Monarch Financial Holdings, Inc. - FORM 10-K/A

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Monarch Financial Holdings, Inc. Reports

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EX-31.2 - EXHIBIT 31.2 - Monarch Financial Holdings, Inc.	d283754dex312.htm
EX-32.2 - EXHIBIT 32.2 - Monarch Financial Holdings, Inc.	d283754dex322.htm
EX-31.1 - EXHIBIT 31.1 - Monarch Financial Holdings, Inc.	d283754dex311.htm
EX-32.1 - EXHIBIT 32.1 - Monarch Financial Holdings, Inc.	d283754dex321.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K/A

(Amendment 1)

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

For the fiscal year ended December 31, 2011

Commission File No. 001-34565

MONARCH FINANCIAL HOLDINGS, INC.

[EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER]


Virginia		20-4985388
(State or other jurisdiction of incorporation)		(I.R.S. Employer Identification Number)

1435 Crossways Blvd., Chesapeake, Virginia		23320
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (757) 389-5111

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


Title of each class		Name of each exchange on which registered
Common Stock, $5.00 par value		The Nasdaq Stock Market, LLC
7.80% Series B, Noncumulative Convertible		The Nasdaq Stock Market, LLC
Preferred Stock, $5.00 par value

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 þ

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 þ

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 ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K 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 “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

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

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2011 was approximately $47,020,000.

The number of shares of common stock outstanding as of March 28, 2012 was 5,981,489.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive Proxy Statement relating to its 2011 Annual Meeting of Shareholders are incorporated by reference into Part III of this Annual Report on Form 10-K where indicated.

EXPLANATORY NOTE

This Amendment No. 1 to the Monarch Financial Holdings, Inc. Annual Report on form 10-K for the years ended December 31, 2011 and December 31, 2010, is being filed to correct the date on the Report of Independent Registered Public Accounting Firm from Dixon Hughes Goodman LLP (successor to Goodman & Company, LLP) in Item 8. in which the year was inadvertently reported as 2012 rather than 2011.

Except as described above the remainder of the Form 10-K is unchanged and does not reflect events occurring after the original filing of the Form 10-K with the SEC on March 28, 2012.

Item 8.

Financial Statements and Supplementary Data.

MANAGEMENTS REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. Management regularly monitors its internal control over financial reporting and takes appropriate action to correct any deficiencies that may be identified.

Management assessed our internal controls over financial reporting as of December 31, 2011. This assessment was based on criteria established in Internal Controls – Integrated Framework issued by the Commission of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management concluded that we maintained effective internal control over financial reporting as of December 31, 2011.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Further, because of changes in conditions, internal control effectiveness may vary over time.

This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit us to provide only management’s report in this annual report.

/s/ BRAD E. SCHWARTZ

Brad E. Schwartz

Chief Executive Officer

/s/ LYNETTE P. HARRIS

Lynette P. Harris

Executive Vice President and Chief Financial Officer

March 28, 2012

LOGO

Certified Public Accountants and Consultants

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders

Monarch Financial Holdings, Inc. and Subsidiaries

Chesapeake, VA

We have audited the accompanying consolidated balance sheet of Monarch Financial Holdings, Inc. and Subsidiaries as of December 31, 2011, and the related consolidated statements of income, stockholders’ equity and cash flows for the year then ended. 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 audit. The financial statements of Monarch Financial Holdings, Inc. and Subsidiaries for the year ended December 31, 2010, were audited by other auditors whose report, dated March 28, 2011, expressed an unqualified opinion on those statements.

We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. 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 audit provides 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 Monarch Financial Holdings, Inc. and Subsidiaries as of December 31, 2011, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.

/s/ Yount, Hyde & Barbour, P.C.

Winchester, Virginia

March 28, 2012

Report of Independent Registered Public Accounting Firm

Board of Directors and Stockholders

Monarch Financial Holdings, Inc. and Subsidiary

We have audited the accompanying consolidated statement of condition of Monarch Financial Holdings, Inc. and Subsidiary (Company) as of December 31, 2010, and the related consolidated statements of income, stockholders’ equity and comprehensive income, and cash flows for the year then ended. The financial statements are the responsibility of the management of Monarch Financial Holdings, Inc. and Subsidiary. Our responsibility is to express an opinion on these financial statements 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 the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the 2010 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Monarch Financial Holdings, Inc and Subsidiary as of December 31, 2010, and results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.

/s/ Dixon Hughes Goodman LLP (successor to Goodman & Company, LLP)

March 28, 2011

MONARCH FINANCIAL HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF CONDITION


	December 31,
	2011			2010
ASSETS:
Cash and due from banks	$	20,090,991		$	14,733,974
Interest bearing bank balances		10,188,033			10,150,773
Federal funds sold		1,466,560			2,491,000

Total cash and cash equivalents		31,745,584			27,375,747
Investment securities available-for-sale, at fair value		9,186,697			17,601,718
Loans held for sale		211,555,094			175,388,356
Loans held for investment, net of unearned income		607,612,446			558,868,227
Less: allowance for loan losses		(9,930,000	)		(9,037,800	)

Loans, net		597,682,446			549,830,427
Property and equipment, net		23,093,883			20,841,486
Restricted equity securities, at cost		6,420,500			8,692,450
Bank owned life insurance		6,946,166			7,335,473
Goodwill		775,000			775,000
Intangible assets, net		461,311			639,883
Other real estate owned		3,368,700			1,744,700
Other assets		17,241,547			15,357,505

Total assets	$	908,476,928		$	825,582,745

LIABILITIES:
Deposits:
Demand deposits - non-interest bearing	$	133,855,101		$	97,654,595
Demand deposits - interest bearing		40,930,378			32,346,048
Savings deposits		17,915,622			19,348,291
Money market deposits		269,749,851			283,271,306
Time deposits		277,641,145			273,041,337

Total deposits		740,092,097			705,661,577
Borrowings:
Trust preferred subordinated debt		10,000,000			10,000,000
Federal Home Loan Bank advances		70,927,481			30,282,201

Total borrowings		80,927,481			40,282,201
Other liabilities		10,610,522			7,905,470

Total liabilities		831,630,100			753,849,248

STOCKHOLDERS’ EQUITY:
Preferred stock, $5 par value, 1,185,300 shares authorized; none issued		—			—
Noncumulative perpetual preferred stock, series B, liquidation value of $20.0 million, $5 par value; 800,000 shares authorized, issued and outstanding		4,000,000			4,000,000
Common stock, $5 par value: 20,000,000 shares authorized; issued and outstanding - 5,999,989 shares ( includes nonvested shares of 83,550) at December 31, 2011 and 5,969,039 shares outstanding at December 31, 2010		29,582,195			29,845,195
Additional paid-in capital		22,475,738			22,131,351
Retained earnings		20,537,960			15,925,106
Accumulated other comprehensive loss		(363,028	)		(333,247	)

Total Monarch Financial Holdings, Inc. stockholders’ equity		76,232,865			71,568,405
Noncontrolling interests		613,963			165,092

Total equity		76,846,828			71,733,497

Total liabilities and stockholders’ equity	$	908,476,928		$	825,582,745

The accompanying notes are an integral part of these consolidated financial statements.

MONARCH FINANCIAL HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF INCOME


	Year Ended December 31,
	2011			2010
Interest income:
Interest and fees on loans	$	40,019,749		$	38,935,466
Interest on investment securities		183,288			185,548
Interest on federal funds sold		53,256			30,918
Dividends on equity securities		156,986			114,692
Interest on other bank accounts		6,048			6,209

Total interest income		40,419,327			39,272,833

Interest expense:
Interest on deposits		6,198,080			7,490,038
Interest on trust preferred subordinated debt		492,750			492,750
Interest on borrowings		105,625			814,766

Total interest expense		6,796,455			8,797,554

Net interest income		33,622,872			30,475,279
Provision for loan losses		6,319,887			8,639,292

Net interest income after provision for loan losses		27,302,985			21,835,987

Non-interest income:
Mortgage banking income		51,362,464			50,505,562
Service charges and fees		1,630,416			1,637,364
Investment and insurance commissions		250,461			289,730
Gain on sale of assets		37,223			22,073
Gain on sale of securities		3,107			—
Other		1,461,767			945,564

Total noninterest income		54,745,438			53,400,293

Non-interest expenses:
Salaries and employee benefits		23,236,123			18,642,537
Commissions		25,093,001			27,421,538
Loan origination expenses		6,456,864			5,970,413
Occupancy expenses		3,929,058			3,480,682
Furniture and equipment expenses		1,982,600			1,632,558
Marketing expense		1,541,689			1,190,348
Data processing services		1,197,085			896,075
Professional fees		990,056			774,524
Foreclosed property expense		848,523			128,106
FDIC insurance		751,214			1,077,579
Other		5,018,153			4,265,401

Total noninterest expenses		71,044,366			65,479,761

Income before income taxes		11,004,057			9,756,519
Income tax provision		(3,418,692	)		(3,544,532	)

Net income		7,585,365			6,211,987
Less: Net income attributable to noncontrolling interests		(459,753	)		(262,596	)

Net income attributable to Monarch Financial Holdings, Inc.	$	7,125,612		$	5,949,391

Preferred stock dividend and accretion of preferred stock discount		1,560,000			1,560,000

Net income available to common stockholders	$	5,565,612		$	4,389,391

Basic net income per share	$	0.93		$	0.77
Diluted net income per share	$	0.84		$	0.75

The accompanying notes are an integral part of these consolidated financial statements.

MONARCH FINANCIAL HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME


	Common Stock						Additional Paid-In			Preferred		Retained			Accumulated Other Comprehensive			Noncontrolling
	Shares			Amount			Capital			Stock		Earnings			Income (Loss)			Interest			Total
Balance - December 31, 2009		5,865,534		$	29,327,670		$	22,383,274		$	4,000,000	$	12,360,292		$	(162,939	)	$	106,857		$	68,015,154
Comprehensive income:
Net income for year ended December 31, 2010													5,949,391						262,596			6,211,987
Other comprehensive income:
Change in unrealized loss on interest rate swap																(213,244	)					(213,244	)
Change in unrealized gain on securities available-for-sale, net of reclassification adjustment and income taxes																42,936						42,936

Total comprehensive income																						6,041,679

Stock-based compensation expense net of forfeitures and income tax benefit		74,400			372,000			(23,897	)													348,103
Stock options exercised, including tax benefit from exercise of options		29,105			145,525			31,974														177,499
Redemption of warrants on series A cumulative perpetual preferred stock								(260,000	)													(260,000	)
Cash dividend declared on Series B noncumulative perpetual preferred stock (7.8%)													(1,560,000	)								(1,560,000	)
Cash dividend declared on common stock													(824,577	)								(824,577	)
Contributions from noncontrolling interests																			73,500			73,500
Distributions to noncontrolling interests																			(277,861	)		(277,861	)

Balance - December 31, 2010		5,969,039		$	29,845,195		$	22,131,351		$	4,000,000	$	15,925,106		$	(333,247	)	$	165,092		$	71,733,497
Comprehensive income:
Net income for year ended December 31, 2011													7,125,612						459,753			7,585,365
Other comprehensive income:
Change in unrealized loss on interest rate swap																(41,335	)					(41,335	)
Change in unrealized gain on securities available-for-sale, net of reclassification adjustment and income taxes																11,554						11,554

Total comprehensive income																						7,555,584

Stock-based compensation expense net of forfeitures and income tax benefit		(21,200	)		(106,000	)		429,307														323,307
Cash dividend declared on Series B noncumulative perpetual preferred stock (7.8%)													(1,560,000	)								(1,560,000	)
Cash dividend declared on common stock													(952,758	)								(952,758	)
Common stock repurchase		(31,400	)		(157,000	)		(84,920	)													(241,920	)
Contributions from noncontrolling interests																			490,000			490,000
Distributions to noncontrolling interests																			(500,882	)		(500,882	)

Balance - December 31, 2011		5,916,439		$	29,582,195		$	22,475,738		$	4,000,000	$	20,537,960		$	(363,028	)	$	613,963		$	76,846,828

The accompanying notes are an integral part of these consolidated financial statements.

MONARCH FINANCIAL HOLDINGS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS


	Year Ended December 31,
	2011			2010
Operating activities:
Net income	$	7,585,365		$	6,211,987
Adjustments to reconcile to net cash from operating activities:
Provision for loan losses		6,319,887			8,639,292
Depreciation		1,709,145			1,343,270
Accretion of discounts and amortization of premiums, net		23,387			23,090
Deferral of loan costs, net of deferred fees		978			246,929
Amortization of intangible assets		178,572			178,572
Stock-based compensation		323,307			348,103
Appreciation of bank-owned life insurance		(269,263	)		(285,921	)
Loss from rate lock commitments		503,986			300,854
Net gain on disposition of property and equipment		(37,223	)		(22,073	)
Net (gain) loss on sale of other real estate		524,472			(103,095	)
Net gain on disposition of security investments		(3,107	)		—
Deferred income tax (benefit) expense		(695,572	)		(240,969	)
Amortization of deferred gain		(163,451	)		(163,450	)
Changes in:
Loans held for sale		(36,166,738	)		(96,390,643	)
Interest receivable		(143,523	)		(263,943	)
Other assets		(1,062,997	)		(1,075,684	)
Other liabilities		2,799,923			2,195,162

Net cash used in operating activities		(18,572,852	)		(79,058,519	)

Investing activities:
Purchases of available-for-sale securities		(80,272,582	)		(15,820,723	)
Proceeds from sales and maturities of available-for-sale securities		88,684,829			5,450,900
Proceeds from sale of other real estate		3,210,532			5,356,487
Proceeds from sale of assets		20,200			—
Proceeds from bank owned life insurance		1,077,632			—
Reduction in bank owned life insurance		(656,622	)
Purchases of premises and equipment		(4,171,602	)		(13,193,330	)
Purchase of restricted equity securities, net of redemptions		2,271,950			(1,672,750	)
Loan originations, net of principal repayments		(59,531,888	)		(35,198,866	)

Net cash used in investing activities		(49,367,551	)		(55,078,282	)

Financing activities:
Net increase in noninterest-bearing deposits		36,200,506			21,485,777
Net (decrease) increase in interest-bearing deposits		(1,769,986	)		144,136,912
Cash dividends paid on preferred stock		(1,560,000	)		(1,560,000	)
Cash dividends paid on common stock		(952,758	)		(824,577	)
Net increase (decrease) of FHLB advances		40,645,280			(35,876,573	)
Contributions from noncontrolling interests		490,000			73,500
Distributions to noncontrolling interests		(500,882	)		(191,230	)
Proceeds from issuance of common stock		—			177,499
Repurchase of common stock, net of repurchase costs		(241,920	)		—
Redemption of stock warrants		—			(260,000	)

Net cash from financing activities		72,310,240			127,161,308

CHANGE IN CASH AND CASH EQUIVALENTS		4,369,837			(6,975,493	)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR		27,375,747			34,351,240

CASH AND CASH EQUIVALENTS AT END OF YEAR	$	31,745,584		$	27,375,747

SUPPLEMENTAL SCHEDULES AND CASH FLOW INFORMATION
Cash paid for:
Interest on deposits and other borrowings	$	6,819,988		$	8,808,980
Income taxes	$	3,089,372		$	3,129,028
Loans transferred to foreclosed real estate during the year	$	5,359,004		$	5,617,450
Loans to facilitate the sale of real estate	$	—		$	2,290,057
Unrealized gain on securities available for sale, net	$	17,506		$	77,141
Unrealized loss on interest rate swap, net	$	(62,628	)	$	(410,388	)

The accompanying notes are an integral part of these consolidated financial statements.

