UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

           (Mark One)

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

For the quarterly period ended March 31, 2009

or

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

For the transition period from                      to                     

Commission File Number: 000-49929

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
(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

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

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

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 5, 2009 was 10,297,840 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, 2009 and December 31, 2008 (audited)		Page 2
		Consolidated Statements of Income, three months ended March 31, 2009 and 2008		Page 3
		Consolidated Statements of Changes in Shareholders’ Equity, three months ended March 31, 2009 and 2008		Page 4
		Consolidated Statements of Cash Flows, three months ended March 31, 2009 and 2008		Page 5
		Notes to Consolidated Financial Statements (unaudited)		Page 6
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		Page 19
Item 3.		Quantitative and Qualitative Disclosures About Market Risk		Page 32
Item 4.		Controls and Procedures		Page 33
PART II		OTHER INFORMATION
Item 1.		Legal Proceedings		Page 34
Item1A.		Risk Factors		Page 34
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds		Page 34
Item 3.		Defaults Upon Senior Securities		Page 34
Item 4.		Submission of Matters to a Vote of Security Holders		Page 34
Item 5.		Other Information		Page 34
Item 6.		Exhibits		Page 35
		Signatures		Page 36

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

ACCESS NATIONAL CORPORATION
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except for Share Data)

		March 31,				December 31,
		2009				2008
		(Unaudited)
ASSETS
Cash and due from banks		$	6,483			$	8,785
Interest-bearing deposits in other banks and federal funds sold			66,877				13,697
Securities available for sale, at fair value			83,802				91,015
Loans held for sale, at fair value			93,829				84,312
Loans			485,623				485,929
Allowance for loan losses			(7,641	)			(7,462	)
Net loans			477,982				478,467
Premises and equipment			9,081				9,211
Accrued interest receivable			3,143				3,193
Other real estate owned			4,453				4,455
Other assets			9,585				9,189
Total assets		$	755,235			$	702,324
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Noninterest-bearing deposits		$	114,316			$	75,000
Savings and interest-bearing deposits			91,472				95,730
Time deposits			340,850				314,671
Total deposits			546,638				485,401
Other liabilities
Short-term borrowings			76,999				103,575
Long-term borrowings			54,240				41,107
Subordinated debentures			6,186				6,186
Other liabilities and accrued expenses			10,261				8,110
Total liabilities			694,324				644,379
SHAREHOLDERS’ EQUITY
Common stock, par value, $0.835; authorized, 60,000,000 shares; issued and outstanding,10,294,229 shares in March 31, 2009 and 10,240,747 shares in December 31, 2008			8,596				8,551
Surplus			17,611				17,410
Retained earnings			33,719				31,157
Accumulated other comprehensive income (loss), net			985				827
Total shareholders’ equity			60,911				57,945
Total liabilities and shareholders’ equity		$	755,235			$	702,324

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,
		2009				2008
Interest and Dividend Income
Interest and fees on loans		$	8,667			$	8,903
Interest on deposits in other banks			32				265
Interest and dividends on securities			980				851
Total interest and dividend income			9,679				10,019
Interest Expense
Interest on deposits			3,081				4,268
Interest on short-term borrowings			316				306
Interest on long-term borrowings			476				550
Interest on subordinated debentures			63				113
Total interest expense			3,936				5,237
Net interest income			5,743				4,782
Provision for loan losses			1,369				408
Net interest income after provision for loan losses			4,374				4,374
Non-interest Income
Service fees on deposit accounts			134				103
Gain on sale of loans			13,789				6,854
Mortgage broker fee income			140				562
Other income			1,097				923
Total non-interest income			15,160				8,442
Non-interest Expense
Salaries and employee benefits			7,505				5,930
Occupancy and equipment			632				636
Other operating expenses			6,743				3,615
Total noninterest expense			14,880				10,181
Income before income taxes			4,654				2,635
Income tax expense			1,990				944
NET INCOME		$	2,664			$	1,691
Earnings per common share:
Basic		$	0.26			$	0.16
Diluted		$	0.26			$	0.16
Average outstanding shares:
Basic			10,267,385				10,619,830
Diluted			10,311,653				10,795,800

See accompanying notes to consolidated financial statements (Unaudited).

