UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

þ		Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended March 31, 2008

o		Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                      to                     

ACCESS NATIONAL CORPORATION

(Exact name of registrant as specified in its charter)

Virginia		82-0545425
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

1800 Robert Fulton Drive, Suite 310, Reston, Virginia 20191
(Address of principal executive offices) (Zip Code)

(703) 871-2100

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

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

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o		Smaller reporting company o
				(Do not check if a smaller reporting company)

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

The number of shares outstanding of Access National Corporation’s common stock, par value $0.835, as of May 7, 2008 was 10,171,341 shares.

 

 

Table of Contents

ACCESS NATIONAL CORPORATION
FORM 10-Q

INDEX

PART I FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Consolidated Balance Sheets, March 31, 2008 and December 31, 2007 (audited)		Page 2
Consolidated Statements of Income, three months ended March 31, 2008 and 2007		Page 3
Consolidated Statements of Changes in Shareholders’ Equity three months ended March 31, 2008 and 2007		Page 4
Consolidated Statements of Cash Flows, three months ended March 31, 2008 and 2007		Page 5
Notes to Consolidated Financial Statements		Page 6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		Page 18
Item 3. Quantitative and Qualitative Disclosures About Market Risk		Page 28
Item 4. Controls and Procedures		Page 29
PART II OTHER INFORMATION
Item 1. Legal Proceedings		Page 30
Item 1A. Risk Factors		Page 30
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		Page 30
Item 3. Defaults Upon Senior Securities		Page 30
Item 4. Submission of Matters to a Vote of Security Holders		Page 30
Item 5. Other Information		Page 31
Item 6. Exhibits		Page 31
Signatures		Page 32

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

ACCESS NATIONAL CORPORATION
Consolidated Balance Sheets
(In Thousands, Except for Share Data)

		March 31,				December 31,
		2008				2007
		(unaudited)
ASSETS
Cash and due from banks		$	6,331			$	6,238
Interest-bearing deposits in other banks			23,036				13,266
Securities available for sale, at fair value			64,287				73,558
Loans held for sale — Carried at fair value in 2008			58,043				39,144
Loans			464,323				477,598
Allowance for loan losses			(7,906	)			(7,462	)
Net loans			456,417				470,136
Premises and equipment			9,586				9,712
Other assets			9,501				10,322
Total assets		$	627,201			$	622,376
LIABILITIES AND SHAREHOLDERS’ EQUITY
Non-interest-bearing deposits		$	75,986			$	59,415
Savings and interest-bearing deposits			124,625				142,820
Time deposits			256,494				271,183
Total deposits			457,105				473,418
Short-term borrowings			36,267				41,676
Long-term borrowings			66,637				39,524
Subordinated debentures			6,186				6,186
Other liabilities			5,123				3,611
Total liabilities			571,318				564,415
SHAREHOLDERS’ EQUITY
Common stock, par value, $0.835; authorized, 60,000,000 shares; issued and outstanding, 10,338,741 shares at March 31, 2008 and 10,840,730 shares at December 31, 2007			8,633				9,052
Surplus			18,215				21,833
Retained earnings			28,310				26,846
Accumulated other comprehensive income, net			725				230
Total shareholders’ equity			55,883				57,961
Total liabilities and shareholders’ equity		$	627,201			$	622,376

See accompanying notes to consolidated financial statements unaudited).

ACCESS NATIONAL CORPORATION
Consolidated Statements of Income
(In Thousands, Except for Share Data)
(unaudited)

		Three Months Ended March 31
		2008				2007
Interest and Dividend Income
Interest and fees on loans		$	8,903			$	9,822
Interest on deposits in other banks			265				195
Interest and dividends on securities			851				1,156
Total interest and dividend income			10,019				11,173
Interest Expense
Interest on deposits			4,268				4,008
Interest on short-term borrowings			306				1,399
Interest on long-term borrowings			550				481
Interest on subordinated debentures			113				229
Total interest expense			5,237				6,117
Net interest income			4,782				5,056
Provision for loan losses			408				291
Net interest income after provision for loan losses			4,374				4,765
Noninterest Income
Service fees on deposit accounts			103				102
Gain on sale of loans			6,854				5,773
Mortgage broker fee income			562				1,279
Other income			923				710
Total noninterest income			8,442				7,864
Noninterest Expense
Salaries and employee benefits			5,930				5,219
Occupancy and equipment			636				498
Other operating expenses			3,615				4,953
Total noninterest expense			10,181				10,670
Income before income taxes			2,635				1,959
Income tax expense			944				633
NET INCOME		$	1,691			$	1,326
Earnings per common share:
Basic		$	0.16			$	0.11
Diluted		$	0.16			$	0.11
Average outstanding shares:
Basic			10,619,830				11,954,863
Diluted			10,795,800				12,255,330

See accompanying notes to consolidated financial statements (unaudited).

ACCESS NATIONAL CORPORATION
Statement of Changes in Shareholders’ Equity
For the Three Months Ended March 31, 2008 and 2007
(In Thousands)
(unaudited)

														Accumulated
														Other
		Common								Retained				Comprehensive
		Stock				Surplus				Earnings				Income (Loss)				Total
Balance, December 31, 2007		$	9,052			$	21,833			$	26,846			$	230			$	57,961
Comprehensive income:
Net income			—				—				1,691				—				1,691
Other comprehensive income, unrealized holdings gains arising during the period (net of tax, $255)			—				—				—				495				495
Total comprehensive income																			2,186
Stock option exercises (85,398 Shares)			71				137				—				—				208
Repurchased under share repurchase program (587,387 Shares)			(490	)			(3,787	)			—				—				(4,277	)
Cash dividend			—				—				(227	)			—				(227	)
Stock-based Compensation expense recognized in earnings			—				32				—				—				32
Balance, March 31, 2008		$	8,633			$	18,215			$	28,310			$	725			$	55,883
Balance, December 31, 2006		$	9,867			$	29,316			$	23,641			$	(529	)		$	62,295
Comprehensive income:
Net income			—				—				1,326				—				1,326
Other comprehensive income, unrealized holdings gains arising during the period (net of tax, $81)			—				—				—				157				157
Total comprehensive income																			1,483
Stock option exercises (164,820 Shares)			138				138				—				—				276
Dividend Reinvestment plan (38,838 Shares)			32				322				—				—				354
Repurchased under share repurchase program
Cash dividend			—				—				(120	)			—				(120	)
Stock-based Compensation expense recognized in earnings			—				20				—				—				20
Balance, March 31, 2007		$	10,037			$	29,796			$	24,847			$	(372	)		$	64,308

See accompanying notes to consolidated financial statements (unaudited)

ACCESS NATIONAL CORPORATION
Consolidated Statements of Cash Flows
(In Thousands)
(unaudited)

