UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2010

OR

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

Commission file number: 000-21671

THE NATIONAL BANK OF INDIANAPOLIS CORPORATION

(Exact name of registrant as specified in its charter)

Indiana		35-1887991
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)
107 North Pennsylvania Street
Indianapolis, Indiana		46204
(Address of principal executive offices)		(Zip Code)

(317) 261-9000
(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files). Yes o No o

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

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Common Stock		Outstanding at November 2, 2010
Common Stock, no par value per share		2,317,750

 

 

Table of Contents
The National Bank of Indianapolis Corporation

Report on Form 10-Q
for Quarter Ended
September 30, 2010

PART I — FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (Unaudited)
Consolidated Balance Sheets — September 30, 2010 and December 31, 2009			1
Consolidated Statements of Income — Three Months ended September 30, 2010 and 2009			2
Nine Months ended September 30, 2010 and 2009			3
Consolidated Statements of Cash Flows — Nine Months ended September 30, 2010 and 2009			4
Consolidated Statements of Shareholders’ Equity — Nine Months ended September 30, 2010 and 2009			5
Notes to Consolidated Financial Statements			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			16
Item 3. Quantitative and Qualitative Disclosures about Market Risk			31
Item 4. Controls and Procedures			32
PART II — OTHER INFORMATION
Item 1. Legal Proceedings			33
Item 1A. Risk Factors			33
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			33
Item 3. Defaults Upon Senior Securities			34
Item 4. (Removed and Reserved)			34
Item 5. Other Information			34
Item 6. Exhibits			34
Signatures			36
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

Part I — Financial Information

The National Bank of Indianapolis Corporation

		September 30, 2010				December 31, 2009
Assets
Cash and cash equivalents
Cash and due from banks		$	182,905			$	149,375
Reverse repurchase agreements			1,000				1,000
Federal funds sold			15,137				1,242
Total cash and cash equivalents			199,042				151,617
Investment securities
Available-for-sale securities			84,519				67,296
Held-to-maturity securities (Fair value of $96,472 at September 30, 2010 and $96,588 at December 31, 2009)			91,871				94,922
Total investment securities			176,390				162,218
Loans held for sale			5,474				884
Loans			905,409				863,838
Less: Allowance for loan losses			(15,598	)			(13,716	)
Net loans			889,811				850,122
Premises and equipment			24,017				24,532
Deferred tax asset			8,592				7,133
Accrued interest			4,558				4,199
Federal Reserve and FHLB stock			3,150				3,150
Other real estate owned			9,980				8,432
Other assets			21,250				21,343
Total assets		$	1,342,264			$	1,233,630
Liabilities and shareholders’ equity
Deposits:
Noninterest-bearing demand deposits		$	217,869			$	192,705
Money market and savings deposits			742,888				650,353
Time deposits over $100,000			108,330				131,938
Other time deposits			90,806				77,069
Total deposits			1,159,893				1,052,065
Other short term borrowings			74,840				81,314
Short term debt			3,913				4,138
Subordinated debt			5,000				5,000
Junior subordinated debentures owed to unconsolidated subsidiary trust			13,918				13,918
Other liabilities			7,440				4,164
Total liabilities			1,265,004				1,160,599
Shareholders’ equity:
Preferred stock, no par value — authorized 5,000,000 shares			—				—
Common stock, no par value — authorized 15,000,000 shares issued 2,863,941 shares at September 30, 2010 and 2,840,382 shares at December 31, 2009			35,190				34,440
Treasury stock, at cost; 545,573 shares at September 30, 2010 and 533,204 shares at December 31, 2009			(20,818	)			(20,346	)
Additional paid in capital			12,196				10,873
Retained earnings			50,281				48,067
Accumulated other comprehensive income (loss)			411				(3	)
Total shareholders’ equity			77,260				73,031
Total liabilities and shareholders’ equity		$	1,342,264			$	1,233,630

See notes to consolidated financial statements.

