern Pines. The region’s economy benefits from an emphasis on the golf industry due to the many world class golf courses located in the vicinity and also from a growing retiree population drawn to the mild climate and recreational activities afforded by the Sandhills area.

Cary, the second largest city in Wake County and the seventh largest in North Carolina, has an estimated population of 117,000 as of October 2006. The area has a very strong and diversified economy. The total population of Wake County is over 748,000 as of June 2005. The total population of Johnston County is over 146,000, Moore County has an estimated population of over 80,000 and Lee County has an estimated population of over 55,000 as of June 2005. Our market area is served by several major highways, Interstates 40, 440 and 540, US 1, US 64, and NC 55. International, national, and regional airlines offer service from the Raleigh-Durham International Airport, which is less than five miles from Cary.

The population of our market area is relatively diverse, young and highly educated. As of 2000, over 60% of Cary’s population 25 years or older had at least a bachelor’s degree. This educational level is due to the number of higher education institutions located in our market area as well as the Research Triangle Park’s high technology employee base.

The economic strength of the area is also reflected by the per capita income, which as of the year 2003 for the Raleigh-Durham-Cary metropolitan statistical area was $33,627 compared to $28,071 for North Carolina. The median family income in the Raleigh-Durham-Cary metropolitan statistical area in 2005 was $69,800 compared to $56,712 for the State of North Carolina. Cary is home to the world’s largest privately held software company, SAS Institute, and it has attracted other world-class businesses including MCI, RH Donnelly, Siemens, American Airlines, Oxford University Press and Austin Foods. The Research Triangle Park houses major facilities of IBM, GlaxoSmithKline, Nortel, the U.S. Environmental Protection Agency, Quintiles and numerous other technology and bio-medical firms.

PCCB’s market area includes New Hanover County which is home to Wilmington, North Carolina as well as the University of North Carolina at Wilmington. Wilmington has an estimated population of 100,000 while New Hanover County has a population of approximately 180,000. Wilmington is the ninth largest city in North Carolina. The median family income for Wilmington was $54,200 and per capita income was $21,500. Wilmington has a sizable seaport and is the most eastern point in the United States of Interstate 40. The area has become an important destination for the entertainment industry as over 200 movies or television shows have been produced in Wilmington. The population is culturally diverse and the median age is 34 years old.

Competition

Commercial banking in North Carolina is extremely competitive in large part due to early adoption of statewide branching. We compete in our market area with large regional and national banking organizations, other federally and state chartered financial institutions such as savings and loan institutions and credit unions, consumer finance companies, mortgage companies and other lenders engaged in the business of extending credit. Many of our competitors have broader geographic markets and higher lending limits than we do and are also able to provide more services and make greater use of media advertising. All markets in which we have a banking office are also served by branches of the largest banks in North Carolina

For example, as of June 30, 2006 there were 218 offices of 24 different commercial banks in Wake County, 30 offices of 9 different commercial banks in Johnston County, 37 offices of 11 different commercial banks in Moore County, 19 offices of 8 different commercial banks in Lee County and 70 offices of 15 different commercial banks in New Hanover County. While we typically do not compete directly for loans with larger banks, they do influence our deposit products. We do compete more directly with mid-size and small community banks that have offices in our market areas. There are also a number of new community banks in Wake and Durham Counties that have a direct competitive effect as borrowers tend to “shop” the terms of their loans and deposits.

The enactment of legislation authorizing interstate banking has led to increases in the size and financial resources of some of our competitors. In addition, as a result of interstate banking, out-of-state commercial banks have acquired North Carolina banks and heightened the competition among banks in North Carolina. For example, SunTrust Bank, Atlanta, Georgia, a large multi-state financial institution, has branches throughout North Carolina, including Wake County.

Despite the competition in our market areas, we believe that we have certain competitive advantages that distinguish us from our competition. We offer customers modern banking services without forsaking prompt, personal service and friendliness. We also have established a local advisory board in each of our communities to help us better understand their needs and to be “ambassadors” of the bank. It is our intention to further develop advisory boards as we expand into additional communities in our market area. We offer many personalized services and attract customers by being responsive and sensitive to their individualized needs. We believe our approach to business builds goodwill among our customers, stockholders, and the communities we serve that results in referrals from stockholders and satisfied customers. We also rely on traditional marketing to attract new customers. To enhance a positive image in the community, we support and participate in local events and our officers and directors serve on boards of local civic and charitable organizations.

Employees

At December 31, 2006, the Registrant employed 113 full-time and 16 part-time employees. None of the Registrant’s employees are covered by a collective bargaining agreement. The Registrant believes its relations with its employees to be good.

REGULATION

Regulation of the Banks

The banks are extensively regulated under both federal and state law. Generally, these laws and regulations are intended to protect depositors and borrowers, not shareholders. To the extent that the following information describes statutory and regulatory provisions, it is qualified in its entirety by reference to the particular statutory and regulatory provisions. Any change in applicable law or regulation may have a material effect on the business of the Registrant and the banks.

State Law. The banks are subject to extensive supervision and regulation by the North Carolina Commissioner of Banks (the “Commissioner”). The Commissioner oversees state laws that set specific requirements for bank capital and regulate deposits in, and loans and investments by, banks, including the amounts, types, and in some cases, rates. The Commissioner supervises and performs periodic examinations of North Carolina-chartered banks to assure compliance with state banking statutes and regulations, and the banks are required to make regular reports to the Commissioner describing in detail the resources, assets, liabilities and financial condition of the banks. Among other things, the Commissioner regulates mergers and consolidations of state-chartered banks, the payment of dividends, loans to officers and directors, record keeping, types and amounts of loans and investments, and the establishment of branches.

Deposit Insurance. The banks’ deposits are insured up to applicable limits by the Deposit Insurance Fund, or DIF, of the FDIC. The DIF is the successor to the Bank Insurance Fund and the Savings Association Insurance Fund, which were merged in 2006. The banks’ deposits, therefore, are subject to FDIC deposit insurance assessment.

The FDIC recently amended its risk-based deposit assessment system for 2007 to implement authority granted by the Federal Deposit Insurance Reform Act of 2005, or the Reform Act. Under the revised system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and certain other factors. An institution’s assessment rate depends upon the category to which it is assigned. Risk Category I, which contains the least risky depository institutions, is expected to include more than 90% of all institutions. Unlike the other categories, Risk Category I contains further risk differentiation based on the FDIC’s analysis of financial ratios, examination component ratings and other information. Assessment rates are determined by the FDIC and currently range from five to seven basis points for the healthiest institutions (Risk Category I) to 43 basis points of assessable deposits for the riskiest (Risk Category IV). The FDIC may adjust rates uniformly from one quarter to the next, except that no single adjustment can exceed three basis points.

The FDIC is authorized to set the reserve ratio for the DIF annually at between 1.15% and 1.5% of estimated insured deposits, in contrast to the statutorily fixed ratio of 1.25% under the old system. The ratio, which is viewed by the FDIC as the level that the funds should achieve, was established by the agency at 1.25% for 2007. The Reform Act also provided for the possibility that the FDIC may pay dividends to insured institutions once the DIF reserve ratio equals or exceeds 1.35% of estimated insured deposits. The Reform Act also provided for a one-time credit for eligible institutions based on their assessment base as of December 1996. Subject to certain limitations with respect to institutions that are exhibiting weaknesses, credits can be used to offset future assessments until exhausted.

Capital Requirements. The federal banking regulators have adopted certain risk-based capital guidelines to assist in the assessment of the capital adequacy of a banking organization’s operations for both transactions reported on the balance sheet as assets and transactions, such as letters of credit, and recourse arrangements, which are recorded as off balance sheet items. Under these guidelines, nominal dollar amounts of assets and credit equivalent amounts of off balance sheet items are multiplied by one of several risk adjustment percentages which range from 0% for assets with low credit risk, such as certain U.S. Treasury securities, to 100% for assets with relatively high credit risk, such as business loans.

A banking organization’s risk-based capital ratios are obtained by dividing its qualifying capital by its total risk- adjusted assets. The regulators measure risk-adjusted assets, which include off balance sheet items, against both total qualifying capital (the sum of Tier 1 capital and limited amounts of Tier 2 capital) and Tier 1 capital. “Tier 1,” or core capital, includes common equity, qualifying noncumulative perpetual preferred stock and minority interests in equity accounts of consolidated subsidiaries, less goodwill and other intangibles, subject to certain exceptions. “Tier 2,” or supplementary capital, includes among other things, limited-life preferred stock, hybrid capital instruments, mandatory convertible securities, qualifying subordinated debt, and the allowance for loan and lease losses, subject to certain limitations and less required deductions. The inclusion of elements of Tier 2 capital is subject to certain other requirements and limitations of the federal banking agencies. Banks and bank holding companies subject to the risk-based capital guidelines are required to maintain a ratio of Tier 1 capital to risk-weighted assets of at least 4% and a ratio of total capital to risk-weighted assets of at least 8%. The appropriate regulatory authority may set higher capital requirements when particular circumstances warrant. As of December 31, 2006, CSB was classified as “well-capitalized” with Tier 1 and Total Risk-Based Capital of 9.12% and 10.26%, respectively. As of December 31, 2006, PCCB was classified as “well-capitalized” with Tier 1 and Total Risk-Based Capital of 9.50% and 10.69%, respectively.

The federal banking agencies have adopted regulations specifying that they will include, in their evaluations of a bank’s capital adequacy, an assessment of the bank’s interest rate risk exposure. The standards for measuring the adequacy and effectiveness of a banking organization’s interest rate risk management include a measurement of board of directors and senior management oversight, and a determination of whether a banking organization’s procedures for comprehensive risk management are appropriate for the circumstances of the specific banking organization.

Failure to meet applicable capital guidelines could subject a banking organization to a variety of enforcement actions, including limitations on its ability to pay dividends, the issuance by the applicable regulatory authority of a capital directive to increase capital and, in the case of depository institutions, the termination of deposit insurance by the FDIC, as well as the measures described under the “Federal Deposit Insurance Corporation Improvement Act of 1991” below, as applicable to undercapitalized institutions. In addition, future changes in regulations or practices could further reduce the amount of capital recognized for purposes of capital adequacy. Such a change could affect the ability of the banks to grow and could restrict the amount of profits, if any, available for the payment of dividends to the shareholders.

Federal Deposit Insurance Corporation Improvement Act of 1991. In December 1991, Congress enacted the Federal Deposit Insurance Corporation Improvement Act of 1991 (the “FDIC Improvement Act”), which substantially revised the bank regulatory and funding provisions of the Federal Deposit Insurance Act and made significant revisions to several other federal banking statutes. The FDIC Improvement Act provides for, among other things:

publicly available annual financial condition and management reports for certain financial institutions, including audits by independent accountants,

the establishment of uniform accounting standards by federal banking agencies,

the establishment of a “prompt corrective action” system of regulatory supervision and intervention, based on capitalization levels, with greater scrutiny and restrictions placed on depository institutions with lower levels of capital,

additional grounds for the appointment of a conservator or receiver, and

restrictions or prohibitions on accepting brokered deposits, except for institutions which significantly exceed minimum capital requirements.

The FDIC Improvement Act also provides for increased funding of the FDIC insurance funds and the implementation of risk-based premiums.

A central feature of the FDIC Improvement Act is the requirement that the federal banking agencies take “prompt corrective action” with respect to depository institutions that do not meet minimum capital requirements. Pursuant to the FDIC Improvement Act, the federal bank regulatory authorities have adopted regulations setting forth a five-tiered system for measuring the capital adequacy of the depository institutions that they supervise. Under these regulations, a depository institution is classified in one of the following capital categories: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.” An institution may be deemed by the regulators to be in a capitalization category that is lower than is indicated by its actual capital position if, among other things, it receives an unsatisfactory examination rating with respect to asset quality, management, earnings or liquidity.

The FDIC Improvement Act provides the federal banking agencies with significantly expanded powers to take enforcement action against institutions which fail to comply with capital or other standards. Such action may include the termination of deposit insurance by the FDIC or the appointment of a receiver or conservator for the institution. The FDIC Improvement Act also limits the circumstances under which the FDIC is permitted to provide financial assistance to an insured institution before appointment of a conservator or receiver.

International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001. On October 26, 2001, the USA Patriot Act of 2001 was enacted. This act contains the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001, which sets forth anti-money laundering measures affecting insured depository institutions, broker-dealers and other financial institutions. The Act requires U.S. financial institutions to adopt new policies and procedures to combat money laundering and grants the Secretary of the Treasury broad authority to establish regulations and to impose requirements and restrictions on the operations of financial institutions.

Miscellaneous. The dividends that may be paid by each bank are subject to legal limitations. In accordance with North Carolina banking law, dividends may not be paid unless a bank’s capital surplus is at least 50% of its paid-in capital.

The earnings of the banks will be affected significantly by the policies of the Federal Reserve Board, which is responsible for regulating the United States money supply in order to mitigate recessionary and inflationary pressures. Among the techniques used to implement these objectives are open market transactions in United States government securities, changes in the rate paid by banks on bank borrowings, and changes in reserve requirements against bank deposits. These techniques are used in varying combinations to influence overall growth and distribution of bank loans, investments, and deposits, and their use may also affect interest rates charged on loans or paid for deposits.

The monetary policies of the Federal Reserve Board have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. In view of changing conditions in the national economy and money markets, as well as the effect of actions by monetary and fiscal authorities, no prediction can be made as to possible future changes in interest rates, deposit levels, loan demand or the business and earnings of the banks.

We cannot predict what legislation might be enacted or what regulations might be adopted, or if enacted or adopted, the effect thereof on the banks’ operations.

Regulation of the Registrant

Federal Regulation. The Registrant is subject to examination, regulation and periodic reporting under the Bank Holding Company Act of 1956, as administered by the Federal Reserve Board. The Federal Reserve Board has adopted capital adequacy guidelines for bank holding companies on a consolidated basis.

The Registrant is required to obtain the prior approval of the Federal Reserve Board to acquire all, or substantially all, of the assets of any bank or bank holding company. Prior Federal Reserve Board approval is required for the Registrant to acquire direct or indirect ownership or control of any voting securities of any bank or bank holding company if, after giving effect to such acquisition, it would, directly or indirectly, own or control more than five percent of any class of voting shares of such bank or bank holding company.

The merger or consolidation of the banks with each other or with another bank, or the acquisition by the Registrant of assets of another bank, or the assumption of liability by the Registrant to pay any deposits in another bank, will require the prior written approval of the primary federal bank regulatory agency of the acquiring or surviving bank under the federal Bank Merger Act. The decision is based upon a consideration of statutory factors similar to those outlined above with respect to the Bank Holding Company Act. In addition, in certain such cases an application to, and the prior approval of, the Federal Reserve Board under the Bank Holding Company Act and/or the North Carolina Banking Commission may be required.

The Registrant is required to give the Federal Reserve Board prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of the Registrant’s consolidated net worth. The Federal Reserve Board may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe and unsound practice, or would violate any law, regulation, Federal Reserve Board order or directive, or any condition imposed by, or written agreement with, the Federal Reserve Board. Such notice and approval is not required for a bank holding company that would be treated as “well capitalized” under applicable regulations of the Federal Reserve Board, that has received a composite “1” or “2” rating at its most recent bank holding company inspection by the Federal Reserve Board, and that is not the subject of any unresolved supervisory issues.

The status of the Registrant as a registered bank holding company under the Bank Holding Company Act does not exempt it from certain federal and state laws and regulations applicable to corporations generally, including, without limitation, certain provisions of the federal securities laws.

In addition, a bank holding company is prohibited generally from engaging in, or acquiring five percent or more of any class of voting securities of any company engaged in, non-banking activities. One of the principal exceptions to this prohibition is for activities found by the Federal Reserve Board to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Some of the principal activities that the Federal Reserve Board has determined by regulation to be so closely related to banking as to be a proper incident thereto are:

making or servicing loans;

performing certain data processing services;

providing discount brokerage services;

acting as fiduciary, investment or financial advisor;

leasing personal or real property;

making investments in corporations or projects designed primarily to promote community welfare; and

acquiring a savings and loan association.

In evaluating a written notice of such an acquisition, the Federal Reserve Board will consider various factors, including among others the financial and managerial resources of the notifying bank holding company and the relative public benefits and adverse effects which may be expected to result from the performance of the activity by an affiliate of such company. The Federal Reserve Board may apply different standards to activities proposed to be commenced de novo and activities commenced by acquisition, in whole or in part, of a going concern. The required notice period may be extended by the Federal Reserve Board under certain circumstances, including a notice for acquisition of a company engaged in activities not previously approved by regulation of the Federal Reserve Board. If such a proposed acquisition is not disapproved or subjected to conditions by the Federal Reserve Board within the applicable notice period, it is deemed approved by the Federal Reserve Board.

However, with the passage of the Gramm-Leach-Bliley Financial Services Modernization Act of 1999, which became effective on March 11, 2000, the types of activities in which a bank holding company may engage were significantly expanded. Subject to various limitations, the Modernization Act generally permits a bank holding company to elect to become a “financial holding company.” A financial holding company may affiliate with securities firms and insurance companies and engage in other activities that are “financial in nature.” Among the activities that are deemed “financial in nature” are, in addition to traditional lending activities, securities underwriting, dealing in or making a market in securities, sponsoring mutual funds and investment companies, insurance underwriting and agency activities, certain merchant banking activities and activities that the Federal Reserve Board considers to be closely related to banking.

A bank holding company may become a financial holding company under the Modernization Act if each of its subsidiary banks is “well capitalized” under the Federal Deposit Insurance Corporation Improvement Act prompt corrective action provisions, is well managed and has at least a satisfactory rating under the Community Reinvestment Act. In addition, the bank holding company must file a declaration with the Federal Reserve Board that the bank holding company wishes to become a financial holding company. A bank holding company that falls out of compliance with these requirements may be required to cease engaging in some of its activities. The Registrant has not yet elected to become a financial holding company.

Under the Modernization Act, the Federal Reserve Board serves as the primary “umbrella” regulator of financial holding companies, with supervisory authority over each parent company and limited authority over its subsidiaries. Expanded financial activities of financial holding companies generally will be regulated according to the type of such financial activity: banking activities by banking regulators, securities activities by securities regulators and insurance activities by insurance regulators. The Modernization Act also imposes additional restrictions and heightened disclosure requirements regarding private information collected by financial institutions.

Sarbanes-Oxley Act of 2002. On July 30, 2002, the Sarbanes-Oxley Act of 2002 was signed into law and became some of the most sweeping federal legislation addressing accounting, corporate governance and disclosure issues. The impact of the Sarbanes-Oxley Act is wide-ranging as it applies to all public companies and imposes significant new requirements for public company governance and disclosure requirements.

In general, the Sarbanes-Oxley Act mandates important new corporate governance and financial reporting requirements intended to enhance the accuracy and transparency of public companies’ reported financial results. It establishes new responsibilities for corporate chief executive officers, chief financial officers and audit committees in the financial reporting process and creates a new regulatory body to oversee auditors of public companies. It backs these requirements with new SEC enforcement tools, increases criminal penalties for federal mail, wire and securities fraud, and creates new criminal penalties for document and record destruction in connection with federal investigations. It also increases the opportunity for more private litigation by lengthening the statute of limitations for securities fraud claims and providing new federal corporate whistleblower protection.

The economic and operational effects of this new legislation on public companies, including us, is significant in terms of the time, resources and costs associated with complying with the new law. Because the Sarbanes-Oxley Act, for the most part, applies equally to larger and smaller public companies, we are presented with additional challenges as a smaller, community-oriented financial institution seeking to compete with larger financial institutions in our market.

Capital Requirements. The Federal Reserve Board uses capital adequacy guidelines in its examination and regulation of bank holding companies. If capital falls below minimum guidelines, a bank holding company may, among other things, be denied approval to acquire or establish additional banks or non-bank businesses.

The Federal Reserve Board’s capital guidelines establish the following minimum regulatory capital requirements for bank holding companies:

a leverage capital requirement expressed as a percentage of adjusted total assets;

a risk-based requirement expressed as a percentage of total risk-weighted assets; and

a Tier 1 leverage requirement expressed as a percentage of adjusted total assets.

The leverage capital requirement consists of a minimum ratio of total capital to total assets of 4%, with an expressed expectation that banking organizations generally should operate above such minimum level. The risk-based requirement consists of a minimum ratio of total capital to total risk-weighted assets of 8%, of which at least one-half must be Tier 1 capital (which consists principally of shareholders’ equity). The Tier 1 leverage requirement consists of a minimum ratio of Tier 1 capital to total assets of 3% for the most highly-rated companies, with minimum requirements of 4% to 5% for all others. As of December 31, 2006, the Registrant was classified as “well-capitalized” with Tier 1 and Total Risk-Based Capital of 9.88% and 11.03%, respectively.

The risk-based and leverage standards presently used by the Federal Reserve Board are minimum requirements, and higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual banking organizations. Further, any banking organization experiencing or anticipating significant growth would be expected to maintain capital ratios, including tangible capital positions (i.e., Tier 1 capital less all intangible assets),

well above the minimum levels.

Source of Strength for Subsidiaries. Bank holding companies are required to serve as a source of financial strength for their depository institution subsidiaries, and, if their depository institution subsidiaries become undercapitalized, bank holding companies may be required to guarantee the subsidiaries’ compliance with capital restoration plans filed with their bank regulators, subject to certain limits.

Dividends. As a bank holding company that does not, as an entity, currently engage in separate business activities of a material nature, the Registrant’s ability to pay cash dividends depends upon the cash dividends the Registrant receives from the Bank. At present, the Registrant’s only source of income is dividends paid by the Bank and interest earned on any investment securities the Registrant holds. The Registrant must pay all of its operating expenses from funds it receives from the Bank. Therefore, shareholders may receive dividends from the Registrant only to the extent that funds are available after payment of our operating expenses and the board decides to declare a dividend. In addition, the Federal Reserve Board generally prohibits bank holding companies from paying dividends except out of operating earnings, and the prospective rate of earnings retention appears consistent with the bank holding company’s capital needs, asset quality and overall financial condition. We expect that, for the foreseeable future, any dividends paid by the Bank to us will likely be limited to amounts needed to pay any separate expenses of the Registrant and/or to make required payments on our debt obligations, including the interest payments on our junior subordinated debt.

The FDIC Improvement Act requires the federal bank regulatory agencies biennially to review risk-based capital standards to ensure that they adequately address interest rate risk, concentration of credit risk and risks from non-traditional activities and, since adoption of the Riegle Community Development and Regulatory Improvement Act of 1994, to do so taking into account the size and activities of depository institutions and the avoidance of undue reporting burdens. In 1995, the agencies adopted regulations requiring as part of the assessment of an institution’s capital adequacy the consideration of (a) identified concentrations of credit risks, (b) the exposure of the institution to a decline in the value of its capital due to changes in interest rates and (c) the application of revised conversion factors and netting rules on the institution’s potential future exposure from derivative transactions.

In addition, the agencies in September 1996 adopted amendments to their respective risk-based capital standards to require banks and bank holding companies having significant exposure to market risk arising from, among other things, trading of debt instruments, (1) to measure that risk using an internal value-at-risk model conforming to the parameters established in the agencies’ standards and (2) to maintain a commensurate amount of additional capital to reflect such risk. The new rules were adopted effective January 1, 1997, with compliance mandatory from and after January 1, 1998.