		Three Months Ended March 31,
		2008				2007
Cash Flows from Operating Activities
Net income		$	1,691			$	1,326
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses — net of recoveries			408				291
Deferred tax expense (benefit)			255				(7	)
Stock based compensation			32				21
Valuation allowance on derivatives			(359	)			(1	)
Net amortization accretion on securities			(4	)			(6	)
Depreciation and amortization			192				212
Loss on disposal of assets			5				—
Changes in assets and liabilities:
Valuation of loans held for sale carried at fair value			1,486				—
Increase in loans held for sale			(20,385	)			(1,579	)
Decrease (increase) in other assets			1				(1,638	)
Increase (decrease) in other liabilities			1,511				(1,167	)
Net cash used in operating activities			(15,167	)			(2,548	)
Cash Flows from Investing Activities
Proceeds from maturities and calls of securities available for sale			27,238				15,705
Purchases of securities available for sale			(17,213	)			(3,891	)
Net decrease (increase) in loans			13,312				(24,068	)
Increase in federal fund sold			(123	)			—
Proceeds from sale of equipment			32				—
Proceeds from sales of other real estate owned			567				—
Purchases of premises and equipment			(108	)			(467	)
Net cash provided by (used in) investing activities			23,705				(12,721	)
Cash Flows from Financing Activities
Net (decrease) increase in non-interest bearing and interest-bearing deposits			(1,624	)			6,187
Net (decrease) increase in time deposits			(14,689	)			15,568
Net decrease in short-term borrowings			(5,409	)			(2,042	)
Net increase in long-term borrowings			27,113				1,863
Proceeds from issuance of common stock			208				630
Purchases of common stock			(4,278	)			—
Dividends paid			(119	)			(121	)
Net cash provided by financing activities			1,202				22,085
Increase in cash and cash equivalents			9,740				6,816
Cash and Cash Equivalents
Beginning			19,502				27,365
Ending		$	29,242			$	34,181
Supplemental Disclosures of Cash Flow Information
Cash payments for interest		$	11,459			$	6,116
Cash payments for income taxes		$	850			$	2,115
Supplemental Disclosures of Noncash Investing Activities
Unrealized gain on securities available for sale		$	750			$	238

See accompanying notes to consolidated financial statements (unaudited).

Notes to Consolidated Financial Statements (unaudited)

NOTE 1 – COMMENCEMENT OF OPERATIONS

Access National Corporation (the “Corporation”) is a bank holding company incorporated under the laws of the Commonwealth of Virginia. The Corporation has three wholly-owned subsidiaries, Access National Bank (the “Bank”), which is an independent commercial bank chartered under federal laws as a national banking association, Access Capital Trust I, and Access Capital Trust II. The Corporation does not have any significant operations and serves primarily as the parent company for the Bank. The Corporation’s income is primarily derived from dividends received from the Bank. The amount of these dividends is determined by the Bank’s earnings and capital position.

The Corporation acquired all of the outstanding stock of the Bank in a statutory exchange transaction on June 15, 2002, pursuant to an Agreement and Plan of Reorganization between the Corporation and the Bank.

The Bank opened for business on December 1, 1999 and has two active wholly-owned subsidiaries: Access National Mortgage Corporation (the “Mortgage Corporation”), a Virginia corporation engaged in mortgage banking activities, and Access Real Estate LLC. Access Real Estate LLC is a limited liability company established in July, 2003 for the purpose of holding title to the Corporation’s headquarters building, located at 1800 Robert Fulton Drive, Reston, Virginia.

NOTE 2 – BASIS OF PRESENTATION

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with rules and regulations of the Securities and Exchange Commission. The statements do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. All adjustments have been made, which, in the opinion of management, are necessary for a fair presentation of the results for the interim periods presented. Such adjustments are all of a normal and recurring nature. All significant inter-company accounts and transactions have been eliminated in consolidation. Certain prior period amounts have been reclassified to conform to the current period presentation. The results of operations for the three months ended March 31, 2008 are not necessarily indicative of the results that may be expected for the entire year ending December 31, 2008. These consolidated financial statements should be read in conjunction with the Corporation’s audited financial statements and the notes thereto as of December 31, 2007, included in the Corporation’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007.

NOTE 3 – STOCK-BASED COMPENSATION PLANS

During the first three months of 2008, the Corporation granted 89,375 stock options to officers, directors, and employees under the 1999 Stock Option Plan (the “Plan”). Options granted under the Plan have an exercise price equal to the fair market value as of the grant date. Options granted have a vesting period of two and one half years and expire three and one half years after the issue date. Stock–based compensation expense recognized in other operating expense during the first three months of 2008 was approximately $32 thousand and $21 thousand for the same period in 2007. The fair value of options is estimated on the date of grant using a Black-Scholes option-pricing model with the assumptions noted below.

A summary of stock option activity under the Plan for the three months ended March 31, 2008 is presented as follows:

		Three Months ended
		March 31, 2008
Expected life of options granted			3.22
Risk-free interest rate			3.15	%
Expected volatility of stock			35	%
Annual Expected dividend yield			1	%
Fair Value of Granted Options		$	156,886
Non-Vested Options			165,775

										Weighted Avg.
		Number of				Weighted Avg.				Remaining				Aggregate intrinsic
		Options				Exercise Price				Contractual Term				Value
Outstanding at beginning of year			713,624			$	6.07				1.99			$	979,866
Granted			89,375			$	6.29				3.22			$	—
Exercised			85,398			$	2.59				0.60			$	—
Lapsed or Canceled			3,600			$	8.33				2.60			$	—
Outstanding at March 31, 2008			714,001			$	6.50				2.07			$	1,112,722
Exercisable at March 31, 2008			548,226			$	6.12				1.84			$	1,036,833

NOTE 4 — SECURITIES

Amortized costs and fair values of securities available for sale as of March 31, 2008 and December 31, 2007 are as follows:

		March 31, 2008
						Gross				Gross
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				Losses				Value
						(In Thousands)
U.S. Treasury Securities		$	996			$	29			$	—			$	1,025
U.S. Government Agencies			49,932				1,032								50,964
Mortgage Backed Securities			741				12				—				753
Municipals — tax exempt			2,890				43				—				2,933
Municipals — taxable			2,107				5				—				2,112
CRA Mutual Fund			1,500				—				(23	)			1,477
Restricted Securities
Federal Reserve Bank Stock			894				—				—				894
FHLB Stock			4,129				—				—				4,129
Total Securities		$	63,189			$	1,121			$	(23	)		$	64,287

		December 31, 2007
						Gross				Gross
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				Losses				Value
						(In Thousands)
U.S. Treasury Notes		$	995			$	18			$	—			$	1,013
U.S. Governmental Agencies			61,365				417				(62	)			61,720
Mortgage Backed Securities			793				6				—				799
Municipals — tax exempt			2,890				6				(5	)			2,891
Municipals — taxable			1,110				—				(11	)			1,099
CRA Mutual Fund			1,500				—				(21	)			1,479
Restricted Securities
Federal Reserve Bank Stock			894				—				—				894
FHLB Stock			3,663				—				—				3,663
Total Securities		$	73,210			$	447			$	(99	)		$	73,558

NOTE 4 – SECURITIES (continued)

The amortized cost and fair value of securities available for sale as of March 31, 2008 and December 31, 2007 by contractual maturity are shown below. Expected maturities may differ from contractual maturities because the securities may be called or prepaid without any penalties.

