VIRGINIA COMMERCE BANCORP INC - FORM 10-K

VIRGINIA COMMERCE BANCORP INC - FORM 10-K - March 19, 2010

Attached files

Attached files

file	filename
EX-21 - EXHIBIT 21 - VIRGINIA COMMERCE BANCORP INC	dex21.htm
EX-23 - EXHIBIT 23 - VIRGINIA COMMERCE BANCORP INC	dex23.htm
EX-31.1 - EXHIBIT 31.1 - VIRGINIA COMMERCE BANCORP INC	dex311.htm
EX-10.4 - EXHIBIT 10.4 - VIRGINIA COMMERCE BANCORP INC	dex104.htm
EX-32.2 - EXHIBIT 32.2 - VIRGINIA COMMERCE BANCORP INC	dex322.htm
EX-99.1 - EXHIBIT 99.1 - VIRGINIA COMMERCE BANCORP INC	dex991.htm
EX-31.2 - EXHIBIT 31.2 - VIRGINIA COMMERCE BANCORP INC	dex312.htm
EX-99.2 - EXHIBIT 99.2 - VIRGINIA COMMERCE BANCORP INC	dex992.htm
EX-32.1 - EXHIBIT 32.1 - VIRGINIA COMMERCE BANCORP INC	dex321.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

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

For the fiscal year ended December 31, 2009

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

Commission file number: 000-28635

Virginia Commerce Bancorp, Inc.

(Exact name of registrant as specified in its charter)


Virginia		54-1964895
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

5350 Lee Highway, Arlington, Virginia		22207
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number: 703.534.0700

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


Title of Each Class		Name of Each Exchange on which Registered
Common Stock, $1.00 par value		The Nasdaq Stock Market (Global Select)

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x

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

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 12 months (or for such shorter period that the registrant was required to submit and post such files). ¨ Yes ¨ No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

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 Act). Yes ¨ No x

The registrant’s Common Stock is traded on the Nasdaq Global Select Market under the symbol VCBI. The aggregate market value of the approximately 26,693,074 shares of Common Stock of the registrant issued and outstanding held by non-affiliates on June 30, 2009 was approximately $45.0 million, based on the closing sales price of $2.30 per share on that date. For purposes of this calculation, the term “affiliate” refers to all directors, executive officers and 10% shareholders of the registrant.

As of the close of business on March 18, 2010, 26,933,923 shares of the registrant’s Common Stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive Proxy Statement for the Annual Meeting of Shareholders, to be held on April 28, 2010, are incorporated by reference in Part III hereof.

Form 10-K Cross Reference Sheet

The following shows the location in this Annual Report on Form 10-K or the Company’s Proxy Statement for the Annual Meeting of Stockholders to be held on April 28, 2010, of the information required to be disclosed by the United States Securities and Exchange Commission Form 10-K. References to pages only are to pages in this report.


PART I	Item 1.	Business. See “Business” at pages 63 through 72.

	Item 1A.	Risk Factors. See “Risk Factors” at pages 23 through 27.

	Item 1B.	Unresolved Staff Comments. Not required.

	Item 2.	Properties. See “Properties” at page 72.

	Item 3.	Legal Proceedings. From time to time the Company is a participant in various legal proceedings incidental to its business. In the opinion of management, the liabilities (if any) resulting from such legal proceedings will not have a material effect on the financial position of the Company.

	Item 4.	Removed and Reserved.

PART II	Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. See “Market Price of Stock” at page 73 through 74.

	Item 6.	Selected Financial Data. See “Five Year Financial Summary” at page 3.

	Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” at pages 4 through 22.

	Item 7A.	Quantitative and Qualitative Disclosures About Market Risk. See “Asset/Liability Management and Quantitative and Qualitative Disclosures About Market Risk” at page 9 through 10.

	Item 8.	Financial Statements and Supplementary Data. See Consolidated Financial Statements at pages 32 through 62.

	Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. None.

	Item 9A.	Controls and Procedures. See “Disclosure Controls and Procedures” at page 27 and “Management Report on Internal Control Over Financial Reporting” at page 28.

	Item 9B.	Other Information. None

PART III	Item 10.	Directors, Executive Officers and Corporate Governance. The information required by Item 10 is incorporated by reference from the material under the captions “Election of Directors” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statement. The Company has adopted a code of ethics that applies to its Chief Executive Officer and Chief Financial Officer. A copy of the code of ethics will be provided to any person, without charge, upon written request directed to Krista DiVenere, Assistant Controller, Virginia Commerce Bank, 14201 Sullyfield Circle, Suite 500, Chantilly, Virginia 20151.

		There have been no material changes in the procedures previously disclosed by which stockholders may recommend nominees to the Company’s Board of Directors.

	Item 11.	Executive Compensation. The information required by Item 11 is incorporated by reference from the material under the captions “Executive Officer Compensation” and “Election of Directors – Director Compensation” and “- Compensation Committee Interlocks and Insider Participation” in the Proxy Statement.

	Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. The information required by Item 12 is incorporated by reference from the material under the caption “Voting Securities and Principal Holders” and “Securities Authorized for Issuance Under Equity Compensation Plans” in the Proxy Statement.

	Item 13.	Certain Relationships and Related Transactions, and Director Independence. The information required by Item 13 is incorporated by reference from the material under the captions “Election of Directors” and “Transactions with Management and Related Parties” in the Proxy Statement.

	Item 14.	Principal Accountant Fees and Services. The information required by Item 14 is incorporated by reference from the material under the caption “Independent Registered Public Accounting Firm” in the Proxy Statement.

PART IV	Item 15.	Exhibits, Financial Statement Schedules. See “Financial Statements and Exhibits” at page 75 through 76.

FIVE YEAR FINANCIAL SUMMARY


	Year Ended December 31,
	2009			2008			2007			2006			2005
	(Dollars in thousands, except per share amounts)
Selected Year-End Balances
Total assets	$	2,725,297		$	2,715,922		$	2,339,697		$	1,949,082		$	1,518,425
Total stockholders’ equity		218,868			253,287			169,143			139,851			111,818
Total loans (net)		2,210,064			2,273,086			1,924,741			1,629,827			1,270,255
Total deposits		2,229,327			2,172,142			1,869,165			1,605,941			1,243,506
Summary Results of Operations
Interest income	$	150,633		$	160,468		$	154,138		$	125,292		$	86,478
Interest expense		59,229			77,430			78,981			56,487			29,811
Net interest income	$	91,404		$	83,038		$	75,157		$	68,805		$	56,667
Provision for loan losses		81,913			25,378			4,340			4,406			3,772
Net interest income after provision for loan losses	$	9,491		$	57,660		$	70,817		$	64,399		$	52,895
Non-interest income (charges)		(4,352	)		6,431			7,883			7,323			6,676
Non-interest expense		56,868			44,776			39,694			34,289			29,466
(Loss) income before taxes	$	(51,729	)	$	19,315		$	39,006		$	37,433		$	30,105
(Benefit) provision for income tax		(18,404	)		6,231			13,219			12,925			10,438
Net (loss) income	$	(33,325	)	$	13,084		$	25,787		$	24,508		$	19,667
Effective dividend on preferred stock		4,539			258			—			—			—
Net (loss) income available to common stockholders	$	(37,864	)	$	12,826		$	25,787		$	24,508		$	19,667
Per Common Share Data (1)
Net (loss) income per common share, basic	$	(1.42	)	$	0.48		$	0.98		$	0.95		$	0.77
Net (loss) income per common share, diluted	$	(1.42	)	$	0.47		$	0.95		$	0.89		$	0.72
Book value per common share	$	5.53		$	6.86		$	6.40		$	5.36		$	4.39
Average number of common shares outstanding:
Basic		26,692,570			26,555,484			26,323,242			25,960,838			25,429,399
Diluted		26,692,570			27,249,839			27,379,204			27,449,754			27,205,294
Growth and Significant Ratios
% Change in net income		-354.70	%		-49.26	%		5.22	%		24.61	%		38.22	%
% Change in assets		0.35	%		16.08	%		20.04	%		28.36	%		33.27	%
% Change in loans (net)		-2.77	%		18.10	%		18.09	%		28.31	%		37.21	%
% Change in deposits		2.63	%		16.21	%		16.39	%		29.15	%		28.07	%
% Change in total stockholders’ equity		-13.59	%		49.75	%		20.95	%		25.07	%		22.44	%
Equity to asset ratio		8.03	%		9.33	%		7.23	%		7.18	%		7.36	%
Return on average assets		-1.22	%		0.51	%		1.21	%		1.40	%		1.45	%
Return on average equity		-13.89	%		7.18	%		16.75	%		19.51	%		19.44	%
Average equity to average assets		8.77	%		7.06	%		7.22	%		7.19	%		7.47	%
Efficiency ratio, as adjusted (2)		55.57	%		50.05	%		47.80	%		45.04	%		46.52	%

(1)	Adjusted for all years presented giving retroactive effect to a five-for-four stock split in the form of a 25% stock dividend in 2005, a three-for-two stock split in the form of a 50% stock dividend in 2006, and a 10% stock dividend in 2007 and 2008.

(2)

Computed by dividing non-interest expense by the sum of net interest income on a tax equivalent basis and non-interest income, net of losses on other real estate owned. This is a non-GAAP financial measure, which we believe provides investors with important information regarding our operational efficiency. Comparison of our efficiency ratio with those of other companies may not be possible, because other companies may calculate the efficiency ratio differently.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

This management’s discussion and analysis and other portions of this report, contain forward-looking statements within the meaning of the Securities and Exchange Act of 1934, as amended (the “Exchange Act”), including statements of goals, intentions, and expectations as to future trends, plans, events or results of Company operations and policies and regarding general economic conditions. In some cases, forward-looking statements can be identified by use of words such as “may,” “will,” “anticipates,” “believes,” “expects,” “plans,” “estimates,” “potential,” “continue,” “should,” and similar words or phrases. These statements are based upon current and anticipated economic conditions, nationally and in the Company’s market, interest rates and interest rate policy, competitive factors, and other conditions which by their nature, are not susceptible to accurate forecast, and are subject to significant uncertainty. Because of these uncertainties and the assumptions on which this discussion and the forward-looking statements are based, actual future operations and results may differ materially from those indicated herein. Readers are cautioned against placing undue reliance on any such forward-looking statements. The Company’s past results are not necessarily indicative of future performance.

Non-GAAP Presentations

This management’s discussion and analysis refers to the efficiency ratio, as adjusted, which is computed by dividing non-interest expense by the sum of net interest income on a tax equivalent basis and non-interest income before losses on other real estate owned (“OREO”). This is a non-GAAP financial measure that we believe provides investors with important information regarding our operational efficiency. Comparison of our efficiency ratio with those of other companies may not be possible because other companies may calculate the efficiency ratio, as adjusted, differently. The Company, in referring to its net income, is referring to income under accounting principles generally accepted in the United States, or “GAAP.”

General

The following presents management’s discussion and analysis of the consolidated financial condition and results of operations of Virginia Commerce Bancorp, Inc. and subsidiaries (the “Company”) as of the dates and for the periods indicated. This discussion should be read in conjunction with the Company’s Consolidated Financial Statements and the Notes thereto, and other financial data appearing elsewhere in this report. The Company is the parent bank holding company for Virginia Commerce Bank (the “Bank”), a Virginia state-chartered bank that commenced operations in May 1988. The Bank pursues a traditional community banking strategy, offering a full range of business and consumer banking services through twenty-eight branch offices, one residential mortgage office and one investment services office.

Headquartered in Arlington, Virginia, the Bank serves the Northern Virginia suburbs of Washington, D.C., including Arlington, Fairfax, Fauquier, Loudoun, Prince William, Spotsylvania and Stafford Counties and the cities of Alexandria, Fairfax, Falls Church, Fredericksburg, Manassas and Manassas Park. Its service area also covers, to a lesser extent, Washington, D.C. and the nearby Maryland counties of Montgomery and Prince Georges. The Bank’s customer base includes small-to-medium sized businesses including firms that have contracts with the U.S. government, associations, retailers and industrial businesses, professionals and their firms, business executives, investors and consumers.

Critical Accounting Policies

During the year ended December 31, 2009, there were no changes in the Company’s critical accounting policies as reflected in the Company’s most recent annual or quarterly report.

The Company’s financial statements are prepared in accordance with GAAP. The financial information contained within our 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 either when earning income, recognizing an expense, recovering an asset or relieving a liability. We use historical loss factors as one factor in determining the inherent loss that may be present in our loan portfolio. Actual losses could differ significantly from the historical factors that we use. In addition, 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.

The allowance for loan losses is an estimate of the losses that are inherent in our loan portfolio. The allowance is based on two basic principles of accounting: (i) Accounting for Contingencies (ASC 450 Contingencies), which requires that losses be accrued when they are probable of occurring and estimable and (ii) Accounting by Creditors for Impairment of a Loan (ASC 310 Receivables), 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.

Our allowance for loan losses has two basic components: the specific allowance and the general allowance. Each of these components is determined based upon estimates that can and do change when the actual events occur. The specific allowance is used to individually allocate an allowance for impaired loans. Impairment testing includes consideration of the borrower’s overall financial condition, resources and payment record, support available from financial guarantors and the fair market value of collateral. These factors are combined to estimate the probability and severity of inherent losses based on the Company’s calculation of the loss embedded in the individual loan. Large groups of smaller balance, homogeneous loans, representing 1-4 family residential first and second trusts, including home equity lines-of-credit, are collectively evaluated for impairment based upon factors such as levels and trends in delinquencies, trends in loss and problem loan identification, trends in volumes and concentrations, local and national economic trends and conditions including estimated levels of housing price depreciation/homeowners’ loss of equity, competitive factors and other considerations. These factors are converted into reserve percentages and applied against the homogenous loan pool balances. Impaired loans which meet the criteria for substandard, doubtful and loss are segregated from performing loans within the portfolio. Internally classified loans are then grouped by loan type (commercial, commercial real estate, commercial construction, residential real estate, residential construction or installment). The general formula is used to estimate the loss of non-classified loans. These un-criticized loans are also segregated by loan type and allowance factors are assigned by management based on delinquencies, loss history, trends in volume and terms of loans, effects of changes in lending policy, the experience and depth of management, national and local economic trends, concentrations of credit, quality of the loan review system and the effect of external factors (i.e. competition and regulatory requirements). The factors assigned differ by loan type. The general allowance recognizes potential losses whose impact on the portfolio has yet to be recognized by a specific allowance. Allowance factors and the overall size of the allowance may change from period to period based on management’s assessment of the above described factors and the relative weights given to each factor. For further information regarding the allowance for loan losses see Notes 1 and 4 to the Consolidated Financial Statements and the discussion under the caption “Asset Quality – Provision and Allowance for Loan Losses” at page 11.

The Company’s 1998 Stock Option Plan (the “Plan”), which is shareholder-approved, permits the grant of share options to its directors and officers for up to 2.3 million shares of common stock. Option awards are generally granted with an exercise price equal to the market price of the Company’s stock at the date of grant, generally vest based on 5 years of continuous service and have 10-year contractual terms. The fair value of each option award is estimated on the date of grant using a Black-Scholes option pricing model that currently uses historical volatility of the Company’s stock based on a 7.2 year expected term, before exercise, for the options granted, and a risk-free interest rate based on the U.S. Treasury Department (the “Treasury”) curve in effect at the time of the grant to estimate total stock-based compensation expense. This amount is then amortized on a straight-line basis over the requisite service period, currently 5 years, to salaries and benefits expense. See Notes 1 and 12 to the Consolidated Financial Statements for additional information regarding the Stock Option Plan and related expense.

On a quarterly basis the Company reviews any securities which are considered to be impaired as defined by accounting guidance, to determine if the impairment is deemed to be other-than-temporary. If it is determined that the impairment is other-than-temporary, i.e. impaired because of credit issues rather than interest rate, the investment is written down through the Statement of Operations in accordance with accounting guidance.