Under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”), depository institutions are liable to the FDIC for losses suffered or anticipated by the FDIC in connection with the default of a commonly controlled depository institution or any assistance provided by the FDIC to such an institution in danger of default. This law is applicable to the Registrant because it currently maintains separate subsidiary depository institutions, CSB and PCCB.

Subsidiary banks of a bank holding company are subject to certain quantitative and qualitative restrictions imposed by the Federal Reserve Act on any extension of credit to, or purchase of assets from, or letter of credit on behalf of, the bank holding company or its subsidiaries, and on the investment in or acceptance of stocks or securities of such holding company or its subsidiaries as collateral for loans. In addition, provisions of the Federal Reserve Act and Federal Reserve Board regulations limit the amounts of, and establish required procedures and credit standards with respect to, loans and other extensions of credit to officers, directors and principal shareholders of the Bank, the Registrant, and any subsidiary of the Registrant and related interests of such persons. Moreover, subsidiaries of bank holding companies are prohibited from engaging in certain tie-in arrangements (with the holding company or any of its subsidiaries) in connection with any extension of credit, lease or sale of property or furnishing of services.

Any loans by a bank holding company to a subsidiary bank are subordinate in right of payment to deposits and to certain other indebtedness of the subsidiary bank. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank would be assumed by the bankruptcy trustee and entitled to a priority of payment. This priority would also apply to guarantees of capital plans under the FDIC Improvement Act.

Interstate Branching

Under the Riegle-Neal Interstate Banking and Branching Act (the “Riegle-Neal Act”), the Federal Reserve Board may approve bank holding company acquisitions of banks in other states, subject to certain aging and deposit concentration limits. As of June 1, 1997, banks in one state may merge with banks in another state, unless the other state has chosen not to implement this section of the Riegle-Neal Act. These mergers are also subject to similar aging and deposit concentration limits.

North Carolina “opted-in” to the provisions of the Riegle-Neal Act. Since July 1, 1995, an out-of-state bank that did not already maintain a branch in North Carolina was permitted to establish and maintain a de novo branch in North Carolina, or acquire a branch in North Carolina, if the laws of the home state of the out-of-state bank permit North Carolina banks to engage in the same activities in that state under substantially the same terms as permitted by North Carolina. Also, North Carolina banks may merge with out-of-state banks, and an out-of-state bank resulting from such an interstate merger transaction may maintain and operate the branches in North Carolina of a merged North Carolina bank, if the laws of the home state of the out-of-state bank involved in the interstate merger transaction permit interstate merger.

We cannot predict what legislation might be enacted or what regulations might be adopted, or if enacted or adopted, the effect thereof on our operations.

ITEM 1A - RISK FACTORS

Risks Associated with our Continued Operations

We may not be able to maintain and manage our growth, which may adversely affect our results of operations and financial condition and the value of our common stock.

Our strategy has been to increase the size of our company by opening new offices and aggressively pursuing business development opportunities. We have grown rapidly since we commenced operations. We can provide no assurance that we will continue to be successful in increasing the volume of loans and deposits at acceptable risk levels and upon acceptable terms while managing the costs and implementation risks associated with our growth strategy. There can be no assurance that our further expansion will be profitable or that we will continue to be able to sustain our historical rate of growth, either through internal growth or through successful expansion of our markets, or that we will be able to maintain capital sufficient to support our continued growth. If we grow too quickly, however, and are not able to control costs and maintain asset quality, rapid growth also could adversely affect our financial performance. We may acquire other banks as a means to expand into new markets or to capture additional market share. We are unable to predict whether or when any prospective acquisitions will occur or the likelihood of completing an acquisition on favorable terms and conditions. Any acquisition involves certain risks including, but not limited to:

difficulties assimilating acquired operations and personnel;

potential disruptions of our ongoing business;

the diversion of resources and management time;

the possibility that uniform standards, controls, procedures and policies may not be maintained;

risks associated with entering new markets in which we have little or no experience;

the potential impairment of relationships with employees or customers as a result of changes in management;

difficulties in evaluating the historical or future financial performance of the acquired business; and

brand awareness issues related to the acquired assets or customers.

If we decide to make an acquisition, there can be no assurance that the acquired bank would perform as expected.

Our recent operating results may not be indicative of our future operating results.

We may not be able to sustain our historical rate of growth. Because of our relatively small size and shorter operating history, it will be difficult for us to replicate our historical earnings growth as we continue to expand. Consequently, our historical results of operations will not necessarily be indicative of our future operations. Various factors, such as economic conditions, regulatory and legislative considerations, and competition, may also impede our ability to expand our market presence. If we experience a significant decrease in our historical rate of growth, our results of operations and financial condition may be adversely affected because a high percentage of our operating costs are fixed expenses.

A decrease in interest rates could adversely impact our profitability.

Our results of operations may be significantly affected by the monetary and fiscal policies of the federal government and the regulatory policies of government authorities. A significant component of our earnings is our net interest income. Net interest income is the difference between income from interest-earning assets, such as loans, and the expense of interest-bearing liabilities, such as deposits and our borrowings. Like many financial institutions, we are subject to the risk of fluctuations in interest rates. A significant decrease in interest rates could have a material adverse effect on our net income as we would expect the yields on our earning assets to decrease more quickly than the cost of our interest-bearing deposits and borrowings.

Our profitability depends significantly on economic conditions in our market area.

Our success depends to a large degree on the general economic conditions in Wake, Johnston, Moore, Lee, and New Hanover Counties and adjoining markets. The local economic conditions in these areas have a significant impact on the amount of loans that we make to our borrowers, the ability of our borrowers to repay these loans and the value of the collateral securing these loans. A significant decline in general economic condition caused by inflation, recession, unemployment or other factors beyond our control would impact these local economic conditions and could negatively affect our financial condition and performance.

The lack of seasoning of our loan portfolio makes it difficult to assess the adequacy of our loan loss reserves accurately.

We attempt to maintain an appropriate allowance for loan losses to provide for potential losses in our loan portfolio. We periodically determine the amount of the allowance based on consideration of several factors, including:

an ongoing review of the quality, mix, and size of our overall loan portfolio;

our historical loan loss experience;

evaluation of economic conditions;

regular reviews of loan delinquencies and loan portfolio quality; and

the amount and quality of collateral, including guarantees, securing the loans.

However, there is no precise method of predicting credit losses, since any estimate of loan losses is necessarily subjective and the accuracy depends on the outcome of future events. In addition, due to our rapid growth over the past several years and our limited operating history, a large portion of the loans in our loan portfolio was originated recently. In general, loans do not begin to show signs of credit deterioration or default until they have been outstanding for some period of time, a process referred to as “seasoning.” As a result, a portfolio of older loans will usually perform more predictably than a newer portfolio. Because our loan portfolio is relatively new, the current level of delinquencies and defaults may not be representative of the level that will prevail when the portfolio becomes more seasoned, which may be higher than current levels. If charge-offs in future periods increase, we may be required to increase our provision for loan losses, which would decrease our net income and possibly our capital.

If we experience greater loan losses than anticipated, it will have an adverse effect on our net income.

While the risk of nonpayment of loans is inherent in banking, if we experience greater nonpayment levels than we anticipate, our earnings and overall financial condition, as well as the value of our common stock, could be adversely affected.

We cannot assure you that our monitoring procedures and policies will reduce certain lending risks or that our allowance for loan losses will be adequate to cover actual losses. In addition, as a result of the rapid growth in our loan portfolio, loan losses may be greater than management’s estimates of the appropriate level for the allowance. Loan losses can cause insolvency and failure of a financial institution and, in such an event, our shareholders could lose their entire investment. In addition, future provisions for loan losses could materially and adversely affect our profitability. Any loan losses will reduce the loan loss allowance. A reduction in the loan loss allowance will be restored by an increase in our provision for loan losses. This would reduce our earnings which could have an adverse effect on our stock price.

Liquidity is essential to our business and we rely, in part, on external sources to finance a significant portion of our operations.

Liquidity is essential to our business. Our liquidity could be substantially negatively affected by our inability to access secured lending markets, brokered deposit markets or raise funding in the long-term or short-term capital markets. Factors that we cannot control, such as disruption of the financial markets or negative views about the financial services industry generally, could impair our ability to raise funding. In addition, our ability to raise funding could be impaired if the Federal Home Loan Bank (FHLB) or deposit brokers develop a negative perception of our long-term or short-term financial prospects. Such negative perceptions could be developed if we suffer a decline in the level of our business activity, regulatory authorities take significant action against us, or we discover employee misconduct or illegal activity, among other things. If we were unable to raise funds using the methods described above, we would likely need to liquidate unencumbered assets, such as our investment and loan portfolios, to meet maturing liabilities. We may be unable to sell some of our assets, or we may have to sell assets at a discount from market value, either of which could adversely affect our operations.

We rely heavily on the services of key personnel.

Michael G. Carlton, our president and chief executive officer, has substantial experience with our operations and has contributed significantly to our growth since our founding. The loss of the services of Mr. Carlton or of one or more of the key members of our executive management team may have a material adverse effect on our operations. If Mr. Carlton or other members of our executive management team were no longer employed by us, our ability to implement our growth strategy could be impaired.

Our ability to retain and attract qualified employees is critical to the success of our business and the failure to do so may materially adversely affect our performance.

Our people are our most important resource and competition for qualified employees is intense. In order to attract and retain qualified employees, we must compensate such employees at market levels. Those levels have caused employee compensation to be our greatest expense as compensation is highly variable and moves with performance. If we are unable to continue to attract and retain qualified employees, or if compensation costs required to attract and retain employees become more expensive, our performance, including our competitive position, could be materially adversely affected.

The success of our growth strategy depends on our ability to identify and retain individuals with experience and relationships in the markets in which we intend to expand.

We may expand our banking network over the next several years, not just in our existing core market area, but also in other community markets throughout central North Carolina and other contiguous markets. To expand into new markets successfully, we must identify and retain experienced key management members with local expertise and relationships in these markets. We expect that competition for qualified management in the markets in which we may expand will be intense and that there will be a limited number of qualified persons with knowledge of and experience in the community banking industry in these markets. Even if we identify individuals that we believe could assist us in establishing a presence in a new market, we may be unable to recruit these individuals away from more established banks. In addition, the process of identifying and recruiting individuals with the combination of skills and attributes required to carry out our strategy is often lengthy. Our inability to identify, recruit, and retain talented personnel to manage new offices effectively would limit our growth and could materially adversely affect our business, financial condition, and results of operations.

New or acquired bank office facilities and other facilities may not be profitable.

We may not be able to identify profitable locations for new bank offices and the costs to start up new bank office facilities or to acquire existing bank offices, and the additional costs to operate these facilities, may increase our noninterest expense and decrease earnings in the short term. If offices of other banks become available for sale, we may acquire those offices. It may be difficult to adequately and profitably manage our growth through the establishment or purchase of bank offices. In addition, we can provide no assurance that any such offices will successfully attract enough deposits to offset the expenses of their operation.

We are subject to operational risk and an operational failure could materially adversely affect our businesses.

Operational risk refers to the risk of loss arising from inadequate or failed internal processes, people and/or systems. Operational risk also refers to the risk that external events, such as external changes (e.g., natural disasters, terrorist attacks and/or health epidemics), failures or frauds, will result in losses to our businesses.

Our business is highly dependent on our ability to process, on a daily basis, a large number of transactions and the transactions we process have become increasingly complex. We perform the functions required to operate our business either by ourselves or through agreements with third parties. We rely on the ability of our employees, our internal systems and systems at technology centers operated by third parties to process high numbers of transactions. In the event of a breakdown or improper operation of our or third-party’s systems or improper action by third parties or employees, we could suffer financial loss, an impairment to our liquidity, a disruption of our businesses, regulatory sanctions and damage to our reputation.

In order to be profitable, we must compete successfully with other financial institutions which have greater resources and capabilities than we do.

The banking business in North Carolina in general, and in the Triangle area in particular, which is part of our market area, is extremely competitive. Most of our competitors are larger and have greater resources than we do and have been in existence a longer period of time. We will have to overcome historical bank-customer relationships to attract customers away from our competition. We compete with the following types of institutions:

· other commercial banks	· securities brokerage firms
· savings banks	· mortgage brokers
· thrifts	· insurance companies
· credit unions	· mutual funds
· consumer finance companies	· trust companies

Some of our competitors are not regulated as extensively as we are and, therefore, may have greater flexibility in competing for business. Some of these competitors are subject to similar regulation but have the advantages of larger established customer bases, higher lending limits, extensive branch networks, numerous automated teller machines, greater advertising-marketing budgets or other factors.

Our legal lending limit is determined by law. The size of the loans which we offer to our customers may be less than the size of the loans that larger competitors are able to offer. This limit may affect to some degree our success in establishing relationships with the larger businesses in our market.

We are subject to extensive regulation that could limit or restrict our activities.

We operate in a highly regulated industry and are subject to examination, supervision, and comprehensive regulation by the North Carolina Office of the Commissioner of Banks, the FDIC, and the Federal Reserve Board. Our compliance with these regulations is costly and restricts certain of our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits, and locations of offices. We must also meet regulatory capital requirements. If we fail to meet these capital and other regulatory requirements, our financial condition, liquidity, and results of operations would be materially and adversely affected. Our failure to remain “well capitalized” and “well managed” for regulatory purposes could affect customer confidence, our ability to grow, our cost of funds and FDIC insurance, our ability to pay dividends on common stock, and our ability to make acquisitions.

The laws and regulations applicable to the banking industry could change at any time, and we cannot predict the effects of these changes on our business and profitability. For example, new legislation or regulation could limit the manner in which we may conduct our business, including our ability to obtain financing, attract deposits, and make loans. Many of these regulations are intended to protect depositors, the public, and the FDIC, not shareholders. In addition, the burden imposed by these regulations may place us at a competitive disadvantage compared to competitors who are less regulated. The laws, regulations, interpretations, and enforcement policies that apply to us have been subject to significant change in recent years, sometimes retroactively applied, and may change significantly in the future. Our cost of compliance could adversely affect our ability to operate profitably.

Our growth may require us to raise additional capital that may not be available when it is needed, or at all.

We are required by regulatory authorities to maintain adequate levels of capital to support our operations. We anticipate that our capital resources will satisfy our capital requirements for the foreseeable future. We may at some point, however, need to raise additional capital to support our continued growth. Our ability to raise additional capital, if needed, will depend in part on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, we may be unable to raise additional capital, if and when needed, on terms acceptable to us, or at all. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth and acquisitions could be materially impaired. In addition, if we issue additional equity capital, the interests of existing shareholders would be diluted.

Efforts to comply with the Sarbanes-Oxley Act will involve significant expenditures, and non-compliance with the Sarbanes-Oxley Act may adversely affect us.

The Sarbanes-Oxley Act of 2002, and the related rules and regulations promulgated by the Securities and Exchange Commission that are now applicable to us, have increased the scope, complexity, and cost of corporate governance, reporting, and disclosure practices. We have experienced, and we expect to continue to experience, greater compliance costs, including costs related to internal controls, as a result of the Sarbanes-Oxley Act. We expect these new rules and regulations to continue to increase our accounting, legal, and other costs, and to make some activities more difficult, time consuming, and costly. In the event that we are unable to achieve or maintain compliance with the Sarbanes-Oxley Act and related rules, we may be adversely affected.

We are evaluating our internal control systems in order to allow management to report on, and our independent registered public accounting firm to attest to, our internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. If we identify significant deficiencies or material weaknesses in our internal control over financial reporting that we cannot remediate in a timely manner, or if we are unable to receive a positive attestation from our independent registered public accounting firm with respect to our internal control over financial reporting, the trading price of our common stock could decline, our ability to obtain any necessary equity or debt financing could suffer, and, if accepted for listing, our common stock could ultimately be delisted from the NASDAQ Global Market. In this event, the liquidity of our common stock would be severely limited and the market price of our common stock would likely decline significantly.

In addition, the new rules adopted as a result of the Sarbanes-Oxley Act could make it more difficult or more costly for us to obtain certain types of insurance, including directors’ and officers’ liability insurance, which could make it more difficult for us to attract and retain qualified persons to serve on our board of directors or as executive officers.

Risks Related to an Investment in our Common Stock

Our securities are not FDIC insured.

Our common stock is not a savings or deposit account or other obligation of the bank, and is not insured by the Federal Deposit Insurance Corporation or any other governmental agency and is subject to investment risk, including the possible loss of principal.

We do not plan to pay cash dividends for the foreseeable future.

We do not expect to pay cash dividends on our common stock in the foreseeable future, as we intend to retain earnings to provide the capital necessary to fund our growth strategy. You should not buy shares in this offering if you need dividend income from this investment. Our ability to declare and pay cash dividends will be dependent upon, among other things, restrictions imposed by the reserve and capital requirements of North Carolina and federal banking regulations, our income and financial condition, tax considerations, and general business conditions. Therefore, investors should not purchase shares with a view for a current return on their investment in the form of cash dividends.

We have implemented anti-takeover devices that could make it more difficult for another company to acquire us, even though such an acquisition may increase shareholder value.

In some cases, shareholders would receive a premium for their shares if we were acquired by another company. However, state and federal law and our articles of incorporation and bylaws make it difficult for anyone to acquire us without approval of our board of directors. For example, our articles of incorporation require a supermajority vote of two-thirds of our outstanding common stock in order to effect a sale or merger of the company in certain circumstances. Our bylaws also divide the board of directors into three classes of directors serving staggered three-year terms with approximately one-third of the board of directors elected at each annual meeting of shareholders. The classification of directors makes it more difficult for shareholders to change the composition of the board of directors. As a result, at least two annual meetings of shareholders would be required for the shareholders to change a majority of the directors, whether or not a change in the board of directors would be beneficial and whether or not a majority of shareholders believe that such a change would be desirable. Consequently, a takeover attempt may prove difficult, and shareholders may not realize the highest possible price for their securities.

The holder of our junior subordinated debenture has rights that are senior to those of our common shareholders.

We have supported our continued growth through the issuance of trust preferred securities from a special purpose trust and an accompanying sale of an $8.2 million junior subordinated debenture to this trust. Payments of the principal and interest on the trust preferred securities of this trust are conditionally guaranteed by us. Further, the accompanying junior subordinated debenture that we issued to the trust is senior to our shares of common stock. As a result, we must make payments on the junior subordinated debenture before any dividends can be paid on our common stock and, in the event of our bankruptcy, dissolution or liquidation, the holder of the junior subordinated debenture must be satisfied before any distributions can be made on our common stock. We have the right to defer distributions on the junior subordinated debenture (and the related trust preferred securities) for up to five years, during which time no dividends may be paid on our common stock.

ITEM 1B - UNRESOLVED STAFF COMMENTS

Not applicable.

ITEM 2 - PROPERTIES

The following table sets forth the location of the Registrant’s main office and branch offices, as well as certain information relating to these offices to date.

Office Locations	Year Opened		Approximate Square Footage		Owned or Leased
Main Office 1005 High House Road Cary, NC		2000		8,100		Leased

Cary Office 1155 Kildaire Farm Road Cary, NC		1998		2,960		Leased

Apex Office 303 South Salem Street Apex, NC		1999		3,500		Leased

Clayton Office 315 East Main Street Clayton, NC	2000	2,990	Leased

Holly Springs Office 700 Holly Springs Road Holly Springs, NC	2003	3,500	Owned

Pinehurst Office 211-M Central Park Avenue Pinehurst, NC	2003	2,850	Leased

Southern Pines Office 185 Morganton Road Southern Pines, NC	2003	3,500	Leased

Sanford Office 870 Spring Lane Sanford, NC	2004	3,500	Structure owned with ground lease

Garner Office 574 Village Court Garner, NC	2005	1,960	Leased

Raleigh Loan Production Office 4601 Six Forks Road Raleigh, NC	2005	2,439	Leased

Falls of Neuse Office 6408 Falls of Neuse Road Raleigh, NC	2006	2,442	Owned

Port City Capital Bank 1508 Military Cutoff Road Wilmington, NC 28403	2006	6,634	Leased

Operations Locations		Year Opened			Approximate Square Footage			Owned or Leased
206 High House Road Cary, NC			2005			12,535			Leased

The total net book value of the Company’s real property used for business purposes, furniture, fixtures, and equipment on December 31, 2006 was $5,907,664. All properties are considered by Company management to be in good condition and adequately covered by insurance.

ITEM 3 - LEGAL PROCEEDINGS

There are no pending legal proceedings to which the Registrant is a party, or of which any of its property is the subject other than routine litigation that is incidental to its business.

ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of shareholders in the fourth quarter of 2006.

PART II

ITEM 5 - MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The Registrant’s stock is listed on the NASDAQ Global Market under the symbol “CRFN.” There were 8,265,136 shares outstanding at December 31, 2006 owned by approximately 2,900 shareholders. The table below lists the high and low prices at which trades were completed during each quarter for the last two years. The Company’s stock is considered thinly traded with less than ten thousand shares traded, on average, per day. Our ability to pay cash dividends depends on the cash dividends we receive from the banks. However, the banks are restricted in the amount of dividends they may pay. See the section entitled Regulation in Item 1 for further disclosure regarding cash dividend payments. Moreover, we do not expect to pay cash dividends on our common stock in the foreseeable future, as we intend to retain earnings in order to provide the capital necessary to fund our growth strategy.

	Low (1)		High (1)
January 1, 2005 to March 31, 2005		11.05		12.82

April 1, 2005 to June 30, 2005		12.71		15.00

July 1, 2005 to September 30, 2005		13.57		14.83

October 1, 2005 to December 31, 2005		12.83		14.78

January 1, 2006 to March 31, 2006		13.09		13.57

April 1, 2006 to June 30, 2006		12.91		15.04

July 1, 2006 to September 30, 2006		12.80		14.30

October 1, 2006 to December 31, 2006		12.38		13.50

(1)	The 2005 prices quoted above have been adjusted to reflect the 15% stock split effected as a stock dividend paid in 2006 and a 15% stock distribution in 2005.

See Item 12 of this Report for disclosure regarding securities authorized for issuance under equity compensation plans.