		March 31, 2008								December 31, 2007
		Amortized				Fair				Amortized				Fair
		Cost				Value				Cost				Value
		(In Thousands)								(In Thousands)
U.S. Treasury and Agencies
Due in one year or less		$	20,994			$	21,211			$	38,867			$	38,879
Due after one through five years			—				—				1,995				2,011
Due after five through ten years			29,934				30,778				21,498				21,844
Municipals
Due after one through five years			1,110				1,115				1,110				1,099
Due after five through ten years			2,890				2,933				2,890				2,891
Due after ten years			997				997
Mortgage Backed Securities
Due after one through five years			741				753				793				799
CRA Mutual Fund			1,500				1,477				1,500				1,479
Restricted Securities:
Federal Reserve Bank stock			894				894				894				894
FHLB stock			4,129				4,129				3,663				3,663
Total		$	63,189			$	64,287			$	73,210			$	73,558

NOTE 4 – SECURITIES (continued)

Investment securities available for sale that have an unrealized loss position at March 31, 2008 and December 31, 2007 are as follows:

March 31, 2008

		Securities in a Loss								Securities in a Loss
		Position for Less than								Position for 12 Months
		12 Months								or Longer								Total
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
		Value				Losses				Value				Losses				Value				Losses
										(In Thousands)
Investment securities available for sale:
U.S. Treasury Security		$	—			$	—			$	—			$	—			$	—			$	—
Mortgage Backed Security			—								—				—				—				—
U.S. Government Agencies			—				—				—				—				—				—
Municipals-Taxable			—				—				—				—				—				—
Municipals-Tax Exempt			—				—				—				—				—				—
CRA Mutual Fund			—				—				1,477				(23	)			1,477				(23	)
Total		$	—			$	—			$	1,477			$	(23	)		$	1,477			$	(23	)

December 31, 2007

		Securities in a Loss								Securities in a Loss
		Position for Less than								Position for 12 Months
		12 Months								or Longer								Total
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
		Value				Losses				Value				Losses				Value				Losses
										(In Thousands)
Investment securities available for sale:
U.S. Treasury Security		$	—			$	—			$	—			$	—			$	—			$	—
Mortgage Backed Security			—				—				—				—				—				—
U.S. Government Agencies			—				—				19,812				(62	)			19,812				(62	)
Municipals-Taxable			—				—				1,100				(11	)			1,100				(11	)
Municipals-Tax Exempt			457				(2	)			915				(3	)			1,372				(5	)
CRA Mutual Fund			—				—				1,479				(21	)			1,479				(21	)
Total		$	457			$	(2	)		$	23,306			$	(97	)		$	23,763			$	(99	)

NOTE 5 – LOANS

The following table presents the composition of the loan portfolio at March 31, 2008 and December 31, 2007.

		March 31				Percent of				December 31				Percent of
		2008				Total				2007				Total
						(In Thousands)
Commercial		$	62,758				13.52	%		$	64,860				13.58	%
Commercial real estate			200,447				43.17				199,894				41.85
Real estate construction			50,160				10.80				55,074				11.53
Residential real estate			149,789				32.26				156,731				32.82
Consumer			1,169				0.25				1,039				0.22
		$	464,323				100.00	%		$	477,598				100.00	%
Less allowance for loan losses			7,906								7,462
			456,417							$	470,136

NOTE 6 – SEGMENT REPORTING

The Corporation has two reportable segments: traditional commercial banking and a mortgage banking business. Revenues from commercial banking operations consist primarily of interest earned on loans and investment securities and fees from deposit services. Mortgage banking operating revenues consist principally of interest earned on mortgage loans held for sale, gains on sales of loans in the secondary mortgage market and loan origination fee income.

The commercial banking segment provides the mortgage segment with the short-term funds needed to originate mortgage loans through a warehouse line of credit and charges the mortgage banking segment interest based on the prime rate. These transactions are eliminated in the consolidation process.

Other includes the operations of the Corporation and Access Real Estate LLC. The primary source of income for the Corporation is derived from dividends from the Bank and its primary expense relates to interest on subordinated debentures. The primary source of income for Access Real Estate LLC is derived from rents received from the Bank and Mortgage Corporation.

NOTE 6 – SEGMENT REPORTING (continued)

The following table presents segment information for the three months ended March 31, 2008 and 2007:

2008		Commercial																Consolidated
(In Thousands)		Banking				Mortgage				Other				Eliminations				Totals
Revenues:
Interest income		$	9,837			$	514			$	37			$	(369	)		$	10,019
Gain on sale of loans			—				6,858				—				(4	)			6,854
Other revenues			552				1,329				266				(559	)			1,588
Total revenues		$	10,389			$	8,701			$	303			$	(932	)		$	18,461
Expenses:
Interest expense		$	5,029			$	351			$	227			$	(370	)		$	5,237
Salaries and employee benefits			1,963				3,967				—				—				5,930
Other			1,759				3,078				384				(562	)			4,659
Total operating expenses		$	8,751			$	7,396			$	611			$	(932	)		$	15,826
Income (loss) before income taxes		$	1,638			$	1,305			$	(308	)			—			$	2,635
Total assets		$	584,560			$	62,560			$	43,711			$	(63,630	)		$	627,201

2008		Commercial																Consolidated
(In Thousands)		Banking				Mortgage				Other				Eliminations				Totals
Revenues:
Interest income		$	11,033			$	1,136			$	199			$	(1,195	)		$	11,173
Gain on sale of loans			—				5,773				—				—				5,773
Other revenues			426				2,085				263				(683	)			2,091
Total revenues		$	11,459			$	8,994			$	462			$	(1,878	)		$	19,037
Expenses:
Interest expense		$	5,696			$	1,273			$	344			$	(1,196	)		$	6,117
Salaries and employee benefits			1,668				3,551				—				—				5,219
Other			1,347				4,708				369				(682	)			5,742
Total operating expenses		$	8,711			$	9,532			$	713			$	(1,878	)		$	17,078
Income (loss) before income taxes		$	2,748			$	(538	)		$	(251	)			—			$	1,959
Total assets		$	609,145			$	71,675			$	61,039			$	(74,655	)		$	667,204

NOTE 7 – EARNINGS PER SHARE (EPS)

     The following tables show the calculation of both Basic and Diluted earnings per share (“EPS”) for the three months ended March 31, 2008 and 2007, respectively. The numerator of both the Basic and Diluted EPS is equivalent to net income. The weighted average number of shares outstanding used as the denominator for Diluted EPS is increased over the denominator used for Basic EPS by the effect of potentially dilutive common stock options and warrants utilizing the treasury stock method.