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and Nature of Operations: Monarch Financial Holdings, Inc. (the “Company” or “Monarch”) is a Virginia chartered Bank Holding Company that offers a full range of banking services, primarily to individuals and businesses in the Hampton Roads area of Virginia and northeastern North Carolina. On June 1, 2006, the Company was created through a reorganization plan, under the laws of the Commonwealth of Virginia, in which Monarch Bank (the “Bank”) became a wholly-owned subsidiary of Monarch Financial Holdings, Inc. Monarch Bank was incorporated on May 1, 1998, and commenced operations on April 14, 1999.

In addition to banking services, we originate mortgage loans in both the residential and commercial markets which are then sold. These services are offered under the name Monarch Mortgage and through the Bank’s 100% owned subsidiary, Monarch Capital, LLC. Investment services are provided under the name Monarch Investments. Residential and commercial title insurance is offered to our clients through Real Estate Security Agency, LLC, a 75% owned subsidiary formed in October 2007.

Principles of Consolidation: Our consolidated financial statements include the accounts of the Company, the Bank and its subsidiaries, collectively referred to as the “Company” or “Monarch”. All significant intercompany transactions have been eliminated.

Use of Estimates: Our financial statements are prepared in conformity with accounting principles generally accepted in the United States of America and general practices within the banking industry requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. Our actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses and the fair value of foreclosed real estate, deferred income taxes and the fair values of financial instruments.

Cash and Cash Equivalents: We define cash and cash equivalents to include currency, balances due from banks (including non-interest bearing and interest bearing deposits) and federal funds sold. We are required to maintain certain reserve balances with the Federal Reserve Bank. These required reserves were $5.2 million at December 31, 2011 and $3.5 million at December 31, 2010.

Investment Securities: Investments classified as available-for-sale are stated at fair value with unrealized holding gains and losses excluded from earnings and reported, net of deferred tax, as a component of other comprehensive income until realized. Investments in debt securities classified as held-to-maturity are stated at cost, adjusted for amortization of premiums and accretion of discounts using the interest method. Management has a positive intent and ability to hold these securities to maturity and, accordingly, adjustments are not made for temporary declines in their fair value below amortized cost.

Gains and losses on the sale of securities are determined using the specific identification method. Other-than-temporary declines in the fair value of individual available-for-sale and held-to-maturity securities below their cost, if any, are included in earnings as realized losses.

Loans Held for Sale: Loans originated and intended for sale in the secondary market are carried at the lower of cost or market in the aggregate. Net unrealized losses, if any, are recognized through charges to income.

Loans: Loans are reported at their recorded investment, which is the principal outstanding balance plus accrued interest and net of charge-offs, deferred loan fees and costs on originated loans, unearned income, and unamortized premiums or discounts, if any, on purchased loans. Interest income is recognized over the term of the loan and is calculated using the simple-interest method on principal amounts outstanding. Further information on loans is contained in Note 3 to our Consolidated Financial Statements.

Deferred Loan Fees and Costs: Certain fees and costs associated with loan originations are recognized as an adjustment to interest income and straight-lined over the contractual life of the loans.

Allowance for Loan Losses: The allowance for loan losses reflects management’s judgment of probable losses inherent in the portfolio at the balance sheet date. A loan is considered impaired, based on current information and events, if it is probable that we will be unable to collect the scheduled payments of principal and/or

interest when due, according to the contractual terms of the loan agreement. The measurement of impaired loans is generally based on the present value of expected future cash flows discounted at the historical effective interest rate, except in the case of collateral-dependent loans which may be measured for impairment based on the fair value of the collateral. Further information on loans is contained in Note 3 to our Consolidated Financial Statements.

The establishment of the allowance for loan losses relies on a consistent process that requires multiple layers of management review and judgment and responds to changes in economic conditions, client behavior, and collateral value, among other influences. Management uses a disciplined process and methodology to establish the allowance for loan losses on a monthly basis. To determine the total allowance for loan losses, the Company estimates the reserves needed for each segment of the portfolio, including loans analyzed on a pooled basis and individually.

The allowance for loan losses consists of amounts applicable to three categories: (i) the commercial loan portfolio; (ii) the real estate loan portfolio; (iii) the consumer loan portfolio. Loans within these categories are further separated into classes or segments. Loans are pooled by risk segment and losses were modeled utilizing risk rating, historical experience, known and inherent risks, and quantitative techniques which management determined fit the characteristics of that segment. Additionally, loans that have been specifically identified as a credit risk due to circumstances that may affect the ability of the borrower to repay interest and/or principal are analyzed on an individual basis. Adverse circumstances may include loss of repayment source, deterioration in the estimated value of collateral, elevated trends of delinquencies, and charge-offs.

We evaluate the adequacy of the allowance for loan losses monthly in order to maintain the allowance at a level that is sufficient to absorb probable credit losses. Such factors as the level and trend of interest rates and the condition of the national and local economies are also considered. From time to time, events or economic factors may affect the loan portfolio, causing management to provide additional amounts to or release balances from the allowance for loan losses. The Company’s allowance for loan losses is sensitive to risk ratings assigned to individually evaluated loans, economic assumptions, and delinquency trends driving statistically modeled reserves. In addition, various regulatory agencies, as an integral part of their examination process, periodically review our allowance for losses on loans. Such agencies may require that we recognize additions to the allowance based on their judgments of information available to them at the time of their examination.

The allowance for loan losses is established through charges to earnings in the form of a provision for loan losses. Increases and decreases in the allowance due to changes in the measurement of impaired loans, if applicable, are included in the provision for loan losses. A loan is considered impaired when, based on current information and events; it is probable that we will be unable to collect all amounts due to us according to the contractual terms of the loan agreement. Impairment is measured on a loan by loan basis, by either the present value of expected future cash flows discounted to the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral less costs to sell if the loan is collateral dependent. Loans continue to be classified as impaired unless they are brought fully current and the collection of scheduled interest and principal is considered probable.

When a loan or portion of a loan is determined to be uncollectible, the portion deemed uncollectible is charged against the allowance. Subsequent recoveries, if any, are credited to the allowance until fully recaptured, prior to the resumption of recording additional principal curtailments and/or interest.

Loan Charge-off Policies: Our loan charge-off policy delineates between secured and unsecured loans in addition to consumer, residential real estate, and commercial and construction loans.

•

Unsecured loans are to be charged-off when they become 120 days delinquent or when it is determined that the debt is uncollectible, whichever comes first. Overdrafts are to be charged-off when it is determined a recovery is not likely or the overdraft becomes 90 days old, whichever comes first.

•

Secured consumer loans, except those secured by the borrower’s primary or secondary residence, are to be charged-off or charged-down to net recoverable value of collateral on or before becoming 120 days past due, or whenever collection is doubtful, whichever comes first.

•

Residential real estate loans are to be charged-off when they become 365 days delinquent. Home equity and improvement loans are to be reviewed before they become 180 days past due and are to be charged off unless they are well-secured and in process of collection.

•

Charge-offs on commercial, commercial real estate and constructions loans are to be taken promptly upon determination that all or a portion of any loan balance is uncollectible. A loan is considered uncollectible when the borrower is delinquent in principal or interest repayment and: a) the loan becomes 90 days past due, b) the borrower is unlikely to have the ability to pay the debt in a timely manner, c) the collateral value of the securing asset is insufficient to cover the outstanding indebtedness, and/or d) the guarantors do not provide adequate support for the debt.

•

Charge-offs are taken immediately on any loan graded a “9” or considered statutory bad debt. Statutory bad debt exists when interest on a loan is past due and unpaid for six months and the loan is not well secured and in process of collection.

Income Recognition on Impaired and Nonaccrual Loans: Loans, including impaired loans, are generally classified as nonaccrual if they are past due as to maturity or payment of principal and/or interest for a period of more than 90 days, unless such loans are well-secured and in the process of collection. If a loan or a portion of a loan is classified as doubtful, or is partially charged off, the loan is generally classified as nonaccrual. Loans that are on a current payment status or past due less than 90 days may also be classified as nonaccrual, if repayment in full of principal and/or interest is in doubt.

Loans may be returned to accrual status when all principal and interest amounts contractually due (including arrearages) are reasonably assured of repayment within an acceptable period of time, and there is a sustained period of repayment performance by the borrower, in accordance with the contractual terms of interest and principal.

While a loan is classified as nonaccrual and the future collectability of the recorded loan balance is doubtful, collections of interest and principal are generally applied as a reduction to principal outstanding. When the future collectability of the recorded loan balance is expected, interest income may be recognized on a cash basis. In the case where a nonaccrual loan had been partially charged off, recognition of interest on a cash basis is limited to that which would have been recognized on the recorded loan balance at the contractual interest rate. Cash receipts of interest in excess of that amount are recorded as recoveries to the allowance for loan losses until prior charge-offs have been fully recovered.

Restructured Loans: A restructured loan is an impaired loan in which it has been determined the borrower’s financial difficulties will prevent performance under the original contractual terms of the loan agreement and a concession is made with regard to those terms which would not be considered under normal circumstances.

If the value of a restructured loan is determined to be less than the recorded investment in the loan, a valuation allowance is created with a corresponding charge off. Measurement of the value of a restructured loan is generally based on the present value of expected future cash flows discounted at the loan’s effective interest rate, unless in the case of collateral-dependent loans, the observable market price, or the fair value of the collateral can be readily determined. Restructured loans are periodically reevaluated to determine if additional adjustments to the carrying value are necessary.

Collections of interest and principal are recorded as recoveries to the allowance for loan losses until all charged-off balances have been fully recovered.

Other Real Estate Owned: Real estate properties acquired through or in lieu of loan foreclosure are initially recorded at the fair value less estimated selling costs at the date of foreclosure. Any write-downs based on the asset’s fair value at the date of acquisition are charged to the allowance for loan losses. After foreclosure, valuations are periodically performed by management and property held for sale is carried at the lower of the new cost basis or fair value less cost to sell. Property held and used is considered impaired when the carrying amount of a property exceeds its fair value. Any impairment would be charged to operations. Costs of significant property improvements are capitalized, whereas costs relating to holding property are expensed. The portion of interest costs relating to development of real estate is capitalized. Valuations are periodically performed by management, and any subsequent write-downs are recorded as a charge to operations, if necessary, to reduce the carrying value of a property to the lower of its cost or fair value less cost to sell.

Property and Equipment: Land is carried at cost. Property and equipment are stated at cost less accumulated depreciation. Leasehold improvements are amortized over the terms of the respective leases or the estimated useful lives of the improvement, whichever is shorter. Repairs and maintenance costs are charged to operations as incurred and additions and improvements to premises and equipment are capitalized. For financial reporting purposes, assets are depreciated using the straight-line method over their estimated useful lives, which range from 3 years to 30 years, depending on the asset type and any related contracts. For income tax purposes, the accelerated cost recovery system and the modified accelerated cost recovery system are used.

Restricted Equity Securities: As a requirement for membership, we invest in the stock of the Federal Home Loan Bank of Atlanta (“FHLB”), Community Bankers Bank (“CBB”), and the Federal Reserve Bank (“FRB”). These investments are carried at cost. Due to the redemption provisions of these entities, we estimated that fair value approximates cost and that these investments were not impaired at December 31, 2011.

Transfers of Financial Assets: Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) we do not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

Credit Related Financial Instruments: In the ordinary course of business, we have entered into commitments to extend credit, including commercial letters of credit, and standby letters of credit. Such financial instruments are recorded when they are funded.

Mortgage Banking Income: We derive our mortgage banking income from discounted fees, or points, collected on loans originated, premiums received on the sale of mortgage loans and their related servicing rights to investors, and other fees. We recognize this income, including discount fees and points, at closing. All of these components determine the gain on sale of the underlying mortgage loans to investors.

Rate Lock Commitments: Through our mortgage banking activities, we commit to originate residential mortgage loans whereby the interest rate on the loan is determined prior to funding (i.e. rate lock commitments.) The period of time between the issuance of a loan commitment and closing and sale of the loan generally ranges between 15 to 90 days. The Company protects itself from changes in interest rates by entering into loan purchase agreements with third party investors that provide for the investor to purchase loans at the same terms, including interest rate, as committed to the borrower. Under the contractual relationship with these third party investors, the Company is obligated to sell the loan to the investor, and the investor is obligated to buy the loan, only if the loan closes. No other obligation exists. The Company is not exposed to losses nor will it realize gains related to its rate lock commitments due to changes in interest rates as a result of these contractual relationships with third party investors.

Advertising: Advertising costs are expensed as incurred.

Income Taxes: Deferred income tax assets and liabilities are determined using the 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 the book and tax basis of the various balance sheet assets and liabilities and includes recognition to changes in current tax rates and laws.

Segment Reporting: Public business enterprises are required to report information about operating segments in financial statements and selected information about operating segments in financial reports issued to shareholders. Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by management in determining how to allocate resources and to assess effectiveness of the segments’ performance. Generally, financial information is required to be reported on the basis that is used internally for evaluating segment performance and deciding how to allocate resources to segments. We have two reporting segments, one for general banking service and one for mortgage banking operations.

Earnings Per Share: Basic earnings per share (EPS) excludes dilution, and is computed by dividing income available to common stockholders by the weighted-average number of shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised, converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity.

Reclassifications: Certain reclassifications have been made to prior year’s information to conform to the current year’s presentation.

Derivative Financial Instruments and Hedging Activities: We use derivatives to manage risks related to interest rate movements. Interest rate swap contracts designated and qualifying as cash flow hedges are reported at fair value. The gain or loss on the effective portion of the hedge initially is included as a component of other comprehensive income and is subsequently reclassified into earnings when interest on the related debt is paid. We document our risk management strategy and hedge effectiveness at the inception of and during the term of each hedge. Our interest rate risk management strategy is to stabilize cash flow requirements by maintaining interest rate swap contracts to convert variable-rate debt to a fixed rate. We do not hold or issue derivative financial instruments for trading purposes.