ITEM 6 - SELECTED FINANCIAL DATA

	At or for the Years Ended December 31,
	2006			2005			2004			2003			2002
				(Dollars in thousands, except share and per share data)
Summary of Operations
Interest income	$	36,707		$	22,827		$	15,896		$	10,950		$	8,556
Interest expense		17,257			8,872			5,466			3,749			3,189
Net interest income		19,450			13,955			10,430			7,201			5,367
Provision for loan losses		991			807			736			551			689
Net interest income after the provision for loan losses		18,459			13,148			9,694			6,650			4,678
Non-interest income		2,612			2,417			2,342			1,645			768
Non-interest expense		13,387			10,762			8,531			5,767			4,124
Income before income taxes		7,684			4,803			3,505			2,528			1,322
Income taxes		2,780			1,659			1,172			873			94
Net income		4,904			3,144			2,333			1,655			1,228
Per Share and Shares Outstanding⁽¹⁾
Net income, basic⁽²⁾	$	0.74		$	0.64		$	0.50		$	0.40		$	0.39
Net income, diluted⁽²⁾	$	0.71		$	0.61		$	0.47		$	0.38		$	0.38
Book value at end of period	$	10.05		$	7.17		$	5.68		$	5.20		$	4.53
Tangible book value	$	6.24		$	6.52		$	4.88		$	4.38		$	4.53
Weighted average shares outstanding:
Basic		6,619,105			4,911,264			4,678,604			4,143,766			3,111,805
Diluted		6,922,552			5,165,861			4,925,264			4,295,142			3,201,626
Shares outstanding at period end		8,265,136			5,780,353			4,717,210			4,641,069			3,911,536
Balance Sheet Data
Total assets	$	697,909		$	410,788		$	331,227		$	273,714		$	182,005
Total investments⁽³⁾		85,578			57,752			54,935			38,383			45,559
Total loans, net		542,874			323,971			253,793			213,442			123,962
Total deposits		541,881			322,081			273,649			218,615			153,105
Borrowings		69,699			45,212			29,555			29,003			10,000
Stockholders’ equity		83,034			41,457			26,777			24,150			17,732
Selected Performance Ratios
Return on average assets		0.93	%		0.84	%		0.76	%		0.79	%		0.85	%
Return on average stockholders’ equity		8.72	%		10.34	%		9.14	%		8.25	%		9.31	%
Net interest spread⁽⁴⁾		3.29	%		3.51	%		3.26	%		3.09	%		3.18	%
Net interest margin⁽⁵⁾		3.95	%		3.94	%		3.61	%		3.64	%		3.87	%
Non-interest income as a percentage of total revenue⁽⁶⁾		11.84	%		14.76	%		18.34	%		18.60	%		12.52	%
Non-interest income as a percentage of average assets		0.49	%		0.64	%		0.76	%		0.78	%		0.53	%
Non-interest expense to average assets		2.53	%		2.86	%		2.76	%		2.75	%		2.85	%
Efficiency ratio⁽⁷⁾		60.68	%		65.73	%		66.79	%		65.19	%		67.22	%
Average stockholders’ equity to average total assets		10.64	%		8.08	%		8.27	%		9.55	%		9.13	%
Asset Quality Ratios
Net charge-offs to average loans outstanding		0.02	%		0.04	%		0.15	%		0.05	%		0.09	%
Allowance for loan losses to period end loans		1.26	%		1.33	%		1.42	%		1.52	%		1.36	%
Allowance for loan losses to non- performing loans		5,145	%		16,960	%		73,360	%		2,078	%		NM
Non-performing loans to period end loans		0.02	%		0.01	%		0.00	%		0.07	%		0.00	%
Non-performing assets to total assets⁽⁸⁾		0.03	%		0.01	%		0.09	%		0.06	%		0.00	%
Capital Ratios
Total risk-based capital ratio		11.03	%		13.68	%		11.61	%		12.95	%		13.23	%
Tier 1 risk-based capital ratio		9.88	%		12.51	%		10.38	%		11.70	%		12.04	%
Leverage ratio		9.13	%		11.51	%		9.49	%		10.63	%		10.08	%
Equity to assets ratio		11.90	%		10.09	%		8.08	%		8.82	%		9.74	%
Other Data
Number of full-service banking offices		11			9			8			7			5
Number of full-time equivalent employees		122			90			78			64			37

(1)	Adjusted to reflect the stock splits effected in the form of a 15% stock dividend in each of 2006 and 2005, a 20% stock distribution in 2004, a 15% stock distribution in 2003 and a 12.5% stock distribution in 2002.

(2)	Computed based on the weighted average number of shares outstanding during each period.

(3)	Consists of interest-earning deposits, federal funds sold, investment securities and FHLB stock.

(4)	Net interest spread is the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.

(5)	Net interest margin is net interest income divided by average interest-earning assets.

(6)	Total revenue consists of net interest income and non-interest income.

(7)	Efficiency ratio is non-interest expense divided by the sum of net interest income and non-interest income.

(8)	Non-performing assets consist of non-accrual loans, restructured loans, and foreclosed assets, where applicable.

ITEM 7 - 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 (“Crescent” or the “Company”). The analysis includes detailed discussions for each of the factors affecting Crescent Financial Corporation’s operating results and financial condition for the years ended December 31, 2006 and 2005. It should be read in conjunction with the audited consolidated financial statements and accompanying notes included in this report and the supplemental financial data appearing throughout this discussion and analysis.

The following discussion and analysis contains the consolidated financial results for the Company, Crescent State Bank and Port City Capital Bank for the years ended December 31, 2006 and 2005. The Company had previously discontinued the consolidation of Crescent Financial Capital Trust I and began reporting the junior subordinated debentures that the Company issued in exchange for the proceeds that resulted from the issuance of the trust preferred securities. The trust preferred securities are classified as long-term debt obligations. Except for the accounting treatment, the relationship between the Company and Crescent Financial Capital Trust I has not changed. Crescent Financial Capital Trust I continues to be a wholly owned subsidiary of the Company and the full and unconditional guarantee of the Company for the repayment of the trust preferred securities remains in effect. The financial statements presented contain the consolidation of Crescent Financial Corporation and the Banks only. The Company and its consolidated subsidiaries are collectively referred to herein as the Company unless otherwise noted.

COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 2006 AND 2005

The Company reported total assets of $697.9 million at December 31, 2006, reflecting a $287.1 million or 70% increase over total assets of $410.8 at December 31, 2005. At December 31, 2006 total earning assets increased by 66% or $252.9 million growing to $639.0 million from $386.1 million at December 31, 2005. Earning assets at December 31, 2006 consisted of $549.8 million in gross loans, $88.3 million in investment securities and Federal Home Loan Bank (FHLB) stock and $855,000 in overnight investments and interest bearing deposits. Total liabilities increased by 66% or $245.5 million from $369.3 million at December 31, 2005 to $614.9 million at year-end 2006. Due to the completion of the acquisition of Port City Capital Bank in the third quarter, the exercise of vested stock options and net income for the twelve-month period, total stockholders’ equity increased 100% or $41.6 million from $41.5 million to $83.0 million.

Loans comprise the largest portion of our earning assets and experienced significant growth during the year. Gross loans increased by $221.5 million or 67% growing from $328.3 million at December 31, 2005 to $549.8 million at December 31, 2006. Most loan categories experienced net growth during the twelve-month period. The commercial mortgage loan category experienced the most significant net growth in terms of dollars growing $130.7 million or 75% from $173.7 million to $304.4 million. Net growth in other loan categories, presented in order of dollar growth, were as follows: construction loans increased by $63.4 million or 136% from $46.4 million to $109.8 million, commercial and industrial loans increased by $15.1 million or 29% from $52.7 million to $67.8 million, home equity lines and loans increased by $7.8 million or 22% from $34.9 million to $42.7 million and residential mortgage loans increased by $5.3 million or 36% from $14.9 million to $20.2 million. The consumer loan portfolio declined by 12% or $0.7 million during the year to close at $5.0 million.

The acquisition of Port City Capital Bank on August 31, 2006 added $128.5 million of the total $221.5 million increase in gross loans. Loans acquired by category include $115.2 million of commercial mortgage loans, $9.5 million of commercial loans, $2.3 million home equity lines, $1.2 million residential real estate mortgage loans, and $300,000 in the consumer loan category.

The composition of the loan portfolio, by category, as of December 31, 2006 is as follows: 55% commercial mortgage loans, 20% construction loans, 12% commercial and industrial loans, 8% home equity loans and lines of credit, 4% residential mortgage loans and 1% consumer loans. The composition of the loan portfolio, by category, as of December 31, 2005 was as follows: 53% commercial mortgage loans, 16% commercial and industrial loans, 14% construction loans, 11% home equity loans and lines of credit, 4% residential mortgage loans and 2% consumer loans. The changes in loan composition are primarily due to the composition of the loan portfolio acquired in the PCCB transaction. As of the merger date, August 31, 2006, the composition of PCCB’s portfolio was as follows: 62% commercial mortgage loans, 28% construction, 7% commercial and industrial, 2% home equity lines and loans and 1% residential mortgage loans. Consumer loans comprised less than one half of 1%.

We track each loan we originate using the North American Industry Classification System (NAICS) code. Through the use of this code, we can monitor those industries for which we have a significant concentration of exposure. At December 31, 2006, there were two industry codes for which our concentration exposure exceeded 10% of the total loan portfolio. Loans to investors who lease non-residential buildings other than miniwarehouses comprised 21% of our loan portfolio and loans to builders for land subdivision comprised 11% of the loan portfolio.

The allowance for loan losses was $6.9 million or 1.26% of total outstanding loans at December 31, 2006 compared with $4.4 million or 1.33% of total outstanding loans at December 31, 2005. The acquisition of PCCB added $1.7 million of the total $2.5 million increase in the loan loss allowance. The credit quality of the Company’s loan portfolio remains high. At December 31, 2006, there were two loans totaling approximately $135,000 in non-accrual status. The percentage of non-performing loans to total loans at December 31, 2006 was 0.02%. There were eight loans aggregating $554,000 that were 30 days or more past due. There were no loans past due 90 days or more and still accruing interest at December 31, 2006. At December 31, 2005, there were three loans totaling approximately $26,000 in non-accrual status. Non-performing loans to total loans, expressed as a percentage, at December 31, 2005 was 0.01%. In addition to the three loans in non-accrual status, there were seven loans totaling approximately $404,000 that were 30 days or more past due. There were no loans 90 days or more past due and still accruing interest. See the section entitled “Non Performing Assets” for more details.

The amortized cost and fair market value of the Company’s investment securities portfolio at December 31, 2006 were $85.5 million and $84.7 million, respectively. All investments are accounted for as available for sale under Financial Accounting Standards Board ("FASB") No. 115 and are presented at their fair market value. The portfolio experienced a net increase of $29.2 million or 53% compared with $55.5 million at December 31, 2005. The Company’s investment in debt securities at December 31, 2006, consisted of U.S. Government agency securities, collateralized mortgage obligations (CMOs), mortgage-backed securities (MBSs), municipal bonds, a trust preferred stock issue and common stock of a publicly traded financial institution. Increases in the portfolio during 2006 were attributed to purchases of $25.2 million, acquisition of $16.4 million securities from PCCB, a $0.3 million increase in the fair market value of the portfolio, as well as net premium accretion of $20,000. Activities resulting in portfolio decreases included $6.6 million in principal re-payments on CMOs and MBSs, and $6.1 million in sales of securities available for sale. The Company also owned $3.6 million of Federal Home Loan Bank stock at December 31, 2006 compared with $2.1 million at December 31, 2005.

Interest-earning deposits held at correspondent banks increased by $695,000 from $68,000 at December 31, 2005 to $763,000 at December 31, 2006. Funds held in interest-earning deposit accounts result primarily from the receipt of principal and interest from the investment portfolio. As funds accumulate, they are reinvested in investment securities.

Non-interest earning assets totaled $65.9 million at December 31, 2006 increasing by $36.8 million or 127% compared with $29.1 million at the prior year end. The largest increase was in goodwill which grew by $26.6 million from $3.6 million to $30.2 million due to the acquisition of PCCB in August, 2006. Goodwill was not impaired at December 31, 2006. Cash and due from banks grew by $4.9 million from $9.4 million to $14.3 million. Cash and due from banks includes cash on hand in branches and amounts represented by checks in the process of being collected through the Federal Reserve payment system. These checks were not yet collected and therefore could not be invested overnight. For more details regarding the increase in cash and cash equivalents, see the Consolidated Statements of Cash Flows. Other assets increased by $1.8 million primarily due to the acquisition of PCCB, who had $1.5 million of other assets at December 31, 2006 which included their core deposit intangible of $1.1 million. Accrued interest receivable increased by $1.3 million due to the higher volume of earning assets. Total premises and equipment at December 31, 2006 was $5.9 million compared with $4.8 million the prior year. The $1.1 million net increase resulted from $1.7 million in new purchases, and $85,000 from the acquisition, less $699,000 of depreciation. Deferred tax assets increased by $828,000 mainly due to the acquisition of PCCB. The cash surrender value of bank owned life insurance increased by $200,000 from $5.5 million to $5.7 million.

Between December 31, 2005 and December 31, 2006, total deposits increased by $219.8 million or 68%. Time deposits increased the most growing by $117.5 million from $178.2 million to $295.7 million. Increases in other deposit categories included $69.0 million in savings account balances growing to $78.4 million from $9.4 million, $23.6 million in non-interest bearing demand growing to $70.4 million from $46.8 million, and $13.7 million in money market balances growing from $45.8 million to $59.5 million. Interest bearing demand declined by $4.1 million from $41.9 million to $37.8 million.

We have historically offered a relationship-based interest-bearing checking account that paid an above average market rate. Prior to July 2004 when interest rates were declining, the rate of interest on the relationship-based interest bearing account was higher than the money market and savings rates. As a result, customers shifted funds out of money market accounts into the interest-bearing checking account. During 2006, the Company introduced a high-yielding statement savings account. At its highest balance tier, the new product pays a rate of interest higher than either the money market or the relationship-based interest bearing checking accounts. While the account was very successful in attracting new deposits, there was some shifting of funds from our premium interest-bearing checking account into the new savings product.

The acquisition of Port City Capital Bank on August 31, 2006 added approximately $144.2 million in deposits to the Company’s balance sheet. The total increase included $95.3 million in time deposits, $28.5 million in money market, $14.8 million in non interest bearing demand, $5.6 million in interest bearing demand, and $76,000 in savings accounts.

The Banks maintain a number of deposit relationships with real estate settlement attorneys. Balances in these escrow accounts can fluctuate significantly based on the amount of mortgage loan activity. At December 31, 2006, the aggregate balance in the real estate settlement accounts was $13.1 million compared to $13.7 million at December 31, 2005.

The composition of the deposit base, by category, at December 31, 2006 was as follows: 55% in time deposits, 14% in savings deposits, 13% in non interest-bearing demand deposits, 11% in money market deposits, and 7% in interest-bearing demand deposits. The composition of the deposit base, by category, at December 31, 2005 was as follows: 55% in time deposits, 15% in non interest-bearing demand deposits, 14% in money market deposits, 13% in interest-bearing demand deposits, and 3% in savings deposits. As was the case with the loan portfolio, the acquisition of PCCB in August 2006 impacted deposit composition. The composition of the PCCB deposit base at August 31, 2006 was as follows: 66% in time deposits, 20% in money market, 10% in non-interest bearing and 4% in interest bearing demand and less than 1% in savings accounts. Prior to the acquisition and through the development of the new high-interest yielding statement savings account mentioned above, CSB was able to significantly increase its core deposit base while reducing its reliance on time deposits (brokered funds). Prior to August 2006, time deposits as a percentage of total deposits had fallen to 52%.

At December 31, 2006 the Company had $229.8 million in time deposits of $100,000 or more compared to $118.5 million at December 31, 2005. The acquisition of PCCB brought $88.8 million of time deposits greater than $100,000.The Company uses brokered certificates of deposit as an alternative funding source. Brokered deposits represent a source of fixed rate funds that do not need to be collateralized like Federal Home Loan Bank borrowings. The Company expects to utilize the brokered deposit market in the future. Brokered deposits at December 31, 2006 were $141.7 million compared to $68.0 million at December 31, 2005.

Total borrowings increased by 54% from $45.2 million at December 31, 2005 to $69.7 million at December 31, 2006. Borrowings at December 31, 2006 consisted of $37.0 million in long-term FHLB advances, $18.0 million in short-term FHLB advances, $8.2 million in junior subordinated debt issued to an unconsolidated subsidiary, and $6.5 million in Federal funds purchased from a correspondent bank. The adoption of FASB Interpretation Number (FIN) 46, Consolidation of Variable Interest Equities, resulted in the deconsolidation of the trust subsidiary, Crescent Financial Capital Trust I (“Trust”), formed for the purpose of issuing trust preferred securities. As a result, the subordinated debt issued to the Trust for the proceeds of the trust preferred securities is included in long-term debt. At December 31, 2005, the Company had $22.0 million in long-term FHLB advances, $10.0 million in short-term FHLB advances, $8.2 million in junior subordinated debt issued to an unconsolidated subsidiary, $4.8 million in Federal funds purchased from a correspondent bank and $185,000 in securities sold under a repurchase agreement. Securities sold under repurchase agreements generally mature within one to four days from the transaction date. PCCB had no FHLB borrowings at the time of merger.

Accrued expenses and other liabilities increased by $1.3 million to $3.3 million at December 31, 2006 compared with $2.0 million at December 31, 2005. The increase is due to higher levels of accrued interest and accrued operating expenses.

Total stockholders’ equity increased by $41.6 million between December 31, 2005 and December 31, 2006. The increase was the net result of $36.0 million due to the issuance of common stock pursuant to the merger transaction, net income for the year of $4.9 million, plus $301,000 ($256,000 in cash proceeds and $45,000 in tax benefits) in additional capital from the exercise of stock options, $196,000 in stock based compensation expense and a $181,000 increase in the after-tax value of investment securities.

COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED

DECEMBER 31, 2006 AND 2005

Net Income. For the year ended December 31, 2006, the Company reported an increase in net income of 56% to $4.9 million compared to $3.1 million for the year ended December 31, 2005. Net income per diluted share increased 17% to $0.71 compared to $0.61 for the prior year period. The percentage increase in earnings per share did not mirror that of the increase in net income primarily due to the addition of 2.4 million shares from the acquisition of PCCB. Per share data for 2005 data has been adjusted for the 15% stock split effected as a stock dividend payable on May 31, 2006 to shareholders of record on May 18, 2006. Returns on average assets and average equity were 0.93% and 8.72%, respectively, for the year ended December 31, 2006 compared to 0.84% and 10.34% for the prior year period.

Net Interest Income. Net interest income was $19.4 million for the current year compared to $14.0 million for the prior year. The 39% increase in net interest income was due primarily to significant growth in average earning assets.

Net interest margin is interest income earned on loans, securities and other earning assets, less interest expense paid on deposits and borrowings, expressed as a percentage of total average earning assets. The net interest margin for the year ended December 31, 2006 was 3.95% compared to 3.94% for the prior year. The average yield on earning assets for the current period was 7.46% compared to 6.45% from the year ended December 31, 2005 and the average cost of interest-bearing funds was 4.17% compared to 2.94%. The decline in interest rate spread from 3.51% to 3.29% was partially offset by an improvement in the ratio of average interest-earning assets to average interest-bearing liabilities which increased from 117.14% at December 31, 2005 to 118.88% at December 31, 2006.

Between July 1, 2004 and July 5, 2006, the Federal Reserve (the “Fed”) increased short-term interest rates sixteen times for a total of 400 basis points. Interest rates stabilized over the last five months of 2006. While several factors influence the level of intermediate and long-term interest rates, increases in short-term interest rates would generally result in a parallel shift in the entire yield curve across all investment horizons. The current rate increases did not impact intermediate and long-term rates in the typical manner, as those rates continued to trade in very tight ranges to levels seen prior to July 2004. The result has been a flat to inverted yield curve across investment terms. In other words, where historically interest rates for ten year terms were higher than overnight and other short-term investments, the current rate environment has short-term interest rates at higher levels than ten year rates.

Approximately 55% of the Company’s loan portfolio carry variable rate pricing based on the Prime lending rate or LIBOR (London Inter Bank Offering Rate). As short-term rates have risen, variable rate loans have repriced higher resulting in a higher yield on average earning assets. While the yield on the variable portion of existing loans was rising with rate increases, rates on new loans were trending lower based on competition and new loan mix. Of the $93.0 million in organic loan growth, $51.5 million was in the commercial mortgage loan category. Due to the nature of the collateral and the competitive marketplace, this type of loan typically receives very favorable fixed-rate pricing based on the intermediate to long end of the yield curve. The volume of new loan originations outpaced the generation of lower cost core deposits causing the Company to rely more heavily on savings and brokered certificates of deposit resulting in a higher cost of funds than we would have anticipated. The Company expects to experience some net interest margin compression in the current stable rate environment. In rising or falling interest rate environments, the Company would expect moderate expansion or contraction of margin, respectively.

Total average interest earning assets were $491.8 million for the year ended December 31, 2006, increasing by $137.9 million or 39% when compared to an average of $353.9 million for the year ended December 31, 2005. Increases in average balances by earning asset category are as follows: average loans increased by $117.6 million or 40% from $297.0 million for 2005 to $414.6 million for 2006, investment securities grew by $15.9 million or 29% from $55.3 million for 2005 to $71.2 million for 2006 and Federal funds sold and other earning assets increased from $1.5 million in 2005 to $6.0 million for 2006. Total average interest-bearing liabilities increased by $111.6 million with interest-bearing deposits increasing by $102.2 million or 40% and borrowings increasing by $9.4 million.

Total interest income for 2006 increased by $13.9 million to $36.7 million compared to $22.8 million for the prior year. The increase was the result of a $10.0 million improvement from increased earning asset levels and a $3.9 million increase due to the rising interest rate environment. Total interest expense grew by $8.4 million attributed to a $4.1 million increase from higher interest bearing liability volumes and $4.3 million due to higher interest rates.

Provision for Loan Losses. The Company’s provision for loan losses for 2006 was $991,000 compared to $807,000 recorded in the prior year. The increase in the loan loss provision was due to the increase in net loan growth. Organic loan growth was $93.0 million ($221.5 million total less $128.5 million acquired through PCCB) during 2006 compared to $70.9 million in 2005 and net charge-offs for 2006 were $84,000 compared to $124,000 during the prior year. Provisions for loan losses are charged to income to bring the allowance for loan losses to a level deemed appropriate by management. While net growth in the loan portfolio is the primary driver in determining the loan loss provision, there are other factors which are more fully discussed under the section entitled “Analysis of Allowance for Loan Losses.”

Non-Interest Income. Non-interest income increased by $195,000 or 8% to $2.6 million for 2006 compared to $2.4 million for the prior year period. The largest components of non-interest income in 2006 were $1,090,000 in customer service fees, $642,000 in mortgage loan origination fees, $229,000 in earnings on cash value of bank owned life insurance and $197,000 in service charges and fees on deposit accounts. For the year ended December 31, 2005, the largest components of non-interest income included $870,000 in customer service fees, $755,000 in mortgage loan origination fees, $226,000 in earnings on cash value of bank owned life insurance and $175,000 in service charges and fees on deposit accounts. The Company recognized $16,000 in losses on the disposition of available for sale investment securities in 2005.

Non-Interest Expenses. Non-interest expenses were $13.4 million for year ended December 31, 2006 compared to $10.8 million for the prior year period. The $2.6 million or 24% increase reflects the continuing efforts to expand the Company’s infrastructure and branch network. Of the $2.6 million increase, $1.9 million was in personnel, occupancy and data processing which are the areas most impacted by the branch network and infrastructure improvements.

Total compensation for the year ended December 31, 2006 was $7.3 million reflecting a 24% increase when compared to $5.9 million for the year ended December 31, 2005. As of December 31, 2006, the Company employs 122 full-time equivalent employees in eleven full-service branch offices, one loan production office and various administrative support departments. In comparison, at December 31, 2005, the Company employed 90 full-time equivalent employees in nine full-service branch offices and various administrative support departments.