The National Bank of Indianapolis Corporation

		Three months ended
		September 30,
		2010				2009
Interest income:
Interest and fees on loans		$	10,739			$	10,866
Interest on investment securities taxable			519				745
Interest on investment securities nontaxable			534				513
Interest on federal funds sold			10				—
Interest on due from banks			96				61
Total interest income			11,898				12,185
Interest expense:
Interest on deposits			1,745				2,300
Interest on other short term borrowings			69				49
Interest on short term debt			47				22
Interest on long term debt			391				392
Total interest expense			2,252				2,763
Net interest income			9,646				9,422
Provision for loan losses			1,875				3,955
Net interest income after provision for loan losses			7,771				5,467
Other operating income:
Wealth management fees			1,263				1,226
Service charges and fees on deposit accounts			759				792
Rental income			59				66
Mortgage banking income			1,122				188
Interchange income			330				268
Other			675				451
Total other operating income			4,208				2,991
Other operating expenses:
Salaries, wages and employee benefits			5,249				5,102
Occupancy			610				631
Furniture and equipment			295				331
Professional services			535				472
Data processing			736				656
Business development			438				448
FDIC Insurance			505				411
Non performing assets			964				135
Other			1,805				942
Total other operating expenses			11,137				9,128
Income (loss) before tax			842				(670	)
Federal and state income tax (benefit)			86				(462	)
Net income (loss)		$	756			$	(208	)
Basic earnings (loss) per share		$	0.33			$	(0.09	)
Diluted earnings (loss) per share		$	0.32			$	(0.09	)

See notes to consolidated financial statements.

The National Bank of Indianapolis Corporation

		Nine months ended
		September 30,
		2010				2009
Interest income:
Interest and fees on loans		$	31,725			$	31,542
Interest on investment securities taxable			1,638				2,406
Interest on investment securities nontaxable			1,549				1,557
Interest on federal funds sold			15				3
Interest on due from banks			272				137
Total interest income			35,199				35,645
Interest expense:
Interest on deposits			5,441				7,362
Interest on other short term borrowings			213				134
Interest on short term debt			141				64
Interest on long term debt			1,167				1,194
Total interest expense			6,962				8,754
Net interest income			28,237				26,891
Provision for loan losses			4,344				7,855
Net interest income after provision for loan losses			23,893				19,036
Other operating income:
Wealth management fees			3,934				3,647
Service charges and fees on deposit accounts			2,277				2,316
Rental income			204				251
Mortgage banking income			1,602				1,137
Interchange income			928				721
Net loss on sale of securities			(5	)			—
Other			1,508				1,491
Total other operating income			10,448				9,563
Other operating expenses:
Salaries, wages and employee benefits			17,362				15,859
Occupancy			1,898				1,863
Furniture and equipment			954				1,031
Professional services			1,678				1,404
Data processing			2,263				2,055
Business development			1,328				1,274
FDIC Insurance			1,540				1,708
Non performing assets			1,268				420
Other			3,532				2,784
Total other operating expenses			31,823				28,398
Income before tax			2,518				201
Federal and state income tax (benefit)			304				(515	)
Net income		$	2,214			$	716
Basic earnings per share		$	0.96			$	0.31
Diluted earnings per share		$	0.93			$	0.31

See notes to consolidated financial statements.