		Three Months				Three Months
		Ended				Ended
		March 31, 2008				March 31, 2007
		(In thousands except for share data)
BASIC EARNINGS PER SHARE:
Net income		$	1,691			$	1,326
Weighted average shares outstanding			10,619,830				11,954,863
Basic earnings per share		$	0.16			$	0.11
DILUTED EARNINGS PER SHARE:
Net income		$	1,691			$	1,326
Weighted average shares outstanding			10,619,830				11,954,863
Stock options and warrants			175,970				300,467
Weighted average diluted shares outstanding			10,795,800				12,255,330
Diluted earnings per share		$	0.16			$	0.11

NOTE 8 — DERIVATIVES

The Mortgage Corporation carries all derivative instruments at fair value as either assets or liabilities in the consolidated balance sheets. Statement of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities” as amended (“SFAS 133”), provides specific accounting provisions for derivative instruments that qualify for hedge accounting. The Mortgage Corporation has not elected to apply hedge accounting to its derivative instruments as provided in SFAS 133.

The Mortgage Corporation enters into interest rate lock commitments, which are commitments to originate loans whereby the interest rate on the loan is determined prior to funding and the customers have locked into that interest rate. The Mortgage Corporation also has corresponding forward sales commitments related to these interest rate lock commitments, which are recorded at fair value with changes in fair value recorded in non-interest income. The market value of rate lock commitments and best efforts contracts is not readily ascertainable with precision because rate lock commitments and best efforts contracts are not actively traded in stand-alone markets. The Mortgage Corporation determines the fair value of rate lock commitments and best efforts contracts by measuring the change in the value of the underlying asset while taking into consideration the probability that the rate lock commitments will close.

For derivative instruments not designated as hedging instruments, the derivative is recorded as a freestanding asset or liability with the change in value being recognized in current earnings during the period of change.

At March 31, 2008 and December 31, 2007, the Mortgage Corporation had derivative financial instruments with a notional value of $85.6 million and $33.7 million respectively. The fair value of these derivative instruments at March 31, 2008 and December 31, 2007 was $85.8 million and $33.5 million respectively.

NOTE 9 – RECENT ACCOUNTING PRONOUNCEMENTS

In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, “Fair Value Measurements.” SFAS 157 establishes a framework for measuring fair value in generally accepted accounting principles (“GAAP”), and expands disclosures about fair value measurements. While the Statement applies under other accounting pronouncements that require or permit fair value measurements, it does not require any new fair value measurements. SFAS 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. In addition, the Statement establishes a fair value hierarchy, which prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. Lastly, SFAS 157 requires additional disclosures for each interim and annual period separately for each major category of assets and liabilities. SFAS 157 became effective for the Company on January 1, 2008. See Note 10 of the accompanying notes to the consolidated financial statements for additional information.

In February 2008, the FASB issued FASB Staff Position No. 157-2. The staff position delays the effective date of SFAS 157 for nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis. The delay is intended to allow additional time to consider the effect of various implementation issues with regard to the application of SFAS 157. The new staff position defers the effective date of SFAS No. 157 to January 1, 2009 for items within the scope of the staff position. The Corporation is currently evaluating the impact of FASB Staff Position No. 157-2 on the consolidated financial statements.

In February 2007, the FASB issued SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities—including an amendment of FASB Statement No. 115”. This Statement permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This Statement is expected to expand the use of fair value measurement, which is consistent with the Board’s long-term measurement objectives for accounting for financial instruments. This Statement became effective for the Corporation on January 1, 2008. The Corporation has elected the fair value option for residential mortgage loans originated on or after January 1, 2008 and held for sale. See Note 10 of the accompanying notes to the consolidated financial statements for additional information.

In November 2007, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 109, “Written Loan Commitments Recorded at Fair Value Through Earnings” (“SAB 109”). SAB 109 expresses the current view of the SEC staff that the expected net future cash flows related to the associated servicing of the loan should be included in the measurement of all written loan commitments that are accounted for at fair value through earnings.   SEC registrants are expected to apply this guidance on a prospective basis to derivative loan commitments issued or modified in the first quarter of 2008 and thereafter. The adoption of this standard did not have a material impact on the Corporation’s consolidated financial position or results of operations.

In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations,” (“SFAS 141(R)”) which replaces SFAS 141. SFAS 141(R) establishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any controlling interest; recognizes and measures goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) is effective for acquisitions by the Company taking place on or after January 1, 2009. Early adoption is prohibited. Accordingly, a calendar year-end company is required to record and disclose business combinations following existing accounting guidance until January 1, 2009. The Corporation will assess the impact of SFAS 141(R) if and when a future acquisition occurs.

In December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in Consolidated Financial Statements-an amendment of ARB No. 51” (“SFAS 160”). SFAS 160 establishes new accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. Before this statement, limited guidance existed for reporting non-controlling interests (minority interest). As a result, diversity in practice exists. In some cases minority interest is reported as a liability and in others it is reported in the mezzanine section between liabilities and equity. Specifically, SFAS 160 requires the recognition of a non-controlling interest (minority interest) as equity in the consolidated

NOTE 9 – RECENT ACCOUNTING PRONOUNCEMENTS (continued)

financials statements and separate from the parent’s equity. The amount of net income attributable to the non-controlling interest will be included in consolidated net income on the face of the income statement. SFAS 160 clarifies that changes in a parent’s ownership interest in a subsidiary that do not result in deconsolidation are equity transactions if the parent retains its controlling financial interest. In addition, this statement requires that a parent recognize gain or loss in net income when a subsidiary is deconsolidated. Such gain or loss will be measured using the fair value of the non-controlling equity investment on the deconsolidation date. SFAS 160 also includes expanded disclosure requirements regarding the interests of the parent and its non-controlling interests. SFAS 160 is effective for the Company on January 1, 2009. Earlier adoption is prohibited.  The Corporation is currently evaluating the impact, if any; the adoption of SFAS 160 will have on its consolidated financial statements.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities – an amendment of FASB statement No. 133”, SFAS 161 requires enhanced disclosures about how and why an entity uses derivative instruments, how derivative instruments and related items are accounted for under Statement 133 and how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. The new standard is effective for the Company on January 1, 2009. The Corporation is currently evaluating the impact of adopting SFAS No. 161 on the consolidated financial statements.

NOTE 10 — FAIR VALUE

Effective January 1, 2008, the Corporation adopted SFAS 157 and SFAS 159. SFAS 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. SFAS 157 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair values:

Level 1 — Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2 — Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3- Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Corporation used the following methods to determine the fair value of each type of financial instrument:

Investment securities: The fair values for investment securities are determined by quoted market prices (Level 1).

Residential loans held for sale: The fair value of loans held for sale is determined using quoted prices for a similar asset, adjusted for specific attributes of that loan (Level 2).