ACCESS NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
For the Three Months Ended March 31, 2009 and 2008
(In Thousands)
(Unaudited)

														Accumulated
														Other
		Common								Retained				Comprehensive
		Stock				Surplus				Earnings				Income				Total
Balance, December 31, 2008		$	8,551			$	17,410			$	31,157			$	827			$	57,945
Comprehensive income:
Net income			—				—				2,664				—				2,664
Other comprehensive income, unrealized holdings gains arising during the period (net of tax, $82)			—				—				—				158				158
Total comprehensive income																			2,822
Stock option exercises (27,744 shares)			23				71				—				—				94
Dividend reinvestment plan (46,279 shares)			39				156				—				—				195
Repurchased under share repurchase program (20,542 shares)			(17	)			(76	)			—				—				(93	)
Cash dividend			—				—				(102	)			—				(102	)
Stock-based compensation expense recognized in earnings			—				50				—				—				50
Balance, March 31, 2009		$	8,596			$	17,611			$	33,719			$	985			$	60,911
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
Dividend reinvestment plan			—				—				—				—				—
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

See accompanying notes to consolidated financial statements (Unaudited).

ACCESS NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)

		Three Months Ended March 31,
		2009				2008
Cash Flows from Operating Activities
Net income		$	2,664			$	1,691
Adjustments to reconcile net income to net cash used in operating activities:
Provision for loan losses — net of recoveries			1,369				408
Deferred tax expense			383				255
Stock based compensation			50				32
Valuation allowance on derivatives			(175	)			(359	)
Net amortization accretion on securities			(4	)			(4	)
Depreciation and amortization			163				192
Loss on disposal of assets			—				5
Changes in assets and liabilities:
Valuation of loans held for sale carried at fair value			1,881				1,486
Increase in loans held for sale			(11,398	)			(20,385	)
(Increase) decrease in other assets			(659	)			1
Increase in other liabilities			2,148				1,511
Net cash used in operating activities			(3,578	)			(15,167	)
Cash Flows from Investing Activities
Proceeds from maturities and calls of securities available for sale			18,027				27,238
Purchases of securities available for sale			(10,568	)			(17,213	)
Net (increase) decrease in loans			(884	)			13,312
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			(7	)			(108	)
Net cash provided by investing activities			6,568				23,705
Cash Flows from Financing Activities
Net increase (decrease) in non-interest bearing and interest-bearing deposits			35,058				(1,624	)
Net increase (decrease) in time deposits			26,180				(14,689	)
Net (decrease) in securities sold under agreement to repurchase			(4,961	)			—
Net decrease in other short-term borrowings			(21,615	)			(5,409	)
Net increase in long-term borrowings			13,132				27,113
Proceeds from issuance of common stock			289				208
Purchases of common stock			(93	)			(4,278	)
Dividends Paid			(102	)			(119	)
Net cash provided by financing activities			47,888				1,202
Increase in cash and cash equivalents			50,878				9,740
Cash and Cash Equivalents
Beginning			22,482				19,502
Ending		$	73,360			$	29,242
Supplemental Disclosures of Cash Flow Information
Cash payments for interest		$	3,966			$	5,249
Cash payments for income taxes		$	—			$	850
Supplemental Disclosures of Noncash Investing Activities
Unrealized gain on securities available for sale		$	241			$	750

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 (“SEC”). 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, 2009 are not necessarily indicative of the results that may be expected for the entire year ending December 31, 2009. These consolidated financial statements should be read in conjunction with the Corporation’s audited financial statements and the notes thereto as of December 31, 2008, included in the Corporation’s Annual Report on Form 10-K for the fiscal year ended December 31, 2008.

NOTE 3 — STOCK-BASED COMPENSATION PLANS

During the first three months of 2009, the Corporation granted 99,250 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 2009 was approximately $50 thousand and $32 thousand for the same period in 2008. 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, 2009 is presented as follows:

		Three Months Ended
		March 31, 2009
Expected life of options granted			3.33
Risk-free interest rate			1.07	%
Expected volatility of stock			47	%
Annual expected dividend yield			1	%
Fair Value of Granted Options		$	171,393
Non-Vested Options			259,975