The National Bank of Indianapolis Corporation

		Nine months ended
		September 30,
		2010				2009
Operating Activities
Net Income		$	2,214			$	716
Adjustments to reconcile net income to net cash provided (used) by operating activities:
Provision for loan losses			4,344				7,855
Proceeds from sale of loans			50,286				57,752
Origination of loans held for sale			(42,933	)			(56,783	)
Depreciation and amortization			1,136				1,146
Fair value adjustment on mortgage servicing rights			713				347
Loss on sales of investment securities available for sale			5				—
Gain on sale of loans			(2,006	)			(1,230	)
Net loss on sales and writedowns of other real estate and repossessions			600				120
Net increase in deferred income taxes			(1,730	)			(2,019	)
Net increase in bank owned life insurance			(291	)			(308	)
Excess tax benefit from deferred stock compensation			(56	)			(399	)
Board stock compensation			120				100
Net accretion of discounts and amortization of premiums on investments			868				190
Compensation expense related to restricted stock and options			1,361				1,128
Changes in assets and liabilities:
Accrued interest receivable			(359	)			441
Other assets			(329	)			(4,407	)
Other liabilities			3,332				6,789
Net cash provided provided by operating activities			17,275				11,438
Investing Activities
Proceeds from maturities of investment securities held to maturity			18,328				15,855
Proceeds from maturities of investment securities available for sale			29,775				51,000
Proceeds from sales of investment securities held to maturity			477				—
Purchases of investment securities held to maturity			(16,082	)			(31,426	)
Purchases of investment securities available for sale			(46,858	)			(57,986	)
Net (increase) decrease in loans			(59,195	)			13,953
Proceeds from sales of other real estate and repossessions			3,077				1,668
Purchases of bank premises and equipment			(621	)			(1,829	)
Net cash used by investing activities			(71,099	)			(8,765	)
Financing Activities
Net increase in deposits			107,828				115,219
Net increase (decrease) in short term borrowings			(6,474	)			3,463
Net change in revolving line of credit			(225	)			—
Income tax benefit from deferred stock compensation			56				399
Proceeds from issuance of stock			536				1,057
Repurchase of stock			(472	)			(1,713	)
Net cash provided by financing activities			101,249				118,425
Increase in cash and cash equivalents			47,425				121,098
Cash and cash equivalents at beginning of year			151,617				31,420
Cash and cash equivalents at end of year		$	199,042			$	152,518
Interest paid		$	7,755			$	9,100
Income taxes paid (refunded)		$	(382	)		$	78

See notes to consolidated financial statements.

The National Bank of Indianapolis Corporation

																		Accumulated
										Additional								Other
		Common				Treasury				Paid In				Retained				Comprehensive
		Stock				Stock				Capital				Earnings				Income				TOTAL
Balance at December 31, 2008		$	33,136			$	(18,481	)		$	8,766			$	47,955			$	836			$	72,212
Comprehensive income:
Net income			—				—				—				716				—				716
Other comprehensive income
Net unrealized loss on investments, net of tax of $482			—				—				—				—				(751	)			(751	)
Total comprehensive income																							(35	)
Income tax benefit from deferred stock compensation			—				—				399				—				—				399
Issuance of stock 57,271 shares of common stock under stock-based compensation plans			1,162				—				(5	)			—				—				1,157
Repurchase of stock 45,184 shares of common stock			—				(1,713	)			—				—				—				(1,713	)
Stock based compensation earned			—				—				1,128				—				—				1,128
Balance at September 30, 2009		$	34,298			$	(20,194	)		$	10,288			$	48,671			$	85			$	73,148
Balance at December 31, 2009		$	34,440			$	(20,346	)		$	10,873			$	48,067			$	(3	)		$	73,031
Comprehensive income:
Net income			—				—				—				2,214				—				2,214
Other comprehensive income
Net unrealized gain on investments, net of tax of $270			—				—				—				—				414				414
Total comprehensive income																							2,628
Income tax benefit from deferred stock compensation			—				—				56				—				—				56
Issuance of 23,559 shares of common stock under stock-based compensation plans			750				—				(94	)			—				—				656
Repurchase of 12,369 shares of common stock			—				(472	)			—				—				—				(472	)
Stock based compensation earned			—				—				1,361				—				—				1,361
Balance at September 30, 2010		$	35,190			$	(20,818	)		$	12,196			$	50,281			$	411			$	77,260

See notes to consolidated financial statements.

The National Bank of Indianapolis Corporation

Notes to Consolidated Financial Statements
($ in thousands, except share and per share data)

Note 1: Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of The National Bank of Indianapolis Corporation (“Corporation”) and its wholly-owned subsidiary, The National Bank of Indianapolis (“Bank”). All intercompany transactions between the Corporation and its subsidiary have been properly eliminated. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the nine month period ended September 30, 2010, are not necessarily indicative of the results that may be expected for the year ended December 31, 2010. For further information, refer to the consolidated financial statements and footnotes thereto included in the Corporation’s Form 10-K for the year ended December 31, 2009.