Derivative financial instruments: The fair values of derivative financial instruments are based on derivative market data inputs as of the valuation date (Level 2).

NOTE 10 — FAIR VALUE (continued)

Impaired loans: The fair values of impaired loans are measured for impairment using the fair value of the collateral for collateral-dependent loans on a nonrecurring basis.  Collateral may be in the form of real estate or business assets including equipment, inventory and accounts receivable.  The use of discounted cash flow models and management’s best judgment are significant inputs in arriving at the fair
value measure of the underlying collateral and are therefore classified within (Level 3).

Other real estate owned: The fair value of other real estate owned, which is included in other assets on the balance sheet, consists of real estate that has been foreclosed.  Foreclosed real estate is recorded at the lower of fair value less selling expenses or the book balance prior
to foreclosure. Write downs are provided for subsequent declines in value and are recorded in other non-interest expense (Level 2).

Assets and liabilities measured at fair value under SFAS No. 157 on a recurring and non-recurring basis, including financial assets and liabilities for which the Company has elected the fair value option, are summarized below:

						Fair Value Measurement
						at March, 31, 2008 Using
						Quoted
						Prices in
						Active
						Markets for				Other				Significant
(In Thousands)						Identical				Observable				Unobservable
Description		Carrying Value				Assets (Level 1)				Inputs (Level 2)				Inputs (Level 3)
Financial Assets-Recurring
Available for sale investment securities (1)		$	59,264			$	59,264			$	—			$	—
Residential loans held for sale			58,043				—				58,043				—
Derivative assets			242								242
Financial Liabilities-Recurring
Derivative liabilities			23								23
Financial Assets-Non-Recurring
Impaired loans (2)			5,199												5,199
Other real estate owned (3)			622								622

Financial instruments recorded using SFAS 159

Under SFAS 159, the Corporation may elect to report most financial instruments and certain other items at fair value on an instrument-by instrument basis with changes in fair value reported in net income. After the initial adoption, the election is made at the acquisition of an eligible financial asset, financial liability or firm commitment or when certain specified reconsideration events occur. The fair value election may not be revoked once an election is made. Additionally, the transaction provisions of SFAS 159 permit a one-time election for existing positions at the adoption date with a cumulative-effect adjustment included in beginning retained earnings and future changes in fair value reported in net income. The Corporation did not elect the fair value option for any existing positions at January 1, 2008 and there was no impact to equity.

The Corporation elected the fair value option under SFAS 159 prospectively for the following item:

		Aggregate								Contractual
(In Thousands)		Fair Value				Difference				Principal
Residential loans held for sale		$	58,043			$	1,486			$	56,557

The Corporation elected to account for residential loans held for sale to eliminate the mismatch in recording changes in market value on derivative instruments used to hedge loans held for sale while carrying the loans at the lower of cost or market. The change to fair value accounting for loans held for sale resulted in a pre-tax increase in income of $612 thousand after considering loan origination fees and costs that were previously deferred in accordance with SFAS No. 91, “Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases—an amendment of FASB Statements No. 13, 60, and 65 and a rescission of FASB Statement No. 17.”

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the Corporation’s consolidated financial statements, and notes thereto, for the year ended December 31, 2007 included in the Corporation’s Annual Report on Form 10-K. Operating results for the three months ended March 31, 2008 are not necessarily indicative of the results for the year ending December 31, 2008 or any future period.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

In addition to historical information, this Quarterly Report on Form 10-Q may contain forward-looking statements. For this purpose, any statements contained herein, including documents incorporated by reference, that are not statements of historical fact may be deemed to be forward-looking statements. Examples of forward-looking statements include discussions as the Corporation’s expectations, beliefs, plans, goals, objectives and future financial or other performance or assumptions concerning matters discussed in this document. Forward-looking statements often use words such as “believes,” “expects,” “plans,” “may,” “will,” “should,” “projects,” “contemplates,” “anticipates,” “forecasts,” “intends” or other words of similar meaning. You can also identify them by the fact that they do not relate strictly to historical or current facts. Forward-looking statements are subject to numerous assumptions, risks and uncertainties, and actual results could differ materially from historical results or those anticipated by such statements. Factors that could have a material adverse effect on the operations and future prospects of the Corporation include, but are not limited to: changes in the Corporation’s competitive position, competitive actions by other financial institutions and the competitive nature of the financial services industry and the Corporation’s ability to compete effectively against other financial institutions in its banking markets; the Corporation’s potential growth, including its entrance or expansion into new markets, the opportunities that may be presented to and pursued by it and the need for sufficient capital to support that growth; the Corporation’s ability to manage growth; changes in government monetary policy, interest rates, deposit flow, the cost of funds, and demand for loan products and financial services; the strength of the economy in the Corporation’s target market area, as well as general economic, market, or business conditions; changes in the quality or composition of the Corporation’s loan or investment portfolios, including adverse developments in borrower industries, decline in real estate values in the Corporation’s markets, or in the repayment ability of individual borrowers or issuers; an insufficient allowance for loan losses as a result of inaccurate assumptions; the Corporation’s reliance on dividends from the Bank as a primary source of funds; the Corporation’s reliance on secondary sources, such as Federal Home Loan Bank of Atlanta (“FHLB”) advances, sales of securities and loans, federal funds lines of credit from correspondent banks and out-of-market time deposits, to meet the Bank’s liquidity needs; changes in laws, regulations and the policies of federal or state regulators and agencies; the Corporation’s mortgage loan business and the offering of non-conforming mortgage loans; and other circumstances, many of which are beyond the Corporation’s control. Standard representations and warranties issued in connection with Loans Held for Sale may impact earnings due to the potential need to repurchase loans due to early payment defaults and for other reasons. The subsequent cost of liquidating these loans may have a negative impact on earnings. These risks and uncertainties should be considered in evaluating the forward-looking statements contained herein, and readers are cautioned not to place undue reliance on such statements. Any forward-looking statement speaks only as of the date on which it is made, and the Corporation undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which it is made.

CRITICAL ACCOUNTING POLICIES

General

The Corporation’s financial statements are prepared in accordance with accounting principles generally accepted in the United States GAAP. The financial information contained within the statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained when earning income, recognizing an expense, recovering an asset or relieving a liability. Actual losses could differ significantly from the historical factors that we monitor. Additionally, GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change.

Allowance for Loan Losses

The allowance for loan losses is an estimate of the losses that may be sustained in the Bank’s loan portfolio. The allowance is based on two basic principles of accounting: (i) SFAS No. 5 “Accounting for Contingencies”, which requires that losses be accrued when they are probable of occurring and estimatable and (ii) SFAS No. 114, “Accounting by Creditors for Impairment of a Loan”, which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance.

An allowance for loan losses is established through a provision for loan losses based upon industry standards, known risk characteristics, management’s evaluation of the risk inherent in the loan portfolio and changes in the nature and volume of loan activity. Such evaluation considers, among other factors, the estimated market value of the underlying collateral and current economic conditions. For further information about our practices with respect to allowance for loan losses, please see the subsection “Allowance for Loan Losses” below.