Occupancy expenses were $2.0 million for 2006 compared to $1.7 million in 2005 increasing by $290,000 or 17%. During 2006, the Company opened one new full-service office as well as acquired PCCB in August. During 2005, the Company opened an operations facility, one new full-service office, one loan production office and converted one office from a temporary branch location into a permanent building. Additional expansion opportunities will be explored as we identify the bankers of choice in other communities.

Data processing expenses were $834,000 for 2006 compared to $648,000 for the prior year. The 29% increase was due to growth in account volumes, contractual increases in data processing costs and the additional data line expenses for the new offices. Because data processing expense is tied closely to transaction and account volumes, these expenses should increase as the Company continues to grow.

Professional fees and services totaled $899,000 in 2006, up $187,000 or 26% over the $712,000 for 2005. The largest components of professional fees and services were directors’ fees, legal expenses, and accounting and audit expenses. In anticipation of needing to comply with the provisions of Sarbanes-Oxley Section 404, the Company spent approximately $80,000 documenting and sample testing various major control processes related to financial reporting. The parameters and timing to implement Sarbanes-Oxley Section 404 have changed several times and the Company was not required, as of December 31, 2006, to provide management’s written assessment of the adequacy of its internal controls over financial reporting. The Company will need to comply with Section 404 at December 31, 2007. The amount budgeted in 2007 for Sarbanes-Oxley compliance is approximately $100,000.

The total of all other non-interest expenses for the year ended December 31, 2006 was $2.3 million compared to $1.8 million for the prior year. The increase was primarily the result of the Company’s continued growth. The largest components of other non-interest expenses include office supplies and printing, advertising, and loan related fees. Management expects that as the Company continues to expand, expenses associated with these categories will increase.

Provision for Income Taxes. For 2006, the Company’s provision for income taxes was $2.8 million compared to $1.7 million for the prior year. The effective tax rates for 2006 and 2005 were 36.2% and 34.5%, respectively. The effective tax rate increased because the percentage of total income attributable to tax exempt sources declined as compared with the prior year period as well as the non-tax deductibility of the expensing of the fair value of stock options pursuant to FASB 123R.

COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED

DECEMBER 31, 2005 AND 2004

Net Income. For the year ended December 31, 2005, the Company reported an increase in net income of 35% to $3.1 million compared to $2.3 million for the year ended December 31, 2004. Net income per diluted share increased 30% to $0.61 compared to $0.47 for the prior year period. The percentage increase in earnings per share did not mirror that of the increase in net income primarily due to the sale of 848,000 additional shares of stock during the fourth quarter of 2005. The 2005 and 2004 per share data have been adjusted for the 15% stock split effected as a stock dividend payable on May 31, 2006 to shareholders of record on May 18, 2006. Returns on average assets and average equity were 0.84% and 10.34%, respectively, for the year ended December 31, 2005 compared to 0.76% and 9.14% for the prior year period.

Net Interest Income. Net interest income was $14.0 million for the current year compared to $10.4 million for the prior year. The 34% increase in net interest income was due primarily to significant growth in average earning assets and the 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 net interest margin for the year ended December 31, 2005 was 3.94% compared to 3.61% for the prior year. The average yield on earning assets for the current period was 6.45% compared to 5.51% from the year ended December 31, 2004, and the average cost of interest-bearing funds was 2.94% compared to 2.24%. Although the interest rate spread widened from 3.26% to 3.51%, we became more reliant on interest-bearing funds as the ratio of average interest-earning assets to average interest-bearing liabilities declined from 118.42% at December 31, 2004 to 117.15% at December 31, 2005.

Between July 1, 2004 and December 31, 2005, the Federal Reserve (the “Fed”) increased short-term interest rates thirteen times for a total of 325 basis points. Initially the increases were designed to achieve a more neutral monetary policy than had existed during the thirty months prior to June 30, 2004, and more recent increases were aimed at controlling certain perceived inflationary pressures in the economy. Approximately 61% of the Company’s loan portfolio carries variable rate pricing based on the Prime lending rate or LIBOR (London Inter Bank Offering Rate). While the current rate environment has resulted in an increase in the net interest margin, the magnitude of the increase has been less than we would have anticipated. Despite the sharp increase in the short-term interest rates, intermediate and long-term rates have not risen to the same extent. This has resulted in a flattening of the interest rate yield curve. Of the $70.9 million increase in net loan growth since December 31, 2004, $52.2 million has come in the commercial real estate category. Due to the nature of the collateral and the competitive marketplace, this type of loan typically receives very favorable fixed-rate pricing based on the intermediate to long end of the yield curve. Therefore, interest rates on new commercial real estate loans are not 325 basis points higher, but rather only slightly higher than loans made a year ago. The volume of new loan originations has outpaced the generation of lower cost core deposits causing the Company to rely more heavily on borrowed funds and brokered certificates of deposit resulting in the cost of funds to increase at a higher rate than we would have anticipated. The Company should continue to experience marginal benefit from a moderately rising rate environment. If rates stabilize or begin to trend downward, other things being equal, we will begin to experience some margin compression.

Total average interest earning assets were $353.9 million for the year ended December 31, 2005, increasing by $65.2 million or 23% when compared to an average of $288.7 million for the year ended December 31, 2004. Increases in average balances by earning asset category are as follows: average loans increased by $56.7 million or 24% from $240.3 million for 2004 to $297.0 million for 2005, investment securities grew by $10.8 million or 24% from $44.5 million for 2004 to $55.3 million for 2005 and Federal funds sold and other earning assets declined from $3.9 million in 2004 to $1.5 million for 2005. Total average interest-bearing liabilities increased by $58.3 million with interest-bearing deposits increasing by $37.6 million or 17% and borrowings increasing by $45.8 million.

Total interest income for 2005 increased by $6.9 million to $22.8 million compared to $15.9 million for the prior year. The increase was the result of a $4.1 million improvement from increased earning asset levels and a $2.8 million increase due to the rising interest rate environment. Total interest expense grew by $3.4 million attributed to a $1.8 million increase from higher interest bearing liability volumes and $1.6 million due to higher interest rates.

Provision for Loan Losses. The Company’s provision for loan losses for 2005 was $807,000 compared to $736,000 recorded in the prior year. The increase in the loan loss provision was due to the increase in net loan growth. The loan portfolio grew by $70.9 million during 2005 compared with $40.7 million in 2004 and net charge-offs for 2005 were $124,000 compared to $372,000 during the prior year. Provisions for loan losses are charged to income to bring the allowance for loan losses to a level deemed appropriate by management. While net growth in the loan portfolio is the primary driver in determining the loan loss provision, there are other factors which are more fully discussed under the section entitled “Analysis of Allowance for Loan Losses.”

Non-Interest Income. Non-interest income increased by $193,000 or 9% to $2.4 million for 2005 compared to $2.3 million for the prior year period. The largest components of non-interest income in 2005 were $870,000 in customer service fees, $755,000 in mortgage loan origination, $226,000 in earnings on cash value of bank owned life insurance and $175,000 in service charges and fees on deposit accounts. For the year ended December 31, 2004, the largest components of non-interest income included $689,000 in customer service fees, $643,000 in mortgage loan origination, $235,000 in earnings on cash value of life insurance and $187,000 in service charges and fees on deposit accounts. During 2004, the Company had a membership interest in a mortgage loan origination company and received $287,000 in income distributions. Additionally, when the membership interest was sold during the fourth quarter of 2004, a $118,000 gain on investment was recognized. Earnings on cash value of life insurance fell slightly due to a deceased crediting rate and service charges declined because of the increase in the earnings credit applied to commercial account balances to offset hard service charges. The Company recognized $16,000 in losses on the disposition of available for sale investment securities in 2005.

Non-Interest Expenses. Non-interest expenses were $10.8 million for year ended December 31, 2005 compared to $8.5 million for the prior year period. The $2.2 million or 26% increase reflects the continuing efforts to expand the Company’s infrastructure and branch network. Of the $2.2 million increase, $1.8 million was in personnel, occupancy and data processing which are the areas most impacted by the branch network and infrastructure improvements.

Total compensation for the year ended December 31, 2005 was $5.9 million reflecting a 34% increase when compared to $4.4 million for the year ended December 31, 2004. As of December 31, 2005, the Company employs 90 full-time equivalent employees (81 full-time and 18 part-time) in nine full-service branch offices, one loan production office and various administrative support departments. In comparison, at December 31, 2004, the Company employed 76 full-time equivalent employees (68 full-time and 15 part-time) in eight full-service branch offices and various administrative support departments.

Occupancy expenses were $1.7 million for 2005 compared to $1.5 million in 2004 increasing by $212,000 or 14%. During 2005, the Company opened an operations facility, one new full-service office, one loan production office and converted one office from a temporary branch location into a permanent building. In 2004, the Company operated seven full-service branch locations for the entire year and one branch for the final two months. The Company expects to open a full-service branch office in Raleigh, North Carolina during the second quarter of 2006. Additional expansion opportunities will be explored as we identify the bankers of choice in other communities.

Data processing expenses were $648,000 for 2005 compared to $549,000 for the prior year. The 18% increase was due to growth in account volumes, contractual increases in data processing costs and the additional data line expenses for the new offices. Because data processing expense is tied closely to transaction and account volumes, these expenses should increase as the Company continues to grow.

Professional fees and services totaled $712,000 in 2005, up $146,000 or 26% over the $566,000 for 2004. The largest components of professional fees and services were directors’ fees, legal expenses, and accounting and audit expenses. In anticipation of needing to comply with the provisions of Sarbanes-Oxley Section 404, the Company spent approximately $80,000 documenting and sample testing various major control processes related to financial reporting. The parameters and timing to implement Sarbanes-Oxley Section 404 have changed several times and the Company was not required, as of December 31, 2005, to provide management’s written assessment of the adequacy of its internal controls over financial reporting. Although the final rules of the legislation have not yet been released, the Company is proceeding as though we will need to be compliant at December 31, 2007. The amount budgeted for Sarbanes-Oxley compliance is approximately $120,000.

The total of all other non-interest expenses for the year ended December 31, 2005 was $1.8 million compared to $1.5 million for the prior year. The increase was primarily the result of the Company’s continued growth. The largest components of other non-interest expenses include office supplies and printing, advertising, and loan related fees. Management expects that as the Company continues to expand, expenses associated with these categories will increase.

Provision for Income Taxes. For 2005, the Company’s provision for income taxes was $1.7 million compared to $1.2 million for the prior year. The effective tax rates for 2005 and 2004 were 34.5% and 33.4%, respectively. The effective tax rate increased because the percentage of total income attributable to tax exempt sources declined as compared with the prior year period.

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 table sets forth information relating to average balances of the Company's assets and liabilities for the years ended December 31, 2006, 2005 and 2004. The table reflects 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 table, non-accrual loans are included in the average loan balance.

	For the Years Ended December 31,
	2006								2005								2004
	Average					Average			Average					Average			Average					Average
	balance			Interest		rate			balance			Interest		rate			balance			Interest		rate
	(Dollars in thousands)
Interest-earning assets:
Loan portfolio	$	414,644		$	33,093		7.98	%	$	297,045		$	20,456		6.89	%	$	240,346		$	14,024		5.83	%
Investment securities		71,151			3,303		4.64	%		55,285			2,323		4.20	%		44,469			1,825		4.10	%
Federal funds and other
interest-earning assets		5,996			310		5.17	%		1,531			47		3.07	%		3,862			47		1.22	%

Total interest-earning assets		491,791			36,706		7.46	%		353,861			22,826		6.45	%		288,677			15,896		5.51	%

Non-interest-earning assets		36,654								22,465								19,890

Total assets	$	528,445							$	376,326							$	308,567

Interest-bearing liabilities:
Deposits:
Interest-bearing NOW	$	37,876			553		1.46	%	$	39,609			416		1.05	%	$	40,931			323		0.79	%
Money market and savings		92,620			3,664		3.96	%		46,500			985		2.12	%		34,295			392		1.14	%
Time deposits		226,978			9,990		4.40	%		169,099			5,483		3.24	%		142,406			3,716		2.61	%
Short-term borrowings		16,318			844		5.17	%		12,239			475		3.88	%		1,318			48		3.64	%
Long-term debt		39,906			2,206		5.53	%		34,626			1,513		4.37	%		24,824			987		3.98	%
Total interest-bearing
liabilities		413,698			17,257		4.17	%		302,073			8,872		2.94	%		243,774			5,466		2.24	%

Other liabilities		58,542								43,843								39,279

Total liabilities		472,240								345,916								283,053

Stockholders’ equity		56,205								30,410								25,514
Total liabilities and
stockholders’ equity	$	528,445							$	376,326							$	308,567

Net interest income and
interest rate spread				$	19,449		3.29	%				$	13,954		3.51	%				$	10,430		3.26	%

Net interest margin							3.95	%							3.94	%							3.61	%

Ratio of average interest-
earning assets to average
interest-bearing liabilities		118.88	%							117.14	%							118.42	%

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

	Year Ended								Year Ended
	December 31, 2006 vs. 2005								December 31, 2005 vs. 2004
	Increase (Decrease) Due to								Increase (Decrease) Due to
	Volume			Rate			Total		Volume			Rate		Total
	(Dollars in thousands)
Interest income:
Loan portfolio	$	9,017		$	3,620		$	12,637	$	3,646		$	2,786	$	6,432
Investment securities		718			262			980		453			45		498
Federal funds and other
interest-earning assets		213			50			263		-			-		-

Total interest income		9,948			3,932			13,880		4,099			2,831		6,930

Interest expense:
Deposits:
Interest-bearing NOW		(17	)		154			137		(10	)		103		93
Money market and savings		1,429			1,250			2,679		175			418		593
Time deposits		2,205			2,302			4,507		770			996		1,767
Short-term borrowings		184			185			369		424			3		427
Long-term debt		253			440			693		420			106		526

Total interest expense		4,054			4,331			8,385		1,780			1,626		3,406

Net interest income increase
(decrease)	$	5,894		$	(399	)	$	5,495	$	2,319		$	1,205	$	3,524

NONPERFORMING ASSETS

Our financial statements are prepared on the accrual basis of accounting, including the recognition of interest income on loans, unless we place a loan in nonaccrual status. We account for loans on a nonaccrual basis when we have serious doubts about the collectibility of principal or interest. Generally, our policy is to place a loan on nonaccrual status when the loan becomes past due 90 days. We also place loans on nonaccrual status in cases where we are uncertain whether the borrower can satisfy the contractual terms of the loan agreement. Amounts received on nonaccrual loans generally are applied first to principal and then to interest only after all principal has been collected. Restructured loans are those for which concessions, including the reduction of interest rates below a rate otherwise available to that borrower or the deferral of interest or principal have been granted due to the borrower’s weakened financial condition. We accrue interest on restructured loans at the restructured rates when we anticipate that no loss of original principal will occur. Potential problem loans are loans which are currently performing and are not included as nonaccrual or restructured loans above, but about which we have serious doubts as to the borrower’s ability to comply with present repayment terms. These loans are likely to be included later in nonaccrual, past due or restructured loans, so they are considered by our management in assessing the adequacy of our allowance for loan losses. At December 31, 2006, we identified six loans in the aggregate amount of $857,000 as potential problem loans. The loans possess certain unfavorable characteristics which cause management some concern. These loans will continue to be closely monitored. At December 31, 2005 there were four loans totaling $263,000 as potential problem loans.

At December 31, 2006, there were four foreclosed properties valued at $98,000 and two nonaccrual loans totaling $135,000. Foreclosed property is valued at the lower of appraised value or the outstanding loan balance. Interest foregone on nonaccrual loans for the year ended December 31, 2006 was approximately $9,900. At December 31, 2005 there was one foreclosed property valued at $22,000 and three loans in nonaccrual status totaling $26,000. The foreclosed property held at December 31, 2005 was still held at December 31, 2006. Interest foregone on nonaccrual loans for the prior year period was approximately $5,300. There were no loans at December 31, 2006 or 2005 that were 90 days or more past due and still accruing interest. There were no repossessed assets at December 31, 2006 or 2005.

The table sets forth, for the period indicated, information about our nonaccrual loans, loans past due 90 days or more and still accruing interest, total nonperforming loans (nonaccrual loans plus loans past due 90 days or more and still accruing interest), and total nonperforming assets.

	At December 31,
	2006			2005			2004			2003			2002
	(Dollars in thousands)
Nonaccrual loans	$	135		$	26		$	5		$	159		$	-
Restructured loans		-			-			-			-			-

Total nonperforming loans		135			26			5			159			-

Real estate owned		98			22			245			-			-
Repossessed assets		-			-			48			-			-

Total nonperforming assets	$	233		$	48		$	298		$	159		$	-

Accruing loans past due
90 days or more	$	-		$	-		$	-		$	647		$	-

Allowance for loan losses		6,945			4,351			3,668			3,304			1,711

Nonperforming loans to
period end loans		0.02	%		0.01	%		0.00	%		0.07	%		0.00	%

Nonperforming loans and loans
past due 90 days or more to
period end loans		0.02	%		0.01	%		0.00	%		0.37	%		0.00	%

Allowance for loan losses to
period end loans		1.26	%		1.33	%		1.42	%		1.52	%		1.36	%

Allowance for loan losses to
nonperforming loans		5,144.96	%		16,960.60	%		73,360.00	%		2,077.99	%		NM

Allowance for loan losses to
nonperforming loans and loans
past due 90 days or more		5,144.96	%		16,960.60	%		73,360.00	%		409.93	%		NM

Nonperforming assets to total assets		0.03	%		0.01	%		0.09	%		0.06	%		0.00	%

Nonperforming assets and loans
past due 90 days or more to
total assets		0.03	%		0.01	%		0.09	%		0.29	%		0.00	%

ANALYSIS OF ALLOWANCE FOR LOAN LOSSES

The allowance for loan losses is established through periodic charges to earnings in the form of a provision for loan losses. Increases to the allowance for loan losses occur as a result of provisions charged to operations and recoveries of amounts previously charged-off, and decreases to the allowance occur when loans are charged-off. Management evaluates the adequacy of our allowance for loan losses on a monthly basis. The evaluation of the adequacy of the allowance for loan losses involves the consideration of loan growth, loan portfolio composition and industry diversification, historical loan loss experience, current delinquency levels, adverse conditions that might affect a borrower’s ability to repay the loan, estimated value of underlying collateral, prevailing economic conditions and all other relevant factors derived from our history of operations. Additionally, as an important component of their periodic examination process, regulatory agencies review our allowance for loan losses and may require additional provisions for estimated losses based on judgments that differ from those of management.

We use an internal grading system to assign the degree of inherent risk on each individual loan. The grade is initially assigned by the lending officer and reviewed by the loan administration function. The internal grading system is reviewed and tested periodically by an independent third party credit review firm. The testing process involves the evaluation of a sample of new loans, loans having been identified as possessing potential weakness in credit quality, past due loans and nonaccrual loans to determine the ongoing effectiveness of the internal grading system. The loan grading system is used to assess the adequacy of the allowance for loan losses.

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

Based on the loan grading system, management maintains an internally classified watch list. Loans classified as watch list credits, and those loans that are not watch list credits but possess other characteristics which in the opinion of management suggest a higher degree of inherent risk, are evaluated individually, by loan category, using higher allowance percentages. Using the data gathered during the monthly evaluation process, the model calculates an acceptable range for allowance for loan losses. Management and the board of directors are responsible for determining the appropriate level of the allowance for loan losses within that range.

The primary reason for increases to the allowance for loan losses has been growth in total outstanding loans, however, there were other factors influencing the provision. Other factors influencing the level of the allowance of loan losses included the volume of net charge-offs experienced through the year and the current level of nonperforming loans. At or for the year ended December 31, 2006, there were $84,000 in net loan charge-offs and $135,000 in nonaccrual loans compared with $124,000 in net loan charge-offs and $26,000 in nonaccrual loans at or for the year ended December 31, 2005. The allowance for loan losses at December 31, 2006 was $6.9 million, which represents 1.26% of total outstanding loans compared to $4.4 million and 1.33% for the prior year. The allowance for loan losses as a percentage of total outstanding loans declined from the prior year primarily due to improvement in the asset quality of the portfolio.

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

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

	At December 31,
	2006					2005					2004
			% of Total					% of Total					% of Total
	Amount		Loans (1)			Amount		Loans (1)			Amount		Loans (1)
	(Dollars in thousands)
Real estate - commercial	$	3,920		55.36	%	$	1,876		52.92	%	$	1,290		47.24	%
Real estate - residential		121		3.67	%		90		4.54	%		44		4.50	%
Construction loans		1,379		19.99	%		735		14.17	%		718		15.09	%
Commercial and industrial loans		1,161		12.32	%		1,138		16.03	%		1,105		18.90	%
Home equity loans and lines of credit		269		7.76	%		201		10.62	%		173		12.00	%
Loans to individuals		95		0.90	%		311		1.72	%		338		2.27	%

Total allowance	$	6,945		100.00	%	$	4,351		100.00	%	$	3,668		100.00	%

	At December 31,
	2003					2002
			% of Total					% of Total
	Amount		Loans (1)			Amount		Loans (1)
	(Dollars in thousands)
Real estate - commercial	$	1,330		46.66	%	$	584		41.59	%
Real estate - residential		54		6.80	%		9		1.84	%
Construction loans		778		14.56	%		435		21.84	%
Commercial and industrial loans		841		17.61	%		518		19.60	%
Home equity loans and lines of credit		115		10.59	%		88		12.75	%
Loans to individuals		186		3.78	%		77		2.38	%

Total allowance	$	3,304		100.00	%	$	1,711		100.00	%

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

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

	At or for the Year Ended December 31,
	2006			2005			2004			2003			2002
	(Dollars in thousands)
Balance at beginning of period	$	4,351		$	3,668		$	3,304		$	1,711		$	1,116

Charge-offs:
Construction loans		-			-			15			27			-
Commercial real estate		-			34			21			-			-
Commercial and industrial loans		14			140			345			59			21
Residential real estate		64			-			34			-			-
Loans to individuals		8			9			16			13			74

Total charge-offs		86			183			431			99			95

Recoveries:
Commercial and industrial loans		1			22			57			4			1
Construction loans		-			27			-			-			-
Loans to individuals		1			10			2			8			-

Total recoveries		2			59			59			12			1

Net charge-offs		84			124			372			87			94

Allowance acquired from Port City
Capital Bank merger		1,687			-			-			-			-

Allowance acquired from Centennial
Bank merger		-			-			-			1,129			-

Provision for loan losses		991			807			736			551			689

Balance at the end of the year	$	6,945		$	4,351		$	3,668		$	3,304		$	1,711

Total loans outstanding at year-end	$	549,819		$	328,322		$	257,908		$	217,128		$	125,917

Average loans outstanding for the year	$	414,644		$	297,045		$	240,346		$	160,134		$	104,519

Allowance for loan losses to
loans outstanding		1.26	%		1.33	%		1.42	%		1.52	%		1.36	%

Ratio of net loan charge-offs to
average loans outstanding		0.02	%		0.04			0.15	%		0.05	%		0.09	%

INVESTMENT ACTIVITIES

The Company’s investment portfolio plays a major role in management of liquidity and interest rate sensitivity and, therefore, is managed in the context of the overall balance sheet. The securities portfolio generates a nominal percentage of our interest income and serves as a necessary source of liquidity. We account for investment securities as follows:

Available for sale. Debt and equity securities that will be held for indeterminate periods of time, including securities that we may sell in response to changes in market interest or prepayment rates, needs for liquidity and changes in the availability of and the yield of alternative investments are classified as available for sale. The Company carries these investments at market value, which we generally determine using published quotes as of the close of business. Unrealized gains and losses are excluded from our earnings and are reported, net of applicable income tax, as a component of accumulated other comprehensive income in stockholders’ equity until realized.