Note 2: Investment Securities

The following is a summary of available-for-sale and held-to-maturity securities:

						Gross				Gross				Estimated
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gain				Loss				Value
September 30, 2010
Available-for-sale
U.S. Treasury securities		$	12,200			$	—			$	—			$	12,200
U.S. Government agencies			71,640				681				2				72,319
Total available-for-sale		$	83,840			$	681			$	2			$	84,519
Held-to-maturity
Municipal securities		$	58,094			$	3,614			$	—			$	61,708
Collateralized mortgage obligations, residential			31,208				934				—				32,142
Mortgage backed securities, residential			2,419				53				—				2,472
Other securities			150				—				—				150
Total Held-to-maturity		$	91,871			$	4,601			$	—			$	96,472

						Gross				Gross				Estimated
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gain				Loss				Value
December 31, 2009
Available-for-sale
U.S. Treasury securities		$	506			$	—			$	—			$	506
U.S. Government agencies			66,795				97				102				66,790
Total available-for-sale		$	67,301			$	97			$	102			$	67,296
Held-to-maturity
Municipal securities		$	54,913			$	1,805			$	47			$	56,671
Collateralized mortgage obligations, residential			30,124				29				232				29,921
Mortgage backed securities, residential			9,735				111				—				9,846
Other securities			150				—				—				150
Total Held-to-maturity		$	94,922			$	1,945			$	279			$	96,588

Notes to Consolidated Financial Statements
($ in thousands, except share and per share data)

The fair value of debt securities and carrying amount, if different, at September 30, 2010, by contractual maturity were as follows. Securities not due at a single maturity date, primarily mortgage-backed securities, are shown separately. There was one sale of a held-to-maturity municipal security with a net carrying amount of $483 thousand that was sold for a loss of $5 thousand during the nine month period ending September 30, 2010. Since the security had a non-rated issuer, a credit review of the municipality was conducted. As a result of the review, it was determined that the investment was no longer considered a pass asset and thus below investment grade. Per investment policy, the Corporation is prohibited from holding any securities below investment grade.

		September 30, 2010
		Amortized				Fair
		Cost				Value
Available-for-sale
Due in one year or less		$	12,200			$	12,200
Due from one to five years			71,640				72,319
Total		$	83,840			$	84,519
Held-to-maturity
Due in one year or less		$	6,843			$	6,888
Due from one to five years			5,580				5,978
Due from five to ten years			37,536				40,330
Due after ten years			8,285				8,662
CMO/Mortgage-backed, residential			33,627				34,614
Total		$	91,871			$	96,472

Investment securities with a carrying value of approximately $88 million and $83 million were pledged as collateral for Wealth Management accounts and securities sold under agreements to repurchase at September 30, 2010, and December 31, 2009, respectively.

Securities with unrealized losses at September 30, 2010, and December 31, 2009, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows:

		Less Than 12 Months								12 Months or Longer								Total
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
		Value				Loss				Value				Loss				Value				Loss
September 30, 2010
Available-for-sale
U.S. Government agencies		$	16,090			$	2			$	—			$	—			$	16,090			$	2
Total available-for-sale		$	16,090			$	2			$	—			$	—			$	16,090			$	2
Held-to-maturity
None		$	—			$	—			$	—			$	—			$	—			$	—
December 31, 2009
Available-for-sale
U.S. Government agencies		$	36,515			$	102			$	—			$	—			$	36,515			$	102
Total available-for-sale		$	36,515			$	102			$	—			$	—			$	36,515			$	102
Held-to-maturity
Collateralized mortgage obligations, residential		$	24,851			$	232			$	—			$	—			$	24,851			$	232
Municipal securities			1,796				10				1,424				37				3,220				47
Total Held-to-maturity		$	26,647			$	242			$	1,424			$	37			$	28,071			$	279

Notes to Consolidated Financial Statements
($ in thousands, except share and per share data)

In determining other-than-temporary-impairment (“OTTI”) for debt securities, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the Company has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an other-than-temporary-impairment exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.

