Management's discussion and analysis is intended to assist readers in the understanding and evaluation of the financial condition and consolidated results of operations of Crescent Financial Corporation (the "Company"). The analysis includes detailed discussions for each of the factors affecting Crescent Financial Corporation's operating results and financial condition for the periods ended March 31, 2009 and 2008. It should be read in conjunction with the audited consolidated financial statements and accompanying notes included in this report and the supplemental financial data appearing throughout this discussion and analysis. Because the Company has no operations and conducts no business on its own other than owning Crescent State Bank, the discussion contained in this Management's Discussion and Analysis concerns primarily the business of the Bank. However, for ease of reading and because the financial statements are presented on a consolidated basis, the Company and the Bank are collectively referred to herein as the Company unless otherwise noted. All significant intercompany transactions and balances are eliminated in consolidation.

Total assets increased by $124.0 million to $1.1 billion at March 31, 2009 from $968.3 million at December 31, 2008. At March 31, 2009, earning assets are $1.0 billion or 94% of total assets compared to $898.7 million or 92% at December 31, 2008. Components of earning assets at March 31, 2009 are $787.7 million in gross loans, $209.9 million in investment securities and Federal Home Loan Bank (FHLB) stock and $24.3 in overnight investments and interest bearing deposits with correspondent banks. Earning assets at December 31, 2008 consisted of $785.4 million in gross loans, $112.9 million in investment securities and FHLB stock and $366,000 in overnight investments and interest bearing deposits. Total deposits and stockholders' equity at March 31, 2009 were $731.6 million and $120.5 million, respectively, compared to $714.9 million and $95.1 million at December 31, 2008.

During the first quarter of 2009, gross loans outstanding increased by $2.3 million or 0.29%. In conjunction with a core data processing conversion occurring in early March, we have reclassified certain loans within our portfolio so that reporting is more consistent with the collateral of a particular loan rather than the purpose. For instance, loans secured by homes purchased as investment property were previously reported as commercial real estate whereas they are now reported as residential real estate mortgages. Loans secured by commercial building lots were previously reported as commercial real estate and are now reported as construction and land development. As a result, the comparison of the loan compositions at March 31, 2009 and December 31, 2008 can be misleading. Reclassifications of loan types through the conversion process resulted in $164.6 million of commercial real estate loans and $2.1 million consumer loans being shifted to $81.8 million of construction and land development, $70.7 million residential mortgages, $9.3 million home equity loans and $4.9 million commercial and industrial. When considering these reclassifications, the net growth in the portfolio for the quarter by category was as follows: increases in commercial real estate, residential mortgage, home equity lines and loans and consumer loans of $8.4 million, $3.6 million, $1.2 million and $1.5 million, respectively, and a decrease in construction and land development of $12.4 million. The composition of the loan portfolio, by category, as of March 31, 2009 is 40% commercial mortgage loans, 29% construction loans, 12% residential mortgage loans. 10% commercial loans, 8% home equity loans and lines, and 1% consumer loans. The composition of the loan portfolio, by category, as of December 31, 2008 and before conversion was 60% commercial mortgage loans, 20% construction loans, 10% commercial loans, 7% home equity loans and lines, 2% residential real estate mortgage loans and 1% consumer loans.

The Company had an allowance for loan losses at March 31, 2009 of $13.9 million or 1.76% of outstanding loans compared to $12.6 million or 1.60% at December 31, 2008. At March 31, 2009, there were fifty-five loans totaling $16.4 million in non-accrual status. Thirty-one loans totaling $5.4 million represent one borrowing relationship. Of the $16.4 million in non-accrual loans, $5.8 million are one-to-four family residential. There were two loans past due 90 days or more totaling $4,000 that were still accruing interest at March 31, 2009. Non-performing loans as a percentage of total loans at March 31, 2009 were 2.08%. At December 31, 2008, there were fifty loans totaling approximately $13.1 million in non-accrual status. Thirty-five of those loans totaling approximately $5.7 million represent one borrowing relationship. Of the remaining $7.4 million, an additional $4.5 million of loans were to land developers or residential builders. The remaining $2.9 million of non-accrual loans were spread between commercial loans and residential investment properties. The percentage of non-performing loans to total loans at December 31, 2008 was 1.67%. For a more detailed discussion, see the section entitled Non-Performing Assets.