The following table summarizes the amortized costs and market value of available for sale securities at the dates indicated:

	At December 31, 2006				At December 31, 2005				At December 31, 2004
	Amortized		Fair		Amortized		Fair		Amortized		Fair
	cost		value		cost		value		cost		value
	(In thousands)
Securities available for sale:
U.S. government securities
and obligations of U.S.
government agencies	$	7,493	$	7,385	$	5,945	$	5,793	$	2,943	$	2,932
Mortgage-backed securities		54,949		54,274		35,042		34,147		37,326		37,308
Municipal		22,321		22,182		15,173		15,110		12,685		12,704
Other		779		882		500		500		500		500

Total securities available
for sale	$	85,542	$	84,723	$	56,660	$	55,550	$	53,454	$	53,444

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 securities principal repayments, deposit growth, the brokered deposit market, and borrowings from the Federal Home Loan Bank 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.

At December 31, 2006, liquid assets (cash and due from banks, interest-earning deposits with banks, federal funds sold and investment securities available for sale) were approximately $103.5 million, which represents 15% of total assets and 19% of total deposits. Supplementing this liquidity, the Company has available lines of credit from various correspondent banks of approximately $145.7 million of which $61.5 million was outstanding. At December 31, 2006, outstanding commitments for undisbursed lines of credit and letters of credit amounted to $179.0 million. Management believes that the combined aggregate liquidity position of the Company is sufficient to meet the funding requirements of loan demand and deposit maturities and withdrawals in the near term. Certificates of deposit represented 55% of the Company’s total deposits at December 31, 2006. The Company’s growth strategy will include efforts focused at increasing the relative volume of transaction deposit accounts. Certificates of deposit of $100,000 or more represented 42% of the Company’s total deposits at year-end. 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, the Company must satisfy certain minimum leverage ratio requirements and risk-based capital requirements. At December 31, 2006, the Company’s equity to asset ratio was 10.64%. All capital ratios place the subsidiaries in excess of the minimum required to be deemed well-capitalized banks by regulatory measures. CSB’s ratio of Tier 1 capital to risk-weighted assets at December 31, 2006 was 9.12% while PCCB’s was 9.50%.

ASSET/LIABILITY MANAGEMENT

The primary objective of asset and liability management is to provide sustainable and growing net interest income under varying economic environments, while protecting the economic values of our balance sheet assets and liabilities from the adverse effects of changes in interest rates. Our overall interest-rate risk position is maintained within a series of policies approved by the Board and guidelines established and monitored by ALCO.

Because no one individual measure can accurately assess all of our risks to changes in rates, we use several quantitative measures in our assessment of current and potential future exposures to changes in interest rates and their impact on net interest income and balance sheet values. Net interest income simulation is the primary tool used in our evaluation of the potential range of possible net interest income results that could occur under a variety of interest-rate environments. We also use market valuation and duration analysis to assess changes in the economic value of balance sheet assets and liabilities caused by assumed changes in interest rates. Finally, gap analysis — the difference between the amount of balance sheet assets and liabilities repricing within a specified time period — is used as a measurement of our interest-rate risk position.

To measure, monitor, and report on our interest-rate risk position, we begin with two models: (1) net interest income at risk which measures the impact on net interest income over the next twelve months to immediate, or “rate shock,” and slow, or “rate ramp,” changes in market interest rates; and (2) net economic value of equity that measures the impact on the present value of all net interest income-related principal and interest cash flows of an immediate change in interest rates. Net interest income at risk is designed to measure the potential impact of changes in market interest rates on net interest revenue in the short term. Net economic value of equity, on the other hand, is a long-term view of interest-rate risk, but with a liquidation view of the Company. Both of these models are subject to ALCO-established guidelines, and are monitored regularly.

In calculating our net interest income at risk, we start with a base amount of net interest revenue that is projected over the next twelve months, assuming that the then-current yield curve remains unchanged over the period. Our existing balance sheet assets and liabilities are adjusted by the amount and timing of transactions that are forecasted to occur over the next twelve months. That yield curve is then “shocked,” or moved immediately, ±200 basis points in a parallel fashion, or at all points along the yield curve. Two new twelve-month net interest income projections are then developed using the same balance sheet and forecasted transactions, but with the new yield curves, and compared to the base scenario. We also perform the calculations using interest rate ramps, which are ±100, ±200 and ±300 basis point changes in interest rates that are assumed to occur gradually over the next twelve-month period, rather than immediately as we do with interest-rate shocks.

Net economic value of equity is based on the change in the present value of all net interest income-related principal and interest cash flows for changes in market rates of interest. The present value of existing cash flows with a then-current yield curve serves as the base case. We then apply an immediate parallel shock to that yield curve of ±100 and ±200 basis points and recalculate the cash flows and related present values.

Key assumptions used in the models described above include the timing of cash flows; the maturity and repricing of balance sheet assets and liabilities, especially option-embedded financial instruments like mortgage-backed securities and FHLB advances; changes in market conditions; and interest-rate sensitivities of our customer liabilities with respect to the interest rates paid and the level of balances. These assumptions are inherently uncertain and, as a result, the models cannot precisely calculate future net interest income or predict the impact of changes in interest rates on net interest income and economic value. Actual results could differ from simulated results due to the timing, magnitude and frequency of changes in interest rates and market conditions, changes in spreads and management strategies, among other factors. Projections of potential future streams of net interest income are assessed as part of our forecasting process.

Net Interest Income at Risk Analysis. The following table presents the estimated exposure of net interest income for the next twelve months, calculated as of December 31, 2006 and 2005, due to an immediate and gradual ± 200 basis point shift in then-current interest rates. Estimated incremental exposures set forth below are dependent on management’s assumptions about asset and liability sensitivities under various interest-rate scenarios, such as those previously discussed, and do not reflect any actions management may undertake in order to mitigate some of the adverse effects of interest-rate changes on the Company’s financial performance.

Net Interest Income at Risk
(dollars in thousands)	Estimated Exposure to
	Net Interest Income
Rate change	2006			2005
+200 basis points shock	$	1,925		$	1,535
-200 basis point shock		(1,285	)		(1,983	)

+200 basis point ramp		1,320			963
-200 basis point ramp		(741	)		(1,056	)

Net Economic Value of Equity Analysis. The following table presents estimated EVE exposures, calculated as of December 31, 2006 and 2005, assuming an immediate and prolonged shift in interest rates, the impact of which would be spread over a number of years.

Net Economic Value of Equity	Estimated Exposure to
(dollars in thousands)	Net Economic Value of Equity
Rate Change	2006			2005
+100 basis point shock	$	(1,949	)	$	(649	)
-100 basis point shock		473			(104	)

+200 basis point shock		(4,219	)		(1,122	)
-200 basis point shock		(973	)		(1,245	)

While the measures presented in the tables above are not a prediction of future net interest income or valuations, they do suggest that if all other variables remained constant, in the short term, falling interest rates would lead to net interest income that is lower than it would otherwise have been, and rising rates would lead to higher net interest income. Other important factors that impact the levels of net interest income are balance sheet size and mix; interest-rate spreads; the slope, how quickly or slowly market interest rates change and management actions taken in response to the preceding conditions.

Interest Rate Gap Analysis. As a part of its interest rate risk management policy, the Company calculates an interest rate “gap.” Interest rate “gap” analysis is a common, though imperfect, measure of interest rate risk, which measures the relative dollar amounts of interest-earning assets and interest-bearing liabilities which reprice within a specific time period, either through maturity or rate adjustment. The “gap” is the difference between the amounts of such assets and liabilities that are subject to repricing. A “positive” gap for a given period means that the amount of interest-earning assets maturing or otherwise repricing within that period exceeds the amount of interest-bearing liabilities maturing or otherwise repricing within the same period. Accordingly, in a declining interest rate environment, an institution with a positive gap would generally be expected, absent the effects of other factors, to experience a decrease in the yield on its assets greater than the decrease in the cost of its liabilities and its net interest income should be negatively affected. Conversely, the yield on its assets for an institution with a positive gap would generally be expected to increase more quickly than the cost of funds in a rising interest rate environment, and such institution’s net interest income generally would be expected to be positively affected by rising interest rates. Changes in interest rates generally have the opposite effect on an institution with a “negative gap.”

The table below sets forth the amounts of interest-earning assets and interest-bearing liabilities outstanding at December 31, 2006 that are projected to reprice or mature in each of the future time periods shown. Except as stated below, the amounts of assets and liabilities shown which reprice or mature within a particular period were determined in accordance with the contractual terms of the assets or liabilities. Loans with adjustable rates are shown as being due at the end of the next upcoming adjustment period. Money market deposit accounts and negotiable order of withdrawal or other transaction accounts are assumed to be subject to immediate repricing and depositor availability and have been placed in the shortest period. In making the gap computations, none of the assumptions sometimes made regarding prepayment rates and deposit decay rates have been used for any interest-earning assets or interest-bearing liabilities. In addition, the table does not reflect scheduled principal payments that will be received throughout the lives of the loans or investments. The interest rate sensitivity of the Company’s assets and liabilities illustrated in the following table would vary substantially if different assumptions were used or if actual experience differs from that indicated by such assumptions.

	Terms to Repricing at December 31, 2006
				More Than			More Than
	1 Year			1 Year to			3 Years to			More Than
	or Less			3 Years			5 Years			5 Years			Total
	(Dollars in thousands)
INTEREST-EARNING ASSETS:
Loans receivable:
Commercial mortgage loans	$	152,110		$	69,077		$	77,774		$	5,862		$	304,823
Residential mortgage loans		10,629			7,216			2,339			40			20,224
Construction and development		94,650			6,800			7,191			1,392			110,033
Commercial and industrial loans		54,120			9,703			3,968			31			67,822
Home equity lines and loans		41,809			580			285			30			42,704
Loans to individuals		3,369			1,267			330			11			4,977
Interest-earning deposits with banks		763			-			-			-			763
Fed funds sold		92			-			-			-			92
Investment securities available for sale		13,737			16,293			15,377			39,316			84,723
Federal Home Loan Bank stock		3,583			-			-			-			3,583

Total interest-earning assets	$	374,862		$	110,936		$	107,264		$	46,682		$	639,744

INTEREST-BEARING LIABILITIES:
Deposits:
Money market, NOW and savings	$	175,723		$	-		$	-		$	-		$	175,723
Time		202,070			79,015			14,653			-			295,738
Short-term borrowings		24,451			-			-			-			24,451
Long-term borrowings		40,248			-			-			5,000			45,248

Total interest-bearing liabilities	$	442,492		$	79,015		$	14,653		$	5,000		$	541,160

INTEREST SENSITIVITY GAP PER
PERIOD	$	(67,630	)	$	31,921		$	92,611		$	41,682		$	98,584

CUMULATIVE INTEREST SENSITIVITY
GAP	$	(67,630	)	$	(35,709	)	$	56,902		$	98,584		$	98,584

CUMULATIVE GAP AS A PERCENTAGE
OF TOTAL INTEREST-EARNING ASSETS		(10.57	%)		(5.58	%)		8.89	%		15,41	%		15.41	%

CUMULATIVE INTEREST-EARNING
ASSETS AS A PERCENTAGE OF
CUMULATIVE INTEREST-BEARING
LIABILITIES		84.72	%		93.15	%		110.61	%		118.22	%		118.22	%

CRITICAL ACCOUNTING POLICY

The Company's most significant critical accounting policy is the determination of its allowance for loan losses. A critical accounting policy is one that is both very important to the portrayal of the Company's financial condition and results, and requires management's most difficult, subjective or complex judgments. What makes these judgments difficult, subjective and/or complex is the need to make estimates about the effects of matters that are inherently uncertain. Refer to the discussion within Analysis of Allowance for Loan Losses and Note B to the consolidated financial statements for comprehensive discussion regarding this accounting policy.

QUARTERLY FINANCIAL INFORMATION

The following table sets forth, for the periods indicated, certain of our consolidated quarterly financial information. This information is derived from our unaudited financial statements, which include, in the opinion of management, all normal recurring adjustments which management considers necessary for a fair presentation of the results for such periods. This information should be read in conjunction with our consolidated financial statements included elsewhere in this report. The results for any quarter are not necessarily indicative of results for any future period.

Quarterly Financial Data

(dollars in thousands, except per share data)

	Year Ended December 31, 2006								Year Ended December 31, 2005
	Fourth		Third		Second		First		Fourth		Third			Second		First
	Quarter		Quarter		Quarter		Quarter		Quarter		Quarter			Quarter		Quarter
Operating Data:
Total interest income	$	12,288	$	9,522	$	7,794	$	7,101	$	6,609	$	6,059		$	5,394	$	4,764
Total interest expense		6,044		4,608		3,578		3,027		2,671		2,411			2,069		1,720
Net interest income		6,244		4,914		4,216		4,074		3,938		3,648			3,325		3,044
Provision for loan losses		374		182		164		270		60		240			303		204
Net interest income after provision		5,870		4,732		4,052		3,804		3,878		3,408			3,022		2,840
Non-interest income		701		695		619		596		675		614			583		544
Non-interest expense		3,979		3,432		3,104		2,871		3,006		2,718			2,614		2,423
Income before income taxes		2,592		1,995		1,567		1,529		1,547		1,304			991		961
Provision for income taxes		949		721		564		547		542		459			338		320
Net income	$	1,643	$	1,274	$	1,003	$	982	$	1,005	$	845		$	653	$	641

Securities gains/(losses)	$	-	$	-	$	-	$	-	$	-	$	(17	)	$	1	$	-

Per Share Data:
Earnings per share- basic	$	0.20	$	0.19	$	0.17	$	0.17	$	0.19	$	0.17		$	0.14	$	0.14
Earnings per share - diluted		0.19		0.18		0.17		0.16		0.18		0.17			0.13		0.13

RECENT ACCOUNTING PRONOUNCEMENTS

For recently issued accounting pronouncements that may affect the Company, see Note B of Notes to Consolidated Financial Statements.

OFF-BALANCE SHEET ARRANGEMENTS

The Company has various financial instruments (outstanding commitments) with off-balance sheet risk that are issued in the normal course of business to the meet the financing needs of its customers. See Note N to the consolidated financial statements for more information regarding these commitments and contingent liabilities.

FORWARD-LOOKING INFORMATION

This annual report 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.

ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk reflects the risk of economic loss resulting from adverse changes in market price and interest rates. This risk of loss can be reflected in diminished current market values and/or reduced potential net interest income in future periods. Our market risk arises primarily from interest rate risk inherent in our lending and deposit-taking activities. The structure of our loan and deposit portfolios is such that a significant decline in interest rates may adversely impact net market values and net interest income. We do not maintain a trading account nor are we subject to currency exchange risk or commodity price risk. Interest rate risk is monitored as part of the bank’s asset/liability management function.

See the section entitled Asset/Liability Management in Item 7 for a more detailed discussion of market risk.

ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

CRESCENT FINANCIAL CORPORATION AND SUBSIDIARY

CONSOLIDATED FINANCIAL STATEMENTS

Years Ended December 31, 2006, 2005 and 2004

CRESCENT FINANCIAL CORPORATION AND SUBSIDIARIES

INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS

	Page No.
Report of Independent Registered Public Accounting Firm	49

Consolidated Balance Sheets
as of December 31, 2006 and 2005	50

Consolidated Statements of Operations
for the years ended December 31, 2006, 2005 and 2004	51

Consolidated Statements of Changes in Stockholders’ Equity
for the years ended December 31, 2006, 2005 and 2004	52

Consolidated Statements of Cash Flows
for the years ended December 31, 2006, 2005 and 2004	53

Notes to Consolidated Financial Statements	54

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and the Board of Directors

Crescent Financial Corporation

Cary, North Carolina

We have audited the accompanying consolidated balance sheets of Crescent Financial Corporation and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of operations, changes in stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2006. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Crescent Financial Corporation and subsidiaries at December 31, 2006 and 2005 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America.

Raleigh, North Carolina

March 16, 2007

CRESCENT FINANCIAL CORPORATION AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

December 31, 2006 and 2005

	2006			2005
ASSETS
Cash and due from banks	$	14,295,053		$	9,402,960
Interest-earning deposits with banks		763,057			68,547
Federal funds sold		92,000			-
Investment securities available for sale, at fair value (Note C)		84,722,892			55,550,261

Loans (Note D)		549,818,548			328,321,640
Allowance for loan losses (Note D)		(6,945,000	)		(4,351,000	)
NET LOANS		542,873,548			323,970,640

Accrued interest receivable		3,045,840			1,768,029
Federal Home Loan Bank stock, at cost		3,582,800			2,133,400
Bank premises and equipment (Note E)		5,907,664			4,844,056
Investment in life insurance		5,683,493			5,483,313
Goodwill		30,225,549			3,600,298
Other assets		6,717,324			3,966,671

TOTAL ASSETS	$	697,909,220		$	410,788,175
LIABILITIES AND STOCKHOLDERS’ EQUITY

Deposits:
Demand	$	70,420,392		$	46,829,792
Savings		78,379,431			9,364,575
Money market and NOW		97,343,128			87,695,273
Time (Note F)		295,738,729			178,191,148

TOTAL DEPOSITS		541,881,680			322,080,788

Short-term borrowings (Note G)		24,451,000			14,964,153
Long-term debt (Note G)		45,248,000			30,248,000
Accrued expenses and other liabilities		3,294,562			2,038,020
TOTAL LIABILITIES		614,875,242			369,330,961
Commitments (Notes D, H and N)

Stockholders’ Equity (Note P)
Common stock, $1 par value, 20,000,000
shares authorized; 8,265,136 shares and 5,026,394
shares issued and outstanding at December 31, 2006
and 2005, respectively		8,265,136			5,026,394
Additional paid-in capital		62,659,201			29,405,559
Retained earnings		12,610,588			7,707,054
Accumulated other comprehensive loss		(500,947	)		(681,793	)

TOTAL STOCKHOLDERS’ EQUITY		83,033,978			41,457,214

TOTAL LIABILITIES AND
STOCKHOLDERS’ EQUITY	$	697,909,220		$	410,788,175

See accompanying notes.

CRESCENT FINANCIAL CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF OPERATIONS

Years Ended December 31, 2006, 2005 and 2004

	2006		2005			2004
INTEREST AND FEE INCOME
Loans	$	33,093,487	$	20,456,115		$	14,023,925
Investment securities available for sale		3,302,639		2,323,232			1,824,596
Interest-earning deposits with banks		23,837		15,298			5,440
Federal funds sold		286,473		31,948			42,366

TOTAL INTEREST AND FEE INCOME		36,706,436		22,826,593			15,896,327

INTEREST EXPENSE
Money market, NOW and savings deposits		4,216,641		1,401,267			715,554
Time deposits		9,989,995		5,483,116			3,715,626
Short-term borrowings		843,995		474,665			48,089
Long-term debt		2,206,229		1,513,180			986,700

TOTAL INTEREST EXPENSE		17,256,860		8,872,228			5,465,969

NET INTEREST INCOME		19,449,576		13,954,365			10,430,358

PROVISION FOR LOAN LOSSES (Note D)		990,786		806,796			736,070

NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES		18,458,790		13,147,569			9,694,288

NON-INTEREST INCOME
Mortgage origination revenue		642,188		755,300			643,287
Fees on deposit accounts		1,287,476		1,044,771			876,207
Earnings on life insurance		228,573		226,156			234,950
Gain (loss) on sale of securities		-		(16,422	)		57
Gain (loss) on sale or disposal of assets		2,782		(13,000	)		5,636
Other (Note J)		450,873		420,407			581,837

TOTAL NON-INTEREST INCOME		2,611,892		2,417,212			2,341,974

NON-INTEREST EXPENSE
Salaries and employee benefits		7,307,183		5,904,586			4,421,135
Occupancy and equipment		2,018,079		1,728,366			1,515,868
Data processing		833,923		647,685			549,397
Other (Note J)		3,227,363		2,480,871			2,044,965

TOTAL NON-INTEREST EXPENSE		13,386,548		10,761,508			8,531,365

INCOME BEFORE INCOME TAXES		7,684,134		4,803,273			3,504,897

INCOME TAXES (Note I)		2,780,600		1,658,900			1,172,200

NET INCOME	$	4,903,534	$	3,144,373		$	2,332,697

NET INCOME PER COMMON SHARE
Basic	$	0.74	$	0.64		$	0.50
Diluted	$	0.71	$	0.61		$	0.47

WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING
Basic		6,619,105		4,911,264			4,678,604
Diluted		6,922,552		5,165,861			4,925,264

See accompanying notes.

CRESCENT FINANCIAL CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

Years Ended December 31, 2006, 2005 and 2004

	Common stock				Additional paid-in			Retained		Accumulated other comprehensive income			Total
	Shares		Amount		capital			earnings		(loss)			equity
Balance at December 31, 2003		2,924,429	$	2,924,429	$	18,884,505		$	2,229,984	$	110,982		$	24,149,900

Comprehensive income:

Net income		-		-		-			2,332,697		-			2,332,697

Net unrealized holding loss on
available for sale securities		-		-		-			-		(117,630	)		(117,630	)

Total comprehensive income														2,215,067

Common stock issued pursuant to:

Stock options exercised		57,231		57,231		291,717			-		-			348,948

Stock option related tax benefits		-		-		61,709			-		-			61,709

Stock split effected in the form of
a twenty percent stock dividend
with net cash received for
fractional shares		585,229		585,229		(583,439	)		-		-			1,790

Balance at December 31, 2004		3,566,889		3,566,889		18,654,492			4,562,681		(6,648	)		26,777,414

Comprehensive income:

Net income		-		-		-			3,144,373		-			3,144,373

Net unrealized holding loss on
available for sale securities		-		-		-			-		(675,145	)		(675,145	)

Total comprehensive income														2,469,228

Common stock issued pursuant to:
Stock options exercised		75,539		75,539		317,373			-		-			392,912

Stock option related tax benefits		-		-		199,800			-		-			199,800

Issuance of new stock		848,000		848,000		10,769,858			-		-			11,617,858

Stock split effected in the form of
a fifteen percent stock dividend
with net cash received for
fractional shares		535,966		535,966		(535,964	)		-		-			2

Balance at December 31, 2005		5,026,394		5,026,394		29,405,559			7,707,054		(681,793	)		41,457,214

Comprehensive income:

Net income		-		-		-			4,903,534		-			4,903,534

Net unrealized holding gain on
available for sale securities		-		-		-			-		180,846			180,846

Total comprehensive income														5,084,380

Common stock issued pursuant to:

Stock options exercised		44,029		44,029		211,768			-		-			255,797

Stock option related tax benefits		-		-		45,401			-		-			45,401

Expense recognized in connection with stock options		-		-		195,578			-		-			195,578

Issuance of restricted stock, net of
deferred compensation		7,387		7,387		(719	)		-		-			6,668

Shares issued in connection with
business combination		2,432,374		2,432,374		33,566,001			-		-			35,998,375

Stock split effected in the form of
a fifteen percent stock dividend
with net cash paid for
fractional shares		754,952		754,952		(764,387	)		-		-			(9,435	)

Balance at December 31, 2006		8,265,136	$	8,265,136	$	62,659,201		$	12,610,588	$	(500,947	)	$	83,033,978

See accompanying notes.