When OTTI occurs, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss. If an entity intends to sell or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current-period loss, the OTTI shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment.

As of September 30, 2010, the Corporation held 5 investments of which the amortized cost was greater than fair value.

The unrealized losses for investments classified as available-for-sale is attributable to changes in interest rates and individually is 0.01% or less of its respective amortized costs. The largest unrealized loss relates to one security issued by the Federal Home Loan Bank. Given this investment is backed by the U.S. Government, there is no credit risk.

Note 3: Loans

Loans, including net unamortized deferred fees and costs, consist of the following:

		September 30, 2010				December 31, 2009
Residential loans secured by real estate		$	268,617			$	253,838
Commercial loans secured by real estate			284,738				232,841
Construction loans			48,289				75,615
Other commercial and industrial loans			272,397				273,117
Consumer loans			31,368				28,427
Total loans			905,409				863,838
Less allowance for loan losses			(15,598	)			(13,716	)
Total loans, net		$	889,811			$	850,122

The Corporation periodically sells residential mortgage loans it originates based on the overall loan demand of the Corporation and outstanding balances of the residential mortgage portfolio.

There were no loans pledged as collateral for FHLB advances as of September 30, 2010, and December 31, 2009.

Notes to Consolidated Financial Statements
($ in thousands, except share and per share data)

Activity in the allowance for loan losses was as follows:

		Three months ended								Nine months ended
		September 30,								September 30,
		2010				2009				2010				2009
Beginning balance		$	15,523			$	14,077			$	13,716			$	12,847
Loan charge offs			(1,849	)			(1,171	)			(2,566	)			(3,903	)
Recoveries			49				25				104				87
Provision for loan losses			1,875				3,955				4,344				7,855
Ending balance		$	15,598			$	16,886			$	15,598			$	16,886

Note 4: Real Estate Owned

Activity in real estate owned was as follows:

		Nine months ended				Twelve months ended
		September 30, 2010				December 31, 2009
Balance at beginning of period		$	8,432			$	3,418
Additions			5,225				7,614
Write downs			(731	)			(905	)
Sales			(2,946	)			(1,695	)
Balance at end of period		$	9,980			$	8,432

Expenses related to real estate owned include:

		Three months ended								Nine months ended
		September 30,								September 30,
		2010				2009				2010				2009
Net gain on sales		$	(10	)		$	(3	)		$	(131	)		$	(37	)
Write downs			685				49				731				157
Operating expenses, net of rental income			(22	)			71				273				273
		$	653			$	117			$	873			$	393

Note 5: Mortgage Banking Activities

The unpaid principal balances of mortgage loans serviced for others were $171.4 million and $154.3 million at September 30, 2010, and December 31, 2009, respectively.

Custodial escrow balances maintained in connection with serviced loans were $1.1 million and $1.2 million at September 30, 2010, and December 31, 2009, respectively.

The following table includes activity for mortgage servicing rights:

		Nine months ended				Twelve months ended
		September 30, 2010				December 31, 2009
Balance at beginning of period		$	1,459			$	1,070
Plus additions			396				723
Fair value adjustments			(713	)			(334	)
Balance at end of period		$	1,142			$	1,459

Notes to Consolidated Financial Statements
($ in thousands, except share and per share data)

Mortgage servicing rights are carried at fair value at September 30, 2010, and December 31, 2009. Fair value at September 30, 2010, was determined using discount rates ranging from 10.7% to 16.0%, prepayment speeds ranging from 7.40% to 24.44%, depending on the stratification of the specific right, and a weighted average default rate of 0.50%. Fair value at December 31, 2009, was determined using discount rates ranging from 11.0% to 17.0%, prepayment speeds ranging from 8.68% to 28.92%, depending on the stratification of the specific right, and a weighted average default rate of 0.41%.