Financial Performance Overview

For the year ended December 31, 2009, the Company recorded a net operating loss of $33.3 million. After an effective dividend of $4.5 million to the Treasury on preferred stock, the Company recorded a net loss to common stockholders of $37.9 million, or $1.42 per diluted common share, with a return on average assets and return on average equity of a negative 1.22% and 13.89%, respectively. This loss in 2009, was primarily due to $81.9 million in loan loss provisions, taken in consideration of the level of non-performing loans and $53.2 million in net charge-offs. Earnings were also impacted by a $10.0 million loss on other real estate owned, a $1.8 million impairment loss

on securities, and a $3.0 million provision for a contingent liability related to an off-balance sheet letter-of-credit commitment. For the year ended December 31, 2008, operating earnings of $13.1 million, were down $12.7 million, or 49.3% compared to earnings of $25.8 million for the prior fiscal year as net interest income increased $7.8 million, or 10.5%, from $75.2 million in 2007, to $83.0 million in 2008, non-interest income decreased $1.5 million, or 18.4%, from $7.9 million in 2007, to $6.4 million, while provisions for loan losses were up $21.0 million, and non-interest expense rose 12.8%, from $39.7 million in 2007, to $44.8 million. In 2007, earnings of $25.8 million increased $1.3 million, or 5.2%, compared to earnings of $24.5 million in 2006, with net interest income increasing $6.4 million, or 9.2%, non-interest income rising $560 thousand, or 7.6%, while non-interest expense rose $5.4 million, or 15.8%. On a diluted per common share basis, earnings were $0.47 and $0.95 in 2008 and 2007, respectively, while the Company’s return on average assets was 0.51% for 2008, as compared to 1.21% in 2007, and its return on average equity was 7.18% in 2008 and 16.75% in 2007.

Total assets increased $9.4 million, or 0.35%, from $2.72 billion at December 31, 2008, to $2.73 billion at December 31, 2009, and increased $376.2 million, or 16.1%, from $2.34 billion at December 31, 2007, to $2.72 billion at December 31, 2008. Loans, net of the allowance for loan losses, decreased $63.0 million, or 2.8%, from $2.27 billion at December 31, 2008, to $2.21 billion at December 31, 2009, as non-farm, non-residential real estate loans increased $114.6 million, or 11.3%, and one-to-four family residential loans increased $49.5 million, or 13.9%, while real estate construction loans fell by $156.8 million, or 26.8%, and commercial and industrial loans were down 14.7%. Loan production in 2009 was negatively impacted by declining economic activity and demand in both the business and consumer sectors, a reallocation of lending personnel to problem loan identification and resolution and a strategic decision to moderate loan growth in the face of an uncertain economy and heightened risk factors. Loans are the Company’s principal asset class and primary contributor to interest income.

In 2008, the Company achieved significant growth in loans of $348.3 million, or 18.1%, from $1.92 billion at December 31, 2007, to $2.27 billion at December 31, 2008. The majority of loan growth occurred in non-farm, non-residential real estate loans, which rose $175.8 million, or 21.0%, from $835.5 million at December 31, 2007, to $1.01 billion at December 31, 2008. One-to-four family residential real estate loans represented the second largest increase rising $90.9 million, or 34.1%, from $266.4 million at December 31, 2007, to $357.3 million, while construction loans increased $40.8 million, or 7.5%, from $544.3 million at the end of 2007, to $585.1 million and commercial loans rose $40.8 million, or 17.1%, from $238.7 million at December 31, 2007, to $279.5 million.

While loans are the Company’s major asset, deposits are the Company’s major source of funding and as a result the major contributor to interest expense. Year-over-year, deposits increased $57.2 million, or 2.6%, to slightly over $2.2 billion, as demand deposits increased $44.8 million, or 23.0%, savings and interest-bearing demand deposits grew by $467.1 million, or 90.2%, and time deposits declined by $454.7 million, or 31.2%. The increases in savings and interest-bearing demand deposits were due primarily to success with the Company’s MEGA Savings and MEGA Checking accounts. The declines in time deposits are reflective of lower loan volume, requiring lower levels of funding, and a strategy to reduce the Bank’s historically heavy reliance on certificates of deposit as a funding source with deposit gathering efforts and cross-selling activities focused on demand deposits, and savings and interest-bearing demand accounts. The proportionate share of time deposits to total deposits has declined from 67.2% at year-end 2008 to 45.1% as of December 31, 2009. In 2008, deposits increased by $303.3 million, or 16.2%, with non-interest-bearing demand deposits decreasing by $19.0 million, or 8.9%, to $194.8 million, savings and interest-bearing demand deposits mostly unchanged and time deposits growing $321.1 million, or 28.2%, from $1.14 billion at December 31, 2007, to $1.46 billion.

The Company’s investment securities portfolio represents its second largest asset class and contributor to interest income, and is generally maintained as a primary source of liquidity. Investment securities increased $22.9 million, or 7.0%, from $325.7 million at December 31, 2008, to $348.6 million at December 31, 2009, and increased by $5.6 million, or 1.8%, from $320.1 million at December 31, 2007, to $325.7 million at December 31, 2008. The majority of the year-over-year increase in securities was concentrated in U.S. Government Agency debt obligations and mortgage-backed securities, and bank-qualified municipal bonds.

Stockholders’ equity decreased $34.4 million, or 13.6%, from $253.3 million at December 31, 2008, to $218.9 million at December 31, 2009, with a net loss to common stockholders of $37.9 million over the twelve-month period, a $1.1 million increase in other comprehensive income related to the investment securities portfolio, and $918 thousand in proceeds and tax benefits related to the exercise of options by company directors, officers and employees and stock option expense credits. As a result of these changes, the Company’s Tier 1 capital ratio decreased from 13.07% at December 31, 2008, to 11.48% at December 31, 2009, and its total qualifying capital ratio

declined from 14.44% to 12.73% for the same period. In 2008, stockholders’ equity increased by $84.1 million, or 49.8%, from $169.1 million at December 31, 2007, to $253.3 million, with earnings of $13.1 million, a $1.9 million decrease in other comprehensive income related to the investment securities portfolio, and $911 thousand in proceeds and tax benefits related to the exercise of options by Company directors, officers and employees and stock option expense credits. On September 24, 2008, the Company raised $25 million in qualifying capital through the sale of trust preferred securities to the Company’s directors and certain of its executive officers. In connection with the issuance of the trust preferred securities, the Company also issued warrants to purchase an aggregate of 1.5 million shares of common stock to the purchasers. On December 12, 2008, the Company issued $71 million in preferred stock to the Treasury under the Capital Purchase Program. In connection with the issuance of the preferred stock, the Company also issued to the Treasury warrants to purchase approximately 2.7 million shares of common stock. Please refer to “Capital Issuances” at page 21 for a discussion of the issuance of securities under the Capital Purchase Program.

Net Interest Income

Net interest income is the excess of interest earned on loans and investments over the interest paid on deposits and borrowings and is the Company’s primary revenue source. Net interest income is thereby affected by overall balance sheet growth, changes in interest rates and changes in the mix of investments, loans, deposits and borrowings. For the year ending December 31, 2009, net interest income of $91.4 million was up 10.1%, compared to $83.0 million in 2008, as the net interest margin rose from 3.30% in 2008, to 3.45%. This year-over-year increase in the net interest margin was driven by lower deposit costs due to significant reductions in the level of time deposits, increased levels of demand deposits and increased levels of lower rate interest-bearing transaction accounts. As a result, the average cost of interest-bearing deposits fell from 3.55% in 2008, to 2.50% in 2009, while yields on interest-earning assets fell to a lesser extent from an average of 6.35% in 2008, to 5.67% in 2009.

In 2008, net interest income increased $7.8 million, or 10.5%, from $75.2 million in 2007, to $83.0 million due to significant growth in loans as the net interest margin fell from 3.65% in 2007, to 3.30%, with the yield on interest-earning assets falling 111 basis points from 7.46% to 6.35%, while the cost of interest-bearing liabilities fell 94 basis points to 3.52%. In 2007, net interest income increased $6.4 million, or 9.2%, from $68.8 million in 2006, to $75.2 million due again to significant loan growth as the net interest margin fell from 4.07% in 2006, to 3.65%, with the cost of interest-bearing liabilities rising from 4.00% in 2006 to 4.46%, while the yield on interest-earning assets increased by only five basis points from 7.41% in 2006 to 7.46%. The declines in yields and the cost of funds in 2008 were highly affected by a Federal Open Market Committee campaign, beginning in September 2007, to lower the Federal funds target rate. That campaign ended in September 2008 with a target rate range of 0.25% and as a result the prime lending rate fell to 3.25%. These rates remained unchanged in 2009. Tables 1 and 2 provide further information with regard to yields, costs, the changes in net interest income and associated risk.

TABLE 1: AVERAGE BALANCES, INCOME AND EXPENSE, YIELDS AND RATES

The following table shows the average balance sheets for each of the years ended December 31, 2009, 2008, and 2007. In addition, the amounts of interest earned on interest-earning assets, with related yields, and interest expense on interest-bearing liabilities, with related rates, are shown. Loans placed on a non-accrual status are included in the average balances. Net loan fees and late charges included in interest income on loans totaled $3.3 million, $5.0 million and $5.5 million for 2009, 2008, and 2007, respectively.


	2009						2008						2007
(Dollars in thousands)	Average Balance		Interest Income- Expense		Average Yields/ Rates		Average Balance		Interest Income- Expense		Average Yields/ Rates		Average Balance		Interest Income- Expense		Average Yields/ Rates
Assets
Securities (1)	$	334,873	$	15,641	4.82	%	$	320,497	$	16,265	5.19	%	$	275,645	$	13,640	5.03	%
Restricted stock		11,589		355	3.06	%		7,695		320	4.15	%		5,207		308	5.92	%
Loans, net of unearned income		2,279,294		134,548	5.91	%		2,180,883		143,501	6.57	%		1,766,501		138,919	7.87	%
Interest-bearing deposits in other banks		91		—	0.09	%		4,831		145	2.99	%		2,802		140	5.01	%
Federal funds sold		42,718		89	0.20	%		14,067		237	1.66	%		22,372		1,131	4.98	%

Total interest-earning assets	$	2,668,565	$	150,633	5.67	%	$	2,527,973	$	160,468	6.35	%	$	2,072,527	$	154,138	7.46	%

Other assets		67,737						54,611						61,415

Total assets	$	2,736,302					$	2,582,584					$	2,133,942

Liabilities & Stockholders’ Equity
Interest-bearing deposits
NOW accounts	$	228,189	$	2,825	1.24	%	$	165,374	$	2,655	1.60	%	$	155,047	$	2,499	1.61	%
Money market accounts		157,216		2,302	1.46	%		198,429		5,389	2.71	%		224,524		8,806	3.92	%
Savings accounts		381,042		7,764	2.04	%		175,629		5,124	2.91	%		120,061		5,148	4.29	%
Time deposits		1,221,328		36,707	3.01	%		1,349,116		54,093	4.00	%		1,054,962		52,945	5.02	%

Total interest-bearing deposits	$	1,987,775	$	49,598	2.50	%	$	1,888,548	$	67,261	3.55	%	$	1,554,594	$	69,398	4.46	%

Securities sold under agreement to repurchase and federal funds purchased		186,106		3,475	1.87	%		223,114		5,534	2.47	%		165,499		6,259	3.78	%

Other borrowed funds		25,000		1,077	4.25	%		36,202		1,235	3.36	%		6,986		225	3.18	%

Trust preferred capital notes		65,930		5,079	7.60	%		46,373		3,400	7.21	%		42,614		3,099	7.17	%

Total interest-bearing liabilities	$	2,264,811	$	59,229	2.62	%	$	2,194,237	$	77,430	3.52	%	$	1,769,693	$	78,981	4.46	%

Demand deposits and other liabilities		231,554						206,117						210,262

Total liabilities	$	2,496,365					$	2,400,354					$	1,979,955

Stockholders’ equity		239,937						182,230						153,987

Total liabilities and stockholders’ equity	$	2,736,302					$	2,582,584					$	2,133,942

Interest rate spread					3.05	%					2.83	%					3.00	%
Net interest income and margin			$	91,404	3.45	%			$	83,038	3.30	%			$	75,157	3.65	%

(1)

Yields on securities available-for-sale have been calculated on the basis of historical cost and do not give effect to changes in the fair value of those securities, which are reflected as a component of stockholders’ equity. Average yields on tax-exempt securities are stated on a tax equivalent basis, using a 35% rate.

TABLE 2: RATE-VOLUME VARIANCE ANALYSIS

Interest income and expense are affected by changes in interest rates, by changes in the volumes of earning assets and interest-bearing liabilities, and by changes in the mix of these assets and liabilities. Changes attributable to both volume and rate have been allocated proportionately. The following analysis shows the year-to-year changes in the components of net interest income.


	2009 compared to 2008									2008 compared to 2007
	Increase/(Decrease) Due to						Total Increase/ (Decrease)			Increase/(Decrease) Due to						Total Increase/ (Decrease)
(Dollars in thousands)	Volume			Rate			Total Increase/ (Decrease)			Volume			Rate			Total Increase/ (Decrease)
Interest Income
Loans	$	5,425		$	(14,378	)	$	(8,953	)	$	27,628		$	(23,046	)	$	4,582
Securities		566			(1,190	)		(624	)		2,170			456			2,626
Restricted Stock		120			(85	)		35			103			(92	)		11
Interest bearing deposits in other banks		(4	)		(141	)		(145	)		61			(56	)		5
Federal funds sold		58			(206	)		(148	)		(137	)		(757	)		(894	)

Total interest income	$	6,165		$	(16,000	)	$	(9,835	)	$	29,825		$	(23,495	)	$	6,330

Interest Expense
Interest-bearing deposits:
NOW accounts	$	770		$	(600	)	$	170		$	173		$	(17	)	$	156
Money market accounts		(618	)		(2,469	)		(3,087	)		(684	)		(2,733	)		(3,417	)
Savings accounts		4,171			(1,531	)		2,640			1,635			(1,659	)		(24	)
Time deposits		(4,496	)		(12,890	)		(17,386	)		11,406			(10,258	)		1,148

Total interest-bearing deposits	$	(173	)	$	(17,490	)	$	(17,663	)	$	12,530		$	(14,667	)	$	(2,137	)
Securities sold under agreement to repurchase and federal funds purchased		(706	)		(1,353	)		(2,059	)		1,446			(2,171	)		(725	)
Other borrowed funds		(486	)		328			(158	)		997			13			1,010
Trust preferred capital notes		1,497			182			1,679			284			17			301

Total interest expense	$	132		$	(18,333	)	$	(18,201	)	$	15,257		$	(16,808	)	$	(1,551	)

Change in Net Interest Income	$	6,033		$	2,333		$	8,366		$	14,568		$	(6,687	)	$	7,881

Asset/Liability Management and Quantitative and Qualitative Disclosures about Market Risk

In the normal course of business, the Company is exposed to market risk, or interest rate risk, as its net income is largely dependent on its net interest income. Market risk is managed by the Company’s Asset/Liability Management Committee that formulates and monitors the performance of the Company based on established levels of market risk as dictated by policy. In setting tolerance levels, or limits on market risk, the Committee considers the impact on earnings and capital, the level and general direction of interest rates, liquidity, local economic conditions and other factors. Interest rate risk, or interest sensitivity, can be defined as the amount of forecasted net interest income that may be gained or lost due to favorable or unfavorable movements in interest rates. Interest rate risk, or sensitivity, arises when the maturity or repricing of interest-earning assets differs from the maturing or repricing of interest-bearing liabilities and as a result of the difference between total interest-earning assets and interest-bearing liabilities. The Company seeks to manage interest rate sensitivity while enhancing net interest income by periodically adjusting this asset/liability position. In order to closely monitor and measure interest sensitivity, the Company uses earnings simulation models on a quarterly basis.