CRESCENT FINANCIAL CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years Ended December 31, 2006, 2005 and 2004

	2006			2005			2004
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	4,903,534		$	3,144,373		$	2,332,697
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation		698,754			613,388			542,570
Provision for loan losses		990,786			806,796			736,070
Amortization of core deposit intangible		58,384			20,901			20,901
Deferred income taxes		(210,710	)		(11,549	)		160,602
(Gain) loss on disposition of assets		(2,782	)		13,000			(5,636	)
(Gain) loss on sale of securities		-			16,422			(57	)
Net (accretion) amortization of premiums on securities		(20,023	)		82,702			100,458
Gain on sale of membership interest in mortgage company		-			-			(118,048	)
Net increase in cash surrender value life insurance		(200,180	)		(200,050	)		(210,575	)
Stock based compensation		202,246			-			-
Change in assets and liabilities:
Increase in accrued interest receivable		(592,718	)		(549,457	)		(254,196	)
(Increase) decrease in other assets		(579,977	)		(116,897	)		(1,416,879	)
Increase in accrued interest payable		136,282			309,284			25,663
Increase (decrease) in accrued expenses
and other liabilities		269,732			482,878			(726,882	)

NET CASH PROVIDED BY
OPERATING ACTIVITIES		5,653,328			4,611,791			1,186,688

CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of investment securities
available for sale		(25,248,980	)		(13,524,336	)		(28,835,075	)
Proceeds from maturities and repayments
of investment securities available for sale		6,646,100			6,374,682			7,782,416
Proceeds from sale of securities available for sale		6,106,354			3,845,157			4,312,157
Proceeds from sale of membership interest
in mortgage company		-			-			580,548
Loan originations and principal collections, net		(93,377,653	)		(70,984,109	)		(41,087,890	)
Purchases of premises and equipment		(1,679,226	)		(2,440,261	)		(876,310	)
Proceeds from disposals of premises and equipment		800			-			1,851
Proceeds from sales of foreclosed assets		127,450			297,978			60,006
Purchases of Federal Home Loan Bank stock		(1,163,300	)		(686,200	)		(497,200	)
Net cash acquired in business combination		8,221,923			-			-

NET CASH USED BY
INVESTING ACTIVITIES		(100,366,532	)		(77,117,089	)		(58,559,497	)

CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits accounts		75,613,197			48,431,967			55,033,864
Net increase (decrease) in short-term borrowings		9,486,847			13,657,048			(7,695,441	)
Net increase in long-term debt		15,000,000			2,000,000			8,248,000
Proceeds from sale of common stock, net		-			11,617,858			-
Proceeds from stock options exercised		255,797			392,912			348,948
Net cash received for fractional shares		(9,435	)		2			1,790
Excess tax benefits from stock options exercised		45,401			199,800			61,709

NET CASH PROVIDED BY
FINANCING ACTIVITIES		100,391,807			76,299,587			55,998,870

NET INCERASE (DECREASE) IN
CASH AND CASH EQUIVALENTS		5,678,603			3,794,289			(1,373,939	)

CASH AND CASH EQUIVALENTS, BEGINNING		9,471,507			5,677,218			7,051,157

CASH AND CASH EQUIVALENTS, ENDING	$	15,150,110		$	9,471,507		$	5,677,218

See accompanying notes.

CRESCENT FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2006, 2005 and 2004

NOTE A - ORGANIZATION AND OPERATIONS

On June 29, 2001, Crescent Financial Corporation (the “Company”) was formed as a holding company for Crescent State Bank (“CSB”). Upon formation, one share of the Company’s $1 par value common stock was exchanged for each of the outstanding shares of CSB’s $5 par value common stock. The Company acquired Port City Capital Bank (“PCCB”) on August 31, 2006.

CSB was incorporated December 22, 1998 and began banking operations on December 31, 1998. CSB is engaged in general commercial and retail banking in Wake, Johnston, Lee and Moore Counties, North Carolina, operating under the banking laws of North Carolina and the rules and regulations of the Federal Deposit Insurance Corporation and the North Carolina Commissioner of Banks. CSB undergoes periodic examinations by those regulatory authorities.

Port City Capital Bank was organized and incorporated under the laws of the State of North Carolina on June 13, 2002 and commenced operations on July 1, 2002. PCCB currently serves New Hanover County, North Carolina and surrounding areas through one banking office. As a state chartered bank that is not a member of the Federal Reserve, PCCB is subject to regulation by the State of North Carolina Banking commission and the Federal Deposit Insurance Corporation.

The Company formed Crescent Financial Capital Trust I during 2003 in order to facilitate the issuance of trust preferred securities. The Trust is a statutory business trust formed under the laws of the state of Delaware, of which all common securities are owned by the Company. Under Financial Accounting Standards Board (“FASB”) Interpretation No. (“FIN”) 46, Consolidation of Variable Interest Entities, Crescent Financial Capital Trust I is not included in the Company’s consolidated financial statements. The junior subordinated debentures issued by the Company to the trust are included in long-term debt and the Company’s equity interest in the trust is included in other assets.

The trust preferred securities presently qualify as Tier 1 regulatory capital and are reported in Federal Reserve regulatory reports as a minority interest in a consolidated subsidiary. The junior subordinated debentures do not qualify as Tier 1 regulatory capital. On March 1, 2005, the Board of Governors of the Federal Reserve issued the final rule that would retain the inclusion of trust preferred securities in Tier 1 capital of bank holding companies, but with stricter quantitative limits and clearer qualitative standards. Under the new rule, after a three-year transition period, the aggregate amount of trust preferred securities and certain other capital elements would be limited to 25 percent of Tier 1 capital elements, net of goodwill less any associated deferred tax liability. The amount of trust preferred securities and certain other elements in excess of the limit could be included in Tier 2 capital, subject to restrictions. The Company believes that the Bank will remain "well capitalized" under the new Federal Reserve Board guidelines (or the Company would still exceed the regulatory required minimums for capital adequacy purposes).

NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying consolidated financial statements include the accounts and transactions of Crescent Financial Corporation and its wholly-owned subsidiaries Crescent State Bank and Port City Capital Bank. All significant intercompany transactions and balances have been eliminated in consolidation. Crescent Financial Corporation and its subsidiaries are collectively referred to herein as the “Company.”

Use of Estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses.

CRESCENT FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2006, 2005 and 2004

NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Cash and Cash Equivalents

For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash and due from banks, interest-earning deposits with banks and federal funds sold.

Securities Available for Sale

Available for sale securities are carried at fair value and consist of bonds, notes, and marketable equity securities not classified as trading securities or as held to maturity securities. Unrealized holding gains and losses on available for sale securities are reported as a net amount in other comprehensive income, net of related tax effects. Gains and losses on the sale of available for sale securities are determined using the specific-identification method. Declines in the fair value of individual held to maturity and available for sale securities below their cost that are other than temporary would result in write-downs of the individual securities to their fair value. Such write-downs would be included in earnings as realized losses. Premiums and discounts are recognized in interest income using the interest method over the period to maturity.

Loans

Loans that management has the intent and ability to hold for the foreseeable future, or until maturity, are reported at their outstanding principal adjusted for any charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans and unamortized premiums or discounts on purchased or acquired loans. Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield of the related loan. Interest on loans is recorded based on the principal amount outstanding. The accrual of interest on impaired loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due. Generally, loans are placed on nonaccrual when they are past due 90 days. While a loan is classified as nonaccrual and the future collectibility of the recorded loan balance is doubtful, collections of interest and principal are generally applied as a reduction to the principal outstanding. When the future collectibility of the recorded loan balance is not in doubt, interest income may be recognized on a cash basis. When a loan is charged-off, all unpaid accrued interest is reversed.

Allowance for Loan Losses

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. The provision for loan losses is based upon management’s best estimate of the amount needed to maintain the allowance for loan losses at an adequate level. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of the current status of the portfolio, historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. Management segments the loan portfolio by loan type in considering each of the aforementioned factors and their impact upon the level of the allowance for loan losses.

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.

CRESCENT FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2006, 2005 and 2004

NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Allowance for Loan Losses (Continued)

Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

Premises and Equipment

Land is carried at cost. Other components of premises and equipment are stated at cost less accumulated depreciation. Depreciation is calculated on the straight-line method over the estimated useful lives of the assets which are 37 - 40 years for buildings and 3 - 10 years for furniture and equipment. Leasehold improvements are amortized over the terms of the respective leases or the estimated useful lives of the improvements, whichever is shorter. Repairs and maintenance costs are charged to operations as incurred, and additions and improvements to premises and equipment are capitalized. Upon sale or retirement, the cost and related accumulated depreciation are removed from the accounts and any gains or losses are reflected in current operations.

Foreclosed Assets

Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in net expenses from foreclosed assets.

Stock in Federal Home Loan Bank of Atlanta

As a requirement for membership, the Company invests in stock of the Federal Home Loan Bank of Atlanta (“FHLB”). This investment is carried at cost. Due to the redemption provisions of the FHLB, the Company estimated that fair value equals cost and that this investment was not impaired at December 31, 2006.

Income Taxes

Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes. Deferred tax assets are also recognized for operating loss carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which the temporary differences are expected to be recovered or settled. Deferred tax assets are reduced by a valuation allowance if it is more likely than not that the tax benefits will not be realized.

Goodwill

Goodwill of $26,625,251 arose from the 2006 purchase of Port City Capital Bank. Goodwill of $3,600,298 arose from the 2003 purchase of Centennial Bank. Pursuant to Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets, goodwill acquired will not be amortized but will be subject to an annual impairment test. Goodwill recorded by the Company amounted to $30,225,549 and $3,600,298 at

December 31, 2006 and 2005, respectively. There were no impairment charges recorded in 2006 or 2005 as a result of the goodwill testing.

CRESCENT FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2006, 2005 and 2004

NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Other Intangible Assets

Other intangible assets were acquired in conjunction with the 2006 purchase of Port City Capital Bank and the 2003 purchase of Centennial Bank. Subject to the provisions of SFAS No. 142, such other intangible assets, which consist solely of the deposit base premiums acquired through the purchase of these banks, are amortized over the approximate estimated lives of the related acquired deposit relationships. In accordance with the Company's estimate of the approximate lives of the acquired deposit relationships, a 10 year straight-line amortization schedule has been established for these intangible assets. The Company will continue to evaluate the amortization period and such amortization period could be revised downwards (but not upwards) in the future if circumstances warrant. The initial deposit premium related to the purchase of Port City Capital Bank was $1,124,481 and the premium related to the purchase of Centennial Bank was $209,012. The balance of the unamortized deposit premiums was $1,226,339 and $160,242 at December 31, 2006 and 2005, respectively. Amortization of the deposit premium amounted to $58,384, $20,901, and $20,901 for the years ended December 31, 2006, 2005 and 2004, respectively. Amortization of the core deposit intangible is estimated to be $133,349 per year for each of the next six years, $126,383 in year seven, and $112,448 annually thereafter until fully amortized.

Stock Compensation Plans

Effective January 1, 2006, the Company adopted SFAS No. 123 (revised 2004), Share-Based Payment ("SFAS No. 123R"), which was issued by the FASB in December 2004. SFAS No. 123R revises SFAS No. 123 Accounting for Stock Based Compensation, and supersedes Accounting Principles Board Opinion (“APB”) No. 25, Accounting for Stock Issued to Employees, and its related interpretations. SFAS No. 123R requires recognition of the cost of employee services received in exchange for an award of equity instruments in the financial statements over the period the employee is required to perform the services in exchange for the award (usually the vesting period). SFAS No. 123R also requires measurement of the cost of employee services received in exchange for an award based on the grant-date fair value of the award. SFAS No. 123R also amends SFAS No. 95, Statement of Cash Flows, to require that excess tax benefits be reported as financing cash inflows, rather than as a reduction of taxes paid, which is included within operating cash flows.

The Company adopted SFAS No. 123R using the modified prospective application as permitted under SFAS No. 123R. Accordingly, prior period amounts have not been restated. Under this application, the Company is required to record compensation expense for all awards granted after the date of adoption and for the unvested portion of previously granted awards that remain outstanding at the date of adoption. Prior to the adoption of SFAS No. 123R, the Company used the intrinsic value method as prescribed by APB No. 25 and thus recognized no compensation expense for options granted with exercise prices equal to the fair market value of the Company's common stock on the date of grant.

The impact of the adoption of SFAS 123(R) is as follows:

	For the year ended
	December 31, 2006
Income before income tax expense	$	(202,000	)
Net income	$	(202,000	)
Cash flow from operating activities	$	(45,000	)
Cash flow provided by financing activities	$	45,000
Basic earnings per share	$	(0.03	)
Diluted earnings per share	$	(0.03	)

CRESCENT FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2006, 2005 and 2004

NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Stock Compensation Plans (Continued)

The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS 123R to options granted under the Company’s stock option plans for the years ended December 31, 2005 and 2004. For purposes of this pro forma disclosure, the value of the options is estimated using the Black-Scholes option-pricing model and amortized to expense over the options’ vesting periods.

	2005			2004
	(Dollars in thousands)
Net income:
As reported	$	3,144		$	2,333
Deduct: Total stock-based employee compensation
expense determined under fair value method for all
awards, net of related tax effects		(135	)		(69	)
Pro forma	$	3,009		$	2,264
Basic earnings per share:
As reported	$	.64		$	.50
Pro forma		.61			.48
Diluted earnings per share:
As reported	$	.61		$	.47
Pro forma		.58			.46

Per Share Results

During 2006, 2005 and 2004, the Company effected stock splits in the form of 15%, 15% and 20% stock dividends, respectively. Basic and diluted net income per common share have been computed by dividing net income for each period by the weighted average number of shares of common stock outstanding during each period after retroactively adjusting for these stock splits. All references herein to net income per share and weighted average shares outstanding have been adjusted to give effect to these stock splits.

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

the Company relate to outstanding stock options and restricted stock and are determined using the treasury stock method. For the years ended December 31, 2006, 2005 and 2004, there were 37,083, 9,000 and 24,725 outstanding stock options, respectively, which were not included in the computation of diluted earnings per share because they had no dilutive effect.

Comprehensive Income

The Company reports as comprehensive income all changes in stockholders’ equity during the year from sources other than shareholders. Other comprehensive income refers to all components (revenues, expenses, gains, and losses) of comprehensive income that are excluded from net income. The Company’s only component of other comprehensive income is unrealized gains and losses on investment securities available for sale.

CRESCENT FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2006, 2005 and 2004

NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Comprehensive Income (Continued)

The components of other comprehensive income and related tax effects are as follows:

	2006			2005			2004
Change in unrealized holding gains (losses)
on available for sale securities	$	289,891		$	(1,115,858	)	$	(170,495	)
Realized (gain) loss on sale of available
for sale securities		-			16,422			(57	)
Tax effect		(109,045	)		424,291			52,922
		180,846			(675,145	)		(117,630	)
Net of tax amount	$	180,846		$	(675,145	)	$	(117,630	)

Mortgage Loan Origination and Other Fees

Mortgage loan origination fees represent fees received for the origination of loans for sale in the secondary market through the Company’s relationship with various mortgage brokers. These fees are recognized in income as they are earned upon the closing of each loan. A membership interest in Sidus (a mortgage broker) was sold during 2004, and although the Company no longer receives dividend distributions from Sidus, we will continue to originate loans for and collect mortgage loan origination fees from Sidus.

Fees derived from leasing and investment transactions with Technology Capital Partners and the Capital Investment

Group, Inc., respectively, are recognized in income as these transactions are consummated.

Segment Reporting

SFAS No. 131, Disclosure about Segments of an Enterprise and Related Information, requires that public entities disclose information about products and services provided by operating segments, geographic areas and major customers, differences between the measurements used in reporting segment information and those used in the entity’s general-purpose financial statements, and changes in the measurement of segment amounts from period to period.

Operating segments are components of an enterprise with separate financial information available for use by the chief operating decision maker to allocate resources and to assess performance. The Company has determined that it has one significant operating segment, the providing of financial services, including commercial and retail banking, mortgage, and investment services, to customers located in its market areas. The various products are those generally offered by community banks, and the allocation of resources is based on the overall performance of the Company, rather than the performance of individual branches or products.

New Accounting Standards

SFAS No. 155, Accounting for Certain Hybrid Financial Instruments — an amendment of SFAS No. 133 and 140 provides entities relief from the requirement to separately determine the fair value of an embedded derivative that would otherwise be bifurcated from the host contract under SFAS 133. This statement allows an irrevocable election on an instrument-by-instrument basis to measure such a hybrid financial instrument at fair value. This statement is effective for all financial instruments acquired or issued after the beginning of the fiscal years beginning after September 15, 2006. The Company has evaluated this statement and does not believe it will have a material effect on the Company’s financial position, results of operations and cash flows.

CRESCENT FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2006, 2005 and 2004

NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

New Accounting Standards (Continued)

SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans. This statement requires recognition on the balance sheet of a plan’s overfunded or underfunded status with an offset to comprehensive income. This statement also requires, with limited exceptions, that the funded status of the plan be determined as of the employer’s fiscal year end. The balance sheet recognition provisions of SFAS 158 are effective for entities with publicly traded equity securities for years ending after December 15, 2006 and for all other entities for years ending after June 15, 2007. The Company does not anticipate that this statement will have an impact on the Company’s financial position, results of operations and cash flows.

In July 2006, the FASB issued FIN. 48, Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109, which is a change in accounting for income taxes. FIN 48 specifies how tax benefits for uncertain tax positions are to be recognized, measured, and derecognized in financial statements; requires certain disclosures of uncertain tax matters; specifies how reserves for uncertain tax positions should be classified on the balance sheet; and provides transition and interim period guidance, among other provisions. FIN 48 is effective for fiscal years beginning after December 15, 2006 and as a result, is effective for the Company in the first quarter of fiscal 2008. The Company is currently evaluating the impact of FIN 48 on its Consolidated Financial Statements.

In September 2006, the SEC staff issued Staff Accounting Bulletin (“SAB”) No. 108, Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in the Current Year Financial Statements. SAB No. 108 addresses the diversity in practice by registrants when quantifying the effect of an error on the financial statements. SAB No. 108 provides guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements and is effective for annual periods ending after November 15, 2006. The Company adopted the provisions of SAB No. 108 effective December 31, 2006. The adoption of SAB No. 108 did not have a material financial impact on the Company’s consolidated financial statements.

The Emerging Issues Task Force (“EITF”) reached a consensus at its September 2006 meeting regarding EITF 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements. The scope of EITF 06-4 is limited to the recognition of a liability and related compensation costs for endorsement split-dollar life insurance policies that provide a benefit to an employee that extends to postretirement periods. Therefore, this EITF would not apply to a split-dollar life insurance arrangement that provides a specified benefit to an employee that is limited to the employee’s active service period with an employer. This EITF 06-4 is effective for fiscal years beginning after December 15, 2007, with earlier application permitted. The effects of this EITF have not yet been evaluated.

The EITF reached a consensus at its September 2006 meeting regarding EITF 06-5, Accounting for Purchases of Life Insurance Determining the Amount That Could be Realized in Accordance with FASB Technical Bulletin No. 85-5. The scope of EITF 06-5 is limited to the determination of net cash surrender value of a life insurance contract in accordance with Technical Bulletin 85-4. This EITF outlines when contractual limitations of the policy should be considered when determining the net realizable value of the contract. EITF 06-5 is effective for fiscal years beginning after December 15, 2006, with earlier application permitted. The Company has evaluated the effects of this EITF and concluded that it will not have a material effect on our consolidated financial statements.

From time to time the FASB issues exposure drafts for proposed statements of financial accounting standards. Such exposure drafts are subject to comment from the public, to revisions by the FASB and to final issuance by the FASB as statements of financial accounting standards. Management considers the effect of the proposed statements on the consolidated financial statements of the Company and monitors the status of changes to and proposed effective dates of exposure drafts.

CRESCENT FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2006, 2005 and 2004

NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Reclassifications

Certain amounts in the 2005 and 2004 consolidated financial statements have been reclassified to conform to the 2006 presentation. The reclassifications had no effect on net income or stockholders’ equity as previously reported.

NOTE C - INVESTMENT SECURITIES

The following is a summary of the securities portfolios by major classification:

	December 31, 2006
	Amortized cost		Gross unrealized gains		Gross unrealized gains		Fair value
Securities available for sale:
U.S. government securities
and obligations of U.S.
government agencies	$	7,493,079	$	5,790	$	113,998	$	7,384,871
Mortgage-backed		54,949,049		154,157		828,909		54,274,297
Municipals		22,320,984		67,266		206,104		22,182,146
Other		779,398		102,180		-		881,578
	$	85,542,510	$	329,393	$	1,149,011	$	84,722,892

	December 31, 2005
	Amortized cost		Gross unrealized gains		Gross unrealized gains		Fair value
Securities available for sale:
U.S. government securities
and obligations of U.S.
government agencies	$	5,944,426	$	-	$	151,481	$	5,792,945
Mortgage-backed		35,042,315		-		895,212		34,147,103
Municipals		15,173,028		88,274		151,089		15,110,213
Other		500,000		-		-		500,000
	$	56,659,769	$	88,274	$	1,197,782	$	55,550,261

There were no security gains or losses in 2006. There were gross gains from sales of securities of $538 and gross losses of $16,960 in 2005. In 2004 there were gross securities gains of $57 and no security losses from sales of securities.

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 December 31, 2006 and 2005. The 2006 unrealized losses on investment securities relate to nine U.S. Government agency securities, fifty-seven mortgage-backed securities, and thirty municipal securities. The 2005 unrealized losses on investment securities relate to nine U.S. Government agency security, fifty-one mortgage-backed securities, and fifteen municipal 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.