Periodically, we participate in a “mandatory” delivery program for mortgage loans. Under the mandatory delivery system, loans with interest rate locks are paired with the sale of a notional security bearing similar attributes. Interim income or loss on the pairing of the loans and securities is recorded in mortgage banking income on our income statement. In addition, at the time the loan is delivered to an investor, matched securities are repurchased and a gain or loss on the pairing is recorded in mortgage banking income on our income statement. Management has elected to limit our exposure to this form of delivery to $50 million in outstanding loans. We were not participating in the mandatory delivery program at December 31, 2011.

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. Components of other comprehensive income consist of unrealized gains and losses on available-for-sale securities and a derivative financial liability related to an interest rate swap as follows:


	2011			2010
Unrealized holding gains on securities available for sale arising during the period	$	20,613		$	65,055
Plus reclassification adjustments for losses included in income		(3,107	)		—

Total other comprehensive income before income tax expense		17,506			65,055
Less income tax expense		(5,952	)		(22,119	)

Net unrealized gains	$	11,554		$	42,936

Unrealized holding losses on interest rate swap arising during the period	$	(62,628	)	$	(424,656	)
Plus reclassification adjustments for losses included in income		—			—

Total other comprehensive income before income tax expense		(62,628	)		(424,656	)
Add income tax benefit		21,293			211,412

Net unrealized losses	$	(41,335	)	$	(213,244	)

Stock Compensation Plans: In May 2006, our shareholders ratified the adoption of a new stock-based compensation plan to succeed the Monarch Bank 1999 Incentive Stock Option Plan. The new 2006 Equity Incentive Plan authorizes the compensation committee to grant options, stock appreciation rights, stock awards, performance stock awards, and stock units to designated directors, officers, key employees, consultants and advisors to the Company and its subsidiaries. We are authorized through the Plan to issue up to 630,000 split-adjusted shares of our common stock plus the number of shares of our common stock outstanding under the 1999 Plan. The Plan also provides that no award may be granted more than 10 years after the May 2006 ratification date.

On January 1, 2006, we adopted Accounting Standards Codification (“ASC”) 718-10, that addresses the accounting for share-based payment transactions in which a company receives employee services in exchange for either equity instruments of the company or liabilities that are based on the fair value of the company’s equity instruments or that may be settled by the issuance of such equity instruments. ASC 718-10 eliminates the ability to account for share-based compensation transactions using the intrinsic method and requires that such transactions be accounted for using a fair-value-based method and recognized as expense in the consolidated statement of income.

Fair Value Measurements: Fair Value is the exchange price in an orderly transaction, which is not a forced liquidation or distressed sale, between market participants to sell an asset or transfer a liability in the market in which the reporting entity would transact for the asset or liability, that is, the principal or most advantageous market for the asset/liability. The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the asset/liability. Fair Value focuses on exit price and prioritizes, within a measurement of fair value, the use of market-based inputs over entity-specific inputs. The framework for measuring fair value is comprised of a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

The three levels of valuation hierarchy are as follows:

Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

Level 3 – inputs to the valuation methodology are unobservable and significant to the fair value measurement.

For additional information on Fair Value Measurements see Note 20.

We review the appropriateness of our classification of assets/liabilities within the fair value hierarchy on a quarterly basis, which could cause such assets/liabilities to be reclassified among the three hierarchy levels. We use inputs that are current as of the measurement date, which may include periods of market dislocation, during which price transparency may be reduced. While we believe our valuation methods are appropriate and consistent with other market participants, the use of different methodologies, or assumptions, to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. The methods used to produce a fair value calculation may not be indicative of net realizable value or reflective of future fair values.

RECENT ACCOUNTING PRONOUNCEMENTS

In December 2011, the FASB issued ASU 2011-12, “Comprehensive Income (Topic 220) – Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05.” The amendments are being made to allow the Board time to redeliberate whether to present on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income for all periods presented. While the Board is considering the operational concerns about the presentation requirements for reclassification adjustments and the needs of financial statement users for additional information about reclassification adjustments, entities should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before ASU 2011-05. All other requirements in ASU 2011-05 are not affected by ASU 2011-12, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. Public entities should apply these requirements for fiscal years, and interim periods within those years, beginning after December 15, 2011. We are currently assessing the impact that ASU 2011-12 will have on our consolidated financial statements.

In December 2011, the FASB issued ASU 2011-11, “Balance Sheet (Topic 210) – Disclosures about Offsetting Assets and Liabilities.” This ASU requires entities to disclose both gross information and net information about both instruments and transactions eligible for offset in the balance sheet and instruments and transactions subject to an agreement similar to a master netting arrangement. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. We are currently assessing the impact that ASU 2011-11 will have on our consolidated financial statements.

In September 2011, the FASB issued ASU 2011-08, “Intangible – Goodwill and Other (Topic 350) – Testing Goodwill for Impairment.” The amendments in this ASU permit an entity to first assess qualitative factors related to goodwill to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill test described in Topic 350. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. Under the amendments in this ASU, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. The amendments in this ASU are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued. We are currently assessing the impact that ASU 2011-08 will have on our consolidated financial statements.

In August 2011, the SEC issued Final Rule No. 33-9250, “Technical Amendments to Commission Rules and Forms related to the FASB’s Accounting Standards Codification.” The SEC has adopted technical amendments to various rules and forms under the Securities Act of 1933, the Securities Exchange Act of 1934, and the Investment Company Act of 1940. These revisions were necessary to conform those rules and forms to the FASB Accounting Standards Codification. The technical amendments include revision of certain rules in Regulation S-X, certain items in Regulation S-K, and various rules and forms prescribed under the Securities Act, Exchange Act and Investment Company Act. The Release was effective as of August 12, 2011. The adoption of the new guidance did not have a material impact on our consolidated financial statements.

In June 2011, the FASB issued ASU 2011-05, “Comprehensive Income (Topic 220) – Presentation of Comprehensive Income.” The objective of this ASU is to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income by eliminating the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. The amendments require that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The single statement of comprehensive income should include the components of net income, a total for net income, the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present all the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income. The amendments do not change the items that must be reported in other comprehensive income, the option for an entity to present components of other comprehensive income either net of related tax effects or before related tax effects, or the calculation or reporting of earnings per share. The amendments in this ASU should be applied retrospectively. The amendments are effective for fiscal years and interim periods within those years beginning after December 15, 2011. Early adoption is permitted because compliance with the amendments is already permitted. The amendments do not require transition disclosures. We are currently assessing the impact that ASU 2011-05 will have on our consolidated financial statements.

In May 2011, the FASB issued ASU 2011-04, “Fair Value Measurement (Topic 820) – Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” This ASU is the result of joint efforts by the FASB and International Accounting Standards Board (IASB) to develop a single, converged fair value framework on how (not when) to measure fair value and what disclosures to provide about fair value measurements. The ASU is largely consistent with existing fair value measurement principles in U.S. GAAP (Topic 820), with many of the amendments made to eliminate unnecessary wording differences between U.S. GAAP and International Financial Reporting Standards (IFRS). The amendments are effective for interim and annual periods beginning after December 15, 2011 with prospective application. Early application is not permitted. We are currently assessing the impact that ASU 2011-04 will have on our consolidated financial statements.

In April 2011, the FASB issued ASU 2011-03, “Transfers and Servicing (Topic 860) – Reconsideration of Effective Control for Repurchase Agreements.” The amendments in this ASU remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee and (2) the collateral maintenance implementation guidance related to that criterion. The amendments in this ASU are effective for the first interim or annual period beginning on or after December 15, 2011. The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. We are currently assessing the impact that ASU 2011-03 will have on our consolidated financial statements.

In April 2011, the FASB issued ASU 2011-02, “Receivables (Topic 310) – A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.” The amendments in this ASU clarify the guidance on a creditor’s evaluation of whether it has granted a concession to a debtor. They also clarify the guidance on a creditor’s evaluation of whether a debtor is experiencing financial difficulty. The amendments in this ASU are effective for the first interim or annual period beginning on or after June 15, 2011. Early adoption is permitted. Retrospective application to the beginning of the annual period of adoption for modifications occurring on or after the beginning of the annual adoption period is required. As a result of applying these amendments, an entity may identify receivables that are newly considered to be impaired. For purposes of measuring impairment of those receivables, an entity should apply the amendments prospectively for the first interim or annual period beginning on or after June 15, 2011. We have adopted ASU 2011-02 and included the required disclosures in our consolidated financial statements.

In January 2011, the FASB issued ASU 2011-01, “Receivables (Topic 310) – Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings.” The amendments in this ASU temporarily delayed the effective date of the disclosures about troubled debt restructurings in Update 2010-20 for public entities. The delay was

intended to allow the Board time to complete its deliberations on what constitutes a troubled debt restructuring. The effective date of the new disclosures about troubled debt restructurings for public entities and the guidance for determining what constitutes a troubled debt restructuring was effective for interim and annual periods ending after June 15, 2011. We have adopted ASU 2011-01 and included the required disclosures in our consolidated financial statements.

In March 2011, the SEC issued Staff Accounting Bulletin (SAB) 114. This SAB revises or rescinds portions of the interpretive guidance included in the codification of the Staff Accounting Bulletin Series. This update is intended to make the relevant interpretive guidance consistent with current authoritative accounting guidance issued as a part of the FASB’s Codification. The principal changes involve revision or removal of accounting guidance references and other conforming changes to ensure consistency of referencing through the SAB Series. The effective date for SAB 114 is March 28, 2011. The adoption of the new guidance did not have a material impact on our consolidated financial statements.

The Securities Exchange Commission (SEC) issued Final Rule No. 33-9002, “Interactive Data to Improve Financial Reporting.” The rule requires companies to submit financial statements in extensible business reporting language (XBRL) format with their SEC filings on a phased-in schedule. Large accelerated filers and foreign large accelerated filers using U.S. generally accepted accounting principles (GAAP) were required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2010. All remaining filers were required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2011. We have submitted financial statements in extensible business reporting language (XBRL) format with our SEC filings in accordance with the phased-in schedule.

In December 2010, the FASB issued ASU 2010-29, “Business Combinations (Topic 805) – Disclosure of Supplementary Pro Forma Information for Business Combinations.” The guidance requires pro forma disclosure for business combinations that occurred in the current reporting period as though the acquisition date for all business combinations that occurred during the year had been as of the beginning of the annual reporting period. If comparative financial statements are presented, the pro forma information should be reported as though the acquisition date for all business combinations that occurred during the current year had been as of the beginning of the comparable prior annual reporting period. ASU 2010-29 is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted. The adoption of the new guidance did not have a material impact on our consolidated financial statements.

In December 2010, the FASB issued ASU 2010-28, “Intangible – Goodwill and Other (Topic 350) – When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts.” The amendments in this ASU modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. The amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted. The adoption of the new guidance did not have a material impact on our consolidated financial statements.

In July 2010, the FASB issued ASU 2010-20, “Receivables (Topic 310) – Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” The new disclosure guidance significantly expands the existing requirements and will lead to greater transparency into an entity’s exposure to credit losses from lending arrangements. The extensive new disclosures of information as of the end of a reporting period became effective for both interim and annual reporting periods ending on or after December 15, 2010. Specific disclosures regarding activity that occurred before the issuance of the ASU, such as the allowance roll forward and modification disclosures will be required for periods beginning on or after December 15, 2010. We have included the required disclosures in our consolidated financial statements.

In January 2010, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 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 adoption of the new guidance did not have a material impact on our consolidated financial statements.

NOTE 2 – INVESTMENT SECURITIES

Securities available-for-sale consisted of the following:


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
December 31, 2011
U.S. government agency obligations	$	6,058,680	$	48,244	$	(1,331	)	$	6,105,593
Mortgage-backed securities		1,249,269		12,556		(2,977	)		1,258,848
Municipal securities		1,244,362		69,555		(3,016	)		1,310,901
Corporate debt securities		500,000		11,355		—			511,355

	$	9,052,311	$	141,710	$	(7,324	)	$	9,186,697


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
December 31, 2010
U.S. government agency obligations	$	16,581,900	$	85,272	$	—		$	16,667,172
Mortgage-backed securities		402,937		16,404		—			419,341
Corporate debt securities		500,000		15,205		—			515,205

	$	17,484,837	$	116,881	$	—		$	17,601,718

The Company did not have any held-to-maturity or trading securities at December 31, 2011 or December 31, 2010.

The amortized cost and estimated fair value of securities, all of which are classified as available for sale, at December 31, 2011, by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to prepay obligations with or without call or prepayment penalties.

Securities available-for-sale:


	Amortized Cost		Fair Value
Due in one year or less	$	500,140	$	501,885
Due from one to five years		5,081,935		5,140,391
Due from five to ten years		1,098,911		1,098,467
Due after ten years		2,371,325		2,445,954

Total	$	9,052,311	$	9,186,697

The gross unrealized losses in our securities portfolio at December 31, 2011 are as follows:

GROSS UNREALIZED LOSSES AND FAIR VALUE

AS OF DECEMBER 31, 2011

Less than 12 months

12 months or more

Total

Securities
Description

Fair
Value

Unrealized
Loss

Fair
Value

Unrealized
Loss

Fair
Value

Unrealized
Loss

U.S. government agency obligations

1,497,700

(1,331

)

—

1,497,700

(1,331

)

Mortgage-backed securities

1,025,075

(2,977

)

—

1,025,075

(2,977

)

Municipal securities

250,467

(3,016

)

—

250,467

(3,016

)

Corporate bonds

—

Total temporarily impaired securities

2,773,242

(7,324

)

—

2,773,242

(7,324

)

There were no gross unrealized losses in our securities portfolio at December 31, 2010. There are no investments in our securities portfolio that have been in a continuous unrealized loss position for more than 12 months. If we were to have unrealized losses in our securities portfolio for more than 12 months, we have the ability to carry such investments to the final maturity of the instruments. Other-than-temporarily impaired (“OTTI”) guidance for investments state that an impairment is OTTI if any of the following conditions exist: the entity intends to sell the security; it is more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis; or, the entity does not expect to recover the security’s entire amortized cost basis (even if the entity does not intend to sell). An impaired security identified as OTTI should be separated and losses should be recognized in earnings. Based on this guidance, there were no securities considered OTTI at December 31, 2011 or December 31, 2010 and there were no losses related to OTTI recognized in accumulated other comprehensive income at either, December 31, 2011 or 2010.

All of our mortgage-backed securities are government agency issued. The carrying value of our government agency issued mortgage backed securities was $1,258,848 or 100% of the total mortgage-backed securities at December 31, 2011 and $419,314 or 100% at December 31, 2010.

Securities with carrying values of $3,221,216 and $6,101,096 were pledged to secure treasury tax and loan, public deposits and borrowings from the Federal Home Loan Bank of Atlanta at December 31, 2011 and 2010, respectively.

We recorded a gross realized gain on the sale of an available-for-sale investment of $3,107 in 2011. There were no gross realized gains or losses on available-for-sale securities in 2010. Proceeds from maturities, sales and calls of investment securities were $88,684,829 and $5,450,900 for 2011 and 2010, respectively.