The Company has investment securities with an amortized cost of $197.0 million at March 31, 2009. All investments are accounted for as available for sale and are presented at their fair market value of $198.0 million compared with $105.6 million at year-end 2008. The Company's investment securities at March 31, 2009, consist of U.S. Government agency securities, collateralized mortgage obligations, mortgage-backed securities, municipal bonds and marketable equity securities. The increase during the first three months of 2009 was the net result of $99.7 million in new purchases, a $128,000 decrease in the fair value of the portfolio and $175,000 in net amortization of premiums, less $7.2 million in principal re-payments and called principal. The Company implemented a leverage strategy to offset the impact on earnings per share anticipated as a result of having to pay dividends on the investment made by the US Treasury pursuant to the Capital Purchase Plan (CPP). While the funds received through the CPP has been allocated for the purpose of making loans to purchasers of completed properties held in inventory by our residential construction customers, an amount equal to the CPP funds was leveraged four times and used to purchase investment securities. The additional spread earned on the strategy will offset reduction in earnings per share for common shareholders due to payment of the preferred dividend.

The Company owns $11.9 million of Federal Home Loan Bank stock at March 31, 2009 compared to $7.3 million at December 31, 2008. The increase was required due to the increased level of borrowing necessitated by the leverage strategy discussed above.

There were $99,000 in Federal funds sold at both March 31, 2009 and December 31, 2008. These funds are required as a compensating balance with one of our correspondent banking relationships.

Interest-earning deposits held at correspondent banks increased by approximately $24.0 million from $267,000 at December 31, 2008 to $24.2 million at March 31, 2009. In conjunction with its actions designed to stabilize the banking industry, the Federal Reserve Bank begin to pay interest on excess funds on deposit. This rate is 0.25% as opposed to the Fed funds rate from correspondent banks that fluctuates based on demand. These funds were parked in overnight investments as opposed to being invested in more permanent earning assets due to the maturity of certain deposit obligations expected in early second quarter.

Non-earning and other assets increased by approximately $2.1 million between December 31, 2008 and March 31, 2009. Bank premises and equipment increased by $1.0 million as we completed building construction and finished the build-out on a branch opened in early April 2009. Non-interest bearing cash due from banks, the majority of which represents checks in the process of being collected through the Federal Reserve payment system, increased by $456,000. For more details regarding the increase in cash and cash equivalents, see the Consolidated Statement of Cash Flows. There was a net increase in other real estate owned of $195,000 which was comprised of a new foreclosed property of $220,000 less a write-down on an existing property of $25,000. Additionally, The Company recorded a write-down of $188,000 on a non-marketable equity security due to other than temporarily impairment.

Total deposits increased by $16.7 million between December 31, 2008 and March 31, 2009 from $714.9 million to $731.6 million. The largest dollar increase occurred in the time deposit category, which grew by $11.5 million or 3% to $473.1 million at March 31, 2009 from $461.6 million at year end 2008. Interest-bearing demand deposit balances increased by $11.3 million or 26% to $53.9 million, non-interest bearing demand deposits increased by $1.0 million or 1% to $65.0 million and savings deposits increased by $559,000 or 1% to $59.4 million. During January, we lost one account with a $14.0 million balance which contributed to a quarterly decline in money market of $7.6 million from $87.9 million to $80.3 million.

The composition of the deposit base, by category, at March 31, 2009 is as follows: 65% time deposits, 11% money market, 9% non-interest-bearing demand deposits, 8% statement savings accounts and 7% interest-bearing demand deposits. The composition of the deposit base, by category, at December 31, 2008 was 65% time deposits, 12% money market, 9% non-interest-bearing demand deposits, 8% in statement savings and 6% in interest-bearing demand deposits. Time deposits of $100,000 or more totaled $378.1 million at March 31, 2009 compared to $359.3 million at December 31, 2008. The Company uses brokered certificates of deposit as an alternative funding source. Brokered deposits represent a source of fixed rate funds priced competitively with FHLB borrowings, but do not require collateralization like FHLB borrowings. Brokered deposits were $251.2 million at March 31, 2009 compared with $256.1 million at December 31, 2008.