CRESCENT FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2006, 2005 and 2004

NOTE C - INVESTMENT SECURITIES (Continued)

	December 31, 2006
	Less Than 12 Months				12 Months or More				Total
	Fairvalue		Unrealized losses		Fair value		Unrealized losses		Fair value		Unrealized losses
Securities available for sale:
U.S. government securities
and obligations of U.S.
government agencies	$	-	$	-	$	5,350,947	$	113,998	$	5,350,947	$	113,998
Mortgage-backed		6,823,616		32,598		27,048,461		796,311		33,872,077		828,909
Municipals		11,531,302		79,878		4,255,378		126,226		15,786,680		206,104
Total temporarily impaired securities	$	18,354,918	$	112,476	$	36,654,786	$	1,036,535	$	55,009,704	$	1,149,011

	December 31, 2005
	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:
U.S. government securities
and obligations of U.S.
government agencies	$	4,357,371	$	98,615	$	1,435,574	$	52,866	$	5,792,945	$	151,481
Mortgage-backed securities		15,763,472		278,572		17,319,426		616,640		33,082,898		895,212
Municipals		4,715,660		71,011		2,778,200		80,078		7,493,860		151,089
Total temporarily impaired securities	$	24,836,503	$	448,198	$	21,533,200	$	749,584	$	46,369,703	$	1,197,782

At December 31, 2006 and 2005, investment securities with a carrying value of $12,146,961 and $17,765,148, 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 December 31, 2006 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	$	9,233,636	$	9,209,363
Due after one year through five years		39,262,431		38,713,193
Due after five years through ten years		24,606,755		24,390,330
Due after ten years		12,439,688		12,410,006
	$	85,542,510	$	84,722,892

CRESCENT FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2006, 2005 and 2004

NOTE C - INVESTMENT SECURITIES (Continued)

The following table presents the carrying values, intervals of maturities or repricings, and weighted average yields of our investment portfolio at December 31, 2006:

	Repricing or Maturing
	Less than one year			One to five years			Five to ten years			Over ten years			Total
	(Dollars in thousands)
Securities available for sale:
U. S. government agencies
Balance	$	-		$	5,196		$	2,189		$	-		$	7,385
Weighted average yield		-			4.62	%		4.77	%		-			4.66	%
Mortgage-backed securities
Balance	$	7,715		$	29,333		$	12,273		$	4,953		$	54,274
Weighted average yield		4.84	%		4.88	%		5.10	%		5.24	%		4.95	%
Municipal securities
Balance	$	1,113		$	4,184		$	9,928		$	6,957		$	22,182
Weighted average yield		3.66	%		3.47	%		4.04	%		4.17	%		3.95	%
Other
Balance	$	382		$	-		$	-		$	500		$	882
Weighted average yield		-			-			-			9.00	%		5.77	%
Total
Balance	$	9,210		$	38,713		$	24,390		$	12,410		$	84,723
Weighted average yield		4.55	%		4.69	%		4.64	%		4.79	%		4.68	%

NOTE D - LOANS

Following is a summary of loans at December 31, 2006 and 2005.

		2006			2005
Real estate - commercial	$	304,822,939		$	174,038,866
Real estate - residential		20,223,856			14,914,096
Construction loans		110,032,772			46,607,263
Commercial and industrial loans		67,822,285			52,707,715
Home equity loans and lines of credit		42,704,279			34,920,770
Loans to individuals		4,976,566			5,670,103
Total loans		550,582,697			328,858,813
Less:
Deferred loan fees		(764,149	)		(537,173	)
Allowance for loan losses		(6,945,000	)		(4,351,000	)
Total	$	542,873,548		$	323,970,640

Loans are primarily made in the Company’s market area of North Carolina, principally Wake, Johnston, Lee, Moore, and New Hanover counties. Real estate loans can be affected by the condition of the local real estate market. Commercial and consumer and other loans can be affected by the local economic conditions.

CRESCENT FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2006, 2005 and 2004

NOTE D - LOANS (Continued)

No loans have been restructured during 2006 or 2005. Loans totaling $135,000 and $26,000 were considered impaired as of December 31, 2006 and 2005, respectively. Impaired loans at December 31, 2006 of $135,000, which represented all of the Company’s non-accruing loans on that date, had a corresponding valuation allowance of $20,000. Impaired loans at December 31, 2005 of $26,000, which represented all of the Company’s non-accruing loans on that date, had a corresponding valuation allowance of $10,000. The average recorded investment in impaired loans during the years ended December 31, 2006 and 2005 was $148,000 and $94,000, respectively. For the years ended December 31, 2006 and 2005, the interest income the Company recognized from impaired loans during the portion of the year that they were impaired was not material.

The Company has granted loans to certain directors and executive officers of the Company and their related interests. Such loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other borrowers and, in management’s opinion, do not involve more than the normal risk of collectibility. All loans to directors and executive officers or their related interests are submitted to the Board of Directors for approval. A summary of loans to directors, executive officers and their interests follows:

Loans to directors and officers as a group at December 31, 2005	$	15,990,828
Loans acquired from Port City Capital Bank		13,680,599
Net payments during year ended December 31, 2006		1,421,719
Loans to directors and officers as a group at December 31, 2006	$	28,249,708

At December 31, 2006, the Company had pre-approved but unused lines of credit totaling $3,737,609 to executive officers, directors and their related interests. No additional funds are committed to be advanced at December 31, 2006.

An analysis of the allowance for loan losses follows:

	2006			2005			2004
Balance at beginning of year	$	4,351,000		$	3,668,000		$	3,304,250
Provision for loan losses		990,786			806,796			736,070
Charge-offs		(85,571	)		(182,973	)		(431,318	)
Recoveries		2,168			59,177			58,998
Net charge-offs		(83,403	)		(123,796	)		(372,320	)
Allowance recorded related to loans acquired in acquisition of Port City Capital Bank		1,686,617			-			-
Balance at end of year	$	6,945,000		$	4,351,000		$	3,668,000

CRESCENT FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2006, 2005 and 2004

NOTE E - PREMISES AND EQUIPMENT

Following is a summary of premises and equipment at December 31, 2006 and 2005:

	2006			2005
Land	$	2,102,283		$	1,293,923
Buildings and leasehold improvements		3,298,026			3,015,307
Furniture and equipment		3,081,514			2,540,053
Less accumulated depreciation		(2,574,159	)		(2,005,227	)
Total	$	5,907,664		$	4,844,056

Depreciation and amortization amounting to $698,754 in 2006, $613,388 in 2005, and $542,570 in 2004 is included in occupancy and equipment expense.

NOTE F - DEPOSITS

The weighted average cost of time deposits was 4.40% and 3.24% at December 31, 2006 and 2005, respectively.

At December 31, 2006, the scheduled maturities of certificates of deposit are as follows:

	Less than		$100,000
	$100,000		or more		Total
Three months or less	$	14,748,573	$	55,899,672	$	70,648,245
Over three months through one year		37,569,053		93,601,775		131,170,828
Over one year through three years		12,500,400		66,766,075		79,266,475
Over three years to five years		1,154,885		13,498,296		14,653,181
Total	$	65,972,911	$	229,765,818	$	295,738,729

NOTE G - BORROWINGS

Borrowings are comprised of the following at December 31, 2006 and 2005:

	2006		2005
Short-term borrowings:
Federal funds purchased	$	6,451,000	$	4,779,000
Repurchase agreements		-		185,153
Federal Home Loan Bank advances maturing within one year		18,000,000		10,000,000
Total short-term borrowings	$	24,451,000	$	14,964,153
Long-term debt:
Federal Home Loan Bank advances maturing beyond one year	$	37,000,000	$	22,000,000
Junior subordinated debentures		8,248,000		8,248,000
Total long-term debt	$	45,248,000	$	30,248,000

CRESCENT FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2006, 2005 and 2004

NOTE G - BORROWINGS (Continued)

Short-term Borrowings

The Company may purchase federal funds through unsecured federal funds guidance lines of credit totaling $44.2 million at December 31, 2006. These lines are intended for short-term borrowings and are subject to restrictions limiting the frequency and terms of advances. These lines of credit are payable on demand and bear interest based upon the daily federal funds rate. The Company had $6,451,000 outstanding balance on the lines of credit as of December 31, 2006 compared to $4,779,000 at December 31, 2005.

Also included in short-term borrowings are repurchase agreements with outstanding balances of $185,153 at December 31, 2005. There were no outstanding balances in repurchase agreements at December 31, 2006. Securities sold under agreements to repurchase generally mature within one day from the transaction date and are collateralized by U.S. Government Agency obligations.

A summary of selected data related to short-term borrowed funds follows:

	For the Year Ended December 31,
	2006			2005
	(Dollars in thousands)
Short-term borrowings:
Repurchase agreements and federal funds
purchased:
Balance outstanding at end of year	$	6,451		$	4,964
Maximum amount outstanding at any month
end during the year		7,603			5,809
Average balance outstanding during the year		3,258			2,393
Weighted-average interest rate during the year		5.33	%		3.60	%
Weighted-average interest rate at end of year		5.63	%		4.34	%

Federal Home Loan Bank Advances

The Company has a $101.5 million credit line available with the Federal Home Loan Bank for advances. These advances are secured by a blanket floating lien on qualifying commercial real estate, first mortgage loans and pledged investment securities with a market value of $9.8 million.

At December 31, 2006, the Company had the following advances outstanding from the Federal Home Loan Bank of Atlanta:

Maturity	Interest Rate			Rate Type		2006		2005
May 10, 2006		4.56	%		Fixed	$	-	$	2,000,000
July 6, 2011		4.44	%		Convertible		-		5,000,000
July 20, 2006		4.19	%		Adjustable		-		8,000,000
July 16, 2012		3.84	%		Convertible		5,000,000		5,000,000
May 18, 2007		5.44	%		Prime Based		8,000,000		-
December 31, 2007		5.09	%		Convertible		10,000,000		-
July 28, 2008		5.40	%		Prime Based		10,000,000		-
March 25, 2019		4.87	%		Convertible		10,000,000		-
January 28, 2019		4.93	%		Convertible		12,000,000		12,000,000
						$	55,000,000	$	32,000,000

CRESCENT FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2006, 2005 and 2004

NOTE G - BORROWINGS (Continued)

Federal Home Loan Bank Advances (Continued)

At December 31, 2006 and 2005, the weighted average interest rates on the above advances were 5.01% and 4.12%, respectively. The advance maturing on July 16, 2012 and bearing interest at 3.84%, is continuously convertible every three months to a variable rate at the three month London Inter- Bank Offering Rate (“LIBOR”) if this rate is equal to or exceeds 7%. The advance maturing on May 18, 2007 bears interest at Prime less 2.85%. The advance maturing December 31, 2007 bears a fixed interest rate of 5.09% and is convertible every three months to a variable rate based on LIBOR. The advance maturing on July 28, 2008 bears interest at Prime less 2.81%. The advance maturing on March 25, 2019 bears interest at the three month LIBOR minus 50 basis points until March 25, 2009 and then will bear interest at 4.26%, at which time it becomes subject to conversion to a variable rate at the three month LIBOR. The advance maturing on January 28, 2019 bears interest at the 1 month LIBOR minus 42.5 basis points until January 27, 2009 and then bears interest at 3.90%, at which time it becomes subject to conversion to a variable rate at the three month LIBOR.

At December 31, 2006, two notes with maturities of less than one year were classified as short-term borrowings, totaling $18,000,000. At December 31, 2005, two notes with maturities of less than one year were classified as short-term borrowings, totaling $10,000,000.

Junior Subordinated Debentures

In 2003, the Company issued $8,248,000 of junior subordinated debentures to Crescent Financial Capital Trust I (the “Trust”) in exchange for the proceeds of trust preferred securities issued by the Trust. The junior subordinated debentures are included in long-term debt and the Company’s equity interest in the trust is included in other assets.

The junior subordinated debentures pay interest quarterly at an annual rate, reset quarterly, equal to LIBOR plus 3.10%. The debentures are redeemable on October 7, 2008 or afterwards, in whole or in part, on any January 7, April 7, July 7, or October 7. Redemption is mandatory at October 7, 2033. The Company guarantees the trust preferred securities through the combined operation of the junior subordinated debentures and other related documents. The Company’s obligation under the guarantee is unsecured and subordinate to senior and subordinated indebtedness of the Company.

NOTE H - LEASES

The Company has entered into eleven non-cancelable operating leases for its main office, operations center, and branch facilities. Future minimum lease payments under these leases for the years ending December 31 are as follows:

2007	$	948,472
2008		887,778
2009		816,612
2010		427,592
2011		320,284
Thereafter		2,359,118
Total	$	5,759,856

CRESCENT FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2006, 2005 and 2004

NOTE H - LEASES (Continued)

The leases contain renewal options for various additional terms after the expiration of the initial term of each lease. The cost of such rentals is not included above. Total rent expense for the years ended December 31, 2006, 2005 and 2004 amounted to $892,734, $743,095, and $539,240, respectively.

NOTE I - INCOME TAXES

The significant components of the provision for income taxes for the years ended December 31, 2006, 2005 and 2004 are as follows:

	2006			2005			2004
Current tax provision:
Federal	$	2,422,394		$	1,366,832		$	809,768
State		568,916			303,617			201,830
		2,991,310			1,670,449			1,011,598
Deferred tax provision (benefit):
Federal		(153,224	)		(34,424	)		117,839
State		(57,486	)		22,875			42,763
		(210,710	)		(11,549	)		160,602
Provision for income taxes	$	2,780,600		$	1,658,900		$	1,172,200

The difference between the provision for income taxes and the amounts computed by applying the statutory federal income tax rate of 34% to income before income taxes is summarized below:

	2006			2005			2004
Tax computed at statutory rate of 34%	$	2,612,868		$	1,633,113		$	1,191,665
Effect of state income taxes		337,544			235,976			173,645
Non-taxable income		(217,265	)		(158,773	)		(114,271	)
Non-taxable Bank Owned Life Insurance		(77,169	)		(77,119	)		(90,573	)
Other		124,622			25,703			11,734
	$	2,780,600		$	1,658,900		$	1,172,200

Significant components of deferred taxes at December 31, 2006 and 2005 are as follows:

	2006			2005
Deferred tax assets:
Allowance for loan losses	$	2,540,149		$	1,539,907
Net operating loss carryforwards		76,390			215,279
Premises and equipment		147,092			109,702
Rent abatement		11,807			15,856
Unrealized loss on securities		318,671			427,715
Fair value adjustments		305,377			-
Deferred compensation		260,443			-
Other		86,833			96,866
Net deferred tax assets		3,746,762			2,405,325
Deferred tax liabilities:
Intangible assets		(472,803	)		(61,780	)
Deferred loan costs		(30,062	)		(62,881	)
Prepaid expenses		(107,316	)		(64,421	)
Net deferred tax liabilities		(610,181	)		(189,082	)
Net deferred tax asset included in other assets	$	3,136,581		$	2,216,243

CRESCENT FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2006, 2005 and 2004

NOTE I - INCOME TAXES (Continued)

It is management’s opinion that realization of the net deferred tax asset is more likely than not based on the Company’s history of taxable income and estimates of future taxable income.

The Company has net operating loss carryforwards for federal tax purposes of approximately $225,000, which were acquired in the merger of Centennial Bank and which expire beginning in 2020.

NOTE J - NON-INTEREST INCOME AND OTHER NON-INTEREST EXPENSE

The major components of non-interest income for the years ended December 31, 2006, 2005 and 2004 are as follows:

	2006		2005		2004
Distribution from mortgage company		46,099		38,152		286,646
Brokerage referral fees		78,510		203,168		138,237
Gain on sale of membership interest in mortgage company		-		-		118,048
Other		326,264		179,087		38,906
Total	$	450,873	$	420,407	$	581,837

The major components of other non-interest expense for the years ended December 31, 2006, 2005 and 2004 are as follows:

	2006		2005		2004
Postage, printing and office supplies	$	472,542	$	411,673	$	335,961
Advertising and promotions		517,015		396,772		318,901
Professional fees and services		899,389		711,805		566,171
Other		1,338,417		960,621		823,932
Total	$	3,227,363	$	2,480,871	$	2,044,965

NOTE K - RESERVE REQUIREMENTS

The aggregate net reserve balance maintained under the requirements of the Federal Reserve, which is non-interest bearing, was approximately $4,950,000 at December 31, 2006.

NOTE L - REGULATORY MATTERS

The Company (on a consolidated basis) and the Banks are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s and Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Banks must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.

CRESCENT FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2006, 2005 and 2004

NOTE L - REGULATORY MATTERS (Continued)

The Banks, as North Carolina banking corporations, may pay dividends to the Company only out of undivided profits as determined pursuant to North Carolina General Statutes Section 53-87. However, regulatory authorities may limit payment of dividends by any bank when it is determined that such a limitation is in the public interest and is necessary to ensure the financial soundness of the bank.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Banks to maintain minimum amounts and ratios (set forth in the following table) of total and Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2006 and 2005, that the Company and the Banks met all capital adequacy requirements to which they are subject.

As of December 31, 2006, the most recent notification from the Federal Deposit Insurance Corporation categorized both Crescent State Bank and Port City Capital Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following tables. There are no conditions or events since the notification that management believes have changed either Bank’s category. The Bank’s actual capital amounts and ratios as of December 31, 2006 and 2005 are presented in the table below.

	Actual					Minimum for capital adequacy purposes					Minimum to be well capitalized under prompt corrective action provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
	(Dollars in thousands)
Crescent State Bank
As of December 31, 2006:
Total Capital (to Risk-Weighted Assets)	$	46,980		10.26	%	$	36,640		8.00	%	$	45,800		10.00	%
Tier I Capital (to Risk-Weighted Assets)		41,774		9.12	%		18,320		4.00	%		27,480		6.00	%
Tier I Capital (to Average Assets)		41,774		8.47	%		19,717		4.00	%		24,646		5.00	%
As of December 31, 2005:
Total Capital (to Risk-Weighted Assets)	$	38,275		10.33	%	$	29,643		8.00	%	$	37,053		10.00	%
Tier I Capital (to Risk-Weighted Assets)		33,924		9.16	%		14,821		4.00	%		22,232		6.00	%
Tier I Capital (to Average Assets)		33,924		8.42	%		16,123		4.00	%		20,155		5.00	%
Port City Capital Bank
As of December 31, 2006:
Total Capital (to Risk-Weighted Assets)	$	16,002		10.69	%	$	11,971		8.00	%	$	14,964		10.00	%
Tier I Capital (to Risk-Weighted Assets)		14,217		9.50	%		5,985		4.00	%		8,978		6.00	%
Tier I Capital (to Average Assets)		14,217		8.64	%		6,585		4.00	%		8,232		5.00	%

The Company is also subject to these requirements. At December 31, 2006, the Company’s total capital to risk-weighted assets, Tier I capital to risk-weighted assets and Tier I capital to average assets were 11.03%, 9.88% and 9.13%, respectively. At December 31, 2005, the Company’s total capital to risk-weighted assets, Tier I capital to risk-weighted assets and Tier I capital to average assets were 13.68%, 12.51% and 11.51%, respectively.

CRESCENT FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2006, 2005 and 2004

NOTE M - BUSINESS COMBINATION

On April 6, 2006, the Company entered into a definitive agreement to acquire Port City Capital Bank in Wilmington, North Carolina. The acquisition was approved at the annual shareholders’ meeting on July 11, 2006 and the transaction took place effective with the close of business on August 31, 2006. Port City Capital Bank is now a wholly-owned banking subsidiary of Crescent Financial Corporation operating under its current name and with its current board of directors and management. Port City Capital Bank shareholders received $3.30 in cash for each share of Port City Capital Bank stock they owned, and exchanged each share of Port City Capital Bank stock for 2.262 shares of Crescent Financial Corporation common stock. As a result of the acquisition, the Company paid $3.6 million in cash and has issued 2,432,374 additional shares of stock. The acquisition was accounted for using the purchase method of accounting, with the operating results of Port City Capital Bank subsequent to August 31, 2006 included in the Company’s financial statements.

The following table reflects the unaudited proforma combined results of operations for the years ended December 31, 2006 and 2005, assuming the acquisition had occurred at the beginning of fiscal year 2005.

	2006		2005
Net interest income	$	26,250,692	$	18,802,822
Net income		6,833,502		4,960,512
Net income per share:
Basic	$	0.75	$	0.68
Diluted		0.72		0.65

The proforma net income for the year ended December 31, 2006 does not reflect approximately $1,575,000 in merger related costs incurred by Port City Capital Bank. In management’s opinion, these unaudited results are not necessarily indicative of what actual combined results of operations might have been if the acquisition had been effective at the beginning of fiscal 2005.

A summary of the total purchase price of the transaction is as follows:

Fair value of common stock issued	$	31,669,470
Fair value of common stock options issued		4,328,905
Cash paid for shares		3,550,620
Transaction costs paid in cash		609,505
Total purchase price	$	40,158,500

A summary of the fair value of assets acquired and liabilities assumed is as follows:

Cash and cash equivalents	$	12,382,048
Investment securities available for sale		16,366,192
Stock in FHLB of Atlanta		286,100
Loans receivable, net		126,715,970
Premises and equipment		84,775
Deferred tax asset		817,430
Goodwill		26,625,251
Core deposit intangible		1,124,481
Other assets		794,477
Deposits		(144,187,695	)
Other liabilities		(850,529	)
Net assets acquired	$	40,158,500

CRESCENT FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2006, 2005 and 2004

NOTE N - OFF-BALANCE SHEET RISK

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of conditions established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank, upon extension of credit is based on management’s credit evaluation of the borrower. Collateral obtained varies but may include real estate, stocks, bonds, and certificates of deposit.

A summary of the contract amount of the Company’s exposure to off-balance sheet credit risk as of December 31, 2006 is as follows (amounts in thousands):

Financial instruments whose contract amounts represent credit risk:
Commitments to extend credit	$	128,299
Undisbursed equity lines of credit		40,346
Financial standby letters of credit		10,336
Commitment to invest in Small Business Investment Corporation		63

NOTE O - DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS

Financial instruments include cash and due from banks, interest-earning deposits with banks, federal funds sold, investment securities, loans, Federal Home Loan Bank stock, investment in life insurance, accrued interest receivable, accrued interest payable, deposit accounts, and borrowings. Fair value estimates are made at a specific moment in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no active market readily exists for a portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

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.

CRESCENT FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2006, 2005 and 2004

NOTE O - DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)

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.

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.

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.

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 December 31, 2006 and 2005:

	2006				2005
	Carrying		Estimated		Carrying		Estimated
	amount		fair value		amount		fair value
Financial assets:
Cash and cash equivalents	$	15,150,110	$	15,150,110	$	9,471,507	$	9,471,507
Investment securities		84,722,892		84,722,892		55,550,261		55,550,261
Federal Home Loan Bank stock		3,582,800		3,582,800		2,133,400		2,133,400
Loans, net		542,873,548		538,653,000		323,790,640		321,215,000
Investment in life insurance		5,683,493		5,683,493		5,483,313		5,483,313
Accrued interest receivable		3,045,840		3,045,840		1,768,029		1,768,029

Financial liabilities:
Deposits		541,881,680		523,783,000		322,080,788		310,537,800
Short-term borrowings		24,451,000		24,451,000		14,964,153		14,964,153
Long-term borrowings		45,248,000		38,620,000		30,248,000		29,856,000
Accrued interest payable		1,237,808		1,237,808		801,571		801,571

CRESCENT FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2006, 2005 and 2004

NOTE P - EMPLOYEE AND DIRECTOR BENEFIT PLANS

All information presented under this caption has been adjusted for the effects of the stock splits effected in the form of stock dividends discussed in Note B under the caption Per Share Results. During 1999 the Company adopted, with shareholder approval, an Employee Stock Option Plan (the “Employee Plan”) and a Director Stock Option Plan (the “Director Plan”). During 2002 and 2005, with shareholder approval, the Company amended the Employee plan to increase the number of shares available under the plan. In 2003, in conjunction with the merger between Crescent and Centennial Bank of Southern Pines, stock options approved under Centennial’s Plan were acquired by Crescent. Certain of the options granted under the Director Plan vested immediately at the time of grant. All other options granted vested twenty-five percent at the grant date, with the remainder vesting over a three-year period. All unexercised options expire ten years after the date of grant.

At the time of the PCCB merger, PCCB had two stock option plans, the 2002 Incentive Stock Option Plan and the 2002 Nonstatutory Stock Option Plans, whose options were converted to options to purchase Crescent Financial Corporation stock at an exchange rate of 2.5133. There were 225,954 incentive stock options and 228,459 non-statutory stock options converted. Since all options authorized under the PCCB plans had been granted, there will be no more options granted under either of these plans.