NOTE 3 – LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES

Loans consisted of the following at December 31:


	2011			2010
Commercial	$	81,209,758		$	86,633,856
Real estate
Construction		139,255,002			119,881,034
Residential (1-4 family)		85,750,291			84,822,652
Home equity lines		74,870,706			81,013,642
Multifamily		26,710,732			20,959,832
Commercial		196,198,979			162,541,959

Real estate subtotal		522,785,710			469,219,119

Consumers
Consumer and installment loans		3,548,466			2,937,347
Overdraft protection loans		58,232			66,647

Loans to individuals subtotal		3,606,698			3,003,994

Total gross loans		607,602,166			558,856,969
Allowance for loan losses		(9,930,000	)		(9,037,800	)

Loans net of allowance for loan losses		597,672,166			549,819,169

Unamortized loan costs, net of deferred fees		10,280			11,258

Total net loans	$	597,682,446		$	549,830,427

We have certain lending policies and procedures in place that are designed to balance loan growth and income with an acceptable level of risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, credit concentrations, policy exceptions, loan delinquencies and non-performing and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions.

Our loan portfolio is divided into three loan types; commercial, real estate and consumer. Some of these loan types are further broken down into classes or segments. The commercial loan portfolio is not broken down further, but includes commercial and industrial loans which are usually secured by the assets being financed or other business assets. The real estate loan portfolio is broken down into construction, residential 1-4 family, home equity lines, multifamily, and commercial real estate loan segments. The consumer loan portfolio is segmented into consumer and installment loans, and overdraft protection loans.

Commercial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand its business. Underwriting standards are designed to promote relationship banking rather than transactional banking. Once it is determined that the borrower’s management possesses sound ethics and solid business acumen, we examine current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and normally incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

Commercial real estate loans are subject to underwriting standards and processes similar to commercial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation or sale of the income producing property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing our commercial real estate portfolio are diverse in terms of type. This diversity helps reduce our exposure to adverse economic events that affect any single market or industry. Management monitors and evaluates commercial real estate loans based on purpose, collateral, geography, cash flow, loan to value and risk grade criteria. As a general rule, we avoid financing special purpose projects unless other underwriting factors are present to help mitigate risk. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. At December 31, 2011, approximately 55% and at December 31, 2010, approximately 58% of the outstanding principal balance of our commercial real estate loans portfolio was secured by owner-occupied properties.

With respect to loans to developers and builders that are secured by non-owner occupied properties that we may originate from time to time, we generally require the borrower to have an existing relationship with the Company and a proven record of success. Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of considerable funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to the Interest rate sensitivity of their ultimate source of repayment, supply and demand, and governmental regulation of real property, general economic conditions and the availability of long-term financing.

We generally require multifamily real estate loan borrowers to have an existing relationship with the Company, a proven record of success and guarantor financial strength, commensurate with the project size. The underlying feasibility of a multifamily project is stress tested for sensitivity to both capitalization and interest rate changes. Each project is underwritten separately and additional underwriting standards are required for the guarantors, which include, but are not limited to, a maximum loan-to-value percentage, global cash flow analysis and contingent liability analysis. Sources of repayment for these types of loans may be rent rolls or sales of the developed property, either by unit or as a whole.

Consumer and residential loan originations, including home equity lines of credit, utilize analytics to supplement the underwriting process. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed. This monitoring, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Additionally, trend, sensitivity analysis, shock analysis and outlook reports are reviewed by management on a regular basis. Underwriting standards for home equity loans are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage of 80%, collection remedies, the number of such loans a borrower can have at one time and documentation requirements.

We perform periodic reviews on various segments of our loan portfolio in addition to presenting the majority of our loan relationships for loan committee review. We utilize an independent company to perform a periodic review to evaluate and validate our credit risk program. Results of these reviews are presented to management and our board. Additionally, we are subject to annual examination by our regulators. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as our policies and procedures.

We have an established methodology to determine the adequacy of the allowance for loan losses that assesses the risks and losses inherent in the loan portfolio. This methodology begins with a look at the three loan types; commercial, real estate, and consumer. Loans within the commercial and real estate types are evaluated on an individual or relationship basis and assigned a risk grade based on the characteristics of the loan or relationship. Loans within the consumer type are assigned risk grades and evaluated as a pool, unless specifically identified through delinquency or other signs of credit deterioration, at which time the identified loan would be individually evaluated.

There are nine numerical risk grades which are assigned to loans. These numeric designations represent, from best to worst: minimal, modest, average, acceptable, acceptable with care, special mention, substandard, doubtful and loss.

A loan risk graded as loss is generally charged-off when identified. A loan risk graded as doubtful is considered “watch list” and classified as nonaccrual. We did not have any loans in our portfolio classified as doubtful or loss on December 31, 2011 or December 31, 2010. Additionally, some special mention and all substandard loans are considered watch list and may or may not be classified as nonaccrual, based on current performance. Watch list graded loans or relationships are evaluated individually to determine if all, or a portion of our investment in the borrower, is at risk. If a risk is quantified, a specific loss allowance will be assigned to the identified loan or relationship. We evaluate our investment in the borrower using either the present value of expected future cash flows, discounted at the historical effective interest rate of the loan, or for a collateral-dependent loan, the fair value of the underlying collateral. Special mention loans, which do not appear to be impaired, are included in the “satisfactory” risk grade groups.

“Pass” loans with a risk rating of modest to acceptable with care, along with the special mention loans having lower risk profiles, are assigned an expected loss factor. This loss factor, which is multiplied by the outstanding principal within each risk grade to arrive at an overall loss estimate, is based on a three-year moving average “look-back” at our historical losses, adjusted for environmental risk factors described below.

Additional metrics, in the form of environmental risk factors, are applied to a specific class or risk grade of loans within the portfolio based on local or national trends, identifiable events or other economic factors. At December 31, 2011, four environmental factors were applied to the general risk grade groups. The first environmental factor was applied to our real estate construction loans due to the concentration in our portfolio. The second environmental factor was applied to our home equity lines based on delinquency rates. The third environmental factor was applied to all “pass” loans based on economic conditions, including local unemployment and gross regional product. The final environmental factor was applied to all “satisfactory” loans based on trends in our nonperforming assets. The assumptions used to determine the allowance are reviewed to ensure that their theoretical foundation, data integrity, computational processes, and reporting practices are appropriate and properly documented.

We utilize various sources in assessing the economic conditions in our target markets and areas of concentration. We track unemployment trends in both Hampton Roads and Virginia compared to the national average. We monitor trends in our industry and among our peers through reports such as the Uniform Bank Performance Report which are made available to us through the Federal Financial Institutions Examination Council. Additionally, we utilize various industry sources that include information published by CB Richard Ellis, an international firm specializing in commercial real estate reporting and CoStar Group, a provider of commercial real estate information and analytics to monitor local, state and national trends.

We evaluate the adequacy of our allowance for loan losses monthly. A degree of imprecision or uncertainty is inherent in our allowance estimates because it requires that we incorporate a range of probable outcomes which may change from period to period. It requires that we exercise judgment as to the risks inherent in our portfolios, economic uncertainties, historical loss and other subjective factors, including industry trends. No single statistic or measurement determines the adequacy of the allowance for loan loss. Changes in the allowance for loan loss and the related provision expense can materially affect net income.

A summary of our loan portfolio by class and delineated between pass and watchlist as of December 31, 2011 and December 31, 2010 is as follows:

December 31, 2011

Watchlist

Weighted
Average

Pass

Special Mention

Substandard

Total

Risk Grade

Commercial

72,166,118

3,073,611

5,970,029

81,209,758

4.06

Real estate

Construction

124,747,757

495,479

14,011,766

139,255,002

4.08

Residential (1-4 family)

75,240,661

1,259,491

9,250,139

85,750,291

4.43

Home equity lines

71,487,540

2,229,059

1,154,107

74,870,706

4.12

Multifamily

24,408,006

—

2,302,726

26,710,732

3.82

Commercial

187,102,529

1,518,206

7,578,244

196,198,979

4.06

Real estate subtotal

482,986,493

5,502,235

34,296,982

522,785,710

4.12

Consumers

Consumer and installment loans

3,528,103

—

20,364

3,548,467

3.78

Overdraft protection loans

58,231

—

58,231

4.07

Loans to individuals subtotal

3,586,334

—

20,364

3,606,698

3.78

Total gross loans

558,738,945

8,575,846

40,287,375

607,602,166

4.11


	December 31, 2010
			Watchlist						Weighted Average
	Pass		Special Mention		Substandard		Total		Risk Grade
Commercial	$	76,751,687	$	8,038,429	$	1,843,740	$	86,633,856		4.14
Real estate
Construction		95,236,104		5,643,773		19,001,157		119,881,034		4.39
Residential (1-4 family)		68,184,218		5,946,666		10,691,768		84,822,652		4.58
Home equity lines		75,470,348		1,830,661		3,712,633		81,013,642		4.19
Multifamily		17,403,263		3,556,569		—		20,959,832		3.65
Commercial		157,903,052		3,444,500		1,194,407		162,541,959		3.93

Real estate subtotal		414,196,985		20,422,169		34,599,965		469,219,119		4.20

Consumers
Consumer and installment loans		2,706,795		62,182		168,370		2,937,347		4.04
Overdraft protection loans		59,637		7,010		—		66,647		4.00

Loans to individuals subtotal		2,766,432		69,192		168,370		3,003,994		4.04

Total gross loans	$	493,715,104	$	28,529,790	$	36,612,075	$	558,856,969		4.19

An aging of our loan portfolio by class as of December 31, 2011 and December 31, 2010 is as follows:

Age Analysis of Past Due Loans


	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Recorded Investment > 90 days and Accruing		Recorded Investment Nonaccrual Loans
December 31, 2011
Commercial	$	676,519	$	21,870	$	1,060,983	$	1,759,372	$	79,450,386	$	—	$	1,654,635
Real estate
Construction		—		—		128,722		128,722		139,126,280		—		128,723
Residential (1-4 family)		5,692,220		871,229		861,815		7,425,264		78,325,027		138,562		1,224,263
Home equity lines		109,851		102,600		257,450		469,901		74,400,805		—		856,932
Multifamily		—		—		—		—		26,710,732		—		—
Commercial		—		195,074		34,015		229,089		195,969,890		39,018		229,088

Real estate subtotal		5,802,071		1,168,903		1,282,002		8,252,976		514,532,734		177,580		2,439,006

Consumers
Consumer and installment loans		36,469		—		—		36,469		3,511,997		—		20,365
Overdraft protection loans		—		—		—		—		58,232		—		—

Loans to individuals subtotal		36,469		—		—		36,469		3,570,229		—		20,365

Total gross loans		6,515,059		1,190,773		2,342,985		10,048,817		597,553,349		177,580		4,114,006

December 31, 2010
Commercial:	$	231,500	$	446,484	$	1,284,790	$	1,962,774	$	84,671,082	$	270,728	$	1,575,207
Real estate
Construction		—		—		1,998,424		1,998,424		117,882,610		240,672		1,757,752
Residential (1-4 family)		333,562		—		2,274,052		2,607,614		82,215,038		418,608		3,620,443
Home equity lines		265,139		1,477,353		437,542		2,180,034		78,833,608		179,992		757,585
Multifamily		—		—		—		—		20,959,832		—		—
Commercial		114,925		—		—		114,925		162,427,034		—		178,941

Real estate subtotal		713,626		1,477,353		4,710,018		6,900,997		462,318,122		839,272		6,314,721

Consumers
Consumer and installment loans		159,755		—		20,816		180,571		2,756,776		20,816		—
Overdraft protection loans		—		—		—		—		66,647		—		—

Loans to individuals subtotal		159,755		—		20,816		180,571		2,823,423		20,816		—

Total gross loans		1,104,881		1,923,837		6,015,624		9,044,342		549,812,627		1,130,816		7,889,928

A summary of the activity in the allowance for loan losses account is as follows:

Allocation of the Allowance for Loan Losses

For the Years Ended December 31, 2011 and 2010


				Real Estate														Consumers
2011	Commercial			Construction			Residential			Home Equity			Multifamily		Commercial			Consumer and Installment loans			Overdraft Protection			Unallocated		Total
Allowance for credit losses:
Beginning balance	$	919,774		$	1,931,797		$	2,114,094		$	2,443,275		$	146,923	$	1,308,073		$	84,384		$	466		$	89,014	$	9,037,800
Charge-offs		(907,116	)		(798,943	)		(983,445	)		(3,158,030	)		—		(276,361	)		(960	)		(1,745	)		—		(6,126,600	)
Recoveries		55,398			65,100			196,478			367,442			—		10			12,447			2,038			—		698,913
Provision		1,878,472			228,181			1,406,136			1,417,622			198,847		1,191,784			(68,772	)		3,611			64,006		6,319,887

Ending balance	$	1,946,528		$	1,426,135		$	2,733,263		$	1,070,309		$	345,770	$	2,223,506		$	27,099		$	4,370		$	153,020	$	9,930,000

Ending balance
Individually evaluated for impairment	$	1,306,744		$	307,429		$	2,073,889		$	393,003		$	131,601	$	570,648		$	—		$	—		$	—	$	4,783,314
Collectively evaluated for impairment		639,784			1,118,706			659,374			677,306			214,169		1,652,858			27,099			4,370			153,020		5,146,686
Financing receivables:
Ending balance	$	81,209,758		$	139,255,002		$	85,750,291		$	74,870,706		$	26,710,732	$	196,198,979		$	3,548,466		$	58,232		$	—	$	607,602,166
Ending balance: individually evaluated for impairment		6,631,666			14,011,766			9,250,139			1,947,178			2,302,727		7,829,251			20,364			—			—		41,993,091
Ending balance: collectively evaluated for impairment		74,578,092			125,243,236			76,500,152			72,923,528			24,408,005		188,369,728			3,528,102			58,232			—		565,609,075

				Real Estate														Consumers
2010	Commercial			Construction			Residential			Home Equity			Multifamily		Commercial			Consumer and Installment loans			Overdraft Protection			Unallocated		Total
Allowance for credit losses:
Beginning balance	$	742,206		$	3,623,237		$	1,746,390		$	2,521,078		$	37,047	$	607,279		$	22,579		$	184		$	—	$	9,300,000
Charge-offs		(303,881	)		(3,903,040	)		(1,842,885	)		(2,887,006	)		—		(195,000	)		(38,221	)		(1,000	)		—		(9,171,033	)
Recoveries		74,386			11,225			10,256			142,308			—		29,427			575			1,364			—		269,541
Provision		407,063			2,200,375			2,200,333			2,666,895			109,876		866,367			99,451			(82	)		89,014		8,639,292

Ending balance	$	919,774		$	1,931,797		$	2,114,094		$	2,443,275		$	146,923	$	1,308,073		$	84,384		$	466		$	89,014	$	9,037,800

Ending balance
Individually evaluated for impairment	$	352,200		$	1,200,197		$	1,615,621		$	1,859,370		$	—	$	220,726		$	65,061		$	—				$	5,313,175
Collectively evaluated for impairment		567,574			731,600			498,473			583,905			146,923		1,087,347			19,323			466			89,014		3,724,625
Financing receivables:
Ending balance	$	86,633,856		$	119,881,034		$	84,822,652		$	81,013,642		$	20,959,832	$	162,541,959		$	2,937,347		$	66,647		$	—	$	558,856,969
Ending balance: individually evaluated for impairment		2,341,934			9,814,050			12,403,602			3,764,977			—		1,590,156			168,370			—			—		30,083,089
Ending balance: collectively evaluated for impairment		84,291,922			110,066,984			72,419,050			77,248,665			20,959,832		160,951,803			2,768,977			66,647					528,773,880

During 2011, we developed a new allowance model. As disclosed during the second and third quarter 10-Q filings, we ran the original model and the new model concurrently, which resulted in no difference in the calculated provision for loan losses. As of December 31, 2011, we reverted back to the original model.