Note 6: Subordinated Term Loan Agreement/Revolving Line of Credit

On June 29, 2007, the Bank entered into a Subordinated Debenture Purchase Agreement with U.S. Bank in the amount of $5.0 million, which will mature on June 28, 2017. Under the terms of the Subordinated Debenture Purchase Agreement, the Bank pays 3-month LIBOR plus 1.20% which equated to 1.76% at September 30, 2010. Interest payments are due quarterly.

On June 29, 2007, the Corporation entered into a $5.0 million revolving loan agreement with U.S. Bank, which matured on June 27, 2009, and was renewed and matured on August 31, 2009. The revolving loan agreement was used to provide additional liquidity support to the Corporation, if needed. On September 5, 2008, and December 11, 2008, the Corporation drew $1.3 million and $2.9 million, respectively, on the revolving loan agreement with U.S. Bank.

On August 31, 2009, U.S. Bank renewed the revolving loan agreement which matured on August 31, 2010. As part of the renewal of the revolving loan agreement, U.S. Bank reduced the revolving loan amount from $5.0 million to $2.0 million and $3.0 million was moved to a separate one-year term facility with principal payments of $62.5 thousand and interest payments due quarterly. The revolving loan agreement and one-year term facility were renewed and will now mature on August 31, 2011. Under the terms of the one-year term facility, the Corporation pays prime plus 1.25% which equated to 4.50% at September 30, 2010.

Under the terms of the revolving loan agreement, the Corporation paid prime minus 1.25% which equated to 2.00% through August 31, 2009, and interest payments were due quarterly. Beginning September 1, 2009, the Corporation pays prime plus 1.25% which equated to 4.50% at September 30, 2010. In addition, beginning October 1, 2009, U.S. Bank assessed a 0.25% fee on the unused portion of the revolving line of credit.

The revolving loan agreement contains various financial and non-financial covenants. As of September 30, 2010, the Corporation was in compliance with all covenants.

Note 7: Trust Preferred Securities

In September 2000, the Corporation established the Trust, a Connecticut statutory business trust, which subsequently issued $13.5 million of company obligated mandatorily redeemable capital securities and $418 thousand of common securities. The proceeds from the issuance of both the capital and common securities were used by the Trust to purchase from the Corporation $13.9 million fixed rate junior subordinated debentures. The capital securities and debentures mature September 7, 2030, or upon earlier redemption as provided by the Indenture. The Corporation has the right to redeem the capital securities, in whole or in part, but in all cases, in a principal amount with integral multiples of a thousand dollars, on any March 7 or September 7 on or after September 7, 2010, at a premium, declining ratably to par on September 7, 2020. The capital securities and the debentures have a fixed interest rate of 10.60%, and are guaranteed by the Bank. The subordinated debentures are the sole assets of the Trust, and the Corporation owns all of the common securities of the Trust. The net proceeds received by the Corporation from the sale of capital securities were used for general corporate purposes. The indenture, dated September 7, 2000, requires compliance with certain non-financial covenants.

The Corporation does not have the power to direct the activities of the trust, therefore, the trust is not consolidated in the Corporation’s financial statements. The junior subordinated debt obligation issued to the Trust of $13.9 million is reflected in the Corporation’s consolidated balance sheets at September 30, 2010, and December 31, 2009. The junior subordinated debentures owed to the Trust and held by the Corporation qualify as Tier 1 capital for the Corporation under Federal Reserve Board guidelines.

Interest payments made on the junior subordinated debentures are reported as a component of interest expense on long-term debt.

Notes to Consolidated Financial Statements
($ in thousands, except share and per share data)

Note 8: Stock Based Compensation

During the first quarter of 2010, four officers of the Corporation exercised options to purchase 5,300 common shares in aggregate. The weighted average exercise price was $24.68 and the weighted average fair market value of the stock was $37.44.

During the second quarter of 2010, two directors and one officer of the Corporation exercised options to purchase 5,600 common shares in aggregate. The weighted average exercise price was $24.00 and the weighted average fair market value of the stock was $38.86.