										Weighted Avg.
		Number of				Weighted Avg.				Remaining				Aggregate Intrinsic
		Options				Exercise Price				Contractual Term				Value
Outstanding at beginning of year			589,617			$	5.96				1.57			$	284,885
Granted			99,250			$	3.99				3.33			$	—
Exercised			27,744			$	3.37				0.03			$	—
Lapsed or Canceled			18,800			$	7.40				0.25			$	—
Outstanding at March 31, 2009			642,323			$	5.72				1.73			$	272,752
Exercisable March 31, 2009			382,348			$	5.32				1.24			$	212,210

NOTE 4 — SECURITIES

Amortized costs and fair values of securities available for sale as of March 31, 2009 and December 31, 2008 are as follows:

		March 31, 2009
						Gross				Gross
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				Losses				Value
						(In Thousands)
U.S. Treasury Securities		$	—			$	—			$	—			$	—
U.S. Government Agencies			69,903				1,092				—				70,995
Mortgage Backed Securities			1,333				3				(73	)			1,263
Municipals — taxable			5,015				495				—				5,510
CRA Mutual Fund			1,500				—				(23	)			1,477
Restricted Securities
Federal Reserve Bank Stock			894				—				—				894
FHLB Stock			3,663				—				—				3,663
Total Securities		$	82,308			$	1,590			$	(96	)		$	83,802

		December 31, 2008
						Gross				Gross
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				Losses				Value
						(In Thousands)
U.S. Treasury Securities		$	999			$	7			$	—			$	1,006
U.S. Governmental Agencies			74,934				1,420				—				76,354
Mortgage Backed Securities			1,428				2				(39	)			1,391
Municipals — taxable			5,006				3				(89	)			4,920
CRA Mutual Fund			1,500				—				(52	)			1,448
Restricted Securities
Federal Reserve Bank Stock			894				—				—				894
FHLB Stock			5,002				—				—				5,002
Total Securities		$	89,763			$	1,432			$	(180	)		$	91,015

NOTE 4 — SECURITIES (continued)

The amortized cost and fair value of securities available for sale as of March 31, 2009 and December 31, 2008 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, 2009								December 31, 2008
		Amortized				Fair				Amortized				Fair
		Cost				Value				Cost				Value
		(In Thousands)								(In Thousands)
U.S. Treasury and Agencies
Due in one year or less		$	—			$	—			$	999			$	1,006
Due after one through five years			10,000				10,052				25,000				25,121
Due after five through ten years			59,903				60,943				49,934				51,233
Municipals
Due after one through five years			905				909				905				907
Due after ten years			4,110				4,601				4,101				4,013
Mortgage Backed Securities
Due in one year or less			450				454				381				382
Due after one through five years			—				—				127				128
Due after ten years			883				809				920				881
Mutual Fund			1,500				1,477				1,500				1,448
Restricted Securities:
Federal Reserve Bank stock			894				894				894				894
FHLB stock			3,663				3,663				5,002				5,002
Total		$	82,308			$	83,802			$	89,763			$	91,015

NOTE 4 — SECURITIES (continued)

Investment securities available for sale that have an unrealized loss position at March 31, 2009 and December 31, 2008 are as follows:

		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
March 31, 2009		Value				Losses				Value				Losses				Value				Losses
		(In Thousands)
Investment securities available for sale:
Mortgage Backed Securities		$	—			$	—			$	809			$	(73	)		$	809			$	(73	)
CRA Mutual Fund			—				—				1,477				(23	)			1,477				(23	)
Total		$	—			$	—			$	2,286			$	(96	)		$	2,286			$	(96	)

		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
December 31, 2008		Value				Losses				Value				Losses				Value				Losses
		(In Thousands)
Investment securities available for sale:
Mortgage Backed Securities		$	881			$	(39	)		$	—			$	—			$	881			$	(39	)
Municipals-Taxable			4,012				(89	)			—				—				4,012				(89	)
CRA Mutual Fund			—				—				1,448				(52	)			1,448				(52	)
Total		$	4,893			$	(128	)		$	1,448			$	(52	)		$	6,341			$	(180	)

Management does not believe that any individual unrealized loss as of March 31, 2009 and December 31, 2008 is other than a temporary impairment. These unrealized losses are primarily attributable to changes in interest rates. The Corporation has the ability to hold these securities for a time necessary to recover the amortized cost or until maturity when full repayment would be received.