The Company had total borrowings of $236.5 million at March 31, 2009 compared with $154.5 million at December 31, 2008. The composition of borrowings at March 31, 2009 is $106.0 million in long-term advances and $114.0 million in short-term advances from the Federal Home Loan Bank of Atlanta (FHLB), $8.2 million in junior subordinated debt issued to an unconsolidated subsidiary, $7.5 million in a subordinated term loan issued to a non-affiliated financial institution and $758,000 in federal funds purchased from a correspondent bank. Borrowings at December 31, 2008 included $99.0 million in long-term FHLB advances, $29.0 million in short-term FHLB advances, $8.2 million in junior subordinated debt, $7.5 million in a subordinated term loan, $2.0 million outstanding on a holding company line of credit and $8.7 million in federal funds purchased. Of the $82.0 million increase in total borrowings, $75.0 million in short-term advances were attributable to the leverage strategy previously discussed.

Accrued interest payable and other liabilities decreased by $121,000 and were $3.8 million and $3.9 million at March 31, 2000 and December 31, 2008, respectively.

Between December 31, 2008 and March 31, 2009, total stockholders' equity increased by $25.4 million. On January 9, 2009, the Company issued $24.9 million in Fixed Rate Cumulative Perpetual Preferred Stock, Series A under the US Treasury's Capital Purchase Program. In addition, the Company provided warrants to purchase 833,705 shares of the Company's common stock at an exercise price of $4.48 per share. The warrant is immediately exercisable and expire ten years from the date of issuance. The preferred stock is non-voting, other than having class voting rights on certain matters, and pays cumulative dividends quarterly at a rate of 5% per annum for the first five years and 9% thereafter. The preferred shares are redeemable at the option of the Company subject to regulatory approval.

COMPARISON OF RESULTS OF OPERATIONS FOR THE THREE MONTH PERIODS ENDED MARCH 31, 2009 AND 2008

Net Income. Net income available to common shareholders for the three-month period ended March 31, 2009 was $443,000 or $0.05 per diluted share compared with $1.0 million or $0.10 per diluted share for the three-month period ended March 31, 2008. Net income before the preferred dividend was $611,000. Annualized return on average assets and equity for the current period were 0.24% and 2.08%, respectively, compared with 0.47% and 3.97% for the prior period. Despite significant balance sheet growth over the past 12 months, the performance ratios have been impacted by net interest margin compression and increases in both loan loss provision and non-interest expenses.

Net Interest Income. Net interest income increased by almost $707,000 or 11% from $6.5 million to $7.2 million for the three-month period ended March 31, 2009. Total interest income benefited from a higher volume of earning assets despite a lower yield earned on those assets. Total interest expense from deposits and other borrowings decreased despite the higher volume of interest-bearing liabilities due to the steady repricing of fixed rated time deposits and borrowings in response to the 400 basis point drop in short-term interest rates during 2008. The decline in short-term rates over the past twelve months resulted in the contraction of the net interest margin. Lower margins and the overhead costs associated with branch expansion and personnel growth led to a decline in earnings.

Total average earning assets increased by more than $183.8 million or 23% from an average of $802.0 million for the prior year three-month period to an average of $985.8 million for the three-month period ended March 31, 2009. The average balance of loans outstanding increased by $92.1 million to $788.8 million at March 31, 2009, a 13% increase over the $696.7 million of average outstanding loans for the prior period. The average balance of the investment securities portfolio for the current period was $191.9 million, increasing by $92.1 million or 92% compared to an average of $99.8 million at March 31, 2008. The significant increase in average balances for investment securities was due to the leverage strategy previously discussed. The average balance of federal funds sold and other earning assets decreased from $5.5 million for the prior three-month period to $5.0 million for the current period.

Average interest-bearing liabilities increased by $170.5 million or 24% from $701.5 million for the quarter ended March 31, 2008 to $872.0 million for the current quarter. The total increase is comprised of a $77.4 million increase in interest bearing deposits and a $93.1 million increase in borrowed funds. Time deposits experienced the largest increase of the interest-bearing deposit group increasing $82.0 million to $461.5 million during the current year period compared to $379.5 million for the prior period. Short-term borrowings increased by $93.2 million from $13.1 million to $106.3 million due to the leverage strategy discussed earlier.

Total interest income increased by $356,000 million or 3%. The increase is comprised of $2.5 million due to the growth in total average earning assets and a $2.1 million decrease due to lower yields realized on earning assets. Total interest expense for the current period declined by $351,000. The decrease is the net result of a $1.4 million increase due to growth in interest-bearing funds and a $1.8 million decrease due to the lower interest rate environment.