During the third quarter of 2010, one officer of the Corporation exercised options to purchase 1,600 common shares in aggregate. The weighted aerage exercise price was $27.75 and the weighted average fair market value of the stock was $39.36.

Due to the exercise of these options and the vesting of restricted stock for the nine months ended September 30, 2010, the Corporation will receive a deduction for tax purposes for the difference between the fair value of the stock at the date of grant and the date of exercise. The Corporation recorded an income tax benefit of $56 thousand as additional paid in capital for the nine months ended September 30, 2010, as per guidance issued by the Financial Accounting Standards Board (FASB) on stock compensation.

Note 9: Earnings per Share

The following table sets forth the computation of basic and diluted earnings per share:

		Three months ended								Nine months ended
		September 30,								September 30,
		2010				2009				2010				2009
Basic average shares outstanding			2,318,032				2,305,849				2,312,148				2,299,892
Net income (loss)		$	756			$	(208	)		$	2,214			$	716
Basic net income (loss) per common share		$	0.33			$	(0.09	)		$	0.96			$	0.31
Diluted
Average shares outstanding			2,318,032				2,305,849				2,312,148				2,299,892
Nonvested restricted stock			50,050				25,707				43,193				12,208
Net effect of the assumed exercise of stock options			18,664				24,813				20,017				29,947
Diluted average shares			2,386,746				2,356,369				2,375,358				2,342,047
Net income (loss)		$	756			$	(208	)		$	2,214			$	716
Diluted net income (loss) per common share		$	0.32			$	(0.09	)		$	0.93			$	0.31

For the three month period ending September 30, 2010, options to purchase 183,800 shares and 108,300 restricted shares were outstanding but not included in the computation of diluted earnings per share because they were antidilutive.

For the nine month period ending September 30, 2010, options to purchase 183,800 shares and 108,300 restricted shares were outstanding but not included in the computation of diluted earnings per share because they were antidilutive.

Notes to Consolidated Financial Statements
($ in thousands, except share and per share data)

For the three month period ending September 30, 2009, options to purchase 192,200 shares and 4,325 restricted shares were outstanding but not included in the computation of diluted earnings per share because they were antidilutive.

For the nine month period ending September 30, 2009, options to purchase 192,200 shares and 70,850 restricted shares were outstanding but not included in the computation of diluted earnings per share because they were antidilutive.

Note 10: Comprehensive Income

Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available-for-sale. Following is a summary of other comprehensive income (loss):

		Three months ended								Nine months ended
		September 30,								September 30,
		2010				2009				2010				2009
Net income (loss)		$	756			$	(208	)		$	2,214			$	716
Other comprehensive income (loss)
Change in securities available for sale:
Net unrealized gains (loss) during the period			41				(327	)			684				(1,233	)
Tax effect			(15	)			127				(270	)			482
Total other comprehensive income (loss)			26				(200	)			414				(751	)
Comprehensive income (loss)		$	782			$	(408	)		$	2,628			$	(35	)

Note 11: Commitments and Contingencies

Some financial instruments, such as loan commitments, credit lines, letters of credit, and overdraft protection are issued to meet customer financing needs. These are agreements to provide credit or to support the credit of others, as long as conditions established in the contract are met, and usually have expiration dates. Commitments may expire without being used. Off-balance sheet risk to credit loss exists up to the face amount of these instruments, although material losses are not anticipated.

The contractual amount of financial instruments with off-balance sheet risk was as follows:

		September 30, 2010				December 31, 2009
Unused commercial credit lines		$	199,697			$	198,815
Unused revolving home equity and credit card lines			104,366				99,629
Standby letters of credit			7,227				24,338
Demand deposit account lines of credit			2,545				2,499
		$	313,835			$	325,281

The majority of commitments to fund loans are variable rate. The demand deposit account lines of credit are a fixed rate at 18% with no maturity.

The credit risk associated with loan commitments and standby letters of credit is essentially the same as that involved in extending loans to customers and is subject to normal credit policies. Collateral may be obtained based on management’s credit assessment of the customer.