We use a duration gap of equity approach to manage our long term interest rate risk. This approach uses a model which generates estimates of the change in our market value of portfolio equity (“MVPE”) over a range of interest rate scenarios. MVPE is the present value of expected cash flows from assets and liabilities using various assumptions about estimated loan prepayment rates, reinvestment rates and deposit decay rates.

Our short term interest rate sensitivity is managed through the use of a model that generates estimates of the change in the net interest income over a range of interest rate scenarios. Net interest income depends upon the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rates earned or paid on them. The model assumes that the composition of interest sensitive assets and liabilities existing at December 31, 2009, remains constant over a one year period (base case) and also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities.

The following table provides an analysis of our interest rate risk as measured by the estimated change in MVPE and net interest income from the base case, resulting from instantaneous and sustained parallel shifts in interest rates as of December 31, 2009 (in thousands):


	Sensitivity of Market Value of Portfolio Equity December 31, 2009									Sensitivity of Net Interest Income December 31, 2009
	Market Value of Portfolio Equity									Net Interest Income					Net Interest Margin
Interest Rate Scenario	Amount		$ Change from Base			Percent		% of Total Assets		Amount		$ Change from Base			Percent		% Change from Base
Up 300 bps	$	165,528	$	(66,065	)	-28.53	%	6.07	%	$	92,622	$	(5,796	)	3.48	%	-5.82	%
Up 200 bps		189,646		(41,948	)	-18.11	%	6.96	%		94,464		(3,954	)	3.55	%	-3.97	%
Base Case		231,594		—		0.00	%	8.50	%		98,418		—		3.69	%	0.00	%
Down 100 bps		236,389		4,795		2.07	%	8.67	%		98,051		(367	)	3.68	%	-0.39	%

Management believes the modeled results are consistent with the short duration of its balance sheet and given the many variables that affect the actual timing of when assets and liabilities will reprice. Since the earnings model uses numerous assumptions regarding the effect of changes in interest rates on the timing and extent of repricing characteristics, future cash flows and customer behavior, the model cannot precisely estimate net income and the effect on net income from sudden changes in interest rates. Actual results will differ from the simulated results due to the timing, magnitude and frequency of interest rate changes and changes in market conditions and management strategies, among other factors.

Non-Interest Income (Charges)

The Company’s non-interest income sources include service charges and other fees on deposit accounts, fees and net gains from loans originated and sold through its mortgage lending division, commissions from non-deposit investment sales and increases in the cash surrender value of Bank owned life insurance policies. For the year ended December 31, 2009, non-interest income (charges) reflects a loss of $4.4 million compared to $6.4 million of income in 2008 due to $10.0 million in losses on other real estate owned and a $1.8 million impairment loss on securities. Excluding this total of $11.8 million in losses, non-interest income rose $1.0 million with slightly lower deposit account service charges offset by a $1.4 million increase in fees and net gains on mortgage loans originated and sold. The losses on OREO are consistent with management’s commitment to aggressive disposition of these assets, while the impairment loss on securities was due to deferrals and defaults by the underlying issuers of the Bank’s investment in pooled trust preferred securities. In 2008, non-interest income decreased $1.5 million or 18.4%, from $7.9 million in 2007 to $6.4 million, and increased $560 thousand, or 7.6%, from $7.3 million in 2006, to $7.9 million in 2007. Of the total decline in non-interest income in 2008, $1.2 million was due to lower fees and net gains on mortgage loans originated for sale as the level of mortgages originated declined from $158.0 million in 2007, to $80.6 million in 2008. This was due to the Bank holding more of its originations in portfolio rather than selling them, due to a reduction in demand and available loan products in the secondary market. In 2009, the Bank originated $188.7 million in mortgages for sale.

Service charges and other fees, which include monthly deposit account maintenance charges, overdraft fees, ATM fees and charges, debit card interchange income, safe deposit box rents, merchant discount fee income, and lock-box service fees, decreased $296 thousand, or 7.6%, from $3.9 million in 2008, to $3.6 million in 2009, and increased $514 thousand, or 15.2%, from $3.4 million in 2007, to $3.9 million in 2008. In 2007, service charges and other fees were up $162 thousand, or 5.0%, from $3.2 million to $3.4 million. The decline in 2009 was due to lower levels of overdraft fees, while the increase in 2008 was the result of a new debit card rewards program that increased debit card interchange income.

Non-deposit investment services commissions, which the Bank offers through a third party arrangement, were down $102 thousand in 2009, from $702 thousand to $600 thousand, were down $68 thousand in 2008 from $770 thousand in 2007, and were up $149 thousand in 2007 from $621 thousand in 2006. In 2007, non-interest income results also include a gain on the sale of OREO of $638 thousand and a loss of $387 thousand on the sale of securities related to a partial restructuring of the securities portfolio.

Non-Interest Expense

Non-interest expense increased $12.1 million, or 27.0%, from $44.8 million in 2008, to $56.9 million in 2009, increased $5.1 million, or 12.8%, from $39.7 million in 2007, to $44.8 million in 2008, and increased $5.4 million, or 15.8%, from $34.3 million in 2006, to $39.7 million in 2007. In 2009, non-interest expense includes a $3.0 million contingent liability provision related to an off-balance sheet letter-of-credit commitment. Excluding that expense item non-interest expense increased $9.1 million, or 20.4%.

In 2009, salaries and benefits were down $322 thousand, or 1.4%, while they accounted for $826 thousand, or 16.2%, of the total increase in non-interest expense in 2008, and $2.6 million, or 48.6%, of increases in non-interest expense in 2007. Commissions and incentive compensation associated with the significant increases in total loans and the hiring of additional loan officers, together with increased compensation and benefits expense associated with additional employees added due to overall growth and branch expansion were the reason for the increase in 2007 while the much lower increase in 2008 and the decline in 2009 were due to lower commissions and incentive compensation due to lower Company earnings.

Occupancy expenses, which include rents, depreciation, maintenance on buildings, leaseholds and equipment, increased $1.4 million, or 15.8%, from $8.9 million in 2008, to $10.3 million in 2009, increased $1.9 million, or 26.0%, from $7.0 million in 2007, to $8.9 million in 2008, and increased $1.6 million, or 29.1%, in 2007. These increases over the three year period were due to the opening of nine new branch locations and expanded office facilities for lending units and other back office support departments. The Bank opened its twenty-eighth branch in January 2010.

Other operating expenses, which include advertising and public relations expenses, legal and professional fees, insurance, OREO expense, telecommunications and supplies, increased $2.3 million, or 31.3%, from $7.4 million in 2008, to $9.7 million in 2009, increased $1.3 million, or 19.7%, from $6.2 million in 2007, to $7.4 million in 2008, and increased $384 thousand, or 6.7%, from $5.7 million in 2006, to $6.1 million in 2007. The increases over the years are generally due to branch expansion and overall growth, with year-over-year increases in advertising and public relations as well as higher legal and professional services expenses associated with the resolution of non-performing loans and $1.2 million in expenses on other real estate owned.

Income Taxes

The Company’s income tax provisions are adjusted for non-deductible expenses and non-taxable interest after applying the U.S. federal income tax rate of 35%. The provision for income taxes totaled $13.2 million and $6.2 million for the years ended December 31, 2007, and 2008, while the Company recorded a carry-back benefit of $18.4 million in 2009. The effects of non-deductible expenses and non-taxable interest on the Company’s income tax provisions are minimal. For further information regarding the provisions for income taxes see Note 8 to the Consolidated Financial Statements.

Asset Quality - Provision and Allowance For Loan Losses

For the year ended December 31, 2009, provisions for loan losses were $81.9 million compared to $25.4 million in 2008, with total net charge-offs in 2009 of $53.2 million versus $11.2 million for the year ended December 31, 2008. In 2007, provisions totaled $4.3 million with net charge-offs of $181 thousand. As a result of these provisions, the total allowance for loan losses increased $28.7 million, or 78.6%, from $36.5 million at December 31, 2008, to $65.2 million at December 31, 2009, increased from $22.3 million at December 31, 2007, to $36.5 million at December 31, 2008, increased $14.2 million, or 63.9%, in 2008, and increased $4.2 million, or 23.0%, in 2007.

The increase in the total allowance in 2007 was consistent with an 18.1% increase in loans as net-charge offs were minimal and the level of non-performing assets and loans 90 + days past due were very low. In 2008, while some of the increase in the allowance was associated with overall loan growth, the most significant factor was a $120.5 million increase in non-performing assets and loans 90 + days past due from $4.4 million at December 31, 2007, to $124.9 million at December 31, 2008. While non-performing assets and loans 90+ days past due declined in 2009, to $98.1 million, the allowance increased as other identified potential problem loans, which are classified as impaired loans, although well-secured and currently performing, but in some instances requiring higher reserve levels, rose from $49.3 million at December 31, 2008, to $171.8 million at December 31, 2009. As a percent of total loans, the allowance has increased from 1.58% as of December 31, 2008, to 2.86% as of December 31, 2009, and as a percent of non-performing loans it has increased from 31.1% as of December 31, 2008, to 93.6% at December 31, 2009. See “Risk Elements and Non-Performing Assets” later in this discussion for more information on non-performing assets and loans 90 + days past due and other impaired loans.

Management feels that the allowance for loan losses is adequate at December 31, 2009. However, there can be no assurance that additional provisions for loan losses will not be required in the future, including as a result of possible changes in the economic assumptions underlying management’s estimates and judgments, adverse developments in the economy, and the residential real estate market in particular, on a national basis or in the Company’s market area, or changes in the circumstances of particular borrowers.

The Company generates a quarterly analysis of the allowance for loan losses, with the objective of quantifying portfolio risk into a dollar figure of inherent losses, thereby translating the subjective risk value into an objective number. Emphasis is placed on semi-annual independent external loan reviews and monthly internal reviews. The determination of the allowance for loan losses is based on applying and summing the results of eight qualitative factors and a historical loss factor to each category of loans along with any specific allowance for impaired and adversely classified loans within the particular category. Each factor is assigned a percentage weight and that total weight is applied to each loan category. The resulting sum from each loan category is then combined to arrive at a total allowance for all categories. Factors are different for each loan category. Qualitative factors include: levels and trends in delinquencies and non-accruals, trends in volumes and terms of loans, effects of any changes in lending policies, the experience, ability and depth of management, national and local economic trends and conditions, concentrations of credit, quality of the Company’s loan review system, and regulatory requirements. The total allowance required thus changes as the percentage weight assigned to each factor is increased or decreased due to its particular circumstance, as historical loss factors are updated, as the various types and categories of loans change as a percentage of total loans and as specific allowances are required on impaired loans and charge-offs occur. The decision to specifically reserve for or to charge-off or partially charge-off an impaired loan balance is based upon an evaluation of that loan’s potential to improve, based upon near term change in financial or market conditions, which would enable collection of the portion of the loan determined to be impaired. If these conditions are determined to be favorable, a specific reserve would be established as opposed to a charge-off. For further information regarding the allowance for loan losses see Notes 1 and 4 to the Consolidated Financial Statements.

TABLE 3: PROVISION AND ALLOWANCE FOR LOAN LOSSES


(Dollars in thousands)	2009			2008			2007			2006			2005
Allowance, beginning of period	$	36,475		$	22,260		$	18,101		$	13,821		$	10,402

Charge-Offs
Real estate loans	$	37,879		$	7,493		$	—		$	—		$	—
Commercial loans		16,317			3,436			—			112			341
Consumer loans		417			392			212			77			21

Total charge-offs	$	54,613		$	11,321		$	212		$	189		$	362

Recoveries
Real estate loans	$	571		$	77		$	—		$	—		$	—
Commercial loans		739			16			—			—			—
Consumer loans		67			65			31			63			9

Total recoveries	$	1,377		$	158		$	31		$	63		$	9

Net charge-offs	$	53,236		$	11,163		$	181		$	126		$	353

Provision for loan losses		81,913			25,378			4,340			4,406			3,772

Allowance, end of period	$	65,152		$	36,475		$	22,260		$	18,101		$	13,821

Ratio of net charges-offs to average total loans outstanding during period		2.34	%		0.51	%		0.01	%		0.01	%		0.03	%

TABLE 4: ALLOCATION OF ALLOWANCE FOR LOAN LOSSES

The allowance for loan losses includes specific allowances for impaired loans and a general allowance applicable to all loan categories; however, management has allocated the allowance to provide an indication of the relative risk characteristics of the loan portfolio. The allocation is an estimate and should not be interpreted as an indication that charge-offs will occur in these amounts, or that the allocation indicates future trends. The allocation of the allowance at December 31 for the years indicated and the ratio of related outstanding loan balances to total loans are as follows:


(Dollars in thousands)	2009			2008			2007			2006			2005
Allocation of allowance for loan losses:
Real estate – mortgage	$	26,514		$	9,375		$	9,226		$	8,654		$	7,298
Real estate – construction		26,957			18,485			6,612			4,939			3,599
Commercial		11,241			8,489			6,304			4,449			2,865
Consumer		440			126			118			59			59

Balance, December 31,	$	65,152		$	36,475		$	22,260		$	18,101		$	13,821

Ratio of loans to total year-end loans:
Real estate – mortgage		70	%		62	%		59	%		57	%		60	%
Real estate – construction		19	%		25	%		28	%		31	%		30	%
Commercial		10	%		12	%		12	%		11	%		9	%
Consumer		1	%		1	%		1	%		1	%		1	%

		100	%		100	%		100	%		100	%		100	%

See Notes 1 and 4 to the Consolidated Financial Statements for additional information regarding the provision and allowance for loan losses.

Risk Elements and Non-Performing Assets

Non-performing assets consist of non-accrual loans and other real estate owned (foreclosed properties). For the year ended December 31, 2009, the total non-performing assets and loans 90+ days past due and still accruing interest decreased by $26.8 million, or 21.4%, from $124.9 million at December 31, 2008, to $98.1 million at December 31, 2009, and increased $120.5 million from $4.4 million at year-end 2007, to $124.9 million at year-end 2008. As a result, the ratio of non-performing assets and loans 90+ days past due and still accruing to total assets decreased from 4.60% at December 31, 2008, to 3.60% at December 31, 2009. In addition, other impaired loans, which include loans well-secured and currently performing, but in some instances requiring higher reserve levels, and troubled debt restructurings, performing in accordance with their modified terms, increased from $49.3 million at December 31, 2008, to $171.8 million at December 31, 2009. Troubled debt restructuring represented $71.9 million of total impaired loans as of December 31, 2009. There were no trouble debt restructurings as of December 31, 2008.

Loans are placed in non-accrual status when in the opinion of management the collection of additional interest is unlikely or a specific loan meets the criteria for non-accrual status established by regulatory authorities. No interest is taken into income on non-accrual loans. A loan remains on non-accrual status until the loan is current as to both principal and interest or the borrower demonstrates the ability to pay and remain current, or both. Troubled debt restructurings continue to be individually tested for impairment for a period of one year from their modification date.