NOTE 5 — LOANS

The following table presents the composition of the loan portfolio at March 31, 2009 and December 31, 2008:

		March 31,				Percent of				December 31,				Percent of
		2009				Total				2008				Total
		(In Thousands)
Commercial		$	64,714				13.33	%		$	69,537				14.31	%
Commercial real estate			223,090				45.94				218,539				44.97
Real estate construction			45,755				9.42				42,600				8.77
Residential real estate			150,684				31.03				153,740				31.64
Consumer			1,380				0.28				1,513				0.31
		$	485,623				100.00	%		$	485,929				100.00	%
Less allowance for loan losses			7,641								7,462
		$	477,982							$	478,467

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, 2009 and 2008:

		Commercial				Mortgage												Consolidated
2009		Banking				Banking				Other				Eliminations				Totals
(In Thousands)
Revenues:
Interest income		$	9,197			$	915			$	10			$	(443	)		$	9,679
Gain on sale of loans			—				13,789				—				—				13,789
Other revenues			376				1,258				308				(571	)			1,371
Total revenues			9,573				15,962				318				(1,014	)			24,839
Expenses:
Interest expense			3,816				390				173				(443	)			3,936
Salaries and employee benefits			1,848				5,657				—				—				7,505
Other			2,897				5,963				455				(571	)			8,744
Total operating expenses			8,561				12,010				628				(1,014	)			20,185
Income before income taxes		$	1,012			$	3,952			$	(310	)		$	—			$	4,654
Total assets		$	709,741			$	96,427			$	44,471			$	(95,404	)		$	755,235

		Commercial				Mortgage												Consolidated
2008		Banking				Banking				Other				Elimination				Totals
(In Thousands)
Revenues:
Interest income		$	9,837			$	514			$	38			$	(370	)		$	10,019
Gain on sale of loans			—				6,858				—				(4	)			6,854
Other revenues			552				1,329				265				(558	)			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 before income taxes		$	1,638			$	1,305			$	(308	)		$	—			$	2,635
Total assets		$	584,560			$	62,560			$	43,711			$	(63,630	)		$	627,201

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, 2009 and 2008, 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 utilizing the treasury stock method.

		Three Months				Three Months
		Ended				Ended
		March 31, 2009				March 31, 2008
		(In thousands except for share data)
BASIC EARNINGS PER SHARE:
Net income		$	2,664			$	1,691
Weighted average shares outstanding			10,267,385				10,619,830
Basic earnings per share		$	0.26			$	0.16
DILUTED EARNINGS PER SHARE:
Net income		$	2,664			$	1,691
Weighted average shares outstanding			10,267,385				10,619,830
Stock options and warrants			44,268				175,970
Weighted average diluted shares outstanding			10,311,653				10,795,800
Diluted earnings per share		$	0.26			$	0.16

NOTE 8 — DERIVATIVES

As part of its mortgage banking activities, 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 then either locks the loan and rate in with an investor and commits to deliver the loan if settlement occurs (“Best Efforts”) or commits to deliver the locked loan in a binding (“Mandatory”) delivery program with an investor. Certain loans under rate lock commitments are covered under forward sales contracts of mortgage-backed securities (MBS). Forward sales contracts of MBS are recorded at fair value with changes in fair value recorded in non-interest income. Interest rate lock commitments and commitments to deliver loans to investors are considered derivatives. The market value of interest rate lock commitments and best efforts contracts are not readily ascertainable with precision because they not actively traded in stand-alone markets. The Mortgage Corporation determines the fair value of rate lock commitments and delivery contracts by measuring the fair value of the underlying asset, which is impacted by current interest rates and taking into consideration the probability that the rate lock commitments will close or will be funded.

Certain additional risks arise from these forward delivery contracts in that the counterparties to the contracts may not be able to meet the terms of the contracts. The Mortgage Corporation does not expect any counterparty to fail to meet its obligation. Additional risks inherent in mandatory delivery programs include the risk that if the Mortgage Corporation does not close the loans subject to interest rate risk lock commitments, they will be obligated to deliver MBS to the counterparty under the forward sales agreement. Should this be required, the Mortgage Corporation could incur significant costs in acquiring replacement loans or MBS and such costs could have an adverse effect on mortgage banking operations in future periods.

Since the Mortgage Corporation’s derivative instruments are not designated as hedging instruments, the fair value of the derivatives are recorded as a freestanding asset or liability with the change in value being recognized in current earnings during the period of change. The Mortgage Corporation has not elected to apply hedge accounting to its derivative instruments as provided in SFAS 133.