Derivative Financial Instruments

The Mortgage Corporation carries all derivative instruments at fair value as either assets or liabilities in the consolidated balance sheets. SFAS 133 provides specific accounting provisions for derivative instruments that qualify for hedge accounting. The Mortgage Corporation has not elected to apply hedge accounting to its derivative instruments as provided in SFAS 133.

Off-Balance Sheet Items

In the ordinary course of business, the Bank issues commitments to extend credit and, at March 31, 2008, these commitments amounted to $35.2 million. These commitments do not necessarily represent cash requirements, since many commitments are expected to expire without being drawn on.

At March 31, 2008, the Bank had approximately $86.6 million in unfunded lines of credit and letters of credit. These lines of credit, if drawn upon, would be funded from routine cash flows and short-term borrowings. As the Corporation continues the planned expansion of the loan portfolio held for investment, the volume of commitments and unfunded lines of credit are expected to increase accordingly.

The Bank maintains a reserve for potential off-balance sheet credit losses that is included in other liabilities on the balance sheet. At March 31, 2008 the balance in this account totaled $277 thousand. The Mortgage Corporation maintains a similar reserve for standard representations and warranties issued in connection with loans sold that totaled $579 thousand at March 31, 2008.

FINANCIAL CONDITION (March 31, 2008 compared to December 31, 2007)

At March 31, 2008, the Corporation’s assets totaled $627.2 million compared to $622.4 million at December 31, 2007, an increase of $4.8 million. Loans held for investment decreased $13.3 million from year end 2007 due to payoffs that exceeded new loan production during the first quarter of 2008. Loans held for sale increased approximately $18.9 million due to an increase of $15.3 million in loans originated in March 2008. Interest-bearing deposits in other banks increased $9.8 million and investment securities decreased $9.3 million from December 31, 2007 levels. Non-interest-bearing deposits increased $16.6 million partially, offsetting a $32.9 million decrease in interest-bearing deposits. The decrease in interest-bearing deposits was largely in rate sensitive and wholesale deposits that were replaced with an increase in longer term borrowings at lower interest rates.

Securities

The Corporation’s securities portfolio is comprised of U.S. Treasury securities, U.S. Government Agency securities, mortgage backed securities, obligations of states and political subdivisions, CRA mutual fund and Federal Reserve Bank and FHLB stock. At March 31, 2008 the securities portfolio totaled $64.3 million, down from $73.6 million on December 31, 2007, as a result of maturities and called securities that were not reinvested. All securities were classified as available for sale. Securities classified as available for sale are accounted for at fair market value with unrealized gains and losses recorded directly to a separate component of shareholders’ equity, net of associated tax effect. The Corporation’s securities classified as available for sale had an unrealized gain net of deferred taxes of $725 thousand on March 31, 2008. Investment securities are used to provide liquidity, to generate income, and to temporarily supplement loan growth as needed.

Loans

The loans held for investment portfolio constitutes the largest component of earning assets and is comprised of commercial loans, real estate loans, construction loans, and consumer loans. These lending activities provide access to credit to small businesses, professionals and consumers in the greater Washington, D.C. metropolitan area. All lending activities of the Bank and its subsidiaries are subject to the regulations and supervision of the Office of the Comptroller of Currency. At March 31, 2008, loans held for investment totaled $464.3 million, down $13.3 million from $477.6 million at December 31, 2007. The decrease in loans is due to payoffs that exceeded new loan production and stricter credit standards. See Note 5 of the accompanying notes to consolidated financial statements for a table that summarizes the composition of the Corporation’s loan portfolio. The following is a summary of the loans held for investment portfolio at March 31, 2008.

Commercial Loans: Commercial Loans represent 13.5% of the loans held for investment portfolio. These loans are made to businesses or individuals within our target market for business purposes. Typically the loan proceeds are used to support working capital and the acquisition of fixed assets of an operating business. We underwrite these loans based upon our assessment of the obligor(s)’ ability to generate operating cash flows in the future necessary to repay the loan. To address the risks associated with the uncertainties of future cash flows, these loans are generally well secured by assets owned by the business or its principal shareholders and the principal shareholders are typically required to guarantee the loan.

Commercial Real Estate Loans: Also known as commercial mortgages, loans in this category represent 43.2% of the loans held for investment portfolio. These loans generally fall into one of three situations in order of magnitude: first, loans supporting an owner occupied commercial property; second, properties used by non-profit organizations such as churches or schools where repayment is dependent upon the cash flow of the non-profit organizations; and third, loans supporting a commercial property leased to third parties for investment. Commercial real estate loans are secured by the subject property and underwritten to policy standards. Policy standards approved by the Board of Directors from time to time set forth, among other considerations, loan to value limits, cash flow coverage ratios, and the general creditworthiness of the obligors.

Real Estate Construction Loans: Real Estate Construction Loans, also known as construction and land development loans, comprise 10.8% of the loans held for investment portfolio. These loans generally fall into one of three categories: first, loans to individuals that are ultimately used to acquire property and construct an owner occupied residence; second, loans to builders for the purpose of acquiring property and constructing homes for sale to consumers; and third, loans to developers for the purpose of acquiring land that is developed into finished lots for the ultimate construction of residential or commercial buildings. Loans of these types are generally secured by the subject property within limits established by the Board of Directors based upon an assessment of market conditions and updated from time to time. The loans typically carry recourse to principal owners. In addition to the repayment risk associated with loans to individuals and businesses, loans in this category carry construction completion risk. To address this additional risk, loans of this type are subject to additional administration procedures designed to verify and ensure progress of the project in accordance with allocated funding, project specifications and time frames.

Residential Real Estate Loans: This category includes loans secured by first or second mortgages on one to four family residential properties and represents 32.3% of the portfolio. Of this amount, the following sub-categories exist as a percentage of the whole Residential Real Estate Loan portfolio: Home Equity Lines of Credit 17.2%; First Trust Mortgage Loans 73.1%; Loans Secured by a Junior Trust 6.0%; Multi-family loans and loans secured by Farmland 3.7%.

Home Equity Lines of Credit are extended to borrowers in our target market. Real estate equity is the largest component of consumer wealth in our marketplace. Once approved, this consumer finance tool allows the borrower to access the equity in their home or investment property and use the proceeds for virtually any purpose. Home Equity Lines of Credit are most frequently secured by a second lien on residential property. The proceeds of First Trust Mortgage Loans are used to acquire or refinance the primary financing on owner occupied and residential investment properties. Junior Trust Loans are loans to consumers wherein the proceeds have been used for a stated consumer purpose. Examples of consumer purposes are education, refinancing debt, or purchasing consumer goods. The loans are generally extended in a single disbursement and repaid over a specified period of time.

Loans in the Residential Real Estate portfolio are underwritten to standards within a traditional consumer framework that is periodically reviewed and updated by management and Board of Directors: repayment source and capacity, value of the underlying property, credit history, savings pattern and stability.