A loan is considered impaired when, based on current information and events; it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. All amounts due according to the contractual terms means that both the contractual interest payments and the contractual principal payments of a loan will be collected as scheduled in the loan agreement. In addition to loans 90 days past due and still accruing and nonaccrual loans, all restructured loans, all loans risk graded doubtful or substandard and a portion of the loans risk graded special mention qualify, by definition, as impaired. Loans 90 days past due and still accruing totaling $177,580 and nonaccrual loans totaling $3,481,336 are included in impaired loans at December 31, 2011. Loans 90 days past due and still accruing totaling $1,130,816 and nonaccrual loans totaling $7,583,305 are included in impaired loans at December 31, 2010.

The following table summarizes our impaired loans at December 31, 2011 and 2010.


Impaired Loans
	With No Related Allowance
	Recorded Investment		Unpaid Principal Balance		Average Recorded Investment		Interest Income Recognized
December 31, 2011
Commercial	$	1,429,128	$	1,429,128	$	1,490,481	$	106,008
Real estate
Construction		12,624,485		12,624,485		13,224,612		846,676
Residential (1-4 family)		3,976,594		3,976,594		4,089,612		246,109
Home equity lines		793,071		793,071		793,189		39,746
Multifamily		824,126		824,126		835,342		64,528
Commercial		3,634,801		5,234,801		3,709,150		313,680
Consumers
Consumer and installment loans		20,364		20,364		23,936		2,386
Overdraft protection loans		—		—		—		—

Total	$	23,302,569	$	24,902,569	$	24,166,322	$	1,619,133

December 31, 2010
Commercial	$	1,376,790	$	1,447,373	$	731,937	$	51,131
Real estate
Construction		2,522,200		4,152,564		5,198,112		234,684
Residential (1-4 family)		3,516,555		4,185,054		2,537,481		112,580
Home equity lines		437,442		644,992		807,606		13,786
Multifamily		—		—		—		—
Commercial		178,941		223,941		267,766		20,170
Consumers
Consumer and installment loans		20,816		20,816		14,210		1,941
Overdraft protection loans		—		—		—		—

Total	$	8,052,744	$	10,674,740	$	9,557,112	$	434,292


	With Related Allowance
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
December 31, 2011
Commercial	$	5,202,538	$	5,211,577	$	1,306,744	$	4,281,663	$	263,444
Real estate
Construction		1,387,281		1,387,281		307,429		1,663,625		102,103
Residential (1-4 family)		5,273,545		5,404,545		2,073,889		5,468,953		325,278
Home equity lines		1,154,107		1,361,657		393,003		1,155,515		39,654
Multifamily		1,478,601		1,478,600		131,601		1,492,547		113,044
Commercial		4,194,450		4,194,450		570,648		4,268,709		593,834
Consumers
Consumer and installment loans		—		—		—		—		—
Overdraft protection loans		—		—		—		—		—

Total	$	18,690,522	$	19,038,110	$	4,783,314	$	18,331,012	$	1,437,357

December 31, 2010
Commercial	$	965,144	$	969,144	$	352,200	$	588,758	$	79,435
Real estate
Construction		7,291,850		7,410,900		1,200,197		7,589,440		427,378
Residential (1-4 family)		8,887,047		8,887,047		1,615,621		8,661,283		453,452
Home equity lines		3,327,535		3,347,535		1,859,370		3,084,212		106,631
Multifamily		—		—		—		—		—
Commercial		1,411,215		1,411,215		220,726		1,421,195		393,647
Consumers
Consumer and installment loans		147,554		147,554		65,061		73,777		905
Overdraft protection loans		—		—		—		—		—

Total	$	22,030,345	$	22,173,395	$	5,313,175	$	21,418,665	$	1,461,448

Interest received in cash and recognized on impaired loans was $3,056,490 and $1,895,740 for 2011 and 2010, respectively.

Restructured loans are loans for which it has been determined the borrower will not be able to perform under the original terms of the loan agreement and a concession has been made to those terms that would not otherwise have been considered. If the value of a restructured loan is determined to be less than the recorded investment in the loan, a valuation allowance is created with a corresponding charge-off to the allowance for loan losses and any collection of interest and principal are recorded as recoveries to the allowance for loan losses until all charged-off balances are fully recovered. Measurement of the value of a restructured loan is generally based on the present

value of expected future cash flows discounted at the loan’s effective interest rate, unless in the case of collateral-dependent loans, the observable market price, or the fair value of the collateral can be readily determined. Restructured loans are reevaluated periodically and additional adjustments to the carrying value may be made. In addition, if it is determined the borrower is unable to perform under the modified terms, further steps, such as a full charge-off or foreclosure may be taken. We did not have any commitments to lend additional funds on restructured loans at December 31, 2011 or 2010.

We currently have two loans classified as restructured loans; a residential 1-4 family loan for $103,189 and a commercial loan for $632,670. The commercial loan was restructured during the last quarter of 2011 and represents the only loan restructured during the year ended December 31, 2011. We have not had any defaults on restructured loans within twelve months of restructuring during the year ended December 31, 2011.

Additional information on restructured loans in our portfolio at December 31, 2011 is as follows:

Trouble Debt Restructurings


	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Year Ended December 31, 2011	1	$	632,670	$	632,670

Troubled Debt Restructurings That Subsequently Defaulted


	Number of Contracts	Recorded Investment
Year Ended December 31, 2011	None		—

NOTE 4 – OTHER REAL ESTATE

Other real estate is real estate properties acquired through or in lieu of loan foreclosure. At foreclosure, these properties are recorded at their fair value less estimated selling costs as a nonperforming asset, with any write-downs to the carrying value of our investment charged to the allowance for loan loss. After foreclosure, periodic evaluations are performed to determine if any decrease in the fair value less estimated selling costs has occurred. Further adjustments to this fair value are charged to operations, in noninterest expense, when identified. Expenses associated with the maintenance of other real estate are charged to operations, as incurred. When a property is sold, any gain or loss on the sale is recorded as noninterest expense.

Information on other real estate:


	2011						2010
	Balance			Number			Balance			Number
January 1,	$	1,744,700			5		$	2,115,700			8
Balance moved into other real estate		5,359,004			15			5,617,450			13

		7,103,704			20			7,733,150			21

Write down of property charged to operations		(574,192	)					(51,955	)
Payments received after foreclosure		—						(40,665	)
Properties sold		(3,160,812	)		(14	)		(5,895,830	)		(16	)

Balance December 31,	$	3,368,700			6		$	1,744,700			5

Gross gains of sale of other real estate	$	195,533					$	409,566
Gross losses on sale of other real estate		(145,813	)					(254,516	)
Write down of property charged to operations		(574,192	)					(51,955	)

Net gain (loss) on other real estate	$	(524,472	)				$	103,095

*	Two units moved to other real estate in 2010 were originally held and reported as one property. During the first quarter of 2011, the property was split into two parcels which were sold separately.

The net loss of $524,472 realized in 2011 and the net gain of $103,095 realized in 2010 are included in our income statement as part of the “Foreclosed property expense” of $848,523 and 128,106, respectively.

NOTE 5 – PROPERTY AND EQUIPMENT

Property and equipment consist of the following at December 31:


	2011			2010
Buildings	$	14,052,144		$	12,055,040
Land		5,730,394			5,730,394
Leasehold improvements		1,531,132			1,418,813
Equipment, furniture and fixtures		8,096,277			7,806,972

		29,409,947			27,011,219
Less accumulated depreciation		(6,316,064	)		(6,169,733	)

Property and equipment, net	$	23,093,883		$	20,841,486

Depreciation expense of $1,709,145, and $1,343,270 was included in occupancy and equipment expense for 2011 and 2010, respectively.

We have thirty-four non-cancellable leases for premises. The lease terms are from one to fifty years and have various renewal dates. Rental expense was $2,776,355 and $2,447,838 in 2011 and 2010, respectively. Minimum lease payments for succeeding years pertaining to these non-cancellable operating leases are as follows:


2012	$	2,522,057
2013		1,405,886
2014		970,588
2015		483,467
2016		387,575
Thereafter		8,605,649

	$	14,375,222

NOTE 6 – GOODWILL AND INTANGIBLE ASSETS

On August 10, 2007, we acquired a Maryland mortgage office plus certain other mortgage related assets from Resource Bank (now Fulton Bank), a Virginia Beach based bank owned by Fulton Financial of Lancaster, Pennsylvania. The assets and results of operations have been included in the consolidated financial statements since that date. The aggregate purchase price was $2.1 million including legal expenses of $53,000. The intangible assets have a weighted-average useful life of seven years.

Information concerning intangible assets and goodwill attributable to the Maryland mortgage office acquired on August 10, 2007 is presented in the following table:


	December 31,				Acquisition
	2011		2010		Cost
Amortizable intangible assets, net	$	461,311	$	639,883	$	1,250,000
Goodwill		775,000		775,000		775,000
Amortization expense		178,572		178,572


Estimated Amortization Expense:
For the year ended 12/31/2012		178,572
For the year ended 12/31/2013		178,572
For the year ended 12/31/2014		104,167

	$	461,311

Annual impairment review indicated that goodwill was not impaired in 2011 or 2010.

NOTE 7 – RESTRICTED EQUITY SECURITIES

Restricted equity securities are securities that do not have a readily determinable fair value and lack a market. Therefore, they are carried at cost. The following table represents balances as of December 31, 2011 and 2010, respectively:


	2011		2010
Federal Reserve Bank Stock	$	1,855,800	$	1,847,250
Federal Home Loan Bank Stock		4,431,000		6,711,500
Community Bankers Bank Stock		133,700		133,700

Total restricted equity securities	$	6,420,500	$	8,692,450

As a member bank our stock requirement with the Federal Reserve is based on our capital levels as reported on the most recent filing of our Consolidated Reports of Condition and Income and is subject to change when our capital levels increase or decrease. Our stock requirements with the Federal Home Loan Bank consists of two levels; membership stock based on total assets as of December 31^st of each year and collateral stock based on our highest borrowing levels which is evaluated for release on a periodic basis. The stock we hold with Community Bankers Bank is membership stock.

NOTE 8 – DEPOSITS

Interest-bearing deposits for the years ending December 31, 2011 and December 31, 2010 are as follows:


	2011		2010
Interest bearing demand	$	40,930,378	$	32,346,048
Money market accounts		269,749,851		283,271,306
Savings accounts		17,915,622		19,348,291
Certificates of deposit $100,000 and over		198,554,676		189,690,729
Other time deposits		79,086,469		83,350,608

Total interest-bearing deposits	$	606,236,996	$	608,006,982

Scheduled maturities for time deposits as of December 31, 2011 are as follows:


Year Maturing
2012	$	209,748,971
2013		38,673,152
2014		7,857,230
2015		8,568,449
2016		12,773,343
Thereafter		20,000

	$	277,641,145

At December 31, 2011, brokered money market balances included in money markets totaled $10,536,168. CDARS balances included in certificates of deposit $100,000 and over totaled $78,874,065 at year end 2011.

NOTE 9 – BORROWINGS

We have federal funds arrangements with five financial institutions that provide approximately $34.5 million of unsecured short-term borrowing capacity. As of December 31, 2011, there were no outstanding balances on these federal funds lines of credits. Information concerning federal funds purchased is summarized, as follows:


	2011			2010
Average balance during the year	$	88,151		$	212,959
Average interest rate during the year		0.63	%		0.90	%
Maximum month end balance during the year	$	18,000,139		$	—

We are a member of the Federal Home Loan Bank of Atlanta (“FHLB”) and as such, we may borrow funds based on criteria established by the FHLB. We are allowed under our lines of credit to borrow up to 30% of assets, or approximately $272,543,018, if collateralized, as of December 31, 2011. We have two borrowing programs with FHLB. Under our primary program, we have pledged blanket liens on our portfolio of 1-4 family residential loans, our home equity lines of credit/loans portfolio, and on qualifying commercial real estate loans. Additionally, investment securities with collateral fair values of $233,712 at December 31, 2011 and $419,341 at December 31, 2010 were also pledged to secure any advances. In February 2009, we negotiated an additional line of credit with FHLB that is secured by a portion of our loans held for sale (“LHFS”). We pledge these loans, which have been sold to FHLB approved investors, as collateral. In return, we are allowed to borrow up to 78% of these loans for 120 days.

As of December 31, 2011, we could borrow approximately $58.4 million under our primary line, based upon collateral pledged. This line is reduced by $8.0 million, which has been pledged as collateral for public funds. In addition we had total borrowings on the line of $24,875,430. These borrowings consisted of two advances; one in the amount of $1,375,430 that matures September 28, 2015 and bears a fixed interest rate of 4.96% throughout the term and, a second in the amount of $23,500,000 that matures September 10, 2012 and bears a rate which changes daily. That rate was 0.36% on December 31, 2011. Our fixed interest rate advance was utilized to match fund ten-year amortizing loans to clients.

We could borrow up to $91.4 million under our LHFS line at December 31, 2011. We had total borrowings on that date of $46,052,051, which consisted of three advances. The first advance, in the amount of $5,052,051 matures March 26, 2012. The second advance was for $2,000,000 and matures March 28, 2012, and the third advance in the amount of $39,000,000 matures March 29, 2012. All three advances bear a variable interest rate that was 0.86% on December 31, 2011.

Should we ever desire to increase the line of credit beyond the 30% limit, the FHLB would allow borrowings of up to 40% of total assets once we met specific eligibility criteria.