At March 31, 2009 and December 31, 2008, the Mortgage Corporation had derivative financial instruments with a notional value of $239.2 million and $131.8 million respectively. The fair value of these derivative instruments at March 31, 2009 and December 31, 2008 was $265 thousand and $100 thousand respectively and included in other assets.

Included in other non-interest income at March 31, 2009 and March 31, 2008 was a net loss of $290 and a net gain of $100 thousand respectively relating to derivative instruments.

NOTE 9 — RECENT ACCOUNTING PRONOUNCEMENTS

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 157 to January 1, 2009 for items within the scope of the staff position. The expiration of the delay did not have a material impact on the Corporation’s consolidated financial statements.

In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations”. SFAS 141(R) 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 Corporation 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.

NOTE 9 — RECENT ACCOUNTING PRONOUNCEMENTS (continued)

In December 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in Consolidated Financial Statements-an amendment of ARB No. 51”. 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 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 Corporation on January 1, 2009. Earlier adoption is prohibited. The adoption of SFAS 160 did not have a material impact on the Corporation’s 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 SFAS 133 and how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. The new standard became effective for the Corporation on January 1, 2009. The adoption of SFAS 161 did not have a material impact on the Corporation’s consolidated financial statements.

In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, “Interim Disclosures About Fair Value of Financial Instruments” (“FSP FAS 107-1”) which amends SFAS No. 107, “Disclosures about Fair Value of Financial Instruments” to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. This FSP also amends Accounting Principles Board Opinion No. 28, “Interim Financial Reporting”, to require those disclosures in summarized financial information at interim reporting periods. FSP FAS 107-1 is effective for interim reporting periods ending after June 15, 2009, and will be effective June 30, 2009, for the Corporation.

In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary-Impairment” (“FSP FAS 115-2”) which amends the other-than-temporary impairment guidance under GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. This FSP requires that the annual disclosures in FAS 115 and FSP FAS 115-1 and FAS 124-1 “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” be made for interim periods. This FSP does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities. FSP FAS 115-2 is effective for interim and annual reporting periods ending after June 15, 2009 and will be effective June 30, 2009, for the Corporation. Management does not anticipate that this FSP will have a material impact on the Corporation’s consolidated financial condition or results of operations.

In April 2009, the FASB issued FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability has Significantly Decreased and Identifying Transactions that are Not Orderly” (“FSP FAS 157-4”) which provides additional guidance for estimating fair value in accordance with SFAS No. 157 “Fair Value Measurement” when the volume and level of activity for the asset or liability have significantly decreased. This FSP also includes guidance on identifying circumstances that indicate a transaction is not orderly. FSP FAS 157-4 is effective for interim and annual reporting periods ending after June 15, 2009 and will be effective June 30, 2009, for the Corporation, and should be applied prospectively. Management does not anticipate that this FSP will have a material impact on the Corporation’s consolidated financial condition or results of operations.

NOTE 10 — FAIR VALUE

Fair Value Pursuant to SFAS No. 157, “Fair Value Measurements” (“SFAS 157”), the fair value is the exchange price in an orderly transaction, that is not a forced liquidation or distressed sale, between market participants to sell an asset or transfer

a liability in the market in which the reporting entity would transact for the asset or liability, that is, the principal or most advantageous market for the asset/liability. The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the asset/liability. SFAS 157 provides a consistent definition of fair value which focuses on exit price and prioritizes, within a measurement of fair value, the use of market-based inputs over entity-specific inputs. In addition, SFAS 157 provides a framework for measuring fair value and establishes a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. 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 from active markets (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: Derivative instruments are used to hedge residential mortgage loans held for sale and the related interest-rate lock commitments and include forward commitments to sell mortgage loans and mortgage backed securities. The fair values of derivative financial instruments are based on derivative market data inputs as of the valuation date and the underlying value of mortgage loans for rate lock commitments (Level 3).