Consumer Loans: Consumer Loans make up approximately 0.3% of the loans held for investment portfolio. Most loans are well secured with assets other than real estate, such as marketable securities or automobiles. Very few consumer loans are unsecured. As a matter of
operation, management discourages unsecured lending. Loans in this category are underwritten to standards within a traditional consumer framework that is periodically reviewed and updated by management and the Board of Directors and takes into consideration repayment capacity, collateral value, savings pattern, credit history and stability.

Loans Held for Sale (“LHFS”)

LHFS are originated by the Mortgage Corporation. Effective January 1, 2008 LHFS are carried on the books at fair value. These loans are residential mortgage loans extended to consumers and underwritten in accordance with standards set forth by an institutional investor to whom we expect to sell the loans for a profit. Loan proceeds are used for the purchase or refinance of the property securing the loan. Loans are sold with the servicing released to the investor. The LHFS loans are closed by the Mortgage Corporation and carried on its books until the loan is delivered to and purchased by an investor. In the three months ended March 31, 2008 we originated $217.2 million of loans processed in this manner. Loans are sold without recourse and subject to industry standard representations and warranties that may require the repurchase, by the Mortgage Corporation, of loans previously sold. The repurchase risks associated with this activity center around early payment defaults, and borrower fraud. There is also a risk that loans originated may not be purchased by our investors. The Mortgage Corporation attempts to manage these risks by the on-going maintenance of an extensive quality control program, an internal audit and verification program, and a selective approval process for investors and programs offered. At March 31, 2008, LHFS totaled $58.0 million (at fair value) compared to $39.1 million at year end 2007.

Brokered Loans

Brokered loans are underwritten and closed by a third party lender. The Mortgage Corporation is paid a fee for procuring and packaging brokered loans. For the first three months of 2008, $27.9 million in residential mortgage loans was originated under this type of delivery method, as compared to $59.7 million for the same period of 2007. Brokered loans accounted for 12.8% of the total loan volume for the first three months of 2008 compared to 19.3% for the same period of 2007.

Allowance for Loan Losses

The allowance for loan losses totaled $7.9 million at March 31, 2008 compared to $7.5 million at year end 2007. The allowance for loan losses is equivalent to approximately 1.7% of total consolidated loans held for investment at March 31, 2008. The methodology to derive the allowance for loan losses is a combination of specific allocations and percentages allocation of the unallocated portion of the allowance for loan losses, as discussed below. The Bank has developed a comprehensive risk weighting system based on individual loan characteristics that enables the Bank to allocate the composition of the allowance for loan losses by types of loans, risk ratings and systemic risk factors.

Adequacy of the reserve is assessed, and appropriate expense and charge offs are taken, no less frequently than at the close of each fiscal quarter end. The methodology by which we systematically determine the amount of the reserve is set forth by the Board of Directors in our Credit Policy. Under this Policy, the Chief Credit Officer is charged with ensuring that each loan is individually evaluated and the portfolio characteristics are evaluated to arrive at an appropriate aggregate reserve. The results of the analysis are documented, reviewed and approved by the Board of Directors no less than quarterly. The following elements are considered in this analysis: loss estimates on specific problem credits (the “Specific Reserve”), individual loan risk ratings, lending staff changes, loan review and Board oversight, loan policies and procedures, portfolio trends with respect to volume, delinquency, composition/concentrations of credit, risk rating migration, levels of classified credit, off-balance sheet credit exposure, any other factors considered relevant from time to time (the “General Reserve”) and, finally, an “Unallocated Reserve” to cover any unforeseen factors not considered above in the appropriate magnitude. Each of the reserve components, General, Specific and Unallocated, is discussed in further detail below. With respect to the General Reserve, all loans are graded or “Risk Rated” individually for loss potential at the time of origination and as warranted thereafter, but no less frequently than quarterly. Loss potential factors are applied based upon a blend of the following criteria: our own direct experience at this Bank; our collective management experience in administering similar loan portfolios in the market for over 60 years; and peer data contained in statistical releases issued by both the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation. Although looking only at peer data and the Bank’s historically low charge-offs would suggest a lower loan loss allowance, management’s experience with similar portfolios in the same market combined with the fact that the portfolio is relatively unseasoned, justify a conservative approach in contemplating external statistical resources. Accordingly, management’s collective experience at this Bank and other banks is the most heavily weighted criterion, and the weighting is subjective and varies by loan type, amount, collateral, structure, and repayment terms. Prevailing economic conditions, generally and within each individual borrower’s business sector are considered, as well as any changes in the borrower’s own financial position and, in the case of commercial loans, management structure and business operations. As of March 31, 2008, our evaluation of these factors supported approximately 95.3% of the total loss reserve. As our portfolio ages and we gain more direct experience, the direct experience will weigh more heavily in our evaluation.

When deterioration develops in an individual credit, the loan is placed on a “watch list” and the loan is monitored more closely. All loans on the watch list are evaluated for specific loss potential based upon either an evaluation of the liquidated value of the collateral or cash flow deficiencies. If management believes that, with respect to a specific loan, an impaired source of repayment, collateral impairment or a change in a debtor’s financial condition presents a heightened risk of non-performance of a particular loan, a portion of the reserve may be specifically allocated to that individual loan. The aggregation of this loan by loan analysis comprises the Specific Reserve and accounted for 25.1% of the total loss reserve at March 31, 2008.

The Unallocated Reserve is maintained to absorb risk factors outside of the General and Specific Reserves. Maximum and minimum target limits are established by us on a quarterly basis for the Unallocated Reserve. As of March 31, 2008, the threshold range for this component was 0.00% to 0.15% of the total loan portfolio and accounted for approximately 4.7% of the total loss reserve. At March 31, 2008, the unallocated reserve amounted to $0.4 million and equaled 0.08% of total loans. Outside of the Corporation’s analysis, our reserve adequacy and methodology are reviewed on a regular basis by our internal audit program and bank regulators and such reviews have not resulted in any material adjustment to the reserve. The schedule below apportions the allowance for loan losses by loan types.