Other information concerning FHLB advances is summarized below:


	2011			2010
Average balance during the year	$	7,240,970		$	63,131,552
Average interest rate during the year		1.45	%		1.29	%
Maximum month end balance during the year	$	70,927,481		$	129,215,633

NOTE 10 – TRUST PREFERRED SUBORDINATED DEBT

Monarch Financial Holdings Trust is a wholly-owned special purpose finance subsidiary of the Parent, operating in the form of a grantor trust (the Trust). The Trust was created in June 2006 to issue capital securities and remit the proceeds to the Company. We are the sole owner of the common stock securities of the Trust. On July 5, 2006 the Trust issued 10,000 shares of preferred stock capital securities with a stated value of $1,000 per share, bearing a variable dividend rate, reset per quarter, equal to 90 day London Interbank Offered Rate (“LIBOR”) plus 1.60%. The Trust securities have a mandatory redemption date of September 30, 2036, and are subject to varying call provisions at our option beginning September 30, 2011.

We unconditionally guarantee the stated value of the Trust preferred stock on a subordinated basis. Through an intercompany lending transaction, proceeds received by the Trust from the sale of securities were lent to the Company for general corporate purposes.

The Trust preferred stock is senior to our common stock in event of claims against Monarch, but is subordinated to all senior and subordinated debt securities. The shares of the Trust preferred stock are capital securities, which are distinct from the common stock or preferred stock of the Company, and the dividends thereon are tax-deductible. Dividends accrued for payment by the Trust are classified as interest expense on long-term debt in our consolidated statement of income. The Trust preferred stock is shown as “Trust preferred subordinated debt” and classified as a liability in the consolidated balance sheets.

NOTE 11 – DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES

We entered into an interest rate swap agreement with PNC Bank (“PNC”) of Pittsburgh, PA on July 29, 2009, for our $10 million Trust preferred borrowing, which carries a floating interest rate of 90 day LIBOR plus 160 basis points. The terms of this hedge allows us to mitigate our exposure to interest-rate fluctuations by swapping our

floating rate obligation for a fixed rate obligation. The notional amount of the swap agreement is $10 million, and has an expiration date of September 30, 2014. Under the terms of our agreement, at the end of each quarter we will swap our floating rate for a fixed rate of 3.26%. Including the additional 160 basis points, the effective fixed rate of interest cost will be 4.86% on our $10 million Trust Preferred borrowing for five years.

The fixed-rate payment feature of this swap is structured to mirror the provisions of the hedged borrowing agreement. This swap qualifies as a cash flow hedge and the underlying liability is carried at fair value in other liabilities, with the tax-effective changes in the fair value of the instrument included in Stockholders’ Equity in accumulated other comprehensive income (loss).

Our credit exposure, if any, on the interest rate swap is limited to the net favorable value (net of any collateral pledged) and interest payments of the swap by the counterparty. Conversely, when an interest rate swap is in a liability position we are required to have collateral on deposit at PNC which is evaluated daily and adjusted based on the fair value of the hedge on the last day of the month. The fair value of this swap instrument was a liability of approximately $684 thousand and $622 thousand at December 31, 2011 and 2010, respectively. Our collateral requirement on December 31, 2011 and 2010 was $650 thousand.

At various times, when the market is favorable, we participate in a “mandatory” delivery program for a portion of our mortgage loans. Under the mandatory delivery program, we commit to deliver a block of loans to an investor at a preset cost prior to the close of such loans. This differs from a “best efforts” delivery, which sets the cost to the investor on a loan by loan basis at the close of the loan. Mandatory delivery creates a higher level of risk for us because it relies on rate lock commitments rather than closed loans, thereby exposing the Company to fluctuations in interest rate and pricing. A rate lock commitment is a binding commitment for us but is not binding to the client. Our client could decide, at any time, between the time of the rate lock and actual closing on their mortgage loan, not to proceed with the commitment. There is a higher occurrence of this during periods of volatility.

To mitigate this risk, we pair the rate lock commitment with the sale of a notional security bearing similar attributes. At the time the loan is delivered to the investor, matched securities are repurchased. Any gains or losses associated with this pairing are recorded in mortgage banking income on our income statement as incurred. Our board approved “mandatory” deliver policy will only allow us to commit $50.0 million to the program at any given time. We utilize the services of Capital Markets Cooperative (“CMC”) of Ponte Vedra Beach, Florida to help monitor and manage our rate lock activities in this program.

We are not currently participating in a mandatory delivery program due to the volatility of the market in 2011. We did, however participate in the program early in the year. Losses associated with the mandatory delivery program in 2011 were $153.0 thousand. At December 31, 2010, we recorded a net gain of $34 thousand on gross loans of $12.9 million committed to mandatory delivery, paired with $11.3 million in securities and related income of $298 thousand.

NOTE 12 – PUBLIC OFFERING OF PREFERRED STOCK

In November 2009, based on our filing of Form S-1 with the Securities and Exchange Commission, we received formal approval from the Commission to register up to 800,000 shares of Series B noncumulative convertible perpetual preferred stock with a per share dividend rate of 7.80%. On November 30, 2009, we issued and sold 800,000 shares Series B noncumulative convertible perpetual preferred stock at $25.00 per share in a public offering. Proceeds and costs are as follows:

Date

Shares Placed

Per
Share
Price

Offering Proceeds

November 30, 2009

800,000

25.00

20,000,000

Less underwriter discount

(1,169,275

)

Less other expenses

(422,629

)

Net Proceeds

18,408,096

This stock is convertible at the option of the shareholder into 3.125 shares of common stock (which reflects an initial conversion price of $8.00 per share of common stock), subject to some adjustments. It also carries a convertible option for the Company which may be exercised if for 20 trading days within any period of 30 consecutive trading days, the closing price of common stock exceeds 130% of the then applicable conversion price. The Series B preferred stock is also redeemable by us, in whole or in part, on or after the third anniversary of the issue date for the liquidation amount of $25.00 per share plus any undeclared and unpaid dividends. Dividends declared on the 800,000 shares of Series B noncumulative convertible perpetual preferred stock were $1,560,000 in 2011 and 2010.

NOTE 13 – CUMULATIVE PERPETUAL PREFERRED STOCK

On December 23, 2009 we redeemed 14,700 shares of Series A, $1,000 par value, cumulative perpetual preferred stock, issued in December 2008 to the U.S. Treasury Department (“Treasury”) under the TARP Capital Purchase Program. This stock carried a 5% dividend for each of the first 5 years of the investment, and 9% thereafter, unless we elected to redeem the shares.

Additionally, on December 23, 2009, Treasury returned half of the warrants to purchase shares of Monarch Financial Holdings, Inc. Common Stock with an exercise price of $8.33 that were issued in association with initial stock purchase. On February 10, 2010, we redeemed the remaining warrants from the Treasury for $260,000. This transaction is carried as an adjustment to Stockholders’ Equity in additional paid-in capital.

NOTE 14 – INCOME TAXES

The principal components of income tax benefit (expense) for 2011 and 2010 are as follows:


	2011			2010
Current
Federal	$	(3,757,662	)	$	(3,411,154	)
State		(363,556	)		(374,347	)
Equity adjustment		6,954			—

		(4,114,264	)		(3,785,501	)

Deferred
Federal		651,458			217,140
State		44,114			23,829

		695,572			240,969

Total
Federal		(3,106,204	)		(3,194,014	)
State		(319,442	)		(350,518	)
Equity adjustment		6,954			—

	$	(3,418,692	)	$	(3,544,532	)

Differences between income tax expense calculated at the statutory rate and that shown in the statement of income for 2011 and 2010 are summarized, as follows:


	2011			2010
Federal income tax expense at statutory rate	$	(3,314,026	)	$	(3,317,216	)
Tax effect of:
Income taxed at 35%		(427,353	)		—
BOLI cash surrender value (decrease) increase		206,596			97,213
Meals and entertainment		(111,522	)		(99,418	)
State and local income taxes		(191,894	)		(234,570	)
Other		419,507			9,459

Income tax expense	$	(3,418,692	)	$	(3,544,532	)

Our income before tax exceeded $10.0 million in 2011, thereby triggering a change in the statutory federal tax rate from 34% to 35% for all income in excess of $10.0. This change had an impact on our deferred taxes.

We have the following deferred tax assets and liabilities at December 31, 2011 and 2010:


	December 31,
	2011			2010
Deferred tax assets:
Bad debt provision	$	3,632,576		$	3,149,416
Available for sale securities		187,014			288,553
Deferred gain on sale/leaseback		59,794			115,526
Deferred compensation		404,432			303,656
Reserve for available for sale loan repurchase		726,568			501,681
Other		676,219			259,817

Total deferred tax assets		5,686,603			4,618,649

Deferred tax liabilities:
Fixed assets		(1,337,824	)		(688,751	)
Premium amortization on securities		(5,424	)		(13,040	)
Other		(89,187	)		(256,723	)

Total deferred tax liabilities		(1,432,435	)		(958,514	)

Net deferred tax assets	$	4,254,168		$	3,660,135

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered in income. Deferred tax assets are reduced by a valuation allowance if it is more likely than not that the tax benefits will not be realized. Management has evaluated the effect of the guidance provided by U.S. GAAP on Accounting for Uncertainty in Income Taxes that became effective in 2009, and all other tax positions that could have a significant effect on the financial statements and determined the Company had no uncertain material income tax positions at December 31, 2011.

We file income tax returns in the U.S. federal jurisdiction and the states of Virginia, Maryland, North Carolina and South Carolina. With few possible exceptions, we are no longer subject to U.S. or state income tax examinations by tax authorities for the years prior to 2008.

NOTE 15 – COMMITMENTS AND CONTINGENCIES

We have outstanding at any time a significant dollar amount of commitments to extend credit. To accommodate major customers, we also provide standby letters of credit and guarantees to third parties. Those arrangements are subject to strict credit control assessments. Guarantees and standby letters of credit specify limits to our obligations. The amounts of loan commitments, guarantees and standby letters of credit are set out in the following table as of December 31, 2011 and 2010. Because many commitments and almost all standby letters of credit and guarantees expire without being funded, in whole or in part, the contract amounts are not estimates of future cash flows. The majority of commitments to extend credit have terms up to one year. Interest rates on fixed-rate commitments range from 2.0% to 26.0%. All of the guarantees written and the standby letters of credit at December 31, 2011 expire during 2012.


	Commitments
	2011		2010
Commitments to grant loans	$	174,466,733	$	134,007,125
Unfunded commitments under lines of credit and similar arrangements	$	172,442,171	$	168,227,549
Standby letters of credit and guarantees written	$	16,287,588	$	5,820,097

Loan commitments, standby letters of credit and guarantees written have off-balance-sheet credit risk because only origination fees and accruals for probable losses, if any, are recognized in the statement of financial position, until the commitments are fulfilled or the standby letters of credit or guarantees expire. Credit risk represents the accounting loss that would be recognized at the reporting date if counterparties failed completely to perform as contracted. The credit risk amounts are equal to the contractual amounts, assuming that the amounts are fully advanced and that, in accordance with the requirements of FASB guidance for Disclosure of Information about

Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit Risk, collateral or other security is of no value. Our policy is to require customers to provide collateral prior to the disbursement of approved loans. For retail loans, we usually retain a security interest in the property or products financed, which provides repossession rights in the event of default by the customer. For business loans and financial guarantees, collateral is usually in the form of inventory or marketable securities (held in trust) or property (notations on title).

Concentrations of credit risk relative to capital (whether on or off balance sheet) arising from financial instruments exist in relation to certain groups of customers. A group concentration arises when a number of counterparties have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions. At December 31, 2011, we had two loan concentrations which exceeded 10% in the area of loans to borrowers who are principally engaged in acquisition, development and construction of 1-4 single family homes and developments and to residential home owners with equity lines. A geographic concentration arises because we operate primarily in southeastern Virginia.

The credit risk amounts represent the maximum accounting loss that would be recognized at the reporting date if counterparties failed completely to perform as contracted and any collateral or security proved to be of no value. We have experienced little difficulty in accessing collateral when required. The amounts of credit risk shown, therefore, greatly exceed expected losses, which are included in the allowance for loan losses.

Various legal claims also arise from time to time in the normal course of business that, in the opinion of management, will have no material effect on our consolidated financial statements.

NOTE 16 – STOCK COMPENSATION AND BENEFIT PLANS

In May 2006, our shareholders approved the adoption of a new stock-based compensation plan to succeed the 99ISO. The new 2006 Equity Incentive Plan (“2006EIP”) authorizes the compensation committee to grant options, stock appreciation rights, stock awards, performance stock awards, and stock units to designated directors, officers, key employees, consultants and advisors to the Company and its subsidiaries. The Plan authorizes us to issue up to 630,000 split-issue adjusted shares of Company Common Stock plus the number of shares of Company Common Stock outstanding under the 1999 Plan. The Plan also provides that no award may be granted more than 10 years after the May 2006 ratification date. On September 18, 2006, we issued the first stock awards under the new Plan at a price equal to the stock price on that date with vesting periods of up to three years from issue. Total compensation costs will be recognized over the service period to vesting.

The following is a summary of our stock option activity, and related information. All shares and per share prices have been restated for stock splits and dividends in the years presented:


	2011							2010
Options	Number of Options			Weighted Average Exercise Price		Aggregate Intrinsic Value		Number of Options			Weighted Average Exercise Price
Outstanding - Beginning of year		257,283		$	7.97				296,486		$	7.75
Granted		—			—				—			—
Exercised		—			—				(29,105	)		6.31
Forfeited		(29,536	)		7.34				(10,098	)		6.31

Outstanding - End of year		227,747		$	8.06	$	113,749		257,283		$	7.97

Options exercisable at year-end		227,747		$	8.06	$	113,749		257,283		$	7.97

Weighted average fair value per option granted during year				$	—						$	—

The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the quoted price of our common stock for those awards that have an exercise price currently below the closing price. There were no options exercised during the year ended December 31, 2011. The total intrinsic value of options exercised during the year ended December 31, 2010 was $44,598. No options were granted under the plan in 2011 or 2010. All options granted in relation to the 99ISO plan were fully vested at December 31, 2005.

Cash received for option exercise under share-based payment arrangements for 2011 and 2010 was $0 and $183,743, respectively. Tax expense of $6,244 was recognized in 2010.

Other information pertaining to options outstanding at December 31, 2011 is as follows:


Range of Exercise Prices	Number Outstanding		Remaining Contractual Life (Years)		Average Exercise Price
$6.31 to $9.42		227,747		3.71	$	8.06

A summary of the status of the our non-vested shares in relation to our restricted stock awards as of December 31, 2011 and 2010, and changes during the years ended December 31, 2011 and 2010, is presented below; the weighted average price is the weighted average fair value at the date of grant:


	2011					2010
Restricted Share Awards	Shares			Weighted Average Price		Shares			Weighted Average Price
Nonvested - Beginning of year		218,040		$	7.87		167,640		$	8.16
Granted		85,550			7.70		75,900			7.58
Vested		(21,400	)		7.91		(24,000	)		9.01
Forfeited		(23,200	)		7.02		(1,500	)		7.53

Nonvested - End of year		258,990		$	7.82		218,040		$	7.87

Compensation expense related to the restricted stock awards was $323,307 and $348,103 for 2011 and 2010, respectively. The total fair value of awards vested during 2011 and 2010 was $169,246 and $182,837, respectively. As of December 31, 2011 and 2010, there was $701,694 and $1,137,479, respectively, of total unrecognized cost related to the non-vested share-based compensation arrangements granted under the 2006EIP. That cost is expected to be recognized over a weighted-average period of 3.0 years. The grant date fair value of common stock is used in determining unused compensation cost.