TABLE 5: NON-PERFORMING ASSETS


	December 31,
(Dollars in thousands)	2009			2008			2007			2006			2005
Non-accrual loans	$	65,809		$	111,234		$	3,826		$	3,920		$	1,994
Other real estate owned		28,499			7,569			—			—			—

Total non-performing assets	$	94,308		$	118,803		$	3,826		$	3,920		$	1,994

Loans past due 90 days and still accruing		3,826			6,118			579			—			7

Total non-performing assets and past due loans	$	98,134		$	124,921		$	4,405		$	3,920		$	2,001

Allowance for loan losses to total loans		2.86	%		1.58	%		1.14	%		1.10	%		1.07	%
Allowance for loan losses to non-performing loans		93.56	%		31.08	%		505.33	%		461.76	%		693.1	%
Non-performing assets and past due loans to total loans		4.31	%		5.40	%		0.23	%		0.24	%		0.15	%
Non-performing assets and past due loans to total assets		3.60	%		4.60	%		0.19	%		0.20	%		0.13	%

Non-performing loans continue to be concentrated in residential and commercial construction and land development loans in outer sub-markets hardest hit by the residential downturn and commercial and consumer credits experiencing the after shocks in sub-contracting businesses and workforce employment. Overall, as of December 31, 2009, $37.5 million, or 53.9%, of non-performing loans represented acquisition, development and construction loans, $15.1 million, or 21.7%, represented non-farm, non-residential loans, $10.7 million, or 15.4%, represented commercial and industrial loans and $6.2 million, or 8.9%, represented loans on one-to-four family residential properties. The Company would have recorded additional gross interest income of approximately $5.2 million for 2009, $3.8 million for 2008 and $305 thousand for 2007, if non-accrual loans had been current throughout these periods. Interest actually received on non-accrual loans was $979 thousand in 2009, $174 thousand in 2008 and $134 thousand in 2007. See Notes 1 and 4 to the Consolidated Financial Statements for additional information regarding the Company’s non-performing assets. Tables 6 and 7 provide a breakdown of the construction loan portfolio by location including loans on non-accrual status and percentage of net-charge offs in 2009. Table 8 provides a breakdown of the non-farm/non-residential portfolio by location including loans on non-accrual status and percentage of net charge-offs in 2009.

TABLE 6: RESIDENTIAL, ACQUISITION, DEVELOPMENT AND CONSTRUCTION LOANS


	As of December 31, 2009
(Dollars in thousands) County/Jurisdiction of Origination:	Total Outstandings		Percentage of Total		Non-accrual Loans		Non-accruals as a % of Outstandings		Net charge-offs as a % of Outstandings
District of Columbia	$	16,480	6.9	%	$	—	—		-0.1	%
Montgomery, MD		9,621	4.0	%		2,972	1.2	%	0.9	%
Prince Georges, MD		23,437	9.8	%		1,000	0.4	%	2.2	%
Other Counties in MD		4,834	2.0	%		—	—		0.5	%
Arlington/Alexandria, VA		47,756	19.9	%		4,159	1.7	%	—
Fairfax, VA		56,679	23.6	%		7,524	3.1	%	1.3	%
Culpeper/Fauquier, VA		1,022	0.4	%		200	0.1	%	0.1	%
Frederick, VA		12,631	0.0	%		6,250	2.6	%	0.9	%
Henrico, VA		—	0.0	%		—	—		0.1	%
Loudoun, VA		28,551	11.9	%		770	0.3	%	0.3	%
Prince William, VA		11,659	4.9	%		2,854	1.2	%	0.9	%
Spotsylvania, VA		871	0.4	%		—	—		—
Stafford, VA		22,514	9.4	%		4,898	2.0	%	—
Other Counties in VA		3,851	6.9	%		—	—		0.3	%
Outside VA, MD & DC		110	0.0	%		—	—		0.4	%

Totals	$	240,016	100.0	%	$	30,627	12.8	%	7.8	%

TABLE 7: COMMERCIAL, ACQUISITION, DEVELOPMENT AND CONSTRUCTION LOANS


	As of December 31, 2009
(Dollars in thousands) County/Jurisdiction of Origination:	Total Outstandings		Percentage of Total		Non-accrual Loans		Non-accruals as a % of Outstandings		Net charge-offs as a % of Outstandings
District of Columbia	$	14,709	7.8	%	$	—	—		—
Montgomery, MD		1,407	0.7	%		—	—		—
Prince Georges, MD		11,215	6.0	%		—	—		—
Other Counties in MD		7,749	4.1	%		—	—		—
Arlington/Alexandria, VA		9,312	4.9	%		—	—		—
Fairfax, VA		18,060	9.6	%		—	—		5.8	%
Henrico, VA		816	0.4	%		—	—		—
Loudoun, VA		32,528	17.3	%		4,797	2.5	%	1.3	%
Prince William, VA		51,399	27.3	%		2,114	1.1	%	0.1	%
Spotsylvania, VA		2,679	1.4	%		—	—		—
Stafford, VA		29,005	15.4	%		—	—		—
Other Counties in VA		6,997	3.7	%		—	—		—
Outside VA, MD & DC		2,400	1.3	%		—	—		—

Totals	$	188,276	100.0	%	$	6,911	3.6	%	7.2	%

TABLE 8: NON-FARM/NON-RESIDENTIAL LOANS


	As of December 31, 2009
(Dollars in thousands) County/Jurisdiction of Origination:	Total Outstandings		Percentage of Total		Non-accrual Loans		Non-accruals as a % of Outstandings		Net charge-offs as a % of Outstandings
District of Columbia	$	73,355	6.5	%	$	—	—		—
Montgomery, MD		33,637	3.0	%		—	—		—
Prince Georges, MD		60,130	5.3	%		1,156	0.1	%	—
Other Counties in MD		48,411	4.3	%		—	—		—
Arlington/Alexandria, VA		180,193	16.0	%		4,065	0.4	%	0.02	%
Fairfax, VA		277,116	24.6	%		1,242	0.1	%	—
Culpeper/Fauquier, VA		1,289	0.1	%		—	—		—
Henrico, VA		31,317	2.8	%		1,875	0.2	%	—
Loudoun, VA		111,076	9.9	%		1,122	0.1	%	0.04	%
Prince William, VA		185,269	16.5	%		1,622	0.1	%	0.10	%
Spotsylvania, VA		20,305	1.8	%		—	—		—
Stafford, VA		22,176	2.0	%		—	—		—
Other Counties in VA		71,421	6.3	%		4,024	0.4	%	—
Outside VA, MD & DC		10,250	0.9	%		—	—		—

Totals	$	1,125,945	100.0	%	$	15,106	1.3	%	0.16	%

Foreclosed real properties include properties that have been substantively repossessed or acquired in complete or partial satisfaction of debt. Such properties, which are held for resale, are carried at the lower of book value or fair value, including a reduction for the estimated selling expenses, or principal balance of the related loan. Reviews and discussions with regard to value and disposition of each foreclosed property are conducted monthly by the Company’s Special Assets Committee. The carrying value of a foreclosed asset is immediately adjusted down when new information is obtained, including a potentially acceptable offer, the sale of a similar property in the vicinity of one of the Company’s assets, and/or a change in the price the property is being listed for. In 2007, the Company foreclosed on a $1.8 million non-performing loan and subsequently sold the collateral property for a pre-tax gain of $638 thousand. In 2009, the Company recorded $10.0 million in losses on foreclosed real properties. The following tables provide a breakdown of foreclosed real properties by type and a roll-forward of activity for the years ended December 31, 2008 and 2009:

TABLE 9: OTHER REAL ESTATE OWNED BY TYPE


	Year-end December 31,
(Dollars in thousands)	2009		2008
Residential Land	$	15, 081	$	7,569
Residential Building		2,649		—
Commercial Land		1,430		—
Commercial Building		9,339		—
Total other real estate owned	$	28,499	$	7,569

TABLE 10: OTHER REAL ESTATE OWNED ACTIVITY


	Year-ended December 31,
(Dollars in thousands)	2009			2008
Beginning Balance	$	7,569		$	0
Additions		40,229			7,499
Capital improvements		372			395
Valuation adjustments		(9,067	)		—
Dispositions		(9,719	)		(331	)
(Loss) gain on disposition		(885	)		—
Ending Balance	$	28,499		$	7,569

Loan Portfolio

The Bank’s lending activities are its principal source of income. Real estate loans, including residential permanents and construction, and commercial permanents, represent the major portion of the Bank’s loan portfolio. Loans, net of unearned income and the allowance for loan losses, decreased $63.0 million, or 2.8%, from $2.27 billion at December 31, 2008, to $2.21 billion at December 31, 2009, as non-farm, non-residential real estate loans increased $114.6 million, or 11.3%, and one-to-four family residential loans increased $49.5 million, or 13.9%, while real estate construction loans fell by $156.8 million, or 26.8%, and commercial and industrial loans were down 14.7%. In 2008, net loans increased $348.3 million, or 18.1%, from $1.92 billion at December 31, 2007, to $2.27 billion at year-end 2008, and included an increase in real estate mortgage loans of $276.4 million, or 23.9%, an increase in commercial loans of $40.8 million, or 17.1%, and an increase in real estate construction loans of $40.8 million, or 7.5%. At December 31, 2009, $224.9 million of total real estate construction loans were to commercial builders of single-family housing, $15.2 million were to individuals on single-family properties and $188.3 million were related to commercial properties. At December 31, 2008, $296.3 million of real estate construction loans were to commercial builders of single-family housing, $20.7 million were to individuals on single-family properties and $268.1 million were related to commercial properties. The Bank expects that its real estate construction loan portfolio will continue to decline as that lending focus is significantly curtailed.

As noted above, the majority of the Bank’s loan portfolio consists of construction and commercial real estate loans. At December 31, 2009, the Bank had $224.9 million of construction loans to commercial builders of single family housing in the Northern Virginia market, representing 9.9% of total loans. These loans are made to a number of unrelated entities and generally have a term of twelve to eighteen months. Adverse developments in the Northern Virginia real estate market and economy have adversely impacted this portfolio of loans and the Company’s income and financial position. In addition, the Bank had $1.12 billion, or 49.4% of the loan portfolio at December 31, 2009, secured by non-farm non-residential properties with $452.8 million of these loans representing owner-occupied properties. These non-farm non-residential loans represent obligations of a diversified pool of borrowers across numerous businesses and industries in the Northern Virginia market and include some loans that, although secured by commercial real estate, are commercial purpose loans made based on the financial condition of the underlying business. At December 31, 2009, the Company had no other concentrations of loans in any one industry exceeding 10% of its total loan portfolio. An industry for this purpose is defined as a group of counterparties that are engaged in similar activities and have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions. For further information regarding concentrations of loans see Note 17 to the Consolidated Financial Statements.

Under guidance from the federal banking regulators, banks which have concentrations in construction, land development or commercial real estate loans would be expected to maintain higher levels of risk management and, potentially, higher levels of capital. It is possible that we may be required to maintain higher levels of capital than we would otherwise be expected to maintain as a result of our levels of construction, development and commercial real estate loans, which may require us to obtain additional capital. The Bank seeks to manage its concentrations of loans through the establishment of limits on the level of its various loan types to total loans and to total capital. Excluded from the scope of this guidance are loans secured by non-farm nonresidential properties where the primary source of repayment is the cash flow from the ongoing operations and activities conducted by the party, or affiliate of the party, who owns the property

Tables 11 and 12 present information pertaining to the composition of the loan portfolio including unearned income, the allowance for loan losses, and the maturity and repricing characteristics of selected loans.

TABLE 11: SUMMARY OF TOTAL LOANS


	December 31,
(Dollars in thousands)	2009		2008		2007		2006		2005
Real estate - mortgage	$	1,599,478	$	1,435,189	$	1,158,820	$	940,270	$	778,788
Real estate - construction		428,292		585,076		544,290		515,040		380,997
Commercial		238,327		279,470		238,670		190,527		122,243
Consumer		10,368		11,698		8,714		6,997		7,386
Farmland		2,675		2,498		1,468		—		—

Total loans	$	2,279,140	$	2,313,931	$	1,951,962	$	1,652,834	$	1,289,414
Less unearned income		3,924		4,370		4,961		4,906		5,338
Less allowance for loan losses		65,152		36,475		22,260		18,101		13,821

Loans, net	$	2,210,064	$	2,273,086	$	1,924,741	$	1,629,827	$	1,270,255

TABLE 12: MATURITY/REPRICING SCHEDULE OF TOTAL LOANS


At December 31, 2009 (Dollars in thousands)	Real estate- mortgage		Real estate- construction		Commercial		Consumer		Farmland		Total
Variable:
Within 1 year	$	207,857	$	79,995	$	12,671	$	3,388	$	2,499	$	306,410
1-to-5 years		418,160		12,895		3,206		—		—		434,261
After 5 years		38,873		3,081		966		—		—		42,920

Total	$	664,890	$	95,971	$	16,843	$	3,388	$	2,499	$	783,591

Fixed Rate:
Within 1 year	$	93,556	$	200,016	$	98,375		4,286	$	—	$	396,233
1-to-5 years		374,718		124,023		87,563		1,783		176		588,263
After 5 years		466,314		8,282		35,546		911		—		511,053

Total	$	934,588	$	332,321	$	221,484	$	6,980	$	176	$	1,495,549

Total Loans	$	1,599,478	$	428,292	$	238,327	$	10,368	$	2,675	$	2,279,140

Investment Securities

The securities portfolio serves as a primary source of liquidity, is used as needed to meet certain collateral requirements, helps in the management of interest rate risk, and provides additional interest income. The securities portfolio consists of two components, securities held-to-maturity and securities available-for-sale. Securities are classified as held-to-maturity based on management’s intent and the Company’s ability, at the time of purchase, to hold such securities to maturity. These securities are carried at amortized cost. Securities which may be sold in response to changes in market interest rates, changes in the securities’ prepayment risk, increased loan demand, general liquidity needs, and other similar factors are classified as available-for-sale and are carried at estimated fair value.

Total securities increased $22.9 million, or 7.0%, from $325.7 million at December 31, 2008, to $348.6 million at December 31, 2009, and increased $5.6 million, or 1.7%, from $320.1 million at December 31, 2007, to $325.7 million at December 31, 2008. Increases in both years were concentrated in obligations of states and political subdivisions as the level of U.S. Government Agencies declined. However, securities of U.S. Government Agencies still represent the majority of the portfolio. The portfolio also contains four pooled trust preferred securities with an amortized cost basis of $7.2 million and a book value of $2.0 million. The Bank performs a quarterly analysis of these securities for other than temporary impairment due to significantly depressed current market value indications. The analysis includes stress tests on the underlying collateral and cash flow estimates based on the current and projected future levels of deferrals and defaults within each pool. In 2009, the Bank recorded an impairment loss of an aggregate of $1.8 million on three of the four pools. Table 13 provides information regarding the composition of the securities portfolio and Table 14 details the maturities and weighted average yields (on a tax equivalent basis) at the dates indicated. U.S. Government Agency obligations include senior debt issuances, mortgage-backed pass-through securities and collateralized mortgage obligations issued by the Federal Home Loan Banks, Federal Home Loan Mortgage Corporation, and Federal National Mortgage Association. See Note 2 to the Consolidated Financial Statements for additional information regarding the securities portfolio.

TABLE 13: SECURITIES PORTFOLIO


	December 31,
	2009				2008				2007
(Dollars in thousands)	Book Value		Percent of total		Book Value		Percent of total		Book Value		Percent of total
Available-for-sale:
U.S. Government Agency obligations	$	247,134	70.90	%	$	235,434	72.28	%	$	242,965	75.90	%
Obligations of states/political subdivisions		42,357	12.15	%		29,454	9.04	%		23,001	7.19	%
Pooled trust preferred securities		2,030	0.58	%		3,948	1.21	%		8,544	2.67	%

	$	291,521	83.63	%	$	268,836	82.53	%	$	274,510	85.76	%

Held-to-maturity:
U.S. Government Agency obligations	$	12,323	3.53	%	$	18,764	5.76	%	$	33,725	10.53	%
Obligations of states/political subdivisions		44,741	12.84	%		38,143	11.71	%		11,874	3.71	%

	$	57,064	16.37	%	$	56,907	17.47	%	$	45,599	14.24	%

	$	348,585	100.00	%	$	325,743	100.00	%	$	320,109	100.00	%


TABLE 14: MATURITY OF SECURITIES

	2009				2008				2007
At December 31, (Dollars in thousands)	Book Value		Weighted Average Yield		Book Value		Weighted Average Yield		Book Value		Weighted Average Yield
Maturing within one year	$	4,541	4.57	%	$	1,869	4.11	%	$	8,269	5.02	%
Maturing after one through five years		28,013	4.19	%		73,457	4.78	%		165,110	5.26	%
Maturing after five through ten years		110,745	4.16	%		65,058	5.06	%		49,555	5.19	%
Maturing after ten years		205,286	5.07	%		185,359	5.39	%		97,175	5.67	%

	$	348,585	4.71	%	$	325,743	5.18	%	$	320,109	5.37	%

Deposits

The Company’s principal source of funds is deposit accounts comprised of demand deposits, savings and money market accounts, and time deposits. The majority of the Bank’s deposits are attracted from individuals and businesses in the Northern Virginia and the metropolitan Washington D.C. area, and the interest rates the Bank pays are generally near the top of the local market.