An analysis of the Bank’s allowance for loan losses as of and for the periods indicated is set forth in the following tables:

		Three months ended
Allowance for Loan Losses		March 31,
(In Thousands)		2008				2007
Balance at beginning of period		$	7,462			$	5,452
Charge-offs			(87	)			—
Recoveries			123				3
Provision			408				291
Balance as of March 31, 2008 and 2007		$	7,906			$	5,746

Allocation of the Allowance for Loan Losses

		March 31, 2008																December 31, 2007
										Allowance for																Allowance for
		Amount				Percentage				Loan Loss				Percentage				Amount				Percentage				Loan Loss				Percentage
		(Dollars In Thousands)
Commercial		$	62,758				13.52	%		$	1,390				17.58	%		$	64,860				13.58	%		$	1,341				17.97	%
Commercial real estate			200,447				43.17				4,498				56.89				199,894				41.85				3,487				46.73
Real estate construction			50,160				10.80				693				8.77				55,074				11.53				929				12.45
Residential real estate			149,789				32.26				1,314				16.62				156,731				32.82				1,695				22.72
Consumer			1,169				0.25				11				0.14				1,039				0.22				10				0.13
		$	464,323				100.00	%		$	7,906				100.00	%		$	477,598				100.00	%		$	7,462				100.00	%

Non-performing Assets and Impaired Loans

At March 31, 2008, the Bank had two loans identified as impaired in the amounts of $6.9 million and $173 thousand in non-accrual status. A valuation allowance, based on the fair value of collateral and discounted cash flows, in the amount of $1.9 million is included in the allowance for loan losses. Non-performing assets at the Mortgage Corporation are comprised of one non-accrual loan in the amount of $184 thousand and other real estate owned totaling $622 thousand. Non-performing assets at the Mortgage Corporation decreased from $2.1 million at December 31, 2007 to $806 thousand at March 31, 2008.

Deposits

Deposits are one of the primary sources of funding loan growth. At March 31, 2008, deposits totaled $457.1 million compared to $473.4 million on December 31, 2007, a decrease of $16.3 million. Interest-bearing deposits decreased $32.9 million, which was partially offset by a $16.6 million increase in non-interest bearing deposits from December 31, 2007 levels. The increase in non-interest-bearing deposits is due to new commercial accounts and increased balances of existing accounts. The decrease in interest-bearing deposits is primarily due a decrease in wholesale interest- bearing and other interest sensitive accounts. The Bank’s core deposit base is comprised primarily of commercial accounts and, due to the inherent nature of these accounts, balances can be subject to wide fluctuations.

Shareholders’ Equity

Shareholders’ equity was $55.9 million at March 31, 2008 compared to approximately $58.0 at December 31, 2007. Shareholders’ equity decreased by $2.1 million during the three months ended March 30, 2008. The decrease is due to the repurchase of 587,387 shares under our share repurchase program at a weighted average price of $7.23 per share that was partially offset by retained earnings of $1.7 million and $495 thousand in other comprehensive income. On February 25, 2008 the Corporation paid a $0.01 cash dividend to shareholders of record February 13, 2008.

Banking regulators have defined minimum regulatory capital ratios that the Corporation and the Bank are required to maintain. These risk based capital guidelines take into consideration risk factors, as defined by the banking regulators, associated with various categories of assets, both on and off the balance sheet. Both the Corporation and Bank are classified as Well Capitalized, which is the highest rating.

The following table outlines the regulatory components of capital and risk based capital ratios.

Risk Based Capital Analysis

		March 31,				December 31,
		2008				2007
		(In Thousands)
Tier 1 Capital:
Common stock		$	8,633			$	9,052
Capital surplus			18,215				21,833
Retained earnings			28,310				26,846
Less: Net Unrealized loss on equity Securities			(15	)			(14	)
Subordinated debentures			6,000				6,000
Total Tier 1 capital			61,143				63,717
Subordinated debentures not included in Tier 1			—				—
Allowance for loan losses			6,269				6,436
Total risk based capital		$	67,412			$	70,153
Risk weighted assets		$	499,619			$	513,598
Quarterly average assets		$	617,306			$	632,752

										Regulatory
										Minimum
Capital Ratios:
Tier 1 risk based capital ratio			12.24	%			12.41	%			4.00	%
Total risk based capital ratio			13.49	%			13.66	%			8.00	%
Leverage ratio			9.90	%			10.07	%			4.00	%

RESULTS OF OPERATIONS (March 31, 2008)

Summary

Net income for the three months ended March 31, 2008 totaled $1.7 million, compared to $1.3 million for the same period in 2007. Basic earnings per common share amounted to $0.16 per share for the three months ended March 31, 2007, compared to $0.11 per share for the same period in 2007. Diluted earnings per share were $0.16 for the three month periods ended March 31, 2008 compared to $0.11 for the three month period in 2007.

Interest and fees on loans decreased by $919 thousand in the quarter ended March 31, 2008 compared to the same period of 2007. The decrease in interest and fees on loans is due to a combination of a decrease in interest rates and average balances of loans outstanding during the period. Noninterest income totaled $8.4 million for the three months ended March 31, 2008 compared to $7.9 million for the same period in 2007. This increase is primarily due to a $1.1 million increase in gains on the sale of mortgage loans including $612.0 thousand in unrealized gains on the sale of loans as a result of adopting SFAS 159. Mortgage broker fee income decreased $717.0 thousand, partially offsetting the gains on loans held for sale.

Net Interest Income

Net interest income, the principal source of earnings, is the amount of income generated by earning assets (primarily loans and investment securities) less the interest expense incurred on interest-bearing liabilities (primarily deposits) used to fund earning assets. Net interest income decreased $274 thousand for the three months ended March 31, 2008 over the same period in 2007. Net interest margin decreased 4 basis points during the first three months from 3.23% in 2007 to 3.19% in 2008. The decrease in net interest margin is primarily due to a decrease in average earning assets during the period.

Total interest expense for the first three months of 2008 decreased approximately $900 thousand from $6.1 million in 2007 to $5.2 million. Total interest-bearing deposits averaged approximately $403.0 million for the three month period ended March 31, 2008 compared to $353.0 million for the three month period ended March 31, 2007. Borrowed funds for the three months ended March 31, 2008 averaged $96.5 million compared to $161.3 million for the corresponding period in 2007. The average cost of interest-bearing liabilities during the three months ended March 31, 2008 was 4.19%, down from 4.76% during the three months ended March 31, 2007.

The following table presents volume and rate analysis for three months ended March 31, 2008 and 2007:

Volume and Rate Analysis

		Three Months Ended March 31,
		2008 compared to 2007
		Change Due To:
		Increase /
		(Decrease)				Volume				Rate
		(In Thousands)
Interest Earning Assets:
Securities		$	(305	)		$	(403	)		$	98
Loans			(919	)			(263	)			(656	)
Interest-bearing deposits			70				177				(107	)
Total Decrease in Interest Income			(1,154	)			(489	)			(665	)
Interest-Bearing Liabilities:
Interest-bearing demand deposits			(19	)			(5	)			(14	)
Money market deposit accounts			(171	)			120				(291	)
Savings accounts			(19	)			(34	)			15
Time deposits			469				487				(18	)
Total interest-bearing deposits			260				568				(308	)
FHLB Advances			(1,006	)			(872	)			(134	)
Securities sold under agreements to repurchase			20				49				(29	)
Other short-term borrowings			(107	)			(28	)			(79	)
Long-term borrowings			69				94				(25	)
Subordinated debentures			(116	)			(80	)			(36	)
Total Decrease in Interest Expense			(880	)			(269	)			(611	)
Decrease in Net Interest Income		$	(274	)		$	(220	)		$	(54	)