Other information pertaining to restricted stock at December 31, 2011 is as follows:


Range of Issuance Prices	Number Outstanding		Remaining Contractual Life (Years)
$5.00 to $10.00		258,990		5.0

We have a 401(k) defined contribution plan applicable to all eligible employees. Contributions to the plan are made at the employee’s election. Employees may contribute up to 91% of their salaries up to IRS limits. We began making contributions in April 2001. We matched 50% of the first 6.0% of employee contributions in 2011 and 2010. Our expense for 2011 and 2010 was $623,414 and $699,405, respectively.

NOTE 17 – RELATED PARTY TRANSACTIONS

We have loan transactions with our executive officers and directors, and with companies in which our executive officers and directors have a financial interest. These transactions have occurred in the ordinary course of business on substantially the same terms as those prevailing at the time for persons not related to the lender. A summary of related party loan activity is as follows during 2011 and 2010.


	2011			2010
Outstanding - Beginning of year	$	17,236,785		$	19,265,300
Originations		15,989,012			5,749,809
Repayments		(7,877,662	)		(7,778,324	)

Outstanding - End of year	$	25,348,135		$	17,236,785

Commitments to extend credit and letters of credit to related parties amounted to $9,142,783 and $3,210,516 at December 31, 2011 and 2010, respectively.

At December 31, 2011 and 2010 total deposits held by related parties were $11,048,253 and $13,442,031, respectively.

NOTE 18 – REGULATORY CAPITAL REQUIREMENTS

The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, banks must meet specific capital guidelines that involve quantitative measures of the bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. Capital amounts and classification are also subject to qualitative judgments by the regulators about components (such as interest rate risk), risk weighting, and other factors.

The Bank, as a Virginia banking corporation, may only pay dividends from retained earnings. In addition, regulatory authorities may limit payment of dividends by any bank, when it is determined that such limitation is in the public interest and necessary to ensure financial soundness of the Bank. Regulatory agencies place certain restrictions on dividends paid and loans and loans or advances made by the Bank to the Company. The amount of dividends the Bank may pay to the Company, without prior approval, is limited to current year earnings plus retained net profits for the two preceding years. At December 31, 2011, the amount available was approximately $14.5 million. Loans and advances are limited to 10% of the Bank’s common stock and capital surplus. As of December 31, 2011, funds available for loans or advances by the Bank to the Company were approximately $6.2 million.

Quantitative measures established by regulation to ensure capital adequacy require that the Bank maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2011, the Bank meets all capital adequacy requirements to which it is subject.

As of December 31, 2011 the Bank was categorized as “well capitalized”, the highest level of capital adequacy. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. The Company is also subject to certain capital adequacy ratio requirements. The Company and Bank’s actual capital amounts and ratios are also presented in the table as of December 31, 2011 and 2010.

Actual

For Capital
Adequacy
Purposes

To Be Well Capitalized
Under Prompt
Corrective Action

Amounts

Ratio

Amounts

Ratio

Amounts

Ratio

(Dollars in Thousands)

As of December 31, 2011

Total Risk-Based Capital Ratio

Consolidated Company

94,918

12.42

61,144

8.00

N/A

Bank

91,374

11.97

61,052

8.00

76,315

10.00

(Total Risk-Based Capital to Risk-Weighted Assets)

Tier 1 Risk-Based Capital Ratio

Consolidated Company

85,360

11.17

30,572

4.00

N/A

Bank

81,826

10.72

30,526

4.00

45,789

6.00

(Tier 1 Capital to Risk-Weighted Assets)

Tier 1 Leverage Ratio

Consolidated Company

85,360

9.88

34,543

4.00

N/A

Bank

81,826

9.48

34,543

4.00

43,178

5.00

(Tier 1 Capital to Average Assets)

As of December 31, 2010

Total Risk-Based Capital Ratio

Consolidated Company

89,061

12.99

54,846

8.00

N/A

Bank

85,075

12.42

54,820

8.00

68,526

10.00

(Total Risk-Based Capital to Risk-Weighted Assets)

Tier 1 Risk-Based Capital Ratio

Consolidated Company

80,486

11.74

27,423

4.00

N/A

Bank

76,503

11.16

27,410

4.00

41,115

6.00

(Tier 1 Capital to Risk-Weighted Assets)

Tier 1 Leverage Ratio

Consolidated Company

80,486

9.35

34,424

4.00

N/A

Bank

76,503

8.89

34,424

4.00

43,030

5.00

(Tier 1 Capital to Average Assets)

NOTE 19 – FAIR VALUE OF FINANCIAL INSTRUMENTS

The following table presents the carrying amounts and fair value of our financial instruments at December 31, 2011 and December 31, 2010. GAAP defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than through a forced or liquidation sale for purposes of this disclosure. The carrying amounts in the table are included in the consolidated balance sheet under the indicated captions.

Estimation of Fair Values


	2011				2010
	Carrying Value		Fair Value		Carrying Value		Fair Value
Financial Assets
Cash and cash equivalents	$	31,745,584	$	31,745,584	$	27,375,747	$	27,375,747
Investment securities available-for- sale		9,186,697		9,186,697		17,601,718		17,601,718
Mortgage loans held for sale		211,555,094		211,555,094		175,388,356		175,388,356
Loans held for investment (net)		597,682,446		607,718,906		549,830,427		566,893,439
Accrued interest receivable		2,023,874		2,023,874		1,880,351		1,880,351
Restricted equity securities		6,420,500		6,420,500		8,692,450		8,692,450
Rate lock commitments, net		—		—		503,386		503,386
Bank owned life insurance		6,946,166		6,946,166		7,335,473		7,335,473
Financial Liabilities
Deposit liabilities	$	740,092,097	$	736,450,654	$	705,661,577	$	670,860,094
Total borrowings		80,927,481		81,103,891		40,282,201		40,145,059
Accrued interest payable		101,020		101,020		124,553		124,553
Derivative financial liability		684,428		684,428		621,800		621,800

The following notes summarize the significant assumptions used in estimating the fair value of financial instruments:

Short-term financial instruments are valued at their carrying amounts included in the Company’s balance sheet, which are reasonable estimates of fair value due to the relatively short period to maturity of the instruments. This approach applies to cash and cash equivalents and overnight borrowings.

Loans are valued on the basis of estimated future receipts of principal and interest, which are discounted at various rates. Loan prepayments are assumed to occur at the same rate as in previous periods when interest rates were at levels similar to current levels. Future cash flows for homogeneous categories of consumer loans, such as motor vehicle loans, are estimated on a portfolio basis and discounted at current rates offered for similar loan terms to new borrowers with similar credit profiles.

Investment securities available-for-sale are valued at quoted market prices, if available. For securities upon which no quoted market price is available, we estimate the fair value on the basis of quotes for similar instruments or other available information. Investment securities classified as available-for-sale are reported at their estimated fair value with unrealized gains and losses reported in accumulated other comprehensive income. To the extent that the cost basis of investment securities exceeds the fair value and the unrealized loss is considered to be other than temporary, an impairment charge is recognized and the amount recorded in accumulated other comprehensive income or loss is reclassified to earnings as a realized loss. The specific identification method is used in computing gains or losses.

Restricted equity securities are recorded at cost, which approximates fair value.

Rate lock commitments. Our mortgage loan pipeline consists of mortgage loan applications that have been received but the loan has not yet closed. The interest rates on pipeline loans float with market rates or are accompanied by interest rate lock commitments. A “locked pipeline loan” is a loan where the potential borrower has set the interest rate for the loan by entering into an interest rate lock commitment, or “rate lock commitment,” resulting in the potential for interest rate risk. The Company protects itself from interest rate risk by entering into loan purchase agreements with third party investors that provide for the investor to purchase loans at the same terms, including interest rate, as committed to the borrower. Under the contractual relationship with these third party investors, the Company is obligated to sell the loan to the investor, and the investor is obligated to buy the loan, only if the loan closes. No other obligation exists. Therefore, the Company is not exposed to losses nor will it realize gains related to its rate lock commitments due to changes in interest rates. This represents a change from 2010 when we treated rate lock commitments on mortgage loans that are intended to be sold as derivatives in which we would assume risk related to interest rates. Accordingly, such commitments, along with any related fees received from potential borrowers net of related costs, were recorded at fair value in derivative assets or liabilities, with changes in fair value recorded in the net gain or loss on sale of mortgage loans.

Bank owned life insurance. Bank owned life insurance represents insurance policies on officers of the Bank. The cash values of the policies are estimated using information provided by insurance carriers. These policies are carried at their cash surrender value, which approximates the fair value.

The fair value of demand deposits and deposits with no defined maturity is taken to be the amount payable on demand at the reporting date. The fair value of fixed-maturity deposits is estimated using rates currently offered for deposits of similar remaining maturities. The intangible value of long-term relationships with depositors is not taken into account in estimating the fair values disclosed.

The fair value of all borrowings is based on discounting expected cash flows at the interest rate of debt with the same or similar remaining maturities and collateral requirements.

The carrying amounts of accrued interest approximate fair value.

The fair value of the derivative financial liability, which relates to our interest rate swap, is based on the income approach using observable market inputs, reflecting market inputs of future interest rates as of the measurement date. Consideration is given to our credit risk as well as the counterparty’s credit quality in determining the fair value of the derivative.

It is not practicable to separately estimate the fair values for off-balance-sheet credit commitments, including standby letters of credit and guarantees written, due to the lack of cost-effective reliable measurement methods for these instruments.

NOTE 20 – FAIR VALUE ACCOUNTING

Fair Value Hierarchy and Fair Value Measurement

We group our assets and liabilities that are recorded at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

•

Level 1 – Valuations based on quoted prices in active markets for identical assets or liabilities. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment.

•

Level 2 – Valuations based on quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-based valuations for which all significant assumptions are observable or can be corroborated by observable market data.

•

Level 3 – Valuations based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Valuations are determined using pricing models and discounted cash flow models and includes management judgment and estimation which may be significant.

The methods we use to determine fair value on an instrument specific basis are detailed in the section titled “Valuation Methods” below.

The following table presents our assets and liabilities, which are measured at fair value on a recurring basis for each of the fair value hierarchy levels, as of December 31, 2011 and December 31, 2010:


	Fair Value Measurements at Reporting Date Using
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Description
Assets at December 31, 2011
Investment securities - available for sale
U.S. government agency obligations	$	6,105,593	$	—	$	6,105,593	$	—
Mortgage-backed securities		1,258,848				1,258,848
Municipal securities		1,310,901				1,310,901
Corporate debt securities		511,355				511,355
Loans held for sale		211,555,094		—		211,555,094		—
Rate lock commitments, net		—		—		—		—

Total Assets	$	220,741,791	$	—	$	220,741,791	$	—

Derivative financial liability	$	684,428	$	—	$	684,428	$	—


Assets at December 31, 2010
Investment securities - available for sale
U.S. government agency obligations	$	16,667,172	$	—	$	16,667,172	$	—
Mortgage-backed securities		419,341				419,341
Municipal securities		—				—
Corporate debt securities		515,205				515,205
Loans held for sale		175,388,356		—		175,388,356		—
Rate lock commitments, net		503,386		—		—		503,386

Total Assets	$	193,493,460	$	—	$	192,990,074	$	503,386

Derivative financial liability	$	621,800	$	—	$	621,800	$	—

The changes in rate lock commitments (Level 3 assets) measured at fair value on a recurring basis are summarized below as:


	2011			2010
Balance, January 1	$	503,386		$	804,240
Issuances and settlements, net		(503,386	)		(804,240	)
Income ( loss)		—			503,386

Balance, December 31	$	—		$	503,386

The following table provides quantitative disclosures about the fair value measurements of our assets related to continuing operations which are measured at fair value on a nonrecurring basis as of December 31, 2011 and 2010:


	Fair Value Measurements at Reporting Date Using
Description	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
At December 31, 2011
Real estate owned	$	3,368,700	$	—	$	3,368,700	$	—
Restructured and impaired loans		13,907,208		—		13,907,208		—
At December 31, 2010
Real estate owned	$	1,744,700	$	—	$	—	$	1,744,700
Restructured and impaired loans		7,385,413		—		—		7,385,413

The gain on sale of real estate owned, which is recorded within foreclosed property expense in non-interest expenses totaled $49,720 in 2011 and $155,050 in 2010.

Valuation Methods

Securities – available-for-sale. Securities – available-for-sale are valued at quoted market prices, if available. For securities for which no quoted market price is available, we estimate the fair value on the basis of quotes for similar instruments or other available information. Investment securities classified as available-for-sale

are reported at their estimated fair value with unrealized gains and losses reported in accumulated other comprehensive income. To the extent that the cost basis of investment securities exceeds the fair value and the unrealized loss is considered to be other than temporary, an impairment charge is recognized and the amount recorded in accumulated other comprehensive income or loss is reclassified to earnings as a realized loss. The specific identification method is used in computing realized gains or losses.

Real estate owned. Real estate owned is carried at fair value less estimated selling costs. Upon foreclosure and through liquidation, we evaluate the property’s fair value as compared to its carrying amount and record a valuation adjustment when the carrying amount exceeds fair value less selling costs. Any valuation adjustments at the time a loan becomes real estate owned is charged to the allowance for loan losses. Current appraisals are obtained for all properties in real estate owned. Any subsequent valuation adjustments are applied to earnings in our consolidated statements of income. We recorded losses of $574,192 and $51,955 due to valuation adjustments on real estate owned within foreclosed property expense in non-interest expense in December 31, 2011 and 2010, respectively.

Restructured and impaired loans. Measurement of the value of restructured and impaired loans is generally based on the present value of expected future cash flows discounted at the loan’s effective interest rate, unless in the case of collateral-dependent loans, the observable market price, or the fair value of the collateral can be readily determined. Current appraisals are obtained for collateral-dependent loans. Restructured and impaired loans are periodically reevaluated to determine if additional adjustments to the carrying value are necessary.

Loans held for sale. Loans held for sale are recorded at their fair value when originated, based on our expected return from the secondary market.