Total deposits increased $57.2 million, or 2.6%, from $2.17 billion at December 31, 2008, to $2.23 billion at December 31, 2009, and increased $303.0 million, or 16.2%, from $1.87 billion at December 31, 2007, to $2.17 billion at December 31, 2008. In 2009, growth by deposit category included an increase in demand deposits of $44.8 million, or 23.0%, an increase in savings and interest-bearing demand deposits of $467.1 million, or 90.2%, and a decrease of $454.7 million, or 31.2%, in time deposits. The increases in savings and interest-bearing demand deposits were due primarily to success with the Company’s MEGA Savings and MEGA Checking accounts. The declines in time deposits are reflective of lower loan volume, requiring lower levels of funding, and a strategy to reduce the Bank’s historically heavy reliance on certificates of deposit as a funding source with deposit gathering efforts and cross-selling activities focused on demand deposits, savings and interest-bearing demand accounts.

In 2008, growth included an 8.9% decrease in demand deposits, only a slight change in savings and interest-bearing demand deposits and a $321.1 million, or 28.2% increase in time deposits. Time deposit growth was concentrated in CDARS, Certificate of Deposit Account Registry Service, as depositors sought to maximize FDIC insurance coverage. CDARS allows depositors to access up to $50 million in FDIC insurance coverage. Through the program, a customer’s deposit is divided into sub-$100,000 increments and placed at other banks that participate in the program. Those participating banks, in turn, place deposits in the same amount at the Bank. Growth was concentrated in time deposits due to very strong local competition, very high short-term interest rates for a significant part of the year and the aforementioned flight to safety of FDIC insurance coverage in our CDARS program.

Table 15 details maturities of time deposits with balances of $100,000 or more, which represent 29.7% of total time deposits as of December 31, 2009, compared to 37.5% at December 31, 2008. Total time deposits represent 45.1% of total deposits as of December 31, 2009, compared to 67.2% at December 31, 2008. Brokered time deposits represented $50.1 million, or 2.3%, of total deposits at December 31, 2009, and $168.3 million, or 7.6%, of total deposits as of December 31, 2008. See Note 6 to the Consolidated Financial Statements and Table 1 to this Management’s Discussion and Analysis for additional information regarding the maturities of time deposits and average rates paid on all interest-bearing deposits.

TABLE 15: MATURITIES OF TIME DEPOSITS WITH BALANCES OF $100,000 OR MORE


	December 31,
(Dollars in thousands)	2009		2008		2007
3 months or less	$	88,680	$	215,378	$	209,165
3-6 months		65,809		108,592		243,880
6-12 months		77,956		132,668		99,465
Over 12 months		66,122		91,058		19,975

Total	$	298,567	$	547,696	$	572,485

Short-Term Borrowings

Short-term borrowings consist of securities sold under agreements to repurchase, of which, as of December 31, 2009, $101.7 million are secured transactions with customers that mature the business day following the date sold, and the other $75 million are secured transactions with other banks. The secured transactions with customers are provided to significant commercial demand deposit customers and are considered a core funding source of the Bank. Short-term borrowings also include Federal funds purchased, which are unsecured overnight borrowings from other banks and are generally used to accommodate short-term liquidity needs. Table 16 provides information on the balances and interest rates on short-term borrowings for the years ended December 31, 2009, 2008 and 2007 (dollars in thousands):

TABLE 16: SHORT-TERM BORROWINGS


At December 31,	2009			2008			2007
Securities sold under agreement to repurchase	$	176,728		$	175,959		$	200,534
Federal funds purchased		—			12,000			22,000

Total	$	176,728		$	187,959		$	222,534
Weighted interest rate at year end		2.24	%		1.58	%		3.36	%
Averages for the year ended December 31,
Outstanding	$	186,106		$	223,114		$	165,499
Interest rate		1.87	%		2.47	%		3.78	%
Maximum month-end outstanding	$	198,774		$	187,959		$	222,534

Liquidity

The Company’s principal source of liquidity and funding is its deposit base. The level of deposits necessary to support the Company’s lending and investment activities is determined through monitoring loan demand. Considerations in managing the Company’s liquidity position include, but are not limited to, scheduled cash flows from existing loans and investment securities, anticipated deposit activity including the maturity of time deposits, and projected needs from anticipated extensions of credit. The Company’s liquidity position is monitored daily by management to maintain a level of liquidity that can efficiently meet current needs and is evaluated for both current and longer term needs as part of the asset/liability management process.

The Company measures total liquidity through cash and cash equivalents, securities available-for-sale, mortgage loans held-for-sale, other loans and investment securities maturing within one year, less securities pledged as collateral for repurchase agreements, public deposits and other purposes, and less any outstanding Federal funds purchased. These liquidity sources decreased $22.5 million, or 3.5%, from $637.7 million at December 31, 2008, to $615.2 million at December 31, 2009, and increased $60.2 million, or 10.4%, from $577.5 million at December 31, 2007, to $637.7 million at December 31, 2008. Additional sources of liquidity available to the Bank include the capacity to borrow funds through established short-term lines of credit with various correspondent banks and the Federal Home Loan Bank of Atlanta. See Note 14 to the Consolidated Financial Statements for further information regarding these additional liquidity sources.

Capital

The assessment of capital adequacy depends on a number of factors such as asset quality, liquidity, earnings performance, changing competitive conditions and economic forces, and the overall level of growth. The adequacy of the Company’s current and future capital is monitored by management on an ongoing basis. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and to absorb potential losses.

Both the Company’s and the Bank’s capital levels continue to meet regulatory requirements. The primary indicators relied on by bank regulators in measuring the capital position are the Tier 1 risk-based capital, total risk-based capital, and leverage ratios. Tier 1 capital consists of common and qualifying preferred stockholders’ equity, less goodwill, and for the Company includes certain minority interests relating to bank subsidiary issued shares, and a limited amount of restricted core capital elements. Restricted core capital elements include qualifying cumulative preferred stock interests, certain minority interests in subsidiaries and qualifying trust preferred securities. All of the $71 million in preferred stock interests issued to the Treasury under the Capital Purchase Program qualify as Tier 1 capital. Total risk-based capital consists of Tier 1 capital, qualifying subordinated debt, and a portion of the allowance for loan losses, and for the Company, a limited amount of excess restricted core capital elements. Risk-based capital ratios are calculated with reference to risk-weighted assets. The leverage ratio compares Tier 1 capital to total average assets. The Bank’s Tier 1 risk-based capital ratio was 11.41% at December 31, 2009, compared to 13.16% at December 31, 2008, and its total risk-based capital ratio was 12.66% at December 31, 2009, compared to 14.41% at December 31, 2008. These ratios are in excess of the mandated minimum requirement of 4.00% and 8.00%, respectively. The Bank’s leverage ratio was 10.23% at December 31, 2009, compared to 11.81% at December 31, 2008. The Company’s Tier 1 risk-based capital ratio, total risk-based capital ratio, and leverage ratio

was 11.48%, 12.73%, and 10.29%, respectively, at December 31, 2009, compared to 13.07%, 14.44%, and 11.76% at December 31, 2008. The declines in these capital ratios in 2009, are due to net operating losses and dividends paid on preferred stock to the Treasury. Both the Company’s and Bank’s capital positions reflect proceeds from the issuance of a total of $65 million in trust preferred securities.

The ability of the Company to continue to maintain its overall asset size, or to grow, is dependent on its earnings and the ability to obtain additional funds for contribution to the Bank’s capital, through earnings, borrowing, the sale of additional common stock, or through the issuance of additional trust preferred securities or other qualifying securities. In the event that the Company is unable to obtain additional capital for the Bank on a timely basis, the growth of the Company and the Bank may be curtailed, and the Company and the Bank may be required to reduce their level of assets in order to maintain compliance with regulatory capital requirements. Under those circumstances net income and the stockholders’ equity may be adversely affected.

Guidance by the federal banking regulators provides that banks which have concentrations in construction, land development or commercial real estate loans (other than loans for majority owner occupied properties) would be expected to maintain higher levels of risk management and, potentially, higher levels of capital. It is possible that we may be required to maintain higher levels of capital than we would otherwise be expected to maintain as a result of our levels of construction, development and commercial real estate loans, which may require us to obtain additional capital.

The Federal Reserve has revised the capital treatment of trust preferred securities. As a result, the capital treatment of trust preferred securities has been revised to provide that beginning in 2011, such securities can be counted as Tier 1 capital at the holding company level, together with other restricted core capital elements, up to 25% of total capital (net of goodwill), and any excess as Tier 2 capital, subject to limitation. At December 31, 2009, trust preferred securities represented 22.7% of the Company’s Tier 1 capital and 20.4% of its total risk-based capital. See Note 15 to the Consolidated Financial Statements for further information regarding trust preferred securities.

Capital Issuances. As noted above, during 2008, the Company accepted an investment by Treasury under the Capital Purchase Program. In connection with that investment, the Company entered into and consummated a Securities Purchase Agreement with the Treasury, pursuant to which the Company issued 71,000 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A (“Series A Preferred Stock”), having a liquidation amount per share equal to $1,000, for a total purchase price of $71 million. The Series A Preferred Stock pays cumulative dividends at a rate of 5% per year for the first five years and thereafter at a rate of 9% per year. Subject to consultation with the Company’s and Bank’s federal regulators, the Company may, at its option, redeem the Series A Preferred Stock at the liquidation amount plus accrued and unpaid dividends. The Series A Preferred Stock is non-voting, except in limited circumstances. Prior to the third anniversary of issuance, unless the Company has redeemed all of the Series A Preferred Stock or the Treasury has transferred all of the Series A Preferred Stock to a third party, the consent of the Treasury will be required for the Company to commence paying a cash common stock dividend or repurchase its common stock or other equity or capital securities, other than in connection with benefit plans consistent with past practice and certain other circumstances specified in the Purchase Agreement.

In connection with the purchase of the Series A Preferred Stock, the Treasury was issued a warrant (the “Warrant”) to purchase 2,696,203 shares of the Company’s common stock at an initial exercise price of $3.95 per share. The Warrant provides for the adjustment of the exercise price and the number of shares of the common stock issuable upon exercise pursuant to customary anti-dilution provisions, such as upon stock splits or distributions of securities or other assets to holders of the common stock, and upon certain issuances of the common stock (or securities exercisable or exchangeable for, or convertible into, common stock) at or below 90% of the market price of the common stock on the trading day prior to the date of the agreement on pricing such securities. The Warrants expire ten years from the date of issuance. If the Company redeems the Series A Preferred Stock in full prior to exercise of the Warrant, the Warrant will be liquidated based upon the then current fair market value of the common stock. The Treasury has agreed not to exercise voting power with respect to any shares of common stock issued upon exercise of the Warrant.

Please refer to Note 15 to the Consolidated Financial Statements for additional information regarding the issuance of $25 million of trust preferred securities and warrants to purchase 1.5 million shares to certain directors and executive officers of the Company.

Contractual Obligations

The Company has entered into certain contractual obligations including long term debt, operating leases and obligations under service contracts. The following table summarizes the Company’s contractual cash obligations as of December 31, 2009:

TABLE 17: CONTRACTUAL OBLIGATIONS


	Payments Due-By Period
(Dollars in thousands)	Total		Within One Year		One To Three Years		Three To Five Years		After Five Years
Securities sold under agreements to repurchase and Federal funds purchased	$	176,728	$	101,728	$	—	$	25,000	$	50,000
Other borrowed funds		25,000		—		25,000		—		—
Trust preferred securities		65,000		—		—		—		65,000
Operating leases		34,034		3,985		7,685		7,370		14,994
Data processing services		5,582		2,310		3,272		—		—

Total contractual cash obligations	$	306,344	$	108,023	$	35,957	$	32,370	$	129,994

The obligation for data processing services represents estimates of early termination charges. Of the $65.0 million of trust preferred securities shown as due after 5 years, $15.0 million is subject to redemption, at par, at the Company’s option, on any semi-annual distribution payment date, the next one being June 30, 2010. The table does not reflect deposit liabilities entered into in the ordinary course of the Company’s banking business. At December 31, 2009, the Company had approximately $1.2 billion of demand and savings deposits, exclusive of interest, which have no stated maturity or payment date. The Company also had approximately $1.0 billion of time deposits, exclusive of interest, the maturity distribution of which is set forth in Note 6 to the Consolidated Financial Statements. For additional information about the Company’s deposit obligations, see “Net Interest Income” and “Deposits” above. The trust preferred securities exclude $2.0 million of capital notes held by the trusts that relate to the common securities of the issuing trusts, all of which are owned by the Company. See Note 15 to the Consolidated Financial Statements for additional information regarding the trust preferred capital notes.

Off-Balance Sheet Arrangements

The Company enters into certain off-balance sheet arrangements in the normal course of business to meet the financing needs of its customers. These off-balance sheet arrangements include commitments to extend credit, standby letters of credit and financial guarantees which would impact the Company’s liquidity and capital resources to the extent customers accept and or use these commitments. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. See Note 16 to the Consolidated Financial Statements for further discussion of the nature, business purpose and elements of risk involved with these off-balance sheet arrangements. With the exception of these off-balance sheet arrangements, and the Company’s obligations in connection with its trust preferred securities, the Company has no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources, that is material to investors. For further information, see Notes 15 and 16 to the Consolidated Financial Statements.

RISK FACTORS

An investment in our common stock involves various risks. The following is a summary of certain risks identified by us as affecting our business. You should carefully consider the risk factors listed below, as well as other cautionary statements made in this Annual Report, and risks and uncertainties which we may identify in our other reports and documents filed with the Securities and Exchange Commission or other public announcements. These risk factors may cause our future earnings to be lower or our financial condition to be less favorable than we expect. In addition, other risks of which we are not aware, which relate to the banking and financial services industries in general, or which we do not believe are material, may cause earnings to be lower, or hurt our future financial condition. You should read this section together with the other information in this Annual Report.

We may not be able to maintain our historical growth rate, which may adversely impact our results of operations and financial condition.

Over the years our asset level has increased rapidly. We may not be able to sustain our historical rate of growth, or grow at all. Various factors, such as economic conditions, regulatory considerations and competition, may impede our rate of growth and our branch expansion, or may make future growth or branching less profitable or more expensive. If we experience a significant decrease in our rate of growth as compared to our historic rate of growth, our income, or our rate of income growth, may decline, our capacity to absorb any additional losses resulting from, or loan loss provisions related to, declining loan quality may be diminished, and we may not be able to maintain or reduce our expense levels and efficiency ratio, which would adversely affect our results of operations and financial condition.

Our concentrations of loans could result in higher than normal risk of loan defaults and losses.