Net interest margin is interest income earned on loans, securities and other earning assets, less interest expense paid on deposits and borrowings, expressed as a percentage of total average earning assets. The net interest margin for the three-month period ended March 31, 2009 was 2.98% compared to 3.27% for the three-month period ended March 31, 2008. The average yield on earning assets for the current three-month period declined 109 basis points to 5.79% compared with 6.88% for the prior year period, while the average cost of interest-bearing funds decreased by 95 basis points to 3.18% from 4.13%. The interest rate spread, which is the difference between the average yield on earning assets and the cost of interest-bearing liabilities, decreased by 14 basis points from 2.75% for the quarter ended March 31, 2008 to 2.61% for the quarter ended March 31, 2009. The percentage of interest earning assets to average interest-bearing liabilities declined to 113.04% from 114.32%.

Between September 1, 2007 and December 17, 2008, the Federal Reserve (the "Fed") reduced short-term interest rates ten times for a total of 500 basis points. Prior to September 2007, rates had been stable since July 2006. The Fed's rate reductions were more pronounced than the "measured" 25 basis point increments used when increasing the Federal funds rate from 1% to 5.25% back in 2004 to 2005 and have been directed toward addressing the poor economic conditions being experienced throughout the country.

Approximately 49% of the Company's loan portfolio has variable rate pricing based on the Prime lending rate or LIBOR (London Inter Bank Offering Rate). As short-term rates have fallen, variable rate loans have repriced downward resulting in a lower yield on average earning assets. The Company has shifted its strategic focus from a growth orientation to a more performance-related orientation. While loan demand remains good, we are being more disciplined with our loan pricing and as a result, the loan portfolio growth will not match the prior growth rates in the foreseeable future. This should result in better yields on earning assets and less reliance on supporting that growth with wholesale forms of funding. While we attempt to focus on local market relationships, we will not lose sight that, from time to time, wholesale forms of funding make more sense from an economic standpoint.

Many economists believe that we will continue to be in a stable rate environment for some extended period of time. The Company expects that net interest margin will continue to expand in the coming months as approximately 57% of our time deposit portfolio carrying a weighted average rate of 3.69% matures and is subject to being renewed at lower rates. We believe there is very little probability that rates will fall further. In the spring of 2008, we began to implement interest rate floors on many of our new and renewing variable rate loans. Short-term interest rates must increase by 250 to 300 basis points before the calculated rate of the variable loans surpasses the current floor.

Provision for Loan Losses. The Company's provision for loan losses for the three-month period ended March 31, 2009 was $1.7 million compared to $806,000 for the prior year period. Provision for loan losses is charged to income to bring the allowance for loan losses to a level deemed appropriate by management based on factors discussed under "Analysis of Allowance for Loan Losses." The increase in the loan loss provision is primarily due to continuing credit quality issues resulting from the current economic conditions in our markets. The allowance for loan losses was $13.9 million at March 31, 2009, representing 1.76% of total outstanding loans. See the sections on Nonperforming Assets and Analysis of Allowance for Loan Losses for additional details.

Non-Interest Income. For the three-month period ended March 31, 2009, non-interest income decreased by $46,000 to $763,000 compared to $809,000 for the same period in 2008.

The Company recorded increases of $125,000 in brokered mortgage loan origination fees, $109,000 in earnings on life insurance and $6,000 in customer service fees and service charges on deposit accounts. Other non-interest income fell by $80,000 due primarily to $72,000 of non-recurring income recorded in the first quarter of 2008 related to a recovery of a previously charged-off deposit account. Due to the volatility in the stock market, revenue from brokerage referrals declined by $15,000. For the quarter ended March 31, 2009, the Company recorded a $25,500 write-down of other real estate owned and a $188,000 loss on the impairment of a non-marketable equity security.

Non-Interest Expenses. Non-interest expenses were $5.6 million for the three-month period ended March 31, 2009 compared with $5.0 million for the same period ended March 31, 2008. The major categories of non-interest expense experiencing increases include personnel, occupancy, data processing and FDIC deposit insurance assessments.

The largest component of non-interest expense for the current period was personnel expense. Salaries and benefits expense increased by $167,000 or 6% to $3.0 million for the current year period compared to $2.8 million for the same period in the prior year. We have added personnel for one branch office opened on March 31, 2008 and hired additional people in several operational support departments.