Derivative financial instruments. Derivative financial instruments are recorded at fair value, which is based on the income approach using observable Level 2 market inputs, reflecting market expectations of future interest rates as of the measurement date. Standard valuation techniques are used to calculate the present value of the future expected cash flows assuming an orderly transaction. Valuation adjustments may be made to reflect both our credit risk and the counterparties’ credit quality in determining the fair value of the derivative. Level 2 inputs for the valuations are limited to observable market prices for London Interbank Offered Rate (LIBOR) observable market prices for LIBOR swap rates, and three month LIBOR basis spreads at commonly quoted intervals. Our derivative financial liability consists of an interest rate swap that qualifies as a cash flow hedge which had an unrealized loss of $684,428 at December 31, 2011 and $621,800 at December 31, 2010.

NOTE 21 – EARNINGS PER SHARE RECONCILIATION

The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share computations.


	2011			2010
Net income	$	7,125,612		$	5,949,391
Less: non-cumulative perpetual preferred dividend		(1,560,000	)		(1,560,000	)

Net Income available for common stock (numerator, basic)		5,565,612			4,389,391
Weighted average shares outstanding (denominator)		5,956,075			5,715,532

Income per common share - basic	$	0.93		$	0.77

Net income	$	7,125,612		$	5,949,391
Less: non-cumulative perpetual preferred dividend		—			(1,560,000	)

Net Income available for common stock (numerator, diluted)		7,125,612			4,389,391
Weighted average shares - diluted (denominator)		8,470,921			5,836,297

Income per common share - diluted	$	0.84		$	0.75

Dilutive effect - average number of common shares		14,846			120,765
Dilutive effect - average number of convertible non-cumulative perpetual preferred, if converted		2,500,000			—

Dilutive effect - average number of shares		2,514,846			120,765

The dilutive effect of stock options is 14,846 and 120,765 shares for 2011 and 2010 respectively. The dilutive effect of the conversion to common stock of our convertible non-cumulative perpetual preferred stock is 2,500,000 in 2011 and 0 in 2010. Anti-dilutive options excluded for the dilutive earnings per share calculation totaled 145,320 in 2011 and 121,198 in 2010.

NOTE 22 – SEGMENT REPORTING

Reportable segments include community banking and retail mortgage banking services. Community banking involves making loans to and generating deposits from individuals and businesses in the markets where the Bank has offices. Retail mortgage banking originates residential loans and subsequently sells them to investors. The mortgage banking segment is a strategic business unit that offers different products and services. It is managed separately because the segment appeals to different markets and, accordingly, requires different technology and marketing strategies. The segments most significant revenue and expense is non-interest income and non-interest expense, respectively. The Bank does not have other reportable operating segments. The accounting policies of the segment are the same as those described in the summary of significant accounting policies. All intersegment sales prices are market based. The assets and liabilities and operating results of the Bank’s other wholly owned subsidiary, Monarch Capital, LLC, is included in the mortgage banking segment. Monarch Capital, LLC, provides commercial mortgage brokerage services.

Segment information for the years 2011 and 2010 is shown in the following table. The “Other” column includes corporate related items, results of insignificant operations and, as it relates to segment profit (loss), income and expense not allocated to reportable segments and intercompany eliminations.

Selected Financial Information


	Commercial and Other Banking			Mortgage Banking Operations			Intersegment Eliminations			Total
Year Ended December 31, 2011
Net interest income after provision for loan losses	$	26,577,180		$	725,805		$	—		$	27,302,985
Noninterest income		4,275,449			51,018,091			(548,102	)		54,745,438
Noninterest expenses		(21,026,211	)		(50,566,257	)		548,102			(71,044,366	)

Net income before income taxes and minority interest	$	9,826,418		$	1,177,639		$	—		$	11,004,057

Year Ended December 31, 2010
Net interest income after provision for loan losses	$	21,053,224		$	782,763		$	—		$	21,835,987
Noninterest income		3,830,122			49,837,096			(266,925	)		53,400,293
Noninterest expenses		(16,995,243	)		(48,751,443	)		266,925			(65,479,761	)

Net income before income taxes and minority interest	$	7,888,103		$	1,868,416		$	—		$	9,756,519

Segment Assets
2011	$	699,999,396		$	229,286,806		$	(20,809,274	)	$	908,476,928
2010	$	650,645,549		$	185,530,329		$	(10,593,133	)	$	825,582,745

NOTE 23 – CONDENSED PARENT COMPANY ONLY FINANCIAL INFORMATION

On June 1, 2006, a parent corporation, Monarch Financial Holdings, Inc. was formed through a reorganization plan under the laws of the Commonwealth of Virginia. With this reorganization, Monarch Bank became a wholly-owned subsidiary of Monarch Financial Holdings, Inc.

The condensed financial position as of December 31, 2011 and December 31, 2010 and the condensed results of operations and cash flows for Monarch Financial Holdings, Inc., parent company only, for the years ended December 31, 2011 and 2010 are presented below.

CONDENSED BALANCE SHEET


	December 31, 2011		December 31, 2010
ASSETS
Cash	$	4,148,095	$	4,148,095
Investment in Monarch Bank		82,536,493		77,830,698
Investment in Trust		310,000		310,000
Due from Monarch Bank		232,705		211,412

Total assets	$	87,227,293	$	82,500,205

LIABILITIES AND STOCKHOLDERS’ EQUITY
Floating rate subordinated debenture (trust preferred securities)	$	10,310,000	$	10,310,000
Valuation adjustment for trust preferred securities		684,428		621,800
Other liabilities		—		—
Total stockholders’ equity		76,232,865		71,568,405

Total liabilities and stockholders’ equity	$	87,227,293	$	82,500,205

CONDENSED INCOME STATEMENT


	December 31, 2011		December 31, 2010
INCOME
Dividends from subsidiaries	$	3,005,508	$	2,877,327
Dividend from nonbank subsidiary		5,990		6,101

Total income		3,011,498		2,883,428

EXPENSES
Interest on borrowings		498,740		498,851

Total expenses		498,740		498,851

INCOME BEFORE EQUITY IN UNDISTRIBUTED NET INCOME OF SUBSIDIARIES		2,512,758		2,384,577
EQUITY IN UNDISTRIBUTED NET INCOME OF SUBSIDIARIES		4,612,854		3,564,814

NET INCOME		7,125,612		5,949,391
Preferred stock dividend and accretion of preferred stock discounts		1,560,000		1,560,000

NET INCOME AVAILABLE TO COMMON STOCK HOLDERS	$	5,565,612	$	4,389,391

The condensed statements of cash flows for Monarch Financial Holdings, Inc., parent company only, for the years ended December 31, 2011 and 2010 are presented below.

CONDENSED STATEMENTS OF CASH FLOWS


	December 31, 2011			December 31, 2010
Operating activities:
Net income	$	7,125,612		$	5,949,391
Adjustments to reconcile net cash provided by operating activities:
Equity in undistributed net income of subsidiaries		(4,612,854	)		(3,564,814	)
Stock-based compensation		323,307			348,103
Valuation adjustment on trust preferred securities (net)		—			213,244
Changes in:
Due to (from) Monarch Bank		—			(85,732	)
Interest payable and other liabilities		(81,387	)		(587,460	)

Net cash from operating activities		2,754,678			2,272,732

Investing activities:
Increase in investment in subsidiaries		—			(14,000,000	)

Net cash from investing activities		—			(14,000,000	)

Financing activities:
Dividends paid on perpetual preferred stock		(1,560,000	)		(1,560,000	)
Redemption of stock warrants		—			(260,000	)
Dividends paid on common stock		(952,758	)		(824,577	)
Repurchase of common stock		(241,920	)		—
Proceeds from issuance of common stock		—			183,743

Net cash from financing activities		(2,754,678	)		(2,460,834	)

CHANGE IN CASH AND CASH EQUIVALENTS		—			(14,188,102	)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD		4,148,095			18,336,197

CASH AND CASH EQUIVALENTS AT END OF YEAR	$	4,148,095		$	4,148,095

PART IV

Item 15.

Exhibits and Financial Statements Schedules.

(a)

(1) and (2). The response to this portion of Item 15 is included in Item 8 above.

(3). Exhibits

(a.)

The following exhibits are filed on behalf of the Registrant as part of this report:


No.		Description

3.1		Articles of Incorporation of Monarch Financial Holdings, Inc., attached as Exhibit 3.1 to the Registrant’s Current Report on Form 8-K, filed with the Commission on October 14, 2009, incorporated by reference herein.

3.2		Form of Articles of Amendment to the Articles of Incorporation of Monarch Financial Holdings, Inc. establishing the Series B Noncumulative Convertible Perpetual Preferred Stock, attached as Exhibit 3.2 to the Registrant’s Amendment No. 2 to Form S-1, filed with the Commission on November 25, 2009, incorporated by reference herein.

3.3		Bylaws of Monarch Financial Holdings, Inc., attached as Exhibit 3.2 to the Registrant’s Current Report on Form 8-K, filed with the Commission on June 6, 2006, incorporated by reference herein.

4.1		Specimen of Series B Noncumulative Convertible Perpetual Preferred Stock Certificate, attached as Exhibit 4.1 to the Registrant’s Amendment No. 2 to Form S-1, filed with the Commission on November 25, 2009, incorporated by reference herein.

4.2		Form of Registration Rights Agreement, attached as Exhibit 4.1 to the Registrant’s Current Report on Form 8-K, filed with the Commission on June 12, 2008, incorporated by reference herein.

4.3		Form of Subscription Agreement, attached as Exhibit 99.1 to the Registrant’s Current Report on Form 8-K, filed with the Commission on June 12, 2008, incorporated by reference herein.

4.4		Junior Subordinated Debenture between Monarch Financial Holdings, Inc. and Wilmington Trust Company dated as of July 5, 2006, attached as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, filed with the Commission on July 10, 2006, incorporated by reference herein.

4.5		Rights of holders of Monarch Financial Holdings, Inc. Series B Noncumulative Convertible Perpetual Preferred Stock, attached as Exhibit 3.2 to the Registrant’s Amendment No. 2 to Form S-1, filed with the Commission on November 25, 2009, incorporated by reference herein.

10.1		Guaranty Agreement between Monarch Financial Holdings, Inc. and Wilmington Trust Company dated as of July 5, 2006, attached as Exhibit 10.2 to the Registrant’s Current Report on Form 8-K, filed with the Commission on July 10, 2006, incorporated by reference herein.

10.2		Amended and Restated Trust Agreement among Monarch Financial Holdings, Inc., Wilmington Trust Company, and the Administrative Trustees Named herein dated as of July 5, 2006, attached as Exhibit 10.3 to the Registrant’s Current Report on Form 8-K, filed with the Commission on July 10, 2006, incorporated by reference herein.

10.3		Employment Agreement entered into between Monarch Bank and Brad E. Schwartz attached as Exhibit 10.2 to the Registrant’s Current Report on Form 8-K, filed with the Commission on January 6, 2011, incorporated by reference herein.



10.4		Employment Agreement entered into between Monarch Bank and E. Neal Crawford, Jr. attached as Exhibit 10.3 to the Registrant’s Current Report on Form 8-K, filed with the Commission on March 11, 2008, incorporated by reference herein.

10.5		Employment Agreement entered into between Monarch Bank and William T. Morrison attached as Exhibit 10.10 to the Registrant’s Current Report on Form 8-K, filed with the Commission on January 6, 2011, incorporated by reference herein.

10.6		Monarch Bank 2006 Equity Incentive Plan filed by our predecessor Monarch Bank with the Federal Reserve on March 31, 2006, incorporated by reference herein.

10.7		Form of Change in Control Agreement between Monarch Bank and Brad E. Schwartz attached as Exhibit 10.3 to the Registrant’s Current Report on Form 8-K, filed with the Commission on January 6, 2011, incorporated by reference herein.

10.8		Form of Change in Control Agreement between Monarch Bank and William T. Morrison attached as Exhibit 10.11 to the Registrant’s Current Report on Form 8-K, filed with the Commission on January 6, 2011, incorporated by reference herein.

10.9		Form of Change in Control Agreement between Monarch Bank and E. Neal Crawford attached as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, filed with the Commission on October 28, 2011, incorporated by reference herein.

10.10		Form of Change in Control Agreement between Monarch Bank and Lynette P. Harris attached as Exhibit 10.3 to the Registrant’s Current Report on Form 8-K, filed with the Commission on October 28, 2011, incorporated by reference herein.

10.11		Supplemental Executive Retirement Plan effective January 1, 2011, by and between Monarch Bank and Brad E. Schwartz attached as Exhibit 10.4 to the Registrant’s Current Report on Form 8-K, filed with the Commission on January 6, 2011, incorporated by reference herein.

10.12		Supplemental Executive Retirement Plan effective January 1, 2011, by and between Monarch Bank and Brad E. Schwartz attached as Exhibit 10.5 to the Registrant’s Current Report on Form 8-K, filed with the Commission on January 6, 2011, incorporated by reference herein.

10.13		Supplemental Executive Retirement Plan effective January 1, 2011, by and between Monarch Bank and William T. Morrison attached as Exhibit 10.12 to the Registrant’s Current Report on Form 8-K, filed with the Commission on January 6, 2011, incorporated by reference herein.

10.14		Supplemental Executive Retirement Plan effective January 1, 2011, by and between Monarch Bank and William T. Morrison attached as Exhibit 10.13 to the Registrant’s Current Report on Form 8-K, filed with the Commission on January 6, 2011, incorporated by reference herein.

10.15		Supplemental Executive Retirement Plan effective January 1, 2011, by and between Monarch Bank and E. Neal Crawford attached as Exhibit 10.2 to the Registrant’s Current Report on Form 8-K, filed with the Commission on October 28, 2011, incorporated by reference herein.

10.16		Supplemental Executive Retirement Plan effective January 1, 2011, by and between Monarch Bank and Lynette P. Harris attached as Exhibit 10.4 to the Registrant’s Current Report on Form 8-K, filed with the Commission on October 28, 2011, incorporated by reference herein.

21.1		Subsidiaries of Registrant, attached as Exhibit 21.1, to the Registrant’s Annual Report on Form 10-K filed with the Commission on March 28, 2012, incorporated by reference herein.



31.1		Certification of the Principal Financial Officer pursuant to Rule 13a-14(a), filed herewith.

31.2		Certification of the Chief Executive Officer pursuant to Rule 13a-14(a), filed herewith.

32.1		Certification of the Principal Financial Officer pursuant to section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.

32.2		Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.

101.0		Financial statements and schedules in interactive data format, attached as Exhibit 101.0 to the Registrant’s Annual Report on Form 10-K filed with the Commission on March 28, 2012, incorporated by reference herein.

(b)

Exhibits

See Item 15(a)(3) above.

(c)

Financial Statement Schedules

See Item 15(a)(2) above.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.


MONARCH FINANCIAL HOLDINGS, INC. April 20, 2012

By:		/s/ LYNETTE P. HARRIS
		Lynette P. Harris Executive Vice President, Secretary, Treasurer & Chief Financial Officer (On behalf of the Company and as principal financial and accounting officer)

/s/ BRAD E. SCHWARTZ

Brad E. Schwartz, Director, Chief Executive Officer

(as principal executive officer)

April 20, 2012

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