We have a substantial amount of loans secured by real estate in the Northern Virginia/Washington, D.C. metropolitan area, and substantially all of our loans are to borrowers in that area. We also have a significant amount of real estate construction loans and land related loans for residential and commercial developments. At December 31, 2009, 89.1% of our total loans were secured by real estate, primarily commercial real estate. Of these loans, $428 million, or 18.8% of total loans, were construction and land loans. An additional 10.4% of total loans were commercial and industrial loans which are not secured by real estate. These loans have a higher risk of default than other types of loans, such as well underwritten conforming single family residential mortgage loans. In addition, the repayments of these loans, often depends on the successful operation of a business or the sale or development of the underlying property, and as a result are more likely to be adversely affected by adverse conditions in the real estate market or the economy in general. These concentrations expose us to the risk that adverse developments in the real estate market, or in the general economic conditions in the Northern Virginia/Washington, D.C. metropolitan area, could increase the levels of non-performing loans and charge-offs, and reduce loan demand. In that event, we would likely experience lower earnings or losses. Additionally, if, for any reason, economic conditions in the area deteriorate, or there is significant volatility or weakness in the economy or any significant sector of the area’s economy, our ability to develop our business relationships may be diminished, the quality and collectibility of our loans may be adversely affected, the value of collateral may decline and loan demand may be reduced. Additionally, under guidance from the banking agencies, we may be required to maintain higher levels of capital than we would otherwise be expected to maintain, and to employ greater risk management efforts, as a result of our real estate concentrations.

Commercial, commercial real estate and construction loans also generally have larger balances than single family mortgages loans and other consumer loans. Because the loan portfolio contains a significant number of commercial and commercial real estate and construction loans with relatively large balances, the deterioration of one or a few of these loans may cause a significant increase in nonperforming assets. An increase in nonperforming loans could result in: a loss of earnings from these loans, an increase in the provision for loan losses, or an increase in loan charge-offs, which could have an adverse impact on our results of operations and financial condition.

Lack of seasoning of our loan portfolio could increase the risk of credit defaults in the future.

Due to the rapid growth of the Bank, a large portion of the loans in our loan portfolio and of our lending relationships is of relatively recent origin. In general, loans do not begin to show signs of credit deterioration or default until they have been outstanding for some period of time, a process referred to as “seasoning.” As a result, a portfolio of older loans will usually behave more predictably than a newer portfolio. Because a large portion of our loan portfolio is relatively new, the current level of delinquencies and defaults may not be representative of the level that will prevail when the portfolio becomes more seasoned, which may be higher than current levels. If delinquencies and defaults increase, we may be required to increase our provision for loan losses, which would adversely affect our results of operations and financial condition.

Our financial condition and results of operations would be adversely affected if our allowance for loan losses is not sufficient to absorb actual losses or if we are required to increase our allowance for loan losses.

Experience in the banking industry indicates that a portion of our loans will become delinquent, that some of our loans may only be partially repaid or may never be repaid and we may experience other losses for reasons beyond our control. Further, despite our underwriting criteria and historical experience, we may be particularly susceptible to losses due to: (1) the geographic concentration of our loans, (2) the concentration of higher risk loans, such as commercial real estate, construction and commercial and industrial loans, and (3) the relative lack of seasoning of certain of our loans. At December 31, 2009, we had elevated levels of non-performing assets and other impaired loans, $94.3 million and $171.8 million, respectively, aggregating 9.8% of assets. This level, which is significantly in excess of our historical level, is primarily a result of high levels of non-performing residential and commercial real estate construction and land loans. As a result, our provision and allowance for loan losses, as well as our level of charge-offs, have significantly increased over prior years. Although we believe that our allowance for loan losses is maintained at a level adequate to absorb any inherent losses in our loan portfolio, these estimates of loan losses are necessarily subjective and their accuracy depends on the outcome of future events. If we need to make significant and unanticipated increases in our loss allowance in the future, our results of operations and financial condition would be materially adversely affected at that time.

While we strive to carefully monitor credit quality and to identify loans that may become nonperforming, at any time there are loans included in the portfolio that will result in losses, but that have not been identified as nonperforming or potential problem loans. We cannot be sure that we will be able to identify deteriorating loans before they become nonperforming assets, or that we will be able to limit losses on those loans that are identified. As a result, future additions to the allowance may be necessary.

We may not be able to successfully manage continued growth.

We intend to seek further growth in the level of our assets and deposits and, to a limited extent, the number of our branches. In the future, we may seek further branch expansion, both within our existing footprint and to expand our footprint in Northern Virginia. We cannot be certain as to our ability to manage increased levels of assets and liabilities, and an expanded branch system, without increased expenses and higher levels of non-performing assets. We may be required to make additional investments in equipment and personnel to manage higher asset levels and loan balances and a larger branch network, which may adversely impact earnings, shareholder returns and our efficiency ratio. Increases in operating expenses or non-performing assets may have an adverse impact on the value of our common stock.

Our ability to pay cash dividends on the common stock and to repurchase any shares of common stock is highly restricted.

The Company has no recent history of paying cash dividends, and other than repurchases of fractional shares issued in connection with stock splits or stock dividends. Our ability to pay dividends on the common stock, or repurchase shares, is limited by state and federal law and regulation, and by the terms of the Series A Preferred Stock issued to the Treasury. Under the terms of the Series A Preferred Stock, the Company may not pay a dividend, or subject to limited exceptions, repurchase or acquire any common stock, without the prior approval of the Treasury, until December 12, 2011, or the earlier redemption or transfer of all securities issued to Treasury. Additionally, we may not pay any dividends on the common stock, or subject to limited exceptions, repurchase or acquire any common stock, without prior Treasury approval, when any dividend on the Series A Preferred Stock is in arrears. Further, we cannot pay any dividends on the common stock, or acquire any shares of common stock, if any distribution on our trust preferred securities are in arrears. In light of the foregoing restrictions, it is unlikely that the Company will pay any dividends on the common stock or repurchase any shares of common stock in the near future.

Our continued growth depends on our ability to meet minimum regulatory capital levels. Growth and shareholder returns may be adversely affected if sources of capital are not available to help us meet them.

Since we became the holding company for the Bank, we have sought to maximize shareholder returns by leveraging our capital. If earnings do not meet our current estimates, if we incur unanticipated losses or expenses, or if we grow faster than expected, we may need to obtain additional capital sooner than expected, through borrowing, additional issuances of debt or equity securities, or otherwise. If we do not have continued access to sufficient capital, we may be required to reduce our level of assets or reduce our rate of growth in order to maintain regulatory compliance. Under those circumstances net income and the rate of growth of net income may be adversely affected. Additional issuances of equity securities could have a dilutive effect on existing shareholders.

There is no assurance that we will be able to successfully compete with others for business.

The Northern Virginia/Washington, D.C. metropolitan area in which we operate is considered highly attractive from an economic and demographic viewpoint, and is a highly competitive banking market. We compete for loans, deposits, and investment dollars with numerous regional and national banks, online divisions of out-of-market banks, and other community banking institutions, as well as other kinds of financial institutions and enterprises, such as securities firms, insurance companies, savings associations, credit unions, mortgage brokers, and private lenders. Many competitors have substantially greater resources than us, and operate under less stringent regulatory environments. The differences in resources and regulations may make it harder for us to compete profitably, reduce the rates that we can earn on loans and investments, increase the rates we must offer on deposits and other funds, and adversely affect our overall financial condition and earnings.

Turmoil in the financial markets may make it more difficult for the Bank to meet its liquidity needs.

During 2008 and 2009, financial markets experienced unprecedented pressure associated with the declining value of residential real estate, and deleveraging by investors in mortgage related securities. This has resulted in a sharp decline in the value of home mortgage loans and securities that derive their value from such loans. Many commercial banks have faced large write-downs of their loan and investment portfolios, resulting in large losses, repeated over a number of quarters, declining stock prices, significant capital issuances, bank failures, and loss of confidence in the safety of the banking system. In several well-publicized cases, this loss of confidence has led to large rapid withdrawals and the failure, or federally assisted mergers, of prominent financial institutions.

The Bank positions itself in the marketplace as a business bank. It does not (and did not) originate low quality home loans for sale, and invests only in high quality mortgage-backed securities and as such has not experienced many of the issues facing other institutions. Nevertheless, the turmoil in the financial markets has caused many depositors to seek safety in government securities, resulting in liquidity challenges for all banks. The Bank has responded to these challenges by promoting participation in the CDARS program and by participating in the increased deposit insurance programs provided by the FDIC. However, should turmoil in the markets continue, the Bank may be forced to pay higher interest rates to obtain deposits and meet the needs of its depositors and borrowers, resulting in reduced net interest income. If conditions worsen significantly, it is possible that banks such as the Bank may be unable to meet the needs of their depositors and borrowers, which could, in the worst case, result in the Bank being placed into receivership.

Trading in our common stock has been relatively light. As a result, shareholders may not be able to quickly and easily sell their common stock.

Although our common stock is listed on the Nasdaq Global Select Market, and a number of brokers offer to make a market in the common stock on a regular basis, trading volume to date has been relatively light, averaging approximately 28,429 shares per day over the year ended December 31, 2009. There can be no assurance that an active and liquid market for the common stock can be maintained. Accordingly, shareholders may find it difficult to sell a significant number of shares at the prevailing market price.

The number of shares owned by our directors and executive officers could make it more difficult to obtain approval for some matters submitted to shareholder vote, including mergers and acquisitions.

Our directors and executive officers and their affiliates own approximately 25.5% of the outstanding common stock. By voting against a proposal submitted to shareholders, the directors and officers, as a group, may be able to make approval more difficult for proposals requiring the vote of shareholders, such as some mergers, share exchanges, asset sales, and amendments to the Articles of Incorporation. The results of the vote may be contrary to the desires or interests of the public shareholders.

Changes in interest rates and other factors beyond our control could have an adverse impact on our earnings.

Our operating income and net income depend to a great extent on our net interest margin, i.e., the difference between the interest yields we receive on loans, securities and other interest-earning assets and the interest rates we pay on interest-bearing deposits and other liabilities. The net interest margin is affected by changes in market interest rates, because different types of assets and liabilities may react differently, and at different times, to market interest rate changes. When interest-bearing liabilities mature or reprice more quickly than interest-earning assets in a period, an increase in market rates of interest could reduce net interest income. Similarly, when interest-earning assets mature or reprice more quickly than interest-bearing liabilities, falling interest rates could reduce net interest income. These rates are highly sensitive to many factors beyond our control, including competition, general economic conditions and monetary and fiscal policies of various governmental and regulatory authorities, including the Board of Governors of the Federal Reserve System.

We attempt to manage our risk from changes in market interest rates by adjusting the rates, maturity, repricing, and balances of the different types of interest-earning assets and interest-bearing liabilities, but interest rate risk management techniques are not exact. As a result, a rapid increase or decrease in interest rates could have an adverse effect on our net interest margin and results of operations. The results of our interest rate sensitivity simulation models depend upon a number of assumptions which may not prove to be accurate. There can be no assurance that we will be able to successfully manage our interest rate risk. Increases in market rates and adverse changes in the local residential real estate market, the general economy or consumer confidence would likely have a significant adverse impact on our non-interest income, as a result of reduced demand for residential mortgage loans, that we make on a pre-sold basis.

Adverse changes in the real estate market in our market area could also have an adverse affect on our cost of funds and net interest margin, as we have a large amount of non-interest bearing demand deposits related to real estate sales and development. While we expect that we would be able to replace the liquidity provided by these deposits, the replacement funds would likely be more costly, negatively impacting earnings. Additionally, changes in applicable law, if enacted, including those that would permit banks to pay interest on checking and demand deposit accounts established by businesses, could have a significant negative effect on net interest income, net income, the net interest margin, and our return on assets and return on equity.

Government regulation will significantly affect the Bank’s business and may result in higher costs and lower shareholder returns.

The banking industry is heavily regulated. Banking regulations are primarily intended to protect the federal deposit insurance funds and depositors, not shareholders. The Company and Bank are regulated and supervised by the Board of Governors of the Federal Reserve System, the Virginia Bureau of Financial Institutions and the Federal Deposit Insurance Corporation. The burden imposed by federal and state regulations puts banks at a competitive disadvantage compared to less regulated competitors such as finance companies, credit unions, mortgage banking companies and leasing companies. Changes in the laws, regulations and regulatory practices affecting the banking industry may increase our costs of doing business or otherwise adversely affect us and create competitive advantages for others. Regulations affecting banks and financial services companies undergo continuous change, and we cannot predict the ultimate effect of these changes, which could have a material adverse effect on our profitability or financial condition. Federal economic and monetary policy may also affect our ability to attract deposits and other funding sources, make loans and investments, and achieve satisfactory interest spreads.

The Company is subject to additional uncertainties, and potential additional regulatory or compliance burdens, as a result of its participation in the Capital Purchase Program.

The Company accepted an investment of $71 million from the Treasury under the Capital Purchase Program. The Securities Purchase Agreement executed by the Company (and all other participating institutions) and Treasury, provides that Treasury may unilaterally amend the agreement to the extent required to comply with any subsequent changes in applicable federal statutes. As a result of this provision, the Treasury and Congress may impose additional requirements or restrictions on the Company and the Bank in respect of reporting, compliance, corporate governance, executive or employee compensation, dividend payments, stock repurchases, lending or other business practices, capital requirements or other matters. As a result, the Company and Bank may be required to expend additional resources in order to comply with these requirements. Such additional requirements could impair the Company’s ability to compete with institutions that are not subject to the restrictions because they did not accept an investment

from the Treasury. To the extent that additional restrictions or limitations on employee compensation are imposed, such as those contained in the American Recovery and Reinvestment Act of 2009 (the “ARRA”), the Company and Bank may be less competitive in attracting successful incentive compensation based lenders and customer relations personnel. Additionally, the ability of Congress to utilize the amendment provisions to effect political or public relations goals, could result in the Company and Bank being subjected to additional burdens as a result of public perceptions of issues relating to the largest banks, and which are not applicable to community oriented institutions such as the Company. There can be no assurance that the Company could be disadvantaged as a result of these uncertainties.

Substantial regulatory limitations on changes of control and anti-takeover provisions of Virginia law may make it more difficult for you to receive a change in control premium.

With certain limited exceptions, federal regulations prohibit a person or company or a group of persons deemed to be “acting in concert” from, directly or indirectly, acquiring more than 10% (5% if the acquirer is a bank holding company) of any class of our voting stock or obtaining the ability to control in any manner the election of a majority of our directors or otherwise direct the management or policies of our company without prior notice or application to and the approval of the Federal Reserve. There are comparable prior approval requirements for changes in control under Virginia law. Also, Virginia corporate law contains several provisions that may make it more difficult for a third party to acquire control of us without the approval of our Board of Directors, and may make it more difficult or expensive for a third party to acquire a majority of our outstanding common stock.

DISCLOSURE CONTROLS AND PROCEDURES

The Company’s management, with the participation of the Company’s Chief Executive Officer and the Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2009, to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and that such information is accumulated and communicated to the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that the Company’s disclosure controls and procedures will detect or uncover every situation involving the failure of persons within the Company or its subsidiary to disclose material information required to be set forth in the Company’s periodic reports.

MANAGEMENT REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Management of the Company is also responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Management believes that internal controls over financial reporting, which are subject to scrutiny by management and the Company’s internal auditors, support the integrity and reliability of the financial statements. Management recognizes that there are inherent limitations in the effectiveness of any internal control system, including the possibility of human error and the circumvention or overriding of internal controls. Accordingly, even effective internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation and presentation. In addition, because of changes in conditions and circumstances, the effectiveness of internal control over financial reporting may vary over time.

Management assessed the effectiveness of Company’s system of internal control over financial reporting as of December 31, 2009. This assessment was conducted based on the criteria set forth by the Committee of Sponsoring Organizations (“COSO”) of the Treadway Commission in “Internal Control - Integrated Framework”. Based on this assessment, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2009. Management’s assessment concluded that there were no material weaknesses within the Company’s internal control structure.

The effectiveness of the Company’s internal control over financial reporting as of December 31, 2009, has been audited by Yount, Hyde & Barbour, P.C., the independent registered public accounting firm who also audited the Company’s consolidated financial statements included in this Annual Report on Form 10-K. Yount, Hyde & Barbour, P.C.’s attestation report on the Corporation’s internal control over financial reporting appears on pages 30 and 31 hereof.

There were no changes in the Company’s internal control over financial reporting during the quarter ended December 31, 2009, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

LOGO

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and Board of Directors

Virginia Commerce Bancorp, Inc.