Occupancy and equipment expenses increased by $88,000 or 13% from $663,000 for the three-month period ended March 31, 2008 to $751,000 for the current year period. Data processing expenses increased by $178,000 or 66% from $271,000 to $449,000. During the first quarter of 2009, the Company converted all core and ancillary data processing systems to a new provider. The non-recurring, one-time costs associated with the conversion were approximately $235,000 of which $156,000 was recorded in data processing, $40,000 was consulting, $26,000 was printing and postage for various communications to customers and $13,000 was employee travel and training expense. The after-tax impact of the conversion was approximately $144,000. Deposit insurance assessments from the Federal Deposit Insurance Corporation increased by $153,000 or 159% over insurance expense for the prior year.

Other non-interest expenses increased by $138,000 to $1.4 million for the first quarter of 2009 compared with $1.3 million for the prior year quarter. The $153,000 increase of FDIC deposit insurance premiums discussed above is included in other non-interest expenses on the face of the income statement. The remainder of other non-interest expenses, the largest of which include professional fees and services, office supplies and printing, advertising, and loan related fees, declined by $15,000. Management will continue to emphasize cost control over non-interest expenses.

Provision for Income Taxes. The Company recorded income tax expense of $94,000 for the three-months ended March 31, 2009 compared with $505,000 for the prior year period. The effective tax rate for the three-month period ended March 31, 2009 was 13% compared with 34% for the prior year period. The decrease in the effective tax rate is attributable to the larger percentage of income coming from tax exempt sources.

Net interest income represents the difference between income derived from interest-earning assets and interest expense incurred on interest-bearing liabilities. Net interest income is affected by both (1) the difference between the rates of interest earned on interest-earning assets and the rates paid on interest-bearing liabilities ("interest rate spread") and (2) the relative amounts of interest-earning assets and interest-bearing liabilities ("net interest-earning balance"). The following tables set forth information relating to average balances of the Company's assets and liabilities for the three-month periods ended March 31, 2009 and 2008. The tables reflect the average yield on interest-earning assets and the average cost of interest-bearing liabilities (derived by dividing income or expense by the daily average balance of interest-earning assets or interest-bearing liabilities, respectively) as well as the net interest margin. In preparing the tables, non-accrual loans are included, when applicable, in the average loan balance. For purposes of the analysis, Federal Home Loan Bank stock is included in Investment Securities totals.

Average Balances, Interest and Average Yields/Cost
(Dollars in Thousands)

                                                         For the Three Months Ended March 31,
                                                   2009                                          2008
                                Average                       Average          Average                     Average
                                Balance         Interest      Yield/Cost       Balance       Interest      Yield/Cost
                                                                (Dollars in thousands)
Interest-earnings assets
Loan portfolio                  $   788,810     $  12,077             6.21 %   $ 696,751     $  12,472             7.20 %
Investment securities               191,909         1,999             4.17 %      99,768         1,206             4.84 %
Fed funds and other
interest-earning assets               5,036             2             0.16 %       5,479            44             3.23 %
Total interest-earning assets       985,755        14,078             5.79 %     801,998        13,722             6.88 %
Noninterest-earning assets           67,692                                       63,016
Total Assets                    $ 1,053,447                                    $ 865,014

Interest-bearing liabilities
Interest-bearing NOW            $    42,771            96             0.91 %   $  32,973            21             0.26 %
Money market and savings            140,333           495             1.43 %     154,726         1,086             2.82 %
Time deposits                       461,539         4,652             4.09 %     379,526         4,602             4.88 %
Short-term borrowings               106,254           463             1.74 %      13,067           117             3.58 %
Long-term borrowings                121,159         1,141             3.77 %     121,248         1,372             4.53 %
Total interest-bearing
liabilities                         872,056         6,847             3.18 %     701,540         7,198             4.13 %
Noninterest-bearing deposits         59,229                                       67,080
Other liabilities                     3,092                                        3,202
Total Liabilities                   934,377                                      771,822
Stockholders' Equity                119,070                                       93,192
Total Liabilities &
Stockholders' Equity            $ 1,053,447                                    $ 865,014

Net interest income                             $   7,231                                    $   6,524
Interest rate spread                                                  2.61 %                                       2.75 %
Net interest-margin                                                   2.98 %                                       3.27 %

Percentage of average
interest-earning assets to
average interest-bearing
liabilities                                                         113.04 %                                     114.32 %

The following tables analyze the dollar amount of changes in interest income and . . .