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. (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 157 on a recurring and non-recurring basis, including financial assets and liabilities for which the Corporation has elected the fair value option, are summarized below:

						Fair Value Measurement
						at March 31, 2009 Using
						(In Thousands)
						Quoted Prices in
						Active Markets for								Significant
						Identical Assets				Other Observable				Unobservable Inputs
Description		Carrying Value				(Level 1)				Inputs (Level 2)				(Level 3)
Financial Assets-Recurring
Available for sale investment securities (1)		$	79,245			$	79,245			$	—			$	—
Residential loans held for sale			93,829				—				93,829				—
Derivative assets			737				—				—				737
Financial Liabilities-Recurring
Derivative liabilities			471				—				—				471
Financial Assets-Non-Recurring
Impaired loans (2)			5,538				—				—				5,538
Other real estate owned (3)			4,453				—				4,453				—

The changes in Level 3 assets and liabilities measured at fair value on a recurring basis are summarized as follows for three month period ended March 31, 2009.

		Net Derivatives
		(In Thousands)
Balance December 31, 2008		$	91
Realized and unrealized gains (losses) included in earnings			174
Unrealized gains (losses) included in other comprehensive income			—
Purchases, Settlements, paydowns, and maturities			—
Transfer into Level 3			—
Balance March 31, 2009		$	265

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 of SFAS 159, 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, with respect to an item, may not be revoked once an election is made.

The following table reflects the differences between the fair value carrying amount of residential mortgage loans held for sale at March 31, 2009, measured at fair value under SFAS 159 and the aggregate unpaid principal amount the Corporation is contractually entitled to receive at maturity.

		Aggregate								Contractual
(In Thousands)		Fair Value				Difference				Principal
Residential mortgage loans held for sale		$	93,829			$	1,881			$	91,948

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, included in the Corporation’s Annual Report on Form 10-K for the fiscal year ended December 31, 2008. Operating results for the three months ended March 31, 2009 are not necessarily indicative of the results for the year ending December 31, 2009 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 to our 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: continued deterioration in general business and economic conditions and in the financial markets and the impact of any policies or programs implemented pursuant to the Emergency Economic Stabilization Act of 2008 (the “EESA”), as amended by the American Recovery and Reinvestment Act of 2009 (the “ARRA”), branch expansion plans, interest rates, general economic conditions, monetary and fiscal policies of the U.S. Government, including policies of the Office of the Comptroller of the Currency (“Comptroller”), the U.S. Department of the Treasury and the Board of Governors of the Federal Reserve System and the Federal Reserve Bank of Richmond, the economy of Northern Virginia, including governmental spending and real estate markets, the quality or composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, and accounting principles, policies and guidelines. 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 we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which it is made.

In addition, a continuation of the recent turbulence in significant portions of the global financial markets, particularly if it worsens, could impact our performance, both directly by affecting our revenues and the value of our assets and liabilities, and indirectly by affecting our counterparties and the economy generally. Dramatic declines in the housing market in the past year have resulted in significant write-downs of asset values by financial institutions in the United States. Concerns about the stability of the U.S. financial markets generally have reduced the availability of funding to certain financial institutions, leading to a tightening of credit, reduction of business activity, and increased market volatility. There can be no assurance that the EESA, the ARRA or the actions taken by the U.S. Treasury thereunder will stabilize the U.S. financial system or alleviate the industry or economic factors that may adversely affect our business. In addition, our business and financial performance could be impacted as the financial industry restructures in the current environment, both by changes in the creditworthiness and performance of our counterparties and by changes in the competitive landscape. For additional discussion of risk factors that may cause our actual future results to differ materially from the results indicated within forward looking statements, please see “Item 1A — Risk Factors” of the Corporation’s 2008 Form 10-K.

CRITICAL ACCOUNTING POLICIES

The Corporation’s consolidated financial statements have been prepared in accordance with GAAP. In preparing the Corporation’s financial statements management makes estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses. Management believes that the most significant subjective judgments that it makes include the following:

Allowance for Loan Losses

The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two basic principals of accounting: (i) Statement of Financial Accounting Standards (“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, and 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.

Other Than Temporary Impairment of Investment Securities

The Bank’s investment portfolio is classified as available-for-sale. The estimated fair value of the portfolio fluctuates due to changes in market interest rates and other factors. Changes in estimated fair value are recorded in stockholders’ equity as a component of comprehensive income. Securities are monitored to determine whether a decline in their value is other-than-temporary. Management evaluates the investment portfolio on a quarterly basis to determine the collectability of amounts due per the contractual terms of the investment security. Once a decline in value is determined to be other than temporary, the value of the security is reduced and a corresponding charge to earnings is recognized. At March 31, 2009 there were no securities with other than temporary impairment.