Arlington, Virginia

We have audited the accompanying consolidated balance sheets of Virginia Commerce Bancorp, Inc. and subsidiaries as of December 31, 2009 and 2008, and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for the years ended December 31, 2009, 2008 and 2007. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Virginia Commerce Bancorp, Inc. and subsidiaries as of December 31, 2009 and 2008, and the results of their operations and their cash flows for the years ended December 31, 2009, 2008 and 2007, in conformity with U.S. generally accepted accounting principles.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Virginia Commerce Bancorp, Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 19, 2010 expressed an unqualified opinion on the effectiveness of Virginia Commerce Bancorp, Inc. and subsidiaries’ internal control over financial reporting.

LOGO

Winchester, Virginia

March 19, 2010

LOGO

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and Board of Directors

Virginia Commerce Bancorp, Inc.

Arlington, Virginia

We have audited Virginia Commerce Bancorp, Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Virginia Commerce Bancorp, Inc. and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (a) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (b) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (c) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, Virginia Commerce Bancorp, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets as of December 31, 2009 and 2008, and the related consolidated statements of operations, changes in stockholders’ equity and cash flows for the years ended December 31, 2009, 2008 and 2007 of Virginia Commerce Bancorp, Inc. and subsidiaries and our report dated March 19, 2010 expressed an unqualified opinion.

LOGO

Winchester, Virginia

March 19, 2010

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands except share data)


	December 31,
	2009		2008
Assets
Cash and due from banks	$	25,211	$	33,515
Securities (fair value: 2009, $349,836; 2008, $326,695)		348,585		325,743
Restricted stocks, at cost		11,751		11,076
Loans held-for-sale		6,492		6,221
Loans, net of allowance for loan losses of $65,152 in 2009 and $36,475 in 2008		2,210,064		2,273,086
Bank premises and equipment, net		13,794		14,740
Accrued interest receivable		10,537		10,593
Other real estate owned, net of valuation allowance of $9,067 in 2009 and $0 in 2008		28,499		7,569
Other assets		70,364		33,379

Total assets	$	2,725,297	$	2,715,922

Liabilities and Stockholders’ Equity
Deposits
Demand deposits	$	239,604	$	194,791
Savings and interest-bearing demand deposits		985,152		518,054
Time deposits		1,004,571		1,459,297

Total deposits	$	2,229,327	$	2,172,142
Securities sold under agreement to repurchase and federal funds purchased		176,729		187,959
Other borrowed funds		25,000		25,000
Trust preferred capital notes		66,057		65,800
Accrued interest payable		4,014		8,160
Other liabilities		5,302		3,574
Commitments and contingent liabilities		—		—

Total liabilities	$	2,506,429	$	2,462,635

Stockholders’ Equity
Preferred stock, net of discount, $1.00 par, 1,000,000 shares authorized, Series A; $1,000.00 liquidation value; 71,000 issued and outstanding in 2009 and 2008	$	63,993	$	62,541
Common stock, $1.00 par, 50,000,000 shares authorized, issued and outstanding 2009, 26,744,545; 2008, 26,575,569		26,745		26,575
Surplus		96,588		95,840
Warrants		8,520		8,520
Retained earnings		22,671		60,535
Accumulated other comprehensive income (loss), net		351		(724	)

Total stockholders’ equity	$	218,868	$	253,287

Total liabilities and stockholders’ equity	$	2,725,297	$	2,715,922

See Notes to Consolidated Financial Statements.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands except per share data)


	Year Ended December 31,
	2009			2008		2007
Interest and dividend income:
Interest and fees on loans	$	134,548		$	143,501	$	138,919
Interest and dividends on investment securities:
Taxable		14,050			15,017		12,888
Tax-exempt		1,591			1,248		752
Dividends		355			320		308
Interest on deposits with other banks		—			145		140
Interest on federal funds sold		89			237		1,131

Total interest and dividend income	$	150,633		$	160,468	$	154,138

Interest expense:
Deposits	$	49,598		$	67,261	$	69,398
Securities sold under agreement to repurchase and federal funds purchased		3,475			5,534		6,259
Other borrowed funds		1,077			1,235		225
Trust preferred capital notes		5,079			3,400		3,099

Total interest expense	$	59,229		$	77,430	$	78,981

Net interest income	$	91,404		$	83,038	$	75,157
Provision for loan losses		81,913			25,378		4,340

Net interest income after provision for loan losses	$	9,491		$	57,660	$	70,817

Non-interest income (charges):
Service charges and other fees	$	3,606		$	3,902	$	3,388
Non-deposit investment services commissions		600			702		770
Fees and net gains on loans held-for-sale		2,912			1,498		2,706
(Loss) gain on other real estate owned		(9,952	)		—		638
Loss on securities available-for-sale in 2009, consist of other-than-temporary impairment losses of $5.1 million of which $3.3 million is recognized in other comprehensive income and a net impairment loss of $1.8 million recognized in earnings		(1,821	)		—		(387	)
Other		303			329		768

Total non-interest income (charges)	$	(4,352	)	$	6,431	$	7,883

Non-interest expense:
Salaries and employee benefits	$	23,040		$	23,362	$	22,536
Occupancy expense		10,253			8,857		7,031
FDIC insurance expense		5,411			1,500		758
Franchise tax		3,100			1,528		1,279
Data processing		2,436			2,166		1,940
Provision for unfunded commitments		2,960			—		—
Other operating expense		9,668			7,363		6,150

Total non-interest expense	$	56,868		$	44,776	$	39,694

(Loss) income before taxes	$	(51,729	)	$	19,315	$	39,006
(Benefit) provision for income taxes		(18,404	)		6,231		13,219

Net (loss) income	$	(33,325	)	$	13,084	$	25,787
Effective dividend on preferred stock		4,539			258		—

Net (loss) income available to common stockholders	$	(37,864	)	$	12,826	$	25,787

(Loss) earnings per common share, basic	$	(1.42	)	$	0.48	$	0.98
(Loss) earnings per common share, diluted	$	(1.42	)	$	0.47	$	0.95

See Notes to Consolidated Financial Statements.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(Dollars in thousands)


	Preferred Stock			Common Stock		Surplus		Warrants		Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Comprehensive Income (Loss)			Total Stockholders’ Equity
Balance, December 31, 2006	$	—		$	21,560	$	31,231	$	—	$	87,744		$	(684	)				$	139,851

Comprehensive Income:
Net Income 2007											25,787					$	25,787			25,787
Other comprehensive income, unrealized holding gains arising during the period (net of tax of $1,019)														1,893			1,893			1,893

Total comprehensive income																$	27,680

10% stock dividend		—			2,172		41,108		—		(43,280	)		—						—
Cash paid in lieu of fractional shares		—			—		—		—		(12	)		—						(12	)
Stock options exercised		—			289		876		—		—			—						1,165
Employee stock purchase plan		—			2		30		—		—			—						32
Stock option expense		—			—		427		—		—			—						427

Balance, December 31, 2007	$	—		$	24,023	$	73,672	$	—	$	70,239		$	1,209					$	169,143

Comprehensive Income:
Net Income 2008											13,084					$	13,084			13,084
Other comprehensive loss, unrealized holding losses arising during the period (net of tax of $1,043)														(1,933	)		(1,933	)		(1,933	)

Total comprehensive income																$	11,151

10% stock dividend		—			2,411		20,112		—		(22,523	)		—						—
Cash paid in lieu of fractional shares		—			—		—		—		(7	)		—						(7	)
Stock options exercised		—			141		173		—		—			—						314
Stock option expense		—			—		597		—		—			—						597
Warrant expense in regards to trust preferred securities		—			—		1,283		—		—			—						1,283
Preferred stock issued		71,000			—		—		—		—			—						71,000
Discount on preferred stock		(8,459	)		—		—		—		—			—						(8,459	)
Warrants issued in regard to preferred stock		—			—		—		8,520		—			—						8,520
Effective dividend on preferred stock		—			—		—		—		(258	)		—						(258	)
Employee stock purchase plan		—			—		3		—		—			—						3

Balance, December 31, 2008	$	62,541		$	26,575	$	95,840	$	8,520	$	60,535		$	(724	)				$	253,287

Comprehensive Loss:
Net loss 2009											(33,325	)				$	(33,325	)		(33,325	)
Other comprehensive loss:
reclassification adjustment for impairment loss on securities (net of tax $637)														1,184			1,184			1,184
unrealized holding losses arising during the period (net of tax of $59)														(109	)		(109	)		(109	)

Total comprehensive loss																$	(32,250	)

Stock options exercised		—			170		118		—		—			—						288
Stock option expense		—			—		630		—		—			—						630
Discount on preferred stock		1,452			—		—		—		(1,452	)		—						—
Dividend on preferred stock		—			—		—		—		(3,087	)		—						(3,087	)

Balance, December 31, 2009	$	63,993		$	26,745	$	96,588	$	8,520	$	22,671		$	351					$	218,868

See Notes to Consolidated Financial Statements.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)


	Year Ended December 31,
	2009			2008			2007
Cash Flows from Operating Activities:
Interest received	$	151,173		$	161,235		$	151,608
Other income received		7,422			6,431			7,246
Net change in loans held-for-sale		(271	)		(1,882	)		3,456
Interest paid		(63,375	)		(78,211	)		(75,962	)
Cash paid to suppliers and employees		(101,533	)		(50,903	)		(37,784	)
Income tax benefit of stock options/warrants exercised		(44	)		(45	)		(440	)
Income taxes paid		—			(12,150	)		(16,055	)

Net cash (used in) provided by operating activities	$	(6,628	)	$	24,475		$	32,069

Cash Flows from Investing Activities:
Proceeds from maturities and principal payments on securities held-to-maturity	$	11,261		$	15,516		$	4,765
Proceeds from maturities and principal payments on securities available-for-sale		168,225			139,733			51,794
Purchases of securities held-to-maturity		(11,350	)		(26,799	)		(4,441	)
Purchases of securities available-for-sale		(192,301	)		(141,916	)		(175,844	)
Sales of securities available-for-sale		—			—			35,000
Net increase in loans		(18,891	)		(373,723	)		(298,615	)
Purchase of bank premises and equipment		(1,776	)		(4,599	)		(5,427	)

Net cash used in investing activities	$	(44,832	)	$	(391,788	)	$	(392,768	)

Cash Flows from Financing Activities:
Net increase (decrease) in demand, NOW, money market and savings accounts	$	511,911		$	(18,140	)	$	84,551
Net (decrease) increase in time deposits		(454,726	)		321,117			178,673
Net (decrease) increase in securities sold under agreement to repurchase and federal funds purchased		(11,230	)		(34,575	)		73,663
Net increase in other borrowed funds		—			—			25,000
Increase (decrease) in trust preferred capital notes		—			25,775			(3,100	)
Proceeds from issuance of preferred stock		—			71,000			—
Proceeds from exercise of stock options and warrants		288			317			1,197
Dividend paid on preferred stock		(3,087	)
Cash paid in lieu of fractional shares		—			(7	)		(12	)

Net cash provided by financing activities	$	43,156		$	365,487		$	359,972

Decrease in cash and cash equivalents	$	(8,304	)	$	(1,826	)	$	(727	)
Cash and Cash Equivalents:
Beginning		33,515			35,341			36,068

Ending	$	25,211		$	33,515		$	35,341

See Notes to Consolidated Financial Statements.

CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)


	Year Ended December 31,
	2009			2008			2007
Reconciliation of net income (loss) to net cash (used in) provided by operating activities:
Net (loss) income	$	(33,325	)	$	13,084		$	25,787
Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:
Depreciation and amortization		2,722			2,565			1,995
Provision for loan losses		81,913			25,378			4,340
Stock based compensation expense		630			597			427
Deferred tax benefit		(15,539	)		(5,353	)		(2,087	)
Amortization of trust preferred securities discount		257			64			—
Amortization of security premiums and accretion of discounts, net		482			(90	)		(394	)
Origination of loans held-for-sale		(188,677	)		(80,622	)		(158,026	)
Sale of loans		187,334			77,920			160,246
Gain on sale of loans		1,071			820			1,236
Loss (gain) on the sale/valuation of OREO		9,952			—			(638	)
Impairment loss on securities		1,821			—			—
Provision for unfunded commitments		2,960			—			—
Increase in other assets		(52,908	)		(9,655	)		(1,216	)
Decrease in other liabilities		(1,232	)		(308	)		(483	)
Decrease (increase) in accrued interest receivable		56			857			(2,136	)
(Decrease) increase in accrued interest payable		(4,146	)		(782	)		3,018

Net cash (used in) provided by operating activities	$	(6,628	)	$	24,475		$	32,069

Supplemental Schedule of Noncash Investing Activities:
Unrealized gain (loss) on securities	$	1,653		$	(2,974	)	$	2,912
OREO transferred from loans	$	33,461		$	7,569		$	1,862
Loans made on the disposition of OREO	$	3,400		$	—		$	2,500

See Notes to Consolidated Financial Statements.

Notes to Consolidated Financial Statements

Note 1. Nature of Banking Activities and Significant Accounting Policies

Business

On December 22, 1999, Virginia Commerce Bancorp, Inc. (the “Company”) became the holding company for Virginia Commerce Bank (the “Bank”). The Company acquired the Bank through a share exchange in which the stockholders of the Bank received one share of common stock of the Company for each share of common stock of the Bank. The exchange was a tax-free transaction for federal income tax purposes. The merger was accounted for on the same basis as a pooling-of-interests.

The Company provides loan and deposit products to commercial and retail customers in the Washington Metropolitan Area, with the primary emphasis on Northern Virginia. The loan portfolio is generally collateralized by assets of the customers and is expected to be re-paid from cash flows or proceeds from the sale of selected assets of the borrowers.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, the Bank, VCBI Capital Trust II, VCBI Capital Trust III, VCBI Capital Trust IV, Northeast Land and Investment Company, Tombstone Land Company and Virginia Commerce Insurance Agency L.L.C. In consolidation, all significant intercompany accounts and transactions have been eliminated. Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 810 requires that the Company no longer eliminate through consolidation the equity investments in VCBI Capital Trust II, III and IV, by the parent company, Virginia Commerce Bancorp, Inc, which approximated $2.0 million at December 31, 2009. The subordinated debt of the trusts is reflected as a liability of the Company, and the common securities of the trusts as an other asset.

Risks and Uncertainties

In its normal course of business, the Company encounters two significant types of risk: economic and regulatory. There are three main components of economic risk: interest rate risk, credit risk and market risk. The Company is subject to interest rate risk to the degree that its interest-bearing liabilities mature or reprice more rapidly or on a different basis than its interest-earning assets. Credit risk is the risk of default on the Company’s loan portfolio that results from the borrowers’ inability or unwillingness to make contractually required payments. Market risk reflects changes in the value of collateral underlying loans receivable and the valuation of real estate held by the Company.

The determination of the allowance for loan losses is based on estimates that are particularly susceptible to significant changes in the economic environment and market conditions. Management believes that, as of December 31, 2009, the allowance for loan losses is adequate based on information currently available. A worsening or protracted economic decline or substantial increase in interest rates, would increase the likelihood of losses due to credit and market risks and could create the need for substantial increases to the allowance for loan losses. The Company is subject to the regulations of various regulatory agencies, which can change significantly from year to year. In addition, the Company undergoes periodic examinations by regulatory agencies, which may subject it to further changes based on the regulators’ judgments about information available to them at the time of their examination.

Securities

Investments in debt securities with readily determinable fair values are classified as either held-to-maturity or available-for-sale (“AFS”) based on management’s intent. Equity investments in the FHLB, the Federal Reserve Bank of Richmond and Community Bankers Bank are separately classified as restricted securities and are carried at cost. AFS securities are carried at estimated fair value with the corresponding unrealized gains and losses excluded from earnings and reported in other comprehensive income. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities.