At the Company’s annual meeting on July 11, 2006, the shareholders approved the 2006 Omnibus Stock Ownership and Long Term Incentive Plan (the “Omnibus Plan”) to replace the previous plans. This plan authorizes 335,000 shares of the common stock of Crescent to be issued in the form of incentive stock option grants, non-statutory stock option grants, restricted stock grants, long term incentive compensation units, or stock appreciation rights. In the event that the number of shares of common stock that remain available for future issuance under the Plan as of December 31, 2006 and as of the last day of each calendar year commencing thereafter, is less than 1.5% of the total number of shares of common stock issued and outstanding as of such date (the “Replacement Amount”), then the Plan Pool shall be increased as of such date by a number of shares of common stock equal to the Replacement Amount. At December 31, 2006, there were 313,163 unissued shares in this plan.

The share-based awards granted under the aforementioned plans have similar characteristics, except that some awards have been granted in options and certain awards have been granted in restricted stock. Therefore, the following disclosures have been disaggregated for the stock option and restricted stock awards of the plans due to their dissimilar characteristics. The Company funds the option shares and restricted stock from unauthorized but un-issued shares.

Stock Option Plans

A summary of the Company’s option plans as of and for the years ended December 31, 2006, 2005 and 2004, adjusted for the stock split effected in the form of a 15% stock dividend distributed in May 2006, is as follows:

	2006					2005					2004
	Number			Weighted Average Option Price		Number			Weighted Average Option Price		Number			Weighted Average Option Price
Options outstanding, beginning of year		550,102		$	5.84		618,265 $			5.31		655,706		$	4.92
Granted		14,450			13.17		32,258			13.35		46,684			9.92
Exercised		(45,655	)		5.60		(87,939	)		8.89		(75,955	)		4.59
Forfeited		(12,065	)		12.87		(12,482	)		8.89		(8,170	)		7.41
Converted from PCCB plans		454,413			4.81		-			-		-			-
Options outstanding, end of year		961,245		$	5.39		550,102 $			5.84		618,265		$	5.31

CRESCENT FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2006, 2005 and 2004

NOTE P - EMPLOYEE AND DIRECTOR BENEFIT PLANS (Continued)

Stock Option Plans (continued)

The following table provides the range of exercise prices for options outstanding at December 31, 2006:

Range of Exercise Prices		Stock Options Outstanding		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life
	$4.33 -$6.74		869,287	$	4.84		62 months
	$6.75 -$9.15		40,650	$	8.10		83 months
	$9.16 -$11.56		13,225	$	10.78		93 months
	$11.57 -$13.98		38,083	$	13.13		110 months
			961,245	$	5.39		65 months

The fair market value of each option award is estimated on the date of grant using the Black-Scholes option pricing model. The risk-free interest rate is based upon a U.S. Treasury instrument with a life that is similar to the expected life of the option grant. Expected volatility is based upon the historical volatility of the Company’s stock price based upon the previous 3 years trading history. The expected term of the options is based upon the average life of previously issued stock options.

The assumptions used in estimating fair values, together with the estimated per share value of options granted are displayed below:

	2006			2005			2004
Assumptions in estimating option values:
Risk-free interest rate		4.58	%		4.36	%		3.66	%
Dividend yield		-	%		-	%		-	%
Volatility		34.24	%		36.50	%		39.29	%
Expected life		7 years			7 years			7 years
The weighted average grant date fair value of options	$	6.03		$	6.25		$	2.29

Compensation cost charged to income was approximately $202,000 for the year end December 31, 2006 as a result of the implementation of SFAS No. 123R. Cash received from option exercise under all share-based payment arrangements for the year ended December 31, 2006 was $256,000. The actual tax benefit in stockholders equity realized for the tax deductions from option exercise of the share-based payment arrangements totaled $45,000 for the year ended December 31, 2006.

The total intrinsic value of options exercised during the years ended December 31, 2006 was $351,000. The aggregate intrinsic value of options outstanding and options exercisable at December 31, 2006 was $7,102. As of December 31, 2006, there was $133,000 of unrecognized compensation cost related to the nonvested stock option plans. That cost is expected to be recognized as follows: $79,000 in 2007, $48,000 in 2008 and $5,000 in 2009.

Stock Award Plans

A summary of the status of the Company’s non-vested stock awards as of December 31, 2006, and changes during the year then ended is presented below:

			Weighted
			average
			grant date
	Shares		fair value
Non-vested - December 31, 2005		-	$	-
Granted		7,387		13.54
Vested		-		-
Forfeited		-		-
Non-vested - December 31, 2006		7,387	$	13.54

CRESCENT FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2006, 2005 and 2004

NOTE P - EMPLOYEE AND DIRECTOR BENEFIT PLANS (Continued)

Stock Award Plans (Continued)

The total fair value of restricted stock grants issued during the year ended December 31, 2006 was $100,020. There were no restricted stock grants vested during the period.

As of December 31, 2006, there was $93,352 of unrecognized compensation cost related to the nonvested stock award plan. That cost is expected to be recognized over a weighted average period of 4.6 years.

Supplemental Retirement

During 2003, the Company adopted a Supplemental Executive Retirement Plan (SERP) for its senior executives. The Company has purchased life insurance policies in order to provide future funding of benefit payments. Plan benefits will accrue and vest during the period of employment and will be paid in monthly benefit payments over the officer’s remaining life commencing with the officer’s retirement at any time after attainment of age sixty-five. Expenses attributable to the matching contributions for the years ended December 31, 2006, 2005 and 2004 were $87,657, $80,022, and $77,963, respectively. The accrued liability of the plan at December 31, 2006 and 2005 was $263,884 and $176,227, respectively.

Defined Contribution Plan

The Company sponsors a contributory profit-sharing plan which provide for participation by substantially all employees. Participants may make voluntary contributions resulting in salary deferrals in accordance with Section 401(k) of the Internal Revenue Code. The plans provide for employee contributions up to $15,000 of the participant's annual salary and an employer contribution of 100% matching of the first 6% of pre-tax salary contributed by each participant. The Company may make additional discretionary profit sharing contributions to the plan on behalf of all participants; in 2005 the Company declared an $80,000 discretionary contribution. There were no discretionary contributions for 2006 or 2004. Amounts deferred above the first 6% of salary are not matched by the Company. Expenses related to these plans for the years ended December 31, 2006, 2005 and 2004 were $269,058, $172,450, and $111,442, respectively.

Employment Agreements

The Company has entered into employment agreements with certain of its executive officers to ensure a stable and competent management base. The agreements provide for benefits as spelled out in the contracts and cannot be terminated by the Board of Directors, except for cause, without prejudicing the officers’ rights to receive certain vested rights, including compensation. In the event of a change in control of the Company, as outlined in the agreements, the acquirer will be bound to the terms of the contracts.

CRESCENT FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2006, 2005 and 2004

NOTE Q - PARENT COMPANY FINANCIAL DATA

Condensed statements of financial condition as of December 31, 2006 and 2005, and its related condensed statements of operations and cash flows for each of the years in the three-year period ended December 31, 2006 are as follows:

Condensed Balance Sheets

December 31, 2006 and 2005

	2006			2005
ASSETS
Cash and due from banks	$	4,218,479		$	12,535,544
Investment in subsidiaries		87,188,534			37,249,786
Other assets		73,694			112,162

TOTAL ASSETS	$	91,480,707		$	49,897,492

LIABILITIES AND STOCKHOLDERS' EQUITY

Liabilities:
Accrued interest payable	$	166,963		$	142,851
Due to former Centennial Shareholders		27,113			33,974
Accrued expenses and other liabilities		4,653			15,453
Subordinated debentures		8,248,000			8,248,000

TOTAL LIABILITIES		8,446,729			8,440,278

Stockholders' equity:
Common stock		8,265,136			5,026,394
Additional paid-in capital		62,659,201			29,405,559
Retained earnings		12,610,588			7,707,054
Accumulated other comprehensive loss		(500,947	)		(681,793	)

TOTAL STOCKHOLDERS’ EQUITY		83,033,978			41,457,214

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	91,480,707		$	49,897,492

Condensed Statements of Operations

Years Ended December 31, 2006, 2005 and 2004

	2006			2005			2004
Equity in earnings of subsidiaries	$	4,988,649		$	3,397,675		$	2,539,365
Interest income		630,505			233,179			144,117
Dividend income		20,669			16,238			11,520
Other miscellaneous income		23,286			803			-
Interest expense		(720,822	)		(573,438	)		(416,547	)
Other operating expenses		(81,853	)		(59,784	)		(50,558	)
Income tax benefit (expense)		43,100			129,700			104,800
Net income	$	4,903,534		$	3,144,373		$	2,332,697

CRESCENT FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2006, 2005 and 2004

NOTE Q - PARENT COMPANY FINANCIAL DATA

Condensed Statements of Cash Flows

Years Ended December 31, 2006, 2005 and 2004

	2006			2005			2004
Cash flows from operating activities:
Net income	$	4,903,534		$	3,144,373		$	2,332,697
Adjustments to reconcile net income to net cash
provided (used) by operating activities:
Amortization		33,400			33,400			33,400
Stock based compensation		202,246			-			-
Equity in earnings of Crescent State Bank		(4,194,284	)		(3,397,675	)		(2,539,365	)
Equity in earnings of Port City Capital Bank		(794,365	)		-			-
Changes in assets and liabilities:
Increase in other assets		5,068			(10,765	)		(18,235	)
Increase (decrease) in accrued interest payable		24,112			40,983			(21,504	)
Increase (decrease) in accrued expenses
and other liabilities		(10,799	)		25,353			(2,200	)
Net cash provided (used) by operating activities		168,912			(164,331	)		(215,207	)
Cash flows from investing activities:
Investment in Subsidiaries		(8,770,879	)		(1,750,000	)		-
Net cash used by investing activities		(8,770,879	)		(1,750,000	)		-
Cash flows from financing activities:
Net proceeds from issuance of common stock		-			11,617,858			-
Proceeds from exercise of stock options		255,797			392,912			348,948
Excess tax benefits from stock options exercised		45,401			199,800			61,709
Payments to former Centennial Shareholders		(6,861	)		(101,820	)		(748,816	)
Cash (paid) received in lieu of fractional shares		(9,435	)		2			1,790
Net cash provided (used) by financing activities		284,902			12,108,752			(336,371	)
Net increase (decrease) in cash and cash equivalents		(8,317,065	)		10,194,421			(551,578	)
Cash and cash equivalents, beginning		12,535,544			2,341,123			2,892,701
Cash and cash equivalents, ending	$	4,218,479		$	12,535,544		$	2,341,123

CRESCENT FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2006, 2005 and 2004

NOTE R - SUPPLEMENTAL DISCLOSURE FOR STATEMENT OF CASH FLOWS

	2006		2005			2004
Supplemental Disclosure of Cash Flow Information:
Cash paid during the year for:
Interest	$	17,120,578	$	8,562,944		$	5,440,306
Income taxes	$	2,655,001	$	1,330,000		$	1,031,500
Supplemental Disclosure of Noncash Investing
and Financing Activities:
Transfer of loans to foreclosed assets	$	199,900	$	48,300		$	375,400
Increase (decrease) in fair value of securities
available for sale, net of tax		180,846		(675,145	)		(117,630	)

The fair value of assets acquired and liabilities assumed in the PCCB merger are presented in Note M.

NOTE S - SALE OF COMMON STOCK

The Company completed the sale of 848,000 shares of its common stock at $15.00 per share on November 2, 2005. Expenses associated with the sale amounted to $1,102,142 resulting in net proceeds from the offering of $11,617,858.

ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

Not applicable.

ITEM 9A - CONTROLS AND PROCEDURES

The Registrant’s Chief Executive Officer and Chief Financial Officer have conducted an evaluation of the Registrant’s disclosure controls and procedures as of December 31, 2006. Based on their evaluation, the Registrant’s Chief Executive Officer and Chief Financial Officer have concluded that the Registrant’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Registrant in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the applicable Securities and Exchange Commission rules and forms. There were no changes in the Registrant’s internal controls or in other factors that could materially affect these controls subsequent to the date of the most recent evaluation of these controls by the Registrant’s Chief Executive Officer and Chief Financial Officer, including any corrective actions with regard to deficiencies and weaknesses.

ITEM 9B - OTHER INFORMATION

Not applicable.

PART III

ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Incorporated by reference from the discussion under the headings “Proposal 1: Election of Directors,” “Executive Compensation - Executive Officers,” “Director Relationships,” “Section 16(a) Beneficial Ownership Reporting Compliance” and “Meetings and Committees of the Board of Directors - Audit Committee” in the Registrant’s Proxy Statement for the 2007 Annual Meeting of Shareholders to be filed with the SEC.

The Registrant has adopted a Code of Ethics that applies, among others, to its principal executive officer and principal financial officer. The Registrant’s Code of Ethics is available at www.crescentstatebank.com.

ITEM 11 - EXECUTIVE COMPENSATION

Incorporated by reference from the discussion under the heading “Executive Compensation,” “Director Compensation,” “Compensation Committee Interlocks and Insider Participation” and “Compensation Committee Report” in the Registrant’s Proxy Statement for the 2007 Annual Meeting of Shareholders to be filed with the SEC.

ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

Incorporated by reference from the discussion under the heading “Beneficial Ownership of Voting Securities” in the Registrant’s Proxy Statement for the 2007 Annual Meeting of Shareholders to be filed with the SEC.

Stock Option Plans

Set forth below is certain information regarding the Registrant’s various stock option plans.

EQUITY COMPENSATION PLAN INFORMATION

Plan Category	Number of securities to be issued upon exercise of outstanding options, warrants, and rights (a)		Weighted-average exercise price of outstanding options, warrants, and rights (b)		Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) (c)
Equity compensation plans approved by security holders		961,245	$	5.39		313.163
Equity compensation plans not approved by security holders		None		None		None
Total		961,245	$	5.39		313,163

See additional information in Note P under the heading "Employee and Director Benefit Plans - Stock Option Plans" in Item 8 of this report.

ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Incorporated by reference from the discussion under the headings “Director Independence” and “Indebtedness of and Transactions with Management” in the Registrant’s Proxy Statement for the 2007 Annual Meeting of Shareholders to be filed with the SEC.

ITEM 14 - PRINCIPAL ACCOUNTING FEES AND SERVICES

Incorporated by reference from pages the discussion under the heading “Proposal 2: Ratification of Independent Public Accountants” and “Audit Committee Report” in the Registrant’s Proxy Statement for the 2007 Annual Meeting of Shareholders to be filed with the SEC.

ITEM 15 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES

(a) Exhibits

3(i) Articles of Incorporation of Registrant (Incorporated by reference from the Annual Report on Form 10-KSB of the Registrant for the fiscal year ended December 31, 2001, as filed with the Securities and Exchange Commission on March 27, 2002)

3(ii) Bylaws of Registrant (Incorporated by reference from the Annual Report on Form 10-KSB of the Registrant for the fiscal year ended December 31, 2001, as filed with the Securities and Exchange Commission on March 27, 2002)

4 Form of Stock Certificate (Incorporated by reference from the Annual Report on Form 10-KSB of the Registrant for the fiscal year ended December 31, 2001, as filed with the Securities and Exchange Commission on March 27, 2002)

10(i) 1999 Incentive Stock Option Plan, approved by shareholders on April 27, 1999 (Incorporated by reference from Registrant’s Registration Statement on Form S-8 as filed with the SEC on September 5, 2001)

10(ii) 1999 Nonqualified Stock Option Plan for Directors, approved by shareholders on April 27, 1999 (Incorporated by reference from Registrant’s Registration Statement on Form S-8 as filed with the SEC on September 5, 2001)

10(iii) Employment Agreement between the Registrant and Michael G. Carlton (Incorporated by reference from Registrant’s Annual Report on Form 10-KSB filed with the SEC on March 30, 2004)

10(iv) Employment Agreement between the Registrant and Bruce W. Elder (Incorporated by reference from Registrant’s Annual Report on Form 10-KSB filed with the SEC on March 30, 2004)

10(v) Employment Agreement between the Registrant and Thomas E. Holder, Jr. (Incorporated by reference from Registrant’s Annual Report on Form 10-KSB filed with the SEC on March 30, 2004)

10(vi) Amended and Restated Trust Agreement of Crescent Financial Capital Trust I (Incorporated by reference from Registrant’s Annual Report on Form 10-KSB filed with the SEC on March 30, 2004)

10(vii) Indenture (Incorporated by reference from Registrant’s Annual Report on Form 10-KSB filed with the SEC on March 30, 2004)

10(viii) Junior Subordinated Debenture (Incorporated by reference from Registrant’s Annual Report on Form 10-KSB filed with the SEC on March 30, 2004)

10(ix) Guarantee Agreement (Incorporated by reference from Registrant’s Annual Report on Form 10-KSB filed with the SEC on March 30, 2004)

10(x) Salary Continuation Agreement with Michael G. Carlton (Incorporated by reference from Registrant’s Annual Report on Form 10-KSB filed with the SEC on March 30, 2004)

10(xi) Salary Continuation Agreement with Bruce W. Elder (Incorporated by reference from Registrant’s Annual Report on Form 10-KSB filed with the SEC on March 30, 2004)

10(xii) Salary Continuation Agreement with Thomas E. Holder, Jr. (Incorporated by reference from Registrant’s Annual Report on Form 10-KSB filed with the SEC on March 30, 2004)

10(xiii) Endorsement Split Dollar Agreement with Michael G. Carlton (Incorporated by reference from Registrant’s Annual Report on Form 10-KSB filed with the SEC on March 30, 2004)

10(xiv) Endorsement Split Dollar Agreement with Bruce W. Elder (Incorporated by reference from Registrant’s Annual Report on Form 10-KSB filed with the SEC on March 30, 2004)

10(xv) Endorsement Split Dollar Agreement with Thomas E. Holder, Jr. (Incorporated by reference from Registrant’s Annual Report on Form 10-KSB filed with the SEC on March 30, 2004)

10(xvi) Crescent State Bank Directors’ Compensation Plan (Incorporated by reference from Registrant’s Annual Report on Form 10-K filed with the SEC on March 28, 2006)

10(xvii) Employment Agreement with Ray D. Vaughn (Incorporated by reference from Registrant’s Annual Report on Form 10-K filed with the SEC on March 28, 2006)

10(xviii) 2006 Omnibus Stock Ownership and Long Term Incentive Plan, approved by shareholders on July 11, 2006 (incorporated by reference from Registrant’s Registration Statement on Form S-8 filed with the SEC on August 11, 2006)

Subsidiaries (Filed herewith)

31(i)

Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes Oxley Act (Filed herewith)

31(ii)

Certification of Principal Accounting Officer Pursuant to Section 302 of the Sarbanes Oxley Act (Filed herewith)

32(i)

Certification of Principal Executive Officer Pursuant to Section 906 of the Sarbanes Oxley Act (Filed herewith)

32(ii)

Certification of Principal Accounting Officer Pursuant to Section 906 of the Sarbanes Oxley Act (Filed herewith)

99(i)

Registrant’s Proxy Statement for the 2007 Annual Meeting of Shareholders (Filed with the Securities and Exchange Commission pursuant to Rule 14a-6)

SIGNATURES

In accordance with the requirements of Section 13 of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.


	CRESCENT FINANCIAL CORPORATION Registrant

	By:	/s/ Michael G. Carlton
Date: March 27, 2007		Michael G. Carlton President and Chief Executive Officer

In accordance with the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.


/s/ Michael G. Carlton		March 27, 2007
Michael G. Carlton, President and
Chief Executive Officer, Director


/s/ Bruce W. Elder		March 27, 2007
Bruce W. Elder, Vice President
(Principal Accounting Officer)


/s/ Brent D. Barringer		March 27, 2007
Brent D. Barringer, Director


/s/ William H. Cameron		March 27, 2007
William H. Cameron, Director


/s/ Bruce I. Howell		March 27, 2007
Bruce I. Howell, Director


/s/ James A. Lucas		March 27, 2007
James A. Lucas, Director


/s/ Kenneth A. Lucas		March 27, 2007
Kenneth A. Lucas, Director


/s/ Sheila Hale Ogle		March 27, 2007
Sheila Hale Ogle, Director


/s/ Charles A. Paul		March 27, 2007
Charles A. Paul, Director


/s/ Francis R. Quis, Jr.		March 27, 2007
Francis R. Quis, Jr., Director


/s/ Jon S. Rufty		March 27, 2007
Jon S. Rufty, Director


/s/ Jon T. Vincent		March 27, 2007
Jon T. Vincent, Director


/s/ Stephen K. Zaytoun		March 27, 2007
Stephen K. Zaytoun, Director

EXHIBIT INDEX

Exhibit Number	Exhibit
3(i)	Articles of Incorporation.	*

3(ii)	Bylaws	*

4	Form of Stock Certificate	*

10(i)	1999 Incentive Stock Option Plan	**

10(ii)	1999 Nonqualified Stock Option Plan	**

10(iii)	Employment Agreement Michael G. Carlton	***

10(iv)	Employment Agreement of Bruce W. Elder	***

10(v)	Employment Agreement of Thomas E. Holder, Jr.	***

10(vi)	Amended and Restated Trust Agreement of Crescent Financial Capital Trust I	***

10(vii)	Indenture	***

10(viii)	Junior Subordinated Debenture	***

10(ix)	Guarantee Agreement	***

10(x)	Salary Continuation Agreement with Michael G. Carlton	***

10(xi)	Salary Continuation Agreement with Bruce W. Elder	***

10(xii)	Salary Continuation Agreement with Thomas E. Holder, Jr.	***

10(xiii)	Endorsement Split Dollar Agreement with Michael G. Carlton	***

10(xiv)	Endorsement Split Dollar Agreement with Bruce W. Elder	***

10(xv)	Endorsement Split Dollar Agreement with Thomas E. Holder, Jr.	***

10(xvi)	Crescent State Bank Directors’ Compensation Plan	****

10(xvii)	Employment Agreement with Ray D. Vaughn	****

21	Subsidiaries	Filed herewith

23	Consent of Dixon Hughes PLLC

31(i)	Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes Oxley Act	Filed herewith

31(ii)	Certification of Principal Accounting Officer Pursuant to Section 302 of the Sarbanes Oxley Act	Filed herewith

32(i)	Certification of Principal Executive Officer Pursuant to Section 906 of the Sarbanes Oxley Act	Filed herewith

32(ii)	Certification of Principal Accounting Officer Pursuant to Section 906 of the Sarbanes Oxley Act	Filed herewith

99(i)	Registrant’s Proxy Statement for the 2007 Annual Meeting of Shareholders	*****

* Incorporated by reference to the Registrant’s 10-KSB for the year ended December 31, 2001, as filed with the SEC on March 27, 2002.

** Incorporated by reference to the Registrant’s Registration Statement on Form S-8 as filed with the SEC on September 5, 2001.

*** Incorporated by reference from Annual Report on Form 10-KSB filed with the SEC on March 30, 2004.

**** Incorporated by reference from Annual Report on Form 10-K filed with the SEC on March 28, 2006.

***** Filed with the Securities and Exchange Commission pursuant to Rule 14a-6.