Income Taxes

The Corporation uses the liability method of accounting for income taxes. This method results in the recognition of deferred tax assets and liabilities that are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. The deferred provision for income taxes is the result of the net change in the deferred tax asset and deferred tax liability balances during the year. This amount combined with the current taxes payable or refundable results in the income tax expense for the current year.

Fair Value

Fair values of financial instruments are estimated using relevant market information and other assumptions. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates. The fair value estimates of existing on and off balance sheet financial instruments do not include the value of anticipated future business or the values of assets and liabilities not considered financial instruments. For additional information about our financial assets carried at fair value, refer to Note 10 of the accompanying notes to the consolidated financial statements.

Off-Balance Sheet Items

In the ordinary course of business, the Bank issues commitments to extend credit and, at March 31, 2009, these commitments amounted to $33.3 million. These commitments do not necessarily represent cash requirements, since many commitments are expected to expire without being drawn on.

At March 31, 2009, the Bank had approximately $160.5 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

Off-Balance Sheet Items (continued)

the planned expansion of the loans held for investment portfolio, 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, 2009 and December 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 $2.0 million at March 31, 2009 and $1.4 million at December 31, 2008.

FINANCIAL CONDITION (March 31, 2009 compared to December 31, 2008)

At March 31, 2009, the Corporation’s assets totaled $755.2 million compared to $702.3 million at December 31, 2008, an increase of $52.9 million. Loans held for investment totaled $485.6 million down slightly from $485.9 million at year end 2008 primarily due to a decrease in loan demand. Loans held for sale totaled $93.8 million, up from $84.3 million at December 31, 2008, an increase of $9.5 million, due to lower interest rates and increased refinancing activity. Total deposits increased $61.2 million to $546.6 million, compared to $485.4 million at December 31, 2008.

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, a Community Reinvestment Act mutual fund and Federal Reserve Bank and FHLB stock. At March 31, 2009 the securities portfolio totaled $83.8 million, down from $91.0 million on December 31, 2008, 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. 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 Comptroller. At March 31, 2009, loans held for investment totaled $485.6 million, down $0.3 million from $485.9 million at December 31, 2008. Commercial loans decreased $4.8 million and residential real estate loans decreased $3.1 million. Commercial real estate loans increased $4.6 million and construction loans increased $3.2 million. See Note 5 of the accompanying notes to the 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, 2009.

Commercial Loans: Commercial Loans represent 13.3% of the loans held for investment portfolio as of March 31, 2009. 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 45.9% of the loans held for investment portfolio as of March 31, 2009. 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 9.4% of the loans held for investment portfolio as of March 31, 2009. 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 31.0% of the loans held for investment portfolio as of March 31, 2009. Of this amount, the following sub-categories exist as a percentage of the whole residential real estate loan portfolio: home equity lines of credit, 16.9%; first trust mortgage loans, 70.5%; junior trust loans, 10.4%; and multi-family loans and loans secured by farmland 2.2%.

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 borrowers 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 residential mortgage loans originated by the Mortgage Corporation 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, 2009 we originated $439.1 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, 2009, LHFS at fair value totaled $93.8 million compared to $84.3 million at December 31, 2008.

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 2009, $8.4 million in residential mortgage loans were originated under this type of delivery method, as compared to $27.9 million for the same period of 2008. Brokered loans accounted for 1.9% of the total loan volume for the first three months of 2009 compared to 12.8% for the same period of 2008. We typically broker loans that do not conform to the products offered by the Mortgage Corporation and for this reason the level of brokered loans is subject to wide fluctuations.

Allowance for Loan Losses

The allowance for loan losses totaled $7.6 million at March 31, 2009 compared to $7.5 million at year end 2008. The allowance for loan losses is equivalent to approximately 1.6% of total consolidated loans held for investment at March 31, 2009. The level of the allowance for loan losses is determined by management through an ongoing detailed analysis of risk and loss potential within the portfolio as a whole and they have concluded the amount of our reserve and the methodology applied to arrive at the amount of the reserve is justified and appropriate. Outside of our own analysis, our reserve adequacy and methodology are reviewed on a regular basis by an internal audit program, and bank regulators and such reviews have not resulted in any material adjustment to the reserve. The schedule below, Allocation of the Allowance for Loan Losses, reflects the allocation by the different loan types. The methodology as to how the allowance was derived is a combination of specific allocations and percentage allocations 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. The methodology as to how the allowance was derived is detailed below. Adequacy of the allowance is assessed monthly and increased by provisions charged to expense. Charge-offs are taken, no less frequently than at the close of each fiscal quarter. The methodology by which we systematically determine the amount of our allowance is set forth by the Board of Directors in our Credit Policy, pursuant to which our 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, 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. 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; and peer data contained in statistical releases issued by both the Comptroller and the Federal Deposit Insurance Corporation (“FDIC”).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. 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 loss, the loan is classified as impaired and the book balance of the loan is reduced to the expected liquidation value by charging the allowance for loan losses.