Impairment of securities occurs when the fair value of a security is less than its amortized cost. For debt securities, impairment is considered other-than-temporary and recognized in its entirety in net income if either (i) we intend to sell the security or (ii) it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis. If, however, we do not intend to sell the security and it is not more-than-likely that we will be

required to sell the security before recovery, we must determine what portion of the impairment is attributable to a credit loss, which occurs when the amortized cost of the security exceeds the present value of the cash flows expected to be collected from the security. If there is no credit loss, there is no other-than-temporary impairment. If there is a credit loss, other-than-temporary impairment exists, and the credit loss must be recognized in net income and the remaining portion of impairment must be recognized in other comprehensive income.

For equity securities carried at cost as restricted securities, impairment is considered to be other-than-temporary based on our ability and intent to hold the investment until a recovery of fair value. Other-than-temporary impairment of an equity security results in a write-down that must be included in income. We regularly review each security for other-than-temporary impairment based on criteria that include the extent to which costs exceeds market price, the duration of the market decline, the financial health of and specific prospects for the issuer, our best estimate of the present value of cash flows expected to be collected from debt securities, our intention with regard to holding the security to maturity and the likelihood that we would be required to sell the security before recovery.

Loans Held-for-Sale

Loans held-for-sale are carried at the lower of cost or market, determined in the aggregate. Market value considers commitment agreements with investors and prevailing market prices. Loans originated by the Company’s mortgage banking unit and held-for-sale to outside investors, are made on a pre-sold basis with servicing rights released. Gains and losses on sales of mortgage loans are recognized based on the difference between the selling price and the carrying value of the related mortgage loans sold.

Loans

The Company grants mortgage, commercial and consumer loans to customers. A substantial portion of the loan portfolio is represented by real estate loans. The ability of the Company’s debtors to honor their contracts is dependent upon the general economic conditions and real estate climate of the Company’s market area.

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding unpaid principal balances adjusted for the allowance for loan losses and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method.

The accrual of interest on real estate and commercial loans is discontinued at the time the loan is 90 days delinquent unless the credit is well-secured and in the process of collection. Installment loans are typically charged-off no later than 180 days past due. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.

All interest accrued but not collected for loans that are placed on nonaccrual or charged-off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Allowance for Loan Losses

The allowance for loan losses is established to address potential losses that could occur through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. These factors are combined to estimate the probability and severity of inherent losses. When impairment is identified, then a specific reserve may be established based on the Company’s calculation of the loss embedded in the individual loan. Large groups of smaller balance, homogeneous loans are collectively evaluated for impairment. Impaired loans which meet the criteria for substandard, doubtful and loss are segregated from performing loans within the portfolio. Internally classified loans are then grouped by loan type (commercial, commercial real estate, commercial construction, residential real estate, residential construction or installment). The general formula is used to estimate the loss of non-classified loans. These un-criticized loans are also segregated by loan type and allowance factors are assigned by management based on delinquencies, loss history, trends in volume and terms of loans, effects of changes in lending policy, the experience and depth of management, national and local economic trends, concentrations of credit, quality of the loan review system and the effect of external factors (i.e. competition and regulatory requirements). The factors assigned differ by loan type. The general allowance recognizes potential losses whose impact on the portfolio has yet to be recognized by a specific allowance. Allowance factors and the overall size of the allowance may change from period to period based on management’s assessment of the above described factors and the relative weights given to each factor. See Note 4 for information regarding the allowance for loan losses.

Bank Premises and Equipment

Premises and equipment are stated at cost less accumulated depreciation and amortization. Land is carried at cost. Furniture, fixtures, equipment and computer software are depreciated over their estimated useful lives, generally from three to seven years; leasehold improvements are depreciated over the term of the respective leases or the estimated useful life of the leasehold improvement. Depreciation and amortization are recorded on the straight-line method. Costs of maintenance and repairs are charged to expense as incurred. The costs of replacing structural parts of major units are considered individually and are expensed or capitalized as the facts dictate.

Other Real Estate Owned

Other real estate owned, or foreclosed real properties, that have been substantively repossessed or acquired in complete or partial satisfaction of debt, are held for resale, and carried at the lower of book value or fair value, including a reduction for estimated selling expenses, or principal balance of the related loan. The carrying value of a foreclosed asset is immediately adjusted down when new information is obtained, including a potentially acceptable offer, the sale of a similar property in the vicinity of one of the Company’s assets, and/or a change in the price the property is being listed for.

Income Taxes

Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws.

When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the

position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. Interest and penalties associated with unrecognized tax benefits are classified as additional income taxes in the statement of income.

Advertising Cost

The Company follows the policy of charging the production costs of advertising to expense as incurred. Total advertising expense was $503 thousand, $437 thousand and $500 thousand in 2009, 2008 and 2007, respectively.

Use of Estimates

In preparing consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of deferred tax assets, fair value, impairment on securities and other real estate owned.

Rate Lock Commitments

The Company enters into commitments to originate mortgage loans whereby the interest rate on the loans is determined prior to funding (rate lock commitments). Rate lock commitments on mortgage loans that are intended to be sold are considered to be derivatives. The period of time between issuance of a loan commitment and closing and the sale of the loan generally ranges from thirty to ninety days. The Company protects itself from changes in interest rates through the use of best efforts forward delivery commitments, whereby the Company commits to sell a loan at the time the borrower commits to an interest rate with the intent that the buyer has assumed interest rate risk on the loan. As a result, the Company is not exposed to losses nor will it realize significant gains related to its rate lock commitments due to changes in interest rates. The correlation between the rate lock commitments and the best efforts contracts is very high due to their similarity. Because of this high correlation, no gain or loss occurs on the rate lock commitments.

Cash and Cash Equivalents

For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, and Federal funds sold. Generally, Federal funds are sold and purchased for one-day periods.

Earnings Per Share

Basic earnings per share represent income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options and warrants and are determined using the treasury method.

Comprehensive Income

Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet. Such items, along with net income, are components of comprehensive income.

Recent Accounting Pronouncements

In June 2009, FASB issued new accounting guidance related to U.S. GAAP (FASB ASC 105, Generally Accepted Accounting Principles). This guidance establishes FASB ASC as the source of authoritative U.S. GAAP recognized by FASB to be applied by nongovernmental entities. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative U.S. GAAP for SEC registrants. FASB ASC supersedes all existing non-SEC accounting and reporting standards. All other nongrandfathered, non-SEC accounting literature not included in FASB ASC has become nonauthoritative. FASB will no longer issue new standards in the form of Statements, FASB Staff Positions or Emerging Issues Task Force Abstracts. Instead, it will issue Accounting Standards Updates (“ASU”), which will serve to update FASB ASC, provide background information about the guidance and provide the basis for conclusions on the changes to FASB ASC. FASB ASC is not intended to change U.S. GAAP.

The Company adopted new guidance impacting FASB Topic 805: Business Combinations (“Topic 805”) on January 1, 2009. This guidance requires the acquiring entity in a business combination to recognize the full fair value of assets acquired and liabilities assumed in the transaction (whether a full or partial acquisition); establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; requires expensing of most transaction and restructuring costs; and requires the acquirer to disclose to investors and other users all of the information needed to evaluate and understand the nature and financial effect of the business combination. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In April 2009, the FASB issued new guidance impacting Topic 805. This guidance addresses application issues raised by preparers, auditors, and members of the legal profession on initial recognition and measurement, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in a business combination. This guidance was effective for business combinations entered into on or after January 1, 2009. This guidance did not have a material impact on the Company’s consolidated financial statements.

In April 2009, the FASB issued new guidance impacting FASB Topic 820: Fair Value Measurements and Disclosures (“Topic 820”). This interpretation provides additional guidance for estimating fair value when the volume and level of activity for the asset or liability have significantly decreased. This also includes guidance on identifying circumstances that indicate a transaction is not orderly and requires additional disclosures of valuation inputs and techniques in interim periods and defines the major security types that are required to be disclosed. This guidance was effective for interim and annual periods ending after June 15, 2009, and should be applied prospectively. The adoption of the standard did not have a material impact on the Company’s consolidated financial statements.

In April 2009, the FASB issued new guidance impacting FASB Topic 320-10: Investments – Debt and Equity Securities. This guidance amends 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 guidance was effective for interim and annual periods ending after June 15, 2009, with earlier adoption permitted for periods ending after March 15, 2009. The Company did not have any cumulative effect adjustment related to the adoption of this guidance. The additional disclosures required are included in the consolidated Statements of Operations and in Note 2 to the consolidated financial statements.

In May 2009, the FASB issued new guidance impacting FASB Topic 855: Subsequent Events. This update provides guidance on management’s assessment of subsequent events that occur after the balance sheet date through the date that the financial statements are issued. This guidance is generally consistent with current accounting practice. In addition, it requires certain additional disclosures. This guidance was effective for periods ending after June 15, 2009 and had no impact on the Company’s consolidated financial statements.

In August 2009, the FASB issued new guidance impacting Topic 820. This guidance is intended to reduce ambiguity in financial reporting when measuring the fair value of liabilities. This guidance was effective for the first reporting period (including interim periods) after issuance and had no impact on the Company’s consolidated financial statements.

In September 2009, the FASB issued new guidance impacting Topic 820. This creates a practical expedient to measure the fair value of an alternative investment that does not have a readily determinable fair value. This guidance also requires certain additional disclosures. This guidance is effective for interim and annual periods ending after December 15, 2009. The adoption of the new guidance did not have a material impact on the consolidated financial statements.

In October 2009, the FASB issued ASU 2009-15, Accounting for Own-Share Lending Arrangements in Contemplation of Convertible Debt Issuance or Other Financing. ASU 2009-15 amends Subtopic 470-20 to expand accounting and reporting guidance for own-share lending arrangements issued in contemplation of convertible debt issuance. ASU 2009-15 is effective for fiscal years beginning on or after December 15, 2009 and interim periods within those fiscal years for arrangements outstanding as of the beginning of those fiscal years. The adoption of ASU 2009-15 did not have a material impact on the consolidated financial statements.

Accounting Standards Not Yet Effective

In June 2009, the FASB issued new guidance relating to the accounting for transfers of financial assets. The new guidance, which was issued as SFAS No. 166, Accounting for Transfers of Financial Assets, an amendment to SFAS No. 140, was adopted into Codification in December 2009 through the issuance of ASU 2009-16. The new standard provides guidance to improve the relevance, representational faithfulness, and comparability of the information that an entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. The Company will adopt the new guidance in 2010 and is evaluating the impact, if any, it will have on its consolidated financial statements.

In June 2009, the FASB issued new guidance relating to variable interest entities. The new guidance, which was issued as SFAS No. 167, Amendments to FASB Interpretation No. 46(R), was adopted into the Codification in December 2009. The objective of the guidance is to improve financial reporting by enterprises involved with variable interest entities and to provide more relevant and reliable information to users of financial statements. SFAS No. 167 is effective as of January 1, 2010. The Company does not expect the adoption of the new guidance to have a material impact on its consolidated financial statements.

In January 2010, the FASB issued ASU 2010-01, Equity (Topic 505): Accounting for Distributions to Shareholders with Components of Stock and Cash – a consensus of the FASB Emerging Issues Task Force. ASU 2010-01 clarifies that the stock portion of a distribution to shareholders that allows them to elect to receive cash or stock with a potential limitation on the total amount of cash that all shareholders can elect to receive in the aggregate is considered a share issuance that is reflected in EPS prospectively and is not a stock dividend. ASU 2010-01 is effective for interim and annual periods ending on or after December 15, 2009 and should be applied on a retrospective basis. The Company does not expect the adoption of ASU 2010-01 to have a material impact on its consolidated financial statements.

In January 2010, the FASB issued ASU 2010-02, Consolidation (Topic 810): Accounting and reporting for Decreases in Ownership of a Subsidiary – a Scope Clarification. ASU 2010-02 amends Subtopic 810-10 to address implementation issues related to changes in ownership provisions including clarifying the scope of the decrease in ownership and additional disclosures. ASU 2010-02 is effective beginning in the period that an entity adopts Statement 160. If an entity has previously adopted Statement 160, ASU 2010-02 is effective beginning in the first interim or annual reporting period ending on or after December 15, 2009 and should be applied retrospectively to the first period Statement 160 was adopted. The Company does not expect the adoption of ASU 2010-02 to have a material impact on its consolidated financial statements.

In January 2010, the FASB issued ASU 2010-04, Accounting for Various Topics – Technical Corrections to SEC Paragraphs. ASU 2010-04 makes technical corrections to existing SEC guidance including the following topics: accounting for subsequent investments, termination of an interest rate swap, issuance of financial statements - subsequent events, use of residential method to value acquired assets other than goodwill, adjustments in assets and liabilities for holding gains and losses, and selections of discount rate used for measuring defined benefit obligation. The Company does not expect the adoption of ASU 2010-04 to have a material impact on its consolidated financial statements.

In January 2010, the FASB issued ASU 2010-05, Compensation – Stock Compensation (Topic 718): Escrowed Share Arrangements and the Presumption of Compensation. ASU 2010-05 updates existing guidance to address the SEC staff’s views on overcoming the presumption that for certain shareholders escrowed share arrangements represent compensation. The Company does not expect the adoption of ASU 2010-05 to have a material impact on its consolidated financial statements.

In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. ASU 2010-06 amends Subtopic 820-10 to clarify existing disclosures, require new disclosures, and includes conforming amendments to guidance on employers’ disclosures about postretirement benefit plan assets. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The Company does not expect the adoption of ASU 2010-06 to have a material impact on its consolidated financial statements.

In February 2010, the FASB issued ASU 2010-08, Technical Corrections to Various Topics. ASU 2010-08 clarifies guidance on embedded derivatives and hedging. ASU 2010-08 is effective for interim and annual periods beginning after December 15, 2009. The Company does not expect the adoption of ASU 2010-08 to have a material impact on its consolidated financial statements.

Stockholders’ Equity

A 10% stock dividend was declared on March 26, 2008. This transaction was recorded by increasing common stock by $2.4 million, increasing surplus by $20.1 million and decreasing retained earnings by $22.5 million.

A 10% stock dividend was declared on March 28, 2007. This transaction was recorded by increasing common stock by $2.2 million, increasing surplus by $41.1 million and decreasing retained earnings by $43.3 million.

Note 2. Securities

Amortized cost and fair value of the securities available-for-sale and held-to-maturity as of December 31, 2009 and 2008, are as follows (dollars in thousands):


December 31, 2009	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Fair Value
Available-for-sale:
U.S. Government Agency obligations	$	242,129	$	6,004	$	(999	)	$	247,134
Pooled trust preferred securities		7,241		—		(5,211	)		2,030
Obligations of states and political subdivisions		41,610		873		(126	)		42,357

	$	290,980	$	6,877	$	(6,336	)	$	291,521
Held-to-maturity:
U.S. Government Agency obligations	$	12,323	$	430	$	—		$	12,753
Obligations of state and political subdivisions		44,741		821		—			45,562

	$	57,064	$	1,251	$	—		$	58,315


December 31, 2008	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Fair Value
Available-for-sale:
U.S. Government Agency obligations	$	230,497	$	4,951	$	(14	)	$	235,434
Pooled trust preferred securities		8,817		—		(4,869	)		3,948
Obligations of states and political subdivisions		30,637		49		(1,232	)		29,454

	$	269,951	$	5,000	$	(6,115	)	$	268,836
Held-to-maturity:
U.S. Government Agency obligations	$	18,764	$	347	$	—		$	19,111

Obligations of state and political subdivisions		38,143		614		(9	)		38,748

	$	56,907	$	961	$	(9	)	$	57,859

The amortized cost and fair value of the securities, as of December 31, 2009, by contractual maturity, are shown below (dollars in thousands):


December 31, 2009		Amortized Cost		Fair Value
Available-for-sale:
Due within one year		$	80	$	82
Due after one year through five years			13,443		13,758
Due after five years through ten years			98,437		99,676
Due after ten years	<

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company