Neither the Corporation or any of its subsidiaries are involved in any pending material legal proceedings at this time, other than routine litigation incidental to the business.

Note 12: Fair Value

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:

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

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

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

The Corporation used the following methods and significant assumptions to estimate the fair value of each type of asset or liability carried at fair value:

The fair value of available-for-sale securities are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on securities’ relationship to other benchmark quoted securities (Level 2 inputs).

The fair value of mortgage servicing rights is based on a valuation model that calculates the present value of estimated net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income. The Corporation is able to compare the valuation model inputs and results to widely available published industry data for reasonableness.

The fair value of other real estate owned and impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Assets and Liabilities Measured on a Recurring Basis

Assets and liabilities measured at fair value on a recurring basis are summarized below:

						Fair Value Measurements Using:
						Quoted Prices
						in Active Markets				Significant				Significant
						for Identical				Other				Unobservable
						Assets				Observable Inputs				Inputs
September 30, 2010		Carrying Value				(Level 1)				(Level 2)				(Level 3)
Assets:
U.S. Treasury securities		$	12,200			$	—			$	12,200			$	—
U.S. Government agencies			72,319				—				72,319				—
Mortgage servicing rights			1,142				—				1,142				—
December 31, 2009
Assets:
U.S. Treasury securities		$	506			$	—			$	506			$	—
U.S. Government agencies			66,790				—				66,790				—
Mortgage servicing rights			1,459				—				1,459				—

A detailed breakdown of the fair value for the available-for-sale investment securities is provided in the Investment Securities note.

Assets and Liabilities Measured on a Non-Recurring Basis

Assets and liabilities measured at fair value on a non-recurring basis are summarized below:

						Fair Value Measurements Using:
						Quoted Prices
						in Active Markets				Significant				Significant
						for Identical				Other				Unobservable
						Assets				Observable Inputs				Inputs
September 30, 2010		Carrying Value				(Level 1)				(Level 2)				(Level 3)
Assets:
Impaired loans		$	1,869			$	—			$	—			$	1,869
Other real estate			1,597				—				—				1,597
December 31, 2009
Assets:
Impaired loans		$	6,120			$	—			$	—			$	6,120
Other real estate			2,017				—				—				2,017

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $3.7 million, with a valuation allowance of $1.8 million, at September 30, 2010. This resulted in an additional provision for loan losses of $374 thousand and $1.6 million for the three month and nine month periods ending September 30, 2010, respectively.

Other real estate that has been written down to fair value less costs to sell subsequent to being transferred to other real estate, had a carrying amount of $1.6 million at September 30, 2010. There was a charge to earnings through non performing asset expense of $685 thousand and $731 thousand for the three month and nine month periods ending September 30, 2010, respectively.

The estimated fair value of the Corporation’s financial instruments is as follows:

		September 30, 2010								December 31, 2009
		Carrying				Fair				Carrying				Fair
		Amount				Value				Amount				Value
Assets
Cash and due from banks		$	182,905			$	182,905			$	149,375			$	149,375
Federal funds sold			15,137				15,137				1,242				1,242
Reverse repurchase agreements			1,000				1,000				1,000				1,000
Investment securities available-for-sale			84,519				84,519				67,296				67,296
Investment securities held-to-maturity			91,871				96,472				94,922				96,588
Loans held for sale			5,474				5,614				884				879
Net loans			889,811				901,062				850,122				849,998
Federal Reserve and FHLB stock			3,150				N/A				3,150				N/A
Accrued interest receivable			4,558				4,558				4,199				4,199
Liabilities
Deposits			1,159,893				1,161,039				1,052,065				1,053,849
Repurchase agreements and other secured short-term borrowings			74,840				74,885				81,314				81,415
Short-term debt			3,913				3,913				4,138				4,138
Subordinated debt			5,000				5,000				5,000				5,000
Junior subordinated debt			13,918				10,209				13,918				10,102
Accrued interest payable			1,365				1,365				2,158				2,158