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

Allowance for Loan Losses

		Three months ended
		March 31,
(In Thousands)		2009				2008
Balance at beginning of period		$	7,462			$	7,462
Charge offs			(1,195	)			(87	)
Recoveries			5				123
Provision			1,369				408
Balance as of March 31, 2009 and 2008		$	7,641			$	7,906

Allocation of the Allowance for Loan Losses

		March 31, 2009																December 31, 2008
										Allowance																Allowance
										for Loan																for Loan
		Amount				Percentage				Loss				Percentage				Amount				Percentage				Loss				Percentage
		(Dollars In Thousands)
Commercial		$	64,714				13.33	%		$	1,696				22.20	%		$	69,537				14.31	%		$	1,816				24.34	%
Commercial real estate			223,090				45.94				3,172				41.51				218,539				44.97				2,948				39.51
Real estate construction			45,755				9.42				874				11.44				42,600				8.77				805				10.79
Residential real estate			150,684				31.03				1,888				24.71				153,740				31.64				1,880				25.19
Consumer			1,380				0.28				11				0.14				1,513				0.31				13				0.17
		$	485,623				100.00	%		$	7,641				100.00	%		$	485,929				100.00	%		$	7,462				100.00	%

Non-performing Assets

At March 31, 2009, the Bank had non-performing assets totaling $10.0 million consisting of non-accrual loans and other real estate owned. Non-accrual loans totaled approximately $5.5 million and are composed of a commercial loan in the amount of $478 thousand, a commercial real estate loan in the amount of $2.0 million, two residential construction loans totaling $2.6 million, and a real estate residential first trust loan in the amount of $457 thousand. Other real estate owned consists of two commercial properties totaling $4.5 million. Subsequent to March 31, 2009 a payoff was received on one construction loan in the amount of $.6 million.

Deposits

Deposits are one of the primary sources of funding loan growth. At March 31, 2009, deposits totaled $546.6 million compared to $485.4 million on December 31, 2008, an increase of $61.2 million. Savings and interest-bearing deposits decreased $4.3 million from December 31, 2008. Time deposits increased $26.2 million from $314.7 million at December 31, 2008 to $340.9 million at March 31, 2009. Non-interest-bearing deposits increased $39.3 million from $75.0 million at December 31, 2008 to $114.3 million at March 31, 2009. The increase in non-interest-bearing deposits is largely due to fluctuations in balances of commercial accounts.

Shareholders’ Equity

Shareholders’ equity was $60.9 million at March 31, 2009 compared to approximately $57.9 million at December 31, 2008. Shareholders’ equity increased by $3.0 million during the three month period ended March 31, 2009. The increase in shareholders’ equity is primarily due to net income for the three months ended March 31, 2009 of $2.7 million.

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, 2009				December 31,
		2009				2008
		(In Thousands)
Tier 1 Capital:
Common stock		$	8,596			$	8,551
Capital surplus			17,611				17,411
Retained earnings			33,719				31,157
Less: Net unrealized loss on equity securities			(15	)			(34	)
Subordinated debentures			6,000				6,000
Total Tier 1 capital			65,911				63,085
Subordinated debentures not included in Tier 1			—				—
Allowance for loan losses			6,741				6,662
Total risk based capital		$	72,652			$	69,747
Risk weighted assets		$	538,086			$	532,195
Quarterly average assets		$	733,758			$	649,817
Capital Ratios:										Regulatory Minimum
Tier 1 risk based capital ratio			12.25	%			11.85	%			4.00	%
Total risk based capital ratio			13.50	%			13.11	%			8.00	%
Leverage ratio			8.98	%			9.71	%			4.00	%